China Pharmaceuticals Inc - FORM 10-Q

Attached files

file	filename
EX-31.2 - EXHIBIT 31.2 - China Pharmaceuticals Inc	ex312.htm
EX-31.1 - EXHIBIT 31.1 - China Pharmaceuticals Inc	ex311.htm
EXCEL - IDEA: XBRL DOCUMENT - China Pharmaceuticals Inc	Financial_Report.xls
EX-32.1 - EXHIBIT 32.1 - China Pharmaceuticals Inc	ex321.htm
EX-32.2 - EXHIBIT 32.2 - China Pharmaceuticals Inc	ex322.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number: 000-52763

CHINA PHARMACEUTICALS, INC.

______________________________________________________

(Exact name of small business issuer as specified in its charter)

Nevada		20-2638087
(State or other jurisdiction of incorporation or organization)		(IRS Employer identification No.)

24th Floor, Building A, Zhengxin Mansion

No. 5 of 1st Gaoxin Rd, Hi-Tech Development Zone

Xi’an City, People’s Republic of China 710075

(Address of principal executive offices)

(86) 29-8406-7215

(Registrant’s telephone number, including area code)

Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 o

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 x No o

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)	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 o No x

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Check whether the registrant filed all documents and reports required to be filed by Section l2, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes o No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 75,237,972 shares of common stock, $0.001 par value, were outstanding as of May 18, 2012.

TABLE OF CONTENTS

		Page
	PART I
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
	PART II
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.	Defaults Upon Senior Securities	28
Item 4.	Mine Safety Disclosures	28
Item 5.	Other Information	28
Item 6.	Exhibits	28
SIGNATURES		29

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CHINA PHARMACEUTICAL INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2012 and DECEMBER 31, 2011


	Notes	2012 (Unaudited)		2011
ASSETS

CURRENT ASSETS
Cash and cash equivalents	2	$	16,727,962	$	16,947,343
Accounts receivable, net of doubtful accounts of $853,620 and $897,765 at March 31, 2012 and December 31, 2011, respectively	2		5,449,966		5,150,061
Inventory	2		159,779		193,199
Deposits and other receivables			81,815		83,460
Income tax receivable			336,593		343,742
Deferred tax asset	9		128,043		134,665

Total current assets			22,884,158		22,852,470

NONCURRENT ASSETS
Prepayment for patents	3		3,971,848		3,967,687
Property and equipment, net	2		12,369,927		12,537,315
Construction in progress	4		3,145,703		2,793,252
Intangible assets	2		8,391,489		8,522,566
Deferred tax asset	9		455,169		454,692

Total noncurrent assets			28,334,136		28,275,512

TOTAL ASSETS		$	51,218,294	$	51,127,982


LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable		$	651,386	$	217,613
Accrued liabilities and other payables	5		1,324,163		1,467,944
Value-added and other tax payable			164,587		14,229
Due to shareholders	6		650,100		650,100

Total current liabilities			2,790,236		2,349,886

CONTINGENCIES AND COMMITMENT

STOCKHOLDERS' EQUITY
Common stock, par value, $0.001 per share; 150,000,000 shares authorized, 75,237,972 shares issued and outstanding			75,238		75,238
Paid in capital			16,231,557		16,231,557
Statutory reserve	12		3,274,593		3,274,593
Accumulated other comprehensive income			5,982,646		5,931,371
Retained earnings			22,864,024		23,265,337

Total stockholders' equity			48,428,058		48,778,096

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	51,218,294	$	51,127,982

CHINA PHARMACEUTICAL INC.
CONSOLIDATED STATEMENTS OF OPERATION AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED MARCH 31, 2012 and 2011
(UNAUDITED)

	Notes	2012			2011

Net sales		$	1,580,229		$	7,687,217

Cost of goods sold			812,869			3,367,530

Gross profit			767,360			4,319,687

Operating expenses
Selling, general and administrative expenses			1,220,251			1,255,868
(Recovery) / reserve of bad debt allowance			(44,993	)		(280,503	)

Total operating expenses			1,175,258			975,365

(Loss) income from operations			(407,898	)		3,344,322

Non-operating income (expenses)
Interest income			20,885			9,888
Financial expense			(56	)		(342	)
Other expense			-			(1,651	)

Total non-operating income, net			20,829			7,895

(Loss) income before income tax			(387,069	)		3,352,217

Income tax expense	10		14,243			464,204

Net (Loss) income			(401,312	)		2,888,013

Other comprehensive item
Foreign currency translation			51,275			470,668

Comprehensive (loss) income		$	(350,037	)	$	3,358,681

Weighted average common shares outstanding
Basic	2		75,237,972			68,397,972
	2
Diluted			75,237,972			70,668,240

Basic (loss) earnings per share	2	$	(0.01	)	$	0.04

Diluted (loss) earnings per share *	2	$	(0.01	)	$	0.04


* For the purpose of calculating diluted earnings per share, the warrants issued was excluded due to anti-dilution for the three months ended March 31, 2012.

CHINA PHARMACEUTICAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE ENDED MARCH 31, 2012 and 2011
(UNAUDITED)

		2012			2011

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	(401,312	)	$	2,888,013
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision of bad debt allowance			(44,993	)		(280,503	)
Changes in deferred tax			6,749			-
Loss on assets disposed			-			1,651
Depreciation and amortization			319,987			392,271
(Increase) decrease in current assets:
Accounts receivable			(248,900	)		661,349
Inventory			33,552			680,909
Deposits and other receivables			1,728			230,750
Trade deposit paid			-			(56,443	)
Increase (decrease) in current liabilities:
Accounts payable			432,644			39,115
Accrued liabilities and other payables			(144,841	)		44,872
Taxes payable			157,523			110,982

Net cash provided by operating activities			112,137			4,712,966

CASH FLOWS FROM INVESTING ACTIVITIES:
	Construction in progress		(348,797	)		-

Net cash used in investing activities			(348,797	)		-

EFFECT OF EXCHANGE RATE CHANGE ON CASH & CASH EQUIVALENTS			17,278			66,996

NET INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS			(219,381	)		4,779,962

CASH & CASH EQUIVALENTS, BEGINNING OF PERIOD			16,947,343			4,729,149

CASH & CASH EQUIVALENTS, END OF PERIOD		$	16,727,962		$	9,509,111


Supplemental Cash flow data:
Income tax paid		$	39,520		$	412,689
Interest paid		$	-		$	-

CHINA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012 (UNAUDITED) AND DECEMBER 31, 2011

Note 1 - ORGANIZATION

China Pharmaceuticals, Inc. (“the Company”), formerly named Allstar Restaurants, was incorporated in the United States in Nevada on December 22, 2004. China Qinba Pharmaceuticals, Inc. (“China Qinba”), a wholly-owned subsidiary of the Company, was incorporated in the United States in Delaware on May 29, 2008. China Qinba formed and owned 100% of Xi’an Pharmaceuticals Development Co., Ltd. (“Xi’an Pharmaceuticals” or the “WOFE”) in the People’s Republic of China (“PRC”) on August 18, 2008.

On October 28, 2008, WOFE entered into a series of agreements including a Management Entrustment Agreement, a Shareholders’ Voting Proxy Agreement, an Exclusive Option Agreement and a Share Pledge Agreement (the “Agreements”) with Xi’an Qinba Pharmaceutical Co., Ltd ("Xi’an Qinba") and its shareholders (the “Transaction”). Xi’an Qinba is a corporation formed under the laws of the PRC. According to these Agreements, WOFE acquired management control of Xi’an Qinba whereby WOFE is entitled to all of the net profits of Xi’an Qinba as a management fee, and is obligated to fund Xi’an Qinba’s operations and pay all of the debts. In exchange for entering into the Agreements, on October 28, 2008, WOFE issued 25,000,000 shares of its common stock to Xi’an Qinba owners, representing approximately 80% of the Company’s common stock outstanding after the Transaction. Consequently, the owners of Xi’an Qinba own a majority of WOFE's common stock immediately following the Transaction, therefore, the Transaction is being accounted for as a "reverse acquisition", and Xi’an Qinba is deemed to be the accounting acquirer in the reverse acquisition between Xi’an Qinba and WOFE.

These contractual arrangements completed on October 28, 2008 provide that WOFE has controlling interest in Xi’an Qinba as defined by FASB Accounting Standards Codification (“ASC”) 810, Consolidation, Section 10-15, “Variable Interest Entities” (“VIE”), which requires WOFE to consolidate the financial statements of Xi’an Qinba and ultimately consolidate with its parent company, China Qinba (see Note 2, “Principles of Consolidation”). The WOFE, as an entity that consolidates a Variable Interest Entity is called the primary beneficiary of the VIE. Accordingly the WOFE is the primary beneficiary of Xian Qinba.

On February 12, 2010, the Company completed its merger with China Qinba in accordance with a Merger Agreement (the “Merger Transaction”). Prior to the reverse merger, the Company was a non-operating public shell corporation. Pursuant to Securities and Exchange Commission rules, the merger or acquisition of a private operating company into a non-operating public shell corporation with nominal net assets is considered a capital transaction in substance, rather than a business combination. Accordingly, for accounting purposes, the transaction has been treated as a reverse acquisition and a recapitalization, and pro-forma information is not presented. Transaction costs incurred in the reverse acquisition have been charged to expense, The Company (the legal acquirer) is considered the accounting acquiree and China Qinba (the legal acquiree) is considered the accounting acquirer for accounting purposes. Pursuant to the Merger Agreement, the Company issued 56,000,000 shares of Common Stock to the shareholders China Qinba in exchange for 100% of the outstanding shares of China Qinba. Immediately after the Closing, the Company had a total of 64,083,354 shares (post-reverse split) of common stock outstanding, with all of the shareholders of China Qinba Pharmaceuticals (and their assignees) owning approximately 87.39 % of the Company’s outstanding common stock, and the balance held by those who held the Company’s common stock prior to the Closing. Subsequent to the Merger Transaction, the financial statements of the combined entity will in substance be those of China Qinba. The assets, liabilities and historical operations prior to the Merger Transaction will be those of China Qinba. Subsequent to the date of the Merger Transaction, China Qinba is deemed to be a continuation of the business of the Company. As a result, the accompany consolidated financial statements have been retroactively presented to reflect the recapitalization.

Upon the closure of the Merger Transaction, the Company changed its name from Allstar Restaurants to China Pharmaceutical, Inc. The Company, through its subsidiary and exclusive contractual arrangement with Xi’an Qinba Pharmaceutical Co., Ltd., is engaged in the business of manufacturing and marketing over-the-counter (“OTC”) and prescription pharmaceutical products which include capsules, granules and powder type medicines.

On June 8, 2010, the Company effected a 5 for 6 reverse split of issued and outstanding shares of common stock of the Company without changing the par value of the stock. Shares after reverse split were retroactively restated from beginning of the period for all the periods presented.

On August 23, 2010, the Company sold 2,314,616 (post-reverse split) shares of common stock for approximately $1,600,000. On September 10, 2010 the Company effected a 1 for 3 reverse split of issued and outstanding shares of common stock of the Company without changing the par value of the stock. Shares after reverse split were retroactively restated from beginning of the period for all the periods presented.

On April 21, 2011, the Company issued 6,840,000 (post-reverse split) shares of its common stock to its employees with respect to its 2011 Incentive Stock Plan.

On June 7, 2011, the Company effected a 6 for 1 split of authorized, issued and outstanding shares of common stock of the Company without changing the par value of the stock. The shares outstanding before split were 12,539,662 shares; the shares outstanding after split were 75,237,972. Shares after split were retroactively restated from beginning of the period for all the periods presented.

The consolidated interim financial information as of March 31, 2012 and for the three month periods ended March 31, 2012 and 2011 have been prepared without audit, pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures, which are normally included in consolidated financial statements prepared in accordance with U.S. GAAP have not been included. The interim consolidated financial information should be read in conjunction with the Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, previously filed with the SEC.

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company’s consolidated financial position as of March 31, 2012, its consolidated results of operations and cash flows for the three month periods ended March 31, 2012 and 2011, as applicable, have been made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements have been prepared in conformity with US GAAP. The Company's functional currency is the Chinese Yuan Renminbi; however the accompanying consolidated financial statements have been translated and presented in United States Dollars. The accompanying financial statements present the historical financial condition, results of operations and cash flows of the operating companies.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, its subsidiary and VIE, for which the Company is the primary beneficiary. All inter-company accounts and transactions have been eliminated in consolidation. An enterprise should consolidate a VIE if it has variable interest that provide it with a controlling financial interest as evidenced by (a) the power to direct the activities of the VIE that most significantly impact its economic performance and (b) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE.

In determining that Xi’an Qinba is a VIE and that Xi’an Pharmaceuticals is the primary beneficiary of Xi’an Qinba, the Company considered the following indicators, among others:

Xi’an Pharmaceuticals has the full right to control and administrate the financial affairs and daily operation of Xi’an Qinba and has the right to manage and control all assets of Xi’an Qinba. The equity holders of Xi’an Qinba as a group have no right to make any decision about Xi’an Qinba’s activities without the consent of Xi’an Pharmaceuticals.

·	Xi’an Pharmaceuticals was assigned all voting rights of Xi’an Qinba and has the right to appoint all directors and senior management personnel of Xi’an Qinba. The equity holders of Xi’an Qinba possess no substantive voting rights.

·	Xi’an Pharmaceuticals will provide financial support if Xi’an Qinba requires additional funds to maintain its operations and to repay its debts.

Xi’an Pharmaceuticals should be paid a management fee equal to 100% of the earnings before tax. If there are no earnings before taxes and other cash expenses, then no fee shall be paid. If Xi’an Qinba sustains losses, they will be carried over to the next period and deducted from the next management fee. Xi’an Pharmaceuticals should assume all operation risks of Xi’an Qinba and bear all losses of Xi’an Qinba. Therefore, Xi’an Pharmaceuticals is the primary beneficiary of Xi’an Qinba.

Xi’an Qinba is wholly owned by the majority shareholders of the Company. The capital provided to Xi’an Qinba by the Company was recorded as interest-free loan to Xi’an Qinba. There was no written note to this loan and the loan is not interest bearing and was eliminated during consolidation. Under various contractual agreements, the shareholders of Xi’an Qinba are required to transfer their ownership to the Company’s subsidiary in China when permitted by PRC laws and regulations or to designees of the Company at any time when the Company considers it is necessary to acquire Xi’an Qinba. In addition, the shareholders of Xi’an Qinba have pledged their shares in Xi’an Qinba as collateral to secure these contractual arrangements.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.

Risks and Uncertainties

The Company is subject to substantial risks from, among other things, intense competition associated with the industry in general, other risks associated with financing, liquidity requirements, rapidly changing customer requirements, limited operating history, foreign currency exchange rates and the volatility of public markets.

Contingencies

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed. Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantee, in which case the guarantee would be disclosed.

Cash

Cash and cash equivalents included cash in hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.

Accounts Receivable

The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves.

The standard credit period of the Company’s most of client is three months. Within the medical industry in China, the collection period is generally longer than for other industries. Management evaluates the collectability of the receivables at least quarterly. The estimated average collection period was 90 days as of March 31, 2012. The allowance for doubtful account as March 31, 2012 and December 31, 2011 was $853,620 and $897,765, respectively.

Inventories

Inventories are valued at the lower of cost (determined on a weighted average basis) or market. Costs that are capitalized to inventory primarily include direct manufacturing overhead such as labor costs and packing materials. There was no impairment of inventory for the three months ended March 31, 2012 and year ended December 31, 2011. As of March 31, 2012 and December 31, 2011, inventories consisted of the following:

	2012		2011

Raw materials	$	84,291	$	106,254
Finished goods		75,488		86,945
	$	159,779	$	193,199

Property, Plant & Equipment

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:

Building and improvements	20-42 years
Machinery	8-30 years
Fixture, furniture and equipment	5-15 years
Motor vehicles	5-7 years

Property, Plant & Equipment consisted of the following as of March 31, 2012 and December 31, 2011:

	2012			2011
Building and improvements	$	6,219,222		$	6,212,708
Machinery		9,508,755			9,498,795
Fixture, furniture and equipment		151,548			151,389
Motor vehicles		150,716			150,558
		16,030,241			16,013,450
Less: Accumulated depreciation		(3,660,314	)		(3,476,135	)
	$	12,369,927		$	12,537,315

Depreciation expense for the three months ended March 31, 2012 and 2011 was approximately $180,265 and $258,913, respectively. At December 3, 2011, the Company made a provision for impairment of property and equipment of $3.03 million as a result of one of the Company’s factory ceased production since January 2012 due to rebuilding the plant to GMP standards. The provision charged in the Consolidated Statements of Operation and Comprehensive Income in the amount of $2,957,175 as impairment loss provision and $11,474 as foreign currency translation gain.

Intangible Assets

Intangible assets are amortized using the straight-line method over their estimated period of benefit, ranging from twenty to fifty years. Management evaluates the recoverability of intangible assets at least annually and takes into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. No impairments of intangible assets have been identified during any of the periods presented. The land use right purchased in 2003 will expire in 2053. All of the Company’s intangible assets are subject to amortization with estimated lives of:

Land use right	50 years
Proprietary technologies	20 years

As of March 31, 2012 and December 31, 2011, the components of intangible assets were as follows:

	2012			2011

Land use right	$	1,375,109		$	1,373,669
Proprietary technologies		9,390,780			9,380,943
		10,765,889			10,754,612
Less: Accumulated amortization		(2,374,400	)		(2,232,046	)
	$	8,391,489		$	8,522,566

Amortization expense for the three months ended March 31, 2012 and 2011 was $139,722 and $133,358, respectively. The estimated future yearly amortization expenses related to intangible asset as of March 31, 2012 are as follows:


Year 1	$	540,000
Year 2		540,000
Year 3		540,000
Year 4		540,000
Year 5		540,000
Thereafter		5,691,489
	$	8,391,489

Long-Lived Assets

The Company accounts for long-lived assets in accordance with Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144), included in the Codification as ASC 360, Property, Plant, and Equipment, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations for a Disposal of a Segment of a Business”, included in the Codification as ASC 225, Income Statement. The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with ASC 360. ASC 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 March 31, 2012 and December 31, 2011, $3.03 million of the Company’s property and equipment was impaired as a result of ceased production of one factory since January 2012 due to rebuild the plant to GMP standards.

Fair Value of Financial Instruments

Statement of Financial Accounting Standard No. 107, “Disclosures about Fair Value of Financial Instruments”, included in the Codification as ASC 820, Fair Value Measurements and Disclosures, requires that the Company discloses estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying as financial instruments are a reasonable estimate of fair value.

Fair Value Measurements and Disclosures

ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures. The three levels are defined as follow:

●

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

	●	Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
	●	Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

As of March 31, 2012 and December 31, 2011, the Company did not identify any assets and liabilities that are required to be presented on the balance sheet at fair value.

Value Added Tax Payable (“VAT”)

The Company is subject to a value added tax rate of 17% on product sales by the People’s Republic of China. Value added tax payable is computed net of value added tax paid on purchases for all sales in the People’s Republic of China.

Revenue Recognition

The Company’s revenue recognition policies are in compliance with Staff Accounting Bulletin (SAB) 104, “Revenue Recognition”, included in the Codification as ASC 605, Revenue Recognition. Sales revenue is recognized when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Revenue is reported net of VAT. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue. There was no unearned revenue at March 31, 2012 and December 31, 2011.

The Company has one revenue source from manufacturing and selling the pharmaceutical products, and does not allow its customers to return products. The Company’s customers can exchange products only if they are damaged in transportation.

Advertising

Advertising expenses consist primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses all advertising costs as incurred. For the years ended March 31, 2012and 2011, the Company didn’t incur any significant advertising expense.

Income Taxes

The Company utilizes SFAS No. 109, “Accounting for Income Taxes”, included in the Codification as ASC 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years for differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The Company adopted the provisions of the FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (codified in FASB ASC Topic 740). When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest associated with unrecognized tax benefits is classified as interest expense and penalties are classified as selling, general and administrative expense in the statements of income. The adoption of FIN 48 did not have a material impact on the Company’s financial statements. At March 31, 2012 and December 31, 2011, the Company had not taken any significant uncertain tax position on its tax return for 2011 and prior years or in computing its tax provision for 2012.

Comprehensive Income

Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. For the Company, comprehensive income for the periods presented includes net income, and foreign currency translation adjustments.

Foreign Currency Translation

The Company’s reporting currency is the U.S. dollar. The Company’s operation in China uses Chinese Yuan Renminbi (CNY) as its functional currency. The financial statements of the subsidiary are translated into U.S. Dollars (USD) in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, “Foreign Currency Translation”, included in the Codification as ASC 830, Foreign Currency Matters. According to the Statement, all assets and liabilities were translated at the current exchange rate, stockholders’ equity are translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with SFAS No. 130, “Reporting Comprehensive Income,” as a component of shareholders’ equity, included in the Codification as ASC 220, Comprehensive Income. Foreign exchange transaction gains and losses are reflected in the income statement. The exchange rates used in translation from RMB to USD amount were published by People’s Bank of the People’s Republic of China.

	March 31, 2012	December 31, 2011

Balance sheet items, except for the registered and paid-up capital and retained earnings as of March 31, 2012 and December 31, 2011.	US$1=RMB6.2943	US$1=RMB6.3009

	Three months Ended March 31,
	2012	2011

Amounts included in the statements of operations, and statements of cash flow for the three months ended March 31, 2012 and 2011.	US$1=RMB6.3074	US$1=RMB6.5832

Statement of Cash Flows

In accordance with SFAS No. 95, “Statement of Cash Flows”, included in the Codification as ASC 230, Statement of Cash Flows, cash flows from the Company’s operations are based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.

Basic and Diluted Earnings (Loss) per Share (EPS)

Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is similarly computed, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Diluted net earnings per share are based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to have been exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

The following table presents a reconciliation of basic and diluted earnings per share for the three months ended March 31, 2012 and 2011:

	2012		2011
Net income (loss)	$	(401,312)	$	2,888,013
Weighted average shares outstanding - basic		75,237,972		68,397,972
Effect of dilutive securities:
Warrants issued		-		2,270,268
Weighted average shares outstanding – diluted *		75,237,972		70,668,240,
Earnings (loss) per share – basic	$	0.01	$	0.04
Earnings (loss) per share – diluted	$	0.01	$	0.04

* For the purpose of calculating diluted earnings per share, the warrants issued was excluded due to anti-dilution for the three months ended March 31, 2012.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, most of which are in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.

Research and Development

Research and development costs are related primarily to the development of new drugs by the Company. Research and development costs are expensed as incurred.

The Company also develops new products through arrangements and corporation with several research institutes to develop new pharmaceutical products. The Company only pays these institutes for their research expenses if the research goals are accomplished, including certification of the product and approval for production, and these achievements are then transferred to the Company and recorded as intangible assets. There was no Research and Development expense in the three months ended March 31, 2012 and 2011.

Segment Reporting

Statement of Financial Accounting Standards No. 131, “Disclosure about Segments of an Enterprise and Related Information”, included in Codification ASC 280, Segment Reporting, requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.

SFAS 131 has no effect on the Company's financial statements as substantially all of the Company's operations are conducted in one industry segment of manufacturing and marketing over-the-counter and prescription pharmaceutical products. All of the Company's assets are located in the PRC.

New Accounting Pronouncements

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”, which is adopted for fiscal years, and interim periods beginning after December 15, 2011 for public entities with retrospective application. There is no material impact on the consolidated financial statements upon adoption.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income”. Under the amendments in this ASU, an entity has two options for presenting its total comprehensive income: to present total comprehensive income and its components along with the components of net income in a single continuous statement, or in two separate but consecutive statements. The amendments in this ASU are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. There is no material impact on the consolidated financial statements upon adoption.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment, to simplify how entities test goodwill for impairment. ASU No. 2011-08 allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If greater than 50 percent likelihood exists that the fair value is less than the carrying amount then a two-step goodwill impairment test as described in Topic 350 must be performed. The guidance provided by this update becomes effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopts this ASU beginning with its Quarterly Report on Form 10-Q for the three months ended March 31, 2012. There is no material impact on the consolidated financial statements upon adoption.

In December 2011, the FASB issued Accounting Standards Updates No. 2011-11, “Balance Sheet (Topic 210): Disclosure about Offsetting Assets and Liabilities,” (“ASU 2011-11”). ASU 2011-11 enhances disclosure regarding financial instruments and derivative instruments. Entities are required to provide both net information and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS. This new guidance is to be applied retrospectively. The adoption of these provisions does not have a material impact on the Company’s consolidated financial statements.

As of March 31, 2012, there are no other recently issued accounting standards not yet adopted that would have a material effect on the Company’s consolidated financial statements.

Note 3 – PREPAYMENTS FOR PATENTS

The Company signed two contracts with Xi’an Keli Pharmaceutical Co., Ltd (“Keli”), a local pharmaceutical company, to purchase two medicine formulation that were in the process of completion of their research and development and obtaining of patent from the relevant PRC Governmental Authority from them; the total contracted amount was approximately $4.7 million (RMB 30 million). As of March 31, 2012, the Company had prepayment for patents of $3,971,848 (RMB 25 million), and was committed to pay the remaining $0.79 million (RMB 5 million) upon the Company obtaining the registration certificate of the medicine. These two contracts will expire on May 3, 2013. On June 30, 2011, the Company entered into a supplemental agreement with Keli for changing the final completion date to March 31, 2014 as a result of implementing the new medicine manufacturing GMP standards issued in February 2011 by PRC Food and Drug Administration (“PRC FDA”) into the medicine formulation research and development process. Since 2011, PRC government has been strengthening the supervision of food and drug safety and upgrading large amount of medicine quality standards; accordingly, on April 23, 2012, the Company and Keli entered into a supplemental agreement for further extension of the final completion date to March 31, 2016 due to increased R&D work and testing cycle as a result of enhanced quality control standards and government regulation. Based on the agreement, if Keli cannot obtain the patents of new medicine formulation, from the relevant PRC governmental Authority as set out in the agreement before the agreement expiration date, Keli will refund the full amount of the prepayment to the Company within 30 days of the agreement expiration date.

Note 4 – CONSTRUCTION IN PROGRESS

On November 29, 2011, the Company entered into a contract for construction for the sum of $3.5 million (RMB 22,000,000) with Shanxi Zian Property Development Limited Company for the factory workshop improvement. The project was commenced from December 2011, and will finish in July 2012. Up to March 31, 2012, the Company paid $3.15 million (RMB19, 800,000) and is required to pay an additional $0.35 million (RMB2, 200,000).

Note 5 – ACCRUED LIABILITIES AND OTHER PAYABLES

Accrued liabilities and other payables consisted of the following at March 31, 2012 and December 31, 2011:

	2012		2011
Accrued salaries	$	6,988	$	7,715
Accrued welfare		28,660		28,630
Other payables		15,953		15,937
Accrued expenses - Note 14		1,267,362		1,414,659
Other levies		5,200		1,003
Total	$	1,324,163	$	1,467,944

Accrued expenses consisted of accrued employees welfare, insurance, and utilities of the manufacturing plants; and accrual of an arbitration decision of $168,750 representing 1,125,000 shares at $0.15 per share to be awarded to ValueRich (see Note 14).

Note 6 – DUE TO A SHAREHOLDER

As of March 31, 2012 and December 31, 2011, the Company had a short-term loan of $650,100 from its shareholder for the Company’s working capital needs; this loan bears no interest and was payable upon demand.

Note 7 – COMPENSATED ABSENCES

Regulation 45 of local labor law entitles employees to annual vacation leave after 1 year of service. In general all leave must be utilized annually, with proper notification. Any unutilized leave is cancelled.

Note 8 – COMMITMENTS

Purchasing Agreement

The Company signed two contracts with Xi’an Keli, a local pharmaceutical company to purchase two patents of medicine formulation from them; the total contracted amount was approximately $4.7 million (RMB 30 million). As of March 31, 2012, the Company paid $3.97 million (RMB 25,000,000) as prepayment for patents, and the remaining $0.79 million (RMB 5 million) was committed to pay upon the Company obtaining the registration certificate of the medicine. These two contracts will expire on May 3, 2013. On June 30, 2011, the Company entered into a supplemental agreement with Keli for changing the final completion date to March 31, 2014 as a result of implementing the new medicine manufacturing GMP standards issued in February 2011 by PRC Food and Drug Administration (“PRC FDA”) into the medicine formulation research and development process. Since 2011, PRC government has been strengthening the supervision of food and drug safety and upgrading large amount of medicine quality standards; accordingly, on April 23, 2012, the Company and Keli entered into a supplemental agreement for further extension of the final completion date to March 31, 2016 due to increased R&D work and testing cycle as a result of enhanced quality control standards and government regulation. Based on the agreement, if Keli cannot obtain the patents of new medicine formulation from the relevant PRC governmental Authority as set out in the agreement before the agreement expiration date, Keli will refund the full amount of the prepayment to the Company within 30 days of the agreement expiration date.

Employment Agreements

Through our wholly-owned subsidiary, China Qinba Pharmaceuticals, Inc., the Company has executed employment agreements with each of its executive officers, specifically, Guozhu Wang, Chief Executive Officer; Guiping Zhang, President and Teo Lei, Chief Financial Officer. Each employment agreement has a term of two years.

On January 1, 2010, the Company entered into a three year Employment Agreement with Guozhu Wang to serve as the Company’s Chief Executive Officer. The Agreement provides for an annual salary of $5,095 and an annual bonus of up to 50% of the executive’s annual salary.

On January 1, 2010, the Company entered into a three year Employment Agreement with Guiping Zhang to serve as the Company’s President. The Agreement provides for an annual salary of $5,622 and an annual bonus of up to 50% of the executive’s annual salary.

On January 1, 2010, the Company entered into a three year Employment Agreement with Tao Lei to serve as the Company’s Chief Financial Officer. The Agreement provides for an annual salary of $4,392 and an annual bonus of up to 50% of the executive’s annual salary.

Construction in Process

Note 9 – DEFERRED TAX ASSET

Deferred tax asset represented bad debt allowance, and provision for property impairment booked by the Company, which were not allowed per tax purpose. As of March 31, 2012, and December 31, 2011, deferred tax asset consisted of the following:

	2012		2011
Deferred tax asset - current (bad debt allowance)	$	128,043	$	134,665


Deferred tax asset - noncurrent (impairment of fixed assets)	$	455,169	$	454,692

Note 10 – INCOME TAX

The Company is subject to income taxes by entity on income arising in or derived from the tax jurisdiction in which each entity is domiciled.

China Pharmaceuticals, Inc., the parent company, was incorporated in the U.S. and has net operating losses (NOL) for income tax purposes. China Pharmaceuticals had no net operating loss carry forwards for income taxes at March 31, 2012, which may be available to reduce future years’ taxable income; NOL can be carried forward up to 20 years from the year the loss is incurred.

The Company’s Chinese subsidiary (WOFE) and VIE were incorporated in the PRC which is governed by the Income Tax Laws of the PRC and various local tax laws. Effective January 1, 2008, China adopted a uniform tax rate of 25% for all enterprises (including foreign-invested enterprises). Currently the Company is not subject to examination by major tax jurisdictions, but the tax authority in PRC has the right to examine the Company’s tax position in all past years.

The Company’s VIE is a high-tech enterprise and under PRC Income Tax Laws, it is entitled to a two-year tax exemption for 2006 through 2007. Starting from 2008, the Enterprise Income Tax (EIT) was at a statutory rate of 15%. The Company recorded $14,243 and $464,204 income tax expense for the three months ended March 31, 2012 and 2011.

The following table reconciles the U.S. statutory rates to the Company’s consolidated effective tax rate for the three months ended March 31, 2012 and 2011:

	2012			2011
US statutory rates		(34.0)	%		34.0	%
Tax rate difference		9.0	%		(9.0)	%
Effect of tax holiday		9.8	%		(10.3)	%
Others		18.5	%		(1.5)	%
Valuation allowance		0.4	%		0.7	%
Tax per financial statements		3.7	%		13.9	%

The provision for income tax for the three months ended March 31, 2012 and 2011 consisted of the following:

	2012		2011
Income tax expense - current	$	7,494	$	4,64,204
Income tax expense - deferred		6,749		-
Total income tax expense	$	14,243	$	464,204

Note 11 – MAJOR CUSTOMERS AND CREDIT RISK

For the three months ended March 31, 2012, three customers accounted for 41%, 18%, and 11% of the Company’s sales. For the three months ended March 31, 2011,no customer accounted for 10% or more of the Company’s sales. Total accounts receivable from these customers were $3,011,809 at March 31, 2012.

Three vendors provided 22%, 15%, and 14% of the Company’s purchases of raw materials for the three months ended March 31, 2012; three vendors provided 25%, 15% and 13% of the Company’s purchase of raw materials for the three months ended March 31, 2011. At March 31, 2012, total payable due to these vendors was approximately $281,369.

Note 12 – STATUTORY RESERVES

In accordance with the laws and regulations of the PRC, a wholly-owned Foreign Invested Enterprises income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public affair fund. Prior to January 1, 2006 the proportion of allocation for reserve was 10 percent of the profit after tax to the surplus reserve fund and additional 5-10 percent to the public affair fund. The public affair fund reserve was limited to 50 percent of the registered capital. Effective January 1, 2006 there is now only one fund requirement. The reserve is 10 percent of income after tax, not to exceed 50 percent of registered capital.

Statutory Reserve funds are restricted for set off against losses, expansion of production and operation or increase in register capital of the respective company. Statutory public welfare fund is restricted to the capital expenditures for the collective welfare of employees. These reserves are not transferable to the Company in the form of cash dividends, loans or advances. These reserves are therefore not available for distribution except in liquidation. As of March 31, 2012 and December 31, 2011, the Company had allocated $ 3,274,593 and $3,274,593 to these non-distributable reserve funds.

Note 13 – STOCK-BASED COMPENSATION PLAN

On December 17, 2009, China Qinba entered into a Shell Referral agreement with Dragon Link Investments, Ltd (Dragon Link) for Dragon Link to identify and refer a public shell company to the Company to consummate a reverse merger in the US. As consideration for the services provided by Dragon Link (and in accordance with a warrant placement agreement dated February 12, 2010 between the Company and Dragon Link), China Qinba agreed to issue to Dragon Link warrants to acquire 2,000,000 shares of the Company’s common stock, with registration rights, and exercisable at a price of $0.50 per post-split share within three years after the control acquisition or merger by China Qinba with a public company identified by Dragon Link . The warrants will expire on February 11, 2013. The fair value of the warrants at issuing date was $701,058; accordingly, the Company recorded the stock compensation expense of $701,058. The warrants were fully exercised in May of 2010. The Company received $1 million proceeds from exercise of the warrants.

On January 5, 2010, China Qinba entered into an agreement with IFG Investments Services, Inc. (IFG) to obtain certain consulting services including advising on a merger/acquisition transaction and regulatory filings, and other services and support as requested. In consideration for the consulting services to be performed by IFG (and in accordance with a warrant placement agreement dated February 12, 2010 between the Company and IFG), China Qinba agreed to issue to IFG warrants to acquire 3,000,000 shares of the Company’s common stock, with registration rights, exercisable at $0.50 per post-split share within three years after the closing of the control acquisition or merger by China Qinba with public company. The warrants will expire on February 11, 2013. The warrants were vested immediately. The fair value of the warrants at issuing date was $1,051,588; accordingly, the Company recorded the stock compensation expense of $1,051,588.

On January 27, 2010, China Qinba entered into an investor relations agreement with HACG Investor Relations Services, Inc. (HACG), to obtain certain public company sector services, including advising on and with respect to investor relations. The term of the contract expires January 31, 2011. As consideration for the services to be performed by HACG (and in accordance with a warrant placement agreement dated February 12, 2010 between the Company and HACG), China Qinba agreed to issue to HACG warrants to acquire 2,000,000 shares of the Company’s common stock, with registration rights, exercisable at $0.50 per post-split share until January 31, 2013. The warrants were vested immediately. The fair value of the warrants at issuing date was $469,976; accordingly, the Company recorded the stock compensation expense of $469,976.

Based on the fair value method under ASC Topic 505, the fair value of each warrant granted is estimated on the date of the grant using the Black-Scholes option pricing model and is recognized as compensation expense over the service period of each warrants issued. The Black-Scholes option pricing model has assumptions for risk free interest rates, dividends, stock volatility and expected life of an option grant. The risk free interest rate is based upon market yields for US Treasury debt securities at a maturity near the term remaining on the warrant. Dividend rates are based on the Company’s dividend history. The stock volatility factor is based on the historical volatility of the Company’s stock price. The fair value was estimated at the date of grant using the following range of assumptions: average risk-free interest rate – 1.89%; expected life – 3 years; expected volatility – 219%; and expected dividends – nil. The following table summarizes activities of these warrants (post stock split):

	Number of Shares		Average Exercise Price per Share		Weighted Average Remaining Contractual Term in Years
Outstanding at January 1, 2011		5,000,000	$	0.50		2.11
Exercisable at January 1, 2011		5,000,000		0.50		2.11
Cancelled		-		-		-
Granted		-		-		-
Exercised		-		-		-
Outstanding at December 31, 2011		5,000,000		0.50		1.11
Exercisable at December 31, 2011		5,000,000		0.50		1.11

Granted		-		-		-
Exercised		-		-		-
Outstanding at March 31, 2012		5,000,000	$	0.50		0.86
Exercisable at March 31, 2012		5,000,000	$	0.50		0.86

In April 2011, the Company’s board of Directors approved to issue 6,840,000 shares of its common stock to its employees with respect to its 2011 Incentive Stock Plan upon filing of the Company’s form S-8 with the SEC. Those shares were fully vested and non-forfeitable when issued. The Company recorded $4,856,400 as stock compensation expense based on the fair value of the shares as of the grant date.

Note 14 – CONTINGENCY

ValueRich, Inc. (“ValueRich”) commenced a private arbitration against the Company in Florida asserting breach of contract, conversion, and unjust enrichment claims arising out of a Consulting Agreement between ValueRich and Xi’an Qinba Pharmaceuticals Co. Ltd. (“Qinba”), which is the operating entity that a Company’s wholly owned subsidiary has a contractual Entrust Management Relationship. ValueRich asserts that the Company breached and circumvented the Consulting Agreement by terminating it and becoming a public entity through other means. ValueRich seeks specific performance to obtain 20% of the Company’s outstanding shares, or, in the alternative, unspecified monetary damages equal to the value of 20% of the Company’s outstanding shares, attorneys’ fees, arbitration costs, and interest.

On March 11, 2011, the Company filed its Answer and Counterclaims. ValueRich has filed its Reply to the Company’s Counterclaims. ValueRich filed a Motion to Dismiss the Counterclaims, and the Arbitrator granted the Motion to Dismiss. Thereafter, the Company filed its Answer to the Amended Arbitration Petition, which sought to add additional parties to the proceeding. On December 6, 2011, the Arbitrator heard a hearing on ValueRich’s claims.

On December 7, 2011, the Company received the arbitration decision, in which the Arbitrator awarded 1,125,000 registered shares of the Company to ValueRich for past work performed. To the knowledge of the Company, the award has not been confirmed in a court of competent jurisdiction as of the Balance Sheet date. However, the Company accrued $168,750 (note 5) stock compensation expense for this arbitration decision at the stock price of the arbitration decision date at $0.15 per share.

Note 15 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS

The Company’s major operations are carried out in the PRC; therefore the Company is subject to the risks not typically associated with entities operating in the United States of America. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, by the general state of the PRC's economy. All of the following risks may impair the Company’s business operations. If any of the following risks actually occurs, the Company’s business, financial condition or results of operations could be materially adversely affected. In such case, investor may lose all or part of the investment. Additional risks include:

·	The Company may not be able to adequately protect and maintain its intellectual property.

·	The Company may not be able to obtain regulatory approvals for its products.

·	The Company may have difficulty competing with larger and better financed companies in the same sector. New legislative or regulatory requirements may adversely affect the Company’s business and operations. The Company is dependent on certain key existing and future personnel.

·	The Company’s growth is dependent on its ability to successfully develop, market, or acquire new drugs. The Company may be subject to product liability claims in the future.

·	Changes in the laws and regulations in the PRC may adversely affect the Company’s ability to conduct its business.

·	The Company may experience barriers to conducting business due to governmental policy.

·	Capital outflow policies in the PRC may hamper the Company’s ability to remit income to the United States.

·	Fluctuation of the Renminbi could materially affect the Company’s financial condition and results of operations.

·	The Company may face obstacles from the communist system in the PRC.

·	The Company may have difficulty establishing adequate management, legal and financial controls in the PRC.

·	Trade barriers and taxes may have an adverse affect on the Company’s business and operations.

·	There may not be sufficient liquidity in the market for the Company’s securities in order for investors to sell their securities.

Note 16 – SUBSEQUENT EVENTS

The company has evaluated subsequent events through the issuance of the consolidated financial statements and no subsequent event is identified.

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

The following discussion of the financial condition and results of operation of the Company for the three months ended March 31, 2012, and 2011, should be read in conjunction with the consolidated financial statements and the notes to those statements that are included elsewhere in this Quarterly Report on Form 10-Q (“Report”).

Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of our filings with the Securities and Exchange Commission for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

China Pharmaceuticals, Inc. (the "Company”), formerly named Allstar Restaurants, was incorporated in Nevada on December 22, 2004. China Qinba Pharmaceuticals, Inc. (“China Qinba”), a wholly-owned subsidiary of the Company, was incorporated in Delaware on May 29, 2008. China Qinba formed and owned 100% of Xi’an Development Co., Ltd. (“Xi’an Development” or the “WFOE”) in the People’s Republic of China (“PRC”) on August 18, 2008.

On October 28, 2008, WFOE entered into a series of agreements including a Management Entrustment Agreement, a Shareholders’ Voting Proxy Agreement, an Exclusive Option Agreement and a Share Pledge Agreement (the “Agreements”) with Xi’an Qinba Pharmaceutical Co., Ltd ("Xi’an Pharmaceuticals") and its shareholders (the “Transaction”). Xi’an Pharmaceuticals is a corporation formed under the laws of the PRC. According to these Agreements, WFOE acquired management control of Xi’an Pharmaceuticals whereby WFOE is entitled to all of the net profits of Xi’an Pharmaceuticals as a management fee, and is obligated to fund Xi’an Pharmaceuticals’ operations and pay all of the debts. In exchange for entering into the Agreements, on October 28, 2008, China Qinba, the parent company of WFOE, issued 25,000,000 shares of its common stock to Xi’an Pharmaceuticals’ owners, representing approximately 80% of the its common stock outstanding after the Transaction. Consequently, the owners of Xi’an Pharmaceuticals own a majority of China Qinba’s common stock immediately following the Transaction. Therefore, the Transaction is being accounted for as a "reverse acquisition", and Xi'an Pharmaceuticals is deemed to be the accounting acquirer in the reverse acquisition between Xi'an Pharmaceuticals and WFOE.

These contractual arrangements completed on October 28, 2008 provide that WFOE has controlling interest in Xi’an Pharmaceuticals as defined by FASB Accounting Standards Codification (“ASC”) 810, Consolidation, Section 10-15, “Variable Interest Entities” (“VIE”), which requires WFOE to consolidate the financial statements of Xi’an Pharmaceuticals and ultimately consolidate with its parent company, China Qinba. The WFOE, as an entity that consolidates a Variable Interest Entity is called the primary beneficiary of the VIE. Accordingly the WFOE is the primary beneficiary of Xi’an Pharmaceuticals.

On February 12, 2010, the Company completed its merger with China Qinba in accordance with a Merger Agreement (the “Merger Transaction”). Prior to the reverse merger, the Company was a non-operating public shell corporation. Pursuant to Securities and Exchange Commission rules, the merger or acquisition of a private operating company into a non-operating public shell corporation with nominal net assets is considered a capital transaction in substance, rather than a business combination. Accordingly, for accounting purposes, the transaction has been treated as a reverse acquisition and a recapitalization, and pro-forma information is not presented. Transaction costs incurred in the reverse acquisition have been charged to expense, The Company (the legal acquirer) is considered the accounting acquiree and China Qinba (the legal acquiree) is considered the accounting acquirer for accounting purposes. Pursuant to the Merger Agreement, the Company issued 56,000,000 shares of common stock to the shareholders China Qinba in exchange for 100% of the outstanding shares of China Qinba. Immediately after the Closing, the Company had a total of 64,083,354 shares of common stock outstanding, with all of the shareholders of China Qinba (and their assignees) owning approximately 87.39 % of the Company’s outstanding common stock, and the balance held by those who held the Company’s common stock prior to the Closing. Subsequent to the Merger Transaction, the financial statements of the combined entity will in substance be those of China Qinba. The assets, liabilities and historical operations prior to the Merger Transaction will be those of China Qinba. Subsequent to the date of the Merger Transaction, China Qinba is deemed to be a continuation of the business of the Company. Therefore, post-merger financial statements will include the consolidated balance sheets of the Company and China Qinba, the historical operations of the Company and China Qinba from the closing date of the Merger Transaction forward.

Upon the closing of the Merger Transaction, the Company changed its name from Allstar Restaurants to China Pharmaceuticals, Inc.

The Company, through its subsidiary and exclusive contractual arrangement with Xi’an Pharmaceuticals, is engaged in the business of manufacturing and marketing over-the-counter (“OTC”) and prescription pharmaceutical products which include capsules, granules and powder type medicines. The Company currently sells 85 kinds of pharmaceutical products and processes approval of State Food and Drug Administration for all the products it markets.

Results of Operations

Comparison of the Three Months ended March 31, 2012 and 2011

The following table sets forth the results of our operations for the three months ended March 31, 2012 and 2011 indicated as a percentage of net sales:

	2012				2011
	$		% of Sales		$		% of Sales
Sales		1,580,229				7,687,217
Cost of Goods Sold		812,869		51%		3,367,530		44%
Gross Profit		767,360		49%		4,319,687		56%
Operating Expenses		1,175,258		74%		975,365		12%
(Loss) Income from Operations		(407,898)		(25)%		3,344,322		44%
Other Income (Expenses), net		20,829		1%		7,895		-%
Income Tax Expense (Benefit)		14,243		1%		464,204		6%
Net (Loss) Income		(401,312)		(25)%		2,888,013		38%

Sales

In the three months ended March 31, 2012, we had sales of $1,580,229, a decrease of 79% as compared to $7,687,217 in the same period of 2011. This decrease was primarily due to decrease in production volume starting from the second quarter of 2011as a result of our preparation for GMP certification. In order to meet the requirements of GMP certification, we had to upgrade our machinery and equipment and provide training to our employees, which interrupted our production. We expect our sales will gradually increase as our production capacity is restored to normal level after the GMP certification.

Cost of Goods Sold

Cost of goods sold consisted of costs of raw materials, salary, fuel and electricity, costs related to manufacturing workshop, and others. Cost of goods sold decreased to $812,869 for the three months ended March 31, 2012, representing a 76% decrease as compared to $3,367,530 for the three months ended March 31, 2011. This decrease was primarily due to decrease in sales resulting from decrease in production volume. The cost of goods sold as a percentage to the sales was 51% for the three months ended March 31, 2012 as compared to 44% for the three months ended March 31, 2011. The increase in cost of goods sold as a percentage to the sales was attributable to increase in costs of raw materials and factory overhead, which resulted from the overall inflation in the PRC.

Gross Profit

Gross profit decreased 82% to $767,360 for the three months ended March 31, 2012 as compared to $4,319,687 for the three months ended March 31, 2011. Our gross profit margin decreased from 56% for the three months ended March 31, 2011 to 49% for the three months ended March 31, 2012. The decrease in gross margin was a result of increase in cost of goods sold as a percentage to sales.

Operating Expenses

Operating expenses consisted of selling, general and administrative expenses. Operating expenses were $1,175,258 for the three months ended March 31, 2012, an increase of 20% as compared to $975,365 for the three months ended March 31, 2011. This increase was primarily due to less recovery of bad debt allowance for the three months ended March 31, 2012.

Other Income

Other income was $20,829 for the three months ended March 31, 2012, compared with other income of $7,895 for the same period of 2011, an increase of $12,934 or 164%. The increase in other income was primarily due to an increase in interest income from $9,888 for the three months ended March 31, 2011 to $20,885 for the three months ended March 31, 2012 resulting from increase in bank deposits.

Net (Loss) Income

Net loss was $401,312 for the three months ended March 31, 2012, a decrease of $3,289,325 from net income of $2,888,013 for the three months ended March 31, 2011. Our net profit margin decreased from 38% for the three months ended March 31, 2011 to (25)% for the three months ended March 31, 2012. This decrease was primarily attributable to the significant increase in operating expenses and decrease in gross profit.

Liquidity and Capital Resources

Overview

We had net working capital of $20,093,922 at March 31, 2012, a decrease of $408,662 from $20,502,584 at December 31, 2011. The ratio of current assets to current liabilities was 8.20 at March 31, 2012.

The following is a summary of cash provided by or used in each of the indicated types of activities during the three months ended March 31, 2012 and 2011:

	2012			2011
Cash provided by (used in):
Operating Activities		$	112,137		$	4,712,966
Investing Activities			(348,797)			-
Financing Activities			-			-

Net cash provided by operating activities

Net cash provided by operating activities was $112,137 for the three months ended March 31, 2012, a decrease of $4,600,829, or 98% from $4,712,966 for the three months ended March 31, 2011. The decrease in cash inflow was primarily attributable to increase in accounts receivable, increase in payment of other payables and accrued liability, and also significant decrease in net income for the three months ended March 31, 2012.

Net cash used in investing activities

Net cash used in investing activities was $348,797 for the three months ended March 31, 2012, compared to $0 cash used in investing activities for the three months ended March 31, 2011. The cash outflow was due to construction in progress of $348,797 for the three months ended March 31, 2012. On November 29, 2011, we entered into a construction agreement with Shanxi Zi’an Property Development Limited Company for the factory workshop improvement for $3.5 million (RMB22, 000,000). The project was commenced in December 2011, and will be completed in July 2012. We have paid $3.15 million (RMB 19,800,000) and are obligated to pay the remaining $0.35 million (RMB 2,200,000) to complete the construction.

Net cash provided by financing activities

There was no financing activities for the three months ended March 31, 2012 and the same period of 2011.

Contractual Obligations and Off-Balance Sheet Arrangements

We have certain fixed contractual obligations and commitments that may include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments.

We signed two contracts with Xi’an Keli Pharmaceutical Co., Ltd. (“Keli”), a local pharmaceutical company to purchase two medicine formulations. Keli is in the process of completion of their research and development and obtaining of patent from the relevant PRC Government Authority for the two medicine formulations. The total contracted amount was approximately $4.7 million (RMB 30 million). As of March 31, 2012, we paid $3.97 million (RMB 25,000,000), and the remaining $0.79 million (RMB 5 million) will be paid upon the Company obtaining the registration certificate of the medicine. In the event that the registration certificate and related medicine production permit cannot be obtained, Keli is obligated to return the prepayment of $3.97 million. These two contracts will expire on May 3, 2013. On June 30, 2011, the Company entered into a supplemental agreement with Keli for changing the final completion date to March 31, 2014 as a result of the implementation of the new medicine manufacturing GMP standards on the medicine formulation research and development process issued in February 2011 by PRC Food and Drug Administration. Since 2011, PRC government has been strengthening the supervision of food and drug safety and upgrading large amount of medicine quality standards. Accordingly, on April 23, 2012, the Company and Keli entered into a supplemental agreement to further extend the final completion date to March 30, 2016 due to increased research and development work and testing cycle as a result of enhanced quality control standards and government regulation. Based on the supplemental agreement, if Keli cannot obtain the patents of new medicine formulations from the relevant PRC Governmental Authority as set out in the agreement before the agreement expiration date, which is March 30, 2016, Keli will refund the full amount of the prepayment to the Company within 30 days after the agreement expiration date.

Our anticipated needs for the future are to be negotiated in accordance with manufacturing and operation needs, and market conditions of next year.

We do not have any off-balance sheet arrangements.

Critical Accounting Policies

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements, we believe the following accounting policies are the most critical to aid you in fully understanding and evaluating this management’s discussion and analysis.

Use of Estimates

In preparing the financial statements in conformity with accounting principles generally accepted in the United States of America, 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 year. Significant estimates, required by management, include the recoverability of long-lived assets and the valuation of inventories. Actual results could differ from those estimates.

Accounts Receivable

Revenue Recognition

Income Taxes

The Company utilizes SFAS No. 109, “Accounting for Income Taxes”, included in the Codification as ASC 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

Inflation

Inflation in recent years has affected the business results of the Company. First of all, on the global economic expansion, supply has been restricted and coupled with the fact that USA has adopted a relaxed currency policy etc., these increase inflation risks. Secondly, GNP increases in China also elevates consumption ability and production cost, prices increase as a natural tendency. Finally, as a result of the macro economic trends and price increases, the Company’s procurement prices are also affected resulting in increase in cost of sales.

The Company operates in China and as such, the Company’s business activities, financial position and operational results will be affected by PRC politics, economic and legal environments and also affected by the overall economic situation of China. The business of the Company may be affected by the relevant laws, regulations, anti-inflation measures, currency conversion and overseas remittance and exchange rates issues etc. that are related to China politics.

New Accounting Pronouncements

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-15(e)) under the Exchange Act) that is designed to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time specified in the Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Pursuant to Rule 13a-15(b) under the Exchange Act, the Company carried out an evaluation with the participation of the Company’s management, including Guozhu Wang, the Company’s Chief Executive Officer (“CEO”), and Tao Lei, the Company’s Chief Financial Officer (“CFO”), of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the three months ended March 31, 2012. Based upon that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were not effective due to a material weakness in the Company’s internal control over financial reporting. Specifically, the material weakness is related to the lack of accounting personnel with U.S. GAAP proficiency. The Company’s internal accounting department has primarily engaged in ensuring compliance with PRC accounting and reporting requirements for our operating affiliates. As a result, the Company’s current internal accounting department responsible for financial reporting of the Company, on a consolidated basis, is relatively new to U.S. GAAP and the related internal control procedures required of U.S. public companies. Although the Company’s accounting staff is professional and experienced in accounting requirements and procedures generally accepted in the PRC, management has determined that they require additional training and assistance in U.S. GAAP matters. In order to mitigate this material weakness to the fullest extent possible, external consultants were used and the Company’s review process was strengthened.

On November 18, 2011, the management of the Company concluded that it was necessary to restate the financial statements for the nine months ended September 30, 2009 previously filed by the Company with the Securities Exchange Commission (the “SEC”) on a Current Report on Form 8-K , for each of the fiscal years ended December 31, 2009 and December 31, 2010 previously filed by the Company with the SEC on an Annual Report on Form 10-K and for each of the quarterly periods ended March 31, 2010, June 30, 2010, September 30, 2010, March 31, 2011 and June 30, 2011 previously filed by the Company with the SEC on a Quarterly Report on Form 10-Q because in the process of preparing the aforementioned financial statements, the translation of the Company’s fixed assets and intangible assets from Renminbi yuan to U.S. dollar was erroneously based on the historical exchange rate while the U.S. generally accepted accounting principles require the translation of assets at the exchange rate on the balance sheet date. As a result, such financial statements should no longer be relied upon. Management has since resolved to take corrective actions designed to ensure that material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and regulations and accumulated and communicated to them as appropriate to allow timely decisions regarding required disclosure.

Therefore, management believes that the consolidated financial statements and other information presented herewith are materially correct. Management believes that the weakness did not have any effect on the accuracy of the Company’s consolidated financial statements for the current reporting period.

Changes in internal control over financial reporting

Our management, with the participation of our CEO and CFO, performed an evaluation as to whether any change in our internal control over financial reporting occurred during the quarter ended March 31, 2012. Based on that evaluation, our CEO and CFO concluded that no change occurred in the Company's internal control over financial reporting during the quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

On December 6, 2011, the Arbitrator heard a hearing on ValueRich’s claims.

We know of no other material, active, pending or threatened proceeding against us or our subsidiaries, nor are we, or any subsidiary, involved as a plaintiff or defendant in any other material proceeding or pending litigation.

Item 1A. Risk Factors.

Not applicable.

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

None.

Item 3. Defaults Upon Senior Securities.

To our knowledge, there are no material defaults upon senior securities.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

(a) Exhibits

31.1		Certification pursuant to Section 302 of Sarbanes Oxley Act of 2002.*

31.2		Certification pursuant to Section 302 of Sarbanes Oxley Act of 2002.*

32.1		Certification pursuant to Section 906 of Sarbanes Oxley Act of 2002.*

32.2		Certification pursuant to Section 906 of Sarbanes Oxley Act of 2002.*

101.INS		XBRL Instance Document.**

101.SCH		XBRL Taxonomy Extension Schema Document.**

101.CAL		XBRL Taxonomy Calculation Linkbase Document.**

101.PRE		XBRL Taxonomy Presentation Linkbase Document.**

101.LAB		XBRL Taxonomy Label Linkbase Document.**

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.**

* The exhibits attached to this Form 10-Q shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange Act") or otherwise subject to liability under that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as expressly set forth by specific reference in such filing.

** Attached as Exhibits 101 to this Form 10-Q are the following financial statements from the Company’s Form 10-Q for the quarterly period ended March 31, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Comprehensive Income, (iii) the Consolidated Statements of Cash Flows, and (iv) related notes to these unaudited condensed consolidated financial statements tagged as blocks of text.

The XBRL related information in Exhibits 101 to this Form 10-Q shall not be deemed “filed” or a part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, and is not filed for purposes of Section 18 of the Exchange Act, as amended, or otherwise subject to the liabilities of those sections.

SIGNATURES

Pursuant to the requirements 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.

	CHINA PHARMACEUTICALS, INC.

Dated: May 21, 2012	By:	/s/ Guozhu Wang
		Name: Guozhu Wang
		Title: Chief Executive Officer



Dated: May 21, 2012	By:	/s/ Tao Lei
		Name: Tao Lei
		Title: Chief Financial Officer

Attached files

China Pharmaceuticals Inc Reports

Also read