UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ending December 31, 2011

 

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: 000-52954

 

Tongli Pharmaceuticals (USA), Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		84-1090791
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification number)
14 Wall Street, 20th Floor New York, NY		10005
(Address of Principal Executive Offices)		(Zip Code)

 

212-842-8837             212-842-8837      

(Registrant’s Telephone Number, Including Area Code)

 

n/a

(Former name, former address and former fiscal year, if changed since last report)

 

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes £ No S

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or 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. (Check one): Yes ¨  No  x

 

Large accelerated filer ¨		Accelerated filer ¨
Non-accelerated filer ¨		Smaller reporting company x
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨ Nox

 

As of February 8, 2012, there were 13,414,789 shares of company’s common stock issued and outstanding.

 

 

 

TABLE OF CONTENTS

 

Cautionary Note on Forward Looking Statements		ii
PART I – FINANCIAL INFORMATION		1
Item 1.	Unaudited Condensed Consolidated Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4(T).	Controls and Procedures	23
PART II – OTHER INFORMATION		25
Item 1.	Legal Proceedings	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	25
Item 4.	Mine Safety Disclosures	25
Item 5.	Other Information	25
Item 6.	Exhibits	25
SIGNATURES		26

 

Unless otherwise provided in this Quarterly Report on Form 10-Q, references to “the Company,” “the Registrant,” “Tongli,” “we,” “us,” and “our” refer to Tongli Pharmaceuticals (USA), Inc. together with its wholly-owned subsidiaries.

 

 

CAUTIONARY NOTE ON FORWARD LOOKING STATEMENTS

 

In addition to historical information, this Quarterly Report on Form 10-Q contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These 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.  We cannot give any guarantee that the plans, intentions or expectations described in the forward looking statements 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 described in the “Risk Factors” section of our Annual Report for the fiscal year ended March 31, 2011 (the “2011 10-K”).  Readers should carefully review such risk factors as well as factors described 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 “guidance,” “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “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 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 Chinese government granted rights to exclusively manufacture or co-manufacture our products;

 

·

the availability of Chinese 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

 

·

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.

 

Readers are cautioned not to place undue reliance on our 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 our forward-looking statements, except as required by law.

 

 

 

PART I 

ITEM 1.    FINANCIAL STATEMENTS

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

		December 31, 2011				March 31,2011
		(Unaudited)
ASSETS
Current assets:
Cash		$	76,306			$	592,671
Accounts Receivable			3,764,118				2,060,773
Inventories			2,669,657				194,052
Prepaid expense and advances			47,132				10,072
Deferred tax assets			51,202				47,566
Contract deposit-current portion			-				1,073,512
Total current assets			6,608,415				3,978,646
Long-term assets:
Property and equipment, net			6,305,050				6,383,717
Land use right, net			4,125,821				4,144,912
Contract deposits-long term			3,463,313				3,359,497
Due from related parties			157,360				-
Total long-term assets			14,051,544				13,888,126
Total assets		$	20,659,959			$	17,866,772
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilties:
Accounts payable		$	123,303			$	756,355
Taxes payables			785,224				834,934
Accrued expenses			143,265				199,474
Total current liabilities			1,051,792				1,790,763
Long-term liabilities:
Due to related parties - long term			-				1,072,071
Stockholders' Equity
Preferred stock, $0.001 par value,authorized 1,000,000 shares; none issued and outstanding			-				-
Common stock, $0.001 par value,authorized 200,000,000 shares issued and outstanding- 13,294,778 and 11,663,207 shares, as of December 31,2011 and March 31,2011 respectively			13,295				11,663
Additional paid-in-capital			8,843,219				8,031,031
Accumulated other comprehensive income			2,292,845				1,704,153
Retained earnings			8,458,808				5,257,091
Total Stockholders' equity			19,608,167				15,003,938
Total liablities and Stockholders' equity		$	20,659,959			$	17,866,772

 

The accompanying notes are an intergral part to the consolidated financial statements

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME AND OTHER COMPREHENSIVE INCOME

(UNAUDITED)

 

		For the Three Months Ended December 31,								For the Nine Months Ended December 31,
		2011				2010				2011				2010
Revenue		$	4,127,532			$	4,402,342			$	13,583,418			$	9,782,220
Cost of sales			2,083,889				2,265,302				7,176,389				5,240,369
Gross Profit			2,043,643				2,137,040				6,407,029				4,541,851
Operating expenses:
General and administrative expenses			216,733				136,468				1,352,135				567,277
Depreciation and amortization expenses			40,517				38,216				216,156				119,324
Selling expenses			53,451				14,982				159,880				42,505
Total operating expenses			310,701				189,666				1,728,171				729,106
Operating income			1,732,942				1,947,374				4,678,858				3,812,745
Other Income (expenses):
Interest expense-related party, net			-				(14,834	)			(27,881	)			(43,280	)
Total other income (expenses)			-				(14,834	)			(27,881	)			(43,280	)
Income before income taxes			1,732,942				1,932,540				4,650,977				3,769,465
Income Taxes			468,896				506,526				1,449,260				1,058,526
Net Income			1,264,046				1,426,014				3,201,717				2,710,939
Other Comprehensive income
Foreign Currency Translation adjustment			110,191				158,601				588,692				402,573
Comprehensive income		$	1,374,237			$	1,584,615			$	3,790,409			$	3,113,512
Basic and diluted income per share		$	0.10			$	0.12			$	0.26			$	0.24
Basic and diluted weighted average shares outstanding			13,252,321				11,654,318				12,325,741				11,500,974

 

The accompanying notes are an integral part to the consolidated financial statements

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 

		For the Nine Months Ended December 31,
		2011				2010
Cash flows from operating activities
Net income		$	3,201,717			$	2,710,939
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			419,622				269,455
Accrued interest- related party			27,881				43,280
Stock issued for services			813,821				117,500
Deferred Tax			(2,143	)			-
Impairment of intangible asset			-				152,401
Changes in operating assets and liabilities:			-
Accounts receivable			(1,623,358	)			(721,922	)
Inventory			(2,445,052	)			(168,110	)
Prepaid expenses and advances			(36,947	)			(599,100	)
Accounts payable			(649,891	)			20,209
Accrued expenses and tax payables			(131,040	)			420,102
Net cash provided by (used in) operating activities			(425,390	)			2,244,754
Cash flows from investing activities
Deposit of land use right			-				(1,778,015	)
Acquistion of property and equipment			(857	)			-
Refund of contract deposit			1,095,681				-
Net cash provided by (used in) investing activities			1,094,824				(1,778,015	)
Cash flows from financing activities
Proceeds from related party loans			-				13,184
Repayement of related party loans			(1,169,990	)			-
Net cash provided by (used in) financing activities			(1,169,990	)			13,184
Effect of exchange rate changes on cash			(15,809	)			10,336
Net increase (decrease) in cash			(516,365	)			490,259
Cash, beginning of the period			592,671				30,066
Cash , end of the period		$	76,306			$	520,325
Supplemental cash flow information
During the period, cash was paid for the following:
Income taxes		$	1,555,613			$	837,626
Interest paid		$				$	-

  

The accompanying notes are an integral part to the cosolidated financial statements

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

1.

ORGANIZATION AND BASIS OF PRESENTATION

 

Tongli Pharmaceuticals (USA), Inc.(the “Company”), through an indirect wholly-owned subsidiary, Harbin Tianmu Pharmaceuticals Co., Ltd. (“Tianmu Pharmaceuticals”), develops, produces and sells a wide variety of pharmaceuticals and healthcare products in the People’s Republic of China (“PRC” or “China”) that are based on traditional Chinese medicine (“TCM”).  In August 2011, the Company formed Harbing Lvnong Plant Ltd. (“Lvnong”) to plant and sell herbs in China. Lvnong is 100% owned by the Company’s indirect wholly owned subsidiary, Heilongjiang Tongli Technology Co., Ltd. (“Tongli Technology”).

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”)for interim financial  information and pursuant to the requirements for reporting on Form 10-Q. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of the management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year or any other periods. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

 

The balance sheet as of March 31, 2011 has been derived from the audited financial statements of the Company at that date, but does not include all of the information and footnotes required by U.S. GAAP for the complete financial statements.

 

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of consolidation

 

The consolidated financial statements include the accounts of: (i) the Company (ii) the Company’s wholly owned subsidiary American Tony Pharmaceuticals, Inc., a Delaware corporation (“American Tony”), (iii) American Tony’s wholly owned subsidiary Tongli Technology, and (iv) Tongli Technology’s wholly owned subsidiaries, Tianmu Pharmaceuticals and Lvnong, each PRC companies.  All significant inter-company accounts and transactions have been eliminated upon consolidation.

 

Uses of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during each reporting period.  Actual results could differ from those estimates.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

Fair Value of Financial Instruments

 

The Company adopted ASC 820, Fair Value Measurements and Disclosures. ASC 820 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, inventory, prepaid expense, accounts payable and other accrued expenses approximate their fair market value based on the short-term maturity of these instruments. The Company did not identify any assets or liabilities that are required to be presented on the consolidated balance sheets at fair value in accordance with ASC 820.

 

Inventory

 

Inventory is stated at the lower of cost, determined using the weighted average cost method, and net realizable value.  Costs include materials, labor and manufacturing overhead.  Net realizable value is the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose.  Management periodically compares the cost of inventory with the market value and an allowance is made for writing down the inventory to its market value, if lower than cost. No allowance for inventory markdown is considered necessary for nine months ended December 31, 2011and 2010.

 

Harvested Chinese herbs inventories are stated at lower of cost or market. Cost of growing herbs includes director labor and material costs accumulated through the balance sheet date.

 

Impairment of Long Lived Assets

 

Long-lived assets, which include property, plant and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the assets.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

The Company accounts for the impairment of long-lived assets in accordance with the guidance of FASB ASC 360-10-20. Long-lived assets are reviewed for impairment when circumstances indicate the carrying value of an asset may not be recoverable.  For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with the asset or group of assets is less than their carrying value.  If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value.  Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable.  Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value. Based on its review, the Company believes that, as of December 31, 2011, there were no impairment of its long-lived assets.

 

Deferred income taxes

 

The Company accounts for income taxes in accordance with FASB ASC 740 “Income Taxes” which requires that deferred tax assets and liabilities be recognized for future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  In addition, ASC 740 requires recognition of future tax benefits, such as carry-forwards, to the extent that realization of such benefits is more likely than not and that a valuation allowance be provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Management reviews this valuation allowance periodically and makes adjustments as warranted.

 

Foreign currency translation

 

Since the Company operates primarily in the PRC, the Company’s functional currency is the Chinese Renminbi (“RMB”).  For financial reporting purposes, RMB has been translated into United States dollars (“USD”) as the reporting currency.  Equity accounts are translated at historical rates. Assets and liabilities are translated at the exchange rate in effect at the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the reporting period. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders' equity as “Accumulated other comprehensive income”. Gains and losses resulting from foreign currency translations are included in accumulated other comprehensive income.

 

2

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

   

Revenue Recognition

 

Revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, and no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as advances from customers. The Company sells primarily to distributors who subsequently sell the merchandise. The agreements with distributors do not provide for the right of return.  Return from distributors has historically been immaterial and accordingly no reserve is deemed necessary as of December 31, 2011 and 2010.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

3.

INVENTORY

 

As of December 31, 2011 and March 31, 2011, inventory consists the following:

  

		December 31, 2011				March 31, 2011
Raw materials		$	2,131,500			$	61,478
Finished goods			436,495				132,574
Growing herbs			101,662				-
Total		$	2,669,657			$	194,052

 

4.

CONTRACT DEPOSIT

 

Contract deposit represents payments under material contracts by which the Company intends to purchase drug formula to be used in the manufacturing and increasing its product lines.

 

As of December 31, 2011 and March 31, 2011, contract deposit consists the following:

 

		December 31, 2011				March 31, 2011
Contract deposit-Lanhai (1)		$	-			$	1,073,512
Contract deposit-Tonghua (2)			3,463,313				3,359,497
			3,463,313				4,433,009
Less: current portion			-				(1,073,512	)
Total		$	3,463,313			$	3,359,497

 

(1)

In September 2008, the Company entered into a Patent Assignment Agreement (the “Lanhai Agreement”) with Harbin Lanhai Biochemical Company Limited (“Lanhai”) under which the Company agreed to acquire a patent related to a product called LanhaiSpirulina Calcium Tablet. Pursuant to the Lanhai Agreement, Lanhai agreed to provide the Company with the product formula as well as the technical support and assistance necessary for the Company to obtain approval for the product by the China State Food & Drug Administration (“SFDA”).  Under the Lanhai Agreement, the Company made a payment of RMB7,030,000 (approximately $1.03 million) in October 2008, representing the entire purchase price for the subject patent. The Company is not obligated to make any subsequent payment. The patent application was accepted by the State Intellectual Property Office of China (“SIPO”) on March 14, 2008 and, if granted, the patent will expire on March 13, 2028 pursuant to PRC patent laws.

 

The term of the Lanhai Agreement is from November 1, 2008 to October 30, 2013. Title to this patent will not be assigned to the Company until the patent assignment is properly recorded with SIPO. The recording of this assignment was yet to be confirmed by SIPO.

 

Based on ASC 805-50-30 “Initial Measurement of Acquisition of Assets Rather Than a Business” and ASC350-30 “General Intangibles Other Than Goodwill”, the payment of RMB7,030,000 for acquiring the patent was recorded as an asset at cost. The payment was originally recorded as a deposit which would be recorded as an intangible asset once the Company obtains title to this patent, which asset will be subsequently amortized over the life of the patent.

 

During 2010, the Company reached an unwritten mutual understanding with Lanhai that if the Company cannot obtain title to the patent before the end of the contract period (i.e., October 30, 2013), the entire payment will be refunded to the Company. Although the Company believes this understanding to be binding on the parties, it was not explicitly stipulated in the Lanhai Agreement or otherwise memorialized.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

On June 17, 2011, the Company entered into a Termination Agreement with Lanhai pursuant to which the Lanhai Agreement was terminated. The parties agreed that, because the patent assignment recording process took too long, the Company will return the LanhaiSpirulina Calcium Tablet product and related intellectual property to Lanhai.  Pursuant to the Termination Agreement, Lanhai agreed to refund the total purchase price of RMB7,030,000 in three installments. The first installment of RMB2,000,000 will be refunded prior to June 30, 2011, the second installment of RMB2,000,000 will be refunded prior to July 30, 2011 and the last installment of RMB3,030,000 will be refunded prior to August 30, 2011. The Termination Agreement also provides that the Company is entitled to initiate litigation against Lanhai if Lanhai fails to fully refund the total purchase price before August 30, 2011. On June 27, 2011, Lanhai refunded the first installment of RMB2,000,000.  The recording of the patent assignment was terminated in June 2011 as well. The second portion of refund of RMB 2,000,000 was received on July 18, 2011. The third portion of refund of RMB 3,030,000 was received on August 2, 2011.

 

(2)

On March 21, 2010, the Company entered into a New Drug Assignment Agreement (the “Tonghua Agreement”) with TonghuaYisheng Pharmaceuticals Company Limited (“Tonghua”) pursuant to which the Company agreed to purchase a new drug candidate, called Nafarelin, from Tonghua for a purchase price of RMB33,000,000 (approximately $4.85 million). The total purchase price is payable in three installments: 33% of the total purchase price (approximately $1.6 million) was paid upon execution of the Tonghua Agreement in March 2010; another 33% (approximately $1.6 million) was paid in March 2011 (although it is required to be paid upon conclusion of third clinical trial for the product pursuant to the terms of the Tonghua Agreement) and the balance is payable upon conclusion of the transfer.

 

Nafarelin is a proposed treatment for endometriosis and prostate cancer. At a minimum, completion of the third phase clinical trail is a pre-condition to receipt of the New Drug Approval Certificate from the SFDA. The SFDA new drug approval procedure is separate and distinct from the patent prosecution procedure. To date, neither Tonghua nor the Company has applied or intend to apply for patent protection for Nafarelin or the formula or process related to Nafarelin. Once Tonghua is granted the New Drug Approval Certificate for Nafarelin, according to pharmaceutical laws of PRC, the Company, as the assignee of the New Drug Approved Certificate, shall receive 4 years of exclusive protection.  As described below, the Company regards such protection period as the appropriate amortization period. The patent protection is irrelevant for purposes of amortization in determining the life of the drug as the Company will not apply for patent protection for Nafarelin.

 

The Company is not be responsible for conducting or paying for any clinical trial and/or research and development in connection with the new drug application for Nafarelin. Pursuant to the Tonghua Agreement, Tonghua shall continue the research, development and clinical trial work for Nafarelin until the SFDA grants the New Drug Approval Certificate and the product is ready to be marketed. Tonghua is listed as the applicant for the SFDA new drug approval process for this product. Once SFDA approval is obtained, the Company will be able to consummate the assignment and enjoy the protection afforded by the New Drug Approval Certificate. In addition, the Company’s ability to commercialize this new product also requires assistance and cooperation from Tonghua, which Tonghua is obligated to provide to us under the Tonghua Agreement.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

 

Under PRC law, the SFDA’s New Drug Approval Certificate grants certain exclusive protections to approved new drugs, meaning that the subject formula may not be manufactured by other parties in China. The exclusive protection periods for the new drugs vary from 4 to 12 years depending on the category of the new drug. Because the Company shall be the beneficiary of the exclusive protection during the applicable period (the so-called “new drug approval period”), upon consummation of the transaction contemplated by the Tonghua Agreement, the Company will regard the protection period as the appropriate amortization period. Based on ASC 805-50-30 “Initial Measurement on Acquisition of Assets Rather Than a Business” and ASC350-30 ”General Intangibles Other Than Goodwill”, the total payment pursuant to the Tonghua Agreement will be recorded as an intangible asset once the Company obtains the SFDA New Drug Approval Certificate and will be amortized over the term of the new drug protection period.

 

Based on a written mutual understanding between the Company and Tonghua, any payments the Company made to Tonghua under the Tonghua Agreement will be refunded if SFDA approval is not abtained for Nafarelin. Such mutual understanding, although the Company believes to be binding, was not explicitly stipulated in the Tonghua Agreement or otherwise memorialized. As such, the first two installment under the Tonghua Agreement was accounted as a deposit and the remaining last installment payment will be also accounted as deposits until the New Drug Approval Certificate is obtained, at which point the total payment will be recorded as intangible asset and amortized over the term of the new drug protection period.

 

The Tonghua Agreement also provides that the Company and Tonghua will compensate one another for all losses incurred by the other party if the purchase is not concluded due to reasons attributable to the offending party.

 

5.

LAND USE RIGHT

 

The executive offices and manufacturing facilities of the Company’s subsidiary Tianmu Pharmaceuticals are located in the Limin Pharmaceutical Technology Park in the City of Harbin, which is the capital of Heilongjiang Province in The People’s Republic of China.  In 2008, Tianmu Pharmaceuticals paid RMB 2.7 million (approximate to $400,000) to local government to obtain a land use right of 50,000 square meters for 50 years for manufacturing purposes. The Company amortizes this land use right on a straight-line basis over 50 years.

 

On December 20, 2010, the Company entered into a contract with a non-affiliated individual to acquire rights to use a parcel of land and fixtures thereon for twenty years (from December 20, 2010 to December 30, 2030) for RMB20 million (approximately $3 million). RMB12 million (equivalent to $1,817,541) was paid upon execution of the contract in December 2010. The balance was required to be paid within 20 days after the conveyance of a list of land and fixtures. Due to the nature of the subject parcel of land, there is no PRC government approval or recording required for the transfer of land use right. The Company paid the outstanding balance under the contract on February 21, 2011 and the transfer was concluded in March 2011. As such, the total contract price was recorded as long-term assets and is amortized over the twenty years use right period.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

In March 2011, the Company entered into a supplemental contract with the same third-party to acquire a nearby fish pond for twenty years with total contract price of RMB 5.5 million (approximate to $0.85 million). The Company will use this fish pond to provide water supply to the planted traditional Chinese medicine. Total amount of this contract was amortized on a straight-line basis over twenty years.

 

As of December 31, 2011 and March 31, 2011, land use rights consist of the following: 

 

		December 31, 2011				March 31, 2011
Land use rights		$	4,439,337			$	4,306,264
Less: Accumulated amortization			(313,516	)			(161,352	)
		$	4,125,821			$	4,144,912

  

The amortization expense for the nine months ended December 31, 2011 and 2010 was $158,148 and $6,233 respectively.

 

6.

DUE TO/(FROM) RELATED PARTIES

 

Due to/(from) related parties consist of the following:

 

		December 31, 2011				March 31, 2011
Harbin Tianmu Real Estate Development Co. Ltd (a)		$	(786,845	)		$	344,899
Chairman of the Company (b)			541,923				541,304
US Hua Sky International Investment LLC (c)			27,727				27,727
Due to a shareholder Yao Yuan (d)			59,835				158,141
Total		$	(157,360	)		$	1,072,071

  

(a)

We obtained an unsecured line of credit in the amount of RMB 20million (approximately $3 million) from Harbin Tianmu Real Estate Development Co., Ltd., an entity owned by our Chairman, Mr. Mingli Yao, in 2008. The loan had a term of five-year and is due on September 30, 2013. The loan bears an interest rate of 7% per annum. The loan was paid in November 2011. The Company extended a loan in the amount of RMB 7million (approximately $1.1 million) to Harbin Tianmu Real Estate Development Co. Ltd. in December 2011. The loan is non-interest bearing and due on demand. During February 2012, RMB 1 million (approximately $158,000) was paid back.

 

(b)

Our wholly owned subsidiary American Tony obtained an unsecured line of credit in the amount of RMB 4,000,000(approximately $600,000) from our Chairman, Mr. Mingli Yao, in January 2011.  The loan had a term of two years and is due on January 09, 2013. The loan bears an interest rate of 7% per annum. We also obtained an unsecured interest free line of credit in the amount of $100,000 from our Chairman, Mr. Mingli Yao, in May 2010.  The loan had a term of two years and is due on May 4, 2012.

 

(c)

We obtained an unsecured interest free loan in the amount of $27,727 from US Hua Sky International Investment LLC, an entity owned by our Chairman, Mr. Mingli Yao, on February 17, 2011. The loan had a term of five years and is due on February 16, 2016.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

(d)

We obtained an unsecured loan in the amount of RMB 1,000,000 (approximately $150,000) from our shareholder and director Ms. Yuan Yao (our Chairman’s daughter) in December 2010. The loan had a term of two years and is due on December 29, 2012. The loan bears an interest rate of 7% per annum.

 

7.

STOCKHOLDERS’ EQUITY

 

Pursuant to an Independent Director Agreement the Company entered into with Mr. Stephen J. Sax on April 14, 2011, the Company granted an award of 100,000 shares of restricted stock of the Company on the date of appointment.  The Company recorded the fair value of $65,000 for these issued shares

 

On April 18, 2011, the Company issued 28,571 common shares to its legal counsel Ellenoff Grossman &   Schole LLP for services rendered. The Company recorded the fair value of $20,000 for these issued shares.

 

On September 22, 2011, the Company issued 1,377,000 common shares to several officers, employees and consultants for their services. 580,000 shares were issued to the officers and directors. The Company recorded the fair value of $688,500 for these issued shares.

 

On November 1, 2011, the Company issued 126,000 common shares to its consultant in China for services rendered. The Company recorded the fair value of $40,320 for these issued shares.

 

8.

TAXES

 

(a)

Corporation income tax (“CIT”)

 

The Company’s Chinese subsidiaries are governed by the Income Tax Law of the People’s Republic of China concerning the private-run enterprises, which are generally subject to tax at a new statutory rate of 25%. As of December 31, 2011, for the Company’s PRC entities remain open for statutory examination by PRC tax authorities.

 

The Company is incorporated in the United States.  It had net operating loss carry forwards for United States income tax purposes amounted to $1,749,943 and $1,359,147 for the nine months ended December 31, 2011 and the year ended March 31, 2011 respectively, which may be available to reduce future years' taxable income in the United States. These carry forwards will expire between 2028 and 2030. Management doesn't expect to remit any of its net income back to the United States in the foreseeable future.  Accordingly, the Company recorded a full valuation allowance as of December, 2011 and 2010.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED) 

 

The reconciliation of income tax expense at the U.S. statutory rate at 35% in 2011 and 2010, to the Company’s effective tax is as follows: 

 

		For the Nine Months Ended December 31,
		2011				2010
U.S. Statutory income tax rate		$	1,631,646			$	1,370,431
Taxable difference between U.S. and China			(570,114	)			(423,394	)
Expenses not deductable for tax purpose in China			10,080				-
Change in valuation allowance			377,648				111,489
Effective income tax		$	1,449,260			$	1,058,526

 

The provisions for income taxes for the nine months ended December 31, 2011 and 2010 are summarized as follows:

 

		For the Nine Months Ended December 31,
		2011				2010
Current		$	1,451,960			$	1,095,039
Deferred-China			(2,700	)			(36,513	)
Total		$	1,449,260			$	1,058,526

 

The components of income (loss) before income taxes from China and U.S. for the nine months ended December 31, 2011 and 2010 were as follows:

 

		For the Nine Months Ended December 31,
		2011				2010
China		$	5,041,773			$	4,087,883
United States			(390,796	)			(318,418	)
Income before income tax		$	4,650,977			$	3,769,465

 

(b)

Value added tax (“VAT”)

 

Enterprises or individuals who sell commodities, engage in repair and maintenance or import or export goods in the PRC are subject to a value added tax in accordance with the PRC laws. The value added tax standard rate is 17% of the gross sales price. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on the sales of the finished products.

 

(c)

Other taxes

  

The Company is also subject to 5% of business tax, 7% of City Construction Tax and 4% of Education Fees based on VAT.

 

9.

COMMITMENTS AND CONTINGENCIES

 

On March 21, 2010, the Company signed a patent purchase agreement with an outside party, Tonghua Yisheng Pharmaceuticals Company Limited, for purchase of a new drug. Total contract price for this patent transaction amounted to RMB 33,000,000 (approximate to USD 5 million) to be paid in three installments. As of March 31, 2011, the Company has paid the first two installments of RMB 22,000,000 (equivalent to USD 3 million) to Tonghua Yisheng Pharmaceuticals Company Limited and is still liable to pay remaining installment in the near future.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

 

On August 31, the Company renewed the lease agreement for the Company’s New York office which will have a rental arrangement of $3,856 per month. Pursuant to the new lease agreement, the term of the lease is from December 2011 to November 2012. The office rental for November 2012 was waived. As of December 31, 2011, the Company was obligated to pay $38,560 under the lease agreement.

 

10.

CONCENTRATION OF CREDIT RISKS

 

During the three months ended December 31, 2011, 15% of sales were generated from one major distributor.

 

For the three months ended December 31, 2011, four products manufactured by the Company, including Panax and Radix Polygoni Capsule, Antihyperlipidemics, Calcium Gluconate Oral Liquid, and Anti-bacterial Mouthwash, represented 44.14%, 18.23%, 16.30% , and 14.38% respectively of the total sales. as compared to three products manufactured by the Company, including Antihyperlipidemics, Anti-bacterial Mouthwash, and Calcium Gluconate Oral Liquid represented 23.98%, 18.36%, and 17.95%, respectively of total sales for the three months ended December 31, 2010.

 

During the nine months ended December 31, 2011, no major distributors accounted for more than 10% of the Company’s total sales.

 

For the nine months ended December 31, 2011, four products manufactured by the Company, including Panax and Radix Polygoni Capsule, Antihyperlipidemics, Calcium Gluconate Oral Liquid, and Anti-bacterial Mouthwash, represented 45.10%, 20.25%, 14.68% , and 14.66% respectively of the total sales. For the nine months ended December 31, 2010, the Company’s five major products Antihyperlipidemics, Calcium Gluconate Oral Liquid, Anti-bacterial Mouthwash, Panax and Radix Polygoni Capsule, and Yan Li Xiao Capsule, represented 24.85%, 21.37%, 20.56%, 15.32% and 11.25%, respectively, of the total sales.

 

11.

VULNERABILITY DUE TO OPERATIONS IN PRC

 

The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than thirty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.

 

Substantially all of the Company’s businesses are transacted in RMB, which is not freely convertible. The Peoples Bank of China or other banks are authorized to buy and sell foreign currencies at the exchange rates quoted by the Peoples Bank of China. Approval of foreign currency payments by the Peoples Bank of China or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.

 

 

TONGLI PHARMACEUTICALS (USA), INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010

(UNAUDITED)

  

Since the Company has its primary operations in the PRC, the majority of its revenues will be settled in RMB, not U.S. Dollars. Due to certain restrictions on currency exchanges that exist in the PRC, the Company’s ability to use revenue generated in RMB to pay any dividend payments to its shareholders outside of China may be limited.

 

The Company’s business depends on maintaining licenses of its current products from SFDA. Obtaining licenses for additional products can be expensive and is usually time consuming. Failure to obtain the required licenses can cause the Company’s business plan to be delayed. If the delays prevent the Company from generating positive cash flows or introducing a significant number of products, there will be a material adverse effect on the Company.

 

12.

SUBSEQUENT EVENTS

 

The Company has evaluated events after the date of these financial statements through the date that these financial statements were issued and no subsequent event is required to be disclosed.

 

 

Item 2. Management’s Discussion and Analysis of Financial Conditions of Operations.

 

The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the financial statements of Tongli Pharmaceuticals (USA) Inc. for the three and six months ended December 31, 2011 and 2010, 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 above.

 

Company Overview

 

Tongli Pharmaceuticals (USA), Inc. (the “Company”), owns all of the outstanding capital stock of American Tony Pharmaceutical, Inc., a Delaware corporation (“American Tony”).

 

American Tony is a holding company.  In February 2007, American Tony acquired, through its wholly owned subsidiary, Heilongjiang Tongli Technology Co., Ltd., a PRC company (“Tongli Technology”), all of the registered capital of Harbin Tianmu Pharmaceuticals Co., Ltd. (“Tianmu Pharmaceuticals”), a corporation organized under the laws of the PRC on November 26, 1999.  Tianmu Pharmaceuticals is our principal operating subsidiary and is engaged in developing, manufacturing and marketing pharmaceutical and health care products that incorporate elements of Chinese Traditional Medicine with elements of western medicine.  Our research and development activities have been carried out at relatively low cost because they have been carried out by our in house research and development team and, in the past, in concert with a number of research institutes and universities, including the Jilin Research Institute of Chinese Traditional Medicine, the Sichuan Research Institute of Chinese Medicine, the Heilongjiang Institute of Chinese Traditional Medicine, the Chemistry Department of Tsinghua University, and the R&D Center of Harbin Medical University.

 

In August 2011, we formed HarbingLvnong Plant Ltd. (“Lvnong”) to plant and sell herbs in China. Lvnong is 100% owned by Tongli Technology.

 

In 2005, Tianmu Pharmaceuticals obtained the GMP certificate (Good Manufacturing Practices for Pharmaceutical Products), and Drug Register License and Drug Production Certificate from the SFDA for its 10 products. The Company’s main products include cholesterol reduction pill, mouthwash, anti-inflammatory tablet and calcium supplement. These products are sold through distributors or directly to customers; no service is required of the Company after sales are made.  The Company’s primary customers are drug stores and hospitals located in China.

 

Development and Strategy

 

For the nine months ended December 31, 2011, we continued the execution of our product channel expansion strategy that resulted in increased market penetration of our products and expanded revenue growth.

 

Panax and Radix Polygoni Capsule

 

Revenue growth for the year was aided in October, 2010, when we began to manufacture and sell our new product Panax and Radix Polygoni Capsule. This new product has helped us to generate about 45.1% of our total sales for nine months ended December 31, 2011. We believe that this new product have great market potential and will continue to generate sustainable income for our company in the foreseeable future.

 

 

Nafarelin

 

On March 21, 2010, we entered a New Drug Assignment Agreement with a third party TonghuaYisheng Pharmaceuticals Company Limited (“Tonghua”) to purchase a new drug candidate, called Nafarelin, which we believe has great market potential. Total consideration for this patent transaction amounted to RMB 33,000,000 (approximate to USD 4.85 million) payable in three installments. We paid the first installment of RMB 11,000,000 (equivalent to USD 1.6 million) to Tonghua in March 2010 upon execution of the patent purchase agreement. The second installment of RMB 11,000,000 has been paid to Tonghua during the fourth quarter of 2011. As of December 31, 2011, we have paid total of RMB 22,000,000 to Tonghua on this new drug. The third installment payment is expected to be paid to Tonghua upon completion of the clinic test and the application for Certificate of the new drug is filed with relevant government authority, which is expected to occur in calendar year 2012.

 

Our ability to conclude this purchase and ultimately commercialize this product requires additional assistance from the seller and obtaining government approvals, including the approvals from the SFDA. Nafarelin is a proposed treatment for endometriosis and prostate cancer. At a minimum, completion of the third phase clinical trail is a pre-condition to receipt of the New Drug Approval Certificate from the SFDA. The SFDA new drug approval procedure is separate and distinct from the patent prosecution procedure. To date, neither Tonghua nor we have applied or intend to apply for patent protection for Nafarelin or the formula or process related to Nafarelin. Once Tonghua is granted the New Drug Approval Certificate for Nafarelin, according to pharmaceutical laws of PRC, we, as the assignee of the New Drug Approved Certificate, shall receive 4 years of exclusive protection. As described below, we regard such protection period as the appropriate amortization period. The patent protection is irrelevant for purposes of amortization in determining the life of the drug as we will not apply for patent protection for Nafarelin.

 

We shall not be responsible for conducting or paying for any clinical trial and/or research and development in connection with the new drug application for Nafarelin. Pursuant to the Tonghua Agreement, Tonghua shall continue the research, development and clinical trial work for Nafarelin until the SFDA grants the New Drug Approval Certificate and the product is ready to be marketed. Tonghua is listed as the applicant for the SFDA new drug approval process for this product. Once SFDA approval is obtained, we will be able to consummate the assignment and enjoy the protection afforded by the New Drug Approval Certificate. In addition, our ability to commercialize this new product also requires assistance and cooperation from Tonghua, which Tonghua is obligated to provide to us under the Tonghua Agreement.

 

Under PRC law, the SFDA’s New Drug Approval Certificate grants certain exclusive protections to approved new drugs, meaning that the subject formula may not be manufactured by other parties in China. The exclusive protection periods for the new drugs vary from 4 to 12 years depending on the category of the new drug. Because we shall be the beneficiary of the exclusive protection during the applicable period (the so-called “new drug approval period”), upon consummation of the transaction contemplated by the Tonghua Agreement, we will regard the protection period as the appropriate amortization period. Based on ASC 805-50-30 “Initial Measurement on Acquisition of Assets Rather Than a Business” and ASC350-30 “General Intangibles Other Than Goodwill”, the total payment pursuant to the Tonghua Agreement will be recorded as an intangible asset once we obtain the SFDA New Drug Approval Certificate and will be amortized over the term of the new drug protection period.

 

 

Based on a written mutual understanding between us and Tonghua, any payments we made to Tonghua under the Tonghua Agreement will be refunded if SFDA approval is not abtained for Nafarelin. Such mutual understanding, although we believed to be binding, was not explicitly stipulated in the Tonghua Agreement or otherwise memorialized. As such, the first installment under the TonghuaAgreement was accounted as a deposit and the remaining two installment payments will be also accounted as deposits until the New Drug Approval Certificate is obtained, at which point the total payment will be recorded as intangible asset and amortized over the term of the new drug protection period.

 

New Land Parcel

 

On December 20, 2010, we entered into a contract with third party to acquire the right to use a parcel of land for twenty years (from December 20, 2010 to December 30, 2030) with a total contract price of RMB 20 million (approximate to $3 million).  We are using this parcel of land to plant the traditional Chinese medicine. We paid the contract price in two installments. The first installment of RMB 12 million (equivalent to $1,817,541) was paid in December 2010 and the second installment payment of RMB 8 million (equivalent to $1,211,694) was paid to the third party upon closing of the transaction on February 21, 2011. In addition, In March 2011, we entered into a supplemental contract with the same third-party to acquire the right to use a nearby fish pond for twenty years with total contract price of RMB 5.5 million (approximate to $0.85 million). We will use this fish pond to provide water supply to the planted traditional Chinese medicine.

 

Management plans to continue to emphasize on expanding and enhancing marketing and sales in the fiscal year 2012 and beyond.  Part of this strategy involves increasing and improving marketing and sales activities to enhance the market position of our key products and to increase the sales of other products by expanding our sales force, solidifying our distribution network and expanding market segment coverage, and increasing marketing and promotional activities. Management also plans to selectively pursue strategic acquisition opportunities to further consolidate our resources and expand our market coverage. We believe that such initiatives will provide effective means to broaden our product lines, expand our market coverage and complement our research and development capabilities. As of the date of this report, we are not engaged in any material discussions regarding any potential acquisition.

 

Management believes that our emphasis on further commercializing and broadening our product lines, enhanced sales and marketing efforts shall continue to yield increases in revenue in fiscal 2012 and beyond.

 

Discussion of Operating Results

 

Operating results for the three months ended December 31, 2011 and 2010

 

Revenues, cost of sales and gross profit

 

Revenues decreased 6.2% to approximately $4.1 million for the three months ended December 31, 2011 from approximately $4.4 million for the three months ended December 31, 2010.  The $274,810 decrease in revenue was primarily attributable to decrease in orders from customers. We generated $1.8 million sales from the new product Panax and Radix Polygoni Capsule.  For the three months ended December 31, 2011, about 44.1% of our revenue was generated by our recently manufactured new products Panax and Radix Polygoni Capsule, which broadened our product offerings and helped to increase our sales. In addition, 18.2%, 16.3% and 14.4% of our sales were generated from sales of our products Antihyperlipidemics, Calcium Gluconate Oral Liquid and Anti-bacterial Mouthwash, respectively. The decrease in our sales was partly offset by the foreign currency exchange rate fluctuation during the year. Our reporting currency is US dollar but our functional currency is Chinese RMB. The average translation rates applied to the income statements accounts fluctuated from USD$1: RMB 6.7413 for the three months ended December 31, 2010 to USD$1: RMB 6.4161 for the three months ended December 31, 2011, representing a 5% decrease. Our sales revenue increased by approximately $206,376 as a result of the foreign currency translation rate fluctuation.

 

 

The Company had distribution contracts with various distributors during the three months ended December 31, 2011and 2010 to sell its products in China.  The Company manufactures its products and ships the products to distributors based on the sales order from distributors each month.  Revenue is recognized at the time of the shipment.  No return is allowed, unless there is a quality problem.  During the three months ended December 31, 2011 and 2010, there were no returns from distributors or customers.  Distributors normally make payments upon receiving the products; however, in some cases, the Company may extend credit to certain creditable distributors for certain period until the next shipment.

 

Management expects that our emphasis on broadening our product pipeline coupled with our continued sales channel expansions, along with our enhanced sales and marketing efforts will continue to yield increases in revenue for fiscal year 2012 and beyond.

 

Cost of sales was approximately $2.08 million for the three months ended December 31, 2011 compared to $2.26 million for the three months ended December 31, 2010. The $181,413 decrease in cost of sales was mainly attributable to the decrease in sales in the corresponding period. Cost of sales as a percentage of revenue decreased from 51.5% to 50.5% as compared to the prior comparative period.

 

Gross profit was approximately $2.04 million for the three months ended December 31, 2011 compared to $2.14 million for the three months ended December 31, 2010, a decrease of $93,397 or 4.4% due to decreased sales of our products Antihyperlipidemics, Calcium Gluconate Oral Liquid and Anti-bacterial Mouthwash. The gross profit as a percent of revenues for the three months ended December 31, 2011 increased to 49.5% compared to 48.5% in the prior comparative period, remaining on approximately the same level. We expect our gross profit margin will remain in its current level with slight growth in the future.

 

Operating expenses

 

Total operating expenses increased by approximately $121,035 for the three months ended December 31, 2011 from $189,666 for the three months ended December 31, 2010 to $310,701 for the three months ended December 31, 2011, representing a 63.8% increase. The increase in our total operating expense for the three months ended December 31, 2011 as compared to the prior comparative period was primarily related to increase in our marketing and advertisement expenses and additional amortization expenses of land use right.

 

Interest expense

 

Interest expense was $0 for the three months ended December 31, 2011 compared to interest expense of $14,834 for the three months ended December 31, 2010. Interest expense for the period was only related to the loans to related parties.

 

Income taxes

 

All of our net income for the three months ended December 31, 2011 was from Tianmu Pharmaceuticals, which conducts substantially of our operation in the PRC. Our Chinese subsidiaries are governed by the Income Tax Law of the PRC concerning the private-run enterprises, which are generally subject to tax at a new statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.

 

 

Income tax expense of $468,869 for three months ended December 31, 2011, a decrease of $37,630 or 7.4% from $506,526 for the same period ended December 31, 2010, was attributed to the decreased pre-tax income primarily derived from Tianmu Pharmaceutical.

 

Net income

 

As a result of the above factors, we reported net income of $1,264,046 for the three months ended December 31, 2011, an decrease of $161,968, or 11.4%, as compared to the net income of $1,426,014 for the three months ended December 31, 2010.

 

For the three months ended December 31, 2011, the decrease in our net income was primarily due to our decrease sales.

 

Operating results for the nine months ended December 31, 2011 and 2010

 

Revenues, cost of sales and gross profit

 

Revenues increased 38.9% to approximately $13.6million for the nine months ended December 31, 2011 from approximately $9.8 million for the nine months ended December 31, 2010.  The $3.8 million increase was primarily attributable to increased recognition of our products in the market.  We generated $6.1 million sales from the new product Panax and Radix Polygoni Capsule, a $4.55million increase from the same prior period. For the nine months ended December 31, 2011, about 45.1% of our revenue was generated by our recently manufactured new products Panax and Radix Polygoni Capsule, which broadened our product offerings and helped to increase our sales. In addition, 14.7%, 14.7% and 20.3% of our sales were generated from sales of our products Antihyperlipidemics, Calcium Gluconate Oral Liquid and Anti-bacterial Mouthwash, respectively. The increase in our sales revenue was also affected by the foreign currency exchange rate fluctuation during the year. Our reporting currency is US dollar but our functional currency is Chinese RMB. The average translation rates applied to the income statements accounts fluctuated from USD$1: RMB 6.7413 for the nine months ended December 31, 2010 to USD$1: RMB 6.4161 for the nine months ended December 31, 2011, representing a 5% decrease. As a result, approximately $679,171 increase in our sales revenue was resulted from the foreign currency translation rate fluctuation.

 

The Company had distribution contracts with various distributors during the nine months ended December 31, 2011 to sell its products in China.  The Company manufactures its products and ships the products to distributors based on the sales order from distributors each month.  Revenue is recognized at the time of the shipment.  No return is allowed, unless there is a quality problem.  During the nine months ended December 31, 2011, there were no returns from distributors or customers.  Distributors normally make payments upon receiving the products; however, in some cases, the Company may extend credit to certain creditable distributors for certain period until the next shipment.

 

Management expects that our emphasis on broadening our product pipeline coupled with our continued sales channel expansions, along with our enhanced sales and marketing efforts will result in increases in revenue for fiscal year 2012 and beyond.

 

Cost of sales was approximately $7.2 million for the nine months ended December 31, 2011 compared to $5.2 million for the nine months ended December 31, 2010. The $1.9 million increase in cost of sales was mainly attributable to the increased manufacturing costs of our major products associated with increased sales. Cost of sales as a percentage of revenue decreased from 53.6% to 52.8% as compared to the prior comparative period.

 

 

Gross profit was approximately $6.4 million for the nine months ended December 31, 2011 compared to $4.5 million for the nine months ended December 31, 2010, an increase of $1.86 million or 41.1% due to increased sales of our new products. The gross profit as a percent of revenues for the nine months ended December 31, 2011 increased to 47.2% compared to 46.4% in the prior comparative period mainly due to increased sales of our major products. We expect our gross profit margin will remain in its current level with slight growth in the future.

 

Operating expenses

 

Total operating expenses increased by approximately $999,065 for the nine months ended December 31, 2011 from $729,106 for the nine months ended December 31, 2010 to $1,728,171 the nine months ended December 31, 2011, representing a 137% increase. The increase in our total operating expense for the nine months ended December 31, 2011 as compared to the prior comparative period was primarily due to increase expenses in stock-based compensation expenses, amortization expenses and sales commission.

 

Interest expense

 

Interest expense was $27,881 for the nine months ended December 31, 2011 compared to $43,280 for the nine months ended December 31, 2010. Interest income for the period was only related to the loans to related parties.

 

Income taxes

 

All of our net income for the nine months ended December 31, 2011 was from Tianmu Pharmaceuticals, which conducts substantially of our operation in the PRC. Our Chinese subsidiaries are governed by the Income Tax Law of the PRC concerning the private-run enterprises, which are generally subject to tax at a new statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.

 

Income tax expense of $1,449,260 for the nine months ended December 31, 2011, an increase of $390,734 or 36.9% from December 31, 2010, was attributed to the increased pre-tax income primarily derived from Tianmu Pharmaceutical.

 

Net income

 

As a result of the above factors, we reported net income of $3.2 million for the nine months ended December 31, 2011, an increase of $490,778, or 18.1%, as compared to the net income of approximately $2.7 million for the nine months ended December 31, 2010.

 

For the nine months ended December 31, 2011, the increase in our net income was primarily due to our increased revenue and improved gross margin.

 

Other comprehensive income

 

We operate primarily in the PRC and the functional currency of our operating subsidiary is the Chinese Renminbi (“RMB”).  The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.  No representation is intended to imply that the Renminbi amounts could have been, or could be, converted, realized or settled into USD at the rate on December 31, 2011 or at any other rate.

 

 

The value of RMB against U.S. dollar may fluctuate and is affected by changes in political and economic conditions. Our revenues, costs and financial assets are mostly dominated in RMB while our reporting currency is the U.S. dollar. Accordingly, this may result in gains or losses from currency translation on our financial statements.

 

Translation adjustments resulting from this process amounted to a gain of $588,692 and $402,573 as of December 31, 2011 and 2010, respectively.  The balance sheet amounts with the exception of equity at December 31, 2011 were translated at 6.3523 RMB to 1.00 USD as compared to 6.5918RMB to 1.00 USD at December 31, 2010. The equity accounts were stated at their historical rate. The average translation rates applied to the income statements accounts for the years ended December 31, 2011 and 2010 were 6.4161 RMB and 6.7413 RMB, respectively.

 

Liquidity and Capital Resources

 

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. We have historically financed our operation and capital expenditures through cash from operations as well as loans from the members of our management group and an entity owned by our Chairman. As of the date of this report, we do not have any outstanding bank loans, though we believe we have access to short-term bank loans with local banks in China.

 

We obtained an unsecured line of credit in the amount of RMB 20 million (approximately $3 million) from Harbin Tianmu Real Estate Development Co., Ltd., an entity owned by our Chairman, Mr. Mingli Yao, in 2008. The loan had a term of five-year and is due on September 30, 2013. The loan bears an interest rate of 7% per annum. The loan was repaid in November 2011. The Company extended a loan in the amount of RMB 7million (approximately $1.1 million) to Harbin Tianmu Real Estate Development Co. Ltd in December 2011. The loan is non-interest bearing and due on demand. During February 2012, RMB 1,000,000 (approximately $158,000) was paid back.

 

Our wholly owned subsidiary American Tony obtained an unsecured line of credit in the amount of RMB 4,000,000 (approximately $590,000) from our Chairman, Mr. Mingli Yao, in January 2011.  The loan had a term of two years and is due on January 9, 2013. The loan bears an interest rate of 7% per annum.

 

We obtained an unsecured interest free line of credit in the amount of $100,000 from our Chairman, Mr. Mingli Yao, in May 2010.  The loan has a term of two years and is due on May 4, 2012.

 

We obtained an unsecured interest free loan in the amount of $27,727 from US Hua Sky International Investment LLC, an entity owned by our Chairman, Mr. Mingli Yao, in February 2011.  The loan had a term of five years and is due February 16, 2016.  

 

We obtained an unsecured loan in the amount of RMB 1,000,000 (approximately $149,000) from our shareholder and director Ms. Yuan Yao (our Chairman’s daughter) in December 2010.  The loan had a term of two years and is due on December 29, 2012. The loan bears an interest rate of 7% per annum. The Company has paid RMB 1 million back to Ms. Yao Yuan on June 28, 2011.

 

The net outstanding balance of the loans from related parties included interest as of December 31, 2011 was $157,360. During February 2012, RMB 1,000,000 (approximately $158,000) was paid to the Company.

 

 

We plan to fund operations and capital expenditures including without limitation the payments to Tonghua under the New Drug Assignment Agreement with cash from operations, as well as loans from major shareholders and management members and their affiliates.  We might also pursue sources additional financing in the form of debt, equity or convertible security offerings. There can be no assurance that we will be able to obtain such additional financing at acceptable terms to us, or at all.

 

Total current assets increased to approximately $6.6 million as of December 31, 2011 as compared to $4.0 million at March 31, 2011.  The primary changes in our current assets during this period were from changes in cash, accounts receivable, inventory and prepaid expenses. The decrease in cash from $592,671 at March 31, 2011 to $76,306 at December 31, 2011 was because we purchased more inventories. The increase of accounts receivables from $2,060,773 at March 31, 2011 to $3,764,118 at December 31, 2011 was due to increased credit sales. The increase of inventory from $194,025 at March 31, 2011 to $2,669,657 at December 31, 2011 was due to increased raw materials purchased for increased projected sales.

 

Our current liabilities as of December 31, 2011 was approximately $1.05 million as compared to $1.79 million at March 31, 2011.The decrease in our current liabilities during this period were mainly from the decrease in accounts payable and accrued expenses. 

 

The growth of our company will require additional debt and/or equity financing.  Currently we have budgeted $3.5 million for capital improvements. We intend to pursue additional debt financing which could be secured by our property and equipment and approach international equity markets for additional debt and/or equity financing.  To date we have no commitment from any source for the funds we require.

 

Discussion of Cash Flow

 

Operating activities

 

Cash flows used in operating activities for the nine months ended December 31, 2011 amounted to $425,390, which consists of our net income of $3,201,717, adds back noncash adjustments of $1,259,181 (including depreciation and amortization of $419,622, accrued interest expense on related party loan of $27,881, stock issued for services of $813,821 and deferred tax asset of $2,143) and offset by net changes in operating assets and liabilities, primarily including increase of accounts receivable of $1,623,358 which represented the temporarily uncollected amount from our increased credit sales during the year, an increase in inventory of 2,445,052 to for increased projected sales.

 

Investing activities

 

Net cash provided by investing activities for the nine months ended December 31, 2011 amounted to $1,094,824 which consists of repayment of contract deposit from the termination agreement with Lanhai and acquisition of property and equipments.

 

Financing activities

 

Cash flows used in by financing activities amounted to $1,169,990 for the nine months ended December 31, 2011, which consists of repayment of related party loan by the same amount.

 

 

Off-Balance Sheet Arrangements

 

As of the date of this report, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have: (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

 

Inflation

 

Inflation has not had a material impact on our business and we do not expect inflation to have a material impact on our business in the near future.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 4T.  CONTROLS AND PROCEDURES

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended ( the “Exchange Act”)  is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Evaluation of Disclosure Controls and Procedures.

 

As of December 31, 2011, the end of the fiscal quarter covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not operating effectively as of December 31, 2011. Our disclosure controls and procedures were not effective because of certain “material weaknesses” described in the “Management’s Annual Report on Internal Control over Financial Reporting” section in Item 9A of our annual report for the fiscal year ended March 31, 2011. As of December 31, 2011, we had not completed the remediation of these material weaknesses.

 

Limitations on the Effectiveness of Disclosure Controls.  

 

Readers are cautioned that our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error.  An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any control design will succeed in achieving its stated goals under all potential future conditions.

   

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the third quarter of 2011 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting, except as disclosed above

 

 

PART II - OTHER INFORMATION

 

Item 1.     Legal Proceedings

 

From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. We are currently not aware of any such legal proceedings or claims that will have, individually or in the aggregate, a material adverse affect on our business, financial condition or operating results. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm business.

 

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.     Defaults Upon Senior Securities

 

None.

 

Item 4.     Mine Safety Disclosures

 

Not applicable.

 

Item 5.     Other Information

 

None.

 

Item 6.     Exhibits

 

(a)  Exhibits

 

Exhibit No.		Description
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS   **		XBRL Instance Document
101.SCH   **		XBRL Taxonomy Extension Schema Document
101.CAL   **		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   **		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   **		XBRL Taxonomy Extension Label Linkbase Document
101.PRE   **		XBRL Taxonomy Extension Presentation Linkbase Document

 

*          Filed herewith.

**     XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 

SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	Tongli Pharmaceuticals (USA), Inc.
February 14, 2012	By:	/s/ Mingli Yao
		Mingli Yao Chief Executive Officer (Principal Executive Officer)
February 14, 2012	By:	/s/ Li Li
		Li Li Chief Financial Officer (Principal Accounting Officer)