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EX-31.2 - CERTIFICATION - CHINA JO-JO DRUGSTORES, INC.f10q0914ex31ii_chinajojo.htm
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EXCEL - IDEA: XBRL DOCUMENT - CHINA JO-JO DRUGSTORES, INC.Financial_Report.xls

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2014

 

or

 

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

 

For the transition period from  _______________ to ___________________
 
Commission File Number: 001-34711

 

CHINA JO-JO DRUGSTORES, INC.
(Exact name of registrant as specified in its charter)

 

Nevada   98-0557852

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer 

Identification No.)

     

1st Floor, Yuzheng Plaza, No. 76,

Yuhuangshan Road, Hangzhou, Zhejiang Province

People’s Republic of China

 

310002

   (Address of principal executive offices)   (Zip Code)

 

+86 (571) 88077078
(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

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  ☐ Accelerated Filer                    ☐
Non-accelerated filer      ☐ (Do not check if a smaller reporting company) Smaller reporting company    ☒

 

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

 

As of November 7, 2014, the registrant had 15,035,504 shares of common stock, par value $0.001 per share, outstanding.

 

 

 
 

  

TABLE OF CONTENTS

 

TO QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2014

 

    Page
PART I FINANCIAL INFORMATION  
Item 1. Financial Statements 4
  Unaudited Condensed Consolidated Balance Sheets as of September 30, 2014 and March 31, 2014  
  Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income for the Three and Six Months ended September 30, 2014 and 2013 5 
  Unaudited Condensed Consolidated Statements of Cash Flows for the Three and Six Months Ended September 30, 2014 and 2013 6
  Notes to Unaudited Condensed Consolidated Financial Statements 7 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations  
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures  
    33
PART II OTHER INFORMATION  
Item 5. Other Information 34
Item 6. Exhibits 34
Signatures 35

  

2
 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

 

All statements contained in this Quarterly Report on Form 10-Q (“Form 10-Q”) for the registrant, other than statements of historical facts, that address future activities, events or developments are forward-looking statements, including, but not limited to, statements containing the words “believe,” “anticipate,” “expect” and words of similar import. These statements are based on certain assumptions and analyses made by us in light of our experience and our assessment of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. However, whether actual results will conform to the expectations and predictions of management is subject to a number of risks and uncertainties that may cause actual results to differ materially.

 

Such risks include, among others, the following: national and local general economic and market conditions: our ability to sustain, manage or forecast our growth; raw material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other factors referenced in this and previous filings.

 

Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by management will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our business operations.

 

3
 

 PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CHINA JO-JO DRUGSTORES, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

   September 30,   March 31, 
   2014   2014 
         
ASSETS        
         
CURRENT ASSETS        
Cash  $7,352,723   $4,445,276 
Restricted cash   5,485,545    3,114,543 
Notes receivable   65,000    - 
Trade accounts receivable, net   6,733,217    6,734,536 
Inventories   8,421,989    7,047,397 
Other receivables, net   792,852    149,546 
Advances to suppliers, net   2,082,163    4,577,194 
Other current assets   1,472,693    1,663,102 
Total current assets   32,406,182    27,731,594 
           
PROPERTY AND EQUIPMENT, net   8,828,548    9,412,688 
           
OTHER ASSETS          
Farmland assets   1,373,425    1,371,735 
Long term deposits   2,452,191    2,786,437 
Other noncurrent assets   2,853,797    3,036,930 
Intangible assets, net   1,555,478    1,569,443 
Total other assets   8,234,891    8,764,545 
           
Total assets  $49,469,621   $45,908,827 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
CURRENT LIABILITIES          
Short-term loan payable  $32,500   $162,300 
Accounts payable, trade   14,014,983    14,554,726 
Notes payable   11,205,188    7,820,718 
Other payables   2,056,070    1,282,211 
Other payables - related parties   1,906,973    2,384,294 
Loan from third parties   234,812    294,042 
Customer deposits   3,599,840    3,185,885 
Taxes payable   417,768    373,501 
Accrued liabilities   689,973    1,208,242 
Total current liabilities   34,158,107    31,265,919 
           
Purchase option and warrant liability   202,559    278,916 
Total liabilities   34,360,666    31,544,835 
           
COMMITMENTS AND CONTINGENCIES          
           
STOCKHOLDERS' EQUITY          
Preferred stock; $0.001 par value; 10,000,000 shares authorized; nil issued and outstanding   as of September 30, 2014 and March 31, 2014   -    - 
Common stock; $0.001 par value; 250,000,000 shares authorized; 15,035,504 and 14,416,022   shares issued and outstanding as of September 30, 2014 and March 31, 2014   15,036    14,416 
Additional paid-in capital   18,427,053    17,355,555 
Statutory reserves   1,309,109    1,309,109 
Accumulated deficit   (8,643,697)   (8,260,767)
Accumulated other comprehensive income   3,963,596    3,905,136 
Total stockholders' equity   15,071,097    14,323,449 
           
Noncontrolling interests   37,858    40,543 
Total equity   15,108,955    14,363,992 
           
Total liabilities and stockholders' equity  $49,469,621   $45,908,827 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4
 

  

CHINA JO-JO DRUGSTORES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

 

   For the three months ended
September 30,
   For the six months ended
September 30,
 
   2014   2013   2014   2013 
REVENUES, NET  $18,444,065   $16,855,421   $34,903,297   $32,191,940 
                     
COST OF GOODS SOLD   15,678,808    13,907,018    29,627,421    25,642,368 
                     
GROSS PROFIT   2,765,257    2,948,403    5,275,876    6,549,572 
                     
SELLING EXPENSES   1,933,780    2,979,131    3,702,357    4,659,973 
GENERAL AND ADMINISTRATIVE EXPENSES   746,175    491,981    1,827,376    3,132,799 
TOTAL OPERATING EXPENSES   2,679,955    3,471,112    5,529,733    7,792,772 
                     
INCOME (LOSS)  FROM OPERATIONS   85,302    (522,709)   (253,857)   (1,243,200)
                     
OTHER (LOSS) INCOME, NET   (52,692)   37,021    (168,528)   (3,392)
CHANGE IN FAIR VALUE OF DERIVATIVE LIABILITIES   (47,342)   (21,049)   76,357    (8,384)
                     
LOSS BEFORE INCOME TAXES   (14,732)   (506,737)   (346,028)   (1,254,976)
                     
PROVISION FOR INCOME TAXES   22,680    39,589    38,821    79,109 
                     
NET LOSS   (37,412)   (546,326)   (384,849)   (1,334,085)
                     
ADD: NET LOSS ATTRIBUTABLE TO NONCONTROLLING INTEREST   1,219    264    1,919    507 
                     
NET LOSS ATTRIBUTABLE TO CHINA JO-JO DRUGSTORES, INC.   (36,193)   (546,062)   (382,930)   (1,333,578)
                     
OTHER COMPREHENSIVE INCOME                    
Foreign currency translation adjustments   6,192    259,814    58,460    1,019,605 
                     
COMPREHENSIVE INCOME (LOSS)  $(30,001)   $(286,248)  $(324,470)  $(313,973)
                     
WEIGHTED AVERAGE NUMBER OF SHARES:                    
Basic   14,981,637    13,609,003    14,700,375    13,609,003 
Diluted   14,981,637    13,609,003    14,700,375    13,609,003 
                     
LOSS PER SHARES:                    
Basic  $(0.00)  $(0.04)  $(0.03)  $(0.10)
Diluted  $(0.00)  $(0.04)  $(0.03)  $(0.10)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5
 

 

CHINA JO-JO DRUGSTORES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Six months ended
September 30,
 
   2014   2013 
CASH FLOWS FROM OPERATING ACTIVITIES:        
Net loss  $(384,849)  $(1,334,085)
Adjustments to reconcile net (loss) income to net cash provided by (used in)
   operating activities:
          
Depreciation and amortization   832,570    1,140,586 
Stock-based compensation   129,692    58,801 
Bad debt provision   (1,611,497)   (747,930)
Inventory reserve   136,575    - 
Change in fair value of purchase option derivative liability   (76,357)   8,384 
Change in operating assets:          
Accounts receivable, trade   694,722    972,975 
Notes receivable   (64,932)   - 
Inventories   (1,501,054)   (3,361,143)
Other receivables   (425,699)   (262,493)
Advances to suppliers   3,207,686    5,117,601 
Other current assets   192,254    (849,209)
Long term deposit   337,326    - 
Other noncurrent assets   186,680    92,785 
Change in operating liabilities:          
Accounts payable, trade   (557,095)   5,323,371 
Other payables and accrued liabilities   252,409    (654,911)
Customer deposits   409,600    (2,925,130)
Taxes payable   43,762    (45)
Net cash provided by operating activities   1,801,793    2,579,557 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchase of equipment   (246,097)   (54,413)
Increase in long-term deposits  for land use right   -    (1,351,030)
Additions to leasehold improvements   (12,485)   (26,619)
Payments on construction-in-progress   -    (111,524)
Net cash used in investing activities   

(258,582

)   (1,543,586)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Proceeds from short-term bank loan   32,466    161,770 
Repayment of short-term bank loan   (162,330)   - 
Repayment of  third parties loan   (59,529)   - 
Change in restricted cash   (2,364,687)   245,504 

    Repayments of notes payable

   (7,822,163)   (795,002)
Proceeds from notes payable   11,193,465    - 
Proceeds from other payables-related parties   463,848   879,958 
Net cash provided by financing activities   1,281,070    492,230 
           
EFFECT OF EXCHANGE RATE ON CASH   83,166    244,420 
           
INCREASE IN CASH   2,907,447    1,772,621 
           
CASH, beginning of period   4,445,276    4,524,094 
           
CASH, end of period  $7,352,723   $6,296,715 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid for interest  $1,458   $- 
Cash paid for income taxes  $43,788   $12,797 
Issuance of common stocks in exchange of debts  $941,613   $- 
Reclassification of leasehold improvement to equipment  $37,011   $- 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

6
 

 

CHINA JO-JO DRUGSTORES, INC., AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1– DESCRIPTION OF BUSINESS AND ORGANIZATION

 

China Jo-Jo Drugstores, Inc. (“Jo-Jo Drugstores” or the “Company”), was incorporated in Nevada on December 19, 2006, originally under the name “Kerrisdale Mining Corporation.” On September 24, 2009, the Company changed its name to “China Jo-Jo Drugstores, Inc.” in connection with a share exchange transaction as described below.

 

On September 17, 2009, the Company completed a share exchange transaction with Renovation Investment (Hong Kong) Co., Ltd. (“Renovation”), whereby 7,900,000 shares of common stock were issued to the stockholders of Renovation in exchange for 100% of the capital stock of Renovation. The completion of the share exchange transaction resulted in a change of control. The share exchange transaction was accounted for as a reverse acquisition and recapitalization and, as a result, the consolidated financial statements of the Company (the legal acquirer) is, in substance, those of Renovation (the accounting acquirer), with the assets and liabilities, and revenues and expenses, of the Company being included effective from the date of the share exchange transaction. Renovation has no substantive operations of its own except for its holdings of Zhejiang Jiuxin Investment Management Co., Ltd. (“Jiuxin Management”), Zhejiang Shouantang Medical Technology Co., Ltd. (“Shouantang Technology”) and Hangzhou Jiutong Medical Technology Co., Ltd (“Jiutong Medical”), its wholly-owned subsidiaries.

 

The Company is a retail and wholesale distributor of pharmaceutical and other healthcare products in the People’s Republic of China (“China” or the “PRC”). The Company’s retail business is comprised primarily of pharmacies, which are operated by Hangzhou Jiuzhou Grand Pharmacy Chain Co., Ltd. (“Jiuzhou Pharmacy”), a company that the Company controls through contractual arrangements. One drugstore previously operated by Hangzhou Quannuo Grand Pharmacy Co., Ltd. (“Hangzhou Quannuo”) which closed as of March 31, 2013; however, as of September 30, 2014, Hangzhou Quannuo has not been dissolved although it had no operation. Hangzhou Quannuo is the wholly-owned subsidiary of Zhejiang Quannuo Internet Technology Co., Ltd. (“Quannuo Technology”), which is wholly-owned by Shouantang Technology.

 

The Company’s retail business also includes two medical clinics through Hangzhou Jiuzhou Clinic of Integrated Traditional and Western Medicine (“Jiuzhou Clinic”) and Hangzhou Jiuzhou Medical and Public Health Service Co., Ltd. (“Jiuzhou Service”), both of which are also controlled by the Company through contractual arrangements. In addition, Jiuzhou Service established Hangzhou Shouantang Health Management Co. Ltd (“Shouantang Health”) in December 2013 and holds 51% equity interests in Shouantang Health.

 

The Company’s wholesale business is primarily conducted through Zhejiang Jiuxin Medicine Co., Ltd. (“Jiuxin Medicine”), which is licensed to distribute prescription and non-prescription pharmaceutical products throughout China. Jiuzhou Pharmacy acquired Jiuxin Medicine on August 25, 2011.

 

The Company’s herb farming business is conducted by Hangzhou Qianhong Agriculture Development Co., Ltd. (“Qianhong Agriculture”), a wholly-owned subsidiary of Jiuxin Management, which operates a cultivation project of herbal plants used for traditional Chinese medicine (“TCM”).

 

7
 

 

The accompanying consolidated financial statements reflect the activities of the Company and each of the following entities:

 

Entity Name   Background   Ownership
Renovation    ● Incorporated in Hong Kong SAR on September 2, 2008   100%
         
Jiuxin Management  

● Established in the PRC on October 14, 2008

● Deemed a wholly foreign owned enterprise (“WFOE”) under PRC law

● Registered capital of $4.5 million fully paid

  100%
         
Shouantang Technology  

● Established in the PRC on July 16, 2010 by Renovation

● Registered capital of $20 million

● Registered capital requirement reduced by the SAIC to $11 million in July 2012 and is fully paid

● Deemed a WFOE under PRC law

● Invests and finances the working capital of Quannuo Technology

  100%
         
Qianhong Agriculture   

● Established in the PRC on August 10, 2010 by Jiuxin Management

● Registered capital of RMB 10 million fully paid

● Carries out herb farming business

  100% 
         
Quannuo Technology  

● Established in the PRC on July 7, 2009

● Registered capital of RMB 10 million fully paid

● Acquired by Shouantang Technology in November 2010

● Operates the Company’s online pharmacy website and provide software and technical support

  100%
         
Hangzhou Quannuo  

● Established in the PRC on July 8, 2010 by Quannuo Technology

● Registered capital of RMB 800,000 fully paid

● Currently has no operation and has closed, pending dissolution

  100%
         
Jiuzhou Pharmacy (1)   

● Established in the PRC on September 9, 2003

● Registered capital of RMB 5 million fully paid

● Operates the “Jiuzhou Grand Pharmacy” stores in Hangzhou

  VIE by contractual  arrangements (2)
         
Jiuzhou Clinic (1)  

● Established in the PRC as a general partnership on October 10, 2003

● Operates a medical clinic adjacent to one of Jiuzhou Pharmacy’s stores

 

VIE by contractual arrangements (2)

 

         
Jiuzhou Service (1)  

● Established in the PRC on November 2, 2005

● Registered capital of RMB 500,000 fully paid

● Operates a medical clinic adjacent to one of Jiuzhou Pharmacy’s stores

 

VIE by contractual  arrangements (2)

 

         
Jiuxin Medicine    

● Established in PRC on December 31, 2003

● Acquired by Jiuzhou Pharmacy in August 2011

● Registered capital of RMB 10 million fully paid

● Carries out pharmaceutical distribution services

  VIE by contractual arrangements as a wholly-owned subsidiary of Jiuzhou Pharmacy (2)
         
Jiutong Medical    

● Established in the PRC on December 20, 2011 by Renovation

● Registered capital of $2.6 million fully paid

● Currently has no operation

  100% 
         
Shouantang Health  

● Established in the PRC on December 18, 2013 by Jiuzhou Service

● Registered capital of RMB 500,000 fully paid

● 51% held by Jiuzhou Service

● Currently has no operations

 

VIE by contractual arrangements as a

controlled entity of Jiuzhou Service (2)

 

8
 

 

(1) Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service have been under the common control of Renovation ( the “Owner”) since their respective establishment dates, pursuant to agreements amongst the Owner to vote their interests in concert as memorialized in a voting agreement. Based on such voting agreement, the Company has determined that common control exists among these three companies. Operationally, the Owner has operated these three companies in conjunction with one another since each company’s respective establishment date. Jiuxin Medicine is also deemed under the common control of the Owner as a subsidiary of Jiuzhou Pharmacy, as is Shouantang Health as a subsidiary of Jiuzhou Service.

 

(2) To comply with certain foreign ownership restrictions of pharmacy and medical clinic operators, Jiuxin Management entered into a series of contractual arrangements with Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service on August 1, 2009. These contractual arrangements are comprised of five agreements: consulting services agreement, operating agreement, equity pledge agreement, voting rights agreement and option agreement. As a result of these agreements, which obligate Jiuxin Management to absorb all of the risks of loss from the activities of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, and enable the Company (through Jiuxin Management) to receive all of their expected residual returns, the Company accounts for all three companies (as well as the two subsidiaries of Jiuzhou Pharmacy) as a variable interest entity (“VIE”) under the accounting standards of the Financial Accounting Standards Board (“FASB”). Accordingly, the financial statements of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, as well as Shouantang Health, the subsidiaries and entity under the control of Jiuzhou Service, are consolidated into the financial statements of the Company.

 

Note 2 – LIQUIDITY

 

Our accounts have been prepared in accordance with U.S. GAAP on a going concern basis. The going concern basis assumes that assets are realized and liabilities are extinguished in the ordinary course of business at amounts disclosed in the financial statements. Our ability to continue as a going concern depends upon aligning our sources of funding (debt and equity) with our expenditure requirements and repayment of the short-term debts as and when they become due.

 

The drug retail business is a highly competitive industry in PRC. Several large drugstore chains and a variety of single stores operate in Hangzhou City and Zhejiang Province. The Company closed unprofitable stores, including those in Shanghai in fiscal 2013 and 2014. The remaining existing drugstores have historically been profitable and are not expected to require additional financing.

 

The Company’s principal sources of liquidity consist of existing cash, bank facilities from local banks as well as personal loans from its principal shareholders if necessary. The Company has three credit line agreements from three local banks as displayed in detail in Note 12. The three credit lines from Hangzhou United Bank (“HUB”), Bank of Hangzhou (“BOH”) and Industrial and Commercial Bank of China (“ICBC”) allow the Company to borrow up to $9.99 million in sum. Any borrowing therefrom is guaranteed by a third-party guarantor company, and secured by the Company’s assets pursuant to a collateral agreement, as well as personal guarantees of some of its principal shareholders.

 

The Company has taken measures to reduce its losses and generate positive cash flow by accelerating cash or goods collections from suppliers against advances, and attracting talent to improve and enhance traditional retail pharmacy plus in-store clinic business. In its retail sector, the Company has closed five unprofitable pharmacies in Shanghai last fiscal year and is looking to open additional in-store clinics to attract customer traffic. The remaining stores are considered profitable and are currently generating positive cash flow. The drug wholesale industry is usually marked with low profit margin. However, as the Company is strengthening its customer and supplier credit policy and ceased extremely low profit margin transactions that cannot cover related overhead, it does not expect a significant loss in the future.  The Company has gradually settled and collected certain aged accounts during the six months ended September 30, 2014. The wholesale business is not expected to contribute a significant gross margin for the remaining of fiscal 2015, and sales have been projected to be approximately the same as the prior year. Farming business is not expected to have any sales and may incur limited operating costs. Retail drugstores have been projected to increase as compared to the prior year with lower profit margins. During the six months ended September 30, 2014, the drugstore sales have increased by 20.4% over the same period of last year. The rising sales contributed to our positive operation cash flow. Online pharmacy sales are expected to grow significantly with similar profit margin as compared to the prior year. During the six months ended September 30, 2014, the online pharmacy sales have increased by 92.7% over the same period of last year. As of September 30, 2014, approximately $4.22 million bank credit line has not been used and is still available for further borrowing. Management believes that the foregoing measures collectively will provide sufficient liquidity for the Company to meet its future liquidity and capital obligations in the next twelve months.

 

However, in the event the banks withdraw their credit lines with the Company, or the Company’s existing store performance suddenly deteriorate due to unexpected government policy change, or its operating license is cancelled as a result of violation of industry regulation, the Company may or may not obtain alternative financing resources to support its continuing operation. At that time, the Company may not be able to continue to present itself on a going concern basis.

  

Note 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of presentation and consolidation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“US GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. These condensed consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the fiscal year ended March 31, 2014 filed with the SEC on June 27, 2014. Operating results for the three and six months ended September 30, 2014 may not be necessarily indicative of the results that may be expected for the full year.

 

9
 

 

The condensed consolidated financial statements include the financial statements of the Company, its subsidiaries and VIEs.  All significant inter-company transactions and balances between the Company, its subsidiaries and VIEs are eliminated upon consolidation.

 

Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no effect on net income or cash flows as previously reported.

 

Consolidation of variable interest entities

 

In accordance with accounting standards regarding consolidation of variable interest entities, VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.

 

The Company has concluded, based on the contractual arrangements, that Jiuzhou Pharmacy (including its subsidiaries and controlled entities), Jiuzhou Clinic and Jiuzhou Service are each a VIE and that the Company’s wholly-owned subsidiary, Jiuxin Management, absorbs a majority of the risk of loss from the activities of these companies, thereby enabling the Company, through Jiuxin Management, to receive a majority of their respective expected residual returns.

 

Additionally, as Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service are under common control, the consolidated financial statements have been prepared as if the transactions had occurred retroactively as to the beginning of the reporting period of these consolidated financial statements.

 

Control and common control are defined under the accounting standards as “an individual, enterprise, or immediate family members who hold more than 50 percent of the voting ownership interest of each entity.” Because the Owners collectively own 100% of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, and have agreed to vote their interests in concert since the establishment of each of these three companies as memorialized the Voting Rights Proxy Agreement, the Company believes that the Owners collectively have control and common control of the three companies. Accordingly, the Company believes that Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service were constructively held under common control by Jiuxin Management as of the time the Contractual Agreements were entered into, establishing Jiuxin Management as their primary beneficiary. Jiuxin Management, in turn, is owned by Renovation, which is owned by the Company.  

  

Risks and Uncertainties

 

The operations of the Company are located in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by political, economic, and legal environments in the PRC, as well as by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political, regulatory and social conditions in the PRC. Although the Company has not experienced losses from these situations and believes that it is in compliance with existing laws and regulations including its organization and structure disclosed in Note 1, this may not be indicative of future results.

 

The Company has significant cash deposits with suppliers in order to obtain and maintain inventory. The Company’s ability to obtain products and maintain inventory at existing and new locations is dependent upon its ability to post and maintain significant cash deposits with its suppliers. In the PRC, many vendors are unwilling to extend credit terms for product sales that require cash deposits to be made. The Company does not generally receive interest on any of its supplier deposits, and such deposits are subject to loss as a result of the creditworthiness or bankruptcy of the party who holds such funds, as well as the risk from illegal acts such as conversion, fraud, theft or dishonesty associated with the third party. If these circumstances were to arise, the Company would find it difficult or impossible, due to the unpredictability of legal proceedings in China, to recover all or a portion of the amount on deposit with its vendors or landlords.

 

Members of the current management team own controlling interests in the Company and are also the Owners of the VIEs in the PRC.  The Company only controls the VIEs through contractual arrangements which obligate it to absorb the risk of loss and to receive the residual expected returns.  As such, the controlling shareholders of the Company and the VIEs could cancel these agreements or permit them to expire at the end of the agreement terms, as a result of which the Company would not retain control of the VIEs.

 

Use of estimates

 

The preparation of unaudited condensed consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The significant estimates made in the preparation of the accompanying unaudited condensed consolidated financial statements relate to the assessment of the carrying values of accounts receivable, advances to suppliers and related allowance for doubtful accounts, useful lives of property and equipment, inventory reserve and fair value of its purchase option derivative liability. Because of the use of estimates inherent in the financial reporting process, actual results could materially differ from those estimates.

 

10
 

 

Revenue recognition

 

Revenue from sales of prescription medicine at the drugstores is recognized when the prescription is filled and the customer picks up and pays for the prescription.

 

Revenue from sales of other merchandise at the drugstores is recognized at the point of sale, which is when a customer pays for and receives the merchandise. Sales of drugs reimbursed by the local government medical insurance agency and receivables from the agency are recognized when a customer pays for the drugs at a store. Based on historical experience, a reserve for potential loss from denial of reimbursement on certain unqualified drugs is made to the receivables from the government agency.

 

Revenue from medical services is recognized after the service has been rendered to a customer.

 

Revenue from online pharmacy sales is recognized when merchandise is delivered to customers. While most deliveries take one day, certain deliveries may take longer depending on a customer’s location. Any loss caused in a shipment will be reimbursed by the Company’s courier company. In addition, a proper sales discount is made to account for the potential loss from returns from customers. Historically, sales returns have been minimal.

 

Revenue from sales of merchandise to non-retail customers is recognized when the following conditions are met: (1) persuasive evidence of an arrangement exists (sales agreements and customer purchase orders are used to determine the existence of an arrangement); (2) delivery of goods has occurred and risks and benefits of ownership have been transferred, which is when the goods are received by the customer at its designated location in accordance with the sales terms; (3) the sales price is fixed or determinable; and (4) collectability is probable. Historically, sales returns have been minimal.

 

The Company’s revenue is net of value added tax (“VAT”) collected on behalf of PRC tax authorities in respect to the sales of merchandise. VAT collected from customers, net of VAT paid for purchases, is recorded as a liability in the accompanying consolidated balance sheets until it is paid to the relevant PRC tax authorities.

 

Restricted cash

 

The Company’s restricted cash consists of cash in a bank as security for its notes payable. The Company has notes payable outstanding with the bank and is required to keep certain amounts on deposit that are subject to withdrawal restrictions. The notes payable are generally short term in nature due to their short maturity period of six to nine months; thus, restricted cash is classified as a current asset.

 

Accounts receivable

 

Accounts receivable represents the following: (1) amounts due from banks relating to retail sales that are paid or settled by the customers’ debit or credit cards, (2) amounts due from government social security bureaus and commercial health insurance programs relating to retail sales of drugs, prescription medicine, and medical services that are paid or settled by the customers’ medical insurance cards, and (3) amounts due from non-retail customers for sales of merchandise. 

 

Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as necessary. In its wholesale business, the Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, bad debt percentages are determined by management, based on historical experience and the current economic climate, are applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. The Company also reviews historical trend and will provide additional allowance if it determines a particular account has become uncollectible. The ability to collect is attributed to the steps taken prior to extending credit to customers.  Account balances are written off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. To accommodate for potential loss in accounts receivable, the Company puts up a reserve for what we do not believe to be collectible, and most aged receivables have been reserved. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate.

 

In its retail business, accounts receivable mainly consist of reimbursements due from the government insurance bureaus and commercial health insurance programs and are usually collected within two or three months. The Company directly writes off delinquent account balances, which is determined to be uncollectible after confirming with the appropriate bureau or program each month. Additionally, the Company also makes estimated reserves on related outstanding accounts receivable based on historical trend.

 

11
 

 

Inventories

 

Inventories are stated at the lower of cost or market value. Cost is determined by the first in first out (FIFO) method. Market value is the lower of replacement cost or net realizable value. The Company carries out physical inventory counts on a monthly basis at each store and warehouse. Herbs that the Company farms are recorded at their costs, which includes direct costs such as seed selection, fertilizer, and labor costs that are spent in growing herbs on the leased farmland, and indirect costs such as amortization of farmland development costs. Since April 2014, amortization of farmland development costs has been expensed instead of allocated into inventory due to unpredictable future market value of planted gingko trees. All costs are accumulated until the time of harvest and then allocated to harvested herbs when they are sold. The Company periodically reviews its inventory and records write-downs to inventories for shrinkage losses and damaged merchandise that are identified. The Company provides a reserve for estimated inventory obsolescence or excess quantities on hand equal to the difference between the cost of the inventory and its estimated realizable value. 

 

Property and equipment

 

Property and equipment are stated at cost, net of accumulated depreciation or amortization. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets, taking into consideration the assets’ estimated residual value. Leasehold improvements are amortized over the shorter of lease term or remaining lease period of the underlying assets. Following are the estimated useful lives of the Company’s property and equipment:

 

   Estimated Useful Life
Leasehold improvements  3-10 years
Motor vehicles  3-5 years
Office equipment & furniture  3-5 years
Buildings  35 years

 

Maintenance, repairs and minor renewals are charged to expenses as incurred. Major additions and betterment to property and equipment are capitalized.

  

Intangibles

 

Intangible assets are acquired individually or as part of a group of assets, and are initially recorded at their fair value.  The cost of a group of assets acquired in a transaction is allocated to the individual assets based on their relative fair values.

 

The estimated useful lives of the Company’s intangible assets are as follows:

 

   Estimated Useful Life
Land use right  50 years
Software  3 years

 

The Company evaluates intangible assets for impairment whenever events or changes in circumstances indicate that the assets might be impaired. 

 

Impairment of long lived assets

 

The Company evaluates long lived tangible and intangible assets for impairment, whenever events or changes in circumstances indicate that the carrying value may not be recoverable from its estimated future cash flows. Recoverability is measured by comparing the assets’ net book value to the related projected undiscounted cash flows from these assets, considering a number of factors including past operating results, budgets, economic projections, market trends and product development cycles. If the net book value of the asset exceeds the related undiscounted cash flows, the asset is considered impaired, and a second test is performed to measure the amount of impairment loss. There was no additional impairment occurred during fiscal 2015.

 

Notes payable

 

During the normal course of business, the Company regularly issues bank acceptance bills as a payment method to settle outstanding accounts payables with various material suppliers. The Company records such bank acceptance bills as notes payable. Such notes payable are generally short term in nature due to their short maturity period of six to nine months.

 

Income taxes

 

The Company records income taxes pursuant to the accounting standards for income taxes. These standards require the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consists of taxes currently due and the net change in deferred taxes.  A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized.

 

The accounting standards clarify the accounting and disclosure requirements for uncertain tax positions and prescribe a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. The accounting standards also provide guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.  No significant penalties, uncertain tax provisions or interest relating to income taxes were incurred during the periods ended September 30, 2014 and 2013.

 

 

12
 

 

Value added tax

 

Sales revenue represents the invoiced value of goods, net of VAT. All of the Company’s products are sold in the PRC and are subjected to a VAT on the gross sales price. The VAT rates range up to 17%, depending on the type of products sold. The VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing or acquiring its finished products. The Company recorded a VAT payable net of payments in the accompanying financial statements. 

 

Stock based compensation

 

The Company follows the provisions of ASC 718, “Compensation — Stock Compensation,” which establishes accounting standards for non-employee and employee stock-based awards. Under the provisions of ASC 718, the fair value of stock issued is used to measure the fair value of services received as the Company believes such approach is a more reliable method of measuring the fair value of the services. For non-employee stock-based awards, fair value is measured based on the value of the Company’s common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty’s performance is complete. The fair value of the equity instrument is calculated and then recognized as compensation expense over the requisite performance period. For employee stock-based awards, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense with graded vesting on a straight–line basis over the requisite service period for the entire award.

 

Advertising and promotion costs

 

Advertising and promotion costs are expensed as incurred and amounted to $81,321 and $18,632 for three months ended September 30, 2014 and 2013, respectively, and $131,239 and $56,533 for the six months ended September 30, 2014 and 2013, respectively. Such costs consist primarily of print and promotional materials such as flyers to local communities.

 

Operating leases

 

The Company leases premises for retail drugstores, offices and wholesale warehouse under non-cancelable operating leases. Operating lease payments are expensed over the term of lease. A majority of the Company’s retail drugstore leases have a 3 to 8 year term with a renewal option upon the expiration of the lease; the wholesale warehouse lease has a 10-year term with a renewal option upon the expiration of the lease. The Company has historically been able to renew a majority of its drugstores leases. Under the terms of the lease agreements, the Company has no legal or contractual asset retirement obligations at the end of the lease. In addition, land leased from the government is amortized on a straight-line basis over a 30-year term.

 

Foreign currency translation

 

The Company uses the United States dollar (“U.S. dollars” or “USD”) for financial reporting purposes. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency the Renminbi (“RMB”), the currency of the PRC.  

 

In general, for consolidation purposes, the Company translates the assets and liabilities of its subsidiaries and VIEs into U.S. dollars using the applicable exchange rates prevailing at the balance sheet date, and the statements of income and cash flows are translated at average exchange rates during the reporting period. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the financial statements of the subsidiaries and VIEs are recorded as accumulated other comprehensive income.

 

The balance sheet amounts, with the exception of equity, at September 30, 2014 and March 31, 2014 were translated at 1 RMB to $0.1625 USD and at 1 RMB to $0.1623 USD, respectively. The average translation rates applied to income and cash flow statement amounts for the six months ended September 30, 2014 and 2013 were at 1 RMB to $0.1623 USD and at 1 RMB to $0.1618 USD, respectively.

 

13
 

 

Concentrations and credit risk

  

Certain financial instruments, which subject the Company to concentration of credit risk, consist of cash and restricted cash. The Company has cash balances at financial institutions located in Hong Kong and PRC. Balances at financial institutions in Hong Kong may, from time to time, exceed Hong Kong Deposit Protection Board’s insured limits. Balances at financial institutions and state-owned banks within the PRC are not covered by insurance. As of September 30, 2014 and March 31, 2014, the Company had deposits totaling $12,483,659 and $7,204,626 that were not covered by insurance, respectively. To date, the Company has not experienced any losses in such accounts.

 

For the three months ended September 30, 2014, the two largest vendors accounted for 29% of the Company’s total purchases and one vendor accounted for 19% of total advances to suppliers. For the three months ended September 30, 2013, no vendor accounted for more than 10% of the Company’s total purchases and one vendor accounted for 20% of total advances to suppliers.

 

For the six months ended September 30, 2014, the two largest vendors accounted for 27% of the Company’s total purchases and one vendor accounted for 19% of total advances to suppliers. For the six months ended September 30, 2013, one vendor accounted for approximately 10% of the Company’s total purchases and another vendor accounted for 20% of total advances to suppliers.

 

For the three months ended September 30, 2014, no customer accounted for more than 10% of the Company’s total sales or accounts receivable. For the three months ended September 30, 2013, no customer accounted for more than 10% of the Company’s total sales and one customer accounted for 12% of total accounts receivable.

 

For the six months ended September 30, 2014, no customer accounted for more than 10% of the Company’s total sales or accounts receivable. For the six months ended September 30, 2013, no customer accounted for more than 10% of the Company’s total sales, and one customer accounted for 12% of total accounts receivable.

 

Noncontrolling interest

 

As of September 30, 2014, Yi Wang, an individual, owned 49% of the equity interests of Shouantang Health, which was not under the Company’s control.

 

Recent Accounting Pronouncements

 

In April 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASU No. 2014-08"). Under ASU No. 2014-08, only disposals representing a strategic shift in operations should be presented as discontinued operations. ASU No. 2014-08 also requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in ASU No. 2014-08 are effective in the first quarter of 2015 for public business entities with annual periods beginning on or after December 15, 2014. Early adoption is permitted. The Company does not expect that the adoption of ASU No. 2014-08 will have a significant impact on the Company’s consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606. This Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this Update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to illustrate the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a cohesive set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a reporting organization’s contracts with customers. This ASU is effective for fiscal years, and interim periods within those years beginning after December 15, 2016 for public companies and 2017 for non-public entities. Management is evaluating the effect, if any, on the Company’s financial position and results of operations. 

 

NOTE 4 – TRADE ACCOUNTS RECEIVABLE

 

Trade accounts receivable consisted of the following:

 

   September 30,
2014
   March 31,
2014
 
Accounts receivable  $10,935,920   $11,869,866 
Less: allowance for doubtful accounts   (4,202,703)   (5,135,330)
Trade accounts receivable, net  $6,733,217   $6,734,536 

 

For the three months ended September 30, 2014 and 2013, $64,636 and $96,250 in accounts receivable were directly written off respectively. For the six months ended September 30, 2014 and 2013, $129,494 and $347,395 in accounts receivable were directly written off respectively.

 

14
 

 

Note 5 – OTHER CURRENT ASSETS

 

Other current assets consisted of the following:

 

  

September 30,

2014

  

March 31,

2014

 
Prepaid rental expenses  $986,565   $1,165,633 
Lease rights transfer fees (1)   -    11,939 
Prepaids and other current assets   486,128    485,530 
Total  $1,472,693   $1,663,102 

 

(1) Lease rights transfer fees are paid by the Company to secure store rentals in coveted areas. These additional costs of acquiring the right to lease new store locations are capitalized and amortized over the period of the initial lease term.

 

Note 6 – PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

  

September 30,

2014

  

March 31,

2014

 
Building  $1,140,816   $1,139,412 
Leasehold improvements   11,415,370    11,849,753 
Farmland improvements   1,462,925    1,037,212 
Office equipment and furniture   5,726,735    5,535,667 
Motor vehicles   642,656    579,834 
Total   20,388,502    20,141,878 
Less: Accumulated depreciation   (11,559,954)   (10,729,190)
Property and equipment, net  $8,828,548   $9,412,688 

 

Total depreciation expense for property and equipment was $322,362 and $512,065 for the three months ended September 30, 2014 and 2013, respectively, and $816,444 and $1,061,755 for the six months ended September 30, 2014 and 2013, respectively.   

  

 

Note 7 – ADVANCES TO SUPPLIERS

 

Advances to suppliers consist of deposits with or advances to outside vendors for future inventory purchases. Most of the Company’s vendors require a certain amount of money to be deposited with them as a guarantee that the Company will receive its purchases on a timely basis. This amount is refundable and bears no interest.  As of September 30, 2014 and March 31, 2014, advance to suppliers consist of the following:

 

  

September 30,

2014

  

March 31,

2014

 
Advance to suppliers  $7,965,478   $11,162,767 
Less: allowance for doubtful accounts   (5,883,315)   (6,585,573)
Advance to suppliers, net  $2,082,163   $4,577,194 

 

For the three months ended September 30, 2014 and 2013, none of advances to suppliers were written off against the allowance for doubtful accounts, respectively. For the six months ended September 30, 2014 and 2013, $0 and $452,246 of advances to suppliers were written off against the allowance for doubtful accounts, respectively.

 

15
 

 

Note 8 – INVENTORY

 

Inventory consisted of the following: 

 

   September 30,   March 31, 
   2014   2014 
Finished goods  $9,334,368   $7,822,102 
Work-in-process (1)   -    - 
Total inventory  $9,334,368   $7,822,102 
Less: reserve for inventory    (912,379)   (774,705)
Inventory, net  $8,421,989   $7,047,397 

 

(1) Work-in-process includes gingko trees expected to be harvested and sold in two or three years. Due to its long-term nature, $2,195,074 of work-in process and $821,649 of inventory reserve for gingko trees are reclassified to farmland assets as of September 30, 2014, respectively; and $2,192,372 of work-in process and $820,637 of inventory reserve for gingko trees are reclassified to farmland assets as of March 31, 2014, respectively.

 

Note 9 – LONG TERM DEPOSITS, LANDLORDS

 

Long term deposits are money deposited with or advanced to landlords for securing retail store leases for which the Company does not anticipate applying or being returned within the next twelve months. Most of the Company’s landlords require a minimum of nine months’ rent being paid upfront plus additional deposits.

 

Note 10 – OTHER NONCURRENT ASSETS

 

Other noncurrent assets consisted of the following:

 

  

September 30,

2014

  

March 31,

2014

 
Prepayment for lease of land use right – noncurrent, net(1)  $2,800,984   $2,878,687 
Long term prepaid expense   52,813    158,243 
Total   2,853,797    3,036,930 

 

(1) This is a payment made to a local government in connection with entering into a 30-year operating land lease agreement. The land is currently used to cultivate Ginkgo trees. This prepayment includes a deposit of $1,137,500, which will be refundable on the due date. Based on expected output from planted Gingko trees such as expected fruit production and tree market value, the fair value of the lease prepayment was lower than carrying cost. As a result, the Company recorded an impairment amounted to $2,475,688 on lease prepayment.

 

The amortization of the prepayment for the lease of land use right was approximately $16,761 and $40,577 for the three months ended September 30, 2014 and 2013, respectively. The amortization of the prepayment for the lease of land use right was approximately $33,517 and $80,885 for the six months ended September 30, 2014 and 2013, respectively.

 

The Company’s amortization of the prepayment for lease of land use right for the next five years and thereafter are as follows:

 

Periods ending September 30,  Amount 
2015  $67,035 
2016   67,035 
2017   67,035 
2018   67,035 
2019   67,035 
Thereafter   1,328,309 

  

Note 11– INTANGIBLE ASSETS

 

Net intangible assets consisted of the following at:

 

   September 30,
2014
   March 31,
2014
 
Land use rights (1)  $1,584,627   $1,582,677 
Software   474,672    474,088 
Total other intangible assets   2,059,299    2,056,765 
Less: accumulated amortization   (503,821)   (487,322)
Intangible assets, net  $1,555,478   $1,569,443 

 

 

16
 

 

Amortization expense of intangibles amounted to $7,864 and $39,584 for the three months ended September 30, 2014 and 2013, respectively, and $15,883 and $78,831 for the six months ended September 30, 2014 and 2013, respectively.

 

(1) In July 2013, the Company purchased the land use right of a plot of farmland in Lin’An, Hangzhou, intended for the establishment of an herb processing plant in the future. However, as our farming business in Lin’An has not grown, the Company does not expect completion of the plant in the near future.

  

Note 12 – NOTES PAYABLE

 

The Company has credit facilities with Hangzhou United Bank (“HUB”), Bank of Hangzhou (“BOH”) and Industrial and Commercial Bank of China (“ICBC”) that provided working capital in the form of the following bank acceptance notes at September 30 and March 31, 2014:

 

       Origination  Maturity  September 30,   March 31, 
Beneficiary  Endorser   date  date  2014   2014 
Jiuzhou Pharmacy(1)   ICBC    12/27/13   06/26/14  $-   $1,351,959 
Jiuzhou Pharmacy(1)   ICBC    10/11/13   04/11/14   -    730,350 
Jiuzhou Pharmacy(2)   HUB    10/08/13   04/08/14   -    486,900 
Jiuzhou Pharmacy(2)   HUB    11/05/13   05/05/14   -    1,720,380 
Jiuzhou Pharmacy(2)   HUB    12/26/13   06/26/14   -    117,960 
Jiuzhou Pharmacy(2)   HUB    02/07/14   05/07/14   -    649,200 
Jiuzhou Pharmacy(2)   HUB    02/07/14   08/07/14   -    985,161 
Jiuzhou Pharmacy(2)   HUB    03/06/14   09/06/14   -    1,778,808 
Jiuzhou Pharmacy(3)   HUB    04/08/14   10/08/14   882,375    - 
Jiuzhou Pharmacy(3)   HUB    05/04/14   11/04/14   1,963,000    - 
Jiuzhou Pharmacy(3)   HUB    08/04/14   02/04/15   1,478,750    - 
Jiuzhou Pharmacy(3)   HUB    08/05/14   08/04/15   1,625,000    - 
Jiuzhou Pharmacy(3)   HUB    09/03/14   03/03/15   1,803,750    - 
Jiuzhou Pharmacy(4)   BOH    06/12/14   12/12/14   1,852,500    - 
Jiuzhou Pharmacy(4)   BOH    06/27/14   12/27/14   1,599,813    - 
Total                 $11,205,188   $7,820,718 

 

(1) As of March 31, 2014, the Company had a total of $2,082,309 (RMB12,830,000) in notes payable from ICBC. A third party, Hangzhou Small and Medium sized Guarantee CO., Ltd. signed loan guarantee agreements with the bank to guarantee these borrowings. In addition, the Company is required to hold 30% of amounts borrowed as restricted cash with ICBC as additional collateral against these bank notes.  All the outstanding notes payable have been repaid upon maturity.
   
(2) As of March 31, 2014, the Company had $5,738,409 (RMB35,356,800) notes payable from HUB. The Company is required to hold restricted cash of $2,489,851 (RMB15,341,040) with HUB as collateral against these bank notes. All the outstanding notes payable have been repaid upon maturity.
   
(3) As of September 30, 2014, the Company had $7,752,875 (RMB47,710,000) notes payable from HUB. The Company is required to hold restricted cash of $4,401,101 (RMB27,083,700) with HUB as collateral against these bank notes.
   
(4) As of September 30, 2014, the Company had $3,452,313 (RMB21,245,000) notes payable from BOH. The land use right of the farmland in Lin’An, Hangzhou is pledged as collateral for these bank acceptance notes (see Note 11). The Company is required to hold restricted cash of $1,035,694 (RMB6,373,500) with BOH as collateral against these bank notes.

 

As of September 30, 2014, the Company had a credit line of approximately $9.99 million (RMB 61.4 million) in the aggregate from HUB, BOH and ICBC. By putting up the restricted cash of $5.44 million deposited in the bank, the credit line is raised up to $15.43 million in total. As of September 30, 2014, we have approximately $11.21 million bank notes payable, approximately $4.22 million bank credit line has not been used and is still available for further borrowing. The bank notes are also secured by buildings owned by our major shareholders with a value of approximately $6,139,250 (RMB37,780,000) personally guaranteed by our major shareholders and guaranteed by Zhejiang Jin Qiao Guarantee Company.

 

Note 13 – TAXES

 

Income tax

 

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

 

Entity   Income Tax Jurisdiction
Jo-Jo Drugstores   United States
Renovation   Hong Kong, PRC
All other entities   Mainland, PRC

 

17
 

 

The following table reconciles the U.S. statutory tax rates with the Company's effective tax rate for the three and six months ended September 30, 2014 and 2013:

 

   For the three months   For the six months 
   ended September 30,   ended September 30, 
   2014   2013   2014   2013 
U.S. Statutory rates   34 .0%   34.0%   34.0%   34.0%
Foreign income not recognized in the U.S.   (34.0)   (34.0)   (34.0)   (34.0)
China income taxes   25.0    25.0    25.0    25.0 
Change in valuation allowance (1)   (117.2)   (32.1)   (29.9)   (31.0)
Non-deductible expenses-permanent difference (2)   (61.8)   (0.7)   (6.3)   (0.3)
Effective tax rate   (154.0)%   (7.8)%   (11.2)%   (6.3)%

 

(1) It represents non-taxable expense reversal due to decrease in allowance for accounts receivables and advance to suppliers.

 

(2) The (61.8)% and (0.7)% rate adjustments for the three months ended September 30, 2014 and 2013, and the (6.3)% and (0.3)% rate adjustments for the six months ended September 30, 2014 and 2013 represents expenses primarily included legal, accounting and other expenses incurred by the Company that were not deductible for PRC income tax.

 

Jo-Jo Drugstores is incorporated in the U.S. and incurred a net operating loss for income tax purposes for three and six months ended September 30, 2014 and 2013.  As of September 30, 2014, the estimated net operating loss carryforwards for U.S. income tax purposes amounted to $1,430,000 which may be available to reduce future years’ taxable income.  These carryforwards will expire, if not utilized by 2032. Management believes that the realization of the benefits arising from this loss appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes.  Accordingly, the Company has provided a 100% valuation allowance at September 30, 2014.  There was no net change in the valuation allowance for the three and six months ended September 30, 2014 and 2013.  Management reviews this valuation allowance periodically and makes adjustments as necessary.

 

Taxes payable at September 30, 2014 and March 31, 2014 consisted of the following:

 

   September 30,
2014
   March 31,
2014
 
VAT  $386,130   $344,329 
Income tax   7,963    7,851 
Others   23,675    21,321 
Total taxes payable  $417,768   $373,501 

 

Note 14– POSTRETIREMENT BENEFITS

 

Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all permanent employees. The contribution for each employee is based on a percentage of the employee’s current compensation as required by the local government. The Company contributed $209,773 and $176,883 in employment benefits and pension for the three months ended September 30, 2014 and 2013, respectively, and $400,271 and $321,947 in employment benefits and pension for the six months ended September 30, 2014 and 2013, respectively.

 

Note 15– RELATED PARTY TRANSACTIONS AND ARRANGEMENTS

 

Amounts payable to related parties are summarized as follows:

 

   September 30,
2014
   March 31,
2014
 
Due to cofounders (1):  $577,529   $576,818 
Due to a director and CEO (2):   1,329,444    1,807,476 
Total  $1,906,973   $2,384,294 

  

(1) As of September 30, 2014 and March 31, 2014, amount due to cofounders represents contributions from the Owners to Jiuxin Management to enable Jiuxin Management to meet its approved PRC registered capital requirements.

 

(2) Due to foreign exchange restrictions, the Company’s director and CEO, Mr. Lei Liu personally lent U.S. dollars to the Company to facilitate its payments of expenses in the United States. On July 2, 2014, the Company issued a total of 619,482 shares of common stock to Lei Liu, at $1.52 per share, the fair market value, or the closing stock price on Nasdaq on July 1, 2014, to offset the debts of $941,613 owed to Mr. Liu.

 

18
 

 

As of September 30, 2014 and March 31, 2014, notes payable totaling $5,789,875 and $5,738,409 were secured by the personal properties of certain of the Company’s shareholders, respectively.

 

The Company has a lease with Mr. Lei Liu for a retail space which expires in September 2015 and had a lease for corporate office which has expired in December 2013. Since the Company has moved its headquarter to a new location in Hangzhou in January 2014, the corporate office lease with Mr. Liu was terminated. Rent expense amounted to $24,350 and $48,702 for the three months ended September 30, 2014 and 2013, respectively, and $48,692 and $97,062 for the six months ended September 30, 2014 and 2013. None was paid to Mr. Liu for the three and six months ended September 30, 2014 and 2013.

 

Note 16– PURCHASE OPTION DERIVATIVE LIABILITY

 

In connection with the public offering of the Company’s common stock that closed on April 28, 2010, the Company issued to its underwriters, Madison Williams and Company and Rodman & Renshaw, LLC, an option for $100 to purchase up to a total of 105,000 shares of common stock (3% of the shares sold in the public offering) at $6.25 per share (125% of the price of the shares sold in the public offering). The option is exercisable commencing on October 23, 2010 and expires on April 22, 2015.

 

The Company is treating the common shares underlying the option as a derivative liability as the strike price of the option is denominated in U.S. dollars, a currency other than the Company’s functional currency, the Chinese RMB. As a result, the option is not considered indexed to the Company’s own stock, and as such, all future changes in the fair value of the option are recognized currently in earnings until such time as the option is exercised or expired.

 

On April 22, 2010, the issue date of the option, the Company classified the fair value of this option as a liability resulting in a decrease of additional paid-in capital of $402,451 and the establishment of a $402,451 in liability to recognize the option’s fair value. The Company recognized a gain of $10,975 and $48,363 from the change in fair value of the option liability for the three and six months ended September 30, 2014. The Company recognized a loss of $1,036 from the change in fair value of the option liability for the three months ended September 30, 2013, and a gain of $11,629 for the six months ended September 30, 2013.

 

This option does not trade in an active securities market, and as such, the Company estimates its fair value using the Black-Scholes Option Pricing Model (the “Black-Scholes Model”) on the date that the option was originally issued and as of September 30, 2014 using the following assumptions:

 

   Underwriter
Purchase Option
 
   September 30,
2014 (1)
 
     
Stock price  $1.94 
Exercise price  $6.25 
Annual dividend yield   0%
Expected term (years)   0.55 
Risk-free interest rate   0.03 
Expected volatility   92.28%

 

(1) As of September 30, 2014, the option to purchase 105,000 shares of common stock had not been exercised.

 

Expected volatility is based on historical volatility. Historical volatility is computed using daily pricing observations for recent periods that correspond to the term of the option. The Company believes this method produces an estimate that is representative of future volatility over the expected term of this option. The expected life is based on the remaining term of the option. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the option.

 

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. Depending on the product and the terms of the transaction, the fair values of option liability are modeled using a series of techniques, including closed-form analytic formula such as the Black-Scholes Model, which does not entail material subjectivity because the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.

 

19
 

 

The fair value of the 105,000 shares underlying the option outstanding as of September 30, 2014 was determined using the Black-Scholes Model, with certain inputs significant to the valuation methodology as level 2 inputs, and the Company recorded the change in fair value in earnings. As a result, the option liability is carried on the consolidated balance sheets at fair value.

 

Note 17 – WARRANTS

 

On September 26, 2013, as annual compensation for its financial advisory service, the Company issued a warrant to a financial consulting firm to purchase up to 150,000 shares of common stock at $1.20 per share. The warrant is exercisable from September 26, 2013 to September 25, 2016.

 

Because the warrant is denominated in U.S. dollars and the Company’s functional currency is the RMB, it does not meet the requirements of the accounting standard to be indexed only to the Company’s stock. Accordingly, it is accounted for at fair value as derivative liabilities and marked to market price each period.

 

The warrant does not trade in an active securities market, and as such, the Company estimates its fair value using the Black-Scholes Model on the date that the warrant was originally issued and as of September 30, 2014 using the following assumptions:

 

   Common Stock
Warrants
 
   September 30,
2014 (1)
 
Stock price  $1.94 
Exercise price  $1.20 
Annual dividend yield   0%
Expected term (years)   1.99 
Risk-free interest rate   0.58%
Expected volatility   121.83%

 

(1) As of September 30, 2014, the warrant had not been exercised.

 

On September 26, 2013, the issue date of the warrant, the Company classified its fair value as a liability of $33,606. The Company recognized a loss of $58,318 and a gain of $27,994 from the change in fair value of the warrant liability for the three and six months ended September 30, 2014, respectively. The Company recognized a loss of $20,012 from the change in fair value of the warrant liability for the three and six months ended September 30, 2013.

 

Note 18 – STOCKHOLDERS’ EQUITY

 

Stock-based compensation

 

On September 26, 2013, the Company agreed to grant a total of 350,000 shares of restricted common stock to a financial consulting firm for its financial advisory services. The term of the service agreement is one year. The trading value of the Company’s common stock on September 26, 2013 was $0.51. For the three and six months ended September 30, 2014, $42,547 and $87,049 was recorded as a service compensation expense. For the three months and six months ended September 30, 2013, $2,445 was recorded as service compensation expense.

 

On January 16, 2012, the Company granted a total of 297,000 shares of restricted common stock under the Plan to a group of 46 employees. These restricted shares will vest on January 16, 2015, provided that the employees are still employed by the Company on such date. $19,612 was charged to general and administrative expense and $4,010 selling expense was reversed due to two employees left the Company before the vesting date for the three months ended September 30, 2014, and $39,011 and $3,632 for the six months ended September 30, 2014, respectively. $19,612 and $7,226 were charged to general and administrative expense and selling expense, respectively, for the three months ended September 30, 2013, and $39,224 and $15,452 for the six months ended September 30, 2013, respectively.

 

Statutory reserves

 

Statutory reserves represent restricted retained earnings. Based on their legal formation, the Company is required to set aside 10% of its net income as reported in their statutory accounts on an annual basis to the Statutory Surplus Reserve Fund (the “Reserve Fund”). Once the total amount set aside in the Reserve Fund reaches 50% of the entity’s registered capital, further appropriations become discretionary. The Reserve Fund can be used to increase the entity’s registered capital upon approval by relevant government authorities or eliminate its future losses under PRC GAAP upon a resolution by its board of directors. The Reserve Fund is not distributable to shareholders, as cash dividend or otherwise, except in the event of liquidation.

 

20
 

 

Appropriations to the Reserve Fund are accounted for as a transfer from unrestricted earnings to statutory reserves. During the three and six months ended September 30, 2014 and 2013, the Company did not make appropriations to the statutory reserves.

 

There are no legal requirements in the PRC to fund the Reserve Fund by transfer of cash to any restricted accounts, and the Company does not do so.

 

Note 19 – LOSS PER SHARE

 

The Company reports earnings per share in accordance with the provisions of the FASB’s related accounting standard. This standard requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution, but includes vested restricted stocks and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period.  Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.

 

The following is a reconciliation of the basic and diluted earnings per share computation:

 

   Three months ended
September 30,
   Six months ended
September 30,
 
   2014   2013   2014   2013 
Net loss attributable to controlling interest  $(36,193)  $(546,590)  $(382,930)  $(1,333,578)
Weighted average shares used in basic computation   14,981,637    13,609,003    14,700,375    13,609,003 
Diluted effect of purchase options and warrants   -    -    -    - 
Diluted effect of restricted shares   -    -    -    - 
Weighted average shares used in diluted computation   14,981,637    13,609,003    14,700,375    13,609,003 
Loss per share – Basic:                    
Net loss before noncontrolling interest  $(0.00)  $(0.04)  $(0.03)  $(0.10)
Add: Net loss attributable to noncontrolling interest  $-   $-   $-   $- 
Net loss attributable to controlling interest  $(0.00)  $(0.04)  $(0.03)  $(0.10)
Loss per share – Diluted:                    
Net loss before noncontrolling interest  $(0.00)  $(0.04)  $(0.03)  $(0.10)
Add: Net loss attributable to noncontrolling interest  $-   $-   $-   $- 
Net loss attributable to controlling interest  $(0.00)  $(0.04)  $(0.03)  $(0.10)

 

For the three and six months ended September 30, 2014 and 2013, the 105,000 and 150,000 shares, underlying outstanding purchase options and a warrant, respectively, were excluded from the calculation of diluted loss per share as the options and the warrant were anti-dilutive. 

 

Note 20 – SEGMENTS

 

The Company operates within four main reportable segments: retail drugstores, online pharmacy, drug wholesale and herb farming.  Online pharmacy sells OTC drugs, dietary supplement, medical devices and sundry items to customers through Alibaba’s Tmall and its own platform all over China. The retail drugstores segment sells prescription and over-the-counter (“OTC”) medicines, TCM, dietary supplement, medical devices, and sundry items to retail customers.   The drug wholesale segment includes supplying the Company’s own retail drugstores with prescription and OTC medicines, TCM, dietary supplement, medical devices and sundry items (which sales have been eliminated as intercompany transactions), and also selling them to other drug vendors and hospitals. The Company’s herb farming segment cultivates selected herbs for sales to other drug vendors. The Company is also involved in online sales and clinic services that do not meet the quantitative thresholds for reportable segments and are included in the retail drugstores segment.

 

The segments' accounting policies are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operations before interest and income taxes not including nonrecurring gains and losses.    

 

The Company's reportable business segments are strategic business units that offer different products and services. Each segment is managed separately because they require different operations and markets to distinct classes of customers.

 

21
 

 

The following table presents summarized information by segment of the continuing operation for the three months ended September 30, 2014:

 

    Retail drugstores     Online Pharmacy     Drug wholesale     Herb
farming
    Total  
Revenue   $ 12,406,038     $ 2,949,391     $ 3,088,636     $ -     $ 18,444,065  
Cost of goods     10,302,519       2,463,352       2,912,937       -       15,678,808  
Gross profit   $ 2,103,519     $ 486,039     $ 175,699     $ -     $ 2,765,257  
Selling expenses     1,795,108       666       138,006       -       1,933,780  
General and administrative expenses     1,412,896       155,861       (911,544 )*     88,962       746,175  
(Loss) income from operations   $ (1,104,485)     $ 329,512     $ 949,237     $ (88,962 )   $ 85,302  
Depreciation and amortization   $ 222,829     $ 1,376     $ 24,022     $ 80,081     $ 328,308  
Total capital expenditures   $ 107,573     $ 3,210     $ 6,106     $ -     $ 116,889  

  

* include the accounts receivable and advance to suppliers allowance reversal of $987,383.

 

The following table presents summarized information of the continuing operations by segment for the three months ended September 30, 2013:

 

    Retail
drugstores
    Online
pharmacy
    Drug
wholesale
    Herb
farming
    Total  
Revenue   $ 9,452,053     $ 1,600,889     $ 5,802,479     $ -     $ 16,855,421  
Cost of goods     7,161,091       1,383,653       5,362,274       -       13,907,018  
Gross profit   $ 2,290,962     $ 217,236     $ 440,205     $ -     $ 2,948,403  
Selling expenses     1,573,856       248       1,405,027       -       2,979,131  
General and administrative expenses     1,140,589       124,216       (818,103 )     45,280       491,981  
Loss from operations   $ (423,481 )   $ 92,770   $ (146,719 )   $ (45,280 )   $ (522,709 )
Depreciation and amortization   $ 417,983     $ (7,462)     $ 140,867     $ 262     $ 551,650  
Total capital expenditures   $ 1,386,499     $ 307     $ 16,088     $ -     $ 1,402,894  

 

The following table presents summarized information of the continuing operation by segment for the six months ended September 30, 2014:

 

    Retail
drugstores
     Online
pharmacy
    Drug
wholesale
    Herb
farming
    Total  
Revenue   $ 23,001,797     $ 5,521,933     $ 6,379,567     $ -     $ 34,903,297  
Cost of goods     18,982,408       4,630,716       6,014,297       -       29,627,421  
Gross profit   $ 4,019,389     $ 891,217     $ 365,270     $ -     $ 5,275,876  
Selling expenses     3,465,497       666       236,194               3,702,357  
General and administrative expenses     2,676,192       299,560       (1,323,439 )     175,063       1,827,376  
Loss from operations   $ (2,122,300 )   $ 590,991     $ 1,452,515     $ (175,063 )   $ (253,857 )
Depreciation and amortization   $ 492,846     $ 3,538     $ 175,581     $ 160,605     $ 832,570  
Total capital expenditures   $ 141,800     $ 3,513     $ 76,258     $ -     $ 221,571  

 

* include the accounts receivable and advance to suppliers allowance reversal of $1,634,886.

 

The following table presents summarized information of the continuing operation by segment for the six months ended September 30, 2013:

 

    Retail
drugstores
    Online
pharmacy
    Drug
wholesale
    Herb
farming
    Total  
Revenue   $ 19,100,271     $ 2,865,061     $ 10,226,608     $ -     $ 32,191,940  
Cost of goods     14,308,218       2,363,997       8,970,153       -       25,642,368  
Gross profit   $ 4,792,053     $ 501,064     $ 1,256,455     $ -     $ 6,549,572  
Selling expenses     3,248,103       248       1,411,622               4,659,973  
General and administrative expenses     2,610,261       221,586       195,564       105,387       3,132,798  
Loss from operations   $ (1,066,309 )   $ 279,227     $ (350,731 )   $ (105,387 )   $ (1,243,200 )
Depreciation and amortization   $ 867,839     $ -     $ 272,225     $ 522     $ 1,140,586  
Total capital expenditures   $ 1,503,207     $ 307     $ 17,424     $ -     $ 1,520,938  

 

22
 

 

The Company does not have long-lived assets located outside the PRC. In accordance with the enterprise-wide disclosure requirements of FASB’s accounting standard, the Company's net revenue from external customers through its retail stores by main products is as follows:

 

    Three months ended
September 30,
  Six months ended
September 30,
    2014   2013   2014   2013
Prescription drugs   $ 4,957,751     $ 4,637,114     $ 9,378,003     $ 9,924,263  
Over-the-counter drugs     4,291,738       3,381,486       8,234,531       6,737,739  
Nutritional supplements     547,218       216,609       1,171,143       716,217  
Traditional Chinese medicine     1,991,112       907,266       3,186,746       1,428,513  
Sundry products     502,724       200,864       859,783       123,053  
Medical devices     115,495       108,714       171,591       170,486  
Total   $ 12,406,038     $ 9,452,053     $ 23,001,797     $ 19,100,271  

 

The Company’s net revenue from external customers through online pharmacy by main products is as follows:

 

   Three months ended
September 30,
   Six months ended
September 30,
 
   2014   2013   2014   2013 
Prescription drugs  $-   $-   $-   $- 
Over-the-counter drugs   826,755    708,250    1,519,598    1,277,437 
Nutritional supplements   191,953    394,616    341,893    454,843 
Traditional Chinese medicine   -    -    -    - 
Sundry products   455,521    308,971    775,491    684,076 
Medical devices   1,475,162    189,052    2,884,951    448,705 
Total  $2,949,391   $1,600,889   $5,521,933   $2,865,061 

 

The Company’s net revenue from external customers through wholesale by main products is as follows:

 

   Three months ended
September 30,
   Six months ended
September 30,
 
   2014   2013   2014   2013 
Prescription drugs  $2,362,902   $4,276,822   $4,261,984   $7,649,675 
Over-the-counter drugs   611,219    96,125    1,948,429    875,345 
Nutritional supplements   6,387    875    33,949    261,130 
Traditional Chinese medicine   80,905    -    89,268    927 
Sundry products   6,583    1,428,657    6,777    1,432,811 
Medical devices   20,640    -    39,160    6,720 
Total  $3,088,636   $5,802,479   $6,379,567   $10,226,608 

 

Note 21 – COMMITMENTS AND CONTINGENCIES

 

Operating lease commitments

 

The Company recognizes lease expense on a straight line basis over the term of its leases in accordance with the relevant accounting standards. The Company has entered into various tenancy agreements for its store premises and for the land leased from a local government to farm herbs.

 

The Company’s commitments for minimum rental payments under its leases for the next five years and thereafter are as follows:

 

Periods ending September 30, Retail
drugstores
  Online
pharmacy
    Drug
wholesale
    Herb farming     Total
Amount
 
2015 $ 3,906,015   $  108,059     $  176,379     $ -     $  4,190,453  
2016   2,039,822      121,764        176,695       -        2,338,281  
2017   1,410,708      139,159        150,756       -        1,700,623  
2018   1,228,290      139,159        150,756       -        1,518,205  
2019   745,191      139,159        150,756       -        1,035,106  
Thereafter   359,140      208,739        113,067           -        680,946  

 

Total rent expense amounted to $1,215,232 and $923,572 for the three months ended September 30, 2014 and 2013, respectively, and $2,397,776 and $1,889,150 for the six months ended September 30, 2014 and 2013, respectively.

 

Note 22 – SUBSEQUENT EVENTS

 

On October 9, 2014, the Company, through Jiuzhou Pharmacy, a pharmacy that the Company controls through contractual arrangements, entered into an acquisition agreement to acquire Sanhao Grand Pharmacy Chain Co., Ltd.(“Sanhao Pharmacy”), a local drugstore chain located in Hangzhou, at a total price of $1.56 million (RMB9.6 million). Sanhao Pharmacy presently has eleven stores where customers can use insurance cards issued by Hangzhou government for purchases in eight of those stores. The Company expects to further expand its market shares in Hangzhou City through Sanhao’s existing insurance-applicable stores. The Company intends to fund its acquisition through its improved cash flow generated by rising sales from its retail business as well as bank financing. As of the date of the report, the registered shareholder of Sanhao Pharmacy has been listed under Jiuzhou Pharmacy.

 

23
 

 

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

 

The following management’s discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto and the other financial information appearing elsewhere in this item.  In addition to historical information, the following discussion contains certain forward-looking statements within the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995.  These statements relate to our future plans, objectives, expectations and intentions.  These statements may be identified by the use of words such as "may," "will," "could," "expect," "anticipate," "intend," "believe," "estimate," "plan," "predict," and similar terms or terminology, or the negative of such terms or other comparable terminology.  Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ materially from those discussed in these statements.  Factors that could contribute to such differences include, but are not limited to, those discussed in the "Risk Factors" section of our annual report on Form 10-K for the year ended March 31, 2014 and filed with the SEC on June 27, 2014.  We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future.

 

Our financial statements are prepared in U.S. Dollars and in accordance with accounting principles generally accepted in the United States. See "Exchange Rates" below for information concerning the exchanges rates at which Renminbi ("RMB") were translated into U.S. Dollars (“USD” or “$”) at various pertinent dates and for pertinent periods.

 

Overview

 

We currently operate in four business segments in China: (1) retail drugstores, (2) online pharmacy, (3) wholesale of products similar to those that we carry in our pharmacies, and (4) farming and selling herbs used for traditional Chinese medicine (“TCM”).

 

Our drugstores offer customers a wide variety of pharmaceutical products, including prescription and over-the-counter (“OTC”) drugs, nutritional supplements, TCM, personal and family care products, and medical devices, as well as convenience products, including consumable, seasonal, and promotional items. Additionally, we have licensed doctors of both western medicine and TCM on site for consultation, examination and treatment of common ailments at scheduled hours. We currently have 51 pharmacies in Hangzhou under the store brand of “Jiuzhou Grand Pharmacy.” During the three months ended September 30, 2014, we opened two new pharmacies in Hangzhou.

 

We operate a wholesale business through Jiuxin Medicine distributing third-party pharmaceutical products (similar to those carried by our pharmacies) primarily to trading companies throughout China. We also farm certain herbs used in TCM that we currently sell to a local vendor. Since May 2010, we have also been selling certain OTC drugs and nutritional supplements online.

 

Recent Developments

 

On October 9, 2014, the Company, through Jiuzhou Pharmacy, a pharmacy that the Company controls through contractual arrangements, entered into an acquisition agreement with two individual owners of Sanhao Grand Pharmacy Chain Co., Ltd.(“Sanhao Pharmacy”), a local drugstore chain located in Hangzhou, for a total purchase price of $1.56 million (RMB9.6 million).

 

Sanhao Pharmacy presently has eleven stores where customers can use insurance cards issued by Hangzhou government for their purchases in eight of those stores. The reimbursement from local government insurance program has always been an important source of revenue for drugstores chains. As the government is controlling its budget and tightening up its policy to admit new stores into its insurance system, we expect to further strengthen our market shares in Hangzhou by using Sanhao’s existing insurance-applicable stores and its network.

 

Critical Accounting Policies and Estimates

 

In preparing our unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, we are required to make judgments, estimates and assumptions that affect: (i) the reported amounts of our assets and liabilities; (ii) the disclosure of our contingent assets and liabilities at the end of each reporting period; and (iii) the reported amounts of revenue and expenses during each reporting period. We continually evaluate these estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ materially from those estimates.

 

We believe that any reasonable deviation from those judgments and estimates would not have a material impact on our financial condition or results of operations. To the extent that the estimates used differ from actual results, however, adjustments to the statement of operations and corresponding balance sheet accounts would be necessary. These adjustments would be made in future financial statements.

 

When reading our financial statements, you should consider: (i) our critical accounting policies; (ii) the judgment and other uncertainties affecting the application of such policies; and (iii) the sensitivity of reported results to changes in conditions and assumptions.  The critical accounting policies and related judgments and estimates used to prepare our financial statements are identified in Note 3 to our unaudited condensed consolidated financial statements accompanying in this report.  We have not made any material changes in the methodology used in our accounting policies that are inconsistent with those discussed in our annual report on Form 10-K for the year ended March 31, 2014.

 

24
 

 

Results of Operations

 

Comparison of three months ended September 30, 2014 and 2013

 

The following table summarizes our results of operations for the three months ended September 30, 2014 and 2013:

 

   Three months ended September 30, 
   2014   2013 
   Amount   Percentage
of total
revenue
   Amount   Percentage
of total
revenue
 
Revenue  $18,444,065    100.0%  $16,855,421    100.0%
Gross profit  $2,765,257    15.0%  $2,948,403    17.5%
Selling expenses  $1,933,780    10.5%  $2,979,131    17.7%
General and administrative expenses  $746,175    4.0%  $491,981    2.9%
(Loss) from operations  $85,302    0.5%  $(522,709)   (3.1)%
Other (expense), net  $(52,692)   (0.3)%  $37,021    0.2%
Change in fair value of purchase option derivative liability  $(47,342)   (0.3)%  $(21,049)   (0.1)%
Income tax expense  $22,680    0.1%  $39,589    0.2%
Net loss attributable to controlling interest  $(37,412)   (0.2)%  $(546,590)   (3.2)%
Net loss attributable to noncontrolling interest  $(1,219)   (0.0)%  $(264)   (0.0)%

 

Revenue

 

 

 Revenue increased by $1,588,644 or 9.4% for the three months ended September 30, 2014, as compared to the same period in the previous fiscal year, primarily due to an increase in our retail business, especially in online pharmacy, offset by decline in our wholesale business.

 

   

Quarterly Revenue by Segment

 

The following table breaks down the revenue for our four business segments for the three months ended September 30, 2014 and 2013:

 

    Three months ended September 30,              
    2014     2013              
    Amount     % of total
  revenue
    Amount     % of total
      revenue
    Variance by
amount
    % of
change
 
Revenue from retail drugstores   $ 12,406,038       67.2 %   $ 9,452,053       56.1 %   $ 2,953,985       31.3 %
Revenue from online sales     2,949,391       16.1 %     1,600,889       9.5 %     1,348,502       84.2 %
Revenue from wholesale business     3,088,636       16.7 %     5,802,479       34.4 %     (2,713,843 )     (46.8 )%
Revenue from farming business            — %              — %              — %
Total revenue   $ 18,444,065       100.0 %   $ 16,855,421       100.0 %   $ 1,588,644       9.4 %

 

 

25
 

  

 

Retail sales, which accounted for approximately 83.3% of total revenue for the three months ended September 30, 2014, increased by $4,302,487, or 38.9%, to $15,355,429. Same-store sales increased by approximately $2,602,868, or 28.8%, while our five new stores contributed approximately $300,737 in revenue in the three months ended September 30, 2014. The increase in same-store sales reflects the implementation of key drugstore operational strategies such as promoting sales through our doctors and clinics, stricter internal staff assessments that stimulate sales, increased adaptability to community demand, closer monitor to the operation of local stores in Hangzhou, keeping competitive drug retail price, and modest economic improvements in China. We expect same-store sales will keep growing in the near future. Our online pharmacy sales increased by approximately $1,348,502, or 84.2% for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013. We have expanded cooperation with business-to-consumer online vendors, including Taobao, JD and Amazon, by posting our products on their online platforms, which direct customers back to our website. Such arrangements have exposed our online presence to a wider consumer base. In addition, we have spent considerable efforts identifying popular products that can drive sales, while we keep close watch on cost. Online shopping is also experiencing explosive expansion in China. As a result, we have seen steady growth in online sales. On the other hand, we ceased operation of all five stores in Shanghai in February 2014 due to their continuous loss. All Shanghai subsidiaries have canceled their SAIC registration. Although these stores were underperforming, they nevertheless contributed approximately $177,861 in revenue prior to their closures in the three months ended September 30, 2013. Our store count kept 51 as of September 30, 2014 and 2013, as a net effect of closing five stores in Shanghai and opening five stores in Hangzhou. Among the five new stores, two were opened in January 2014, one was opened in May 2014 and the remaining two were opened in the three months ended September 30, 2014.

 

 

 

Wholesale revenue decreased by $2,713,843 or 46.8% primarily as a result of discontinuing aggressive volume-driven sales strategy and slow progress made by new management team in marketing profitable products since August 2013, when a new management and sales team, which has over twenty years of industry experience in wholesale pharmaceutical distribution has been brought into our pharmaceutical distribution operations to expand sales to other drug vendors and develop a chain of supply to local pharmacies and hospitals. However, as local hospitals and pharmacies had strong ties with their existing suppliers, during the six months ended September 30, 2014, the new management had not been able to make significant progress. Until the new sales and management team develops and establishes a new customer base, we do not expect our wholesale business to expand in the immediate future.

 

Gross Profit

 

Gross profit decreased by $183,146 or 6.2% period over period primarily as a result of the contraction in wholesale business.  At the same time, gross margin decreased from 17.5% to 15.0% due to lower retail profit margins.  The average gross margins for each of our three business segments are as follows:

 

   Three months ended
September 30,
   2014  2013
Average gross margin for retail drugstores   17.0%   24.2%
Average gross margin for online sales   16.5%   13.6%
Average gross margin for wholesale business   5.7%   7.6%
Average gross margin for farming business   N/A    N/A 

 

Retail drugstores gross margin decreased primarily due to lower sale prices caused by strong market competition and the implementation of government subsidies to all drugs sold at public hospitals in Zhejiang Province. The China Food and Drug Administration (the “CFDA”) continued to add more drugs into its drug retail price controls list. Although most of our drug prices are below the price limit, we adjust our prices from time to time to be competitive in the market. Furthermore, since April 2014, local public hospitals in Zhejiang Province are required to sell all drugs at cost. In turn, local governments reimburse these hospitals with subsidies. Confronted with low or no profit margin sales and government subsidies, we have to maintain low profit margins in order to attract customers.

 

Online pharmacy sales gross margins are usually lower than gross margins of drugs sold at physical drugstores and vary from time to time depending on the products we carry. During the three months ended September 31, 2014, we were able to sell certain nutritional supplements with high profit margin. However, in order to keep competitive and drive fast sales growth, we may lower our sales prices in long run.

 

Wholesale gross margin decreased primarily due to competitive prices offered by the new wholesale management team in order to retain and develop customers. We have been transitioning in a new sales and management team for Jiuxin Medicine since the third quarter of fiscal 2014. However, the departure of the old salespersons took away certain business. In order to make up the lost business and actively explore the new customers, the new team decided to keep low prices for the majority of our products. As a result, our gross margin became relatively low in the three months ended September 30, 2014.

 

During the three months ended September 30, 2014, we continued to plant and grow Ginkgo trees based on our best estimate as to future market demands. Due to the prolonged life cycle, we were unable to harvest those herbs in the three months ended September 30, 2014. We expect to continue planting Ginkgo trees and other herbs in the near future. We plan to harvest and sell Ginkgo trees based on our best estimation of the market but do not expect within a year. Revenue from the herbs will be generated when they are harvested.

 

26
 

 

Selling and Marketing Expenses

 

Sales and marketing expenses decreased by $1,045,351 or 35.1% period over period.  The difference in absolute dollars is primarily attributable to approximately $1.3 million membership rewards to commemorate Jiuzhou Pharmacy’s ten-year anniversary in August and September 2013, which were distributed during the three months ended September 30, 2013 and therefore increased the expenses during the same period last year. Excluding the membership rewards, our selling and marketing expenses increased by approximately $0.25 million or 13% mainly due to rental increases and higher labor cost. As a result, such expenses as a percentage of our revenue decreased to 10.5%, from 17.7% for the same period a year ago.  We expect future sales and marketing expenses to not deviate significantly from its current levels.

 

General and Administrative Expenses

 

General and administrative expenses increased by $254,194 or 51.7% period over period.  Such expenses as a percentage of revenue increased to 4.0% from 2.9% for the same period a year ago. The increase in absolute dollars is partly attributable to a decrease of $973,696 in allowance for accounts receivable and advance to suppliers in the three months ended September 30, 2014, as compared to $1,111,689 in the three months ended September 30, 2013. Excluding such allowance effects, general and administrative expense increased by $116,201 or 23.6%. The increase in absolute dollars primarily reflects modest increase in labor cost. We expect future general and administrative expenses to remain at its current levels.

 

Income (Loss) from Operations

 

As a result of decreased gross margin, we had income from operations of $85,302, as compared to loss from operations of $522,709 a year ago.  Our operating margin for the three months ended September 30, 2014 and 2013 was 0.5% and (3.1)%, respectively.

 

Income Taxes

 

Our income tax expense decreased by $16,909 period over period due to decline in Jiuzhou Pharmacy’s profit.

 

Net Loss

 

As a result of the foregoing, net loss decreased by $508,914 period over period. 

 

Comparison of six months ended September 30, 2014 and 2013

 

The following table summarizes our results of operations for the six months ended September 30, 2014 and 2013:

 

   Six months ended September 30, 
   2014   2013 
   Amount   Percentage
of total
revenue
   Amount   Percentage
of total
revenue
 
Revenue  $34,903,297    100.0%  $32,191,940    100.0%
Gross profit  $5,275,876    15.1%  $6,549,572    20.3%
Selling expenses  $3,702,357    10.6%  $4,659,973    14.5%
General and administrative expenses  $1,827,376    5.2%  $3,132,799    9.7%
(Loss) from operations  $(253,857)   (0.7)%  $(1,243,200)   (3.9)%
Other (expense), net  $(168,528)   (0.5)%  $(90,332)   (0.3)%
Change in fair value of purchase option derivative liability  $76,357    0.2%  $8,384    (0.1)%
Income tax expense  $38,821    0.1%  $79,109    0.2%
Net loss attributable to controlling interest  $(384,849)   (1.1)%  $(1,333,578)   (4.1)%
Net loss attributable to noncontrolling interest  $(1,919)   (0.0)%  $(507)   (0.0)%

 

Revenue

 

 

 Due to the expansion of our retail business, revenue increased by $2,711,357 or 8.4% for the six months ended September 30, 2014, as compared to the same period in the previous fiscal year, primarily due to an increase in our retail business, especially online pharmacy, offset by decline in our wholesale business.

 

27
 

   

Quarterly Revenue by Segment

 

The following table breaks down the revenue for our four business segments for the six months ended September 30, 2014 and 2013:

 

    Six months ended September 30,            
    2014   2013            
    Amount     % of total
revenue
    Amount     % of total
revenue
    Variance by
amount
    % of change  
Revenue from retail drugstores   $ 23,001,797       65.9 %   $ 19,100,271       59.3 %     3,901,526       20.4 %
Revenue from online sales     5,521,933       15.8 %     2,865,061       0.9 %     2,656,872       92.7 %
Revenue from wholesale business     6,379,567       18.3 %     10,226,608       31.8 %     (3,847,041 )     (37.6 )%
Revenue from farming business           %           %           %
Total revenue   $ 34,903,297       100.0 %   $ 32,191,940       100 %   $ 2,711,357       8.4 %

 

 

 

 

Retail sales, which accounted for approximately 81.7% of total revenue for the six months ended September 30, 2014, increased by $6,558,398, or 29.9%, to $28,523,730. Same-store sales increased by approximately $3,245,750, or 18.1%, while five new stores contributed approximately $434,564 in revenue in the six months ended September 30, 2014. The increase in same-store sales reflects the implementation of key drugstore operational strategies such as promoting sales through our doctors and clinics, stricter internal staff assessments that stimulate sales, increased adaptability to community demand, closer monitor to the operation of local stores in Hangzhou and modest economic improvements in China. We expect same-store sales will keep growing in the near future. Our online pharmacy sales increased by approximately $2,646,954, or 92.1% for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013. We have expanded cooperation with business-to-consumer online vendors, including Taobao, JD and Amazon, by posting our products on their online platforms, which direct customers back to our website. Such arrangements have exposed our online presence to a wider consumer base. In addition, we have spent considerable efforts identifying popular products that can drive sales, while we keep close watch on cost. Online shopping is also experiencing explosive expansion in China. As a result, we have seen steady growth in online sales. On the other hand, we ceased operation of all five stores in Shanghai in February 2014 due to their continuous loss. All Shanghai subsidiaries have canceled their SAIC registration. Although these stores were underperforming, they nevertheless contributed approximately $369,430 in revenue prior to their closures in the three months ended September 30, 2013. Our store count kept 51 as of September 30, 2014 and 2013, as a net effect of closing five stores in Shanghai and opening five stores in Hangzhou. Among the five new stores, two were opened in January 2014, one was opened in May 2014 and the remaining two were opened in the three months ended September 30, 2014.

 

Wholesale revenue decreased by $3,847,041 or 37.6% primarily as a result of discontinuing aggressive volume-driven sales strategy and slow progress made by new management team in marketing profitable products since August 2013 as mentioned above. Until the new sales and management team develops and establishes a new customer base, we do not expect our wholesale business to expand in the immediate future.

 

Gross Profit

 

Gross profit decreased by $1,273,696 or 19.4% period over period primarily as a result of the contraction in wholesale business.  At the same time, gross margin decreased from 20.3% to 15.1% due to lower retail profit margins.  The average gross margins for each of our three business segments are as follows:

 

   Six months ended
September 30,
   2014  2013
Average gross margin for retail drugstores   17.4%   25.1%
Average gross margin for online sales   16.1%   17.5%
Average gross margin for wholesale business   5.7%   12.3%
Average gross margin for farming business    N/A    N/A 

 

 

Retail gross margin decreased primarily due to lower sale prices caused by strong market competition and the implementation of government subsidies to all drugs sold at public hospitals in Zhejiang Province. The CFDA continue to add more drugs into its drug retail price controls list. Although most of our drug prices are below the price limit, we adjust our prices from time to time to be competitive in the market. Furthermore, since April 2014, local public hospitals in Zhejiang Province are required to sell all drugs at cost. In turn, local governments reimburse these hospitals with subsidies. Confronted with low or no profit margin sales and government subsidies, we have to maintain low profit margins in order to attract customers.

 

Online pharmacy sales gross margins are usually lower than gross margins of drugs sold at physical drugstores and vary from time to time depending on the products we carry. In order to keep competitive and drive fast sales growth, we may lower our sales prices in long run.

 

Wholesale gross margin decreased primarily due to competitive prices offered by the new wholesale management team in order to retain and develop customers. We have been transitioning in a new sales and management team for Jiuxin Medicine since the third quarter of fiscal 2014. However, the departure of the old salespersons took away certain business. In order to make up the lost business and actively explore the new customers, the new team decided to keep low prices for the majority of our products. As a result, our gross margin became relatively low in the six months ended September 30, 2014.

 

28
 

 

During the six months ended September 30, 2014, we continued to plant and grow Ginkgo trees based on our best estimate as to future market demands. Due to the prolonged life cycle, we were unable to harvest those herbs in the six months ended September 30, 2014. We expect to continue planting Ginkgo trees and other herbs in the near future based on our best estimation of the market. We plan to harvest and sell Ginkgo trees based on our best estimation of the market but do not expect within a year. Revenue from the herbs will be generated when they are harvested.

 

Selling and Marketing Expenses

 

Sales and marketing expenses decreased by $957,616 or 20.5% period over period.  The difference in absolute dollars is primarily attributable to approximately $1.3 million membership rewards to commemorate Jiuzhou Pharmacy’s ten-year anniversary in August and September 2013, which were distributed during the three months ended September 30, 2013 and therefore increased the expenses during the same period last year. Excluding the membership rewards, our selling and marketing expenses increased by approximately $0.35 million or 7.6%, which is mainly due to rental increases and higher labor cost. Such expenses as a percentage of our revenue decreased to 10.6%, from 14.5% for the same period a year ago as a result of significantly lower wholesale revenue.  We expect future sales and marketing expenses to not deviate significantly from its current levels.

 

General and Administrative Expenses

 

General and administrative expenses decreased by $1,305,423 or 41.7% period over period.  Such expenses as a percentage of revenue decreased to 5.2% from 9.7% for the same period a year ago.  The decrease in absolute dollars is primarily attributable to a decrease of $1,647,605 in allowance for accounts receivable and advance to suppliers in the six months ended September 30, 2014, as compared to $489,071 in the six months ended September 30, 2013. Excluding such allowance effects, general and administrative expense decreased by $146,889 or 4.7%. We expect future general and administrative expenses to remain at its current levels.

 

 

Loss from Operations

 

As a result of lower operational expense, we had loss from operations of $253,857, as compared to loss from operations of $1,243,200 a year ago.  Our operating margin for the three months ended September 30, 2014 and 2013 was (0.7)% and (3.9)%, respectively.

 

Income Taxes

 

Our income tax expense decreased by $40,288 period over period due to decline in Jiuzhou Pharmacy’s profit.

 

Net Loss

 

As a result of the foregoing, net loss decreased by $950,648 period over period.

 

Accounts receivable

 

 

Accounts receivable, which are unsecured, are stated at the amount we expect to collect.  We continuously monitor collections and payments from our customers (our distributors) and maintain a provision for estimated credit losses. To prepare for potential loss in such accounts, we made corresponding reserves.

 

Our accounts receivable aging was as follows for the periods described below:

 

From date of invoice to customer  Retail
drugstores
   Online
Pharmacy
   Drug
wholesale
   Herb
farming
   Total
amount
 
1- 3 months  $4,533,477   $166,569   $2,054,931   $-   $6,754,977 
4- 6 months   158,839    -    481,952    -    640,791 
7- 9 months   58,778    -    145,512    -    204,290 
10 - 12 months   111    -    329,822    -    329,933 
Over one year   267,665    -    2,107,815    630,448    3,005,928 
Allowance for doubtful accounts   (633,138)   -    (2,939,116)   (630,448)   (4,202,702)
Total accounts receivable  $4,385,732   $      166,569   $2,180,916   $-   $6,733,217 

 

 

Accounts receivable from our retail business mainly consist of reimbursements from government health insurance bureaus and commercial health insurance programs.  In the six months ended September 30, 2014, we wrote off an approximately $129,494 collectible from provincial and Hangzhou City government insurance, as such amount has been determined by the health insurance bureaus to be unqualified for reimbursement.

 

29
 

 

 

Accounts receivable from our drug wholesale business and herb farming business consist of receivables from our customers such as drug distributors. In the six months ended September 30, 2014, we reversed bad debt provision for $932,628. Our drug wholesale business transitioned away from focusing on sales volume beginning in the second half of fiscal 2013, and it tightened its customer credit policy and strengthened monitoring of uncollected receivables. In addition, the new management team came on board and started implemented a stricter credit policy in August 2013. Furthermore, the new management team expensed significant efforts in clearing outstanding balances with certain customers and suppliers. During the six months ended September 30, 2014, we were able to continually collect certain aged accounts. As a result, we reversed approximately $1,068,630 in allowance.

  

Subsequent to September 30, 2014 and through October 30, 2014, we collected approximately $3.4 million in receivables relating to our drugstore business, $0.5 million relating to our wholesale business, and $0 relating to our herb farming business.

 

Advances to suppliers

 

Advances to suppliers are mainly prepayments to secure certain products or services and favorable pricing. The aging of our advances to suppliers is as follows for the periods described below:

 

From date of cash prepayment to suppliers  Retail
drugstores
   Online Pharmacy   Drug
wholesale
   Herb
farming
   Total
amount
 
1- 3 months  $-   $-   $1,893,884   $-   $1,893,884 
4- 6 months   -    -    979,154    -    979,154 
7- 9 months   -    -    1,166,950    -    1,166,950 
10 - 12 months   -    -    319,542    -    319,542 
Over one year   -    -    3,605,947    -    3,605,947 
Allowance for doubtful accounts   -    -    (5,883,314)   -    (5,883,314)
Total advances to suppliers  $         -   $        -   $2,082,163   $       -   $2,082,163 

 

Since the acquisition of Jiuxin Medicine, we have gradually transferred almost all logistics services of our retail drugstores to Jiuxin Medicine. Jiuzhou Pharmacy only purchases certain non-medical products such as sundry. As a result, our retail chain had little advances to suppliers as of September 30, 2014.

 

Advances to suppliers for our drug wholesale business consist of prepayments to our vendors such as drug manufacturers and other distributors.  We typically receive products from vendors within three to six months after making prepayments.  We continuously monitor delivery from and payments to our vendors and maintain a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified.  If we are having difficulty receiving products from a vendor, we take the following steps: cease purchasing products from the vendor, ask for return of our prepayment promptly, and if necessary, take legal recourse.  If all of these steps are unsuccessful, management then determines whether or not the prepayments should be reserved or written off.  To facilitate its initial expansion, Jiuxin Medicine made significant prepayments to certain vendors.  Lack of timely supplier account reconciliation caused by several accounting staff rotations delayed the monitoring of such accounts.  To accommodate potential loss in advances to suppliers, we made reserve for amounts considered to be uncollectible. As previously discussed, Jiuxin Medicine transitioned away from focusing on sales volume beginning in the second half of fiscal 2013, and since then we have tightened our customer credit policy and strengthened monitoring of uncollected receivables. During the six months ended September 30, 2014, we were able to continually collect and sold goods from certain suppliers which we made advances in the past. As a result, we reversed approximately $709,631 in allowance. In addition, the new management team came on board and started implemented a stricter credit policy in August 2013. As a result, we do not expect a significant increase in bad debts going forward.

 

 

Liquidity and Capital Resources

 

Our cash flows for the periods indicated are as follows:

 

   Six months ended
September 30
   2014  2013
Net cash provided by operating activities  $1,801,793   $2,579,557 
Net cash used in investing activities  $(258,582)  $(1,543,586)
Net cash provided by financing activities  $1,281,070   $492,230 

 

For the six months ended September 30, 2014, cash provided by operating activities amounted to $1,801,793, as compared to $2,579,557 a year ago.  The change is primarily attributable to a decrease in cash used in inventory of $1,860,089, a decrease in cash used in customer deposit of $3,334,730, offset by increase in cash used in decrease of accounts payable of $5,880,466, and advances to suppliers of $1,909,915.

 

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For the six months ended September 30, 2014, net cash used in investing activities amounted to $258,582, as compared to $1,543,586 a year ago. The change is attributable to the deposit made in the six months ended September 30, 2013.

 

For the six months ended September 30, 2014, net cash provided by financing activities amounted to $1,281,070, as compared to $492,230 in net cash used in financing activities a year ago.

 

As of September 30, 2014, we had cash of approximately $7,352,723.  Our total current assets as of September 30, 2014, were $32,406,182 and total current liabilities were $34,158,107, which resulted in a negative net working capital of $1,751,925.

 

 

 

Our ability to continue as a going concern depends upon aligning our sources of funding (debt and equity) with our expenditure requirements and repayment of the short-term debts as and when they become due (See Note 2 – liquidity).

The drug retail business is a highly competitive industry in PRC. Several large drugstore chains and a variety of single stores operate in Hangzhou City and Zhejiang Province. The Company closed unprofitable stores including those in Shanghai in fiscal 2013 and 2014. The Shanghai stores alone contributed a loss of $1.3 million in fiscal 2014. The remaining drugstores have historically been profitable and are not expected to require additional financing.

As reflected in our consolidated financial statements, we had a net loss of $384,849 for the six months ended September 30, 2014. We have taken measures to address some of these challenges, such as accelerating cash or goods collections from suppliers against advances, and attracting talent to improve and enhance our traditional retail pharmacy plus in-store clinic business. We are looking to open additional in-store clinics to attract customer traffic. Moreover, the Company is actively developing its high profit margin product line of Chinese Medicine and high-grade nutritional supplements such as Ginseng under its own trademark of Shouantang. We have collected certain aged accounts from our suppliers and customers and will continue to pursue the collection of certain older accounts receivables. Additionally, we will sublease our healthcare center under Jiuyingtang to cut loss in the near future. By doing so, we hope to utilize the value of leasehold improvement we invested in Jiuyingtang fiscal 2013. We have also adjusted our wholesale strategy to focus on profitability and timely collection of credit sales rather than immediate sales volume growth, even though we anticipate that this will lower our wholesale revenue in the near term. A new management and sales team, whose members have been involved with wholesale pharmaceutical distribution for over twenty years, has been transitioning into the Company’s wholesale business in the third quarter of fiscal 2014. The new team is actively seeking out potential customers, such as local hospitals, which have higher profit margins for sales than sales to other wholesale customers. Additionally, the new team has established an OTC Drug department looking to supply other smaller retails drugstores which, if successful, can increase our sales. The Company plans to fund current operations by continuing to focus on profitability for its wholesale operations and focus on strengthening and expanding its core business model of integrated pharmacy and clinic, which has proven to be a key profit driver.

 

As of September 30, 2014, our current liabilities exceed current assets by $1.75 million. In assessing its liquidity, management monitors and analyzes the Company’s cash balance, its ability to renew bank facilities, and its operating and capital expenditure commitments. Its principal liquidity needs are to meet its working capital requirements, operating expenses and capital expenditure obligations. As of the latest applicable date of this report, the Company has obtained the following financial supports, which are listed below:

 

Line of bank credit

 

Banks  Amount of
Line of Credit as
of September 30, 2014
(in millions)
   Unused Amount of
Line of Credit as
of September 30, 2014
(in millions)
   Expiration Date
Hangzhou United Bank  $1.38   $-   November 7, 2014
Hangzhou United Bank   0.81    0.01   April 2, 2014
Hangzhou United Bank   1.17    -   October 23, 2014
Industrial and Commercial Bank of China   1.95    1.95   July, 16, 2015
Bank of Hangzhou   1.82    1.82   June 12, 2015
Bank of Hangzhou   2.86    0.44   June 12, 2015
Total  $9.99   $4.22    

 

Our principal sources of liquidity consist of existing cash, bank facilities from local banks as well as personal loans from our principal shareholders if necessary. We have three credit line agreements from three local banks as displayed in detail in Note 12. The three credit lines from HUB, ICBC, and BOH allow us to borrow up to $9.99 million in sum. By putting up the restricted cash of $5.44 million deposited in the bank, the credit line is raised up to $15.43 million in total. As of September 30, 2014, we have approximately $11.21 million bank notes payable, approximately $4.22 million bank credit line has not been used and is still available for further borrowing. Any borrowing therefrom is guaranteed by a third-party guarantor company, and secured by our assets pursuant to a collateral agreement, as well as the personal guarantees of some of its principal shareholders.

 

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We have taken measures to reduce its losses and generate positive cash flow by accelerating cash or goods collections from suppliers against advances, and attracting talent to improve and enhance traditional retail pharmacy plus in-store clinic business. In its retail sector, we have closed five unprofitable pharmacies in Shanghai last year and are looking to open additional in-store clinics to attract customer traffic. The remaining stores are considered profitable and are currently generating positive cash flow. We plan to implement O2O (Online to Offline) business model that allows drugstores to deliver goods to online customers in neighborhood communities. Through O2O model, customers can make orders online and our drugstores will deliver ordered products to them within a few hours. As O2O business model cuts the in-store shelf space need for products exhibition, we expect the model can eventually save rental cost in the future. We are actively negotiating with several large suppliers including Pfizer to obtain more purchase discounts and financial support. Moreover, we are actively developing its high profit margin product line of Chinese Medicine and high-grade nutritional supplements such as Ginseng under its own trademark of Shouantang. As healthcare products have become more popular in China, we anticipate a reasonable positive gross margin driving profitability. The drug wholesale industry is usually marked with low profit margin. However, as we are strengthening its customer and supplier credit policy and ceased extremely low profit margin transactions that cannot cover related overhead, we do not expect a significant loss in the future.  Additionally, we will sublease our healthcare center under Jiuyingtang to cut loss.

 

The retail drugstores have been projected to slightly increase as compared to the prior year with lower profit margins. The online pharmacy sales are expected to grow significantly with similar profit margin. The wholesale business is not expected to contribute a significant gross margin to support overhead for the remaining of fiscal 2015, and sales have been projected to be approximately the same as the prior year. The farming business is not expected to have any sales and may incur limited operating costs.

 

Our good credit history with local banks may also enable us to obtain additional credit lines from the same banks or seek new loans from other banks if necessary.  In addition, our CEO Mr. Lei Liu has agreed to provide the necessary financial support to meet our financial obligations in the event that we require additional liquidity. However, since we have no formal agreement with Mr. Liu contractually obligating him to meet our anticipated cash needs for the near future, we cannot be certain that additional financing will be available through shareholder loans, or even if available, if it will be available on terms acceptable to us.

 

We believe that the foregoing sources will collectively provide sufficient liquidity for us to meet our liquidity and capital obligations for the next twelve months.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations

 

When we open store locations, we typically enter into lease agreements that are generally between three to ten years.  Our commitments for minimum rental payments under our leases for the next five years and thereafter are as follows:

 

Periods ending September 30,  Retail
drugstores
  Online
pharmacy
  Drug
wholesale
  Herb farming  Total
Amount
 2015   $3,906,015   $108,059   $176,379   $-   $4,190,453 
 2016    2,039,822    121,764    176,695    -    2,338,281 
 2017    1,410,708    139,159    150,756    -    1,700,623 
 2018    1,228,290    139,159    150,756    -    1,518,205 
 2019    745,191    139,159    150,756    -    1,035,106 
 Thereafter    359,140    208,739    113,067    -    680,946 

 

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Off-balance Sheet Arrangements

 

We do not have any outstanding financial guarantees or commitments to guarantee the payment obligations of any third parties.  We have not entered into any derivative contracts that are indexed to our shares and classified as stockholder’s equity or that are not reflected in our consolidated financial statements.  Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity.  We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

Exchange Rates

 

Our subsidiaries and affiliated companies in the PRC maintain their books and records in RMB, the lawful currency of the PRC.  In general, for consolidation purposes, we translate their assets and liabilities into USD using the applicable exchange rates prevailing at the balance sheet date, and the statement of income is translated at average exchange rates during the reporting period.  Adjustments resulting from the translation of their financial statements are recorded as accumulated other comprehensive income.

 

The exchange rates used to translate amounts in RMB into USD for the purposes of preparing the unaudited condensed consolidated financial statements or otherwise disclosed in this report were as follows:

 

    September 30,
2014
    March 31,
2014
    September 30,
2013
 
Balance sheet items, except for the registered and paid-up capital, as of end of period/year   USD1: RMB 0.1625    USD1: RMB 0.1623    USD1: RMB 0.1630 
                
Amounts included in the statement of Operations and statement of cash flows for the period/ year ended   USD1: RMB 0.1623    USD1: RMB 0.1626    USD1: RMB 0.1618 

  

 

Inflation

 

We believe that inflation has not had a material effect on our operations to date.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of September 30, 2014, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based upon such evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were ineffective at the reasonable assurance level. Such conclusion is based on the presence of the following material weaknesses in internal control over financial reporting as following:

 

·the significance of the audit adjustments’ impact on the overall financial statements; and
·how adequately we complied with U.S. GAAP on transactions.

 

Accounting and Finance Personnel Weaknesses - As noted in Item 9A of our annual reports on Form 10-K for the preceding three fiscal years, management concluded that in light of the inexperience of our accounting staff with respect to the requirements of U.S. GAAP-based reporting and SEC rules and regulations, we did not maintain effective controls and did not implement adequate and proper supervisory review to ensure that significant internal control deficiencies can be detected or prevented.

 

Management anticipates that our disclosure controls and procedures will remain ineffective until such material weakness is remediated.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934) during the period covered by this Quarterly Report on Form 10-Q 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 5. OTHER INFORMATION.

 

On October 9, 2014, the Company, through Jiuzhou Pharmacy, a pharmacy that the Company controls through contractual arrangements, entered into an acquisition agreement with two individual owners of Sanhao Grand Pharmacy Chain Co., Ltd.(“Sanhao Pharmacy”), a local drugstore chain located in Hangzhou, for a total purchase price of $1.56 million (RMB9.6 million), 20% of which was paid within three business days upon the entry into the agreement; 40% shall be paid upon the completion of the registration of the new business license of Sanhao Pharmacy by the local State Administration of Industrial and Commerce, and the balance shall be paid within one year from the entry into the agreement. The Company intends to fund its acquisition through its improved cash flow generated by rising sales from its retail business as well as bank financing.

 

Sanhao Pharmacy presently has eleven stores where customers can use insurance cards issued by Hangzhou government for purchases in eight of those stores. The Company expects to further expand its market shares in Hangzhou City through Sanhao’s existing insurance-applicable stores. As of the date of the report, the registered shareholder of Sanhao Pharmacy has been listed under Jiuzhou Pharmacy.

 

ITEM 6. EXHIBITS.

 

EXHIBIT INDEX

 

Exhibit
Number
  Description
10.1   Acquisition Agreement between Jiuzhou Pharmacy and Sanhao Pharmacy dated October 9, 2014 *
31.1   Section 302 Certification by the Corporation’s Chief Executive Officer *
31.2   Section 302 Certification by the Corporation’s Chief Financial Officer *
32.1   Section 906 Certification by the Corporation’s Chief Executive Officer *
32.2   Section 906 Certification by the Corporation’s Chief Financial Officer *
101.INS   XBRL Instance Document*  **
101.SCH   XBRL Taxonomy Extension Schema Document*  **
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document*  **
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document*  **
101.LAB   XBRL Taxonomy Extension Label Linkbase Document*  **
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document*  **

   

* Filed herewith.
** Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those 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 JO-JO DRUGSTORES, INC.
  (Registrant)
     
Date: November 12, 2014 By: /s/ Lei Liu
   

Lei Liu

Chief Executive Officer

     
Date: November 12, 2014 By: /s/ Ming Zhao
    Ming Zhao
    Chief Financial Officer

 

 

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