ITEM 1.
DESCRIPTION OF BUSINESS
With the exception of historical facts stated herein, the following discussion may contain forward-looking statements regarding events and financial trends that may affect Dragon Pharmaceutical Inc.’s future operating results and financial position. Such statements are subject to risks and uncertainties that could cause Dragon Pharmaceutical Inc.’s actual results and financial position to differ materially from those anticipated in such forward-looking statements. Factors that could cause actual results to differ materially include, in addition to other factors identified in this report, that Dragon Pharmaceutical Inc. has a substantial amount of liabilities, all of which factors are set forth in more detail in the sections entitled “Item 1A.
ITEM 1A
RISK FACTORS
An investment in the Company’s common stock involves a high degree of risk. Before you invest, you should carefully consider the risks described below. If any of the following risks occur, the Company’s financial condition or results of operations could be materially affected.
Certain Officers and Directors have significant control.
Messrs. Han and Weng and Ms. Liu, who are officers and Directors of the Company, own, in the aggregate, 58.05% of the Company’s issued and outstanding shares of common stock. As a result, these stockholders will be able to control certain corporate governance matters requiring stockholders’ approval. Such matters may include the approval of significant corporate transactions requiring a majority vote without seeking other stockholders’ approval. They will also have the ability to control other matters requiring stockholders’ approval including the election of directors that could result in the entrenchment of management.
Dragon Pharma has a negative working capital and it must restructure the short-term loans.
As of December 31, 2008, the Company had current liabilities of $70.19 million and current assets of $48.25 million, including cash and cash equivalents of $4.93 million and accounts receivable of $10.50 million. The excess of current liabilities over current assets was mainly due to the fact that the Company financed its operations and increased sales and production level for both Cephalosporin and Penicillin divisions through operating revenues, accounts payable and short-term loans. As a result, Dragon Pharma must, during the upcoming twelve months, negotiate with its banks to restructure or renew its loans. Assuming that Dragon Pharma is successful in renegotiating its loans and that vendors continue to work with Dragon Pharma regarding accounts payable, Dragon Pharma believes that it will be able to fund its operations from product sales for the near future. However, there is no assurance that the Company will be able to renegotiate and extend its loans. If the Company’s banks do not extend its loan or if they are extended on unfavorable terms, the Company may be adversely affected.
Dragon Pharma relies heavily on main clients.
Sales to the Company’s five largest customers accounted for approximately 37% and 46% of the Company’s sales for the year ended December 31, 2008 and 2007, respectively; while sales to the Company’s largest customer accounted for approximately 12% and 20%, respectively. Although the Company does not anticipate that there will be a material change in these customer relationships, a change in demand for these products due to world competition, market forces or other factors outside of the control of clients, could adversely affect its sales and net income.
Shanxi Weiqida is required to contribute a portion of its net income to Reserve Funds which may not be distributed.
By law, Shanxi Weiqida is required to contribute at least 10% of its after tax net income (as determined in accordance with Chinese GAAP) into a reserve fund until the reserve is equal to 50% of Shanxi Weiqida’s registered capital, a further percentage of its after tax net income, as determined by Shanxi Weiqida’s Board of Directors, into a staff welfare fund, and into an enterprise expansion fund if determined by the Board of Directors. The reserve fund and enterprise expansion fund are recorded as part of stockholders’ equity but are not available for distribution to shareholders other than in the case of liquidation, while the staff welfare fund is recorded as a liability, and is not available for distribution to shareholders. As a result of this requirement, the amount of net income available for distribution to shareholders will be limited.
The Company intends to raise additional capital through the issuance of equity securities that will dilute the ownership of other shareholders.
The Company intends to raise additional capital through the issuance of its equity securities to finance its growth and reduce short-term debt and other liabilities. No assurance can be given that the Company will be successful in its efforts. Furthermore, the issuance of equity securities will reduce other shareholders’ ownership in the Company.
The Company may be subject to product liability claims in the future that could harm its business and reputation.
Product liability claims may arise if harmful products are sold to members of the public or if there are any alleged harmful effects from the consumption of the Company’s products. Under current Chinese laws, manufacturers and vendors of defective products in China may incur liability for loss and injury caused by such products, including having their business licenses revoked and facing criminal liability. Consistent with industry practice in China, Shanxi Weiqida does not carry product liability insurance coverage. Should any product liability claim be brought against the Company, there is no assurance that it would not have an adverse impact on its business, profitability or business reputation.
The Company will be dependent upon the services of its CEO and Chairman, Mr. Yanlin Han.
Mr. Yanlin Han is the Company’s largest shareholder and serves as its CEO and Chairman of the Board. As a result, the Company’s operations will be dependent on Mr. Han who has been the driving force behind the Company. If something happens to Mr. Han, this could divert management’s time and attention and adversely affect the management’s ability to conduct the business operations effectively.
Dragon Pharma relies heavily on the China market and changes in the market could harm its business.
During 2008 and 2007, 83% and 71% of Dragon Pharma’s sales, respectively, were derived from China. It is anticipated that Dragon Pharma’s products in China will continue to represent a significant portion of sales in the near future. As a result of its reliance on the China market, the operating results and financial performance of Dragon Pharma could be affected by any adverse changes in economic, political and social conditions in China. In addition, the Company will be subject to varying degrees of regulation and licensing by governmental agencies in China. At this time, the management of the Company is unaware of any China legislative proposals that could adversely affect the Company’s business. There can be no assurance that future regulatory, judicial and legislative changes will not have a material adverse effect on Dragon Pharma, that regulators or third parties will not raise material issues with regard to compliance or non-compliance with applicable laws or regulations or that any changes in applicable laws or regulations will not have a material adverse effect on Shanxi Weiqida or the Company’s operations.
Certain products are subject to price controls and if the related manufacturing costs increase, the Company’s potential profits may be harmed.
In July 2000, in an effort to enhance market competition in the pharmaceutical industry and to reduce medical expenses, the former State Development and Planning Commission of the People’s Republic of China promulgated a new policy to reform the price control of pharmaceutical products in China. For details, please refer to the Regulation section. All powder for injection products from the Company’s Cephalosporin division are subject to retail price control imposed by the government administration authorities, which accounted for approximately 26% of 2008 sales and 20% of 2007 sales. If manufacturing costs increase for these products that are subject to price ceilings, and the retail price for those products is not adjusted upwards, the Company’s profitability will be adversely affected.
Dragon Pharma is required to maintain compliance with GMP standards.
All pharmaceutical manufacturers in China, including Shanxi Weiqida, a subsidiary of Dragon Pharma, are required to comply with certain Good Manufacturing Practice, or GMP, standards by certain time limits and, if not met, their pharmaceutical manufacturing enterprise permits will be revoked or they will not be renewed and accordingly production will have to be terminated. A GMP certificate is valid for five years from the issuance date of the certificate.
Shanxi Weiqida has been accredited with all GMP certificates it requires for its production facilities. The standard of compliance required in connection with GMP certificates may change from time to time, which may give rise to substantial compliance burdens and increase Shanxi Weiqida’s costs in the future. If the recertification of any required GMP-related status is not granted, the relevant operations of Shanxi Weiqida may have to be terminated which in turn would have an adverse impact on the Company’s profitability.
Currency conversion and exchange control could adversely affect the Company’s operations and profitability.
The sales and expenses of Shanxi Weiqida are substantially settled in Renminbi, or RMB, however, the Company’s financial statements are reported in U.S. dollars. Accordingly, the Company’s net income, the value of its assets and its ability to pay dividends, if any, in U.S. dollars may be adversely affected by negative changes in the exchange rate of RMB against the U.S. dollar or other currencies.
On July 22, 2005, the Chinese government decided to no longer peg the value of the Renminbi to the US dollar but rather to a basket of currencies of its largest trading partners. The result was an appreciation of the Renminbi against the value of the US dollar. The effect of the revaluation was an increase in the assets, liabilities, revenues and expenses of the Company and a foreign currency gain included in comprehensive income.
The majority of the Company’s assets, liabilities, revenues and expenses are denominated in Renminbi, which was tied to the US Dollar until July 22, 2005 and is now tied to a basket of currencies of China’s largest trading partners, is not a freely convertible currency. The appreciation of the Renminbi against the US dollar would result in an increase in the assets, liabilities, revenues and expenses of the Company and a foreign currency gain included in comprehensive income. Conversely, the devaluation of the Renminbi against the US Dollar would result in a decrease in the assets, liabilities, revenues and expenses of the Company and a foreign currency loss included in comprehensive income.
Dragon Pharma does not have patent protection and is subject to substantial competition.
Dragon Pharma competes in the generic drug segment of the pharmaceutical industry and has no patent protection for any of its products. Many pharmaceutical companies compete in the same market segment with similar products or products having comparable medicinal applications or therapeutic effects which may be used as direct substitutes for Dragon Pharma’s products. Further, many of these competitors are larger and have greater resources and market presence than Dragon Pharma. Larger competitors may, as a result of economies of scale, be able to afford to sell competing products at lower prices than Dragon Pharma. This will have an adverse effect on Dragon Pharma’s profitability. As a result of the lack of patent protection, competitors with potential substitutes could launch similar products in the market with their prices analogous to or lower than those manufactured and sold by Dragon Pharma. Further, the lack of patent protection could also attract an even greater number of competitors who believe they can develop products that are substantially similar to those of Dragon Pharma at a lower cost.
Chinese economic planning could negatively impact the pharmaceutical market in which the Company’s products are sold.
China has a long history of a planned economy and is still subject to plans formulated by the Central Chinese government. In recent years, the Chinese government has introduced economic reforms aimed at transforming the Chinese economy from a planned economy into a market economy with socialist characteristics. These economic reforms allow greater utilization of market forces in the allocation of resources and greater autonomy for enterprises in their operations. However, many rules and regulations implemented by the Chinese government are still at an early stage of development and further refinements and amendments are necessary to enable the economic system to develop into a more market oriented form. No assurance can be given that any change in economic conditions as a result of the economic reform and macroeconomic measures adopted by the Chinese government will have a positive impact on the Chinese economic development or its pharmaceutical sector, which is the market where the Company’s products are sold. At the same time, there can be no assurance that such measures will be consistent and effective or that the Company will benefit from or will be able to capitalize on all such reforms.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2.
DESCRIPTION OF PROPERTY
The Company’s corporate administrative office is located at Suite 310, 650 West Georgia Street, Vancouver, British Columbia, Canada covering 2,222 square feet for approximately Cdn$81,345 ($67,788) per annum until March 31, 2011. The Company also has an office in Beijing, China, which manages the Company’s marketing and sales for Chinese and international market outside of China.
The Company’s production facilities are all located in Datong city, China. The Company’s own production campus, with a total area of approximately 947,200 square feet, houses the clavulanic acid and 7-ACA production facilities complete with a entire production infrastructure including power supply, boiler, steam and chilled water facilities and water treatment plant. The land use right for this facility expires in August 2053.
In the past, the Company has used contract manufacturers to produce the cephalosporin powder for injection. As the Company’s sales volume and market share for its formulation products continue to increase in the Chinese market, the Company now leases a 84,000 square feet manufacturing facility with a production line for cephalosporin powder for injection. This facility also includes several workshops for other crude sterilized bulk drugs for cephalosporin antibiotics. This allows the Company to ensure enough production volume to meet a growing demand of the Company’s products, better control of manufacturing cost, as well as facilitate product quality.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company is not currently involved in any litigation.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for shareholders vote during 2008.
PART II
ITEM 5.
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company’s common stock began quotation on the OTC Bulletin Board on October 9, 1998 under the symbol “DRUG”. In addition, the Company’s shares of common stock are listed on the Toronto Stock Exchange under the symbol “DDD” and are quoted on the Berlin-Bremen Exchange, the Frankfurt Exchange and the XETRA Exchange under the symbol “DRP”. The OTC Bulletin Board represents the Company’s primary market. The Company’s common stock being quoted and traded on the Berlin-Bremen Exchange, Frankfurt Exchange and XETRA Exchange are without the Company’s prior knowledge. The following quotations reflect the high and low bids for the Company’s common stock on a quarterly basis for the past two fiscal years as quoted on the OTC Bulletin Board. These quotations are based on inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Holders
As of March 15, 2009, there were 60 registered holders of the Company’s common stock. Many of the shares of common stock are held in street name and there may be additional beneficial holders of the Company’s common stock.
Dividend Policy
The Company has paid no dividends on its common stock since its inception and may not do so in the future. For the foreseeable future, the management expects earnings, if any, will be retained to finance the growth of the Company.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
Because the Company is a smaller reporting company, it does not need to provide the information required by this Item 6.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Except for statements of historical facts, this section contains forward-looking statements involving risks and uncertainties. You can identify these statements by forward-looking words including “believes,” “considers,” “intends,” “expects,” “may,” “will,” “should,” “forecast,” or “anticipates,” or the negative equivalents of those words or comparable terminology, and by discussions of strategies that involve risks and uncertainties. Forward-looking statements are not guarantees of the Company’s future performance or results, and the Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors.” This section should be read in conjunction with the Company’s consolidated financial statements.
The following discusses the Company’s financial condition and results of operations for the years ended December 31, 2008 and 2007 based upon the Company’s audited consolidated financial statements which have been prepared in accordance with the United States generally accepted accounting principles. Since the Company sold the Biotech division during 2007, the results for the Biotech division have been shown separately as discontinued operations on the Company’s Consolidated Statements of Operations for the years ended December 31, 2008 and 2007.
Scheduled Periodic Overhaul During August 2008
The Company currently produces its products in three facilities in two different locations in the city of Datong, China, one for 7-ACA, one for clavulanic acid and the third one for the cephalosporin API and downstream formulation products. During the third quarter of 2008, the Company completed its scheduled periodic overhaul of its 7-ACA, clavulanic acid and related production infrastructure such as industrial boilers (steam supply), water circulation system, power distribution system as well as the water treatment plant.
Since the pilot production of 7-ACA and clavulanic acid in this facility back in 2004, the Company has experienced several rounds of capacity and yield improvement from the initial production capacity of 400 tons and 30 tons for 7-ACA and clavulanic acid to the current capacity of 780 tons and 78 tons respectively. In addition, due to the continuous nature of the fermentation process for the 7-ACA and clavulanic acid production, this facility has been operating continuously in shifts 24 hours a day, 7 days a week and all year around. Certain overhaul procedures such as refurbishment of the power distribution system, the clearance of the water circulation system as well as the servicing of the industrial boilers that produce steam for the fermentation process, cannot be performed concurrently during normal production. As a result, it is essential to perform such scheduled overhaul through suspending the production process on a temporary basis. The Company also took advantage of this overhaul period to complete the transformation of the 7-ACA production line from the old chemical method to the enzymatic (biotech) method which is more cost efficient as well as environmental friendly.
Management scheduled the overhaul in August 2008 because summer has traditionally been the slow and high cost season for our business and such scheduled overhaul would allow the Company to better prepare for the upcoming busy season. Starting September 1, 2008, the 7-ACA and clavulanic acid production facility has resumed normal operations. According to industry practice, Company management expects that the next scheduled periodic overhaul of a similar nature will be carried out in two years.
In anticipation of the scheduled overhaul in August 2008, the Company had accumulated enough inventories for clavulanic acid to fulfill the demand of the products during the third quarter of 2008. In addition, this scheduled periodic overhaul did not involve the cephalosporin formulation facility and therefore the production and sales of the cephalosporin formulation products were not affected during the third quarter of 2008. However, sales of 7-ACA for the third quarter of 2008 were lower than the same period of 2007. This decrease was mainly due to lower production output during the third quarter of 2008 as a result of the scheduled overhaul.
Results of Operations for the Fiscal Years Ended December 31, 2008 and 2007
Sales for the year ended December 31, 2008 increased 77% to $151.94 million from $85.78 million for the same period in 2007. $125.75 million, or approximately 83%, of the sales for the year ended December 31, 2008 were generated from the sales of products in the Chinese market, and the remaining $26.19 million, or approximately 17%, were generated from the sales of products in the markets outside of China. By comparison, 71% of the sales for the year ended December 31, 2007 were generated from the sale of products in the Chinese market while the remaining 29% of the sales were generated in the international markets, outside of China. For the year ended December 31, 2008, $48.17 million, or 32%, of sales were from the Penicillin division and $103.77 million, or 68%, of the sales were from the Cephalosporin division. For the same period in 2007, 20% of sales were from the Penicillin division and 80% of sales were from the Cephalosporin division. The increase in sales for the full year of 2008 as compared to 2007 was primarily due to the increase in sales of clavulanic acid (61% year-over-year growth), cephalosporin API (1,392% year-over-year growth) and cephalosporin formulation (131% year-over-year growth) as well as the introduction of cefalexin and cefadroxil in the market during 2008.
Cost of sales for the year ended December 31, 2008 was $127.40 million compared to $67.99 million for the same period in 2007. The increase in the cost of sales was mainly due to the increase in production and sales of products from both the Penicillin and Cephalosporin divisions. Gross profit and gross margin for the year ended December 31, 2008 were $24.54 million and 16% compared to $17.79 million and 21% for the same period of 2007. The decrease in overall gross margin was mainly due to a change in product mix, with the significant increase in cephalosporin API and formulation, together with the introduction of cefalexin and cefadroxil initially with lower margins. Individual products from both divisions experienced an increase in gross margin in 2008 as compared to 2007.
Divisional Revenues and Gross Margin Analysis
The Company’s businesses are currently organized under two business divisions: the Penicillin division and the Cephalosporin division. The Company sold the assets of the biotech division during the fourth quarter of 2007 and therefore the results of the former biotech division have been reclassified as discontinued operations.
Penicillin Division
Sales for the Penicillin division for the year ended December 31, 2008 were $48.17 million, representing a 183% increase from the revenues of $17.03 million during the same period in 2007. Sales from both the Chinese and international market increased 338% and 47% respectively from 2007 to 2008. The increase in sales is mainly due to the increase in sales volume of clavulanic acid (61% year-over-year growth in sales), as well as the introduction of cefalexin and cefadroxil in the market during 2008.
The Penicillin division’s gross margin for the year ended December 31, 2008 was 18% compared to 26% for the year ended December 31, 2007. The decrease in the overall gross margin for the division was mainly reflected the change in product mix within the division as the newly introduced cefalexin and cefadroxil already accounted for 41% of the divisional sales in 2008 as compared to nil % in 2007. Gross margin for Clavulanic acid further improved to 31% in 2008 as compared to 26% in 2007 which mainly reflected the contribution of improvements in production technology.
Cephalosporin Division
The Cephalosporin division’s sales for the year ended December 31, 2008 were $103.77 million, accounting for 68% of the total sales of the Company. By comparison, Cephalosporin division’s sales were $68.75 million for the same period in 2007, contributing 80% of the total sales of the Company. The 51% increase in sales of the Cephalosporin division during 2008 as compared to 2007 was mainly due to the significant increase in cephalosporin API (1,392% year-over-year growth) and cephalosporin formulation (131% year-over-year growth). Sales of 7-ACA in 2008 were slightly lower than in 2007 because of the lower production volume due to the scheduled overhaul during August, 2008 (please refer to the above section “Scheduled Periodic Overhaul During August 2008” for further information) and the increased in-house usage of 7-ACA to produce cephalosporin API during 2008.
The overall gross margin for the division for the year ended December 31, 2008 was 15% as compared to 19% for the same period in 2007. While every product group within the division experienced an increase in gross margin, the decrease in the overall gross margins for the division was due to a change in product mix between 2007 and 2008. Cephalosporin formulation currently carried lower gross margin than other product groups within the division as the Company has been pursuing a sales strategy of capturing market share from the fast growing Chinese market.
Expenses
Total operating expenses were $14.89 million for the year ended December 31, 2008. The major category of operating expenses was general and administration expenses of $8.57 million, selling expense of $4.00 million, and depreciation and amortization expenses of $1.04 million. Total operating expenses were $10.93 million for the year ended December 31, 2007 with the major expenses being general and administration expenses of $6.75 million, selling expense of $3.14 million, and depreciation and amortization expenses of $0.55 million.
The increase in operating expenses of $3.97 million for the year ended December 31, 2008 as compared to the same period for the prior year mainly reflected the increase of $0.87 million in selling expenses due to an increase in delivery charges related to the increase in sales volume from both the Cephalosporin and Penicillin divisions, an increase of $0.78 million in research and development expense, an increase of $0.49 million in deprecation and amortization as well as an increase of $1.82 million in general and administration expenses.
The increase in general and administration expenses for 2008 was mainly due to the following reasons: 1) expenses of $1.45 million specifically related to the scheduled periodic overhaul of the 7-ACA & clavulanic acid facility in August, 2008 (please refer to the above section “Scheduled Periodic Overhaul during August 2008” for further information), 2) an increase of $1.00 million related to an increase in personnel, rent and office expenses mainly related to the formulation facilities; and 3) an increase in travel expenses of $0.34 million, 4) an increase in foreign exchange loss of $0.25 million and 5) an increase in property tax expenses of $0.34 million due to the receipt of certain exemption for prior years property tax expenses during 2007. However, these increases in expenses were partially offset by a decrease in accounting & auditing expenses of $0.50 million, consulting expenses of $0.15 million as well as a decrease of the stock based compensation expenses of $0.91 million.
Total operating expenses as a percentage of sales was 9.8% for 2008 as compared to 12.7% for 2007. However, excluding the $1.45 million expenses specifically related to the scheduled periodic overhaul, the operating expenses as a percentage of sales lowered to 9% for 2008 (please refer to the above section “Periodic Scheduled Overhaul during August 2008” for further information).
Other Expense
During the year ended December 31, 2008, the Company recognized a net other expense of $2.73 million. This amount primarily consisted of $3.63 million of interest expense (including $ 3.57 million cash interest expense and $0.06 million non-cash accreted interest expense on the long term payable) which was offset partly by a $1.09 million government grants for bringing in investment & new technology to Datong city as well as subsidies for employee’s mandated employee benefit contributions. Other expenses for the year ended December 31, 2007 were 1.27 million.
After-tax Income from Continuing Operations
The Company realized a 23% increase of after-tax Income from Continuing Operations of $4.90 million for 2007 to $6.03 million for 2008. The improvement can be attributed to the growth of revenues from increased sales and production volumes and increased margins in both the Cephalosporin and Penicillin divisions.
After-tax Income / (Loss) from Discontinued Operations.
For the year ended December 31, 2008, the Company recognized an after-tax income from discontinued operations of $0.80 million as compared to an after-tax loss from discontinued operations of $2.40 million in 2007, which was mainly due to the write-off of $2.14 million for intangible assets and $0.97 million for goodwill. These intangible assets and goodwill in the Biotech division were created as a result of the reverse take-over of Dragon Pharmaceutical Inc. by Oriental Wave Holdings Limited on January 12, 2005. The write-off of the Biotech division’s intangible assets and goodwill had no cash impact on the Company’s financial results, but created a loss from discontinued operations for the full year of 2007.
Net Income
For the year ended December 31, 2008, the Company had a net income of $6.83 million as compared to $2.50 million for the same period in 2007, representing 173% year-over-year growth.
Comprehensive Income
Including a gain on foreign currency translation of $3.18 million, the Company had a comprehensive income of $10.01 million for the full year of 2008, compared to a comprehensive income of $5.36 million for the same period of 2007, which included a gain on foreign currency translation of $2.86 million. The gain on foreign currency translation results from translation of the financial statements expressed in RMB to United States Dollar. The increase mainly reflected the appreciation of the RMB relative to the United States dollar.
Net Income per Share - Basic
The Company’s net income per share has been computed by dividing the net income for the period by the weighted average number of shares outstanding during the same period. The weighted-average number of shares outstanding was 66,867,818 and 64,640,625 for the full year of 2008 and 2007 respectively.
Net income per share for the year of 2008 was $0.10 per share as compared to $0.04 per share for the year of 2007, representing a 150% year-over-year growth.
Net Income per Share - Diluted
During 2008, some of the stock options outstanding had a dilutive impact of the Company’s net income. The weighted-average number of shares outstanding was 68,396,616 and 64,640,625 for the full year of 2008 and 2007 respectively.
Net income per share for the year of 2008 was $0.10 per share as compared to $0.04 per share for the year of 2007, representing a 150% year-over-year growth.
Liquidity and Capital Resources
As of December 31, 2008, Dragon Pharma had current liabilities of $70.19 million and current assets of $48.25 million, including cash of $4.93 million and accounts receivables of $10.50 million. The deficiency in working capital was mainly due to the fact that the Company financed its operations and increased sales and production level for both Cephalosporin and Penicillin divisions through operating revenues, accounts payables and short-term loans.
The Company has developed and is implementing a plan to decrease its debt and increase its working capital which will allow the Company to continue operations. To meet these objectives, the Company plans to seek additional equity through the conversion of some of its liabilities and expects to raise funds through private placements in order to support existing operations and expand the range and scope of its business. In addition, the Company intends to continue to renegotiate and extend loans, as required, when they become due, as has been done in the past. There is no assurance that such additional funds will be available for the Company on acceptable terms, if at all, or that the Company will be able to negotiate and extend the loans. If adequate funds are not available or not available on acceptable terms or the Company is unable to negotiate or extend its loans, the Company may be required to scale back or abandon some activities. Management believes that actions presently taken provide the opportunity for the Company to continue as a going concern. The Company’s ability to achieve these objectives cannot be determined at this time. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The Company’s financial statements do not include any adjustments that might result from this uncertainty.
As of December 31, 2008, Dragon Pharma had current liabilities of $70.19 million as follows:
As of December 31, 2008, Dragon Pharma had outstanding short-term loans (less than one year term) totaling $20.87 million. Dragon Pharma believes that it will be successful in the renegotiating loans due based on the assumption that the Company has enhanced its ability to generate additional cash flow from its operation since the loans were originally entered into, even though there is no assurance of renewing the loans.
Long-term Liabilities:
At December 31, 2008, Dragon Pharma had long-term loan payable of $20.57 million and deferred revenue of $0.39 million.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Because the Company is a smaller reporting company, it does not need to provide the information required by this Item 7A
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this section appears after the signature page (see -). The Company has elected to provide the information required by Item 8 (b).
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Nil.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Not Applicable
ITEM 9A.(T)
CONTROLS AND PROCEDURES
(a)
Evaluation of Disclosure Controls and Procedures
As of December 31, 2008, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in the Company’s periodic reports filed under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s rules and regulations.
(b)
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America (“GAAP”). We recognize that because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
To evaluate the effectiveness of our internal control over financial reporting, management used the criteria described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Management’s assessment is that our internal control over financial reporting was effective as of December 31, 2008. These internal control procedures ensure the effective recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.
(c)
Attestation Report of Independent Registered Public Accounting Firm
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to current rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
(d)
Changes in internal control over financial reporting.
There has been no change in the Company’s internal control over financial reporting that occurred during the Company’s fourth fiscal quarter ended December 31, 2008 and that has materially affected, or is reasonably likely to affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The Company has eight directors consisting of Mr. Han, Mr. Weng, Ms. Liu, Dr. Wick, Dr. Sun, Mr. Mak, Dr. Frey and Dr. Li. who were all re-elected as directors at the annual meeting of shareholders held on June 26th, 2008. The following describes the background for Mr. Han, Mr. Weng, Ms. Liu, Dr. Wick, Dr. Sun, Mr. Mak, Dr. Frey and Dr. Li.
Description of Current Directors
Mr. Yanlin Han, age 45, is the Chief Executive Officer and the Chairman of the Board of Director of Dragon Pharma, positions he assumed in January 2005. Prior to the reverse take-over of the Company, Mr. Han was the founder and Chairman of Oriental Wave and responsible for the overall strategic planning and direction of the Company. Mr. Han has over 20 years of experience in the pharmaceutical industry in many positions like material buyer, product sales and manager for state-own companies in China and has very extensive sales and production management experience in China. He founded his private company named Shanxi Tongling Pharmaceutical Company in 1994, which became the vehicle to acquire state-owned pharmaceutical companies through bankruptcy process or contractual management agreements. Mr. Han set up a joint venture with a large Indian pharmaceutical company to produce pharmaceutical intermediates with mass fermentation technology. Mr. Han also serves as the Vice-President of Shanxi Province Foreign Investment Enterprise Association and Vice-President of Datong City Trade Council. Mr. Han graduated from Shanxi Institute of Economic Management in 1986.
Mr. Zhanguo Weng, age 54, had been a Director of the Company since January 2005. Mr. Weng was the Vice President, China Operation until July 1, 2006 when the Company completed the sales of part of its formulation business. Mr. Weng has over 25 years of experience in pharmaceutical industry including being the General Manager for Shanxi Tongzhen Pharmaceutical Co. Ltd. from August 1997 to January 2002 and Superintendent for Datong No. 2 Pharmaceutical Factory from June 1992 to August 1997. He graduated from the Business Administration faculty of Shanxi Broadcasting University in 1986 and has also participated the Senior Program of MBA (Pharmaceutical Line) of People’s University of China for two years. Subsequent to the sales of part of the company’s formulation business on July 1, 2007, Mr. Weng became a director of Shanxi C&Y Pharmaceutical Company, the buyer of the Company’s formulation business.
Ms. Xuemei Liu, age 39, has been a Director of the Company since January 2005. Ms. Liu is currently the Chairman of Tera Science & Technology Development Co. Ltd. which engages in a wide range of investment projects in real estate development, coal trading and media and publishing industry. Prior to her present position as Chairman of Tera Science & Technology Development Co. Ltd., Ms. Liu was the vice general manager of Beijing Chemical Baifeng Investment Corporation Futures Broker Company from 1996 to 1999. Ms. Liu graduated from Beijing University with a Bachelor degree in 1996 and graduated from the Graduate School of the Chinese Academy of Social Sciences with a Master degree in 1998.
Dr. Heinz Frey, age 71, has been a Director of Dragon Pharma since September 2005, graduated from University of Bern, Switzerland in 1966, has 30 years of experience in the telecommunication industry, security manufacturing and service industry. He has broad experience in the management of various sizes of companies with global presence, financing and controlling of international companies, leading development, production, sales and finance departments. He is also a board member of various companies.
Dr. Alexander Wick, Ph.D., age 71, has been a Director of Dragon Pharma since 1998 and was the President from 2002 until his resignation effective on February 2, 2006. As of February 3, 2009, Dr. Wick is an independent director of the Company. Dr. Wick holds a doctorate degree in synthetic organic chemistry from the Swiss Federal Institute of Technology and has completed post-doctoral studies at Harvard University. He has had leading positions in the pharmaceutical research departments of F. Hoffmann-La Roche in the United States and Switzerland and Synthelabo in France (Director of Chemical Research and Development) for over 25 years in the field of antibiotics, prostaglandius, vitamins, cardiovascular CNS and AIDS. In 1995 he created the fine chemicals company Sylachim S.A., a 100% subsidiary of Synthelabo, active in chemical intermediates and API’s for the world’s largest pharmaceutical companies (turnover of over 100 million Euros) and was its President until its acquisition by the German conglomerate mg Technologies (Dynamit-Nobel GmbH) in 2001. In 2006 he founded AS Biotech in Bern, Switzerland and is currently its president.
Dr. Yiu Kwong Sun, M.D., age 65, has been a Director of Dragon Pharma since 1999. Dr. Sun graduated from the University of Hong Kong Faculty of Medicine in 1967. He is a Founding Fellow of the Hong Kong College of Family Physicians and a Fellow of the Hong Kong Academy of Medicine. Since 1995, he has served as the Chairman of the Dr. Sun Medical Centre Limited, which has been operating a network of medical centers in Hong Kong and China for the past 20 years. He is also the Administration Partner of United Medical Practice, which manages a large network of medical facilities throughout Hong Kong and Macau. Dr. Sun has been a member of the Dr. Cheng Yu Tung Fellowship Committee of Management of the University of Hong Kong Faculty of Medicine since 1997.
Mr. Peter Mak, age 47, has been a Director of Dragon Pharma since September 2005. Mr. Mak is currently the managing director of Venfund Investment, a boutique investment banking service firm which he co-founded in late 2001. Prior to that, Mr. Mak was a partner at Arthur Andersen Worldwide and the managing partner of Arthur Andersen Southern China. Mr. Mak currently serves as an independent director and audit committee chairman of Trina Solar Limited, an NYSE-listed solar company, China Security & Surveillance Technology, Inc., an NYSE-listed security system company, China GrenTech Corporation Limited, a Nasdaq National Market-listed radio frequency technology and product developer, and Network CN Inc., an OTC Bulletin Board-quoted information and entertainment network service provider. Mr. Mak is a fellow member of the Association of Chartered Certified Accountants and the Hong Kong Institute of Certified Public Accountants. Mr. Mak received his Professional diploma in accountancy from the Hong Kong Polytechnic University in 1985.
Dr. Jin Li, age 41, has been a Director of Dragon Pharma since September 2005, is currently a senior advisor of Phycos International Co., Ltd. Prior to joining Phycos, he was a partner at the international law firm, Linklaters. Mr. Li studied biochemistry at Peking University in China and received his Master of Science degree in Biochemistry from the University of Michigan and his JD degree from Columbia University Law School. He has more than ten years of experience in international IPOs, M&A and business transactions.
Description of Executive Officers
The following sets forth the Company’s executive officers.
For a description of Mr. Han, please see his biography above under “Description of Current Directors.”
Garry Wong has been the Chief Financial Officer of the Company since January 2005. Prior to his current position, Mr. Wong served as the Company’s Executive Assistant to President and Chief Executive Officer of the Company from February 2002 to January 2005. Before joining the Company, Mr. Wong was a manager of the Global Mergers and Acquisitions Group at Nortel Networks since 1996. He managed and executed transactions consisting of acquisitions, divestitures, equity investments, spin-offs, public market listing and joint ventures, in Europe, North America, Asia and the Middle East. Mr. Wong is a Chartered Financial Analyst, or CFA, who received an International MBA degree from York University, Canada with double majors in Corporate Finance and Greater China studies and a Bachelor degree in Business Administration from University of Hong Kong.
Maggie Deng has been the Chief Operating Officer and Corporate Secretary of the company since January 2005, holding bachelor degree from Tsinghua University in China. Ms. Deng has over 10 years of experience working in or with public companies as investment banker, mainly on IPOs and secondary offering for Chinese companies on domestic stock exchange as well as international ones. Ms. Deng was the senior manager of China International Capital Corporation, a Morgan Stanley joint venture investment banking firm in China, from 1998 to 2001. Ms. Deng moved to Canada in 2001 and held a position of Assistant President in a start-up biotech company in Vancouver, Canada until she joined Dragon Pharma in January 2005.
Audit Committee
On June 26th, 2008, the Board reappointed Mr. Mak, Dr. Frey and Dr. Li, each of whom is independent director, to the Audit Committee. Mr. Mak, the Chairman of the Audit Committee, is an expert within the meaning of Item 407(d)(5)((ii) of Regulation S-X. The Audit Committee operates under a written charter.
Nominating Committee
Due to the size of the Company, the Company does not have a separate nominating committee. Instead, the Board of Directors serves as the nominating committee. The Board of Directors will consider nominations to the Board by its shareholders. Requests for consideration should be made to the Company’s Corporate Secretary, Maggie Deng.
Code of Ethics
The Company has adopted a series of ethical standards and related policies, that are applicable to the officers, directors and employees of the Company, including the Company’s principal executive officer, principal financial officer, principal accounting officer, controller, or persons performing similar functions. These standards and policies include Code of Ethical Conduct, Code of Ethical Conduct for Financial Managers, Anti-fraud Policy and Whistleblower Policy, which are all available on the Company’s website at www.dragonpharma.com. Amendments to and waivers from these standards and policies will also be disclosed on the Company’s website.
Compliance with Section 16 of the Securities Exchange Act of 1934
Section 16(a) of the Exchange Act requires the Company’s executive officers and directors to file reports of ownership and changes in ownership of the Company’s common stock with the SEC. Executive officers and directors are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely upon a review of Forms 3, 4 and 5 delivered to the Company as filed with the Securities and Exchange Commission, the management believes that the Company’s executive officers and directors and persons who own more than 10% of the Company’s common stock timely filed all required reports pursuant to Section 16(a) of the Exchange Act.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
Compensation Committee
The Board first established the Compensation Committee in 2005. On June 26th 2008, the Board elected Dr. Sun, Dr. Frey and Dr. Li, each of whom is independent director, to the Compensation Committee. Dr. Sun is elected as the Chairman of the Compensation Committee. The Compensation Committee operates under a written charter.
General Philosophy
The primary purpose of the Compensation Committee is to assist the Board of Directors by reviewing and making recommendations to the Board of Directors in matters related to compensation of the Company’s executives, employees and members of the Board. The Company’s Board of Directors is ultimately responsible for establishing, approving and administering the Company’s executive and director compensation.
Executive Compensation
The Board of Director’s compensation objective is designed to attract and retain the best available talent while efficiently utilizing available resources. The Company compensates executive management consisting primarily of a base salary and equity compensation designed to be competitive with comparable employers in the location of countries in which it operates primarily China and Vancouver, Canada, and to align management’s compensation with the long-term interests of shareholders. In considering executive management’s compensation, the Board also takes into consideration the financial condition of the Company.
Currently, the Company does not maintain any incentive compensation plans based on pre-defined performance criteria. The Board of Directors has the general authority, however, to award equity incentive compensation, i.e. stock options, to the Company’s executive officers in such amounts and on such terms as the Board of Directors determines in its sole discretion. The Board of Directors does not have a determined formula for determining the number of options available to be granted. The Compensation Committee reviews each executive’s contribution to the Company’s strategic goals periodically and makes recommendation to the Board of Directors.
The Board of Directors did not consider any change in control provisions, tax considerations nor performance criteria in granting the increasing these executives’ base salary and the granting of options. The Chief Executive Officer was consulted and gave his opinion as to the compensation to be paid to the executive officers, but the actual compensation amount was recommended by the Compensation committee and approved by the Board of Directors.
The base salary for the Company’s executive officers was determined by negotiation in connection of the reverse takeover merger involving Oriental Wave and the Company that was completed in January 2005. Since that time, there has been no change in the executives’ base salary. As the Company’s headquarters and executive office is located in Vancouver, Canada, the Company pays its executive officers in Canadian dollars. These base salaries increased approximately 0.72% from 2007 to 2008 which reflects solely the appreciation of Canadian dollars against U.S. dollars. The absolute amount of those base salaries of the Company’s executive officers in Canadian dollars remained the same since January 2005.
The amount of the option awards granted to executive officers in 2007 which represents an arbitrary amount was granted by the Compensation Committee after discussions with the Chief Executive Officer. The Chief Executive Officer abstained from voting on his option award.
Compensation Summary
The following table summarizes all compensation earned by or paid to the Company’s Chief Executive Officer (Principal Executive Officer), Chief Financial Officer (Principal Financial Officer) and other executive officer, during the past two fiscal years.
Summary Compensation Table
Option Grants in 2007 and 2008
For the year 2008, the Company granted options of 170,000 shares to certain employees at an exercise price of $0.75 per share on February 17, 2008.
For the year 2007, the Company granted options of 4,760,000
shares to certain directors and employees at an exercise price of $0.51 per share on May 17, 2007.
Aggregated Option Exercises in Last Fiscal Year and Ten-Year Options/SAR Repricings
There was no repricing of options for the fiscal years ended December 31, 2007 and 2008.
Fiscal Year End Option
The following table sets forth for the Company’s executive officers named in the Summary Compensation Table and the number and exercise price of exercisable and un-exercisable options as at December 31, 2008.
Director’s Compensation
Directors are not routinely compensated for their services. However, from time to time, Board members are awarded stock options as recommended by the Compensation committee and determined by the Board. The exercise price of the options is based on the fair market value of the underlying shares of common stock at the time of grant. No directors received any compensation including option grants during 2008. No directors received any compensation, except options to purchase common stock, during 2007.
At a directors meeting held on May 16, 2007, Mr. Han, Mr. Weng, Ms. Liu, Dr. Wick,, Dr. Sun, Mr. Mak, Dr. Frey and Dr. Li were granted options to purchase 800,000, 300,000, 300,000, 300,000, 300,000, 500,000, 400,000 and 400,000 shares of common stock, respectively, at $0.51 per share which represented the closing per share price as of that date.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table shows the number of the Company’s common stock beneficially owned (unless otherwise indicated) by each shareholder known by the Company to be the beneficial owner of more than 5% of the Company’s common stock, by the Company’s named executive officer and current directors and the executive officers and directors as a group. Except as otherwise indicated, all information is as of March 15, 2009
(1)
Except as otherwise indicated, the Company believes that the beneficial owners of the common stock listed above, based on information furnished by such owners or publicly available, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable, or exercisable within sixty days, are deemed outstanding for purposes of computing the percentage ownership of the person holding such option or warrants, but are not deemed outstanding for purposes of computing the percentage ownership of any other person.
(2)
Includes options to purchase 1,300,000 shares.
(3)
Includes options to purchase 600,000 shares.
(4)
Includes options to purchase 700,000 shares.
(5)
Includes options to purchase 1,100,000 shares.
(6)
Includes options to purchase 700,000 shares. Also includes 600,000 shares of common stock owned by Yukon Health Enterprise for which Mr. Sun serves as director and officer.
(7)
Represents options exercisable within sixty days.
(8)
Includes options to acquire 7,700,000 shares of common stock.
Equity Compensation Plan Information
The Company’s shareholders approved a share option plan at its Annual Meeting held on December 18, 2001, authorizing 4,500,000 shares for issuance under the plan. At its Annual Meeting held on August 12, 2005, the Company’s shareholders approved another share option plan authorizing the issuance of a further 15,000,000 shares. The following table provides aggregate information as of December 31, 2008 with respect to all compensation plans (including individual compensation arrangements) under which equity securities are authorized for issuance.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
During the past two years, the Company has been a party to transactions involving one of its directors. See also Note 17 to the Company’s financial statements.
On June 29, 2006, the Company signed an agreement with an arm-length third party to sell part of the original Pharma division, including all the formulation production facilities located in the Economic Development Zone in Datong, China, 258 drug approvals from the Chinese SFDA, 900 employees and the whole direct sales team to hospitals for the formulation business and related inventories, account receivables and account payables. The total selling price for the assets is $13.32 million. The transaction was completed on July 1, 2006. In addition, the Company also signed a separate agreement, with an amendment on July 28, 2006, to deliver international registration documentation and services on a related product to this arm-length third party. This documentation and services agreement is valued at $1.5 million and was completed in September, 2006. Subsequent to the transaction, Mr. Weng, a Director of the Company became a director of this party. During 2007 and 2008, the Company has supplied some raw materials to this party and has used this party as a contract manufacturer for some of its Cephalosporin formulation products.
Director Independence
Dr. Yiu Kwong Sun, Ms. Xuemei Liu, Mr. Peter Mak, Dr. Heinz Frey and Dr. Jin Li are deemed to be independent directors within the meaning of NASD listing standards. As of February 2, 2009, Dr. Alexander Wick is also deemed to be an independent director within the meaning of NASD listing standards.
ITEM 14.
ITEM 14.
ACCOUNTING FEES AND SERVICES
For the year ended December 31, 2007 and 2008, Ernst & Young LLP was engaged by the Company to provide both audit and non-audit services. The following fees were paid for services provided by Ernst & Young LLP.
Audit Fees. The aggregate fees paid for the annual audit of financial statements included in the Company’s Annual Report for the year ended December 31, 2008 and 2007 and the review of the Company’s quarterly reports for such years, amounted to approximately $363,000 and $410,000 respectively.
Audit Related Fees. For the years ended December 31, 2008 and 2007 the Company paid $Nil and $Nil to Ernst & Young for other audit related fees.
Tax Fees. For the year ended December 31, 2008 and 2007, the Company paid $Nil and $20,000 to Ernst & Young for tax fees.
All Other Fees. For the years ended December 31, 2008 and 2007, the Company paid $Nil and $13,800 to Ernst & Young for any non-audit services.
The above-mentioned fees are set forth as follows in tabular form:
Audit Committee Approval of Audit and Non-Audit Services of Independent Accountants
The Audit Committee approves all audit and non-audit services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. The independent accountants and management are required to periodically report to the Audit Committee regarding the extent of services provided by the independent accountants, and the fees for the services performed to date.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENTS SCHEDULES
(a)
The following documents are filed as a part of this report.
(1)
Financial Statements
(b)
Exhibits
99.1
(e)
Code of Ethics
______________________
(a)
Previously filed with Dragon Pharma’s initial registration statement on Form 10-SB, filed with the SEC on November 4, 1999.
(b)
Incorporated by reference to Dragon Pharma’s proxy statement for the Annual Meeting held on December 17, 2001.
(c)
Incorporated by reference to Form 8-K filed on January 18, 2005
(d)
Incorporated by reference to Form 8-K filed on March 2, 2005, portions of which have been omitted for confidential treatment.
(e)
Incorporated by reference to the Company’s proxy statement for 2005.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 2009
Dragon Pharmaceutical Inc.,
a Florida Corporation
/s/ Yanlin Han
Yanlin Han, Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signatures
Date
/s/ Yanlin Han
Mr. Yanlin Han, Chairman of the Board and Chief Executive Officer
March 30, 2009
/s/ Zhanguo Weng
Mr. Zhanguo Weng, Director
March 30, 2009
/s/ Dr. Yiu Kwong Sun
Dr. Yiu Kwong Sun, Director
March 30, 2009
/s/ Dr. Alexander Wick
Dr. Alexander Wick, Director
March 30, 2009
/s/ Xuemei Liu
Ms. Xuemei Liu, Director
March 30, 2009
/s/ Peter Mak
Mr. Peter Mak, Director
/s/ Heinz Frey
Dr. Heinz Frey, Director
/s/ Jin Li
Dr. Jin Li, Director
/s/ Garry Wong
Garry Wong, Chief Financial Officer
(Principal Financial Officer)
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
DRAGON PHARMACEUTICAL INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
CONTENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Dragon Pharmaceutical Inc.
We have audited the accompanying consolidated balance sheets of Dragon Pharmaceutical Inc. as of December 31, 2008 and 2007 and the consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Dragon Pharmaceutical Inc. as at December 31, 2008 and 2007, and the consolidated results of its operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1(B) to the consolidated financial statements, the Company’s recurring working capital deficiency raises substantial doubt about its ability to continue as a going concern. Management’s plan in regard to this matter also is described in Note 1(B). These consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Vancouver, Canada
/s/ Ernst & Young LLP
March 25, 2009
Chartered Accountants
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS AT DECEMBER 31, 2008 AND 2007
Expressed in Thousands ($'000) of US Dollars Except Share Data
(Basis of Presentation - Note 1)
The accompanying notes are an integral part of these consolidated financial statements.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in Thousands of US Dollars ($'000) Except Share and Per Share Data
The accompanying notes are an integral part of these consolidated financial statements.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in Thousands ($'000) of US Dollars Except Share Data
The accompanying notes are an integral part of these consolidated financial statements.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in Thousands of US Dollars ($ '000)
The accompanying notes are an integral part of these consolidated financial statements.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
NOTE 1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION
(A) Organization and principal activities
The Company was originally formed on August 22, 1989, as First Geneva Investments, Inc. First Geneva Investments was formed for the purpose of evaluating and acquiring businesses. On August 17, 1998, the Company acquired Allwin Newtech Ltd., a British Virgin Islands corporation. Allwin Newtech Ltd. was formed on February 10, 1998, for the purpose of developing pharmaceutical products in China. On September 21, 1998, First Geneva Investments Inc. changed its name to Dragon Pharmaceutical Inc.
On January 12, 2005, the Company completed the acquisition of Oriental Wave Holding Limited (“Oriental Wave”). Oriental Wave was principally engaged in the production and sale of pharmaceutical products in China. In connection with the acquisition of Oriental Wave, the Company issued 44,502,004 shares of common stock to the three prior owners of Oriental Wave. As a result, these three prior owners of Oriental Wave collectively owned 70.78% of the outstanding shares.
The Company is a leading manufacturer and distributor of a broad line of high-quality antibiotic products including Clavulanic Acid, 7-ACA, and downstream cephalosporin active pharmaceutical ingredient (“API”) and formulated powder for injection in both Chinese and other emerging markets.
The Company currently has three production facilities in Datong, China, including two that have been GMP (“Good Manufacturing Practice”) production facilities certified by the Chinese State Food and Drug Administration ("SFDA"): one facility producing bulk clavulanic acid and related active pharmaceutical ingredient (“API”), and another facility with a capacity of producing cephalosporin crude & sterilized bulk drugs and formulated powder for injection. The third facility produces bulk 7-ACA, a core intermediate for downstream cephalosporin antibiotics.
Starting on January 1, 2008, the Company has realigned its business segments into two divisions: Penicillin and Cephalosporin divisions. This realignment better reflects the Company’s business strategy to become a leading vertically integrated manufacturer and distributor of a broad line of high-quality antibiotic products.
The Penicillin Division currently operates the production and sales of Clavulanic Acid, Cefalexin and Cephadroxil.
The Cephalosporin Division operates the production and sales of 7-ACA, its downstream APIs and cephalosporin formulated finished drugs. 7-ACA is a core intermediate for over 50 cephalosporin downstream API and formulated finished drugs. Downstream API products include Ceftazidime (crude powder), Cefotaxime (crude powder & sterilized bulk) and Cefuroxime (sterilized bulk). Formulated finished products include 31 dosage forms from 10 different types of cephalosporin powder for injection.
The Company’s headquarters, located in Vancouver, British Columbia accommodates corporate functions such as financial reporting, SEC compliance, corporate finance, risk management and entity-wide internal control oversight and investor relations. The Company also has corporate offices in Beijing, China to manage the sales and marketing for the Chinese market as well as international markets outside of China.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(B) Basis of presentation and accounting policies
The consolidated financial statements include the accounts of the Company and its 100% owned subsidiaries: Oriental Wave Holding Limited (“Oriental Wave”) (incorporated in the British Virgin Islands), Shanxi Weiqida Pharmaceutical Co., Ltd. (“Shanxi Weiqida”) (incorporated in China), Beijing Weixang Bio-tech Co. Ltd.(“Beijing Weixiang”) (incorporated in China), Allwin Newtech Ltd. (incorporated in the British Virgin Islands), Sanhe Kailong Bio-pharmaceutical Co., Ltd. (incorporated in China), Nanjing Huaxin Bio-pharmaceutical Co. Ltd. (“Huaxin”) (incorporated in China), Allwin Biotrade Inc. (incorporated in the British Virgin Islands) and Dragon Pharmaceuticals (Canada) Inc. (incorporated in Canada). All significant inter-company balances and transactions have been eliminated upon consolidation.
The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, which contemplate continuation of the Company as a going concern. The Company has a working capital deficiency of $21.95 million as at December 31, 2008, however, the Company has developed and is implementing a plan to reduce its reliance on short term financing.
The Company plans to seek additional equity through the conversion of some of its liabilities and expects to raise funds through private placements in order to support existing operations and expand the range and scope of its business. The Company has also significantly increased production levels which is expected to generate additional cash flow under contracted supply agreements. In addition, the Company intends to continue to renegotiate and extend loans, as required, when they become due, as has been done in the past. Subsequent to December 31, 2008, the Company successfully refinanced its loans due in January 2010 amounting to $4,377,000 (RMB30 million). There is no assurance that additional funds will be available for the Company on acceptable terms, if at all, or that the Company will be able to negotiate and extend the loans. If adequate funds are not available or not available on acceptable terms or the Company is unable to negotiate or extend its loans, the Company may be required to scale back or abandon some activities. Management believes that actions presently taken provide the opportunity for the Company to continue as a going concern. The Company’s ability to achieve these objectives cannot be determined at this time. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might result from this uncertainty.
(C) Use of Estimates
In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the reported period. Actual results could differ from those estimates.
(D) Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(E) Accounts Receivable
The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is established and recorded based on management’s assessment of the credit history with the customer and current relationships with them. The Company uses the specific identification method to determine its allowance for doubtful accounts.
(F) Investments
The Company’s investment in a private company represents less than 1% of the total equity of the private company as of December 31, 2008. The investment is carried at cost and written down to estimated fair market value when indications exist that this investment has other than temporarily declined in value. No write downs have been recorded to date.
(G) Inventories
Inventories are stated at the lower of cost or replacement cost with respect to raw materials and the lower of cost and net realizable value with respect to finished goods and work-in-progress, cost being determined on a weighted average basis. Idle facility costs, abnormal freight, handling costs, and amounts of wasted materials (spoilage) are treated as current period costs.
The Company provides inventory allowances based on excessive spoilage and obsolete inventories determined principally by customer demand and product expiration dates.
(H) Property and Equipment
Property and equipment is recorded at cost, less accumulated depreciation. Expenditures for additions, major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred.
Interest costs that are attributable to the acquisition, construction or production of property and equipment that take a substantial period of time to get ready for its intended use are capitalized as part of the cost. During the years ended December 31, 2008 and 2007, the Company capitalized interest of $0 and $26,000, respectively.
Land use rights are recorded at cost, less accumulated amortization.
Depreciation is provided on a straight-line basis over the assets’ estimated useful lives, less an estimated residual value. The estimated useful lives are as follows:
Depreciable assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable based on projected undiscounted cash flows associated with the assets. A loss is recognized for the difference between the fair value and the carrying amount of the assets. Fair value is determined using a discounted cash flow analysis.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(I) Intangible Assets
Intangible assets represent licenses and permits for the production and sales of pharmaceutical products in China and are amortized on a straight-line basis over a period of ten years.
Intangible assets are tested for impairment whenever events or circumstances indicate that a carrying amount may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows. The amount of the impairment loss to be recorded is calculated by the excess of the asset’s carrying value over its fair value. Fair value is determined using a discounted cash flow analysis.
(J )Goodwill
Goodwill represents the excess of the cost of investments in subsidiaries over the fair value of the net identifiable assets acquired. The Company reviews the goodwill of all of its reporting units on at least an annual basis to ensure its fair value is in excess of its carrying value in the financial statements. Any impairment in the value of goodwill is charged to income in the period such impairment is determined.
(K) Revenue Recognition
The Company recognizes revenue, net of estimated provisions for returns, rebates and sales allowances, from the sale of pharmaceutical products. Revenues are recognized only when the Company has transferred to the customer the significant risk and rewards of ownership of the goods, title to the products transfers, the amount is fixed and determinable, evidence of an agreement exists, there is reasonable assurance of collection of the sales proceeds, the Company has no future obligations and the customer bears the risk of loss.
(L) Shipping and handling costs
Shipping and handling costs related to the movement of finished goods from manufacturing locations to customer locations are recorded as selling expenses. Shipping and handling costs were $1,794,000 and $858,000 for the years ended December 31, 2008 and 2007, respectively.
(M) Advertising Costs
Advertising costs are expensed as incurred. Advertising expense totaled $25,000 and $11,000 for the years ended December 31, 2008 and 2007, respectively.
(N) Research and Development
Research and development costs related to both present and future products are expensed as incurred. Total expenditures on research and development for the years ended December 31, 2008 and 2007 were $1,277,000 and $493,000, respectively.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(O) Income Taxes
The Company accounts for income taxes under the Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“Statement 109”). Under Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. 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. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company’s subsidiary, Shanxi Weiqida is registered in a special economic region in China. This economic region allows foreign enterprises a two-year income tax exemption from central government tax beginning in the first year after they become profitable, being the year commencing on January 1, 2003 to December 31, 2004 and a 50% income tax reduction for the following three years, being 2005 to 2007. Shanxi Weiqida was approved as a wholly owned foreign enterprise in October 2002. The applicable income tax rate for Shanxi Weiqida was 15% from 2005 to 2007.
Pursuant to the Chinese Corporate Income Tax Law approved on March 16, 2007, the applicable income tax rate for Shanxi Weiqida is 25% of the taxable income from January 1, 2008.
Pursuant to a new regulation, “No. 7 enacted during 2006 by the Shanxi Provincial Government”, Shanxi Weiqida is eligible to be exempted from the Provincial income tax, which is 3% of the taxable income, from 2006 to 2012.
The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a two-step process to determine the amount of tax benefit to recognize. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon examination by a tax authority. If the tax position is deemed “more-likely-than-not” to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50 percent likelihood of being realized upon ultimate settlement. If the tax position does not meet the “more-likely-than-not” threshold then it is not recognized in the financial statements.
The Company has reviewed the tax positions taken, or to be taken, in its tax returns for all tax years currently open to examination by a taxing authority in accordance with the recognition and measurement standards of FIN 48. The Company’s adoption of FIN 48 as of January 1, 2007 did not have a material impact on the Company’s financial position or results of operations. Upon adoption and as of December 31, 2008, the Company had no interest and penalty accrual or expense.
The Company files income tax returns in the United States, Canada and China tax jurisdictions. These tax returns are generally open to examination by the relevant tax authorities from three to seven years from the date they are filed. The Company is currently not under examination by any authority for income tax purposes.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(P) Foreign Currency Translation
Shanxi Weiqida, Huaxin and Dragon Pharmaceuticals (Canada) Inc. maintain their accounting records in their functional currencies (Renminbi Yuan and Canadian dollar, respectively), however, the Company’s reporting currency is U.S. dollars. The financial statements of the Company’s subsidiaries having a functional currency other than US dollars are translated into United States dollars using period end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. Net gains and losses resulting from foreign exchange translations are included in the statements of operations and stockholders’ equity as other comprehensive income. Foreign currency exchange gains and losses on transactions occurring in a currency other than the Company’s functional currency are included in the determination of net income in the period.
(Q) Other Comprehensive Income
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income, its components and accumulated balances. The Company is disclosing comprehensive income in its Consolidated Statement of Operations and accumulated other comprehensive income in its Statement of Stockholders' Equity. Comprehensive income comprises all changes in equity for the period except those resulting from investments by owners and distributions to owners.
(R) Segments
Starting on January 1, 2008, the Company has realigned its business segments into two divisions: Penicillin and Cephalosporin divisions. This realignment better reflects the Company’s business strategy to become a leading vertically integrated manufacturer and distributor of a broad line of high-quality antibiotic products.
The Penicillin Division currently operates the production and sales of Clavulanic Acid, Cefalexin and Cefadroxil. Clavulanic Acid is a drug that combines with penicillin group antibiotics to increase the effectiveness against bacteria resistance. Cefalexin is a Penicillin G downstream product that is widely used to treat urinary tract infections, respiratory tract infections, skin and soft tissue infections. Cefalexin and Cefadroxil were launched and included in the Company’s product portfolio in January 2008.
The Cephalosporin Division operates the production and sales of 7-ACA, its downstream APIs and cephalosporin formulated finished drugs. 7-ACA is a core intermediate for over 50 cephalosporin downstream API and formulated finished drugs. Downstream API products include Ceftazidime (crude powder), Cefotaxime (crude powder & sterilized bulk) and Cefuroxime (sterilized bulk). Formulated finished products include 31 dosage forms from 10 different types of cephalosporin powder for injection.
(S) Earnings Per Share
Earnings per share are computed using the weighted average number of shares outstanding during the year. Diluted earnings per share, as determined using the treasury stock method, is equal to the basic income per share as common stock equivalents consisting of options to acquire 9,760,000 and 9,975,500 common shares that are outstanding at December 31, 2008 and 2007, respectively. For the years ended December 31, 2008 and 2007, diluted weighted average number of shares outstanding includes the dilutive effect of stock options of 7,790,000 and nil, respectively, and excludes the antidilutive effect of stock options of 1,970,000 and 9,975,000, respectively.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(T) Government Grants and Deferred Revenue
The Company received grants from federal and provincial governments. Government grants are recognized only when there is reasonable assurance that the Company will comply with any conditions attached to the grant and the grant will be received.
A grant relating to current expenditures is reported separately as 'other income' in the period in which the grant is earned and the expenditures have been incurred. A grant relating to capital assets is recorded as deferred revenue and amortized to income on a straight-line basis as the asset is depreciated.
(U) Stock Based Compensation
In December 2004, the Financial Accounting Standards Board (FASB) issued their final standard on accounting for share-based payments in FASB Standard No. 123R (revised 2004), Share-Based Payment (SFAS 123R). This statement replaces FASB Statement 123, Accounting for Stock-Based Compensation (SFAS 123), and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. The statement is effective for all interim and annual periods beginning after December 15, 2005 and requires companies to measure and recognize compensation expense for all share-based payments at fair value in the consolidated statement of income. Effective January 1, 2006, the Company adopted SFAS 123R using the modified-prospective-transition method. Under this transition method, stock compensation cost recognized beginning January 1, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Results for prior periods have not been restated.
In December 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 110 (“SAB 110”). SAB 110 amends and replaces Question 6 of Section D.2 of Topic 14, Share-Based Payment. SAB 110 expresses the views of the staff regarding the use of the “simplified” method in developing an estimate of expected term of “plain vanilla” share options in accordance with FASB Statement No. 123(R), Share Based Payment. The use of the “simplified” method was scheduled to expire on December 31, 2007. SAB 110 extends the use of the “simplified” method for “plain vanilla” awards in certain situations. The Company currently uses the “simplified” method to estimate the expected term for share option grants and will continue to use the “simplified” method until the Company has sufficient data to provide a reasonable estimate of expected term in accordance with SAB 110.
(V) Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. FAS 141(R) is to be applied prospectively to business combinations for which the acquisition date is on or after an entity's fiscal year that begins after December 15, 2008. The Company will assess the impact of SFAS 141R if and when a future acquisition occurs.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
Effective January 1, 2008, the Company adopted, on a prospective basis, SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) as amended by FASB Staff Position SFAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” (“FSP FAS 157-1”) and FASB Staff Position SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”). SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and provides for expanded disclosure about fair value measurements. SFAS 157 applies prospectively to all other accounting pronouncements that require or permit fair value measurements. FSP FAS 157-1 amends SFAS 157 to exclude from the scope of SFAS 157 certain leasing transactions accounted for under SFAS No. 13, “Accounting for Leases.” FSP FAS 157-2 amends SFAS 157 to defer the effective date of SFAS 157 for all non-financial assets and non-financial liabilities except those that are recognized or disclosed at fair value in the financial statements on a recurring basis to fiscal years beginning after November 15, 2008.
The adoption of SFAS 157 did not have a material impact on the Company’s consolidated financial statements. Management is evaluating the impact that SFAS 157 will have on its non-financial assets and non-financial liabilities since the application of SFAS 157 for such items was deferred to January 1, 2009. The Company believes that the impact of these items will not be material to its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No.133." SFAS No. 161 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," to amend and expand the disclosure requirements of SFAS No. 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. To meet those objectives, SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Company's financial condition or results of operations.
NOTE 2
ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 2008 and December 31, 2007 consisted of the following:
For the year ended December 31, 2008, the Company recorded a provision for doubtful accounts of $22,000 in the Consolidated Statements of Operations compared to $15,000 for the year ended December 31, 2007.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
NOTE 3
INVENTORIES
Inventories at December 31, 2008 and December 31, 2007 consisted of the following:
As at December 31, 2008 and 2007, the Company recorded an inventory valuation provision for lower of net realizable value or cost of $591,000 and $908,000 in the Consolidated Statements of Operations and Comprehensive Income, respectively.
NOTE 4
PROPERTY AND EQUIPMENT
The following is a summary of property and equipment at December 31, 2008 and December 31, 2007:
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
Depreciation expense for the years ended the December 31, 2008 and 2007 was $ 7,875,000 and $5,579,000 respectively. Equipment with a net book value of $22 million is pledged as collateral for $8 million in loans payable (Note 9).
During the year ended December 31, 2008, certain assets that were previously under construction and included in construction in progress, were completed and accordingly transferred to plant and equipment. Assets completed during the year ended December 31, 2008 included $6,864,000 related to 7-ACA production facility, $10,795,000 related to the formulation drugs production facility, $1,402,000 related to clavulanic acid production line and $2,603,000 related to utility facilities and office building. Assets completed during the year ended December 31, 2007 included $6,034,000 related to the 7-ACA production facility and $4,350,000 related to the water treatment facility.
In 2008, the Company signed an agreement with a subcontractor to sell buildings and equipment with a net book value of $2.29 million. The selling price is $2.39 million. The subcontractor agreed to off-set the $1.89 million debt owned by the Company, and pay the remaining balance of $0.51 million before September 30, 2009.
The balance of construction in progress as at December 31, 2008 represents capital expenditures for expansion of 7-ACA and formulation drugs production line. These projects are expected to be completed in 2009.
NOTE 5
INTANGIBLE ASSETS
Intangible assets consist of the following as of December 31, 2008 and December 31, 2007:
Amortization expense for the years ended December 31, 2008 and 2007 was $157,000 and $34,000 respectively. Amortization expense over the next five years will be approximately $171,000 per year.
NOTE 6
OTHER ASSETS
The Company is actively exploring additional business opportunities which may involve an investment in a new production campus. In this regard, the Company paid the deposits to the land bureau and various contractors for possible land and construction costs. According to the respective agreements, which were revised in August 2008, the Company will notify the contractors of the final decision of the project by April 1, 2009 and such deposits are refundable.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
NOTE 7 DISCONTINUED OPERATIONS
The Company signed an agreement on November 5, 2007 with a non-affiliated third party to sell the assets of the biotech operation excluding finished goods on hand. According to the agreement, the buyer agreed to pay the Company, before June 2008, a total of US$ 2.14 million (or RMB 15.6 million), in exchange for certain fixed assets and certain net working capital as at October 31, 2007 of the biotech business. The loss on disposal of biotech division was as follow:
The Company received $525,000 of the amount receivable from the buyer of the biotech division in 2007, and the remaining balance of $1,613,000 was received in 2008 (Note 2).
The operations of the biotech division have been reclassified and are presented in the consolidated financial statements as discontinued operation. A summary of such discontinued operation of the biotech division is as follows:
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
NOTE 8
OTHER PAYABLES AND ACCRUED LIABILITIES
Other payables and accrued liabilities at December 31, 2008 and December 31, 2007 consist of the following:
* The Company received $2,187,000 (RMB16 million) of government grants relating to the construction of a water treatment facility in 2007. According to an approval of expenditure of the project from the local provincial government in 2008, the Company reclassified $438,000 (RMB3 million) to deferred revenue and recognized on a straight-line basis as the assets is depreciated over 10 years (Note 11). Upon receipt of final approval of the completed project, the remaining balance of $1,897,000 (RMB13 million) will be reclassified as deferred revenue and recognized on a straight-line basis as the asset is depreciated.
NOTE 9
LOANS PAYABLE
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
Maturities are as follows:
* The Company has guaranteed the third party to obtain a bank loan of $2,918,000 (RMB20 million) due November 2009, interest on the loan is charged at 9.99%. The third party loaned $2,189,000 (RMB15 million) to the Company and charged the same interest rate at 9.99%. According to an agreement between the third party and the Company, the Company will pay the loan balance of $2,189,000 directly to the bank upon maturity (Note 14(B)).
** The Company has guaranteed the third party to obtain a bank loan of $2,918,000 (RMB20 million) due June 2010. Interest on the loan is charged at 9.828%. The third party loaned the $2,918,000 to the Company and charged the same interest rate at 9.828%. According to an agreement between the third party and the Company, the Company will pay the loan balance of $2,918,000 directly to the bank upon maturity.
NOTE 10
NOTES PAYABLE
The Company has a banking facility whereby the Company has issued several non-interest bearing notes payables to several vendors totalling $2,918,000 (RMB 20 million) as at December 31, 2008. These notes are due on February 26, 2009, and are collateralized by $2,918,000 of bank deposits that may only be used to repay the notes. The Company paid the notes payable with the $2,918,000 bank deposits in February 2009.
The Company also entered into an agreement with a bank providing a facility of up to $4,272,000 (RMB 30 million) pursuant to which the company may issue promissory notes that are guaranteed by the bank and which can be provided to suppliers to guarantee payment for purchases. This facility is for one year and expires on February 2, 2009. The bank will charge a fee of 0.05% on the total amount of each promissory notes issued. The facility is collateralized by equipment with a net book value of $6,982,000. As at December 31, 2008, the Company issued several non-interest bearing notes under this facility to vendors totalling $2,918,000. The Company did not renew the facility with the bank, but obtained a bank loan of $2,918,000 to pay the notes payable in February 2009 (Note 21).
NOTE 11
DEFERRED REVENUE
Deferred revenue consisted of the following as of December 31, 2008 and 2007
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
The Company received government grants of $438,000 (RMB3 million) from provincial government relating to the construction of a water treatment facility in 2007. The Company obtained the final approval from the government that the Company has complied with all conditions attached to the grant in 2008. $438,000 was recorded as deferred revenue and recognized as other income on a straight-line basis as the asset is depreciated over 10 years (Note 13(A)).
NOTE 12
SEGMENTS
The accounting policies of the segments are the same as described in the summary of significant accounting policies. The Company evaluates segment performance based on gross profit. All sales by division were to external customers (Note 19). Sales relating to the cephalosporin division’s 7-ACA product represented approximately 32.67% of the total sales for the year ended December 31, 2008 (2007: 58.75%). Substantially all of the Company’s assets are located in China. The following is a summary of the Company’s segment information for the years ended December 31, 2008 and 2007 and as of December 31, 2008 and December 31, 2007.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
Geographical segments information is as follow:
NOTE 13
OTHER INCOME
(A)
Government grants
During the year ended December 31, 2008, Shanxi Weiqida, a wholly-owned subsidiary of the Company, applied for, and received, non-refundable grants of $342,000 ($116,000 for the year ended December 31, 2007)) from the government of China for bringing in investment and new technology to Datong city, Shanxi Province, China.
During the year ended December 31, 2008, the Company recognized amortization income of $43,000 of government grants related to the construction of a water treatment facility (Note 11).
(B)
Subsidies for employee benefit
During 2007, Shanxi Weiqida received subsidies of $1,370,000 from the government of China for mandated employee benefit contributions for the period from July 2005 to June 2008. These subsidies were deposited directly into the employee’s social benefit and insurance accounts, $420,000 was recognized as other income in 2008 and $950,000 was recognized as other income in 2007.
NOTE 14
COMMITMENTS AND CONTINGENCIES
(A) Employee Benefits
The full time employees of Shanxi Weiqida are entitled to employee benefits including medical care, worker compensation, unemployment insurance and pension benefits through a Chinese government mandated multi-employer defined contribution plan. The Company is required to accrue for those benefits based on certain percentages of the employees’ salaries. The total provision for such employee benefits was $914,000 and $479,000 for the years ended December 31, 2008 and 2007, respectively. The Company is required to make contributions to the plans out of the amounts accrued for medical and pension benefits. The Chinese government is responsible for the medical benefits and the pension liability to be paid to these employees.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(B) Loan Guarantees (Note 9)
The Company has guaranteed a bank loan to a supplier in the amount of $2,597,000 (RMB17.8 million), due on July 7, 2009. Interest on the loan is charged at 10.46% and the bank has the right to seek settlement from the Company for payment should the supplier fail to repay the loan. There is no recourse or possible recovery for the Company should the supplier default on its bank loan. The maximum potential amount of future payments (undiscounted) that the Company could be required to make is $2,737,000 (RMB 18.76 million). The Company provided the guarantee to the supplier to maintain a good business relationship. This supplier has pledged certain property and equipment to the Company as collateral for this guarantee.
The Company has also issued a guarantee to a bank as collateral for loans to a third party vendor of $2,772,000 (RMB19 million) due on September 25, 2009 and $4,158,000 (RMB28.5 million) due on October 26, 2009. Interest is charged at 8.715 %. The bank has the right to seek settlement from the Company for payment should the third party vendor fail to repay the loan. The maximum potential amount of future payments (undiscounted) that the Company could be required to make is $7,404,000 (RMB50.75 million). This vendor has pledged certain property and equipment to the Company as collateral for this guarantee. The vendor also provided a guarantee to the Company to obtain a bank loan of $496,000 (RMB3.4 million) due April 2009 (Note 9).
The Company has guaranteed a third party to obtain bank loans of $2,918,000 (RMB20 million) due November 2009, interest on these loans is charged at 9.99%. The third party loaned $2,189,000 (RMB15 million) to the Company and charged the same interest rate at 9.99%. The Company has booked $2,189,000 (RMB15 million) as a liability as at December 31, 2008 (Note 9). The remaining balance of $729,000 (RMB5 million) was used by the third party and the maximum potential amount of future payments (undiscounted) that the Company could be required to make is $791,000 (RMB 5.42 million). This third party has pledged certain property and equipment to the Company as collateral for this guarantee.
(C) Capital Commitments
According to the approval of the Business Bureau of Shanxi province on December 12, 2007, the total registered capital to Shanxi Weiqida, increased from $29,179,000 (RMB200 million) to $58,358,000 (RMB400 million). The Company is required to contribute the additional registered capital of $29,179,000 (RMB 200 million) by paying cash of $15,465,000 (RMB106 million) and transferring $13,714,000 (RMB94 million) of retained earnings of Shanxi Weiqida within 3 years from November 20, 2007. For the years ended December 31, 2008 and 2007, the Company transferred $6,104,000 (RMB45 million) and $6,704,000 (RMB49 million) of retained earnings of Shanxi Weiqida to registered capital of Shanxi Weiqida, respectively (Note 15(B)). As at December 31, 2008, the Company has capital commitment of $15,465,000 (Rmb106 million) to Shanxi Weiqida.
According to the Articles of Association of Beijing Weixiang, the Company is required to contribute registered capital of $5,000,000 to Beijing Weixiang within five years from August 1, 2005. As of December 31, 2008, the Company has contributed $1,099,000 of the registered capital requirement and has registered capital commitments of $3,901,000.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
(D) Operating Leases
The Company has commitments related to operating leases for property which require the following payments for each year ending December 31:
The rent expense for the years ended December 31, 2008 and 2007 was $1,637,000 and $198,000 respectively,
During the fourth quarter of 2007, the Company signed a one-year operating lease agreement to lease a manufacturing facility, with a total area of approximately 84,000 square foot, together with certain production assets in Datong, China to produce its formulation products under the Cephalosporin Division. This facility also includes several workshops for other crude bulk drugs and sterilized bulk drugs for cephalosporin antibiotics. The Company has acquired part of the production assets with total amount of $5,408,000 from the lessor in September 2008.
(E) Other Commitments
Capital expenditure contracted for but not yet incurred at December 31, 2008 is $1,868,000.
NOTE 15
STOCKHOLDERS’ EQUITY
(A) Reserves
Pursuant to PRC regulations, Shanxi Weiqida is required to make appropriations to reserves funds, comprising the reserve fund, staff welfare fund and enterprise expansion fund, based on after-tax net income determined in accordance with generally accepted accounting principles of the People’s Republic of China (the “PRC GAAP”). Appropriations to the reserve fund should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of Shanxi Weiqida’s registered capital. The reserve fund is established for covering potential losses. Appropriations to the staff welfare fund are at a percentage, as determined by the Board of Directors, of the after tax net income determined in accordance with the PRC GAAP.
The staff welfare fund is established for the purpose of providing employee facilities and other collective benefits to the employees. Appropriations to the enterprise expansion fund are made at the discretion of the Board of Directors. The enterprise expansion fund is established for expanding business operation. The reserve fund and enterprise expansion fund are recorded as part of shareholders’ equity but are not available for distribution to shareholders other than in liquidation, while the staff welfare fund is recorded as a liability and is not for distribution to shareholders. The appropriations to reserves are made by the Board of Directors on an annual basis.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
In order to fulfil Shanxi Weiqida’s additional registered capital requirement, the Company transferred $6,104,000 and $6,704,000 of retained earnings of Shanxi Weiqida to registered capital during the years ended December 31, 2008 and 2007. As at December 31, 2008 and 2007, Shanxi Weiqida has paid in capital of 36,983,000 (RMB294 million) and $30,879,000 (RMB 249 million), respectively (Note 14 (C)).
During the years ended December 31, 2008 and 2007, the Company appropriated reserves of $820,000 and $1,140,000, respectively, and staff welfare fund of $7,000 and $9,000, respectively, based upon the respective year’s net income.
(B) Share capital
During the years ended December 31, 2007, the Company issued 3,496,503 common shares pursuant to a private placement for $0.429 per common share, representing a 15% discount to the then current market price as allowed pursuant to the rules of the TSX.
(C) Stock Options
The Company has adopted the 2005 Stock Option Plan, effective August 13, 2005, which allows for the granting of options to Directors and Employees for a period of up to ten years.
The Company granted options on February 17, 2008 to its employees to purchase 170,000 shares at an exercise price of $0.75 (being the market price at the time) expiring on February 17, 2011. Of this grant, options to purchase 120,000 shares vested immediately with 25,000 options vesting on each of February 17, 2009, and 2010.
The Company granted options on May 17, 2007 to its directors and employees to purchase 4,760,000 shares at an exercise price of $0.51 (being the market price at the time) expiring on May 16, 2010. Of this grant, options to purchase 3,960,000 shares vested immediately with 400,000 options vesting on each of May 16, 2008, and May 16, 2009.
During the year ended December 31, 2008, a director of the Company exercised 200,000 stock options at a price of $0.68. Pursuant to the share purchase agreement, dated September 11, 2004 and the escrow agreement, dated January 12, 2005 (the “Agreements”), the Company released 431,911 shares from escrow to the former shareholders of Oriental Wave Holding Limited. The Agreements related to the acquisition of Oriental Wave Holding Limited and provided for the release of the escrowed shares if certain stock options outstanding at the date of acquisition were exercised prior to the expiry dates. As the release of the escrowed shares did not change the original purchase price, no value was ascribed to the common shares. As at December 31, 2008, no escrowed shares remain outstanding.
During the year ended December 31, 2008, a former employee of the Company exercised 60,000 stock options at a price of $0.51.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
The following table summarizes stock options information for the years ended December 31, 2008 and 2007:
The Company recorded stock-based compensation expense of $154,000 for the year ended December 31, 2008 ($1,068,000 for the year ended December 31, 2007) related to stock options granted to directors and employees, which amounts are included in general and administrative expenses. The estimated fair value of stock options granted during the year ended December 31, 2008 was determined using the Black-Scholes option pricing model with the following weighted average assumptions: expected volatility - 81.51 % (2007: 67.23%); risk-free rate - 4.4% (2007: 4.58%); expected average life of the options - 3 years (2007: 3 year); dividend yield - 0% (2007: 0%). The Company estimated a 0% forfeiture rate by considering the historical employee turnover rates and expectations about the future, and will subsequently adjust compensation cost for differences between expectations and actual experience. The estimated fair value of the options granted during the year ended December 31, 2008 was $0.41 per share (2007: 0.25 per share). The fair value of the options is being expensed on a straight-line basis over the vesting period of the options.
Aggregate intrinsic value of the Company’s stock options is calculated as the difference between the exercise price of the options and the quoted price of the common shares that were in-the-money. The aggregate intrinsic value of the Company's outstanding stock options as at December 31, 2008 and 2007 was $422,000 and $960,000, respectively. The estimated fair value of stock options vested during the years ended December 31, 2008 and 2007 was $145,000 and $1,008,000 respectively. There is approximately $48,000 of unrecognized compensation expense as of December 31, 2008 that is expected to be recognized over the next 13 months.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
NOTE 16
INCOME TAXES
Shanxi Weiqida and Huaxin are subject to income taxes in China on their taxable income as reported in their statutory accounts at a tax rate in accordance with the relevant income tax laws.
Oriental Wave, Allwin Newtech Ltd. and Allwin Biotrade Inc are British Virgin Islands (“BVI”) companies and are not subject to income taxes. During the year ended December 31, 2006, the three BVI companies elected to be treated as disregarded entities in the U.S. After this election, the three BVI companies would be viewed as branches of Dragon Pharmaceutical Inc. and be subject to taxes in the U.S.
Dragon Pharmaceutical Inc. and Dragon Pharmaceuticals (Canada) Inc. are U.S. and Canadian companies, respectively, and are subject to taxes in those jurisdictions.
On March 16, 2007, The National People’s Congress of China passed “The Law of the People's Republic of China on Enterprise Income Tax” (the “Enterprise Income Tax Law”). The Enterprise Income Tax Law became effective on January 1, 2008. This new law eliminated the existing preferential tax treatment that is available to the foreign invested enterprises (“FIE”s) but provides grandfathering of the preferential tax treatment currently enjoyed by the FIEs. Under the new law, both domestic companies and FIEs are subject to a unified income tax rate of 25% starting from 2008. In 2007, Shanxi Weiqida and Huaxin were in the tax holiday with an income tax rate of 15%.
The Company has structured its business and operations on an international basis. The Company's history is that they have also been involved in a number of business combinations. As a result the Company could be involved in various investigations, claims and tax reviews that arise in the ordinary course of business activities. The tax effect of temporary differences that give rise to significant components of the deferred tax assets are as follows:
The valuation allowance is reviewed periodically. When circumstance changes and this causes a change in management’s judgment about the realizability of deferred tax assets, the impact of the change on the valuation allowance is generally reflected in current income.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
The Company has non-capital losses carried forward of approximately $1.9 million in Canada, expiring between 2009 and 2027. The Company also has non-capital losses carried forward of approximately $5.5 million in the US expiring between 2023 and 2028. Deductibility of the losses and period of expiration is subject to the normal review by taxation authorities.
All income and taxes are attributable to foreign operations. A reconciliation of the federal statutory income tax, at the statutory rate of 35% to the Company’s effective income tax rate, for the years ended December 31, 2008 and 2007 are as follows:
Undistributed earnings of the Company’s non Canadian subsidiaries amounted to approximately $7,429,000 and $5,616,000 as of December 31, 2008 and 2007, respectively. The Company has not provided any additional U.S. federal or state income taxes or foreign withholding taxes on the undistributed earnings as such earnings have been indefinitely reinvested in the business as defined in the provisions of FAS109 as well as Accounting Principles Board (APB) 23. The determination of the amount of the unrecognized deferred tax liability related to the undistributed earnings is not practicable because of the complexities associated with its hypothetical calculation.
In 2008, Shanxi Weiqida applied for and received an income tax credit for reinvestment of $457,000 and $nil from the government of China in 2008 and 2007, respectively. This credit is related to reinvestment of retained earnings of 2006 of $6,704,000 (RMB 49 million) to paid-in capital of 2007. These credits were recorded as a reduction of income taxes for the year ended December 31, 2008.
Shanxi Weiqida received tax credits of $706,000 and $342,000 from Chinese local tax authority for purchasing domestically manufactured equipment in 2008 and 2007, respectively. These credits were treated as a reduction of income taxes expense.
The effective income tax rate for Shanxi Weiqida for the years ended December 31, 2008 and 2007 was 11.8% and 8.7%, respectively.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
NOTE 17
RELATED PARTY TRANSACTIONS
The Company supplied certain raw materials to a related party, whose director is also a stockholder of the Company, for which the Company charged $2,244,000 and $1,690,000 for the years ended December 31, 2008 and 2007, respectively. The Company also used this party as a contract manufacturer of certain cephalosporin products for which the party charged $431,000 and $231,000 for the years ended December 31, 2008 and 2007. The transactions were recorded at the exchange amount.
The balance arising from sales/purchase of goods and services are as follows:
The balances due from/to related parties bear no interest and are under normal trade repayment terms.
NOTE 18
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of the Company’s cash and cash equivalents, accounts receivable, investments, amounts due to related parties and short-term loans and other payables approximates their fair value. The fair value of long-term loans payables and long-term accounts payable are estimated using discounted cash flow analysis, based upon the Company’s current borrowing rates, and approximate their carrying value.
NOTE 19
CONCENTRATIONS AND RISKS
83% and 71% of the Company’s revenues for the years ended December 31, 2008 and 2007, respectively, were derived from customers located in China. During the years ended December 31, 2008 and 2007, the Company had sales of $21,052,000 and $20,864,000 respectively to customers in India, representing 14% and 24% respectively of the Company’s revenues for the years ended December 31, 2008 and 2007. Sales to the Company’s largest customer, a Cephalosporin Division customer, accounted for approximately 12% and 20% of the Company’s sales for the years ended December 31, 2008 and 2007, respectively. Amounts owing from one customer represented 18% of the Company’s trade and other receivables at December 31, 2008.
The Company is exposed to the risk arising from changing interest rates. A detailed analysis of the Company’s Loans Payable, together with their respective interest rates and maturity dates, are included in Note 9.
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in US Dollars
The majority of the Company’s assets, liabilities, revenues and expenses are denominated in Renminbi, which was tied to the US Dollar and is now tied to a basket of currencies of China’s largest trading partners, is not a freely convertible currency. The appreciation of the Renminbi against the US Dollar would result in an increase in the assets, liabilities, revenues and expenses of the Company and a foreign currency gain included in comprehensive income. Conversely, the devaluation of the Renminbi against the US Dollar would result in a decrease in the assets, liabilities, revenues and expenses of the Company and a foreign currency loss included in comprehensive income. As at December 31, 2008, approximately US$4,819,000 of the cash and restricted cash (December 31, 2007: US$4,633,000) were held in Renminbi.
NOTE 20
COMPARATIVE FIGURES
Certain figures for the prior year have been reclassified to conform with the current year's consolidated financial statement presentation
NOTE 21
SUBSEQUENT EVENTS
(A)
Subsequent to December 31, 2008, the Company issued a guarantee to a bank as collateral for loans to a third party of $8,024,000 (RMB55 million) due February 2010. Interest is charged at 8.19%. The bank has the right to seek settlement from the Company for payment should the third party fail to repay the loan. This party provided a guarantee to the Company to obtain a bank loan of $8,024,000 (RMB55 million) due September 2009 (Note 9).
(B)
Subsequent to December 31, 2008, the Company obtained a bank loan of $2,918,000 (RMB20 million) due in January 2010. Interest on this loan is charged at 5.841%. A related party provided a guarantee to the Company for this loan. The Company obtained another bank loan of $1,459,000 (RMB10 million) due in January 2010. Interest on this loan is charged at 6.903 %. Equipment with a net book value of $21 million is pledged as collateral for this bank loan.
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-55794) pertaining to Stock Options Granted to Directors, Technical Advisors, and Employees under Stock Option Agreements of our report dated March 25, 2009, with respect to the consolidated financial statements of Dragon Pharmaceutical Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2008
Vancouver, Canada
/s/ Ernst & young LLP
March 25, 2009
Chartered Accountants
Exhibit 31.1
Section 302 Certification of Principal Executive Officer
I, Yanlin Han, certify that:
1. I have reviewed this annual report on Form 10-K of Dragon Pharmaceutical Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.
Date: March 30, 2009
/s/ Yanlin Han
Yanlin Han
Chairman and Chief Executive Officer
Exhibit 31.2
Section 302 Certification of Principal Financial Officer
I, Garry Wong, certify that:
1. I have reviewed this annual report on Form 10-K of Dragon Pharmaceutical Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.
Date : March 30, 2009
/s/ Garry Wong
Garry Wong,
Chief Financial Officer
Exhibit 32
CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF
TITLE 18, UNITED STATES CODE)
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of Title 18, United States Code), each of the undersigned officers of Dragon Pharmaceutical Inc., a Florida corporation (the “Company”), does hereby certify with respect to the Annual Report of the Company on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission (the “Form 10-K”) that, to the best of their knowledge:
(1) the Form 10-K fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: : March 30, 2009
/s/ Yanlin Han
Yanlin Han
Chairman and Chief Executive Officer
Dated: : March 30, 2009
/s/ Garry Wong
Garry Wong
Chief Financial Officer