UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

 

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

For the transition period from                        to

 

Commission File Number: 000-53401

 

Bohai Pharmaceuticals Group, Inc.

(Exact name of registrant as specified in its charter)

 

Nevada		98-0697405
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

 

c/o Yantai Bohai Pharmaceuticals Group Co. Ltd.
No. 7 Tianzheng Road, Laishan District
Yantai, Shandong Province, China		264003
(Address of principal executive offices)		(Zip Code)

 

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

 

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

 

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

 

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

 

Large accelerated filer [  ]		Accelerated filer [  ]
Non-accelerated filer [  ]		Smaller reporting company [X]
(Do not check if a smaller reporting company)

 

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

  

As of November 14, 2014, there were 19,522,865 shares of company common stock issued and outstanding.

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Bohai Pharmaceuticals Group, Inc.

 

Quarterly Report on Form 10-Q

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION
Cautionary Note Regarding Forward-Looking Statements
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and June 30, 2013	5
	Condensed Consolidated Statements of Income and Comprehensive Income for the Three months Ended September 30, 2014 and 2013 (unaudited)	6
	Condensed Consolidated Statement of Changes In stockholders’ equity	7
	Condensed Consolidated Statements of Cash Flows for the Three months Ended September 30, 2014 and 2013 (unaudited)Condensed Consolidated Statement of Changes In stockholders’ equity	8
	Notes to Unaudited Condensed Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.	Controls and Procedures	43
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.	Defaults Upon Senior Securities	45
Item 4.	Mine Safety Disclosures	45
Item 5.	Other Information	45
Item 6.	Exhibits	45
SIGNATURES		46

 

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

In addition to historical information, this Quarterly Report on Form 10-Q contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. We cannot give any guarantee that the plans, intentions or expectations described in the forward looking statements will be achieved. All forward-looking statements involve significant risks and uncertainties, and actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those factors described in the “Risk Factors” section of our Annual Report for the fiscal year ended June 30, 2014. Readers should carefully review such risk factors as well as factors described in other documents that we file from time to time with the Securities and Exchange Commission.

 

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

 

	·	our ability to generate or obtain through financing sufficient working capital to (i) satisfy our obligations under our convertible notes which are due on April 5, 2016 (currently $4,917,139 outstanding) or (ii) otherwise to support our business plans;

 

	·	our ability  to continue to integrate the business of Yantai Tianzheng Pharmaceuticals Company, Ltd. (“Yantai Tianzheng”) and any future acquisitions into our business;

 

	·	our ability to improve the cost efficiency of our existing products and maintain their quality;

 

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

 

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

 

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

 

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

 

	·	our ability to maintain or protect our intellectual property and land use rights;

 

	·	our ability to maintain our proprietary technology;

 

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

 

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

 

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

 

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

 

We cannot give any guarantee that our plans, intentions or expectations will be achieved. All forward-looking statements involve significant risks and uncertainties, and actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those factors listed above and described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2014. Except as required by applicable law and including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.

 

 

4

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes to the condensed consolidated financial statements

5

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF

INCOME AND COMPREHENSIVE INCOME

 

(UNAUDITED) 

See accompanying notes to the condensed consolidated financial statements

6

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

 

See accompanying notes to the consolidated financial statements

7

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See accompanying notes to the condensed consolidated financial statements

8

BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2014

1.

 ORGANIZATION AND PRINCIPAL ACTIVITIES

The Company’s Operations

Bohai Pharmaceuticals Group, Inc. (“BPGI”) was incorporated under the laws of the State of Nevada on January 9, 2008 under the name of Link Resources, Inc. Prior to January 5, 2010; BPGI was a public “shell” company. BPGI became a public operating company on January 5, 2010 pursuant to a Share Exchange Transaction completed on January 5, 2010. 

BPGI is engaged in the production, manufacturing and distribution of herbal pharmaceuticals based on traditional Chinese medicine (“TCM”) in the People’s Republic of China (“China” or the “PRC”) through the following two operating subsidiaries:

(i)YantaiBohai Pharmaceuticals Group Co., Ltd., (“Bohai”) a PRC Company and the Company’s original operating subsidiary. BPGI controls Bohai through a variable interest entity arrangement (“VIE”) described below; and

(ii)YantaiTianzheng Pharmaceuticals Company, Ltd., a PRC company (“YantaiTianzheng”), which BPGI acquired effective July 1, 2011 through a newly formed PRC wholly-foreign owned enterprise subsidiary, YantaiNirui Pharmaceuticals, Ltd. (“WOFE II”).

BPGI owns 100 % of Chance High International Limited, a British Virgin Islands company (“Chance High”). Chance High owns 100 % of the issued and outstanding shares of capital stock of a Chinese wholly-foreign owned enterprise known as YantaiShencaojishi Pharmaceuticals Co., Ltd. (the “WOFE”). On December 7, 2009 (prior to the date of the Share Exchange Transaction), the WOFE entered into a series of variable interest entity contractual agreements (the “VIE Agreements”) with Bohai and its three shareholders, including Mr. Hongwei Qu, the Company’s current Chairman and Chief Executive Officer (“Mr. Qu”). Mr. Qu currently owns 96.7% of the outstanding equity interests of Bohai and two other shareholders who collectively own the remaining 3.3% of Bohai.

The VIE Agreements include (i) a Consulting Services Agreement, (ii) an Operating Agreement, and (iii) a Proxy Agreement, through which the WOFE has the right to advise, consult, manage and operate Bohai for an annual fee equal to all of Bohai’s yearly net profits after tax. Pursuant to these agreements, the WOFE indirectly owns but has100 % managerial and economic control of the business activities of Bohai including the right to appoint all executives and senior management and members of the board of directors of Bohai. Additionally, Bohai’s shareholders pledged their rights, titles and equity interest in Bohai as security for the WOFE to collect consulting and services fees provided to Bohai pursuant to an equity pledge agreement. In order to further reinforce the WOFE’s rights to control and operate Bohai, Bohai’s shareholders granted the WOFE an exclusive right and option to acquire all of their equity interests in Bohai through an option agreement. The VIE Agreements have perpetual terms unless otherwise determined by PRC law, and can (particularly in the case of the Consulting Services Agreement (which is the principal VIE Agreement) be terminated by the parties under certain circumstances, including material breach, the termination of Bohai’s business or a liquidation of Bohai. The WOFE (which is controlled indirectly by BPGI through Chance High) can also terminate the Consulting Services Agreement at will.

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BPGI, its wholly owned subsidiary Chance High, WOFE, WOFE II, Bohai and YantaiTianzheng are referred to herein collectively and as a consolidated basis as the “Company” or “we”, “us” or “our” or similar terminology. Mr. Qu currently serves the Company’s Chairman, Chief Executive Officer and President. As used herein, the term “Common Stock” means the common stock of BPGI, $0.001 par value per share.

BPGI is headquartered and maintains its principal operations in the city of Yantai, Shandong Province, China, and conducts business operations exclusively in the PRC.

On January 17, 2014, the Company merged WOFE with and into WOFE II. In connection with the merger, and in accordance with relevant PRC laws and regulations, all of WOFE’s rights relating to Bohai were transferred to WOFE II.

2.

LIQUIDITY AND FINANCIAL CONDITION

The Company’s net income amounted to $9,344,056 for the three months ended September 30, 2014. The Company’s cash flows provided by operating activities amounted to $6,485,538 for the three months ended September 30, 2014. The Company had working capital of $54,049,117 as of September 30, 2014. The Company has historically financed its operations principally from cash flows generated from operating activities and external financing through short-term bank loans, convertible notes, and notes payable.

On June 8, 2010, YantaiTianzheng signed an agreement with Yantai Huanghai Construction Co. to construct certain portions of a factory. The total contract price amounted to approximately $3.16 million (RMB 19.5 million). The construction project was100% completed and new buildings were in use as of June 30, 2014. The final cost was $4.82 million (RMB 29.68 million), as of September 30, 2014, $4.82 million (RMB 29.68 million) was fully paid.

The Company is also required to repay the remaining $5,216,023 convertible notes balance, which, pursuant to the fifth amendment to the  original notes, is due on an extended maturity date of April 5, 2016. The Company did not make any payments toward principal during the three months ended September 30, 2014. $2,219,777 principal amount of the convertible notes and $349,365 of the accrued interest were converted to the Company’s common stock during the three months ended September 30, 2014.

As described elsewhere herein, the Company has at times, been in temporary default of its obligation to repay the convertible notes at previously extended maturity dates. The Company cannot predict what the implications of the non-payment of the notes would be. The Company will continue to experience difficulty converting sufficient currency and will maintain an escrow account of restricted funds intended to secure the Note’s repayment. The non-payment of the notes could have a material adverse effect on the Company should the note holders pursue further action.

Management believes, based on the Company’s historical ability to fund operations using internally generated cash flow, that the Company’s currently available cash and funds it expects to generate from operations and through potential short term loans financing from banks will enable it to operate the business and satisfy short term obligations through at least September 30, 2015. Notwithstanding, the Company still has substantial obligations as described herein and there is no assurance that unforeseen circumstances would not have a material adverse effect on the Company’s financial condition.

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The Company will require significant additional capital in order to fund these obligations and execute its longer term business plan. If the Company is unable to generate sufficient operating cash flows or raise additional capital, or encounters unforeseen circumstances that place constraints on its capital resources, management will be required to take various measures to conserve liquidity. Such measures could include, but not necessarily be limited to, curtailing the Company’s business development activities (as was done recently when the Company determined to streamline its operations to focus on the continued distribution of a smaller number of key products), suspending the pursuit of one or more elements of its business plan, and controlling overhead expenses. There is a material risk, and management cannot provide any assurances, that the Company will be able to raise additional capital if needed.

On August 15, 2013, the Company obtained a short term loan from Yantai Rural Commercial Bank Ltd. (“RCB”) due on August 14, 2014 in the principal amount of $4,874,324 (RMB 30,000,000), which was guaranteed by a third party, Shandong Guangyuan Group Ltd. (“Guangyuan”) and the principal shareholder of the Company, Hongwei Qu. Guangyuan is an unrelated third party and has no business relationship with the Company (See Note 13).  As of September 30, 2014, this loan has been paid in full.

On September 2, 2014, the Company obtained a short term loan from Yantai Rural Commercial Bank Ltd.  (“RCB”) due on September 1, 2015 in the principal amount of $4,874,324 (RMB 30,000,000), which was guaranteed by a third party, Shandong Guangyuan Group Ltd. (“Guangyuan”) and the principal shareholder of the Company, Hongwei Qu. Guangyuan is an unrelated third party and has no business relationship with the Company (See Note 13). Except for the loan from RCB, the Company has not received any commitments for new financing, and cannot provide any assurance that new financing will be available to the Company on acceptable terms, if at all. The failure of the Company to fund its obligations when needed would have a material adverse effect on its business and results of operations.

3.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of BPGI, its wholly-owned subsidiary Chance High, WOFE II, YantaiTianzheng and Bohai. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company, in determining whether it is required to consolidate investee businesses, considers both the voting and variable interest models of consolidation as required under applicable GAAP. The Company adopted FASB Accounting Standards Codification (“ASC”) 810- 10 -15-14 and also ASC 810- 10 -05-8, which requires that a VIE be consolidated if that company is entitled to receive a majority of the VIE’s residual returns and has direct ability to make decisions on all operating activities of the VIE. The Company controls Bohai through the VIE Agreements described in Note 1, under the following series of agreements entered into on December 7, 2009.

Under the Operating Agreement entered into between WOFE and Bohai, the WOFE has the direct ability to make decisions on all the operating activities and exercise all voting rights of Bohai. Under the Consulting Services Agreement entered into between WOFE and Bohai, Bohai agreed to pay all of its net income to WOFE quarterly as a consulting fee. Accordingly, WOFE has the right to receive the expected residual returns of Bohai. As such, the Company is the primary beneficiary of and maintains controlling managerial and financial interest in, Bohai in accordance with ASC 810-10-15-14. Accordingly, Bohai’s financial position and results of operations are consolidated with those of the Company for all periods presented.We initially measured the assets, liabilities, and non-controlling interests of Bohai at their carrying amounts as of the date of the Share Exchange. We have subsequently accounted for the assets, liabilities, and non-controlling interest of Bohai as if it was consolidated based on voting interests. The usual accounting rules for which the VIE operates are applied as they would to a consolidated subsidiary as follows:

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

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

The carrying amount and classification of Bohai’s assets and liabilities included in the consolidated balance sheets are as follows:

		September 30, 2014		June 30, 2014
Total current assets*		$ 93,297,653		$ 83,930,195
Total assets*		163,516,875		154,570,385
Total current liabilities**		29,562,990		28,442,197
Total liabilities**		$ 33,613,636		$ 32,438,616

*           Includes intercompany accounts in the amounts of $40,160,116 and $37,511,591 in current assets as of September 30, 2014 and June 30, 2014, respectively, which were eliminated in consolidation. 

**         Includes intercompany accounts in the amounts of $9,429,543 and $9,426,786 in current liabilities as of September 30, 2014 and June 30, 2014, respectively, which were eliminated in consolidation.

Business Combinations

The Company uses the acquisition method of accounting for business combinations which requires that the assets acquired and liabilities assumed be recorded at the date of the acquisition at their respective fair values. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can reasonably be estimated. If the acquisition date fair value of an asset acquired or liability assumed that arises from a contingency cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are charged to expense as incurred. The operating results of acquired business are reflected in the acquirer’s consolidated financial statements and results of operations after the date of the acquisition.  

Basis of Presentation

The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and with the instructions to Form 10-Q and Article 8 of Regulation S-X of the United States Securities and Exchange Commission (“SEC”). Accordingly, they do not contain all information and footnotes required by GAAP for annual financial statements. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary (consisting only of normal recurring accruals) to present the financial position of the Company as of September 30, 2014 and the results of operations and cash flows for the periods presented. The results of operations for the three months ended September30, 2014 are not necessarily indicative of the operating results for the full fiscal year or any future period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2014. The Company’s accounting policies are described in the Notes to Consolidated Financial Statements in its Annual Report on Form 10-K for the year ended

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June 30, 2014, filed on October 14, 2014, and updated, as necessary, in this Quarterly Report on Form 10-Q. 

Business Segments

The Company’s operates its business through a single reporting segment.

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those results.

Significant estimates and assumptions include allocating purchase consideration issued in business combinations, valuing equity securities and derivative financial instruments issued in financing transactions and in share-based payment arrangements, accounts receivable reserves, inventory reserves, and evaluating the carrying amounts and useful lives of intangible assets. Certain estimates, including accounts receivable and inventory reserves and the carrying amounts of intangible assets (including present value of future cash flow estimates for the Company’s pharmaceutical formulas) could be affected by external conditions including those unique to the Company’s industry and general economic conditions. It is reasonably possible that these external factors could have an effect on management’s estimates that could cause actual results to differ from management’s estimates.

Company management re-evaluates all of the accounting estimates at least quarterly based on these conditions and records adjustments, when necessary.

Cash and Cash Equivalents

We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. We maintain bank accounts in the PRC and Hong Kong. We also have restricted cash accounts in the United States and the PRC that include funds designated for interest payments due to convertible note holders. 

Restricted Cash

Escrow account balances amounted to $22,375,805 and $12,623,467 as of September 30, 2014 and June 30, 2014, respectively.

The Company is required by its Note holders to maintain deposits in escrow accounts to fund the principal and interest payments under the Convertible Notes. As of September 30, 2014 and June 30, 2014, there was $12,627,158 and $7,750,568 of cash restricted for this purpose.

The Company has certain outstanding notes payable in the amount of $19,497,295 and $9,745,795 as of September 30, 2014 and June 30, 2014, respectively, and it is required to maintain a portion of these outstanding draft amounts in its bank as restricted cash. As of September 30, 2014 and June 30, 2014, there was $9,748,647 and $4,872,899 cash restricted for this purpose. 

Accounts Receivable

Accounts receivable consists of amounts due from customers. The Company’s credit terms generally range from 90 to 180 days. The Company’s policy with respect to accounts receivable reserves is to establish an allowance for doubtful accounts based on management’s assessment of known requirements, aging of receivables, payment history, specific customer’s current credit worthiness, and the economic environment. The Company has a significantly low history of credit losses and no historical pattern of making any price or collection concessions with respect to its accounts receivable balances. Accordingly, an allowance for doubtful accounts is not considered necessary based on management’s assessment.

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Inventories

Inventories are valued at the lower of cost, determined using the weighted average method, or market. Finished goods inventories include the costs of raw materials, direct labor and overhead associated with the manufacturing process. In assessing the ultimate realization of inventories, management makes judgments as to future demand requirements compared to current or committed inventory levels. Our reserve requirements generally increase/decrease due to management’s projected demand requirements, market conditions and product life cycle changes. As of September 30, 2014 and June 30, 2014, management does not believe that any inventory reserves are necessary.    

Property, Plant and Equipment

Property, plant and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets that range from 5 to 10 years for office equipment, machinery, and vehicles and 30 to 40 years for buildings. The cost of repairs and maintenance is charged to expense as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. We examine the possibility of impairment in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. 

Intangible Asset – Pharmaceutical Formulas

The Company has purchased pharmaceutical formulas that were approved by the State Food and Drug Administration of China (“SFDA”). These formulas can be renewed every 5 years without limitation for a minimum fee and are subject to certain protections under PRC drug regulations for an indefinite period of time. These regulations mitigate competition and the ability of other suppliers to replicate the Company’s products or produce comparable substitutes. These intangible assets are measured initially at cost not subject to amortization and are tested for impairment annually or in interim reporting periods if events or changes in circumstances indicate that the carrying amounts of these intangible assets might not be recoverable.  

Common Stock Purchase Warrants and Other Derivative Financial Instruments

The Company accounts for the issuance of common stock purchase warrants issued as free standing financial instruments in accordance with the applicable provisions ASC 810 “Derivatives and Hedging Activities.” Based on this guidance, the Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) gives the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). The Company assesses classification of its freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The common stock purchase warrants have expired as of June 30, 2013 and we did not issue any warrants during the three months ended September 30, 2014. 

Fair Value Measurements and Fair Value of Financial Instruments

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

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

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

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

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

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

The following table reflects gains and losses for the three months ended September 30, 2014 and year ended June 30, 2014 for all financial assets and liabilities categorized as Level 3.

Liabilities:

Balance of warrant liabilities as of June 30, 2013		$ -
Change in the fair value of warrant liabilities		-
Balance of warrant liabilities as of June 30, 2014		-
Change in the fair value of warrant liabilities		-
Balance of warrant liabilities as of September 30, 2014		$ -

Estimating the fair value of derivative financial instruments require the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. The assumptions used to value the Company’s derivatives, which had a direct effect on the fair values. In addition, valuation techniques are sensitive to changes in the trading market price of the our Common Stock and its estimated volatility interest rate changes and other variables or market conditions not within the Company’s control that can significantly affect management’s estimates of fair value and changes in fair value. Because derivative financial instruments are initially and subsequently carried at fair value, the Company’s net income may include significant charges or credits as these estimates and assumptions change. 

The warrants expired on January 5, 2013. At the expiration time, the portion of this warrant not exercised prior thereto shall be and become void and of no value and this warrant shall be terminated and shall no longer be outstanding.

Foreign Currency Translation  

The Company’s reporting currency is the U.S. dollar. The functional currency of the Company’s operating business based in the PRC is the RMB. For the Company’s subsidiaries and affiliates whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the exchange rate in effect as of the end of the period, and equity is translated at historical exchange rates. Translation adjustments resulting from the process of translating the functional currency financial statements into U.S. dollars are included in comprehensive income.

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Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods. All of the Company’s revenue transactions are transacted in the functional currency. Transaction gains or losses have not had, and are not expected to have a material effect on the Company’s results of operations. 

Period end exchange rates used to translate assets and liabilities and average exchange rates used to translate results of operations in each of the reporting periods are as follows:

		The three months ended September 30, 2014		The three months ended September 30, 2013
Period end US$: RMB exchange rate		6.1547		6.1439
Average periodic US$: RMB exchange rate		6.1600		6.1654

The RMB is not freely convertible into any other currencies. In addition, all foreign exchange transactions in the PRC must be conducted through authorized institutions. Accordingly, management cannot provide any assurance that the RMB underlying the condensed consolidated financial statement amounts could have been, or could be, converted into US dollars at the exchange rates used to translate the functional currency into the reporting currency. 

Revenue Recognition  

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

-Persuasive evidence of an arrangement exists;

-Delivery has occurred or services have been rendered;

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

-Collectability is reasonably assured.

Cost of Revenue

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

Stock-based Compensation

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

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

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Research and Development Costs  

Research and development costs are charged to expense as incurred and included in operating expenses. We have only one full-time employee who is engaged in research and development, so the Company is mainly dependent on third-parties to perform the limited amount of research and development that the Company undertakes (see Note 15). On March 1, 2013, the Company entered into a series of contracts with Binzhou Medical College to establish an institute named Bohai Pharmaceutical Institute in the following 5 years. On May 31, 2013, these two parties entered into two contracts pursuant to which Binzhou Medical College agreed to perform research on two of the Company’s pharmaceutical products, namely Lung Nourishing Cream and Tongbi Capsules, in the following 17 months. These contracts amount to $243,380 (RMB 1,500,000), that has been fully paid as of June 30, 2014. Research and development costs amounted to approximately $2,435 and $39,047 for the three months ended September 30, 2014 and 2013, respectively.

Shipping costs  

Shipping costs are included in selling, general and administrative expense. Shipping costs amounted to $462,770 and $272,203 for the three months ended September 30, 2014 and 2013, respectively. 

Advertising

Advertising and promotion costs are charged to expense as incurred. Advertising expenses included in selling, general and administrative expenses amounted to $763 and $101,280 for the three months ended September 30, 2014 and 2013, respectively.

Income Taxes

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

We account for certain tax positions based upon authoritative guidance that prescribes a recognition threshold and measurement processes for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The guidance also provides direction on recognition, classification, interest and penalties, accounting in interim periods and related disclosure. 

Our policy is to classify assessments, if any, for tax related to interest as interest expense and penalties as general and administrative expense.

Earnings per share

We report earnings per share in accordance with ASC Topic 260, “Earnings Per Share”. Basic earnings (loss) per share are computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period. Common equivalent shares are excluded from the computation of diluted shares in periods for which they have an anti-dilutive effect. Diluted shares underlying stock options and common stock purchase warrants are included in the determination of diluted earnings per share using the treasury stock method. Diluted shares underlying convertible debt obligations are included in the determination of diluted loss per share using the “if converted” method (Note 16).

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Recent Accounting Pronouncements

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”. The amendments in the ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. It also addresses sources of confusion and inconsistent application related to financial reporting of discontinued operations guidance in U.S. GAAP. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. In addition, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The amendments in the ASU are effective in the first quarter of 2015 for public organizations with calendar year ends. Early adoption is permitted. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from contracts with Customers (Topic 606)”. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets. This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The ASU also supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchanged for those goods or services. The standard is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements.

In August 2014, the FASB issued the FASB Accounting Standards Update No. 2014-15 “Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”).

In connection with preparing financial statements for each annual and interim reporting period, an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable). Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued (or at the date that the financial statements are available to be issued when applicable). Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or available to be issued). The term probable is used consistently with its use in Topic 450, Contingencies.

When management identifies conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern, management should consider whether its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. The mitigating effect of management’s plans should be considered only to the extent that (1) it is probable that the plans will be effectively implemented and, if so, (2) it is probable that the plans will mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):

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a.

Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)

b.

Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations

c.

Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or available to be issued). Additionally, the entity should disclose information that enables users of the financial statements to understand all of the following:

a.

Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern

b.

Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations

c.

Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.

Management does not believe that any recently issued, but not yet effective accounting pronouncements, when adopted, will have a material effect on the accompanying financial statements.

4.

INVENTORIES

Inventories consist of the following:

		September 30, 2014		June 30, 2014
Raw materials		$ 2,451,701		$ 2,231,226
Work in progress		1,334,841		1,334,451
Finished goods		1,457,338		935,310
Total inventories		$5,243,880		$4,500,987

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5.

PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment consist of the following:

		September 30, 2014		June 30, 2014
Buildings		$ 14,355,280		$ 13,913,970
Plant equipment		10,941,329		11,309,330
Office equipment		433,010		438,850
Motor vehicles		355,777		283,648
Total		26,085,396		25,945,798
Less: accumulated depreciation		(5,155,918)		(4,823,270)
Construction in progress		5,963		5,961

Property, plant and equipment, net		$ 20,935,441		$ 21,128,489

Depreciation expense for property, plant and equipment for the three months ended September 30, 2014 and 2013 amounted to $330,953 and $276,748, respectively.

On June 8, 2010, YantaiTianzheng signed an agreement with Yantai Huanghai Construction Co. to construct certain portions of a factory. The total contract price amounted to approximately $3.16 million (RMB 19.5 million). The constructionwas 100% completed and the new buildings were in use as of September 30, 2014. The final cost was $4.82 million (RMB 29.68 million) as of September 30, 2014, and such $4.82 million (RMB 29.68 million) was fully paid.

6.

INDEFINITE LIVED INTANGIBLE ASSETS – PHARMACEUTICAL FORMULAS

 The Company purchased, and currently owns exclusive rights to, a series of pharmaceutical formulas that were approved by the SFDA. This asset includes 12 formulas that are included in the Chinese government’s Essential Drug List (“EDL”) and 27 medicines included in the National Drug Reimbursement List (“NDRL”). The intellectual property underlying these formulas can be renewed every 5 years without limitation for a minimum fee and are subject to certain protections under PRC drug regulations for an indefinite period of time. These regulations mitigate competition and the ability of other suppliers to replicate the Company’s products or produce comparable substitutes. These intangible assets are measured initially at cost not subject to amortization and are tested for impairment annually or in interim reporting periods if events or changes in circumstances indicate that the carrying amounts of these intangible assets might not be recoverable.

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Pharmaceutical formulas with indefinite lives consist of the following: 

7.

INTANGIBLE ASSETS - LAND USE RIGHTS, NET

		September 30, 2014		June 30, 2014
Land use rights, at cost		$ 40,262,785		$ 40,251,014
Less: Accumulated amortization		(2,841,221)		(2,632,674)
Intangible assets – land use rights, net		$ 37,421,564		$ 37,618,340

The Company acquired land use right on a parcel of land with an area of 266,668 square meters on November 5, 2012. The Company was granted the right to use the land for a period of 50 years at a cost of approximately $19.44 million (RMB 120,000,000). As of September 30, 2014, the Company had made full payments of $19.44 million (RMB 120,000,000) through four installments:

Installment	Payment date	Amount in USD
First	11/30/2012	$ 3,235,879
Second	12/31/2012	3,235,879
Third	6/30/2013	6,471,759
Fourth	12/31/2013	6,497,199
Total		$ 19,440,716

There is no private ownership of land in the PRC. All land is owned by the government, which grants land use rights for specified periods of time. Amortization expense for land use rights amounted to $207,599 and $206,914 for the three months ended September 30, 2014 and 2013, respectively.

Amortization is calculated over a period of 30 - 50 years.

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Amortization of land use rights for fiscal years ending subsequent to September 30, 2014 is as follows:

		Amortization
1 year after September 30, 2014		$ 831,110
2 years after September 30, 2014		831,110
3 year3 after September 30, 2014		831,110
4 years after September 30, 2014		831,110
5 years after September 30, 2014		831,110
Thereafter		33,266,014
Total		$ 37,421,564

8.

OTHER INTANGIBLE ASSETS, NET

Other Intangible assets, net include customer relationships and certain prescription drug product formulas. The Company acquired these assets in its business combination with YantaiTianzheng. Customer relationships are amortized on a straight line basis over periods of 5 and 8 years. Pharmaceutical formulas including those retained as defensive assets are amortized on a straight t line basis over a period of 8 years.

Approximately $10.37 million for the carrying amount of certain other product formulas that the Company will hold as defensive assets have been reclassified from indefinite life drug formulas. According to the Company’s years of industrial experience and R&D knowledge, to get a new drug formula approved from scratch usually take at least 8 years, so the Company is amortizing the pharmaceutical formulas as defensive assets over 8 years.

Other intangible assets at September 30, 2014 consist of the following:

	Customer Relationships		Yantai Tianzheng Drug Formulas		Defensive Drug Formulas		Total
Cost	$ 14,861,163		$ 10,384,096		$ 10,375,059		$ 35,620,318
Accumulated Amortization	(6,148,634)		(4,258,949)		(2,593,765)		(13,001,348)
Net carrying amount	$ 8,712,529		$ 6,125,147		$ 7,781,294		$ 22,618,970

Other intangible assets at June 30, 2014 consist of the following:

	Customer Relationships		Yantai Tianzheng Drug Formulas		Defensive Drug Formulas		Total
Cost	$ 14,856,818		$ 10,381,061		$ 10,372,025		$ 35,609,904
Accumulated Amortization	(5,674,003)		(3,928,913)		(2,268,880)		(11,871,796)
Net carrying amount	$ 9,182,815		$ 6,452,148		$ 8,103,145		$ 23,738,108

Amortization expense for customer relationships amounted to $472,565 and $472,151 for the three months ended September 30, 2014 and 2013, respectively.

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Amortization expense for YTP drug formulas amounted to $328,605 and $326,377 for the three months ended September 30, 2014 and 2013, respectively.

Amortization expense for defensive drug formulas amounted to $323,942 and $323,658 for the three months ended September 30, 2014 and 2013, respectively. Amortization expenses are recorded in general and administrative expenses.

Amortization expense for fiscal years ending subsequent to September 30, 2014 is as follows:   

		Amortization
1 year after September 30, 2014		$ 4,504,323
2 years after September 30, 2014		4,504,323
3 year3 after September 30, 2014		4,504,323
4 years after September 30, 2014		4,504,323
5 years after September 30, 2014		3,304,797
Thereafter		1,296,881
Total		$ 22,618,970

9.

GOODWILL

On August 8, 2011, the Company acquired 100% of Yantai Tianzheng’s equity interests for total purchase consideration of US$35,000,000 (paid in its RMB equivalent). The Company accounted for its acquisition of YantaiTianzheng using the acquisition method of accounting. The fair value of the purchase consideration issued to the sellers of YantaiTianzheng was allocated to fair value of the net tangible assets acquired, with the resulting excess allocated to separately identifiable intangibles including customer relationships that have a finite life, pharmaceutical formulas that have an indefinite life and the remainder recorded as goodwill. Goodwill recognized from the transactions mainly represented the expected operational synergies upon acquisition of the subsidiary and intangibles not qualifying for separate recognition. Goodwill is nondeductible for income tax purpose in the tax jurisdiction of the acquisition transactions incurred. Goodwill amounted $5,224,186 (RMB 32,153,295) and $5,222,658 (RMB 32,153,295) as of September 30, 2014 and June 30, 2014, respectively. Goodwill is measured initially at cost not subject to amortization and are tested for impairment annually or in interim reporting periods if events or changes in circumstances indicate that the carrying amounts of these intangible assets might not be recoverable. The Company has decided there is no impairment for the three months ended September 30, 2014 and 2013.

10.

ACCRUED EXPENSES

Accrued expense consists of the following:

		September 30, 2014		June 30, 2014
Sales representatives commission and expenses		$ 4,759,455		$ 5,879,162
Other payable for PPE		1,270,165		3,889,955
Other accrued expense		784,001		741,129
Other taxes payable		2,747,643		2,380,031
Accrued Interest expenses		2,372,968		2,372,625
Compensation and related cost		480,755		455,663
Total		$ 12,414,987		$ 15,718,565

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11.

DUE TO RELATED PARTY

Due to related party amounted to $55,461 and $55,626 as of September 30, 2014 and June 30, 2014, respectively. It represents accrued out of pocket expenses of Mr. Hongwei Qu, Chief executive officer of the Company.

12.

NOTES PAYABLE

The Company borrowed from Weihai City Commercial Bank (“City Bank”) under the facility obtained by YantaiTianzheng. The latest outstanding amount of $9,748,647 (RMB 60,000,000) was borrowed on April 22, 2014 and has a term of a period of six months and has a bank charge fee of 0.05%. The latest outstanding amount of $9,748,648 (RMB 60,000,000) was borrowed on September 19, 2014 and has a term of a period of six months and has a bank charge fee of 0.05%. As of September 30, 2014 and June 30, 2014, the outstanding aggregate amount was $19,497,295 (RMB 120,000,000) and $9,745,797 (RMB 60,000,000), respectively. The Company was required to maintain 50% of the notes amounts, or $9,748,647 (RMB 60,000,000) and $4,872,899 (RMB 30,000,000) as guaranteed funds, which was classified as restricted cash as of September 30, 2014 and June 30, 2014, respectively.

YantaiTianzheng entered into this credit facility following its execution of third party guaranty arrangements between YantaiTianzheng, City Bank and Laishan Public Assets Management LLP (“Laishan”) and between YantaiTianzheng, City Bank, and Bohai in April 2013. Under the terms of the Guaranty, Laishan and Bohai each has agreed to act as guarantor of up to$4,872,899 (RMB 30,000,000) of any credit extended by City Bank to YantaiTianzheng at any time during the period from April 25, 2013 through April 25, 2015. Laishan is an unrelated third party and has no business relationship with the Company. As a state-owned enterprise, Laishan provides the guarantee to support the development of Bohai, which is a prominent emerging company in the area.

13.

SHORT-TERM LOAN  

 On August 15, 2013, the Company entered into a short term bank loan agreement with RCB. As of September 30, 2014, the loan amounted to $4,874,324 (RMB 30,000,000) with an interest rate of 9% per annum, which is due on August 14, 2014. The Company entered into this credit facility following its execution of third party guaranty arrangements among the Company, RCB, Guangyuan, and the principal shareholder of the Company, Hongwei Qu, on August 15, 2013. Guangyuan is an unrelated third party and has no business relationship with the Company. Guangyuan is a construction company and expected to be a potential constructor for Bohai’s construction on the land purchased in November 2012. As of September 30, 2014, this loan has been paid in full.

On September 02, 2014, the Company entered into a short term bank loan agreement with RCB. As of September 30, 2014, the loan amounted to $4,874,324 (RMB 30,000,000) with an interest rate of 6% per annum, which is due on September 01, 2015. The Company entered into this credit facility following its execution of third party guaranty arrangements among the Company, RCB, Guangyuan, and the principal shareholder of the Company, Hongwei Qu, on September 02, 2014. Guangyuan is an unrelated third party and has no business relationship with the Company. Guangyuan is a construction company and expected to be a potential constructor for Bohai’s construction on the land purchased in November 2012.

14.

CONVERTIBLE PROMISSORY NOTES IN DEFAULT AND DUE ON DEMAND

Convertible Notes  

On January 5, 2010, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”) with 128 accredited investors (the “Investors”), BPGI sold 6,000,000 units for aggregate gross proceeds of $12,000,000, each unit consisting of an 8% senior convertible promissory note in the principal amount of $2 and one Common Stock purchase warrant (collectively, the “Investor Warrants”). By agreement with the Investors, each investor received: (i) a single Note representing the aggregate number of Notes purchased by them as part of the units (each, a “Note” and collectively, the “Notes”) and (ii) a single Investor Warrant exercisable at $2.40 per share subject to certain anti-dilution provisions. The majority of this debt is guaranteed by third-parties and our CEO, Mr. Qu, and a portion is secured by our inventories and fixed assets.

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The Notes originally bore interest at 8% per annum, payable quarterly in arrears on the last day of each fiscal quarter of the Company. Principal was originally due on January 5, 2012. Each Note, plus all accrued but unpaid interest thereon, is convertible, in whole but not in part, at any time at the option of the holder, into shares of Common Stock at a conversion price of $2.00 per share, subject to adjustments for certain anti-dilution provisions. 

The Convertible Notes were initially recorded at a discounted carrying amount of zero as a result of having allocated a portion of the proceeds to (i) the fair value of the warrants, which were recorded as liabilities stated at fair value, and (ii) a beneficial conversion feature that was not bifurcated as a free standing derivative at the time of issuance or at subsequent reporting dates based on periodic classification assessments. Accretion of the note discount amounted to $0 and $0 for the three months ended September 30, 2014 and 2013, respectively. Accretion of the discount was recorded as a component of interest expense in the accompanying statements of income and comprehensive income. Contractual interest expense amounted to $0 and $253,935 for the three months ended September 30, 2014 and 2013, respectively. 

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

On December 31, 2011, the Company’s Chinese operating subsidiary determined it was unable to convert a sufficient amount of RMB needed to repay the notes on their original maturity date of January 5, 2012. As a result, the Company entered into a series of amendments to the Notes with Euro Pacific as representative of the Investors to extend to the maturity date and increase the interest rate on the Notes.

On April 21, 2014, the Company and Euro Pacific, acting as representative of the holders of certain 8% convertible notes, entered into a fifth amendment to the convertible notes (the “Fifth Amendment”) to extend the maturity date of the convertible notes to April 5, 2016.The Fifth Amendment provides, among other things, that (i) the interest of the convertible notes will cease to accrue as of the date of the Fifth Amendment (the “Effective Date”), (ii) any accrued and unpaid interest as of the Effective Date in an aggregate amount of up to $1,000,000 (unless otherwise converted to the Company’s common stock pursuant to Section 5 of the Notes) will be paid by cash as soon as practicable after the date of consummation of a financing by the Company conducted in the U.S. with net proceeds to the Company of at least $5 million, and (iii) in the event that the volume weighted average public trading price (as reported by Bloomberg Financial Markets) of the Company’s common stock exceeds $2.50 for 20 consecutive trading days (the “Trading Period”) with a daily average volume of 30,000 shares over such Trading Period, the Company will have the right, upon notice to the Investor Representative, to require mandatory conversion of the entire outstanding principal amount (including any accrued but unpaid interest) due thereunder into shares of common stock at a conversion price of $2.00 per share.

In October 2013, the Company paid $400,000 towards the principal. In March 2014, the Company paid $446,450 towards the principal. In May and June 2014, the Company issued 103,629 shares common stock and reduced $182,250 towards the principal and $25,000 toward the accrued interest. In July and August 2014, the Company issued 1,284,571 shares common stock and reduced $2,219,777 towards the principal and $349,365 toward the accrued interest. The outstanding balance of the Notes amounted to $5,216,025 and $7,435,800 as of September 30, 2014 and June 30, 2014, respectively.

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The Company has been in temporary default of this obligation at the previously extended maturity dates. Should the Company be unable to repay the notes in time and in the absence of a further extension of the maturity date, this circumstance would constitute an event of default under the terms of loan agreement. The Company cannot predict what the implications of the non-payment of the loan would be other than it would continue to experience difficulty converting sufficiency currency and will maintain an escrow account of restricted funds intended to secure their repayment. The non-payment of the notes could have a material adverse effect on the Company should the note holders pursue further action.

On June 27, 2012, Euro Pacific also agreed to release us from certain restrictions on our ability to incur debt, to incur liens or to make capital expenditures as stipulated in the note agreement. The purpose of the Third Amendment is to provide us with enhanced flexibility to seek potential sources of financing.

The Company has paid $2,831,950 principle in total and converted into common stock $1,388,200 in total. The payment dates and amounts are as follows:

Payment date		Amount
May 14, 2012		$ 314,000
June 28, 2012		100,000
July 3, 2012		631,000
November 29, 2012		940,500
October 9, 2013		100,000
October 29, 2013		300,000
March 6, 2014		446,450
		$ 2,831,950

As of September 30, 2014 and June 30, 2014, the Company’s principal shareholder, Mr. Qu, is obligated to deliver 1,000,000 shares of Common Stock to the Investors if a default occurs.

15.

COMMITMENTS, CONTINGENCIES AND OTHER MATTERS

(a)Contract Research and Development Arrangement

In May 2009, the Company entered into a contract with YantaiTianzheng Medicine Research and Development Co. to perform research and development on two new pharmaceutical products, namely Fern Injection and Forsythia Capsule. The total contract price is approximately $2,436,449 (RMB 15,000,000). YantaiTianzheng Medicine Research and Development Co. was committed to completing all research work required for clinical trial within 3 years. As of September 30, 2014, the Company has paid $2,127,649 (RMB 13,095,044) and the remaining contract amount will be paid as the research services are performed. All payments of $2,127,649 (RMB 13,095,044) have been charged to expense. The Company extended the term of the contract to May 10, 2017 due to certain changes in government regulations that affected this research project.

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(b)Supplier Concentrations

We have the following concentrations of business with each supplier constituting greater than 10 % of the Company’s purchases of raw materials or other supplies:

		The three months ended September 30, 2014		The three months ended September 30, 2013
Shandong Yantai Medicine Procurement and Supply Station		24.25%		24.4%
Shandong Shuntianyi Chinese Herbal Medicine Co., Ltd		24.92%		23.4%
Yantai Tianyifeng Technology Development Co., Ltd		12.97%		*
Shanxi Guangsheng Capsule Co., Ltd		*		11.7%

* Constitutes less than 10% of the Company’s purchases.

(c)Sales Concentrations

 Sales Product Concentrations

Five of the Company’s products, namely Tongbi Capsules, Tongbi Tablets, Lung Nourishing Syrup, Zhengxintai Capsules and Fangfengtongsheng Granule represented approximately 22.1 %, 3.7 %, 32.9 %, 0.6 % and 40.1%, respectively, of total sales for the three months ended September 30, 2014.

Five of the Company’s products, namely Tongbi Capsules, Tongbi Tablets, Lung Nourishing Syrup, Zhengxintai Capsules and Fangfengtongsheng Granule represented approximately 29.7%, 15.6%, 14.4%, 14.9% and 22.7%, respectively, of total sales for the three months ended September 30, 2013.

Sales Customer Concentrations  

The Company does not have concentrations of business with each customer constituting greater than 10% of the Company’s gross sales for the three months ended September 30, 2014 and 2013. 

(d)Economic and Political Risks

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

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(e)Concentrations of Credit Risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is deposited in state-owned banks within the PRC, and no deposits are covered by insurance. We have not experienced any losses in such accounts and believe that the Company’s loss exposure is insignificant due to the fact that banks in the PRC are state owned and are generally high credit quality financial institutions. A significant portion of the Company’s sales are credit sales which are made primarily to customers whose ability to pay are dependent upon the industry economics prevailing in these areas. We continually monitor the credit worthiness of the Company’s customers in an effort to reduce credit risk. 

At September 30, 2014 and June 30, 2014, the Company’s cash balances by geographic area were as follows:

	September 30, 2014					June 30, 2014
Country:
BVI(Chance High)	$ 77,446		0.29%		$ 23,940			0.10%
China	27,060,707		99.71%		23,284,775			99.90%
Total cash and cash equivalents	$ 27,138,153		100%		$ 23,308,715			100%

 

(f)Certificate of land use right

The Company’s corporate headquarters is located at No. 7Tianzheng Road, Laishan District, Yantai, Shandong Province in China. Under the current PRC laws, land is owned by the state, and parcels of land in rural areas which are known as collective land are owned by the rural collective economic organization. “Land use rights” are granted to an individual or entity after payment of a land use right fee is made to the applicable state or rural collective economic organization. Land use rights allow the holder of the right to use the land for a specified long-term period.

We have 5 land use rights, for a total of approximately 675,364 square meters of land on which the Company maintains its manufacturing facility.

The Company has not obtained a land use right certificate for one parcel of land of 280,235 square meters that is located in the high-tech development district of Laishan and that was purchased on February 22, 2010. Registration of this land use right certification is still in process. On November 12, 2013, the Company obtained the land use right certificate for one parcel land of 266,668square meters that is located in the high-tech development district of Laishan and that was purchased on November 5, 2012.

We currently have not obtained the land use right certificate for another parcel of land located in Xingfu Twelve Village of Zhifu District. The land is about 11,222 square meters. Bohai used to have its manufacturing facility on this land. In the process of the planning of Yantai City, the usage of the aforesaid land use right has been changed from “industrial use” to “commercial use” and therefore, the approval process for the land use right certificates on five relevant parcels of land including the land occupied by Bohai has been suspended until the completion of the planning process.

We cannot provide any assurance that the Company will eventually obtain the land use right certificates for these lands. If the Company is asked by the local government to relocate the Company’s facility, management believes that estimated relocation and other costs will be reimbursed by the local government.

On May 5, 2014, Bohai has relocated its manufacturing facilities to YantaiTianzheng in Laishan. As of September 30, 2014, the Company’s headquarter, Bohai’s manufacturing facility and Yantai Tianzheng’s manufacturing facilities are all located in Laishan. The Company does not believe that relocation of operations would have a material adverse effect on the Company’s financial position or results of operations. 

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(g)Business insurance

Business insurance is not readily available in the PRC. To the extent that the Company suffers a loss of a type that would normally be covered by insurance in the United States, such as product liability and general liability insurance, the Company would incur significant expenses in both defending any action and in paying any claims that could result from a settlement or judgment.

16.

NET INCOME PER SHARE

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

		The three months ended September 30, 2014		The three months ended September 30, 2013
Net Income available to common stockholders – basic		$ 9,344,056		$ 8,087,731
Interest on convertible notes		349,365		253,935
Net Income available for common shareholders - diluted		$ 9,693,421		$ 8,341,666
Weighted average number of common shares outstanding - basic		18,662,544		17,861,085
Common shares if converted from Convertible Debt		1,788,221		4,232,250
Weighted average number of common shares outstanding - diluted		20,450,764		22,093,335
Earnings per share:
Basic		$ 0.50		$ 0.45
Diluted		$ 0.47		$ 0.38

17.

STOCK OPTIONS

On October 13, 2010, we granted stock options to two directors for the purchase of 26,000 shares of our Common Stock at an exercise price of $2.00 per share. The options vested immediately and expire five years from the date of issuance. These options have been valued at $23,844. We use a binomial option pricing model to calculate the grant date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 70 %, risk free interest rate of 0.3%, expected term of 2.5years. 

On May 2, 2011, we granted stock options to a director for the purchase of 6,000 shares of our Common Stock at an exercise price of $2.00 per share. The options vested immediately and expire five years from the date of issuance. These options have been valued at $3,184. We use a binomial option pricing model to calculate the grant date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 55%, risk free interest rate of 0.3%, expected term of 5 years.

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The following table summarizes the weighted average remaining contractual life and exercise price of our outstanding options as of September 30, 2014:

Options Outstanding
Exercise Price		Number Outstanding at September 30, 2014		Number Outstanding Currently Exercisable at September 30, 2014		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price of Options currently exercisable
$ 2.00		32,000		32,000		1.14		$ 2.00

The Company accounts for share-based payments in accordance with ASC 718. Accordingly, it expenses the fair value of awards granted to the directors. Total compensation expense related to the stock options for the three months ended September 30, 2014and 2013 were $0 and $0, respectively.

A summary of our stock option activity as of September 30, 2014, and changes during the three months ended September 30, 2014 and year ended June 30, 2014 is presented in the following table:

		Option Shares		Vested Shares		Exercise Price per Common Stock Range
Balance, June 30, 2013		32,000		32,000		2.00
Granted or vested during the year ended June 30, 2014		-		-		-
Exercised during the year ended June 30, 2014		-		-		-
Expired during the year ended June 30, 2014		-		-		-
Balance, June 30, 2014		32,000		32,000		2.00
Granted or vested during the three months ended September 30, 2014		-		-		-
Exercised during the three months ended September 30, 2014		-		-		-
Expired during the three months ended September 30, 2014		-		-		-
Balance, September 30, 2014		32,000		32,000		$ 2.00

18.

STOCKHOLDERS ’ EQUITY

Authorized Capital

The Company is authorized to issue 150 million shares of Common Stock, par value $ 0.001 per share. Holders of its Common Stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders.

Shares Issued for Conversion

During the three months ended September 30, 2014, the Company issued 1,284,571 shares for conversion of convertible notes. $2,219,777 principal and $349,365 accrued interest for convertible notes were converted.

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Retained earnings

According to the laws and regulations in the PRC, we are required to provide for certain statutory funds, namely, reserve fund by an appropriation from net profit after taxes but before dividend distribution based on the local statutory financial statements of the PRC company prepared in accordance with the accounting principles and relevant financial regulations. 

In the PRC, we are required to allocate at least 10% of our net profit to the reserve fund until the balance of such fund has reached 50% of its registered capital. Appropriation of enterprise expansion fund are determined at the discretion of it directors. The Company allocated $1,022,350 to the reserve fund during the three months ended September 30, 2014 which recorded in retained earnings. 

The reserve fund can only be used, upon approval by the relevant authority, to offset accumulated losses or increase capital.

19.

OPERATING EXPENSES AND OTHER INCOME (EXPENSES)

 For the three months ended September 30, 2014 and 2013, operating expenses consisted of the following:

		The three months ended September 30, 2014		The three months ended September 30, 2013
Sales Commissions		$ 23,695,099		$ 25,036,380
Advertising expense		763		101,280
Audit fees and other professional expenses		35,000		27,628
Depreciation and amortization		742,657		713,560
Staff costs (salary &welfare)		394,938		517,980
Research and development cost		-		39,047
Other operating expenses		1,328,548		1,518,174
Total Operating expenses		$ 26,197,005		$ 27,954,049

20.

INCOME TAXES

The Company is incorporated under the laws of State of Nevada in the United States of America and has legal subsidiaries in the British Virgin Islands (“BVI”) and the PRC. The Company does not have any employees or assets nor or is it engaged in any income producing activities in the Unites States and in the BVI. The Company is currently filing Federal income tax returns in the United States and applicable franchise tax returns in the state of Nevada. The Company’s net operating losses that may be available to offset future taxable income in the United States, if any, amount to approximately $8,500,000 and expire through 2032. The Company has fully reserved for these and all other deferred tax assets generated in the Company’s US operations since it currently more likely than not that those assets will not be realized in future periods.

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The Company’s only income producing activities are in the PRC. The statutory corporation income tax rate in the PRC is 25 %, which is approximately equal to the effective income tax rate that the Company expects to use when recording income tax expense for financial reporting purposes for the year ending June 30, 2015. Accordingly, the Company is recording a tax provision at interim reporting dates for taxable income earned in the PRC using the effective rate expected to be in effect for the year ending June 30, 2015.

21.

VIE

To satisfy PRC laws and regulations, the Company conducts certain business in the PRC through the VIE.

As a result of the VIE Agreements signed between WOFE and Bohai, the Company includes the assets, liabilities, revenues and expenses of Bohai (the “VIE”) in its consolidated financial statements. 

Substantially all of the Company’s assets, including those of Bohai which is considered the VIE and YantaiTianzheng, which is an acquired subsidiary of the Company, are accessible to Bohai through WOFE II creditors irrespective of the VIE arrangement. 

The VIE Agreements include:

Equity Interest Pledge Agreement.  The WOFE and Bohai’s shareholders have entered into Equity Interest Pledge Agreements, pursuant to which each Bohai shareholder has pledged all of his shares of Bohai to the WOFE in order to guarantee cash-flow payments under the applicable Consulting Services Agreement. The Equity Pledge Agreement further entitles the WOFE to collect dividends from Bohai during the term of the pledge. 

Consulting Service Agreement.  Bohai and the WOFE has entered into a Consulting Services Agreement, which provides that the WOFE will be the exclusive provider of technology services to Bohai and Bohai will pay all of its net income based on the quarterly financial statements to the WOFE for such services. Any such payment from the WOFE to the Company would need to comply with applicable Chinese laws affecting payments from Chinese companies to non-Chinese companies. See “Risk Factors – Risks Associated With Doing Business in China.”  

Operating Agreement.  Pursuant to the operating agreement among the WOFE, Bohai and the Bohai shareholders, the WOFE provides guidance and instructions on Bohai’s daily operations and financial affairs. The Bohai shareholders must designate the candidates recommended by the WOFE as their representatives on their respective boards of directors. The WOFE has the right to appoint senior executives of Bohai. In addition, the WOFE agrees to guarantee Bohai’s performance under any agreements or arrangements relating to Bohai’s business arrangements with any third party. Bohai, in return, agrees to pledge its accounts receivable and all of its assets to the WOFE. Moreover, Bohai agrees that without the prior consent of the WOFE, Bohai will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of its assets or intellectual property rights in favor of a third party or transfer of any agreements relating to its business operation to any third party.

These contractual arrangements may not be as effective in providing the Company with control over the VIE as direct ownership. Due to its VIE structure, the Company has to rely on contract right to effect control and management of the VIE, which exposes it to the risk of potential breach of contract by the shareholders of Bohai. The VIE Agreements are subject to significant risks as set forth in the following risk factors.

The PRC government may determine that the VIE Agreements used to control the Company’s operating subsidiary Bohai are not in compliance with applicable PRC laws, rules and regulations and that they are therefore unenforceable.

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There are risks involved with the operation of Bohai under the VIE Agreements. The Company has been advised by PRC legal counsel that if the PRC government determines the VIE Agreement used to control the operating company to be unenforceable as they circumvent the PRC restrictions relating to foreign investment restrictions, the relevant regulatory authorities would have broad discretion in dealing with such breach and could have a material adverse impact on our business, financial condition and results of operations.

The Company depends upon the VIE Agreements in conducting its production, manufacturing, and distribution of traditional Chinese herbal medicines in the PRC, which may not be as effective as direct ownership.

The Company conducts its production, manufacturing and distribution of traditional Chinese herbal medicines in the PRC and generate the revenues from the Bohai business through the VIE Agreements. The VIE Agreements may not be as effective in providing us with control over Bohai as direct ownership. The VIE Agreements are governed by PRC laws and provide for the resolution of disputes through arbitration proceedings pursuant to PRC laws. Accordingly, the VIE Agreements will be interpreted in accordance with PRC laws. If Bohai or its shareholders fail to perform the obligations under the VIE Agreements, the Company may have to rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, and there is a risk that the Company may be unable to obtain these remedies. The legal environment in China is not as developed as in other jurisdictions. As a result, uncertainties in the PRC legal system could limit the Company’s ability to enforce the VIE Agreements.

The pricing arrangement under the VIE Agreements may be challenged by the PRC tax authorities.

The Company could face adverse tax consequences if the PRC tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations. If the PRC tax authorities determine that the VIE Agreements were not entered into on an arm’s length basis, they may adjust the income and expenses of the Company for PRC tax purposes which could result in higher tax liability.

On January 17, 2014, all rights and obligations of WOFE relating to Bohai, including all of WOFE’s rights and obligations under each of the VIE Agreements, were assigned in full to WOFE II.

22.

SUBSEQUENT EVENTS

In October 2014, convertible notes with an aggregate face amount of $298,886 and accrued interest of $41,016 were converted into 169,951 shares of Common Stock.

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Item 2.  Management’s Discussion and Analysis or Plan of Operation.

The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in our unaudited condensed consolidated financial statements for the three months ended September 30, 2014, and should be read in conjunction with such financial statements and related notes included in this report. Those statements in the following discussion that are not historical in nature should be considered to be forward looking statements that are inherently uncertain. Actual results and the timing of the events may differ materially from those contained in these forward looking statements due to a number of factors, including those discussed in the “Cautionary Note on Forward Looking Statements” set forth elsewhere in this Report.

Overview

We are engaged in the production, manufacturing and distribution in China of herbal pharmaceuticals based on traditional Chinese medicine, which we refer to herein as Traditional Chinese Medicine (“TCM”). We are based in the city of Yantai, Shandong Province, China and our operations are exclusively in China.

Our medicines address rheumatoid arthritis, viral infections, gynecological diseases, cardio vascular issues and respiratory diseases. Our initial operating subsidiary, YantaiBohai Pharmaceuticals Group Co., Ltd. (“Bohai”) obtained Drug Approval Numbers (“DANs”) for 29 varieties of traditional Chinese herbal medicines in 2005, and an additional 14 varieties in December 2010. Through our acquisition of YantaiTianzheng in August 2011, we obtained DANs for another 5 varieties in August 2011. We currently produce 7 varieties of approved traditional Chinese herbal medicines in seven delivery systems: tablets, granules, capsules, formulations, concentrated powder, tincture and medicinal wine. Of these 7 products, 4 are prescription drugs and 3 are over the counter (“OTC”) products.

Three of Bohai’s lead products, Tongbi Capsules and Tablets and Lung Nourishing Syrup, are eligible for reimbursement under China’s National Medical Insurance Program (“NRDL”), which we believe significantly increases the marketability of these products. In addition to these lead products, three of our current products and five of our formulas we acquired in 2010 are eligible for NRDL reimbursement. In addition, Bohai’s Lung Nourishing Syrup was included in the new national Essential Drugs List (“EDL”) issued by the Ministry of Health of China on March 15, 2013. The new EDL superseded its previous version formerly issued in 2009 and became effective on May 1, 2013. In addition to Lung Nourishing Syrup, we have another product, Fangfengtongsheng Granule, and four of its previously acquired formulas, which was listed in the 2009 version and are again included in the new EDL. Inclusion on either the EDL or NRDL allows for up to 100% insurance coverage by the Chinese government. YantaiTianzheng owns five prescription products approved by the State Food and Drug Administration of China (“SFDA”) and currently manufactures four of such products. Among Yantai Tianzheng’s products, Fangfengtongsheng Granule has an exclusive status and is on the EDL and NDRL. Zhengxintai Capsule has renewed its protective status to August 2017 and is currently on the NDRL.

Prior to January 5, 2010, we were a public “shell” company operating under the name “Link Resources, Inc.” On January 5, 2010, we consummated a share exchange transaction (the “Share Exchange”) pursuant to which we acquired Chance High International Limited (“Chance High”), the indirect parent company of Bohai, our principal operating subsidiary, which is a Chinese variable interest entity (“VIE”) that we (through a Chinese wholly-owned foreign enterprise subsidiary YantaiNirui Pharmaceuticals Co., Ltd. (“WOFE II”)) control through certain contractual arrangements (the “VIE Agreements”). On August 8, 2012, WOFE II, a PRC company and a newly formed subsidiary of Chance High, entered into a Share Purchase Agreement pursuant to which we acquired, from the three individual holders thereof, one hundred percent (100%) of the outstanding shares of YantaiTianzheng, which became our second operating subsidiary effective as of July 1, 2012.   

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On January 17, 2014, the Company merged YantaiShencaojishi Pharmaceuticals Co., Ltd. (“Shencaojishi”) with and into WOFE II.  In connection with the merger, and in accordance with relevant PRC laws and regulations, WOFE II entered into an assignment agreement with Shencaojishi and Bohai, pursuant to which all rights and obligations of Shencaojishi relating to Bohai, including all of WOFE’s rights and obligations under each of the VIE Agreements, were assigned in full to WOFE II. Following the merger, WOFE II is the Company’s only wholly-owned foreign enterprise (“PRC WOFE”).  

Our current organizational structure is summarized below:

 

Recent Developments

On November 5, 2012, we acquired a land use right with respect to a 266,668 square meters parcel of land located in high-tech development district of Laishan. The land use right grants to us the right to use the land for a period of 50 years at a total cost of approximately $19.44 million (RMB120,000,000). We plan to build workshops, a logistics system and a R&D center on the land to better prepare us for future development.

On May 5, 2014, Bohai has relocated its manufacturing facilities to YantaiTianzheng in Laishan. As of September 30, 2014, our headquarters, Bohai’s manufacturing facility and Yantai Tianzheng’s manufacturing facilities are all located in Laishan.

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On January 17, 2014, we merged WOFE I with and into WOFE II. In connection with the merger, and in accordance with relevant PRC laws and regulations, WOFE II entered into an assignment agreement with Shencaojishi and Bohai, pursuant to which all rights and obligations of Shencaojishi relating to Bohai, including all of Shencaojishi’s rights and obligations under each of the VIE Agreements, were assigned in full to WOFE II.

Principal Factors Affecting Our Financial Performance

We believe that the following factors will continue to affect our financial performance:

Sales of Key Products

Our top selling products as a percentage of total net revenue consist of the following:

	For the three months ended September 30,
	2014		2013
Tongbi Capsules	22.1%		29.7%
Fangfengtongsheng Granule	40.1%		22.7%
Tongbi Tablets	3.7%		15.6%
Zhengxintai Capsule	0.6%		14.9%
Lung Nourishing Syrup	32.9%		14.4%
Other Products	0.7%		2.7%
Total Sales	100%		100%

We expect that a significant portion of our future revenue will continue to be derived from sales of our top five products. 

We held the Certificates of Protected Variety of Traditional Chinese Medicine (Grade Two) issued by the SFDA for Tongbi Capsules and Anti-flu Granules which gave us exclusive or near-exclusive rights to manufacture and distribute these two medicines. Tongbi Capsules’ certificates expired in September 2009. We filed an application for extending the protection period on March 12, 2009 and received certification extension until September 13, 2016. Lung Nourishing Syrup received a patent with duration of 20 years from the State Intellectual Property Office of the PRC and the patent will expire on September 12, 2027. Tongbi Capsule and Tongbi Tablet received a patent with duration of 20 years from the State Intellectual Property Office of the PRC and the patent will expire on May 5, 2032.

Experienced Management  

Management’s marketing strategies and business relationships gives us the ability to expand our product market areas, which provides us with leverage to acquire less sophisticated operators, increase production volumes, and implement quality standards. Our future prospects depend substantially on the continued services of our senior management team, especially our President, Chief Executive Officer and Chairman of the Board, Mr. Qu.

Price Control of Drugs by PRC Government and SDRC

The State Development and Reform Commission of the PRC (“SDRC”) and the price administration bureaus of the relevant provinces of the PRC in which the pharmaceutical products are manufactured are responsible for the retail price control over our pharmaceutical products. The SDRC sets the price ceilings for certain pharmaceutical products in the PRC. All of our products except those under the protection periods are subject to such price controls and could affect our future revenue growth. However, due to the direct support of TCM by the Chinese government, China’s immense market, and our protected drugs, we are optimistic regarding our continuous growth potential for TCM in China.

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Operating Results

Comparison of the three months ended September 30, 2014 and 2013

Net Revenues

Net revenues are comprised of sales of 11 traditional Chinese medicines (corresponding to 7 drug formulas) in China during the three months ended September 30, 2014. We previously sold 20 medicines (corresponding to 16 drug formulas) following our acquisition of YantaiTianzheng on August 8, 2012, but have made the strategic choice to narrow our focus to our top 11 products (corresponding to 7 drug formulas). Net revenues for the three months ended September 30, 2014 increased by $3,853,685, or 7.6%, to $54,742,745 as compared to $50,889,060 for the three months ended September 30, 2013. Net revenues were $32,486,210 and $22,256,535 for Bohai and YantaiTianzheng, respectively, for the three months ended September 30, 2014. Net revenues were $31,793,560 and $19,095,500 for Bohai and YantaiTianzheng, respectively, for the three months ended September 30, 2013.

The increase in Bohai’s revenue was primarily due to a 5.5% net increase in revenues from three leading drug formulas in Bohai: Lung Nourishing Syrup, Tongbi Capsules, and Tongbi Tablets, which together accounted for over 98.9% of our total net revenues for Bohai for the three months ended September 30, 2014. Lung Nourishing Syrup, Tongbi Capsules, and Tongbi Tablets together accounted for 95.6% of our total net revenues for Bohai for the three months ended September 30, 2013. All of our lead products from Bohai are listed for coverage and reimbursement under national medical insurance program starting in December 2009.   

The increase in Tianzheng’s revenue was primarily due to a net increase of 16.5% in revenue derived from two leading drug formulas in Tianzheng: Zhengxintai Capsule and Fangfengtongsheng Granule.

The increase in our revenue is primarily due to increase in market demand for our key products that are included in the government’s essential drug list. The government encourages hospital and doctors to prescribe essential drugs to patients.

The sale of our prescription drug products for the three months ended September 30, 2014 represented 67% of total net revenue compared to 83% for the same period in last year.

Cost of Revenues

Cost of revenues is comprised of raw material costs, labor cost, overhead costs associated with the manufacturing processes and related expenses which are directly attributable to our revenues. Our cost of revenues for the three months ended September 30, 2014 was $15,533,884 as compared to $11,707,654 for the three months ended September 30, 2013, representing an increase of $3,826,230, or 32.7%. Cost of revenues were $9,509,300 and $6,024,584 for Bohai and YantaiTianzheng, respectively, for the three months ended September 30, 2014. Cost of revenues were$6,903,772 and $4,803,882 for Bohai and YantaiTianzheng, respectively, for the three months ended September 30, 2013. The increase in cost of revenues for the three months ended September 30, 2014, compared to the same period in 2013, was mainly due to change of product mix and due to an increase in total costs of raw materials, labor, and overhead as a result of an increase in overall sales.    

Gross Profit    

Gross profit represents the difference between net revenues and cost of revenues. We achieved gross profit of $39,208,861 for the three months ended September 30, 2014, as compared to $39,181,406 for the same period in 2013, representing an increase of $27,455, or 0.1%, over the same period in 2013. The increase of the gross profit is mainly due to increased revenues offset by increased costs of revenues.

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Our overall gross profit margins as a percentage of net revenues increased by approximately 5.4% from 77.0% to 71.6% in the three months ended September 30, 2014, as compared to the same period in 2013.

Operating Expenses

Our operating expenses decreased by $1,757,044, or 6.3%, to $26,197,005, for the three months ended September 30, 2014, as compared to $27,954,049 for the same fiscal period in 2013. The overall decrease in selling, general, and administrative expenses was mainly due to decreased sales commissions and decreased staff cost which is decided by collection of accounts receivable. The percentage of operating expenses to net revenues was 47.9% and 54.9% for the three months ended September 30, 2014 and 2013, respectively, representing a decrease of 7.1% as a percentage of net revenues.

Sales commissions decreased by $1,341,281, or 5.4%, to $23,695,099 for the three months ended September 30, 2014, as compared to $25,036,380 for the same fiscal period in 2013. Sales commissions accounted for 43.3% and 49.2% of the net revenue for the three months ended September 30, 2014 and 2013, respectively. The decrease in commission is due to decreased collection of accounts receivable resulting during the three months ended September 30, 2014 compared to the same period last year.

Depreciation and amortization expenses in operating expenses increased by $29,097, or 4%, to $742,657 for the three months ended September 30, 2014, as compared to $713,560 for the same fiscal period in 2013.   

Total Other Income (Expenses)   

Total other expenses comprised of interest income (expenses), and other income (expenses). Total other expenses were $380,786 for the three months ended September 30, 2014 compared to total other expenses of $385,613 for the period ended September 30, 2013, a decrease of total net other expenses of $4,827. The decrease in total other expenses were principally due to an increase of $74,981 for interest expense, offset by increased other income of $54,225 and increased interest income of $25,583. The increase of interest expenses was mainly due to increased notes payable for the three months ended September 30, 2014 compared to the same period last year.

On June 30, 2012, our Chinese operating subsidiary Bohai determined it was unable to convert a sufficient number of RMB needed to repay the notes issued to certain accredited investors on their original maturity date of January 5, 2012. As a result, we entered into a series of amendments to the notes with Euro Pacific, as representative of the investors, to extend to the maturity date and increase the interest rate on the notes. Pursuant to the most recent amendment, the maturity date of the notes was extended April 5, 2016 and among other things, that (i) the interest of the convertible notes will cease to accrue as of the date of the Fifth Amendment (the “Effective Date”), (ii) any accrued and unpaid interest as of the Effective Date in an aggregate amount of up to $1,000,000 (unless otherwise converted to our common stock pursuant to Section 5 of the Notes) will be paid by cash as soon as practicable after the date of consummation of a financing by us conducted in the U.S. with net proceeds to us of at least $5 million, and (iii) in the event that the volume weighted average public trading price (as reported by Bloomberg Financial Markets) of our common stock exceeds $2.50 for 20 consecutive trading days (the “Trading Period”) with a daily average volume of 30,000 shares over such Trading Period, we will have the right, upon notice to the Investor Representative, to require mandatory conversion of the entire outstanding principal amount (including any accrued but unpaid interest) due thereunder into shares of common stock at a conversion price of $2.00 per share. In October 2013, the Company paid $400,000 towards the principal. In March 2014, the Company paid $446,450 towards the principal. In May and June 2014, the Company issued 103,629 shares common stock and reduced $182,250 towards the principal and $25,000 toward the accrued interest. In July and August 2014, the Company issued 1,284,571 shares common stock and reduced $2,219,777 towards the principal and $349,365 toward the accrued interest. The outstanding balance of the notes amounted to $5,216,023 and $7,435,800 as of September 30, 2014 and June 30, 2014, respectively.

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Provision for Income Tax

Our provision for income taxes for the three months ended September 30, 2014 and 2013 were $3,287,014 and $2,754,013, an increase of $533,001, or 19.4%, for the three months ended September 30, 2014 over the same period last year. The increase in provision for income tax was mainly due to the increase of taxable income. The effective income tax rates were 26% and 25% for the three months ended September 30, 2014 and 2013, respectively.

Net Income

We had a net income of $9,344,056 for the three months ended September 30, 2014, as compared to net income of $8,087,731 for the three months ended September 30, 2013, an increase in net income of $1,256,325, or 15.5%. This translates into basic earnings per common share of $0.50 and $0.45, and diluted earnings per common share of $0.48 and $0.38, for the three months ended September 30, 2014 and 2013, respectively. The increase in net income was primarily attributable to an increase in total gross profit of $27,454 and a decrease in operating expenses of $1,757,044 in the three months ended September 30, 2014 compared to the same period in 2013.

Net income margin was 17.1% for the three months ended September 30, 2014 as compared to net income margin 15.9% for the same period last year, an increase of 1.2%. The increase was mainly due to the decreased selling and general and administrative expenses decreased other expense and the increase of gross income.

Liquidity and Capital Resources

Liquidity is the ability of a company to generate adequate amounts of cash to meet its needs for working capital. As of September 30, 2014, we had cash and cash equivalents of $27,138,153 and restricted cash of $22,375,805, substantially almost all of which is located in financial institutions in China. The following table provides detailed information about our net cash flow for financial statement periods presented in this report: 

Summary of Cash Flow Statements

	For the three months ended September 30,
	2014		2013
Net cash provided by operating activities	$ 6,485,538		$ 7,784,583
Net cash used in investing activities	(2,663,673)		(5,080,749)
Net cash provided by (used in) financing activities	(179)		4,865,107
Effect of foreign currency translation on cash and cash equivalents	7,752		(75,139)
Net increase in cash and cash equivalents	$ 3,819,438		$ 7,493,802

Net Cash Provided By Operating Activities

Net cash provided by operating activities totaled $6,485,538 for the three months ended September 30, 2014 as compared to net cash provided by operating activities of $7,784,583 for the three months ended September 30, 2013. The decrease in net cash provided by operating activities, for the three months ended September 30, 2014 compared to the same period 2013, was primarily due to increased prepaid expenses and other current assets of $7.3 million, and increased accrued liabilities of $3.7 million, offset by increased net income of $1.3 million, increased depreciation and amortization of $1.4 million, decreased purchase of inventories of $1.2 million, and less increase of $6.0 million in accounts receivables.

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Net Cash Used In Investing Activities

Net cash used in investing activities was $2,663,673 for the three months ended September 30, 2014 as compared to net cash used in investing activities of $5,080,749 for the three months ended September 30, 2013. The net decrease in cash used in investing activities was mainly due to less cash payment of approximately $5.0 million made for our YantaiTianzheng acquisition, offset by more cash payment of approximately $2.4 million for property, plant and equipment acquisition, more cash payment of approximately $0.1 million for deposit for property, plant and equipment deposits during the three months ended September 30, 2014 compared to the same period in 2013.

Net Cash Provided By (Used In) Financing Activities

Net cash used in financing activities totaled $179 for the three months ended September 30, 2014 as compared to net cash provided by financing activities of $4,865,107 for the same period in 2013. The reason for the decrease in cash provided by financing activities was mainly due to more net payments from short-term loan of $4.9 million during the three months ended September 30, 2014 compared to the same period in 2013. The short-term loan and note payable credit facility are all following the execution of third party guaranty arrangements.

Cash Position

As of September 30, 2014, we had cash of $27,138,153 as compared to $23,308,715 as of June 30, 2014, an increase of $3,829,438. 

We believe that we can meet our liquidity and capital requirements for our ongoing operations from our currently available working capital and maintain our operations at our current levels. 

However, during the current fiscal year and thereafter, we will require cash to meet certain obligations described under “Obligations under Material Contracts” below, in particular the payment of the principal and interest on our convertible notes for which the principal amount of $5,216,023 was not paid as of the date of this report.  

We believe we would be able to generate enough cash flow from operating activities to meet these obligations. In case we will not be able to generate enough cash flow from operating activities, we may reduce capital expenditures or raise additional capital to fund these obligations, either through the issuance of debt or equity securities, bank loans or other methods. Readers are cautioned that additional funding, capital or loans may be unavailable to us on favorable terms, if at all. If adequate funds are not available, we would likely have to renegotiate the terms of these obligations, which we may be unable to do on favorable terms. We may thus be required to agree to unfavorable terms that could have a material adverse effect on us, our financial condition and our results of operations in 2013 and beyond. Moreover, to the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in ownership and potentially economic dilution to existing shareholders.

In addition, if we are faced with worldwide financial and credit crisis as have occurred in recent years, it may make the future cost of raising funds through the debt or equity markets more expensive or make financial markets unavailable to us at times when we require additional financings.

Finally, it has been very difficult over the past several years for U.S.-listed Chinese companies to raise financing from investors. As a result, our ability to raise needed financing may be compromised.

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Critical Accounting Policies and Estimates

As discussed in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2014, we consider our use of estimates, accounts receivable, revenue recognition, inventories, property plant and equipment, intangible assets and income taxes to be the most critical accounting policies in understanding the judgments that are involved in preparing our condensed consolidated financial statements. There have been no significant changes to these estimates in the three months ended September 30, 2014.

Recent Accounting Pronouncements Adopted

See Note 3 to the condensed consolidated unaudited financial statements included in Item 1, Financial Information, of this Quarterly Report on Form 10-Q.

Recent Accounting Pronouncements Not Yet Adopted

See Note 3 to the condensed consolidated unaudited financial statements included in Item 1, Financial Information, of this Quarterly Report on Form 10-Q.

Obligations under Material Contracts

The following table summarizes our contractual obligations as of September 30, 2014, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

	Payments Due by Period
Contractual Obligations:	Total		Less than 1 year		1-3 Years		4-5 years		6 Years+
Convertible notes	$ 5,216,023		$ -		$ 5,216,023		$ -		$ -
Construction payable	-		-				-		-
Total Contractual Obligations:	$ 5,216,023		$ -		$ 5,216,023		$ -		$ -

Other than discussed above, there are no other foreseeable material commitments or contingencies as of September 30, 2014.

Off-Balance Sheet Arrangements

We did not engage in any “off-balance sheet arrangements” (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) during the three months ended September 30, 2014. We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our condensed consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.

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Currency Exchange Risk

Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies. Substantially all of our revenue and expenses are in the Chinese currency, the Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of the Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. In July 2005, the Chinese government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Under this policy, which was halted in 2008 due to the worldwide financial crisis, the Renminbi was permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. In June 2010, the Chinese government announced its intention to again allow the Renminbi to fluctuate within the 2005 parameters. It is possible that the Chinese government could adopt an even more flexible currency policy, which could result in more significant fluctuation of Renminbi against the U.S. dollar, or it could adopt a more restrictive policy. We can offer no assurance that the Renminbi will be stable against the U.S. dollar or any other foreign currency. 

Our consolidated financial statements are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign consolidated subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign consolidated subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to hedge our exchange rate risks. Most of our transactions are settled in Renminbi and U.S. dollars. We are not exposed to significant foreign currency risk.

Credit Risk

Our potential credit risk is mainly attributable to its debtors and bank balances. In respect of debtors, we have policies in place to ensure that it will only accept customers from countries which are politically stable and customers with an appropriate credit history. In addition, all the bank balances were made with financial institutions with high-credit quality. Thus, we are not considered to be subject to significant credit risk.

Interest Rate Risk

Our interest rate risk is primarily attributable to its short-term borrowings, loan to a third party and loan to equity holders. Our borrowings carry interest at fixed rate. Our management has not used any interest rate swaps to hedge its exposure to interest rate risk.

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Inflation

In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as -2.2%. These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products. 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

As of September 30, 2014, the quarterly period covered by this report, our management conducted evaluations of the Company’s disclosure controls and procedures. As defined under Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act”), the term disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, to allow timely decisions regarding required disclosures.

 

Based on this evaluation, our management has concluded that our disclosure controls and procedures were, due to certain material weaknesses in internal control and significant deficiencies on financial reporting discussed below, not effective to ensure that material information is recorded, processed, summarized and reported by our management on a timely basis in order to comply with our disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder.

 

Material weakness

 

We identified two material weaknesses in the design and operation of our internal controls. The material weakness is related to (i) the failure to retain sufficient qualified accounting personnel to prepare financial statements in accordance with accounting principles generally accepted in the US (including a qualified Chief Financial Officer); and (ii) the Company’s accounting department personnel have limited knowledge and experience in US GAAP.

 

To remediate the material weaknesses identified in internal control over financial reporting of the Company, we have commenced to: (i) hire additional personnel with sufficient knowledge and experience in US GAAP; and (ii) provide ongoing training courses in US GAAP to existing personnel, including our Financial Controller in China.

 

We have engaged the service of an outside financial reporting specialist to assist with the preparation of our consolidated financial statements and quarterly and annual report. We will continue to monitor and assess our remediation initiatives to ensure that the aforementioned material weakness is remediated.

 

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Significant deficiency

A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness (within the meaning of PCAOB Auditing Standard No. 5) yet important enough to merit attention by those responsible for oversight of a company’s financial reporting.

 

The significant deficiencies identified by our management continue to be as described in our Annual Report on Form 10-K for the fiscal year ended June 30, 2014, which was filed with the SEC on October 14, 2014, as amended. As a result, our management and board of directors are continuing to evaluate our internal control over financial reporting and our disclosure controls and procedures in an attempt to address such significant deficiencies.

 

Changes in Internal Control over Financial Reporting

 

The Company currently lacks an audit committee. Thus, there is no independent supervision from an audit committee to: (1) select and oversee the Company's independent accountant; (2) monitor the procedures for handling complaints regarding the Company's accounting practices; (3) engage advisors; and (4) ensure funding for the independent auditor and any outside advisors engaged by the audit committee.

 

Subject to the foregoing disclosure, there were no other changes in our internal control over financial reporting during the three months ended September 30, 2014 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on the Effectiveness of Internal Controls

 

Readers are cautioned that our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any control design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

 

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PART II - OTHER INFORMATION

 

Item 1.	Legal Proceedings

 

From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm business. We are currently not aware of any such legal proceedings or claims that will have, individually or in the aggregate, a material adverse affect on our business, financial condition or operating results.

 

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

 

None.

 

Item 3.	Defaults Upon Senior Securities

 

None.

Item 4.	Mine Safety Disclosures

 

Not applicable.

 

 

None.

 

 

(a) Exhibits

 

Exhibit Number		Description of Exhibit
31.1*		Certification of Principal Executive and Financial Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
32.1*		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and principal financial officer).

 

_________________

 

* Filed herewith.

 

 

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SIGNATURES

 

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

 

	Bohai Pharmaceuticals Group, Inc.
November 14, 2014	By:	/s/ Hongwei Qu
		Hongwei Qu Chief Executive Officer (Principal Executive Officer and Principal Financial Officer)

 

 

 

 

 

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