UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period 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 001-34394

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY

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

 

Nevada	33-0901534
(State or other jurisdiction of	(I.R.S. employer
incorporation or organization)	identification number)

 

4/F Building B, Chuangye Square, No. 48 Keji Road,

Gaoxin District, Xi’an, Shaanxi Province, P.R. China

(Address of principal executive offices and zip code)

 

(8629) 8819-3188

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    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 (Check one):

 

	Large Accelerated Filer ¨	Accelerated Filer ¨
	Non-accelerated filer ¨	Smaller Reporting Company x

 

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

 

As of November 10, 2014, the Registrant had 8,696,942 shares of common stock outstanding..

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY

 

FORM 10-Q

 

INDEX

 

			Page No.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS			3
PART I.  FINANCIAL INFORMATION			4
Item 1.	Condensed Consolidated Financial Statements		4
	Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013		4
	Condensed Consolidated Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited)		5
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (unaudited)		6
	Condensed Consolidated Statement of Changes in Equity for the Nine Months Ended September 30, 2014 (unaudited)		7
	Notes to the Condensed Consolidated Financial Statements (unaudited)		8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		35
Item 4.	Controls and Procedures		43
PART II.  OTHER INFORMATION			44
Item 5.	Other Information		44
Item 6.	Exhibits		45
SIGNATURES			46

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words “estimate,” “anticipate,” “believe,” “expect,” or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this Report, including the matters set forth under the captions “Risk Factors” and in our other SEC filings. These risks and uncertainties could cause our actual results to differ materially from those indicated in the forward-looking statements.

 

Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those as subsequently updated in our quarterly filings specifically addressed under the heading “Risks Relating to Our Business” contained in Form 10-K for the year ended December 31, 2013, as well as those discussed elsewhere in this Quarterly Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We file reports with the SEC. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.

 

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

 

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 30, 2014 (Unaudited)				December 31, 2013
ASSETS
CURRENT ASSETS:
Cash		$	14,634,703			$	8,142,296
Restricted cash			7,150,000				-
Accounts receivable, net of allowance for doubtful accounts of $2,523,199 and $602,243 as of September 30, 2014 (Unaudited) and December 31, 2013, respectively			35,346,521				11,009,498
Inventories			23,107,891				25,903,586
Deposits, prepaid expenses and other receivables			1,706,896				2,134,163
Prepayments to suppliers			28,482,798				41,061,144
Advance to a supplier			9,750,000				-
Deferred income tax asset			683,010				364,425
Total current assets			120,861,819				88,615,112
PROPERTY, PLANT AND EQUIPMENT, NET			29,613,684				28,269,155
CONSTRUCTION-IN-PROGRESS			10,739,898				9,284,947
OTHER ASSETS:
Long-term prepayments			2,130,458				4,633,614
Long-term prepayments for acquisitions			3,250,000				183,344
Intangible assets, net			5,012,602				5,237,255
Total other assets			10,393,060				10,054,213
Total assets		$	171,608,461			$	136,223,427
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	9,400,410			$	3,303,531
Other payables and accrued expenses			6,956,227				6,467,605
Short-term loans			19,175,000				10,640,500
Deposits from customers			1,656,175				1,877,211
Taxes payable			7,966,573				1,315,486
Due to related parties			2,959,619				1,361,548
Warrant liability			193,517				-
Purchase option liability			-				62,440
Total current liabilities			48,307,521				25,028,321
OTHER LIABILITIES:
Deferred government grants			796,250				802,130
Total other liabilities			796,250				802,130
Total liabilities			49,103,771				25,830,451
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
Preferred stock, $0.001 par value, 50,000,000 shares authorized, No Series “A” shares authorized. 48,000,000 Series “B” convertible preferred stock authorized. No Series “B” convertible preferred stock issued and outstanding. 1,000 Series "C" convertible preferred stock authorized, issued and outstanding as of September 30, 2014 (Unaudited) and all nil as of December 31, 2013			1				-
Common stock, $0.001 par value, 40,000,000 shares authorized, 8,499,314 and 7,604,800 shares issued and outstanding as of September 30, 2014 (Unaudited) and December 31, 2013, respectively			8,499				7,605
Paid-in capital			41,883,258				37,631,142
Statutory reserves			5,952,692				5,952,692
Retained earnings			63,685,817				54,990,154
Accumulated other comprehensive income			10,974,423				11,811,383
Total shareholders’ equity			122,504,690				110,392,976
Total liabilities and shareholders’ equity		$	171,608,461			$	136,223,427

 

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

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013

(Unaudited)

 

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2014				2013				2014				2013
REVENUE, NET		$	18,352,693			$	15,992,408			$	39,424,886			$	32,858,294
COST OF REVENUE			9,589,925				7,778,691				21,480,313				16,087,401
GROSS PROFIT			8,762,768				8,213,717				17,944,573				16,770,893
OPERATING EXPENSES:
Research and development			378,487				324,353				1,181,680				417,740
Selling expenses			1,081,403				1,266,444				2,286,217				2,213,617
General and administrative			1,903,304				1,885,219				4,537,024				3,785,302
Total operating expenses			3,363,194				3,476,016				8,004,921				6,416,659
INCOME FROM OPERATIONS			5,399,574				4,737,701				9,939,652				10,354,234
OTHER INCOME (EXPENSE):
Other income (expense), net			4,807				32,757				178,755				28,908
Interest income			155,510				106,266				490,451				380,097
Interest expense			(252,161	)			(154,792	)			(464,942	)			(565,252	)
Change in fair value of derivative liabilities			314,657				(205,758	)			377,097				(200,158	)
Total other income (expense), net			222,813				(221,527	)			581,361				(356,405	)
INCOME BEFORE PROVISION FOR INCOME TAXES			5,622,387				4,516,174				10,521,013				9,997,829
PROVISION FOR INCOME TAXES			712,934				781,977				1,825,350				1,800,018
NET INCOME			4,909,453				3,734,197				8,695,663				8,197,811
OTHER COMPREHENSIVE INCOME
Foreign currency translation adjustment			(4,936	)			513,281				(836,960	)			2,576,408
COMPREHENSIVE INCOME		$	4,904,517			$	4,247,478			$	7,858,703			$	10,774,219
EARNINGS PER SHARE:
Basic		$	0.58			$	0.49			$	1.09			$	1.08
Diluted		$	0.57			$	0.49			$	1.08			$	1.08
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:
Basic			8,487,425				7,617,726				7,959,506				7,615,733
Diluted			8,574,462				7,617,726				8,050,359				7,615,733

 

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

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(Unaudited)

 

		For the Nine months ended September 30,
		2014				2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	8,695,663			$	8,197,811
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation			1,249,569				1,086,914
Amortization			186,513				184,496
Provision for doubtful accounts			1,927,978				1,274,058
Change in fair value of derivative liabilities			(377,097	)			200,158
Loss on sale of office equipment			-				1,748
Common stock to be issued to related parties for compensation			209,523				3,227
Deferred income tax asset			(363,865	)			(339,618	)
Warrant issue expenses			49,793				-
Change in operating assets and liabilities
Accounts receivable			(26,378,763	)			(17,685,435	)
Inventories			2,609,336				(3,775,636	)
Deposits, prepaid expenses and other receivables			413,365				1,099,950
Prepayments to suppliers			12,293,970				(3,552,385	)
Accounts payable			6,129,382				(513,989	)
Other payables and accrued expenses			532,753				1,391,003
Deposits from customers			(207,556	)			(74,589	)
Taxes payable			6,669,747				2,932,621
Government grants			-				(450,688	)
Due to related parties			1,604,154				928,312
Net cash provided by (used in) operating activities			15,244,465				(9,092,042	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Refund of long-term prepayments for acquisitions			183,507				-
Payment of long-term prepayments for acquisitions			(3,254,400	)			(3,510,666	)
Payments of long-term prepayments			(1,020,700	)			-
Loan to third parties			(1,049,544	)			-
Repayment of loans from third parties			1,049,544				1,094,190
Advance to a supplier			(9,763,200	)			-
Placement of restricted cash			(7,159,680	)			(59,555	)
Purchases of property, plant and equipment			(8,645	)			(9,290	)
Proceeds from sale of plant and equipment			-				161
Payments on construction-in-progress			(827,884	)			(10,977	)
Net cash used in investing activities			(21,851,002	)			(2,496,137	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of common stock, preferred stock and warrants, net of cash issuance expenses of $498,130			4,501,870				-
Proceeds from short-term loans			19,200,960				10,462,400
Repayment of short-term loans			(10,576,800	)			(4,506,880	)
Repayment of long-term loans			-				(1,287,680	)
Net cash provided by financing activities			13,126,030				4,667,840
EFFECT OF EXCHANGE RATE CHANGES ON CASH			(27,086	)			55,110
INCREASE (DECREASE) IN CASH			6,492,407				(6,865,229	)
CASH, beginning of year			8,142,296				11,321,848
CASH, end of period		$	14,634,703			$	4,456,619
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest		$	392,028			$	454,336
Cash paid for income taxes		$	1,350,576			$	329,968
Non-cash investing and financing activities
Long-term prepayments transferred to construction-in-progress		$	3,491,971			$	22,438
Construction-in-progress transferred to property, plant and equipment		$	2,794,780			$	-

 

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

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014

(Unaudited)

  

																														Accumulated
																						Retained earnings								Other
		Preferred stock								Common stock								Paid-in				Statutory								Comprehensive
		Shares				Amount				Shares				Amount				capital				reserves				Unrestricted				Income				Total
BALANCE, January 1, 2014			-			$	-				7,604,800			$	7,605			$	37,631,142			$	5,952,692			$	54,990,154			$	11,811,383			$	110,392,976
Foreign currency translation			-				-				-				-				-				-				-				(836,960	)			(836,960	)
Share based compensation			-				-				-				-				209,523				-				-				-				209,523
Common and preferred stock issued			1,000				1				790,514				790				4,042,697				-				-				-				4,043,488
Common stock issued			-				-				104,000				104				(104	)			-				-				-				-
Net income											-				-				-				-				8,695,663				-				8,695,663
BALANCE, September 30, 2014			1,000			$	1				8,499,314			$	8,499			$	41,883,258			$	5,952,692			$	63,685,817			$	10,974,423			$	122,504,690

 

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

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 1 - ORGANIZATION

 

Organization and description of business

 

Skystar Bio-Pharmaceutical Company (“Skystar” or the “Company”) was incorporated in Nevada on September 24, 1998. Since its acquisition on November 7, 2005 of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), a Cayman Islands company, the Company has been engaged in the research, development, production, marketing, and sales of veterinary healthcare and medical care products.

 

All current operations of the Company are in the People’s Republic of China (“China” or the “PRC”).

 

All of the Company’s operations are carried out by its subsidiaries in China and Xi’an Tianxing Bio-Pharmaceutical Co., Limited (“Xi’an Tianxing”), a PRC joint stock company that the Company controls through contractual arrangements originally between Skystar Cayman and Xi’an Tianxing. On March 10, 2008, the Company entered into a series of agreements transferring all of the rights and obligations of Skystar Cayman under the contractual arrangements to Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), a PRC company. Sida is the wholly owned subsidiary of Fortunate Time International Limited (“Fortunate Time”), a Hong Kong company and wholly owned subsidiary of Skystar Cayman. Xi’an Tianxing also has a wholly owned subsidiary, Shanghai Siqiang Biotechnological Co., Ltd. (“Shanghai Siqiang”), a PRC company.

 

On September 18, 2009, Skystar Bio-Pharmaceutical Inc. (“Skystar California”) was incorporated in California and became a wholly owned subsidiary of Skystar. On December 20, 2010, Skystar California was dissolved.

 

On April 21, 2010, Kunshan Sikeda Biotechnology Co., Ltd. (“Kunshan Sikeda”) was incorporated in Kunshan, Jiangsu Province, China with a registered capital of $81,250 (RMB 500,000), of which Xi’an Tianxing and Sida each contributed $40,625 (RMB 250,000). Kunshan Sikeda is jointly owned by Xi’an Tianxing and Sida. On July 31, 2013, Kunshan Sikeda was dissolved.

 

On May 7, 2010, Fortunate Time formed Skystar Biotechnology (Kunshan) Co., Limited (“Skystar Kunshan”) in Kunshan, Jiangsu Province, China with a registered capital of $15,000,000, of which $2,250,000 was paid by Fortunate Time in cash. On March 26, 2014, the Company received the government approval of extension for payment of the remaining registered capital of $12,750,000 by May 6, 2015. Skystar Kunshan was formed in connection with an acquisition of assets to meet part of the registered capital requirements, and was intended to be a micro-organism manufacturing facility for the Company once the acquisition was complete. The asset acquisition was completed in September 2011. On July 30, 2014, the Company injected $3,000,500 of capital by cash to this entity.

 

On August 11, 2010, Sida became the parent company of Skystar Biotechnology (Jingzhou) Co., Limited (“Skystar Jingzhou”), a company established in Jingzhou, Hubei Province, China on February 5, 2010, with registered capital of approximately $4.2 million (RMB 26,000,000) paid by Sida.

 

On March 15, 2011, Xi’an Tianxing formed Xi’an Sikaida Bio-products Co., Ltd. (“Xi’an Sikaida”) with a registered capital of approximately $1,625,000 (RMB 10,000,000) paid by Xi’an Tianxing.

 

Hereinafter, Skystar, Skystar Cayman, Fortunate Time, Sida, Xi’an Tianxing, Skystar Kunshan, Skystar Jingzhou, Shanghai Siqiang, and Xi’an Sikaida are sometimes collectively referred to as the “Company”.

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles (“U.S. GAAP”) applicable to interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (which include all significant normal and recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. The accompanying results of operations are not necessarily indicative of the operating results that may be expected for the entire year ending December 31, 2014. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes thereto of the Company, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”).

  

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Principles of consolidation

 

The accompanying condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The condensed consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiaries, and its variable interest entities (“VIEs”).  All significant inter-company transactions and balances between the Company, its subsidiaries, and its VIEs have been eliminated in consolidation.

 

The Company has evaluated the relationship with Xi’an Tianxing and Xi’an Tianxing’s wholly owned subsidiaries, Xi’an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company is the primary beneficiary of these VIEs and thus it accounts for Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi’an Tianxing. Xi’an Sikaida and Shanghai Siqiang.

 

Use of estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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 level of uncertainty in estimates and assumptions increases with the length of time to complete the underlying transactions. Actual results may differ from these estimates in amounts that may be material to the consolidated financial statements and accompanying notes. Significant estimates and assumptions made by the Company are used for, but not limited to the allowance for doubtful accounts, useful lives of property, plant and equipment and intangible assets, assumptions used in assessing impairment for long-lived assets, classification of prepayments to suppliers and the fair value for derivative instruments.

  

Foreign currency translation

 

The Company uses the United States dollar (“U.S. dollar”) for financial reporting purposes and the Chinese Renminbi (“RMB”) as its functional currency. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency, being the primary currency of the economic environment in which their operations are conducted.

 

The Company translates the subsidiaries’ and VIEs’ assets and liabilities into U.S. dollars using the applicable exchange rates prevailing at the balance sheet dates, and the statements of comprehensive 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 consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the subsidiaries’ and VIEs’ financial statements are recorded as accumulated other comprehensive income.

 

The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China.

 

Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents, and signed contracts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

  

  

 SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Fair values of financial instruments

 

ASC Topic 820, Fair Value Measurement and Disclosures , defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy, which requires classification based on observable and unobservable inputs when measuring fair value. Certain current assets and current liabilities are financial instruments.  Management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, their current interest rates are equivalent to interest rates currently available. The three levels of valuation hierarchy are defined as follows:

   

¨

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

 

¨

Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

 

¨

Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2014 and December 31, 2013:

 

		Carrying Value at September 30,				Fair Value Measurement at September 30, 2014
		2014				Level 1				Level 2				Level 3
Warrant liability		$	193,517			$	—			$	—			$	193,517

  

		Carrying Value at December 31,				Fair Value Measurement at December 31, 2013
		2013				Level 1				Level 2				Level 3
Purchase option liability		$	62,440			$	—			$	62,440			$	—

 

Below is a reconciliation of the change in fair values of derivative liabilities from January 1, 2014 to September 30, 2014:

 

Balance, January 1, 2014		$	62,440
Warrants issued			508,174
Change in fair value			(377,097	)
Balance, September 30, 2014		$	193,517

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Revenue recognition

 

Revenue of the Company is primarily derived from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected in these consolidated financial statements as sales returns historically have been insignificant.

 

There are two types of sales upon which revenue is recognized:

 

	a.	Credit sales: revenue is recognized when the products have been delivered to the customers.
	b.	Full payment before delivery: Cash received is recorded as “deposits from customers” and revenue is recognized when the products have been delivered to the customers.

 

Cash

 

Cash includes currency on hand and demand deposits with banks with an original maturity of three months or less.

 

Accounts receivable

 

Accounts receivable are stated at cost, net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses, if any, resulting from the failure of customers to make required payments. The Company reviews the accounts receivable on a periodic basis and makes allowances where there is doubt as to the collectibility of individual balances. In evaluating the collectibility of individual receivable balances, the Company considers many factors, including the age of the balance, the customer’s payment history, its current credit-worthiness and current economic trends.

 

Inventories

 

Inventories are stated at the lower of cost as determined on a weighted-average basis, or market. Inventories include purchases and related costs incurred in bringing the inventories to their present location and condition. Management reviews inventories for obsolescence and cost in excess of market and records a write-down against the inventory and additional cost of goods sold when the carrying value exceeds market.

 

Property, plant and equipment

 

Property, plant and equipment are stated at cost less accumulated depreciation and impairment losses, if any. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance and repairs that do not improve or extend the useful lives of the assets are charged to operations as incurred, while renewals and betterments are capitalized. Gains and losses on disposals are included in the results of operations. Estimated useful lives of the assets are as follows:

 

		Estimated useful life
Buildings and improvements		Shorter of lease term or 10-40 years
Machinery and equipment		5-10 years
Office equipment and furniture		3-10 years
Vehicles		5-10 years

 

Management assesses the carrying value of property, plant and equipment annually or more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management believes that, as of September 30, 2014 and December 31, 2013, there was no impairment of its property, plant and equipment.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Construction-in-progress

 

Construction-in-progress includes direct costs of construction of factory buildings. Interest incurred during the period of construction, if significant, is capitalized. All other interest is expensed as incurred. Construction-in-progress is not depreciated until such time as the asset is completed and put into service.

 

Intangible assets

 

Land use rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on the straight-line method over the contractual lease terms.  The land use right granted to the Company’s Huxian facility was for 50 years.  The land use right granted to the Company’s Jingzhou facility was 30 years. The land use right granted to the Company’s Kunshan facility was for 41 years.

 

Technological know-how — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over an estimated useful life of between five to eleven years that reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.

 

Impairment of intangible assets —Intangible assets are evaluated at least annually for impairment if events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Based on the existence of one or more indicators of impairment, the Company measures any impairment of long-lived assets by comparing the asset's estimated fair value with its carrying value, based on cash flow methodology. Based on its review, the Company believes that, as of September 30, 2014 and December 31, 2013, there was no impairment of its intangible assets.

 

Comprehensive income

 

Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income is comprised of the foreign currency translation adjustments.

 

Shipping and handling costs

 

Shipping and handling costs related to costs of goods sold are included in selling expenses, and totaled $721,529 and $805,492 for the three months ended September 30, 2014 and 2013, respectively, and $1,447,318 and $1,452,981 for the nine months ended September 30, 2014 and 2013, respectively.

 

Advertising costs

 

Advertising costs are charged to selling expenses as incurred. Advertising costs were insignificant for both the three and nine months ended September 30, 2014 and 2013.

 

Research and development costs

 

Research and development costs are charged to expense as incurred and include the cost of raw materials, salaries, professional fees, and technical support fees related to such efforts.

 

Income taxes

 

The Company accounts for income taxes using an asset and liability method.  Under this method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. 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.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Income taxes (Continued)

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. As of September 30, 2014 and December 31, 2013, there are no unrecognized tax benefits, and the Company does not expect a significant change in tax benefits in the next 12 months.  Penalties and interest levied by taxing authorities, if any, are classified as income tax expense in the year incurred.  No significant penalties or interest relating to income taxes have been incurred during the three and nine months ended September 30, 2014 and 2013.

 

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent.  The statute of limitations extends to five years under special circumstances. In the case of transfer pricing issues, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. Accordingly, the income tax returns of the Company’s PRC operating subsidiaries for the years ended December 31, 2008 through 2013 are open to examination by the PRC state and local tax authorities.

 

Government grants

 

The Company’s subsidiaries in China receive government subsidies from local Chinese government agencies in accordance with relevant Chinese government policies. In general, the Company presents the government subsidies received as part of other income unless the subsidies received are earmarked to compensate for a specific expense, which have been accounted for by offsetting the specific expense, such as research and development expense or interest expenses. Unearned government subsidies received are deferred for recognition until the criteria for such recognition could be met.

 

For research and development expenses, the Company matches and offsets the government grants with the expenses of the research and development activities as specified in the grant approval document in the corresponding period when such expenses are incurred. No government grants were offset against the research and development expenses for the three and nine months ended September 30, 2014 and government grants of $2,040 and $482,880 were offset against the research and development expenses for the three and nine months ended September 30, 2013.

 

No government grants were offset against the finance costs for the three and nine months ended September 30, 2014. Government grants of $63,708 were offset against the finance costs for the three and nine months ended September 30, 2013.

 

Government grants of $34,251 and $201,578 were received and recognized as other income during the three and nine months ended September 30, 2014. Government grants of $25,448 and $25,448 were received and recognized as other income during the three and nine months ended September 30, 2013.

 

Stock-based compensation

 

The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

 

Earnings per share

 

Basic earnings per share is based upon the weighted-average number of common and Series “C” convertible preferred shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including warrants and stock options were converted or exercised. Further, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period or after the end of the period but before the release of the financial statements, by considering it outstanding for the entirety of each period presented. Diluted earnings per share is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Related parties

 

Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of such principal owners and management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.

 

Operating segments

 

While the chief operating decision-makers monitor the revenue streams of the various products lines, operations are managed and financial performance is evaluated on a Company-wide basis. Product lines are aggregated into one as operating results for all product lines are similar. Accordingly, all of the major product lines (micro-organism, veterinary medicine, feed additives and vaccines) are considered by management to be aggregated in one reportable operating segment.

 

As the Company primarily generates its revenues from customers in the PRC, no geographical segments are presented.

 

Reclassification

 

Certain amounts included in the 2013 condensed consolidated balance sheets, statements of comprehensive income and cash flows have been reclassified to conform to the 2014 financial statement presentation as follows;

 

The Company has reclassified the purchase option liability of $62,440 for the year ended December 31, 2013 from other liabilities to current liabilities.

 

As a result of such reclassification, other liabilities for the year ended December 31, 2013 has changed from $864,570 to $802,130 and current liabilities has changed from $24,965,881 to $25,028,321.

 

The Company has separately presented interest income of $106,266 and $380,097 on the face of condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2013, instead of presenting it net of interest expenses.

 

As a result of such reclassification, interest expense for the three months ended September 30, 2013, has changed from $48,526 to $154,792; and interest expense for the nine months ended September 30, 2013, has changed from $185,155 to $565,252. 

 

The change in due to related parties of $928,312 was classified into cash flows from financing activities in the Company’s condensed consolidated statements of cash flows for the nine months ended September 30, 2013. The Company has reclassified this amount as a component of cash flows from operating activities.

 

As a result of such reclassification, net cash provided by financing activities for the nine months ended September 30, 2013 has changed from $5,596,152 to $4,667,840 and net cash used in operating activities has changed from $10,020,354 to $9,092,042.

 

Recently issued accounting pronouncements

 

In April 2014, the FASB issued ASU 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”, which changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Entities may “early adopt” the guidance for new disposals. The Company is currently evaluating the impact on its consolidated financial statements of adopting this guidance.

 

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" which clarifies and improves the principles for recognizing revenue and develops a common revenue standard for United States generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) that among other things, improves comparability of revenue recognition practices and provides more useful information to users of financial statements through improved disclosure requirements. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company is currently reviewing the effect of ASU 2014-09 on its revenue recognition.

 

In June 2014, the FASB issued ASU 2014-12, "Compensation - Stock Compensation (Topic 718)" which provides explicit guidance on the treatment of awards with performance targets that could be achieved after the requisite service period. The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. The Company does not expect that the adoption will have a material impact on its consolidated financial statements.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Recently issued accounting pronouncements (Continued)

 

In August 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements-Going concern (Subtopic 205-40) which provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes. This guidance in ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The Company does not expect that the adoption will have a material impact on its consolidated financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.

 

Note 3 - CONCENTRATIONS AND CREDIT RISK

 

The Company’s operations are all carried out in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific 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 environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

 

Financial instruments which subject the Company to concentration of credit risk consist of cash and accounts receivable, prepayments to suppliers and advance to a supplier. Balances at financial institutions or state-owned banks within the PRC are not covered by insurance. The Company has not experienced any losses in such accounts. The Company provides unsecured credit terms for sales to certain customers and places unsecured prepayments for purchase and advance to suppliers. As a result, there are credit risks with the accounts receivable and prepayment to suppliers balances. The Company constantly re-evaluates the credit worthiness of customers buying on credit and recoverability of suppliers and maintains an allowance for doubtful accounts.

 

For the three and nine months ended September 30, 2014 and 2013, all of the Company’s sales occurred in the PRC. No major customers accounted for more than 10% of the Company’s total revenues. All accounts receivable at September 30, 2014 and December 31, 2013 are from customers located in the PRC.

 

The Company’s six largest vendors accounted for approximately 76% and 79% of the Company’s total purchases for the three months ended September 30, 2014 and 2013, respectively. The Company’s six largest vendors accounted for approximately 68% and 75% of the Company’s total purchases for the nine months ended September 30, 2014 and 2013, respectively. For the three months ended September 30, 2014, 2 suppliers accounted for 29% and 23% of the Company’s total purchases, respectively. For the three months ended September 30, 2013, 3 suppliers accounted for 32%, 20% and 14% of the Company’s total purchases, respectively. For the nine months ended September 30, 2014, 2 suppliers accounted for 26% and 21% of the Company’s total purchases, respectively. For the nine months ended September 30, 2013, 3 suppliers accounted for 28%, 25% and 12% of the Company’s total purchases respectively. As of September 30, 2014, 2 suppliers accounted for 66% and 12% of total prepayments to suppliers, respectively. As of December 31, 2013, 2 suppliers accounted for 76% and 10% of total prepayments to suppliers, respectively.

 

The Company had one product that accounted for 11% and 17% of the Company’s total revenues for the three and nine months ended September 30, 2014, respectively. The Company had another product that accounted for 10% and 9% of the Company’s total revenues for the three and nine months ended September 30, 2014, respectively.  No other product accounted for more than 10% of the Company’s total revenues for the three and nine months ended September 30, 2014. The Company had one product that accounted for 23% and 25% of the Company’s total revenues for the three months and nine months ended September 30, 2013, respectively.

  

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 4 - ACCOUNTS RECEIVABLE, NET

 

Accounts receivable consisted of the following:

 

		September 30, 2014				December 31, 2013
Accounts receivable		$	37,869,720			$	11,611,741
Allowance for doubtful accounts			(2,523,199	)			(602,243	)
Accounts receivable, net		$	35,346,521			$	11,009,498

 

The following table presents the movement of the allowance for doubtful accounts:

 

Balance, January 1, 2014		$	602,243
Addition			1,927,978
Recovery			—
Translation adjustment			(7,022	)
Balance, September 30, 2014		$	2,523,199

 

Note 5 – INVENTORIES

 

Inventories consist of the following:

 

		September 30, 2014				December 31, 2013
Raw materials		$	18,724,264				23,001,461
Packing materials			493,796				396,067
Work-in-process			180,752				23,140
Finished goods			3,629,306				2,409,083
Other			79,773				73,835
Total		$	23,107,891				25,903,586

 

No write-down of inventories was recorded for the three and nine months ended September 30, 2014 and 2013.

  

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 6 - DEPOSITS, PREPAID EXPENSES AND OTHER RECEIVABLES

 

Deposits, prepaid expenses and other receivables are comprised of the following:

 

		September 30, 2014				December 31, 2013
Other prepayments		$	396,571			$	478,144
Deposits placed with guarantors (note 13)			487,500				491,100
Interest receivable (notes 7 and 12)			154,510				497,844
Other receivables			668,315				667,075
Total		$	1,706,896			$	2,134,163

 

Note 7 – PREPAYMENTS TO SUPPLIERS AND ADVANCE TO A SUPPLIER

 

a)

PREPAYMENTS TO SUPPLIERS

 

Prepayments to suppliers are comprised of the following:

 

		September 30, 2014				December 31, 2013
Prepayments for raw materials		$	27,486,902			$	39,937,944
Prepayments for packaging materials			995,896				1,123,200
Total		$	28,482,798			$	41,061,144

 

As part of the Company’s strategy to reduce inventory costs, the Company maintains a balance for prepayments to suppliers in order to secure favorable pricing for raw materials.  As inventory is received throughout the period, this balance will fluctuate with the business operations.

 

Starting from January 1, 2013, the Company began to charge two major suppliers interest at an annual rate of 2.0% on the unused prepayments for raw materials. Starting from January 1, 2014, in addition to these two major suppliers, the Company began to charge another supplier interest at an annual rate of 2.0% on the unused prepayments for raw materials. As of September 30, 2014 and December 31, 2013, prepayments to these suppliers were $21,151,982 and $31,953,084, respectively. For the three months ended September 30, 2014 and 2013, $154,410 and $103,617, respectively, of interest income were recognized on these prepayments. For the nine months ended September 30, 2014 and 2013, $469,109 and $332,477, respectively, of interest income were recognized on these prepayments. The unpaid interest balance of $154,410 and $497,844 as of September 30, 2014 and December 31, 2013, respectively, was included in “Deposits, prepaid expenses and other receivables” (note 6). As of the date of this report, the interest balance was fully paid.

 

b)

ADVANCE TO A SUPPLIER

 

As of September 30, 2014, the Company advanced $9,750,000 (RMB 60,000,000) to Xi’an Yanghua Chemical Co., Ltd. (“Xi’an Yanghua), the Company’s key raw material supplier to secure favorable pricing on future raw material supplies. This advance was interest-bearing at 2%, unsecured and has no fixed repayment term.

 

On October 10, 2014, the Company entered into a one-year loan agreement from October 10, 2014 to October 9, 2015 with Xi’an Yanghua for this advance for the purpose of receiving favorable pricing and deepening the relationship with an important and major supplier. The loan bears interest at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 20% of that rate, which was 7.2% at the date when the agreement was entered. This loan is guaranteed by Shaanxi Mingrui Agriculture Development Co., Ltd, (“Shaanxi Mingrui”), an unrelated third party to the Company. One of the shareholders of Shaanxi Mingrui was the common shareholder of Xian Tiantai Investment Co., Ltd. who was engaged by the Company to facilitate potential acquisition projects (Note 10). On November 12, 2014, the Board of Directors approved and ratified this loan agreement.

  

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 8 - PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment consist of the following:

 

		September 30, 2014				December 31, 2013
Buildings and improvements		$	28,068,545			$	27,703,872
Machinery and equipment			8,277,944				6,093,533
Office equipment and furniture			338,012				337,688
Vehicles			607,502				611,989
Total			37,292,003				34,747,082
Less: accumulated depreciation			(7,678,319	)			(6,477,927	)
Plant and equipment, net		$	29,613,684			$	28,269,155

 

Depreciation expense was $378,518 and $456,392 for the three months ended September 30, 2014 and 2013, respectively. Depreciation expense was $1,249,569 and $1,086,914 for the nine months ended September 30, 2014 and 2013, respectively.

 

As of September 30, 2014 and December 31, 2013, property, plant and equipment with a carrying amount of $21,994,640 and $19,969,335, respectively, was pledged against the Company’s short-term loans.

 

Note 9 - CONSTRUCTION-IN-PROGRESS

 

Construction-in-progress (“CIP”) relates to facilities being built in Xi’an, Jingzhou and Kunshan.

 

Xi’an facility

 

Xi’an Tianxing has a vaccine facility and animal laboratory being built in Huxian, Xi’an.

 

In 2011, the Company started two projects at the vaccine facility to modify air filtration, water treatment, and other facility changes based on recommendations by outside experts hired by the Company to advise on the Good Manufacturing Practices (“GMP”) qualification process for the vaccine facility. In September 2012, the China’s Ministry of Agriculture (“MOA”) physically inspected this facility and deemed the facility GMP compliant. Following physical inspection, the MOA’s inspection team recommended that the Office of the Working Committee proceed with Stage 2 of its GMP certification process.  On December 26, 2013, the MOA granted the GMP certificate for this new facility that is valid for five years, and the facility started to launch trial production in the quarter ended March 31, 2014. CIP of $2,462,966 was transferred to property, plant and equipment during the first quarter of 2014. The facility is currently in the process of applying for individual product permits from the government. During the third quarter, three vaccine production permits have been received from the government.

 

In 2011, the Company started a facility improvement project in the amount of approximately $324,600 for the Huxian Animal Laboratory. The facility is a supporting project to the Huxian vaccine facility. The project was completed and passed GMP inspection in December 2013. The cost of the animal laboratory of $324,600 was transferred to property, plant and equipment during the first quarter of 2014.

 

Jingzhou facility

 

In 2011, the Company started a facility improvement project to expand the veterinary medicine production capacity at the Jingzhou facility. The project includes plant construction and water supply and drainage and has an estimated total cost of $1,706,251, of which $1,213,713 had been incurred as of September 30, 2014. Due to the revision in the project blueprint to comply with GMP requirements, the project was temporarily halted. The project was resumed in the second quarter of 2014 and the Company expects it to be completed by the end of the first quarter of 2015.

  

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 9 - CONSTRUCTION-IN-PROGRESS (Continued)

 

Kunshan facility

 

In 2011, the Company started a supporting project at the Kunshan micro-organism facility that includes the construction and installation of plumbing, sewer, electrical, HVAC, fire protection and alarm system, drainage, office, lab, road construction, parking, and landscaping. As of September 30, 2014, the construction and installation of these facilities was completed, inspected and accepted. However, the construction-in-progress of $5,353,997 has not been transferred to property, plant and equipment as the Kunshan micro-organism facility was not operational at this point. During the third quarter of 2013, the Company contracted with an unrelated third party to purchase machinery and equipment at a total consideration of approximately $9,410,148, of which $4,172,188 has been incurred and $1,037,562 was paid and was included in “Long-term prepayments” (note 10) as of September 30, 2014. The Company expects the purchase and installation of this equipment will be completed by the end of the fourth quarter of 2014.

 

No depreciation is provided for construction-in-progress until such time as the assets are completed and placed into service.

 

The construction projects the Company was in the progress of completing are as follows:

 

		Total in CIP as of
Project		September 30, 2014				Estimated Cost to Complete				Estimated Total Cost				Estimated Completion Date
Jingzhou veterinary medication facility		$	1,213,713			$	492,538			$	1,706,251			First quarter of 2015
Kunshan micro-organism facility			9,526,185				5,237,960				14,764,145			Construction - completed, Installation of machinery and equipment – First quarter of 2015
Total		$	10,739,898			$	5,730,498			$	16,470,396

 

As of September 30, 2014 and December 31, 2013, the Company had construction in progress amounting to $6,567,710 and $9,284,947, respectively.

 

Interest expense of $42,400 and $nil has been capitalized for construction in progress for the three months ended September 30, 2014 and 2013, respectively. Interest expense of $132,907 and $nil has been capitalized for construction in progress for the nine months ended September 30, 2014 and 2013, respectively.

 

Note 10 - LONG-TERM PREPAYMENTS

 

Long-term prepayments consist of the following:

 

		September 30, 2014				December 31, 2013
Deposits for equipment purchase and land use rights		$	1,373,659			$	3,871,228
Construction deposits			386,700				366,688
Prepayments for R&D project			364,000				389,556
Deposits for other			6,099				6,142
Long-term prepayments		$	2,130,458			$	4,633,614
Long-term prepayments for acquisitions		$	3,250,000			$	183,344

 

As of September 30, 2014 and December 31, 2013, refundable deposits for potential acquisitions totaled $3,250,000 and $183,344, respectively, all of which was held by an unrelated third party engaged to facilitate potential acquisition projects.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 11 – INTANGIBLE ASSETS

 

Intangible assets consist of the following:

 

		September 30, 2014				December 31, 2013
Land use rights		$	4,915,627			$	4,951,927
Technological know-how			2,600,000				2,619,200
Total			7,515,627				7,571,127
Less: accumulated amortization			(2,503,025	)			(2,333,872	)
Intangible assets, net		$	5,012,602			$	5,237,255

 

For the three months ended September 30, 2014 and 2013, amortization expense for intangibles assets amounted to $62,049 and $62,018, respectively. For the nine months ended September 30, 2014 and 2013, amortization expense for intangibles assets amounted to $186,513 and $184,496, respectively.

 

Amortization expense expected for the next five years and thereafter is as follows:

 

Years ending December 31,		Amount
2014		$	62,086
2015			248,348
2016			248,348
2017			248,348
2018			248,348
Thereafter			3,957,124
Total		$	5,012,602

 

As of September 30, 2014 and December 31, 2013, land use rights with a carrying amount of $3,164,209 and $1,529,960, respectively, were pledged against the Company’s short-term loans.

 

Note 12 – LOANS RECEIVABLE

 

On January 2, 2014, the Company entered a loan agreement with Shaanxi Feilong Logistics Co., Ltd., (“Feilong”), the Company’s major logistics provider, to lend up to $1,300,000 (RMB 8,000,000) to Feilong. This loan agreement expired on May 31, 2014 with an annual interest rate of 6%. During the nine months ended September 30, 2014, Feilong borrowed a total amount of $1,048,125 (RMB 6,450,000) from the Company.   Interest income earned on this unsecured loan amounted to $nil and $18,431 for the three and nine months ended September 30, 2014. The loan was fully repaid on June 25, 2014 and interest was fully repaid in August 2014.

 

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 13 – SHORT-TERM LOANS

 

On January 16, 2013, the Company obtained a one year loan with Industrial Bank Co. Ltd. Xi’an branch for $4,875,000 (RMB 30,000,000) at an annual interest rate of 6.6%. This loan was secured by the Company’s land use rights and manufacturing plant located in Huxian County. This loan was also personally guaranteed by the Company’s Chairman and CEO and his wife. On January 15, 2014, the loan was fully repaid.

 

On April 16, 2013, the Company obtained a one year loan from May 27, 2013 to May 26, 2014 with Postal Savings Bank of China Xi’an Branch for $3,250,000 (RMB 20,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 20% of that rate, which was 7.2% at September 30, 2014. This loan was guaranteed by Xi’an Investment and Financing Guarantee Co., Ltd., an unrelated party. For this guarantee, the Company was required to pay $58,500 (RMB 360,000) of fees to Xi’an Investment and Financing Guarantee Co., Ltd. and 10% of the loan or $325,000 (RMB 2,000,000) was required to be kept by Xi’an Investment and Financing Guarantee Co., Ltd. to serve as collateral until the loan is repaid. This loan was secured by the Company’s office buildings located in Xi’an, Shaanxi Province and the manufacturing equipment in Huxian County, with a total carrying value of $1,601,227 as of September 30, 2014. The Company’s Chairman and CEO, his wife, and two other company’s managers had provided personal guarantees to Xi’an Investment and Financing Guarantee Co., Ltd. for the repayment of the loan. On May 22, 2014, the loan was fully repaid. On June 4, 2014, the Company obtained a one year loan from June 10, 2014 to June 9, 2015 with Postal Savings Bank of China Xi’an Branch for $3,250,000 (RMB 20,000,000). The interest and security terms of this loan are identical to those of the loan that the Company repaid on May 22, 2014.

 

On June 13, 2013, the Company obtained a one year loan from June 20, 2013 to June 19, 2014 with Industrial and Commercial Bank of China (ICBC) Songzi Branch for $812,500 (RMB 5,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate, which was 7.8% at September 30, 2014. The Company was originally required to keep 10% of the loan or $81,250 (RMB 500,000) with the bank as collateral. During the fourth quarter of 2013, the collateral was waived. This loan was secured by the Company’s buildings and land use rights in Jingzhou, Hubei Province. On June 19, 2014, the loan was fully repaid.

 

On April 14, 2014, the Company entered into a six-month Banker’s Acceptance agreement with Chang’an Bank for $7,800,000 (RMB 48,000,000) at a six-month interest rate of 3%. The Banker’s Acceptance was issued on April 21, 2014 and secured by pledged deposits placed with Chang’an Bank of $3,900,000 (RMB 24,000,000), and the Company’s land use rights and manufacturing plant located in Huxian County with a carrying value of $329,431 and $16,461,615 as of September 30, 2014, respectively. This Banker’s Acceptance was also personally guaranteed by the Company’s Chairman and CEO and his wife. The fee to cash the Banker’s Acceptance is 0.05% of the face value of this Banker’s Acceptance or $3,900 (RMB 24,000). Pursuant to this Bank’s Acceptance, loans of $7,800,000 (RMB 48,000,000) were drawn down as of April 21, 2014. On October 21, 2014, the loan was fully repaid and this Bank’s Acceptance was renewed for another six months with the same terms.

 

On May 7, 2014, the Company entered into a six-month Banker’s Acceptance agreement with Qishang Bank for $6,500,000 (RMB 40,000,000). The Banker’s Acceptance was issued on May 7, 2014 and secured by pledged deposits placed with Qishang Bank of $3,250,000 (RMB 20,000,000), the Company’s land use rights and manufacturing plant located in Kunshan with a carrying value of $2,834,779 and $3,532,308 as of September 30, 2014, respectively. This Banker’s Acceptance was also personally guaranteed by the Company’s Chairman and CEO and his wife. This loan is also guaranteed by Qinglong Ltd. of Huangling County, an unrelated party. The fee to cash the Banker’s Acceptance is 0.05% of the face value of this Banker’s Acceptance or $3,250 (RMB 20,000). Pursuant to this Bank’s Acceptance, loans of $6,500,000 (RMB 40,000,000) were drawn down as of May 7, 2014. The Banker’s Acceptance bears a six-month interest rate of 3% and interest was deducted from the loan proceeds when the loan was drawn down. The recipient of the loan proceeds is responsible for the interest costs. On November 7, 2014, the loan was fully repaid.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 13 – SHORT-TERM LOANS (Continued)

 

On September 10, 2013, the Company entered into a loan agreement with its Chairman and CEO. Under the agreement, the Chairman and CEO obtained a one year personal bank loan from September 12, 2013 to September 11, 2014 with Bank of Beijing of $1,625,000 (RMB 10,000,000) and lent the entire loan proceeds to the Company. The interest and repayment terms of the loan from the Chairman and CEO are identical to those of the personal bank loan. The annual interest rate is determined by using the prime rate over the same period plus 30% of that rate, which was 7.8% at the date that the loan was issued. The Company agrees to bear all the costs and expenses associated with the personal bank loan. The personal bank loan is guaranteed by Xi’an Investment and Financing Guarantee Co., Ltd. For this guarantee, the CEO is required to (i) pay $29,250 (RMB 180,000) of fees to Xi’an Investment and Financing Guarantee Co., Ltd. This cost has been paid and recorded as an expense of the Company using the effective interest method for the three and nine months ended September 30, 2014; and (ii) place 10% of the loan or $162,500 (RMB 1,000,000) at Xi’an Investment and Financing Guarantee Co., Ltd. to serve as collateral until the loan is repaid. The Company had placed such a deposit with Xi’an Investment and Financing Guarantee Co., Ltd. as of September 30, 2014. The personal bank loan is also secured by the Chairman and CEO’s real estate properties and the Company’s office buildings and machineries located in Xi’an. On August 7, 2014, the loan was fully repaid and was renewed for another year from August 15, 2014 to August 15, 2015 with the same terms.

 

Outstanding short-term loans consisted of the following:

 

		September 30, 2014								December 31, 2013										Interest
Bank		RMB				USD				RMB				USD				Due Date		Rate
Industrial Bank Co. Ltd. Xi’an Branch			-			$	-				30,000,000			$	4,911,000			01/15/14			6.60	%
Postal Savings Bank of China Xi’an Branch			-				-				20,000,000				3,274,000			05/26/14			(2	)
ICBC Songzi Branch			-				-				5,000,000				818,500			06/19/14			(1	)
Postal Savings Bank of China Xi’an Branch			20,000,000				3,250,000				-				-			06/09/15			(2	)
Chang'an Bank Xi’an Branch			48,000,000				7,800,000				-				-			10/21/14			(3	)
Qishang Bank			40,000,000				6,500,000				-				-			11/07/14			(3	)
			108,000,000				17,550,000				55,000,000				9,003,500
Related-party Individual – Chairman and CEO			-				-				10,000,000				1,637,000			09/11/14			7.8	%
Related-party Individual – Chairman and CEO			10,000,000				1,625,000				-				-			08/15/15			(1	)
Total			118,000,000			$	19,175,000				65,000,000			$	10,640,500

  

(1)

People's Bank of China floating benchmark lending rate over the same period plus 30%, which was 7.8% at September 30, 2014.

(2)

People's Bank of China floating benchmark lending rate over the same period plus 20%, which was 7.2% at September 30, 2014.

(3)

Six-month interest rate of 3%.

 

Interest expense incurred and associated with the short-term loans amounted to $206,692 and $213,133 for the three months ended September 30, 2014 and 2013, respectively. Interest expense incurred and associated with the short-term loans amounted to $509,980 and $517,899 for the nine months ended September 30, 2014 and 2013, respectively.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 14 - DEFERRED GOVERNMENT GRANTS

 

The subsidies for Good Manufacturing Practice projects were granted by Shaanxi provincial government and Xi’an municipal government which may require the subsidies to be repaid. As of September 30, 2014 and December 31, 2013, the subsidies were RMB2,500,000, equivalent to $406,250 and $409,250, respectively.

 

The subsidies granted by Xi’an City Science and Technology Bureau and Xi’an City High-Tech Industrial Development Zone are required to be used exclusively for the fish disease multi associated anti-idiotypic monoclonal antibody vaccine project during the development period from January 2012 through December 2014. As of September 30, 2014 and December 31, 2013, 70% of the subsidies or RMB4,200,000, equivalent to $682,500 and $687,540, respectively had been received and RMB3,000,000 equivalent to $487,500 and $491,100 has been expensed on this project and were accounted for as an offset against deferred government grant as of September 30, 2014 and December 31, 2013, respectively.

 

The interest subsidies granted by Xi’an municipal government were required to be used exclusively for the chicken coccidia vaccine project in the third quarter of 2013. As of September 30, 2014 and December 31, 2013, the subsidies of RMB1,200,000, equivalent to $195,000 and $196,440 had been received and nil has been expensed on this project.

 

Note 15 - CAPITAL TRANSACTIONS

 

Equity Compensation Plan

 

On December 8, 2009, the Company’s board of directors approved a stock incentive plan for officers, directors, employees and consultants entitled the “Skystar Bio-Pharmaceutical Company 2010 Stock Incentive Plan” (the “2010 Plan”). The maximum number of shares that may be issued under the 2010 Plan is 700,000 shares of common stock. The 2010 Plan was approved by the Company’s stockholders on December 31, 2009, and awards may be granted thereunder until December 7, 2019. On May 4, 2012, the Board approved common stock grants in the total amount of 442,881 shares to the Company’s employees and members of the Board of Directors, all of which grants were made pursuant to the terms and provisions of the Plan. As of September 30, 2014 and December 31, 2013, there are 143,119 shares and 247,119 shares of the Company’s common stock remaining available for future issuance under the Plan, respectively. As of September 30, 2014 and December 31, 2013, there are 36,168 shares and 70,112 shares, respectively, vested pending to be issued as follows:

 

On March 10, 2013, the Company entered into an agreement with a non-executive director to grant him restricted common stock under the Company’s 2010 Stock Incentive Plan, vested in quarterly installments of 7,000 shares each. The agreement shall continue until the director terminates it upon not less than 30 days’ written notice to the Company. The Board of Directors approved his agreement with the Company on March 10, 2014. On August 14, 2014, the Company issued 63,000 shares of the Company’s common stock to this non-executive director. As of September 30, 2014 and December 31, 2013, 7,000 shares and 49,000 shares, respectively, were vested and to be issued to this non-executive director.

 

On May 26, 2009, the Company agreed to issue 5,556 shares of common stock to a director at the beginning of each term of his directorship, which runs from May 26 to May 25 the following year. In accordance with the agreement between the Company and this director, this director must continue to serve as a member of the Board until his successor is duly elected and qualified in order to receive the shares. As of September 30, 2014 and December 31, 2013, 16,668 shares and 11,112 shares, respectively, were vested and to be issued to this non-executive director.

 

On July 29, 2012, the Company entered into another one-year employment agreement with the CFO effective July 29, 2012. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, vested in four equal quarterly installments of 2,000 shares which shall be issuable on each three-month anniversary thereof. The closing price per share of the stock on the next business day of the grant date was $2.17. On July 29, 2013, the Company entered into another one-year employment agreement with the CFO effective July 29, 2013. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, vested in four equal quarterly installments of 2,000 shares. The closing price per share of the stock on the next business day of the grant date in 2013 and 2012 was $1.37 and $2.17 respectively. The Board of Directors ratified and approved the CFO’s employment agreement with the Company on March 10, 2014. On July 29, 2014, the Company entered into a three-year employment agreement with the CFO effective July 29, 2014. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock annually, vested in four equal quarterly installments of 2,000 shares. The closing price per share of the stock on the grant date in 2014 was $5.18. On August 14, 2014, the Company issued 16,000 shares of the Company’s common stock to the CFO. As of September 30, 2014 and December 31, 2013, nil shares and 10,000 shares, respectively, were vested and to be issued to this executive. 

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 15 - CAPITAL TRANSACTIONS (Continued)

 

The Company entered into a five-year employment agreement with its Chief Executive Officer on May 5, 2008. After the agreement expired on December 31, 2013, the Company renewed the employment agreement with its Chief Executive Officer for another five year period effective January 1, 2014. Under the agreement, he is entitled to receive an aggregate 50,000 shares of common stock, vested in four equal quarterly installments of 12,500 shares, per year. The closing price per share of the stock on the next business day of each of the grant date in 2014 was $3.59. The Board of Directors ratified and approved the CEO’s employment agreement with the Company on March 10, 2014. On August 18, 2014, the Company issued 25,000 shares of the Company’s common stock to the CEO. As of September 30, 2014, 12,500 shares were vested and to be issued to this executive.

 

A summary of changes in the Company’s non-vested shares for the year follows:

 

		Non-vested Shares
Non-vested at January 1, 2013			6,000
Granted			69,556
Vested			(62,556	)
Forfeited			-
Non-vested at December 31, 2013			13,000
Granted			293,556
Vested			(70,056	)
Forfeited			-
Non-vested at September 30, 2014			236,500

 

As of September 30, 2014, there was $887,195 of total unrecognized compensation costs related to non-vested shares granted.  The total fair value of shares vested during the three months ended September 30, 2014 and 2013 was $54,293 and $4,340, respectively, based on the closing price of the Company’s common stock on the next business day of the grant date. The total fair value of shares vested during the nine months ended September 30, 2014 and 2013 was $209,523 and $13,020, respectively, based on the closing price of the Company’s common stock on the next business day of the grant date.

 

Purchase Options

 

In connection with the 2009 equity offering, the Company granted 140,000 common stock purchase options to five designees of the Underwriters with a vesting date of September 30, 2010. The options were exercisable from June 30, 2010 to June 30, 2014, and each option is exercisable for one share of the Company’s common stock at an exercise price at $8.11 per share. As of December 31, 2013, 140,000 common stock purchase options remained outstanding. As of September 30, 2014, all 140,000 common stock purchase options expired and unexercised.

 

Outstanding purchase options do not trade in an active securities market, and as such, the Company estimated the fair value of these purchase options using the Black-Scholes Option Pricing Model (“Black-Scholes Model”) using the following assumptions:

 

		Purchase Options
		December 31, 2013
Stock price		$	3.51
Exercise price		$	8.11
Annual dividend yield			-
Expected term (years)			0.50
Risk-free interest rate			0.10	%
Expected volatility			125	%
Option value		$	0.45

 

The fair value of the 140,000 purchase options outstanding as of December 31, 2013 was determined using the Black-Scholes Model, utilizing level 2 inputs, and the change was recorded in earnings. The Company recognized a loss of $nil and $205,758 from the change in fair value of these purchase options for the three months ended September 30, 2014 and 2013, respectively. The Company recognized a gain of $62,440 and a loss of $200,158 from the change in fair value of these purchase options for the nine months ended September 30, 2014 and 2013, respectively.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 15 - CAPITAL TRANSACTIONS (Continued)

 

Sale of Common Stock, Preferred Stock and Warrants

 

On July 18, 2014, the Company filed a Certificate of Designation of Preferences, Rights and Limitations of Series C Convertible Preferred Stock (the “Certificate of Designation”) (the “Series C Preferred Stock”) with the Secretary of State of the State of Nevada, establishing and designating the Series C Preferred Stock. Each share of Series C Preferred Stock has a par value of $0.001 per share and a stated value of $1,000. The Series C Preferred Stock is not redeemable and does not have any liquidation preference. No dividends will be paid on shares of Series C Preferred Stock. Except as required by law, holders of the Series C Preferred Stock do not have rights to vote on any matters, questions or proceedings, including the election of directors. Subject to certain ownership limitations as described below, each share of the Series C Preferred Stock is convertible at any time at the option of the holder into shares of the Company’s common stock at a conversion ratio determined by dividing the stated value of the Series C Preferred Stock (or $1,000) by a conversion price of $5.06 per share. The conversion price is subject to adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. Subject to limited exceptions, a holder of shares of Series C Preferred Stock will not have the right to convert any portion of its Series C Preferred Stock if the holder, together with its affiliates, would beneficially own in excess of 9.99% of the number of shares of the Company’s common stock outstanding immediately after giving effect to its conversion.

 

On July 15, 2014, the Company entered into a Securities Purchase Agreement with an institutional investor (the “SPA”), pursuant to which the Company agreed to sell an aggregate of $5 million of registered securities of the Company in a registered direct offering.  Pursuant to the terms of the SPA, the investor purchased from the Company 790,514 shares of common stock, 1,000 shares of Series C Preferred Stock and warrants to purchase up to 247,036 shares of common stock.  Each share of common stock, accompanied by a warrant to purchase up to 0.25 shares of common stock at an exercise price of $6.25 per share, was sold at $5.06 with a maximum offering of $4 million. Each share of Series C Preferred Stock, accompanied by a warrant to purchase up to 25% of the shares of common stock issuable upon conversion of the Series C Preferred Stock at an exercise price of $6.25 per share (collectively the “Investor Warrants”), was sold at $1,000. The Series C Preferred stock has an aggregate stated value of $1 million and a conversion price of $5.06 and carries no dividend rights.  The Investor Warrants have an exercise price of $6.25 per share, will be exercisable six months following issuance and will expire twelve months from the initial exercise date.

 

As of September 30, 2014, the Series C Preferred Stock can be convertible into 197,628 shares of common stock and none of the Series C Preferred Stock was converted into common stock. Subsequently on November 7, 2014, the Series C Preferred Stock was converted into 197,628 shares of common stock.

 

In addition, the placement agent for this transaction also received a cash fee, equal to 6.4% of the aggregate gross proceeds raised in each offering, and warrants for the purchase of up to 3% of the aggregate number of shares of common stock placed in the offering (“Placement Agent Warrants”). The Placement Agent Warrants have the same terms as the Investor Warrants, except that the Placement Agent Warrants have an exercise price equal to 125% of the per share public offering price (ie $6.325 per share) and have a term of exercise equal to 30 months from the effective date of the registration statement used in connection with the offering. The offering was closed on July 21, 2014, and net proceeds of $4,501,870 (net of issuance expenses of $498,130) were received.

 

Accounting for Common Stock, Series C Preferred Stock and Warrants

 

The Series C Preferred Stock is not entitled to dividends, has no voting rights, is not redeemable and has no liquidation preference. As such, it would appear to be, in effect, equivalent to common stock (except as of September 30, 2014, absent conversion, it would not receive any dividends that may be paid on the common stock). Accordingly, for the purpose of allocating a portion of the proceeds received to be the Preferred Stock, it was valued as if it were common stock.

 

The warrants are denominated in a currency (U.S. dollar) that is different from the Company’s functional currency (Renminbi). Therefore, in accordance with ASC 815 Derivatives and Hedging, they are accounted for as derivative liabilities in the consolidated balance sheets, to be measured at fair value for at each reporting period, with changes reflected in earnings, until they are exercised or expired.

 

Gross proceeds are first allocated the initial fair value of the freestanding derivative instruments (ie the Investor Warrants). The remaining proceeds are allocated between the common Stock and the Series C Preferred Stock based on the relative numbers of common stock underlying these equity instruments. The related issuance expenses, including the placement agent cash fees, legal fees, the initial fair value of the Placement Agent Warrants, etc, were allocated between the equity instruments and the Investor Warrants based on the proceeds allocated to these instruments. Expenses related to the issuance of equity instruments were charged to paid-in capital. Expenses related to issuance of the derivative instruments were expensed upon issuance.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 15 - CAPITAL TRANSACTIONS (Continued)

 

The warrants do not trade in an active securities market, and as such, the Company estimated the fair value of these warrants using a binomial option pricing model using the following assumptions:

 

		September 30, 2014								July 21, 2014
		Investor Warrants				Placement Agent Warrants				Investor Warrants				Placement Agent Warrants
Stock price		$	4.19			$	4.19			$	5.32			$	5.32
Exercise price		$	6.25			$	6.325			$	6.25			$	6.325
Annual dividend yield			-				-				-				-
Expected term (years)			1.31				2.31				1.50				2.50
Risk-free interest rate			0.08	%			0.24	%			0.10	%			0.25	%
Expected volatility			62	%			74	%			81	%			82	%
Fair Value		$	154,310			$	39,207			$	438,350			$	69,824

 

 

Expected volatility is based on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the term of the warrants. The Company believes this method produces an estimate that is representative of future volatility over the expected term of these warrants. The Company has no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the warrants.

 

As required by the FASB’s accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The fair value of the warrants was determined using a binomial option pricing model, utilizing level 3 inputs.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 16 - STATUTORY RESERVES

 

Statutory reserves represent restricted retained earnings. Based on the legal formation of the entities, all PRC entities are required to set aside 10% of net income as reported in their statutory accounts on an annual basis to the statutory surplus reserve fund. Once the total statutory surplus reserve reaches 50 % of the entity’s registered capital, further appropriations are discretionary. The statutory surplus reserve can be used to increase the entity’s registered capital (upon approval by relevant government authorities) and eliminate its future losses under PRC regulatory requirements (upon a resolution by the board of directors). The statutory surplus reserve is not distributable to shareholders except in the event of liquidation.

 

Appropriations to the above statutory reserves are accounted for as a transfer from unrestricted earnings to statutory reserves. There are no legal requirements in the PRC to fund these statutory reserves by the transfer of cash to any restricted accounts, and as such, the Company has not transferred any cash to these accounts. These reserves are not distributable as cash dividends.

 

Note 17 – TAXES

 

Provision for income taxes consisted of the following:

 

		For the three months ended September 30,								For the nine months ended September 30,
		2014				2013				2014				2013
PRC income taxes
Current		$	1,021,544			$	1,121,595			$	2,147,041			$	2,139,636
Deferred			(308,610	)			(339,618	)			(321,691	)			(339,618	)
Total		$	712,934			$	781,977			$	1,825,350			$	1,800,018

 

Skystar is subject to United States federal income tax. Skystar Cayman is a tax-exempt company incorporated in the Cayman Islands. Fortune Time did not have any assessable profits arising in or derived from Hong Kong for the three and nine months ended September 30, 2014 and 2013, and accordingly no provision for Hong Kong profits tax was made in these periods.

 

The Company’s subsidiaries and VIEs are subject to the PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25%. Xi’an Tianxing has been approved as a new technology enterprise, and under PRC Income Tax Laws is entitled to a preferential tax rate of 15%.

 

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

 

		For the three months ended September 30,								For the nine months ended September 30,
		2014				2013				2014				2013
U.S. Statutory rate			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 tax rate			25.0				25.0				25.0				25.0
China income tax exemption			(10.0	)			(10.0	)			(10.0	)			(10.0	)
Valuation allowance on tax loss			0.8				0.7				1.3				1.3
Other items (1)			(3.1	)			1.6				1.0				1.7
Total provision for income taxes			12.7	%			17.3	%			17.3	%			18.0	%

 

(1)

Other items are primarily for operating expenses (income) incurred by Skystar that are not deductible (taxable) in the PRC, expenses incurred by other subsidiaries that are not deductible on the consolidated level, the difference of taxable income under US GAAP rather than Chinese GAAP, and the difference of Enterprise Income Tax imposed at a statutory rate of 25% rather than preferential tax rate of 15% on the income from the subsidiaries other than Xi’an Tianxing, which resulted in a decrease in the effective tax rate of 2.3% and an increase of 2.3% for the three months ended September 30, 2014 and 2013, respectively, and an increase in the effective tax rate of 2.3% and 3.0% for the nine months ended September 30, 2014 and 2013, respectively.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 17 – TAXES (Continued)

 

Other items consisted of the following:

 

		For the three months ended September 30,								For the nine months ended September 30,
		2014				2013				2014				2013
Income taxed at statutory rate			(3.5	)%			(0.5	)%			(0.5	)%			(0.2	)%
Share based compensation			0.1				-				0.3				-
Change in fair value of derivative liabilities			(0.8	)			0.7				(0.5	)			0.3
Non-deductible expenses			1.1				1.4				1.7				1.6
Total other items			(3.1	)%			1.6	%			1.0	%			1.7	%

 

Deferred tax assets

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets are as follows:

 

		September 30, 2014				December 31, 2013
Current assets
Allowance on doubtful debts		$	630,800			$	150,560
Accrued expenses			52,210				213,865
Valuation allowance			-				-
Total		$	683,010			$	364,425

 

		September 30, 2014				December 31, 2013
Non-current assets
Net operating loss carried forward		$	3,389,699			$	2,823,528
Valuation allowance			(3,389,699	)			(2,823,528	)
Total		$	-			$	-

 

As of September 30, 2014 and December 31, 2013, the estimated net operating loss carry forwards of Skystar for U.S. income tax purposes amounted to $5,475,844 and $4,942,557, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, beginning in 2025 and through 2033. As of September 30, 2014 and December 31, 2013, the estimated net operating loss carry forwards of Skystar for PRC income tax purposes amounted to $5,802,170 and $4,572,233, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, through 2018. Management believes that the realization of the tax benefits arising from these losses appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. and PRC income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at September 30, 2014 and December 31, 2013. The Company’s management reviews this valuation allowance periodically and makes adjustments as necessary.  

 

The Company did not provide for deferred income taxes and foreign withholding taxes on the cumulative undistributed earnings of foreign subsidiaries as of September 30, 2014 and December 31, 2013 of approximately $61.2 million and $50.9 million, respectively. The cumulative undistributed earnings of foreign subsidiaries were included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations.  Accordingly, no provision has been made for U.S. deferred taxes or applicable withholding taxes, related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if management concluded that such earnings will be remitted in the future.

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 17 – TAXES (Continued)

 

Taxes payable consisted of the following:

 

		September 30, 2014				December 31, 2013
Income taxes		$	1,453,341			$	662,811
Value added taxes			5,714,816				576,603
Other taxes			798,416				76,072
Total		$	7,966,573			$	1,315,486

 

Note 18 - EARNINGS PER SHARE

 

The following is the calculation of earnings per share:

 

		For the three months ended September 30,								For the nine months ended September 30,
		2014				2013				2014				2013
Net income		$	4,909,453			$	3,734,197			$	8,695,663			$	8,197,811
Weighted average shares used in basic computation			8,487,425				7,617,726				7,957,506				7,615,733
Effect of dilutive potential non-vested common shares			87,037				-				92,853				-
Weighted average shares used in diluted computation			8,574,462				7,617,726				8,050,359				7,615,733
Earnings per share:
Basic		$	0.58			$	0.49			$	1.09			$	1.08
Diluted		$	0.57			$	0.49			$	1.08			$	1.08

 

For the three and nine months ended September 30, 2013, the outstanding 140,000 options were excluded from the diluted earnings per share calculation as they are anti-dilutive as the average stock price was less than the exercise prices of the options.

 

For the three and nine months ended September 30, 2013, the outstanding 8,000 non-vested shares were excluded from the diluted earnings per share calculation as they were anti-dilutive.

 

For the three and nine months ended September 30, 2014, the outstanding 276,680 investors and placement agent warrants were excluded from the diluted earnings per share calculation as they are anti-dilutive as the average stock price was less than the exercise prices of the warrants.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 19 - RELATED PARTY TRANSACTIONS AND ARRANGEMENTS

 

Amounts payable to related parties are summarized as follows:

 

		September 30, 2014				December 31, 2013
Amounts due to related parties
Weibing Lu – CEO (1)		$	2,410,490			$	857,012
Bing Mei – CFO (3)			35,188				41,283
Scott Cramer – non-executive director and shareholder (2)			7,844				300,203
Directors, shareholders and other related parties (4)			506,097				163,050
Total		$	2,959,619			$	1,361,548

 

(1)

As of September 30, 2014 and December 31, 2013, the Company had unpaid reimbursements, compensation, interest expenses of Bank of Beijing (note 13) and advances for business expenses due to Weibing Lu valued at $2,410,490 and $857,012, respectively.

 

(2)

As of September 30, 2014 and December 31, 2013, the Company had unpaid reimbursements and compensation due to Scott Cramer valued at $7,844 and $300,203, respectively. On March 10, 2014, the Board of Directors, including all of the independent members of the Board, reviewed and approved the terms of Mr. Cramer’s Consulting Services Agreement with the Company pursuant to which the Company would continue employing him as its US representative in consideration of (i) a quarterly cash fee of $7,500, (ii) 7,000 restricted shares of the Company’s common stock issuable on a quarterly basis pursuant to the Company’s 2010 Stock Incentive Plan (note 15), and (iii) reimbursement of out of pocket expenses.  In addition, Mr. Cramer agreed to pay certain invoices of the Company to its vendors (and the Company agreed to reimburse Mr. Cramer) in the form of a no interest bearing loan in the aggregate amount of approximately $250,000.

 

(3)

As of September 30, 2014 and December 31, 2013, the Company had unpaid reimbursements and compensation due to Bing Mei valued at $35,188 and $41,283, respectively.

 

(4)

The amounts due to directors, shareholders and other related parties at September 30, 2014 and December 31, 2013 include unpaid reimbursements to and advances from other related parties for business expenses.

 

Also refer to Notes 13, 15 and 20 for other related party transactions and arrangements.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 20 - COMMITMENTS AND CONTINGENCIES

 

(a)  Lease commitments

 

The Company recognizes lease expense on the straight-line basis over the term of the lease.

 

The Company entered into a tenancy agreement for the lease of factory premises of Xi’an Tianxing in Sanqiao for a period of ten years from October 1, 2004 to December 31, 2014. The annual rent for the factory premises is subject to a 10% increase every two years starting October 1, 2009. As of September 30, 2014, the annual rent for the factory premises was approximately $22,808 (RMB 140,360).

 

The Company leased office space in Xi’an from Mr. Weibing Lu, the Company’s Chairman and CEO, for a period of five years from January 1, 2012 to December 31, 2016 at a rent of approximately $29,250 (RMB 180,000) per year.

 

The Company also entered into a tenancy agreement with Mr. Weibing Lu for the lease of Shanghai Siqiang’s office in Shanghai for a period of ten years from August 1, 2007 to August 1, 2017 with an annual rent of approximately $23,400 (RMB 144,000).

 

The Company entered into a one year tenancy agreement for an office lease in Kunshan, Jiangsu Province from April 15, 2013 to April 14, 2014 with a one-year rent of approximately $3,830 (RMB 23,536). On April 17, 2014, the Company entered into an another one-year tenancy agreement for this office from April 15, 2014 to April 14, 2015 with a one-year rent of approximately $3,695 (RMB 22,736).

 

The Company entered into a tenancy agreement for the lease of warehouse premises in Xi’an for a period of three years from July 20, 2011 to July 19, 2014 with an annual rent of approximately $38,188 (RMB 235,000) subject to a 10% increase every two years starting July 20, 2013. On July 20, 2014, the Company entered into an another three-year tenancy agreement for this warehouse from July 20, 2014 to July 19, 2017 with a one-year rent of approximately $50,050 (RMB 308,000) subject to a 5% increase every two years starting July 20, 2016.

 

The Company entered into a tenancy agreement for the lease of a sales office in Jingzhou, Hubei Province for a period of five years from April 18, 2012 to April 17, 2017 with an annual rent of approximately $8,775 (RMB 54,000) for the first three years subject to increase during last two years.

 

The minimum future lease payments for the next five years and thereafter are as follows:

 

Period		Unrelated third parties				Related parties				Total
Year ending December 31, 2014		$	21,332			$	13,163			$	34,495
Year ending December 31, 2015			59,749				52,650				112,399
Year ending December 31, 2016			60,076				52,650				112,726
Year ending December 31, 2017 and thereafter			28,470				13,650				42,120
Total		$	169,627			$	132,113			$	301,740

 

Rental expense to unrelated third parties for the three months ended September 30, 2014 and 2013 amounted to $23,614 and $15,570, respectively. Rental expense to unrelated third parties for the nine months ended September 30, 2014 and 2013 amounted to $62,252 and $46,569, respectively.

 

Rental expense to related third parties for the three months ended September 30, 2014 and 2013 amounted to $13,154 and $13,038, respectively. Rental expense to related third parties for the nine months ended September 30, 2014 and 2013 amounted to $39,541 and $39,113, respectively.

 

(b)  Legal proceedings

 

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation that would have a significant effect on the Company’s condensed consolidated financial statements as of September 30, 2014.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 20 - COMMITMENTS AND CONTINGENCIES (Continued)

 

(c) R&D project

 

In 2008, Xi’an Tianxing contracted with Northwestern Agricultural Technology University to work jointly on an R&D project concerning the application of nano-technology in the prevention of major milk cow disease. The total projected budget for this project is approximately $650,000 (RMB 4,000,000), which is to be paid according to completed stages of the project. The project reached trial stage in September 2009. As of September 30, 2014, the Company has incurred approximately $568,750 (RMB 3,500,000) of cumulative expenses relating to this project.

 

In 2009, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project on fish diseases linked immunosorbent detection kit and fish diseases multi-linked monoclonal antibody therapeutic agents. The contracted amount for this project is approximately $975,000 (RMB 6,000,000). As of September 30, 2014, the Company has incurred approximately $845,000 (RMB 5,200,000) of cumulative expenses relating to this project.

 

During the first quarter of 2011, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project to develop new treatment and diagnosis method for Mycoplasmal pneumonia of swine. The project term is from January 2011 through September 2013. The cost to the Company for the initial phase is approximately $325,000 (RMB 2,000,000). As of September 30, 2014, the project was extended for clinical trials and the Company has incurred approximately $243,750 (RMB 1,500,000). The project is expected to be completed by the end of 2015.

 

During the fourth quarter of 2012, Xi’an Tianxing launched eight in-house R&D projects as set forth in the following table. As of September 30, 2014, the Company incurred all the budget expenses and these projects were still under development.

 

During the second quarter of 2013, Xi’an Tianxing launched an R&D project to develop monoclonal antibody vaccine to prevent common fish skin disease. The cost to the Company for this project is approximately $568,750 (RMB 3,500,000). As of September 30, 2014, the Company has incurred $487,500 (RMB 3,000,000) and this project is still under development.

 

During the third quarter of 2013, Xi’an Tianxing launched an R&D project to develop livestock and avian disease multi-joint yolk antibody therapeutic agents and contracted with Lantian County Chicken Farm to test the effect of its developed agents. The project is expected to be completed by the end of 2014. The total projected budget for this project is approximately $715,000 (RMB 4,400,000). As of September 30, 2014, the Company has incurred $650,000 (RMB 4,000,000) and this project is still under development.

 

During the second quarter of 2014, Xi’an Tianxing launched various R&D projects to develop veterinary medications such as sulfamonomethoxine pyrimidine sodium Injection / soluble powder, clindamycin hydrochloride injection / soluble powder, sulfachloropyridazine sodium hydrochloride soluble powder, and minjection of neostigmine. The costs to the Company for these projects were approximately $672,240 (RMB 4,136,858). As of September 30, 2014, the Company incurred all the budget expenses. These projects are expected to be completed by the end of 2014.

 

In addition, the Company also launched various R&D projects on veterinary products formula adjustment, pet drug development, fermentation engineering design and development, GMP inspection trial production tests and lab tests. As of September 30, 2014, $1,846,657 (RMB 11,364,042) has been incurred related to these projects and lab tests.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 20 - COMMITMENTS AND CONTINGENCIES (Continued)

 

(c) R&D project (Continued)

 

R&D projects are summarized as follows:

 

Project		Amount incurred as of 09/30/2014				Amount expected to be incurred				Total amount of project
Project with Northwestern Agricultural Technology University
Application of nano-technology in the prevention of major milk cow disease		$	568,750			$	81,250			$	650,000
Project with the Fourth Military Medical University
Fish diseases linked immunosorbent detection kit and fish diseases Multi-linked monoclonal antibody therapeutic agents			845,000				130,000				975,000
New treatment and diagnosis method for Mycoplasmal pneumonia of swine			243,750				81,250				325,000
In-house R&D projects during 2012:
Oral liquid products R&D and field trials			162,500				-				162,500
Powder for injection products R&D and field trials			162,500				-				162,500
Vitamin E injection product development			81,250				-				81,250
Anthelmintic product development			81,250				-				81,250
Three disease grams product development			81,250				-				81,250
Premixes class product development			81,250				-				81,250
Bulk powder products development			81,250				-				81,250
Livestock and fish diseases immunoassay kit development			406,250				-				406,250
In-house R&D projects during 2013:
Fish monoclonal antibody vaccine			487,500				81,250				568,750
Livestock and avian disease multi-joint yolk antibody therapeutic agents			650,000				65,000				715,000
In-house R&D projects during 2014:
Sulfamonomethoxine pyrimidine sodium Injection /soluble powder, Clindamycin hydrochloride injection /soluble powder, Sulfachloropyridazine sodium hydrochloride soluble powder, and Minjection of neostigmine			672,240				-				672,240
Other projects for veterinary products formula adjustment, pet drug development, fermentation engineering design and development, GMP inspection trial production tests and other lab tests			1,846,657				16,250				1,862,907
Total		$	6,451,397			$	455,000			$	6,906,397

 

All payments made for R&D projects have been expensed as incurred.

 

(d) Registered capital commitment

 

Skystar Kunshan’s remaining registered capital of $12,750,000 was originally required to be invested by May 7, 2012. On March 26, 2014, the Company received the approval of extension for payment of the remaining registered capital to May 6, 2015. On July 30, 2014 and August 28, 2014, the Company injected $3,000,500 and $400,000 of capital by cash to this entity.

 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

Note 20 - COMMITMENTS AND CONTINGENCIES (Continued)

 

(e) Capital commitment

 

The Company’s commitments for capital expenditure as of September 30, 2014 are as follows:

 

Contracted but not accrued for:
Kunshan micro-organism facility		$	4,031,397
Jingzhou veterinary medication facility			492,538
Purchase of machinery and construction (Note 9)		$	4,523,935

 

Note 21 – SEGEMENT INFORMATION

 

The Company currently engages in one business segment, the research, development, production, marketing and sales of veterinary healthcare and medical care products. The Company’s revenues and cost of revenues by product line were as follows:

 

		For the three months ended September 30,								For the nine months ended September 30,
		2014				2013				2014				2013
Revenue
Veterinary Medications		$	10,325,506			$	9,828,431			$	23,774,474			$	19,567,721
Micro-organism			7,069,929				4,946,687				13,445,737				10,644,982
Feed Additives			956,144				610,082				2,062,501				1,410,531
Vaccines			1,114				607,208				142,174				1,235,060
Total Revenue			18,352,693				15,992,408				39,424,886				32,858,294
Cost of Revenue
Veterinary Medications			5,873,199				5,826,896				14,157,589				11,672,910
Micro-organism			3,118,953				1,416,068				5,944,738				3,182,984
Feed Additives			597,641				466,490				1,303,306				1,081,010
Vaccines			132				69,237				74,680				150,497
Total Cost of Revenue			9,589,925				7,778,691				21,480,313				16,087,401
Gross Profit		$	8,762,768			$	8,213,717			$	17,944,573			$	16,770,893

 

  

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

 

Overview

 

We were incorporated in Nevada on September 24, 1998.  We are a holding company that, through our wholly owned subsidiaries in China, including Skystar Biotechnology (Jingzhou) Co. (“Skystar Jingzhou”), and a variable interest entity (“VIE”), Xi’an Tianxing Bio-Pharmaceutical Co., Ltd. (“Xi’an Tianxing”), researches, develops, manufactures, and distributes veterinary health care and medical care products in the People’s Republic of China (“PRC”).

 

All of our operations are carried out by our subsidiaries in China and Xi’an Tianxing, which the Company controls through contractual arrangements between Xi’an Tianxing and Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), the wholly owned subsidiary of Fortunate Time International Limited (“Fortune Time”), the wholly owned subsidiary of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), which became our wholly owned subsidiary in 2005. Such contractual arrangements are necessary to comply with PRC laws limiting foreign ownership of certain companies. Through these contractual arrangements, we have the ability to substantially influence Xi’an Tianxing’s daily operations and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control Xi’an Tianxing, we are considered the primary beneficiary of Xi’an Tianxing.

 

In addition to Xi’an Tianxing, Skystar Jingzhou also manufactures and distributes veterinary medicines, including aquaculture medicines in China. Skystar Jingzhou is a wholly owned subsidiary of the Company’s Sida entity. It was formed with the August 2010 acquisition of a veterinary medicine manufacturing facility in Hubei Province, China.

 

On August 21, 2007, Xi’an Tianxing invested $81,250 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Co. Ltd. (”Shanghai Siqiang”). Xi’an Tianxing is the 100% shareholder. Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipment.

 

On May 7, 2010, Fortunate Time formed Skystar Biotechnology (Kunshan) Co., Limited (“Skystar Kunshan”) in Kunshan, Jiangsu Province, China with a registered capital of $15,000,000, of which $2,250,000 was paid by Fortunate Time in cash. On March 26, 2014, the Company received the government approval of extension for payment of the remaining registered capital of $12,750,000 by May 6, 2015. Skystar Kunshan was formed in connection with an acquisition of assets to meet part of the registered capital requirements, and was intended to be a micro-organism manufacturing facility for the Company once the acquisition was complete. The asset acquisition was completed in September 2011. On July 30, 2014 and August 28, 2014, the Company injected $3,000,500 and $400,000 of capital by cash to this entity, respectively.

 

On March 15, 2011, Xi’an Tianxing formed Xi’an Sikaida Bio-products Co., Ltd. (“Xi’an Sikaida”) with a registered capital of approximately $1,625,000 (RMB 10,000,000) paid by Xi’an Tianxing.

 

We rely on a combination of trademark, copyright and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property and our brand. On September 23, 2009, we purchased an exclusive aquaculture vaccine technology from and signed a collaborative research and development agreement with China’s Fourth Military Medical University (“FMMU”) for approximately $1.2 million (RMB 8 million), granting us exclusive rights to sell and market the aquaculture vaccine through 2020. The patent on this acquired technology expired in December 2011. However, we retain know-how for the production line for the vaccine. In collaboration with FMMU, we are in a position to produce the first vaccine in China designed to prevent and treat certain bacterial infection and diseases in marine life without causing harmful side effects. Based on the vaccine’s first-to-market status, the Ministry of Agriculture (“MOA”) has issued a Grade I Veterinary Certificate for our vaccine. In addition, in 2013 and 2014, we filed 4 additional patent applications with the PRC SIPO, all of which are currently in the review stage. We intend to seek other licenses or apply for exclusivity as necessary in order to protect our rights, and we also enter into confidentiality, non-compete and invention assignment agreements with our employees and consultants and nondisclosure agreements with third parties. Skywing, Stardove, Tian Xing, Hao Shou Yi, and the Chinese characters that transliterate as “Jia Teng Jun,” “Jia Teng”, “Lan Yuan Kang”, “Bao Li Jian”, and “Bi Ke Ting” are our registered trademarks in the PRC .

 

Critical Accounting Policies

 

In preparing the consolidated financial statements in accordance with U.S. GAAP, we make estimates and assumptions about the effect of matters that are inherently uncertain and may change in subsequent periods.  The resulting accounting estimates will, by definition, vary from the related actual results.  We consider the following to be the most critical accounting policies:

 

Principles of consolidation

 

The accompanying unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of our company, our wholly-owned subsidiaries, and our VIEs.  All significant inter-company transactions and balances between our company, its subsidiaries, and its VIEs have been eliminated in consolidation.

 

 

We have evaluated the relationship with Xi’an Tianxing and Xi’an Tianxing’s wholly owned subsidiaries, Xi’an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang.

 

Revenue recognition

 

Our revenue is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected in these consolidated financial statements as sales returns are de minimus based on historical experience.

There are two types of sales upon which revenue is recognized:

	a.	Credit sales: revenue is recognized when the products have been delivered to the customers.
	b.	Full payment before delivering: Cash received is recorded as “deposits from customers” and revenue is recognized when the products have been delivered to the customers.

 

Accounts receivable

 

Accounts receivable are stated at cost, net of an allowance for doubtful accounts. We maintain allowances for doubtful accounts for estimated losses, if any, resulting from the failure of customers to make required payments. We review the accounts receivable on a periodic basis and makes allowances where there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, we consider many factors, including the age of the balance, the customer’s payment history, its current credit-worthiness and current economic trends.

 

Stock based compensation

 

We record and report stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

 

Recently Issued Accounting Pronouncements

 

See Item 1 of Part I, “Notes to the Condensed Consolidated Financial Statements — Note 2 – Summary of Significant Accounting Policies — Recently Issued Accounting Pronouncements.”

 

 

Results of Operations – 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				% of total revenue				Amount				% of total revenue
Revenue		$	18,352,693				100.0	%		$	15,992,408				100.0	%
Gross Profit		$	8,762,768				47.7	%		$	8,213,717				51.4	%
Operating Expenses		$	3,363,194				18.3	%		$	3,476,016				21.7	%
Income from Operations		$	5,399,574				29.4	%		$	4,737,701				29.7	%
Other Income (Expense)		$	222,813				1.2	%		$	(221,527	)			(1.4	)%
Income Tax Expenses		$	712,934				3.9	%		$	781,977				4.9	%
Net Income		$	4,909,453				26.7	%		$	3,734,197				23.4	%

 

Revenues.   All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC.  For the three months ended September 30, 2014, we had revenues of $18,352,693 as compared to revenues of $15,992,408 for the three months ended September 30, 2013, an increase of $2,360,285 or 14.8%.  We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  The average selling prices of our products decreased 7.0% in the three months ended September 30, 2014 compared to the same period of 2013, which is largely due to the change of composition of product sales. The increase in revenue was mainly due to the increase of sales volume.

  

Revenue — Veterinary Medication. Revenue from sales of our veterinary medications increased by $497,075 or 5.1%, from $9,828,431 for the three months ended September 30, 2013 to $10,325,506 for the three months ended September 30, 2014. This modest year-to-year growth in sales was primarily the result of our increased sales efforts and a stabilized veterinary drug market in China with no major large-scale epidemic outbreak this year. We have two veterinary medication plants located in Huxian and Jingzhou, with Huxian historically being our main facility. Of the total revenues from veterinary medications during the three months ended September 30, 2014, approximately 85.8% of total revenue resulted from the sale of products from the Huxian facility. In October, as required by the local environmental protection department,  Huxian facility was in a process of replacing its coal boiler with a natural gas one. As a result, the manufacturing of certain verterinary products was affected and production for these products were temporarily suspended. We expect to finish the project and resume our production in early December. The revenue from sales of veterinary medication products was the largest revenue contributor for the entire company and contributed 56.3% of total revenue during the three months ended September 30, 2014. The average selling prices of our products decreased 12.4% in the three months ended September 30, 2014 compared to the same period of 2013. The increase in revenue was mainly due to the increase of sales volume of our products with a lower average selling price.

 

Revenue — Micro-Organism. Revenue from sales of our micro-organism products increased by $2,123,242 or 42.9% from $4,946,687 for the three months ended September 30, 2013 to $7,069,929 for the three months ended September 30, 2014. The increase was primarily due to increased market demand for our improved products with better efficacy of prevention of disease and healthcare of livestock and poultry. Currently, we have a micro-organism plant located in Sanqiao. The average selling prices of our products decreased 7.8% in the three months ended September 30, 2014 compared to the same period of 2013. The increase in revenue was mainly due to the increase of sales volume.

 

Revenue — Feed Additives. Revenue from sales of our feed additives product line increased by $346,062 or 56.7% from $610,082 for the three months ended September 30, 2013 to $956,144 for the three months ended September 30, 2014. The increase was primarily the result of newly implemented sales strategy to bundle the feed additives products with our other best-selling products to promote the sales of feed additive products. Currently, we have a feed additive plant located in Sanqiao. The average selling prices of our feed additive products for the three months ended September 30, 2014 have not materially changed from last year. The increase in revenue was mainly due to the increase of sales volume.

 

Revenue — Vaccines. Revenue from sales of our vaccines decreased by $606,094 or 99.8% from $607,208 for the three months ended September 30, 2013 to $1,114 for the three months ended September 30, 2014. The significant decrease was primarily the impact of our transition from small scale lab production to large scale factory manufacturing as our new state-of-art vaccine facility has been completed and certified by the Chinese GMP standard. We currently no longer produce vaccine products in our lab. We received three vaccine production permits from the government in the third quarter and the manufacturing of these approved vaccines has been launched in our new facility at the date of this report. According to MOA's requirements for the sale of vaccine products in China, a sample from each batch of vaccine must be randomly chosen and submitted to MOA for inspection before commercial sales can be taken place. The approval period is around 20 to 30 days. As a result, the newly approved vaccine products manufactured in this facility were still under the Government's inspection and no sales occurred during the third quarter for these products. The average selling prices of our vaccine products increased approximately 27.3% for the three months ended September 30, 2014 compared to those in 2013. The decrease in revenue was primarily due to the

decrease of sales volume.

 

Cost of Sales.   Cost of sales was $9,589,925 for the three months ended September 30, 2014, as compared to $7,778,691 for the three months ended September 30, 2013, an increase of $1,811,234 or 23.3%, as a result of the increased sales. For the three months ended September 30, 2014, raw material costs comprised the majority or approximately 81.0% of total cost of sales, packing material costs comprised approximately 16.4% of the total cost of sales, and labor costs and manufacturing overhead comprised approximately 2.6% of the total cost of sales. The decreased gross margin for the three months ended September 30, 2014 was mainly because the majority of our revenue during the three months came from the less profitable veterinary medications product line.

 

 

Cost of Sales — Veterinary Medications.   Cost of sales of our veterinary medications product line increased from $5,826,896 for the three months ended September 30, 2013 to $5,873,199 for the three months ended September 30, 2014, an increase of $46,303 or 0.8%.  This increase was mainly due to the increase in corresponding sales. Cost of sales of veterinary medications product line comprised 61.2% of total cost of sales for the three months ended September 30, 2014.

 

Cost of Sales — Micro-Organism.   Cost of sales of our micro-organism product line increased from $1,416,068 for the three months ended September 30, 2013 to $3,118,953 for the three months ended September 30, 2014, an increase of $1,702,885 or 120.3%.  This increase was significantly higher than the 42.9% of increase in sales. The increase was mainly due to the changes in the production formula aimed to improve the product efficacy for some of our micro-organism products to promote sales, which significantly increased our unit raw material costs to produce these micro-organism products as compared to last year.

 

Cost of Sales — Feed Additives.   Cost of sales of our feed additives product line increased from $466,490 for the three months ended September 30, 2013 to $597,641 for the three months ended September 30, 2014, an increase of $131,151 or 28.1%.  This increase in cost of sales was mainly due to the corresponding increase in feed additive sales. The changes in the production formula and better quality of the raw materials used in production helped us partially offset the increase of cost of sales during the third quarter of 2014.

 

Cost of Sales — Vaccines.   Cost of sales of our vaccines product line decreased from $69,237 for the three months ended September 30, 2013 to $132 for the three months ended September 30, 2014, a decrease of $69,105 or 99.8%.  This decrease was the result of the corresponding decrease of vaccine product sales.

 

Operating Expenses

 

		Three Months Ended September 30,
		2014								2013
		Amount				% of total revenue				Amount				% of total revenue
Operating Expenses
Research and Development Costs		$	378,487				2.1	%		$	324,353				2.0	%
Selling Expenses		$	1,081,403				5.9	%		$	1,266,444				7.9	%
General and Administrative Expenses		$	1,903,304				10.3	%		$	1,885,219				11.8	%
Total Operating Expenses		$	3,363,194				18.3	%		$	3,476,016				21.7	%

 

Research and Development Costs.  Research and development costs totaled $378,487 for the three months ended September 30, 2014 as compared to $324,353 for the three months ended September 30, 2013, an increase of $54,134 or 16.7%. The increase was primarily due to expenditures of $325,440 on the existing R&D projects during the third quarter of 2014 to develop two veterinary medications.

 

Selling Expenses.  Selling expenses totaled $1,081,403 for the three months ended September 30, 2014 as compared to $1,266,444 for the three months ended September 30, 2013, a decrease of $185,041 or 14.6%.  This decrease is mainly due to the decrease in sales commissions of $76,479 and shipping and handling expenses of $83,963, primarily caused by our efforts to control these expenses.

 

General and Administrative Expenses.  General and administrative expenses totaled $1,903,304 for the three months ended September 30, 2014 as compared to $1,885,219 for the three months ended September 30, 2013, a slight increase of $18,085 or 1.0%. This increase was mainly due to an additional $157,439 of allowance on doubtful accounts during the quarter and partially offset by the decreased depreciation expense in the third quarter.

 

Other Income (Expenses). Other net income was $222,813 for the three months ended September 30, 2014 as compared to other net expense of $221,527 for the three months ended September 30, 2013, an increase in other income of $444,340. This increase was primarily due to increase in a gain from fair value changes on our derivative liabilities of $520,415 and offset by finance cost on our additional bank acceptance notes in borrowing this year.

 

Provision for Income Taxes. Income tax expenses were $712,934 for the three months ended September 30, 2014 as compared to $781,977 for the three months ended September 30, 2013, a decrease of $69,043 or 8.8%, representing an effective tax rate of 12.7% and 17.3% for the three months ended September 30, 2014 and 2013, respectively. For the three months ended September 30, 2014 and 2013, Xi’an Tianxing was subject to a preferential income tax rate of 15% while other PRC subsidiaries were subject to statutory tax rate of 25%. For the three months ended September 30, 2014 and 2013, Xi’an Tianxing contributed the majority of consolidated profits in China. Excluding the valuation allowances on tax losses incurred by the Company and its PRC subsidiaries, the effective tax rate was 11.9% and 16.6%, respectively which was mainly attributable to the deferred income tax arising from the allowance for doubtful debts for the period.

 

  

Results of Operations – Nine Months ended September 30, 2014 and 2013

 

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

 

		Nine Months Ended September 30,
		2014								2013
		Amount				% of  total  revenue				Amount				% of total revenue
Revenue		$	39,424,886				100.0	%		$	32,858,294				100.0	%
Gross Profit		$	17,944,573				45.5	%		$	16,770,893				51.0	%
Operating Expenses		$	8,004,921				20.3	%		$	6,416,659				19.5	%
Income from Operations		$	9,939,652				25.2	%		$	10,354,234				31.5	%
Other Income (Expenses)		$	581,361				1.5	%		$	(356,405	)			(1.1	)%
Income Tax Expenses		$	1,825,350				4.6	%		$	1,800,018				5.5	%
Net Income		$	8,695,663				22.1	%		$	8,197,811				24.9	%

 

Revenues.   All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC.  For the nine months ended September 30, 2014, we had revenues of $39,424,886 as compared to revenues of $32,858,294 for the nine months ended September 30, 2013, an increase of $6,566,592 or 20.0%.  We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  The average selling prices of our products increased 2.4% in the nine months ended September 30, 2014 compared to the same period of 2013. The increase in revenue was primarily due to the increase of sales volume.

 

Revenue — Veterinary Medications. Revenue from sales of our veterinary medications increased by $4,206,753 or 21.5% from $19,567,721 for the nine months ended September 30, 2013 to $23,774,474 for the nine months ended September 30, 2014. The increase of revenue was primarily a result of more veterinary medication product permits received this year for manufacturing after the GMP re-certification of our Huxian facility. The revenue from sales of veterinary medication products was the largest revenue contributor for the entire company and contributed 60.3% of total revenue during the nine months ended September 30, 2014. The average selling prices of our veterinary medication products for the nine months ended September 30, 2014 increased 5.9% from the same period of last year. The increase in revenue was primarily due to the increase of sales volume by 14.7%.

 

Revenue — Micro-Organism. Revenue from sales of our micro-organism products increased by $2,800,755 or 26.3% from $10,644,982 for the nine months ended September 30, 2013 to $13,445,737 for the nine months ended September 30, 2014. The increase was primarily due to increased market demand for our improved products. The average selling prices of our micro-organism products for the nine months ended September 30, 2014 decreased 5.2% from the same period of last year. The increase in revenue was mainly due to the increase of sales volume by 33.3% resulting from the increase in market demand after our improvement of the product formula.

 

Revenue — Feed Additives. Revenue from sales of our feed additives product line increased by $651,970 or 46.2% from $1,410,531 for the nine months ended September 30, 2013 to $2,062,501 for the nine months ended September 30, 2014. The increase was primarily due to our improved sales strategy to promote our feed additive products. The average selling prices of our feed additives products for the nine months ended September 30, 2014 have not materially changed from the same period of last year. The increase in revenue was primarily due to the increase of sales volume by 45.5%.

 

Revenue — Vaccines . Revenue from sales of our vaccines decreased by $1,092,886 or 88.5% from $1,235,060 for the nine months ended September 30, 2013 to $142,174 for the nine months ended September 30, 2014. The significant decrease was primarily due to our transition from small scale lab production to large scale factory manufacturing of vaccine as our new Huxian vaccine facility has been completed and GMP certified. As a result, we no longer produced vaccine products in our lab starting from the second quarter of 2014. As of the end of the third quarter, three vaccine production permits have been received from the government and the production has been launched in our new facility to prepare for the sales in the fourth quarter. The average selling prices of our feed additives products for the nine months ended September 30, 2014 have not materially changed from the same period of last year. The decrease in revenue was primarily due to the decrease of sales volume.

 

Cost of Sales.   Cost of sales was $21,480,313 for the nine months ended September 30, 2014, as compared to $16,087,401 for the nine months ended September 30, 2013, an increase of $5,392,912 or 33.5%, as a result of the increased sales of our product lines except vaccine products. For the nine months ended September 30, 2014, raw material costs comprised the majority or approximately 81.3% of total cost of sales, packing material costs comprised approximately 14.9% of total cost of sales, and labor costs and manufacturing overhead comprised approximately 3.8% of the total cost of sales. The decreased gross margin was mainly because the majority of our revenue growth during the first nine months came from the less profitable veterinary medications product lines.

 

Cost of Sales — Veterinary Medications.   Cost of sales of our veterinary medications product line increased from $11,672,910 for the nine months ended September 30, 2013 to $14,157,589 for the nine months ended September 30, 2014, an increase of $2,484,679 or 21.3%.  This increase was mainly due to the increase in corresponding sales of 21.5% and the change of composition of our product mix with relatively higher production costs during the first nine months of 2014. Cost of sales of veterinary medications product line comprised 65.9% of the total cost of sales for the nine months ended September 30, 2014.

 

  

Cost of Sales — Micro-Organism.   Cost of sales of our micro-organism product line increased from $3,182,984 for the nine months ended September 30, 2013 to $5,944,738 for the nine months ended September 30, 2014, an increase of $2,761,754 or 86.8%.  This increase was significantly higher than the 26.3% increase in sales. The increase was mainly due to the changes in the production formula aimed to improve the product efficacy for some of our micro-organism products, which increased our unit raw material costs to produce these micro-organism products.

 

Cost of Sales — Feed Additives.   Cost of sales of our feed additives product line increased from $1,081,010 for the nine months ended September 30, 2013 to $1,303,306 for the nine months ended September 30, 2014, an increase of $222,296 or 20.6%.  This increase was mainly due to the corresponding increased sales. However, the changes in the production formula and better quality of the raw materials used in production helped us partially offset the increase of cost of sales in 2014.

 

Cost of Sales — Vaccines.   Cost of sales of our vaccines product line decreased from $150,497 for the nine months ended September 30, 2013 to $74,680 for the nine months ended September 30, 2014, a decrease of $75,817 or 50.4%.  This decrease in percentage term was significantly lower than the 88.5% decrease in corresponding sales. In the first quarter of 2014, a significant amount of overhead was incurred to complete and following the completion of the new vaccine plant.

 

The following table summarizes our operating expense for the nine months ended September 30, 2014 and 2013.

 

		Nine Months Ended September 30,
		2014								2013
		Amount				% of total revenue				Amount				% of total revenue
Operating Expenses
Research and Development Costs		$	1,181,680				3.0	%		$	417,740				1.3	%
Selling Expenses		$	2,286,217				5.8	%		$	2,213,617				6.7	%
General and Administrative Expenses		$	4,537,024				11.5	%		$	3,785,302				11.5	%
Total Operating Expenses		$	8,004,921				20.3	%		$	6,416,659				19.5	%

 

Research and Development Costs.  Research and development costs totaled $1,181,680 for the nine months ended September 30, 2014 as compared to $417,740 for the nine months ended September 30, 2013, an increase of $763,940 or 182.9%. The increase was primarily due to new R&D efforts undertaken during the second quarter and the expenditures on existing R&D projects in the third quarter of 2014 to develop various new veterinary medications.

 

Selling Expenses.  Selling expenses totaled $2,286,217 for the nine months ended September 30, 2014 as compared to $2,213,617 for the nine months ended September 30, 2013, an increase of $72,600 or 3.3%. This increase was significantly lower than the 20.0% increase in sales primarily caused by our efforts to control shipping and handling expenses.

 

General and Administrative Expenses.  General and administrative expenses totaled $4,537,024 for the nine months ended September 30, 2014 as compared to $3,785,302 for the nine months ended September 30, 2013, an increase of $751,722 or 19.9%. This increase was mainly due to additional bad debt expense of $653,920 and an increase of $197,616 in stock based compensation. Under the new employment agreement with our CEO effective January 1, 2014, he is entitled to receive an aggregate 50,000 shares of common stock each year. During the first nine months of 2014, stock based compensation of $134,625 was incurred in relation to this grant to our CEO.

 

Other Income (Expenses). Other net income was $581,361 for the nine months ended September 30, 2014 as compared to other net expense of $356,405 for the nine months ended September 30, 2013, an increase in other income of $937,766. This increase was primarily due to (i) a decrease in interest expenses and finance charges of $100,310 caused by our borrowings carrying lower interest in 2014 than 2013; (ii) an increase in other income of $149,847 primarily for the government interest subsidies and awards; (iii) an increase in gain on fair value change of our warrant and purchase option liability of $577,255; and (iv) an increase in interest income of $110,354 largely due to our increased interest income earned on the prepayments to our suppliers and loans receivable to a third party.

 

Provision for Income Taxes. Income tax expenses were $1,825,350 for the nine months ended September 30, 2014 as compared to $1,800,018 for the nine months ended September 30, 2013, an increase of $25,332 or 1.4%, representing an effective tax rate of 17.3% and 18.0% for the nine months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014 and 2013, Xi’an Tianxing was subject to a preferential income tax rate of 15% while other PRC subsidiaries were subject to statutory tax rate of 25%. For the nine months ended September 30, 2014 and 2013, Xi’an Tianxing contributed the majority of consolidated profits in China. Excluding the valuation allowances on tax losses incurred by the Company and its PRC subsidiaries, the effective tax rate was 16.0% and 16.7%, respectively.

 

 

Liquidity

 

For the nine months ended September 30, 2014, cash provided by operating activities was $15,244,465, as compared to cash used in operating activities of $9,092,042 for the nine months ended September 30, 2013. The major operating activities that provided cash for the nine months ended September 30, 2014 were net income (excluding non-cash expenses such as depreciation, amortization, etc) of $11,578,077, an increase in accounts payable of $6,129,382, an increase of taxes payable of $6,669,747, a decrease of inventories of $2,609,336 and a decrease of prepayments for raw materials purchasing of $12,293,970. The major operating activities that used cash for the nine months ended September 30, 2014 were an increase in accounts receivable of $26,378,763. The inflation rate in China decreased to 1.6% in September 2014 from 2.3% in June this year. We will monitor the market situation closely and continue the strategy of prepaying our suppliers to ensure the supply of raw materials at relatively lower cost levels. As of September 30, 2014, we had 72 suppliers as compared to 75 suppliers as of September 30, 2013 to which we made advances to secure our raw material needs and to obtain favorable pricing. We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.

 

Cash used in investing activities for the nine months ended September 30, 2014 was $21,851,002, as compared to cash used in investing activities of $2,496,137 for the nine months ended September 30, 2013. Cash used in investing activities for the nine months ended September 30, 2014 was primarily the result of advance to a supplier of $9,763,200, placement of restricted cash of $7,159,680 and long term prepayments for acquisition of $3,254,400 made to an unrelated third party engaged to facilitate potential acquisition targets.

 

Cash provided by financing activities for the nine months ended September 30, 2014 was $13,126,030, as compared to cash provided by financing activities of $4,667,840 for the nine months ended September 30, 2013. Cash provided by financing activities for the nine months ended September 30, 2014 was primarily the result of proceeds from short-term loans of $19,200,960, net of repayment of short-term loans of $10,576,800, and net cash proceeds from sales of our common stock, preferred stock and warrants in July 2014 of $4,501,870.

 

As of September 30, 2014, we had unrestricted cash of $14,634,703. Our total current assets were $120,861,819, and our total current liabilities were $48,307,521, which resulted in a net working capital of $72,554,298.

 

Capital Resources

 

We finance our ongoing operating activities by using funds from our operations and external credit or financing arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources. We secured $19,200,960 in short-term loans and repaid $10,576,800 of short-term loans during the nine months ended September 30, 2014.

 

Apart from the above, on July 15, 2014, we entered into a Securities Purchase Agreement with an institutional investor (the “SPA”), pursuant to which we agreed to sell an aggregate of $5 million of our registered securities in a registered direct offering.  Pursuant to the terms of the SPA, the investor purchased from us 790,514 shares of common stock, 1,000 shares of Series C preferred stock and warrants to purchase up to 247,036 shares of common stock.  Each share of common stock, accompanied by a warrant to purchase up to 0.25 shares of common stock at an exercise price of $6.25 per full share, was sold at $5.06 with a maximum offering of $4 million. Each share of preferred stock, accompanied by a warrant to purchase up to 25% of the shares of common stock issuable upon conversion of the preferred stock at an exercise price of $6.25 per share, was sold at $1,000 with a maximum offering of $1 million. The convertible preferred stock has an aggregate stated value of $1 million and a conversion price of $5.06 and carries no dividend rights. The investor warrants will have an exercise price of $6.25 per share, will be exercisable six months following issuance and will expire twelve months from the initial exercise date. The offering closed on July 21, 2014, and net proceeds of $4,501,870 (net of offering expenses of $498,130) were received by us.

 

As of September 30, 2014, the Series C Preferred Stock can be convertible into 197,628 shares of common stock and none of the Series C Preferred Stock was converted into common stock. Subsequently on November 7, 2014, the Series C Preferred Stock was converted into 197, 628 share of common stock.

 

Considering our existing working capital position and our ability to access equity and debt funding sources, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements to support our ongoing operations for at least next twelve months.

 

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations

 

		Payments Due by Period
Contractual Obligations		Total				Less than 1 year				1 – 3 years				3 – 5 years				More than 5 years
R&D Project Obligation		$	455,000			$	455,000			$	-			$	-			$	-
Construction-in-progress Obligation			4,523,935				4,523,935				-				-				-
Operating Lease Obligations			301,740				119,024				182,716				-				-
Total		$	5,280,675			$	5,097,959			$	182,716			$	-			$	-

 

In addition to the contractual obligations listed above, we have a future registered capital commitment related to our subsidiary Skystar Kunshan. Skystar Kunshan has a registered capital of $15,000,000, of which we invested $2,250,000 in cash. The remaining $12,750,000 of capital was originally required to be invested prior to May 7, 2012. On March 26, 2014, we received the approval of extension for payment of the remaining registered capital by May 6, 2015. On July 30, 2014 and August 28, 2014, the Company injected $3,000,500 and $400,000 of capital by cash to this entity, respectively.

 

Short-term loans:

 

		September 30, 2014								December 31, 2013										Interest
Bank		RMB				USD				RMB				USD				Due Date		Rate
Industrial Bank Co. Ltd. Xi’an Branch			-			$	-				30,000,000			$	4,911,000			01/15/14			6.60	%
Postal Savings Bank of China Xi’an Branch			-				-				20,000,000				3,274,000			05/26/14			(2	)
ICBC Songzi Branch			-				-				5,000,000				818,500			06/19/14			(1	)
Postal Savings Bank of China Xi’an Branch			20,000,000				3,250,000											06/09/15			(2	)
Chang'an Bank Xi’an Branch			48,000,000				7,800,000				-				-			10/21/14			(3	)
Qishang Bank			40,000,000				6,500,000				-				-			11/07/14			(3	)
Related-party Individual – Chairman and CEO			-				-				10,000,000				1,637,000			09/11/14			7.8	%
Related-party Individual – Chairman and CEO			10,000,000				1,625,000				-				-			08/15/15			(1	)
Total			118,000,000			$	19,175,000				65,000,000			$	10,640,500

  

	(1)	People's Bank of China floating benchmark lending rate over the same period plus 30%, which was 7.8% at September 30, 2014.
	(2)	People's Bank of China floating benchmark lending rate over the same period plus 20%, which was 7.2% at September 30, 2014.
	(3)	Six-month interest rate of 3%.

 

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 stockholders’ 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 Rate

 

Our operating subsidiaries in China maintain their books and records in Renminbi (“RMB”), the currency of China. In general, for consolidation purposes, we translate the subsidiaries’ assets and liabilities into US Dollars using the applicable exchange rates prevailing at the balance sheet date, and the statement of comprehensive income is translated at average exchange rates during the reporting period. Adjustments resulting from the translation of the financial statements of the Company’s Chinese subsidiaries are recorded as accumulated other comprehensive income.

 

  

The exchange rates used to translate amounts in RMB into US Dollars for the purposes of preparing the consolidated financial statements or otherwise stated in this MD&A were as follows:

 

		September 30, 2014				December 31, 2013
Assets and liabilities		1 RMB = 0.1625 USD				1 RMB = 0.1637 USD

  

		Nine Months Ended September 30,
		2014				2013
Statements of operations and cash flows			1 RMB = 0.16272 USD				1 RMB = 0.16028 USD

 

Inflation

 

China's annual inflation slowed to 1.6% in September 2014, which was the lowest in the world's second-largest economy for almost five years. The inflation fell well below the 3.5% annual target set by the government in March, and indicates that deflationary pressures are rising. The World Bank cut its forecast for Chinese growth to 7.4% for 2014 and 7.2% for 2015. The September inflation figure gives Chinese policy makers more room to take steps to stimulate the economy growth. For the nine months ended September 30, 2014, we were able to secure favorable pricing by prepaying certain suppliers to lock in prices ahead of time. As a result, we did not experience as much cost pressure as evidenced in the spot market prices of raw materials. To take precautions to minimize the negative impact of cost increases that erode our profit margin, we will continue the practice of prepayments to suppliers.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”), performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), which are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, to allow timely decisions regarding required disclosure.

 

Based on the evaluation, the Certifying Officers concluded that, as of September 30, 2014, our disclosure controls and procedures were not effective due to an ongoing material weakness related to the lack of accounting personnel with an appropriate level of knowledge, experience, and training in the application of U.S. GAAP.

 

Since the foregoing weaknesses were identified, we carried out a number of measures to address and remediate these weaknesses related to the insufficient number of our U.S. reporting accounting and finance personnel and overall lack of requisite experience in U.S. GAAP. As a result, the Company saw a steady improvement in its internal controls over financial reporting as evidenced by a gradually decreasing number and significance of adjustments proposed by the Company’s independent auditors during their periodical financial reviews and noticeable improvement in the accounting staff’s abilities to handle U.S. GAAP-based reporting. Although we believe that we achieved significant progress in addressing the identified material weaknesses, in our view, such efforts have not yet yielded the results required to fully remediate the material weaknesses. In 2013 (aside from continuing the remediation measures that we initiated in the previous years) we engaged a third party consulting firm to assist us in remediation of the identified material weakness. This consulting firm is a global leading provider of consulting and internal audit services and the only consulting firm represented on the COSO advisory board guiding the development of a conceptual framework on Enterprise Risk Management. With such additional external assistance, we have been and are in the process of improving our accounting policies and procedures manual in accordance to U.S. GAAP, and are going to provide proper training on the manual for our accounting team and continue to standardize our accounting treatments in compliance with U.S. GAAP, especially non-routine transactions, and improve our accounting team’s U.S. GAAP competence. In September 2013, this third party consulting firm completed its initial field work at our main administrative offices in China and helped us develop a draft of a new accounting policies and procedures manual in accordance to U.S. GAAP. We intend to complete the project by no later than the end of 2014 and will conduct quarterly assessments of the state of the Company’s financial reporting measures and systems, as a whole.

 

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation that would have a significant effect on the Company’s condensed consolidated financial statements as of September 30, 2014.

 

ITEM 1A. RISK FACTORS

 

There were no material changes from the risk factors as previously disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2013 and our subsequent public filings.

 

ITEM 5. OTHER INFORMATION

 

Employment Agreement with Bing Mei, CFO

 

On November 10, 2014, the Company’s Board of Directors approved and ratified an employment agreement with the Company’s Chief Financial Officer (CFO). The Company agreed to compensate Mr. Mei for his services with a base annual salary of $210,000, subject to 5% increases on an annual basis, for a term of three years, and a total 8,000 shares of common stock, 2,000 of which will be issued on each three-month anniversary of his engagement with the Company. While employed as the Company’s CFO, Mr. Mei may continue to devote his business time to operating Bing Mei, CPA. In addition, Mr. Mei agreed not to engage in any business competitive with that of the Company during the term of his employment and three years following such term. The employment agreement contains certain termination, confidentiality and other terms and provisions customary for the agreements of this nature. The foregoing summary of the Bing Mei Employment Agreement does not purport to be complete and is qualified in its entirety by reference to the Mei Employment Agreement attached hereto as Exhibit 10.1, which is incorporated herein by reference.

 

Board and Committee Membership Changes

 

Qiang Fan, a member of the Board of Directors of the Company, tendered his resignation, effective November 10, 2014. Mr. Fan was a member of the Audit Committee and Chairman of the Compensation Committee of the Board. The Company is thankful to him for years of service to the Company.

 

Following Mr. Fan’s departure from the Board and the Board committees, the Board appointed Chengtun Qu, a current independent member of the Board, to the Audit Committee and the Compensation Committee of the Board, and Weirong Shen, a current independent member of the Board, was appointed to chair the Compensation Committee of the Board.

 

In addition, Wei Wen, a Board member and the Company’s Corporate Secretary, determined not to stand for re-election at the 2014 Annual Meeting of the Company’s shareholders set to take place on December 4, 2014. Mr. Wen cited personal reasons and other professional commitments for his decision not to stand for re-election. He will remain as the Company’s Corporate Secretary.

 

  

Exh. No.		Description
3.1		Articles of Incorporation, as amended  (2)
3.2		Bylaws, as amended (1)
10.1		Employment Agreement between Skystar Bio-Pharmaceutical Company and Weibing Lu (3)
10.2		Employment Agreement between Skystar Bio-Pharmaceutical Company and Bing Mei
10.3		Consulting Services Agreement with R. Scott Cramer dated March 10, 2013 (4)
31.1		Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbase
101.DEF		XBRL Taxonomy Extension Definition Linkbase
101.LAB		XBRL Taxonomy Extension Label Linkbase
101.PRE		XBRL Taxonomy Extension Presentation Linkbase

 

(1)	Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 15, 2008.

 

(2)	Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q filed on November 15, 2010.

 

(3)	Incorporated by reference from Registrant’s Current Report on Form 8-K filed on March 13, 2014.

 

(4)	Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q filed on May 15, 2014.

 

  

SIGNATURES

 

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

 

	SKYSTAR BIO-PHARMACEUTICAL COMPANY
November 14, 2014	By:	/s/ Weibing Lu
		Weibing Lu
		Chief Executive Officer
		(Principal Executive Officer)

 

November 14, 2014	By:	/s/ Bing Mei
		Bing Mei
		Chief Financial Officer
		(Principal Financial and Accounting Officer)