China BCT Pharmacy Group, Inc. - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - China BCT Pharmacy Group, Inc.	Financial_Report.xls
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT - China BCT Pharmacy Group, Inc.	f10q0611ex31i_chinabct.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT - China BCT Pharmacy Group, Inc.	f10q0611ex31ii_chinabct.htm
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT - China BCT Pharmacy Group, Inc.	f10q0611ex32i_chinabct.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 June 30, 2011

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

For the transition period from ____ to _____

Commission File Number: 033-145620

China BCT Pharmacy Group, Inc.

(Exact name of registrant as specified in its charter)

Delaware		20-8067060
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

No. 102, Chengzhan Road, Liuzhou City, Guangxi Province, P.R.C.		545007
(Address of principal executive offices)		(Zip Code)

+86 (772) 363 8318

(Registrant’s telephone number, including area code)

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

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

Large Accelerated filer o Accelerated Filer o

Non-Accelerated Filer o Smaller Reporting Company x

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

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

As of August 10, 2011 the registrant had 38,154,340 shares of common stock outstanding.

TABLE OF CONTENTS

	Part I -- Financial Information

Item 1.	Financial Statements			1

		Consolidated Statements of Incomes (Unaudited) – Three and Six Months Ended June 30, 2011 and June 30, 2010	1

		Consolidated Balance Sheets as of June 30, 2011 (Unaudited) and December 31, 2010	2-3

		Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2011 and June 30, 2010	3-5

		Consolidated Statements of Stockholders’ Equity (Unaudited) - Six Months Ended June 30, 2011	6

		Notes to Consolidated Financial Statements – June 30, 2011 (Unaudited) and December 31, 2010	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			31

Item 3.	Quantitative and Qualitative Disclosures About Market Risk			49

Item 4T.	Controls and Procedures			49

	Part II – Other Information

Item 1.	Legal Proceedings			49

Item 1A.	Risk Factors			49

Item 2.	Unregistered shares of Equity Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

Item 4.	(Reserved and Removed)

Item 5.	Other Information

Item 6.	Exhibits			49

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Consolidated Statements of Income and Comprehensive Income

(Stated in US Dollars)

	Three months ended						Six months ended
	June 30						June 30
	(unaudited)						(unaudited)
	2011			2010			2011			2010

Sales revenue	$	65,115,748		$	47,492,718		$	123,718,988		$	81,521,596
Cost of sales		49,043,088			34,879,110			94,039,127			60,046,311
Gross profit		16,072,660			12,613,608			29,679,861			21,475,285

Operating expenses
Administrative expenses		2,685,357			1,294,476			5,716,052			2,936,899
Selling expenses		1,770,562			1,059,916			3,715,147			2,086,435
Total operating expenses		4,455,919			2,354,392			9,431,199			5,023,334

Income from operations		11,616,741			10,259,216			20,248,662			16,451,951

Non-operating income (expense)
Interest income		24,162			4,023			25,989			4,142
Other income		114,545			28,667			136,741			126,707
Change in fair value of warrant liabilities		300,662			(418,027	)		576,044			(706,810	)
Other expenses		(17,586	)		(1,387	)		(17,586	)		(40,699	)
Finance costs		(195,846	)		(264,480	)		(389,904	)		(477,609	)
Total non-operating income (expense)		225,937			(651,204	)		331,284			(1,094,269	)

Income before income taxes		11,842,678			9,608,012			20,579,946			15,357,682
Income taxes		(3,239,723	)		(2,475,603	)		(5,727,520	)		(3,981,108	)
Net income		8,602,955			7,132,409			14,852,426			11,376,574
Other comprehensive income
Foreign currency translation adjustments		1,996,994			(25,872	)		2,350,904			(1,334	)
Total comprehensive income	$	10,599,949		$	7,106,537		$	17,203,330		$	11,375,240

Earnings per share - basic	$	0.19		$	0.19		$	0.35		$	0.30
Earnings per share - diluted	$	0.19		$	0.19		$	0.35		$	0.30

Weighted average number of shares
outstanding - basic		38,154,340			38,119,340			38,154,340			37,942,936
Weighted average number of shares
outstanding - diluted		38,154,340			38,471,274			38,154,340			38,294,870

Reconciliation of net income to income
applicable to common stock:
Net income	$	8,602,955		$	7,132,409		$	14,852,426		$	11,376,574
Less: dividends and accretion on preferred stock		(1,167,011	)		-			(1,556,015	)		-
Income applicable to common stock	$	7,435,944		$	7,132,409		$	13,296,411		$	11,376,574

See the accompanying notes to consolidated financial statements.

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Consolidated Balance Sheets

(Stated in US Dollars)

	June 30,		December 31,
	2011		2010
	(Unaudited)			(*)

Assets
Current assets
Cash and cash equivalents	$	63,100,570	$	20,157,112
Restricted cash		1,615,155		1,334,868
Accounts receivable, net		70,680,351		68,664,308
Bills receivable		23,205		-
Amounts due from related companies - note 12		1,079,596		3,784,069
Other receivables, prepayments and deposits		4,707,578		3,332,747
Inventories - note 7		16,458,159		10,776,877
Deferred income taxes		211,739		207,222
Total current assets		157,876,353		108,257,203

Property, plant and equipment, net - note 9		15,625,002		14,605,888
Land use rights, net - note 10		13,567,738		13,422,048
Long-term deposit - note 16		6,961,500		3,482,200
Goodwill - note 8		570,280		560,418
Other intangible assets, net - note 8		536,727		581,481
Deferred income taxes		645,375		629,798
Total assets	$	195,782,975	$	141,539,036

(*) Derived from audited financial statements.

See the accompanying notes to consolidated financial statements.

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Consolidated Balance Sheets (Cont’d)

(Stated in US Dollars)

	June 30,		December 31,
	2011		2010
	(Unaudited)			(*)

Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	42,275,442	$	35,497,337
Bills payable - note 13		2,613,799		2,669,752
Other payables and accrued expenses		4,992,112		4,856,956
Dividend payable - note 17		500,000		-
Amounts due to directors - note 11		157,023		190,484
Amounts due to related companies - note 12		214,162		139,219
Income tax payable		3,141,063		2,564,359
Secured bank loans - note 13		10,672,726		8,898,218
Other loans - note 14		169,087		162,664
Retirement benefit costs		22,424		33,412
Total current liabilities		64,757,838		55,012,401

Secured long-term bank loans - note 13		243,893		1,941,606
Warrant liabilities - note 15		697,149		1,273,193
Retirement benefit costs		215,513		213,763
Total liabilities		65,914,393		58,440,963

Commitments and contingencies - note 16

Convertible Redeemable Preferred Stock
Series A convertible, redeemable preferred stock:
$0.001 par value; 20,000,000 shares authorized;
9,375,000 and zero shares issued and outstanding as of
June 30, 2011 and December 31, 2010, respectively - note 17		30,551,881		-


Stockholders’ Equity - notes 15, 17 and 18
Common stock: par value $0.001 per share;
150,000,000 and 100,000,000 shares authorized;
38,154,340 shares issued and outstanding as of June 30, 2011 and
December 31, 2010, respectively - note 18		38,154		38,154
Additional paid-in capital		17,204,725		16,633,411
Statutory and other reserves		4,585,854		4,585,856
Accumulated other comprehensive income		6,778,769		4,427,865
Retained earnings		70,709,199		57,412,787
Total Stockholders’ Equity		99,316,701		83,098,073
Total Liabilities and Stockholders’ Equity	$	195,782,975	$	141,539,036

(*) Derived from audited financial statements

See the accompanying notes to consolidated financial statements.

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Consolidated Statements of Cash Flows

(Stated in US Dollars)

	Six months ended June 30
	(Unaudited)
	2011			2010

Cash flows from operating activities :
Net income	$	14,852,426		$	11,376,574
Adjustments to reconcile net income to net cash flows
provided by operating activities :
Depreciation and amortization		693,078			574,981
Deferred income taxes		(2,737	)		(1,218	)
Gain on sale of land use right		-			(44,919	)
Loss on sale of property, plant and equipment		10,960			-
Change in fair value of warrant liabilities		(576,044	)		706,810
Share-based compensation expense		571,314			25,717
Changes in operating assets and liabilities, net of effects of acquisitions of retail stores :
Accounts receivable		2,598,361			(11,889,740	)
Bills receivables		(23,052	)		-
Other receivables, prepayments and deposits		(634,987	)		(1,338,371	)
Inventories		(4,673,617	)		(3,116,638	)
Accounts payable		10,732,080			9,119,546
Bills payables		(109,528	)		(322,516	)
Other payables and accrued expenses		(915,249	)		(1,138,461	)
Retirement benefit costs		(14,454	)		12,976
Income tax payable		517,804			2,023,721
Total adjustments		8,173,929			(5,388,112	)
Net cash flows provided by operating activities	$	23,026,355		$	5,988,462

See the accompanying notes to consolidated financial statements.

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Consolidated Statements of Cash Flows (Cont’d)

(Stated in US Dollars)

	Six months ended June 30
	(Unaudited)
	2011			2010

Cash flows from investing activities :
Acquisition of property, plant and equipment	$	(1,175,346	)	$	(70,183	)
Payments to acquire retail stores		-			(4,278,998	)
Net cash from acquisition of distribution chains		36,502			-
Acquisition of intangible assets		(6,730	)		-
Proceeds from sale of property, plant and equipment		4,039			-
Proceeds from sale of land use right		-			697,495
Payment for long-term deposit		(3,365,600	)		-
Net cash flows used in investing activities		(4,507,135	)		(3,651,686	)

Cash flows from financing activities :
Advance/repayment activities with related companies, net		(5,697,634	)		(1,133,858	)
Proceeds received from private placement		-			2,315,138
Proceeds received from placement of preferred stock		29,495,866			-
Changes in restricted cash		(251,467	)		230,242
Repayments to directors		(37,397	)		(311,817	)
Proceeds from bank loans		5,839,840			6,865,560
Repayments of bank loans		(5,958,109	)		(4,750,189	)
Proceeds from other loans		-			35,208
Repayments of other loans		-			(2,392,476	)
Net cash flows provided by financing activities		23,391,099			857,808

Effect of foreign currency translation on cash and cash equivalents		1,033,139			(1,334	)

Net increase in cash and cash equivalents		42,943,458			3,193,250

Cash and cash equivalents - beginning of period		20,157,112			13,304,158

Cash and cash equivalents - end of period	$	63,100,570		$	16,497,408

Supplemental disclosures for cash flow information :
Cash paid for :
Interest	$	359,815		$	485,932
Income taxes	$	5,212,452		$	1,958,606

See the accompanying notes to consolidated financial statements.

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Consolidated Statements of Stockholders’ Equity

(Unaudited)

(Stated in US Dollars)

									Accumulated
					Additional		Statutory		other
	Common stock				paid-in		and surplus		comprehensive		Retained
	No. of shares		Amount		capital		reserves		income		earnings			Total

Balance, December 31, 2010		38,154,340	$	38,154	$	16,633,411	$	4,585,854	$	4,427,865	$	57,412,788		$	83,098,072
Net income		-		-		-		-		-		14,852,426			14,852,426
Foreign currency translation adjustments		-		-		-		-		2,350,904		-			2,350,904
Share-based compensation		-		-		571,314		-		-		-			571,314
Dividends on preferred stock		-		-		-		-		-		(500,000	)		(500,000	)
Accretion of preferred stock to redemption		-		-		-		-		-		(1,056,015	)		(1,056,015	)

Balance, June 30, 2011		38,154,340	$	38,154	$	17,204,725	$	4,585,854	$	6,778,769	$	70,709,199		$	99,316,701

See the accompanying notes to consolidated financial statements.

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Notes to Consolidated Financial Statements (Unaudited)

(Stated in US Dollars)

1. Corporate information

China BCT Pharmacy Group Inc. (the “Company”), formerly known as China Baicaotang Medicine Limited and, previous to that, Purden Lake Resource Corp., was incorporated in the State of Delaware on November 30, 2006 as a limited liability company.

The Company is principally engaged in the distribution, production, and retail sale of pharmaceutical products in the People’s Republic of China (the “PRC”).

Currently the Company has five subsidiaries:

		The Company’s
	Place/date of	effective
	incorporation or	ownership	Common stock/	Principal
Company name	establishment	interest	registered capital	activities

Ingenious Paragon Global Limited (“Ingenious”)	British Virgin Islands (“BVI”) / May 29, 2008	100%	Authorized, issued and fully paid 50,000 common shares of $1 par value each	Investment holding

Forever Well Asia Pacific Limited (“Forever Well”)	Hong Kong / January 10, 2008	100%	Authorized, issued and fully paid 10,000 common shares of HK$1 each	Investment holding

Guangxi Liuzhou Baicaotang Medicine Limited (“Liuzhou BCT”)	PRC / April 3, 1986	100%	Registered and fully paid up capital RMB145,984,768	Investment holding and distribution of drugs

Guangxi Liuzhou Baicaotang Medicine (Retail Chain) Limited (“BCT Retail”)	PRC / October 30, 2001	100%	Registered and fully paid up capital RMB3,000,000	Retail sales of drugs

Guangxi Hefeng Pharmaceutical Company Limited (“Hefeng Pharmaceutical”)	PRC / September 18, 2000	100%	Registered and fully paid up capital RMB5,000,000	Production and sales of drugs

China BCT Pharmacy Group, Inc.

(Formerly named China Baicaotang Medicine Limited)

Notes to Consolidated Financial Statements (Unaudited)

(Stated in US Dollars)

2. Basis of presentation

The accompanying unaudited consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) including the instructions to Form 10-Q and Regulation S-X. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted from these statements pursuant to such rules and regulations and, accordingly, they do not include all the information and notes necessary for comprehensive consolidated financial statements and should be read in conjunction with our audited consolidated financial statements, included in our Annual Report on Form 10-K for the years ended December 31, 2010 and 2009.

In the opinion of the management of the Company, all adjustments, which are of a normal recurring nature, necessary for a fair statement of the results for the periods presented herein have been made. Results for the interim periods presented are not necessarily indicative of the results that might be expected for the entire fiscal year.

3. Summary of significant accounting policies

Basis of consolidation

The consolidated financial statements include the accounts of China BCT Pharmacy Group, Inc. and its subsidiaries Ingenious, Forever Well, Liuzhou BCT, BCT Retail, and Hefeng Pharmaceutical. All significant inter-company accounts and transactions have been eliminated in consolidation.

Use of estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, 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 and the estimation on useful lives of property, plant and equipment and intangible assets. Actual results could differ from those estimates.

Cash and cash equivalents

Cash and cash equivalents include all cash, deposits in banks and other highly liquid investments with initial maturities of three months or less. As of June 30, 2011 and December 31, 2010, the cash and cash equivalents mainly denominated in Renminbi (“RMB”) and United States dollars were placed with banks in the PRC and Hong Kong. For those denominated in RMB, they are not freely convertible into foreign currencies and the remittance of these funds out of the PRC is subject to exchange control restrictions imposed by the PRC government. The remaining insignificant balance of cash and cash equivalents were denominated in Hong Kong dollars.

Restricted Cash

Deposits in banks pledged as securities for bills payable (note 10) that are restricted in use are classified as restricted cash under current assets.

Allowance for doubtful accounts

The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of accounts receivable. A considerable amount of judgment is required in assessing the amount of the allowance, the Company considers the historical level of credit losses of all segments (retail, wholesale, and manufacturing) and applies percentages to aged receivable categories. The Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future for all segments. If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a larger allowance may be required.

Based on the above assessment, during the reporting periods, management establishes the general provisioning policy to make allowance equivalent to 40% of gross amount of accounts receivable due between half and one year and 100% of gross amount of accounts receivable due over one year for all segments. Additional specific provision is made against accounts receivable whenever they are considered to be doubtful.

Bad debts are written off when identified. The Company extends unsecured credit to customers ranging from three to six months in the normal course of business. The Company does not accrue interest on accounts receivable.

Inventories

Inventories are stated at the lower of cost or market value. Cost is determined on weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale. The Company’s inventory reserve requirements generally fluctuate based on projected demands, market conditions, and product life cycles. In determining the adequate level of inventories to have on hand, management make judgments as to the projected inventory demands as compared to the current or committed inventory levels. Inventory quantities and expiration dates are reviewed regularly and provisions for excess or obsolete inventory are recorded primarily based on the expiration dates and the Company’s forecast of future demand and market conditions.

No provision for excess or obsolete inventory was made at June 30, 2011 and December 31, 2010.

Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use.

Depreciation is computed using straight-line method over estimated useful lives. The depreciation rates are as follows:

	Annual rate			Residual value

Buildings		2.54% - 9.84	%	Nil - 2	%
Plant and machinery		7% - 18.4	%	Nil - 10	%
Motor vehicles		6% -18.4	%	10	%
Furniture, fixtures and equipment		6% -18.4	%	10	%

Construction in progress mainly represents expenditures in respect of the construction of a new production line and the improvements of the manufacturing process. All direct costs relating to the new production line and the improvements of the manufacturing process are capitalized as construction in progress. No depreciation is provided in respect of construction in progress.

Maintenance or repairs are charged to expense as incurred. Upon sale or disposition, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount less proceeds from disposal is charged or credited to income. Cost and related accumulated depreciation of property sold or otherwise disposed are removed from the accounts and any resulting gain or loss is included in operation.

Goodwill and intangible assets

The Company applies the provisions of FASB ASC 805, “Goodwill and Intangible Assets” (“FASB ASC 805”). Under FASB ASC 805, goodwill and intangible assets with indefinite useful lives are not amortized, but instead are tested for impairment at least annually.

Goodwill, with an infinite useful life, is stated at cost less accumulated impairment.

Pharmaceutical licenses, customer contracts, trademarks, technology know-how, and patents are stated at cost less accumulated amortization. Amortization is computed using straight-line method over estimated useful lives as follows:

Pharmaceutical licenses	10 years
Customer contracts, trademarks, technology know-how and patents	1–3 years

Land use rights

Land use rights are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the terms of the leases of 40 to 70 years obtained from the relevant PRC land authority.

Impairment of long-lived assets

Long-lived assets are tested for impairment in accordance with FASB ASC 360-10-45 “Impairment or Disposal of Long-Lived Assets”. The Company periodically evaluates potential impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company recognizes impairment of long-lived assets in the event that the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. During the reporting period, the Company has not identified any indicators that would require testing for impairment.

Revenue recognition

Revenue from sales of the Company’s products in both the wholesale and manufacturing segments is recognized upon customer acceptance. This occurs at the time of delivery to customer, provided persuasive evidence of an arrangement exists, such as a signed sales contract. The significant risks and rewards of ownership are transferred to the customer at the time when the products are delivered and there is no significant post-delivery obligation to the Company. In addition, the sales price is fixed or determinable and collection is reasonably assured. The Company does not provide customers with contractual rights of products. When there are significant post-delivery performance obligations, revenue is recognized only after such obligations are fulfilled. The Company evaluates the terms of sales agreement with its customer in order to determine whether any significant post-delivery performance obligations exist. Currently, the sales under both the wholesale and manufacturing segments do not include any terms which may impose any significant post-delivery performance obligations on the Company.

Revenue from sales of the Company’s products in its retail segment is recognized upon customer acceptance. This occurs at the time the product is purchased by the retail customers at the Company’s retail stores, and there is no significant post-delivery obligation, and collection is reasonably assured. The Company does not have a return policy allowing customers to return the products sold. When there are any significant post-delivery performance obligations, revenue is recognized only after such obligations are fulfilled. The Company evaluates the rules and regulations relating to the retail sales of drugs in the PRC in order to determine whether any significant post-delivery performance obligations exist. Currently, the rules and regulations relating to retail sales of drugs in the PRC do not include any provisions which may impose any significant post-delivery performance obligations on the Company.

Revenue from the sales of the Company’s product represents the invoiced value of goods, net of the value-added tax (VAT). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17 percent of the gross sales price. This VAT may be offset by VAT paid by the Company on raw and other materials included in the cost of producing the Company’s finished product products.

Advertising, research and development expenses

Advertising and research and development expenses are expensed as incurred.

Retirement benefit costs

Liuzhou BCT adopted a retirement plan to provide for eligible employees who were hired prior to April 23, 2002. These eligible employees are entitled to receive certain amounts. The amounts are based on the employees’ years of service in Liuzhou BCT up to April 23, 2002, upon termination or retirement from the company. The obligation of retirement benefit costs is recorded at the present value of the cost that is expected to settle the obligation and is recognized when the retirement plan is approved. Employees hired after April 23, 2002 are not entitled to this retirement plan.

Shipping and handling costs

Shipping and handling costs are expensed as incurred and are included in selling expenses.

Vendor allowances

The Company receives allowances from certain vendors whose products it purchases for resale. These allowances are received for a variety of buying activities such as the volume purchase allowance associated with the vendor programs. Consideration received from a vendor is a reduction in the cost of the inventory and is recognized as a reduction in the cost of goods sold. The Company also receives promotional allowance funds for specific vendor-sponsored programs per the allowance agreements. These promotional allowance funds are recognized as a reduction of cost of goods sold as the program occurs.

Store opening costs

Costs incurred in connection with store start-up costs, such as travel for recruitment, training, and setup of new store openings, are expensed as incurred.

Dividends

Dividends are recorded in the Company’s financial statements in the period in which they are declared.

Off-balance sheet arrangements

The Company does not have any off-balance sheet arrangements.

Income taxes

The Company uses the asset and liability method of accounting for income taxes pursuant to FASB ASC 740 "Income Taxes”. Under the asset and liability method of FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statements carrying amounts of existing assets and liabilities and loss carry forwards and their respective tax bases. 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.

Comprehensive income

The Company adopted FASB ASC 220, “Comprehensive Income”, which establishes standards for reporting and display of comprehensive income (loss), its components and accumulated balances. Components of comprehensive income (loss) include net income (loss) and foreign currency translation adjustments.

Concentrations of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and cash equivalents, restricted cash, accounts receivable, and amounts due from related companies. As of June 30, 2011 and December 31, 2010, substantially all of the Company’s cash and cash equivalents and restricted cash were held by major financial institutions located in the PRC, which management believes are of high credit standing. With respect to accounts receivable, the Company extends credit based on an evaluation of the customer’s financial condition. The Company generally does not require collateral for credit sales and maintains an allowance for doubtful accounts of accounts receivable.

During the six months ended June 30, 2011 and 2010, no single customer accounted for 10% or more of the Company’s consolidated sales and no single customer constituted 10% or more of the Company’s accounts receivable.

Foreign currency translation

The functional currency of the Company is RMB and RMB is not freely convertible into foreign currencies. The Company maintains its financial statements in the functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet date. 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.

Assets and liabilities of the Company’s operation are translated into the reporting currency, United States dollars, at the exchange rates in effect at the balance sheet dates. Revenues and expenses are translated at average rates in effect during the reporting periods. The resulting translation adjustment is reflected as accumulated other comprehensive income (loss), a separate component at stockholders’ equity in the consolidated statement of stockholders’ equity.

Basic and diluted earnings per share

The Company reports basic earnings per share in accordance with FASB ASC 260, “Earnings Per Share”. Basic earnings per share is computed using the weighted average number of shares outstanding during the periods presented. The weighted average number of shares of the Company represents the common stock outstanding during the reporting periods. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the periods plus the effect of dilutive securities outstanding during the periods.

Fair value of financial instruments

The Company adopted FASB ASC 820 on January 1, 2008. The adoption of FASB ASC 820 did not materially impact the Company's financial position, results of operations or cash flows.

FASB ASC 820 requires the disclosure of the estimated fair value of financial instruments including those financial instruments for which fair value option was not elected. The carrying amounts of the financial assets and liabilities approximate to their fair values due to short maturities or the applicable interest rates approximate the current market rates.

4.	Finance costs

	Three months ended				Six months ended
	June 30				June 30
	2011		2010		2011		2010

Bank and other loans interest	$	184,429	$	242,903	$	365,197	$	439,165
Bank charges		7,787		4,391		17,484		21,258
Finance charges from retirement
benefits costs		3,630		17,186		7,223		17,186

	$	195,846	$	264,480	$	389,904	$	477,609

5. Income taxes

United States

The Company is subject to the United States of America tax law at tax rates up to 34%. No provision for the US federal income taxes has been made as the Company had no taxable income in this jurisdiction for the reporting periods.

BVI

Ingenious was incorporated in the BVI and, under the current laws of the BVI, is not subject to income taxes.

Hong Kong

Forever Well is subject to the Hong Kong Profits tax at a tax rate of 16.5%. No provision for the Hong Kong Profits tax has been made as the Company had no taxable income in this jurisdiction since its incorporation.

PRC

Corporate income tax (“CIT”) to Liuzhou BCT and BCT Retail was charged at 25% starting from fiscal year 2008.

In accordance with the Circular of the State Council on Policies and Measures Pertaining to the Development of the Western Region (“DOWR”), the companies are entitled to preferential rate of 15% if they are engaged in the projects listed in Guiding Catalogue, and the revenue derived from accounts for over 70% of total revenue. Hefeng Pharmaceutical met this DOWR requirement; as a result, the tax authority approved and granted a preferential tax rate of 15% for fiscal years from 2003 to 2010. Hefeng is now taxed at a rate of 25% under the new tax law upon the expiration of the preferential treatment.

6. Earnings per share

Basic earnings per share has been computed using the weighted average number of common shares outstanding. Potential dilutive shares are excluded from the computation of earnings per share as average market price of the Company’s common stock did not exceed the weighted average exercise price of such options, warrants, preferred shares, and to have included them would have been anti-dilutive. Accordingly, the basic and diluted earnings per share are the same.

7.	Inventories

	June 30, 2011		December 31, 2010

Raw materials	$	1,207,256	$	860,993
Work-in-progress		205,758		160,730
Finished goods		15,045,145		9,755,154

	$	16,458,159	$	10,776,877

8.	Goodwill and other intangible assets, net



	June 30, 2011			December 31, 2010
Goodwill
Acquisitions of retail stores	$	462,312		$	452,450
Acquisition of Hefeng		107,968			107,968

Total	$	570,280		$	560,418

Other intangible assets
Pharmaceutical licenses	$	799,197		$	799,197
Customer contracts		90,729			90,729
Trademarks, technology know-how, and patents		106,667			99,892
		996,593			989,818
Accumulated amortization		(459,866	)		(408,337	)

Net	$	536,727		$	581,481

During the six months ended June 30, 2011 and 2010, amortization of intangible assets amounted to $51,883 and $32,568, respectively.

9.	Property, plant and equipment, net

Property, plant and equipment are stated at cost, as follows:

	June 30, 2011			December 31, 2010

Buildings	$	13,410,953		$	12,750,902
Plant and machinery		1,500,106			1,453,435
Furniture, fixtures and equipment		4,233,934			3,055,934
Motor vehicles		427,434			420,683
		19,572,427			17,680,954
Accumulated depreciation		(3,947,425	)		(3,437,366	)
		15,625,002			14,243,588
Construction in progress		-			362,300

	$	15,625,002		$	14,605,888

(a)

An analysis of buildings, plant and machinery pledged to banks for banking loans and facilities (note 13(d)(i)) is as follows :

	June 30, 2011			December 31, 2010

Buildings, plant and machinery	$	6,648,471		$	6,669,969
Accumulated depreciation		(1,500,204	)		(1,469,600	)

	$	5,148,267		$	5,200,369

10.	Land use rights

	June 30, 2011			December 31, 2010

Land use rights	$	16,190,028		$	15,848,693
Accumulated amortization		(2,622,290	)		(2,426,645	)

	$	13,567,738		$	13,422,048

The Company has obtained land use rights from the relevant PRC land authority. The lease terms of the land use rights range from 40 to 70 years, and permit the use of the land on which the office premises, production facilities, and warehouse of the Company are situated. As of June 30, 2011 and December 31, 2010, land use rights with carrying amount of $1,209,818 and $5,239,133, respectively, were pledged to a bank for the bank loans granted to the Company (note 13(d)(ii)).

During the six months ended June 30, 2011 and 2010, amortization of land use rights amounted to $137,863 and $156,143, respectively.

11. Amounts due to directors

The amounts due to directors are unsecured and repayable on demand. The balances are interest-free, except for the amounts of $46,410 as of June 30, 2011, and $75,700 as of December 31, 2010, which were interest bearing at fixed rate ranging from 6.96% to 8.16% per annum.

12. Amounts due from/to related companies

The related companies are controlled by certain of the Company’s directors including Mr. Huitian Tang, the Company’s Chief Executive Officer and Chairman. These amounts due from or to related companies are interest-free, unsecured and payable on demand.

13. Secured bank loans

	June 30, 2011			December 31, 2010

Short-term loans - note 13(a)	$	7,116,200		$	7,085,520
Current maturities of long-term bank loan		3,556,526			1,812,698

	$	10,672,726		$	8,898,218

Long-term bank loans - note 13(b)		3,800,419			3,754,305
Less: current maturities		(3,556,526	)		(1,812,699	)

	$	243,893		$	1,941,606

(a)

The weighted average interest rates for short-term loans as of June 30, 2011 and December 31, 2010 were 7.43% and 5.84% per annum, respectively.

(b)

The long term loans as of June 30, 2011 were interest bearing at variable rates ranging from PRC Benchmark rate plus 7.68% to PRC Benchmark rate plus 8.32% per annum, respectively.

(c)

As of June 30, 2011, the Company’s banking facilities were composed of the following:

Facilities granted	Granted		Amount Utilized		Unused
Bills payable	$	2,939,300	$	998,644	$	1,940,656
Secured bank loans	$	10,916,619	$	10,916,619	$	-

(d)	As of June 30, 2011, the above bills payable and bank loans were secured by the following:

(i)

Buildings, plant and machinery with carrying value of $5,148,267 (note 9);

(ii)

Land use rights with carrying value of $1,209,818 (note 10); and

(iii)

Buildings and land use rights owned by the related companies which are controlled by certain of the Company’s directors.

(e)	Long-term borrowings are repayable as follows:

	June 30, 2011		December 31, 2010

Within one year	$	3,556,526	$	1,812,698
After one year but within two years		82,327		1,742,903
After two years but within three years		89,444		83,935
After three years but within four years		72,122		90,902
After four years but within five years		-		23,867

	$	3,800,419	$	3,754,305

During the reporting periods, there was no covenant requirement under the banking facilities granted to the Company.

14.	Other loans

	June 30, 2011		December 31, 2010

Other loans from third parties bear interest at 7.2%.	$	169,087	$	162,664

15. Warrant liabilities

As of December 30, 2009, the Company completed a private placement of 2,489,370 shares of common stock and five-year warrants to purchase up to 1,244,368 shares of common stock (“First Batch Warrants”) at an exercise price of $3.81 per share for gross proceeds of $6,322,952 which include related issuance expenses of $1,016,290. In accordance with FASB ASC 815, these warrants are not considered indexed to the Company’s own stock and should be classified as financial derivative liabilities at fair value for each reporting period. However, the Company considered the amount to be immaterial to the financial statements for the year ended December 31, 2009 as the fair value of First Batch Warrants was $1,294,142 as of December 31, 2009, thus, none of the net proceeds were allocated to First Batch Warrants resulting in the entire amount recorded as equity.

Upon the completion of a private placement as of February 1, 2010, as stated in note 17(a), of which five-year warrants to purchase up to 514,933 shares of common stock (“Second Batch Warrants”) were issued to investors and should be classified as financial derivative liabilities at fair value for each reporting period in accordance with FASB ASC 815, the Company determined that the aggregate fair value of warrants issued as of February 1, 2010 was material to the financial statements for the three months ended March 31, 2010. Accordingly, a reallocation was made for the fair value of First Batch Warrants as of December 31, 2009 amounting to $1,294,142 from the Company’s equity to warrant liabilities as of February 1, 2010. For the Second Batch Warrants, part of the net proceeds amounting to $561,277, representing the fair value as of February 1, 2010, was allocated to warrant liabilities at initial recognition.

The fair value of the warrants was calculated using the binomial model. The assumptions that were used to calculate fair value of First Batch Warrants and Second Batch Warrants as of June 30, 2011 are as follows:

·	Expected volatility of 48.03% and 48.15%, respectively

·	Expected dividend yield of 0%

·	Risk-free interest rate of 1.62% and 1.66%, respectively

·	Expected lives of 3.50 years and 3.59 years for First Batch Warrants and Second Batch Warrants, respectively

·	Exercise price of $3.81 per share

As of June 30, 2011, the fair value of warrant liabilities was $697,149 and corresponding gain on change in fair value of warrant liabilities of $576,044 was recognized in the Company’s statement of income and comprehensive income for the six months ended June 30, 2011.

Warrants issued and outstanding, all of which are exercisable at June 30, 2011, are summarized as follows:

	Number of shares

First Batch Warrants		1,244,368
Second Batch Warrants		514,933

		1,759,301

16. Commitments and contingencies

Capital commitment

As of June 30, 2011, the Company had no capital commitments in respect of the acquisition of property, plant and equipment which were contracted for but not provided in the consolidated financial statements.

Operating lease commitments

As of June 30, 2011, the Company had non-cancelable operating leases for its retail stores and future minimum lease payments to be paid are as follows:


Year

Within one year	$	636,258
After one year but within two years		1,190,938
After two years but within three years		592,438
After three years		220,073

	$	2,639,707

The rental expense relating to the operating leases was $601,038 and $334,439 for the six months ended June 30, 2011 and 2010, respectively.

Operating lease arrangement

As of June 30, 2011, the Company leases its premises in PRC under an operating lease arrangement until 2013. Future minimum lease payments to be received under the non-cancelable operating leases are as follows:

	June 30, 2011		December 31, 2010

Within one year	$	34,517	$	29,251
After one year but within two years		8,440		-

	$	42,957	$	29,251

d.	Employment agreements

During 2010, the Company entered into employment agreements with Huitian Tang, the Company’s CEO, and Xiaoyan Zhang, the Company’s CFO. The employment agreements were approved by the board of directors and Compensation Committee. The following is a summary of the material provisions of the employment agreements for Mr. Tang and Ms. Zhang:

On May 18, 2010, the Company entered into an employment agreement with Mr. Tang to employ him as CEO for a term from January 1, 2010 to January 1, 2012, pursuant to which he will be paid RMB 79,600 ($11,600) per month (or RMB 955,200 ($139,200) per year) and additional share-based compensation based upon our 2010 financial performance (see note 19). The agreement may be terminated upon mutual agreement between the Company and Mr. Tang in writing. In addition, the Company shall have the right to unilaterally terminate the agreement under certain circumstances, including, among other things, (i) serious violations of the labor laws or the rules or regulations of the Company; (ii) causing serious damage to the interests of the Company; or (iii) Mr. Tang is criminally prosecuted under the law.

In 2011, the Board of Directors authorized and approved to increase Mr. Tang’s annual salary from US$139,000 to US$200,000 starting from January 6, 2011.

The Company may also terminate the agreement by serving 30 days' prior written notice to Mr. Tang or giving Mr. Tang one month’s salary in lieu of notice in any one of the following circumstances: (i) where Mr. Tang, after undergoing a legally prescribed period of medical treatment and recuperation for an illness or a non-work-related injury, remains unable to carry out his job responsibilities; (ii) where Mr. Tang is unable to fulfill the duties of his position to the standards required under the terms of the agreement; or (iii) where the agreement cannot be performed due to any major changes of any objective circumstances, which includes, but is not limited to, a merger of the Company into another business entity, or sale or transfer by the Company of substantial portion of the assets it owns to third parties, a material adjustment in operative policy, or a declaration of bankruptcy, dissolution or liquation by the Company.

Mr. Tang may terminate the agreement during the term upon 30 days prior written notice to the Company. In addition, Mr. Tang may terminate the agreement in certain circumstances, including if (i) the Company fails to pay the social insurance premiums for Mr. Tang in accordance with the law; (ii) the Company forces Mr. Tang to work by means of violence or intimidation; or (iii) the Company fails to pay labor remuneration in full and on time or fails to provide the labor protection or working conditions as agreed under the agreement.

On May 18, 2010, the Company entered into an employment agreement with Ms. Zhang to employ her as CFO for a term from January 1, 2010 to January 1, 2012, pursuant to which we have agreed to pay her HKD70,000 ($9,091) per month (or HKD840,000 ($109,092) per year) and additional share-based compensation based upon our 2010 financial performance (see note 19).

In 2011, the Board of Directors authorized and approved to increase Ms. Zhang’s annual salary from US$109,092 to US$160,000 starting from January 6, 2011.

The agreement may be terminated upon mutual agreement between the Company and Ms. Zhang in writing. In addition, the Company shall have the right to unilaterally terminate the agreement under certain circumstances, including, among other things, (i) serious violations of the labor laws or the rules or regulations of the Company; (ii) causing serious damage to the interests of the Company; or (iii) Ms. Zhang is criminally prosecuted under the law.

The Company may terminate the agreement by serving 30 days' prior written notice to Ms. Zhang or giving Ms. Zhang one month’s salary in lieu of notice in any one of the following circumstances: (i) where Ms. Zhang, after undergoing a legally prescribed period of medical treatment and recuperation for an illness or a non-work-related injury, remains unable to carry out her job responsibilities; (ii) where Ms. Zhang is unable to fulfill the duties of her position to the standards required under the terms of the agreement; or (iii) where the agreement cannot be performed due to any major changes of any objective circumstances, which includes, but is not limited to, a merger of the Company into another business entity, or sale or transfer by the Company of substantial portion of the assets it owns to third parties, a material adjustment in operative policy, or a declaration of bankruptcy, dissolution or liquation by the Company.

Ms. Zhang may terminate the agreement during the term upon 30 days prior written notice to the Company. In addition, Ms. Zhang may terminate the agreement in certain circumstances, including if (i) the Company fails to pay the social insurance premiums for Ms. Zhang in accordance with the law; (ii) the Company forces Ms. Zhang to work by means of violence or intimidation; or (iii) the Company fails to pay labor remuneration in full and on time or fails to provide the labor protection or working conditions as agreed under the agreement.

Registration payment agreements

On December 30, 2009, the Company completed a private placement of 2,489,370 shares of common stock and warrants to purchase up to 1,244,368 shares of common stock at an exercise price of $3.81 per share. In connection with the private placement, warrants to purchase up to 248,937 shares of common stock at an exercise price of $3.05 per share were issued to the Co-Placement Agents.

Pursuant to the subscription agreement, the Company was required to file a registration statement (the “Registration Statement”) under the Securities Act of 1933, as amended, (i) registering for resale by the investors for 2,489,370 shares of common stock and the warrants to purchase up to 1,244,368 shares of common stock issued to the investors; and (ii) registering for resale for the Co-Placement Agents for the warrants to purchase up to 248,937 shares of common stock (all of the foregoing securities being collectively referred to herein as the “Registrable Securities”). The Company agreed to use its best efforts to file the Registration Statement within 30 days from the Second Closing, dated February 1, 2010 (“Registration Filing Date”) and to have the Registration Statement declared effective prior to the 150th day following the Second Closing, provided, however, that in the event of a “full review” by the SEC, the Company shall be afforded an additional 30 days and shall have the Registration Statement declared effective prior to the 180th day following the Second Closing (the “Registration Effective Date”).

In the event that (i) the Registration Statement has not been filed on or prior to the Registration Filing Date or declared effective by the SEC on or before the Registration Effective Date; and (ii) the Registrable Securities included in such Registration Statement are not saleable under Rule 144, the Company shall pay to each investor as liquidated damages, a cash payment equal to 1% of the aggregated amount invested by such investors in the private placement for the first 30 days and 1% of the aggregated amount vested by such investors in the private placement for every 30-day period thereafter until the registration statement has been filed and/or declared effective, or such proportionate percentage for any period less than 30 days. In accordance with FASB ASC 825-20, if the Company determines a registration payment arrangement is probable and can be reasonably estimated, a liability will recorded. Provision for registration payment has been provided in the amount of $178,783. As of June 30, 2011 and up to the date of approval of these financial statements, it is not considered probable that the Company will be required to make any further payments under the registration rights arrangement and therefore no provision for such contingent liability has been made.

Distribution agreements

During September of 2010, the Company entered into separate distribution agreements with three government-owned hospitals, each for a term of three years, pursuant to which the hospitals agreed to further increase its business with them ranging from 30% to 95% of their respective purchase plans for its drugs. The Company agreed to use its best efforts to fulfill the orders by distributing the drugs under the statutory requirement of the mandated collective tender plan.

During the six months ended June 30, 2011, the Company entered into separate distribution agreements with another three government-owned hospitals for a term of three years, pursuant to which the hospitals agreed to further increase its business with them from 30% to 40% of their respective purchase plans for its drugs.

In addition to the existing deposits of RMB 23,000,000 ($3,558,100) paid in 2010, the Company made another deposit totaling RMB 22,000,000 ($3,403,400) for the security of these new distribution agreements entered in 2011. These hospitals are required to repay the deposit amounts in full when the agreements expire or when terminated, which may be done only under certain circumstances. The Company entered into such agreements to pursue relationships with these large hospitals in order to achieve a higher share of these customers’ purchases.

The Company anticipates the revenues derived from the existing distribution agreements will contribute additional revenue of approximately $7 million annually. Additional $6 million revenues has been contributed for the nine months from October 2010 to June 30, 2011 derived from these three hospitals after signing the distribution agreements during September 2010. The Company believes that the revenues from these distribution agreements entered in 2011 will contribute additional revenue of $14 million annually, commencing in the third or fourth quarter of 2011.

17.	Convertible redeemable preferred stock

On January 18, 2011, the Company entered into a Series A Convertible Preferred Shares Purchase Agreement (the “Purchase Agreement”) with Milestone Longcheng Limited (“Milestone”) pursuant to which Milestone on February 28, 2011 purchased 9,375,000 shares of the Company’s Series A Convertible Preferred Shares, par value $.001 per share (the “Preferred Shares”), for an aggregate purchase price of $30,000,000. The Preferred Shares carry a dividend of 5% and are convertible initially into an equal number of shares of our Common Stock at an initial conversion price of $3.20 per share.

Upon the consummation of a qualified public offering (as defined in the Purchase Agreement) in which the sale price of the Preferred Shares exceeds the product of 2.0 multiplied by the initial conversion price (as adjusted from time to time as provided in the Purchase Agreement), without the payment of additional consideration thereof, all the Preferred Shares shall be automatically converted into Conversion Shares at the then applicable Conversion Rate.

The holders of the Preferred shares may require the Company to redeem all or any portion of the outstanding Preferred Shares upon the occurrence of certain events, including: (a) any change of control of the Company;(b) any substantial asset sale; (c) any consolidation or merger or acquisition or sale of voting securities of the Company resulting in the holders of the issued and outstanding voting securities of the Company immediately prior to such transaction beneficially owning or controlling less than a majority of the voting securities of the continuing or surviving entity immediately following such transaction;(d) any tender offer, exchange offer or repurchase offer for any common shares;(e) cessation of listing of the common shares (or equity securities of an entity that holds all or substantially all the share capital of the Company) on an internationally recognized exchange; (f) it has been three years since the issue date (g) cessation of provision of services by Mr. Huitian Tang to the Company or any of its Subsidiaries by reason of resignation, discharge, death, disability, retirement or otherwise.

The redemption price to be paid by the Company for such required redemptions shall be equal to an amount necessary to provide an annual return of fifteen percent (15%) compounded annually on the stated value of the Preferred Shares for the period commencing on February 28, 2011 and ending on the applicable redemption date. The redemption price shall take into account and be credited with any dividends paid during such period.

The conversion price shall be subject to adjustment as follows if any of the events listed below occur prior to the conversion of any Preferred Shares being converted:

(a)

In the event the Company pays a dividend or makes a distribution on its common shares in common shares, subdivides or reclassifies its outstanding common shares into a greater number of shares, or consolidates or reclassifies its outstanding common shares into a smaller number of shares, the conversion price in effect immediately prior to such event shall be adjusted so that the holders of the Preferred Shares thereafter converted shall be entitled to receive the number of common shares of the Company which they would have owned or have been entitled to receive after the occurrence of such event had the Preferred Shares been converted immediately prior to the occurrence of such event.

(b)

In the event the Company issues common shares, issues rights, options or warrants to subscribe for or purchase common shares, or issues or sells other rights for common shares or securities whether or not convertible or exchangeable into common shares for a consideration per share less than the then effective conversion price on the date the Company issues or sells such securities, then in each such case the conversion price in effect immediately prior to the issuance of such securities shall be reduced, concurrently with the issue of such securities, to the price appropriately readjusted.

(c)

In the event the Company’s net income after tax under U.S. GAAP, but excluding the effects of extraordinary gains, and non-cash expenses relating to options and warrants, and qualified public offering related expenses as and when expensed in the Company’s audited annual financial statements for the twelve-month period ending December 31, 2011, and prepared on a pro forma basis, is less than US$31,200,000, the conversion price shall be adjusted, effective on the date of the issuance of the 2011 annual audited financial statements.

(d)

In the event the Company distributes to all holders of its common shares any share capital of the Company (other than common shares) or evidences of indebtedness or cash or other assets (excluding regular cash dividends or distributions paid from retained earnings of the Company and dividends or distributions referred to in (a) above) or rights, options or warrants to subscribe for or purchase any of its securities (excluding those referred to in (b) above) then, in each such case, the conversion price shall be adjusted.

(e)

In the event any securities of the Company (other than Preferred Shares) , are amended or otherwise modified by operation of their terms or otherwise in any manner whatsoever that results in the reduction of the exercise, conversion or exchange price of such securities payable upon the exercise for, or conversion or exchange into, common shares or other securities exercisable for, or convertible or exchangeable into, common shares and/or such securities becoming exercisable for, or convertible or exchangeable into more shares or a greater amount of such securities which are, in turn exercisable for, or convertible or exchangeable into, common shares, or more common shares, then such amendment or modification shall be treated as if the securities which have been amended or modified have been terminated and new securities have been issued with the amended or modified terms for purposes of Section (b) above.

We classify the Preferred Shares as temporary equity in accordance with ASR 268 (Securities and Exchange Commission, Financial Reporting Codification, Section No. 211, Redeemable Preferred Stocks) because the Preferred Shares contain a conditional obligation that may require us, at the option of the holders, to redeem some or all of these shares by transferring our assets upon the occurrence of certain events that are not solely within the control of the Company.

The initial fair value of the Preferred Shares was $29,495,865 representing the transaction price of $30,000,000, in accordance with the FASB ASC 820-10-30-3, less related issue costs of $504,134.

We evaluated the economic characteristics and risks of the conversion feature as an embedded derivative and determined such economic characteristics and risks are clearly and closely related to the host contract. Therefore, the conversion feature does not meet the requirements of FASB ASC 815-15-25-1.a. for bifurcation and separate fair value accounting.

The Company has elected to adjust the carrying amount of the Preferred Shares at each reporting date by applying periodic accretions, using the interest method, so that the carrying amount will be equal to the possible redemption amount at the earliest determinable redemption date of February 28, 2014. As of June 30, 2011, such accretion amount was $1,056,015 resulting in a carrying amount for the Preferred Shares of $30,551,881 at that date. The Company has recorded a dividend payable of $500,000 as of June 30, 2011.

18.	Common stock and additional paid-in capital


					Additional
	Number of				paid-in
	shares		Amount		capital

Balance, January 1, 2011		38,154,340	$	38,154	$	16,633,411
Share-based compensation - Note 19		-		-		571,314

Balance, June 30, 2011		38,154,340	$	38,154	$	17,204,725

On December 29, 2010, the Board of Directors of the Company unanimously adopted a resolution approving the amendment and restatement of the Certificate of Incorporation to increase the authorized Common Stock of the Company from 100,000,000 shares to 150,000,000 shares and was effective on February 28, 2011 after filing the Certificate of Amendment.

19.	Stock option arrangements

On June 27, 2010, we adopted the China BCT Pharmacy Group, Inc. 2010 Omnibus Securities and Incentive Plan (the “Plan”) for the benefit of our employees, nonemployee directors and consultants and the employees, nonemployee directors and consultants of its affiliates, for purposes of assisting us to attract, retain and provide incentives to key management employees and nonemployee directors, and consultants of ours and our affiliates, and to align the interests of such individuals with those of our stockholders. Accordingly, the Plan provides for the granting of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, restricted stock unit awards, stock appreciation rights, tandem stock appreciation rights, unrestricted stock awards or any combination of the foregoing, as may be best suited to the circumstances of the particular employee, director or consultant as provided in the Plan.

On June 27, 2010, we granted options under the Plan to two executive employees. The options vest and become exercisable with respect to all of the shares only if our after-tax net income for fiscal 2010 equals at least U.S. $26,000,000 (excluding any non-cash expenses) (the “2010 Income Target”), determined on the basis of our audited financial statements for our 2010 fiscal year, as confirmed by our independent auditor in their report on said financial statements (the “Audit Report”). If the 2010 Income Target is met, the options shall vest and become exercisable on the date on which the Audit Report is dated, and if the options do not become exercisable due to the failure to meet the 2010 Income Target, the option shall terminate on the date on which the Audit Report is dated.

On July 16, 2010, we entered into separate stock option agreements with each of our three independent directors, Messrs. Lee, Choi and Chiu, which agreements provide for the grant to each such individual of an option to purchase 10,000 shares of our common stock at an exercise price of $4.00 per share. Each option vests and becomes exercisable with respect to all of the shares on June 6, 2011. The exercise price of each option may be paid for in cash or by cancellation of existing shares of our common stock held by the independent directors. Each option terminates on the earlier of (i) July 16, 2015 or (ii) the date as of which the option has been fully exercised. On August 18, 2010, we entered into separate stock agreements with two senior staff, which agreements provide for the grant to each such individual of an option to purchase 10,000 and 5,000 shares separately of our common stock at an exercise price of $5.00 per share. Each option vests and becomes exercisable on January 1, 2012 so long as they are employed by the Company as of December 31, 2011.

The fair value of options granted to the two executive employees at the date of grant was $1,774,440. Fair values were estimated using the binominal model. The assumptions that were used to calculate fair value of stock options as of June 27, 2010 were: 0% dividend yield, expected volatility of 30%, risk-free interest rate of 4.78% an exercise multiple of 2, and a post-vesting forfeiture rate of 0%. The Company expensed the remaining compensation cost of $565,763 for the six months ended June 30, 2011 related to non-vested awards upon the 2010 Income Target being concluded.

The fair value of options granted to the three independent directors at the date of grant was $41,010 and was expensed in share-based compensation for the year ended December 31, 2010. Fair values were estimated using the binominal model. The assumptions that were used to calculate fair value of stock options as of July 16, 2010 were: 0% dividend yield, expected volatility of 41.8%, risk-free interest rate of 3.427% an exercise multiple of 2, and a post-vesting forfeiture rate of 0%.

The fair value of options granted to the two senior staff at the date of grant was $15,365. Fair values were estimated using the binominal model. The assumptions that were used to calculate fair value of stock options as of August 18, 2010 were: 0% dividend yield, expected volatility of 51.31%, risk-free interest rate of 2.46% an exercise multiple of 2, and a post-vesting forfeiture rate of 0%. The Company expensed $5,551 in share-based compensation for the six months ended June 30, 2011. The remaining compensation cost of $5,643 related to non-vested awards will be recognized over the implied remaining requisite service period of July 1, 2011 through December 31, 2011 for both options.

The Company expensed the above options in share-based compensation included in administrative expense in the amount of $571,314 and $25,717 for the six months ended June 30, 2011 and 2010, respectively.

There were no options granted with exercise prices below the market value of the stock at the grant date. All outstanding options at June 30, 2011 had no intrinsic value because the Company’s stock price was lower than all option exercise prices. A summary of the Company’s stock options outstanding as of June 30, is presented below:

	Number of options		Exercise Price
Stock options granted and outstanding		15,000	$	5.00
Stock options granted and outstanding		1,110,000	$	4.00

20. Defined contribution plan

Pursuant to the relevant PRC regulations, the Company is required to make contributions at a rate of 30.5% to employees’ salaries and wages to a defined contribution retirement scheme organized by a state-sponsored social insurance plan in respect of the retirement benefits for the Company’s employees in the PRC. The only obligation of the Company with respect to the retirement scheme is to make the required contributions under the plan. No forfeited contribution is available to reduce the contribution payable in the future years. The defined contribution plan contributions were charged to the consolidated statements of income. The Company contributed $308,448 and $225,548 for the six months ended June 30, 2011 and 2010, respectively.

21. Acquisitions of distributors

During the second quarter of 2011, the Company acquired the businesses of two sub-distributors and one vendor engaged in packaging of Chinese traditional herbs. The acquisitions were structured in such a manner that the Company assumed liabilities equal to the estimated fair value of the assets acquired. No additional consideration was paid, or is payable. The following summarizes the major class of assets acquired and liabilities assumed at the date of acquisition:

Cash	$	36,502
Inventory		751,112
Accounts receivable		4,737,280
Other current assets (a)		5,724,522
Property, plant and equipment		35,006
Accounts payables		(1,783,102	)
Other current liabilities (b)		(9,501,320	)

Total	$	-

(a) Includes amounts due from the Company of 5,397,757 that are eliminated in consolidation.

(b) Includes amounts due to the Company of $4,127,756 that are eliminated in consolidation.

22. Segment information

The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. Management, including the chief operating decision maker, reviews operating results solely by monthly revenue of Pharmaceutical distribution, retail pharmacy and manufacturing pharmacy segments and operating results of the Company and, as such, the Company has determined that the Company has three operating segments as defined by FASB ASC 280 : pharmaceutical distribution, retail pharmacy and pharmacy manufacturing.

	Three Months Ended,				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010

Net Sales
Wholesale	$	48,493,250	$	33,347,366	$	91,744,421	$	56,666,289
Retail		13,151,576		11,611,241		25,700,933		20,513,865
Manufacturing		3,470,922		2,534,111		6,273,634		4,441,442

	$	65,115,748	$	47,492,718	$	123,718,988	$	81,621,596

	Three Months Ended,				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010

Operating Income
Wholesale	$	7,769,085	$	6,085,974	$	14,328,166	$	9,508,069
Retail		2,485,093		3,066,440		4,273,249		4,837,011
Manufacturing		1,774,233		1,386,825		3,244,874		2,396,070

	$	12,028,411	$	10,539,239	$	21,846,289	$	16,741,150

	Three Months Ended,					Six Months Ended
	June 30,					June 30,
	2011			2010		2011		2010

Depreciation and Amortization Expenses
Wholesale		$	122,347	$	94,320	$	292,106	$	292,350
Retail			46,202		10,118		89,596		11,408
Manufacturing			160,048		146,143		311,376		271,223

		$	328,597	$	250,581	$	693,078	$	574,981

	June 30,		December 31,
	2011		2010

Assets
Wholesale	$	150,453,417	$	108,182,966
Retail		16,291,294		16,860,112
Manufacturing		18,256,211		16,386,308

	$	185,000,922	$	141,429,386

A reconciliation is provided for unallocated amounts relating to corporate operations which is not included in the segment information.

	Three months ended						Six months ended
	June 30						June 30
	(Unaudited)						(Unaudited)
	2011			2010			2011			2010

Total consolidated revenue	$	65,115,748		$	47,492,718		$	123,718,988		$	81,521,596

Total profit for reportable
segments		12,028,411			10,539,239			21,846,289			16,741,150
Unallocated amounts relating to
operations:
Change in fair value of warrant liabilities		300,662			(418,027	)		576,044			(706,810	)
Share based compensation		(2,791	)		(25,717	)		(571,314	)		(25,717	)
Interest income		21,708			-			21,708			-
Exchange difference		72,047			-			72,047			-
Other general expenses		(576,605	)		(487,212	)		(1,363,643	)		(648,329	)
Finance costs		(754	)		(271	)		(1,185	)		(2,612	)

Income before income taxes	$	11,842,678		$	9,608,012		$	20,579,946		$	15,357,682

	June 30,		December 31,
	2011		2010
	(Unaudited)		(Audited)

Assets
Total assets for reportable segments	$	185,000,922	$	141,429,386
Cash and cash equivalents		10,782,053		109,650

	$	195,782,975	$	141,539,036

All of the Company’s long-lived assets and revenues are located in the PRC.

23. Subsequent events

The Company has evaluated subsequent events through the filing date of this Form 10-Q and has determined that there were no other subsequent events to recognize or disclose in these financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q and other reports filed by the Company from time to time with the Securities and Exchange Commission (collectively the “Filings”) contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available to, the Company’s management as well as estimates and assumptions made by Company’s management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the filings, the words “anticipate”, “believe”, “estimate”, “expect”, “future”, “intend”, “plan”, or the negative of these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors, including the risks contained in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission, relating to the Company’s industry, the Company’s operations and results of operations, and any businesses that the Company may acquire. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results.

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.

Overview

Business Review

We are engaged in pharmaceutical distribution, retail pharmacy and manufacture of pharmaceuticals through our three subsidiaries Liuzhou BCT, Hefeng Pharmaceutical, and BCT Retail, each of which is located in Guangxi Province, China.

We have integrated operations in the following three business segments.

Pharmaceutical distribution segment

We provide a comprehensive offering of pharmaceutical and healthcare products, including branded and generic prescription medicines, over-the counter medicines, Western and Chinese medicines, as well as personal care products and medical supplies, Chinese herbs, and medical instruments from manufacturers and suppliers through distribution to our customers, including hospitals, retail drug stores, other pharmaceutical wholesalers, clinics, medical centers, and individuals located mainly in Guangxi Province except for the other pharmaceutical wholesalers. Over 8,000 products are distributed in compliance with China’s regulations over the pharmaceutical industry. For the six months ended June 30, 2011, our pharmaceutical distribution segment accounted for approximately 74.5% of our total revenue after elimination of inter-segment sales. Revenue derived from Chinese herbal medicine, family planning products, medical instruments, injection drugs and other packaged medicine drugs constituted 1.3%, 0.1%, 0.1%, 14.5%, and 84% of our pharmaceutical distribution segment’s total revenue for the six months ended June 30, 2011, respectively.

The terms of our distribution agreements vary between suppliers and vary in terms of payment period, arrangement of delivery, pricing and quality requirements. The general payment period terms vary from advance deposit, to cash on delivery, and to payment up to 90 days from the date of delivery, and the payment can be settled by means of bank collection, remittance, bills payable, postal check.

Retail pharmacy segment

BCT Retail operates a large regional retail pharmacy network of stores in Guangxi province, consisting of 187 directly owned retail stores under the registered name “Baicaotang 百草堂” as of June 30, 2011. Our retail stores provide high-quality convenient and professional pharmaceutical services, and supply a wide variety of medicines for selling prescription medicines, over-the-counter medicines, Chinese herbal medicine, roughly processed Chinese herbal medicine, family planning products, and other pharmaceutical products and healthcare products. Revenue from the retail pharmacy segment is generated by cash sales or medi-card reimbursement from the national insurance plan. There is no difference in the sales price of our products in our medi-care qualified stores between cash and medi-card payment. No co-payment is collected with respect to payments by medi-card. For the six months ended June 30, 2011, our retail pharmacy segment accounted for approximately 20.1% of our total revenue after elimination of the inter-segment sales

The following table sets forth the accounts receivable from the National Program for our retail pharmacy segment as of June 30, 2011 and December 31, 2010:

	As of June 30,		As of December 31,
	2011		2010
Payor		(000)		(000)
National Program	$	438	$	349

Our billing system does not currently have the capacity to generate an aging schedule for all of our receivables. Nevertheless, we are able to create aging schedules by reference to data from our accounting system. The payment from the National Program is made on a lump sum basis after the invoices are approved. Our system is linked with the one at National Program. At the end of each month, we reconcile our records with those of the National Program and send invoices to it for reimbursement. Once amounts are confirmed by the National Program, such amounts due for the current month will be available for reimbursement. No allowance for bad debts has been made as medi-card reimbursement under the national insurance program is assured.

Manufacturing segment

Located in Donglan District, Guangxi province and built on approximately 40,000 square meters of land of which we own the use rights, Hefeng Pharmaceutical has four product processing units: (1) Chinese herbal medicine abstraction unit for raw material and medicine paste with 670 tons of annual abstraction capacity; (2) granular formulation unit with an annual production capacity of 0.25 billion packages; (3) pill formulation unit with annual production capacity of 0.36 billion pills, and (4) liquid formulation unit with an annual production capacity of 0.1 billion injections. We manufacture and sell both the generic and clinic drugs all over the China. For the six months ended June 30, 2011, our manufacturing segment accounted for approximately 5.4% of our total revenue after elimination of the inter-segment sales.

Growth Strategy

Pharmaceutical distribution segment

We expect to focus on obtaining more contracts for the distribution side of our business. As the centralized bidding for the 2011 contract was closed in the second quarter of year 2011, so far, to our best knowledge, we have won 2,000-3,000 more product distribution rights with regard to our hospital and clinic clients, which represents approximately a 50% increase compared to our product distribution rights in 2010. In addition, we have almost doubled the number of bids awarded to us for counties and cities under the New Rural Cooperate Medicare from the 6 counties and cities that were awarded to us in last year’s bidding.

Retail pharmacy segment

We are continuously focusing on rapidly growing our retail pharmacy networks by selectively acquiring drugstore chains to establish a presence in new markets. In particular, we plan to grow through first acquiring similar businesses in the cities in Guangxi province and then acquiring business targets outside of the Guangxi province. We target retail chains or individual stores in prime locations and with good brand names, well-developed facilities and customer bases that are complementary to ours, and which are commercially attractive. We believe that our relationship with many industry participants and our knowledge of, and operational expertise in, the drugstore market in China will assist us in making acquisitions. We also believe that we can rapidly and successfully integrate newly acquired stores into our current distribution network and quickly realize operating and financial benefits.

We intend to spend additional money and effort to open and acquire more chain stores in 2011 and 2012. We will put priority in focusing on quality rather than quantity of the stores that we are going to acquire. However, there are no assurances that such expansion strategy will be delivered at desirable price. As a result, we may not be able to fully implement our growth strategy.

Manufacturing segment

We have registered one of our existing product license for Levodopa raw materials successfully in India and we are now planning to invest in the construction of a production workshop for it. The production is expected to begin by the end of the year 2011 and we anticipate that these products will contribute revenue commencing by the end of the year 2011.

Effect of Price Controls on Our Operating Results

A number of our pharmaceutical products, primarily those included in the national and provincial medical insurance catalogs, are subject to price controls in the form of fixed retail prices or retail price ceiling controls administered by the Price Control Office under the National Development and Reform Commission, or the NDRC, and provincial price control authorities. Approximately 60% to 70% of our total retail sales are subject to price controls. The retail prices of these products are also subject to periodic downward adjustments as the PRC governmental authorities seek to make pharmaceutical products more affordable to the general public. Any future price controls or government mandated price reductions may cause potential variability of our earnings and cash flows.

RESULTS OF OPERATIONS

Three months ended June 30, 2011 compared to three months ended June 30, 2010.

The following table sets forth the key components of our results of operations for the periods indicated.

	Three months ended June 30
	2011							2010
		‘000			% of total sales				‘000		% of total sales
Sales revenue	$	65,116			100.0			$	47,493		100.0
Cost of sales		49,043				75.3			34,879			73.4
Gross profit		16,073				24.7			12,614			26.6
Operating expenses
Administrative expenses		2,685				4.1			1,294			2.8
Selling expenses		1,771				2.7			1,060			2.2
Total operating expenses		4,456				6.8			2,354			5.0

Income from operations		11,617				17.8			10,260			21.6

Non-operating income (expense)
Interest income		24				-			4			-
Other income		115				0.2			28			-
Change in fair value of warrants liabilities		301				0.5			(418	)		(0.9	)
Other expenses		(18		)		-			(1	)		-
Finance costs		(196		)		(0.3	)		(265	)		(0.6	)
Total non-operating income (expense)		226				0.3			(652	)		(1.5	)

Income before income taxes		11,843				18.2			9,608			20.2

Income taxes		(3,240		)		(5.0	)		(2,476	)		(5.2	)

Net income			8,603			13.2			7,132			15.0
Other comprehensive income
Foreign currency translation adjustments		1,997				3.1			(26)			-
Total comprehensive income	$	10,600				16.3		$	7,106			15.0

The table below sets forth a breakdown of our external segment revenue after elimination of inter-segment sales, and each segment revenue item as a percentage of our total revenue, as well as our inter-segment sales for the three months ended June 30, 2011 and June 30, 2010. For the three months ended June 30, 2011, we had approximately $10.6 million of inter-segment revenue, which includes approximately $10.3 million in sales from our distribution segment to our retail segment, and approximately $0.3 million in sales from our manufacturing segment to our distribution segment. External segment revenue refers to segment revenue after inter-segment elimination.

	Three months ended June 30,
	2011				2010
External Segment revenue		‘000	%			‘000	%
Pharmaceutical distribution	$	48,493		74.5	$	33,348		70.2
Retail pharmacy		13,152		20.1		11,611		24.5
Manufacturing pharmacy		3,471		5.4		2,534		5.3
	$	65,116		100.0	$	47,493		100.0
Inter-segment revenue	$	10,654			$	6,649

Sales Revenue

During the three months ended June 30, 2011, we had sales revenue of $65.1 million, as compared to sales revenue of $47.5 million during the three months ended June 30, 2010, an increase of $17.6 million or approximately 37.1%. This increase was mainly attributable to the respective increases in sales revenue of $15.1 million and $1.5 million from our distribution segment and our retail segment during the period, respectively.

Pharmaceutical distribution segment

We derive the majority of our revenue from our pharmaceutical distribution segment from sales of pharmaceutical products to our customers. We distribute a comprehensive offering of pharmaceutical and health care products, including branded and generic prescription medicines, over-the-counter medicines, Western and traditional Chinese medicine (“TCM”), as well as personal care products and medical supplies.

The following table sets forth revenue from our pharmaceutical distribution operations by category of customers:

	Three months ended June 30,
	2011				2010
		‘000	%			‘000	%
Hospitals	$	30,545		63.0	$	25,633		76.9
Other drug stores		8,454		17.4		51		0.2
Clinics and health care centres		6,227		12.8		3,954		11.9
Distributors and others		3,267		6.8		3,710		11.0
Total	$	48,493		100.0	$	33,348		100.0

Revenue from our pharmaceutical distribution segment increased by 45.6% from $33.3 million for the three months ended June 30, 2010 to $48.5 million for the three months ended June 30, 2011. The increase in revenue of $15.1 million is the result of the increase in volume by $15.5 million and offset with the price reduction of approximately $0.7 million. The change in price is attributed mainly to the change in prices paid by hospitals based upon the PRC Government-mandated collective tender process. The increase in sales revenue from our pharmaceutical distribution segment was attributed primarily to the increase of $8.4 million to other drug stores. There was a further increase of $4.9 million in sales to hospitals and $2.3 million in sales to clinics and other health care centers concurrently. The increase in sales to other drug stores was the result of the increase in the quantity and range of products to new stores as a result of our marketing effort at the rural area. The increase in sales to hospitals was the result of an increase in the quantity and range of products sold to our existing hospital clients, which was attributable to the increase in coverage by the national insurance plan and the implementation of the New Rural Cooperative-Medicare plan. Further, we have entered into separate distribution agreements with six government-owned hospitals since the third quarter of 2011. Our share of hospital purchases has been increased with these new agreements.

Retail pharmacy segment

Revenue from our retail pharmacy segment increased by 13.8% from $11.6 million for the three months ended June 30, 2010 to $13.2 million for the three months ended June 30, 2011. The increase in revenue resulted from the increase in sales volume of $2.3 million after the offset of the price reduction by approximately $0.8 million. The increase in volume of sales was primarily attributed to the 62 stores opened since the second quarter of year 2010 inclusive of the 8 stores newly opened during the three months ended June 30, 2011. The slight reduction in our retail prices was the result of the adjustment of our selling prices in accordance with the price control office. The reduction in sales from the existing stores was mainly due to the increase in the number of the drug stores within the saturated market.

The following table sets forth revenue from our retail pharmacy segment by existing stores and new stores opened during each period.

	Three months ended June 30,
	2011		2010
		(000)		(000)
Existing stores	$	10,639	$	8,207
New stores (1)		2,513		3,404
Total	$	13,152	$	11,611
Number of stores		187		125

(1) Represents the 62 stores opened after period ended June 30, 2010, including the 8 stores opened during the three months ended June 30, 2011. The sales derived from those stores opened for the three months ended June 30, 2011 were $296,437.

Manufacturing segment

Revenue from our manufacturing segment increased by 37.0% from $2.5 million for the three months ended June 30, 2010 to $3.5 million for the three months ended June 30, 2011. The increase was attributed to the volume of sales solely as there were no changes in prices between the periods. The increase in sales was attributed to the increase in sales through the penetration of sales to distributors as a result of efforts made by our sales representatives.

Cost of Sales

Cost of sales was $49.0 million for the three months ended June 30, 2011 as compared to $34.9 million for the three months ended June 30, 2010. Our cost of sales consists of the cost of merchandise and raw materials and other costs. Other costs include direct labor, packaging, depreciation and other overhead expenses. The increase was primarily due to an increase in the costs of purchasing merchandise following the increase in our revenue.

Gross Profit

Gross profit was $16.1 million for the three months ended June 30, 2011 as compared to $12.6 million for the three months ended June 30, 2010, representing an increase of $3.5 million or approximately 27.8%. Our gross profit margin was 24.7% and 26.6% for the three months ended June 30, 2011 and 2010, respectively. The gross profit margin was relatively stable as we maintained the margin between our cost of purchasing pharmaceutical products from our suppliers and our prices of pharmaceutical products sold to our hospital, pharmaceutical distributor and other customers. For hospital customers, we establish a pricing range aligned with our suppliers through the PRC Government-mandated collective tender process. For other pharmaceutical product distributors, we arrange three party negotiations with distributors and suppliers. The decrease in gross profit margin was mainly attributed to the increase in the portion of sales derived from our distribution segment whose gross profit margin is comparatively lower.

Pharmaceutical distribution segment

The gross profit margin for our pharmaceutical distribution segment was approximately 19.2% and 21.8% for the three months ended June 30, 2011 and 2010, respectively. The cost of sales includes only the cost of merchandise. In order to penetrate and capture growth from the medical insurance plan and the distribution rights that we were granted to deliver within the counties that we are entitled to sell to, we attempted to satisfy the demand of hospital customers for both high-profit margin and low-profit margin products. This resulted in a slight decrease in the gross profit margin for the three months ended June 30, 2011 compared to the same period in 2010. Further, the gross profit margin derived from the other drug stores is lower when compared with the hospitals. The increase in portion of sales derived from the other drug stores did reduce the gross profit margin.

Retail pharmacy segment

The gross profit margin for our retail pharmacy segment was approximately 34.2% and 32.1% for the three months ended June 30, 2011 and 2010, respectively. The cost of sales includes only the cost of merchandise, and we adjust the retail price in accordance with the cost of merchandise. There are no significant changes in gross profit margin and the slight increase in gross profit margin was attributed to the fact that we used fewer price reductions in the strategy for our marketing campaign during the three months ended June 30, 2011.

Manufacturing segment

The gross profit margin for our manufacturing segment was approximately 64.7% and 65.2% for the three months ended June 30, 2011 and 2010, respectively. The cost of sales includes only the cost of raw materials and other costs. Other costs include direct labor, depreciation and other overhead expenses. There was no material price change for the cost of sales and other prices and the gross profit margin was stable for each of our manufactured products. The decrease was mainly due to the increase in the portion of sales derived from products of comparatively lower gross profit margin.

Operating Expenses - Combined

Selling, and administrative expenses totaled $4.5 million for the three months ended June 30, 2011, as compared to $2.4 million for the three months ended June 30, 2010, representing an increase of $2.1 million or approximately 87.5%. The increase was attributed to the increase of administrative expenses and selling expenses by $1.4 million and $0.7 million, respectively.

Selling Expenses

Selling expenses increased by 63.6% from $1.1 million for the three months ended June 30, 2010 to $1.8 million for the three months ended June 30, 2011. The increase was primarily due to the increase in our marketing staff’s wages and salaries, payment for staff welfare in connection with our increased sales and marketing activities. The percentage of our distribution and selling expenses to our total revenue gradually increased from 2.2% to 2.7%.

Pharmaceutical distribution segment

The selling expenses of our pharmaceutical distribution segment increased by 40.0% from $0.5 million for the three months ended June 30, 2010 to $0.7 million for the three months ended June 30, 2011. The increase was primarily due to the increase in transportation and lodging costs of $0.1 million which was partly a result of, and offset by, our increase in sales.

Retail pharmacy segment

The selling expenses of our retail pharmaceutical distribution segment increased by 81.8% from $0.44 million for the three months ended June 30, 2010 to $0.8 million for the three months ended June 30, 2011. The increase was primarily due to the increase in salaries and staff benefits of retail staff of $0.4 million upon the increase in the number of staff after the acquisition of stores since the second quarter of 2010.

Manufacturing segment

The selling expenses of our retail pharmaceutical distribution segment increased by 117% from $0.12 million for the three months ended June 30, 2010 to $0.26 million for the three months ended June 30, 2011. The increase was primary due to the increase of sales commission to regional sales representatives by $0.1 million upon the increase in sales. The increase was further attributed to the increase in advertising of $0.05 million.

Administrative expenses

Administrative expenses increased by 107.7% from $1.3 million for the three months ended June 30, 2010 to $2.7 million for the three months ended June 30, 2011. The increase in administrative expenses for the three months ended June 30, 2011 was primarily due to an increase in the legal and consultancy fees and expenses in connection with public company compliance and SEC requirements by $0.2 million and the increase in salaries and staff benefits by $0.3 million. Further there was an increase of $0.1 million of the rental expenditures resulting from the opening of new stores and the $0.2 million in connection with the post-acquisition cost. The percentage of our administrative expenses to our total revenue increased from 2.7% in 2010 to 4.1% in 2011.

Pharmaceutical distribution segment

The administrative expenses of our pharmaceutical distribution segment increased by 98.3% from $0.6 million for the three months ended June 30, 2010 to $1.19 million for the three months ended June 30, 2011. The increase was primarily due to the increase in the staff benefit by $0.19 million and the increase in expenditures by $0.24 million in connection with the conference meeting held with suppliers and other parties.

Retail pharmacy segment

The administrative expenses of our retail pharmaceutical distribution segment increased by 133% from $0.30 million for the three months ended June 30, 2010 to $0.70 million for the three months ended June 30, 2011. The increase was primarily attributable to the increase of rental charges by $0.1 million upon the opening of new stores after the second quarter 2010. Further, there is incurrence of the post-acquisition service fees in connection with the acquisition of stores concluded in 2010 by approximately $0.2 million.

Manufacturing segment

The administrative expenses of our manufacturing segment increased by 75.0% from $0.12 million for the three months ended June 30, 2010 to $0.21 million for the three months ended June 30, 2011. The increase was primarily attributable to the increase in the management and staff salaries and benefits by $0.04 million.

Change in fair value of warrants

For the three months ended June 30, 2011, we incurred a non-cash gain of $0.3 million from the change in fair value of warrants issued to investors in conjunction with the Company’s issuance of warrants in December 2009 and February 2010 pursuant to provisions of FASB ASC Topic 85, “Derivative and Hedging”. The accounting treatment of the warrants resulted from a provision providing anti-dilution protection to the warrant holders.

Income before income tax

As a result of the foregoing, our income before income tax increased by 22.9% to $11.8 million for the three months ended June 30, 2011 compared to $9.6 million for the same period in 2010. The percentage of our income before income tax to total revenue was 18.2% in 2011 as compared to 20.2% in 2010. The decrease is mainly attributed to the increase of legal and management staff cost in connection with public company compliance and SEC requirements and the decrease in gross profit margin due to a change in proportion of segment sales.

Pharmaceutical distribution segment

Our income before income tax from distribution operations increased by 27.9% from $6.1 million for the three months ended June 30, 2010, to $7.8 million for the three months ended June 30, 2011. The profit margin decreased to 16.0% from 18.2%.

Retail pharmacy segment

Our income before income tax from retail pharmacy segment operations was decreased by 19.4% from $3.1 million to $2.5 million for the three months ended June 30, 2011. The profit margin decreased to 18.9% from 24.5%. The reduction is mainly attributed to the incurrence of the post-acquisition expenses for the acquisition of stores and the reduction in contribution of income by older stores which operate in a saturated market.

Manufacturing segment

Our income before income tax from manufacturing segment operations increased by 28.6% from $1.4 million for the three months ended June 30, 2012, to $1.8 million for the three months ended June 30, 2011. The profit margin decreased to 51.1% from 54.4%.

Net Income

As a result of the above factors, we had net income of $8.6 million for the three months ended June 30, 2011 as compared to $7.1 million for the three months ended June 30, 2010, representing an increase of $1.5 million or approximately 21.1%. For the three months ended June 30, 2011 our net income was impacted by a non-cash charge of $0.3 million as a result of warrant liabilities unrelated to our operations. Excluding this $0.3 million net non-cash charge, our net income for the three months ended June 30, 2011 would have been $8.3 million, representing an increase of 10.7% compared to $7.5million excluding the non-cash expense of $0.4 million for the same period of 2010.

Earning per Share

For the three months ended June 30, 2011, our basic and diluted earnings per share were $0.19, which were the same as the same period in 2010.

Six months ended June 30, 2011 compared to six months ended June 30, 2010.

The following table sets forth the key components of our results of operations for the periods indicated.

	Six months ended June 30
	2011						2010
		‘000		% of total sales				‘000		% of total sales
Sales revenue	$	123,719			100.0		$	81,521			100.0
Cost of sales		94,039			76.0			60,046			73.7
Gross profit		29,680			24.0			21,475			26.3
Operating expenses
Administrative expenses		5,716			4.6			2,937			3.6
Selling expenses		3,715			3.0			2,086			2.6
Total operating expenses		9,431			7.6			5,023			6.2

Income from operations		20,249			16.4			16,452			20.2

Non-operating income (expense)
Interest income		26			-			4			-
Other income		137			0.1			127			0.2
Change in fair value of warrants liabilities		576			0.5			(707	)		(0.9	)
Other expenses		(18	)		-			(41	)		-
Finance costs		(390	)		(0.3	)		(477	)		(0.6	)
Total non-operating income (expense)		331			0.3			(1,094	)		(1.3	)

Income before income taxes		20,580			16.6			15,358			18.9
Income taxes		(5,728	)		(4.6	)		(3,981	)		(4.9	)
Net income		14,852			12.0			11,377			14.0
Other comprehensive income
Foreign currency translation adjustments		2,351			1.9			(1	)		-
Total comprehensive income	$	17,203			13.9		$	11,376			14.0

The table below sets forth a breakdown of our external segment revenue after elimination of inter-segment sales, and each segment revenue item as a percentage of our total revenue, as well as our inter-segment sales for the six months ended June 30, 2011 and June 30, 2010. For the six months ended June 30, 2011, we had approximately $19.7 million of inter-segment revenue, which includes approximately $19.2 million in sales from our distribution segment to our retail segment, and approximately $0.5 million in sales from our manufacturing segment to our distribution segment. External segment revenue refers to segment revenue after inter-segment elimination.

	Six months ended June 30,
	2011				2010
External Segment revenue		‘000	%			‘000	%
Pharmaceutical distribution	$	91,744		74.2	$	56,566		69.4
Retail pharmacy		25,701		20.8		20,514		25.2
Manufacturing pharmacy		6,274		5.0		4,441		5.4
	$	123,719		100	$	81,522		100.0
Inter-segment revenue	$	19,713			$	15,774

Sales Revenue

During the six months ended June 30, 2011, we had sales revenue of $123.7 million, as compared to sales revenue of $81.5 million during the six months ended June 30, 2010, an increase of $42.2 million or approximately 51.8%. This increase was mainly attributable to the respective increases in sales revenue of $35.1 million and $5.2 million from our distribution segment and our retail segment during the period.

Pharmaceutical distribution segment

We derive the majority of our revenue from our pharmaceutical distribution segment from sales of pharmaceutical products to our customers. We distribute a comprehensive offering of pharmaceutical and health care products, including branded and generic prescription medicines, over-the-counter medicines, Western and TCM medicines, as well as personal care products and medical supplies.

The following table sets forth revenue from our pharmaceutical distribution operations by category of customers:

	Six months ended June 30,
	2011				2010
		‘000	%			‘000		%
Hospitals	$	57,878		63.1	$	44,040			77.8
Other drug stores		12,404		13.5		118			0.2
Clinics and health care centres		10,981		12.0		5,014			8.9
Distributors and others		10,481		11.4		7,394			13.1
Total	$	91,744		100.0	$	56,566	100.0

Revenue from our pharmaceutical distribution segment increased by 62.28% from $56.6 million for the six months ended June 30, 2010 to $91.7 million for the six months ended June 30, 2011. The increase in revenue of $35.1 million is the result of the increase in volume by $35.8 million and offset by the reduction in price level by $0.7 million. The price effect is attributed mainly to the change in prices paid by hospitals based upon the PRC Government-mandated collective tender process. The increase in sales revenue from our pharmaceutical distribution segment was attributed primarily to the increase of $13.8 million in sales to hospitals. There was a further increase of $6.0 million in sales to clinics and health care centers, $12.3 million in sales to other drug stores and $3.0 million in sales to other distributors concurrently. The increase in sales to hospitals was the result of an increase in the quantity and range of products sold to our existing hospital clients, which was attributable to the increase in coverage by the national insurance plan and the implementation of the New Rural Cooperative-Medicare plan. Further, as we signed the distribution agreement with three government hospitals during September 2010, the increase of the grant of the portion of the purchase plan to us contributed to the sales to hospitals. The increase in sales to clinics and health care centers was attributed to the penetration of the market at the community region after we won the six cities and townships’ distribution business bid from Basic Drugs Catalogue Plan in the middle of 2009. The increase in sales to other drug stores was the result of the increase in the quantity and range of products to new stores as a result of our marketing effort at the rural area.

Retail pharmacy segment

Revenue from our retail pharmacy segment increased by 25.4% from $20.5 million for the six months ended June 30, 2010 to $25.7 million for the six months ended June 30, 2011. The increase in revenue resulted from the increase in sales volume of $6.2 million after the offset of the price reduction by approximately $1 million. The increase in volume of sales was primarily attributed to the 62 stores opened since the third quarter of year 2010, including the 17 stores opened during the six months ended June 30, 2011. The slight reduction in our retail prices was the result of the adjustment of our selling prices in accordance with the price control office. The reduction in sales from the existing stores was mainly due to the increase in the number of the drug stores in the market.

The following table sets forth revenue from our retail pharmacy segment by existing stores and new stores opened during each period.

	Six months ended June 30,
	2011		2010
		(000)		(000)
Existing stores (1)	$	17,940	$	16,622
New stores (2)		7,761		3,892
Total	$	25,701	$	20,514
Number of stores		187		125

(1) One store was closed during the six months ended June 30, 2011 and no sales were incurred with respect to that store for the six months ended June 30, 2011. The sales derived from that store for the six months ended June 30, 2010 were $113,749.

(2) Represents the 62 stores opened after June 30, 2011, including the 17 stores opened during the six months ended June 30, 2011. The sales derived from those stores opened during the six months ended June 30 2011 were $708,037.

Manufacturing segment

Revenue from our manufacturing segment increased 41.3% from $4.4 million for the six months ended June 30, 2010 to $6.3 million for the six months ended June 30, 2011. The increase was attributed to the volume of sales solely as there were no changes in prices between the periods. The increase in sales was as a result of efforts made by our sales representatives.

Cost of Sales

Cost of Sales was $94.0 million for the six months ended June 30, 2011 as compared to $60.0 million for the six months ended June 30, 2010. Our cost of sales consists of the cost of merchandise, raw materials, and other costs. Other costs include direct labor, depreciation and other overhead expenses. The increase was primarily due to an increase in the costs of purchasing merchandise following the increase in our revenue.

Gross Profit

Gross profit was $29.7 million for the six months ended June 30, 2011 as compared to $21.5 million for the six months ended June 30, 2010, representing an increase of $8.2 million or approximately 38.1%. Our gross profit margin was 24.0% and 26.3% for the six months ended June 30, 2011 and 2010, respectively. The gross profit margin was relatively stable as we maintained the margin between our cost of purchasing pharmaceutical products from our suppliers and our prices of pharmaceutical products sold to our hospital, pharmaceutical distributor and other customers. For hospital customers, we establish a pricing range aligned with our suppliers through the PRC Government-mandated collective tender process. For other pharmaceutical product distributors, we arrange three party negotiations with distributors and suppliers. The decrease in profit margin was mainly attributed to the increase in the portion of sales derived from our distribution segment whose profit margin is comparatively lower.

Pharmaceutical distribution segment

The gross profit margin for our pharmaceutical distribution segment was approximately 18.6% and 17.3% for the six months ended June 30, 2011 and 2010, respectively. The cost of sales includes only the cost of merchandise. In order to penetrate and capture growth from the medical insurance plan and the distribution rights that we were granted to deliver within the counties that we are entitled to sell to, we attempted to satisfy the demand of hospital customers for both high-profit margin and low-profit margin products. This resulted in a slight increase in the gross profit margin for the six months ended June 30, 2011 as compared to the same period in 2010. Further, the gross profit margin derived from stores is lower when compared with the hospitals and community health care centres. The increase in the portion of sales derived from these two customer bases did reduce the overall gross profit margin.

Retail pharmacy segment

The gross profit margin for our retail pharmacy segment was approximately 33.2% and 30.1% for the six months ended June 30, 2011 and 2010, respectively. The cost of sales includes only the cost of merchandise, and we adjusted the retail price in accordance with the cost of merchandise. There are no significant changes in gross profit margin.

Manufacturing segment

The gross profit margin for our manufacturing segment was approximately 64.4% and 60.0%% for the six months ended June 30, 2011 and 2010, respectively. The cost of sales includes only the cost of raw materials and other costs. Other costs include direct labor, depreciation and other overhead costs. There was no material price change for the cost of sales and other prices and the gross profit was stable for each of our manufactured products. The increase was mainly due to the increase of sales of the higher profit margin product.

Operating Expenses

Selling and administrative expenses totaled $9.4 million for the six months ended June 30, 2011, as compared to $5.0 million for the six months ended June 30, 2010, representing an increase of $4.4 million or approximately 88.0%. The increase was attributed to the increase of administrative expenses and selling expenses by $2.8 million and $1.6 million, respectively.

Selling Expenses

Selling expenses increased by 76.2% from $2.1 million for the six months ended June 30, 2010 to $3.7 million for the six months ended June 30, 2011. The increase was primarily due to the increase in our marketing staff’s wages and salaries, payment for staff welfare in connection with our increased sales and marketing activities. The percentage of our distribution and selling expenses to our total revenue gradually increased from 2.6% to 3.0%.

Pharmaceutical distribution segment

The selling expenses of our pharmaceutical distribution segment increased by 13.4% from $1.12 million for the six months ended June 30, 2010 to $1.27 million for the six months ended June 30, 2011. The increase was primarily due to the increase in transportation costs of $0.18 million which is partly a result of, and offset by our, increase in sales.

Retail pharmacy segment

The selling expenses of our retail pharmaceutical distribution segment increased by 142.2% from $0.83 million for the six months ended June 30, 2010 to $2.01 million for the six months ended June 30, 2011. The increase was primarily due to the increase in salaries and staff benefits of retail staff of $1.11 million upon the increase in the number of staff resulting from the acquisition of retail stores during the second quarter.

Manufacturing segment

The selling expenses of our manufacturing distribution segment increased by 186.7% from $0.15 million for the six months ended June 30, 2010 to $0.43 million for the six months ended June 30, 2011. The increase was primary due to the increase of sales commission to regional sales representatives of $0.22 million upon the increase in sales. The increase was further attributed to the increase in advertising of $0.05 million.

Administrative Expenses

Administrative expenses increased by 96.6% from $2.9 million for the six months ended June 30, 2010 to $5.7 million for the six months ended June 30, 2011. The increase in administrative expenses for the six months ended June 30, 2011 was primarily due to an increase in the management staff cost and the legal and consultancy fees and expenses in connection with public company compliance and SEC requirements by $0.92 million and the increase in share-based compensation by $0.5 million. Further there was an increase of $0.29 million of the rental expenditures and $0.42 million of post-acquisition service fees in connection with the acquisition of retail stores. The percentage of our administrative expenses to our total revenue increased from 3.6% in 2010 to 4.6% in 2011.

Pharmaceutical distribution segment

The administrative expenses of our pharmaceutical distribution segment increased by 32.9% from $1.58 million for the six months ended June 30, 2010 to $2.10 million for the six months ended June 30, 2011. The increase was primarily due to the increase in the expenditures by $0.2 million for business meetings with the suppliers and other parties. Further, there is additional increase in the repair cost and information technology costs by $0.17 million and other staff cost by $0.06 million.

Retail pharmacy segment

The administrative expenses of our retail pharmacy segment increased by 126.3% from $0.57 million for the six months ended June 30, 2010 to $1.29 million for the six months ended June 30, 2011. The increase was primarily attributable to the incurrence of the post-acquisition service fees in connection with the acquisition of retail stores concluded in 2010 by $0.42 million. Further, there is an increase of rental expenses by $0.29 million upon the opening of new stores since the second quarter of 2010.

Manufacturing segment

The administrative expenses of our manufacturing segment increased by 28.6% from $0.28 million for the six months ended June 30, 2010 to $0.36 million for the six months ended June 30, 2011. The increase was primarily attributable to the increase in the staff salaries by $0.04 million.

Change in Fair Value of Warrants

For the six months ended June 30, 2011, we incurred a non-cash gain of $0.6 million from the change in fair value of warrants issued to investors in conjunction with the Company’s issuance of warrants in December 2009 and February 2010 pursuant to provisions of FASB ASC Topic 85, “Derivative and Hedging.” The accounting treatment of the warrants resulted from a provision providing anti-dilution protection to the warrant holders.

Income before Income Tax

As a result of the foregoing, our income before income tax increased by 33.8% to $20.6 million for the six months ended June 30, 2011 compared to $15.4 million for the same period in 2010. The percentage of our income before income tax to total revenue was 16.6% in 2011 as compared to 18.9% in 2010. The decrease is mainly attributed to the increase of legal and consultancy fees and expenses in connection with public company compliance and SEC requirements and the reduction in the contribution of income derived from the existing retail stores located in a saturated market.

Pharmaceutical distribution segment

Our income before income tax from pharmaceutical distribution operations increased by 50.5% from $9.5 million for the six months ended June 30, 2010, to $14.3 million for the six months ended June 30, 2011. The profit margin decreased to 15.6% from 13.2%.

Retail pharmacy segment

Our income before income tax from retail pharmacy segment operations reduced by 11.6% from $4.8 million for the six months ended June 30, 2010, to $4.3 million for the six months ended June 30, 2011. The profit margin decreased to 16.6% from 23.6%. The reduction is mainly attributed to the incurrence of the post-acquisition expenses for the acquisition of stores and the increase in special bonus granted to the staff.

Manufacturing segment

Our income before income tax from manufacturing segment operations increased by 37.5% from $2.4 million for the six months ended June 30, 2010, to $3.3 million for the six months ended June 30, 2011. The profit margin increased to 51.7% from 50.0%.

Net Income

As a result of the above factors, we had net income of $14.9 million for the six months ended June 30, 2011 as compared to $11.4 million for the six months ended June 30, 2010, representing an increase of $3.5 million or approximately 30.7%. Excluding the non-cash items, our net income was $14.9 million for the six months ended June 30, 2011, compared to $12.1 million for the six months ended June 30,2010, representing an increase of $2.8 million or approximately 23.1%.

Earnings per share

For the six months ended June 30, 2011, our basic and diluted earnings per share were $0.35, representing an increase of 16.7%, compared to the same period in 2010.

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitment to repay borrowings, fund business operations, acquisition, and expansion. In addition to our cash on hand, our primary sources of funds for liquidity during the first six months of 2011 consisted of cash generated from operations, proceeds received from placement of preferred stock, and net borrowings. As of June 30, 2011, $3.6 million of our indebtedness was due within one year and $0.24 million was due within longer than one year. During the period ended June 30, 2011 we did not experience any difficulties in renewing our bank loans with our lenders.

Restricted cash and cash equivalents

Our restricted cash consists of collateral we provide for bills payable. As of June 30, 2011 and December 31, 2010, our restricted cash was approximately $1.6 million and $1.3 million, respectively. As of June 30, 2011 and December 31, 2010, we had cash of $63.1 million and $20.2 million, respectively, exclusive of restricted cash.

We believe that our existing sources of liquidity, along with cash expected to be generated from our operating segments will be sufficient to fund our operations, anticipated capital expenditures, working capital, and other financing requirements for at least the next twelve months. We will continue to monitor our expenditures and cash flow position.

	Six months ended June 30,
	2011		2010
		(000)		(000)
Net cash flows provided by operating activities	$	23,026	$	5,988
Net cash flows used in investing activities		(4,507)		(3,652)
Net cash flows provided by financing activities		23,391		858
Foreign currency translation		1,033		(1)
Net increase in cash and equivalents		42,943		3,193
Cash and cash equivalents, beginning of period		20,157		13,304
Cash and cash equivalents, end of period	$	63,100	$	16,497

Operating Activities

We derive our cash flow primarily from operating activities from the sale of our products and services through our three segments. Our cash used in operating activities is primarily used for the purchase of raw materials and products, distribution and selling expenses, general administrative expenses, and taxes. Cash flows from operations can be significantly affected by several factors such as the timing of payment of accounts receivable and the payment of accounts payable to our suppliers.

Cash from operating activities is primarily affected by the pharmaceutical distribution segment, which has a high demand on working capital while the retail pharmacy segment generates primarily cash and a minority of accounts receivable pending reimbursements for medi-card payments. Because the manufacturing segment accounted for only 5.4% of our revenues in 2011, it does not have a significant impact on cash from operating activities.

Cash provided by operating activities was $23.0 million for the six months ended June 30, 2011 compared to $6.0 million provided by operating activities for the same period in fiscal 2010, representing an increase of $17.0 million. Operating cash flows for 2011 reflects primarily net cash receipts derived from business operations. The substantial increase in cash provided by operating activities was mainly attributed to the result of a stable accounts receivable turnover achieved even as the sales increased between the two fiscal periods. The accounts receivable payment for the six months ended June 30, 2011 was 92 days as compared to 104 days for the six months ended June 30, 2010. It is normal practice for the customers to withhold payment at the end of 31 December of each year. As the size of the accounts receivable for the year ended December 31, 2010 is twice the amount of the amount at the year ended December 31, 2009, more older receivables were repaid for this six months ended June 30, 2011 when compared to the six months ended June 30, 2010.

For our pharmacy distribution segment, accounts receivable turnover days for the six months ended June 30, 2011 were 128 as compared to 121 in 2010. The increase in turnover days was partly due to an increase in the time our sub-distributors take to pay us as they get closer to the fiscal period end. In the PRC, all hospitals and the community health care centers are owned or controlled by the PRC government. We believe that it is highly unlikely that a liquidation of one of our hospital or community health care center customers will occur, and that the recovery of accounts receivable from them are highly secure. Therefore, it is our customary practice to grant a longer credit period to hospitals. There have been no instances of write-offs of any receivables owed by a hospital or the community health care centers. In addition to the prompt payment from hospital customers, offset did take place between accounts receivable and accounts payable for certain distributors acting as both the vendor and customer of the company. The offset did take place upon the mutual consent over the amounts owed by and to the parties.

For our retail segment, accounts receivable turnover days were three for both the six months ended June 30, 2011 and June 30, 2010. We generally receive cash from customers at our retail stores except for the medi-care qualified stores. The accounts receivable comprised only unreimbursed medi-card payments under the national program.

For our manufacturing segment, the accounts receivable turnover days were 127 in 2011 compared to 136 in 2010. The reduction was attributed to the effort of the regional managers to monitor the collection of debts.

Investing Activities

Cash flow from investing activities primarily consists of the acquisition of drug stores, long-term deposits, and additions of property, plant and equipment. Cash used in investing activities was $4.5 million for the first six months of 2011, compared to $3.7 million of cash used in investing activities for the same period in 2010, representing an increase of $0.8 million. The increase in cash used was primarily due to the payment of long term deposit of $3.4 million and the increase in acquisition of property plant and equipment of $1.1 million. The increase was offset by the absence of the acquisition of chain stores of $4.3 million and the absence of the sales of land of $0.7 million.

Financing Activities

Our cash from financing activities is derived primarily from private placements of securities and bank loan activities. Cash provided by financing activities was $23.4 million for the six months ending June 30, 2011, compared to $0.8 million provided by financing activities for the same period in 2010 representing an increase of cash provided by financing activities by $22.6 million. The substantial increase was primarily due to the proceeds from the placement of the preferred stock of $29.5 million. The increase was offset partially by the increase in net repayment of the advance from related companies of $4.6 million and absence of proceeds from private placement of $2.3 million received in 2010.

Working capital

Our working capital as of June 30, 2011 and December 31, 2010 was $93.1 million and $53.2 million, respectively. Our working capital is critical to our financial performance. We must maintain sufficient liquidity and financial flexibility to continue our daily operations. Our sales practices with hospitals in our pharmaceutical distribution segment, which have a longer term of repayment when compared with other customers and the substantial portion of our sales to hospitals have resulted in a significant demand for working capital.

The following table sets forth accounts receivable from our pharmaceutical distribution operations by category of customers:

	As of June 30, 2010		As of December31, 2010

Hospitals	$	40,785	$	45,476
Other drug stores		12,481		2,971
Clinics and health care centres		7,802		8,434
Distributors and others		4,932		7,548
Total	$	66,000	$	64,429

Borrowings and Credit Facilities

The short-term bank borrowings outstanding as of June 30, 2011 were $7.1 million while long term bank borrowings outstanding as of June 30, 2011 were $3.8 million. The short term loans bore an average interest rate of 7.43% per annum and it was adjusted currently or quarterly in accordance with the benchmark interest rate of the People’s Bank of China. These loans do not contain any financial covenants or restrictions. The loans are secured by the land use rights and properties of the company and properties from its related-parties.

The short-term borrowings have one year terms and expire at various times throughout the year. These facilities contain no specific renewal terms.

The long-term borrowings have three to seven years terms. Part of the borrowings mature at various times over the next years and part of the borrowings are repayable by monthly installments within the four years before maturity. The loans bear an interest rate from 7.68% to 8.32% which are adjusted currently or an annual basis in accordance with the loan rate of the People’s Bank of China.

These loans do not contain any financial covenants or restrictions. The loans are secured by the land use rights, property, plant and equipment of the Company and properties from related-parties.

In addition to bank borrowings mentioned above, we have bills receivable facilities in the amount of $2.9 million as of June 30, 2011 of which $1.0 million was utilized. The facilities are secured by land use rights, property and equipment of the Company.

Critical Accounting Estimates

This section should be read together with the Summary of Significant Accounting Policies included as Notes to the consolidated financial statements included in our financial statements. Our consolidated financial information has been prepared in accordance with generally accepted accounting principles in the United States, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets and liabilities, (2) the disclosure of our contingent assets and liabilities at the end of each fiscal period and (3) the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

When reviewing our financial statements, you should consider (1) our selection of critical accounting policies, (2) the judgment and other uncertainties affecting the application of those policies, and (3) the sensitivity of reported results to changes in conditions and assumptions. We believe the following accounting policies involve the most significant judgment and estimates used in the preparation of our financial statements.

Goodwill

We account for goodwill in accordance with the provisions of FASB ASC 805, “Goodwill and Intangible Assets” (“ASC 805”). We perform an impairment analysis on an annual basis and, in addition, if we notice any indication of impairment, we conduct that test immediately. The application of the impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units and the determination of the fair value of each reporting unit. Fair value is primarily determined by computing the future discounted cash flows expected to be generated by the reporting unit that are believed to be reasonable under current and forecasted circumstances, the results of which form the basis for making judgments about carrying values of the reported net assets of our reporting units. We do not believe that there is any indication of impairment of goodwill as of June 30, 2011.

Long-lived assets

Long-lived assets are tested for impairment in accordance with FASB ASC 360-10-45 “Impairment or Disposal of Long-Lived Assets” (previously SFAS No. 144). We periodically evaluate potential impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The application of the impairment test requires judgment inclusive of the future cash flow attributable from the use of the asset. If the asset is determined not to be recoverable, it is considered to be impaired and the impairment to be recognized.

Depreciation

Property, plant and equipment is depreciated on a straight-line basis over their estimated useful lives. We determine the estimated useful lives, residual values and related depreciation charges for our property, plant and equipment. This estimate is based on the historical experience of the actual useful lives and residual values of property, plant and equipment of similar nature and functions. We will revise the depreciation charge where useful lives and residual values are different from those previously estimated, or we will write-off or write-down technically obsolete or assets that have been abandoned or sold.

Allowances for doubtful accounts

We establish a general provisioning policy to make the allowance equivalent to 40% of gross amount of accounts receivable due from six months to one year and 100% of gross amount of accounts receivable due over one year. Additional specific provisions are made when accounts receivable are considered uncollectible. We make judgments over the customer’s ability to pay their outstanding invoices on a timely basis and whether their financial position might deteriorate significantly in the future affecting their capability for repayments.

Allowances for inventories

In assessing the ultimate realization of inventories, we make judgments as to future demand requirements compared to current or committed inventory levels. We estimate the demand requirements based on market conditions, forecasts over the demand by our customers, sales contracts, and orders in hand. As of June 30, 2011, 12% of our inventory will expire within 1-6 months, 4% will expire within 7 to 9 months time, 4% will expire within 10 to 12 months time, and 80% of inventory will expire in over 1 year. We estimate the extent of provision made for inventory which expires within 6 months after assessing the capability of a selling campaign and the possibility of return of drugs to the vendors. As for the drugs which will expire in over half a year’s time, we judge that the drugs are still marketable and estimate the provision upon our estimate of the future demand and the current inventory level.

Revenue recognition

Revenue is recognized when the following criteria under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605 “Revenue Recognition” are met:

1)	Persuasive evidence of an arrangement exists;

2)	Delivery has occurred or services have been rendered;

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

4)	Collectability is reasonably assured.

The Company bases its estimates on historical results, taking into consideration the type of customer, the type of transaction and the specifics of each arrangement.

Pharmaceutical distribution segment

We sell a range of pharmaceutical products to various customers and the majority of revenue results from the contracts signed with various distributors and government-owned hospitals. Revenues from pharmaceutical distribution operation are recognized when substantially all of the usual risks and rewards of ownership of the inventory have been transferred to the buyer. Generally, this occurs when the inventory is shipped to the customer. Currently, we do not have any sales on consignment and we do not use consignment sales as our sales method. The price to the buyer is fixed and no cancellation clause exists and there is no right of return except in rare cases where those pharmaceutical goods are damaged during the delivery process. In the absence of the right of return clause, we estimate that the product return was insignificant other than for returns because of damage arising from delivery. We are not obligated to accept the return should the inventory kept by the customers be excessive or expire without being sold by them. We do accept return of inventory damaged during delivery. We grant credit to customers with proven payment records. Collectability is assessed by background checks for new customers.

Retail pharmacy segment

We operate a chain of retail pharmacy stores for selling the pharmacy products. Revenue from the operation of these stores are recognized when sales occur. We estimate that no significant post-delivery obligations exist. Retail sales are paid by either cash or medi-insurance card, in which the reimbursement is assured as it is run by the government. No return is allowed after sales are made.

Manufacturing segment

The revenue recognition criteria used with our manufacturing segment are the same as the operation under our pharmaceutical distribution segment except that all customers are distributors for our manufacturing operation.

During the period ended June 30, 2011, $385,332 worth of goods were returned as a result of damage. We have not sold goods to customers as a result of incentives. We do not grant sales discount or any allowances to customers if they don’t re-sell their goods before the expiration date. No return of goods is allowed except that the goods are damaged during delivery. As the return of goods are not allowed, we assess and estimate the return only arising from damage during delivery and the estimate of return is negligible. Thus, we do not assess any return derived from the levels of inventory in the distribution channel, estimated shelf life, and/or the introduction of new products as these factors are not relevant to us for the estimate of return.

Off Balance Sheet Arrangements

We have various operating leases for office, manufacturing, and retail space which expire through 2015. We have future minimum rental payments under non-cancellable operating leases with initial or remaining terms of one year or more of approximately $ 2.6 million as of June 30, 2011.

We did not have any other off balance sheet arrangements in place as of June 30, 2011.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain “disclosure controls and procedures” as such term is defined under Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We have carried out an evaluation as required by Rule 13a-15(d) under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures of June 30, 2011. Based on an evaluation of our disclosure controls and procedures as of June 30, 2011 covered by this report (and the financial statements contained in the report), our Chief Executive Officer and Chief Financial Officer have determined that our current disclosure controls and procedures were effective. We engaged BDO CHINA SHU LUN PAN Certified Public Accountants in the first quarter of 2011 to assist our internal control department to rigorously perform its role in SOX 404 compliance.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the second quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION.

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors.

Investing in our common stock involves a high degree of risk. Before you invest, you should carefully consider the risks and uncertainties described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Form 10-K”), under the caption “Risk Factors,” our Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 2 of Part I of this Quarterly Report on Form 10-Q, our consolidated financial statements and related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and our consolidated financial statements and related notes, as well as our Management’s Discussion and Analysis of Financial Condition and Results of Operations and the other information in our 2010 Form 10-K. Readers should carefully review those risks, as well as additional risks described in other documents we file from time to time with the Securities and Exchange Commission.

Item 2. Unregistered shares of Equity Securities and Use of Proceeds

We have not sold any equity securities during the period ended June 30, 2011 that were not previously disclosed in a current report on Form 8-K.

Item 6. Exhibits.

Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	China BCT Pharmacy Group, Inc.

Dated: August 15, 2011	By:	/s/ Huitian Tang
		Huitian Tang
		Chief Executive Officer and Chairman
		(principal executive officer)



Dated: August 15, 2011	By:	/s/ Xiaoyan Zhang
		Xiaoyan Zhang
		Chief Financial Officer
		(principal financial and accounting officer)

Exhibit Index

Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

Attached files

China BCT Pharmacy Group, Inc. Reports

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