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EX-32.2 - EXHIBIT 32.2 - Bohai Pharmaceuticals Group, Inc.v235062_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - Bohai Pharmaceuticals Group, Inc.v235062_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - Bohai Pharmaceuticals Group, Inc.v235062_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - Bohai Pharmaceuticals Group, Inc.v235062_ex32-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K/A
(Amendment No. 1)
 
x
Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934.

For the fiscal year ending June 30, 2010

OR

¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from ________    to ________.

Commission file number 000-53401

Bohai Pharmaceuticals Group, Inc.
(Exact name of registrant as specified in its charter)
 
Nevada
 
98-0697405
(State or other jurisdiction
of incorporation or organization)
 
(IRS Employer
Identification number)
 
c/o Yantai Bohai Pharmaceuticals Group Co. Ltd.
No. 9 Daxin Road, Zhifu District
Yantai, Shandong Province, China
 
264000
(Address of Principal Executive Offices)
 
(Zip Code)

+86(535)-685-7928
(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

None
(Title of Class)

Name of each exchange on which registered

None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ¨     No   x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes   ¨     No   x .

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x     No   ¨ .

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨
 
Accelerated filer  ¨
Non-accelerated filer  ¨
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨     No  x .

The aggregate market value of the voting and non-voting common stock, other than shares held by persons who may be deemed affiliates of the registrant, computed by reference to the closing sales price for the registrant’s Common Stock on December 31, 2009, as reported on the OTC Bulletin Board, was approximately $4,095,000.

As of September 21, 2010, there were 16,500,000 outstanding shares of common stock of the registrant, par value $.001 per share.

DOCUMENTS INCORPORATED BY REFERENCE

None
 
 
 

 
 
EXPLANATORY NOTE

Bohai Pharmaceuticals Group, Inc. (the “Company”) is filing this Amendment No. 1 to the Company’s Annual Report on Form 10-K (this “Amendment No. 1”) to amend the Company’s Annual Report on Form 10-K (the “Original 10-K”) for the fiscal year ended June 30, 2010, which was originally filed with the Securities and Exchange Commission (the “SEC”) on September 28, 2010 (the “Original Filing Date”).

As disclosed in the Footnote No. 3 to the financial statements included within this Amendment No. 1, the financial statements and the corresponding footnotes in the Original 10-K (together with corresponding disclosure in Part II, Item 7., Management’s Discussion and Analysis or Plan of Operation) are being restated solely in order to properly recognize certain non-cash deferred tax charges related to the Company’s pharmaceutical formulas as an intangible indefinite asset which the Company did not previously recognize.  For additional information, please refer to the Company’s Current Report on Form 8-K filed with the SEC on September 14, 2011.
 
Except for the amendments described above, this Amendment No. 1 does not modify or update other disclosures in, or exhibits to, the Original 10-K, and, accordingly, this Amendment No. 1 should be read in conjunction with the Original 10-K.
 
Readers are cautioned that information contained in this Amendment No. 1 is only current as of the Original Filing Date; therefore, to obtain more current information regarding the Company, readers are advised to review the Company’s subsequent filings with the SEC.
 
As a result of this Amendment No. 1, the certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, as filed as exhibits to the Original 10-K, have been re-executed and re-filed as of the date of this Amendment.

 
 

 
 
Bohai Pharmaceuticals Group, Inc.

Amendment No. 1 to Annual Report on Form 10-K for the
Fiscal Year Ended June 30, 2010

TABLE OF CONTENTS

   
Page
     
Cautionary Note Regarding Forward Looking Statements
-i-
 Part II
   
Item 7.
Management’s Discussion and Analysis or Plan of Operation.
1
Part IV
   
Index to Consolidated Financial Statements
F-1
 
 
 

 

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

In addition to historical information, this Annual Report on Form 10-K/A contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  The forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements.  Factors that might cause such a difference include, but are not limited to those discussed in the sections entitled “Business”, “Risk Factors”, and “Management’s Discussion and Analysis or Plan of Operation.”  Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date thereof.  We undertake no obligation to revise or publicly release the results of any revision of these forward-looking statements.  Readers should carefully review the risk factors described in this Report and in other documents that we file from time to time with the Securities and Exchange Commission.

In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “guidance,” “potential,” “proposed,” “intended,” or “continue” or the negative of these terms or other comparable terminology. You should read statements that contain these words carefully, because they discuss our expectations about our future operating results or our future financial condition or state other “forward-looking” information. There may be events in the future that we are not able to accurately predict or control. You should be aware that the occurrence of any of the events described in our risk factors and other disclosures included in this Report could substantially harm our business, results of operations and financial condition, and that upon the occurrence of any of these events, the trading price of our securities could decline.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, growth rates, and levels of activity, performance or achievements.  Factors that may cause actual results, our performance or achievements, or industry results, to differ materially from those contemplated by such forward-looking statements include, without limitation:

 
·
our ability to obtain sufficient working capital to support our business plans;
 
 
·
our ability to expand our product offerings and maintain the quality of our products;
 
 
·
the availability of government granted rights to exclusively manufacture or co-manufacture our products;
 
 
·
the availability of national healthcare reimbursement of our products;
 
 
·
our ability to manage our expanding operations and continue to fill customers’ orders on time;

 
·
our ability to maintain adequate control of our expenses allowing us to realize anticipated revenue growth;

 
·
our ability to maintain or protect our intellectual property;

 
·
our ability to maintain our proprietary technology;

 
·
the impact of government regulation in China and elsewhere, including the support provided by the Chinese government to the Traditional Chinese Medicine and healthcare sectors in China;

 
·
our ability to implement product development, marketing, sales and acquisition strategies and adapt and modify them as needed;

 
·
our ability to integrate any future acquisitions;

 
·
our implementation of required financial, accounting and disclosure controls and procedures and related corporate governance policies; and
 
 
-i-

 
 
 
·
our ability to anticipate and adapt to changing conditions in the Traditional Chinese Medicine and healthcare industries resulting from changes in government regulations, mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics.

Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results. The following discussion should be read in conjunction with our financial statements and the related notes that appear elsewhere in this Annual Report.

We cannot give any guarantee that these plans, intentions or expectations will be achieved.  All forward-looking statements involve significant risks and uncertainties, and actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those factors listed above and described in the “Risk Factors” section of this Annual Report.

 Item 7.  Management’s Discussion and Analysis or Plan of Operation.

The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the audited condensed consolidated financial statements of the Company for the fiscal year ended June 30, 2010 and 2009, and should be read in conjunction with such financial statements and related notes included in this report.  Those statements in the following discussion that are not historical in nature should be considered to be forward looking statements that are inherently uncertain. Actual results and the timing of the events may differ materially from those contained in these forward looking statements due to a number of factors, including those discussed in the “Cautionary Note on Forward Looking Statements” set forth elsewhere in this Annual Report.

Overview

We were incorporated under the laws of the State of Nevada on January 9, 2008. Since January 5, 2010, our business consists of the production, manufacturing and distribution of herbal pharmaceuticals in the PRC which are based on traditional Chinese medicine. We are based in the city of Yantai, Shandong Province, China.

Our medicines are intended to address rheumatoid arthritis, viral infections, gynecological diseases, cardio vascular issues and respiratory diseases. We have obtained Drug Approval Numbers in China for 29 varieties of traditional Chinese herbal medicines in 2004 and we currently produce 15 varieties of approved traditional Chinese herbal medicines in seven delivery systems: tablets, granules, capsules, syrup, concentrated powder, tincture and medicinal wine. Of these 15 products, 8 are prescription drugs and 7 are over-the-counter products.

Prior to January 5, 2010, we were a public “shell” company operating under the name “Link Resources, Inc.” On January 5, 2010, we consummated a share exchange transaction (the “Share Exchange”) pursuant to which we acquired Chance High, the parent company of Yantai Bohai Pharmaceuticals Group Co. Ltd., our principal operating subsidiary, which is a Chinese variable interest entity that we (through a Chinese wholly-owned foreign enterprise subsidiary) control through certain contractual arrangements.

Critical Accounting Policies and Estimates

Use of Estimates

In preparing the condensed consolidated financial statements in conformity with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods.  These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes, derivative liabilities, and the estimation on useful lives of plant and machinery.  Actual results could differ from those estimates.

Accounts Receivable

Accounts receivable consists of amounts due from customers.  We extend unsecured credit to our customers in the ordinary course of business but we seek to mitigate the associated risks by performing credit checks and actively pursuing past due accounts.  An allowance for doubtful accounts is established and determined based on management’s assessment of known requirements, aging of receivables, payment history, the customer’s current credit worthiness and the economic environment.  As of June 30, 2010 and 2009, no allowance for doubtful accounts was deemed necessary based on management’s assessment.

Revenue recognition

Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Pursuant to the guidance of ASC Topic 605 and ASC Topic 36, revenue is recognized when all of the following criteria are met:
 
 
1

 
 
 
·
Persuasive evidence of an arrangement exists;

 
·
Delivery has occurred or services have been rendered;

 
·
The seller’s price to the buyer is fixed or determinable; and

 
·
Collectability is reasonably assured.

We account for sales returns by establishing an accrual in an amount equal to its estimate of sales recorded for which the related products are expected to be returned.  We determine the estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also by considering other factors that could impact sales returns. These factors include levels of inventory in the distribution channel, estimated shelf life, product discontinuances, and price changes of competitive products, introductions of generic products and introductions of competitive new products.  For the year ended June 30, 2010 and 2009, sales return rate is low and deemed immaterial and accordingly, no provision for sales returns was recorded.

Inventories

Inventories are valued at the lower of cost or market with cost is determined using the weighted average method. Finished goods inventories consist of raw materials, direct labor and overhead associated with the manufacturing process. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels.  Our reserve requirements generally increase or decrease due to management’s projected demand requirements, market conditions and product life cycle changes.  As of June 30, 2010 and June 30, 2009, we did not make any allowance for slow-moving or defective inventories.

Property, plant and equipment

Property, plant and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized.  When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition.  We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

Included in property and equipment was construction-in-progress which consisted of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use. The principal annual rates are as follows:

Leasehold land and buildings
 
30 to 40 years
Motor vehicles
 
10 years
Plant and machinery
 
10 years
Office equipment
 
5 years

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of income and comprehensive income in the periods that includes the enactment date.
 
Recent Accounting Pronouncements

The following Accounting Standards Codification (“ASC”) Updates have been issued, or became effective, since the beginning of the current year covered by these financial statements:

In June 2008, the FASB issued FASB ASC 260-10, “Determining Whether Instruments Granted in Share- based Transactions are Participating Securities”. Under ASC 260-10, unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing EPS. The adoption of ASC 260-10 beginning July 1, 2009 did not have a material impact on our consolidated financial statements.

 
2

 
 
In June 2009, the FASB issued ASC 810, “Amendments to FASB Interpretation No.46(R)”. ASC 810 amends FASB Interpretation No.46(R), “ Variable Interest Entities “ for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under ASC 810, an enterprise has a controlling financial interest when it has a) the power to direct the activities of a VIE that most significantly impact the entity’ s economic performance and b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. ASC 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. ASC 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. ASC 810 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. ASC 810 is effective for our company in the first quarter of fiscal 2011. We are currently evaluating the effect of ASC 810 on our consolidated financial statements.

In August 2009, the FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair Value”, which is codified as ASC 820, “Fair Value Measurements and Disclosures”.  This Update provides amendments to ASC 820-10, Fair Value Measurements and Disclosures – Overall, for the fair value measurement of liabilities. This Update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or that is consistent with the principles of ASC 820. The amendments in this Update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents transfer of the liability. The amendments in this Update also clarify that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the assets are required are Level 1 fair value measurements. ASC 820 is effective for the first reporting period (including interim periods) beginning after August 28, 2009. The adoption of this Update did not have a significant impact to the Group’s consolidated financial statements.

In December 2009, the FASB issued ASU No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”)”. ASU 2009-17 amends the variable- interest entity guidance in FASB ASC 810-10-05-8 to clarify the accounting treatment for legal entities in which equity investors do not have sufficient equity at risk for the entity to finance its activities without financial support. ASU 2009-17 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009.  ASU 2009-17 is effective for our company in the first quarter of fiscal 2011. We are currently evaluating the effect of ASU 2009-17 on our consolidated financial statements.
 
In January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair Value Measurements. This update provides amendments to Subtopic 820-10 that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number). This update provides amendments to Subtopic 820-10 that clarifies existing disclosures as follows: 1) Level of disaggregation. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities. 2) Disclosures about inputs and valuation techniques. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements.  These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We are currently evaluating the impact of this ASU; however, we do not expect the adoption of this ASU to have a material impact on our consolidated financial statements.

In February 2010, FASB issued ASU No. 2010-9 –Amendments to Certain Recognition and Disclosure Requirements. This update addresses certain implementation issues related to an entity’s requirement to perform and disclose subsequent-events procedures, removes the requirement that public companies disclose the date of their financial statements in both issued and revised financial statements. According to the FASB, the revised statements include those that have been changed to correct an error or conform to a retrospective application of U.S. GAAP. The adoption of this ASU did not have a material impact on our consolidated financial statements.

 
3

 
 
In April 2010, the FASB issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades - a consensus of the FASB Emerging Issues Task Force.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  Earlier application is permitted.  We do not expect the provisions of ASU 2010-13 to have a material effect on our financial position, results of operations or cash flows.

In May 2010, the FASB issued ASU 2010-19, Foreign Currency (Topic 830): Foreign Currency Issues: Multiple Foreign Currency Exchange Rates.  The amendments in this Update are effective as of the announcement date of March 18, 2010.  The adoption of this update did not have a material effect on our financial position, results of operations or cash flows.

Operating Results

The following table sets forth key components of our results of operations for the periods indicated:
 
   
For The Year Ended
             
  
 
June 30
             
                     
Percentage
 
   
2010
   
2009
   
Increase
   
Increase
 
   
restated
   
restated
             
Net revenues
  $ 59,264,724     $ 49,348,614     $ 9,916,110       20.1 %
                                 
Cost of revenues
    10,164,853       7,975,267       2,189,586       27.5 %
                                 
Gross profit
    49,099,871       41,373,347       7,726,524       18.7 %
                                 
Selling, general, and administrative expenses
    36,253,075       31,347,139       4,905,936       15.7 %
                                 
Income from operations
    12,846,796       10,026,208       2,820,588       28.1 %
                                 
Total other income (expenses)
    (385,315 )     (171,323 )     (213,992 )     124.9 %
                                 
Income before provision for income taxes
    12,461,481       9,854,885       2,606,596       26.4 %
                                 
Provision for income taxes
    3,404,509       2,337,479       1,067,030       45.7 %
                                 
Net income
  $ 9,056,972     $ 7,517,406     $ 1,539,566       20.5 %
 
     
For The Year Ended
 
     
June 30
 
                 
   
2010
   
2009
 
                 
Net revenues
   
100.0
%
   
100.0
%
                 
Cost of revenues
   
17.2
%
   
16.2
%
                 
Gross profit
   
82.8
%
   
83.8
%
                 
Selling, general, and administrative expenses
   
61.2
%
   
63.5
%
                 
Income from operations
   
21.7
%
   
20.3
%
                 
Total other income(expenses)
   
(0.7
)%
   
(0.3
)%
                 
Income before provision for income taxes
   
21.0
%
   
20.0
%
                 
Provision for income taxes
   
5.8
%
   
4.8
%
                 
Net income
   
15.3
%
   
15.3
%
 
 
4

 
 
Net Revenues

Net revenues for the twelve months ended June 30, 2010 increased by approximately $9,916,110, or 20.1%, to $59,264,724 as compared to $49,348,614 for the twelve months ended June 30, 2009.  This increase was primarily due to increase in revenue from three of our main products, Lung Nourishing Cream, Tongbi Capsules and Tongbi Tablets, which together had over 50% of our total net revenue and all of which are listed for coverage and reimbursement under national medical insurance starting in December 2009.  The increase was also due to the marketing strategy we implemented beginning in January 2010.

Net revenues for the fourth quarter ended June 30, 2010 decreased by approximately $173,000, or approximately 1%, compared to the fourth quarter ended June 30, 2009.  The decrease was due to the fact that some product orders were put on hold by hospitals as a result of changes in bidding processes for some state and local Chinese governments.  The national health insurance reform started in 2009 at national levels and, as a result, some state and local governments have tried to improve their overall new policies.  Changes in local bidding processes were temporary and should not have a material impact of our overall net revenues going forward. 

 We anticipate our overall net revenue will continue to increase due to a national medical and health plan initiated by Chinese government in 2009, which plan will eventually cover individual health insurance over 90% of China’s population by 2011 and includes traditional Chinese medicines for coverage and reimbursement from hospitals and medical centers all over China.

Cost of Revenues

Our cost of revenues for the twelve months ended June 30, 2010 was $10,164,853 as compared to $7,975,267 for the twelve months ended June 30, 2009, representing an increase of $2,189,586, or 27.5%. The increase in cost of revenues was mainly attributable to the increase in cost of raw material as a result of increase of sales and five new products we introduced this fiscal year as well as increase of cost of raw material itself this fiscal year compared to last fiscal year.  Overall increase in cost of raw material itself this fiscal year over last year was immaterial.

Gross Profit

We achieved gross profit of $49,099,871 for the twelve months ended June 30, 2010, compared to $41,373,347 for the same fiscal in 2009, representing an increase of $7,726,524, or 18.7%, over fiscal year 2009.  Our overall gross profit margins as a percentage of revenue had been consistently maintained over the past two years and they represented 82.8% and 83.80% for the twelve months ended June 30, 2010 and 2009, respectively.

Selling, General and Administrative Expenses

Our operating expenses, consisting of selling, general and administrative expenses, increased by $4,905,936 to $36,253,075, for the twelve months ended June 30, 2010 compared to $31,347,139 for the same fiscal year end in 2009.  This increase was mainly attributable to an increase of advertising expense of approximately $2,278,000 this fiscal year compared to the same fiscal year last year.   We increased product promotion activities through various media, especially through television advertising in different provinces within the PRC for our new products as well as some major products that are eligible for coverage and reimbursement under national medical insurance. The increase was also due to increase on commission expense of approximately $2,673,000 this fiscal year over last fiscal year as we continue to increase our sale volume and expand sale personnel.

Total Other Income (Expenses)

Finance and non-operating expense was $385,315 for the period ended June 30, 2010 compared to non-operating expenses of $171,323 from prior fiscal year, an increase of expense of $213,992.  The increase was principally due to non-cash income of $925,063 associated with a change in fair value of warrants offset by amortization of deferred fees of $510,717 and interest charges of $588,811 on convertible debt in connection with our private placement on January 5, 2010 as well as increase of $161,797 in interest charge for short term loan.

Provision for Income Tax

Our provisions for income taxes for the twelve months ended June 30, 2010 and 2009 were $3,404,509 and $2,337,479, an increase of $1,067,030 or 45.7% from year to year. The increase in income tax this fiscal year over prior fiscal year was principally due to increase in income available for Chinese tax and the deferred tax provision on the temporary difference relating to amortization expense deduction on the indefinite lives intangible asset taken for PRC tax purposes.
 
 
5

 
Net Income

We had a net income of $9,056,972 for the twelve months ended June 30, 2010, as compared to net income of $7,517,406 for the twelve months ended June 30, 2009, an increase in net income of $1,539,566, or 20.5%.  The increase in net income was primarily attributable to increase in total gross profit of $7,726,524 and offset by increase in advertising expenses and other operating expense of $5,119,929 and tax provision of $1,066,304 this fiscal year compared to prior fiscal year.

Liquidity and Capital Resources

As of June 30, 2010, we had cash and cash equivalents of $17,149,082 and restricted cash of $576,019. The following table provides detailed information about our net cash flow for financial statement periods presented in this report:

Summary of Cash Flow Statements
   
 
For the years ended
 
 
June 30,
 
 
2010
 
2009
 
Net cash provided by (used in) operating activities
$
13,214,620
 
$
(1,513,062
)
Net cash provided by (used in)  investing activities
 
(7,360,781
)
 
(788,993
)
Net cash provided by (used in) financing activities
 
8,756,059
   
3,963,300
 
Effect of foreign currency translation on cash and cash equivalents
 
45,018
   
3,871
 
Net (decrease) increase in cash and cash equivalent
$
14,654,916
 
$
1,665,116
 

Comparison of Year Ended June 30, 2010 and 2009

Net Cash Provided (Used in) by Operating Activities.  Net cash provided in operating activities totaled $13,214,620 for the year ended June 30, 2010 as to net cash used in operating activities of $1,513,062 for the year ended June 30, 2009. The increase in net cash provided by operating activities was primarily due to increases in accounts receivable, other receivables and prepayment, decrease in accounts payable and other accrual liability, partially offset by changes in fair value of warrants and inventory of raw materials during the year ended June 30, 2010. We expect our cash flow from operating activities to improve due to a national medical and health plan initiated by Chinese government in 2009, which plan will eventually cover individual health insurance over 90% of China’s population by 2011 and includes traditional Chinese medicines for coverage and reimbursement from hospitals and medical centers all over China. 

Net Cash Used In Investing Activities.  Net cash used in investing activities was $7,360,781 for the year ended June 30, 2010 and $788,993 for the year ended June 30, 2009.  The increase in cash used in investing activities was due to our cash payment of approximately $7.3 million for the purchase of leased land use rights from the Shandong provincial government in January 2010 for approximately $14.3 million, which land we may use for potential future expansion of our manufacturing operation.  Subsequent to June 30, 2010, we made an additional payment under the contract to purchase such rights, and as of the date of this Annual Report, we have a remaining payment of approximately $5.2 million which is due by March 31, 2011.

Net Cash Provided by Financing Activities. Net cash provided by financing activities totaled $8,756,059  for the year ended June 30, 2010 as compared to net cash provided in financing activities of $3,963,300 for the year ended June 30, 2009. The reason for the increase in cash provided by financing activities was due to issue of convertible promissory notes in January 5, 2010.  As of June 30, 2010, cash payments to placement agent and other financing costs were $1,570,000.  The proceeds from short-term borrowings and convertible promissory notes amounted to $6,575,000 and $12,000,000 respectively and the repayment of borrowings amounted to $8,045,000 resulted in a net cash inflow by financing activities of $8,756,059.

Cash.  As of June 30, 2010, we had cash of $17,149,082 as compared to $2,494,166 as of June 30, 2009. This increase was due primarily to $12,000,000 cash received from the private placement in January this year and our overall improvement in cash provided in operating activities. 

 Loan Facilities

We had a total of $4,398,849 and $5,860,000 outstanding on loans and credit facilities as of June 30, 2010 and 2009, respectively.  Total interest expense on short-term loans for the year ended June 30, 2010 and 2009 amounted to $337,424 and $184,404, respectively. Bohai obtains short-term loan facilities from financial institution in the PRC.  

Short-term borrowings as of June 30, 2010 were as follows:

 
6

 

Loan from
 
  
 
Annual
 
  
     
financial institution
 
Loan period
 
Interest rate
 
Secured by
 
Amount
 
  
                 
China Construction
 
From Feb 24, 2010
    5.8410 %
Shandong Dai Xin Heavy
  $ 3,524,954  
Bank
 
to Feb 23, 2011
       
Industries Co. Ltd
       
                       
Yantai Laishan Rural
 
From Sept 28, 2009
    9.0270 %
Yantai Ka Wah Medical
    587,492  
Credit Union
 
to Sept 26, 2010
       
Equipment Co. Ltd
       
                       
Yantai Laishan Rural
 
From Sept 28, 2009
    6.9030 %
Bohai's machinery and
    286,402  
Credit Union
 
to Sept 26, 2010
       
vehicle
       
                       
                  $ 4,398,849  

Short-term borrowings as of June 30, 2009 were as follows:

Loan from
 
  
 
Annual
 
  
     
financial institution
 
Loan period
 
Interest rate
 
Secured by
 
Amount
 
   
  
     
  
     
Shanghai Pudong
 
From Dec 12, 2008
    6.6960 %
Haiyang Construction
  $ 2,197,500  
Development Limited
 
to Dec 11, 2009
       
Industry Training Centre
       
             
and personal guarantee
       
             
by equity holders
       
                       
Yantai City
 
From Jan 20, 2009
    6.9030 %
Yantai Hai Pu Can End
    1,318,500  
Commercial Bank
 
to Jan 20, 2010
       
Making Co. Ltd
       
                       
Yantai Laishan Rural
 
From Sep 27, 2008
    9.3600 %
Yantai Ka Wah Medical
    293,000  
Credit Union
 
to Sep 26, 2009
       
Equipment Co. Ltd
       
                       
Yantai Laishan Rural
 
From Sep 27, 2008
    12.2400 %
Bohai's machinery
    586,000  
Credit Union
 
to Sep 26, 2009
       
and vehicle
       
                       
China Construction
 
From May 12, 2008
    0.0000 %
Personal guarantee by
    1,465,000  
Bank
 
to Nov 11, 2009
       
equity holders
       
                       
                  $ 5,860,000  
 
Obligations under Material Contracts

As of June 30, 2010, we had commitments to purchase land use rights that we intend for our future business expansion, including, potentially, additional manufacturing space.  The total purchase price is approximately $14,320,100 (RMB 97,500,000).  As of June 30, 2010, we have prepaid for approximately $7,343,700 (RMB 50,000,000), which is included in Prepayment for Land Use Right on the consolidated balance sheets.  In addition, we paid approximately $1,796,000 (RMB 12,160,000) in July 2010 and the remaining balance of RMB 35,340,000 (approximately $5,180,400) is required to be paid before March 31, 2011.

Off-Balance Sheet Arrangements

We did not engage in any “off-balance sheet arrangements” (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) during the twelve months ended June 30, 2010. We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholder’s equity or that are not reflected in our condensed consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.

Currency Exchange Risk

Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies.  Substantially all of our revenue and expenses are in the Chinese currency, the Renminbi.  We are subject to the effects of exchange rate fluctuations with respect to any of these currencies.  For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market.  Since 1994, the official exchange rate for the conversion of the Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar.  In July 2005, the Chinese government changed its policy of pegging the value of the Renminbi to the U.S. dollar.  Under this policy, which was halted in 2008 due to the worldwide financial crisis, the Renminbi was permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies.  In June 2010, the Chinese government announced its intention to again allow the Renminbi to fluctuate within the 2005 parameters.  It is possible that the Chinese government could adopt an even more flexible currency policy, which could result in more significant fluctuation of Renminbi against the U.S. dollar, or it could adopt a more restrictive policy.  We can offer no assurance that the Renminbi will be stable against the U.S. dollar or any other foreign currency.

 
7

 

Our financial statements are translated into U.S. dollars at the average exchange rates in each applicable period.  To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations.  Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations.  We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign consolidated subsidiaries into U.S. dollars in consolidation.  If there is a change in foreign currency exchange rates, the conversion of the foreign consolidated subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income.  In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency.  Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss.  We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future.  The availability and effectiveness of any hedging transaction may be limited and we may not be able to hedge our exchange rate risks. Most of our transactions are settled in Renminbi and U.S. dollars.  We are not exposed to significant foreign currency risk.  

Credit risk

Our potential credit risk is mainly attributable to its debtors and bank balances.  In respect of debtors, we have policies in place to ensure that it will only accept customers from countries which are politically stable and customers with an appropriate credit history.  In addition, all the bank balances were made with financial institutions with high-credit quality.  Thus, we are not considered to be subject to significant credit risk.

Interest rate risk

Our interest rate risk is primarily attributable to its short-term borrowings, loan to a third party and loan to equity holders.  Our borrowings carry interest at fixed rate.  Our management has not used any interest rate swaps to hedge its exposure to interest rate risk.

Inflation

In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as -2.2%. These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.

Part IV

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
Page(s)
   
Report of Independent Registered Public Accounting Firm
F-2
   
Consolidated Financial Statements:
 
   
Consolidated Balance Sheets as of June 30, 2010 and 2009
F-3
   
Consolidated Statements of Income and Comprehensive Income for the years ended June 2010 and 2009
F-4
   
Consolidated Statements of Changes in Stockholders’ Equity for the years ended June 2010 and 2009
F-5
   
Consolidated Statements of Cash Flows as of June 30, 2010 and 2009
F-6
   
Notes to Consolidated Financial Statements
F-7-F-28
 
 
F-1

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
To the Board of Directors and Equity Holders of Bohai Pharmaceuticals Group, Inc.
 
We have audited the accompanying consolidated balance sheets of Bohai Pharmaceuticals Group, Inc. (“the Company”) as of June 30, 2010 and 2009, and the related consolidated statements of income and comprehensive income, stockholders’ equity and cash flows for the years ended June 30, 2010 and 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2010 and 2009, and the results of its operations and its cash flows for the years ended June 30, 2010 and 2009 in conformity with accounting principles generally accepted in the United States of America.
 
PARKER RANDALL CF
 
Parker Randall CF (H.K.) CPA Limited Certified Public Accountant Hong Kong
 
September 28, 2010
Except for Note (3, 11, 17) to the Consolidated Financial Statements as at September 14, 2011

 
F-2

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2010 AND 2009

         
As of
   
As of
 
         
June 30,
   
June 30,
 
   
Notes
   
2010
   
2009
 
         
restated
   
restated
 
ASSETS
                 
Current assets
                 
Cash and cash equivalents
        $ 17,149,082     $ 2,494,166  
Restricted cash
          576,019       -  
Accounts receivable
          10,409,527       11,070,129  
Other receivables and prepayments
    4       1,449,590       3,493,800  
Amount due from equity holder
    5       40,160       1,465,000  
Inventories
    6       748,422       307,834  
                         
Total current assets
            30,372,801       18,830,929  
                         
Non-current assets
                       
Property, plant and equipment, net
    8       7,895,042       8,149,279  
Prepayment for land use right
            7,343,654       -  
Intangible assets
    7       17,342,772       17,298,720  
Deferred fees on convertible notes
    14       1,562,617       -  
                         
Total non-current assets
            34,144,085       25,447,999  
                         
TOTAL ASSETS
          $ 64,516,886     $ 44,278,928  
                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                       
Current liabilities
                       
Short-term borrowings
    9     $ 4,398,849     $ 5,860,000  
Accounts payable
            741,621       971,208  
Other accrued liabilities
    12       2,984,988       2,835,672  
Income taxes payable
    17       700,326       677,666  
                         
Total current liabilities
            8,825,784       10,344,546  
                         
Non-current liabilities
                       
Deferred tax liabilities
            2,309,321       1,869,924  
Derivative liabilities - investor and agent warrants
    13       5,481,928       -  
Convertible note, net of discount
    13       124,820       -  
                         
Total non-current liabilities
            7,916,069       1,869,924  
                         
TOTAL LIABILITIES
            16,741,852       12,214,470  
                         
STOCKHOLDERS' EQUITY
                       
Common stock, $0.001 par value, 150,000,000 shares authorized, 16,500,000 and 13,163,000 shares issued and outstanding as of June 30, 2010 and 2009, respectively
    10       16,500       13,163  
Additional paid-in capital
    10       15,317,621       8,794,838  
Accumulated other comprehensive income
            460,577       333,100  
Statutory reserves
    20       2,201,817       2,201,811  
Retained earnings
            29,778,519       20,721,547  
                         
Total stockholders' equity
            47,775,034       32,064,458  
                         
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
          $ 64,516,886     $ 44,278,928  

See accompanying notes to the consolidated financial statements

 
F-3

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED JUNE 30, 2010 AND 2009

     
For The Year Ended
 
     
June 30,
 
 
Notes
 
2010
   
2009
 
     
restated
   
restated
 
Net revenues
   
$
59,264,724
   
$
49,348,614
 
                   
Cost of revenues
     
10,164,853
     
7,975,267
 
                   
Gross profit
     
49,099,871
     
41,373,347
 
                   
Selling, general and administrative expenses
15
   
36,253,075
     
31,347,139
 
                   
Income from operations
     
12,846,796
     
10,026,208
 
                   
Other incomes (expenses)
                 
Other income
     
152,330
     
49,447
 
Amortization of deferred financing fees
     
(510,717
)
   
-
 
Interest expenses
16
   
(926,235
)
   
(184,404
)
Other expense
     
(25,756
)
   
(36,366
)
Change in fair value of derivative liabilities
     
925,063
     
-
 
                   
Total other income (expenses)
     
(385,315
)
   
(171,323
)
                   
Income before provision for income taxes
     
12,461,481
     
9,854,885
 
                   
Provision for income taxes
17
   
(3,404,509
)
   
(2,337,479
)
                   
Net income
   
$
9,056,972
   
$
7,517,406
 
                   
Comprehensive income:
                 
Net income
   
$
9,056,972
   
$
7,517,406
 
Other comprehensive income
                 
Unrealized foreign currency translation gain
     
127,477
     
99,503
 
Comprehensive income
   
$
9,184,449
   
$
7,616,909
 
                   
Earnings per common share
                 
Basic
   
$
0.62
   
$
0.57
 
Diluted
   
$
0.55
   
$
0.57
 
                   
Weighted average common shares outstanding
                 
Basic
     
14,722,055
     
13,162,500
 
Diluted
     
17,569,315
     
13,162,500
 

See accompanying notes to the consolidated financial statements

 
F-4

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED JUNE 30, 2010 AND 2009

                     
Accumulated
                   
   
Common Stock
   
Additional
   
other
                   
   
Shares
         
Paid-in
   
comprehensive
   
Statutory
   
Retained
       
   
outstanding
   
Amount
   
Capital
   
income
   
reserves
   
earnings
   
Total
 
                                           
Balance at June 30, 2008 – as reported
    13,162,500     $ 13,163     $ 8,794,838     $ 384,698     $ 1,464,861     $ 15,222,690     $ 25,880,250  
                                                         
Cumulative effect of prior period adjustment – June 30, 2008
    -       -       -       (151,101 )             (1,281,599 )     (1,432,700 )
Net income for the year
    -       -       -       -       736,950       6,780,456       7,517,406  
Foreign currency translation adjustment
    -       -       -       99,503       -       -       99,503  
                                                         
Balance at June 30, 2009 - restated
    13,162,500       13,163       8,794,838       333,100       2,201,811       20,721,547       32,064,458  
                                                         
Recapitalization
    3,087,500       3,088       419,366       -       -       -       422,454  
Beneficial conversion feature on convertible notes
    -       -       6,175,462       -       -       -       6,175,462  
Conversion of convertible notes on additional paid-in capital adjustments
    250,000       250       (250 )     -       -       -       -  
Conversion of convertible notes credits on carrying amount and deferred fees
    -       -       (71,795 )     -       -       -       (71,795 )
Net income for the year
    -       -       -       -       6       9,056,972       9,056,978  
Foreign currency translation
    -       -       -       127,477       -       -       127,477  
                                                         
Balance, June 30, 2010 - restated
    16,500,000     $ 16,500     $ 15,317,621     $ 460,577     $ 2,201,817     $ 29,778,519     $ 47,775,034  

See accompanying notes to the consolidated financial statements

 
F-5

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2010 AND 2009

   
For The Year Ended
 
   
June 30
 
   
2010
   
2009
 
   
restated
   
restated
 
Cash flows from operating activities
           
Net income
 
$
9,056,972
   
$
7,517,406
 
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation
   
310,551
     
302,762
 
Loss on disposals of property, plant and equipment
   
10,589
     
31,630
 
Amortization of deferred fees on convertible notes
   
510,716
     
-
 
Interest expense on convertible notes
   
132,146
     
-
 
Change in fair value of warrants
   
(925,063
)
   
-
 
    Deferred income tax provision
   
431,220
     
430,494
 
                 
Changes in assets and liabilities
               
(Increase)/decrease in accounts receivable
   
685,854
     
(2,151,920
)
(Increase)/decrease in other receivables and prepayments
   
1,994,621
     
(2,436,718
)
(Increase)/decrease in inventories
   
(437,998
)
   
741,357
 
(Decrease)/increase in amount due from equity holder
   
1,462,700
     
(1,465,000
)
(Decrease)/increase in accounts payable
   
(231,107
)
   
(2,094,181
)
(Decrease)/increase in other payable
   
(99,884
)
   
-
 
(Decrease)/increase in accrued liabilities
   
292,454
     
(2,468,368
)
(Decrease)/increase in income taxes payable
   
20,849
     
79,476
 
                 
Net cash (used in)/provided by operating activities
   
13,214,620
     
(1,513,062
)
                 
Cash flows from investing activities
               
Purchases of property, plant and equipment
   
(47,279
)
   
(803,643
)
Proceeds from disposals of property, plant and equipment
   
-
     
14,650
 
Purchase of leased land use rights
   
(7,313,502
)
   
-
 
                 
Net cash used in investing activities
   
(7,360,781
)
   
(788,993
)
                 
Cash flows from financing activities
               
Cash fees on placement agent and other financing costs
   
(1,570,000
)
   
-
 
Proceeds of convertible promissory notes
   
12,000,000
     
-
 
Proceeds of borrowings
   
6,574,838
     
5,860,000
 
Repayment of borrowings
   
(8,044,852
)
   
(1,896,700
)
Advanced to related party
   
(51,926
)
   
-
 
Advanced from related party
   
11,980
     
-
 
Restricted cash
   
(163,981
)
   
-
 
                 
Net cash provided by financing activities
   
8,756,059
     
3,963,300
 
                 
Effect of foreign currency translation on cash and cash equivalents
   
45,018
     
3,871
 
                 
Net increase in cash and cash equivalents
   
14,654,916
     
1,665,116
 
                 
Cash and cash equivalents at beginning of year
   
2,494,166
     
829,050
 
                 
Cash and cash equivalents at end of year
 
$
17,149,082
   
$
2,494,166
 
                 
Cash paid during the year for
               
Interest paid
 
$
342,517
   
$
288,307
 
Income taxes paid
 
$
2,952,441
   
$
1,829,969
 
                 
Supplemental cash flow information:
               
Interest paid on convertible notes
 
$
226,667
   
$
-
 
Placement agent warrants issued
 
$
582,454
   
$
-
 

See accompanying notes to the consolidated financial statements
 
 
F-6

 

 
BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR ENDED JUNE 30, 2010 AND 2009

1.          ORGANIZATION AND PRINCIPAL ACTIVITIES

Bohai Pharmaceuticals Group, Inc. (the “Company”) (formerly known as Link Resources, Inc.) was incorporated under the laws of the State of Nevada on January 9, 2008.  Until January 5, 2010, its principal office was located in Calgary, Alberta, Canada.  The Company was a public “shell“ company in the exploration stage since its formation and had not yet realized any revenues from its planned operations.

Pursuant to a Share Exchange Agreement, dated January 5, 2010 (the “Share Exchange Agreement” and the transactions contemplated thereby, the “Share Exchange”), the Company acquired Chance High International Limited, a British Virgin Islands company (“Chance High”) from Chance High’s shareholders (the “Chance High Shareholders”) and, as a result, acquired Chance High’s indirect, controlled affiliate, Yantai Bohai Pharmaceuticals Group Co., Ltd. (“Bohai”), a Chinese company engaged the production, manufacturing and distribution in the People ‘ s Republic  of China (“China” or the “PRC”) of herbal medicines, including capsules and other products, based on traditional Chinese medicine.  The closing of the Share Exchange (the “Closing”) took place on January 5, 2010 (the “Closing Date”).  On the Closing Date, pursuant to the terms of the Share Exchange Agreement, the Company acquired all of the outstanding equity securities (the “Chance High Shares”) of Chance High from the Chance High Shareholders, and the Chance High Shareholders transferred and contributed all of their Chance High Shares to the Company.  In exchange, the Company issued to Chance High Shareholders an aggregate of 13,162,500 newly issued shares of common stock, par value $0.001 per share (the “Common Stock”).  In addition, pursuant to the terms of the Share Exchange Agreement, Anthony Zaradic, the former President and Chief Executive Officer of the Company, cancelled a total of 1,500,000 shares of Common Stock.

Chance High owns 100% of the issued and outstanding capital stock of the Yantai Shencaojishi Pharmaceuticals Co., Ltd. (“WFOE”).  On December 7, 2009, the WFOE entered into a series of variable interest entity contractual agreements (the “VIE Agreements”) with Bohai and its three shareholders, including Mr. Hongwei Qu, currently the Company’s Chairman, Chief Executive Officer and President (“Qu”), pursuant to which WFOE effectively assumed management of the business activities of Bohai and has the right to appoint all executives and senior management and the members of the board of directors of Bohai. Chance High, WFOE and Bohai are referred to herein collectively as the “Company” or “we”, “us” or “our”.

The VIE Agreements are comprised of a series of agreements, including a Consulting Services Agreement, Operating Agreement and Proxy Agreement, through which WFOE has the right to advise, consult, manage and operate Bohai  for  an annual fee in the amount of Bohai’s yearly net profits after tax.  Additionally, Bohai’s shareholders pledged their rights, titles and equity interest in Bohai as security for WFOE to collect consulting and services fees provided to Bohai through an Equity Pledge Agreement.  In order to further reinforce WFOE’s rights to control and operate Bohai, Bohai’s shareholders granted WFOE an exclusive right and option to acquire all of their equity interests in Bohai through an Option Agreement.

On January 29, 2010, the Company entered into an Agreement and Plan of Merger, the sole purpose of which was to effect a change of the Company’s corporate name from Link Resources Inc. to Bohai Pharmaceuticals Group, Inc.

2.          BASIS OF PREPARATION

The Company maintains its general ledger and journals with the accrued method accounting for financial reporting purposes.  Accounting policies adopted by the Company conform to generally accepted accounting principles in the United States of America (“US GAAP“) and have been consistently applied in the presentation of financial statements, which are compiled on the accrual basis of accounting.

This basis of accounting differs in certain material respects from that used for the preparation of the books of account of the Company, which are prepared in accordance with the accounting principles and the relevant financial regulations applicable to enterprises with limited liabilities established in the PRC (“PRC GAAP”), the accounting standards used in the places of their domicile.  The accompanying financial statements reflect necessary adjustments not recorded in the books of account of the Company to present them in conformity with US GAAP.
 
 
F-7

 
 
The consolidated financial statements as of and for the year ended June 30, 2010 reflect all adjustments which, in  the opinion of management, are necessary to present fairly the financial position, results of operations and cash flows for the period presented in accordance with the accounting principles generally accepted in the United States of America. All adjustments are of a normal recurring nature.

The Share Exchange was accounted for as a reverse recapitalization effected as of January 5, 2010. Although the Company legally acquired Chance High and its controlled subsidiary Bohai, for accounting purposes, Chance High and Bohai are considered to be the accounting acquirers and Link Resources, Inc. as the accounting acquiree. As a result, the historical consolidated financial statements for periods prior to January 5, 2010 are those of Chance High and Bohai and the operating results, financial position and cash flows of the Company (formerly known as Link Resources, Inc.) are consolidated only from its acquisition on January 5, 2010.  As the transaction between Link Resources, Inc. and Chance High and its subsidiaries is treated as reverse acquisition, no goodwill was recorded.  Intercompany transactions and balances are eliminated in consolidation.
 
3.          SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Restatements

Since 2005, the Company has not amortized its indefinite-lived drug formula for financial reporting purposes in accordance with US GAAP but did amortize these drug formulas for tax purposes, resulting in a difference for financial reporting purposes and tax purposes in the basis of these intangible assets. Upon a further study by the Company of the deferred tax liability issues, the Company concluded that although the tax effect of such amortization may be delayed indefinitely, the ability to do so is not a factor in the determination of whether a temporary difference exists. ASC 740-10-55-63 addresses this issue and states that “deferred tax liabilities may not be eliminated or reduced because an entity may be able to delay the settlement of those liabilities by delaying the events that would cause taxable temporary differences to reverse.” Accordingly, the Company has determined that a non-cash deferred tax liability should be recognized.
 
The Company’s consolidated financial statements as of and for the years ended June 30, 2010 and 2009 are being restated as follows:
 
   
For the year ended
   
For the year ended
 
Consolidated Statements of Income:
 
June 30, 2010
   
June 30, 2009
 
   
As previously
reported
   
As restated
   
As previously
reported
   
As restated
 
Income before provision for income taxes
  $ 12,461,481     $ 12,461,481     $ 9,854,885     $ 9,854,885  
Provision for income taxes
    (2,973,289 )     (3,404,509 )     (1,906,985 )     (2,337,479 )
Net income
  $ 9,488,192     $ 9,056,972     $ 7,947,900     $ 7,517,406  
                                 
Comprehensive Income:
                               
Net income
  $ 9,488,192     $ 9,056,972     $ 7,947,900     $ 7,517,406  
Unrealized foreign currency translation gain (loss)
    135,653       127,477       106,233       99,503  
Comprehensive Income:
  $ 9,623,845     $ 9,184,449     $ 8,054,133     $ 7,616,909  
                                 
Earnings per share – basic
  $ 0.64     $ 0.62     $ 0.60     $ 0.57  
Earnings per share – diluted
  $ 0.57     $ 0.55     $ 0.60     $ 0.57  

             
Consolidated Balance Sheets: 
 
As of June 30, 2010
   
As of June 30, 2009
 
   
As previously
reported
   
As restated
   
As previously
reported
   
As restated
 
Deferred tax liabilities
  $ -     $ 2,309,321     $ -     $ 1,869,924  
Total liabilities
    14,432,532       16,741,852       10,344,546       12,214,470  
                                 
Accumulated other comprehensive income
    626,584       460,577       490,931       333,100  
Retained earning
    31,921,832       29,778,519       22,433,640       20,721,547  
Total shareholders’ equity
  $ 50,084,354     $ 47,775,034     $ 33,934,383     $ 32,064,458  
 
   
Year Ended
   
Year Ended
 
Consolidated Statements of Cash Flows: 
 
June 30, 2010
   
June 30, 2009
 
   
As previously
reported
   
As restated
   
As previously
reported
   
As restated
 
Net income
  $ 9,488,192     $ 9,056,972     $ 7,947,900     $ 7,517,406  
Deferred tax liabilities
    -       431,220       -       430,494  
Net cash provided by (used in) operating activities
  $ 13,214,620     $ 13,214,620     $ (1,513,062 )   $ (1,513,062 )

The Company’s restated consolidated financial statements as of and for the nine months ended March 31, 2010 and 2009 have been restated as follows

   
For the three months ended
   
For the nine months ended
 
Consolidated Statements of Income: 
 
March 31, 2010
   
March 31, 2010
 
   
As previously
reported
   
As restated
   
As previously
reported
   
As restated
 
Income before provision for income taxes
  $ 3,727,693     $ 3,727,693     $ 9,946,524     $ 9,946,524  
Provision for income taxes
    (585,135 )     (692,950 )     (2,193,931 )     (2,517,901 )
Net income
  $ 3,142,558     $ 3,034,743     $ 7,752,593     $ 7,428,623  
                                 
Comprehensive Income:
                               
Net income
  $ 3,142,558     $ 3,034,743     $ 7,752,593     $ 7,428,623  
Unrealized foreign currency translation gain (loss)
    (157,384 )     (159,418 )     (108,823 )     (114,400 )
Comprehensive Income:
  $ 2,985,174     $ 2,875,325     $ 7,643,770     $ 7,314,223  
                                 
Earnings per share – basic
  $ 0.20     $ 0.19     $ 0.48     $ 0.46  
Earnings per share – diluted
  $ 0.16     $ 0.16     $ 0.37     $ 0.35  
 
   
For the three months ended
   
For the nine months ended
 
Consolidated Statements of Income: 
 
March 31, 2009
   
March 31, 2009
 
  
 
As previously
reported
   
As restated
   
As previously
reported
   
As restated
 
Income before provision for income taxes
  $ 2,528,403     $ 2,528,403     $ 7,437,907     $ 7,437,907  
Provision for income taxes
    (423,569 )     (531,193 )     (1,224,833 )     (1,547,704 )
Net income
  $ 2,104,834     $ 1,997,210     $ 6,213,074     $ 5,890,203  
                                 
Comprehensive Income:
                               
Net income
  $ 2,104,834     $ 1,997,210     $ 6,213,074     $ 5,890,203  
Unrealized foreign currency translation gain (loss)
    (157,384 )     (159,067 )     (108,823 )     (113,871 )
Comprehensive Income:
  $ 1,947,450     $ 1,838,144     $ 6,104,251     $ 5,776,333  
                                 
Earnings per share – basic
  $ 0.16     $ 0.15     $ 0.47     $ 0.45  
Earnings per share – diluted
  $ 0.16     $ 0.15     $ 0.47     $ 0.45  
 
   
As of
   
As of
 
Consolidated Balance Sheets: 
 
March 31, 2010
   
June 30, 2010
 
   
As previously
reported
   
As restated
   
As previously
reported
   
As restated
 
Deferred tax liabilities
  $ -     $ 2,199,471     $ -     $ 2,309,321  
Total liabilities
    13,999,091       16,198,562       14,432,532       16,741,853  
                                 
Accumulated other comprehensive income
    382,108       218,145       626,584       460,577  
Retained earning
    29,402,584       27,367,076       31,921,832       29,778,519  
Total shareholders’ equity
  $ 48,164,745     $ 45,965,274     $ 50,084,354     $ 47,775,034  

   
For the nine months ended
 
Consolidated Statements of Cash Flows: 
 
March 31, 2009
 
   
As previously
reported
   
As restated
 
Net income
  $ 6,213,074     $ 5,890,203  
Deferred income tax provision
    -       322,871  
Net cash provided by operating activities
  $ 818,523     $ 818,523  

   
For the nine months ended
 
Consolidated Statements of Cash Flows: 
 
March 31, 2010
 
   
As previously
reported
   
As restated
 
Net income
  $ 7,752,593     $ 7,428,623  
Deferred income tax provision
    -       323,970  
Net cash provided by operating activities
  $ 4,144,506     $ 4,144,506  

Basis of Presentation and Consolidation

The Company has adopted FAS ASC 810-10-15-14 and also FIN 46R, which requires that a Variable Interest Entity (“VIE”) to be consolidated by a company if that company is entitled to receive a majority of the VIE’s residual returns and have direct ability to made decision on all operation activities of the voting right of the VIE. The Company controls Bohai through the VIE Agreements described in Note 1 and accordingly it is consolidated for all periods presented.

The Operating Agreement provided that Bohai, as operating company, which is wholly foreign owned under control of Chance High that empowers to WFOE the direct ability to make decisions on all the operation activities of the voting right of Bohai.

Under Consultant Service Agreement entered between WFOE and Bohai on December 7, 2009, Bohai agreed to pay all of its net income to WOFE quarterly as a consultant fee. Accordingly, WOFE has the right to receive the expected residual returns of Bohai.
 
Under  above  mentioned  contractual  arrangement,  the  Company qualifies as the primary beneficiary of such controlling financial interest in Bohai as operating under FASB ASC230-10-45 and FASB Interpretation No. 46R “Consolidation of Variable Interest Entities “ (“FIN 46R “), an Interpretation of Accounting Research Bulletin No. 51. The result of subsidiaries or variable interest entities acquired prior to date of Share Exchange Agreement on January 5, 2010 entered are included in the consolidated financial statement.

As of June 30, 2010, the particulars of the Company’s subsidiaries and VIEs are as follows:

Name of Company
 
Place of
incorporation
 
Date of
incorporation
 
Attributable
equity interest
   
Issued Capital
(US Dollars)
 
Chance High International Limited
 
British Virgin Islands
 
July 2, 2009
    100 %   $ 50,000  
Yantai Shencaojishi Pharmaceuticals Co., Ltd.
 
People’s Republic
of China
 
November 25, 2009
    100 %   $ 9,500,000  
Yantai Bohai Pharmaceuticals
 
People’s Republic
 
July 8, 2004
    *     $ 2,918,000  
Group Co., Ltd.
 
of China
             
(RMB20,000,000
)

*   The Company has indirect controlling interest of Bohai under the VIE Agreements entered on December 7, 2009, which are described in Note 1 above.
 
 
F-8

 
 
Initial measurement of VIE: the Company initially measures the assets, liabilities, and non-controlling interests of the VIEs at their carrying amount at the date of the acquisition.

Accounting after initial measurement of VIE: subsequent accounting for the assets, liabilities, and non- controlling interest of a consolidated variable interest entity are accounted for as if the entity were consolidated based on voting interests and the usual accounting rules for which the VIE operates are applied as they would to a consolidated subsidiary as follows:

 
·
Carrying amounts of the VIE are consolidated into the financial statements of the Company as the primary beneficiary (referred as “Primary Beneficiary” or “PB”); and

 
·
Inter-company transactions and balances, such as revenues and costs, receivables and payables between or among the Primary Beneficiary and the VIE(s) are eliminated in their entirety.

Economic and Political Risks

The Company’s operations are conducted solely in the PRC.  There are significant risks associated with doing business in the PRC, among others, political, economic, legal and foreign currency exchange risks. The Group’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.

Use of Estimates

In preparing the consolidated financial statements in conformity with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods.  These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes, the estimation on useful lives of plant and machinery, and the fair value of derivative liabilities.  Actual results could differ from those estimates.

Fair Value Measurements and Fair Value of Financial Instruments

The Company adopted the guidance of Accounting Standards Codification (“ASC”) 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The carrying amounts reported in the balance sheets for cash, accounts receivable, other receivables, short-term borrowings, accounts payable and accrued expenses, customer advances, and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments.

ASC 825-10 “Financial Instruments,” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company uses Level 3 inputs to value its derivative liabilities.
 
 
F-9

 

The following table reflects gains and losses for fiscal 2010 for all financial assets and liabilities categorized as Level 3 as of June 30, 2010.

Liabilities:
     
Balance of derivative liabilities as of July 1, 2009
  $ -  
Initial fair value of derivative liabilities
    6,406,991  
Change the in fair value of derivative liabilities
    (925,063 )
Balance of derivative liabilities as of June 30, 2010
  $ 5,481,928  

Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, valuation techniques are sensitive to changes in the trading market price of our common stock and its estimated volatility. Because derivative financial instruments are initially and subsequently carried at fair values, our income may include significant charges or credits as these estimates and assumptions change.

The potential credit risk to the company is mainly attributable to its accounts receivable and bank balances. The Company has policies in place to ensure that it will only accept customers from countries which are politically stable and customers with an appropriate credit history. In addition, all bank balances are on deposit with financial institutions with high-credit quality. Accordingly, the Company does not consider that it is subject to significant credit risk.

The Company’s interest rate risk is primarily attributable to its borrowings, all of which have fixed interest rates. The Company does not use interest rate swaps to hedge its exposure to interest rate risk.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.  The Company maintains bank accounts in the PRC and restricted cash accounts in the United States of America. The restricted cash accounts were created for dividend payments of Convertible Note holders and payments of investor relation activities in the US.

Concentrations of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is maintained with state-owned banks within the PRC, and no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts. A significant portion of the Company’s sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms.  The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk.

At June 30, 2010 and 2009, the Company’s cash balances by geographic area were as follows:

   
June 30, 2010
   
June 30, 2009
 
Country:
                       
United States
  $ -       -     $ 2,440       0.1 %
China
    1,7149,082       100.0 %     2,491,726       99.9 %
Total cash and cash equivalents
  $ 17,149,082       100.0 %   $ 2,494,166       100.0 %
 
 
F-10

 

Accounts Receivable

Accounts receivable consists of amounts due from customers. The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts.  An allowance for doubtful accounts is established and determined based on management’s assessment of known requirements, aging of receivables, payment history, the customer’s current credit worthiness and the economic environment.  As of June 30, 2010 and 2009, no allowance for doubtful accounts was deemed necessary based on management’s assessment.

Inventories

Inventories are valued at the lower of cost or market with cost is determined using the weighted average method. Finished goods inventories consist of raw materials, direct labor and overhead associated with the manufacturing process. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels.  The Company’s reserve requirements generally increase/decrease due to management projected demand requirements, market conditions and product life cycle changes.  As of June 30, 2010 and June 30, 2009, the Company did not make any allowance for slow-moving or defective inventories

Intangible Assets

Intangible assets consist of “Pharmaceutical Formulas”, which were acquired with indefinite useful lives are measured initially at cost and not subject to amortization shall be tested for impairment annually or more frequently if there is indication of impairment. If the carrying amount exceeds fair value, an impairment loss should be recognized. Subsequently reversal of a recognized impairment loss is prohibited. There was no material impairment of the intangible assets as of June 30, 2010 and 2009.

Property, Plant and Equipment

Property, plant and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized.  When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

Included in property and equipment was construction-in-progress which consisted of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use. The principal annual rates are as follows:

Leasehold land and buildings
30 to 40 years
Motor vehicles
10 years
Plant and machinery
10 years
Office equipment
5 years

Accounting for the Impairment of Long-Lived Assets

The Company uses ASC Topic 360, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with ASC Topic 360. ASC Topic 360 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on its review, the Company believes that, as of June 30, 2010 and June 30, 2009, there were no significant impairments of its long-lived asset.
 
 
F-11

 

Foreign Currency Translation

The reporting currency of the Company is the U.S. dollar. The Company maintains its consolidated financial statements in the functional currency. The functional currency of the Company is the Chinese Renminbi (RMB). For the subsidiaries and affiliates whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets.  Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income.   Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchanges rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods. All of the Company’s revenue transactions are transacted in the functional currency. The Company does not enter any material transaction in foreign currencies and, accordingly, transaction gains or losses have not had, and are not expected to have, a material effect on the results of operations of the Company.

Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates using the following exchange rates:

   
June 30, 2010
   
June 30, 2009
 
Year end US$: RMB exchange rate
    6.80860       6.88480  
Average periodic US$: RMB exchange rate
    6.83667       6.84819  

RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US dollar at the rates used in translation.

Revenue Recognition

Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Pursuant to the guidance of ASC Topic 605 and ASC Topic 36, revenue is recognized when all of the following criteria are met:

 
·
Persuasive evidence of an arrangement exists;

 
·
Delivery has occurred or services have been rendered;

 
·
The seller’s price to the buyer is fixed or determinable; and

 
·
Collectability is reasonably assured.

The Company accounts for sales returns by establishing an accrual in an amount equal to its estimate of sales recorded for which the related products are expected to be returned. The Company determines the estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also by considering other factors that could impact sales returns. These factors include levels of inventory in the distribution channel, estimated shelf life, product discontinuances, and price changes of competitive products, introductions of generic products and introductions of competitive new products.  For the year ended June 30, 2010 and 2009, sales return rate is low and deemed immaterial and accordingly, no provision for sales returns was recorded.

Cost of Revenue

Cost of revenue consists primarily of raw material costs, labor cost, overhead costs associated with the manufacturing process and related expenses which are directly attributable to the Company’s revenues.
 
 
F-12

 
 
Stock-based compensation

Stock based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting period). The FASB Accounting Standards Codification also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. The Company records compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.

Research and Development Costs

Research and development costs are charged as expense when incurred and included in operating expenses. Research and development costs totaled $440,931 and $293,000 for the year ended June 30, 2010 and 2009, respectively.

Shipping costs

Shipping costs are included in selling expense and totaled $525,611 and $516,770 the years ended June 30, 2010 and 2009, respectively.

Advertising and Promotion

Advertising and promotion is expensed as incurred. Advertising and promotion expenses were included in operating expenses and amounted to $13,237,648 and $10,959,424 for the years ended June 30, 2010 and 2009, respectively.

Income Taxes

The Company is governed by the Income Tax Law of the People’s Republic of China and the United States. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of income and comprehensive income in the periods that includes the enactment date.

Comprehensive Income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. The Company’s current components of other comprehensive income are the foreign currency translation adjustment.

 
F-13

 

Commitments and Contingencies

Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.

Earnings Per Share

The Company reports basic earnings per share in accordance with ASC Topic 260, “Earnings Per Share”.  Basic earnings/(loss) per share is computed by dividing net income/ (loss) by weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period. Common equivalent shares are excluded from the computation in periods for which they have an anti-dilutive effect. Stock options for which the exercise price exceeds the average market price over the period are anti-dilutive and, accordingly, are excluded from the calculation.  At June 30, 2010, the Company had 2,847,260 common stock equivalents from convertible notes that could potentially dilute future earnings per share. Warrants to purchase 6,600,000 shares of common stock were outstanding during the year ended June 30, 2010, but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive.

Recent Accounting Pronouncements

The following Accounting Standards Codification (“ASC”) Updates have been issued, or became effective, since the beginning of the current year covered by these financial statements:

In June 2008, the FASB issued FASB ASC 260-10, “Determining Whether Instruments Granted in Share- based Transactions are Participating Securities”. Under ASC 260-10, unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing EPS. The adoption of ASC 260-10 beginning July 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued ASC 810, “Amendments to FASB Interpretation No.46(R)”. ASC 810 amends FASB Interpretation No.46(R), “Variable Interest Entities” for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under ASC 810, an enterprise has a controlling financial interest when it has a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. ASC 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. ASC 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. ASC 810 is effective as of the beginning of each reporting entity’ s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. ASC 810 is effective for the Company in the first quarter of fiscal 2011. The Company is currently evaluating the effect of ASC 810 on its consolidated financial statements.

In August 2009, the FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair Value”, which is codified as ASC 820, “Fair Value Measurements and Disclosures”. This Update provides amendments to ASC 820-10, Fair Value Measurements and Disclosures – Overall, for the fair value measurement of liabilities. This Update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or that is consistent with the principles of ASC 820. The amendments in this Update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents transfer of the liability. The amendments in this Update also clarify that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the assets are required are Level 1 fair value measurements. ASC 820 is effective for the first reporting period (including interim periods) beginning after August 28, 2009. The adoption of this Update did not have a significant impact to the Group’s consolidated financial statements.

 
F-14

 
 
In December 2009, the FASB issued ASU No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”)”. ASU 2009-17 amends the variable- interest entity guidance in FASB ASC 810-10-05-8 to clarify the accounting treatment for legal entities in which equity investors do not have sufficient equity at risk for the entity to finance its activities without financial support. ASU 2009-17 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009. ASU 2009-17 is effective for the Company in the first quarter of fiscal 2011. The Company is currently evaluating the effect of ASU 2009-17 on its consolidated financial statements.

In January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair Value Measurements. This update provides amendments to Subtopic 820-10 that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number). This update provides amendments to Subtopic 820-10 that clarifies existing disclosures as follows: 1) Level of disaggregation. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities. 2) Disclosures about inputs and valuation techniques. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU; however, the Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.

In February 2010, FASB issued ASU No. 2010-9 – Amendments to Certain Recognition and Disclosure Requirements. This update addresses certain implementation issues related to an entity’s requirement to perform and disclose subsequent-events procedures, removes the requirement that public companies disclose the date of their financial statements in both issued and revised financial statements. According to the FASB, the revised statements include those that have been changed to correct an error or conform to a retrospective application of U.S. GAAP. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In April 2010, the FASB issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades - a consensus of the FASB Emerging Issues Task Force.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  Earlier application is permitted.  The Company does not expect the provisions of ASU 2010-13 to have a material effect on the financial position, results of operations or cash flows of the Company.

In May 2010, the FASB issued ASU 2010-19, Foreign Currency (Topic 830): Foreign Currency Issues: Multiple Foreign Currency Exchange Rates.  The amendments in this Update are effective as of the announcement date of March 18, 2010. The adoption of this update did not have a material effect on the financial position, results of operations or cash flows of the Company.

 
F-15

 

4.          OTHER RECEIVABLES AND PREPAYMENTS

Other receivables and prepayments consist of the following:

   
As of
June 30, 2010
   
As of
June 30, 2009
 
Prepayment for advertising and promotion
  $ 1,198,484     $ 1,736,025  
Loan to a third party
    -       1,465,000  
Prepayment for director and officer insurance
    29,792       -  
Other receivables
    221,314       292,775 *
Total other receivable s and prepayments
  $ 1,449,590     $ 3,493,800  

*           Inter-company balance of June 30, 2009 has been reclassified in order to conform with current period’s presentation.

Loan to a third party is un-secured with interest bearing at 5.31% per annum. The loan was repaid during fiscal year ended June 30, 2010.

5.          AMOUNT DUE FROM EQUITY HOLDER

Amount due from equity holder consists of the following:

   
As of
   
As of
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
             
Mr. Hongwei Qu
  $ 40,160     $ 1,465,000  
 
The amount due from an equity holder as of June 30, 2010 is unsecured, non-interest bearing. The balance of $40,160 was repaid in July 2010.  The amount due from an equity holder as of June 30, 2009 is unsecured with interest bearing at 3.93% per annum was repaid during fiscal year ended June 30, 2010.

6.          INVENTORIES

Inventories consist of the following:

   
As of
June 30, 2010
   
As of
June 30, 2009
 
Raw materials
  $ 445,693     $ 250,405  
Finished goods
    302,729       57,429  
Total inventories
  $ 748,422     $ 307,834  
 
 
F-16

 

7.           INTANGIBLE ASSETS

Intangible assets consist of the following:

   
As of
June 30, 2010
   
As of
June 30, 2009
 
             
Pharmaceuticals formulas, at cost
  $ 17,342,772     $ 17,298,720  

8.           PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment consisted of the following:

   
As of
June 30,
2010
   
As of
June 30,
2009
 
             
Cost
           
             
Leasehold land and buildings
  $ 7,629,498     $ 7,447,211  
Plant and equipment
    1,234,994       1,156,557  
Office equipment
    85,174       74,700  
Construction in progress
    -       236,597  
Motor vehicles
    414,622       389,075  
Total
    9,364,288       9,304,140  
                 
Less: accumulated depreciation
    1,469,246       1,154,861  
                 
Property, plant and equipment, net
  $ 7,895,042     $ 8,149,279  

Depreciation expense for the year ended June 30, 2010 and 2009 were $310,551 and $302,762 respectively.

As of June 30, 2010 and 2009, the Company has pledged plant and machinery having a carrying amount of $534,102 and $562,331, respectively to secure a bank loan to the Bohai.

9.          SHORT-TERM BORROWINGS

Bohai obtained several short-term loan facilities from financial institution in the PRC.  Short-term borrowings as of June 30, 2010 are consisted, of the following:

Loan from financial
institution
 
Loan period
 
Annual
interest rate
   
Secured by
 
Amount
 
China Construction Bank
 
February 24, 2010 to February 23, 2011
    5.8410 %  
Shandong Dai Xin Heavy Industries Co. Ltd.
  $ 3,524,954  
Yantai Laishan Rural Credit Union
 
September 28, 2009 to September 26, 2010
    9.0270 %  
Yantai Ka Wah Medical Equipment Co. Ltd
  $ 587,492  
Yantai Laishan Rural Credit Union
 
September 28, 2009 to September 26, 2010
    6.9030 %  
Bohai’s machinery and vehicle
  $ 286,402  
TOTAL
                  $ 4,398,849  
 
 
F-17

 
 
Short-term borrowings as of June 30, 2009 are consisted, of the following:

 
Loan from financial
institution
 
Loan period
 
Annual
interest rate
   
Secured by
 
Amount
 
Shanghai Pudong Development Limited
 
December 12, 2008 to December 11, 2009
    6.6960 %  
Haiyang Construction Industry Training Centre and personal guarantee by equity holders
  $ 2,197,500  
Yantai City Commercial Bank
 
January 20, 2009 to January 20, 2010
    6.9030 %  
Yantai Hai Pu Can End Making Co. Ltd.
  $ 1,318,500  
Yantai Laishan Rural Credit Union
 
September 27, 2008 to September 26, 2009
    9.3600 %  
Yantai Ka Wah Medical Equipment Co. Ltd.
  $ 293,000  
Yantai Laishan Rural Credit Union
 
September 27, 2008 to September 26, 2009
    12.2400 %  
Bohai’s machinery and vehicle
  $ 586,000  
China Construction Bank
 
May 12, 2008 to November 11, 2009
    0.0000 %  
Personal guarantee by equity holders
  $ 1,465,000  
TOTAL
                  $ 5,860,000  

10.       COMMON STOCK

The Company is authorized to issue 150 million shares of common stock, par value $0.001 per share.  Holders of common stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders.  Holders of common stock do not have a cumulative voting right, which means that the holders of more than one half of the Company’s outstanding shares of common stock, subject to the rights of the holders of preferred stock, can elect all of our directors, if they choose to do so.  In this event, the holders of the remaining shares of common stock would not be able to elect any directors.  Subject to the prior rights of any class or series of preferred stock which may from time to time be outstanding, if any, holders of common stock are entitled to receive ratably, dividends when, as, and if declared by the Company’s Board of Directors out of funds legally available for that purpose and, upon our liquidation, dissolution, or winding up, are entitled to share ratably in all assets remaining after payment of liabilities and payment of accrued dividends and liquidation preferences on the preferred stock, if any.  Holders of common stock have no preemptive rights and have no rights to convert their common stock into any other securities.  The outstanding common stock is duly authorized and validly issued, fully-paid, and non-assessable.  Except as required or permitted by law or the Company’s charter documents, all stockholder action is taken by the vote of a majority of the outstanding shares of common stock present at a meeting of stockholders at which a quorum consisting of a majority of the outstanding shares of common stock is present in person or by proxy.

On December 17, 2009, prior to the reverse re-capitalization on January 5, 2010, the Company issued 687,500 shares to Cawston Enterprises Limited and 450,000 shares to Regeneration Capital Group, LLC and its affiliates for consulting services rendered to the Company.  As described in Note 2, for accounting purposes, Chance High is deemed to have acquired the Company as of January 5, 2010.  The fair value of these shares was accounted for by the Company prior to its acquisition by Chance High and is not reflected in these consolidated financial statements.

On January 5, 2010, pursuant to the terms of the Share Exchange Agreement described in Note 2, the Company acquired all of the outstanding equity securities (the “Chance High Shares”) of Chance High from the Chance High Shareholders, and the Chance High Shareholders transferred and contributed all of their Chance High Shares to the Company.  In exchange, the Company issued to Chance High Shareholders an aggregate of 13,162,500 newly issued shares of common stock, par value $0.001 per share. In addition, pursuant to the terms of the Share Exchange Agreement, Anthony Zaradic, the former President and Chief Executive Officer of the Company, cancelled a total of 1,500,000 shares of Common Stock.

On April 1, 2010, Notes with an aggregate face amount of $500,000 were converted into 250,000 shares of Common Stock.

 
F-18

 

11.       EARNINGS PER SHARE

Basic earnings per share are computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the if-converted method for the convertible notes and the treasury stock method for warrants.  The following table sets forth the computation of basic and diluted net income per common share:

   
As of
   
As of
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
   
restated
   
restated
 
Net income from continuing operating available common stockholders
  $ 9,056,972     $ 7,517,406  
Effective Interest charge on convertible note
    588,811       -  
Net income for diluted earnings per common share
  $ 9,645,783     $ 7,517,406  

   
As of
   
As of
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
Basic weighted average common stocks outstanding
    14,722,055       13,162,500  
Effect of dilutive securities:
               
Warrants - incremental shares based on  assumed proceeds & re-purchases
    -       -  
Common shares if converted form Convertible Debt
    2,847,260       -  
Diluted weighted average for common stocks outstanding
    17,569,315       13,162,500  

Warrants to purchase 6,600,000 shares of common stock were outstanding during the year ended June 30, 2010, but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive.

For the year ended June 30, 2009, there were no common stock equivalents outstanding; therefore the amounts reported for basic and dilutive earning per share were the same.

12.       OTHER ACCRUED LIABILITIES

Other accrued liabilities as of June 30, 2010 and 2009 are consisted of the following:

   
As of
   
As of
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
Accrued selling expenses
  $ 1,542,280     $ 1,677,026  
Accrued staff costs
    221,810       173,130  
Value added tax payable
    686,478       709,688  
Other taxes payable
    78,370       77,374  
Other accrued expenses
    456,051       198,454  
Total Other accrued liabilities
  $ 2,984,988     $ 2,835,672  

*           Inter-company balance of June 30, 2009 has been reclassified in order to conform with current period’s presentation.

 
F-19

 
 
13.          CONVERTIBLE PROMISSORY NOTES AND WARRANTS

On January 5, 2010, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”) with 128 accredited investors (the “Investors”), the Company sold 6,000,000 units for aggregate gross proceeds of $12,000,000, each unit consisting of an 8% senior convertible promissory note in the principal amount of $2 and one common stock purchase warrant (each, an “Investor Warrant” and collectively, the “Investor Warrants”). By agreement with the Investors, each investor received: (i) a single Note representing the aggregate number of Notes purchased by them as part of the units (each, a “Note” and collectively, the “Notes”) and (ii) a single Investor Warrant representing the aggregate number of Investor Warrants purchased by them as part of the units.

The Notes bear interest at 8% per annum, payable quarterly in arrears on the last day of each fiscal quarter of the Company. No principal payments are required until maturity of the Notes on January 5, 2012. Each Note, plus all accrued but unpaid interest thereon, is convertible, in whole but not in part, at any time at the option of the holder, into shares of the Company’s common stock, par value $0.001 per share, at a conversion price of $2.00 per share, subject to adjustment as set forth in the Note. The 128 Notes issued have face amounts that range from $43,200 to $500,000.

The conversion price of the Notes is subject to standard anti-dilution adjustments for stock splits and similar events. In addition, in the event the Company issues or sells any additional shares of Common Stock or instruments convertible or exchangeable for Common Stock at a price per share less than the conversion price then in effect or without consideration, then the conversion price upon each such issuance will be adjusted to that price determined by multiplying the conversion price then in effect by a fraction: (1) the numerator of which is the sum of (x) the number of shares of Common Stock outstanding immediately prior to the issuance of such additional shares of Common Stock plus (y) the number of shares of Common Stock which the aggregate consideration for the total number of such additional shares of Common Stock so issued would purchase at a price per share equal to the conversion price then in effect, and (2) the denominator of which is the number of shares of Common Stock outstanding immediately after the issuance of such additional shares of Common Stock. Notwithstanding any provision of the Note to the contrary, no adjustment will cause the conversion price to be less than $1.00, as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction.

Effective as of June 30, 2010, the Company entered into an Amendment and Agreement with the Investors, pursuant to which the Company and the Investors agreed to make certain amendments to the Notes and the Warrants.  Pursuant to the Amendment, the anti-dilution protection provisions in the Notes and the Warrants were eliminated and a provision specifically precluding net cash settlement by the Company of the Notes and the Warrants was added.  In return, and subject to certain non-financing exceptions, the Company agreed not to issue any new equity securities at a price per share below $2.20 until the earlier of (i) January 5, 2013 or (ii) the date on which, collectively with any prior conversions or exercises of Notes and Warrants, 75% of the principal face value of the Notes in the aggregate has been converted into shares of Common Stock and Warrants representing, in the aggregate, 75% of the aggregate shares of Common Stock underlying the Warrants have been exercised.  This Amendment did not change the Company’s accounting for the Notes and the Warrants described below.

The Notes contain certain Events of Default, including non-payment of interest or principal when due, bankruptcy, failure to maintain a listing of the Common Stock or to make required filings on a timely basis. No premium is payable by the Company if an Event of Default occurs. However, upon an Event of Default, and provided no more than 50% of the aggregate face amount of the Notes have been converted, the Investors holding Notes have the right to receive a portion, based on their pro-rata participation in the transaction, of 1,000,000 shares of the Company’s Common Stock that have been placed in escrow by the Company’s principal stockholder. The shares in escrow will be returned to the principal stockholder when 50% of the aggregate face amount of the Notes has been converted or, if later, when the Notes are repaid.

 
F-20

 

The Investor Warrants expire on January 5, 2013 and may be exercised by the holder at any time to purchase one share of Common Stock at an exercise price of $2.40 per share (subject to adjustment as set forth in the Investor Warrants). The exercise price of the Investor Warrants is subject to adjustment in the same manner as the conversion price of the Notes described above, except that the exercise price will not be adjusted to less than $1.20, as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction. The Investor Warrants may only be exercised for cash and do not permit the holder to perform a cashless exercise.

In connection with the sale of the units, the Company paid its placement agents a cash fee of $1,200,000. In addition, the placement agents received warrants (the “Placement Agent Warrants” and, together with the Investor Warrants, the “Warrants”) to purchase 600,000 shares of Common Stock, which warrants are substantially identical to the Investor Warrants, except that, pursuant to separate lock-up agreements executed by the holders of the Placement Agent Warrants, the Placement Agent Warrants are not exercisable until the six month anniversary of the later of: (i) the date of effectiveness of the registration statement registering the resale of the Common Stock underlying the Notes and Warrants or (ii) the date of commencement of sales in connection with such registration statement.

In addition to the placement agent fee, the Company paid $370,000 of legal and other expenses. As required by the Securities Purchase Agreement, $500,000 of the proceeds from the sale of the units were placed in escrow to pay investor relations expenses to be incurred by the Company and $240,000, equivalent to one quarter’s interest expense on the Notes, was also placed in escrow. The interest escrow will be released to the Company at such time as 75% of all shares underlying the Notes have been issued upon conversion of Notes. After payment of the placement agent fees and other expenses and the amounts required to be placed in escrow, the Company received net proceeds of $9,690,000. At June 30, 2010, $576,019 remained in escrow and is included in restricted cash.

The Company also entered into a Registration Rights Agreement with the Investors. The Company agreed to file, no later than March 6, 2010, a registration statement to register the shares underlying the Notes and the Warrants and to have such registration statement effective no later than August 13, 2010. The required registration statement was filed on March 2, 2010 and became effective on August 12, 2010. Accordingly, the Company did not incur any registration delay payments.

Valuation

At the time the Notes and Warrants were issued, there had not been any market activity for the Common Stock.  Accordingly, determining the fair value of the Common Stock required the Company to make complex and subjective judgments. The Company estimated the value of its enterprise as of January 5, 2010 based on a review of the enterprise value derived from the use of market and income valuation approaches. The Company also reviewed an asset-based approach to assess whether the result of such an approach was consistent with the value derived from the market and income valuation approaches. The market approach was based on the market price to earnings multiple for companies considered by management to be comparable to the Company. The income approach was based on applying discount rates to estimated future net income. The estimated enterprise value was then allocated to the Company’s existing outstanding Common Stock, the Notes and the Warrants using the option pricing method. The option pricing method was based on the two year period to maturity of the Notes and the three year period to expiration of the Warrants, risk-free interest rates commensurate with those periods and the expected volatility used was based on a review of the historical volatility of companies considered by management to be comparable to the Company.

Based on the allocation of the estimated enterprise value, the Company estimated the fair value of the Common Stock at $2.28 per share, as of January 5, 2010. The Investor Warrants and the Placement Agent Warrants were valued at $5,824,538 and $582,454, respectively, based on the estimated fair value of the Common Stock of $2.28, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 1.57% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life of the Warrants and estimated volatility of 65%, based on a review of the historical volatility of companies considered by management to be comparable to the Company.  As noted above, prior to the June 30, 2010 Amendment described above, the Warrants contained a down-round anti-dilution protection feature. As of January 5, 2010, the value of this feature was not considered to be material and no adjustment was made for it in the estimated fair value of the Warrants.

 
F-21

 
 
Accounting for Convertible Notes

At January 5, 2010 and June 30, 2010, the conversion options embedded in the Notes are not derivative instruments as defined in FASB ASC 815-10-15-83 because the Notes do not permit or require net settlement, there is no market mechanism outside the contracts that permits net settlement and the shares to be received on conversion of the Notes are not readily convertible to cash. At the time the Notes were issued, there had not been any market activity for the Common Stock. On March 31, 2010, an initial trade of 500 shares of the Common Stock occurred in the market, the only trading activity during that period. The Notes can be exercised only in whole but not in part and through March 31, 2010 and continuing, there has been insufficient trading volume to permit the shares to be received on conversion of each Note to be readily sold in the market, thus precluding the shares to be received by the holder of each Note from being readily convertible to cash.

In future periods, whether or not the embedded conversion option in each Note is considered to be a derivative instrument will depend on whether or not the aggregate number of shares to be received on exercise of each of the 128 Notes, which Notes can be exercised only in whole but not in part, could be readily sold in the market without significantly affecting the market price of the Common Stock, thus permitting the shares received by the holder of each Note to be readily convertible to cash. At each reporting date, the Company will re- evaluate each Note, based on the level of activity in the market for the Common Stock at that time, to determine whether or not the embedded conversion option in each Note is a derivative instrument. Depending on the trading volume for the Common Stock that develops in the future and the face amount of each Note, the embedded conversion option may be considered a derivative instrument for some Notes but not for others and its status as a derivative instrument may vary from period to period.

FASB ASC 815-10-15-74 provides that a contract which would otherwise meet the definition of a derivative instrument but that is both (a) indexed to a company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. FASB ASC 815-40-15 and 815-40-25 provide guidance for determining whether those two criteria are met. Because the Company’s functional currency is the Renminbi but the Notes are denominated in U.S. Dollars, FASB ASC 815-40-15-7I provides that the embedded conversion options are not considered to be indexed only to the Company’s Common Stock. Furthermore, prior to the June 30, 2010 Amendment described above, the criteria that the instruments be indexed only to the Common Stock was also not met because the conversion price of the Notes would be reduced if the Company issued securities at a lower exercise or conversion price. Because the requirement that the instruments be indexed only to the Common Stock is not met, the exemption in FASB ASC 815-10-15-74 will not be available and the Company will account for the embedded conversion options in the Notes as derivative instrument liabilities, if and when the shares to be issued on conversion are considered to be readily convertible to cash..

Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. If and when the embedded conversion option in any of the Notes first qualifies as a derivative instrument, the fair value at that time of the embedded derivative instrument will be re-classified and separately recognized and subsequently marked-to-market each reporting period, as long as the embedded conversion option continues to qualify as a derivative instrument. If the embedded conversion option ceases to be a derivative instrument, it will be marked-to-market as of the date of re-classification but thereafter will no longer be marked-to-market.

Warrants

Because the Company’s functional currency is the Renminbi but the Warrants are denominated in U.S. Dollars, the Warrants are not considered to be indexed only to the Company’s Common Stock. Furthermore, prior to the June 30, 2010 Amendment described above, the criteria that the instruments be indexed only to the Common Stock was also not met because the exercise price of the Warrants would be reduced if the Company issued securities at a lower exercise or conversion price. In accordance with ASC 815-10-S99-4, the Warrants (including the Placement Agent Warrants) are accounted for at fair value, with changes in their fair value charged or credited to income each period.
 
 
F-22

 
At January 5, 2010, the Investor Warrants were valued at $5,824,538, as described above. At June 30, 2010, the Investor Warrants were re-valued at $4,983,571 using a binomial model, based on the closing market price on that date of $2.21, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 0.81% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life of the Warrants and estimated volatility of 65%, based on a review of the historical volatility of companies considered by management to be comparable to the Company. The effect of the down-round anti-dilution protection was not considered to be material and no adjustment was made for it in the estimated fair value of the Investor Warrants.

The Placement Agent Warrants were initially valued at $582,454, as described above.. The cost of these instruments, together with the cash fees paid to the placement agents and the other fees and expenses paid by the Company, as described above, in the aggregate amount of $2,152,454, have been deferred and are being amortized on a straight-line basis over the two year period to maturity of the Notes. At June 30, 2010, the Placement Agent Warrants were re-valued at $498,357, based on the closing market price on that date of $2.21, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 0.81% and estimated volatility of 65%. The effect of the down-round anti-dilution protection was not considered to be material and no adjustment was made for it in the estimated fair value of the Placement Agent Warrants.

The aggregate change in the value of the Investor and Placement Agent Warrants between January 5, 2010 and June 30, 2010 of $925,063 has been credited to income.

The following table summarizes all of the Company’s warrants outstanding as of June 30, 2010:
 
   
Warrant
Shares
   
Exercisable
Shares
   
Exercise Price per
Common Stock Range
 
Balance, June 30, 2009
    -       -       -  
Granted or vested during the year ended June 30, 2010
    6,600,000       6,000,000     $ 2.40  
Exercised during the year ended June 30, 2010
    -       -       -  
Expired during the year ended June 30, 2010
    -       -       -  
Balance, June 30, 2010
    6,600,000       6,000,000     $ 2.40  
 
The following table summarizes the weighted average remaining contractual life and exercise price of the Company’s outstanding warrants.
 
Warrants Outstanding
 
           
Number
   
Weighted
   
Weighted Average
 
           
Outstanding
   
Average
   
Exercise Price of
 
     
Number
   
Currently
   
Remaining
   
Warrants
 
Exercise
   
Outstanding
   
Exercisable
   
Contractual Life
   
currently
 
Price
   
at June 30, 2010
   
at June 30, 2010
   
(Years)
   
exercisable
 
                           
$ 2.40       6,600,000       6,000,000       2.52     $ 2.40  

Convertible Notes

The Investor Warrants were initially recorded at their fair value of $5,824,538 and the remainder of the $12,000,000 gross proceeds received from the Investors of $6,175,463 was allocated to the Notes. Based on the proceeds allocated to the Notes, the Notes are convertible into Common Stock at an effective conversion price of approximately $1.03 per share. Because the effective conversion price is less than the fair value of the Common Stock at the time the Notes were issued, the Company recognized a beneficial conversion feature, which was limited to the amount of proceeds allocated to the Notes of $6,175,463. The Notes were initially recorded at a carrying value of zero and are being amortized, together with interest accruing on the Notes, to their maturity value over the period to maturity, at an effective interest rate of approximately 540% per annum. Interest expense for the year ended June 30, 2010 was $588,811. On April 1, 2010, Notes with an aggregate face amount of $500,000 were converted into 250,000 shares of Common Stock. After allocating of interest credit of $7,326 to equity resulting from 250,000 converted shares and payment of cash interest due on March 31, 2010 and June 30, 2010 of $456,667, the amortized cost carrying value of the Notes at June 30, 2010 was $124,820.

 
F-23

 
 
 Escrowed Shares

As of January 5, 2010 and at June 30, 2010, the Company’ s principal stockholder is obligated to deliver 1,000,000 shares of Common Stock to the Investors if certain Events of Default occur (as defined in the Notes). The fair value of this obligation is not considered to be material as the probability of such events occurring is currently considered to be minimal. Accordingly, at January 5, 2010 and June 30, 2010, no liability for this obligation has been recognized.

14.
DEFERRED FEES ON CONVERTIBLE NOTES

The Company incurred total placement fees of $2,152,454 in connection with our private placement of Convertible Notes (see Note 13) that occurred on January 5, 2010. The placement fees are being amortized on a straight line basis over the two year expected life of the Convertible Notes, starting on the date of closing, January 5, 2010.

   
As of
   
As of
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
             
Deferred fees, beginning balance on January 5, 2010
 
$
2,152,454
   
$
-
 
Transferred to equity on conversion
   
(79,120
)
   
-
 
Amortization of deferred fees
   
(510,717
)
   
-
 
                 
Deferred fee, ending balance
 
$
1,562,617
   
$
-
 

15.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses for the years ended June 30, 2010 and 2009 are consisted, of the followings:

   
Year ended
   
Year ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
             
Accommodation
 
$
4,215,298
   
$
5,151,876
 
Advertising and promotion
   
13,237,648
     
10,959,424
 
Audit fee
   
40,073
     
8,937
 
Commissions
   
4,092,716
     
1,419,478
 
Conferences
   
4,010,143
     
5,089,283
 
Depreciation
   
37,726
     
20,514
 
Staff costs
   
2,034,566
     
1,536,496
 
Travel
   
2,264,489
     
2,755,259
 
Research and development cost
   
440,931
     
293,000
 
Other operating expenses
   
5,879,485
     
4,112,872
 
                 
Total selling, general and administrative expense
 
$
36,253,075
   
$
31,347,139
 
 
 
F-24

 

16.
INTEREST EXPENSES

   
Year ended
   
Year ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
             
Interest on short-term bank borrowings wholly repayable within one year
 
$
337,424
   
$
184,404
 
Effective interest charge on Convertible Notes
   
588,811
     
-
 
Total interest expenses
 
$
926,235
   
$
184,404
 

17.
INCOME TAXES

For the years ended June 30, 2010 and 2009, income tax expense consisted of the following:

   
Year ended
   
Year ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
   
restated
   
restated
 
Current taxes
           
United States
 
$
-
   
$
-
 
PRC
   
2,973,289
     
1,906,985
 
                 
Deferred taxes
               
United States
   
(308,406
)
   
(15,411
)
PRC
   
431,220
     
430,494
 
                 
Change in valuation allowance
   
308,406
     
15,411
 
   
 
   
 
 
Total income tax expenses
 
$
3,404,509
   
$
2,337,479
 

As of June 30, 2010, the Company incurred $907,077 of net operating losses carry forwards available for federal tax purposes that may be used to offset future taxable income and will begin to expire in 2029, if unutilized. The Company has provided for a full valuation allowance against the deferred tax assets of $308,406 on the expected future tax benefits from the net operating loss carry forwards as the management believes it is more likely than not that these assets will not be realized in the future.

 
F-25

 
 
PRC Tax

PRC’s legislative body, the National People’s Congress, adopted the unified Enterprise Income Tax (“EIT”) Law on March 16, 2007. This new tax law replaces the existing separate income tax laws for domestic enterprises and foreign-invested enterprises and became effective on January 1, 2008. Under the new tax law, a unified income tax rate is set at 25% for both domestic enterprises and foreign-invested enterprises. However, there will be a transition period for enterprises, whether foreign-invested or domestic, that are currently receiving preferential tax treatments granted by relevant tax authorities. Enterprises that are subject to an enterprise income tax rate lower than 25% may continue to enjoy the lower rate and will transit into the new rate over a five year period beginning on the effective date of the EIT Law. Enterprises that are currently entitled to exemptions for a fixed term may continue to enjoy such treatment until the exemption term expires. Preferential tax treatments may continue to be granted to industries and projects that qualify for such preferential treatments under the new law.

United States Tax

The Company is subject to income tax in the United States. No provision for income tax in the United States has been made as the Company had no taxable income for the year ended June 30, 2010. The statutory tax rate is 34%.

The table below summarizes the differences between the U.S. statutory federal rate and the Company’s effective tax rate and as follows for the years ended June 30, 2010 and 2009:

   
Year ended
   
Year ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
 
   
restated
   
restated
 
United States Tax at statutory rate
 
$
4,236,906
   
$
3,350,661
 
Foreign tax rate difference
   
(1,199,091
)
   
(891,019
)
Net operating loss carry forward
   
292,995
     
15,411
 
Additional income tax expense resulted from prior year’s tax assessment
   
81,567
     
-
 
Permanent difference
   
(7,868
)
   
(137,574)
 
Income tax expense
 
$
3,404,509
   
$
2,337,479
 

The Company’s deferred tax assets as of June 30, 2010 and 2009 are as follows:
 
   
June 30,
 
   
2010
   
2009
 
   
restated
   
restated
 
Deferred tax asset:
           
Net operating loss carry forward
 
$
308,406
   
$
15,411
 
Total gross deferred tax asset
   
308,406
     
15,411
 
Less: valuation allowance
   
(308,406
)
   
(15,411
)
Net deferred tax asset
 
$
-
   
$
-
 
                 
Deferred tax liability:
               
Indefinite lives intangible assets
 
$
2,309,321
   
$
1,869,924
 

During 2010, the valuation allowance increased by approximately $292,995.

VAT

Certain of the Company’s revenues (including sales revenue) are subject to output VAT generally calculated at 6%, 13% and 17% of the selling price. Input credit relating to input VAT paid on purchase can be used to offset the output VAT.

 
F-26

 

   
Year ended
June 30,
2010
   
Year ended
June 30,
2009
 
             
Net value added tax expenses
 
$
8,674,186
   
$
7,443,011
 

18.
COMMITMENTS AND CONTINGENCIES

As of June 30, 2010, the Company has commitments to purchase land use right for future factory expansion. The purchase price is approximately $14,320,100 (RMB 97,500,000). As of June 30, 2010, the Company has prepaid for approximately $7,343,700 (RMB 50,000,000), which is included in Prepayment for Land Use Right on the consolidated balance sheets, the remaining balance of $6,976,400 (RMB 47,500,000) as of June 30, 2010 will be paid by March 31, 2011.

There are no other foreseeable material commitments or contingencies as of June 30, 2010 and 2009.

19.
SIGNIFICANT CONCENTRATIONS

(a)           Customer Concentrations

The Company does not have concentrations of business with each customer constituting greater than 10% of the Company’s gross sales for the years ended June 30, 2010 and 2009.
 
The Company has not experienced any significant difficulty in collecting its accounts receivable in the past and is not aware of any financial difficulties being experienced by its major customers.

(b)           Supplier Concentrations

The Company has the following concentrations of business with each supplier constituting greater than 10% of the Company’s purchase:

   
Year ended
June 30,
2010
   
Year ended
June 30,
2009
 
Shandong Yantai Medicine Procurement and Supply Station
    13.5 %     *  
Anhui DeChang Pharmaceutical Co. Ltd.
    11.9 %     15.2 %
Yantai Tianyifeng Science and Technology Development Co., Ltd.
    *       10.8 %
                 
*           Constitutes less than 10% of the Company’s purchase.
               

20.
STATUTORY RESERVES

According to the laws and regulations in the PRC, the Company is required to provide for certain statutory funds, namely, reserve fund by an appropriation from net profit after taxes but before dividend distribution based on the local statutory financial statements of the PRC company prepared in accordance with the accounting principles and relevant financial regulations.

 
F-27

 

The Company in PRC is required to allocate at least 10% of its net profit to the reserve fund until the balance of such fund has reached 50% of its registered capital. Appropriation of enterprise expansion fund are determined at the discretion of it directors.  The Company had satisfied statutory reserve requirement in the first quarter of the fiscal year 2010.

The reserve fund can only be used, upon approval by the relevant authority, to offset accumulated losses or increase capital. The enterprise expansion fund can only be used to increase capital upon approval by the relevant authority.

21.
RECLASSIFICATION

Certain comparative figures have been reclassified in order to conform with the current period’s presentation.

22.
SUBSEQUENT EVENTS

The Company has performed an evaluation of subsequent events through the date of these financial statements are issued.

 
F-28

 

SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 21st day of September, 2011.

 
Bohai Pharmaceuticals Group, Inc.
     
 
By:
/s/ Hongwei Qu
   
Name: Hongwei Qu
   
Tile: President and Chief Executive Officer
   
(Principal Executive Officer)
     
 
By:
/s/ Gene Hsiao
   
Name: Gene Hsiao
   
Tile: Chief Financial Officer
   
(Principal Financial Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. 
 
Signature
 
Title
 
Date
         
 /s/ Hongwei Qu
       
Hongwei Qu
 
Chief Executive Officer and Chairman
 
September 21, 2011
         
/s/ Chengde Wang
 
Director
 
 September 21, 2011
Chengde Wang
       
         
/s/ Thomas Tan
 
Director
 
September 21, 2011
Thomas Tan
       
         
/s/ Adam Wasserman
 
Director
 
 September 21, 2011
Adam Wasserman
       
         
/s/ Gene Hsiao
 
Director
 
 September 21, 2011
Gene Hsiao
       
 
 
8