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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q

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
 
OR
 
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)
 
Delaware
 
20-2903562
(State or Other Jurisdiction of Incorporation or Organization)
 
(IR.S. Employer Identification No.)
     
No. 2 , Jing You Road,
   
Kunming National Economy &
   
Technology Developing District
   
People’s Republic of China 650217
 
N/A
(Address of Principal Executive Offices)
 
(Zip Code)
 
0086-871-728-2628
(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.
 
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller Reporting Company þ
 
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

     
Page
 
         
PART I - FINANCIAL INFORMATION
     
         
ITEM 1.
CONDENSED FINANCIAL STATEMENTS
    F-1  
           
 
Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and December 31, 2011
    F-1  
           
 
Consolidated Statements of Operations and Comprehensive (Loss) Income for the Three Months Ended March 31, 2012 and 2011 (Unaudited)
    F-2  
           
 
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (Unaudited)
    F-3  
           
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
    F-4  
           
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    3  
           
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    13  
           
ITEM 4T.
CONTROLS AND PROCEDURES
    13  
           
PART II - OTHER INFORMATION
    14  
         
ITEM 6.
EXHIBITS
    14  
           
SIGNATURES
    15  
 
 
2

 
 
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in USD)

   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
       
Assets:
           
Current Assets:
           
Cash and cash equivalents
  $ 6,676,938     $ 1,247,230  
Restricted Cash
    794,791       794,115  
Accounts and notes receivable, net
    19,693,400       18,076,050  
Other receivables, net
    4,076,263       4,084,102  
Advances to suppliers, net
    360,536       542,153  
Inventories, net
    3,594,896       2,695,388  
Due from related parties
    152,897       574,899  
Current deferred tax assets
    1,509,050       1,394,101  
Other current assets
    526,871       199,929  
Total Current Assets
    37,385,642       29,607,967  
                 
Property, plant and equipment, net
    25,846,785       25,873,670  
Intangible assets, net
    1,452,976       1,473,074  
Deposits for long-live assets
    1,079,977       1,078,846  
Non-current deferred tax assets
    346,493       275,677  
    $ 66,111,873     $ 58,309,234  
Liabilities and Equity:
               
Current Liabilities:
               
Accounts payable
  $ 8,960,710       9,395,483  
Other payables and accrued expenses
    13,298,492       11,819,179  
Sales representative deposits
    6,127,394       6,106,287  
Due to related parties
    18,434       18,414  
Short-term borrowings
    21,388,449       15,858,895  
Advances from customers
    3,952,315       1,090,668  
Taxes payable and other current liabilities
    1,671,803       2,255,322  
Current portion of long-term borrowings
    5,941,884       6,253,075  
Total Current Liabilities
    61,359,481       52,797,323  
Commitments and Contingencies
               
Equity:
               
Common stock, $0.0001 par value, 100,000,000 shares    authorized and 19,679,400 shares issued and outstanding
    1,968       1,968  
Additional paid-in capital
    6,014,688       6,014,688  
Appropriated retained earnings
    147,023       147,023  
Accumulated deficit
    (6,235,141 )     (5,790,759 )
Accumulated other comprehensive income
    1,748,239       1,743,393  
Total stockholder's equity
    1,676,777       2,116,313  
Non-controlling interest
    3,393,363       3,395,598  
Due from non-controlling interest for hotel project
    (317,748 )     -  
Total non-controlling interest
    3,075,615       3,395,598  
Total Equity
    4,752,392       5,511,911  
Total liabilities and equity
  $ 66,111,873       58,309,234  
 
See notes to condensed consolidated financial statements.
 
 
F-1

 
 
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE (LOSS) INCOME (UNAUDITED)
(Amounts in USD, except shares)
 
   
Three months ended March 31,
 
   
2012
   
2011
 
             
Sales
  $ 11,372,453     $ 9,441,626  
Cost of Goods Sold
    4,669,455       3,805,692  
Gross Margin
    6,702,998       5,635,934  
Operating Expenses:
               
   Selling expenses
    5,168,179       4,076,430  
   General and administrative expenses
    1,378,138       1,030,215  
   Research and development expense
    231,947       121,725  
      6,778,264       5,228,370  
(Loss) Income from Operations
    (75,266 )     407,564  
Other Income (Expenses):
               
                 
   Subsidy income
    8,244       7,598  
   Interest and other expense
    (500,672 )     (314,481 )
      (492,428 )     (306,883 )
(Loss) Income Before Income Tax Expenses
    (567,694 )     100,681  
Income tax benefit (expense)
    121,073       (14,980 )
Net (Loss) Income
    (446,621 )     85,701  
Net loss attributable to non-controlling interests
    (2,239 )     (13,672 )
Net (Loss) Income Attributable to Stockholders
  $ (444,382 )   $ 99,373  
Comprehensive (Loss) Income:
               
Net (Loss ) Income
    (446,621 )     85,701  
Foreign currency translation adjustment
    4,850       19,794  
Comprehensive (Loss) Income
  $ (441,771 )   $ 105,495  
Less: Comprehensive loss attributable to  non-controlling interests
    (2,235 )     (16,830 )
Comprehensive (Loss) Income Attributable to Stockholders
    (439,536 )     122,325  
Basic and diluted (loss) earnings  per share
  $ (0.02 )   $ 0.01  
Weighted-average number of shares outstanding   -basic and diluted     19,679,400       19,679,400  
 
See notes to condensed consolidated financial statements.
 
 
F-2

 

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Amounts in USD)
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Net Cash Provided by Operating Activities
  $ 896,967     $ 2,609,836  
Cash Flows from Investing Activities:
               
Purchase of long-lived assets
    (664,383 )     (2,290,979 )
Proceeds from disposal of Property
    -       169  
Net Cash Used in Investing Activities
    (664,383 )     (2,290,810 )
                 
Cash Flows from Financing Activities:
               
Increase in restricted cash
    (156     -  
Proceeds from borrowings
    8,513,809       3,292,326  
Payments on borrowings
    (3,329,423 )     (3,886,067 )
Net Cash Provided by (Used in) Financing Activities
    5,184,230       (593,741 )
                 
Effect of exchange rate changes on cash and cash equivalents
    12,894       14,632  
Net Increase (Decrease) in Cash and Cash Equivalents
    5,429,708       (260,083 )
Cash and Cash Equivalents at Beginning of Period
    1,247,230       1,669,387  
Cash and Cash Equivalents at End of Period
  $ 6,676,938     $ 1,409,304  
                 
Supplemental Information
               
Cash paid for interest
  $ 565,730     $ 332,323  
Cash paid for income taxes
  $ 61,161     $ -  
 
See notes to condensed consolidated financial statements.
 
 
F-3

 
 
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
 
NOTE 1 – ORGANIZATION AND NATURE OF OPERATIONS
 
(a) 
Nature of Business
 
 
China Shenghuo Pharmaceutical Holdings, Inc., (“CSPH”), incorporated in Delaware, United States of America, through its subsidiaries (collectively the “Company”), designs, develops, markets, sells and exports pharmaceutical, nutritional supplements, cosmetic products, and also engages in the hotel operating business mainly in the People’s Republic of China (“PRC”). The Company also conducts research and development using the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi, or Tienchi, which is grown in two provinces in the PRC. Sales from the cosmetic products represent less than 10% of total sales of the Company.
 
(b) 
Organization
 
 
As of March 31, 2012, the CSPH owns a 94.95% equity interest in Kunming Shenghuo Pharmaceuticals (Group) Co., Ltd. (“Shenghuo”). Shenghuo owns a 100% equity interest in Kunming Shenghuo Medicine Co., Ltd. (“Medicine”), Kunming Pharmaceutical Importation and Exportation Co., Ltd. (“Import/Export”) and Kunming Shenghuo Cosmetics Co., Ltd. (“Cosmetic”), respectively.
 
On April 30, 2009, Shenghuo formed Shi Lin Shenghuo Co., Ltd. (“Shi Lin”) as a wholly owned subsidiary. Shi Lin was formed for the purpose of purchasing or leasing land suitable for cultivating the medicinal herb Panax notoginseng for use in the production of the Company’s medicinal products.
 
On November 15, 2010, Shenghuo formed Kunming Shenghuo Hotel Management Co., Ltd. (“Hotel”). According to the investment agreement with an independent third party, Shenghuo holds 80% equity interest in Hotel. Hotel was formed to run the hotel business.
 
Except for CSPH, all other entities are formed in and operate within the PRC.
 
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
(a)
Basis of presentation
 
 
The accompanying unaudited interim condensed consolidated financial statements (“consolidated financial statements”) have been prepared in accordance with the accounting policies described in the Company’s Form 10-K filed on March 30, 2012 (“2011 Form 10-K”), and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s 2011 Form 10-K.
 
 
F-4

 
 
 
The consolidated financial statements have been prepared on the basis that the Company will continue to operate throughout the next twelve months as a going concern. The Company’s consolidated current liabilities exceeded its consolidated current assets by approximate USD 23,974,000 as of March 31, 2012 and USD23,189,000 as of December 31, 2011. These factors and the capital commitment described in note 9(b) 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. The accompanying consolidated financial statements do not include any adjustments relating to the classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the company be unable to continue in existence.

In the opinion of the management of the Company (“Management”), all normal recurring adjustments which are necessary for a fair statement of financial position, operating results and cash flows for the interim periods presented have been made. Interim results of operations are not necessarily indicative of the results of the full year.
 
(b)
Principle of consolidation
 
 
The consolidated financial statements include the financial statements of the CSPH and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.

Non-controlling interests represents the ownership interests in the subsidiaries that are held by owners other than the parent and are part of the equity of the consolidated group. The non-controlling interests are reported in the consolidated balance sheets within equity, separately from the parent’s equity. Net income or loss and comprehensive income or loss is attributed to the parent and the non-controlling interests. If losses attributable to the parent and the non-controlling interests in a subsidiary exceed their interests in the subsidiary’s equity, the excess, and any further losses attributable to the parent and the non-controlling interests, is attributed to those interests.
 
(c)
Accounts and notes receivable
 
 
Accounts receivable are recognized and carried at original sale amounts less an allowance for uncollectible accounts, as needed.

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. Accounts receivable balances are written off after all collection efforts have been exhausted.

Notes receivable represent bankers’ acceptances that have been arranged with third-party financial institutions by certain customers to settle their purchases from us. These bankers’ acceptances are non-interest bearing and are collectible within six months. Such sales and purchasing arrangements are consistent with industry practices in the PRC.

There are no outstanding amounts from customers that individually represent greater than 10% of the total balance of accounts receivable for the periods presented.

The Company entered into a factoring agreement with Bank of China (“BOC”), to transfer accounts receivable with full recourse. The Company is required to repurchase the transferred accounts receivable, if any controversy arises on the accounts receivable, at a price of proceeds received from BOC less settled accounts receivable plus interest and other necessary penalty or expense. The Company accounts for its transferred accounts receivable in accordance with Accounting Standard Codification (“ASC”) Topic 810, with the proceeds received from BOC being recognized as collateralized borrowings.
 
 
F-5

 
 
(d)
Income taxes
 
 
CSPH and its consolidated entities each file tax returns separately.

The Company follows ASC Topic 740, 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.

The Company follows ASC Topic 740, which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income tax in interim periods, and income tax disclosures.

The CSPH is subject to income tax in the United States. Shenghuo is qualified to enjoy preferential tax rate under relevant PRC tax laws and regulations, with effective income tax rate of 10% in 2009, 11% in 2010 and 12% in 2011. No deferred United States income taxes are provided for since all accumulated profits will be permanently reinvested in the PRC. From 2012, Shenghuo will be subject to income tax at a rate of 15%. All other subsidiaries in the PRC were subject to income tax at a rate of 25% for the periods presented.
 
(e)
Revenue recognition
 
 
The Company recognizes revenue in accordance with ASC Topic 605. All of the following criteria must exist in order for the Company to recognize revenue: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.
 
Delivery does not occur until products have been shipped to the wholesale companies, risk of loss has transferred to the wholesale companies and wholesale companies’ acceptance has been obtained, or the Company has objective evidence that the criteria specified in wholesale companies’ acceptance provisions have been satisfied. The sales price is not considered to be fixed or determinable until all contingencies related to the sale have been resolved.
 
In general, the Company does not allow wholesale companies to return products unless there are defects in manufacturing or workmanship. Sales returns are subject to a strict process and have to be authorized by Management. Sales returns are netted against sales when occurred. Historically, the amounts of sales returns have been immaterial.
 
(f)
Property, plant and equipment
 
 
Property, plant and equipment are stated at historical cost less accumulated depreciation and impairment. The historical cost of acquiring an item of property, plant and equipment includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use. If an item of property, plant and equipment requires a period of time in which to carry out the activities necessary to bring it to that condition and location, the interest cost incurred during that period as a result of expenditures for the item is a part of the historical cost. This item is categorized as construction in progress and is not depreciated until substantially all the activities necessary to bring it to the condition and location necessary for its intended use are completed.
 
 
F-6

 
 
 
Depreciation of property, plant and equipment is calculated using the straight-line method (after taking into account their respective estimated residual values) over the estimated useful lives of the assets as follows:
 
Asset
 
Useful life (years)
   
Residual value %
 
Buildings
   
25 - 40
     
5
%
Machinery
   
3 - 20
     
0-5
%
Office equipment and furnishing
   
3 - 10
     
0-5
%
Vehicles
   
3 - 10
     
0-5
%
 
 
Depreciation of property, plant and equipment attributable to manufacturing activities is capitalized as part of inventories, and expensed to cost of goods sold when inventories are sold.
 
Expenditure for maintenance and repairs is expensed as incurred.
 
The gain or loss on the disposal of property, plant and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets and is recognized in the consolidated statements of operations.
 
(g)
Fair value of financial instruments
 
 
The carrying amounts reported in the consolidated balance sheets for accounts and notes receivable, other receivables, advances to suppliers, accounts payable, advances from customers, other payables and accrued expenses, deposits payable approximate fair value because of the immediate or short-term maturity of these financial instruments. Management believes the interest rates on short-term notes payable and long-term debt reflect rates currently available in the PRC. Thus, the carrying value of these loans approximates fair value.
 
(h)
Recently issued accounting standards affecting the Company
 
 
In the three months ended March 31, 2012, the FASB has not issued any Accounting Standards Update.
 
NOTE 3 – SEGMENT REPORTING
 
 
The Company has four major reportable segments, Medicine, Cosmetic, Hotel and Shi Lin. The Company’s reportable segments are based primarily on different types of business and represent the primary mode used to assess allocation of resources and performance. Performance is measured by various factors such as segment revenue and segment profit (loss).
 
(a) 
Segment reporting for the three months ended March 31, 2012 (unaudited):

   
Medicine
   
Hotel
   
Shi Lin
   
Others
    Elimination    
Total
 
                                     
Revenues from external customers
  $ 10,373,886     $ 912,240     $ -     $ 86,327     $ -     $ 11,372,453  
Inter segment revenue
  $ 15,341     $ -     $ -     $ -     $       $ 15,341  
Segment (loss) profit
  $ (595,050 )   $ 104,841     $ (88,129 )   $ 31,226     $ (20,582 )   $ (567,694 )
 
 
F-7

 
 
(b) 
Segment reporting for the three months ended March 31, 2011 (unaudited):
 
   
Medicine
   
Hotel
   
Shi Lin
   
Others
   
Elimination
   
Total
 
                                     
Revenues from external customers
  $ 8,841,946     $ 413,996     $ -     $ 185,684     $ -     $ 9,441,626  
Inter segment revenue
  $ 108,830     $ -     $ -     $ -     $ -     $ 108,830  
Segment (loss) profit
  $ 262,361     $ (109,379 )   $ (39,804 )   $ 41,673     $ (54,170 )   $ 100,681  
 
 
During the three months ended March 31, 2012 and 2011, the revenue from external customers in other segment was generated from the Cosmetic business.
 
NOTE 4 – INVENTORIES, NET
 
 
Inventories consisted of the following:
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(Unaudited)
       
Raw materials
  $ 719,133     $ 808,009  
Work-in-process
    1,666,346       1,361,386  
Finished goods
    1,209,417       525,993  
Total inventories
  $ 3,594,896     $ 2,695,388  
 
NOTE 5 – BORROWINGS
 
 
The Company’s borrowings are payable to banks, governmental financial bureaus and Kunming Land and Mine Reserve Center (the “Reserve Center”). The following summarizes the Company’s debt obligations and respective balances as of March 31, 2012 and December 31, 2011:
 
   
March 31
   
December 31
 
   
2012
   
2011
 
   
(Unaudited)
       
Current:
           
Short-term borrowings from banks and Reserve Center, collateralized
  $ 21,346,297     $ 15,816,788  
Current portion of long-term borrowings, collateralized
    5,941,884       6,253,075  
Borrowings from governmental financial bureau, uncollateralized
    42,151       42,107  
    $ 27,330,333     $ 22,111,970  
 
 
F-8

 
 
(a)  
The current portion of the long-term bank borrowings mature in April 2012 and was repaid in full subsequently.
(b)  
As of March 31, 2012, the balance of borrowings from Agricultural Bank of China (the “ABC”) was approximately USD16,269,000, among which, borrowings amounting to approximately USD10,708,000 was collateralized by land use rights and buildings, while the others in an aggregate amount of approximately USD5,561,000 were guaranteed by the CSPH’s 94.95% shares in Shenghuo.
(c)  
As of March 31, 2012, short-term borrowings of approximately USD1,271,000 from Fudian Bank was collateralized by the Shenghuo’s patent and was repaid in full subsequently.
(d)  
As of July 29, 2011,the Company was granted of a one-year line of credit by BOC with a maximum of RMB30,000,000 (approximately USD4,766,000) factoring advance between July 29, 2011 and July 28, 2012. As of March 31, 2012, short-term borrowings of approximately USD2,971,000, were secured by accounts receivable, with an amount of approximately USD3,729,000. The unused line of credit as of March 31, 2012 was approximately USD1,795,000 which required additional collaterals upon withdrawal.
(e)  
As of March 31, 2012, short-term borrowing of RMB5,000,000 (approximately USD794,000) from China Minsheng Bank Corporation was guaranteed by a maximum loan guarantee contract of RMB10,000,000, or approximately USD1,589,000. The unused line of credit as of March 31, 2012 was approximately USD795,000.
(f)  
As of March 31, 2012, short-term borrowings of RMB2,660,000 (approximately USD423,000) from China Merchant Bank was collateralized by the bank acceptance notes in the amount of approximately USD450,000.
(g)  
As of March 31, 2012, short-term borrowing of RMB35,000,000 (approximately USD5,561,000) from Reserve Center was collateralized by buildings. RMB25,000,000 (approximately USD3,972,000) of the borrowing was repaid subsequently and the Company has orally agreed with the Reserve Center on repaying the rest of the borrowing (RMB10,000,000, approximately USD1,589,000) on extended maturity date from April 29, 2012 until when they have adequate working capital. During the period that the loan is in default, the Company is required to pay an additional interest penalty at 0.04% per diem of the interest rate defined in the original loan agreement.
(h)  
The weighted average interest rate for the borrowings at March 31, 2012 and December 31, 2011 are as follows:
                   
    March 31     December 31  
   
2012
   
2011
 
   
(Unaudited)
       
Current:
           
Short-term borrowings from banks and Reserve Center
    7.20 %     6.91 %
Current portion of long-term borrowings
    5.40 %     5.40 %
Borrowings from governmental financial bureau
    0.00 %     0.00 %
 
NOTE 6 – RELATED PARTY TRANSACTIONS AND BALANCES

   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(Unaudited)
       
             
Amounts due from related parties
           
Kunming Dianjiao Nutritional Supplements Co., Ltd. (“Dianjiao”)
 
$
152,897
   
$
574,899
 
                 
Amounts due to related parties
               
Officers
 
$
18,434
   
$
18,414
 
 
 
As of March 31, 2012, the amount due from Dianjiao which is under common control with the Company was for business purpose, it was interest free and repaid on demand.
 
 
F-9

 
 
NOTE 7 – BASIC AND DILUTED EARNINGS (LOSS) PER SHARE
 
 
Basic earnings per share is computed by dividing net income or loss attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted income or (loss) per share reflects the potential dilution from the exercise or conversion of other securities into common stock, but only if dilutive. Potentially dilutive securities for the periods ended March 31, 2012 and 2011 include 46,000 warrants and 246,000 warrants, respectively. However, since the exercise price of the related common stock for these two periods exceeds the average market price and dilutive loss per share excludes all potential common shares if their effect is anti-dilutive, the warrants are considered as no dilutive effect in computation of earnings per share.
 
   
Three Months Ended March 31,
 
   
 2012 
(Unaudited)
   
2011
(Unaudited)
 
Net income(loss) attributable to stockholders
  $ (444,382 )   $ 99,373  
Weighted-average number of shares outstanding -basic and diluted
    19,679,400       19,679,400  
Basic and diluted earnings (loss) per share
  $ (0.02 )   $ 0.01  
 
NOTE 8 – CONCENTRATIONS
 
 
For the three months ended March 31, 2012, the Company had concentrations of purchases raw materials from two vendors accounting for 67.2% of total purchases, as compared to approximately 68.5% of total purchase for the three months ended March 31, 2011, respectively.

Concentration of sales from three customer accounting for 45.5% of total sales for the three months ended March 31,2012, as compared to one customer accounting for 16.7% of total sales for the three months ended March 31, 2011. As of March 31, 2012 and December 31, 2011, the Company had no significant concentration on accounts receivable.

Approximately 89% of the sales came from a single product, Xuesaitong Soft Capsules for the three months ended March 31, 2012, as compared to approximately 86% for the three months ended March 31, 2011, respectively.
 
NOTE 9 – COMMITMENTS AND CONTINGENCIES
 
(a) 
Operating lease commitment
 
 
On September 8, 2010, the Company signed an agreement with Management Commission of Kunming Shilin Taiwan Farmer Entrepreneur Centre (“Entrepreneur Centre”) to rent the 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 USD 4,738,000 with a lease term of 20 years. According  to the lease agreement, the rental for the first five years should be paid annually, and the rental for the remaining 15 years should be fully prepaid in 2015.

As of March 31, 2012, the operating lease commitment is summarized as below:
 
Year Ending December 31,
 
Amount
 
2012
 
$
335,581
 
2013
   
236,881
 
2014
   
236,881
 
2015
   
3,553,215
 
   
$
4,362,558
 
 
 
F-10

 
 
(b) 
Capital Commitment
 
 
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.
 
NOTE 10– SUBSEQUENT EVENTS
 
 
In April, 2012, we obtained a loan of RMB40 million (approximately $6 million) from Agricultural Bank of China for working capital.
 
On April 17, 2012, the Company received a deficiency letter (the “Deficiency Letter”) from NYSE Amex LLC (the “NYSE Amex” or “Exchange”) 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.
 
 
F-11

 
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-Looking Statements
 
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.
 
Overview

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.

 
3

 
 
New drug pipeline 
 
  
Wei Dingkang Soft Capsules - a type of traditional Chinese medicine designed to treat peptic ulcer disease by inhibiting bacterial growth, relieving stomach muscle spasms, and reducing inflammation of the intestinal lining. The product is designed to be effective for upset stomach, vomiting, pain and degradation of the stomach lining. The product has been approved by the State Food and Drug Administration (SFDA) for clinical testing. Phase II clinical trials were completed in December 2007, and the phase II exploratory and enhanced clinical trials were completed in 2010. In the third quarter of 2011, we held a seminar with related experts and drafted a preliminary clinical research protocol. We entered into an agreement with a clinical study company to run phase III clinical trials. We anticipate Phase III clinical trials will begin in July of 2012 and will be completed by the first half of 2014. Thereafter, we will submit the application for production approval. We expect to obtain production approval by the end of 2014. We expect to incur a cost of approximately RMB4.2 million (approximately $0.65 million) to run Phase III clinical trials from 2012 to 2014.

  
Dencichine for Injection - is designed to treat hemorrhage diseases, such as stop or reduce bleeding during/after operations. The pharmacology and toxicology studies are almost finished and the results demonstrate that Dencichine for Injection shows high effectiveness and high safety both in our internal animal models tests and the test conducted by Nanjing Evaluation and Research Center. Now we are conducting additional pharmacodynamics experiment to observe Dencichine for Injection’s function on treating thrombocytopenia in patients undergoing chemotherapy. We will submit our application for clinical trials to State Food and Drug Administration (SFDA) after getting the result of the pharmacodynamics experiment and now it’s difficult to anticipate how long time the pharmacodynamics experiment will take. Assuming required governmental approvals are obtained in a timely fashion, we anticipate that production and marketing of the product will begin in 2014. Dencichine for Injection is a drug requiring extensive testing by the national SFDA, including neurotoxicity testing, which may take a significant amount of time. In addition, clinical testing and audit processes are out of our control, so we must allow for additional time. We incurred approximately RMB658,404 (approximately $101,939) in 2011 and expect to incur approximately RMB4 to 6 million (approximately $0.6 million to $0.9 million) from 2012 to 2014 in connection with clinical trials.

  
Sh1002 - is designed to treat one of complications of diabetes mellitus: retinal vascular lesions. We submitted Investigational New Drug Application (IND) for Sh1002 to FDA in October 2010 and have been approved to start IND study after December 24, 2010. The application for clinical trials for Sh1002 in America has also been approved by FDA and the Phase I clinical trial started in the second quarter of 2011 and a group consisted of 18 patient cases accepted the Phase I clinical trial and no one has any adverse drug reactions. With the completion of the Phase I clinical trial in January 2012, we are now preparing for the Phase II clinical trials. We plan to continue conducting the Phase II clinical trials in America and then license our technology to a foreign pharmaceutical company, while retaining the China domestic marketing and the global manufacturing right of Sh1002. We incurred approximately $303,335 for Phase I clinical trials and the preparation for Phase II clinical trials in 2011. Approximately $1.5 million is expected to be expended for Phase II clinical trials.

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.

 
4

 
 
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.

 
5

 
 
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.

 
6

 
 
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.

 
7

 
 
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):
 
   
Three months ended March 31,
             
   
2012
   
2011
   
Change ($)
   
Variance (%)
 
   
Unaudited
   
Unaudited
             
Sales
  $ 11,372,453     $ 9,441,626       1,930,827       20.5 %
Cost of Sales
    4,669,455       3,805,692       863,763       22.7 %
Gross Margin
    6,702,998       5,635,934       1,067,064       18.9 %
Operating Expenses:
                               
   Selling expenses
    5,168,179       4,076,430       1,091,749       26.8 %
   General and administrative expenses
    1,378,138       1,030,215       347,923       33.8 %
   Research and development expenses
    231,947       121,725       110,222       90.6 %
                                 
(Loss) Income from Operations
    (75,266 )     407,564       (482,830 )     -118.5 %
                                 
Other Expenses
    (492,428 )     (306,883 )     (185,545 )     60.5 %
 (Loss) Income Before Income Tax Expenses
    (567,694 )     100,681       (668,375 )     -663.9 %
   Income taxes benefit (expense)
    121,073       (14,980 )     136,053       -908.2 %
Net (Loss) Income
    (446,621 )     85,701       (532,322 )     -621.1 %
   Net loss attributable to non-controlling  interests
    (2,239 )     (13,672 )     11,433       -83.6 %
Net (Loss ) Income Attributable to Stockholders
  $ (444,382 )     99,373       (543,755 )     -547.2 %
Basic and diluted (loss) earnings per share
  $ (0.02 )     0.01       (0.03 )     -300.00 %
Weighted-average number of shares outstanding-basic and diluted
    19,679,400       19,679,400       -       -  
 
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.
 
 
8

 
 
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.
 
 
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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:

  
cash flow from operating activities;

  
new borrowings and credit facilities to be obtained; and

  
revolving of existing borrowings.
 
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.
 
Cash flow 
 
 
Three months ended March 31,
 
 
2012
   
2011
 
  Unaudited     Unaudited  
 
In thousands
 
Net cash provided by operating activities
  $ 896,967     $ 2,609,836  
Net cash used in investing activities
    (664,383 )     (2,290,810 )
Net cash provided by (used in) financing activities
    5,184,230       (593,741 )
Cash and Cash Equivalents at End of Period
  $ 6,676,938     $ 1,409,304  
 
 
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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.
 
 
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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.
 
 
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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
 
Smaller reporting companies are not required to provide the information required by this Item.
 
ITEM 4T. CONTROLS AND PROCEDURES
 
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.

 
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PART II - OTHER INFORMATION
 
ITEM 6. EXHIBITS
 
Exhibit Number
 
Description of Exhibit
     
 
English translation of Borrowing Contract, dated March 30, 2012 by and between Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. and Kunming Land and Mine Reserve Center.
     
 
English translation of Loan Contract , dated April 19, 2012, by and between Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. And Agricultural Bank of China.
     
 
English translation of Mortgage Contract (Machinery as Collateral), dated April 19, 2012, by and by and between Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. And Agricultural Bank of China.
     
 
English translation of Mortgage Contract (Real Estate as Collateral), dated April 19, 2012, by and by and between Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. And Agricultural Bank of China.
     
 
Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a).
     
 
Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a).
     
 
Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
     
101.INS*
 
XBRL Instance Document
     
101.SCH*
 
XBRL Taxonomy Extension Schema Document
     
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB*
 
XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE*
 
XBRL Taxonomy Extension Presentation Linkbase Document
________
* 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.

 
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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 SHENGHUO PHARMACEUTICAL HOLDINGS, INC.  
    (Registrant)  
       
May 30, 2012
By:
/s/ Feng Lan  
    Feng Lan  
    Chief Executive Officer and President  
    (Principal Executive Officer)  
 
 
 
 
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