ITEM 1. DESCRIPTION OF BUSINESS
OVERVIEW
We are a vertically integrated bio-pharmaceutical company focused on developing, manufacturing and distributing innovative drugs in the People's Republic of China ("China" or PRC").
We, a Delaware corporation, were originally organized as a corporation under the laws of the state of New York on August 6, 1976 under the name of Globuscope, Inc. On August 7, 1984, its name was changed to Globus Growth Group, Inc., which was its name until it was merged into China Biopharmaceuticals Holdings, Inc. (CBH), its wholly owned subsidiary in the state of Delaware on August 28, 2004 through an internal re-organizational merger. Effective August 28, 2004, CBH completed the acquisition of China Biopharmaceuticals Corp. ("CBC"), a British Virgin Islands corporation as the parent, the management company and holder of 90% of the ownership interest in its then only operating subsidiary and asset, Nanjing Keyuan Pharmaceutical R&D Co., Ltd., doing business in English a.k.a. Nanjing Chemsource Pharmaceutical R&D Co. Ltd, ("Keyuan" or "Chemsource"), a company established in China and engaged in the discovery, development and commercialization of innovative drugs and related bio-pharmaceutical products in China. Nanjing Keyuan Pharmaceutical R&D Co., Ltd. was established in March 2000 in Nanjing City of Jiangsu Province, China. It was founded and spear-headed by graduates from China Pharmaceutical University to engage in new drug research and discovery and in the development of new drug screening technologies.
On February 27, 1986, the stockholders of our company approved the divestiture and sale of assets pertaining to camera manufacturing and photography operations as well as the sale of certain shares of stock in a photographic related company owned by it and its interest in the Company's then owned premises. The sale was consummated as of February 28, 1986. After such divestiture, the Company's activities consisted of the holding of interests in various companies and the seeking out of acquisition and joint-venture opportunities in various fields of business endeavor. On May 27 1988, the company filed with the Securities and Exchange Commission a notification of election to be treated as a "Business Development Company" ("BDC") as that term is defined in the Investment Company Act of 1940 (the "1940 Act"). The decision to become a BDC was made primarily to better reflect the Company's anticipated future business and development relationships. A BDC is an investment company designed to assist eligible portfolio companies with capital formation. As a result of the reorganization the acquisition of CBC pursuant to the Exchange Agreement, our company is no longer a BDC and is now an operating company.
On August 4, 2004, our company filed Definitive Information Statement ("Information Statement") pursuant to Section 14(c) of the Securities Exchange Act of 1934, as amended, notifying its shareholders the execution and pending implementation of an Agreement and Plan of Merger was signed by and between Globus Growth Group, Inc., a New York corporation ("Globus") and the predecessor of our company and its wholly owned subsidiary in the State of Delaware under the name of China Biopharmaceuticals Holdings, Inc. ("CBH") The Agreement and Plan of Merger Agreement provided for a tax-free reorganization pursuant to the provisions of Section 368 of the Internal Revenue Code, according to which Globus, Inc. merged with and into our company, ceasing its corporate existence and having the Company as the surviving corporation of the merger (the "Merger"). In the Merger, all issued and outstanding shares of the common stock of Globus have been converted into shares of common stock of the Company. On August 28, 2004, the internal reorganizational Merger was completed with Globus merging into the Company as the surviving entity.
Pursuant to a share exchange agreement ("Exchange Agreement") between the Company, CBC, Keyuan, and Chris Peng Mao as the sole shareholder of CBC, our company received all of the issued and outstanding common stock of CBC in exchange for 20,842,779 shares of restricted (as defined in Rule 144 of the Securities Act of 1933, as amended) common stock of our company, par value $0.01 per share, representing approximately 90% of the issued and outstanding common capital stock of our company following the time of the issuance. As of March 30, 2007, there were 36,848,399 issued and outstanding shares of our common stock and 202 holders of record.
On September 29, 2004, we signed a purchase agreement which was amended on December 31, 2004 to acquire approximately 75.8% ownership interest of Suzhou Hengyi Pharmaceuticals of Feedstock Co., Ltd ("Hengyi"), a Chinese company established in Suzhou, China for 1,200,000 of common shares and additional $1,600,000 as additional contribution into the acquired Hengyi for working capital and/or expansion purposes. The cash contribution is to be made in installments. On August 29, 2006, we entered into an agreement with the minority shareholders of our subsidiary, Hengyi to divest Hengyi and its subsidiary, Suzhou Sintofarm, in which Hengyi has 50% controlling ownership interest from its subsidiary portfolio. Pursuant to the agreement all consideration paid to the shareholders of Hengyi, namely, 1,200,000 shares of our common stock and $620,000 was to be returned to us and we no longer have any other obligations to Hengyi or its shareholders. Simultaneously our 75.8% ownership interest of Hengyi has been returned to Hengyi's shareholders or its designated party. As a result, Hengyi ceased to be a subsidiary of our company.
On June 11, 2005, we signed a purchase agreement, which was amended on August 3, 2005 under which, we acquired controlling ownership interest (approximately 51%) in Suzhou Erye Pharmaceutical Limited Company ("Erye"), a company established in Suzhou, China. Total consideration paid by us to acquire 51% ownership interest in Erye is $3,000,000 cash to be paid in installments, and 3,300,000 common shares valued at $0.50 per share or $1,650,000. Out of the $3,000,000 to be paid in cash, $2,200,000 was contributed to the acquired Erye for working capital and/or expansion purposes.
On May 16, 2006, we entered into a Conditional Stock Purchase Agreement with RACP Pharmaceutical Holdings Ltd., a British Virgin Islands company ("RACP Pharmaceutical"), Mr. Li Xiaobo and certain other parties to acquire 100% ownership interest in Shenyang Enshi Pharmaceutical Co, Ltd. ("Enshi"), a pharmaceuticals manufacturer. On June 6, 2006, our management moved into Enshi's offices to take over Enshi's operations. On June 30, 2006, all required paperwork and procedures were completed and ownership of Enshi was transferred to us. As a result of the acquisition of RACP Pharmaceutical and Enshi, we assumed approximately $12,000,000 indebtedness owed to RimAsia Capital Partners ("RimAsia") that provided the funding for Enshi acquisition through RACP Pharmaceutical as a special purpose acquisition vehicle and assumed the obligation to issue RACP 12,000,000 warrants at an exercise price of $1.375 per share of the Company's common stock for a 3 year period. Upon the acquisition of Enshi the Company identified major breaches and fraud by the previous owner and controlling shareholders of Enshi, Mr. Li Xiaobo and his related parties ("Defendants") in the representations and warranties provided by him to the Company and the Defendants' refusal to honor their indemnification obligations to the Company. The Company's subsidiary RACP filed a lawsuit against the Defendants alleging fraud and for rescission and damages. Enshi's operations have been interfered and as a result we decided to suspend its operations. In addition, since Enshi was pledged as collateral for the $11.5 million debt owed to RimAsia in connection with the Enshi Acquisition, Enshi was taken over by RimAsia in July 2007. As a result, Enshi is no longer a subsidiary of the Company.
On November 19, 2007, we entered into an agreement (the "Agreement") RimAsia as a follow-up to letters of intent signed on July 14, 2007 and August 2, 2007, under which the principal amount of the $11.5 million Loan owed to RimAsia in connection with the acquisition of Enshi plus unpaid interest of $1,008,534 (total of $12,508,534) was converted in full into 6,185,607 shares of senior redeemable convertible preferred shares of the Company ("Preferred Shares") at a conversion price of $2.0222 per Preferred Share. Each Preferred Share may be converted into two shares of common stock. Additionally, the exercise price of $1.375 for the 12 million existing warrants exercisable into the Company's common stock previously issued to and currently held by RimAsia in connection with the extension of the Loan financing ("Existing Warrants") was lowered to $1.26 per share and the term of the Existing Warrants extended to 4.5 years from the closing date. This was conditioned on us signing a letter of intent for acquisition of a new company (or for the injection of the remaining 49% equity stake of Erye not already owned by the registrant) before January 15, 2008, having such acquisition closed before June 30, 2008 and then extended to January 1, 2009. In connection therewith, the parties also entered into a registration rights agreement and certain other agreements, and we issued additional common stock purchase warrant and a modified common stock purchase warrant.
As reported on our Current Report on Form 8-K dated November 6, 2008, on November 2, 2008, we entered into an Agreement and Plan of Merger (the "Merger agreement") with our subsidiary CBC, NeoStem, Inc., and CBH Acquisition LLC ("Merger Sub"). The Merger Agreement contemplates the merger of our company with and into Merger Sub, with Merger Sub as the surviving entity (the "Merger"). Prior to the consummation of the Merger, we will spin off all of our shares of capital stock of CBC to our stockholders in a liquidating distribution so that the only material assets of CBH following such spin-off will be CBH's 51% ownership interest in Erye, plus net cash which shall not be less than $550,000.
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, all of our common stock, par value $.01 per share, issued and outstanding immediately prior to the effective time of the Merger (the "Effective Time") will be converted into the right to receive, in the aggregate, 7,500,000 shares of NeoStem's common stock at par value of $.001 per share (of which 150,000 shares will be held in escrow pursuant to the terms of an escrow agreement to be entered into between CBH and NeoStem).
Subject to the cancellation of outstanding warrants to purchase shares of CBH Common Stock held by RimAsia, all of the shares of CBH series B preferred stock solely held by RimAsia, issued and outstanding immediately prior to the Effective Time will be converted into NeoStem's common stock, series C convertible preferred stock and warrants to purchase NeoStem's common stock. See details in Note 13.
At the Effective Time, in exchange for cancellation of all of the outstanding shares of CBH series A convertible preferred stock which is held by Stephen Globus, our director, and/or related persons, NeoStem will issue to Mr. Globus and/or related persons 50,000 shares of NeoStem common stock. NeoStem also will issue 60,000 shares of NeoStem Common Stock to Mr. Globus and 40,000 shares of NeoStem common stock to Chris Peng Mao, our Chief Executive Officer, in exchange for the cancellation and the satisfaction in full of indebtedness in the aggregate principal amount of $90,000, plus any and all accrued but unpaid interest thereon, and other obligations of CBH to Globus and Mao. NeoStem will bear 50% of up to $450,000 of our expenses post-merger, and satisfaction of the liabilities of Messrs. Globus and Mao will count toward that obligation. NeoStem also will issue 200,000 shares to CBC to be held in escrow, payable if NeoStem successfully consummates its previously announced acquisition of control of Shandong New Medicine Research Institute of Integrated Traditional and Western Medicine Limited Liability Company. Also at the Effective Time, subject to acceptance by the holders of all of the outstanding warrants to purchase shares of CBH common stock (other than warrants held by RimAsia), such warrants shall be canceled and the holders thereof shall receive warrants to purchase up to an aggregate of up to 2,012,097 shares of NeoStem common stock at an exercise price of $2.50 per share.
Upon consummation of the transactions contemplated by the Merger, Merger Sub will own 51% of the ownership interests in Erye, and Suzhou Erye Economy and Trading Co. Ltd., a company incorporated in the PRC ("EET"), will own the remaining 49% ownership interest. In connection with the execution of the Merger Agreement, NeoStem, Merger Sub and EET have negotiated a revised joint venture agreement (the "Joint Venture Agreement"), which, subject to finalization and approval by the requisite PRC governmental authorities, will become effective and will govern the rights and obligations with respect to their respective ownership interests in Erye. Pursuant to the terms and conditions of the Joint Venture Agreement, dividend distributions to EET and Merger Sub will be made in proportion to their respective ownership interests in Erye; provided, however, that for the three-year period commencing on the first day of the first fiscal quarter after the Joint Venture Agreement becomes effective, (i) 49% of undistributed profits (after tax) will be distributed to EET and lent back to Erye by EET for use by Erye in connection with the construction of a new plant for Erye; (ii) 45% of the net profit (after tax) will be provided to Erye as part of the new plant construction fund, which will be characterized as paid-in capital for Merger Sub's 51% interest in Erye; and (iii) 6% of the net profit will be distributed to Merger Sub directly for NeoStem's operating expenses. In the event of the sale of all of the assets of Erye or liquidation of Erye, Merger Sub will be entitled to receive the return of such additional paid-in capital before distribution of Eyre's assets is made based upon the ownership percentages of NeoStem and EET, and upon an initial public offering of Erye which raises at least $7,300,000 (RMB 50,000,000), Merger Sub will be entitled to receive the return of such additional paid-in capital. CBC will receive $300,000 from the settlement proceeds from the settlement of the litigation in Hong Kong and Canada by RACP Pharmaceutical Holdings Limited, a wholly-owned subsidiary of CBC, against Li Xiaobo and certain other defendants in connection with the acquisition of shares of Enshi (the "LXB Litigation") and use it as working capital.
Our current directors and officers, AN Lufan, LIU Xiaohao and Chris Mao, will give up their personal portions of the Neostem shares to be received to Erye minority holders holding 49% control of Erye to incentivize them to approve the transaction.
The transactions contemplated by the Merger Agreement are subject to the authorization for listing on the American Stock Exchange (or any other stock exchange on which shares of NeoStem Common Stock are listed) of the shares to be issued in connection with the Merger, shareholder approval, approval of NeoStem's acquisition of 51% ownership interest in Erye by relevant PRC governmental authorities, receipt of a fairness opinion and other customary closing conditions set forth in the Merger Agreement. As part of the Merger negotiation, CBC will receive $300,000 from the settlement proceeds from the settlement of the LXB Litigation and use it as working capital. The Merger currently is expected to be consummated in the second quarter of 2009. Further description of the Merger terms and related agreements can be found in Current Report on Form 8-K dated November 6, 2008 and in the Merger Agreement, which was filed as Exhibit 2.1 to the said Form 8-K hereto and is incorporated herein by reference.
The shares of our common stock are quoted on the Over the Counter Bulletin Board ("OTC Bulletin Board") under the symbol CHBP.OB.
Although to date we have been successful in developing our business and products, we face many challenges typically faced by a growing company, including limited access to capital, competition, research and development risks, among many other risks. Our inability to overcome these risks could have an adverse effect on our operations, financial condition and prospects. Investments in our company may also be materially and adversely affected by the fluctuation of the Renminbi.
BUSINESS DESCRIPTION
Our business is composed of three parts: Research & Development, Raw Materials and Manufacturing.
Research & Development
We through our subsidiary Keyuan, have a research and development ("R&D") team focused on discovering new small and large molecule drugs as well as developing generic and improved drugs based on existing products already on the market and traditional Chinese medicine products. Keyuan has developed a solid discovery and development platform with advanced R&D capabilities based on post genome era technological advances to enable rapid drug discovery and development. Keyuan also has a rich existing product pipeline. The technological backbone of the Keyuan advanced R&D capabilities is a Drug Screening and Testing System--an advanced drug screening and testing system based on certain bio-technologies that have only recently been made possible by rapid technological advances in the Post-Genomics Era. This proprietary gene-level technology platform enables Keyuan to deliver the next generation of drugs--which are more effective and have fewer side effects in a much shorter period than by traditional pharmaceutical developmental routes. The technology team is lead by capable drug research scientists and development experts in China. Keyuan has a product pipeline containing approximately forty major products, including eight drugs that are ready for commercialization in China. Keyuan also offers contractual research and development products by licensing the access to its proprietary screening and testing platforms to other pharmaceutical companies. Keyuan has built a Library of Targeted Drug Candidates ("LTDC") with 20,000 chemical compounds. Drug candidates undergo screening to reveal their potential to become new drugs. Keyuan collaborates with China Pharmaceutical University in enhancing the resources of chemical compounds in the LTDC. Keyuan has built its LTDC to both accelerate its own drug discovery and to generate revenue in the form of access fees paid by other pharmaceutical companies. Due to the Chinese government overhaul of the regulatory framework for research and development of new drugs, there was a slow down in the new drug research and development field in China overall and in Keyuan as a result.
Raw Materials
Our subsidiary Erye specializes in research and development, production and sales of pharmaceutical products as well as chemicals used in pharmaceutical products. Erye's raw material Acetylspiramycin per oral has gained 15% of domestic market share in year 2006. (According to Statistics China Association of Pharmaceutical Commerce).
Manufacturing
Our subsidiary, Erye, specializes in research and development, production and sales of pharmaceutical products as well as chemicals used in pharmaceutical products. The acquisition of 51% of the ownership interest of Erye, added new drug products to our pipeline, manufacturing capabilities that comply with China Good Manufacturing Practices (GMP) standard set by the State Food and Drug Administration ("SFDA") of China and marketing network that covers 30 provinces in China. Erye has obtained production certificates for 131 drug items, among which 108 are in production, mainly antibiotics drugs such as Ampicillin Sodium for injection, Cefoperazone Sodium for injection and Amoxicillin Sodium for injection. Erye's sales exceeded $31 million in 2007, and Oxacillin Sodium taking 95% of domestic market share (According to Statistics of China Association of Pharmaceutical Commerce).
ABOUT OUR PRODUCTS AND TECHNOLOGY
We have a diversified portfolio of drugs and robust drug screening and testing platforms. We concentrate on the development of drugs for treatment of common diseases such as cardiovascular diseases, cancer, infectious diseases and diabetes, etc.
Our products can be divided into three categories; new drugs through R&D, drug materials & intermediates and commercialized drugs:
New drug:
Our subsidiary Keyuan has an existing pipeline of approximately forty-four new drugs we intend to introduce to the Chinese market. The drugs are superior to existing comparable drugs with reduced toxicity, enhanced effectiveness and cheaper manufacturing costs due to technological innovation. The recent overhaul of SFDA has substantially stopped or slowed down our new drug approvals and has cast serious doubt on the value of our product pipeline. In the past two years, Keyuan had to postpone the development of some new drugs and cancel some new drug projects. The table below lists the products of Keyuan. For each drug, the table indicates the condition for treatment and SFDA approval and licensing status. SFDA provides administrative protection for a period of 3-5 years for drugs newly introduced to China. And in year 2009, we expect Keyuan to have 3 new drugs that will be commercialized.
Raw Materials and Intermediaries
Our subsidiary Erye specializes in research and development, production and sales of pharmaceutical products as well as chemicals used in pharmaceutical products. Erye's Acetylspiramycin per oral has gained 15% and Oxacillin Sodium gained 95%of domestic market share.
Below is a list of Erye's major intermediary products (According to Statistics of China Association of Pharmaceutical Commerce):
Drug/Product Name Target Treatment Market Share - ----------------- ----------------- ------------ Azlocillin Sodium Antibiotics 30%
Oxacillin Sodium Antibiotics 95% Acetylspiramycin Antibiotics 15%
Commercialized Drugs
The acquisition of 51% of the ownership interest of Erye added new drug products to our pipeline, manufacturing capabilities that comply with China GMP standard set by the SFDA of China and marketing network that covers 30 provinces in China. Erye has obtained production certificates for 127 drug items, among which 125 are in production, mainly antibiotics drugs such as Ampicillin Sodium for injection, Cefoperazone Sodium for injection and Amoxicillin Sodium for injection. Erye's drugs Oxacillin Sodium accounted in 2008 for 95% of domestic market share.
Below is a list of Erye's major pharmaceutical products:
Library of Targeted Drug Candidates:
We have built a Library of Targeted Drug Candidates ("LTDC") with 20,000 chemical compounds. Drug candidates undergo screening to reveal their potential to become new drugs. We collaborate with China Pharmaceutical University in enhancing the resources of chemical compounds in the library. We invest in LTDC to both accelerate our own drug research and discovery as well as to generate revenue in the form of access fees paid by other pharmaceutical companies.
OUR CUSTOMERS AND DISTRIBUTION CHANNELS
We have three groups of customers:
Pharmaceutical Companies- We maintain a fine reputation in the pharmaceutical industry in China for new drug R & D. We work with other pharmaceutical companies to license or jointly distribute our products.
Drug Distribution Companies- There are approximately 10,000 drugs distribution companies in China. We work with various distribution companies to distribute our products. The demand for new drugs in China is substantial as the drug distribution companies suffer from very low profit margins from the distribution of old generic drugs.
Hospitals- We have a network of connections with hospitals in the areas of Shanghai, Zhejiang province and Jiangsu province. The population in these areas is approximately 150 million. Our sales executives have held senior sales positions in various pharmaceutical companies that sell in these areas and have an extensive network of contacts that provide direct access to hospitals in these areas.
We currently have 30 sales representative offices in China, covering nearly all the main cities of China.
OUR RESEARCH AND DEVELOPMENT
We have a robust research and development ("R&D") team focused on discovering new small and large molecule drugs as well as developing generic and improved drugs based on existing products already on the market and traditional Chinese medicinal products. Our R&D team consists of experts in the fields of medical technology, biotechnology, and pharmaceuticals with over 10-years of market place experience and a proven record of success in the management of pharmaceutical businesses in China. The Company has developed a discovery and development platform with advanced R&D capabilities based on post genome era technological advances to enable rapid drug discovery and development. We also have a rich product pipeline. The technological backbone of the Company's R&D capabilities is a Drug Screening and Testing System based on certain Post-Genomics Era bio-technologies. This proprietary gene-level technology platform enables the Company to deliver the next generation of drugs which are more effective and have fewer side effects in a much shorter period than by traditional pharmaceutical developmental routes. The technology team is lead by some of the best drug research scientists and development experts in China. Our subsidiary Keyuan, has a product pipeline of about forty major new drugs for the treatment of diseases such as cardiovascular and infectious diseases. We also offer contractual research and development products by licensing the access to its proprietary screening and testing platforms to other pharmaceutical companies. We have built a Library of Targeted Drug Candidates ("LTDC") with 40,000 chemical compounds. Drug candidates undergo screening to reveal their potential to become new drugs. We collaborate with China Pharmaceutical University, which is a shareholder of the Company, in building allied R&D laboratory for drug screening and testing and enhancing the resources of chemical compounds in the library. Due to the Chinese government overhaul of the regulatory framework for research and development of new drugs, there was a slow down in the new drug research and development field in China overall and in Keyuan as a result.
We leverage our relationship with the research laboratory of China Pharmaceutical University which is a minor shareholder of our company. We have the right of first refusal on their new drug discoveries.
We spent $ 388,848 and $271,030 on research and development during 2008 and 2007, respectively.
PRODUCTION FACILITIES AND EQUIPMENT
Our subsidiary Keyuan has a drug R&D laboratory. The laboratory is equipped with various type of equipment for compound synthesis, drug testing, screening, drug analysis, Pharmacological study, Pharmacokinetic study, efficiency study and toxicity study such as High Performance Liquid Chromatography (HPLC), Incubator, Ultraviolet-Visible Spectrometer, Centrifuge and Clean Bench, etc. Our subsidiary Erye has seven laboratories, including Microorganism lab, Biological inspection lab, Apparatus lab, Chemical lab, Standard solution lab, Sample lab and Animal lab. The labs are equipped with advanced Gas Chromatography, HPLC, and Infrared Spectroscopy.
Our subsidiary Erye has seven SFDA approved and certified production lines. The capsule pharmaceutical workshop and the Azlocillin sodium workshop are all designed by the Designing Institute of Medical Engineering of Nanjing. The total construction area for the workshop is approximately 2,400 square meters with an area of 1,450 square meters of medicine workshop of aseptic raw materials, 550 square meters for 100,000 grades purification control zone and 350 square meters for 300,000 grades purification control zone. Different production control zones are furnished with separated air conditioning system respectively according to different varieties and control request. Erye's total area of warehouse is 4,570 square meters and is set up for finished product storehouse, original auxiliary materials storehouse and packing materials storehouse. Erye has an industrial waste reservoir which is situated at a separated area outside the main production premises. The area of quality control building is 685 square meters and it consists of the microbiology laboratory, biological examination room, instrument laboratory, chemical laboratory, standard solution room, sample room and animal's laboratory. The quality control room is furnished with the gaseous phase chromatograph of Model GC-14C, SPD-10AVP type high-efficient liquid phase chromatograph, the titri-metric appearance of electric potential of Model ZDJ-ID, FTIR-8400S type infrared spectro-comparator, etc. Every workshop uses the special-purpose production equipment. The equipment directly contacted with the medicines is making of high quality stainless steel materials and apt to production operation, repairing, maintaining and washes. It can also prevent the operation mistake and reduce pollution.
COMPETITION AND COMPETITIVE STRENGTHS
Vertically integrated pharmaceutical operation is still at an early stageof development in China due to heavy state involvement in the past. The industry is fragmented. We face competition from domestic drug R&D companies, drug manufacturing companies which are growing rapidly. Our direct competitors are domestic pharmaceutical companies and new drug R&D institutes that have fairly strong R&D capabilities in new drug R&D such as Beijing Venture Biopharma Technology Co., Ltd., Fosun Group Co., Ltd. and Chongqing Pharmaceutical Research Institute, Co. Ltd. We also face competition of foreign companies who have strong proprietary pipeline and strong financial resources. Our advantage is our local concentration in research and discovery as well as our local distribution network. We possess certain competitive advantages over our competitors due to our own discovery capability. Our relationship with China Pharmaceutical University, one of the leading pharmaceutical scientific research institution in China, provides us with a unique opportunity to benefit from the latest discovery in its research laboratory and reduce our fundamental research cost so that we can concentrate more on application and commercialization. We are in a competitive position to seize substantial market opportunities as the pharmaceutical industry in China rapidly moves toward consolidation, privatization, and commercialization.
Good Product Pipeline
Our subsidiary Keyuan has an existing pipeline of approximately forty four new drugs we intend to introduce to the Chinese market or license to other pharmaceutical companies. The drugs are superior to existing comparable drugs with reduced toxicity, enhanced effectiveness and cheaper manufacturing costs due to technological innovation.
R&D Capabilities and Technology
We have managed to obtain intellectual property rights for our advanced technologies and to gain a strong competitive edge over the vast majority of all domestic pharmaceutical companies. Our R&D capabilities are one of the most advanced in the Chinese pharmaceutical industry. Our advanced R&D technology platform represents the latest drug discovery and development tools available for screening potential drug candidates for new drugs. Additionally, through our joint venture with the University's R & D laboratory, we have access to China's most promising pharmaceutical development projects and to the nation's top-level expertise from academia, government, and industry.
Strong Experience in Dealing with Approval Authorities
Several of our leading management team members used to work with SFDA in various high level drug approval and screening positions. Our research and discovery is keyed to the SFDA requirements and we are familiar with the criteria used and standards expected. This gives us competitive advantage in government approvals and licenses as well as revenues from participation in selected government projects and grants.
Examination and Appraisement Committee for Small Molecule Drugs.
In August, 2004, we signed an agreement with China Pharmaceutical University to establish a joint laboratory for potential drug candidates (effective chemical compounds and effective single ingredient extract from traditional Chinese medicinal herbs) screening and new drug research and development.
INTELLECTUAL PROPERTY
An asset base of intellectual property is the foundation of our operations and R&D facilities. We have the capacity to rapidly generate intellectual property in the many forms as described above: New drugs / full product pipeline, Drug screening & testing platforms, Proprietary technologies, and Library of Targeted Drug Candidates (LTDC). This asset base of valuable intellectual property is leveraged to derive revenues, form strategic partnerships, and make acquisitions to expand our operations and profit-earning capacity.
Our subsidiary, Keyuan, owns the following patents, one of which approved and two pending approval:
(1) Low dose Diclofenac Sodium Lozenges and preparation. (Indication: oral ulcer, stomatitis, small oral operation); Patent Application number: 011360828; Application date: Oct.8, 2001; Approval date: Jan.15, 2005; Patent Number: CN1413583A; Patent Expiration date: Oct 7, 2021.
(2) Usage of the abstracts of Rhodiola rosea L. in the preparation of drugs treating Alzheimer disease; Application number: 031583490; Application date: Sep.27, 2003; Patent Expiration date: Sep. 26, 2023
(3) Preparation of a platinum(II) compound Yibo, anticancer drug Application number: 2004100147727; Application date: Apr.28, 2004; Patent Expiration date: April 27, 2024
The typical duration of these patents is twenty years from the date of application. Other drugs of Keyuan are subject to pending or existing SFDA administrative protection.
The TCM protected by China SFDA can apply for continuous protection after expiration. Upon approval, both of the above medicines can be protected for another 7 years.
Our Subsidiary, Erye, has purchased the patent right for "The New Crystal and Composition of Adefovir Dipivoxil and Methods for Preparing Them" in 2007.
REGULATORY ENVIRONMENT
Our principal sales market is presently in China. We are subject to the Drug Administration Law of China, which governs the licensing, manufacturing, marketing and distribution of pharmaceutical products in China and sets penalties for violations of the law. Additionally, we are also subject to various regulations and permit systems by the Chinese government.
The application and approval procedure in China for a newly developed drug product is described below. New drug applicants prepare the documentation of pharmacological study, toxicity study and pharmacokinetics and drug metabolism (PKDM) study and new drug samples. Documentation and samples are then submitted to provincial food and drug administration ("provincial FDA"). The provincial FDA sends its officials to the applicant to check the applicant's R&D facilities and to arrange new drug examination committee meeting for approval deliberations. This process usually takes three months. After the documentation and samples being approved by the provincial FDA, the provincial FDA will submit the approved documentation and samples to SFDA. SFDA examines the documentation and tests the samples and arranges new drug examination committee meeting for approval deliberations. If the application is approved by SFDA, SFDA will issue a clinical trial license to the applicant for clinical trials. The clinical trial license approval typically takes one year. The applicant completes the clinical trial process and prepares documentation and files submitted to SFDA for new drug approval. The clinical trial process usually takes one year or two depending on the category and class of the new drug. SFDA examines the documentation and gives final approval for the new drug and issues the new drug license to the applicant. This process usually takes 8 months. The whole process for new drug approval usually takes three to four years.
The Government approval procedure in China for application for new patents is as follows. The applicant prepares documentation and sends application to State Intellectual Property Office of China ("SIPO"), usually through patent application agencies. The application is then examined by SIPO. If the application is approved, SIPO issues and releases patent illustration book for challenges by competing claimants. Once the illustration book issued, the patent is protected. Within a three year period depending on different categories of the patent, if there are no challenges against the patent, then SIPO will issue patent license to the applicant
The Chinese government is in the process of reviewing its industry policies relating to the pharmaceutical industry in face of problems involving the healthcare industry. SFDA has been in the process of reviewing past drug permits and licenses. As of now, the Company maintains good standing of its drug permits and licenses.
COMPLIANCE WITH ENVIRONMENTAL LAW
We comply with the Environmental Protection Law of China and its local regulations. In addition to statutory and regulatory compliance, we actively ensure the environmental sustainability of our operations.
EMPLOYEES
The number of our employees has remained relevantly stable as compared to 2006. Currently we have approximately 520 full-time employees, with all employees falling into the following categories:
By company:
Number of Company Employees - -------------------------------------------------------------------------------- CBH & CBC 6 Keyuan 20 Erye 580 TOTAL: 606
By job:
Number of Job Employees - -------------------------------------------------------------------------------- Management & Administration 56 Technology and research 55 Sales and marketing 100 Production - drug material & drugs 395 TOTAL: 606
We have employment contracts with a significant number of our employees. None of our employees is covered by a collective bargaining agreement, and we believe our employee relations are good. All of our employees are located in Jiangsu Province, China.
ITEM 1A.
ITEM 1A. RISKS FACTORS
Our business involves a high degree of risk, and our securities are highly speculative. Potential investors should carefully consider the risks and uncertainties described below and the other information in this report on Form 10-K before deciding whether to invest in shares of our common stock. If any of the following risks actually occur, our business, financial condition, and results of operations could be materially and adversely affected. This could cause the trading price of our common stock to decline, with the loss of part or all of an investment in our common stock.
RISKS RELATED TO THE MERGER WITH NEOSTEM, INC.
The consummation of the transactions contemplated by the Agreement and Plan of Merger entered between us and Neostem is dependent upon NeoStem's obtaining all relevant and necessary governmental approvals from the relevant PRC government authorities.
Pursuant to the Agreement and Plan of Merger, NeoStem will acquire, indirectly a 51% ownership interest in Erye from us. NeoStem, Merger Sub and EET must enter into the Joint Venture Agreement to govern the rights and obligations of NeoStem, Merger Sub and EET with respect to their ownership in Erye. The Joint Venture Agreement, together with the articles of incorporation of Erye, must be delivered to the relevant PRC governmental organizations for inspection and approval, and the closing of the transactions contemplated by the Agreement and Plan of Merger are contingent upon, among other things, obtaining all relevant and necessary governmental approvals from the relevant PRC government authorities for the Joint Venture Agreement, the articles of incorporation and the transactions contemplated thereby. There can be no assurance that NeoStem will be able to obtain all such relevant and necessary governmental approvals from the relevant PRC government authorities on a timely basis or at all.
If the necessary approvals for the Merger are not obtained and the Merger is not Consummated, we will fail to comply with our agreement with RimAsia which may in cause ireperavle damage to our business and operations.
On November 19, 2007, we entered into an agreement (the "Agreement") RimAsia as a follow-up to letters of intent signed on July 14, 2007 and August 2, 2007, under which, among other things, the principal amount of the $11.5 million Loan owed to RimAsia in connection with the acquisition of Enshi plus unpaid interest of $1,008,534 (total of $12,508,534) was converted in full into 6,185,607 shares of senior redeemable convertible preferred shares of the Company ("Preferred Shares") at a conversion price of $2.0222 per Preferred Share. This was conditioned on us signing a letter of intent for acquisition of a new company (or for the injection of the remaining 49% equity stake of Erye not already owned by the registrant) before January 15, 2008, having such acquisition closed before June 30, 2008, then extended to January 1, 2009 and then extended to October 31, 2009. If we fail to obtain the necessary approvals for the Merger and the Merger is not consummated, then we will fail to comply with our Agreement with RimAsia, which in turn may convert the Preferred Shares back to a loan, accelerate and foreclose back on our assets causing irreparable damage to our business and operations.
The consummation of the Merger and related transactions is contingent upon the satisfaction of certain closing conditions, and the failure or delay in satisfying such closing conditions could result in increased costs and enhanced expenditure of resources or a decline in our stock price.
The transactions contemplated by the Agreement and Plan of Merger are subject to the satisfaction of several closing conditions. In order to consummate the Merger, the stockholders of NeoStem must approve both the issuance of securities in connection with the Merger and the amendment to NeoStem's amended and restated certificate of incorporation to increase the number of authorized shares of Preferred Stock and our stockholders must approve the Merger and the Spin-off. In addition, in order to consummate the Merger, the shares of NeoStem Common Stock to be issued in connection with the Merger must be authorized for listing on the NYSE Alternext US, LLC (or any other stock exchange on which shares of NeoStem Common Stock are listed); approval by the relevant PRC and other governmental authorities of NeoStem's acquisition of 51% ownership interest in Erye, as described above, must be obtained; NeoStem must receive a re-affirmation of the fairness opinion issued by vFinance; and other customary closing conditions set forth in the Agreement and Plan of Merger must be satisfied. There is no guarantee that such approvals will be obtained or that such conditions will be satisfied.
Any failure to satisfy or delay in satisfying any condition to closing, could result in increased costs as a result of additional efforts directed towards attempting to consummate the transactions, as well as decreased operational performance pending the outcome of the efforts directed at completion of the transactions. Legal, accounting, and printing fees must be paid whether or not the Merger is consummated, and the amount of any or all of these fees may be enhanced if there is any failure or delay in satisfying the closing conditions. Any such delays or failures to satisfy conditions could materially adversely affect our business, financial condition and results of operations. In addition, a failure to complete the Merger and/or the Share Exchange, or a delay in completing either or both transactions, could result in a decline of the market price of NeoStem Common Stock to the extent that the relevant current market price reflects a market assumption that either the Merger and/or the Share Exchange will be completed.
CHINA RELATED RISKS
Our assets are located in China and its revenues are derived from its operations in China
In terms of industry regulations and policies, the economy of China has been transitioning from a planned economy to market oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reforms, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China are still owned by the Chinese government. For example, all lands are state owned and are leased to business entities or individuals through governmental granting of State-owned Land Use Rights. The granting process is typically based on government policies at the time of granting and it could be lengthy and complex. This process may adversely affect our company's future manufacturing expansions. The Chinese government also exercises significant control over China's economic growth through the allocation of resources, controlling payment of foreign currency and providing preferential treatment to particular industries or companies. Uncertainties may arise with changing of governmental policies and measures. At present, our company's development of research and development technologies and products is subject to approvals from the relevant government authorities in China. Such governmental approval processes are typically lengthy and complex, and never certain to be obtained.
Political and economic risks
China is a developing country with a young market economic system overshadowed by the state. Its political and economic systems are very different from the more developed countries and are still in the stage of change. China also faces many social, economic and political challenges that may produce major shocks and instabilities and even crises, in both its domestic arena and in its relationship with other countries, including but not limited to the United States. Such shocks, instabilities and crises may in turn significantly and adversely affect our performance.
Risks related to interpretation of China laws and regulations which involves significant uncertainties
China's legal system is based on written statutes and their interpretation by the Supreme People's Court. Prior court decisions may be cited for reference but have limited value as precedents. Since 1979, the Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. In addition, as the Chinese legal system develops, we cannot assure that changes in such laws and regulations, and their interpretation or their enforcement will not have a material adverse effect on our business operations.
FOREIGN EXCHANGE CONTROL RISKS
Currency conversion and exchange rate volatility could adversely affect our financial condition.
The PRC government imposes control over the conversion of Renminbi into foreign currencies. Under the current unified floating exchange rate system, the People's Bank of China publishes an exchange rate, which we refer to as the PBOC exchange rate, based on the previous day's dealings in the inter-bank foreign exchange market. Financial institutions authorized to deal in foreign currency may enter into foreign exchange transactions at exchange rates within an authorized range above or below the PBOC exchange rate according to market conditions.
Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the State Council which came into effect on April 1, 1996, and the Regulations on the Administration of Foreign Exchange Settlement, Sale and Payment of the PRC which came into effect on July 1, 1996, regarding foreign exchange control, conversion of Renminbi into foreign exchange by Foreign Investment Enterprises, or FIEs for use on current account items, including the distribution of dividends and profits to foreign investors, is permissible. FIEs are permitted to convert their after-tax dividends and profits to foreign exchange and remit such foreign exchange to their foreign exchange bank accounts in the PRC.
Conversion of Renminbi into foreign currencies for capital account items, including direct investment, loans, and security investment, is still subject to certain restrictions. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and added, among other things, an important provision, which provides that the PRC government shall not impose restrictions on recurring international payments and transfers under current account items.
Enterprises in PRC (including FIEs) which require foreign exchange for transactions relating to current account items, may, without approval of the State Administration of Foreign Exchange, or SAFE, effect payment from their foreign exchange account or convert and pay at the designated foreign exchange banks by providing valid receipts and proofs.
Convertibility of foreign exchange in respect of capital account items, such as direct investment and capital contribution, is still subject to certain restrictions, and prior approval from the SAFE or its relevant branches must be sought.
We are a FIE to which the Foreign Exchange Control Regulations are applicable. There can be no assurance that we will be able to obtain sufficient foreign exchange to pay dividends or satisfy other foreign exchange requirements in the future.
Since 1994, the exchange rate for Renminbi against the United States dollars has remained relatively stable, most of the time in the region of approximately RMB8.28 to US$1.00. However, in 2005, the Chinese government announced that would begin pegging the exchange rate of the Chinese Renminbi against a number of currencies, rather than just the U.S. dollar. As our operations are primarily in China, any significant revaluation of the Chinese Renminbi may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert United States dollars into Chinese Renminbi for our operations, appreciation of this currency against the United States dollar could have a material adverse effect on our business, financial condition and results of operations. Conversely, if we decide to convert Chinese Renminbi into United States dollars for other business purposes and the United States dollar appreciates against this currency, the United States dollar equivalent of the Chinese Renminbi we convert would be reduced. During 2008, the RMB value appreciated and as of December 31, 2008, the exchange rate of the RMB against the USD was RMB6.82 for US$ 1.00.
REGULATORY RISKS
Governmental regulatory and policy risks
We must follow various government regulations and in particular, the SFDA regulations. Government regulations may have material impact on our operations, increase costs and could prevent or delay our company in licensing, manufacturing and selling our products. Our research, development, testing, manufacturing and marketing activities are subject to various governmental regulations in China, including health and drug regulations. Government regulations, among other things, cover the inspection of and controls over testing, manufacturing, safety and environmental considerations, efficacy, labeling, advertising, promotion, record keeping and sale and distribution of pharmaceutical products. We will not be able to license, manufacture, sell and distribute the vast majority of its products without a proper approval from government agencies and in particular the SFDA.
There is no assurance that we will obtain such approvals.
In addition, delays or rejections may be encountered based upon additional government regulation from future legislation, administrative action or changes in governmental policy and interpretation during the period of product development and product assessment. Although we have, so far, obtained the marketing rights for selling some of our products in China, we may not continue to receive and maintain regulatory approvals for the sales of these products. Our marketing activities are also subject to government regulations with respect to the prices that we intend to charge or any other marketing and promotional related activities. Government regulations may substantially increase our costs for developing, licensing, manufacturing and selling products, impacting negatively on our operation, revenue, income and cash flow.
There could be changes in government regulations towards the pharmaceutical industries that may adversely affect our business and products. Our future growth and profitability depend to a large extent on our ability to obtain regulatory approvals. State Food and Drug Administration of China recently implemented new guidelines for licensing of pharmaceutical products. All existing manufacturers with licenses, which are currently valid under the previous guidelines, are required to apply for the Good Manufacturing Practices ("GMP") certifications by June 30, 2004, and to receive approvals by December 31,2004. We have received our certifications. However, should we fail to receive or maintain the GMP certifications under the new guidelines in the future; our businesses would be materially and adversely affected.
Recently SFDA and other relevant authorities in China are implementing a series of new punitive and stringent measures regarding the pharmaceuticals industry to redress certain past misconducts in the industry and certain deficiencies in the public health reform policies. Given the nature and extent of such new enforcement measures and the aggressive manner in which such enforcement is being conducted, there may be possibilities of large scale and significant penalties meted out to manufacturers given the regulatory environment and the fact that newly constituted local level branches are encouraged to issue such punishments and fines. These new measures may include fines, restriction and suspension of operations and marketing and other unspecified penalties. This new regulatory environment has added significantly to the risks of our business and may have material negative impact on our operation results.
Moreover, the laws and regulations regarding acquisitions of the pharmaceutical industry in the PRC may also change and may significantly impact our ability to grow through acquisitions. In addition to the regular approvals, new industry review and approval may be needed from the Ministry of Commerce depending on the size and the nature of future acquisitions. We may not be able to pass such reviews and obtain the necessary approvals.
COMPANY'S RELATED RISKS
Risks related to our strategy and risks related to our inability to carry out such strategy
Our strategy may be based on wrong assumptions and may be seriously flawed and may even in fact damage our performance, competitive position in the market and even our ability to survive in the market place. Even if the strategy is correct, we may never be able to successfully implement our strategy or implement the strategy in the desired fashion. These risk factors may cause major risks to our performance and even survival.
Risks related to the implementation of our operational and marketing plan
Our operational plan and marketing plan may be seriously flawed and even in fact damage our performance, competitive position in the market and even our ability to survive in the market place. Even if the operational plan and the marketing plan are correct, we may never be able to successfully implement the plans or implement the strategy in the desired fashion. These risk factors may cause major risks to our performance and even survival.
Risks related to our products and services
Our products and services involve direct or indirect impact on human health and life. The drugs, products and services provided may be flawed and cause dangerous side effects and even fatality in certain cases and lead to major business losses and legal and other liabilities and damages to us.
Risks related to product liability claims
We face the risk of loss resulting from, and adverse publicity associated with, product liability lawsuits, whether or not such claims are valid. We may not be able to avoid such claims. In addition, our product liability insurance may not be adequate to cover such claims and we may not be able to obtain adequate insurance coverage in the future at acceptable costs. A successful product liability claim that exceeds our policy limits could require us to pay substantial sums.
Risks related to our technology and our platforms
Our technologies and platforms may be seriously defective and flawed producing wrong and harmful results, exposing us to significant liabilities. Even if they are not defective or flawed, these technologies and platforms may become outdated, losing their value and thus affect our competitive advantages.
Risks related to competition
We compete with other companies, many of whom are developing or can be expected to develop products similar to ours. Our market is a large market with many competitors. Many of our competitors are more established than we are, and have significantly greater financial, technical, marketing and other resources than we presently possess. Some of our competitors have greater name recognition and a larger customer base. These competitors may be able to respond more quickly to new or changing opportunities and customer requirements and may be able to undertake more extensive promotional activities, offer more attractive terms to customers, and adopt more aggressive pricing policies. We cannot assure you that we will be able to compete effectively with current or future competitors or that the competitive pressures we face will not harm our business
Marketing risks
Newly developed drugs and technologies may not be compatible with market needs. Because markets for drugs differentiate geographically inside China, we must develop and manufacture our products to accurately target specific markets to ensure product sales. If we fail to invest in extensive market research to understand the health needs of consumers in different geographic areas, we may face limited market acceptance of our products, which could have material adverse effect on our sales and earning.
Risks related to research and the ability to develop new drugs
Our growth and survival depends on our ability to consistently discover, develop and commercialize new products and find new and improve on existing technologies and platforms. As such, if we fail to make sufficient investments in research, be attentive to consumer needs or do not focus on the most advanced technologies, our current and future products could be surpassed by more effective or advanced products of other companies.
Risks relating to difficulty in defending intellectual property rights from infringement
Our success depends, in large part, on our ability to protect our current and future technologies and products and to defend our intellectual property rights. If we fail to protect our intellectual property adequately, competitors may manufacture and market products similar to ours. Numerous patents covering our technologies have been issued to us, and we have filed, and expect to continue to file, patent applications seeking to protect newly developed technologies and products in various countries, including China. Some patent applications in China are maintained in secrecy until the patent is issued. Because the publication of discoveries tends to follow their actual discovery by many months, we may not be the first to invent, or file patent applications on any of our discoveries. Patents may not be issued with respect to any of our patent applications and existing or future patents issued to or licensed by us may not provide competitive advantages for our products. Patents that are issued may be challenged, invalidated or circumvented by our competitors. Furthermore, our patent rights may not prevent our competitors from developing, using or commercializing products that are similar or functionally equivalent to our products.
We also rely on trade secrets, non-patented proprietary expertise and continuing technological innovation that we seek to protect, in part, by entering into confidentiality agreements with licensees, suppliers, employees and consultants. These agreements may be breached and there may not be adequate remedies in the event of a breach. Disputes may arise concerning the ownership of intellectual property or the applicability of confidentiality agreements. Moreover, our trade secrets and proprietary technology may otherwise become known or be independently developed by our competitors. If patents are not issued with respect to products arising from research, we may not be able to maintain the confidentiality of information relating to these products.
Risks relating to third parties that may claim that we infringe on their proprietary rights and may prevent us from manufacturing and selling certain of our products
There has been substantial litigation in the pharmaceutical industry with respect to the manufacturing, use and sale of new products. These lawsuits relate to the validity and infringement of patents or proprietary rights of third parties. We may be required to commence or defend against charges relating to the infringement of patent or proprietary rights. Any such litigation could:
|_| require us to incur substantial expense, even if we are insured or successful in the litigation;
|_| require us to divert significant time and effort of our technical and management personnel;
|_| result in the loss of our rights to develop or make certain products; and
|_| require us to pay substantial monetary damages or royalties in order to license proprietary rights from third parties.
Although patent and intellectual property disputes within the pharmaceutical industry have often been settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include the long-term payment of royalties. These arrangements may be investigated by regulatory agencies and, if improper, may be invalidated. Furthermore, the required licenses may not be made available to us on acceptable terms. Accordingly, an adverse determination in a judicial or administrative proceeding or a failure to obtain necessary licenses could prevent us from manufacturing and selling some of our products or increase our costs to market these products.
In addition, when seeking regulatory approval for some of our products, we are required to certify to regulatory authorities, including the SFDA, that such products do not infringe upon third party patent rights. Filing a certification against a patent gives the patent holder the right to bring a patent infringement lawsuit against us. Any lawsuit would delay regulatory approval by the SFDA. A claim of infringement and the resulting delay could result in substantial expenses and even prevent us from manufacturing and selling certain of our products.
Our launch of a product prior to a final court decision or the expiration of a patent held by a third party may result in substantial damages to us. Depending upon the circumstances, a court may award the patent holder damages equal to three times their loss of income. If we are found to infringe a patent held by a third party and become subject to such treble damages, these damages could have a material adverse effect on the results of our operations and financial condition.
Our Internal Control Over Financial Reporting was Not Considered Effective as of December 31, 2008 and May Continue to be Ineffective in the Future, Which Could Result in Our Financial Statements Being Unreliable, Government Investigation or Loss of Investor Confidence in Our Financial Reports.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to furnish an annual report by our management assessing the effectiveness of our internal control over financial reporting. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Management's report as of the end of 2008 identified several material weaknesses and concluded that we did not have effective internal control over financial reporting. Ineffective internal controls can result in errors or other problems in our financial statements. Even if material weaknesses identified do not cause our financial statements to be unreliable, if we continue to be unable to assert that our internal controls are effective, our investors could still lose confidence in the accuracy and completeness of our financial reports, which in turn could cause our stock price to decline. Failure to maintain effective internal control over financial reporting could also result in investigation or sanctions by regulatory authorities. In addition, 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 temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.
Risks related to financial reports and estimates
Our company is subject to critical accounting policies and actual results may vary from our estimates. Our company follows generally accepted accounting principles for the United States in preparing its financial statements. As part of this work, we must make many estimates and judgments concerning future events. These affect the value of the assets and liabilities, contingent assets and liabilities, and revenue and expenses reported in our financial statements. We believe that these estimates and judgments are reasonable, and we make them in accordance with our accounting policies based on information available at the time. However, actual results could differ from our estimates, and this could require us to record adjustments to expenses or revenues that could be material to our financial position and results of operations in the future.
There have been historical deficiencies with our internal controls and these remain areas of our internal and disclosure controls that require improvements, and we are exposed to potential risks from legislation requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002.
We are exposed to potential risks from legislation requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002. Under the supervision and with the participation of our management, we have evaluated our internal controls systems in order to allow management to report on, our internal controls, as required by Section 404 of the Sarbanes-Oxley Act. We have performed the system and process evaluation and testing required in an effort to comply with the management certification and auditor attestation requirements of Section 404. As a result, we have incurred additional expenses and a diversion of management's time. If we are not able to continue to meet the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC. Any such action could adversely affect our financial results and the market price of our stock.
Risks related to significant financing needs
We need significant amount of capital to invest in our research and development, in our acquisitions and in our operations. We may not be able to identify and raise sufficient capital in a timely manner to finance our research and development activity, operation, acquisitions, growth and even survival. Even if such financings are available, they may not be timely or sufficient or on the terms desirable, acceptable or not harmful to our existing shareholders.
Risks related to growth and the ability to manage growth
For our company to survive and to succeed, we have to consistently grow. However, the management and we may not be able to achieve or manage such growth. The inability to achieve and maintain and manage growth will significantly affect our survival and market position.
Dependence on key personnel
We depend on our key management and technological personnel. The unavailability or departure of such key personnel may seriously disrupt and harm our operations, business and the implementation of our business strategy and plans. Although most of these personnel are founders and shareholders of our company, there can be no assurance that we can be successful in retaining them.
Risks related to not declaring or paying any dividends to our shareholders
We did not declare any dividends for the year ended December 31, 2008. Our board of directors does not intend to distribute dividends in the near future. The declaration, payment and amount of any future dividends will be made at the discretion of the board of directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors as the board of directors considers relevant. There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend.
It may be difficult to effect service of process and enforcement of legal judgments upon our company and our officers and directors because they reside outside the United States.
As our operations are presently based in China and our key directors and officers reside in China, service of process on our company and our key directors and officers may be difficult to effect within the United States. Also, our main assets are located in China and any judgment obtained in the United States against us may not be enforceable outside the United States.
Most of our assets are located in china, any dividends of proceeds from liquidation is subject to the approval of the relevant Chinese government agencies.
Our assets are predominantly located inside China. Under the laws governing foreign invested enterprises in China, dividend distribution and liquidation are allowed but subject to special procedures under the relevant laws and rules. Any dividend payment will be subject to the decision of the board of directors and subject to foreign exchange rules governing such repatriation. Any liquidation is subject to both the relevant government agency's approval and supervision as well the foreign exchange control. This may generate additional risk for our investors in case of dividend payment and liquidation.
The Company's financial structure is leveraged which may risk our ability to raise additional financing
Due to the $11.5 million acquisition financing of Enshi the Company's capital structure is leveraged with a convertible preferred shares from RimAsia Capital Partners, L.P., which may be converted back into a loan if the Merger with Neostem is not completed, which may significantly limit the Company's ability to raise additional financing for its operations and growth and negatively impact on the Company's business operations and financial results.
RISKS RELATED TO COMMON STOCK
Risks of lack of liquidity and volatility risks
Currently our common stock is quoted in the OTC Bulletin Board market, the liquidity of our common stock may be very limited and affected by its limited trading market. The OTC Bulletin Board market is an inter-dealer market much less regulated than the major exchanges and is subject to abuses and volatilities and shorting. There is currently no broadly followed and established trading market for our common stock. An established trading market may never develop or be maintained. Active trading markets generally result in lower price volatility and more efficient execution of buy and sell orders. Absence of an active trading market reduces the liquidity of the shares traded there.
The trading volume of our common stock may be limited and sporadic. As a result of such trading activity, the quoted price for our common stock on the OTC Bulletin Board may not necessarily be a reliable indicator of its fair market value. Further, if we cease to be quoted, holders would find it more difficult to dispose of, or to obtain accurate quotations as to the market value of our common stock and as a result, the market value of our common stock likely would decline.
Risks related to penny stocks
Our common stock may be subject to regulations prescribed by the SEC relating to "Penny Stock." The SEC has adopted regulations that generally define a penny stock to be any equity security that has a market price (as defined in such regulations) of less than $5.00 per share, subject to certain exceptions. If our common stock meets the definition of a penny stock, it will be subject to these regulations, which impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investor, generally institutions with assets in excess of $5,000,000 and individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 (individually) or $300,000 (jointly with their spouse).
Risks of depressed price and downward pressure on the shares
A significant number of our shares are eligible for sale and their sale could depress the market price of our stock. Sales of a significant number of shares of our common stock in the public market following the merger and related transactions could harm the market price of our common stock. Moreover, as additional shares of our common stock become available for resale in the public market pursuant to the registration of the sale of the shares, and otherwise, the supply of our common stock will increase, which could decrease its price. Some or all of the shares of common stock may be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect on the market for the shares of common stock.
In general, a person who has held restricted shares for a period of one year may, upon filing with the SEC a notification on Form 144, sell into the market common stock in an amount equal to the greater of 1% of the outstanding shares or the average weekly number of shares sold in the last four weeks prior to such sale. Such sales may be repeated once each three months, and any of the restricted shares may be sold by a non-affiliate after they have been held two years.
Existing shareholders may experience some dilution
We have issued convertible preferred stock and warrants to different investors. Conversion of these preferred stock and exercise of these warrants may cause dilution in the interests of other shareholders as a result of the additional common stock that would be issued upon conversion or exercise. In addition, sales of the shares of our common stock issuable upon conversion of the preferred stock or exercise of the warrants could have a depressive effect on the price of our stock, particularly if there is not a coinciding increase in demand by purchasers of our common stock..
Moreover, we may need to raise additional funds in the future to finance new developments or expand existing operations. If we raise additional funds through the issuance of new equity or equity-linked securities, other than on a pro rata basis to our existing shareholders, the percentage ownership of the existing shareholders may be reduced. Existing shareholders may experience subsequent dilution and/or such newly issued securities may have rights, preferences and privileges senior to those of the existing shareholders Risks related to concentration of ownership
Certain of our principal stockholders have significant voting power and may take actions that may not be in the best interest of other stockholders. Certain of our officers, directors and principal stockholders control a significant percentage of our outstanding common stock. If these stockholders act together, they may be able to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all Registrant's stockholders.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable
ITEM 2.
ITEM 2. PROPERTIES
Our subsidiary Erye owns approximately 49,000 square meters in the city of Suzhou, Jiangsu Province. As of December 31, 2008, the book value of our total assets was $40,604,261. Erye's land use right and buildings, amount to approximately 20.3% of this book value. Keyuan does not own any land use right or building.
ERYE'S PROPERTIES
Properties of Erye are located at No. 839, Pan Xu Road, Suzhou City and twelve of the buildings serve as office, general purpose, warehouse, production, utilities and waste disposal. All buildings are fully occupied and used by us. Erye solely owns all properties with land use right title and certificates of building's ownership. In 2007, there was a US$2,371,830 rollover short-term bank loan secured by the company's land. There was no major renovation, improvement or development occurred in 2008. The ages of all buildings are over 25 years. Erye's land is situated at the heart of city and is restricted by government regulation of not allowing any new building development. Erye purchased a new land in economic zone in Suzhou for building new GMP standard facilities in year 2006. The cost of acquiring the land use right for the new land was $1,775,171. In 2008, there was a US$3,314,769 short-term notes payables secured by the company's land use right. The construction for new GMP facility has been started and Erye had invested $7,379,805 into the construction as of December 31, 2008.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In July 2007, Enshi was foreclosed on by RimAsia and ceased to be part of the Company. RimAsia assumed the litigation activities against Mr. Li Xiaobo and certain other defendants in connection with the acquisition of shares of Enshi ("LXB") and on October 17, 2008 reached a settlement with LXB pursuant to which Enshi was returned to LXB against a payment of certain sum of funds of which the residual sum post litigation costs were to be eventually transferred to the Company. The expected residual is not expected to be meaningful to the Company
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the last quarter of our fiscal year ended December 31, 2008.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET FOR OUR SECURITIES
Our common stock began quotation on the Over-the-Counter Bulletin Board during the fourth quarter of 2005, on December 19, 2005, and is currently quoted under the symbol "CHBP.OB" The following sets forth the high and low bid quotations for the common stock as reported on the Over-the-Counter Bulletin Board for the four quarters of 2007 and of 2008. These quotations reflect prices between dealers do not include retail mark-ups, markdowns, and commissions and may not necessarily represent actual transactions.
FISCAL YEAR ENDED DECEMBER 31, 2007 HIGH LOW - -------------------------------------------------------------------------------- First Quarter Ended March 31, 2007 $ 1.00 $ 0.49 Second Quarter Ended June 30, 2007 $ 0.47 $ 0.28 Third Quarter Ended September 30, 2007 $ 0.41 $ 0.28 Fourth Quarter Ended December 31, 2007 $ 0.50 $ 0.24
FISCAL YEAR ENDED DECEMBER 31, 2008 HIGH LOW - -------------------------------------------------------------------------------- First Quarter Ended March 31, 2008 $ 0.27 $ 0.15 Second Quarter Ended June 30, 2008 $ 0.27 $ 0.13 Third Quarter Ended September 30, 2008 $ 0.28 $ 0.17 Fourth Quarter Ended December 31, 2008 $ 0.22 $ 0.09
As of March 3, 2009, there were 283 stockholders of record of our common stock.
DIVIDEND POLICY
We have not declared or paid any cash dividends to date, and we do not intend to declare any cash dividends on the shares of our common stock in the foreseeable future. We intend to retain any future earnings for use in the operation and expansion of our business. Any future decision to pay dividends on shares of our common stock will be solely at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, restrictions in future financing agreements, if any, and other business and financial considerations our board of directors may deem relevant.
EQUITY COMPENSATION PLAN INFORMATION
Stock Option Plan
The Company currently does not have but intend to formally adopt a stock option or restricted share plan. Analysis is being done on the impact of recent accounting and regulatory rule changes on the Company and on its future incentive plans.
RECENT SALES OF UNREGISTERED SECURITIES
In December 2008 we issued to our consultant 100,000 shares of our common stock in consideration for services rendered. The issuance was deemed to be exempt under Regulation D and Section 4(2) of the Securities Act.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes thereto. The following discussion contains forward-looking statements. China Biopharmaceuticals Holdings, Inc. is referred to herein as "we", "our,", "us", or "the Company" The words or phrases "would be," "will allow," "expect to", "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," or similar expressions are intended to identify forward-looking statements. Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under "Liquidity and Capital Resources. Statements made herein are as of the date of the filing of this Form 10-KS with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.
OVERVIEW
OUR BUSINESS
We are a vertically integrated bio-pharmaceutical company focused on developing, manufacturing and distributing innovative drugs in China. Our mission is to maximize investment returns for our shareholders by integrating our strong drug discovery and development strength with manufacturing and commercialization capabilities and by actively participating in the consolidation and privatization of the pharmaceutical industry in China to become a dominant player in the bio-pharmaceutical industry in China.
As reported on our Current Report on Form 8-K dated November 6, 2008, on November 2, 2008, we entered into an Agreement and Plan of Merger (the "Merger agreement") with our subsidiary CBC, NeoStem, Inc., and CBH Acquisition LLC ("Merger Sub"). The Merger Agreement contemplates the merger of our company with and into Merger Sub, with Merger Sub as the surviving entity (the "Merger"). Prior to the consummation of the Merger, we will spin off all of our shares of capital stock of CBC to our stockholders in a liquidating distribution so that the only material assets of CBH following such spin-off will be CBH's 51% ownership interest in Erye, plus net cash which shall not be less than $550,000.
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, all of ourcommon stock, par value $.01 per share, issued and outstanding immediately prior to the effective time of the Merger (the "Effective Time") will be converted into the right to receive, in the aggregate, 7,500,000 shares of NeoStem's common stock at par value of $.001 per share (of which 150,000 shares will be held in escrow pursuant to the terms of an escrow agreement to be entered into between CBH and NeoStem).
Subject to the cancellation of outstanding warrants to purchase shares of CBH Common Stock held by RimAsia, all of the shares of CBH series B preferred stock solely held by RimAsia, issued and outstanding immediately prior to the Effective Time will be converted into NeoStem's common stock, series C convertible preferred stock and warrants to purchase NeoStem's common stock.
At the Effective Time, in exchange for cancellation of all of the outstanding shares of CBH series A convertible preferred stock which is held by Stephen Globus, our director, and/or related persons, NeoStem will issue to Mr. Globus and/or related persons 50,000 shares of NeoStem common stock. NeoStem also will issue 60,000 shares of NeoStem Common Stock to Mr. Globus and 40,000 shares of NeoStem common stock to Chris Peng Mao, our Chief Executive Officer, in exchange for the cancellation and the satisfaction in full of indebtedness in the aggregate principal amount of $90,000, plus any and all accrued but unpaid interest thereon, and other obligations of CBH to Globus and Mao. NeoStem will bear 50% of up to $450,000 of our expenses post-merger, and satisfaction of the liabilities of Messrs. Globus and Mao will count toward that obligation. NeoStem also will issue 200,000 shares to CBC to be held in escrow, payable if NeoStem successfully consummates its previously announced acquisition of control of Shandong New Medicine Research Institute of Integrated Traditional and Western Medicine Limited Liability Company.
Also at the Effective Time, subject to acceptance by the holders of all of the outstanding warrants to purchase shares of CBH common stock (other than warrants held by RimAsia), such warrants shall be canceled and the holders thereof shall receive warrants to purchase up to an aggregate of up to 2,012,097 shares of NeoStem common stock at an exercise price of $2.50 per share.
Upon consummation of the transactions contemplated by the Merger, Merger Sub will own 51% of the ownership interests in Erye, and Suzhou Erye Economy and Trading Co. Ltd., a company incorporated in the PRC ("EET"), will own the remaining 49% ownership interest. In connection with the execution of the Merger Agreement, NeoStem, Merger Sub and EET have negotiated a revised joint venture agreement (the "Joint Venture Agreement"), which, subject to finalization and approval by the requisite PRC governmental authorities, will become effective and will govern the rights and obligations with respect to their respective ownership interests in Erye. Pursuant to the terms and conditions of the Joint Venture Agreement, dividend distributions to EET and Merger Sub will be made in proportion to their respective ownership interests in Erye; provided, however, that for the three-year period commencing on the first day of the first fiscal quarter after the Joint Venture Agreement becomes effective, (i) 49% of undistributed profits (after tax) will be distributed to EET and lent back to Erye by EET for use by Erye in connection with the construction of a new plant for Erye; (ii) 45% of the net profit (after tax) will be provided to Erye as part of the new plant construction fund, which will be characterized as paid-in capital for Merger Sub's 51% interest in Erye; and (iii) 6% of the net profit will be distributed to Merger Sub directly for NeoStem's operating expenses. In the event of the sale of all of the assets of Erye or liquidation of Erye, Merger Sub will be entitled to receive the return of such additional paid-in capital before distribution of Eyre's assets is made based upon the ownership percentages of NeoStem and EET, and upon an initial public offering of Erye which raises at least $7,300,000 (RMB 50,000,000), Merger Sub will be entitled to receive the return of such additional paid-in capital. CBC will receive $300,000 from the settlement proceeds from the settlement of the litigation in Hong Kong and Canada by RACP Pharmaceutical Holdings Limited, a wholly-owned subsidiary of CBC, against Li Xiaobo and certain other defendants in connection with the acquisition of shares of Enshi (the "LXB Litigation") and use it as working capital.
Our current directors and officers, AN Lufan, LIU Xiaohao and Chris Mao, will give up their personal portions of the Neostem shares to be received to Erye minority holders holding 49% control of Erye to incentivize them to approve the transaction.
The transactions contemplated by the Merger Agreement are subject to the authorization for listing on the American Stock Exchange (or any other stock exchange on which shares of NeoStem Common Stock are listed) of the shares to be issued in connection with the Merger, shareholder approval, approval of NeoStem's acquisition of 51% ownership interest in Erye by relevant PRC governmental authorities, receipt of a fairness opinion and other customary closing conditions set forth in the Merger Agreement. As part of the Merger negotiation, CBC will receive $300,000 from the settlement proceeds from the settlement of the LXB Litigation and use it as working capital. The Merger currently is expected to be consummated in the second quarter of 2009. Further description of the Merger terms and related agreements can be found in Current Report on Form 8-K dated November 6, 2008 and in the Merger Agreement, which was filed as Exhibit 2.1 to the said Form 8-K hereto and is incorporated herein by reference.
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to understanding of our financial statements. The application of these polices requires management to make estimates and assumptions that affect the valuation of assets and expenses during the reporting period. There can be no assurance that actual results will not differ from these estimates. The impact and any associated risks related to these policies on our business operations are discussed below.
(1) REVENUE RECOGNITION.
The Company has various categories of revenue resources, sales of new drug formulas, R&D services and revenue from sales of medical product.
The Company recognizes revenue from product and drug formula sales when title has passed, the risks and rewards of ownership have been transferred to the customer, the fee is fixed and determinable, and the collection of the related receivable is probable which is generally at the time of shipment. Allowances are established for estimated rebates, wholesaler charge backs, prompt pay sales discounts, product returns, and bad debts.
For revenue from R&D service, revenue is recognized based on fixed-price refundable new drug contracts. The fixed-price refundable new drug contract is also called as milestone contract, which establishes the phase goals of the R&D service provided by the Company and the corresponding milestone payments by the customers. Milestone payments become payable and are recognized as revenue when milestone goals, as defined in the contract, are achieved. Milestones are substantive and not derived solely from arriving at a specific date. Revenue is recognized when milestone goals are achieved at the amount of the corresponding milestone payment. To determine when milestones are achieved, typically, the milestone goals require one or more of the following: (1) a certificate from a licensed authoritative agency, (2) approval/acknowledgement by a governmental agency, such as agency like Food and Drug Administration of the United States, (3) an authoritative professional appraisal report, or (4) an independent technological feasibility report, testing analysis and other form of valuation on the result and value of products and service. After receipt of the certificate, and/or approval and/or report, continued service is not required thus the respective milestone goals are achieved. Therefore, the milestone payment is no longer refundable and revenue is recognized.
2) ACCOUNTS RECEIVABLE.
Accounts receivable are carried at original invoice amount less an estimate made for doubtful accounts based on a review of all outstanding amounts on a monthly basis. Management judgment and estimates are made in connection with establishing the allowance for doubtful accounts. Specifically, we analyze the aging of accounts receivable balances, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. Significant changes in customer concentration or payment terms, deterioration of customer credit-worthiness or weakening in economic trends could have a significant impact on the collectability of receivables and our operating results. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The reserve for bad debts decreased to $1,200,983 at December 31, 2008 from $1,260,760 at December 31, 2007. This decrease represents 0.1% of the revenue mainly due to the collection period of Erye's accounts receivable was shortened. At December 31, 2008, accounts receivable, net of allowance for doubtful accounts, amounted to $3,371,225. The decrease in the collection period was mainly resulted from the shortening of the collection period of Erye's accounts receivable.
The following table provides the roll forward of the allowance for doubtful accounts:
Allowance for doubtful accounts As of December 31, 2007 $ 1,260,760 Recovery for the year of 2008 (59,777) ----------- As of December 31, 2008 $ 1,200,983 ===========
The following list the aging of our accounts receivable as of December 31, 2008
We prepare the above consolidated aging based on the aging for each subsidiary in above format. As each subsidiary of the Company conducts business with different customers with different size and creditworthiness, and each subsidiary has different impact on and different relationship with their customers, we determine the allowance on an individual basis. Basically, we assign various rates to each of the aging group of AR and add up the products for respective aging group to the total allowance for doubtful accounts. Different subsidiaries have different rates for even the same aging category. In addition to that, we also consider the changes in specific financial condition of their customers if situation or events indicate that some accounts may pose unusual risk compared to others, additional allowance may be provided for those accounts.
(3) INCOME TAX
Significant judgment is required in determining our income tax provision. In the ordinary course of business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Although we believe that our estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different than that which is reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax provision and net income in the period in which such determination is made. We apply an asset and liability approach to accounting for income taxes. Deferred tax liabilities and assets are recognized for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The recoverability of deferred tax assets is dependent upon our assessment of whether it is more likely than not that sufficient future taxable income will be generated to utilize the deferred tax asset. In the event we determine that future taxable income will not be sufficient to utilize the deferred tax asset, a valuation allowance is recorded.
(4) SHARES SUBJECT TO MANDATORY REDEMPTION
The Company adopted SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS 150 established classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity. Instruments within the scope of SFAS 150 must be classified as liabilities within the Company's Consolidated Financial Statements and be reported at settlement date value.
The Company issued redeemable stock in November 2007 related to the settlement of notes payables owed to RimAisa. Under the terms of the redeemable stock, the issuer has the right to redeem and the holder has the right to convert any time up to and including the fourth anniversary of the issuance. Therefore, liability accounting is not triggered under SFAS 150, because the stock is not mandatorily redeemable until after the fourth anniversary. However, pursuant to EITF Topic D-98, "Classification and Measurement of Redeemable Securities," the redeemable stock is classified outside of shareholders' equity. If the redeemable stock is not converted by the fourth anniversary, then the shares the mandatory redemption is triggered, and pursuant to SFAS 150, the shares will be reclassified to liabilities.
RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 2008 COMPARED TO YEAR ENDED DECEMBER 31, 2007
We acquired Shenyang Enshi Pharmaceutical Limited Company ("Enshi) on June 6, 2006. Upon the acquisition of Enshi the Company identified major breaches and fraud by the previous owner and controlling shareholders of Enshi, Mr. Li Xiaobo and his related parties ("Defendants") in the representations and warranties provided by him to the Company and the Defendants' refusal to honor their indemnification obligations to the Company. The Company's former subsidiary RACP filed a lawsuit against the Defendants alleging fraud and is pursuing rescission and damages (the "LXB Litigation"). Enshi's operations have been severely hindered and as a result we decided to suspend its operations. In addition, since Enshi was pledged as collateral for the $11.5 million debt owed to RimAsia Capital Partners, L.P. ("RimAsia") in connection with the Enshi Acquisition, Enshi was taken over by RimAsia in July 2007. As a result, Enshi is no longer a subsidiary of the Company. Due to the fact that RACP foreclosed on Enshi, and the subject settlement between RACP and LXB, our management decided to write off the total carrying value of Enshi in the third quarter of 2007 and report it as discontinued operations in the consolidated financial statements. Accordingly, assets, liabilities and operating results that were attributed to Enshi are presented as discontinued operations. Under Statement of Financial Accounting Standards No. 144 ("SFAS 144"), when a component of an entity, as defined in SFAS 144, has been disposed of or is classified as held for sale, the results of its operations, including the gain or loss on its disposal should be classified as discontinued operations and the assets and liabilities of such component should be classified as assets and liabilities attributed to discontinued operations, that is provided that the operations, assets and liabilities and cash flows of the component have been eliminated from the company's consolidated operations and the Company will no longer have any significant continuing involvement in the operations of the component
Therefore, the results of Enshi's operations and cash flows for the year ended December 31, 2007 were reported as discontinued operations in our consolidated financial statements.
REVENUE
Revenue for the year ended on December 31, 2008 was $49,841,158, while the revenue for the year ended December 31, 2007 was $31,927,378, representing an approximately 56.1% increase. The increase is mainly attributed to a significant increase of the Company's subsidiary, Suzhou Erye Pharmaceutical Limited Company ("Erye"). The sales of Erye's intermediary pharmaceutical products increased 47.2% in 2008 compared to 2007. Erye's prescription drugs sales increased 60.6% in 2008 compared to 2007. Reasons for the significant increase include the following: 1.The government has increased its inputs in the healthcare market, especially the medical insurance system in rural areas of China. According to the statistics from competent authorities, the growing rate of the medical care in rural areas is 50 billion RMB to 100 billion RMB annually. 2. The Company has expanded its sales representative offices in provinces and cities of China. Its customers now come from 374 cities across China. 3. After years of effort, Erye's brand and quality have gained client's approbation from both domestic and overseas markets, and its popularity and cost performance have largely upgraded. Erye has become an innovative high-tech enterprise with reasonable financial capacity and relatively complete product structure. 4. The Company has focused efforts on collaborating with other pharmaceuticals companies with good sales capabilities and resources.
In years ahead, the government is expected to increase the coverage of national medical care service to 95% among China, which the Company expects to have a positive impact on the sales of pharmaceutical products. Erye will speed up the construction of its new plant, which is expected to be completed by the end of 2009. After then, the productivity of Erye will be greatly enhanced, which will also adapt to the increasing needs of sales. On the other hand, new products such as Piperacillin Sodium and Sulbactam Sodium will form new sales and profit growth points.
COST OF GOODS SOLD
Along with the significant increase of sales in 2008, the relevant cost of goods sold for the year ended December 31, 2008 has also increased, 45.7% as compared to the year ended December 31, 2007. The increase is mainly attributable to the increase of Erye's sales for the year 2008. Cost of goods sold as a percentage of revenues was approximately 69.1% for the year ended December 31, 2008, as compared to approximately 74.0% for the year ended December 31, 2007, representing a 4.9% decrease. The decrease is attributed to the fact that the fixed cost was allocated on more sales as a result of increase in sales and as a result the cost per product decreased. In addition the Company is gradually using high margin profit products to replace some low profit margin products which also reduce the cost of goods sold.
GROSS PROFIT
The gross profit margin for the year ended December 31, 2008 was 30.9%, as compared to 26.0% for the year ended December 31, 2007 representing a 4.9% increase. The increase of gross profit results from the strong performance of Erye in year 2008. High profit products have replaced the low profit ones, the sales of Powders for injection (Cephems) and Penicillins still plays a dominant role. Company's sales volume has leaped in pace with the deepening of the reform of medical insurance system in rural areas of China and the cost of goods as a percentage of revenues decreased..
OPERATING EXPENSES
Although the sales increased significantly in 2008, the operating expenses for the year ended December 31, 2008 remained stable on the whole, as compared with 2007. The reasons are:
1. Total account receivables outstanding of 2008 remain steady as compared with 2007.
According to 2008's sales results, account receivables as a percentage of sales of 2008 is significantly lower than the same percentage in 2007. Account Receivables which can be paid back within 6 months account for 75.0% of the total account receivables, which is 11.6% improvement compared to the same period in 2007. Therefore, bad debt risk has been reduced. Provision for bad debts under prudence principle has also been reduced trading accounts receivables accordingly.
2. The operating expenses of our Company at the parent level have significantly decreased in 2008 as compared with 2007.
The deduction is around $840,000 in a total. The expenses of the parent company in 2008 were mainly used in daily office expenses, labor charge, travel expenses and professional fees. During 2008 we have reduced our attorney fees, audit fees, public relation expenses and service fees to transfer agent because of the write off of our former subsidiary- Enshi. In addition, our headquarters moved into the facilities of Erye, which saved us rent charges. The parent company has better improved its control over general expenses
3. The Company had $2,602,618 bad debt expenses for the year ended December 31, 2008 with 157.7% increase compared with $1,009,910 for the year ended December 31, 2007. The management of the Company determined that some aged receivables were no longer collectable and had written-off the receivables as of December 31, 2008.
RESEARCH AND DEVELOPMENT
Research and development costs for the year ended December 31, 2008 were $388,848, as compared to $271,030 for the year ended December 31, 2007, representing a 43.5% increase. R&D cost as a percentage of revenue was approximately 0.8% for the year ended December, 2008 which was compatible with the percentage for the year ended December 31, 2007. Our subsidiary Erye has advanced $1,321,561 in a significant R&D project which is expected to generate new sales and profits growth for our company in the future after the project is completed..
NET INCOME (LOSS) FROM CONTINUING OPERATIONS
Gains from continuing operations for the year ended December 31, 2008 amounted at $2,827,017, as compared to a loss of $2,055,815 for the year ended December 31, 2007. Turning from deficits to profit is mainly because of the great performance of Erye in 2008. Additionally, the operating expenses as a percentage of sales revenue were 14.3% in 2008, as compared to 22.7% in 2007. The reduction is also one of the main reasons leading to the increase of gains from continuing operations.
NON-OPERATING INCOME (EXPENSE)
Non-operating income for the year ended December 31, 2008 were $114,953, as compared to non-operating expense $1,623,652 for the year ended December 31, 2007, which representing a 110.2% increase. The main reason for the increase is because the Company recorded $1,008,534 interest expenses for the loan from Rimasia in the year ended December 31, 2007 and no interest expense for the loan booked in the year ended December 31, 2008 due to the Company converted the loan from Rimasia and unpaid interest to redeemable convertible preferred stock in November 16, 2007.
INCOME TAX
According to the Enterprise Income Tax ("EIT") Law of China, Erye was continue to enjoy tax benefit of 50% of the 25% EIT tax rate, or 12.5% from January 1, 2008 through December 31, 2010 as being a High-tech Company in Jiangsu, China. Comparatively, Erye was except from income tax for the year ended December 31, 2007. The income tax expenses for the year ended December 31, 2008 and 2007 were $1,418,334 and $1,245, respectively, which account for 2.8% and 0% of the sales.
DIVIDEND AND ACCRETION OF DEEMABLE PREFERRED STOCK
As disclosed in Note 12 to the consolidated financial statements, according to the conditional loan conversion agreement ("Agreement") entered into between the Company and RimAsia, the Company accrued dividends and accretion on redeemable preferred stock for $1,033,239 for the year ended December 31, 2008, including $574,022 unpaid dividend, $459,217 suspendible premium because the trading volume and trading price of the Company's common stock did not meet the requirement pursuant to the Agreement.
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
Net income for the year ended December 31, 2008 was $1,793,778 as compared to a net loss of $13,546,987 for the year 2007. Erye's strong business performance is the main reason for the significant growth of net income. Also, the significant loss on discontinue operations in 2007 was attributable to the write off of the former subsidiary - Enshi, the total amount of which was $11,491,172.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2008, total current assets were $18,401,629 and total current liabilities were $18,508,221. Cash and cash equivalents on year ended December 31, 2008 were $581,727, a decrease of $87,972 from the $669,699 reported on December 31, 2007.
For the year ended December 31, 2008, net cash provided by continuing operating activities was $9,275,151, net cash used in continuing operation investing activities was $11,593,329, and net cash used in continuing operation financing activities was $2,147,524. For the year ended December 31, 2007, net cash provided by continuing operating activities was $2,072,742, net cash used in continuing operation investing activities was $1,317,154, and net cash used in continuing operation financing activities was $2,003,528. Cash used in investing activities for the year ended December 31, 2008 resulted mainly from purchase of land use right and property, plant and equipment in connection with the expected relocation of Erye to its new facilities. Cash provided by financing activities for the year ended December 31, 2008 results primarily due to less notes payables issued.
On November 19, 2007, we entered into an agreement (the "Agreement") RimAsia as a follow-up to letters of intent signed on July 14, 2007 and August 2, 2007, under which the principal amount of the $11.5 million Loan owed to RimAsia in connection with the acquisition of Enshi plus unpaid interest of $1,008,534 (total of $12,508,534) was converted in full into 6,185,607 shares of senior redeemable convertible preferred shares of the Company ("Preferred Shares") at a conversion price of $2.0222 per Preferred Share. Each Preferred Share may be converted into two shares of common stock. Additionally, the exercise price of US$1.375 for the 12 million existing warrants exercisable into the Company's common stock previously issued to and currently held by RimAsia in connection with the extension of the Loan financing ("Existing Warrants") was lowered to $1.26 per share and the term of the Existing Warrants extended to 4.5 years from the closing date. This was conditioned on us signing a letter of intent for acquisition of a new company (or for the injection of the remaining 49% equity stake of Erye not already owned by the registrant) before January 15, 2008, having such acquisition closed before January 1, 2009. In connection therewith, the parties also entered into a registration rights agreement and certain other agreements, and the registrant issued additional common stock purchase warrant and a modified common stock purchase warrant.
As noted earlier in this Item 7, on November 2, 2008, we entered into the Merger Agreement with NeoStem, CBC, and Merger Sub, pursuant to which, prior to the consummation of the Merger, we will need to spin off all of our shares of capital stock of CBC to our stockholders in a liquidating distribution so that the only material assets of us following such spin-off will be our 51% ownership interest in Erye plus net cash which shall not be less than $550,000. Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, all of our CBH Common Stock issued and outstanding immediately prior to the effective time of the Merger (the "Effective Time") will be converted into the right to receive, in the aggregate, 7,500,000 shares of common stock, par value $.001 per share, of NeoStem (the "NeoStem Common Stock") (of which 150,000 shares will be held in escrow pursuant to the terms of an escrow agreement to be entered into between CBH and NeoStem). Subject to the cancellation of outstanding warrants to purchase shares of CBH Common Stock held by RimAsia, a current holder of approximately 14% of the outstanding shares of NeoStem Common Stock and the sole holder of shares of Series B Convertible Preferred Stock, par value $0.01 per share, of CBH (the "CBH Series B Preferred Stock"), all of the shares of CBH Series B Preferred Stock issued and outstanding immediately prior to the Effective Time will be converted into (i) 5,383,009 shares of NeoStem Common Stock, (ii) 6,977,512 shares of Series C Convertible Preferred Stock, without par value, of NeoStem, each with a liquidation preference of $1.125 per share and convertible into shares of NeoStem Common Stock at a conversion price of $.90 per share, and (iii) warrants to purchase 2,400,000 shares of NeoStem Common Stock at an exercise price of $0.80 per share. At the Effective Time, in exchange for cancellation of all of the outstanding shares of CBH Series A Convertible Preferred Stock, par value $.01 per share, of CBH (the "CBH Series A Preferred Stock") held by Stephen Globus, our director, and/or related persons, NeoStem will issue to Mr. Globus and/or related persons an aggregate of 50,000 shares of NeoStem Common Stock. NeoStem also will issue 60,000 shares of NeoStem Common Stock to Mr. Globus and 40,000 shares of NeoStem Common Stock to Chris Peng Mao, our Chief Executive Officer in exchange for the cancellation and the satisfaction in full of indebtedness in the aggregate principal amount of $90,000, plus any and all accrued but unpaid interest thereon, and other obligations of CBH to Globus and Mao. NeoStem will bear 50% of up to $450,000 of our expenses post-merger, and satisfaction of the liabilities of Messrs. Globus and Mao will count toward that obligation. NeoStem also will issue 200,000 shares to CBC to be held in escrow, payable if NeoStem successfully consummates its previously announced acquisition of control of Shandong New Medicine Research Institute of Integrated Traditional and Western Medicine Limited Liability Company. Also at the Effective Time, subject to acceptance by the holders of all of the outstanding warrants to purchase shares of CBH Common Stock (other than warrants held by RimAsia), such warrants shall be canceled and the holders thereof shall receive warrants to purchase up to an aggregate of up to 2,012,097 shares of NeoStem Common Stock at an exercise price of $2.50 per share. The transactions contemplated by the Merger Agreement are subject to the authorization for listing on the American Stock Exchange (or any other stock exchange on which shares of NeoStem Common Stock are listed) of the shares to be issued in connection with the Merger, shareholder approval, approval of NeoStem's acquisition of 51% ownership interest in Erye by relevant PRC governmental authorities, receipt of a fairness opinion and other customary closing conditions set forth in the Merger Agreement.
Relocation of Erye
The new plant of Erye is currently under construction. To date, all the buildings in the planned manufacturing area have been completed, and the cleaning areas and all the equipments are now installed and under construction. Penicillin and Cephems sterile injection powder workshops will be completed by the end of 2009. In early 2010, the company will apply for GMP approval from SFDA for these two workshops.
The total amount of money for the relocation of Erye is expected up to $29,340,000 (RMB200,000,000), of which $7,379,805 have been spent to date.
OUTLOOK
Our Company has entered into the Merger Agreement with Neostem and our management expects to complete the Merger within the first half of 2009, subject to receipt of all necessary approvals.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, and results of operations, liquidity or capital expenditures.
MANAGEMENT ASSUMPTIONS
Management anticipates, based on internal forecasts and assumptions relating to our current operations, that existing cash and funds generated from operations may not be sufficient to meet capital requirements for future acquisition activities. We could therefore be required to seek additional financing. There can be no assurance that we will be able to obtain such additional financing at acceptable terms to us, or at all.
EFFECT OF FLUCTUATION IN FOREIGN EXCHANGE RATES
Our operating subsidiaries are located in China. Their business activities are mainly in China using Chinese Renminbi as the functional currency. The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China's political and economic conditions. As we rely entirely on revenues earned in China, any significant revaluation of the Renminbi may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar could have a material adverse effect on our business, financial condition and results of operations.
Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our common shares or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of the Renminbi we convert would be reduced. To date, however, we have not engaged in transactions of either type.
Since 1994 China has pegged the value of the Renminbi to the U.S. dollar. We do not believe that this policy has had a material effect on our business. However, there have been indications that the Chinese government may be reconsidering its monetary policy in light of the overall devaluation of the U.S. dollar against the Euro and other currencies during the last two years. In July 2005, the Chinese government revalued the Renminbi by 2.1% against the U.S. dollar, moving from Renminbi 8.28 to Renminbi 8.11 per dollar. At the end of December 31, 2006, the value of the Renminbi to the U.S. dollar was translated at 7.81 RMB to $1.00 USD. .During 2007 and 2008 the RMB value appreciated and as of March 3, 2009, the exchange rate of the RMB against the USD was RMB6.86 for US$ 1.00. Because of the pegging of the Renminbi to the U.S. dollar is loosened, we anticipate that the value of the Renminbi appreciate against the dollar with the consequences discussed above.
NEW ACCOUNTING PRONOUNCEMENTS
In February 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 159, The Fair Value Option for Financial Assets and Financial Liabilities--Including an amendment of FASB Statement No. 115. SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS 159 is to provide opportunities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply hedge accounting provisions. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Company chose not to elect the option to measure the fair value of eligible financial assets and liabilities.
In June 2007, the FASB issued FASB Staff Position ("FSP") Emerging Issues Task Force ("ETIF") 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services Received for use in Future Research and Development Activities" ("FSP EITF 07-3"), which addresses whether nonrefundable advance payments for goods or services that used or rendered for research and development activities should be expensed when the advance payment is made or when the research and development activity has been performed. The Company adopted FSP EITF 07-3 on January 1, 2008 and there is no material effect on financial statements.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements - an amendment of Accounting Research Bulletin No. 51", which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company has not determined the effect that the application of SFAS 160 will have on its consolidated financial statements.
In December 2007, SFAS 141R, "Business Combinations," was issued. SFAS 141R replaces SFAS 141, Business Combinations. SFAS 141R retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. This replaces SFAS 141's cost-allocation process, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. SFAS 141R also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values (or other amounts determined in accordance with SFAS 141R). SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The Company believes adopting SFAS 141R might materially impact the accounting treatment for any future merger or acquisition consummated January 1, 2009.
In March 2008, the FASB issued SFAS 161, "Disclosures about Derivative Instruments and Hedging Activities - An Amendment of SFAS No. 133." SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. SFAS 161 is effective on January 1, 2009. The Company is in the process of evaluating the new disclosure requirements under SFAS 161.
In June 2008, the FASB issued EITF 07-5, "Determining whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock." This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application is not permitted. Paragraph 11(a) of SFAS 133 "Accounting for Derivatives and Hedging Activities" specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company's own stock and (b) classified in stockholders' equity in the statement of financial position would not be considered a derivative financial instrument. EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer's own stock and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception. The Company believes adopting this statement will have a material impact on the financial statements because among other things, any option or warrant previously issued and all new issuances denominated is US dollars will be required to be carried as a liability and marked to market each reporting period.
In June 2008, FASB issued EITF 08-4, Transition Guidance for Conforming Changes to Issue No. 98-5. The objective of EITF 08-4 is to provide transition guidance for conforming changes made to EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that result from EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments", and SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008. Early application is permitted. This issue had no material impact on the Company's financial statements as of December 31, 2008 and for the year then ended.
On October 10, 2008, the FASB issued FSP.157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active," which clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 became effective on October 10, 2008, and its adoption had no material impact on the Company's financial statements as of December 31, 2008 and for the year then ended.
In January 2009, the FASB issued FSP EITF 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No. 99-20, and EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("FSP EITF 99-20-1"). FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be more consistent with the impairment model of SFAS No. 115. FSP EITF 99-20-1 achieves this by amending the impairment model in EITF 99-20 to remove its exclusive reliance on "market participant" estimates of future cash flows used in determining fair value. Changing the cash flows used to analyze other-than-temporary impairment from the "market participant" view to a holder's estimate of whether there has been a "probable" adverse change in estimated cash flows allows companies to apply reasonable judgment in assessing whether an other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1 did not have a material impact on our consolidated financial statements because all of our investments in debt securities are classified as trading securities.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9A
ITEM 9A (T). COTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of December 31, 2008, the end of the fiscal year covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our chief executive officer and chief financial officer concluded that because of the material weakness in internal control over financial reporting described below, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were not effective as of December 31, 2008.
Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's 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. The Company's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected in a timely manner. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
Our management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2008 and concluded that the Company's internal control over financial statements was not effective. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in "Internal Control-Integrated Framework." During our assessment of the effectiveness of internal control over financial reporting as of December 31, 2008, our management identified material weaknesses elated to the following:
1. Insufficient U.S.GAAP qualified accounting and finance personnel.
As U.S. GAAP closing process relates to non-routine transactions and estimates, we didn't have sufficient and skilled accounting and finance personnel necessary to close our books under U.S.GAAP at our subsidiaries in China because of the differences between two accounting policies, and on the other hand, the accounting person aren't familiar with U.S.GAAP and lack of training. This material weakness resulted in adjustments to several significant accounts and disclosures and contributed to other material weakness described above.
2. Lack of Internal Audit System.
The Company does not have the internal audit department, which was ineffective in preventing and detecting control lapses and errors in the accounting of certain key areas like revenue recognition, purchase approvals, inter-company transactions, cash receipt and cash disbursement authorizations, inventory safeguard and proper accumulation for cost of products, in accordance with the appropriate costing method used by the Company.
3. Financial Statement closing process.
We found that controls over the financial statement close process related to account reconciliation and analyses, including bank accounts, certain long-lived assets and accrued liabilities, were not effective. As a result, a large volume of adjustments were necessary to completely and accurately present the financial statements close process to the preparation of reliable financial statements, there is reasonable possibility that a material misstatement of the interim and annual financial statements would not have been prevented or detected on a timely basis.
Remediation of Material Weaknesses in Internal Control over Financial Reporting
The Company's management has identified the steps necessary to address the material weaknesses described above, as follows:
1. Hiring more qualified and experienced accounting personnel and engaging outside contractors with technical accounting expertise, as needed, and reorganizing the accounting and finance department to ensure that accounting personnel with adequate experience, skills and knowledge relating to complex, non-routine transactions are directly involved in the review and accounting evaluation of our complex, non-routine transactions;
2. Involving both internal accounting and operations personnel and outside contractors with technical accounting expertise, as needed, early in the evaluation of a complex, non-routine transaction to obtain additional guidance as to the application of generally accepted accounting principles to such a proposed transaction;
3. Delivered training on the present accounting person in subsidiaries on U.S.GAAP and related knowledge and skills.
4. Requiring senior accounting personnel and the principal accounting officer to review complex, non-routine transactions to evaluate and approve the accounting treatment for such transactions;
5. Interviewing prospective new directors for our Board including a member who is appropriately credentialed as a financial expert with a goal to establish both an audit and compensation committee as well as sufficient number of independent directors; and
6. Evaluating the internal audit function in relation to the Company's financial resources and requirements.
We believe that the foregoing steps will remediate the significant deficiency identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.
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 our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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.
Changes in Internal Controls
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our international control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The following table sets forth the names and ages of our current directors and executive officers, their principal offices and positions and the date each such person became a director or executive officer of the Company. Our executive officers are elected annually by the Board of Directors. Our directors serve one year terms until their successors are elected. The executive officers serve terms of one year or until their death, resignation or removal by the Board of Directors. There are no family relationships between any of the directors and executive officers. In addition, there were no arrangements or understanding between any executive officer and any other person pursuant to which any person was selected as an executive officer. The following persons are the directors and executive officers of our company:
Below are brief descriptions of the backgrounds and experiences of the officers and directors:
Chris Peng MAO, MBA
Age 38.Chris Peng Mao is the Chairman and Chief Executive Officer (CEO) as well as a major shareholder of the Company. Before that, Mr. Mao was the CEO of China Pharmaceuticals Investment Fund Ltd. and managed its investments in the pharmaceutical industry in China. Mr. Mao was also a co-founder and the President of Infogroup Investment Corp., a Canadian company specializing in corporate finance and investment management, and Infogroup Management Consultant Ltd. Canada. He has extensive connections and experience in the pharmaceutical industry. Mr. Mao graduated from Shandong University in 1993 with a B.A. degree in Marketing and graduated in 1997, with an MBA degree from the Lundquist College of Business at the University of Oregon.
AN, Lufan, Ph.D.
Age 43 AN Lufan is the President and Chief Technology Officer (CTO) and a major shareholder of the Company. Mr. An also serves as CEO of Nanjing Keyuan. He served as the CEO of Shandon Tungtai Pharmaceutical Technology Corp. Prior to that, Mr. An served as head of the New Drugs Development Center of Nanjing Keyuan Pharmaceutical Technology Corp. He has extensive experience in new drug R&D and commercialization of new drugs and has been involved in the development of about thirty-two new drugs and published fifteen related articles in national and international professional journals. Mr. An graduated from Jining Medical College in 1985 with a B.S. degree in Medicine and acquired his Ph.D. degree in Pharmacology from China Pharmaceutical University in 1991.
LIU, Xiaohao, M.S.
Age 44. LIU Xiaohao, our Senior Vice President and a major shareholder of the Company, heads the sales operations of the Company. Mr. Liu has accumulated extensive experience and gathered strong track record in drug sales and marketing and has gained broad recognition and high esteem in the industry.
Prior to joining the Company, Mr. Liu held several top marketing and sales positions in some of the most successful companies in the industry. He was especially invited by the management and shareholders of the Company to become a shareholder of the Company to head the Company's sales and marketing department.
He is a major asset for the Company's future growth. Before joining the Company, Mr. Liu served as the vice general manager in Shanghai Fuxin Pharmaceutical Corp.("Fuxin"), the largest and one of the most successful generic drug manufacturers in China and a major part of the Fuxin group listed on the Shanghai Stock Exchange. He was responsible for Fuxin's Sales Department and built up a strong sales team in less than 6 months, achieving major sales growth for Fuxin. Prior to Fuxin, he worked at Shengzhen Haiwang Pharmaceutical Corp. as Project Manager and Sales Manager. He developed, licensed and then put in production "Tai-Rui-Ning", a product for pediatric use. Mr. Liu also worked in Nanjing Tian-Ying Pharmaceutical Corp. and served as Vice General Manager in charge of Sales Department. He built up a top special sales team from the scratch and his team contributed at least 50% of that company's total sales and profits Prior to that, Mr. Liu worked in Jiangsu Chang Ao Pharmaceutical Corp. as Marketing Director. He was in charge of the sales and marketing department in three provinces responsible for planning and marketing major products of the company and turned those products into market leaders in a very short period of time and received "Excellent Management Award" from the company for his achievements. Prior to that, Mr. Liu worked for Jiangsu Xuzhou Pharmaceutical Corp. as Vice General Manager in charge of the Marketing Department. He was responsible for planning, marketing and sales promotions, organized the first "National Forum on Narcotics and Intensive Care" and chaired many seminars on various topics. He graduated from the SFDA Graduate Research Program with a M.S. in Pharmaceutical Administration in 2002 and from China Pharmaceutical University with M.S. degree in Pharmacology in 1986.
Stephen E. Globus
Age 61. Stephen Globus was the Chairman of Globus Growth Group, a company that specialized in venture capital for technology companies. Globus Growth Group was the first or early investor in both biotechnology and technology companies. It was the seed and initial investors to Plasmaco, a USA developer of Plasma Television where Mr. Globus was Chairman and subsequently sold Plasmaco to Matsushita (Panasonic) where he served on one of its Board of Directors. Globus Growth Group was also among the initial investors in Genitope (GTOP), a San Francisco area biotechnology company that is utilizing novel immuno-therapies for the treatment of B-cell Non-Hodgkin's Lymphoma. Globus Growth Group also started Proscure, a Boston based Biotechnology company that was purchased by Repligen (RGEN) and ExSar, a private company involved in drug discovery through the protein/peptide mapping. Among the other portfolio early investments were also Energy Research Company (now FuelCell Energy, FCEL) and Kimeragen, a gene modification company, that was sold to Valigen, a French biotechnology company. Mr. Globus mainly resides in New York City.
SHI, Mingshen
Age 57, SHI Mingshen has been serving as chairman of the board of directors of the Company's subsidiary, Suzhou Erye Pharmaceutical Limited Company ("Erye"), since 2003. Before that, Mr. Shi served for five years as the factory director of Suzhou No.2 Pharmaceutical Limited Company, the predecessor company of Erye. Mr. Shi has a bachelor degree in administrative management from the Chinese Administrative Management University. As a veteran in the Chinese pharmaceuticals industry, Mr. Shi is expected to contribute to the industry knowledge of the board in terms of operational management, strategic growth and future acquisitions.
ZHANG, Jian
Age 48, Ms. ZHANG Jian was the General Manager of our subsidiary, Erye, from 2003 till she was elected to be the Chairwoman and a director of the Company on April 30, 2007. And from the end of 2007, Ms ZHANG Jian was elected to be the Chief Financial Officer (CFO) of the Company. Prior to being the General Manager for Erye, she served for more than 5 years as the deputy general manager of Suzhou Number 2 Pharmaceutical Company and more than a year as the deputy general manager of Suzhou Number 4 Pharmaceutical Company after working in various positions in charge of human resources and quality control there. Ms. Zhang graduated from Central Television University majoring in electronics and later graduated with a certificate in accounting from Suzhou Adult Education University and a graduate degree in finance and accounting from the School of Finance and Economics of Suzhou University. Ms. Zhang has extensive background and experience in the pharmaceuticals industry having worked in various managerial positions and various aspects of the industry. She is an expert in managing a growth company, having turned Erye into a successful operation after taking it over from the government with Mr. Shi Mingsheng and others.
DING, Weihua
Age 59, Mr. DING Weihua was elected as a director of the board of directors of the Company on April 30, 2007. Mr. Ding is a veteran in the pharmaceuticals industry having worked in the filed for more than thirty three years. Mr. Ding worked nine years as a Deputy General Manager and Manager in sales and marketing at Erye. Prior to his positions in Erye, he worked six years in business planning at Jiangsu Nantong Qinfen Pharmaceutical Company. Later he worked sixteen years at Suzhou Number 2 Pharmaceutical Company in sales before he was promoted to the position of Manger of Sales and Deputy General Manager.
AUDIT COMMITTEE
The Company does not have an audit committee and is in search of qualified candidates to form an audit committee. We are in the process of identifying and pursuing qualified candidates to serve on such a committee which is very important for the Company.
CODE OF BUSINESS ETHICS
Pursuant to the requirements of Section 406 of the Sarbanes-Oxley Act of 2002 and related SEC rules, we have adopted a Code of Business Ethics and Conduct, or Code of Ethics.. Our Code of Ethics contains written standards designed to deter wrongdoing and to promote:
|_| honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
|_| full, fair, accurate, timely, and understandable disclosure in reports and documents filed with the SEC and in other public announcements;
|_| compliance with applicable governmental laws, rules and regulations;
|_| the prompt internal reporting of violations of our Code of Ethics to an appropriate person or persons identified in our Code of Ethics; and
|_| accountability for adherence to our Code of Ethics.
We intend to disclose any amendment to, or waiver from, a provision of our Code of Ethics and Business Conduct applicable to our Chief Executive Officer, Chief Financial Officer or principal accounting officer or controller by posting such information on our website.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires our executive officers, directors and persons who own more than 10% of our common stock to file initial reports of ownership on Form 3 and changes in ownership on Forms 4 or 5 with the SEC. Such executive officers, directors and over 10% stockholders are also required by SEC rules to furnish us with copies of all such forms they file.
Based solely on our review of the copies of such forms we have received, or written representations from certain reporting persons, we believe that, during the year ended December 31, 2007, all executive officers and directors filed on a timely basis all reports required to be filed by them under Section 16(a) with respect to our common stock.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE FOR 2008 AND 2007
The following Summary Compensation Table sets forth information concerning compensation during fiscal 2008 for services in all capacities awarded to, earned by or paid to Chris Peng Mao who served as our Chief Executive Officer throughout the period. No other executive officers who were serving as our executive officers at the end of fiscal years 2007 and 2008 received more than $100,000 in salary and bonus in fiscal years 2007 and 2008, and there were no individuals for whom disclosure would have been provided but for the fact that the individual was not serving as an executive officer at the end of fiscal years 2008 and 2007.
EQUITY AWARDS AND OPTION GRANTS
In August 2004 we entered into employment agreements with our top executive officers to secure their commitment to continued service to us. The employment agreements provide, each, for the grant of options to purchase shares of our common stock pursuant to the stock option plan to be adopted by us ("Stock Option Plan"). These options are to be awarded in four quarterly installments on each three-month anniversary after August 29, 2004. The exercise price for each option granted to the executive officer shall be $1.50. Each quarterly grant shall consist of the quantity of shares of our common stock whose aggregate market price at close of trading on the date of grant minus their aggregate exercise price equals $7,500.00. The executive officer's right to receive any quarterly grant of stock options is subject to and conditional upon his status as our full-time employee at the time of such grant, and the executive officer shall not be entitled to any portion of any quarterly grant that has not already been awarded to him prior to his last day of his full-time employment with us. To date, we still have not adopted the Stock Option Plan.
DIRECTOR COMPENSATION
None of our directors has received any compensation for their services rendered as our directors during fiscal years 2007 and 2008. Ding Weihua received a salary for his services to Erye, as Vice President.
EMPLOYMENT AGREEMENTS
In August 2004, we entered into employment agreements with our top executive officers to secure their commitment and continued service to us.
Chris Peng Mao's employment agreement has a term of five years, commencing on September 1, 2004, and provides for a salary of $15,000 for the first year of the term, subject to subsequent annual review by our board of directors. The agreement also provides for the grant of options to purchase shares of our common stock pursuant to the Stock Option Plan. These options are to be awarded in four quarterly installments on each three month anniversary after August 29, 2004, in accordance with the terms and conditions of Stock Option Plan and any other stock option agreement entered into by Mr. Mao and us. We have not adopted the Stock Option Plan yet and therefore no options have been granted. The exercise price for each option granted to Mr. Mao shall be US$1.50. Each quarterly grant shall consist of the quantity of shares of our common stock whose aggregate market price at close of trading on the date of grant minus their aggregate exercise price equals $7,500.00. Mr. Mao's right to receive any quarterly grant of stock options is subject to and conditional upon his status as our full-time employee at the time of such grant, and Mr. Mao shall not be entitled to any portion of any quarterly grant that has not already been awarded to him prior to his last day of full-time employment with us.
AN Lufan's employment agreement has a term of five years, commencing on September 1, 2004, and provides for an annual salary of $15,000 for the first year of the term, subject to subsequent annual review by our board of directors. The agreement also provides for the grant of options to purchase shares of our common stock pursuant to the Stock Option Plan. These options are to be awarded in four quarterly installments on each three month anniversary after August 29, 2004 pursuant to and in accordance with the terms and conditions of the Stock Option Plan and any other stock option agreement entered into by Mr. An and us. We have not adopted the Stock Option Plan yet and therefore no options have been granted. The exercise price for each option granted to Mr. An shall be US$1.50. Each quarterly grant shall consist of the quantity of shares of our common stock whose aggregate market price at close of trading on the date of grant minus their aggregate exercise price equals $7,500.00. Mr. An's right to receive any quarterly grant of stock options is subject to and conditional upon his status as our full-time employee at the time of such grant, and Mr. An shall not be entitled to any portion of any quarterly grant that has not already been awarded to him prior to his last date of full-time employment with us.
LIU Xiaohao's employment agreement has a term of five years, commencing on September 1, 2004, and provides for an annual salary of $12,500 for the first year of the term, subject to subsequent annual review by our board of directors. The agreement also provides for the grant of options to purchase shares of our common stock pursuant to the Stock Option Plan. These options are to be awarded in four quarterly installments on each three month anniversary after August 29, 2004 pursuant to and in accordance with the terms and conditions of the Stock Option Plan and any other stock option agreement entered into by Mr. Liu and us. We have not adopted the Stock Option Plan yet and therefore no options have been granted. The exercise price for each option granted to Mr. Liu shall be US$1.5. Each quarterly grant shall consist of the quantity of shares of our common stock whose aggregate market price at close of trading on the date of grant minus their aggregate exercise price equals $7,500.00. Mr. Liu's right to receive any quarterly grant of stock options is subject to and conditional upon his status as our full-time employee at the time of such grant, and Mr. Liu shall not be entitled to any portion of any quarterly grant that has not already been awarded to him prior to his last date of full-time employment with us.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
As used in this section, the term beneficial ownership with respect to a security is defined by Rule 13d-3 under the Securities Exchange Act of 1934, as amended, as consisting of sole or shared voting power (including the power to vote or direct the vote) and/or sole or shared investment power (including the power to dispose of or direct the disposition of) with respect to the security through any contract, arrangement, understanding, relationship or otherwise subject to community property laws where applicable.
As of March 3, 2009 we had a total of 37,082,313 shares of common stock issued and outstanding, which are our only issued and outstanding voting equity securities.
The following table sets forth, as of March 3, 2009, (a) the names of each beneficial owner of more than five per cent (5%) of our common stock and preferred stock known to us, and the amount and percentage of such ownership; (b) the names and addresses of each director and executive officer that owns more than five per cent (5%) of our common stock and preferred stock, and the amount and percentage of such ownership, by each person and by all of our directors and executive officers as a group. Except as otherwise indicated, the addresses of each of the person below is c/o China Biopharmaceuticals Holdings, Inc., No. 859, Pan Xu Road, Suzhou, Jiangsu Province, China.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Our predecessor company, Globus Growth, was founded by Stephen E. Globus, who is currently one of our directors.
Certain family members of Stephen E.Globus, our director, have participated in the Initial Private Place for Preferred Stock - Series A with a total investment of $170,000. SRG Capital Partnership, a company controlled by Richard D. Globus, purchased $50,000 Series A Preferred Stock in the Initial Preferred A Private Placement. Richard D. Globus is Stephen E Globus' brother.
In December 2005, certain family members of Stephen E. Globus, our director, purchased the Convertible Notes from certain Notes holders in the aggregated amount of $210,000. All of these Convertible Notes purchased by these family members were converted into our common shares.
In March 2006, certain family members of Stephen E. Globus, our director, purchased our common stock in the private placement in the aggregate amount of $100,000.
On Oct 29, 2008, Hainan Kaiye Pharmaceutical Limited Company ("Kaiye"), the former related party of Erye, has being transferred to two unrelated individuals. The transaction was consummated in 2008 including amendment of business license and changing of the company's name. After then, Kaiye is no longer qualified as a related party of Erye. The Company's management evaluated the collectability of receivables for $1.1million (RMB 7,740,000) and decided to write off the entire amount before December 31, 2008.
Accounts Receivables - Related Parties
Accounts receivable included the following:
Hainan Kaiye was a company owned by minority shareholders of Suzhou Erye Pharmaceutical Limited Company. Hainan Kaiye was disposed to two unrelated parties during the year and the transaction was consummated on Oct 29, 2008. As of December 31, 2008, Hainan Kaiye was not qualified as a related party.
Other Receivables - Related Parties
Other receivable contained the following related party balances where Hainan Kaiye was a company owned by minority shareholders of Suzhou Erye Pharmaceutical Limited Company before Oct 29, 2008 and Enshi was the discontinued subsidiary since July 2007.
Loan to Shareholder and Officer
Other Payables - Related Parties
Erye Trading was a company owned by minority shareholders of Suzhou Erye Pharmaceutical Limited Company. The 38 minority shareholders of Erye transferred their shares of Erye to Erye Trading in 2008 and the transactions was consummated on June 24, 2008. Erye Trading is the 49% shareholder of Erye as of December 31, 2008.
Other Payables - Shareholders
Chris Peng Mao is the CEO of the Company. Lufan An & Xiaohao Liu are both Shareholders of the Company.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEE
The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for our audits of our annual financial statements and interim reviews of financial statements included in our Form 10-KSBs and 10-QSBs or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were approximately:
2007: $ 160,000 Moore Stephens Wurth Frazer and Torbet, LLP 2008: $ 100,000 Moore Stephens Wurth Frazer and Torbet, LLP
ALL OTHER FEES
The aggregate fees billed in each of the last two fiscal years for the products and services including fees relating to our tax compliance, tax planning and tax return preparation for the years ended 2008 and 2007 provided by the principal accountant other than the services reported in paragraph (1) were approximately:
2007: $ 5,000 Moore Stephens Wurth Frazer and Torbet, LLP 2008: $ 5,000 Moore Stephens Wurth Frazer and Torbet, LLP
AUDIT COMMITTEE PRE APPROVAL POLICIES AND PROCEDURES
We do not have an audit committee and we are in search of qualified candidates to form such committee.
PART IV
EXHIBIT INDEX
- -------------------------------------------------------------------------------- EXHIBIT NO. DESCRIPTION - ----------- -----------------------------------------------------------
2.1 Agreement and Plan of Merger, dated June 24, 2004, by and between Globus Growth Group, Inc. and China Biopharmaceuticals Holdings, Inc. (incorporated by reference to the Schedule 14C, filed with the SEC on August 4, 2004)
2.2 Conditional Stock Purchase Agreement between and among the registrant, RACP Pharmaceutical Holdings Ltd. and certain other parties dated as of May 16, 2006. (incorporated by reference to Exhibit 2.1 to the registrant's Current Report on Form 8-K filed with the SEC on May 18, 2006)
2.3 Agreement and Plan of Merger, dated as of November 2, 2008 by and among NeoStem Inc., the Company, China Biopharmaceuticals Corp and CBH Acquisition LLC (incorporated by reference to Exhibit 2.1 of the registrant Current Report on Form 8-K filed on November 6, 2008.
3.1 Amendment and Restatement of Articles of Incorporation of CHINA BIOPHARMACEUTICALS HOLDINGS, INC. (incorporated by reference to the Schedule 14C, filed with the SEC on August 4, 2004)
3.2 Bylaws of CHINA BIOPHARMACEUTICALS HOLDINGS, INC. (incorporated by reference to the Schedule 14C, filed with the SEC on August 4, 2004)
4.1. Form of warrant issued on December 31, 2004, (incorporated by reference to Exhibit 10.1 of Form SB-2, filed with the SEC on March 24, 2006)
4.2. Certificate of Designation of Series A Convertible Preferred Stock (incorporated by reference to Exhibit 10.3 of Form SB-2, filed with the SEC on March 24, 2006)
4.3. Form of warrant issued in June, 2005 (incorporated by reference to Exhibit 10.4 of Form SB-2, filed with the SEC on March 24, 2006)
4.4. Form of Subscription Agreement between the Company and the Subscribers relating to the Series A Convertible Preferred Stock (incorporated by reference to exhibit 10.2 of Form SB-2, filed with the SEC on March 24, 2006)
4.5. Form of Securities Purchase Agreement between the Company and the Purchasers relating to the sales and purchases of $1.0 million of the Company's common stock (incorporated by reference to exhibit 4.1 of the Company's Currently Report on Form 8-K/A, filed with the SEC on February 8, 2006).
4.6. Form of Registration Rights Agreement in connection with the private placement of $1.0 million of the Company's common stock (incorporated by reference to Exhibit 4.2 to the Form 8-K/A filed with the SEC on February 8, 2006.
4.7. Form of warrant issued on February 2, 2006 (incorporated by reference to Exhibit 4.3 of the Company's Currently Report on Form 8-K, filed with the SEC on February 8, 2006)
4.8. Form of Securities Purchase Agreement between the Company and the Purchasers relating to the sales and purchases of $6.9 million of the Company's common stock (incorporated by reference to exhibit 4.1 of the Company's Currently Report on Form 8-K, filed with the SEC on March 14, 2006).
4.9. Form of Registration Rights Agreement in connection with the private placement of $6.9 million of the Company's common stock (incorporated by reference to Exhibit 4.2 to the Form 8-K filed with the SEC on March 14, 2006). - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- 4.10. Form of warrant issued on March 10, 2006 (incorporated by reference to exhibit 4.3 of the Company's Currently Report on Form 8-K, filed with the SEC on March 14, 2006)+
4.11 Registration Rights Agreement dated November 19, 2007 by and between the registrant and RimAsia Capital Partners, L.P. (incorporated by reference to Exhibit 4.1 of the registrant's Current Report on Form 8-K, filed with the SEC on November 26, 2007.)
4.12 Additional Common Stock Purchase Warrant dated November 19, 2007 (incorporated by reference to Exhibit 4.2 of the registrant's Current Report on Form 8-K, filed with the SEC on November 26, 2007.)
4.13 Modified Common Stock Purchase Warrant dated November 19, 2007 (incorporated by reference to Exhibit 4.3 of the registrant's Current Report on Form 8-K, filed with the SEC on November 26, 2007.)
10.1 Employment Agreement with AN Lufan dated August 29, 2004 (incorporated by reference to Exhibit 10.3 to Form 10-KSB, filed with the SEC on April 14, 2005)+
10.2 Employment Agreement with LIU Xiaohao dated August 29, 2004 (incorporated by reference to Exhibit 10.4 to Form 10-KSB, filed with the SEC on April 14, 2005)+
10.3 Employment Agreement with MAO Peng dated August 29, 2004 (incorporated by reference to Exhibit 10.1 to to Form 10-KSB, filed with the SEC on April 14, 2005)+
10.4 Conditional Loan Conversion Agreement dated November 19, 2007 by and between the registrant and RimAsia Capital Partners, L.P.(incorporated by reference to Exhibit 10.4 of the registrant's Current Report on Form 8-K, filed with the SEC on November 26, 2007.)
21.1 List of Subsidiaries of the Registrant *
31.1 Certification of Chief Executive Officer of China Biopharmaceuticals Holdings, Inc. pursuant to Rule 13a - 14(a)/15d-14(a) of the Securities Exchange Act of 1934. *
31.2 Certification of Chief Financial Officer of China Biopharmaceuticals Holdings, Inc. pursuant to Rule 13a - 14(a)/15d-14(a) of the Securities Exchange Act of 1934. *
32.1 Certification of Chief Executive Officer of China Biopharmaceuticals Holdings, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **
32.2 Certification of Chief Financial Officer of China Biopharmaceuticals Holdings, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ** - --------------------------------------------------------------------------------
* Filed herewith
** Furnished herewith.
+ Management contract or compensation Plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. - -------------------------------------------------------------------------------- By: /s/ Chris Peng Mao -----------------------------------
Chris Peng Mao Chief Executive Officer Date: March 31, 2009
By: /s/ Zhang Jian -----------------------------------
Zhang Jian Chief Financial Officer Date: March 31, 2009
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Signature Title Date - ---------------------- -------------------------------------- -------------
/s/ Chris Peng Mao Director and Chief Executive Officer March 31, 2009 Chris Peng Mao
/s/ ZHANG Jian Chairwoman and Chief Financial Officer March 31, 2009 - ---------------------- ZHANG Jian
/s/ AN Lufan Director and President March 31, 2009 - ---------------------- AN Lufan
/s/ LIU Xiaohao Director and Vice President March 31, 2009 - ---------------------- LIU Xiaohao
/s/ Stephen E. Globus Director March 31, 2009 Stephen E. Globus
/s/ DING Weihua Director March 31, 2009 DING Weihua
/s/ SHI, Mingsheng Director March 31, 2009 SHI, Mingsheng - --------------------------------------------------------------------------------
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Index to Financial Statements and Financial Statement Schedules
The following audited consolidated financial statements are included on the pages indicated:
Page - ---- Report of Moore Stephens Wurth Frazer and Torbet, LLP, Independent Registered Public Accounting Firm Consolidated Balance Sheet as of December 31, 2008 and 2007 Consolidated Statements of Income and Other Comprehensive Income for the years ended December 31, 2008 and 2007 Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows for the years ended December 31, 2008 and 2007 Notes to Consolidated Financial Statements
(b) Exhibits
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of China Biopharmaceuticals Holdings, Inc
We have audited the accompanying consolidated balance sheets of China Biopharmaceuticals Holdings, Inc and Subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations and comprehensive income, shareholders' equity, and cash flows for each of the years in the two-year period ended December 31, 2008. China Biopharmaceuticals Holdings, Inc.'s management is responsible for these financial statements. 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. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included 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, as well as 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 financial position of Biopharmaceuticals Holdings, Inc and Subsidiaries as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
/s/ Moore Stephens Wurth Frazer & Torbet, LLP - --------------------------------------------- Walnut, California March 30, 2009
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2008 AND 2007
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Note 1- ORGANIZATION AND OPERATIONS
China Biopharmaceuticals Holdings, Inc. (CBH), a Delaware corporation, was originally organized as a Corporation under the laws of the state of New York on August 6, 1976. Since August 2004, the Company acquired various subsidiaries located in mainland China (also referred to as "PRC"). The principal activities of the Company, through its subsidiaries, are research, manufacture, and the sale of drug raw materials and intermediates as well as prescription and non-prescription drugs and traditional Chinese medicines. The Company is also engaged in the discovery, development and commercialization of innovative drugs and related bio-pharmaceutical products in China.
Note 2 - SIGNIFICANT ACCOUNTING POLICIES
Economic and Political Risks
The Company faces a number of risks and challenges since its assets are located in China and its revenues are derived from its operations in China. China is a developing country with a young economic market system overshadowed by the state. Its political and economic systems are very different from the more developed countries and are still in the stage of change. China also faces many social, economic and political challenges that may produce major shocks and instabilities and even crises, in both its domestic arena and its relationship with other countries, including but not limited to the United States. Such shocks, instabilities and crises may in turn significantly and negatively affect the Company's performance.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and all its majority-owned subsidiaries that require consolidation. Material inter-company transactions have been eliminated in the consolidation. The consolidated financial statements of China Biopharmaceuticals Holdings, Inc. and Subsidiaries reflect the activities of the following subsidiaries:
Entity Percentage of Ownership Location - ------------------------------------------------------------------------- CBH Parent Company United States of America CBC 100% owned by CBH British Virgin Inland Erye 51% owned by CBH P.R.C Keyuan 90% owned by CBC P.R.C
Use of Estimates
The preparation of the financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. For example, the Company estimates the collectibility of its receivables which affects the carry value of the related asset and estimates the fair value of share based compensation which affects the amount of compensation recognized in earnings. Management makes these estimates using the best information available at the time the estimate are made; however actual results could differ materially from those estimates.
Land Use Rights
According to Chinese law, the government owns all the land in China. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. Land use rights are being amortized using the straight-line method over the lease term of 40 to 50 years. The Company reviews the carrying value of land use rights at least annually, more often if necessary, to determine whether their carrying value has become impaired. Impairment charges are recorded when the carrying value
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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of the asset exceeds future benefits to be derived from the asset.
Plant and Equipment, Net
Plant and equipment are stated at cost less accumulated depreciation. Depreciation is provided on the straight-line basis over their respective estimated useful lives. Estimated useful lives are as follows.
Equipment and machinery 5 years Motor vehicles 5 years Furniture and fixtures 5 years Buildings 20 years
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of operations. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.
Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company's plant facilities. Interest incurred during the period of construction, if material, is capitalized. No depreciation is provided for construction in progress until the assets are completed and are placed into service.
Long-term assets of the Company are reviewed at least annually, more often if necessary, to determine whether their carrying value has become impaired, pursuant to the guidelines established in Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As of December 31, 2008, management concluded long term assets are not impaired.
Cash and Cash Equivalents
For financial reporting purposes, the Company considers all highly liquid investments purchased with original maturity of three months or less to be cash equivalents.
Short Term Investment
In 2007, the Company opened an account with an investment broker to invest in short term investments in initial public offering securities. The Company classified the account balance as trading securities, which should be carried at fair value with unrealized gains and losses reported in income. Total amount in this account was $4,432,657 as of December 31, 2008 and $1,096,800 as of December 31, 2007. For the years ended December 31, 2008 and 2007, the Company recorded $27,648 and $0 as realized gain on short-term investment.
Accounts Receivable
Accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management's judgment and estimates are made in connection with establishing the allowance for doubtful accounts. Specifically, the Company analyzes the aging of accounts receivables balances, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. Significant changes in customer concentrations or payment terms, deterioration of customer credit-worthiness or weakening economic trends could have a significant impact on the collectibility of the receivables and our operating results. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowance may be required. The ultimate collection of the Company's accounts receivables may take over one year and accounts receivables outstanding more than one year is considered to be written-off.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Inventories
Inventories are stated at the lower of cost or market using the first-in, first-out basis. The Company reviews its inventory periodically for possible obsolescence or to determine if any reserves are necessary.
Patents
The Company obtained various official registration certificates or official approvals for clinical trials representing patented pharmaceutical formulas. No amortization is provided when the Company intends to and has the ability to sell the patent or formulas within not more than two months, otherwise the patent costs will be subject to amortization over its estimated useful life period, generally fifteen years. Such costs comprise purchase costs of patented pharmaceutical formulas and costs incurred for patent application. Patent costs are accounted for on an individual basis. The carrying value of patent costs is reviewed for impairment annually and more often when events and changes in circumstances indicate that the carrying value may not be recoverable.
Research and Development Costs
Research and development (or "R&D") expenses include salaries, benefits, and other headcount related costs, clinical trial and related clinical manufacturing costs, contract and other outside service fees, and facilities and overhead costs. R&D costs are expensed when incurred.
Under the guidance of paragraphs 8 to 11 of SFAS 2, the Company expenses the costs associated with the research and development activities when incurred. None of the intangible assets of the Company was recorded based on R&D costs.
Advertising Costs
The Company expenses the cost of advertising as incurred or, as appropriate, the first time the advertising takes place. Advertising costs for the years ended December 31, 2008 and 2007 amounted $23,021 and $90,804.
Shipping and Handling Costs
Shipping and handling costs related to costs of goods sold are included in selling, general and administrative costs were $385,532 and $340,659 for the years ended December 31, 2008 and 2007, respectively.
Concentration of Risks
Cash includes cash on hand and demand deposits in accounts maintained with banks within the People's Republic of China, Hong Kong and the Untied States. Total cash in these banks at December 31, 2008 and 2007 amounted to $580,492 and $669,699 of which $0 and $65,490 deposits are covered by FDIC insurance, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
The Company sells pharmaceutical products to pharmacies and hospitals. Five major customers accounted for approximately 11.2% 13.8% of the net revenue for the years ended December 31, 2008 and 2007, respectively. No sales revenue from any single customer was above 5% of total sales revenue. As of December 31, 2008 and 2007, the total receivable balances due from these customers were $1,014,498 and $403,018, respectively, representing 22.2% and 8.7% of total accounts receivables.
For the year ended December 31, 2008, five major suppliers provided approximately 49.5% of the Company's purchases of raw materials with each supplier individually accounting for 13.6% 11.9%, 9.1%, 9.1% and 5.7%, respectively. Five suppliers provided 45.4% of the Company's purchase of raw materials for the year ended
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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December 31, 2008, with each suppliers individually accounted for 17.9%, 12.0%, 6.5%, 4.7% and 4.3%, respectively.
Fair Value of Financial Instruments
On January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements, which defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosures requirements for fair value measures. The carrying amounts reported in the balance sheets for current assets and current liabilities qualify as financial instruments are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels are defined as follow:
o Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
o Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
o Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.
Short-term loans amounted to $2,611,260 at December 31, 2008. In accordance with SFAS 157, the Company determined that the carrying value of this loan approximated the fair value using the level 2 inputs by comparing the stated loan interest rates to the rates charged by the Industrial and Commercial Bank of China to similar loans.
As of December 31, 2008, the carrying value of the redeemable convertible preferred stock amounted to $12,508,534. The redeemable shares are carried at redemption value which the management believes to be representative of the fair value.
The Company did not identify any assets or liabilities that are required to be presented on the balance sheet at fair value in accordance with SFAS 157.
Revenue Recognition
The Company has various categories of revenue resources, sales of new drug formulas, R&D services and revenue from sales of medical product.
The Company recognizes revenue from product and drug formula sales when title has passed, the risks and rewards of ownership have been transferred to the customer, the fee is fixed and determinable, and the collection of the related receivable is probable which is generally at the time of shipment. Allowances are established for estimated rebates, wholesaler charge backs, prompt pay sales discounts, product returns, and bad debts.
For revenue from R&D service, revenue is recognized based on fixed-price refundable new drug contracts. The fixed-price refundable new drug contract is also called as milestone contract, which establishes the phase goals of the R&D service provided by the Company and the corresponding milestone payments by the customers. Milestone payments become payable and are recognized as revenue when milestone goals, as defined in the contract, are achieved. Milestones are substantive and not derived solely from arriving at a specific date. Revenue is recognized when milestone goals are achieved at the amount of the corresponding
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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milestone payment. To determine when milestones are achieved, typically, the milestone goals require one or more of the following: (1) a certificate from a licensed authoritative agency, (2) approval/acknowledgement by a governmental agency, such as agency like Food and Drug Administration of the United States, (3) an authoritative professional appraisal report, or (4) an independent technological feasibility report, testing analysis and other form of valuation on the result and value of products and service. After receipt of the certificate, and/or approval and/or report, continued service is not required thus the respective milestone goals are achieved. Therefore, the milestone payment is no longer refundable and revenue is recognized.
Revenue was made up of the following product categories.
For the years ended December 31, 2008 December 31, 2007 ----------------- ----------------- Revenue: Intermediary pharmaceuticals products $ 13,647,392 $ 9,269,591 Prescription drugs 35,948,342 22,380,572 R&D service 245,424 277,215 ----------------- ----------------- Total revenue $ 49,841,158 $ 31,927,378 ================= =================
Income Taxes
Income taxes are provided on the liability method whereby deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax basis and reported amounts of assets and liabilities. Deferred tax assets and liabilities are computed using enacted tax rates expected to apply to taxable income in the periods in which temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date. The Company provides a valuation allowance for certain deferred tax assets, if it is more likely than not that the Company will not realize tax assets through future operations.
The Company adopted FASB Interpretation 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"), as of January 1, 2007. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The adoption had no effect on the Company's financial statements.
Comprehensive Income
SFAS 130, Reporting Comprehensive Income, establishes standards for the reporting and display of comprehensive income, its components and accumulated balances in a full set of general purpose financial statements. SFAS 130 defines comprehensive income to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, SFAS 130 requires that all items that are required to be recognized under current accounting standards as components of comprehensive income be reported in financial statement that is presented with the same prominence as other financial statements. The Company's only current component of comprehensive income is the foreign currency translation adjustment.
Foreign Currency Translation
The reporting currency of the Company is the US dollar. The Company's Chinese subsidiaries' financial records are maintained and the statutory financial statements are stated in its local currency, Renminbi (RMB), as their functional currency. Results of operations are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate as quoted by the People's Bank of China at the end of each reporting period, and equity are stated at their historical rates. Cash flows are also translated
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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at average translation rates for the period, therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
This quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People's Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People's Bank of China.
Approval of foreign currency payments by the Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents and signed contracts. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to $1,771,414 and 774,891 at December 31, 2008 and 2007, respectively. Assets and liabilities at December 31, 2008 and December 31, 2007 were translated at 6.82 and 7.29 RMB to $1.00. The average translation rates applied to income statement accounts, statement of cash flows for years ended of 2008 and 2007 were 6.94 and 7.59 RMB to $1.00. Cash flows are also translated at average translation rates for the period, therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. These amounts are immaterial to the consolidated financial statements.
Earnings per Share
The Company adopted SFAS 128, "Earnings per Share" ("EPS"), which requires the presentation of earnings per share as Basic and Diluted EPS. Basic earnings per share are calculated by taking net income divided by the weighted average shares of common stock outstanding during the period. Diluted earnings per share is calculated by taking basic weighted average shares of common stock and increasing it for dilutive common stock equivalents such as preferred stock, as well as warrants and options that are in the money.
Shares Subject to Mandatory Redemption
The Company adopted SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS 150 established classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity. Instruments within the scope of SFAS 150 must be classified as liabilities within the Company's Consolidated Financial Statements and be reported at settlement date value.
The Company issued redeemable stock in November 2007 related to the settlement of notes payables owed to RimAisa. Under the terms of the redeemable stock, the issuer has the right to redeem and the holder has the right to convert any time up to and including the fourth anniversary of the issuance. Therefore, liability accounting is not triggered under SFAS 150, because the stock is not mandatorily redeemable until after the fourth anniversary. However, pursuant to EITF Topic D-98, "Classification and Measurement of Redeemable Securities," the redeemable stock is classified outside of shareholders' equity. If the redeemable stock is not converted by the fourth anniversary, then the shares the mandatory redemption is triggered, and pursuant to SFAS 150, the shares will be reclassified to liabilities.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities--including an amendment of FASB Statement No. 115. SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS 159 is to provide opportunities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply hedge
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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accounting provisions. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Company chose not to elect the option to measure the fair value of eligible financial assets and liabilities.
In June 2007, the FASB issued FASB Staff Position EITF 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services Received for use in Future Research and Development Activities" ("FSP EITF 07-3"), which addresses whether nonrefundable advance payments for goods or services that used or rendered for research and development activities should be expensed when the advance payment is made or when the research and development activity has been performed. The Company adopted FSP EITF 07-3 on January 1, 2008 and there is no material effect on financial statements.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements - an amendment of Accounting Research Bulletin No. 51", which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company has not determined the effect that the application of SFAS 160 will have on its consolidated financial statements.
In December 2007, SFAS 141R, "Business Combinations," was issued. SFAS 141R replaces SFAS 141, Business Combinations. SFAS 141R retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. This replaces SFAS 141's cost-allocation process, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. SFAS 141R also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values (or other amounts determined in accordance with SFAS 141R). SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The Company believes adopting SFAS 141R might materially impact the accounting treatment for any future merger or acquisition consummated January 1, 2009.
In March 2008, the FASB issued SFAS 161, "Disclosures about Derivative Instruments and Hedging Activities - An Amendment of SFAS No. 133." SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. SFAS 161 is effective on January 1, 2009. The Company is in the process of evaluating the new disclosure requirements under SFAS 161.
In June 2008, the FASB issued EITF 07-5, "Determining whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock." This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application is not permitted. Paragraph 11(a) of SFAS 133 "Accounting for Derivatives and Hedging Activities" specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company's own stock and (b) classified in stockholders' equity in the statement of financial position would not be considered a derivative financial instrument. EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer's own stock and thus able to qualify for
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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the SFAS 133 paragraph 11(a) scope exception. The Company believes adopting this statement will have a material impact on the financial statements because among other things, any option or warrant previously issued and all new issuances denominated is US dollars will be required to be carried as a liability and marked to market each reporting period.
In June 2008, FASB issued EITF 08-4, Transition Guidance for Conforming Changes to Issue No. 98-5. The objective of EITF 08-4 is to provide transition guidance for conforming changes made to EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that result from EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments", and SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008. Early application is permitted. This issue had no material impact on the Company's financial statements as of December 31, 2008 and for the year then ended.
On October 10, 2008, the FASB issued FSP.157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active," which clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 became effective on October 10, 2008, and its adoption had no material impact on the Company's financial statements as of December 31, 2008 and for the year then ended..
In January 2009, the FASB issued FSP EITF 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No. 99-20, and EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("FSP EITF 99-20-1"). FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be more consistent with the impairment model of SFAS No. 115. FSP EITF 99-20-1 achieves this by amending the impairment model in EITF 99-20 to remove its exclusive reliance on "market participant" estimates of future cash flows used in determining fair value. Changing the cash flows used to analyze other-than-temporary impairment from the "market participant" view to a holder's estimate of whether there has been a "probable" adverse change in estimated cash flows allows companies to apply reasonable judgment in assessing whether an other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1 did not have a material impact on our consolidated financial statements because all of our investments in debt securities are classified as trading securities.
Reclassifications
Certain prior period amounts have been reclassified to conform to current period's presentation. Those reclassifications had no material effect on operations or cash flows.
Note 3 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest and income taxes paid
o Interest expense paid amounted to $159,182 and $148,825 for years ended December 31, 2008 and 2007, respectively.
o Income tax was paid $972,642 and $1,131 for the years ended December 31, 2008 and 2007, respectively.
Non-cash investing and financing activities
o On November 16, 2007, the principal of loans payables for $11,500,000 related to Enshi acquisition and the unpaid interest in total of $12,508,534 had been converted into the Company's Series B redeemable preferred stock.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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o In addition, $1,110,346 and $0 were transferred from net income to dividends payable for the year ended December 31, 2008 and 2007.
o The Company written-off $1,988,180 and $576,600 receivables from other receivables and long-term notes receivables, respectively, as of December 31, 2008 and increased bad debt expense in the amount of $2,564,780 at the same time.
o $1,866,454 advance on land use right has being transferred to intangible assets during the year ended December 31, 2008.
o The Company reduced cost of expired patent under intangible assets and the related accumulated amortization in the amount of $151, 790, respectively, during the year ended December 31, 2008.
Note 4 - ACCOUNTS RECEIVABLE, NET
The reserve for bad debts was $1,200,983 and $1,260,760 at December 31, 2008 and, 2007.
Accounts receivable consisted of the following:
December 31, December 31, 2008 2007 ------------ ------------ Accounts receivable $ 4,572,208 $ 4,812,243 Allowance for doubtful accounts (1,200,983) (1,260,760) ------------ ------------ Accounts receivable, net $ 3,371,225 $ 3,551,483 ============ ============
Management regularly reviews aging of receivables and changes in payment trends by its customers, and records a reserve when they believe collection of amounts due are at risk. Accounts considered uncollectible are written off. As of December 31, 2008 and 2007, management concluded its allowance for bad debts were sufficient.
The following table consists of allowance for doubtful accounts.
Allowance for doubtful accounts, December 31, 2006 $ 682,445 Addition 530,938 Recovery Translation adjustment 47,377 ----------- Allowance for doubtful accounts, December 31, 2007 $ 1,260,760 Addition Recovery (140,058) Translation adjustment 80,281 ----------- Allowance for doubtful accounts, December 31, 2008 $ 1,200,983 ===========
Note 5 - INVENTORIES
Inventories consisted of the following:
December 31, December 31, 2008 2007 ------------ ------------ Raw materials $ 2,043,597 $ 1,858,866 Refinery materials 2,231,623 3,139,200 Packaging supplies 274,282 239,624 Sundry supplies 13,736 11,984 Work in process 637,021 351,611
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Finished goods 3,859,646 3,360,770 ------------ ------------ Total inventory 9,059,905 8,962,055 Inventory allowance (26,250) -- ------------ ------------ Total inventories $ 9,033,655 $ 8,962,055 ============ ============
The Company periodically reviews its reserves for slow moving and obsolete inventories. As of December 31, 2008 and 2007, the Company reserved $26,250 and $0 as inventory allowance, respectively.
Note 6 - PLANT AND EQUIPMENT, NET
Plant and equipment consisted of the following:
December 31, December 31, 2008 2007 ------------ ------------ Plant $ 2,446,124 $ 2,286,051 Office equipment 28,420 25,478 Machinery 7,386,881 6,368,927 Vehicles 258,300 228,043 Construction in progress 7,379,805 185,963 ------------ ------------ Total plant and equipment 17,499,530 9,094,462 Less: accumulated depreciation (5,844,350) (4,972,293) ------------ ------------ Plant and equipment, net $ 11,655,180 $ 4,122,169 ============ ============
Depreciation expense for the years ended December 31, 2008 and 2007 amounted to $517,469 and $482,708, respectively. For the year ended December 31, 2008, the Company capitalized interest expense as part of construction-in-progress amounting of $160,375 and $0 with 7.12% and 6.59% effective weighted average interest rate as of December 31, 2008 and 2007, respectively.
Note 7- OTHER ASSETS
Intangible Assets
Intangible assets consist of the following:
December 31, December 31, 2008 2007 ------------ ------------ Land use rights: $ 8,058,504 $ 7,688,637 Less: accumulated amortization (641,074) (459,333) ------------ ------------ Land use rights, net 7,417,430 7,229,304 ------------ ------------
Patent - Approved drugs 190,710 322,596 Less: accumulated amortization (21,083) (153,711) ------------ ------------ Patent, net 169,627 168,885 ------------ ------------ Total intangible assets, net $ 7,587,057 $ 7,398,189 ============ ============
Land use rights are pledged as collateral for bank loans. Amortization expenses for the years ended December 31, 2008 and 2007 amounted $166,984 and $166,470, respectively.
One of the Company's patent of approved drug was fully amortized during 2008, $151,790 of costs and accumulated amortization were deducted from intangible asset account.
The following table consists of the expected amortization expense for the next five years:
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Years ended December 31, Amount ------------ 2009 $ 170,050 2010 170,050 2011 170,050 2012 170,050 2013 170,050 Thereafter 6,736,807 ------------ Total $ 7,587,057 ============
Restricted Cash
Restricted cash represents cash required to be deposited with banks for the balance of bank notes payable but are subject to withdrawal with restrictions according to the agreement with the bank and saving accounts. The required deposit rate is approximately 30-50% of the notes payable. Given the nature of the restricted cash, it is reclassified as a financing activity in Statement of Cash Flows. The following lists the depositors, the amount and names of the banks:
December 31, December 31, Name of Bank 2008 2007 - --------------------------------------------- ------------ ------------ Hua Xia Bank, Suzhou $ 3,863 $ 164,871 Industrial and commercial bank, Suzhou -- 353,718 China CITIC Bank 1,369,365 -- - --------------------------------------------- ------------ ------------ Total $ 1,373,228 $ 518,589 ============ ============
Long Term Notes Receivable
Long term notes receivable represents loans made to third party for cash flow needs for R&D projects on new drugs. The Company has first priority to purchase the new drug rights if the projects are successfully completed. If the Company gives up the right, the debtors are required to repay the loans plus 3% interest per annum within one month after the drug rights are sold to another party. If on or before February 28, 2010, the R&D projects are not completed or failed, the debtors are required to repay the loans plus 6% interest per annum within ten days after such a conclusion was made. As of December 31, 2007, the total amount of the long term notes receivable was $640,518 for the aforesaid projects. However, the Company determined that the long-term notes receivable was deemed no longer collectable and has written off the balance amounted to $586,800 (RMB 4,000,000) as of December 31, 2008.
Note 8 - RELATED PARTIES TRANSACTIONS
Accounts Receivables - Related Parties
Accounts receivable included the following:
Hainan Kaiye was a company owned by minority shareholders of Suzhou Erye Pharmaceutical Limited Company. Hainan Kaiye was disposed to two unrelated parties during the year and the transaction was consummated on Oct 29, 2008. As of December 31, 2008, Hainan Kaiye was not qualified as a related party.
Other Receivables - Related Parties
Other receivable contained the following related party balances where Hainan Kaiye was a company owned
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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by minority shareholders of Suzhou Erye Pharmaceutical Limited Company before Oct 29, 2008 and Enshi was the discontinued subsidiary since July 2007.
Loan to Shareholder and Officer
Other Payables - Related Parties
Erye Trading was a company owned by minority shareholders of Suzhou Erye Pharmaceutical Limited Company. The 38 minority shareholders of Erye transferred their shares of Erye to Erye Trading in 2008 and the transactions was consummated on June 24, 2008. Erye Trading is the 49% shareholder of Erye as of December 31, 2008.
Other Payables- Shareholders
Chris Peng Mao is the CEO of the Company. Lufan An & Xiaohao Liu are both shareholder of the Company.
Note 9 - SHORT TERM LOANS
The Company has a total of $2,611,260 and $2,371,830 in short term loans from different banks in China at December 31, 2008 and 2007, respectively. These loans mature in one year or less. The average interest rates were approximately 7.12% and 7.33% for the year ended December 31, 2008 and 2007, respectively. Bank loans were collateralized by plant owned by Erye in the amount of $127,749 as of December 31, 2008.
Interest expense of the short term bank loans for the years ended December 31, 2008 and 2007 amounted to $1,595 and $206,450 respectively. The Company capitalized interest expense for construction in progress amounting of $160,375 for the year ended December 31, 2008.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Note 10 - NOTES PAYABLE
The Company's subsidiary Erye has $4,563,837 and $1,727,460 notes payable to Erye's vendors for the purchase of drug raw materials as of December 31, 2008 and 2007. Notes payable are interest free and usually mature after a six-month period.
In order to issue noted payable on behalf of the Company, the banks requested collaterals, such as cash deposit which was approximately 30-50% of notes to be issued, or properties owned by companies or etc. As of December 31, 2008, $1,369,365 restricted cash was collateral for the $1,369,365 notes payable, which was approximately 30.0% of the notes payable (See notes 7) the Company issued, and the rest of notes payable is pledged by the land use right the Company owned amounted to $1,880,477.
Note 11 - TAXES PAYABLE
Taxes payable was comprised as follows:
December 31, 2008 December 31, 2007 ----------------- ----------------- Income tax payable $ 1,551,754 $ 1,028,507 VAT payable 657,978 455,043 Other taxes payable 5,935 5,414 ----------------- ----------------- Total $ 2,215,667 $ 1,488,964 ================= =================
Note 12 - REDEEMABLE PREFERRED STOCK
On November 16, 2007, the Company entered a conditional loan conversion agreement (the "Agreement") with RimAsia, under which the principal amount of the $11.5 million loan owed to RimAsia in connection with the Enshi acquisitions plus unpaid interest of $1,008,534 (combined total of $12,508,534) was converted into 6,185,607 shares of Series B redeemable convertible preferred shares of the Company at an effective conversion price at $2.0222 per share. Each series B share may be converted into two shares of common stock. Additionally, the exercise price of $1.375 for the 12 million existing warrants exercisable into common stock previously issued to and currently held by RimAsia in connection with the extension of the loan financing ("Existing Warrants") was lowered to $1.26 per share and the term extended to 4.5 years from the closing date. This Agreement was conditional subsequent to the completion of at least one of sizeable acquisitions by the end of June 2008. RimAsia extended the wavier to not to convert the Series B preferred stock to debt to earlier of (a) October 31, 2009 or (b) abandonment of the merger with NeoStem which is disclosed in Note 18.
The Company adopted SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. Under the terms of the redeemable stock, the issuer has the right to redeem and the holder has the right to convert any time up to and including the fourth anniversary of the issuance. Therefore, liability accounting is not triggered under SFAS 150 because the stock is not mandatorily redeemable until after the fourth anniversary. However, pursuant to EITF Topic D-98, "Classification and Measurement of Redeemable Securities," the redeemable stock is classified outside of shareholders' equity.
According to the Agreement, the series B preferred stock is subject to optional redemption at the Company's option before the 4th anniversary of issuance date and mandatory redemption at the investors of the Company's option thereafter. The Company maybe required to repurchase the remaining series B preferred stock four years after the closing date at a per share price of the sum of (1) the original Series B issue price $2.0222 per share; (2) all accrued but unpaid annual dividends; (3) 5% of the original series B issue price per annum accrued from the occurrence of certain triggering events, such as the Company's failure to pay annual dividends, mandatory redemption price or any other amount due, either in cash or in kind. (4)The four-percent suspendible premium which shall be deemed to have begun to accrue from the Series B Issuance date and shall continue to accrue until the date when the average closing price of the common stock over 30 consecutive trading days each with a daily treading volume of no fewer than 100,000 shares exceeds the following price thresholds: during the 2nd year from the Series B Issuance date, $1.4, during the 3rd year, $1.58, and during the 4th year, $1.72.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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The Series B redeemable stock was recorded at fair value on the date of issuance. As of December 31, 2008 and 2007, balances of redeemable preferred stock amounted to $12,508,534. Dividend payables amounted to $1,110,346 and $77,107 as of December 31, 2008 and 2007, respectively. As of December 31, 2008, pursuant to the optional redemption clause, the holders of the series B shares shall be entitled to receive an annual dividend of 5% amounted to $651,129; and, the four-percent suspendible premium was accrued in the amount of $459,217, which were included in dividend payable.
On November 2, 2008, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Neostem, Inc., a Delaware corporation, and CBH Acquisition LLC ("Merger Sub"), a Delaware "NBS" limited liability company and wholly-owned subsidiary of Neostem. Pursuant to the Merger Agreement, CBH will merge into Merger Sub, with Merger Sub as the surviving entity. All of the shares of the Company's series B shares issued and outstanding immediately prior to the effective time of the Merger will be converted into (i) 5,383,009 shares of NeoStem Common Stock, (ii) 6,977,512 shares of Series C Convertible Preferred Stock, without par value, of NeoStem, each with a liquidation preference of $1.125 per share and convertible into shares of NeoStem Common Stock at a conversion price of $0.90 per share, and (iii) warrants to purchase 2,400,000 shares of NeoStem Common Stock at an exercise price of $0.80 per share.
Note 13 - STATUTORY RESERVES
The laws and regulations of the PRC require that before foreign invested enterprise can legally distribute profits, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations, in proportions determined at the discretion of the board of directors, after the statutory reserves. The statutory reserves include the surplus reserve fund and the common welfare fund.
The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company's registered capital. This statutory reserve fund is planned for future development of the company or use for employee's benefits. These reserves represent restricted retained earnings.
The transfer to this reserve must be made before distribution of any dividends to shareholders. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years' losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital. The Chinese government restricts distributions of registered capital and the additional investment amounts required by a foreign invested enterprise. Approval by the Chinese government must be obtained before distributions of these amounts can be returned to the shareholders.
During the years ended December 31, 2008 and 2007, the Company made total appropriations to these statutory reserves of $532,359 and $314,198, respectively. The component of statutory reserves and the future contribution required pursuant to Chinese Corporation Regulation are as follows at December 31, 2008 and 2007:
2008 2007 ----------- ----------- Statutory surplus reserve $ 1,448,100 $ 915,741 Common welfare reserve 60,698 60,698 ----------- ----------- Total $ 1,508,798 $ 976,439 ----------- -----------
50% of registered share capital of Erye 1,508,798 1,508,798 ----------- ----------- Extra contribution required $ -- $ 532,359 =========== ===========
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Note 14 - INCOME TAXES
Corporation Income Tax (CIT)
The Company's subsidiaries operate in China. According to the Chinese Joint Venture Business Law, these subsidiaries have been registered and incorporated with the status of Sino-foreign joint venture companies and are subject to a two year tax exemption and a three year 50% reduction in income tax rates preference treatment, which generally commences from the first year of establishing a joint venture or the approval date of the income tax preference application.
Effective January 1, 2008, the New Enterprise Income Tax ("EIT") law replaced the existing laws for Domestic Enterprises ("DES") and Foreign Invested Enterprises ("FIEs"). The new standard EIT rate of 25% has replaced the 33% rate previously applicable to both DES and FIEs. Companies established before March 16, 2007 will continue to enjoy tax holiday treatment approved by local government for a grace period of the next 5 years or until the tax holiday term is completed, whichever is sooner.
The Company's subsidiaries, Suzhou Erye was established before March 16, 2007 and therefore is qualified to continue enjoying the reduced tax rate as described above. Erye was granted income tax exemption for two years commencing from January 1, 2006, and is subject to 50% of the 25% EIT tax rate, or 12.5% from January 1, 2008 through December 31, 2010. Keyuan's total revenue is subject to 1.7% to 3.3% income tax rates depends on the range of the taxable income. Provision for CIT amounted $1,418,334 and $1,245 for the years ended December 31, 2008 and 2007, respectively.
The following table reconciles the U.S. statutory rates to the Company's effective tax rate:
For the years ended December 31, -------------------------- 2008 2007 ----------- ----------- U.S. Statutory rate 34.0% 34.0% Foreign income not recognized in USA (34.0) (34.0) China income taxes 25.0 33.0 Income tax exempted (7.6) (33.2) ----------- ----------- Total provision for income taxes 17.4% (0.2)% =========== ===========
The estimated tax savings due to the reduced tax rate for the years ended December 31, 2008 are $1,418,334 and $1,036,854, respectively. The net effect on income per share if the income tax had been applied would decrease income per share by $0.04 and $0.03 for the years ended December 31, 2008 and 2007, respectively.
The Company was incorporated in the United States and incurred a net operating loss for income tax purposes for 2008 and 2007. The net operating loss carry forwards for United States income tax purposes amounted to $5,239,906 and $4,740,785 for the years ended December 31, 2008 and 2007, respectively, which may be available to reduce future years' taxable income. These carry forwards will expire, if not utilized, beginning in 2027 through 2028. Management believes that the realization of the benefits arising from this loss appear to be uncertain due to Company's limited operating history and continuing losses for United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at December 31, 2008 and 2007. Management reviews this valuation allowance periodically and makes adjustments as warranted
The valuation allowance for the years ended December 31, 2008 and 2007 were as follow:
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Years ended December 31, 2008 2007 - ----------------------------------------------------------------------------- Balance of January 01, $ 1,611,867 $ 1,066,972 Increase 169,701 544,895 ----------- ----------- Balance of December 31, $ 1,781,568 $ 1,611,867 =========== ===========
Business Tax
The Company is subject to business tax, which is charged on the selling price of applicable product and service at a general rate of 5% in accordance with the tax law applicable. Keyuan is exempt from business tax according to local applicable favorable tax policy.
Value Added Tax ("VAT")
In accordance with the relevant taxation laws in China, the VAT rate for domestic sales is 17% and 0% for export sales on the invoiced value of sales and is payable by the purchaser. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company's finished products can be used to offset the VAT due on sales of the finished product.
VAT on sales and VAT on purchases amounted to $8,647,372 and $5,888,088 for the years ended December 31, 2008, and $5,614,462 and $4,235,377 for the same period in 2007, respectively. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government. VAT taxes are not impacted by the income tax holiday.
Note 15 - Earnings Per Share
The Company determined that all the warrants were anti-dilutive because the exercise prices were higher than average market price in the period presented as of December 31, 2008. The redeemable convertible preferred stock is mandatorily redeemable for cash at the fourth anniversary if not yet converted. As of December 31, 2008, none of the preferred stock had been converted. Dividends and accretion on the preferred stock were subtracted from net income to determine net income available to common shareholders for the purposes of computing basic earnings per share. In calculating diluted earnings per share, the convertible preferred stock is treated as common stock equivalents on an as-converted basis. Dividends and accretion on the preferred stock are added back to the net income available to common shareholders for calculating diluted earnings per share, as if the preferred stock were converted at the beginning of the period. The convertible preferred stock - series A of 50,000 and redeemable convertible preferred stock - series B of 6,185,607 were anti-dilutive for the year ended December 31, 2008 based on the calculation method above used.
The Company determined that all the warrants, the convertible preferred stock - series A of 50,000 and redeemable convertible preferred stock - series B of 6,185,607 were anti-dilutive for the year ended December 31, 2007 because the Company recorded net loss for the periods presented.
The number of shares used in computing basic earnings per share for the years ended December 31, 2008 and 2007 were 36,348,531 and 36,340,860, respectively. Basic and diluted earnings per share for the years ended December 31, 2008 and 2007 were $0.05 and $(0.37), respectively.
Note 16 - COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space from third parties. Accordingly, for the years ended December 31, 2008 and 2007, the Company recognized rent expenses of $11,892 and $39,074, respectively.
As of December 31, 2008, the Company has outstanding commitments in respect to non-cancelable operating
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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leases as follows:
Amount ----------- For the year ended December 31 2009 $ 6,486 Thereafter -- ----------- Total $ 6,486 ===========
Research and Development Contract
On November 5, 2007, the Company entered into a new drug development contract with a third party ("the Developer"). Pursuant to the contract, the Developer will transfer a drug patent to the Company, and also is responsible for obtaining the New Drug Certificate and the Drug Manufacturing Approval from the PRC Drug Administration Authority no later than July 1, 2009. In exchange, the Company will pay up to approximately $1,600,000 (RMB12,000,000) to the Developer. Of the total $1,600,000, approximately $933,800 and $266,800 will need to be paid before December 31, 2007 and February 25, 2008, respectively, and the final payment ranging from $0 to $400,200 (depending on the date of the Manufacturing Approval) needs to be paid no later than 10 days after the grant date of the Manufacturing Approval. Further, the two parties agreed that the Company will pay sales commission to the Developer based on the sales volume of the contracted new drug during a 10 year period after this drug is put into production. If the PRC Drug Administration Authority denies the application of the Drug Manufacturing, all payments made by the Company would be fully returned to the Company by the Developer. The Company had paid $1,321,561 (RMB9,008,596) and $959,700 (RMB7,000,000) as of December 31, 2008 and 2007, respectively.
Legal Proceedings
In March 2007, the Company identified non-existent trade accounts receivable acquired in the acquisition of Enshi. The Company has commenced legal proceeding for damages of $10,000,000 against Mr. Li Xiaobo ("Mr. Li"), the previous owner and controlling shareholder of Enshi, and his related parties ("Defendants") for breach of representations and warranties and fraud ("LXB Litigation") The Hong Kong courts has frozen approximately $10,000,000 worth of assets per the court order in Hong Kong and the Defendants lost their opposition actions against the seizure order. The Company has been waiting for the court hearing in HK court. The Company reasonably expects to prevail in the lawsuit against the Defendants. The Company reserves the right to take further actions if necessary to seek additional damages and compensation for these serious breaches of representations and warranties and fraud and will make appropriate disclosures pending the legal proceedings. In April 2007, the Company lost an action in a court in Shenyang, China to offset claims against Mr. Li and against Mr. Li's working capital loan to Enshi. The court decided to view each action separately on its own merit. The Company paid the amount of $560,735 due to Liao Ning Xie He and $86,765 due to Mr. Li. The Company reserves the right to take additional actions against Mr. Li and will continue its proceedings in other courts outside as well as in China.
In July 2007, Enshi was foreclosed on by RimAsia and ceased to be part of the Company. RimAsia assumed the litigation activities against Mr. Li Xiaobo and certain other defendants in connection with the acquisition of shares of Enshi ("LXB") and on October 17, 2008_reached a settlement with LXB pursuant to which Enshi was returned to LXB against a payment of certain sum of funds of which the residual sum post litigation costs were to be eventually transferred to the Company. The expected residual is not expected to be meaningful to the Company
On November 16, 2007 and amended on January 22, 2008, the Company and RimAisa entered into a litigation agreement ("Litigation Agreement"). Pursuant to this Litigation Agreement, if RimAisa or RACP (as the plaintiff) prevail in the LXB Litigation or the settlement is reached, any judgment awards, settlement amount and salvage value realized from Enshi, would be firstly used to reimburse all the legal and related expenses incurred by RimAsia in the LXB Litigation, up to $4,000,000, and the remaining amounts of the judgment proceeds would be entitled to the Company. If RimAisa and the Company do not prevail in the LXB Litigation, RACP should be returned to CBH and all the proceeds of any sale of liquidation of Enshi or any assets of or interest in Enshi shall be distributed as agreed by both parties. In addition, all the costs and
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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expenses (including attorneys' fees) incurred by or on behalf of the plaintiffs shall be borne 55% by RimAsia and 45% by the Company.
On September 1, 2008, the Company and RimAisa entered into an Understanding on Litigation Residual Payment (the "Understanding"). Pursuant to this Understanding, if there is no consummation of the Merger, the gross residual (the "Gross Residual") from the LXB Litigation receivable by CBH (being the gross settlement proceeds of the LXB litigation paid by Li Xiao Bo less the litigation and related expenses incurred by and reimbursed to RACP pursuant to the Litigation Agreement shall be paid to CBH in cash or shares of common stock and warrants to purchase common stock of NBS (collectively, "NBS Securities"), such NBS Securities being valued at their original purchase price but in no case to be more than (a) US$1,250,000 or (b) the value of the Gross Residual, whichever is less, and only to the extent there is any such residual from the LXB litigation. Any amount of the Gross Residual remaining after deducting the value of NBS Securities under the immediately preceding sentence shall be immediately paid to CBH in cash. In case of a closing of the Merger, RACP may no longer deliver such NBS Securities to CBH, but shall be able to deliver to Erye Economy & Trade Ltd ("EET") NBS Securities, valued at their purchase price and up to an amount equal to 50% of the "Net Residual" (to be defined below), in exchange for the withholding of an equal amount of cash from the Gross Residual, pursuant to the terms of an agreement with EET that will be documented and signed prior to or at the closing of the Merger. The "Net Residual" means the Gross Residual minus the sum of (a) US$1.3 million representing the legal fees and costs and the un-reimbursed advances and expenses made by Erye to Shenyang Enshi Pharmaceutical Ltd. and CBH, and (b) US$300,000 for operating expenses of CBH over the next 12 months.
Note 17 - SHAREHOLDERS' EQUITY
Issuance of Shares for Services
In December 2008, the Company issued 100,000 shares of common stock to a consultant for the services provided during the period from January 2007 to February 2009. Shares were valued at $27,000 based on the market price at the service contract signing dates.
Warrants
Following is a summary of the status of warrants outstanding at December 31, 2008:
Following is a summary of the Warrant activity:
Outstanding as of January 01, 2007 10,400,396 Granted 12,000,000 Forfeited 510,421 Exercised -- ---------- Outstanding as of December 31, 2007 21,889,975 Granted -- Forfeited 1,639,833 Exercised -- ---------- Outstanding as of December 31, 2008 20,250,142 ==========
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008
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Note 18 - BUSINESS COMBINATIONS
Discontinued Operation - Shenyang Enshi
We acquired Shenyang Enshi Pharmaceutical Limited Company ("Enshi") on June 6, 2006. Subsequent to the acquisition of Enshi, the Company identified fraud by the previous owner and controlling shareholder of Enshi, Mr. Li Xiaobo and his related parties ("Defendants") and breaches in the representations and warranties provided by him to the Company and the Defendants' including their refusal to honor their indemnification obligations to the Company. The Company's subsidiary RACP filed a lawsuit against the Defendants alleging fraud and had requested rescission of the agreement and damages. Enshi's operations have been interfered with and as a result the Company decided to suspend its operations in the third quarter of 2007. In addition, Enshi has been taken over by RimAsia in July 2007 since Enshi was pledged as collateral for the $11.5 million loan owed to RimAsia in connection with the Enshi Acquisition. As a result, Enshi is no longer a subsidiary of the Company. Due to the uncertainty on the amount to be recovered from the lawsuit, management has decided to write off the entire carrying value of Enshi in third quarter of 2007 and has reported a loss on discontinued operations in the consolidated financial statements. The recovered value of Enshi after the completion of the litigation against Li Xiaobo, if any, will be recognized as income.
Merger with NeoStem, Inc.
As previously mentioned in Note 12, on November 2, 2008, CBH entered into an Agreement and Plan of Merger (the "Merger agreement") with CBC, NeoStem, Inc., and CBH Acquisition LLC ("Merger Sub"). The Merger Agreement contemplates the merger of CBH with and into Merger Sub, with Merger Sub as the surviving entity (the "Merger"). Prior to the consummation of the Merger, CBH will spin off all of its shares of capital stock of CBC to CBH's stockholders in a liquidating distribution so that the only material assets of CBH following such spin-off will be CBH's 51% ownership interest in Erye, plus net cash which shall not be less than $550,000.
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, all of CBH's common stock, par value $.01 per share, issued and outstanding immediately prior to the effective time of the Merger (the "Effective Time") will be converted into the right to receive, in the aggregate, 7,500,000 shares of NeoStem's common stock at par value of $.001 per share (of which 150,000 shares will be held in escrow pursuant to the terms of an escrow agreement to be entered into between CBH and NeoStem).
Subject to the cancellation of outstanding warrants to purchase shares of CBH Common Stock held by RimAsia, all of the shares of CBH series B preferred stock solely held by RimAsia, issued and outstanding immediately prior to the Effective Time will be converted into NeoStem's common stock, series C convertible preferred stock and warrants to purchase NeoStem's common stock. See details in Note 13.
At the Effective Time, in exchange for cancellation of all of the outstanding shares of CBH series A convertible preferred stock which is held by Stephen Globus, a director of CBH, and/or related persons, NeoStem will issue to Mr. Globus and/or related persons 50,000 shares of NeoStem common stock at $1.00 per share. NeoStem also will issue 60,000 shares of NeoStem Common Stock to Mr. Globus and 40,000 shares of NeoStem common stock to Chris Peng Mao, the Chief Executive Officer of CBH, in exchange for the cancellation and the satisfaction in full of indebtedness in the aggregate principal amount of $90,000, plus any
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and all accrued but unpaid interest thereon, and other obligations of CBH to Globus and Mao. NeoStem will bear 50% of up to $450,000 of CBH's expenses post-merger, and satisfaction of the liabilities of Messrs. Globus and Mao will count toward that obligation. NeoStem also will issue 200,000 shares to CBC to be held in escrow, payable if NeoStem successfully consummates its previously announced acquisition of control of Shandong New Medicine Research Institute of Integrated Traditional and Western Medicine Limited Liability Company.
Also at the Effective Time, subject to acceptance by the holders of all of the outstanding warrants to purchase shares of CBH common stock (other than warrants held by RimAsia), such warrants shall be canceled and the holders thereof shall receive warrants to purchase up to an aggregate of up to 2,012,097 shares of NeoStem common stock at an exercise price of $2.50 per share.
Upon consummation of the transactions contemplated by the Merger, Merger Sub will own 51% of the ownership interests in Erye, and Suzhou Erye Economy and Trading Co. Ltd., a company incorporated in the PRC ("EET"), will own the remaining 49% ownership interest. In connection with the execution of the Merger Agreement, NeoStem, Merger Sub and EET have negotiated a revised joint venture agreement (the "Joint Venture Agreement"), which, subject to finalization and approval by the requisite PRC governmental authorities, will become effective and will govern the rights and obligations with respect to their respective ownership interests in Erye. Pursuant to the terms and conditions of the Joint Venture Agreement, dividend distributions to EET and Merger Sub will be made in proportion to their respective ownership interests in Erye; provided, however, that for the three-year period commencing on the first day of the first fiscal quarter after the Joint Venture Agreement becomes effective, (i) 49% of undistributed profits (after tax) will be distributed to EET and lent back to Erye by EET for use by Erye in connection with the construction of a new plant for Erye; (ii) 45% of the net profit (after tax) will be provided to Erye as part of the new plant construction fund, which will be characterized as paid-in capital for Merger Sub's 51% interest in Erye; and (iii) 6% of the net profit will be distributed to Merger Sub directly for NeoStem's operating expenses. In the event of the sale of all of the assets of Erye or liquidation of Erye, Merger Sub will be entitled to receive the return of such additional paid-in capital before distribution of Eyre's assets is made based upon the ownership percentages of NeoStem and EET, and upon an initial public offering of Erye which raises at least $7,300,000 (RMB 50,000,000), Merger Sub will be entitled to receive the return of such additional paid-in capital. CBC will receive $300,000 from the settlement proceeds from the settlement of the litigation in Hong Kong and Canada by RACP Pharmaceutical Holdings Limited, a wholly-owned subsidiary of CBC, against Li Xiaobo and certain other defendants in connection with the acquisition of shares of Enshi (the "LXB Litigation") and use it as working capital.
Change of minority shareholders
On June 24, 2008, the original 38 individual shareholders of Erye transferred their ownership interest (in total 49%) in Erye to Erye Ecornomic and Trade company limited ("Erye Trading"). Erye Trading is 49% shareholder of Erye as of December 31, 2008. The transaction was approved by CBH and Erye's board, and consummated before December 31, 2008.