Attached files
file | filename |
---|---|
EX-32.2 - China Yongxin Pharmaceuticals Inc. | v202631_ex32-2.htm |
EX-31.1 - China Yongxin Pharmaceuticals Inc. | v202631_ex31-1.htm |
EX-31.2 - China Yongxin Pharmaceuticals Inc. | v202631_ex31-2.htm |
EX-10.35 - China Yongxin Pharmaceuticals Inc. | v202631_ex10-35.htm |
EX-10.34 - China Yongxin Pharmaceuticals Inc. | v202631_ex10-34.htm |
EX-32.1 - China Yongxin Pharmaceuticals Inc. | v202631_ex32-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 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, 2010
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 No.: 000-26293
CHINA
YONGXIN PHARMACEUTICALS INC.
(Exact
name of Registrant as specified in its charter)
Delaware
|
|
20-1661391
|
(State or other jurisdiction of
incorporation or organization)
|
|
(I.R.S. Employer
Identification Number)
|
927
Canada Court
City
of Industry, California 91748
(Address
of principal executive offices) (Zip code)
(626)
581-9098
(Company’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 o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” as defined in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer o
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes
o
No x
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
o No o
The
registrant had 5,427,000 shares of common stock, par value $0.001 per share,
outstanding as of September 30, 2010.
CHINA
YONGXIN PHARMACEUTICALS INC.
FORM 10-Q
For
the Quarterly Period Ended September 30, 2010
INDEX
Page
|
||||
Part I
|
Financial
Information
|
3
|
||
|
||||
Item
1.
|
Financial
Statements
|
3
|
||
(a) Unaudited
Consolidated Balance Sheets as of September 30, 2010 and
December 31, 2009
|
F-1
|
|||
(b) Unaudited
Consolidated Statements of Income for the Three and Nine month Periods
ended September 30, 2010 and 2009
|
F-2
|
|||
|
||||
(c) Unaudited Consolidated
Statements of Cash Flows for the Nine month Periods ended September 30,
2010 and 2009
|
F-3
|
|||
(d) Notes
to Unaudited Consolidated Financial Statements
|
F-4
|
|||
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
4
|
||
|
||||
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
18
|
||
|
||||
Item
4.
|
Controls
and Procedures
|
18
|
||
|
||||
Part II
|
Other
Information
|
19
|
||
Item
1.
|
Legal
Proceedings
|
19
|
||
|
||||
Item
1A.
|
Risk
Factors
|
20
|
||
|
||||
Item
2.
|
Unregistered
Sale of Equity Securities and Use of Proceeds
|
20
|
||
|
||||
Item
3.
|
Default
Upon Senior Securities
|
20
|
||
Item
4.
|
(Removed
and Reserved)
|
20
|
||
|
||||
Item
5.
|
Other
Information
|
20
|
||
|
||||
Item
6.
|
Exhibits
|
20
|
||
|
||||
Signatures
|
22
|
2
Part I.
Financial Information
Item
1. Financial Statements
CONSOLIDATED
FINANCIAL STATEMENTS
SEPTEMBER
30, 2010
(UNAUDITED)
TABLE
OF CONTENTS
Unaudited
Consolidated Balance Sheets
|
||
As
at September 30, 2010 and December 31, 2009
|
F-1
|
|
Unaudited
Consolidated Statements of Income
|
||
For
the three and nine month periods ended September 30, 2010 and
2009
|
F-2
|
|
Unaudited
Consolidated Statements of Cash Flows
|
||
For
the nine month periods ended September 30, 2010 and 2009
|
F-3
|
|
Notes
to Unaudited Consolidated Financial Statements
|
|
F-4
|
3
CHINA
YONGXIN PHARMACEUTICALS INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
AS
OF SEPTEMBER 30, 2010 AND DECEMBER 31, 2009
(UNAUDITED)
September
30,
2010
|
December
31,
2009
|
|||||||
ASSETS
|
||||||||
Current
Assets:
|
||||||||
Cash
and cash equivalents
|
$ | 1,631,986 | $ | 1,805,271 | ||||
Restricted
cash
|
557,600 | 467,369 | ||||||
Accounts
receivable, net
|
11,710,080 | 12,305,103 | ||||||
Notes
receivable
|
652,413 | 903,867 | ||||||
Other
receivable
|
4,293,869 | 1,931,084 | ||||||
Advances
to suppliers
|
7,226,774 | 5,056,246 | ||||||
Prepaid
expenses
|
89,487 | 534,769 | ||||||
Inventory
|
10,727,867 | 7,811,628 | ||||||
Due
from related party
|
- | 1,199,628 | ||||||
Total
Current Assets
|
36,890,076 | 32,014,966 | ||||||
Property
and Equipment, net
|
8,384,192 | 8,751,813 | ||||||
Construction in Progress | 676,009 | 1,554 | ||||||
Intangible
Assets, net
|
924,467 | 987,332 | ||||||
Total
Assets
|
$ | 46,874,745 | $ | 41,755,662 | ||||
LIABILITIES AND
STOCKHOLDERS' EQUITY
|
||||||||
Current
Liabilities:
|
||||||||
Accounts
payable
|
$ | 4,972,086 | $ | 4,151,219 | ||||
Accrued
expenses & other payable
|
2,706,041 | 5,170,786 | ||||||
Advances
from customers
|
222,480 | 2,055,602 | ||||||
Taxes
payable
|
1,783,314 | 1,421,434 | ||||||
Loans
from related parties
|
- | 184,662 | ||||||
Short-term
bank loans
|
1,609,086 | 1,100,884 | ||||||
Deferred
income
|
328,522 | 419,277 | ||||||
Shares
to be issued
|
35,000 | 65,000 | ||||||
Liabilities
of discontinued operations
|
- | 628,837 | ||||||
Total
Current Liabilities
|
11,656,530 | 15,197,700 | ||||||
Long
term bank loan
|
2,245,500 | 1,320,300 | ||||||
Convertible
note payable, net
|
192,574 | - | ||||||
Commitments
and Contingencies
|
- | - | ||||||
Total Liabilities | $ | 14,094,603 | $ | 16,518,001 | ||||
Stockholders'
Equity:
|
||||||||
Preferred
stock, $0.001 par value; 1,666,667 shares authorized; 1,666,667 shares
issued and outstanding as of September 30, 2010 and December 31,
2009
|
$ | 1,667 | $ | 1,667 | ||||
Common
stock; $0.001 par value; 100,000,000 shares authorized; 5,484,842 shares
issued and outstanding as of September 30, 2010 and 4,704,077 shares
issued and outstanding as of December 31, 2009
|
5,485 | 4,704 | ||||||
Additional
paid in capital
|
4,620,886 | 1,217,644 | ||||||
Deferred
consulting expense - issuance of warrants
|
- | (4,740 | ) | |||||
Prepaid
consulting - issuance of shares
|
(43,004 | ) | (5,000 | ) | ||||
Receivable
from a related party for issuance of shares
|
(50,000 | ) | (50,000 | ) | ||||
Statutory
reserve
|
3,018,232 | 2,630,329 | ||||||
Other
comprehensive income
|
2,352,568 | 1,807,859 | ||||||
Retained
earnings
|
16,233,762 | 13,920,650 | ||||||
Total
|
26,139,597 | 19,523,113 | ||||||
Non-controlling
interest
|
6,640,544 | 5,714,550 | ||||||
Total
Stockholders' Equity
|
32,780,141 | 25,237,663 | ||||||
Total
Liabilities and Stockholders' Equity
|
$ | 46,874,744 | $ | 41,755,664 |
The
accompanying notes are an integral part of these unaudited consolidated
financial statements
F-1
CHINA
YONGXIN PHARMACEUTICALS INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME
FOR
THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009
(UNAUDITED)
For
the Three-Month Periods Ended
|
For
the Nine-Month Periods Ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
Revenues
|
$ | 10,515,586 | $ | 10,812,529 | $ | 32,351,546 | $ | 29,156,020 | ||||||||
Cost
of Goods Sold
|
(6,829,661 | ) | (7,667,014 | ) | (23,442,133 | ) | (21,060,847 | ) | ||||||||
Gross
profit
|
3,685,924 | 3,145,514 | 8,909,412 | 8,095,172 | ||||||||||||
Operating
Expenses:
|
||||||||||||||||
Selling
expenses
|
1,142,085 | 912,094 | 2,900,904 | 2,495,546 | ||||||||||||
General
and administrative expenses
|
2,177,487 | 2,350,837 | 3,623,259 | 3,825,981 | ||||||||||||
Total
operating expenses
|
3,319,572 | 3,262,931 | 6,524,163 | 6,321,527 | ||||||||||||
Income
/ (Loss) From Operations
|
366,353 | (117,416 | ) | 2,385,249 | 1,773,646 | |||||||||||
Other
Income (Expense):
|
||||||||||||||||
Gain
on settlement of debt
|
- | - | 75,000 | - | ||||||||||||
Other
income, net
|
1,002,976 | 1,092,330 | 1,173,599 | 1,866,093 | ||||||||||||
Beneficial
conversion feature and warrant amortization
|
(383,710 | ) | - | (628,153 | ) | - | ||||||||||
Interest
income (expense), net
|
(70,726 | ) | (6,918 | ) | (184,239 | ) | 1,066 | |||||||||
Total
other income
|
548,540 | 1,085,411 | 436,207 | 1,867,158 | ||||||||||||
Operating
Incomefrom continued operations before Income Tax and non controlling
Interest
|
914,891 | 967,995 | 2,821,455 | 3,640,804 | ||||||||||||
Provision
for income tax
|
(658,756 | ) | (233,908 | ) | (1,283,272 | ) | (964,474 | ) | ||||||||
Net
Income Before Non controlling Interest and Discontinued
operations
|
256,137 | 734,088 | 1,538,185 | 2,676,331 | ||||||||||||
Net
Income Attributable to The Non controlling interest
|
(424,738 | ) | (240,361 | ) | (795,807 | ) | (670,747 | ) | ||||||||
Net
Income/ (Loss) from Continued Operations
|
(168,603 | ) | 493,727 | 742,376 | 2,005,585 | |||||||||||
Discontinued
operations
|
||||||||||||||||
Gain/
(loss) from discontinued operations
|
- | (21,611 | ) | 10,997 | (68,679 | ) | ||||||||||
Gain
on disposal of subsidiaries
|
- | - | 1,948,553 | - | ||||||||||||
Total
income/ (loss) from discontinued operations
|
- | (21,611 | ) | 1,959,551 | (68,679 | ) | ||||||||||
Net
Income/ (Loss) Attributable to The Company
|
(168,603 | ) | 472,116 | 2,701,927 | 1,936,907 | |||||||||||
Other
Comprehensive Item:
|
||||||||||||||||
Foreign
exchange translation gain/ (loss)
|
445,180 | (17,742 | ) | 544,710 | 598 | |||||||||||
Net
Comprehensive Income
|
$ | 276,577 | $ | 454,374 | $ | 3,246,637 | $ | 1,937,505 | ||||||||
Earning/(loss)
per share
|
||||||||||||||||
Basic
from continued operations
|
$ | (0.03 | ) | $ | 0.19 | $ | 0.15 | $ | 0.77 | |||||||
Basic
from discontinued operations
|
$ | - | $ | (0.01 | ) | $ | 0.38 | $ | (0.03 | ) | ||||||
Basic
|
$ | (0.03 | ) | $ | 0.18 | $ | 0.52 | $ | 0.74 | |||||||
Diluted
from continued operations
|
$ | (0.03 | ) | $ | 0.18 | $ | 0.12 | $ | 0.76 | |||||||
Diluted
from discontinued operations
|
$ | - | $ | (0.01 | ) | $ | 0.31 | $ | (0.03 | ) | ||||||
Diluted
|
$ | (0.03 | ) | $ | 0.17 | $ | 0.43 | $ | 0.73 | |||||||
Weighted
average number of shares outstanding
|
||||||||||||||||
Basic
|
5,377,378 | 2,638,922 | 5,115,082 | 2,607,409 | ||||||||||||
Diluted
|
6,502,378 | 2,677,160 | 6,240,082 | 2,645,647 |
The
accompanying notes are an integral part of these unaudited consolidated
financial statements
F-2
CHINA
YONGXIN PHARMACEUTICALS INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR
THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009
(UNAUDITED)
Nine
Months Ended
September
30,
|
||||||||
2010
|
2009
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES
|
||||||||
Net
Income
|
$ | 2,701,927 | $ | 1,936,907 | ||||
Adjustments
to reconcile net income to net cash provided by (used in) operating
activities:
|
||||||||
Litigation
settlement
|
- | - | ||||||
Provision
for bad debts
|
- | 1,238,933 | ||||||
Beneficial
conversion feature & warrant fee amortization
|
567,574 | 16,589 | ||||||
Debt
issue costs amortization
|
90,032 | 75,400 | ||||||
Depreciation
and amortization
|
526,156 | 204,737 | ||||||
Amortization
of prepaid & deferred consulting cost
|
9,740 | 141,565 | ||||||
Non-controlling
interest
|
795,807 | 670,747 | ||||||
Gain
on settlement of debt
|
(75,000 | ) | - | |||||
Gain
on sale of subsidiaries
|
(1,948,553 | ) | - | |||||
Shares
issued for services
|
112,500 | - | ||||||
Option
compensation
|
37,361 | - | ||||||
(Increase)
/ decrease in current assets:
|
||||||||
Accounts
receivable
|
831,956 | (1,830,414 | ) | |||||
Notes
receivable
|
265,250 | (1,739,460 | ) | |||||
Other
receivable
|
(2,263,290 | ) | (2,464,957 | ) | ||||
Advances
to suppliers
|
(828,327 | ) | (390,501 | ) | ||||
Prepaid
expenses
|
536,227 | 345,403 | ||||||
Inventory
|
(2,700,832 | ) | (882,627 | ) | ||||
Increase
/ (decrease) in current liabilities:
|
||||||||
Accounts
payable
|
359,569 | 1,484,727 | ||||||
Accrued
expenses and other payable
|
(556,701 | ) | 2,455,696 | |||||
Tax
payable
|
327,031 | 942,517 | ||||||
Advances
from customers
|
(1,842,591 | ) | 320,594 | |||||
Deferred
income
|
(98,606 | ) | 31,582 | |||||
Total
Adjustments
|
(5,854,697 | ) | 620,531 | |||||
Net
cash provided by (used in) operating activities from continuing
operations
|
(3,152,770 | ) | 2,557,438 | |||||
Net
cash provided by (used in) operating activities of discontinued
operations
|
(20,000 | ) | 68,679 | |||||
Net
cash provided by (used in) operating activities
|
(3,172,770 | ) | 2,626,117 | |||||
CASH
FLOWS FROM INVESTING ACTIVITIES
|
||||||||
Acquistion
of sale of property and equipment
|
(577,941 | ) | (1,078,011 | ) | ||||
Additions
to construction in progress
|
- | - | ||||||
Acquisition
of/sale of property and equipment
|
- | - | ||||||
Net cash provided by (used in) investing activities from continuing operations | (577,941 | ) | (1,078,011 | ) | ||||
Net cash provided by investing activities of discontinued operations | - | - | ||||||
Net cash used in investing activities | (577,941 | ) | (1,078,011 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES
|
||||||||
Shares
issued for cash
|
1,155,323 | - | ||||||
Receipt
of loans from non-related parties
|
2,469,447 | (752,249 | ) | |||||
Restricted
cash
|
(93,941 | ) | - | |||||
Net
cash provided by financing activities
|
3,530,829 | (752,249 | ) | |||||
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
(219,882 | ) | 795,856 | |||||
EFFECT
OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
|
46,597 | 35,242 | ||||||
CASH
AND CASH EQUIVALENTS, BEGINNING BALANCE
|
1,805,271 | 609,422 | ||||||
CASH
AND CASH EQUIVALENTS, ENDING BALANCE
|
$ | 1,631,986 | $ | 1,440,521 | ||||
SUPPLEMENTAL
DISCLOSURES:
|
||||||||
Cash
paid during the year for:
|
||||||||
Interest
|
$ | 135,323 | $ | 126,707 | ||||
Income
tax
|
$ | 1,009,360 | $ | 21,158 |
The
accompanying notes are an integral part of these unaudited consolidated
financial statements
F-3
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 ORGANIZATION
China
Yongxin Pharmaceuticals, Inc. and subsidiaries (the “Company” or “We” or “Our”)
was originally established in 1993. Yongxin’s business operations consist of
wholesale and retail sales of pharmaceuticals, medical equipment, other
medical-related products, health products including nutritional and dietary
supplements, and cosmetics. Yongxin’s operations are based in Changchun City,
Jilin Province, China.We own and control 110 retail pharmacy locations, through
our ownership of Yongxin Drugstore and its affiliated entities, Jingyongxin
Drugstore and Caoantang Drugstore. Yongxin previously owned a direct 100% equity
interest in Yongxin Drugstore as a record owner of all of its outstanding share
capital. PRC laws and regulations limit foreign ownership of in excess of 49% of
the outstanding share capital of PRC entities that operate more than 30
drugstores in China that sell a variety of branded pharmaceutical products
sourced from different suppliers.
In May
2010, in an effort to comply with PRC regulatory requirements regarding foreign
ownership of drugstores in the PRC, and in contemplation of future growth of our
Company, we conducted a restructuring of Yongxin’s ownership and control of
Yongxin Drugstore (the “Restructuring”) in which we changed the method by which
we own Yongxin Drugstore. Specifically, we instituted a “variable interest
entity” (“VIE”) structure under which Yongxin is a record holder of 49% of the
outstanding share capital of Yongxin Drugstore, and Mr. Yongxin Liu (our CEO and
Chairman of the Company’s Board of Directors) and Mr. Yongkui Liu (a Company
Vice President and former Company director), each of whom are PRC citizens
(collectively, the “PRC Shareholders”), serve as nominee record holders of the
remaining 51% of the share capital of Yongxin Drugstore. In order to retain the
Company’s rights and authority to control, operate and manage Yongxin Drugstore
and to continue to receive all of the economic benefits of Yongxin Drugstore’s
business operations, concurrent with the equity transfers, Yongxin and the PRC
Shareholders also entered into an Entrustment Agreement dated May 17, 2010 (the
“Entrustment Agreement”), which effectively grants Yongxin beneficial ownership
of the interest attributable to the 51% interest, including but not limited to,
the right to exclusively control, operate and manage Yongxin Drugstore, and all
of the profits, income, distributions, dividends, compensation, payments, assets
property, or other economic benefits from Yongxin Drugstore that the PRC
Shareholders now hold or receive or otherwise become entitled to receive in the
future by virtue of their 51% record ownership of Yongxin Drugstore’s share
capital. As a result of the rights conferred to Yongxin under the Entrustment
Agreement, the Company is considered the primary beneficiary of Yongxin
Drugstore and Yongxin Drugstore is deemed our variable interest entity (“VIE”).
Further, we consolidate 100% of Yongxin Drugstore’s results of operations,
assets and liabilities in our financial statements.
Our
corporate structure consists of the following consolidated
subsidiaries:
·
|
Changchun
Yongxin Durui Medical Co., Ltd. (“Yongxin”), through which we operate our
wholesale pharmaceuticals distribution business and in
which the Company owns an 80% equity ownership
interest;
|
·
|
Jilin Province
Yongxin Chain Drugstore Ltd. (“Yongxin Drugstore”), through which we operate 42
pharmacy retail drugstores and which we control
through Yongxin’s equity ownership interest in Yongxin Drugstore, and
through an Entrustment Agreement described
more fully below by and between Yongxin, on the one hand, and Yongxin Liu
(our CEO and Chairman) and Yongkui Liu
(a Company Vice President and former director), on the other
hand;
|
·
|
Tianjin
Jingyongxin Chain Drugstore Ltd. (“Jingyongxin Drugstore”), through which we operate 26
pharmacy retail drugstores and in which Yongxin
Drugstore owns a 90% equity ownership interest;
and
|
·
|
Baishan
Caoantang Chain Drugstore Ltd. (“Caoantang Drugstore”), through which we operate 32
pharmacy retail drugstores and in which Yongxin
Drugstore owns 100% of the equity ownership
interest.
|
Chinese
laws and regulations concerning the validity of the contractual arrangements
such as the Entrustment Agreement are uncertain, as many of these laws and
regulations are relatively new and may be subject to change. Official
interpretation and enforcement by the Chinese government involves substantial
uncertainty. Additionally, the Entrustment Agreement may not be as effective in
providing control over Yongxin Drugstore as direct majority equity interest
ownership under the current PRC laws and regulations. Due to such uncertainty,
the Entrustment Agreement includes a further assurances provision that allows us
to take any additional steps in the future permissible under the then-applicable
law to ensure the Company’s complete control over, and the realization of the
entirety of all rights and benefits of ownership of Yongxin Drugstore and its
assets and business operations, including but not limited to direct ownership of
selected assets.
F-4
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
2 SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED
INTERIM FINANCIAL INFORMATION
|
The
accompanying unaudited consolidated financial statements have been prepared by
the Company, pursuant to the rules and regulations of the Securities and
Exchange Commission (the “SEC”) and generally accepted accounting principles for
interim financial reporting. The information furnished herein reflects all
adjustments (consisting of normal recurring accruals and adjustments) which are,
in the opinion of management, necessary to fairly present the operating results
for the respective periods. Certain information and footnote disclosures
normally present in annual consolidated financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been omitted pursuant to such rules and regulations. These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and footnotes included in the Company’s Annual
Report on Form 10-K. The results of the nine month period ended September 30,
2010 are not necessarily indicative of the results to be expected for the full
year ending December 31, 2010.
BASIS
OF PRESENTATION
|
The
accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America. The
functional currency of our operating subsidiary, Changchun Yongxin Dirui Medical
Co., Ltd is Chinese Renminbi (“RMB”); however the accompanying financial
statements have been translated and presented in United States Dollars
(“USD”).
TRANSLATION
ADJUSTMENT
|
The
Company’s functional currency is the Chinese Yuan or Renminbi (“RMB”), which
must be translated into US Dollar for financial reporting purposes. All asset
and liability accounts were translated at the exchange rate on the balance sheet
date; stockholder's equity is translated at historical rates and items in the
statements of income and cash flow are translated at the average rate in each
applicable period. Translation adjustments resulting from this process are
included in accumulated other comprehensive income in the statement of
shareholders’ equity. The resulting translation 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.
USE
OF ESTIMATES
|
The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States (“GAAP”) requires management to make
certain estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates include collectability of accounts receivable, accounts
payable, sales returns and recoverability of long-term assets.
PRINCIPLES
OF CONSOLIDATION
|
The
consolidated financial statements include the accounts of China Yongxin
Pharmaceuticals Inc. and its subsidiaries. All material inter-company accounts,
transactions and profits have been eliminated in consolidation.
NON-CONTROLLING
INTEREST
|
The
accompanying consolidated financial statements have been prepared by the
Company, pursuant to the rules and regulations of the Securities and Exchange
Commission (the “SEC”) and in accordance with GAAP. The Company acquired 80% of
Yongxin, and Yongxin Liu and Yongkui Liu own 11% and 9% of Yongxin,
respectively. The 20% equity interest held by Yongxin Liu and Yongkui Liu
represents non-controlling interest amounting to $6,593,628 as at September 30,
2010 compared to $5,687,633 as at December 31, 2009.
The
Company owns a 90% ownership interest in Jinyongxin Drugstore. The remaining 10%
interest in Jinyongxin Drugstore is owned by third parties. As at September 30,
2010 and December 31, 2009, the 10% equity interest amounted to $47,006 and
26,917 respectively.
CASH
AND CASH EQUIVALENTS
|
Cash and
cash equivalents consist primarily of cash in banks and highly liquid
investments with original maturities of 90 days or less.
ACCOUNTS
RECEIVABLE
|
The
Company maintains reserves for potential credit losses on accounts receivable.
Management reviews the composition of accounts receivable and analyzes
historical bad debts, customer concentrations, customer credit worthiness,
current economic trends and changes in customer payment patterns to evaluate the
adequacy of these reserves. Reserves are recorded primarily on a specific
identification basis. As of September 30, 2010 and December 31, 2009, there was
no allowance for doubtful debts.
F-5
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The
Company entered into a factoring agreement with China Jilin Bank Corporation
Limited (“Jilin Bank”), to transfer accounts receivable with full recourse. The
Company is required to repurchase the transferred accounts receivable in the
event of default of debtors or in other certain defined events. This transfer
was recorded as a secured borrowing with a pledge of collateral in the accounts
receivable balances, which are included in the accompanying consolidated
financial statements.
NOTES
RECEIVABLE
|
Notes
receivable represent bankers’ acceptances that have been arranged with
third-party financial institutions by certain customers to settle their
purchases from us. These bankers’ acceptances are non-interest bearing,
guaranteed by a PRC bank, and are collectible within three to six months. Such
sales and purchasing arrangements are consistent with industry practices in the
PRC.
ADVANCES
TO SUPPLIERS
|
The
Company advances to certain vendors for purchase of its material. The advances
to suppliers are interest free and unsecured. As of September 30, 2010 and
December 31, 2009, advance to suppliers amounted to $7,226,774 and $6,255,874,
respectively.
INVENTORIES
|
Inventories
are valued on a lower of weighted average cost or market basis. Inventory
includes product cost, inbound freight, warehousing costs and vendor allowances
not included as a reduction of advertising expense. The management compares the
cost of inventories with the market value and allowance is made for writing down
their inventories to market value, if lower. Work in process inventories include
the cost of raw materials and outsource processing fees.
PROPERTY
AND EQUIPMENT
|
Property
and equipment are recorded at cost. Depreciation is computed using the
straight-line method over useful lives ranging from 5 to 20 years. Expenditures
for maintenance and repairs are charged to earnings as incurred; additions,
renewals and betterments are capitalized. When property and equipment are
retired or otherwise disposed of, the related cost and accumulated depreciation
are removed from the respective accounts, and any gain or loss is included in
operations. Assets held under capital leases are recorded at the lesser of the
present value of the future minimum lease payments or the fair value of the
leased property. Expenditures for maintenance and repairs are charged to
operations as incurred.
Depreciation
of property and equipment is provided using the straight-line method for
substantially all assets with estimated lives of:
Asset
Type
|
Depreciable
Period
|
|
Buildings
|
20
years
|
|
Infrastructures and leasehold
improvements
|
10
years
|
|
Equipment (including electronic
facilities, sports, education and recreation facilities)
|
10
years
|
|
Automobiles
|
10
years
|
|
Furniture and
fixtures
|
5 years
|
|
Computer hardware and
software
|
5
years
|
IMPAIRMENT
OF LONG-LIVED ASSETS
|
The
Company tests long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable through the estimated undiscounted cash flows expected to result
from the use and eventual disposition of the assets. In that event, a loss is
recognized based on the amount by which the carrying amount exceeds the fair
market value of the long-lived assets. Loss on long-lived assets to be disposed
of is determined in a similar manner, except that fair market values are reduced
for the cost of disposal.
REVENUE
RECOGNITION
|
Sales
revenue is recognized at the date of shipment to customers when a formal
arrangement exists, the price is fixed or determinable, the delivery is
completed, no other significant obligations of the Company exist and
collectability is reasonably assured. The Company recognizes revenue net of an
allowance for estimated returns, at the time the merchandise is sold or services
performed. The allowance for sales returns is estimated based on the Company’s
historical experience. Sales taxes are presented on a net basis (excluded from
revenues and costs). Payments received before all of the relevant criteria for
revenue recognition are satisfied are recorded as unearned revenue.
F-6
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
VENDOR
ALLOWANCES
|
Vendor
allowances are principally received as a result of purchase levels, sales or
promotion of vendors’ products. Allowances are generally recorded as a reduction
of inventory and are recognized as a reduction of cost of sales when the related
merchandise is sold. Those allowances received for promoting vendors’ products
are offset against advertising expense and result in a reduction of selling,
occupancy and administration expenses to the extent of advertising costs
incurred, with the excess treated as a reduction of inventory
costs.
INCOME
TAXES
|
The
Company accounts for income taxes using an asset and liability approach which
allows for the recognition and measurement of deferred tax assets based upon the
likelihood of realization of tax benefits in future years. Under the asset and
liability approach, deferred taxes are provided for 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. A
valuation allowance is provided for deferred tax assets if it is more likely
than not these items will either expire before the Company is able to realize
their benefits, or that future deductibility is uncertain.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
|
Fair
value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. Assets and liabilities measured at fair value are categorized
based on whether or not the inputs are observable in the market and the degree
that the inputs are observable. The categorization of financial assets and
liabilities within the valuation hierarchy is based upon the lowest level of
input that is significant to the fair value measurement.
The
Company's financial instruments primarily consist of cash and cash equivalents,
accounts receivable, and accounts payable.
As of the
balance sheet dates, the estimated fair values of the financial instruments were
not materially different from their carrying values as presented on the balance
sheet. This is primarily attributed to the short maturities of these
instruments.
STOCK
BASED COMPENSATION
|
The costs
of all employee stock options, as well as other equity-based compensation
arrangements, are reflected in the consolidated financial statements based on
the estimated fair value of the awards on the grant date. That cost is
recognized over the period during which an employee is required to provide
service in exchange for the award—the requisite service period (usually the
vesting period). 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 data for the three and nine month periods ended September 30, 2010 and
2009 are as follows:
STATEMENT
OF CASH FLOWS
|
Cash
flows from the Company’s operations are calculated based upon the local
currencies. As a result, amounts related to assets and liabilities reported on
the statement of cash flows will not necessarily agree with changes in the
corresponding balances on the balance sheet.
SEGMENT
REPORTING
|
The
Company reports segment information using the “management approach” model. The
management approach model is based on the way a company’s management organizes
segments within the company for making operating decisions and assessing
performance. Reportable segments are based on products and services, geography,
legal structure, management structure, or any other manner in which management
disaggregates a company. The Company allocates its resources and assesses the
performance of its sales activities based upon its products and services (see
Note 21).
RISKS
AND UNCERTAINTIES
|
The
Company is subject to substantial risks from, among other things, intense
competition associated with the industry in general, other risks associated with
financing, liquidity requirements, rapidly changing customer requirements,
limited operating history, foreign currency exchange rates and the volatility of
public markets.
F-7
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The
Company’s operations are 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, by the general state of
PRC’s economy. The Company’s business may be influenced 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.
Under
current PRC law on foreign investment, foreign companies are allowed to
establish or invest in wholly-owned foreign enterprises or joint ventures that
engage in wholesale or retail sales of pharmaceuticals in China. These
regulations limit the number and size of retail pharmacy outlets that a foreign
investor may establish. If a foreign investor owns more than 30 outlets that
sell a variety of branded pharmaceutical products sourced from different
suppliers, the foreign investor’s ownership interests in the outlets may be
limited to 49.0% . The Company currently controls more than 30 retail pharmacy
outlets through its 80% equity ownership interest in Yongxin, 100% equity
ownership in Caoantang Drugstore and 90% equity ownership interest in Jinyongxin
Drugstore. At the time of the establishment of Yongxin, Yongxin already
controlled in excess of 30 retail pharmacy outlets and with this structure in
place it obtained all required approvals from the relevant governmental agencies
in Jilin Province for the joint venture. The Company has been advised by its PRC
counsel, that based on their understanding of the current PRC laws, rules and
regulations and the Company’s receipt of all relevant government approvals for
the equity joint venture, the structure under which it operates and holds equity
ownership in its retail pharmacy businesses complies with all applicable PRC
laws, rules and regulations. However, there are uncertainties regarding the
interpretation and application of PRC laws, rules and regulations by PRC
government authorities, and there is a risk that such authorities may later
issue a differing interpretation of the law and determine that the Company’s
corporate and/or ownership structure does not comply with PRC laws, rules and
regulations. In addition, new PRC laws, rules and regulations may be introduced
from time to time to impose additional requirements that may be applicable to
the Company’s corporate structure or its business operations. If the Company
and/or its PRC subsidiaries are determined to be in violation of any existing or
future PRC laws, rules or regulations, including laws applicable to foreign
investment in retail pharmacy outlets, or fail to obtain or maintain any of the
required governmental permits or approvals, the relevant PRC regulatory
authorities would have broad discretion in dealing with such violations,
including: The imposition of penalties and/or a restructuring of the Company’s
holding structure in order to comply with relevant PRC regulations could
severely disrupt the Company’s ability to conduct business and could have a
material adverse effect on the Company’s financial condition, results of
operations and prospects and also could result in:
·
|
revocation
of the business and operating licenses of the Company’s PRC consolidated
entities;
|
·
|
discontinuation
or restriction of the operations of the Company’s PRC consolidated
entities;
|
·
|
imposition of conditions or
requirements with which the Company or its PRC consolidated entities may
not be able to
comply;
|
·
|
requirements
that the Company or its PRC consolidated entities restructure its
ownership or operations;
|
·
|
restriction or prohibition of the
Company’s use of the proceeds from its financings to fund its business
and operations in China;
or
|
·
|
imposition
of fines.
|
CONCENTRATIONS
OF CREDIT RISK
|
Financial
instruments that potentially subject the Company to concentrations of credit
risk are cash, accounts receivable and other receivables arising from its normal
business activities. The Company places its cash in what it believes to be
credit worthy financial institutions. The Company has a diversified customer
base, most of which are in China. The Company controls credit risk related to
accounts receivable through credit approvals, credit limits and monitoring
procedures. The Company routinely assesses the financial strength of its
customers and, based upon factors surrounding the credit risk, establishes an
allowance, if required, for uncollectible accounts and, as a consequence,
believes that its accounts receivable credit risk exposure beyond such allowance
is limited.
CONTINGENCIES
|
Certain
conditions may exist as of the date the financial statements are issued, which
may result in a loss to the Company but which will only be resolved when one or
more future events occur or fail to occur. The Company’s management and legal
counsel assess such contingent liabilities, and such assessment inherently
involves an exercise of judgment. In assessing loss contingencies related to
legal proceedings that are pending against the Company or unasserted claims that
may result in such proceedings, the Company’s legal counsel evaluates the
perceived merits of any legal proceedings or unasserted claims as well as the
perceived merits of the amount of relief sought or expected to be
sought.
F-8
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
If the
assessment of a contingency indicates that it is probable that a material loss
has been incurred and the amount of the liability can be estimated, then the
estimated liability would be accrued in the Company’s financial statements. If
the assessment indicates that a potential material loss contingency is not
probable but is reasonably possible, or is probable but cannot be estimated,
then the nature of the contingent liability, together with an estimate of the
range of possible loss if determinable and material would be disclosed. Loss
contingencies considered to be remote by management are generally not disclosed
unless they involve guarantees, in which case the guarantee would be
disclosed.
RECENT ACCOUNTING
PRONOUNCEMENTS
|
In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A
reporting entity should disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers. 2) Activity in Level 3 fair value measurements. In
the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. These disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is currently evaluating the impact of this ASU, however, the
Company does not expect the adoption of this ASU to have a material impact on
its consolidated financial statements.
In April
2010, FASB issued ASU No. 2010-13–Stock Compensation. The objective of this
Update is to address the classification of an employee share-based payment award
with an exercise price denominated in the currency of a market in which the
underlying equity security trades. It provides guidance on the classification of
a share-based payment award as either equity or a liability. A share-based
payment award that contains a condition that is not a market, performance, or
service condition is required to be classified as a liability. Under Topic 718,
awards of equity share options granted to an employee of an entity's foreign
operation that provide a fixed exercise price denominated in (1) the foreign
operation's functional currency or (2) the currency in which the employee's pay
is denominated should not be considered to contain a condition that is not a
market, performance, or service condition.
The
amendments in this Update affect entities that issue employee share-based
payment awards with an exercise price denominated in the currency of a market in
which a substantial portion of the entity's equity securities trades that
differs from the functional currency of the employer entity or payroll currency
of the employee. The amendments affect entities that have previously considered
such awards to be liabilities because of their exercise price.
The
amendments in this Update are effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2010. The
amendments in this Update should be applied by recording a cumulative-effect
adjustment to the opening balance of retained earnings. The Company is currently
evaluating the impact of this ASU on its consolidated financial
statements.
In July
2010, the FASB issued Accounting Standards Update 2010-20 which amends
“Receivables” (Topic 310). ASU 2010 20 is intended to provide additional
information to assist financial statement users in assessing an entity’s risk
exposures and evaluating the adequacy of its allowance for credit losses. The
disclosures as of the end of a reporting period are effective for interim and
annual reporting periods ending on or after December 15, 2010. The disclosures
about activity that occurs during a reporting period are effective for interim
and annual reporting periods beginning on or after December 15, 2010. The
amendments in ASU 2010-20 encourage, but do not require, comparative disclosures
for earlier reporting periods that ended before initial adoption. However, an
entity should provide comparative disclosures for those reporting periods ending
after initial adoption. While ASU 2010-20 will not have a material impact on our
consolidated financial statements, we expect that it will expand our disclosures
related to notes receivables.
F-9
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
3 BASIC
AND DILUTED EARNINGS PER SHARE
Basic
earnings per share are computed by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted net income (loss)
per share is based on the assumption that all dilutive convertible shares and
stock options were converted or exercised. Dilution is computed by applying the
treasury stock method. Under this method, options and warrants are assumed to 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. Earnings per share data for the three
and nine month periods ended September 30, 2010 and 2009 are as
follows:
For the
three-months ended
|
For the
nine-months ended
|
|||||||||||||||
September
30
|
September
30
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Earning (loss)
per share
|
||||||||||||||||
Basic from continued
operations
|
$ | (0.03 | ) | $ | 0.19 | $ | 0.15 | $ | 0.77 | |||||||
Basic from discontinued
operations
|
$ | - | $ | (0.01 | ) | $ | 0.38 | $ | (0.03 | ) | ||||||
Basic
|
$ | (0.03 | ) | $ | 0.18 | $ | 0.53 | $ | 0.74 | |||||||
Diluted from continued
operations
|
$ | (0.03 | ) | $ | 0.18 | $ | 0.12 | $ | 0.76 | |||||||
Diluted from discontinued
operations
|
$ | - | $ | (0.01 | ) | $ | 0.31 | $ | (0.03 | ) | ||||||
Diluted
|
$ | (0.03 | ) | $ | 0.18 | $ | 0.43 | $ | 0.73 | |||||||
Weighted
average number of shares
|
||||||||||||||||
outstanding
|
||||||||||||||||
Basic
|
$ | 5,377,378 | $ | 2,638,922 | $ | 5,115,082 | $ | 2,607,409 | ||||||||
Diluted
|
$ | 6,502,378 | $ | 2,677,160 | $ | 6,240,082 | $ | 2,645,647 |
NOTE
4 OTHER
RECEIVABLES
Other
receivables are interest free, unsecured, and due on demand (with the exception
of loans to un-related parties). These receivables as of September 30, 2010, and
December 31, 2009 are summarized as follows:
September 30,
2010
|
December 31,
2009
|
|||||||
Advance to employees
|
$ | 225,724 | $ | 26,493 | ||||
Advances to store
employees
|
42,275 | 15,037 | ||||||
Rent receivable
|
80,838 | 79,218 | ||||||
Deposits
|
342,753 | 765,925 | ||||||
Sponsorship from
customers
|
- | 987,174 | ||||||
Others
|
192,861 | 57,237 | ||||||
Loans to unrelated
parties
|
3,409,418 | - | ||||||
Total
|
$ | 4,293,869 | $ | 1,931,084 |
F-10
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Loans to
un-related parties as of September 30, 2010 accrue interest at an annual
percentage rate (APR) of 4.86% and are summarized as follows:
Term of
Loan
|
Principal
(USD)
|
Principal
(RMB)
|
Accrued
Interest
|
||||||||||
Jilin Province Dingjian Natural
Plant Base
Company Limited
|
July 22 –
November 20,
2010
|
$ | 1,991,010 | $ | 13,300,000 | $ | 18,334 | ||||||
Changchun Golden Century
Commodities
Concrete Construction Company
Limited
|
June 30, 2010 –
October 30, 2010
|
898,200 | 6,000,000 | 10,871 | |||||||||
Jilin Province Shunda Logistics
Company
Limited
|
June 30, 2010 –
November 30,
2010
|
471,555 | 3,150,000 | 5,707 | |||||||||
Changchun City Nanguan District
Xingfu
Town Heizuizi Village
Community
Committee
|
July 1, 2010 –November 30,
2010
|
48,653 | 325,000 | 582 | |||||||||
$ | 3,409,418 | $ | 22,450,000 | $ | 35,494 |
NOTE
5 PREPAID
EXPENSES
The
balance of Company prepaid expenses as of September 30, 2010 and December 31,
2009 comprised of the following:
September
30,
2010
|
December
31,
2009
|
|||||||
Prepaid rent
|
$ | - | $ | 18,088 | ||||
Rent
|
- | 489,156 | ||||||
Other prepaid
expenses
|
- | 27,525 | ||||||
Prepaid debt issue
costs
|
89,487 | - | ||||||
Total
|
$ | 89,487 | $ | 534,769 |
NOTE 6 INVENTORIES
As
of September 30, 2010 and December 31, 2009, inventory consisted of the
following:
September
30,
2010
|
December
31,
2009
|
|||||||
Packaging Materials
|
$ | 211,252 | $ | 200,007 | ||||
Finished Goods
|
10,516,615 | 7,611,621 | ||||||
Total inventory
|
$ | 10,727,867 | $ | 7,811,628 |
NOTE 7 PROPERTIES
AND EQUIPMENT
As of
September 30, 2010 and December 31, 2009 the property and equipment of the
Company consisted of the following:
September
30,
2010
|
December
31,
2009
|
|||||||
Office furniture and
fixtures
|
$ | 997,418 | $ | 930,962 | ||||
Vehicles
|
383,959 | 392,557 | ||||||
Buildings
|
8,684,989 | 8,628,714 | ||||||
Total property and
equipment
|
10,066,366 | 9,952,233 | ||||||
Less: Accumulated
depreciation
|
(1,682,174 | ) | (1,200,420 | ) | ||||
Net value of property and
equipment
|
$ | 8,384,192 | $ | 8,751,813 |
F-11
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The
Company had depreciation expense of $481,754 and $198,687 for the nine month
periods ended September 30, 2010 and 2009, respectively. Depreciation expense
for three months ended September 30, 2010 and 2009 amounted to $135,432 and
$92,655, respectively.
NOTE
8 INTANGIBLE
ASSETS
As of
September 30, 2010 and December 31, 2009, the intangible assets of the Company
consisted of the following:
September 30,
2010
|
December 31,
2009
|
|||||||
Software
|
$ | 1,129,238 | $ | 1,102,893 | ||||
Less: Accumulated
amortization
|
(204,771 | ) | (115,561 | ) | ||||
Net value of intangible
assets
|
$ | 924,467 | $ | 987,332 |
The
amortization expense for the nine month periods ended September 30, 2010 and
2009 amounted to $89,210 and $40,424, respectively. Amortization expense
for the three month periods ended September 30, 2010 and 2009 amounted to
$28,735 and $14,593, respectively.
Amortization
expenses for intangible assets for next five years after September 30, 2010 are
as follows:
September 30, 2011
|
$ | 115,471 | ||
September 30, 2012
|
112,917 | |||
September 30, 2013
|
108,589 | |||
September 30, 2014
|
108,463 | |||
September 30, 2015
|
108,463 | |||
Thereafter
|
370,564 | |||
Total
|
$ | 924,467 |
NOTE
9 ACCRUED EXPENSES AND
OTHER PAYABLE
The other
payable represents the deposits made by the sales representatives and sales
distributors for the right to sell products for the Company. Other payables and
accrued expenses consisted of the following as of September 30, 2010 and
December 31, 2009:
September
30,
2010
|
December
31,
2009
|
|||||||
Accrued compensation
|
$ | 497,004 | $ | 1,091,299 | ||||
Accrued rent expense
|
222,831 | 124,874 | ||||||
Accrued professional
fees
|
294,034 | 86,026 | ||||||
Accrued litigation
|
1,025,544 | 987,515 | ||||||
Accrued interest
|
39,301 | 8,133 | ||||||
Accrued payable
|
565,365 | 2,539,032 | ||||||
Other accrued expense
|
112,151 | |||||||
Sales agent deposits
|
55,776 | 113,265 | ||||||
Other payable
|
6,186 | 108,491 | ||||||
Total
|
$ | 2,706,041 | $ | 5,170,786 |
NOTE
10 ADVANCES FROM
CUSTOMERS
The
advances from customers amounted to $222,480 and $2,055,602 respectively as of
September 30, 2010 and December 31, 2009, representing the deposits made by
customers to purchase inventory from the Company.
F-12
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
11 DEFERRED
INCOME
A portion
of the Company’s net revenue is derived directly from government-sponsored
healthcare programs, and the Company is therefore subject to government
regulations on reimbursement on the sales made through the healthcare programs.
The Jilin Province Social Insurance Bureau and Changchun City Insurance Bureau
(“Insurance Bureaus”) reimburse 90% of the sales that the Company’s pharmacy
retail stores made through the healthcare program networks in the following
month, and retain 10% of the sales until the following year. The amount will be
repaid proportionally based on the level of evaluation made by the Insurance
Bureaus in the following year. The Company classified 10% of the sales made
through the healthcare program networks as deferred income as the collectability
of these sales is uncertain. As of September 30, 2010 and December 31, 2009, the
Company had deferred income of $328,522 and $419,277, respectively.
NOTE
12 SHARES TO BE
ISSUED
The
Company classifies all amounts, against which shares have not been issued, as
shares to be issued. Once the Company issues shares, the amounts are classified
as Common stock. As of September 30, 2010, the Company had a total of 41,667
(post-reverse split) shares to be issued with a balance of $35,000 pursuant to
an agreement with a software consultant entered into by the Company in
2005.
During
the year ended December 31, 2009, the Company entered into an agreement with an
investor relations firm for services. The term of services is one year and the
Company is obligated to issue 50,000 shares (post-reverse split) to the investor
relations firms. During the three month period ended September 30, 2010, the
balance 25,000 shares (post-reverse split), valued at $36,000 were
issued.
NOTE 13 INCOME
TAXES
Tax payable comprised of the following
taxes as of September 30, 2010 and December 31, 2009:
September 30,
2010
|
December 31,
2009
|
|||||||
VAT
|
$ | 23,676 | $ | 7,874 | ||||
Business Tax
|
96,723 | 94,785 | ||||||
City Construction Tax
|
6,966 | 6,658 | ||||||
Education Tax
|
5,541 | 5,356 | ||||||
Income Tax
|
1,649,122 | 1,305,906 | ||||||
Others
|
1,286 | 855 | ||||||
Total
|
$ | 1,783,314 | $ | 1,421,434 |
The
Company is registered in the State of Delaware and has operations in primarily
two tax jurisdictions; the PRC and the United States. For certain operations in
the United States, the Company has incurred net accumulated operating losses for
income tax purposes. The Company believes that it is more likely than not that
these net accumulated operating losses will not be utilized in the future.
Therefore, the Company has provided full valuation allowance for the deferred
tax assets arising from the losses at these locations as of September 30, 2010.
Accordingly, the Company has no net deferred tax assets. The provision for
income taxes from continuing operations on income consists of the following as
of September 30, 2010 and 2009:
September 30,
2010
|
September 30,
2009
|
|||||||
US Federal
|
- | - | ||||||
US State
|
- | - | ||||||
PRC current income tax
expense
|
1,283,272 | 964,474 | ||||||
Total Provision for Income
Tax
|
$ | 1,283,272 | $ | 964,474 |
F-13
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The
following is a reconciliation of the provision for income taxes at the U.S.
federal income tax rate to the income taxes reflected in the Statement of
Operations:
September 30,
2010
|
September 30,
2009
|
|||||||
Tax expense (credit) at statutory
rate – federal
|
34 | % | 34 | % | ||||
State tax expense net of federal
tax
|
6 | % | 6 | % | ||||
Changes in valuation
allowance
|
-40 | % | -40 | % | ||||
Foreign income tax –
PRC
|
25 | % | 25 | % | ||||
Temporary difference
|
1 | % | - | |||||
Non-taxable items -
PRC
|
19 | % | 1 | % | ||||
Tax expense at actual
rate
|
45 | % | 26 | % |
UNITED
STATES OF AMERICA
|
The
Company has significant income tax net operating losses (“NOL”) carried forward
from prior years. Due to the change in ownership of more than fifty percent, the
amount of NOL which may be used in any one year will be subject to a restriction
under section 382 of the Internal Revenue Code. Due to the uncertainty of the
realizability of the related deferred tax assets of $2,392,181, a reserve equal
to the amount of deferred income taxes has been established at September 30,
2010.
PEOPLE’S
REPUBLIC OF CHINA (“PRC”)
|
Pursuant
to the PRC Income Tax Laws, the Company’s subsidiary is generally subject to
Enterprise Income Taxes (“EIT”) at a statutory rate of 25%. The following table
sets forth the significant components of the provision for income taxes for
operation in PRC as of September 30, 2010 and 2009:
September 30,
2010
|
September 30,
2009
|
|||||||
Net taxable income
|
$ | 5,182,311 | $ | 4,489,076 | ||||
Income tax @ 25% and
22%
|
$ | 1,283,272 | $ | 964,474 |
NOTE 14 SHORT-TERM LOANS
PAYABLE
The loans payable at September 30, 2010
comprised of the following:
September 30,
2010
|
December 31,
2009
|
|||||||
Loan payable to Jilin Bank,
interest at 4.86% annually,
|
||||||||
due February 16,
2011 (Note a)
|
$ | 491,016 | - | |||||
Loan payable to Jilin Bank,
interest at 4.86% annually,
|
||||||||
due October 17,
2010 (Note b)
|
550,896 | - | ||||||
Loan payable to non-related
party, interest at 1.5% annually,
|
||||||||
unsecured, due December 23, 2010
(Note c)
|
449,100 | 237,146 | ||||||
January 22, 2010
|
- | 733,500 | ||||||
Various loans, interest free,
unsecured and due on demand
|
118,074 | 130,238 | ||||||
Total
|
$ | 1,609,086 | $ | 1,100,884 |
(a)
|
As of September 30, 2010,
short-term borrowings, amounting to USD 491,106, were secured by accounts
receivable, amounting to USD 613,784 at interest rates of approximately
4.86%, maturing by February 16, 2011.
|
(b)
|
As of September 30, 2010,
short-term borrowings, amounting to USD 550,869 were secured by accounts
receivable, amounting to USD 689,249 at interest rates of approximately
4.86%, maturing by October 17 2010.
|
(c)
|
As of September 30, 2010,
short-term borrowings, amounting to USD 449,100, were secured by accounts
receivable, amounting to USD 580,631 at interest rates of approximately
4.86%, maturing by December 23,
2010.
|
F-14
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
15 LONG-TERM LOAN
PAYABLE
The loans
are secured by personal properties of a significant stockholder of the Company.
The loans payable at September 30, 2010 and December 31, 2009 comprised of the
following:
September 30,
2010
|
December 31,
2009
|
|||||||
Loan Payable to Runfeng
Agriculture Credit Union, annual interest
|
||||||||
at 150% over bank stated rate,
due by January 26, 2011
|
- | 1,320,300 | ||||||
Loan payable to Jilin Bank,
interest at 7.02% annually,
|
||||||||
due by June 24, 2012
|
2,245,500 | - | ||||||
Total
|
$ | 2,245,500 | $ | 1,320,300 |
NOTE
16 CONVERTIBLE NOTE
PAYABLE
During
the nine months ended September 30, 2010, the Company consummated three closings
of a private placement financing. These issuances have a two year term, bear
interest at 10% per annum, and are convertible into common stock of the Company
at a conversion price of $2.40 per share (post-reverse split). Further, these
notes are subject to adjustment for stock splits, recapitalizations and other
similar events and will also be adjusted on a full-ratchet basis to equal the
price per share of any subsequent financing below $2.40 per share. The notes are
secured by a first priority interest in all current and future assets of the
Company, which will be cancelled upon repayment of the notes or upon conversion
of at least 50% of the principal amount of the notes into shares of Company
common stock. The note may be redeemed, by the Company, at any time for 110% of
outstanding principal and interest.
CONVERTIBLE
NOTE ISSUE 1
|
On
January 25, 2010, the Company consummated a private placement of its equity
securities with certain accredited investors pursuant to a Subscription
Agreement for total consideration of $700,000. The notes are convertible into an
aggregate of 291,667 shares (post-reverse split) of the Company’s common stock
at $6 per share (post reverse split) and are exercisable for a period of three
years. The relative fair value of the warrants using the Black-Scholes method
assuming a volatility of the stock of 197.3%, term of three years and a discount
of 1.75% was determined to be $418,783 and was recorded as debt discount, a
reduction of the carrying amount of the debt. The relative fair value of the
beneficial conversion feature of the notes was determined to be $281,217 and
also recorded as a debt discount. Using the effective interest method the
beneficial conversion feature and the value of the warrants will be amortized
over the 36 months term of the note and charged to interest expense. In the nine
month period ended September 30, 2010 $178,646 was expensed. The Company further
incurred broker fees of $56,000 cash and 8,750 warrants (post-reverse split)
having fair market value of $50,037, which is recorded as prepaid debt issue
cost and is being amortized over the term of the note. $27,062 was amortized as
general expense during the nine month period ended September 30, 2009. During
the nine month period ended September 30, 2010, notes aggregating to $300,000
and interest accrued of $15,835 on these notes were converted into 131,600
shares of common stock. The balance of beneficial conversion feature and
warrants discount related to these notes, on the date of conversion, aggregating
to $240,625, was fully amortized as general expense on the conversion of notes.
The balance of debt issue costs related to these notes, on the date of
conversion, aggregating to $36,450, was fully amortized as general expense on
the conversion of notes.
CONVERTIBLE
NOTE ISSUE 2
|
On March
4, 2010, the Company consummated a private placement of its equity securities
with certain accredited investors pursuant to a Subscription Agreement for total
consideration of $125,000. The notes are convertible into an aggregate of 52,083
shares (post-reverse split) of the Company’s common stock at $6 per share (post
reverse split) and are exercisable for a period of three years. The relative
fair value of the warrants using the Black-Scholes method assuming a volatility
of the stock of 197.3%, term of three years and a discount of 1.75% was
determined to be $74,456 and was recorded as debt discount, a reduction of the
carrying amount of the debt. The relative fair value of the beneficial
conversion feature of the notes was determined to be $50,544 and also recorded
as a debt discount. Using the effective interest method the beneficial
conversion feature and the value of the warrants will be amortized over the 36
months term of the note and charged to interest expense. In the nine month
period ended September 30, 2010 $26,687 was expensed. The Company further
incurred broker fees of $10,000 cash and 1,563 warrants (post-reverse split)
having fair market value of $9,115, which is recorded as prepaid debt issue cost
and is being amortized over the term of the note. During the nine month period
ended September 30, 2010, $4,081 was expensed as a general expense. During the
nine month period ended September 30, 2010, notes aggregating to $75,000 and
interest accrued of $3,822 on these notes were converted into 32,842 shares of
common stock. The balance of
F-15
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
beneficial
conversion feature and warrants discount related to these notes, on the date of
conversion, aggregating to $62,092, was fully amortized as general expense on
the conversion of notes. The balance of debt issue costs related to these notes,
on the date of conversion, aggregating to $9,495, was fully amortized as general
expense on the conversion of notes.
CONVERTIBLE NOTE ISSUE
3
|
On May 3,
2010, the Company consummated a private placement of its equity securities with
certain accredited investors pursuant to a Subscription Agreement for total
consideration of $250,000. The notes were convertible into an aggregate of
104,167 shares (post-reverse split) of the Company’s common stock at $6 per
share (post reverse split) and are exercisable for a period of three years. The
relative fair value of the warrants using the Black-Scholes method assuming a
volatility of the stock of 197.3%, term of three years and a discount of 1.75%
was determined to be $141,284 and was recorded as debt discount, a reduction of
the carrying amount of the debt. The relative fair value of the beneficial
conversion feature of the notes was determined to be $108,716 and also recorded
as a debt discount. Using the effective interest method the beneficial
conversion feature and the value of the warrants will be amortized over the 36
months term of the note and charged to interest expense. In the nine month
period ended September 30, 2010, $59,524 was expensed. The Company further
incurred broker fees of $20,000 paid in cash, legal fees of $10,000 paid in cash
and 3,125 warrants (post-reverse split) having a fair market value of $24,367,
which is recorded as prepaid debt issue cost and is being amortized over the
term of the note. In the nine month period ended September 30, 2010, $12,945 was
expensed as a general expense.
Principal
|
Amount
Converted
|
Balance
|
Beneficial
Conversion
and
Warrant
Discount
|
Net
|
||||||||||||||||
Convertible Note Issue
1
|
$ | 700,000 | $ | 300,000 | $ | 400,000 | $ | (280,729 | ) | $ | 119,271 | |||||||||
Convertible Note Issue
2
|
125,000 | 75,000 | 50,000 | (36,221 | ) | 13,779 | ||||||||||||||
Convertible Note Issue
3
|
250,000 | - | 250,000 | (190,476 | ) | 59,524 | ||||||||||||||
Convertible notes
payable
|
$ | 1,075,000 | $ | 375,000 | $ | 700,000 | $ | (507,426 | ) | $ | 192,574 |
NOTE 17 LOANS FROM RELATED
PARTIES
As of
September 30, 2010 and December 31, 2009, the loans from related parties were
comprised of the following:
September 30,
2010
|
September 30,
2009
|
|||||||
Loans payable to ex-officers,
interest free, due on demand, and
|
||||||||
unsecured
|
$ | - | $ | 184,662 |
NOTE 18 STOCK-BASED
INCENTIVE PLAN
The
Company adopted the China Yongxin Pharmaceuticals Inc. 2010 Equity Incentive
Plan (the “Plan”) on June 28, 2010, which was ratified by the stockholders on
September 23, 2010. The purpose of the Plan is to provide an incentive to
attract and retain directors, officers, consultants, advisors and employees
whose services are considered valuable, to encourage a sense of proprietorship
and to stimulate an active interest of such persons in the Company’s development
and financial success. Under the Plan, the Company is authorized to issue up to
250,000 shares of common stock as awards over the term of the Plan, subject to
adjustment to reflect stock splits, reorganizations and other changes in
corporate structure affecting the common stock. Under the Plan, the Company is
authorized to issue incentive stock options intended to qualify under Section
422 of the Internal Revenue Code of 1986, as amended, non-qualified stock
options, restricted stock and other stock or cash awards to eligible directors,
officers and employees of, and consultants and advisors to, the Company or
subsidiary of the Company. The Plan is initially administered by the Company’s
board of directors (the “Board”). The Board determines which employees,
directors, officers, consultants and advisors will participate in the Plan, as
well as the terms of award grants.
Stock
options granted under the Plan may not be exercisable more than 10 years after
the date such option is granted. Awards under the Plan may be conditioned on
continued employment or the passage of time. Vesting requirements are determined
by the Board, provided, however, that stock options shall vest and become
exercisable as to one-twelfth (1/12th) of the total number of shares subject to
the option every three months following the date of grant.
F-16
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 19 STOCKHOLDERS’
EQUITY
REVERSE
STOCK SPLIT
|
Effective
on May 24, 2010, the Company effected a reverse stock split with a ratio of
1-for-12, whereby each twelve (12) issued and outstanding shares of the common
stock of the Company, par value $0.001 per share (“Common Stock”) were combined
into one (1) share of Common Stock (the “Reverse Split”), pursuant to the
Certificate of Amendment of the Certificate of Incorporation that the Company
filed with the State of Delaware’s Secretary of State (“Certificate of
Amendment”).
CERTIFICATE
OF AMENDMENT
|
On April
21, 2010, the Company filed a Certificate of Amendment with Delaware’s Division
of Corporations to amend and restate our Certificate of Incorporation (the
“Restated Certificate of Incorporation”). The revisions in the Restated
Certificate of Incorporation included the following: (a) an increase in the
Company’s authorized shares of Common Stock from 75,000,000 to 100,000,000
shares; (b) a decrease in the authorized number of shares of both our preferred
stock and our Series A Convertible Preferred Stock from 5,000,000 shares to
1,666,667 shares; and (c) additional amendments including changes to the rights
of the holders of our Series A Convertible Preferred Stock which included an
increase in the number of votes that each share of Series A Preferred Stock is
entitled to vote when voting with the common stockholders as a single class
which was increased from six (6) to twenty-five (25). As described in the
Definitive Information Statement that we filed with the SEC on February 22, 2010
and which we mailed to our stockholders on or about February 24, 2010, our board
of directors approved the Restated Certificate of Incorporation by unanimous
written consent on February 8, 2010. Further, on February 8, 2010, the holders
of a majority of our voting capital stock held by holders of Common Stock and
Series A Preferred Stock, voting as a single class, and holders of a majority of
our Series A Preferred Stock, voting as a separate class, each approved the
Restated Certificate of Incorporation and the adoption thereof.
PREFERRED
STOCK
|
The
Series A Convertible Preferred Stock is convertible over a 3 year period, into
up to 30 million shares of common stock on a pre-split basis, adjusted to
2,500,000 shares of common stock on a post-split basis. Holders of Series A
Convertible Preferred Stock have the option to convert any such shares of Series
A Convertible Preferred Stock into such number of fully paid and nonassessable
shares of Common Stock on the basis of one (1) share of Series A Convertible
Preferred Stock for every 0.5 shares of common stock (which has been adjusted
for the Reverse Split). During the year ended September 30, 2009, holders of
preferred shares opted to convert 3,333,333 of preferred shares into 1,666,667
common shares (post reverse split).
COMMON
STOCK
|
Following
is a summary of common stock activity for the period ended September 30,
2010:
Shares
|
||||
Balance, December 31, 2009
(pre-stock split)
|
56,448,923 | |||
Balance, December 31, 2009 as
adjusted for reverse stock split (1-for-12)
|
4,704,077 | |||
Shares issued in private
placements
|
491,322 | |||
Shares issued pursuant to the
equity incentive plan
|
25,001 | |||
Shares issued as consideration
for services
|
||||
Shares issued for other
consideration
|
75,000 | |||
Shares issued on conversion of
convertible notes
|
164,442 | |||
Shares receivable
|
25,000 | |||
Balance, September 30,
2010
|
5,484,842 |
F-17
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Following
is a summary of stock-based compensation activity for the period ended September
30, 2010:
Weighted
|
|||
Average
|
|||
Grant
Date
|
|||
Shares
|
Fair
Value
|
||
Nonvested balance, December 31,
2009
|
|||
Granted
|
16,667
|
6.18
|
|
Vested
|
2,778
|
6.18
|
|
Forfeited
|
-
|
-
|
|
Nonvested balance, September 30,
2010
|
13,889
|
6.18
|
Following is a summary of stock-based
compensation expense for the period ended September 30, 2010:
For the
three-months ended
|
For the
nine-months ended
|
|||||||||||||||
September
30
|
September
30
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Total stock-based compensation
expense
|
27,264 | - | 54,528 | - | ||||||||||||
Income tax benefits related to
compensation
|
14,995 | - | 29,990 | - |
NOTE 20 OPTIONS AND
WARRANTS
WARRANTS
Following is a summary of the warrant
activity for the period ended September 30, 2010:
Average
|
||||||||||||||||
Remaining
|
Average
|
|||||||||||||||
Exercise
|
Contractual
|
Intrinsic
|
||||||||||||||
Warrants
|
Price(s)
|
Life
|
Value
|
|||||||||||||
Balance, December 31,
2009
|
432,365 | $ | 6 - $48 | 2.87 | $ | 1,189,016 | ||||||||||
Granted
|
952,230 | $ | 6 - $48 | |||||||||||||
Exercised
|
- | |||||||||||||||
Expired
|
- | |||||||||||||||
Balance, September 30,
2010
|
1,384,595 | $ | 6 - $48 |
2 years
|
$ | - | ||||||||||
Exerciseable, September 30,
2010
|
8,334 | $ | 6.32 | 2 years | $ | - |
The
assumptions used in calculating the fair value of warrants granted using the
Black-Scholes option-pricing model are as follows:
Risk-free interest
rate
|
1.75% | |||
Expected life of the
options
|
3 years
|
|||
Expected volatility
|
197.30% | |||
Expected dividend
yield
|
- |
F-18
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
|
||||||||||||
(UNAUDITED)
|
OPTIONS
Following is a summary of the options
activity for the period ended September 30, 2010:
Weighted
|
||||||||||||||||
Average
|
||||||||||||||||
Weighted
|
Remaining
|
Average
|
||||||||||||||
Average
|
Contractual
|
Intrinsic
|
||||||||||||||
Shares
|
Exercise
Price
|
Term
|
Value
|
|||||||||||||
Balance, December 31,
2009
|
- | $ | - | - | $ | - | ||||||||||
Granted
|
50,001 | 4.49 | ||||||||||||||
Exercised
|
- | - | ||||||||||||||
Cancelled
|
- | - | ||||||||||||||
Forfeited
|
- | - | ||||||||||||||
Balance, September 30,
2010
|
50,001 | $ | 4.49 | 9.75 | $ | - | ||||||||||
Exerciseable, September 30,
2010
|
8,334 | $ | 4.49 | 9.75 | $ | - |
The
assumptions used in calculating the fair value of options granted during the
nine month period ended September 30, 2010 using the Black-Scholes
option-pricing model are as follows:
Risk-free interest
rate
|
3.50% | |||
Expected life of the
options
|
10 years
|
|||
Expected volatility
|
197.30% | |||
Expected dividend
yield
|
- |
NOTE 21 COMMITMENTS AND
CONTINGENCIES
LEASES
|
The
Company leases its operating locations. Initial terms are typically 5 to 10
years, followed by additional terms containing priority of renewal options at
the maturity of the lease agreements, and may include rent escalation clauses.
The Company recognizes rent expense on a straight-line basis over the term of
the lease.
Minimum
rental commitments at September 30, 2010, under all leases having an initial or
remaining non-cancelable term of more than one year are shown:
Amount
|
||||
2010
|
$ | 1,058,624 | ||
2011
|
959,800 | |||
2012
|
306,110 | |||
2013
|
82,426 | |||
2014
|
17,853 | |||
Total minimum lease
payments
|
$ | 2,424,813 |
The
Company sub-leases its building to an unrelated party. The lease term is one
year.
LEGAL
PROCEEDINGS
|
On or
about October 17, 2008, a former officer initiated an action in the Superior
Court for the State of California, County of Los Angeles, Central District,
against the Company alleging claims for damages related to an alleged employment
agreement. On December 29, 2008, the Company filed an Answer to the Complaint.
The Company defended itself against claims for open account and intentional
misrepresentation. The Plaintiff sought past due attorneys’ fees for services
rendered in the amount of $193,100. The case was settled in October 2009 for
$50,000 cash and 400,000 shares of common stock. The court also ordered interest
at the rate of 10% on $50,000 from June 20, 2009 until the date the amount is
paid off. The Company accrued an aggregate sum of $127,397 for the cash to be
paid and for the fair market value of the shares to be issued. The Company paid
$52,500 in cash and issued 200,000 shares of common stock to the former officer,
valued at $102,000 for the settlement of debt, during the nine month period
ended September 30, 2010.
F-19
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The
Company was involved in a legal proceeding filed in Orange County Superior Court
on or about November 9, 2004. In this action, the Cross-Complainant, Terry
Koosed, sought to amend a $219,000 judgment he obtained to include a subsidiary
of the predecessor-in-interest of the Company, which was not named or a
participant in such lawsuit. The Company strongly disputed the lawsuit and
aggressively defended such action. The Company accrued $219,000 in the
accompanying financials statements. The Company paid $35,000 in cash and 500,000
shares valued at $255,000 for the settlement of the case during the nine month
period ended September 30, 2010.
A former
employee of the Company, the plaintiff, brought a lawsuit against the Company
seeking unpaid wages, bonuses, benefits, penalties and interest. The case went
into trial in November 2009 and the trial court thereafter issued a judgment for
plaintiff in the amount of $641,018. The Company accrued the amount in 2009. The
court entered a revised judgment in the amount of $746,487 against the Company
on April 20, 2010 to reflect attorney fees. As of September 30, 2010, the
Company has not paid the judgment amount and the revised judgment amount has
been accrued in the accompanying financials as accrued litigation. The Company
also accrued interest of $37,324 at the rate of 10% on the settlement
amount.
On or
about March 10, 2009, a former employee of the Company, the plaintiff, brought a
lawsuit against the Company seeking unpaid wages that accrued during his
employment from 2005 to 2008 as well as penalties, interest and attorney fees.
The Company and the former employee entered into a stipulation on May 10, 2010
in the amount of $241,733. The Company accrued the amount in the accompanying
financials as accrued litigation as of September 30, 2010.
NOTE
22 SEGMENT
INFORMATION
|
The
Company operates in two business segments: retail drug stores, pharmaceutical
medicine wholesales sales. These segments were identified based on their
separate and distinct products and services, technology, marketing strategies
and management reporting. Management evaluates the segments’ operating
performance separately and allocates resources based on their respective
financial condition, results of operations and cash flows. Inter-segment
transactions and balances are eliminated in consolidation.
The
retail drug store segment sells prescription and over-the-counter medications,
traditional Chinese medicines, health and beauty products, and other items. As
of September 30, 2010, the retail drug store segment operated 110 retail stores
with business area of 12,021 square meters in three cities in
China.
The
wholesale segment provides wholesale distribution of over-the-counter and
prescribed medicines to hospitals, clinics, medical institutions, other
distributors and retail drug stores.
F-20
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes
significant financial information by segment:
September 30,
2010
|
September 30,
2009
|
|||||||
Revenues from
unaffiliated customers:
|
||||||||
Retail drug stores
|
$ | 11,148,827 | $ | 10,252,383 | ||||
Pharmaceutical medicine
wholesales
|
25,866,500 | 22,603,169 | ||||||
Unallocated
|
- | |||||||
Revenues from inter-company
sales
|
(4,663,781 | ) | (3,699,532 | ) | ||||
Consolidated Totals
|
$ | 32,351,546 | $ | 29,156,020 | ||||
Net
income:
|
||||||||
Retail drug stores
|
$ | 1,017,213 | $ | 1,185,444 | ||||
Pharmacy wholesales
|
2,176,645 | 2,069,823 | ||||||
Unallocated
|
(417,304 | ) | (1,014,771 | ) | ||||
Net income from
inter-company
|
(74,626 | ) | (303,591 | ) | ||||
Consolidated Totals
|
$ | 2,701,928 | $ | 1,936,905 | ||||
Depreciation
and amortization:
|
||||||||
Retail drug stores
|
$ | 197,927 | $ | 109,037 | ||||
Pharmacy wholesales
|
328,229 | 95,700 | ||||||
Unallocated
|
- | - | ||||||
Consolidated Totals
|
$ | 526,156 | $ | 204,737 | ||||
Interest
income:
|
||||||||
Retail drug stores
|
$ | 1,645 | $ | 1,252 | ||||
Pharmacy wholesales
|
9,477 | - | ||||||
Unallocated
|
- | - | ||||||
Consolidated Totals
|
$ | 11,092 | $ | 1,252 |
(CONTINUED)
|
F-21
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30,
2010
|
September 30,
2009
|
|||||||
Interest
expense:
|
||||||||
Retail drug stores
|
$ | 449 | - | |||||
Pharmacy wholesales
|
195,331 | 186 | ||||||
Unallocated
|
- | - | ||||||
Consolidated Totals
|
$ | 195,780 | $ | 186 | ||||
Capital
expenditures:
|
||||||||
Retail drug stores
|
$ | 556,996 | $ | 135,520 | ||||
Pharmacy wholesales
|
20,945 | 942,491 | ||||||
Unallocated
|
- | - | ||||||
Consolidated Totals
|
$ | 577,941 | $ | 1,078,011 | ||||
Identifiable
assets:
|
||||||||
Retail drug stores
|
$ | 13,076,079 | $ | 11,567,766 | ||||
Pharmacy wholesales
|
35,876,397 | 31,862,360 | ||||||
Intercompany
|
(2,190,928 | ) | (1,785,673 | ) | ||||
Unallocated
|
113,196 | 111,211 | ||||||
Consolidated Totals
|
$ | 46,874,744 | $ | 41,755,664 |
NOTE
23 STATUTORY
RESERVE
|
As
stipulated by the Company Law of the PRC, net income after taxation can only be
distributed as dividends after appropriation has been made for the
following:
i.
|
Making up cumulative prior years’
losses, if any;
|
ii.
|
Allocations to the “Statutory
Surplus Reserve” of at least 10% of income after tax, as determined under
PRC accounting rules and regulations, until the fund amounts to 50% of the
Company’s registered capital; and
|
iii.
|
Allocations to the discretionary
surplus reserve, if approved in the stockholders’ general
meeting.
|
For the
nine months ended September 30, 2010 and 2009, the Company transferred $387,904
and $329,564, respectively, representing 10% of the net income generated by the
Company’s subsidiaries located within PRC determined in accordance with PRC
accounting rules and regulations, to this reserve. As of September 30, 2010, the
reserve to fulfill the 50% registered capital requirement has been
met.
NOTE
24 DISCONTINUED
OPERATIONS
|
On
September 30, 2005, Software Education of America, Inc., (“SEA”), a subsidiary
of Nutradyne Group Inc., filed a petition in bankruptcy under Chapter 7 of the
U.S. Bankruptcy Code. The petition was necessitated because SEA was unable to
continue to meet its financial obligations. SEA is presented in the accompanying
financial statements as discontinued operations.
In
November 2009, a subsidiary of the Company, Jilin Dingjian Natural Health
Products Co., Ltd, (“Dingjian”), entered into an agreement (the “Agreement”)
with Sun Shi Wei (the “Buyer”), an individual, to transfer 90% of ownership with
all its assets and liabilities to the Buyer. The 10% minority interest remained
unchanged. Both parties agreed that the Buyer would assume the net liability. No
other consideration was exchanged. The Agreement also indicated that the Company
would be liable for any undiscovered liability. Because the Buyer assumed the
net liability, the Company recorded a gain from disposal of assets and
liabilities at November 30, 2009. Dingjian is presented in the accompanying
financial statements as discontinued operations.
Balance
Sheet information for the discontinued subsidiaries as of September 30, 2010 and
December 31, 2009 is as follows:
F-22
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30,
2010
|
December 31,
2009
|
|||||||
Liabilities:
|
||||||||
Accounts payable
|
$ | - | $ | 227,590 | ||||
Accrued expenses
|
- | 238,581 | ||||||
Loans payable
|
- | 162,666 | ||||||
Net liabilities of discontinued
operations
|
$ | - | $ | 628,837 |
On March
1, 2010, the Company sold its digital e-learning business including its
wholly-owned subsidiary, Digital Learning Institute Inc., a Delaware corporation
(“Digital Learning”); and (i) Digital Learning’s wholly-owned subsidiary
Software Education of America, Inc., a California corporation; (ii) Digital
Learning’s wholly-owned subsidiary McKinley Educational Services, Inc., a
California corporation; (iii) Digital Learning’s wholly-owned subsidiary Digital
Knowledge Works, Inc., a Delaware corporation; (iv) Digital Learning’s
wholly-owned subsidiary Coursemate, Inc., and (v) Digital Learning’s
wholly-owned subsidiary Global, Inc., a California corporation (referred to
collectively herein as the “Digital E-learning Business”). The Company recorded
a gain of $1,948,554.
The following are the assets and
liabilities of the disposed entities:
Amount
|
||||
AP
|
$ | 728,754 | ||
Accrued expenses
|
435,469 | |||
Due to related party
|
140,456 | |||
Loan payable
|
130,238 | |||
Other liabilities
|
492,837 | |||
Current Liabilities
Total
|
1,927,754 | |||
Net liability
disposed
|
(1,927,754 | ) | ||
Additional cash
received
|
20,000 | |||
Gain on disposal of
subsidiaries
|
$ | 1,947,754 |
F-23
Item
2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
The
following discussion and analysis of the financial condition and results of
operations of China Yongxin Pharmaceuticals Inc. and its consolidated
subsidiaries for the three and nine month periods ending September 30, 2010 and
September 30, 2009 should be read in conjunction with its financial statements
and the related notes, and the other financial information included in this
quarterly report on Form 10-Q (“Form 10-Q”).
Forward-Looking
Statements
This Form
10-Q contains forward-looking statements. The words “anticipate,” “estimate,”
“plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,”
“may,” “will,” “should,” “could,” and similar expressions are intended to
identify forward-looking statements. These statements include, among
others, information regarding future operations, future capital expenditures,
and future net cash flow. These forward-looking statements reflect
our management’s current views with respect to future events and financial
performance and involve risks and uncertainties, including, without limitation,
general economic and business conditions, changes in domestic and international
political, social, and economic conditions, regulatory initiatives and
compliance with governmental regulations, the ability to achieve further market
penetration and additional customers, and various other matters, many of which
are beyond our control. Should one or more of these risks or
uncertainties occur, or should underlying assumptions prove to be incorrect,
actual results may vary materially and adversely from those anticipated,
believed, estimated or otherwise indicated. Consequently, all of the
forward-looking statements made in this report are qualified by these cautionary
statements and there can be no assurance of actual results or
outcomes.
Overview
China
Yongxin is a wholesale distributor and retailer of pharmaceuticals and
health-related products in Jilin province in the northeastern region of the
People’s Republic of China (“PRC” or “China”). We currently own and
operate 110 retail locations, most of which are situated in high-traffic
residential districts, and eight wholesale distribution facilities throughout
Jilin province. We enjoy strong retail brand name recognition in Jilin province,
which we believe results from our quality service and reputation. We
believe that our customer service orientation, close contact with the local
community, competitive price format, and broad product offerings provide a
convenient and value-oriented shopping experience for our customers and has
allowed us to build customer loyalty. We also utilize our extensive
retail network as a channel to provide affordable, quality, health and
wellness products and services to our customers. Our business
model is based on integration of wholesale and retail operations, an approach
that we consider to be relatively new in China.
We began
retail operations in China in 2004. The Company has rapidly grown and
it currently has a retail chain of 110 drugstores as well as the wholesale
distribution operations in Northeastern China. Our corporate
headquarters are located in City of Industry, California and the Company’s
distribution operations are based in Changchun City, Jilin Province,
China. Substantially all of our employees are located in
China. As of September 30, 2010, we had 908 employees, including 143
pharmacists with requisite credentials, professional education and training,
working at our retail drugstores.
China’s
pharmaceutical market is one of the top five in the world in terms of overall
size, now valued at over USD $37 billion, and is projected to continue to grow
at an annual rate of 15.45% through 2013. According to Business
Monitor International, consumers spent $22.42 billion on prescription drugs
(including patented and generic) in 2007, another $7.07 billion on OTC generic
drugs, and $21 billion on traditional Chinese medicine. By 2013, per
capita spending on pharmaceuticals is projected to nearly double (from 2009),
and as a percentage of overall GDP, is expected to increase from 0.97% to 1.16%,
as universal health coverage is implemented, China’s economy continues to grow,
more chronic diseases occur, and the average age of the population continues to
increase. The drug pricing and reimbursement environment remains
heavily regulated in China, and the market is dominated by lower cost basic
drugs. However, we foresee rapid growth in the generic drug sector,
and growth in over-the-counter drug sales.
4
The
reform of China’s health care system began in 1997 after the State Council
issued the Decision on Reform of the Health Care System, which historically has
been dominated by state-run hospitals. Since then, in 2004, the
Chinese government initiated new regulations which have profoundly affected the
system of drug prescription and dispensation in China, spurring the growth of
retail pharmacies. In August 2009, the Ministry of Health released a
list of over 300 essential medicines known as the “Essential Drugs List”,
including medicines deemed vital to the basic health care needs of the public,
to be made available at heavily subsidized prices. These reforms have
further prompted the growth of retail pharmacies, as well as consolidation among
distributors. We are currently a licensed distributor and retailer in
Jilin province. We currently sell 290 out of the 307 Essential Drugs, and
over 95% of the drugs included in the Jilin Province Medical Insurance Catalogue
which includes over 2,400 drugs (the “Insurance Catalogue”).
Our
business consists of two major segments – a wholesale segment and a retail
segment. We were one of the first authorized distributors of
essential drugs, and now one of fourteen, in Jilin Province. In
addition through our eight distribution facilities we act as a distributor
for over 7,000 products, which we sell and distribute to over 270 medical
institutions, over 200 community health services centers, over 600 hospitals in
rural areas, over 100 regional sub-distributors and over 2,600 drugstores or
clinics. As for our retail segment, we operate 110 modern retail
locations in Changchun, Baishan and Tianjin, serving over 350,000 customers in
our registry of members. In 2009 we sold or distributed over 800
types of medicines listed in the provincial insurance catalogue.
The
Company considers the following to be its key competitive
strengths:
1.
|
Management team with
extensive industry experience. Our management team is
comprised of 11 members with an average age of 43. Ninety
percent of our management team holds at least a bachelor’s degree and 5
members hold a master’s degree. Most of our management has more than 10
years of experience working in the pharmaceutical industry, and have
extensive logistics management experience and knowledge. We also employ
143 pharmacists, accounting for approximately 17% of all of our employees,
and we employ a sales force of 150
employees.
|
2.
|
Scalability,
reputation, and a wide distribution and retail network. We have an
established reputation of providing reliable, quality customer service,
modern store design, innovative access to medical care at in-store
clinics, and customer access to medical professionals through our EDS
system. We are also capable of expanding our business and
achieving further economies of scale by extending the reach of our
distribution network, acquiring or building more distribution centers and
acquiring or opening more retail
locations.
|
3.
|
Unique industry
position in drug distribution in Jilin province. We have
been designated by the Jilin Food and Drug Administration as a “Pilot
Pharmaceutical Logistics Enterprise”, and management believes this is due
to our modernized approach to logistics management. To our
knowledge we are the only firm to have been granted this status to date,
which allows us to provide storage and logistics services to other drug
distributors and pharmaceutical chain stores. We also act as
one of 14 licensed wholesale distributors certified and permitted by the
Jilin Health Department to sell and distribute essential drugs in Jilin
province.
|
4.
|
Use of modern
information technology. We use sophisticated information
management systems, such as our Enterprise Resource Planning (“ERP”) third
party logistics platform, Warehouse Management System (“WMS”), Warehouse
Control System (“WCS”) and Transport Management System (“TMS”), to unify
our management of drug distribution, operation of retail outlets and
warehouses, transport and delivery, and billing. Our logistics
management system can manage real-time online orders, product storage,
billing and provide storage information, order status and delivery
status.
|
5
5.
|
Strong financial
performance and cash flow generation. We have enjoyed
strong historical financial performance and steady cash flow. Our bank
credit is rated A+ by local banks in Jilin province. We have been
designated as a “AAA Rate Good Standing Enterprise” by the Provincial
Business Association.
|
Notwithstanding
our competitive strengths, we expect to face certain risks and uncertainties,
including but not limited to:
|
·
|
our
need for capital in order to
expand;
|
|
·
|
the
rapid growth of our competitors, and ongoing consolidation in our
industry;
|
|
·
|
our
ability to locate suitable retail locations at reasonable
cost;
|
|
·
|
changes
in government policies and regulations in China that may affect pricing
and reimbursement patterns as well as the structure of our industry;
and
|
|
·
|
change
in the economic conditions in China that may affect consumer spending on
the products we sell, among various other risks and
uncertainties.
|
For a
full discussion of the risks associated with our securities, please review our
“Risk Factors” set forth in our filings with the Securities and Exchange
Commission.
Recent
Developments
In March
2009, the Chinese government announced certain changes to the national medical
policy relating to the extension of medical benefits to rural areas in China
(“National Medical Policy”) that will be gradually implemented from 2009 through
2011. These revisions to the National Medical Policy extend medical
insurance coverage to people who live in the rural areas of China, which
includes approximately 40% of the Chinese population. Management believes the
implementation of these revisions to the National Medical Policy would be highly
beneficial to our sales and operations because the Company has a retail presence
in rural areas and its wholesale distribution sales should also increase because
it sells to retailers and hospitals in rural areas. However, until
recently the direction and specifics of the National Medical Policy has been
unclear. Due to this uncertainty, the Company made changes to its
operations in the second half of 2009, including a shift in emphasis from the
wholesale to the retail sector. Since we began retail operations in
2004, we have established 110 retail locations. Ten of these
locations were opened during 2010 to date.
Specifically,
in 2009 we placed greater emphasis on developing and expanding our retail
segment in response to emerging market opportunities in retail. Over the past
twelve months, the retail sector of our business has begun to generate a
superior profit margin compared to our wholesale sector. The growth
of our retail and wholesale segments both require significant capital
investments. However, we tend to realize more immediate returns from
investments in our retail segment. Although overall sales were down
in 2009, our gross profit nonetheless continued to increase due to the higher
profit margin contributed by the retail segment. In 2009, we
significantly increased our investments in retail, while also continuing to
develop, operate and maintain our wholesale operations, as each segment enhances
the growth and profitability of the other. We plan to further invest
in both segments with capital from a combination of bank loans, equity
offerings, and our internal cash flow.
During
2009 and up to the present, we have also added products with relatively high
profit margins to our retail offerings, including cosmetics and certain health
and nutritional products such as vitamins and supplements. We
believe that the addition of such products has increased our overall gross
profit in 2009 and will continue to increase our gross profit margin over the
next few years.
On June
30, 2010, we made an unsecured short term loan in the amount of $898,204 to
Changchun Golden Century Commodities Concrete Construction Company Limited, a
firm we plan to engage to provide construction material for the construction of
a distribution center in Changchun in 2011. The purpose of the loan
was to provide working capital to our vendor. The loan matures on
November 30, 2010, and bears interest at the rate of 4.86% per
annum. A copy of the loan agreement is included as Exhibit 10.35 to
this report.
On July
22, 2010, we made an unsecured short term loan in the amount of $1,991,018 to
Jilin Province Dingjian Natural Plant Base Company Limited, one of our
suppliers. The purpose of the loan was to provide working capital to
our supplier, and to strengthen our business relationship with the
firm. The loan matures on November 30, 2010, and bears interest at
the rate of 4.86% per annum. A copy of the loan agreement is included
as Exhibit 10.34 to this report.
6
In
September 2010, we entered into two letters of intent to acquire two separate
retail drugstore chains. In the first, we signed a letter of intent
with Liwen Tien (an individual) to conduct a consolidation of 12 Baokang retail
stores and clinics and establish a new company to be named (in part) Baokang
(“New Company”) in order to further develop the drug retail market in Jilin
Province. If consummated, we would pay a total of RMB 8,520,000
(approximately USD $1.3 million) in connection with the consolidation of the
Business, of which RMB 5,540,000 (approximately USD $800,000) would be paid to
Liwen Tien as consideration, and RMB 2,980,000 (approximately USD $440,000) of
which would be contributed as capital to the New Company in exchange for a 65%
interest in the New Company. Second, we signed a letter of intent
with Shan Gao (an individual) to acquire the Changchun Pharmaceutical
Distribution Center and its 13 retail stores for a proposed acquisition price of
RMB 22,920,000 (approximately USD $3.4 million). Under both
letters of intent, upon the payment of a deposit (RMB 500,000 in the case of
Liwen Tien and RMB 1,000,000 in the case of Shan Gao, neither of which have been
paid to date), the sellers must deal with the Company exclusively, these
deposits will be forfeited if we do not consummate the acquisitions within an
agreed amount of time after payment of the deposits.
During
2010, the Chinese central government provided additional guidance and
clarification on medical reform which has improved confidence among
manufacturers, suppliers, distributors, medical service providers and retailers,
and this has encouraged business decisions and commitments that previously may
have been deferred due to uncertainty surrounding application and interpretation
of the new regulations. As evidence of this surge in confidence, in
August 2010, we entered into sales agreements with over 500 medical institutions
in 17 out of 41 counties in Jilin province. Management believes that
this heightened level of contract formation would not have been possible prior
to the government’s guidance and clarification on medical reform. As
a result of these new sales agreements, management expects to solidify its
business relationships with manufacturers and suppliers, providing for greater
stability in wholesale revenue.
Also in
2010, the Chinese central government notably extended medical benefits to cover
residents living in rural areas of China, where approximately two-fifths of the
nation’s population resides. As a result, the Company believes that
its operations and sales are poised to benefit due to anticipated increases in
sales through the Company’s rural retail locations and increased wholesale
distribution sales to drugstores and hospitals in rural
areas. Specifically, increased coverage is expected to result in an
increase in drug consumption, which would lead to more orders and wholesale
volume. Prior to March 2010, we distributed products (especially
essential drugs) to other distributors who then handled distribution to
hospitals and clinics. Since then, increasingly we have been entering
into distribution relationships directly with hospitals and clinics, and have
increased the number of our wholesale customers in the rural areas, thus
increasing revenue from medical institution while earning a higher profit
margin. Currently our sales and distribution network covers all areas
of Jilin province.
The
Insurance Catalogue was revised in 2009 by the Chinese government to include
additional categories and types of pharmaceuticals, and in 2009 we sold or
distributed over 95% of the types of drugs listed in the Insurance Catalogue.
The revenues attributable to sales of products covered under the Insurance
Catalogue during the fiscal years ended December 31, 2009 and 2008 represented
61.7% and 35% respectively, of our total revenues for those periods. However,
the Company’s overall revenues for fiscal year 2009 decreased approximately
19.5% compared to 2008. The decrease was attributable to a decrease in sales
from the wholesale sector of our business, which included sales to hospitals,
medical facilities and other retailers which currently represents approximately
70% of our total net revenues. Sales volume from the wholesale sector of our
business decreased in 2009 due to uncertainty of the direction and
implementation of health care reform in China, as discussed
above. Since December 31, 2009, our wholesale business has rebounded
and stabilized, and management believes that growth in our wholesale segment is
likely to resume.
We
believe that recent developments in medical reform in China pose an
unprecedented opportunity for us to expand our business in the pharmaceutical
distribution and retail industry. However, we face multiple
challenges in achieving our objectives in expanding our business and market
share.
7
Among
these challenges:
|
·
|
We
require external capital in order to establish new retail locations and
distribution hubs at the rate we plan, and this is dependent on our
ability to raise capital on acceptable terms. As part of our
strategy we are seeking to list our securities on a U.S. national
exchange, and to conduct an underwritten offering of our equity
securities. In addition, we are working to secure loans from
other capital sources within China.
|
|
·
|
We
face growing competition from other distributors and retailers who may
pursue the same business opportunities or enter the market in which we
compete. Some of these competitors or potential
competitors have perhaps greater access to capital resources than we
do. In response we are continuing to pursue and develop our
wholesale business relationships by negotiating and establishing
agreements with suppliers and manufacturers. We have also been
actively pursuing acquisition opportunities to capture market share, and
have continued to execute on our plan to open new retail
locations. We have been continuously working to enhance our
customer service by improving our operations management, and by deploying
advanced information technologies to provide customers with vital
information that they need and
require.
|
|
·
|
We
face the prospect of rising lease or property-related costs for new retail
locations, as urban areas in prized key markets in China become
increasingly expensive. We plan to use a portion of the
proceeds from our financing activities to acquire existing businesses that
have favorable leasing arrangements, or the acquisition of real property
to secure favorable arrangements for our retail locations, in an effort to
protect against rising rents for preferred
locations.
|
|
·
|
We
operate in a highly regulated industry in China, and while thus far
government policies have been favorable to drug distributors and
retailers. However, we cannot make any assurances with regard
to how government policies may change in the
future.
|
|
·
|
Growth
of the overall pharmaceuticals market and our market opportunities depend
on continued growth of the Chinese economy and individual spending power,
however we cannot predict the prospects for the Chinese economy,
particularly following the global recession of 2008 –
2009.
|
Despite
the above challenges, risks, trends and uncertainties, we see the growth in per
capita incomes and life expectancies, an aging population which is shifting the
medical needs of the public, a general increase in health care spending per
capita, and the gradual expansion of health care coverage, and the gradual
de-centralization of the hospital-centric medical care system in China, as
continuing trends that now affect and will affect our business. In
2010 and in the foreseeable future, we see no reason for these trends to
discontinue.
Corporate
Structure
Our corporate structure consists of the
following consolidated subsidiaries:
1.
|
Changchun Yongxin Durui Medical
Co., Ltd. (“Yongxin”), through which we operate our wholesale
pharmaceuticals distribution business and in which the Company owns an 80%
equity ownership interest;
|
2.
|
Jilin Province Yongxin Chain
Drugstore Ltd. (“Yongxin Drugstore”), through which we operate 42
pharmacy retail drugstores and which we control through Yongxin’s equity
ownership interest in Yongxin Drugstore, and through an Entrustment
Agreement described more fully below by and between Yongxin, on the one
hand, and Yongxin Liu (our CEO and Chairman) and Yongkui Liu (a Company
Vice President and former director), on the other
hand;
|
8
3.
|
Tianjin Jingyongxin Chain
Drugstore Ltd. (“Jingyongxin Drugstore”), through which we operate
26 pharmacy retail drugstores and in which Yongxin Drugstore owns a 90%
equity ownership interest; and
|
4.
|
Baishan Caoantang Chain
Drugstore Ltd. (“Caoantang Drugstore”), through which we operate 32
pharmacy retail drugstores and in which Yongxin Drugstore owns 100% of the
equity ownership interest.
|
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
management’s discussion and analysis of our financial condition and results of
operations are based on our financial statements that have been prepared in
accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements as well as the reported net sales and expenses
during the reporting periods. On an ongoing basis, we evaluate
our estimates and assumptions. We base our estimates on
historical experience and on various other factors that we believe are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that
are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions.
While our
latest significant accounting policies are described in Note 2 to the
unaudited consolidated financial statements for the period ended September 30,
2010 commencing on page F-1 under the section above titled “Summary of
Significant Accounting Policies,” we believe that the following accounting
policies are the most critical to aid you in fully understanding and evaluating
this management discussion and analysis:
Basis
of Presentation
The
accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America.
The functional currency of our operating Chinese subsidiaries is Chinese
Renminbi (“RMB”); however, the accompanying financial statements have been
translated and presented in United States Dollars (“USD”).
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States (“GAAP”) requires management to make
certain estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates. Significant estimates include collectability of accounts
receivable, accounts payable, sales returns and recoverability of long-term
assets.
Non-Controlling
Interest
The
accompanying consolidated financial statements have been prepared by the
Company, pursuant to the rules and regulations of the Securities and Exchange
Commission (the “SEC”) and in accordance with GAAP. The Company owns an 80%
interest in Yongxin, and Yongxin Liu and Yongkui Liu own 11% and 9% of Yongxin,
respectively. The 20% equity interest held by Yongxin Liu and Yongkui
Liu represents non-controlling interest and the Net Income Attributable to
Minority Shareholders amounted to $6,593,539 as of September 30, 2010
compared to $5,687,633 as of December 31, 2009.
9
The
Company owns, through its subsidiary Yongxin Drugstore, a 90% ownership interest
in Jinyongxin Drugstore. The remaining 10% interest in Jinyongxin
Drugstore is owned by third parties. As of September 30, 2010 and
December 31, 2009, the 10% equity interest and net profit to minority
stockholders amounted to $47,006 and $26,917, respectively.
Inventories
Inventories
are valued on a lower of weighted average cost or market
basis. Inventory includes product cost, inbound freight,
warehousing costs and vendor allowances not included as a reduction of
advertising expense. Management compares the cost of inventory with the market
value and allowance is made for writing down their inventory to market value, if
lower. Work in process inventory includes the cost of raw materials and
outsource processing fees.
Revenue
Recognition
The
Company’s revenue recognition policies are in compliance with Staff Accounting
Bulletin (“SAB”) 104 (ASC 605). Sales revenue is recognized at the
date of shipment to customers when a formal arrangement exists, the price is
fixed or determinable, the delivery is completed, no other significant
obligations of the Company exist and collectability is reasonably
assured. The Company recognizes revenue net of an allowance for
estimated returns, at the time the merchandise is sold or services
performed. The allowance for sales returns is estimated based on the
Company’s historical experience. Sales taxes are presented on a net basis
(excluded from revenues and costs). Payments received before all of
the relevant criteria for revenue recognition are satisfied are recorded as
unearned revenue.
Recent
Accounting Pronouncements
For a
description of new accounting standards that may affect us, see Note 2 in our
consolidated financial statements included under Part I, Item 1 of this Form
10-Q.
Reverse
Stock Split
Effective
May 24, 2010, the Company effected a reverse stock split with a ratio of
1-for-12, whereby each twelve (12) issued and outstanding shares of the common
stock of the Company, par value $0.001 per share (“Common Stock”) was combined
into one (1) share of Common Stock (the “Reverse Split”), pursuant to the
Certificate of Amendment of the Certificate of Incorporation that the Company
filed with the State of Delaware’s Secretary of State (“Certificate of
Amendment”). The Company’s Common Stock, on a split-adjusted basis,
has a new CUSIP number of 16946Y 207.
Throughout
this report, each instance which refers to a number of shares of our common
stock, refers to the number of shares of common stock after giving effect to the
Reverse Split, unless otherwise indicated. The term “pre-reverse
split” as used in this report means a number of shares of common stock issued or
outstanding prior to May 24, 2010 without giving effect to the Reverse
Split. The term “post-reverse split” as used in this report refers
to the number of shares of common stock prior to any adjustment for the Reverse
Split on May 24, 2010.
10
Results
of Operations
Three
and Nine Month Periods Ended September 30, 2010 and 2009.
The
following table sets forth the results of our operations for the periods
indicated:
|
Three Months Ended
September
30,
|
Nine Months Ended
September 30,
|
||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
|
(unaudited)
|
(unaudited)
|
(unaudited)
|
(unaudited)
|
||||||||||||
Net
Revenues
|
$
|
10,515,586
|
$
|
10,812,529
|
$
|
32,351,546
|
$
|
29,156,020
|
||||||||
Cost
of Goods Sold
|
(6,829,661)
|
(7,667,014)
|
(23,442,133)
|
(21,060,847)
|
||||||||||||
Gross
Profit
|
3,685,925
|
3,145,515
|
8,909,413
|
8,095,173
|
||||||||||||
Operating
Expenses:
|
||||||||||||||||
Selling
expenses
|
1,142,085
|
912,094
|
2,900,904
|
2,495,546
|
||||||||||||
General
and administrative
|
2,116,908
|
2,350,837
|
3,623,259
|
3,825,981
|
||||||||||||
Total
Operating Expenses
|
3,258,993
|
3,262,931
|
6,524,163
|
6,321,527
|
||||||||||||
Income
from Operations
|
426,932
|
(117,416)
|
2,385,250
|
1,773,646
|
||||||||||||
Other
Income (Expense):
|
||||||||||||||||
Gain
on settlement of debt
|
-
|
-
|
75,000
|
-
|
||||||||||||
Other
income
|
1,016,312
|
1,112,309
|
1,231,197
|
1,906,864
|
||||||||||||
Other
expense
|
(13,336)
|
(19,981)
|
(57,598)
|
(40,763)
|
||||||||||||
Interest
Income (Expense)
|
(70,726)
|
(6,919)
|
(184,239)
|
1,066
|
||||||||||||
Beneficial
conversion fee and warrant fee amortization
|
(444,289)
|
-
|
(628,153)
|
-
|
||||||||||||
Total
Other Income
|
487,961
|
1,085,409
|
436,207
|
1,867,166
|
||||||||||||
Operating
Income Before Tax & Non-controlling Interest
|
914,893
|
967,993
|
2,821,457
|
3,640,812
|
||||||||||||
Provision
for Income Tax
|
(658,756)
|
(233,908)
|
(1,283,272)
|
(964,474)
|
||||||||||||
Net
Income Before Non-controlling Interest
|
256,137
|
734,085
|
1,538,185
|
2,676,338
|
||||||||||||
Non-controlling
Interest
|
(424,738)
|
(240,362)
|
(795,807)
|
(670,747)
|
||||||||||||
Net
Income / (loss) from continued operations
|
(168,601)
|
493,723
|
742,378
|
2,005,591
|
||||||||||||
Discontinued
operations
|
||||||||||||||||
Gain
on disposal of subsidiaries
|
-
|
-
|
1,948,553
|
-
|
||||||||||||
Gain
/ (loss) from discontinued operations
|
-
|
(21,610)
|
10,997
|
(68,685)
|
||||||||||||
Total
income / (loss) from discontinued operations
|
-
|
(21,610)
|
1,959,550
|
(68,685)
|
||||||||||||
Net
Income
|
(168,601)
|
472,113
|
2,701,928
|
1,936,906
|
||||||||||||
Other
Comprehensive Item
|
||||||||||||||||
Foreign
exchange translation gain (loss)
|
445,180
|
(17,742)
|
544,710
|
598
|
||||||||||||
Net
Comprehensive Income
|
276,579
|
454,371
|
3,246,638
|
1,937,504
|
||||||||||||
Earning
per share
|
||||||||||||||||
Basic
|
(0.03)
|
0.18
|
0.52
|
0.74
|
||||||||||||
Diluted
|
(0.03)
|
0.17
|
0.43
|
0.73
|
||||||||||||
Weighted
average number of shares outstanding
|
||||||||||||||||
Basic
|
5,377,378
|
2,638,922
|
5,115,082
|
2,607,409
|
||||||||||||
Diluted
|
6,502,378
|
2,677,160
|
6,240,082
|
2,645,647
|
11
Comparison
of Three months Ended September 30, 2010 and 2009.
Net
Revenues. For the three month period ended September 30, 2010,
net revenues decreased approximately 2.74% from $10,812,529 for the three month
period ended September 30, 2009 to $10,515,586 for the same period ended
September 30, 2010. For the three months ended September 30, 2010 and
2009, net revenues consisted of the following:
Three
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
||||||
Wholesale
|
$
|
6,749,435
|
$
|
7,055,306
|
||||
Retail
|
3,766,151
|
3,757,223
|
||||||
Total
Net revenues
|
$
|
10,515,586
|
$
|
10,812,529
|
Wholesale
net revenues decreased by $305,871, representing a 4.34% change, from $7,055,306
in the three months ended September 30, 2009 to $6,749,435 in the three months
ended September 30, 2010. This decrease in net revenue was due to a
reduction in sales to other distributors with low gross profit margins, as the
Company made a shift toward higher-margin wholesale customers such as medical
institutions. In 2010, we strategically targeted the medical
institution market to develop sales relationships with hospitals, clinics, and
other medical institutions as high-margin wholesale customers. In the
three month period ended September 30, 2010, we added 238 new medical
institutions and 978 new retailers as wholesale customers. Because of
this shift in wholesale strategy, however, sales to other distributors declined
by $1,953,945 for the three months ended September 30, 2010 as compared to the
prior year, representing a 27.56% decline. However, this decrease was
offset by a $1,243,053 increase in sales to medical institutions (representing a
17.54% increase), and a $372,764 increase in sales to other retailers
(representing a 5.26% increase) for the three months ended September 30, 2010 as
compared to the same period in the prior year. The decrease in
sales to other distributors, offset by the increase in sales to medical
institutions and other retailers, resulted in a net decrease of $338,128 in
revenue from wholesale operations as compared with the three month period ended
September 30, 2009.
Retail
net revenues slightly increased by 0.24%, from $3,575,223 in the three months
ended September 30, 2009 to $3,766,151 in the three months ended September 30,
2010. Retail revenues for the three month period ended September 30,
2010 were higher due to the following factors (1) $425,770 in additional revenue
was from the 21 new retail drugstores that we opened from July 1, 2009 to
September 30, 2010; (2) $105,225 in additional revenue was deferred and
recognized as “accrued revenue” due to the fact that the Jilin Social Security
Administration and Changchun Social Security Administration provided
reimbursement for only 90% of sales in the latest month pending verification of
reimbursements through its medical record system (the remaining 10% is payable
in the following year, provided the government finds we are in full compliance
with national health program regulations). In 2009, 100% of
reimbursement revenue was fully collected with no 10% holdback, thus a holdback
that applied in the most recent quarter caused a $105,225 decrease in net retail
revenue as compared to the three months ended September 30,
2009. Additionally, in the most recent quarter, city road
construction impeded customer traffic to four of our retail stores in Chaungchun
and Baishan, which caused our retail revenue to decline by an estimated
$329,473. Management believes this construction may continue for one or more
quarters, however, once road construction is complete, we expect sales for these
locations to resume at a normal level.
12
Cost of Goods
Sold. Cost of goods
sold, which mainly consisted of the procurement of drugs from suppliers and
manufacturers, was $6,829,661, or approximately 64.95% of net revenues for the
three month period ended September 30, 2009, as compared to $7,667,014, or
approximately 70.91% of net revenues for the same period in 2010. For
the three months ended September 30, 2010 and 2009, cost of goods sold consisted
of the following:
Three
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
||||||
Wholesale
|
$
|
4,711,466
|
$
|
5,270,706
|
||||
Retail
|
2,118,195
|
2,414,663
|
||||||
Total
Cost of Sales
|
$
|
6,829,661
|
$
|
7,667,014
|
Wholesale
cost of goods sold decreased by $559,240, or approximately 10.3%, from
$5,270,706 in the three months ended September 30, 2009 to $4,711,466 for the
three months ended September 30, 2010. The decrease in wholesale
cost of goods was mainly due to a decrease in wholesale revenue, however, the
decrease was partly attributable to efforts to control and reduce procurement
costs by selecting suppliers with the most competitive prices for products
available from multiple suppliers.
Retail
cost of goods sold decreased by $295,468, or approximately 12.3%, from
$2,414,663 in the three months ended September 30, 2009 to $2,118,195 in the
three months ended September 30, 2010. The decrease is mainly
attributable to the Company’s efforts to control and reduce procurement costs
for our retail operation.
Gross
Profit. Gross profit increased approximately $540,410, from
$3,145,515 for the three month period ended September 30, 2009 to $3,685,925 for
the three month period ended September 30, 2010, representing
a 17.18% increase. Of this increase, approximately
$328,218 in additional gross profit was due to increased sales to medical
institutional customers. An additional $100,000 in gross profit was added
through our 21 new retail drugstores opened from July 1, 2009 to
September 30, 2010. Another $66,000 in gross profit was due to the
addition of some products we carry to the Essential Drug Catalogue under the
national medical insurance program. An additional $32,290 in gross
profit was added by increased sales through existing retail drug
stores. The increase in our gross profit for the 3 month period ended
September 30, 2010 reflected the continuous effort of our management in adding
higher margin products to the Company’s wholesale and retail sales
mix.
Selling
Expenses. Selling expenses
increased approximately 25.22% from $912,094 for the three month period ended
September 30, 2009 to $1,142,085 for the same period in
2010. The increase in selling expenses was mainly attributable
to an increase in headcount and salary expense, which added $219, 228 to selling
expenses. This constituted 95% of the total increase of the selling
expenses. From the period ended September 30, 2009 to September 30,
2010, we added 162 employees, including 67 sales professionals and staff in
wholesale, and 95 employees for our retail segment. These employees were
required to meet the demands of our change in strategy for our wholesale
business and to staff our new stores in our retail business.
General and
Administrative Expenses. General and administrative expenses
were $2,350,837 for the three month period ended September 30, 2009, as compared
to $2,116,908 for the three month period ended September 30, 2010, representing
a decrease of 10%. This decrease was largely due to a decrease in bad
debt expenses of $1,056,012, offset by an increase in litigation, service
expense and settlement costs amounting to $822,083, for the three month period
ended September 30, 2010 as compared to the same three month period in the prior
year. The net effect of these two offsetting factors resulted in a
reduction in overall general and administrative expenses.
13
Other
Income. Other income decreased 55.04% from $1,085,409 for the three
month period ended in September 30, 2009 to $487,961 in the same period in
2010. The decrease of other income was mainly due to a reduction in
promotional income for the three month period ended September 30,
2010, as compared to the same period of 2009. For the three
month period ended September 30, 2009, we held fewer promotional events for drug
makers, which resulted in lower promotional income. Instead, in the
three month period ending September 30, 2010 the Company put more efforts into
the development of its own medical market instead of undertaking product
promotion activities on behalf of drug makers.
Other
income was offset by amortization of our financing expenses for our issuance of
convertible debt and warrants. The Company issued a total of
$1,075,000 in principal amount of convertible notes, along with warrants for the
purchase of 952,230 shares of its common stock with an exercise price of $6.00
per share, during the nine months ended September 30, 2010, resulting in the
following expenses:
Nine
Months Ended
September
30,
2010
|
||||
Beneficial
Conversion Feature
|
$ | 601,955 | ||
Fair
Value of Warrants
|
473,045 | |||
Total
Value of Securities Issued
|
1,075,000 | |||
Other
Financing Expenses
|
179,519 | |||
Total
Financing Expenses:
|
$ | 1,254,519 |
Total
expenses for the note and warrant financing amounted to $1,254,519. In
accordance with US GAAP these expenses was amortized within the applicable 36
month vesting period. For the three months ended September 30, 2010,
$95,626 of the above financing expenses had been amortized and
recorded. An additional $348,663 in expenses recorded represent
expenses immediately realized, against $375,000 in principal amount of the
convertible notes that were converted as of September 30, 2010. At
September 30, 2010, the balance of the unamortized financing expense was
$626,366. For details regarding the accounting for our convertible
note and warrant financing, please also refer to information disclosed in Notes
15 and 17 of our unaudited financial statements for the nine months ended
September 30, 2010.
Net
Income. Net income
decreased 135.71% from a net income of $472,113 in the three month period ended
September 30, 2009 to a net loss of $168,601 in the three month period ended
September 30, 2010. For the three months ended September 30, 2010 and
2009, net income consisted of the following:
Three
months Ended
September
30,
|
||||||||
|
2010
|
2009
|
||||||
Wholesale
|
$
|
905,664
|
$
|
494,131
|
||||
Retail
|
591,806
|
508,627
|
||||||
Unallocated
|
(1,666,071)
|
(530,645)
|
||||||
Total
Net Income
|
$
|
(168,601)
|
$
|
472,113
|
Wholesale
net income increased by 83.28% from $494,131 for the three months ended
September 30, 2009 to $905,664 for the three months ended September 30,
2010. The increase was attributable to the additional $411,533 in net
profit generated from sales to customers with higher margins after the Company
adjusted its wholesale strategy.
Retail
net income increased 16.4% from $508,627 for the three months ended September
30, 2009 to $591,806 for the three months ended September 30,
2010. The increase was attributable to the net income generated
from increased essential drug sales and an increase in sales of covered drugs
under the government’s new medical insurance program.
14
Unallocated
net income in the three month period ended September 30, 2010 mainly consisted
of net income from net expense attributable to non-controlling interest of
$424,738, legal and accounting expenses of 822,083, and financing expenses of
$444,289, and certain other items not allocable to a
segment. Unallocated net expense increased by 214% from an expense of
$530,644 for the three months ended September 30, 2009 to an expense of
$1,666,071 for the three months ended September 30, 2010. We
categorize the above expenses as unallocated since they are not directly related
to our business segments are not allocable to a segment.
Comparison
of Nine Months Ended September 30, 2010 and 2009.
Net
Revenues. For the nine month period ended September 30, 2010,
our net revenues increased by approximately 10.96% from $29,156,020 to
$32,351,546 for the nine month period ended September 30, 2010. Net
revenues consisted of the following:
Nine
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
||||||
Wholesale
|
$
|
21,202,719
|
$
|
18,860,332
|
||||
Retail
|
11,148,827
|
10,295,688
|
||||||
Total
Net revenues
|
$
|
32,351,546
|
$
|
29,156,020
|
Wholesale
net revenues increased by $2,342,387, from $18,903,637 in the nine months ended
September 30, 2009 to $21,202,719 in the nine months ended September 30, 2010,
representing a 12.42% increase. This increase in net revenue was due
to higher sales to medical institutions, as we shifted our wholesale strategy
away from selling to lower-margin distributors, and targeted higher-margin
hospitals, clinics and other similar institutions. As a result of
this shift, net sales to other distributors decreased by $157,656, which was
offset by a $1,446,605 increase in sales to medical institutions as well as a
$1,053,438 increase in sales to other retailers.
Retail
net revenues increased by $853,139, or 8.29%, from $10,295,688 in the nine
months ended September 30, 2009 to $11,148,827 in the nine months ended
September 30, 2010. Retail revenues for the nine month period ended
September 30, 2010 were higher mainly due to $825,442 in incremental sales
through 21 new retail drugstores which were added from September 30, 2009 to
September 30, 2010.
Cost of Goods
Sold. Cost of goods
sold, which mainly consisted of the procurement of drugs from suppliers and
manufacturers, was $21,060,847, or approximately 72.23% of net revenues for the
nine month period ended September 30, 2009, as compared to $23,442,133, or
approximately 72.46% of net revenues for the same period in 2010. For
the nine months ended September 30, 2010 and 2009, cost of goods sold consisted
of the following:
Nine
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
||||||
Wholesale
|
$
|
16,486,499
|
$
|
14,327,504
|
||||
Retail
|
6,955,634
|
6,733,343
|
||||||
Total
Cost of Sales
|
$
|
23,442,133
|
$
|
21,060,847
|
Wholesale
cost of goods sold increased by approximately 15.07% from $14,327,504 in the
nine months ended September 30, 2009 to $16,486,499 for the nine months ended
September 30, 2010. The increase in wholesale cost of goods corresponded
with an increase in wholesale net revenues. In addition, an
increase in the prices we pay suppliers and manufacturers for certain drugs,
such as antibiotics and certain herbal medications, led to an increase in
overall wholesale cost of goods. Management also believes that
rising labor costs and inflation in China also contributed to the increase in
wholesale cost of goods.
15
Retail
cost of goods sold increased by approximately 3.3% from $6,733,343 in the nine
months ended September 30, 2009 to $6,955,634 in the nine months ended September
30, 2010. The increase in retail cost of goods sold was mainly
related to the increase of the retail sales, however, some of the reduction in
retail cost of goods was a result of the Company’s efforts to control and reduce
procurement costs for its retail stores.
Gross
Profit. Gross profit increased approximately 10.06% from
$8,095,173 for the nine month period ended September 30, 2009 to $8,909,413 for
the nine month period ended September 30, 2010. This increase in
gross profit was mainly attributable to incremental sales through the 21
new retail drugstores that were added through 21 new retail drugstores
which were added from September 30, 2009 to September 30, 2010. In
addition, incremental sales resulting from the inclusion of products we well in
the Essential Drug Catalogue under the national medical insurance program, which
are reimbursable to recipients when purchased from authorized
pharmacies. The increase in our overall gross profit margin was also
due to adjustments in our product mix to include higher margin
drugs.
Selling
Expenses. Selling expenses
increased approximately 16.24% from $2,495,546 for the nine month period ended
September 30, 2009 to $2,900,904 for the same period in 2010. The
increase of the selling expenses was due to our increase in headcount by 162
employees during the period between September 30, 2009 and 2010. This included
67 sales professionals and staff newly hired to develop and expand our wholesale
segment, and an additional 95 employees for the retail business
respectively. Salary expense increased by $312,411, which represented
77% of the total increased selling expenses. Additional depreciation
expenses of $92,947 were incurred for equipment purchases as well as start-up
costs for newly opened retail drugstores in the nine months period ended
September 30, 2010.
General and
Administrative Expenses. General and administrative expenses
were $3,825,987 for the nine month period ended September 30, 2009, as compared
to $3,623,259 for the nine month period ended September 30, 2010, representing a
decrease of 5.33%. This decrease was largely because we had no bad
debt expense in the nine month period ended September 30, 2010, in contrast to a
bad debt expense of $1,372,350 in the third quarter of 2009. Also, in
the nine months ended September 30, 2010, we had a $1,169,622 increase in
litigation and settlement expenses compared to the same period in the prior
year. The net effect of these two offsetting factors resulted in the
5.33% reduction in overall general and administrative expenses.
Other
Income. Other income decreased by 76.64% from $1,867,166 for the
nine month period ended in September 30, 2009 to $436,207 in the same period in
2010. For the nine month period ended September 30, 2009, we held two
major promotional events through which we garnered substantial sponsorship and
promotional fees from suppliers. These promotional events were held
at the request of our suppliers in order to market and promote new products
during the market downturn in 2009. In 2010, our suppliers did
not hold similar promotional events partly in response to an overall improvement
in local economic conditions. For the nine month period ended
September 30, 2010, we did not conduct any major promotional events, and
accordingly our other income decreased compared to the same period ended
September 30, 2009.
Other
income was offset by amortization of our financing expenses for our convertible
debt and warrant financing. The Company issued a total of $1,075,000
in principal amount in convertible notes, along with warrants for the purchase
of 952,230 shares of its common stock with an exercise price of $6.00 per share,
during the nine months ended September 30, 2010, resulting in the following
expenses:
Nine
Months Ended
September
30, 2010
|
||||
Beneficial
Conversion Features
|
$ | 601,955 | ||
Fair
Value of Warrants
|
473,045 | |||
Total
Value of Securities Issued
|
1,075,000 | |||
Other
Financing Expenses
|
179,519 | |||
Total
Financing Expenses:
|
$ | 1,254,519 |
Total
expenses for the note and warrant financing amounted to $1,254,519. In
accordance with US GAAP these expenses was amortized within the applicable 36
month vesting period. For the nine months ended September 30, 2010,
$279,490 of the above expenses had been amortized and
recorded. An additional $348,663 in expenses recorded represent
the expenses immediately realized, against $375,000 in principle amount of the
convertible notes that were converted as of September 30, 2010. At
September 30, 2010, the balance of the unamortized financing expense was
$626,366. For details regarding the accounting for our convertible
note and warrant financing, please also refer to information disclosed in Notes
15 and 17 of our unaudited financial statements for the nine months ended
September 30, 2010.
Net
Income. Net income
increased 39.5% from a net income of $1,936,906 in the nine month period ended
September 30, 2009 to a net income of $2,701,928 in the nine month period ended
September 30, 2010. For the nine months ended September 30, 2010 and 2009, net
income consisted of the following:
Nine
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
||||||
Wholesale
|
$
|
2,102,020
|
$
|
2,069,823
|
||||
Retail
|
1,017,212
|
1,185,445
|
||||||
Unallocated
|
(417,304)
|
(1,318,362)
|
||||||
Total
Net Income
|
$
|
2,701,928
|
$
|
1,936,906
|
Wholesale
net income declined by 1.56% from $2,069,823 for the nine months ended September
30, 2009 to $2,102,019 for the nine months ended September 30, 2010. The
decrease was attributable to an increase in wholesale cost of goods sold, higher
legal, financing and accounting expenses, and a decrease in sponsorship and
promotional income classified as other income.
Retail
net income decreased 14.2% to $1,017,212 for the nine months ended September 30,
2010, compared to $1,185,445 for the same period in the prior
year. Even though our retail net revenues increased by 8.29% for the
nine months ended September 30, 2010 compared to the same period in 2009, such
revenues were offset by expenses related to the opening of 10 additional retail
drugstores during the nine months ended September 30, 2010, amounting to
approximately $168,233. Excluding these start-up costs, retail net
income did not change substantially between the nine months ended September 30,
2010 and 2009.
Unallocated
net income (expense) in the nine month period ended September 30, 2010 mainly
consisted of income gained from the disposal of the liabilities associated with
the e-learning business of $1,948,553, net income attributable to
non-controlling interest of $795,807, legal, accounting and service fee expenses
of $941,897, financing expenses of $628,153, and certain other expenses not
allocable to a segment. We categorize the above income and expenses
as unallocated since they are not directly related to our business segments are
not allocable to a segment. Unallocated net expense decreased
by 68.35% from an expense of $1,318,362 for the nine months ended September 30,
2009 to an expense of $417,304 for the nine months ended September 30,
2010. This decrease in unallocated net expense was mainly due to the
sale of our e-learning business during the first quarter of 2010, which was
unrelated to our current pharmaceutical operations. As a consequence of this
sale, we transferred approximately $1.9 million in liabilities associated with
the e-learning business, to the purchaser of the e-learning
business.
16
Liquidity
Cash
Flow
Net cash
flow used in operating activities was $3,172,770 for the nine month period ended
September 30, 2010, as compared to net cash flow provided by operating
activities in the amount of $2,626,117 for the nine month period ended September
30, 2009. The decrease in net cash provided by operating activities
was primarily attributable to payments which amounted to $2,700,832 for
procurement of pharmaceuticals, mainly to build up our inventory for the opening
of additional drugstores, and to expand our wholesale operations. In
addition, we agreed to accept bank-guaranteed notes with a three to six month
maturity, similar to letters of credit, from certain of our customers in lieu of
cash for their purchases during the nine month period ended September 30,
2010. Since the notes are bank-guaranteed, risk of non-collectability
is considered negligible. Our acceptance of these notes in lieu of
cash caused a decrease in net cash flow used in operating
activities.
Net
cash flow used in investing activities was $577,941 during the nine months ended
September 30, 2010, as compared to cash outflow of $1,078,011 for the same
period in 2009. For the nine months ended September 30, 2010, the net cash
outflow from investing activities decreased mainly because we purchased less
property and equipment during the nine month period ended September 30, 2010 as
compared to the same period in the prior year.
Net
cash flow provided by financing activities increased from a cash outflow of
$752,249 for the nine months ended September 30, 2009 to a cash inflow of
$3,530,829 for the nine months ended September 30, 2010. The increase
was mainly due to an increase in cash from financing activities in the amount of
$1,155,323 for the issuance of our securities, and receipt of loans from
non-related parties in the amount of $2,375,506.
Capital Resources
At
September 30, 2010, we had cash and cash equivalents of $1,631,986, other
current assets of $35,258,090 and current liabilities of
$11,656,529. We presently finance our operations primarily out of
cash flow from operations, and we anticipate that this will continue to be our
primary source of funds to finance our short-term cash needs. We
expect to generate positive operating cash flow for the remainder of
2010.
In the
nine months ended September 30, 2010 we have thus far opened 10 retail
drugstores, and we expect to open additional stores for the remainder of
2010 through 2012. In order to finance our growth and expansion,
or if we pursue other opportunities for investment, acquisition, or strategic
cooperation, however, we may require additional cash resources. If we
determine that our cash requirements exceed the amounts of cash on hand, we may
rely on proceeds from an equity or other type of financing for additional
working capital to complete these projects. We may seek to issue debt
or equity securities or obtain short-term or long-term bank
financing. Any issuance of equity securities could cause dilution of
our stockholders’ interests. However, at this time, other than the above
we are not aware of any known demands, commitments, events, or uncertainties
that will or may be reasonably likely to result in material changes in our
liquidity.
Contractual
Obligations and Off Balance-Sheet Arrangements
Off-Balance
Sheet Arrangements
We have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered into
any derivative contracts that are indexed to our shares and classified as
stockholder’s equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or engages in leasing or hedging services with
us.
17
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
Derivative Financial
Instruments. We do not use derivative financial instruments
in our investment portfolio and have no foreign exchange contracts. Our
financial instruments consist of cash and cash equivalents, trade accounts
receivable, accounts payable and long-term obligations. We consider investments
in highly-liquid instruments purchased with a remaining maturity of 90 days
or less at the date of purchase to be cash equivalents.
Interest Rates. Our exposure
to market risk for changes in interest rates relates primarily to our short-term
obligations; thus, fluctuations in interest rates would not have a material
impact on the fair value of these securities. At September 30, 2010, we had
approximately $1,631,986 in cash and cash equivalents. A hypothetical
10% increase or decrease in interest rates would not have a material impact on
our earnings or loss, or the fair market value or cash flows of these
instruments.
Foreign Exchange Rate. We use
the United States Dollar (“U.S. Dollars”) for financial reporting purposes but
all of our sales and inputs are transacted in Renminbi (“RMB”). As a result,
changes in the relative values of U.S. Dollars and RMB affect our reported
levels of revenues and profitability as the results are translated into U.S.
Dollars for reporting purposes. However, since we conduct our sales and purchase
inputs in RMB, fluctuations in exchange rates are not expected to
significantly affect our financial stability, or gross and net profit margins.
We do not currently expect to incur significant foreign exchange gains or
losses, or gains or losses associated with any foreign
operations. During the years ended December 31, 2009 and 2008, we
recorded net foreign currency gains of $123,209 and $824,961, respectively.
During the three months ended September 30, 2010, we recorded a net
foreign currency gain of $445,180 compared to a net foreign currency Loss of
$17,742 for the same period in 2009.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls
and Procedures
Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission’s rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by the Company in the reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and forms and that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is accumulated and communicated to our management,
including our principal executive and financial officers, as appropriate to
allow timely decisions regarding required disclosure.
As of the
end of the period covered by this Form 10-Q, we conducted an evaluation, under
the supervision and with the participation of our Chief Executive Officer and
Chief Financial Officer, of our disclosure controls and procedures (as defined
in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures are
effective.
18
Changes
in Internal Control Over Financial Reporting
Based on
the evaluation of our management as required by paragraph (d) of Rule 13a-15 or
15d-15 of the Exchange Act, there were no changes in our internal control over
financial reporting that occurred during our last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Part II.
Other Information
Item 1. Legal Proceedings
Although
China Yongxin is a party in the litigation matters described below, all of these
legal proceedings relate to the Company’s predecessor company, Digital Learning
Management Corporation and its activities prior to the Reverse Acquisition
Transaction, and they are not related to China Yongxin’s current
business:
On or
about October 17, 2008, in the legal proceeding titled Craig Nagasugi v. Digital Learning
Management Corporation, et al., a former officer of the Company
(then named Digital Learning) initiated an action in Los Angeles Superior Court,
Central District, against Digital Learning Management Corporation alleging
claims for damages related to an alleged employment agreement. On
December 29, 2008, the Company filed an Answer to the Complaint. The
matter went to trial on or about November 2, 2009 and concluded as of November
9, 2009. The case resulted in a judgment against the Company for
$641,018. The court entered a revised judgment in the amount of
$746,487.37 against the Company on April 20, 2010 to reflect attorney
fees. As of the date of this filing, the judgment has not been
paid. Presently the Company’s parent corporation holds insufficient
funds to pay the judgment.
Under
Allaudin Jinnah v. China
Yongxin Pharmaceuticals Inc., filed in Los Angeles Superior Court,
Central District, on or about June 27, 2008, the Company defended itself against
claims for open account and intentional misrepresentation. Prior to
the Reverse Acquisition, Plaintiff was an officer of the Company and claimed
that the Company breached an employment agreement concerning compensation and
that the Company, alleging Umesh Patel and Ning Liu committed fraud by making
misrepresentations concerning stock that they promised to give to Plaintiff to
settle his claims. The Plaintiff sought past due attorneys’ fees for
services rendered in the amount of $193,100. The Plaintiff also
sought 67,000 shares (pre-Reverse Split) of the Company’s common
stock. The Plaintiff filed a motion to enforce the Company’s
settlement to receive up to a $50,000 judgment and 200,000 to 400,000
shares (pre-Reverse Split) of the Company’s common stock. At the hearing
to enforce the settlement, the court entered judgment against the Company for
$50,000 plus 200,000 shares (pre-Reverse Split) of the Company’s common
stock. The court ordered the Company to issue an additional 200,000 shares
(pre-Reverse Split) of the Company’s common stock as collateral for the
$50,000. The said judgment was paid and satisfied in full by the Company
in February 2010.
The
Company was also involved in a legal proceeding named Wells Fargo Bank. N.A.. v. Software
Education for America Inc. filed in Orange County Superior Court on or
about November 9, 2004. Wells Fargo brought an action to collect on
a promissory note issued by Software Education and guaranteed by Mr.
Koosed. Mr. Koosed then brought a cross-complaint against
Digital Learning Corporation (the Company as it was named prior to the Reverse
Acquisition) on the grounds that Digital Learning Corporation promised to
indemnify him for his guaranty. A stipulated judgment was entered
against Digital Learning Corporation. Mr. Koosed then amended the
judgment to name the Company as the successor-in-interest to Digital Learning
Corporation. The Cross-Complainant, Mr. Koosed, sought to amend a
$219,000 judgment he obtained to include a subsidiary of the
predecessor-in-interest of the Company, which was not named or a participant in
such lawsuit. On May 8, 2009, the Orange County Superior Court
rendered a decision to enter a judgment of $219,000 against the Company.
This judgment was satisfied in full by the Company in February
2010.
19
Under
Adnan Mann v. China Yongxin
Pharmaceuticals Inc. , on or about March 10, 2009, a former employee
filed claims for unpaid wages and penalties under the California Labor Code and
applicable Industrial Wage Orders. On July 10, 2009, the Company filed an
Answer to the Complaint denying liability. The Company and the former
employee entered into a stipulation on May 10, 2010 in the amount of
$241,733.28.
Item
2. Unregistered Sale of Equity Securities and Use of
Proceeds
None.
Item 3. Default Upon
Senior Securities
Not
applicable.
Item
4. [Removed and Reserved]
Item 5. Other
Information
Item
6. Exhibits
The
following exhibits are included in this Form 10-Q or incorporated by reference
into this Form 10-Q:
Exhibit
Number
|
|
Description
|
|
3.7
|
Amended
and Restated Certificate of Incorporation (incorporated by reference to
Exhibit 3.7 to the Amendment No. 1 to the Registration Statement on Form
S-1 filed with the SEC on August 3, 2010)
|
||
3.9
|
Amended
and Restated Bylaws (incorporated by reference to Exhibit 3.9 to the
Amendment No. 1 to the Registration Statement on Form S-1 filed with the
SEC on August 3, 2010)
|
||
10.32
|
Letter
of Intent entered into by and between the Company and Mr. Shan Gao on
September 25, 2010 (supersedes Framework Agreement dated July 18, 2010).
(English Translation) (incorporated by reference to Exhibit 10.32 to
the Amendment No. 2 to the Registration Statement on Form S-1 filed
with the SEC on November 4, 2010)
|
||
10.33
|
Letter
of Intent entered into by and between the Company and Mr. Liwen Tian on
September 25, 2010 (supersedes Framework Agreement dated May 15, 2010).
(English Translation) (incorporated by reference to Exhibit 10.33 to
the Amendment No. 2 to the Registration Statement on Form S-1 filed
with the SEC on November 4, 2010)
|
||
10.34
|
Loan Agreement dated July 22, 2010 (Dingjian Natural Plant Base Co.) | ||
10.35
|
Loan Agreement dated June 30, 2010 (Changchun Golden Century) | ||
31.1
|
Certification
of Chief Executive Officer Pursuant to Item 601(b)(31) of Regulation S-K,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
20
31.2
|
Certification
of Chief Financial Officer Pursuant to Item 601(b)(31) of Regulation S-K,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
||
32.1
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
||
32.2
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
21
SIGNATURES
CHINA
YONGXIN PHARMACEUTICALS INC.
|
|||
Dated:
November 22, 2010
|
/s/ Yongxin
Liu
|
||
Yongxin
Liu
|
|||
Chairman
of the Board and Chief Executive Officer
|
|||
Dated:
November 22, 2010
|
/s/ Harry
Zhang
|
||
Harry
Zhang
|
|||
Chief
Financial Officer
|
22