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EX-32.1 - Bohai Pharmaceuticals Group, Inc.v222146_ex32-1.htm
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EX-31.1 - Bohai Pharmaceuticals Group, Inc.v222146_ex31-1.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 March 31, 2011

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

For the transition period from                    to                     

Commission File Number:  000-53401

Bohai Pharmaceuticals Group, Inc.
(Exact name of registrant as specified in its charter)

Nevada
98-0588402
(State or other jurisdiction of
 (I.R.S. Employer Identification No.)
incorporation or organization)
 

c/o Yantai Bohai Pharmaceuticals Group Co. Ltd.
 
No. 9 Daxin Road, Zhifu District
 
Yantai, Shandong Province, China
264000
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number (including area code):  +86(535)-685-7928

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨
 
Accelerated filer ¨
Non-accelerated filer ¨
 
Smaller reporting company x
(Do not check if a smaller reporting company)
   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨ Nox

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Date 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).     ¨

As of May 12, 2011, there were 17,821,085 shares of company common stock issued and outstanding.

 
 

 

Bohai Pharmaceuticals Group, Inc.

Quarterly Report on Form 10-Q

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
 
   
Cautionary Note Regarding Forward-Looking Statements
 
   
Item 1.
Financial Statements (unaudited)
 
     
 
Condensed Consolidated Balance Sheets as of March 31, 2011 and June 30, 2010 (audited)
1
     
 
Condensed Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months ended March 31, 2011 and 2010
2
     
 
Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended March 31, 2011
3
     
 
Condensed Consolidated Statements of Cash Flows for the Nine Months ended March 31, 2011 and 2010
4
     
 
Notes to Condensed Consolidated Financial Statements
5
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
35
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
49
     
Item 4(T).
Controls and Procedures
49
   
PART II – OTHER INFORMATION
 
   
Item 1.
Legal Proceedings
51
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
51
Item 3.
Defaults Upon Senior Securities
51
Item 4.
Removed and Reserved
51
Item 5.
Other Information
51
Item 6.
Exhibits
51
   
SIGNATURES
52

 
 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
In addition to historical information, this Quarterly Report on Form 10-Q contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements.  We cannot give any guarantee that the plans, intentions or expectations described in the forward looking statements will be achieved.  All forward-looking statements involve significant risks and uncertainties, and actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those factors described in the “Risk Factors” section of our Annual Report for the fiscal year ended June 30, 2010 (the “2010 10-K”).  Readers should carefully review such risk factors as well as factors described in other documents that we file from time to time with the Securities and Exchange Commission.

In some cases, you can identify forward-looking statements by terminology such as “guidance,” “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “potential,” “proposed,” “intended,” or “continue” or the negative of these terms or other comparable terminology.  You should read statements that contain these words carefully, because they discuss our expectations about our future operating results or our future financial condition or state other “forward-looking” information.  There may be events in the future that we are not able to accurately predict or control.  You should be aware that the occurrence of any of the events described in our risk factors and other disclosures could substantially harm our business, results of operations and financial condition, and that upon the occurrence of any of these events, the trading price of our securities could decline.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, growth rates, and levels of activity, performance or achievements.  Factors that may cause actual results, our performance or achievements, or industry results, to differ materially from those contemplated by such forward-looking statements include, without limitation:

 
·
our ability to obtain sufficient working capital to support our business plans;

 
·
our ability to expand our product offerings and maintain the quality of our products;

 
·
the availability of Chinese government granted rights to exclusively manufacture or co-manufacture our products;

 
·
the availability of Chinese national healthcare reimbursement of our products;

 
·
our ability to manage our expanding operations and continue to fill customers’ orders on time;

 
·
our ability to maintain adequate control of our expenses allowing us to realize anticipated revenue growth;

 
·
our ability to maintain or protect our intellectual property;

 
·
our ability to maintain our proprietary technology;

 
·
the impact of government regulation in China and elsewhere, including the support provided by the Chinese government to the Traditional Chinese Medicine and healthcare sectors in China;

 
 

 

 
·
our ability to implement product development, marketing, sales and acquisition strategies and adapt and modify them as needed;

 
·
our ability to integrate any future acquisitions;

 
·
our implementation of required financial, accounting and disclosure controls and procedures and related corporate governance policies; and

 
·
our ability to anticipate and adapt to changing conditions in the Traditional Chinese Medicine and healthcare industries resulting from changes in government regulations, mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics.

Readers are cautioned not to place undue reliance on our forward-looking statements, which reflect management’s opinions only as of the date thereof.  We undertake no obligation to revise or publicly release the results of any revision of our forward-looking statements, except as required by law. 

 
 

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2011 AND JUNE 30, 2010

   
As of
   
As of
 
   
March 31,
   
June 30,
 
   
2011
   
2010
 
   
(unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 10,665,517     $ 17,149,082  
Restricted cash
    220,043       576,019  
Accounts receivable
    14,798,323       10,409,527  
Other receivables and prepayments
    2,006,268       1,449,590  
Amount due from equity holder
    -       40,160  
Inventories
    1,997,545       748,422  
                 
Total current assets
    29,687,697       30,372,801  
                 
Non-current assets
               
Property, plant and equipment, net
    7,925,075       7,895,042  
Prepayment for land use right
    14,839,957       7,343,654  
Intangible assets
    25,278,154       17,342,772  
Deferred fees on convertible notes
    719,819       1,562,617  
                 
Total non-current assets
    48,763,005       34,144,085  
                 
TOTAL ASSETS
  $ 78,450,702     $ 64,516,886  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities:
               
Accounts payable
  $ 1,466,525     $ 741,621  
Other accrued liabilities
    4,909,783       2,984,988  
Amount due to equity holder
    11,980       -  
Income taxes payable
    945,678       700,326  
Short-term borrowings
    905,618       4,398,849  
                 
Total current liabilities
    8,239,584       8,825,784  
                 
Non-current liabilities
               
Derivative liabilities - investor and agent warrants
    2,300,325       5,481,928  
Convertible notes, net of discount
    438,743       124,820  
                 
Total non-current liabilities
    2,739,068       5,606,748  
                 
TOTAL LIABILITIES
    10,978,652       14,432,532  
                 
STOCKHOLDERS' EQUITY
               
Common stock , $0.001 par value, 150,000,000 shares authorized, 17,821,085 and 16,500,000 shares issued and outstanding as of March 31, 2011 and June 30, 2010, respectively
    17,821       16,500  
Additional paid-in capital
    18,320,431       15,317,621  
Accumulated other comprehensive income
    2,771,433       626,584  
Statutory reserves
    2,201,817       2,201,817  
Retained earnings
    44,160,548       31,921,832  
                 
Total stockholders’ equity
    67,472,050       50,084,354  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 78,450,702     $ 64,516,886  

See accompanying notes to the unaudited condensed consolidated financial statements

 
1

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
INCOME AND COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2011 AND 2010
(UNAUDITED)

   
For The Three Months Ended
   
For The Nine Months Ended
 
   
March 31,
   
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Net revenues
  $ 22,153,412     $ 15,323,878     $ 61,289,991     $ 46,072,455  
                                 
Cost of revenues
    5,213,548       2,841,385       13,341,860       8,205,715  
                                 
Gross profit
    16,939,864       12,482,493       47,948,132       37,866,740  
                                 
Selling, general and administrative expenses
    12,845,962       9,202,873       32,565,981       28,208,753  
                                 
Income from operations
    4,093,901       3,279,620       15,382,151       9,657,987  
                                 
Other income (expenses)
                               
Other income
    1,783       -       99,901       18,864  
Interest income
    11,176       -       40,673       -  
Amortization of deferred financing fees
    (232,200 )     (253,577 )     (736,224 )     (253,577 )
Interest expenses
    (554,428 )     (381,700 )     (2,203,775 )     (538,008 )
Other expenses
    (546 )     -       (2,468 )     (22,092 )
Change in fair value of derivative liabilities
    263,118       1,083,350       3,181,603       1,083,350  
                                 
Total other income (expenses)
    (511,097 )     448,073       379,710       288,537  
                                 
Income before provision for income taxes
    3,582,804       3,727,693       15,761,860       9,946,524  
                                 
Provision for income   taxes
    (897,458 )     (585,135 )     (3,523,145 )     (2,193,931 )
                                 
Net income
  $ 2,685,346     $ 3,142,558     $ 12,238,716     $ 7,752,593  
                                 
Comprehensive income:
                               
Net income
    2,685,346       3,142,558       12,238,716       7,752,593  
Other comprehensive income
                               
Unrealized foreign currency translation gain
    415,307       (157,384 )     2,144,849       (108,823 )
Comprehensive income
  $ 3,100,653     $ 2,985,174     $ 14,383,564     $ 7,643,770  
                                 
Earnings per common share
                               
Basic
  $ 0.15     $ 0.20     $ 0.72     $ 0.48  
Diluted
  $ 0.14     $ 0.16     $ 0.59     $ 0.37  
                                 
Weighted average common shares outstanding
                               
Basic
    17,544,163       16,078,472       16,988,489       16,193,659  
Diluted
    22,808,885       21,745,139       22,439,202       22,084,170  

See accompanying notes to the unaudited condensed consolidated financial statements

 
2

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 2011
(UNAUDITED)

   
Common stock
   
Additional
   
Accumulated
other
               
Total
 
   
Shares
outstanding
   
Amount
   
paid-in
capital
   
comprehensive
income
   
Statutory
reserves
   
Retained
Earnings
   
Stockholders’
Equity
 
                                           
Balance at June 30, 2010
    16,500,000     $ 16,500     $ 15,317,622     $ 626,584     $ 2,201,817     $ 31,921,832     $ 50,084,354  
                                                         
Net income for the period
    -       -       -       -       -       12,238,716       12,238,716  
                                                         
Stock based compensation
    45,000       45       160,455       -       -       -       160,500  
                                                         
Option based compensation
    -       -       23,844       -       -       -       23,844  
                                                         
Conversion of convertible notes
    527,703       528       948,304       -       -       -       948,832  
                                                         
Sale of  common stock
    748,382       748       1,870,207                               1,870,955  
                                                         
Foreign currency translation difference
    -       -       -       2,144,849       -       -       2,144,849  
                                                         
Balance at March 31, 2011
    17,821,085     $ 17,821     $ 18,320,431     $ 2,771,433     $ 2,201,817     $ 44,160,548     $ 67,472,050  

See accompanying notes to the unaudited condensed consolidated financial statements

 
3

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED MARCH 31, 2011 AND 2010
(UNAUDITED)
  
   
For the Nine Months Ended
 
   
March 31,
 
   
2011
   
2010
 
             
Cash flows from operating activities
           
Net income
  $ 12,238,716     $ 7,752,593  
Adjustments to reconcile net income to net cash used in operating activities:
               
                 
Depreciation
    260,577       224,656  
Loss on disposal of property, plant and equipment
    1,908       10,942  
Accretion of beneficial conversion feature
    1,029,487       -  
Amortization of deferred fees on convertible notes
    736,224       253,577  
Interest expense on convertible notes
    339,842       121,126  
Change in fair value of warrants
    (3,181,603 )     (1,083,350 )
Stock and option based compensation
    184,344       -  
                 
Changes in operating assets and liabilities:
               
(Increase) in accounts receivable
    (3,946,124 )     (433,728 )
(Increase)/decrease in other receivables and prepayments
    (496,515 )     4,127,297  
Decrease in amount due from equity holder
    -       1,465,000  
(Increase) in inventories
    (1,201,923 )     (662,830 )
                 
Increase (decrease) in accrued liabilities
    158,949       (10,407,917 )
Increase/ (decrease) in accounts payable
    686,541       (128,858 )
Increase in other payable
    1,633,817       -  
Increase in income taxes payable
    216,325       2,905,998  
Increase in restricted cash
    355,976       -  
                 
Net cash provided by operating activities
    9,016,541       4,144,506  
                 
Cash flows used in investing activities
               
Purchases of property, plant and equipment
    (14,619 )     (280,804 )
Proceeds from disposal of property, plant and equipment
    4,491       -  
Purchase of leased land use rights
    (7,111,204 )     -  
Purchase of intangible assets
    (7,186,059 )     -  
                 
Net cash used in investing activities
    (14,307,391 )     (280,804 )
                 
Cash flows from financing activities
               
Proceeds from borrowings
    890,772       4,381,153  
Repayment of borrowings
    (4,483,801 )     (5,860,000 )
Repayment from related party
    53,147       -  
Cash fees on placement agent and other financing costs
    -       (1,570,000 )
Proceeds from issuance of convertible promissory notes
    -       12,000,000  
Proceeds from sale of common stock
    1,870,955       -  
                 
Net cash flows (used in) provided by financing activities
    (1,668,927 )     8,951,153  
                 
Effect of foreign currency translation on cash and cash equivalents
    476,212       266,544  
                 
Net (decrease) increase in cash and cash equivalents
    (6,483,565 )     13,081,399  
                 
Cash and cash equivalents at beginning of period
    17,149,082       2,493,510  
                 
Cash and cash equivalents at end of period
  $ 10,665,517     $ 15,574,909  
                 
Cash paid during the period for:
               
Interest paid
  $ 811,582     $ 466,135  
Income taxes paid
  $ 3,306,820     $ 2,305,073  
                 
Supplemental cash flow information
               
                 
Non-cash investing and financing activities:
               
Common stock issued upon conversion of convertible notes and accrued interest
  $ 948,832     $ -  
                 
Placement agent warrants issued
  $ -     $ 582,454  

See accompanying notes to the unaudited condensed consolidated financial statements

 
4

 

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2011 AND 2010

1.
ORGANIZATION AND PRINCIPAL ACTIVITIES

Bohai Pharmaceuticals Group, Inc., or the Company (formerly known as Link Resources, Inc.), was incorporated under the laws of the State of Nevada on January 9, 2008.  Until January 5, 2010, our principal office was located in Calgary, Alberta, Canada.  Prior to January 5, 2010, we were a public “shell” company in the exploration stage since our formation had not yet realized any revenues from our planned operations.

Pursuant to a Share Exchange Agreement, dated January 5, 2010 (the “Share Exchange Agreement” and the transactions contemplated thereby, the “Share Exchange”), the Company acquired Chance High International Limited, a British Virgin Islands company, or Chance High, from Chance High’s shareholders, or the Chance High shareholders, and, as a result, acquired Chance High’s indirect, controlled affiliate, Yantai Bohai Pharmaceuticals Group Co., Ltd., or Bohai, a Chinese company engaged the production, manufacturing and distribution in the People’s Republic of China (“China” or the “PRC”) of herbal medicines, including capsules and other products, based on traditional Chinese medicine. 

The closing of the Share Exchange, or the Closing, took place on January 5, 2010, or the Closing Date.  On the Closing Date, pursuant to the terms of the Share Exchange Agreement, the Company acquired all of the outstanding equity securities, or the Chance High shares, of Chance High from the Chance High Shareholders, and the Chance High Shareholders transferred and contributed all of their Chance High Shares to the Company.  In exchange, we issued to Chance High Shareholders an aggregate of 13,162,500 newly issued shares of common stock, par value $0.001 per share, or the Common Stock.  In addition, pursuant to the terms of the Share Exchange Agreement, Anthony Zaradic, the former President and Chief Executive Officer of the Company, cancelled a total of 1,500,000 shares of Common Stock.

Chance High owns 100% of the issued and outstanding capital stock of a Chinese wholly-foreign owned enterprise, Yantai Shencaojishi Pharmaceuticals Co., Ltd., or the WFOE.  On December 7, 2009, the WFOE entered into a series of variable interest entity contractual agreements, or the VIE Agreements, with Bohai and its three shareholders, including Mr. Hongwei Qu, currently the Company’s Chairman, Chief Executive Officer and President, pursuant to which WFOE effectively assumed management of the business activities of Bohai and has the right to appoint all executives and senior management and the members of the board of directors of Bohai.

Chance High, WFOE and Bohai are referred to herein collectively and on a consolidated basis as the “Company” or “we”, “us” or “our” or similar terminology.

The VIE Agreements are comprised of a series of agreements, including a Consulting Services Agreement, Operating Agreement and Proxy Agreement, through which WFOE has the right to advise, consult, manage and operate Bohai  for  an annual fee in the amount of Bohai’s yearly net profits after tax.  Additionally, Bohai’s shareholders pledged their rights, titles and equity interest in Bohai as security for WFOE to collect consulting and services fees provided to Bohai through an equity pledge agreement.  In order to further reinforce WFOE’s rights to control and operate Bohai, Bohai’s shareholders granted WFOE an exclusive right and option to acquire all of their equity interests in Bohai through an option agreement.

 
5

 

1.
ORGANIZATION AND PRINCIPAL ACTIVITIES - Continued

On January 29, 2010, we entered into an agreement and plan of merger, the sole purpose of which was to effect a change of our corporate name from Link Resources Inc. to Bohai Pharmaceuticals Group, Inc.

We are engaged in the production, manufacturing and distribution of herbal pharmaceuticals based on traditional Chinese medicine, or TCM, in the People’s Republic of China.  We are based in the city of Yantai, Shandong Province, China, and our operations are exclusively in China.

2.
BASIS OF PREPARATION

The accompanying unaudited condensed consolidated financial statements of our company and our subsidiaries at March 31, 2011 and for the three and nine months ended March 31, 2011 and 2010 reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly our consolidated financial position and results of operations for the periods presented. Operating results for the three and nine months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending June 30, 2011. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 28, 2010.

The accompanying unaudited condensed consolidated financial statements for our company, our subsidiaries and our variable interest entity (Bohai) have been prepared in accordance with accounting principles generally accepted in the United States of America, or the US, for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X.  Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

The Share Exchange was accounted for as a reverse recapitalization effected as of January 5, 2010. Although we legally acquired Chance High and its controlled subsidiary Bohai, for accounting purposes, Chance High and Bohai are considered to be the accounting acquirers and Link Resources, Inc. as the accounting acquiree.  As a result, the historical consolidated financial statements for periods prior to January 5, 2010 are those of Chance High and Bohai and the operating results, financial position and cash flows of our company (formerly known as Link Resources, Inc.) are consolidated only from its acquisition on January 5, 2010.  As the transaction between our company and Chance High and its subsidiaries is treated as reverse acquisition, no goodwill was recorded.  Intercompany transactions and balances are eliminated in consolidation.

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

We adopted FAS ASC 810-10-15-14 and also ASC 810-10-05-8, which requires that a Variable Interest Entity, or VIE, to be consolidated by a company if that company is entitled to receive a majority of the VIE’s residual returns and has the direct ability to make decisions on all operating activities of the voting right of the VIE.  We controls Bohai through the VIE Agreements described in Note 1 and accordingly it is consolidated for all periods presented.

The Operating Agreement provides that the WFOE has the direct ability to make decisions on all the operating activities and exercise all voting rights of Bohai, the Company’s VIE.

 
6

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Under Consultant Service Agreement entered between WFOE and Bohai on December 7, 2009, Bohai agreed to pay all of its net income to WOFE quarterly as a consulting fee. Accordingly, WOFE has the right to receive the expected residual returns of Bohai.

Under the above mentioned contractual arrangement, our company qualifies as the primary beneficiary of such controlling financial interest in Bohai as operating under ASC 810-10-15-14, an Interpretation of Accounting Research Bulletin No. 51.  The results of subsidiaries or VIEs acquired prior to the date of Share Exchange Agreement on January 5, 2010 are included in the consolidated financial statements.

As of March 31, 2011, the particulars of our company’s subsidiaries and VIE are as follows:

Name of Company
 
Place of
incorporation
 
Date of
incorporation
 
Attributable
equity interest
   
Issued Capital
(US Dollars)
 
Chance High International Limited
 
British Virgin Islands
 
July 2, 2009
    100%     $ 50,000  
Yantai Shencaojishi
Pharmaceuticals Co., Ltd.
 
People’s Republic of China
 
November 25, 2009
    100%     $ 10,000,000  
Yantai Bohai Pharmaceuticals Group Co., Ltd.
 
People’s Republic of China
 
July 8, 2004
    *     $
2,918,000
 

*
We have an indirect controlling interest in Bohai under the VIE Agreements entered on December 7, 2009, which are described in Note 1 above.

Initial measurement of VIE: we initially measured the assets, liabilities, and non-controlling interests of the VIEs at their carrying amount as of the date of the acquisition.

Accounting after initial measurement of VIE: subsequent accounting for the assets, liabilities, and non- controlling interest of a consolidated VIE are accounted for as if the entity were consolidated based on voting interests and the usual accounting rules for which the VIE operates are applied as they would to a consolidated subsidiary as follows:

·
Carrying amounts of the VIE are consolidated into the financial statements of the Company as the primary beneficiary, or Primary Beneficiary, or PB; and

·
Inter-company transactions and balances, such as revenues and costs, receivables and payables between or among the Primary Beneficiary and the VIE(s) are eliminated in their entirety.

 
7

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

The carrying amount and classification of Yantai Bohai’s assets and liabilities included in the Consolidated Balance Sheets are as follows:
    
   
March 31, 2011
   
June 30, 2010
 
   
(unaudited)
       
Total current assets*
 
$
45,056,495
   
$
28,177,777
 
Total assets*
   
78,259,724
     
53,415,591
 
Total current liabilities**
   
19,654,445
     
9,005,735
 
Total liabilities**
 
$
19,654,445
   
$
9,005,735
 

*           Including intercompany accounts of $1,627,814 and $394,821 as at March 31, 2011 and June 30, 2010 be eliminated in consolidation.

**         Including intercompany accounts of $11,471,035 and $457,004 as at March 31, 2011 and June 30, 2010 be eliminated in consolidation

Economic and Political Risks

Our operations are conducted solely in the PRC.  There are significant risks associated with doing business in the PRC, among others, political, economic, legal and foreign currency exchange risks. Our results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.

Use of Estimates

In preparing the condensed consolidated financial statements in conformity with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods.  These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes, the estimation on useful lives of plant and machinery, and the fair value of derivative liabilities.  Actual results could differ from those estimates.
 
Fair Value Measurements and Fair Value of Financial Instruments

We adopted the guidance of Accounting Standards Codification, or ASC, 820 for fair value measurements, which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.

 
8

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The carrying amounts reported in the balance sheets for cash, accounts receivable, other receivables, short-term borrowings, accounts payable and accrued expenses, customer advances, and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments.

ASC 825-10 “Financial Instruments,” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. We use Level 3 inputs to value our derivative liabilities.

The following table reflects gains and losses for the three and nine months ended March 31, 2011 for all financial assets and liabilities categorized as Level 3 as of March 31, 2011.

Liabilities:
     
Balance of derivative liabilities as of December 31, 2010
 
$
2,563,443
 
Change in the fair value of derivative liabilities
   
(263,118)
 
Balance of derivative liabilities as of March 31, 2011
 
$
2,300,325
 

Liabilities:
     
Balance of derivative liabilities as of June 30, 2010
 
$
5,481,928
 
Change in the fair value of derivative liabilities
   
(3,181,603)
 
Balance of derivative liabilities as of March 31, 2011
 
$
2,300,325
 

Estimating fair values of derivative financial instruments require the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, valuation techniques are sensitive to changes in the trading market price of our Common Stock and its estimated volatility. Because derivative financial instruments are initially and subsequently carried at fair values, our net income may include significant charges or credits as these estimates and assumptions change.
 
The potential credit risk to our company is mainly attributable to its accounts receivable and bank balances. We have policies in place to ensure that we will only accept customers from countries which are politically stable and customers with an appropriate credit history. In addition, all bank balances are on deposit with financial institutions with high-credit quality. Accordingly, we do not consider that we are subject to significant credit risk.

Our interest rate risk is primarily attributable to our borrowings, all of which have fixed interest rates. We do not use interest rate swaps to hedge our exposure to interest rate risk.

Cash and Cash Equivalents

We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.  We maintain bank accounts in the PRC and restricted cash accounts and a checking account in the United States of America. The restricted cash accounts were created for interest payments due to convertible note holders and payments for investor relations activities in the US.

 
9

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Concentrations of Credit Risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of our cash is maintained with state-owned banks within the PRC, and no deposits are covered by insurance. We have not experienced any losses in such accounts and believe we are not exposed to any risks on our cash in bank accounts. A significant portion of our sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms.  We also perform ongoing credit evaluations of our customers to help further reduce credit risk.

At March 31, 2011 and June 30, 2010, our cash balances by geographic area were as follows:

  
  
March 31, 2011
   
June 30, 2010
  
  
  
(unaudited)
     
  
Country:
                       
United States
 
$
31,829
     
0.3
%
 
$
-
     
-
%
China
   
10,633,688
     
99.7
%
   
17,149,082
     
100.0
%
Total cash and cash equivalents
 
$
10,665,517
     
100.0
%
 
$
17,149,082
     
100.0
%
  
Accounts Receivable

Accounts receivable consists of amounts due from customers. We extend unsecured credit to our customers in the ordinary course of business but mitigate the associated risks by performing credit checks and actively pursuing past due accounts.  An allowance for doubtful accounts is established and determined based on management’s assessment of known requirements, aging of receivables, payment history, the customer’s current credit worthiness and the economic environment.  As of March 31, 2011 and June 30, 2010, no allowance for doubtful accounts was deemed necessary based on management’s assessment.
 
Inventories

Inventories are valued at the lower of cost or market with cost is determined using the weighted average method. Finished goods inventories consist of raw materials, direct labor and overhead associated with the manufacturing process. In assessing the ultimate realization of inventories, management makes judgments as to future demand requirements compared to current or committed inventory levels.  Our reserve requirements generally increase/decrease due to management’s projected demand requirements, market conditions and product life cycle changes.  As of March 31, 2011 and June 30, 2010, we did not make any allowance for slow-moving or defective inventories.

Intangible Assets

Intangible assets consist of “Pharmaceutical Formulas”, which were acquired with indefinite useful lives. These intangible assets are measured initially at cost and not subject to amortization and will be tested for impairment annually or more frequently if there is indication of impairment. If the carrying amount exceeds fair value, an impairment loss would be recognized.  Subsequently reversal of a recognized impairment loss is prohibited.  There was no impairment of the intangible assets as of March 31, 2011 and June 30, 2010.

 
10

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Property, Plant and Equipment

Property, plant and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized.  When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

Included in property and equipment was construction-in-progress which consisted of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use. The principal annual rates are as follows:

Leasehold land and buildings
 
30 to 40 years
Motor vehicles
 
10 years
Plant and machinery
 
10 years
Office equipment
 
5 years
 
Accounting for the Impairment of Long-Lived Assets
 
We use ASC Topic 360, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. We periodically evaluate the carrying value of long-lived assets to be held and used in accordance with ASC Topic 360. ASC Topic 360 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. 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. Based on our review, we believe that, as of March 31, 2011 and June 30, 2010, there were no impairments of our long-lived asset.

Foreign Currency Translation

Our reporting currency is the U.S. dollar. We maintain our consolidated financial statements in the functional currency. Our functional currency is the Chinese Renminbi, or RMB. For our subsidiaries and affiliates whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets.  Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income.  Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchanges rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods. All of our revenue transactions are transacted in the functional currency. We do not enter any material transaction in foreign currencies and, accordingly, transaction gains or losses have not had, and are not expected to have a material effect on our results of operations.

 
11

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates using the following exchange rates:

  
 
Nine months ended 
March 31, 2011
 
Year ended 
June 30, 2010
 
Nine months ended
March 31, 2010
 
Period end US$: RMB exchange rate
   
6.57010
 
6.80860
   
6.84560
 
Average periodic US$: RMB exchange rate
   
6.67960
 
6.83667
   
6.85094
 

RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US dollar at the rates used in translation.

Revenue Recognition

Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to distributors. Pursuant to the guidance of ASC Topic 605 and ASC Topic 36, revenue is recognized when all of the following criteria are met:

·
Persuasive evidence of an arrangement exists;

·
Delivery has occurred or services have been rendered;

·
The seller’s price to the buyer is fixed or determinable; and

·
Collectability is reasonably assured.

We account for sales returns by establishing an accrual in an amount equal to our estimate of sales recorded for which the related products are expected to be returned. We determine the estimate of the sales return accrual primarily based on our historical experience regarding sales returns, but also by considering other factors that could impact sales returns. These factors include levels of inventory in the distribution channel, estimated shelf life, product discontinuances, and price changes of competitive products, introductions of generic products and introductions of competitive new products.  For the three and nine months ended March 31, 2011 and 2010, our sales return rate is low and deemed immaterial and accordingly, no provision for sales returns was recorded.
 
Cost of Revenue

Cost of revenue consists primarily of raw material costs, labor cost, overhead costs associated with the manufacturing process and related expenses which are directly attributable to our revenues.

 
12

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Stock-based Compensation

Stock based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the employee or director’s requisite service period (presumptively, the vesting period). The FASB Accounting Standards Codification also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. We record compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.

Research and Development Costs

Research and development costs are charged as an expense when incurred and included in operating expenses. Research and development costs totaled $190,440 and $146,640 for the three months ended March 31, 2011 and 2010, respectively. Research and development costs totaled $562,261 and $442,046 for the nine months ended March 31, 2011 and 2010, respectively.

Shipping Costs

Shipping costs are included in selling, general and administrative expens  and totaled $230,938 and $326,097 for the three months ended March 31, 2011 and 2010, respectively,  and totaled $598,525 and $608,500 for the nine months ended March 31, 2011 and 2010, respectively,

Advertising and Promotion

Advertising and promotion is expensed as incurred. Advertising and promotion expenses were included in selling, general and administrative expenses and amounted to $3,962,454 and $2,767,549 for the three months ended March 31, 2011 and 2010, respectively,  and amounted to $10,461,435 and $8,732,252 for the nine months ended March 31, 2011 and 2010, respectively.
 
Income Taxes

We are governed by the Income Tax Law of the People’s Republic of China and the Internal Revenue Code of the United States. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of income and comprehensive income in the periods that includes the enactment date.

 
13

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Comprehensive Income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. Our current components of other comprehensive income are the foreign currency translation adjustment.

Commitments and Contingencies

Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.

Earnings Per Share

We report basic earnings per share in accordance with ASC Topic 260, “Earnings Per Share”.  Basic earnings/ (loss) per share is computed by dividing net income/ (loss) by weighted average number of shares of Common Stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of Common Stock, Common Stock equivalents and potentially dilutive securities outstanding during the period. Common equivalent shares are excluded from the computation in periods for which they have an anti-dilutive effect. Stock options for which the exercise price exceeds the average market price over the period are anti-dilutive and, accordingly, are excluded from the calculation.  At March 31, 2011, we had 5,225,000 Common Stock equivalents from convertible notes and stock options to purchase 26,000 shares of Common Stock that could potentially dilute future earnings per share. Warrants to purchase 6,600,000 shares of Common Stock were outstanding during the three and nine months ended March 31, 2011, but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive.

Reclassification

Sales tax of $231,870 and $729,975 for the three and nine months ended March 31, 2010, respectively, have been reclassified from net revenue to cost of revenue to confirm with the current presentation.  The reclassification has no impact on the net income for the three and nine months ended March 31, 2010.

Recent Accounting Pronouncements Not Yet Adopted

In April 2010, the FASB issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades - a consensus of the FASB Emerging Issues Task Force.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  Earlier application is permitted.  We do not expect the provisions of ASU 2010-13 to have a material effect on our position, results of operations or cash flows.

 
14

 

3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

In December 2010, FASB issued ASU No. 2010-28, Intangibles - Goodwill and Other (ASC Topic 350). Under Topic 350 on goodwill and other intangible assets, testing for goodwill impairment is a two-step test. When a goodwill impairment test is performed (either on an annual or interim basis), an entity must assess whether the carrying amount of a reporting unit exceeds its fair value (Step 1). If it does, an entity must perform an additional test to determine whether goodwill has been impaired and to calculate the amount of that impairment (Step 2). The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. As we do not have any significant intangible assets, we believe that the impact of adopting this update will not be material on our consolidated results of operations and financial position.

In December 2010, FASB issued Accounting Standards Update (ASU) No. 2010-29, Business Combinations (ASC Topic 805). The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination(s). The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is permitted. As we did not enter into any business combinations in fiscal year 2010, we believe that the adoption this update will not have any material impact on our financial statement disclosures. However, if we enter into material business combinations in the future, the adoption of this update may have significant impact on our financial statement disclosures.

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

4.
OTHER RECEIVABLES AND PREPAYMENTS

Other receivables and prepayments consist of the following:

 
15

 

4.           OTHER RECEIVABLES AND PREPAYMENTS - Continued

  
As of
 
As of
 
 
March 31, 2011
 
June 30, 2010
 
 
(unaudited)
     
Prepayment for advertising and promotion
$ 1,749,349   $ 1,198,484  
             
Prepayment for director and office insurance
  5,417     29,792  
             
Advance to suppliers
  8,048     -  
             
Other receivables
  243,454     221,314  
             
Total other receivables and prepayments 
$ 2,006,268   $ 1,449,590  

5.
AMOUNT DUE FROM EQUITY HOLDER

Amount due from equity holder consists of the following:

  
 
As of
   
As of
 
   
March 31, 2011
   
June 30, 2010
 
   
(unaudited)
       
                 
Mr. Hongwei Qu
  $ -     $ 40,160  

The amount due from an equity holder (the Company’s Chairman, President and Chief Executive Officer) as of June 30, 2010 is unsecured, non-interest bearing. The balance of $40,160 was repaid in July 2010.

6.
INVENTORIES

Inventories consist of the following:

   
As of
   
As of
 
   
March 31, 2011
   
June 30, 2010
 
   
(unaudited)
       
             
Raw materials
  $ 973,043     $ 445,693  
Finished goods
    1,024,503       302,729  
Total inventories
  $ 1,997,545     $ 748,422  

 
16

 

7.
INTANGIBLE ASSETS

Intangible assets consist of the following:

  
 
As of
   
As of
 
   
March 31, 2011
   
June 30, 2010
 
   
(unaudited)
       
Pharmaceuticals formulas, at cost
  $ 25,278,154     $ 17,342,772  

On December 9, 2010, we entered into an Intangible Assets Transfer Agreement with Shandong Daxin Microbiology Pharmaceutical Industry Co., Ltd. (“Daxin”), an unrelated party, pursuant to which Daxin transferred to us all rights and title for 14 State Food and Drug Administration previously approved traditional Chinese medicine formulas. The aggregate purchase price of approximately $7,186,100 (RMB 48,000,000) has been paid by March 31, 2011.  The 14 new formulas consist of two new product categories, powder and pellet formulations, which are the most popular product formulations under Chinese government’s Essential Drug List (EDL).  Additionally, 4 of the 14 formulas are included in the EDL and an additional 5 medicines are included in the National Drug Reimbursement List (NDRL).  Inclusion on EDL or NDRL allows for up to 100% insurance coverage by the Chinese government.

8.
PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment consisted of the following:

  
 
As of
   
As of
 
   
March 31, 2011
   
June 30, 2010
 
   
(unaudited)
       
Leasehold land and buildings
  $ 7,906,455     $ 7,629,498  
Plant equipment
    1,279,825       1,238,343  
Office equipment
    103,129       81,799  
Motor vehicles
    421,947       414,648  
Total
    9,711,355       9,364,288  
                 
Less: accumulated depreciation
    1,786,280       1,469,246  
                 
Property, plant and equipment, net
  $ 7,925,075     $ 7,895,042  

Depreciation expense for the three months ended March 31, 2011 and 2010 amounted to $87,847 and $84,518, respectively.  Depreciation expense for the nine months ended March 31, 2011 and 2010 amounted to $260,577 and $224,656, respectively.

As of March 31, 2011 and June 30, 2010, we have pledged plant machinery having a carrying amount of $457,565 and $534,102, respectively to secure a bank loan of Bohai.

 
17

 

9.
SHORT-TERM BORROWINGS

Bohai obtained several short-term loan facilities from financial institution in the PRC.  Short-term borrowings as of March 31, 2011 consisted of the following:

Loan from
financial
institution
 
Loan period
 
Annual
interest rate
 
Secured by
 
Amount
 
                   
Yantai Laishan Rural Credit Union
 
September 21, 2010 to September 20, 2011
    9.03 %  
Bohai’s machinery and vehicles
  $ 608,819  
Yantai Laishan Rural Credit Union
 
September 21, 2010 to September 20, 2011
    6.90 %
Yantai Jiahua Medical Equipment Co. Ltd
    296,799  
                       
                  $ 905,618  

Short-term borrowings as of June 30, 2010 consisted of the following:

Loan from
financial
institution
 
Loan period
 
Annual
interest rate
 
Secured by
 
Amount
 
                   
China Construction Bank
 
February 24, 2010 to February 23, 2011
    5.84 %  
Shandong Dai Xin Heavy Industries Co. Ltd.
  $ 3,524,954  
Yantai Laishan Rural Credit Union
 
September 28, 2009 to September 26, 2010
    9.03 %
Bohai’s machinery and vehicles
    587,492  
Yantai Laishan Rural Credit Union
 
September 28, 2009 to September 26, 2010
    6.90 %
Yantai Jiahua Medical Equipment Co. Ltd
    286,403  
                       
                  $ 4,398,849  

10. 
COMMON STOCK

We are authorized to issue 150 million shares of Common Stock, par value $0.001 per share.  Holders of Common Stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders.  Holders of Common Stock do not have a cumulative voting right, which means that the holders of more than one half of our outstanding shares of Common Stock, subject to the rights of the holders of preferred stock, if any, can elect all of our directors, if they choose to do so.  In this event, the holders of the remaining shares of Common Stock would not be able to elect any directors.  Subject to the prior rights of any class or series of preferred stock which may from time to time be outstanding, if any, holders of Common Stock are entitled to receive ratably, dividends when, as, and if declared by our Board of Directors out of funds legally available for that purpose and, upon our liquidation, dissolution, or winding up, are entitled to share ratably in all assets remaining after payment of liabilities and payment of accrued dividends and liquidation preferences on the preferred stock, if any.  Holders of Common Stock have no preemptive rights and have no rights to convert their Common Stock into any other securities.  The outstanding Common Stock is duly authorized and validly issued, fully-paid, and non-assessable.  Except as required or permitted by law or our charter documents, all stockholder action is taken by the vote of a majority of the outstanding shares of Common Stock present at a meeting of stockholders at which a quorum consisting of a majority of the outstanding shares of Common Stock is present in person or by proxy.

 
18

 

10. 
COMMON STOCK - Continued

On January 21, 2011, we closed a financing transaction under which we sold an aggregate of 748,382 shares of Common Stock to a total of 42 individual investors at $2.50 per share, for total gross proceeds of $1,870,955. The shares were sold pursuant to separate subscription agreements between us and each investor.  All investors are domiciled in and citizens of the People's Republic of China. 

Notes with an aggregate face amount of $1,050,000 and interest of $5,406 on the $1,050,000 Notes were converted into 527,703 shares of Common Stock during the nine months ended March 31, 2011.

Restricted Stock Awards

On June 4, 2010, we issued 120,000 shares of restricted Common Stock to our Chief Financial Officer for three years of service. The restricted stock vests in three equal annual installments over the term of employment. For the three and nine months ended March 31, 2011, the Company recognized $22,000 and $73,000 of the restricted stock as compensation expenses.

On November 10, 2010, we issued 25,000 shares of restricted Common Stock to a third party to create investor awareness programs, which shares vested immediately. For the three and nine months ended March 31, 2011, the Company recognized $24,000 and $52,500 of the restricted stock as general and administrative expenses.

On January 5, 2011, we issued 20,000 shares of restricted Common Stock to a third party to create investor awareness programs, which shares vested immediately. For the three and nine months ended March 31, 2011, the Company recognized $35,000 of the restricted stock as general and administrative expenses.

11. 
EARNINGS PER SHARE

Basic earnings per share are computed on the basis of the weighted average number of shares of Common Stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of Common Stock plus the effect of dilutive potential common shares outstanding during the period using the if-converted method for the convertible notes and the treasury stock method for warrants.  The following table sets forth the computation of basic and diluted net income per common share:

 
19

 

11. 
EARNINGS PER SHARE - Continued

   
Three
months
ended
   
Three
months
ended
   
Nine months
ended
   
Nine months
ended
 
   
March 31,
2011
   
March 31,
2010
   
March 31,
2011
   
March 31,
2010
 
   
(unaudited)
   
(unaudited)
   
(unaudited)
   
(unaudited)
 
                         
Net income available for common shareholders
  $ 2,685,346     $ 3,142,558     $ 12,238,716     $ 7,752,593  
Effective interest charge on convertible note
    438,376       347,793       986,842       347,793  
Net income for diluted earnings per common share
  $ 3,123,722     $ 3,490,351     $ 13,225,558     $ 8,100,386  

   
Three
months
ended
   
Three
months
ended
   
Nine months
ended
   
Nine months
ended
 
   
March 31,
2011
   
March 31,
2010
   
March 31,
2011
   
March 31,
2010
 
   
(unaudited)
   
(unaudited)
   
(unaudited)
   
(unaudited)
 
                         
Basic weighted average common stocks outstanding
    17,544,163       16,078,472       16,988,489       16,193,659  
Effect of dilutive securities:
                               
Warrants - incremental shares based on assumed proceeds & repurchases
    -       -       -       -  
                                 
Options - incremental shares based on  assumed proceeds & repurchases
    -       -       75       -  
Restricted stock
    14,722       -       9,398       -  
                                 
Common shares if converted from Convertible Notes
    5,250,000       5,666,667       5,441,240       5,890,511  
Diluted weighted average for common stocks outstanding
    22,808,885       21,745,139       22,439,202       22,084,170  
                                 
Earnings per share:
                               
Basic
  $ 0.15     $ 0.20     $ 0.72     $ 0.48  
Diluted
  $ 0.14     $ 0.16     $ 0.59     $ 0.37  

 
20

 

11. 
EARNINGS PER SHARE - Continued

Warrants to purchase 6,600,000 shares of Common Stock and stock options to purchase 26,000 shares of Common Stock were outstanding during the three and nine months ended March 31, 2011 but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive.

Warrants to purchase 6,600,000 shares of Common Stock were outstanding during the three and nine months ended March 31, 2010 but were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive

12. 
OTHER ACCRUED LIABILITIES

Other accrued liabilities as of March 31, 2011 and June 30, 2010 are consisted of the following:

  
 
As of
   
As of
 
   
March 31, 2011
   
June 30, 2010
 
   
(unaudited)
       
Accrued selling expenses
  $ 3,233,082     $ 1,541,383  
Accrued staff costs
    259,220       221,810  
Value added tax payable
    998,700       686,478  
Other taxes payable
    150,509       78,370  
Other accrued expenses
    268,272       456,947  
                 
Total other accrued liabilities
  $ 4,909,783     $ 2,984,988  

13.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS

On January 5, 2010, pursuant to a Securities Purchase Agreement, or securities purchase agreement, with 128 accredited investors, or the Investors, we sold 6,000,000 units for aggregate gross proceeds of $12,000,000, each unit consisting of an 8% senior convertible promissory note, or Notes, in the principal amount of $2 and one Common Stock purchase warrant, or Warrant.  By agreement with the Investors, each investor received: (i) a single Note representing the aggregate number of Notes purchased by them as part of the units (each, a “Note” and collectively, the “Notes”) and (ii) a single Investor Warrant representing the aggregate number of Investor Warrants purchased by them as part of the units.

The Notes bear interest at 8% per annum, payable quarterly in arrears on the last day of each fiscal quarter of our company. No principal payments are required until maturity of the Notes on January 5, 2012. Each Note, plus all accrued but unpaid interest thereon, is convertible, in whole but not in part, at any time at the option of the holder, into shares of Common Stock at a conversion price of $2.00 per share, subject to adjustment as set forth in the Note.  The Notes issued have face amounts that range from $43,200 to $500,000.

 
21

 

13.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued

The conversion price of the Notes is subject to standard anti-dilution adjustments for stock splits and similar events. In addition, if we issue or sell any additional shares of Common Stock or instruments convertible or exchangeable for Common Stock at a price per share less than the conversion price then in effect or without consideration, then the conversion price upon each such issuance will be adjusted to that price determined by multiplying the conversion price then in effect by a fraction: (1) the numerator of which is the sum of (x) the number of shares of Common Stock outstanding immediately prior to the issuance of such additional shares of Common Stock plus (y) the number of shares of Common Stock which the aggregate consideration for the total number of such additional shares of Common Stock so issued would purchase at a price per share equal to the conversion price then in effect, and (2) the denominator of which is the number of shares of Common Stock outstanding immediately after the issuance of such additional shares of Common Stock. Notwithstanding any provision of the Note to the contrary, no adjustment will cause the conversion price to be less than $1.00, as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction.

Effective as of June 30, 2010, we entered into an Amendment and Agreement (the "A&A") with the Investors, pursuant to which the Company and the Investors agreed to make certain amendments to the Notes and the Warrants.  Pursuant to the Amendment, the anti-dilution protection provisions in the Notes and the Warrants were eliminated and a provision specifically precluding net cash settlement by us of the Notes and the Warrants was added.  In return, and subject to certain non-financing exceptions, we agreed not to issue any new equity securities at a price per share below $2.20 until the earlier of (i) January 5, 2013 or (ii) the date on which, collectively with any prior conversions or exercises of Notes and Warrants, 75% of the principal face value of the Notes in the aggregate has been converted into shares of Common Stock and Warrants representing, in the aggregate, 75% of the aggregate shares of Common Stock underlying the Warrants have been exercised.  This Amendment did not change the Company’s accounting for the Notes and the Warrants described below.

On and effective as of March 30, 2011, the Company entered into a Termination Agreement (the "Termination Agreement") with Euro Pacific Capital, Inc., as investor representative (the "Investor Representative"), pursuant to which the Company and the Investor Representative agreed to terminate the aforementioned A&A, by and between the Company and the Investor Representative. As a result of the Termination Agreement, the A&A and each of its provisions were terminated. After further study, the Company concluded that the original purpose of the A&A (to mitigate the impact of certain non-cash embedded derivative liabilities associated with the Notes, Warrants and Agent Warrants) would not be achieved. Therefore, the Company determined and agreed with the Investor Representative to terminate the A&A and to thereby restore the Notes, Warrants and Agent Warrants to their original terms.

The Notes contain certain events of default, including non-payment of interest or principal when due, bankruptcy, failure to maintain a listing of the Common Stock or to make required filings on a timely basis. No premium is payable by us if an event of default occurs. However, upon an Event of Default, and provided no more than 50% of the aggregate face amount of the Notes have been converted, the Investors holding Notes have the right to receive a portion, based on their pro-rata participation in the transaction, of 1,000,000 shares of our Common Stock that have been placed in escrow by our principal stockholder. The shares in escrow will be returned to the principal stockholder when 50% of the aggregate face amount of the Notes has been converted or, if later, when the Notes are repaid.

The Investor Warrants expire on January 5, 2013 and may be exercised by the holder at any time to purchase one share of Common Stock at an exercise price of $2.40 per share (subject to adjustment as set forth in the Investor Warrants). The exercise price of the Investor Warrants is subject to adjustment in the same manner as the conversion price of the Notes described above, except that the exercise price will not be adjusted to less than $1.20, as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction. The Investor Warrants may only be exercised for cash and do not permit the holder to perform a cashless exercise.

 
22

 

13.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued

In connection with the sale of the units, we paid our placement agents a cash fee of $1,200,000. In addition, the placement agents received warrants, the Placement Agent Warrants and, together with the Investor Warrants, the Warrants to purchase 600,000 shares of Common Stock, which agent warrants are substantially identical to the Investor Warrants, except that, pursuant to separate lock-up agreements executed by the holders of the Placement Agent Warrants, the Placement Agent Warrants are not exercisable until the six month anniversary of the later of: (i) the date of effectiveness of the registration statement registering the resale of the Common Stock underlying the Notes and Warrants or (ii) the date of commencement of sales in connection with such registration statement.

In addition to the placement agent fee, we paid $370,000 of legal and other expenses. As required by the Securities Purchase Agreement, $500,000 of the proceeds from the sale of the units were placed in escrow to pay investor relations expenses to be incurred by us and $240,000, equivalent to one quarter’s interest expense on the Notes, was also placed in escrow. The interest escrow will be released to us at such time as 75% of all shares underlying the Notes have been issued upon conversion of Notes. After payment of the placement agent fees and other expenses and the amounts required to be placed in escrow, we received net proceeds of $9,690,000. At March 31, 2011 and June 30, 2010, $220,043 and $576,019, respectively, remained in escrow and is included in restricted cash.

We also entered into a Registration Rights Agreement with the Investors. We agreed to file, no later than March 6, 2010, a registration statement to register the shares underlying the Notes and the Warrants and to have such registration statement effective no later than August 13, 2010. The required registration statement was filed on March 2, 2010 and became effective on August 12, 2010. Accordingly, we did not incur any registration delay payments.

Valuation

At the time the Notes and Warrants were issued, there had not been any market activity for the Common Stock.  Accordingly, determining the fair value of the Common Stock required us to make complex and subjective judgments. We estimated the value of our enterprise as of January 5, 2010 based on a review of the enterprise value derived from the use of market and income valuation approaches. We also reviewed an asset-based approach to assess whether the result of such an approach was consistent with the value derived from the market and income valuation approaches. The market approach was based on the market price to earnings multiple for companies considered by management to be comparable to us. The income approach was based on applying discount rates to estimated future net income. The estimated enterprise value was then allocated to our existing outstanding Common Stock, the Notes and the Warrants using the option pricing method. The option pricing method was based on the two year period to maturity of the Notes and the three year period to expiration of the Warrants, risk-free interest rates commensurate with those periods and the expected volatility used was based on a review of the historical volatility of companies considered by management to be comparable to us.

Based on the allocation of the estimated enterprise value, we estimated the fair value of the Common Stock at $2.28 per share, as of January 5, 2010. The Investor Warrants and the Placement Agent Warrants were valued at $5,824,538 and $582,454, respectively, based on the estimated fair value of the Common Stock of $2.28, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 1.57% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life of the Warrants and estimated volatility of 65%, based on a review of the historical volatility of companies considered by management to be comparable to us.  As noted above, prior to the June 30, 2010 Amendment described above, the Warrants contained a down-round anti-dilution protection feature. As of January 5, 2010, the value of this feature was not considered to be material and no adjustment was made for it in the estimated fair value of the Warrants.

 
23

 

13.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued

Accounting for Convertible Notes

At January 5, 2010 and March 31, 2011, the conversion options embedded in the Notes are not derivative instruments as defined in FASB ASC 815-10-15-83 because the Notes do not permit or require net settlement, there is no market mechanism outside the contracts that permits net settlement and the shares to be received on conversion of the Notes are not readily convertible to cash. At the time the Notes were issued, there had not been any market activity for the Common Stock.  Although market trading activity for our Common Stock has developed, the Notes can be exercised only in whole but not in part and through March 31, 2011 and continuing, there has been insufficient trading volume to permit the shares to be received on conversion of each Note to be readily sold in the market, thus precluding the shares to be received by the holder of each Note from being readily convertible to cash.

In future periods, whether or not the embedded conversion option in each Note is considered to be a derivative instrument will depend on whether or not the aggregate number of shares to be received on exercise of each of the Notes, which Notes can be exercised only in whole but not in part, could be readily sold in the market without significantly affecting the market price of the Common Stock, thus permitting the shares received by the holder of each Note to be readily convertible to cash. At each reporting date, the Company will re- evaluate each Note, based on the level of activity in the market for the Common Stock at that time, to determine whether or not the embedded conversion option in each Note is a derivative instrument. Depending on the trading volume for the Common Stock that develops in the future and the face amount of each Note, the embedded conversion option may be considered a derivative instrument for some Notes but not for others and its status as a derivative instrument may vary from period to period.

FASB ASC 815-10-15-74 provides that a contract which would otherwise meet the definition of a derivative instrument but that is both (a) indexed to a company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. FASB ASC 815-40-15 and 815-40-25 provide guidance for determining whether those two criteria are met. Because the Company’s functional currency is the Renminbi but the Notes are denominated in U.S. Dollars, FASB ASC 815-40-15-7I provides that the embedded conversion options are not considered to be indexed only to our Common Stock. Furthermore, prior to the June 30, 2010 Amendment described above, the criteria that the instruments be indexed only to the Common Stock was also not met because the conversion price of the Notes would be reduced if we issued securities at a lower exercise or conversion price. Because the requirement that the instruments be indexed only to the Common Stock is not met, the exemption in FASB ASC 815-10-15-74 will not be available and we will account for the embedded conversion options in the Notes as derivative instrument liabilities, if and when the shares to be issued on conversion are considered to be readily convertible to cash.
 
Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. If and when the embedded conversion option in any of the Notes first qualifies as a derivative instrument, the fair value at that time of the embedded derivative instrument will be re-classified and separately recognized and subsequently marked-to-market each reporting period, as long as the embedded conversion option continues to qualify as a derivative instrument. If the embedded conversion option ceases to be a derivative instrument, it will be marked-to-market as of the date of re-classification but thereafter will no longer be marked-to-market.

 
24

 

13. 
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued

Warrants

Because our functional currency is the Renminbi but the Warrants are denominated in U.S. Dollars, the Warrants are not considered to be indexed only to our Common Stock. Furthermore, prior to the June 30, 2010 Amendment described above, the criteria that the instruments be indexed only to the Common Stock was also not met because the exercise price of the Warrants would be reduced if we issued securities at a lower exercise or conversion price. In accordance with ASC 815-10-S99-4, the Warrants (including the  Placement Agent Warrants) are accounted for at fair value, with changes in their fair value charged or credited to income each period.
 
At January 5, 2010, the Investor Warrants were valued at $5,824,538, as described above. At March 31, 2011, the Investor Warrants were re-valued at $2,091,205 using a binomial model, based on the closing market price on that date of $1.70, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 0.68% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life of the Warrants and estimated volatility of 55%, based on a review of the historical volatility of companies considered by management to be comparable to our company. The effect of the down-round anti-dilution protection was not considered to be material and no adjustment was made for it in the estimated fair value of the Investor Warrants.

The Placement Agent Warrants were initially valued at $582,454, as described above. The cost of these instruments, together with the cash fees paid to the placement agents and the other fees and expenses paid by us, as described above, in the aggregate amount of $2,152,454, have been deferred and are being amortized on a straight-line basis over the two year period to maturity of the Notes. At March 31, 2011, the Placement Agent Warrants were re-valued at $209,120, based on the closing market price on that date of $1.70, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 0.68% and estimated volatility of 55%. The effect of the down-round anti-dilution protection was not considered to be material and no adjustment was made for it in the estimated fair value of the Placement Agent Warrants.

The aggregate change in the value of the Investor and Placement Agent Warrants for the three and nine months ended March 31, 2011 of $263,118 and $3,181,603, respectively, has been recorded as a gain on the consolidated statement of income. The aggregate change in the value of the Investor and Placement Agent Warrants for the three and nine months ended March 31, 2010 of $1,083,350 has been recorded as a gain on the consolidated statement of income.

The following table summarizes all of our warrants outstanding as of March 31, 2011:

 
25

 

13.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued

               
Exercise Price
 
   
Warrant
   
Exercisable
   
per Common
 
   
Shares
   
Shares
   
Stock Range
 
                   
Balance, June 30, 2010
    6,600,000       6,000,000     $ 2.4  
                         
Granted or vested during the nine months ended March 31, 2011
    -       600,000       2.4  
                         
Exercised during the nine months ended March 31, 2011
    -       -       -  
                         
Expired during the nine months ended March 31, 2011
    -       -       -  
                         
Balance, March 31, 2011 (unaudited)
    6,600,000       6,600,000     $ 2.4  

The following table summarizes the weighted average remaining contractual life and exercise price of our outstanding warrants.
 
Warrants Outstanding
 
           
Number
             
           
Outstanding
   
Weighted
   
Weighted Average
 
     
Number
   
Currently
   
Average
   
Exercise Price of
 
     
Outstanding
   
Exercisable
   
Remaining
   
Warrants
 
Exercise
    at March 31,    
at
   
Contractual Life
   
currently
 
Price
   
2011
   
March 31, 2011
   
(Years)
   
exercisable
 
                           
$ 2.40       6,600,000       6,600,000       1.77     $ 2.40  

Convertible Notes

The Investor Warrants were initially recorded at their fair value of $5,824,538 and the remainder of the $12,000,000 gross proceeds received from the Investors of $6,175,462 was allocated to the Notes. Based on the proceeds allocated to the Notes, the Notes are convertible into Common Stock at an effective conversion price of approximately $1.03 per share. Because the effective conversion price is less than the fair value of the Common Stock at the time the Notes were issued, the Company recognized a beneficial conversion feature, which was limited to the amount of proceeds allocated to the Notes of $6,175,462. The Notes were initially recorded at a carrying value of zero and are being amortized, together with interest accruing on the Notes, to their maturity value over the period to maturity, at an effective interest rate of approximately 540% per annum. Interest expense for the three and nine months ended March 31, 2011 was $438,376 and $986,842, respectively. Interest expense for the three and nine months ended March 31, 2010 was $347,793.  As of March 31, 2011, Notes with an aggregate face amount of $1,550,000 and interest of $5,406 on the Notes were converted into 777,703 shares of Common Stock.

 
26

 

13. 
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued

The convertible note liability is as follows at March 31, 2011 and June 30, 2010:

  
As of
 
As of
 
 
March 31, 2011
 
June 30, 2010
 
 
(unaudited)
     
             
Convertible notes payable, at face value
$ 10,450,000   $ 11,500,000  
Less: unamortized beneficial conversion feature and warrants discount on convertible notes
  (10,011,257 )   (11,375,180 )
Convertible notes, net
$ 438,743   $ 124,820  

Escrowed Shares

As of January 5, 2010 and at March 31, 2011, our principal stockholder is obligated to deliver 1,000,000 shares of Common Stock to the Investors if certain Events of Default occur (as defined in the Notes). The fair value of this obligation is not considered to be material as the probability of such events occurring is currently considered to be minimal. Accordingly, at March 31, 2011 no liability for this obligation has been recognized.

14.
DEFERRED FEES ON CONVERTIBLE NOTES

We incurred total placement fees of $2,152,454 in connection with our private placement of Convertible Notes (see Note 13) that occurred on January 5, 2010. The placement fees are being amortized on a straight line basis over the two year expected life of the Convertible Notes, starting on the date of closing, January 5, 2010.

   
As of
   
As of
 
   
 
March 31, 2011
   
June 30, 2010
 
   
(Unaudited)
       
         
Deferred fees, beginning balance
  $ 1,562,617     $ 2,152,454  
Transferred to equity on conversion
    (106,574 )     (79,120 )
Amortization of deferred fees
    (736,224 )     (510,717 )
                 
Deferred Fee, ending balance
  $ 719,819     $ 1,562,617  
 
15.
STOCK OPTIONS

On October 13, 2010, we granted stock options to two directors for the purchase of 26,000 shares of our Common Stock at an exercise price of $2.00 per share.  The options vest immediately on the grant date and expire five years from the date of issuance.

 
27

 

15.
STOCK OPTIONS- Continued

These options have been valued at $23,844. We use a binomial option pricing model to calculate the grant date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 70%, risk free interest rate of 0.3%, expected term of 2.5 years.

The following table summarizes the weighted average remaining contractual life and exercise price of our outstanding options as of March 31, 2011:
 
Options Outstanding
 
           
Number
             
           
Outstanding
   
Weighted
   
Weighted Average
 
     
Number
   
Currently
   
Average
   
Exercise Price of
 
     
Outstanding
   
Exercisable
   
Remaining
   
Warrants
 
Exercise
   
at March 31,
   
at
   
Contractual Life
   
currently
 
Price
   
2011
   
March 31, 2011
   
(Years)
   
exercisable
 
                           
$ 2.00       26,000       26,000       4.54     $ 2.00  
 
We account for share-based payments in accordance with ASC 718. Accordingly, we expense the fair value of awards granted to the directors. Total compensation expense related to the stock options for the three months and nine months ended March 31, 2011 was $23,844 and was recorded as general and administrative expense.

A summary of our stock option activity as of March 31, 2011, and changes during nine months ended March 31, 2011 is presented in the following table:

               
Exercise Price
 
   
Option
   
Vested
   
per Common
 
   
Shares
   
Shares
   
Stock Range
 
                   
Balance, June 30, 2010
    -       -     $ -  
                         
Granted or vested during the nine months ended March 31, 2011
    26,000       26,000     $ 2.0  
                         
Exercised during the nine months ended March 31, 2011
    -       -     $ -  
                         
Expired during the nine months ended March 31, 2011
    -       -     $ -  
                         
Balance, March 31, 2011 (unaudited)
    26,000       26,000     $ 2.0  

 
28

 

16.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

For the three and nine months ended March 31, 2011 and 2010, selling, general and administrative expenses consisted of the following:

  
 
Three months
ended
   
Three months
ended
   
Nine months
ended
   
Nine months
ended
 
  
 
March 31, 2011
   
March 31, 2010
   
March 31, 2011
   
March 31, 2010
 
  
 
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Travel and accommodation
  $ 3,197,894     $ 1,824,750     $ 7,215,635     $ 4,880,926  
Advertising and promotion
    3,962,454       2,767,549       10,461,435       8,732,252  
Audit fees
    12,483       -       101,534       -  
Commission
    1,155,155       1,060,462       2,628,125       3,464,415  
Conference
    1,269,264       738,898       4,161,191       3,070,497  
Depreciation
    10,421       9,397       30,427       27,872  
Staff costs
    966,557       608,263       2,106,130       1,571,400  
Research and development cost
    190,440       146,640       562,261       442,046  
Other operating expenses
    2,081,292       2,046,914       5,299,241       6,019,345  
                                 
Total selling, general and administrative expenses 
  $ 12,845,962     $ 9,202,873     $ 32,565,981     $ 28,208,753  

17.
INTEREST EXPENSE

For the three and nine months ended March 31, 2011 and 2010, interest expense consisted of the following:

 
29

 

17.
INTEREST EXPENSE – Continued

  
Three months
ended
 
Three months
ended
 
Nine months
ended
 
Nine months
ended
 
  
March 31, 2011
 
March 31, 2010
 
March 31, 2011
 
March 31, 2010
 
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
                 
Interest on short-term bank borrowings and notes payable
$ 19,659   $ 33,907   $ 187,446   $ 190,215  
Amortization of beneficial conversion feature and warrants discount on convertible notes converted
  96,393     -     1,029,487     -  
Effective interest charge on Convertible Notes
  438,376     347,793     986,842     347,793  
                         
Total interest expenses
$ 554,428   $ 381,700   $ 2,203,775   $ 538,008  

18.
INCOME TAXES

For the three and nine months ended March 31, 2011 and 2010, income tax expense consisted of the following:
                         
   
Three months
ended March
31, 2011
   
Three months
ended March
31, 2010
   
Nine months
ended March
31, 2011
   
Nine months
ended March
31, 2010
 
Current taxes  
(unaudited)
   
(unaudited)
   
(unaudited)
   
(unaudited)
 
United States
  $ -     $ -     $ -     $ -  
PRC
    897,458       585,135       3,523,145