SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
o 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 001-33537
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
(Exact Name of Registrant as Specified in Its Charter)
(Registrant’s Telephone Number, Including Area Code)
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 þ 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
There were 19,679,400 shares outstanding of the issuer’s common stock, par value $.0001 per share, as of May 29, 2012.
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
See notes to condensed consolidated financial statements.
See notes to condensed consolidated financial statements.
See notes to condensed consolidated financial statements.
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
NOTE 1 – ORGANIZATION AND NATURE OF OPERATIONS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NOTE 3 – SEGMENT REPORTING
NOTE 4 – INVENTORIES, NET
NOTE 5 – BORROWINGS
NOTE 6 – RELATED PARTY TRANSACTIONS AND BALANCES
NOTE 7 – BASIC AND DILUTED EARNINGS (LOSS) PER SHARE
NOTE 8 – CONCENTRATIONS
NOTE 9 – COMMITMENTS AND CONTINGENCIES
NOTE 10– SUBSEQUENT EVENTS
The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and financial condition of China Shenghuo Pharmaceutical Holdings, Inc. Throughout this document, references to “we,” “our,” the “Company” refer to China Shenghuo Pharmaceutical Holdings, Inc. and its subsidiaries. MD&A should be read in conjunction with our financial statements and the related notes, and the other financial information included in this report.
This filing contains forward-looking statements. The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, our ability to repay certain bank loans due in 2012, general economic and business conditions; changes in foreign, political, social, and economic conditions; our expansion into the retail distribution of our cosmetic products; regulatory initiatives and compliance with governmental regulations; the ability to achieve further market penetration and additional customers; and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments. Additional factors that could cause actual results to differ materially from those projected or suggested in any forward-looking statements are contained in our filings with the Securities and Exchange Commission, including those factors discussed under the captions “Risk Factors” and “Forward-Looking Statements” in our most recent Annual Report on Form 10-K for the year ended December 31, 2011, as may be supplemented or amended from time to time, which we urge investors to consider.
We are primarily engaged in the research, development, manufacture, and marketing of pharmaceutical, nutritional supplement and cosmetic products. Almost all of our products are derived from the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi or Tienchi. Panax notoginseng is the root of the greyish-brown or greyish-yellow plant that only grows in a few geographic locations, among which is the Yunnan Province in southwest China, where we are located; this province accounts for 90% of the total global production. The main root of Panax notoginseng are cylindrical shaped and are most commonly one to six centimeters long and one to four centimeters in diameter. Panax notoginseng saponins (PNS), the active ingredients in Panax notoginseng, are extracted from the plant using high-tech equipment and in accord with Good Manufacturing Practice (GMP) standards. Our main product, Xuesaitong Soft Capsules, accounted for approximately 89% and 86% of our sales for the three months ended March 31, 2012 and 2011 respectively.
Shenghuo Plaza and Zhonghuang Hotel
We expect to receive the Building Completion Examination Certificate and Property Ownership Certificate by late 2012. Once the Building Completion Examination Certificate and Property Ownership Certificate are issued, we intend to apply for a business license for Zhonghuang Hotel and use Shenghuo Plaza and the two new office buildings as mortgage collateral for a new loan amounting to RMB100 million (approximately $16 million) to finance the Xinglin International Health-Preserving Tourist Resort discussed below and to reduce current short term debt.
New drug pipeline
On September 22, 2010 the Company received notice from NYSE Amex LLC (the “NYSE Amex” or “Exchange”) Staff indicating that the Company is below certain of the Exchange’s continued listing standards due to the fact that its stockholder’s equity is less than $2,000,000, it has sustained losses from continuing operations, and it has net losses in two out its three most recent fiscal years, as set forth in Section 1003(a) (i) of the NYSE Amex Company Guide. The Company was afforded the opportunity to submit a plan of compliance to the Exchange to demonstrate its ability to regain compliance with the continued listing standards by March 22, 2012. On October 29, 2010 and November 29, 2010, the Company presented its plan to and responded to supplemental questions from the Exchange.
On December 6, 2010 the Exchange notified the Company that it accepted the Company’s plan of compliance and granted the Company an extension until March 22, 2012 to regain compliance with the continued listing standards. On March 21, 2012, the Exchange notified the Company its decision to defer making a determination on whether the Company has regained compliance after the company files the Annual Report on the Form 10-K on March 30, 2012.
On April 17, 2012, the Company received a deficiency letter (the “Deficiency Letter”) from the NYSE Amex stating that the Company has resolved the continued listing deficiency with respect to Section 1003(a)(i) of the NYSE Amex’s Company Guide (the “Company Guide”) referenced in NYSE Amex’s letter dated September 22, 2010. However, as a result of the Company sustaining losses which are so substantial in relation to its overall operations or its existing financial resources, or its financial condition has become so impaired that it appears questionable, in the opinion of NYSE Amex, as to whether such issuer will be able to continue operations and/or meet its obligations as they mature, the Company is no longer in compliance with Section 1003(a)(iv) of the Company Guide. The Deficiency Letter states that, in order to maintain its NYSE Amex listing, the Company must submit a plan of compliance by May 1, 2012, advising NYSE Amex how it intends to regain compliance with Section 1003(a)(iv) of the Company Guide by July 2, 2012.
In view of, among other things, the belief of the Board of Directors that under the Company’s current circumstances, it is not reasonably practicable for the Company to establish and implement a plan of compliance that would satisfy NYSE Amex’s continued listing requirements, the substantial financial burden on the Company as a result of its status as a U.S. public company, the Company’s inability to raise capital in the United States and the minimal benefits derived from being a U.S. public company, the Board of Directors of the Company determined on April 19, 2012 that it is in the best interest of the Company to voluntarily delist the Company’s common stock from NYSE Amex and deregister its shares with U.S. Securities & Exchange Commission (the “SEC”). In connection therewith, the Company notified NYSE Amex on April 20, 2012 of the Company’s intention to file a Form 25 - Notification of Removal from Listing and/or Registration under Section 12(b) of the Securities Exchange Act of 1934 (the “Form 25”), with the SEC on April 30, 2012. The Form 25 became effective on May 10, 2012.
As s result of discussions between the Company's legal counsel and the SEC, the SEC has taken the position that the exemption that the Company had sought to rely upon under Section 15(d) of the Exchange Act to suspend its reporting obligations is unavailable to it at this time. As such, the Company at this time will not file a Form 15, and it will continue to be a reporting company under Section 15(d) of the Exchange Act until such time as it is allowed to suspend its reporting obligations, which the Company expects to be no later than the first quarter of 2013.
We earn revenues mainly from the production and sale of our products and external processing. We hope to increase profits as a result of making new products and increasing sales, since the sale of products is our main source for generating cash. Our business involves a significant degree of risk as a result of the opportunities and challenges we face in selling our products. We have traditionally focused on research and development of products serving cardiovascular and cerebrovascular disease, peptic ulcer disease and health products markets. However, we intend to devote additional resources to research and development and to continue to evaluate and develop additional high-tech product candidates to expand our pipeline where we perceive an unmet need and commercial potential and to improve existing products to enhance their efficacy.
With intense price competition among many similar or identical products in the industry, we believe that building brand equity is the primary means to generate and sustain profitable growth in the future. Our brand strategy is centered on “Lixuwang” - the brand under which our main product “Xuesaitong” Soft Capsules is sold and “Shenhuo” - the brand under which most of our products are sold. "Lixuwang", the trademark of Xuesaitong Soft Capsules, was awarded the Chinese Well-Known Trademark Honor by the State Administration for Industry and Commerce of China in 2010. This prestigious award gives China Shenghuo green path in anti-counterfeit campaign and intellectual property protection. We believe that our relationships within the Chinese pharmaceutical industry are key to building brand equity, and we believe we can benefit from developing and maintaining relationships with professionals within the industry, especially physicians and hospitals.
We have established sales offices in many cities in China that manage sales representatives according to our internal management rules and sales policy. Because the main product “Xuesaitong” Soft Capsules is sold to hospitals through regional wholesale companies located in the various cities of China and because China has thousands of wholesale companies, we employ a large number of sales representatives to expand into new markets and gain new customers.
As of March 31, 2012, our medicine marketing team maintains sales offices in approximately 21 provinces throughout China. The sales network covers approximately 215 cities and is staffed by approximately 708 sales representatives. We intend to grow our internal marketing and sales function and increase our relationships with other national wholesale companies to expand the distribution and presence of our non-prescription brands and cosmetics.
We believe it is in our-long-term best interest to grow our operations through the over-the-counter (“OTC”) market, which will produce higher profit margins. Besides Yunnan province where Xuesaitong has its presence many years ago, we started to expand Xuesaitong’s presence into the OTC market in selected areas outside Yunnan province around China since 2009. We developed several main OTC markets in 2011 in provinces such as Jiangsu, Fujian, Guangdong, Hunan, Liaoning, Shandong, Heilongjiang, Chongqing, Guangxi and Zhejiang. The performance of OTC market in Yunnan province is best among these provinces, with a gross sales of Xuesaitong Soft Capsules in the OTC market amounting to approximately $0.3 million for the three months ended March 31, 2012. As of March 31, 2012, in addition to the 2000 chain drugstores in Yunnan province, we have established sales relations with 12000 chain drugstores in most provinces in China. The Company reimburses the sales representatives their accrued selling expenses when related accounts receivable are collected.
We hope to further expand sales beyond China into other countries where our products could be affordable treatment options. We intend to focus on the expansion of our cosmetics product line and devote additional marketing and sales resources to that end with the aim that our cosmetics products will account for a larger percentage of our revenue in the future.
We also hope to stabilize the sales channel into hospitals and widen the reach of sales in urban and rural communities at the same time. Large increases in medicine sales at an average lower price will ensure the growth of general medicinal sales over the next few years. Also, we are focusing our efforts on developing better channels for selling our products to expand our revenue and to counter fierce market competition. To that extent, we began to build relationships with new high-quality sales agents and terminate our relationships with sales agent with poor historical performances since 2009. We believe that this shift will provide a sound foundation for our operations going forward.
Strategic Adjustment in Cosmetic
Since the marketing of 12 Ways cosmetics, the Company tried to expand its sales and have expanded the geographic region in which our 12 Ways products were sold from our native Yunnan province to a number of cities and provinces outside our local region. But due to the insufficient funding for marketing development, the sales of 12 Ways cosmetics grew slowly and the subsidiary of cosmetics has suffered a continuing loss. The loss adversely effected the holistic operation of the Company. Currently, the Company has a tight budget, in order to focus on our principal business – pharmaceutical with our limited capital, the Company has decided to make adjustment in Cosmetic in the fourth quarter of 2011. We will not fund the market development for 12 Ways cosmetics until we have enough capital.
There is potential for growth in production and sales due to the growth of new products and expansion of new channels into urban and rural communities. However, it will be uncertain which of our new products will pass the applicable tests and get clinical approval without difficulty because of the uncertainty of test results and clinical approvals. Over the last three years, the price of the main raw material we use - Sanchi - has been fluctuating, which will likely increase our cost of product sold. In addition, our expected increased expenses for research and development, marketing and sales may have an adverse effect on future profit levels and available cash resources.
Critical Accounting Policies and Estimates
Application of Critical Accounting Policies
We consider the policies discussed below as critical to understanding our Consolidated Financial Statements, as their application places the most significant demands on management’s judgment, since financial reporting results rely on estimates of the effects of matters that are inherently uncertain. In instances where different estimates could have reasonably been used, we disclosed the impact of these different estimates on our operations. In certain instances, like revenue recognition, the accounting rules are prescriptive; therefore, it would not have been possible to reasonably use different estimates. Changes in assumptions and estimates are reflected in the period in which they occur. The impact of such changes could be material to our results of operations and financial condition in any quarterly or annual period.
Specific risks associated with these critical accounting policies are discussed throughout the MD&A, where such policies affect our reported and expected financial results. For a detailed discussion of the application of these and other accounting policies, refer to Note 2 – Summary of significant accounting policies in the Consolidated Financial Statements.
Allowance for Doubtful Accounts and Credit Losses
Accounts receivable are reviewed periodically as to whether they are past due based on contractual terms and their carrying values have become impaired. An allowance for doubtful accounts is recorded in the period in which loss is determined to be probable based on an assessment of specific evidence indicating doubtful collection, historical experience, account balance aging and prevailing economic conditions. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and financial health of specific customers. We have considered all available information in our assessments of the adequacy of the provision for doubtful accounts and we do not expect there would be significant changes on conditions that would result in material effect on the allowance estimation. We will continue to assess our receivable portfolio in light of the current economic environment and its impact on our estimation of the adequacy of the allowance for doubtful accounts.
Income Taxes and Tax Valuation Allowances
We follow Statement of Accounting Standard Codification (“ASC”) Topic 740 “Accounting for 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.
We regularly review our deferred tax assets for recoverability considering historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and tax planning strategies in making this assessment. If we are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to increase the valuation allowance against all or a significant portion of our deferred tax assets resulting in a substantial adverse impact on our operating results.
Results of Operations
Three Months Ended March 31, 2012 and 2011
The following table sets forth our statements of operations for the three months ended March 31, 2012 and 2011 in U.S. dollars (unaudited):
Sales: Sales for the three months ended March 31, 2012 was approximately $11.4 million, an increase of approximately $1.9 million, or 20.5%, from approximately $9.4 million for the three months ended March 31, 2011. The increase in sales was primarily due to the Company’s main product Xuesaitong’s sales increasing as the Company’s continuous efforts made. In addition, Hotel Segment contributed approximately $1 million in 2012 period, as compared with $0.4 million in the corresponding period of 2011.
Cost of sales: Our cost of sales for the three months ended March 31, 2012 was approximately $4.7 million, an increase of approximately $0.9 million or 22.7% from approximately $3.8 million for the three months ended March 31, 2011. The increase in cost of sales was in line with the increase in sales. In addition, the increase in cost of sales was also due to the increase of the sales volume and the purchase price of Sanqi which is the main raw material of our main product Xuesaitong. Although we have started to grow Sanqi within the Resort, we will not be able to harvest until 2014 because it has a three-year growth cycle.
Gross margin: Our gross profit for the three months ended March 31, 2012 was approximately $6.7 million as compared with approximately $5.6 million for the three months ended March 31, 2011, an increase of approximately $1.1 million, or 18.9%. Gross profit as a percentage of revenues was approximately 58.9% for the three months ended March 31, 2012, a decrease of 0.8% from 59.7% for the three months ended March 31, 2011. The slight decrease in gross profit percentage was primarily due to the increase of cost of raw materials as set forth above.
Selling expense: Selling expenses were approximately $5.2 million for the three months ended March 31, 2012, an increase of approximately $1.1 million, or 26.8%, from approximately $4.1 million for the three months ended March 31, 2011. The primary reason for the increase in selling expenses was due to increase of sales commission to sales representative in line with the sales increment.
We reimburse the sales representatives their selling and marketing expenses when they submit the appropriate documentation to be reimbursed and their sales are collected. We reimburse the sales representatives their accrued selling expenses when related accounts receivable are collected.
General and administrative expense: General and administrative expenses were approximately $1.4 million for the three months ended March 31, 2012, an increase of approximately $0.4 million, or 33.8%, from approximately $1 million for the three months ended March 31, 2011. The increase was primarily due to the increase of staff cost and legal and financial consulting service expenses.
Research and development expense: Research and development expense for the three months ended March 31, 2012 was $ 231,947, as compared to $121,725 for the three months ended March 31, 2011, an increase of $110,222. The increase was primarily due to the expenditures in 2012 period for outside experts for the Phase I clinical test of Sh1002 which amounted to $98,448.
Other expenses: Other expenses were $492,428 for the three months ended March 31, 2012, which consisted of interest expense and non-operating expense, offset by subsidy income, interest income and non-operating income, an increase of $185,545, or 60.5%, from an expense of $306,883 for the three months ended March 31, 2011. The increase was mainly due to an increase in interest expenses occurring and less subsidy income received as compared the same period in 2011.
Income tax benefit (expense): Income tax benefit was $121,073 for the three months ended March 31, 2012 as compared to income tax expense of $14,980 for the three months ended March 31, 2011. The tax benefit was mainly attributable to the medicine segment of the Company and the deferred tax assets benefit from accrued expenses.
Net income (loss): Net loss was $446,621 for the three months ended March 31, 2012 as compared to the net income of $85,701 for the three months ended March 31, 2011, as a result of the factors described above.
Liquidity and Capital Resources
General –As of March 31, 2012, we had cash and cash equivalents of approximately $6.7 million. In the three months ended March 31, 2012, the Company suffered a net loss of $446,621 due to the increase of raw materials’ price from 2012, the increase of selling expense, and general and administrative expense, research and development expense, interest expense and less subsidy income. Our consolidated current liabilities exceeded consolidated current assets by approximately $24 million as of March 31, 2012, and approximately $23.2 million as of December 31, 2011. These factors raise substantial doubt about the Company’s ability to continue as a going concern. In order to continue as a going concern, the Company will need, among other things, additional capital resources. Management’s plan is to obtain such resources for the Company by seeking equity and/or debt financing by using Shenghuo Plaza and the two new office buildings as mortgage collateral after the Company has obtained the Property Ownership Certificate by late 2012. However management cannot provide any assurances that the Company will be successful in accomplishing any of its plans. In the event we are not able to obtain funding, we will not be able to implement or may be required to delay all or part of our business plan, and our ability to attain profitable operations, generate positive cash flows from operating and investing activities and materially expand the business will be materially adversely affected.
For the borrowings which matures in the next twelve months, we expect to settle them through a combination of:
For the three months ended March 31, 2012, we had net cash provided by operating activities of approximately $0.9 million, a decrease of approximately $1.7 million from approximately $2.6 million for the three months ended March 31, 2011. We believe that we will be able to obtain more cash flows from operating activities by strengthen control on working capital management.
Operating Activities: Net cash provided by operating activities for the three months ended March 31, 2012 was approximately $0.9 million, as compared to net cash provided by operating activities of approximately $2.6 million for the three months ended March 31, 2011. The decrease in the net cash provided by operating activities was mainly due to the loss we suffered in 2012 period and the increase in the accounts receivable balance as at March 31, 2012.
Investing Activities: Net cash used in investing activities was approximately $0.7 million for the three months ended March 31, 2012, as compared to net cash used in the amount of approximately $2.3 million for the three months ended March 31, 2011. The decrease in net cash used in investing activities was primarily due to decreases in capital expenditures, specifically, the construction of Shenghuo Plaza.
Financing Activities: Net cash provided by financing activities was approximately $5.2 million for the three months ended March 31, 2012, as compared to net cash used in the amount of approximately $0.6 million for the three months ended March 31, 2011. The increase in cash provided was primarily due to the increase of loans borrowed from banks and Reserve Center.
Working Capital Deficiency
Our consolidated current liabilities exceeded our consolidated current assets by approximately $24.0 million as of March 31, 2012 and approximately $23.2 million as of December 31, 2011.
As of March 31, 2012, our net accounts and notes receivable (less allowance for doubtful accounts of approximately $2.5 million) were approximately $19.7 million, an increase of approximately $1.6 million, from approximately $18.1 million (net of allowance for doubtful accounts of approximately $2.6 million) as of December 31, 2011 which is in line with the increase in sales.
As of March 31, 2012, our accounts payable were approximately $9 million, a decrease of approximately $0.4 million, from approximately $9.4 million as of December 31, 2011.
Our advance from customers increased from approximately $1.1 million as of December 31, 2011 to approximately $4 million in March 31, 2012. The increase of was mainly due to the prepayment in the amount of approximately $2.7 million by our largest customer Tianjin Zhongxing Medicine Co., Ltd. to us for Xuesaitong purchasing.
Our payment cycle is considerably shorter than our receivable cycle, since we typically pay our suppliers all or a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We require our sales representatives to pay a certain percentage of the sales price as deposit before we deliver the products to the customers. The deposits were approximately $6.1 million as of March 31, 2012 and as of December 31, 2011.
Other payables and accrued expense, mainly consisted of accrued commission payable to the sales representatives, increased by approximately $1.5 million, from approximately $11.8 million as of December 31, 2011 to approximately $13.3 million as of March 31, 2012 due to the net effect of payment and accrual for commission for the three months ended March 31, 2012.
To the extent that we cannot satisfy our cash needs, whether from operations or from a financing source, our business may be impaired in that it may be difficult for us to obtain products which could, in turn, impair our ability to generate sales. We have implemented new policies aimed at improving collection of accounts receivable in the future, including more detailed reporting from and increased control over provincial sales offices and representatives, incentives for sales representatives more closely tied to timely collection and more stringent enforcement of payment terms with wholesale companies or distributors. We will continue to accelerate the collection of trade receivables and shorten the turnover days.
The completion of Shenghuo Plaza and the two new office buildings is expected to generate more cash flows and increase our ability to obtain additional financing from banks. By using Shenghuo Plaza and the two new office buildings as mortgage collateral after the Company has obtained the Property Ownership Certificate by late 2012 and the proceeds to be generated from operations, we are confident that we will have sufficient working capital for at least the next 12 months. We will continue to make efforts to expand our sales to get more cash flow.
However, we may require additional capital for acquisitions, for expanding business to related fields, or for the operation of the subsidiaries and there is no assurance that such funding will be available. Please see Note 5 –Borrowings in the Consolidated Financial Statements.
Off- Balance Sheet Commitment and Arrangements
On September 8, 2010, the Company signed an agreement with Management Commission of Kunming Shilin Taiwan Farmer Entrepreneur Centre to lease land for planting suitable-for-cultivating medicinal herb for use in the production of the Company’s medicinal products and to construct a health preserving zone and travel service center. The total operating lease amounted to approximately $4.8 million with a lease term of 20 years. Up to approximately $4.5 million under this lease agreement would be paid in the coming 4 years.
The Company plans to pay the lease expense by using the cash flow from our operations and bank borrowings.
As of March 31, 2012, we have a capital commitment of USD5,688,051 for the second installment of purchasing land use right for Xinglin International Health-Preserving Tourist Resort. Such amount is expected to be paid upon the requirement of the Management Committee of Kunming Shilin Taiwan Farmer Entrepreneur Centre.
Except as aforementioned, the Company does not have any outstanding off-balance sheet guarantees, interest rate swap transactions or foreign currency forward contracts. In addition, the Company does not engage in trading activities involving non-exchange traded contracts. In our ongoing business, we do not enter into transactions involving, or otherwise form relationships with, unconsolidated entities or financials partnerships that are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Foreign Currency Risk
Since all of our operations are conducted in the PRC, we are subject to special considerations and significant risks not typically associated with companies operating in the United States of America. These risks include, among others, the political, economic and legal environments and foreign currency exchange rate fluctuations. Our operational results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to medical reforms and other laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from our operations in the PRC. In addition, all of our revenue is denominated in the Chinese Yuan Renminbi (“RMB”), which must be converted into other currencies before remittance out of the PRC. Both the conversion of RMB into foreign currencies and the remittance of foreign currencies abroad require approval of the PRC government. The effect of the fluctuations of exchange rates is not considered to be material to our business operations.
Interest Rate Risk
We do not have significant interest rate risk, as our debt obligations are primarily fixed interest rate.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Disclosure controls and procedures
Our management, with the participation of our chief executive officer and chief financial officer, Mr. Feng Lan and Mr. Raymond Wang respectively, evaluated the effectiveness of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this report, 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 forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, Mr. Lan and Mr. Wang concluded that despite our hiring of a CFO who is familiar with U.S. GAAP in this April, more training offered to our staff in the accounting department and improvements in areas of previously identified weakness in internal control over financial reporting identified (described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2011), our disclosure controls and procedures were not effective as of March 31, 2012.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
* 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, deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise not subject to liability under these sections.
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.