U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2005
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
Commission File Number 0-51379
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Lounsberry Holdings III, Inc.
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(Name of small business issuer in its charter)
Delaware 51-0539830
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(State or other jurisdiction of (IRS. Employer
incorporation or organization) Identification No.)
51 Everett Drive; Suite A-20;
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West Windsor Professional Center, Princeton Junction, NJ 08550
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code (609)799-1889
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Securities registered pursuant to Section 12(b) of the Act:Common Stock $.0001
par value
Securities registered pursuant to Section 12(g) of the Act:None.
Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act. Yes No X__
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No_____
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes ____ No _X_
State issuer's revenues for its most recent fiscal year. $12,791,031
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State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked price of such common
equity, as of a specified date within the past 60 days. N/A
On March 30, 2006, the issuer had 7,380,000 shares of common stock
outstanding.
Transitional Small Business Disclosure Format (check one):
Yes _______ No: _X_
ii
Lounsberry Holdings III, Inc.
Form 10-KSB
Table of Contents
PART I Page
Item 1. Description of Business..............................................................................2
Item 2. Description of Property.............................................................................10
Item 3. Legal Proceedings...................................................................................10
Item 4. Submission of Matters to a Vote of Security Holders.................................................10
PART II
Item 5. Market for Common Equity, Related Stockholder Matters
and Small Business Issuer Purchases of Equity Securities...........................................11
Item 6. Management's Discussion and Analysis or Plan of Operation...........................................13
Item 7. Financial Statements................................................................................20
Item 8. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure...............................................................................21
Item 8A. Controls and Procedures.............................................................................21
Item 8B. Other Information...................................................................................22
PART III
Item 9. Directors and Executive Officers
of the Registrant..................................................................................22
Item 10. Executive Compensation..............................................................................24
Item 11. Security Ownership of Certain Beneficial
Owners and Management and Related
Stockholder Matters................................................................................25
Item 12. Certain Relationships and Related
Transactions.......................................................................................25
Item 13. Exhibits............................................................................................26
Item 14. Principal Accountant Fees and Services..............................................................27
Signatures.......................................................................................................27
Financial Statements F-1
iii
PREDICTIVE STATEMENTS AND ASSOCIATED RISK
Certain statements in this Report, and the documents incorporated by
reference herein, constitute predictive statements. Such predictive statements
involve known and unknown risks, uncertainties and other factors which may cause
deviations in actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or
implied. Such factors include, but are not limited to: market and customer
acceptance and demand for our products; our ability to market our products; the
impact of competitive products and pricing; the ability to develop and launch
new products on a timely basis; the regulatory environment; our ability to
obtain the requisite regulatory approvals to commercialize our products;
fluctuations in operating results, including spending for research and
development and sales and marketing activities; and other risks detailed from
time-to-time in our filings with the Securities and Exchange Commission (the
"Commission").
The words "believe, expect, anticipate, intend and plan" and similar
expressions identify predictive statements. These statements are subject to
risks and uncertainties that cannot be known or quantified and, consequently,
actual results may differ materially from those expressed or implied by such
predictive statements. Readers are cautioned not to place undue reliance on
these predictive statements, which speak only as of the date they are made.
1
PART I
ITEM 1. DESCRIPTION OF BUSINESS
OVERVIEW
Lounsberry Holdings III, Inc. ("we" or the "Company") was incorporated as
a Delaware corporation on February 10, 2005, with the objective of acquiring, or
merging with, an operating business.
On February 8, 2006, we entered into a Stock Exchange Agreement (the
"Exchange Agreement") pursuant to which we acquired all of the equity of
Guangzhou Konzern Medicine Co., Ltd. ("Konzern"), a company incorporated under
the laws of the People's Republic of China (the "PRC"). Pursuant to the Exchange
Agreement, we issued 6,530,000 shares of common stock to the owners of Konzern.
As a result, our business is the business of Konzern. Konzern's current
main business is the distribution of medical products, including traditional
pharmaceutical medicines, traditional Chinese medicines (finished medicines made
of Chinese herbs), Chinese herbs and nutritional supplements, within the PRC.
The exchange will be accounted for as a reverse acquisition. The accounting
rules for reverse acquisitions require that, beginning with the date of the
acquisition (February 8, 2006), our balance sheet include the assets and
liabilities of Konzern and our equity accounts be recapitalized to reflect the
net equity of Konzern. Accordingly, our historical operating results are now the
operating results of Konzern.
Our executive offices are located at 51 Everett Drive; Suite A-20; West
Windsor Professional Center, Princeton Junction, NJ 08550, telephone (609)
799-1889.
COMPANY HISTORY
We distribute traditional pharmaceutical medicines, traditional Chinese
medicines (finished medicines made of Chinese herbs), Chinese herbs and dietary
supplements in the People's Republic of China (the "PRC") through our
wholly-owned subsidiary, Konzern. Konzern was originally organized and operated
as a state-owned enterprise. In 2000, Konzern was "privatized" in a transaction
by which its three principal shareholders (the "Konzern Shareholders") acquired
all of Konzern's outstanding equity.
On July 19, 2004, Konzern entered into a Joint Venture Agreement with
Bio-One Corporation, a Nevada corporation ("Bio-One"), pursuant to which Bio One
agreed to acquire a 51% equity interest in Konzern for $150,000; however, such
amount was not paid by Bio- One and Bio-One's voting interest in Konzern
reverted to the Konzern Shareholders.
2
On October 25, 2005, the Konzern shareholders and Bio-One entered into
Stock Transfer Agreements with the Company pursuant to which the Konzern
Shareholders agreed to sell all of their shares in Konzern to the Company for an
aggregate purchase price of RMB 24,280,000 and Bio-One agreed to sell all of its
shares in Konzern for RMB1. Consummation of the forgoing transactions under the
Stock Transfer Agreements was conditioned upon Konzern's receiving an additional
$3,000,000 in funding on or before February 28, 2006. At that time, the Company
was a "shell" corporation with no operations or business.
On December 21, 2005, Bio-One and Konzern exchanged mutual general
releases. Therefore, Bio-One has no continuing interest in Konzern and no
interest in the Company.
On February 8, 2006, Konzern, the Konzern Shareholders and the Company
entered into a Stock Exchange Agreement pursuant to which the Company issued an
aggregate of 6,530,000 shares of its common stock to the Konzern Shareholders in
consideration of their transfer of Konzern shares to the Company.
In connection with the foregoing transactions, the Company entered into a
Preferred Stock Purchase Agreement, dated February 8, 2006, with Barron Partners
L.P., Ray and Amy Rivers, JTROS, Steve Mazur and William Denkin (collectively,
the "Preferred Investors") pursuant to which the Company issued and sold an
aggregate of 3,120,000 shares of its Series A Convertible Preferred Stock and
warrants to purchase an aggregate of 7,389,476 shares of its Common Stock
("Investor Warrants") to the Preferred Investors for an aggregate purchase price
of $3,900,000. The Company used $200,000 of the proceeds from its sale of the
Series A Convertible Preferred Stock and Investor Warrants as consideration for
its purchase of 928,000 shares, or 90.27% of its outstanding Common Stock from
Capital Markets Advisory Group, LLC ("Capital Markets") pursuant to a Stock
Redemption Agreement dated February 8, 2006.
Konzern's executive offices are located at Room 702 Guangri Mansion No. 8,
South Wuyang Xin Chengsi, Guangzhou, China. Our telephone number is 011
8620-87372231. Konzern's website is www.konzern.com.cn. Information contained on
Konzern's website or any other website is not part of this annual report on Form
10-KSB.
OUR BUSINESS
We are a distributor of medical products, including traditional
pharmaceutical medicines, traditional Chinese medicines (finished medicines made
of Chinese herbs), Chinese herbs and dietary supplements. These products include
both prescription drugs and over-the-counter drugs. We purchase our products
from Chinese drug manufacturers, and we are the manufacturer's sole distributor
in the People's Republic of China ("PRC") for our five largest suppliers. Our
five largest suppliers, accounted for 74% of our purchases for both of the years
ended December 31, 2005 and 2004. Our agreements with our suppliers generally
have a term of one year and provide that the suppliers will provide us with the
products we order. None of our supply agreements has any minimum purchase
requirements on our part; however, we are frequently required to make a
significant down payment, in the amount of $150,000 to $250,000, for one year's
purchase with our large suppliers when we place an order at the beginning of
each year. Our customers are typically wholesale medical products companies,
hospitals and retail drug stores. Our five largest customers accounted for 88%
of our revenue for the year ended December 31, 2005 and 37% of our revenue for
the year ended December 31, 2004.
3
Prior to 2004, we did not engage in any research and development
activities. On October 8, 2003, we entered into an agreement (the "Agreement")
to establish a cooperative relationship with the Pharmaceutical Research
Institute of Nanhua University. Under the Agreement, Konzern and Nanhua
Univeristy jointly set up a new medicine research facility - New Medicine
Research Center of Konzern and Nanhua University (the "Center"). Konzern
contributes the expenses for medical research, including the salaries of the
research personnel, who are mainly professors at Nanhua University, in return
for the ownership of the new medicines so developed. The Center has been
developing four products: Yutian Capsule for lung cancer treatment, Dioscorea
Collettii Hook F Extraction for high blood pressure treatment, EGFR Test kit for
lung cancer testing, Multi Functional Peptide Derivative for intestine cancer
treatment. All four of these medicines are in the lab study and testing period.
Products
We sell more than 1,100 different products. Our product lines include
traditional pharmaceutical medicines, traditional Chinese herbal medicines,
herbs and dietary supplements. Some of our products are available
over-the-counter, while others require a prescription. Most of our products are
developed and manufactured by other companies; however, we have recently begun
to develop our own proprietary products and currently have 4 such products under
development.
Traditional Pharmaceutical Medicines. Traditional pharmaceutical medicine
accounts for most of our sales, representing sales of approximately $12,107,138,
or 79% of revenue for the year ended December 31, 2005, $7.8 million, or 75.3%
of revenue for the year ended December 30, 2004, and $4.7 million, or 80.7% of
revenue, for the year ended December 31, 2003.
We do not market or advertise our medical products for specific uses or
conditions. The uses of our products described below are based on our
understanding of the general uses of the medical products and the usages that
have been approved by the State Food and Drug Administration Bureau of the
People's Republic of China.
Our five largest selling traditional pharmaceutical medicines for the year
ended December 31, 2005, together with the sales volume for the period, are:
o Lopamidol, a liquid medication which is used for stomach
radiography, which accounted for sales of approximately $3.4
million.
4
o Levocarnitine, which is used for cardiac muscle disease, bone
problem and high blood lipid which is given by injection, which
accounted for sales of approximately $1million.
o SonoVue, which is used in ultrasound radiography, which accounted
for sales of approximately $625,258.
o Cinepazide maleate injection, which is used in the treatment of
vascular sclerosis and accounted for sales of approximately
$314,065.
o Sodium Ozagrel for injection, which is used in the treatment of
stroke and accounted for sales of approximately $250,275.
We do not have exclusive distribution rights to any of these products,
except Lopamidol, in the PRC. Although these drugs are traditional
pharmaceutical medicines, they are not products which are sold in the United
States or Europe, but are products that are used in the Chinese market.
Traditional Chinese Herbal Medicines. Our five largest traditional Chinese
medicines for the year ended December 31, 2005, together with the sales volume
for the period, are:
o Xue shuan tong, which is used for stroke and accounted for sales of
approximately $556,110.
o Qianbai biyan tablet, which is used for rhinitis and accounted for
sales of approximately $312,867.
o Qingre sanjie table, which is used for the common cold and accounted
for sales of approximately $265,319.
o Chuanbei piba gao, which is used for coughs and accounted for sales
of approximately $229,023.
o Zhachong shisanwei, which is used for the common cold and accounted
for sales of approximately $191,078.
Herbs and Dietary Supplements. We also sell a range of Chinese herbs,
which accounted for sales of approximately $138,039 for the year ended December
31, 2005, as well as dietary supplements, which accounted for nominal sales
during that period.
5
Principal Suppliers
Our five largest suppliers, which were the same in each period, accounted
for 74% of our purchases for the year ended December 31, 2005, 74% of our
purchases for the year ended December 31, 2004, and 34% of our purchases for the
year ended December 31, 2003. Among them, our two largest suppliers, accounted
for 59%, 53%, and 25% of our purchases for the years ended December 31, 2005,
2004 and 2003. Our five largest suppliers are Shanghai Bracco Sine
Pharmaceutical Corporation, Guangzhou Pharmaceutical Holdings Limited, Guangzhou
Qixing Pharmaceutical Co., Ltd., Guangdong Shunfeng Pharmaceutical Co., Ltd.,
Guangxi Wuzhou Medicine Group Distribution Co., Ltd.. Our two largest suppliers
for 2005 are Shanghai Bracco Sine Pharmaceutical Corporation (32%) and Guangzhou
Pharmaceutical Holdings Limited (27%). Our agreements with our suppliers
generally have a term of one year and provide that the suppliers will provide us
with the products we order. None of our supply agreements has any minimum
purchase requirements on our part; however, we are frequently required to make a
significant down payment, in the amount of $150,000 to $250,000, for one year's
purchase with our large suppliers when we place an order at the beginning of
each year. The increase in the percentage of our purchases from our five largest
suppliers results from the license requirements of the PRC. Some suppliers did
not obtain necessary manufacturing licenses, which resulted in a concentration
of drug manufacturing in a smaller number of companies. We believe that we have
alternative suppliers for each of our products.
Marketing, Principal Customers
We have a staff of approximately 70 marketing and sales personnel. We do
not sell to end users, and we do not advertise our products. We generate
business by marketing directly to wholesale medical products companies,
hospitals and retail drug stores, which constitute substantially all of our
customers. We had a distribution network in place when Konzern was privatized in
2000, and we used this network as the basis of our current distribution network.
We also market our products at two national medicine trade shows. We generally
sell our products pursuant to one-year contracts, which do not include any
minimum purchase requirements. Hospitals are our end-customer; however, we sell
our products through large medicine companies because hospitals usually demand
up to six months payment period; by selling through large medicine companies, we
have been able to collect on our accounts within a shorter period of time. Our
five largest customers accounted for 88% of our revenue for the year ended
December 31, 2005 and 37% of our revenue for the year ended December 31, 2004.
Among them, our two largest customers accounted for 72% and 25% of our revenue
for the years ended December 31, 2005 and 2004. Our two largest cumstomers for
2005 are Guangdong Sanhong Medicine Co., Ltd. (42%) and Guangdong Saikang
Medical Co., Ltd. (30%).
After Sales Service Network
We contact the end-customers directly to collect their feedback on the
quality of our products and distribution services. All of our 70 sales and
marketing persons are responsible for providing after-sale services, including
on-site visiting to the hospitals and contacting the medicine companies in order
to timely receive feedback. In addition, our on-staff physician will also
communicate with the hospitals regarding dosages, side-effects and patients'
feedback on particular products.
Seasonality of Business
6
Sales are usually highest in the fourth quarter of each year because most
of the medicine companies and hospitals buy some inventory which they deem
useful and promising at the end of each year. Sales in the first quarter are
usually the lowest due to the traditional Chinese Spring Festival, when only
patients with very serious disease ask for immediate treatment.
Competition
Competition in the sale of medical products is intense. There are a large
number of companies that are licensed to sell medical products in China. We
believe that our major competitors are large, state-owned medicine distributors,
such as Guangzhou Medicine Company, Guangzhou Medicine Import and Export
Corporation and Guangdong Pharmaceutical Co., Ltd. They have strong capital
support, which enables them to send medicines to hospitals and collect the
resulting accounts receivable six months later. They also are allowed to sell
anaesthetic products, a right granted only to state-owned companies; however,
such state-owned companies do not have their own research and development
facilities, as Konzern does, and most of them do not provide after-sale customer
services, which we believe gives us a competitive advantage.
We have the sole distribution rights to medical products sold by our five
largest suppliers, which we believe assists us in marketing our products;
however, since other distributors offer comparable products, our ability to
compete successfully is also dependent upon other factors, such as price and the
ability to provide timely delivery. We believe that our ability to develop
proprietary products will improve our competitive position; however, we cannot
assure you that we will be successful in developing business in the face of
continuing competition.
Research and Development Activities
Prior to 2004, we did not engage in any research and development
activities. We intend to increase our efforts to develop proprietary products.
On October 8, 2003, we entered into an agreement (the "Agreement") to establish
a cooperative relationship with the Pharmaceutical Research Institute of Nanhua
University. Under the Agreement, Konzern and Nanhua Univeristy jointly set up a
new medical research facility. Konzern contributes the funds needed to finance
the research, including the salary of the research personnel, who are mainly
professors at Nanhua University, in return for ownership rights to the new
medicines developed. The Center has been developing four products: Yutian
Capsule for lung cancer treatment, Dioscorea Collettii Hook F Extraction for
high blood pressure treatment, EGFR Test kit for lung cancer testing, Multi
Functional Peptide Derivative for intestine cancer treatment. All four medicines
are currently in the lab study and testing period. We also have an agreement
with Guangzhou Laitai Pharmaceutical Co., Ltd. pursuant to which we finance the
development by Laitai of some drugs, and upon approval from the State Food and
Drug Administration, we will hold the sole rights to distribute such drugs for
10 years.
Intellectual Property
7
We have patents pending for seven of our products. These patents have been
approved by the State Health Department, pending approval of the National
Intellectual Property Bureau of the PRC. The patents are for products designed
to treat the following conditions:
o Yutian capsule, a preparation made of slug for use in treating lung
cancer, chronic bronchitis and bronchial asthma.
o Xiao Shu Oral Liquid, an oral medication designed to reduce the
effects of heat exhaustion.
o Qu Shi Qing Chang Du Oral Liquid, an oral medication to treat
constipation.
o Jian Pi Xiao Ji Oral Liquid, an oral medication to treat
indigestion.
o Bao Chu Dan Oral Liquid, an oral medication designed to improve
kidney functions.
o Niu Pi Tang oral medication to relieve tired and strained eyes.
o A chewing gum which is designed to reduce the effects of radiation
from the computer monitor and relieve tired and strained eyes.
Konzern is the holder of the trademark "Konzem" which was registered with
the PRC Trademark Offices of the National Industrial and Commerce Administrative
Bureau (the "PRC Trademark Offices"). The discrepancy between the registered
trademark "Konzem" and the Company's name resulted from a spelling error by the
trademark agent. Until the error is corrected, we may not be able to enforce any
trademark rights with respect to our company name. Trademarks issued in the PRC
have a term of 10 years; the term for our trademark expires on December 13,
2011. The registered use scope of the trademark is medical nutritional liquid,
medical dietary supplements, medical drug, original materials, bio-chemical
medicine, medical oil, medicine treating dandruff, medical plant root, vitamin
drug and nutritional medicine. The PRC Trademark law, adopted in 1982 and
revised in 2001, protects registered trademarks. A registered trademark is
protected for a term of 10 years, renewable for another term of 10 years, so
long as an application for renewal is submitted to the PRC Trademark Offices
within six months prior to the expiration of the initial term.
Konzern has applied for the registration of the following additional
trademarks, which are pending the approval from the PRC Trademark Offices:
---------------------------------------- ------------------------------- --------------------------
Trademark in Application Application Date Process Acceptance Date
---------------------------------------- ------------------------------- --------------------------
(kefei) 05/20/2003 05/20/2003
---------------------------------------- ------------------------------- --------------------------
(shangqing) 12/01/2004 02/23/2005
---------------------------------------- ------------------------------- --------------------------
(buzhongbao) 12/01/2004 02/23/2005
---------------------------------------- ------------------------------- --------------------------
(erxianbaochun) 12/01/2004 02/23/2005
---------------------------------------- ------------------------------- --------------------------
(runxia) 12/01/2004 02/23/2005
---------------------------------------- ------------------------------- --------------------------
(buzhong) 12/13/2004 03/16/2005
---------------------------------------- ------------------------------- --------------------------
(qingshangqing) 12/13/2004 03/16/2005
---------------------------------------- ------------------------------- --------------------------
(wangzeyou) 03/02/1005 05/25/2005
---------------------------------------- ------------------------------- --------------------------
(yutian) 03/15/2005 05/25/2005
---------------------------------------- ------------------------------- --------------------------
(qinghe) 07/18/2005 09/27/2005
---------------------------------------- ------------------------------- --------------------------
Government Regulation
The operation of any business in the PRC, including the manufacture or
distribution of drugs, is subject to government regulations. These regulations
cover a wide range of products, from Chinese herbal products sold
over-the-counter to pharmaceutical products which require a prescription.
The manufacture and sale of drugs in the PRC is governed by the Drug
Administration Law. We do not manufacture any drugs, but all of our drugs are
manufactured at a facility which has received a permit to operate a drug
manufacturing facility. As a distributor of drugs, we are required to obtain a
permit from the drug regulatory department of the government of the province,
autonomous region or municipality directly under the Central Government, where
we are located. We have obtained a permit to operate as a distributor,
Certificate for Drug Distribution, from Guangdong Food and Drug Administration
with a five year term commencing from December 28, 2004 to December 27, 2009.
The scope is the purchase of traditional Chinese medicine materials; wholesale
of traditional Chinese medicine, chemical medicine materials and the related
medicines, antibiotics and the related medicines. In addition, we received a
Certificate for Health issued by Guangzhou Health Bureau with a term of four
years, commencing from July 19, 2005, which grants Konzern the right to engage
in the wholesale of marketing and distribution of health care foods. In the
event that we expand our business scope to manufacture our proprietary
medicines, we will require a certificate for the manufacture of medicine.
The Drug Administration Law also governs other aspects of the drug
manufacturing and distribution business, including packaging, labeling,
advertising and pricing. The Drug Administration Law and the Pricing Law of the
PRC provide for the government to rationally fix and adjust the prices, in order
to ensure that price is commensurate with quality, eliminate excessively high
price, and protect the legitimate interests of users. In general, the prices of
our products are determined by us and our customers on the basis of negotiation
due to the fact that our customers are not the end user. We are required to
operate in accordance with Good Supply Practice (the "GSP") for Pharmaceutical
Products, and we are subject to inspections organized by the local drug
regulatory department of the people's government of the province, autonomous
region or municipality directly under the Central Government. We received the
Certificate for GSP issued by Guangdong Province Administration Bureau for Drugs
with a term of five years commencing from November 19, 2003 to November 18,
2009. The scope in the Certificate for GSP conforms to the distribution scope of
the Certificate for Drug Distribution.
8
The Drug Administration Law provides for penalties for manufacturing or
distributing drugs without obtaining the necessary certificate. If a distributor
distributes drugs without the certificate, the distributor is banned, the drugs
illegally produced or sold and the illegal gains therefrom confiscated, and the
distributor may be fined not less than two times but not more than five times
the value of the drugs (including the drugs sold and not sold, the same below).
If a crime is constituted, criminal penalties may be given in accordance with
law. The law also applies to cases involving the sale of substandard or
counterfeit drugs.
Before any new pharmaceutical product can be marketed it must undergo
testing. The dossier on the research and development of a new drug, including
the manufacturing process, quality specifications, results of pharmacological
and toxicological study and related data, as well as samples, must be submitted
to the drug regulatory department under the State Council for approval in
accordance with the regulations of such department before clinical trials can be
conducted. Measures for verifying the qualifications of clinical study
institutions for drugs are formulated jointly by the drug regulatory department
and the administrative department for health under the State Council. When a new
drug has gone through clinical trials and passed the evaluation, a New Drug
Certificate is issued upon approval by the drug regulatory department under the
State Council.
In order to market a new drug, we must first obtain government approval
for the clinical trial, as described in the preceding paragraph. The government
authority issues a list of hospitals which are qualified to conduct the clinical
trial, and we select one or more hospitals from such list. If the results of the
test are accepted by the State Food and Drug Administration, we must then apply
for a production license so that the drug can be produced at a licensed
manufacturing facility. According to the relevant laws and regulations, the Drug
Certificate may be revoked if the drug is found to cause adverse pharmacological
effects or is found to be harmful to patients' health, or if it is found that
other activities engaged in with respect to manufacturing and marketing the drug
are in violation of the laws. The Drug Certificate sets forth the approved use
of the drug. Four new products are currently being developed by the Center,
which are subject to the clinical trial process herein described after
completion of lab testing.
Employees
As of March 20, 2006, we had 105 employees, of whom 25 are executive and
administrative personnel, 10 are research and development staff and 70 are
marketing and sales personnel.
Risk of Loss and Liability
9
The standard contracts between Konzern and its customers do not specify
the risk of loss allocation; however, the transportation company is generally
responsible for losses and damages which occur during the process of
transportation. In the event that a problem arises which necessitates recalling
a product, any liability associated with the recall or use of the product will
be apportioned among the various parties involved in the commercialization and
distribution of the product as may be determined by testing the recalled
product.
Konzern does not carry any product liability or other similar insurance.
While product liability lawsuits in the PRC are rare and we have never
experienced significant problems with any of our products, there can be no
assurance that we would not face liability in the event that any of our products
is found to be ineffective, harmful, unsafe, defective or tainted.
ITEM 2. DESCRIPTION OF PROPERTY
We lease approximately 4,500 square feet of office space at Room 702
Guangri Mansion No. 8, South Wuyang Xin Chengsi, Guangzhou, China from Guangzhou
Carpentry Company pursuant to a three year lease which expires on August 31,
2006, pursuant to which we pay a current annual rate of approximately $50,000.
We also lease approximately 9,688 square feet of warehouse space in 67
Shahe Road, Tianhe District, Guangzhou City pursuant to a one-year lease
expiring December 31, 2006, for which we pay rent at the annual rate of
approximately $20,250.
We also utilize office space in Princeton Junction, New Jersey from an
affiliate of Meiyi Xia, our Vice President, for which we pay rent of $500 per
month.
We believe that our facilities are adequate for the conduct of our
business for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor Konzern is currently a party to any pending legal
proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders in the fourth quarter
of the fiscal year ended December 31, 2005.
10
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES
As of the date of this report, there is no trading market for the
Company's securities.
As of the date of this report, we had approximately 50 stockholders of
record. At that date, we had 7,380,000 shares of Common Stock outstanding, none
of which may be sold pursuant to Rule 144.
Recent Issuances of Securities
In February 2006, we issued 6,530,000 shares of common stock to the former
Konzern stockholders, and 750,000 shares to other persons who performed services
for us. Those shares are subject to an 18-month lockup, subject to certain
exceptions. The 100,000 shares that were outstanding prior to the reverse
acquisition were issued at a time when we were a shell company, and those
shares, under an interpretation from the SEC relating to shares issued by a
shell company, may not be sold pursuant to Rule 144, and must be registered for
sale.
As of February 10, 2006, we had the following shares of Common Stock reserved
for issuance:
o 3,120,000 shares issuable upon conversion of the Series A Preferred
Stock.
o 7,389,476 shares issuable upon exercise of the warrants issued to
the investors in the February 2006 private placement.
o 1,575,000 shares issuable upon exercise of stock options or other
equity-based incentives pursuant to our 2006 long-term incentive
plan, which is subject to stockholder approval.
Dividends
We have not paid dividends. Our agreement with the investors in the
February 2006 private placement and the Certificate of Designation relating to
the Series A Preferred Stock prohibit our payment of dividends while shares of
Series A Preferred Stock are outstanding.
Equity Compensation Plan Information
The following table summarizes the equity compensation plans under which
our securities may be issued as of the date of the Annual Report on Form 10-KSB.
11
Number of securities to be Weighted-average Number of securities
issued upon exercise of exercise price of remaining available for
outstanding options and outstanding options and future issuance under
Plan Category warrants warrants equity compensation plans
Equity compensation plans approved by -0- -- --
security holders
Equity compensation plan not approved by 1,280,000 $1.25 295,000
security holders
The 2006 long-term incentive plan was approved by the board of directors,
subject to stockholder approval, and the outstanding options are subject to
stockholder approval of the plan. The plan has not yet been submitted to the
stockholders for their approval.
Transfer Agent
The Company currently acts as its own transfer agent, but plans to engage
a transfer agent when, and if, a trading market for its common stock develops.
Penny Stock Regulations
The Commission has adopted regulations which generally define a "penny
stock" to be an equity security that has a market price of less than $5.00 per
share. The Company's common stock, when and if a trading market develops, may
fall within the definition of penny stock and be subject to rules that impose
additional sales practice requirements on broker-dealers who sell such
securities to persons other than established customers and accredited investors
(generally those with assets in excess of $1,000,000, or annual incomes
exceeding $200,000 or $300,000, together with their spouse).
For transactions covered by these rules, the broker-dealer must make a
special suitability determination for the purchase of such securities and have
received the purchaser's prior written consent to the transaction. Additionally,
for any transaction, other than exempt transactions, involving a penny stock,
the rules require the delivery, prior to the transaction, of a risk disclosure
document mandated by the Commission relating to the penny stock market. The
broker-dealer also must disclose the commissions payable to both the
broker-dealer and the registered representative, current quotations for the
securities and, if the broker-dealer is the sole market-maker, the broker-dealer
must disclose this fact and the broker-dealer's presumed control over the
market. Finally, monthly statements must be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks. Consequently, the "penny stock" rules may
restrict the ability of broker-dealers to sell the Company's common stock and
may affect the ability of investors to sell their common stock in the secondary
market.
12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion of the results of our operations and financial
condition should be read in conjunction with the financial statements of Konzern
and the related notes, which appear elsewhere in this Form 10-KSB. The following
discussion includes predictive statements. For a discussion of important factors
that could cause actual results to differ from results discussed in the
predictive statements, see "Predictive Statements."
Overview
Prior to July 25, 2000, Konzern's business was conducted as a state-owned
medicine company in Guangzhou Province, the People's Republic of China (PRC). On
July 25, 2000, Konzern was privatized, in a transaction by which our principal
stockholders acquired the equity in Konzern. Konzern is a distributor of medical
products, including traditional pharmaceutical medicines, traditional Chinese
medicine (finished medicine made of Chinese herbs), Chinese herbs and
nutritional supplements.
In February 2006, Konzern received our business license to operate as a
wholly foreign owned enterprise, commonly known as a WFOE, the Company owns 100%
of Konzern since then and Konzern's business became our business.
Our business is dependent upon our ability both to acquire our products
and sell our products in the Chinese markets. We generally have one-year
contracts with our suppliers and our customers. Our five largest suppliers,
accounted for 74% of our purchases for both the year ended December 31, 2005 and
the year ended December 31, 2004, and 34% of our purchases for the year ended
December 31, 2003. Our agreements with our suppliers generally provide that the
suppliers will provide us with the products we order. None of our supply
agreements has any minimum purchase requirements on our part; however, we are
frequently required to make a significant downpayment at the amount of $150,000
to $250,000 for one year's purchase with our large suppliers when we place an
order at the beginning of each year. By the end of 2005, we have nationwide
exclusive sales right from our suppliers for four products they produce:
Lopamidol, Xue Shuang Tong, Chuanbei Piba Gao, Bumetamide, a sort of injection
to help the patients release their urine before the surgery.
Our contracts with our customers do not provide for minimum purchases, and
our customers are not restricted from purchasing competitive products from
others. Our customers are typically wholesale medical products companies,
hospitals and retail drug stores. Our five largest customers accounted for 88%
of our revenue for the year 2005 and 37% of our revenue for the year ended
December 31, 2004.
Under the laws of the PRC, we are required to have a license to distribute
our products and our suppliers are required to have a license to sell the
products to us. Both we and our suppliers have the required licenses. All of our
suppliers and customers are in China.
13
Prior to 2004, we did not engage in any research and development
activities. Commencing in 2004, we commenced a research and development program
in cooperation with the pharmaceutical department of Nanhua University. Pursuant
to our agreement with Nanhua, we design, fund, supervise and participate in the
research and development project at Nanhua University's facilities. We incurred
research and development expenses of approximately $478,590 during the year 2005
and approximately $527,973 in the year 2004. Our development effort has
concentrated on potential new medical products for which we have received or
have applications pending for patents; however, to date we have not generated
any revenue from these new products because the new products are pending
clinical trials and other necessary regulatory compliance before they can be put
into production.
Since our business is conducted in the PRC, all of our transactions are
accounted for in Chinese Yuan. Our financial condition and the results of our
operations, expressed in terms of United States dollars, is dependent upon the
applicable currency exchange rate, which can change significantly from period to
period.
Prior to the reverse acquisition, we made distributions to our
stockholders in the amounts of $3.1 million for the year ended December 31, 2005
and $2.6 million for the year ended December 31, 2004.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles ("GAAP") in
the United States. We believe the following are the critical accounting policies
that impact the financial statements, some of which are based on management's
best estimates available at the time of preparation. Actual experience may
differ from these estimates.
Use of Estimates -- The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates.
Accounts Receivable - During the normal course of business, we extend
unsecured credit to our customers, and we review our accounts receivable on a
regular basis to determine if the bad debt allowance is adequate at the end of
the period. We record an allowance for bad debts that ranges from 0.3% to 1.0%
of our outstanding accounts receivable at the end of the period in accordance
with generally accepted accounting principles in the PRC, and we consider that
allowance to be reasonable at December 31, 2005 and December 31, 2004.
Intangibles - Under the Statement of Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets," all goodwill and certain intangible
assets determined to have indefinite lives will not be amortized, but will be
tested for impairment at least annually. Other intangible assets will be
amortized over their useful lives and reviewed for impairment in accordance with
SFAS No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets."
14
Revenue Recognition - We recognize revenue when all four of the following
criteria are met: (i) persuasive evidence has been received that there is an
enforceable agreement; (ii) the products have been delivered or the services
have been performed; (iii) the selling price is fixed or determinable; and (iv)
collectibility is reasonably assured. Payments received prior to the time that
these criteria have been met are treated as deferred revenue.
Sales revenue represents the invoiced value of the goods, net of a
value-added tax ("VAT"). All of our products that are sold in the PRC are
subject to a VAT at the rate of 13% to 17% of the gross sales price. This VAT
may be offset by VAT paid by us on raw materials and other materials included in
the cost of producing our products.
Concentrations and Credit Risks - For the years ended December 31, 2005
and 2004, all of our sales were to companies located in the PRC and all of our
assets were located in the PRC. Our operations may be adversely affected by
significant political, economic and social uncertainties in the PRC. Although
the Chinese government has pursued economic reform policies in the past, we
cannot assure you that the Chinese government will continue to pursue such
policies or that such policies will not be significantly altered, especially in
the event of a change in leadership, social or political disruption or
unforeseen circumstances affect China's political, economic and social
conditions. We can give no assurance that the Chinese government's pursuit of
economic reforms will be consistent or effective.
Research and Development Costs - Research and development costs are
expensed as incurred. The costs of material and equipment acquired or
constructed for research and development and having alternative future uses are
classified as property and equipment and depreciated over their estimated useful
lives.
Foreign Currency Translation - Our functional currency is the Chinese
Yuan. Our financial statements are translated into United States dollars, using
the exchange rates at the end of the period as to assets and liabilities and
average exchange rates as to revenue and expenses. Capital accounts are
translated at their historical exchange rates when the transaction occurred. Net
gains and losses resulting from foreign exchange translations are included in
the statements of operations and stockholders' equity as other comprehensive
income.
The quotation of the exchange rates does not imply free convertibility.
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 by the People's Bank of China or other institutions requires us
to submit a payment application form together with invoices, shipping documents
and signed contracts.
New Accounting Pronouncements
15
In March 2004, the FASB issued EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF
03-1 includes new guidance for evaluating and recording impairment losses on
debt and equity investments, as well as new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB issued Staff Position EITF 03-1-1, which delays the effective date until
additional guidance is issued for the application of the recognition and
measurement provisions of EITF 03-1 to investments in securities that are
impaired; however, the disclosure requirements are effective for annual periods
ending after June 15, 2004. Management does not currently believe adoption will
have a material impact on our financial position or results of operations.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4. This statement amends the guidance in ARB
No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that
"...under some circumstances, items such as idle facility expense, excessive
spoilage, double freight, and rehandling costs may be so abnormal as to require
treatment as current period charges..." SFAS No. 151 requires that those items
be recognized as current-period charges regardless of whether they meet the
criterion of "so abnormal." In addition, this requires that allocation of fixed
production overhead to the costs of conversion be based on the normal capacity
of the production facilities. The provisions of SFAS 151 shall be applied
prospectively and are effective for inventory costs incurred during fiscal years
beginning after June 15, 2005, with earlier application permitted for inventory
costs incurred during fiscal years beginning after the date this Statement was
issued. Our adoption of SFAS No. 151 is not currently expected to have a
material impact on our financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004),
"Share-Based Payment," which amends FASB Statement No. 123 and will be effective
for public companies for interim or annual periods beginning after June 15,
2005. The revised standard requires, among other things, that compensation cost
for employee stock options be measured at fair value on the grant date and
charged to expense over the employee's requisite service period for the option.
Due to the absence of observable market prices for employee stock options, the
standard indicates that the fair value of most stock options will be determined
using an option-pricing model. As a result of the reverse acquisition, our
adoption of SFAS No. 123(R) will result is compensation expense upon the grant
of options or other equity-based incentives. Prior to the reverse acquisition we
did not grant any options or other equity-based incentives.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29,
Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
assets exchanged. The guidance in that Opinion, however, included certain
exceptions to that principle. This Statement amends Opinion 29 to eliminate the
exception for nonmonetary exchanges of similar productive assets that do not
have commercial substance. A nonmonetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a
result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges
occurring in fiscal periods beginning after June 15, 2005. Our adoption of SFAS
No. 153 is not expected to have a material impact on our financial position or
results of operations.
16
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting
for Conditional Asset Retirement Obligations," which clarifies that the term,
conditional asset retirement obligations, as used in SFAS No. 143, "Accounting
for Asset Retirement Obligations," refers to a legal obligation to perform an
asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the
entity. The uncertainty about the timing and (or) method of settlement of a
conditional asset retirement obligation should be factored into the measurement
of the liability when sufficient information exists. The interpretation also
clarifies when an entity would have sufficient information to reasonably
estimate the fair value of an asset retirement obligation. This interpretation
is effective no later than the end of 2006. The adoption of this Interpretation
is not expected to have a material effect on our financial position or results
of operations.
In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS No. 154"). SFAS No. 154 replaces APB No. 20 ("APB 20") and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements," and
applies to all voluntary changes in accounting principle, and changes the
requirements for accounting for and reporting of a change in accounting
principle. APB 20 previously required that most voluntary changes in accounting
principle be recognized by including in net income of the period of change a
cumulative effect of changing to the new accounting principle whereas SFAS No.
154 requires retrospective application to prior periods' financial statements of
a voluntary change in accounting principle, unless it is impracticable. SFAS No.
154 enhances the consistency of financial information between periods. SFAS No.
154 will be effective beginning with the Company's first quarter of fiscal year
2006. We do not expect that the adoption of SFAS No. 154 will have a material
impact on our results of operations, financial position or cash flows.
In June 2005, the EITF reached a consensus on Issue No. 05-06,
"Determining the Amortization Period for Leasehold Improvements" (EITF 05-06).
EITF 05-06 provides guidance for determining the amortization period used for
leasehold improvements acquired in a business combination or purchased after the
inception of a lease, collectively referred to as subsequently acquired
leasehold improvements). EITF 05-06 provides that the amortization period used
for the subsequently acquired leasehold improvements to be the lesser of (a) the
subsequently acquired leasehold improvements' useful lives, or (b) a period that
reflects renewals that are reasonably assured upon the acquisition or the
purchase. EITF 05-06 is effective on a prospective basis for subsequently
acquired leasehold improvements purchased or acquired in periods beginning after
the date of the FASB's ratification, which was on June 29, 2005. The Company
does not anticipate that EITF 05-06 will have a material impact on its
consolidated results of operations.
17
In July 2005, the Financial Accounting Standards Board (FASB) issued an
Exposure Draft of a proposed Interpretation "Accounting for Uncertain Tax
Positions--an interpretation of FASB Statement No. 109." Under the proposed
Interpretation, a company would recognize in its financial statements its best
estimate of the benefit of a tax position, only if the tax position is
considered probable of being sustained on audit based solely on the technical
merits of the tax position. In evaluating whether the probable recognition
threshold has been met, the proposed Interpretation would require the
presumption that the tax position will be evaluated during an audit by taxing
authorities. The proposed Interpretation would be effective as of the end of the
first fiscal year ending after December 15, 2005, with a cumulative effect of a
change in accounting principle to be recorded upon the initial adoption. The
proposed Interpretation would apply to all tax positions and only benefits from
tax positions that meet the probable recognition threshold at or after the
effective date would be recognized. We are currently analyzing the proposed
Interpretation and have not determined its potential impact on our Consolidated
Financial Statements. While we cannot predict with certainty the rules in the
final Interpretation, there is risk that the final Interpretation could result
in a cumulative effect charge to earnings upon adoption, increases in future
effective tax rates, and/or increases in future inter period effective tax rate
volatility.
Results of Operations
The following table sets forth our statements of operations for the years
ended December 31, 2005, 2004 and 2003, in U.S. dollars:
Year Ended December 31,
-----------------------
2005 2004 2003
---- ---- ----
Revenue $12,791,031 $10,400,325 $5,820,830
Costs of goods sold 8,656,873 7,159,107 4,441,215
Gross profit 4,134,158 3,241,218 1,379,615
Other operating income 2,134,872 - 197,230
R&D expenses 478,590 527,973 -
Selling expenses 147,020 80,843 57,409
General and administrative costs 364,150 214,680 176,277
Income from operations 5,279,270 2,417,722 1,343,159
Other income, net 410,900 12,907 (12,390)
Income before income taxes 5,690,170 2,430,629 1,330,769
(Credit) for income taxes - (509,031) 403,243
Net income 5,690,170 2,939,660 927,526
Other comprehensive income 101,132 - -
Comprehensive income 5,748,501 $2,939,660 $927,526
Our revenue is derived primarily from the sale of traditional pharmaceutical
medicines, traditional Chinese medicines, which are medicines derived from
Chinese herbs and nutritional products. The following table sets forth the
revenue and percentage of revenue derived from each of these types of products.
Year Ended December 31,
-----------------------
2005 2004 2003
Traditional
Pharmaceutical Medicine $10,107,138 79.02% $7,828,188 75.27% $4,694,630 80.65%
Traditional Chinese
Medicine $2,544,013 19.89% 2,255,672 21.69% 638,090 10.96%
Chinese Herbs $138,039 1.08% 307,508 2.96% 463,624 7.96%
Dietary Supplements $1,841 0.01% 8,957 0.09% 24,486 0.42%
Total $12,791,031 100% $10,400,325 100% $5,820,830 100%
Years Ended December 31, 2005 and 2004
Revenues for the year ended December 31, 2005 were $12.79 million, an
increase of approximately $2.39 million, or 23%, from the revenue of
approximately $10.4 million for the comparable period of 2004. During 2003, we
passed the inspection necessary for us to receive good supply practices
certification from the drug regulatory authorities. Some other drug distribution
companies did not receive this approval during 2005 and we were able to acquire
customers from a number of these other companies. In addition, we obtained the
distribution rights for three new products in 2005, which generated significant
additional revenues for us. These three products were: Levocarnitine to treat
cardiac muscle disease, bone problem and high blood lipid, the sales of which
amounted to $1million, our second largest selling product in 2005; Sodium
Ozagrel to treat stroke, with sales of $250,275, our fifth largest selling
product in 2005; and Konzern Tea Series, a dietary supplement which was put onto
the market in October 2005 with good sales potential, based on the current
market response.
Cost of revenue for the year ended December 31, 2005 was approximately
$8.66 million, an increase of approximately $1.5 million, or 21%, from $7.16
million for the year ended December 31, 2004. Our gross margin for the year
ended December 31, 2005 was 32.3% as compared with 31.2% for the year ended
December 31, 2004. The improvement in our gross margin reflected the increased
sales of the two new western-style drugs that we introduced during the year
ended December 31, 2005, which have lower production costs per unit than our
other products.
Other operating income of approximately $2.10 million represents the
proceeds from the sale of certain technology and know-how on the production of
medicines to nonaffiliated drug manufacturers. We had bought the technology in
its preliminary stage from other companies and then sold the improved technology
to other pharmaceutical companies and helped the buyers go through the approval
procedure for the medicine production license from the PRC State Health
Department by preparing the required documentation. The transaction was
accomplished in several steps.
Research and development expenses were approximately $478,590 for the year
ended December 31, 2005, a decrease of $49,383 from $527,973 for the year ended
December 31, 2004. The expenses in research and development reflect the
expansion of our research and development activities following the initiation of
our relationship with the Pharmaceutical Research Institute of Nanhua
University.
18
Selling expenses were approximately $147,020 for the year ended December
31, 2005, an increase of $66,177 from $80,843 for the year ended December 31,
2004. General and administrative expenses were $364,150 for the year ended
December 31, 2005, an increase of $149,470 from $214,680 for the year ended
December 31, 2004. The increase in selling, general and administrative expenses
reflects the additional new products we distributed in 2005, which required
additional marketing expenses.
Interest income and expense and other income were not significant in
either the year ended December 31, 2005 or the year ended December 31, 2004.
The gain of $337,940 in the year ended December 31, 2005 from the disposal
of intangible assets reflects the gain from the transfer of a certain
technology, called "Yubei Shuang Yan Mei," to Jinan Kangbai Technology Company.
We had no comparable gain in the year ended December 31, 2004.
The gain on an in-kind distribution of approximately $74,828 for the year
ended December 31, 2005 reflects the gain from the distribution of inventory at
fair market value to Konzern's stockholders as part of our distribution to our
stockholders.
In the year ended December 31, 2004, we had a credit for income taxes of
$509,031, which resulted from the waiver of income taxes related to a prior
period by the Chinese tax authorities . The waiver resulted from a change of
status in 2004 from a Chinese-owned business to a foreign joint venture. At that
time, we filed a tax clearance report with the local tax authority as if the
original company was dissolved and a new joint venture was formed. In order to
encourage foreign joint ventures to do business in China, the local tax
authority accepted our tax clearance report and treated the joint venture as a
new company without any tax liability.
As a result of the foregoing, our net income increased from $2,939,660 for
the year ended December 31, 2004 to $5,690,170 in the year ended December 31,
2005. In the year ended December 31, 2005 we also had a foreign currency
translation adjustment of $101,132, which resulted in comprehensive income of
$5,791,302.
Liquidity and Capital Resources
At December 31, 2005, we had working capital of approximately $2.17
million. Other than the revenue from the sales of our products, there was
$337,940 in revenue from our sale of the patent relating to "Yubei Shuang Yan
Mei" and $95,000 of proceeds from a short term loan.
During the year ended December 31, 2005, we made distributions to our
stockholders in the amount of approximately $3.1 million, consisting of $1.9
million in cash and $1.2 million in inventory.
19
In the course of our business, we must make significant deposits to our
suppliers when we place an order. At December 31, 2005, our advance payments to
our suppliers totaled approximately $1.08 million.
In February 2006, pursuant to the reverse acquisition, Konzern's equity
was acquired by the Company. As a result of that transaction, an investor group
invested $3.9 million in the Company, from which the Company received net
proceeds of approximately $3.3 million.
We intend to use our available funds to accelerate the development of new
drugs and establish our own production facilities to manufacture our own
products. We believe that our operations, together with the February 2006
private placement, will provide us with sufficient capital to enable us to
continue to operate and expand our business for at least the next twelve months;
however, to the extent that we make acquisitions, we may require additional
capital for the acquisition or for the operation of the combined companies. We
cannot assure that such funding will be available.
ITEM 7. FINANCIAL STATEMENTS
The following table presents selected financial data for Konzern for the
two previous fiscal years ended December 31, 2004 and 2005. We derived the
selected financial data set forth below with respect to Konzern's statements of
operations for the two fiscal years ended December 31, 2004 and 2005, and
Konzern's balance sheets as at December 31, 2004 and 2005, from our consolidated
financial statements that are included elsewhere in this report. You should read
the following summary financial data in conjunction with the consolidated
financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing elsewhere in this report.
For the Fiscal Year ended December 31,
----------------------------------------------------------
2005 2004
Gross revenues $12,791,031 $10,400,325
Income from operations 5,279,270 2,417,722
Net income 5,690,170 2,939,660
Total assets 5,329,579(1) 3,359,871 (2)
Total liabilities 570,873(1) 1,280,990 (2)
(1) As of December 31, 2005
(2) As of December 31, 2004
20
The Company's financial statements, including the notes thereto, together
with the report of independent certified public accountants thereon; Konzern's
financial statements, including the notes thereto, together with the report of
independent certified public accountants thereon, are presented beginning at
page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During the fiscal years ended December 31, 2005 and December 31, 2004, and
the subsequent interim period, Moore Stephens Wurth Frazer & Torbet, LLP
("MSWFT"), the principal independent accountant of our subsidiary, Konzern, has
not resigned or declined to stand for re-appointment, and was not dismissed.
On March 8, 2006, we dismissed Marcum & Kliegman, LLP ("MK") as our
independent accountant. MK had previously been engaged as the principal
accountant to prepare our financial statements. The reason for the termination
was that we had acquired Konzern, which has been audited by MSWFT as discussed
above. We believe that it was in our best interests to have MSWFT continue to
work with Konzern as auditors of the consolidated financial statements of the
Company and Konzern. The dismissal of MK and retention of MSWFT were reported in
our Current Report on Form 8-K that we filed on March 10, 2006 and the amended
Current Report on Form 8-K that we filed on March 21, 2006.
ITEM 8A. 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 Commission's rules and forms, and that such information is accumulated
and communicated to our management to allow timely decisions regarding required
disclosure. Management necessarily applied its judgment in assessing the costs
and benefits of such controls and procedures, which, by their nature, can
provide only reasonable assurance regarding management's control objectives.
On March 28,2006, we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective in alerting them in a timely manner to
information relating to the Company required to be disclosed in this report.
21
ITEM 8B. OTHER INFORMATION
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following are the officers and directors of the Company as of the date of
this report. Some of our officers and directors are residents of the PRC. As a
result, it may be difficult for investors to effect service of process within
the United States upon them or to enforce judgments obtained in the United
States courts against them in the PRC.
Name Age Position
---- --- --------
Senshan Yang 45 Chief Executive Officer and Director
Minhua Liu 38 Executive Vice President and Director
Huizhen Yu 26 Chief Financial Officer
Meiyi Xia 55 Vice President
Lin Li 36 Vice President & Secretary
Senshan Yang. Mr. Senshan Yang has been our Chief Executive Officer since
February 8, 2006 and a Director since February 10, 2006. He has been Chairman
and General Manager of Konzern in charge of whole operation of Konzern since
July 2000. Prior to that, Mr. Yang had served as a Manager Associate for
Guangdong Maoming Petroleum Corporation, a state-owned company, for nearly 20
years. Mr. Yang obtained his bachelor's degree from South China University of
Technology in 1981.
Minhua Liu. Ms. Minhua Liu has been our Executive Vice President since February
8, 2006 and a Director since February 10, 2006. She has been Vice General
Manager of Konzern since July 2000. Prior to that, she had served as a company
herbalist doctor for China Military Science Qiming Research Center in Beijing,
responsible for all the health care of all staff of the research center. Ms. Liu
obtained her bachelor's degree from Beijing College of Traditional Chinese
Medicine in 1992.
Huizhen Yu. Ms. Huizhen Yu has been our Chief Financial Officer since February
10, 2006. She has been Chief Financial Officer of Konzern since October 2002.
Ms. Yu was an accountant for Shenzhen Liuge Bicycle Equipment Co., Ltd from 2000
until 2002, and an accountant for Guangzhou JoinWin Consultancy Ltd. from 1997
to 2000. She obtained her bachelor's degree from Jinan University in Guangzhou
and Middle Level Accountant Certificate in China in 2002.
22
Meiyi Xia. Ms. Meiyi Xia has been our Vice President since March 22, 2006. Prior
to that, she had been our President from February 8, 2006 to March 21, 20006 and
a Director from February 7 through February 10, 2006. Ms. Xia has been a partner
of Princeton Capital Group, a private investment group, since January 2006 and a
partner of Spring Asset Management LLC since September 2004. From January 2003
to December 2005, Ms. Xia was chief executive officer of AiDi Financial
Investment LLC, a financial consulting company working mainly with companies in
the People's Republic of China. From July 2002 until January 2003, she was a
financial advisor at Morgan Stanley. From January 1999 until June 2002, she was
president of Asia Pacific Consulting and Asia Pacific Securities, a broker
dealer. She obtained her MBA from Long Island University and Diploma of Graduate
School in Financial Management from Scuola Mattei, Milan, Italy. Ms. Xia devotes
only a portion of her time to our business.
Lin Li. Ms. Lin Li has been our Vice President and Secretary since February 8,
2006. Ms. Li has been a partner of Princeton Capital Group, a private investment
group, since December 2005. From January 2005 until December 2005, Ms. Li was an
executive assistant at AiDi Financial Investment LLC. From 2003 to 2004, Ms. Li
was a financial analyst at NYU Medical Center. From 2002 to 2003, she was an
accountant for Princeton Econ Corporation, an information technology company,
and from 2000 to 2001 she was an accountant for Genesis Health Ventures, a
senior health care provider. She obtained her MBA degree from University of
Delaware and Bachelor of Science degree in finance from Renmin University of
China. Ms. Li devotes only a portion of her time to our business.
FAMILY RELATIONSHIPS
Minhua Liu (our shareholder, Director and Executive Vice President) and
Junhua Liu (our shareholder) are sister and brother. There are no other family
relationships among our officers, directors and principal shareholders.
AUDIT COMMITTEE FINANCIAL EXPERT
The full Board of Directors of the Company currently serves as our audit
committee. The Board of Directors does not currently have an audit committee
"financial expert" as defined under Rule 401(e) of Regulation S-B because the
Company only recently consummated its transaction with Konzern and the Board of
Directors is in the process of searching for a suitable candidate for this Board
position.
SECTION 16(a) BENEFICIAL REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's directors and executive officers, and persons who own more than
10% of a registered class of our equity securities, to file with the SEC initial
reports of ownership and reports of changes in ownership of common stock and
other of our equity securities. These insiders are required by SEC regulations
to furnish us with copies of all Section 16(a) forms they file, including Forms
3, 4 and 5. To our knowledge, during the calendar year ended December 31, 2005,
the two Forms 3 filed on September 29, 2005 by Capital Markets Advisory Group
and on September 26, 2005 by Allen Mark were filed late.
23
CODE ETHICS
We have not yet adopted a Code of Ethics for our executive officers. We
intend to adopt a Code of Ethics applying to such persons during the fiscal year
2006.
ITEM 10. EXECUTIVE COMPENSATION
Prior to the reverse acquisition on February 10, 2006, we did not pay any
compensation to any executive officers. Set forth below is information regarding
the compensation paid to Konzern's Chief Executive Officer. No other officer
received compensation in excess of $100,000 for 2005, 2004 and 2003.
ANNUAL COMPENSATION LONG TERM COMPENSATION
Awards Payouts
Other Restricted Securities
Annual Stock Underlying All
Year Compen- Awards Options/ LTIP Other
Name Position Ended Salary($) Bonus($) sation($) $ SARS Payouts Compensation
---- -------- ----- --------- -------- --------- - ---- ------- ------------
Senshan CEO 12/31/2005 $25,488 0 0 0 0 0 0
Yang
12/31/2004 $3,608 0 0 0 0 0 0
12/31/2003 $5,562 0 0 0 0 0 0
Prior to February 8, 2006, Senshan Yang, Minhua Liu and Junhua Liu were
the owners of all of the equity of Konzern. During 2005, Konzern made
distributions to its stockholders in the amount of approximately $3.1 million,
consisting of $1.9 million in cash and $1.2 million in inventory. Konzern made
distributions with respect to the year ended December 31, 2004 in the amount of
$2.6 million, consisting of $2.4 million in cash and $0.2 million in inventory.
These distributions were allocated to the equity holders in proportion to their
respective ownership interests in Konzern -- 50% to Mr. Yang, 40% to Ms. Liu and
10% to Mr. Liu.
Employment Agreements
We do not have employment agreements with any of our officers.
24
2006 Long-Term Incentive Plan
In January 2006, we adopted, subject to stockholder approval, the 2006
Long-Term Incentive Plan covering 1,575,000 shares of common stock. The plan
provides for the grant of incentive and non-qualified options, stock grants,
stock appreciation rights and other equity-based incentives to employees,
including officers, and consultants. The plan is to be administered by a
committee of not less than two directors, each of whom must to be an
"independent" director, within the meaning of the Exchange Act. In the absence
of a committee, the plan is administered by the Board of Directors. Independent
directors are not eligible for discretionary options; however, each newly
elected independent director receives, at the time of his or her election, a
five-year option to purchase 30,000 shares of common stock at the market price
on the date of his or her election. In addition, the plan provides for the
annual grant of an option to purchase 5,000 shares of common stock on April 1st
of each year, commencing April 1, 2007 to each independent director. Pursuant to
the plan, we granted stock options to purchase an aggregate of 430,000 shares of
common stock at $1.25 per share, of which options to purchase 120,000 shares
were granted to Meiyi Xia and options to purchase 50,000 shares were granted to
Lin Li. On March 22, 2006, we granted Meiyi Xia options to purchase an
additional 450,000 shares and Lin Li options to purchase an additional 400,000
shares. The options are subject to stockholder approval of the plan.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth as of the date of this report, certain
information with respect to the beneficial ownership of our voting securities by
(i) each person or group owning more than 5% of the Company's securities, (ii)
each director, (iii) each executive officer and (iv) all executive officers and
directors as a group.
Name and Amount and
Nature of Percent of
Address of Title of Beneficial
Beneficial Owner Class Ownership Class (1)
---------------- ----- --------- ---------
Senshan Yang Common Stock 3,265,000 44.2%
Director and CEO
Room 702 Guangri Mansion No. 8
South Wuyang Xincheng Si
Guangzhou
China
Minhua Liu Common Stock 2,612,000 35.4%
Director and Executive Vice President
Room 702 Guangri Mansion No. 8
South Wuyang Xincheng Si
Guangzhou
China
Junhua Liu Common Stock 653,000 8.9%
Room 702 Guangri Mansion No. 8
South Wuyang Xincheng Si
Guangzhou
China
Meiyi Xia Common Stock 150,000 2.0%
Vice President
51 Everett Drive; Suite A-20
West Windsor Professional Center
Princeton Junction, NJ 08550
Lin Li Common Stock 37,500 *
Vice President and Secretary
51 Everett Drive; Suite A-20
West Windsor Professional Center
Princeton Junction, NJ 08550
All Directors and Officers of the Company Common Stock 6,064,500 82.2%
as a group
* Less than 1%
(1) Based on 7,380,000 shares of Common Stock outstanding as of the date of this
report.
Except as otherwise indicated, each person has the sole power to vote and
dispose of all shares of common stock listed opposite his or her name. Each
person is deemed to own beneficially shares of common stock which are issuable
upon exercise of warrants or options or upon conversion of convertible
securities if they are exercisable or convertible within 60 days of the date of
this Annual Report on Form 10-KSB.
Barron Partners LP owns shares of Series A Convertible Preferred Stock and
Investor Warrants which, if fully converted and exercised, would result in the
ownership of more than 5% of our outstanding common stock; however, the Series A
Preferred Stock may not be converted and the Investor Warrants may not be
exercised if such conversion or exercise would result in Barron Partners LP
owning more than 4.9% of our outstanding Common Stock. This limitation may not
be waived.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We received two loans in the amount of $19,898 and $12,500 respectively
from an affiliate of one of the founding stockholders. These loans were
subsequently paid off when the reverse acquisition on February 8, 2006 took
place.
On February 8, 2006, we purchased 928,000 shares of common stock from
Capital Markets for $200,000. The purchase price was funded from the sale of the
Series A Convertible Preferred Stock and Investor Warrants in the February 2006
private placement. At the time of the purchase, Capital Markets owned
approximately 97.3% of our outstanding common stock.
25
Contemporaneously with the February 2006 private placement, we issued an
aggregate of 750,000 shares for services, including 150,000 shares to Meiyi Xia
and 37,500 shares to Lin Li. In connection with the February 2006 private
placement, we paid a consulting fee of $100,000 to AiDi Financial Investment
LLC. Ms. Xia was Chief Executive Officer of AiDi Financial Investment.
ITEM 13. EXHIBITS
Number Description
2.1 Stock Exchange Agreement, dated as of February 8, 2006, among the Company and the former
stockholders of Konzern (2);
3.1 Certificate of Incorporation, as filed with the Delaware Secretary of State on February 10,
2005 (1);
3.2 By-laws of the Company (1);
4.1 Specimen of Common Stock Certificate;
4.2 Specimen of Preferred Stock Certificate;
4.3 Certificate of Designation for the Series A Convertible Preferred Stock (2);
4.4 Form of warrant issued to investors in the February 2006 private placement (2);
10.1 Preferred stock purchase agreement dated February 8, 2006, between the Registrant and the
investors in the February 2006 private placement (2);
10.2 Registration rights agreement dated February 8, 2006, between the Registrant and the investors
in the February 2006 private placement (2);
10.3 Registration rights provisions pursuant to the stock exchange agreement (2);
21.1 List of Subsidiaries;
31.1 Certification of Senshan Yang pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002;
31.2 Certification of Huizhen Yu pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002;
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002;
99.1 2006 Long-term incentive plan (2).
26
Footnotes:
(1). Incorporated by reference from the exhibit to the Form 10-SB
filed by the Company with the Commission on June 23, 2005.
(2). Incorporated by reference from the exhibit to the Current
Report on Form 8-K filed by the Company with the Commission on
February 14, 2006.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following lists fees paid to Marcum & Kliegman, LLP ("MK"), former auditors
for the Company, during the fiscal year to which this report relates:
From February 10, 2005 (inception)
through December 31, 2005.
Audit Fees $12,500(1)
Audit Related Fees None
Tax Fees None
All Other Fees None
The following lists fees billed by Moore Stephens Wurth Fraser and Torbet, LLP
("MSWFT"), current auditors for the Company, from the date on which MSWFT was
engaged by the Company through the date of this report:
From March 8, 2006 through date of
report.
Audit Fees $40,000(2)
Audit Related Fees None
Tax Fees None
All Other Fees None
(1) Fees billed in connection with MK's audit of the financial statement from
February 10, 2005 to April 30, 2005 for the purpose of the registration
statement on Form 10-SB filed on June 23, 2005 and their review of the
registrant's interim financial statements for the fiscal quarters ended June 30,
2005 and September 30, 2005.
(2) Fees billed for services provided in connection with the audit of the
registrant's financial statements for the year ended December 31, 2005.
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.
LOUNSBERRY HOLDINGS III, INC.
Date: March 30, 2006 /s/ Senshan Yang
-----------------------------
By: Senshan Yang, CEO
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this Report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on March 30, 2006.
/s/ Huizhen Yu
--------------
Huizhen Yu, CFO
/s/ Minhua Liu
--------------
Minhua Liu, Director
/s/ Senshan Yang
----------------
Senshan Yang, Director
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Lounsberry Holdings III, Inc.
We have audited the accompanying balance sheet of Lounsberry Holdings III, Inc.
(a development stage company commencing February 10, 2005) as of December 31,
2005 and the related statements of operations, changes in stockholders'
deficiency, and cash flows for the period from February 10, 2005 (inception) to
December 31, 2005. These financial statements are the responsibility of the
company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit 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 audit provides 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 Lounsberry Holdings III, Inc.
(a development stage company commencing February 10, 2005) as of December 31,
2005 and the results of its operations and its cash flows for the period from
February 10, 2005 (inception) to December 31, 2005, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Moore Stephens Wurth Frazer and Torbet, LLP
----------------------------------------------
Moore Stephens Wurth Frazer and Torbet, LLP
Walnut, California March 30, 2006
1
LOUNSBERRY HOLDINGS III, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEET
AS OF DECEMBER 31, 2005
A S S E T S
-----------
2005
--------
Cash $ 2,000
--------
Total assets $ 2,000
========
L I A B I L I T I E S A N D S T O C K H O L D E R S' D E F I C I E N C Y
Loan payable - related party $ 32,398
--------
Total liabilities 32,398
--------
STOCKHOLDERS' DEFICIENCY:
Preferred stock, $.0001 par value; 10,000,000 shares authorized, 0 issued --
Common stock, $.0001 par value; 90,000,000 shares authorized,
1,028,000 issued and outstanding 103
Paid-in captial 1,999
Deficit accumulated during the development stage (32,500)
--------
Total stockholders' deficiency (30,398)
--------
Total liabilities and stockholders' deficiency $ 2,000
========
See report of independent registered public accounting firm
The accompanying notes are an integral part of this statement.
2
LOUNSBERRY HOLDINGS III, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF OPERATIONS
FOR THE PERIOD FROM FEBRUARY 10, 2005 (INCEPTION) TO DECEMBER 31, 20005
FORMATION COSTS $ 32,500
-----------
NET LOSS $ (32,500)
===========
WEIGHTED AVERAGE SHARES OUTSTANDING 1,020,222
===========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.03)
===========
See report of independent registered public accounting firm
The accompanying notes are an integral part of this statement.
3
LOUNSBERRY HOLDINGS III, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE PERIOD FROM FEBRUARY 10, 2005 (INCEPTION) TO DECEMBER 31, 20005
Deficit
Accumulated
During the Total
Number of Common Paid-in Development Stockholders'
Shares Stock Capital Stage Deficiency
Common stock issued on February 10,
2005 at $0.0001 per share 1,020,000 $ 102 $ -- $ -- $ 102
Common stock issued on December 23, --
2005 at $0.25 per share 8,000 1 1,999 2,000
Net loss (32,500) (32,500)
---------- ---------- ---------- ---------- ----------
BALANCE, December 31, 2005 1,028,000 $ 103 $ 1,999 $ (32,500) $ (30,398)
========== ========== ========== ========== ==========
See report of independent registered public accounting firm
The accompanying notes are an integral part of this statement.
4
LOUNSBERRY HOLDINGS III, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE PERIOD FROM FEBRUARY 10, 2005 (INCEPTION) TO DECEMBER 31, 20005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(32,500)
--------
Net cash used in operating activities (32,500)
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in common stock 102
Increase in loan payable - related party 32,398
Proceeds from issuance of common stock 2,000
--------
Net cash provided by financing activities 34,500
--------
NET INCREASE IN CASH 2,000
CASH, beginning of period --
--------
CASH, end of period $ 2,000
========
See report of independent registered public accounting firm
The accompanying notes are an integral part of this statement.
5
LOUNSBERRY HOLDINGS III, INC.
(A Development Stage Company Commencing February 10, 2006)
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - Organization, Business and Operations
Lounsberry Holdings III, Inc. (the "Company") was incorporated in Delaware on
February 10, 2005, with the objective of acquiring, or merging with, an
operating business.
At December 31, 2005, the Company had not yet commenced any operations. All
activity through December 31, 2005 relates to the Company's formation. The
Company selected December 31 as its fiscal year end.
The Company, based on proposed business activities, is a "blank check" company.
The Securities and Exchange Commission defines such a company as "a development
stage company that has no specific business plan or purpose or has indicated its
business plan is to engage in a merger or acquisition with an unidentified
company or companies, other entity, or person," and is issuing "penny stock," as
defined in Rule 3a-51-1 under the Securities Exchange Act of 1934. Many states
have enacted statutes, rules and regulations limiting the sale of securities of
"blank check" companies in their respective jurisdictions. Management does not
intend to undertake any efforts to cause a market to develop in its securities,
either debt or equity, until the Company concludes a business combination.
The Company was organized as a vehicle to investigate and, if such investigation
warrants, acquire a target company or business seeking the perceived advantages
of being a publicly held corporation and, to a lesser extent that desires to
employ the Company's funds in its business. The Company's principal business
objective for the next 12 months and beyond such time will be to achieve
long-term growth potential through a combination with a business rather than
immediate, short-term earnings ("Business Combination"). The Company will not
restrict its potential candidate target companies to any specific business,
industry or geographical location and, thus, may acquire any type of business.
The analysis of new business opportunities will be undertaken by or under the
supervision of the officers and directors of the Company.
As described in note 6 - subsequent events, on February 8, 2006 the Company
entered into a stock exchange agreement with Guangzhou Konzern Medicine Co. Ltd.
("Konzern"). The merger will be accounted for as a reverse acquisition. The
accounting rules for reverse acquisitions require that beginning with the date
of the acquisition, February 8, 2006, our balance sheet includes the assets and
liabilities of Konzern and its equity accounts are recapitalized to reflect the
net equity of Konzern. In the future, our historical operating results will be
the operating results of Konzern.
NOTE 2 - Summary of Significant Accounting Policies
Net Loss Per Share
Basic and diluted net loss per share is computed by dividing the net loss by the
weighted average number of shares of common stock outstanding during the period.
See report of independent registered public accounting firm
6
LOUNSBERRY HOLDINGS III, INC.
(A Development Stage Company Commencing February 10, 2006)
NOTES TO FINANCIAL STATEMENTS
NOTE 2 - Summary of Significant Accounting Policies, continued
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted 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 reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 3 - Loan Payable - Related Party
The Company received two loans in the amounts of $19,898 and $12,500
respectively from an affiliate of one of the Founding Stockholders. These loans
were subsequently paid off when the reverse merger took place as described in
note 6.
NOTE 4 - Preferred Stock
The Company is authorized to issue 10,000,000 shares of preferred stock with
such designations, voting and other rights and preferences as may be determined
from time to time by the Board of Directors. No shares of preferred stock have
been issued as of December 31, 2005.
NOTE 5 - New Accounting Standards
Management does not believe that any recently issued, but not yet effective,
accounting standards, if currently adopted, would have a material effect on the
accompanying financial statements.
NOTE 6 - Subsequent Events
Capital stock exchange
On February 8, 2006, the Company entered into a Stock Exchange Agreement
("Exchange Agreement") with Guangzhou Konzern Medicine Co. Ltd. ("Konzern") and
all of the stockholders of all the issued and outstanding capital of Konzern
("Konzern Stockholders"). Under the Exchange Agreement, the Company, at closing,
acquired all of the capital of Konzern from the Konzern Stockholders in exchange
for 6,350,000 shares of the Company's common stock.
Contemporaneously with the exchange with the Konzern Stockholders, The Company
sold to an investor group 3,120,000 shares of Series A Convertible Preferred
Stock ("Series A Preferred Stock"), a newly-created series of preferred stock,
which are convertible into 3,120,000 shares of common stock, and warrants to
purchase an additional 3,694,738 shares of common stock at $1.75 per share and
3,694,738 shares of common stock at $2.50 per share. The warrants have a term of
five years and it also provides that, with certain exceptions, if the Company
issues common stock at a price, or warrants or other convertible securities with
an exercise or conversion price which is less than the exercise price of the
warrants, the exercise price of the warrants will be reduced to the sales price,
exercise price or conversion price, as the case maybe, of such other securities.
See report of independent registered public accounting firm
7
LOUNSBERRY HOLDINGS III, INC.
(A Development Stage Company Commencing February 10, 2006)
NOTES TO FINANCIAL STATEMENTS
NOTE 6 - Subsequent Events, continued
The conversion rate of the Series A Preferred Stock and the exercise price of
the warrants are subject to adjustment in certain events, including the failure
to achieve specified levels of adjusted earnings before interest, taxes,
depreciation and amortization or fully diluted pre-tax income per share,
computed as set forth in the applicable agreements. Further, series A preferred
stock can not be converted and warrants can not be exercised if such conversion
or exercise would result in the holder and its affiliates of more than 4.9% of
the then outstanding number of shares of common stock on such date.
The gross proceeds from the sale of the preferred stock and warrants was $3.9
million, from which the Company received net proceeds of approximately $3.4
million.
Capital stock exchange, continued
The Company also purchased, for $200,000, 928,000 shares of common stock from
its then principal stockholder who is not affiliated with the Konzern
Stockholders or any member of the investor group.
Other shares issued
Lounsberry issued 750,000 shares of common stock to individuals for services
performed and of which 187,500 shares were issued to Lounsberry's officers.
Long-term incentive plan
Lounsberry also set up 2006 long-term incentive plan (the "Plan") to enable
Lounsberry to attract, retain and reward employees of Lounsberry and its
subsidiaries and affiliates, and otters who provide services to Lounsberry and
its subsidiaries and affiliates, and strengthen the mutuality of interests
between such key employees and such other persons and Lounsberry's shareholders,
by offering interest or equity-based incentive in Lounsberry, as well as
performance-based incentives payable in cash. The total number of shares of
common stock reserved and available for distribution under the Plan shall be
1,575,000 shares of stock.
See report of independent registered public accounting firm
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Guangzhou Konzern Medicine Co.,
Ltd.
We have audited the accompanying balance sheets of Guangzhou Konzern Medicine
Co., Ltd. as of December 31, 2005 and 2004, and the related statements of income
and other comprehensive income, stockholders' equity, and cash flows for each of
the years in the two-year period ended December 31, 2005. These financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. 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 Guangzhou Konzern Medicine Co.,
Ltd. as of December 31, 2005 and 2004, and the results of its operations and its
cash flows for each of the years in the two-year period ended December 31, 2005,
in conformity with accounting principles generally accepted in the United States
of America.
/s/ Moore Stephens Wurth Frazer and Torbet, LLP
----------------------------------------------
Moore Stephens Wurth Frazer and Torbet, LLP
Walnut, California March 24,2006
1
GUANGZHOU KONZERN MEDICINE CO., LTD.
BALANCE SHEETS
AS OF DECEMBER 31, 2005 AND 2004
ASSETS
------
2005 2004
Cash $ 91,964 $ 243,520
Accounts receivable, trade, net of allowance for doubtful accounts
of $12,333 and $6,839 as of December 31, 2005 and
December 31, 2004, respectively 2,410,824 1,360,929
Inventories 1,382,929 763,388
Other receivables 38,301 2,178
Other receivables - related parties -- 2,263
Advances to suppliers 1,075,546 438,265
Prepaid expenses -- 16,612
---------- ----------
Total current assets 4,999,564 2,827,155
PLANT AND EQUIPMENT, net 330,015 262,282
OTHER ASSETS:
Intangible asset, net -- 270,434
---------- ----------
Total assets $5,329,579 $3,359,871
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable, trade $ 170,196 $ 477,950
Short-term loans 95,480 --
Other payables and accrued liabilities 97,449 45,445
Customer deposits 37,292 694,493
Other taxes payable 170,456 63,102
---------- ----------
Total current liabilities 570,873 1,280,990
---------- ----------
SHAREHOLDERS' EQUITY:
Paid-in capital 121,000 121,000
Statutory reserves 722,909 722,909
Retained earnings 3,813,665 1,234,972
Accumulated other comprehensive income 101,132 --
---------- ----------
Total shareholders' equity 4,758,706 2,078,881
---------- ----------
Total liabilities and shareholders' equity $5,329,579 $3,359,871
========== ==========
See report of independent registered public accounting firm.
The accompanying notes are an integral part of this statement.
2
GUANGZHOU KONZERN MEDICINE CO., LTD.
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
------------ ------------
REVENUES $ 12,791,031 $ 10,400,325
COST OF GOOD SOLD 8,656,873 7,159,107
------------ ------------
GROSS PROFIT 4,134,158 3,241,218
------------ ------------
OTHER OPERATING INCOME 2,134,872 --
------------ ------------
OPERATING EXPENSES
Research and development expenses 478,590 527,973
Selling expenses 147,020 80,843
General and administrative expenses 364,150 214,680
------------ ------------
Total operating expenses 989,760 823,496
------------ ------------
INCOME FROM OPERATIONS 5,279,270 2,417,722
------------ ------------
OTHER INCOME
Interest income (expenses) (1,990) 1,836
Gain on distribution of dividend in-kind 74,828 14,339
Gain on disposal of assets 337,940 --
Other income 122 (3,268)
------------ ------------
Total other income 410,900 12,907
------------ ------------
INCOME BEFORE INCOME TAXES 5,690,170 2,430,629
CREDIT FOR INCOME TAXES -- 509,031
------------ ------------
NET INCOME 5,690,170 2,939,660
OTHER COMPREHENSIVE INCOME :
Foreign currency translation adjustment 101,132 --
------------ ------------
COMPREHENSIVE INCOME $ 5,791,302 $ 2,939,660
============ ============
See report of independent registered public accounting firm.
The accompanying notes are an integral part of this statement.
3
GUANGZHOU KONZERN MEDICINE CO., LTD.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Accumulated
other
Paid-in Statutory Retained comprehensive
capital reserves earnings income Totals
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2003 $ 121,000 $ 386,148 $ 1,189,905 $ -- $ 1,697,053
Net income 2,939,660 2,939,660
Statutory reserves 336,761 (336,761) --
Distributions (2,557,832) (2,557,832)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2004 121,000 722,909 1,234,972 -- 2,078,881
Net income 5,690,170 5,690,170
Distributions (3,111,477) (3,111,477)
Foreign currency translation adjustments 101,132 101,132
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2005 $ 121,000 $ 722,909 $ 3,813,665 $ 101,132 $ 4,758,706
=========== =========== =========== =========== ===========
See report of independent registered public accounting firm.
The accompanying notes are an integral part of this statement.
4
GUANGZHOU KONZERN MEDICINE CO., LTD.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,690,170 $ 2,939,660
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization 104,890 122,018
Gain on sale of intangible assets (337,940) -
Gain on distributions of dividends in-kind (74,828) (14,339)
Allowance for doubtful accounts 5,248 4,772
Change in operating assets and liabilities:
(Increase) decrease in assets:
Accounts receivable, trade (1,006,814) (954,418)
Inventories (1,539,182) (596,007)
Other receivables (35,551) (1,425)
Other receivables - related parties 2,286 (2,263)
Advances to suppliers (617,422) 371,933
Prepaid expenses 16,779 3,932
Increase (decrease) in liabilities:
Accounts payable, trade (315,015) 433,461
Other payables and accrued liabilities 50,147 16,539
Other payables - related parties -- (12,100)
Customer deposits (664,739) 694,493
Income taxes payable -- (401,938)
Other taxes payable (105,058) 49,048
Deferred tax liabilities -- (107,092)
----------- -----------
Net cash provided by operating activities 1,172,971 2,546,274
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of intangible assets 612,526 --
Purchase of equipment (166,914) (8,722)
----------- -----------
Net cash provided by (used in) investing activities
445,612 (8,722)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term loan 95,095 --
Payments on short-term loan -- (121,000)
Distributions (1,892,422) (2,321,882)
----------- -----------
Net cash used in financing activities
(1,797,327) (2,442,882)
----------- -----------
EFFECT OF EXCHANGE RATE ON CASH 27,188 --
----------- -----------
INCREASE (DECREASE) IN CASH (151,556) 94,670
CASH, beginning of year 243,520 148,850
----------- -----------
CASH, end of year $ 91,964 $ 243,520
=========== ===========
NONCASH FINANCING ACTIVITIES:
The Company has distributed inventories at fair market value
to shareholders as dividends in-kind $ 1,219,055 $ 235,950
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ -- $ --
=========== ===========
Cash paid for interest expense $ 1,828 $ 4,605
=========== ===========
See report of independent registered public accounting firm.
The accompanying notes are an integral part of this statement.
5
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 1 - Organization
Organization
Guangzhou Konzern Medicine Co., Ltd. (hereinafter referred to as "the Company")
was privatized from a state-owned medicine company on July 25, 2000 in
Guangzhou, the People's Republic of China (PRC). The registered capital is $
121,000. The Company belongs to an Equity Joint Venture ("EJV"). An EJV must
take the form of a limited liability company. The investment reward and risk,
namely its profit and losses must be allocated according to the partners'
capital contribution ratio. The business license provides for a 24 years term
which began on July 25, 2000 and will end on September 2, 2024. The Company can
extend term of the joint venture dependent upon the business license being
renewed. The following chart presents the current shareholders:
Percentage of Capital Paid in Capital
--------------------- --------------------
Yang Senshan 50% $ 60,500
Liu Minhua 40% 48,400
Liu Junhua 10% 12,100
--------------------- --------------------
Total 100% $121,000
--------------------- --------------------
On July 19, 2004, the Company entered a joint venture agreement with Bio-One
Corporation. Pursuant to the Joint Venture Agreement, Bio-One Corporation
acquired 51% of a joint venture entity with the Company for a cash payment of
$150,000 which should be paid within two months after the new business license
was issued.
Bio-One Corporation (referred to as "Bio-One") was incorporated in the State of
Nevada, with capital stock of 20,000,000 shares at $0.001 par value, and
1,000,000 shares of preferred stock at $0.001 per value. On July 26, 2000,
Bio-One approved and ratified an increase in the number of authorized shares of
its common stock from 20,000,000 to 100,000,000. On the same date, Bio-One
approved and ratified an increase in the number of authorized shares of its
preferred stock from 1,000,000 to 10,000,000. On December 11, 2003, Bio-One
approved and ratified an increase in the number of authorized shares of its
common stock from 100,000,000 to 500,000,000.
As of December 31, 2004, Bio-One had not met the cash payment obligation. On
December 21, 2005, Bio-One submitted a Mutual Release letter to withdraw the
Joint-Venture agreement dated July 19, 2004. This matter is described in detail
in note 16 - Bio-One Corporation Joint Venture Agreement.
Activities
The Company's business operations consist of the purchase of traditional Chinese
medicine materials; wholesale of traditional Chinese medicine, traditional
Chinese medicine raw materials, chemical medicine materials, chemical medicines,
antibiotics, drugs of diagnosis, medical treatment equipment and health care
food and biscuits; research and development of technology of new medicine and
biological pharmacy.
See report of independent registered public accounting firm
6
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies
Basis of preparation
The accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
Use of estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reported period. Actual results could differ
from those estimates.
Cash and cash equivalents
For purposes of the cash flow statements, the Company considers all highly
liquid investments with original maturities of three months or less at the time
of purchase to be cash equivalents.
Accounts receivable, trade
The Company conducts its business operations in the People's Republic of China.
During the normal course of business, the Company extends unsecured credit to
its customers. Management reviews its accounts receivable on a regular basis to
determine if the bad debt allowance is adequate. The Company records a provision
for accounts receivable trade that ranges from 0.3% to 1.0% of the outstanding
accounts receivable balance in accordance with generally accepted accounting
principles in the PRC. The allowance for doubtful accounts as of December 31,
2005 and 2004 amounted to $12,333 and $6,839, respectively.
Inventories
Inventories are stated at the lower of cost or market value and cost is
determined using weighted average method.
Plant and equipment
Plant and equipment are stated at cost less accumulated depreciation.
Depreciation is provided over their estimated service lives, principally on a
straight-line basis. The estimated lives used in determining depreciation are:
Furniture 3 - 5 years
Office equipment 3 - 5 years
Motor vehicles 4 - 10 years
The residual value is estimated to be 5% of cost.
See report of independent registered public accounting firm
7
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Intangibles
Under the Statement of Accounting Standards ("SFAS") No.142, "Goodwill and Other
Intangible Assets", all goodwill and certain intangible assets determined to
have indefinite lives will not be amortized but will be tested for impairment at
least annually. Intangible assets other than goodwill will be amortized over
their useful lives and reviewed for impairment in accordance with SFAS No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets".
Impairment of long-lived assets
Per SFAS No. 144, long-lived assets will be analyzed annually for indications of
impairment. Impairment of long-lived assets is assessed by the Company whenever
there is an indication that the carrying amount of the asset may not be
recovered. Recoverability of these assets is determined by comparing the
forecasted undiscounted cash flows generated by those assets to the assets' net
carrying value. The amount of impairment loss, if any, is measured as the
difference between the net book value of the assets and the estimated fair value
of the related assets.
The Company evaluates the recoverability of long-lived assets by measuring the
carrying amount of the assets against the estimated discounted future cash flows
associated with them. At the time such cash flows of certain long-lived assets
are not sufficient to recover the carrying value of such assets, the assets are
adjusted to their fair values.
Revenue recognition
The Company recognizes revenue when all four of the following criteria are met:
(1) persuasive evidence has been received that an arrangement exists; (2)
delivery of the products and/or services has occurred; (3) the selling price is
fixed or determinable; and (4) collectibility is reasonably assured. The Company
follows the provisions of SAB No. 104 which sets forth guidelines in the timing
of revenue recognition based upon factors such as passage of title,
installation, payments and customer acceptance. Any amounts received prior to
satisfying the Company's revenue recognition criteria is recorded as deferred
revenue.
Sales revenue represents the invoiced value of goods, net of a value-added tax
(VAT). All of the Company's products that are sold in the PRC are subject to a
Chinese value-added tax at a rate of 13% to 17% of the gross sales price. This
VAT may be offset by VAT paid by the Company on raw materials and other
materials included in the cost of producing their finished product.
Research and development costs
Research and development costs are expensed as incurred. The costs of material
and equipment that are acquired or constructed for research and development
activities, and have alternative future uses, either in research and
development, marketing, or sales, are classified as property and equipment and
depreciated over their estimated useful lives.
See report of independent registered public accounting firm
8
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Foreign currency translation
The functional currency of the Company is Chinese Renminbi. The financial
statements of the Company are translated to United Stated dollars using year-end
exchange rates as to assets and liabilities and average exchange rates as to
revenues and expenses. Capital accounts are translated at their historical
exchange rates when the capital transaction occurred. Net gains and losses
resulting from foreign exchange translations are included in the statements of
operations and stockholders' equity as other comprehensive income.
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 balance sheet and amounted to $101,132 and $0
as of December 31, 2005 and 2004, respectively. The balance sheet amounts with
the exception of equity at December 31, 2005 were translated at 8.06 RMB to
$1.00 USD as compared to 8.26 RMB at December 31, 2004. The equity accounts were
stated at their historical rate. The average translation rate of 8.18 RMB and
8.26 RMB for the years ended December 31, 2005 and 2004, respectively, were
applied to accounts within the income statement.
Comprehensive income (loss)
The foreign currency translation gain or loss resulting from the translation of
the financial statements expressed in Chinese Renminbi to United States dollars
is reported as other comprehensive income (loss) in the statement of income and
the statement of stockholders' equity.
Income taxes
The Company accounts for income taxes under the Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("Statement 109").
Under Statement 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under
Statement 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date. The Company has located its operations in a special economic region in
China.
See report of independent registered public accounting firm
9
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Income taxes, continued
This economic region allows foreign enterprises a two-year income tax exemption
and a 50% income tax reduction for the following three years. The Company was
approved as a Chinese-foreign joint venture enterprise in 2004. The Company has
income tax exemption for 2004 and 2005 and 50% income tax reduction for 2006,
2007 and 2008.
Fair value of financial instruments
The carrying amounts of the Company's financial instruments (including accounts
receivable, shareholder loans and notes payable) approximate fair value due to
the relatively short period to maturity of these instruments.
Concentrations and credit risks
For the years ended December 31, 2005 and 2004, 100% of the Company's sales were
to companies located in the PRC. At December 31, 2005 and 2004 all of the
Company's assets were located in the PRC. During 2005, the company extended
credit sale to one customer and the accounts receivable due from this customer
at December 31, 2005 amounted to $1,027,094.
The Company's operations may be adversely affected by significant political,
economic and social uncertainties in China. Although the Chinese government has
pursued economic reform policies in the past, there is no assurance that the
Chinese government will continue to pursue such policies or that such policies
may not be significantly altered, especially in the event of a change in
leadership, social or political disruption or unforeseen circumstances affect
China's political, economic and social conditions. There is also no guarantee
that the Chinese government's pursuit of economic reforms will be consistent or
effective.
Major suppliers
For the years ended December 31, 2005 and 2004, two suppliers accounted for
approximately 59% and 53% of the Company's purchases, respectively.
Major customers
For the years ended December 31, 2005 and 2004, two customers accounted for
approximately 72% and 25% of the Company's sales, respectively.
Cash
Cash includes cash on hand and demand deposits in accounts maintained with
state-owned banks within the People's Republic of China. Total cash in
state-owned banks at December 31, 2005 and December 31, 2004 amounted to $78,319
and $311,828, respectively, of which no deposits were covered by insurance. 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.
See report of independent registered public accounting firm
10
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Recently issued accounting pronouncements
In March 2004, the FASB issued EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF
03-1 includes new guidance for evaluating and recording impairment losses on
debt and equity investments, as well as new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB issued Staff Position EITF 03-1-1, which delays the effective date until
additional guidance is issued for the application of the recognition and
measurement provisions of EITF 03-1 to investments in securities that are
impaired; however, the disclosure requirements are effective for annual periods
ending after June 15, 2004. Management does not currently believe adoption will
have a material impact on the Company's financial position or results of
operations.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage).
Paragraph 5 of ARB No. 43, Chapter 4, previously stated that "...under some
circumstances, items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs may be so abnormal as to require treatment as
current period charges..." SFAS No. 151 requires that those items be recognized
as current-period charges regardless of whether they meet the criterion of "so
abnormal." In addition, this requires that allocation of fixed production
overhead to the costs of conversion be based on the normal capacity of the
production facilities.
The provisions of SFAS 151 shall be applied prospectively and are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005, with
earlier application permitted for inventory costs incurred during fiscal years
beginning after the date this Statement was issued. The Company's adoption of
SFAS No. 151 is not expected to have a material impact on the Company's
financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), "Share-Based
Payment", which amends FASB Statement No. 123 and will be effective for public
companies for interim or annual periods beginning after June 15, 2005. The
revised standard requires, among other things that compensation cost for
employee stock options be measured at fair value on the grant date and charged
to expense over the employee's requisite service period for the option. Due to
the absence of observable market prices for employee stock options, the standard
indicates that the fair value of most stock options will be determined using an
option-pricing model. The Company's adoption of SFAS No. 123(R) is not expected
to have a material impact on the Company's financial position or results of
operations.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets,
an amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29,
Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
assets exchanged. The guidance in that Opinion, however, included certain
exceptions to that principle.
See report of independent registered public accounting firm
11
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Recently issued accounting pronouncements, continued
This Statement amends Opinion 29 to eliminate the exception for nonmonetary
exchanges of similar productive assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of the
entity are expected to change significantly as a result of the exchange. SFAS
No. 153 is effective for nonmonetary exchanges occurring in fiscal periods
beginning after June 15, 2005. The Company's adoption of SFAS No. 153 is not
expected to have a material impact on the Company's financial position or
results of operations.
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," which clarifies that the term,
conditional asset retirement obligations, as used in SFAS No. 143, "Accounting
for Asset Retirement Obligations," refers to a legal obligation to perform an
asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the
entity. The uncertainty about the timing and (or) method of settlement of a
conditional asset retirement obligation should be factored into the measurement
of the liability when sufficient information exists. The interpretation also
clarifies when an entity would have sufficient information to reasonably
estimate the fair value of an asset retirement obligation. This interpretation
is effective no later than the end of the Company's 2006 year end. The adoption
of this Interpretation is not expected to have a material effect on the
Company's financial position or results of operations.
In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS No. 154"). SFAS No. 154 replaces APB No. 20 ("APB 20") and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements," and
applies to all voluntary changes in accounting principle, and changes the
requirements for accounting for and reporting of a change in accounting
principle. APB 20 previously required that most voluntary changes in accounting
principle be recognized by including in net income of the period of change a
cumulative effect of changing to the new accounting principle whereas SFAS No.
154 requires retrospective application to prior periods' financial statements of
a voluntary change in accounting principle, unless it is impracticable. SFAS No.
154 enhances the consistency of financial information between periods. SFAS No.
154 will be effective beginning with the Company's first quarter of 2006. The
Company does not expect that the adoption of SFAS No. 154 will have a material
impact on its results of operations, financial position or cash flows.
In June 2005, the EITF reached a consensus on Issue No. 05-06, "Determining the
Amortization Period for Leasehold Improvements" (EITF 05-06). EITF 05-06
provides guidance for determining the amortization period used for leasehold
improvements acquired in a business combination or purchased after the inception
of a lease, collectively referred to as subsequently acquired leasehold
improvements. EITF 05-06 provides that the amortization period used for the
subsequently acquired leasehold improvements to be the lesser of (a) the
subsequently acquired leasehold improvements' useful lives, or (b) a period that
reflects renewals that are reasonably assured upon the acquisition or the
purchase. EITF 05-06 is effective on a prospective basis for subsequently
acquired leasehold improvements purchased or acquired in periods beginning after
the date of the FASB's ratification, which was on June 29, 2005. The Company
does not anticipate that EITF 05-06 will have a material impact on its
consolidated results of operations.
See report of independent registered public accounting firm
12
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Recently issued accounting pronouncements, continued
In July 2005, the Financial Accounting Standards Board (FASB) issued an Exposure
Draft of a proposed Interpretation "Accounting for Uncertain Tax Positions--an
interpretation of FASB Statement No. 109." Under the proposed Interpretation, a
company would recognize in its financial statements its best estimate of the
benefit of a tax position, only if the tax position is considered probable of
being sustained on audit based solely on the technical merits of the tax
position. In evaluating whether the probable recognition threshold has been met,
the proposed Interpretation would require the presumption that the tax position
will be evaluated during an audit by taxing authorities. The proposed
Interpretation would be effective as of the end of the first fiscal year ending
after December 15, 2005, with a cumulative effect of a change in accounting
principle to be recorded upon the initial adoption. The proposed Interpretation
would apply to all tax positions and only benefits from tax positions that meet
the probable recognition threshold at or after the effective date would be
recognized. The Company is currently analyzing the proposed Interpretation and
has not determined its potential impact on our Consolidated Financial
Statements. While we cannot predict with certainty the rules in the final
Interpretation, there is risk that the final Interpretation could result in a
cumulative effect charge to earnings upon adoption, increases in future
effective tax rates, and/or increases in future interperiod effective tax rate
volatility.
In October 2005, FASB Staff Position (FSB) FAS 13-1, "Accounting for Rental
Costs Incurred during a Construction Period" was issued. This FSP concluded that
rental costs associated with ground or building operating leases that are
incurred during a construction period be expensed. The guidance in the FSP is
required to be applied to the first reporting period beginning after December
15, 2005. The adoption of this pronouncement is not expected to have a material
impact on the Company's financial position or results of operations.
Note 3 - Accounts receivable, trade
Accounts receivable, trade as of December 31, 2005 and 2004 consisted of the
following:
December 31, December 31,
2005 2004
---------- ----------
Accounts receivable $2,423,157 $1,367,768
Less: allowance for
doubtful accounts 12,333 6,839
---------- ----------
Totals $2,410,824 $1,360,929
========== ==========
See report of independent registered public accounting firm
13
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 4 - Inventories
Inventories consisted of the following:
December 31, December 31,
2005 2004
---------- ----------
Chemical medicine $1,382,929 $ 755,965
Traditional Chinese Medicine -- 7,423
---------- ----------
Totals $1,382,929 $ 763,388
========== ==========
Note 5 - Advances to suppliers
Advances to suppliers as of December 31, 2005 and 2004 amounted to $1,075,546
and $438,265 respectively. They represent advances to suppliers on inventory
purchases.
Note 6 - Plant and equipment
Plant and equipment is summarized as follows:
December 31, December 31,
2005 2004
-------- --------
Furniture and fixtures $160,081 $122,464
Office equipment 369,459 237,449
Motor vehicles 132,804 122,815
-------- --------
662,344 482,728
Less: Accumulated
depreciation 332,329 220,446
-------- --------
Plant and equipment, net $330,015 $262,282
======== ========
Depreciation expense for the periods ended December 31, 2005 and 2004 amounted
to $104,890 and $100,384, respectively.
Note 7 - Intangible
The intangible asset is a registered patent purchased from a third party in
2002. The patent is recorded at original cost at acquisition and amortized using
the straight line method over 15 years when the patent expires. On an annual
basis, the Company evaluates the fair value of the patent and determines if the
patent has become impaired.
On January 10, 2005, the Company entered into a contract to sell the patent to
an unrelated party for approximately $610,000. The transfer of the title was
completed at the end of 2005 and the Company received the contract price in full
during 2005.
See report of independent registered public accounting firm
14
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 7 - Intangible, continued
December 31, December 31,
2005 2004
------------- -------------
Yubei Throat Plum and Manufacturing Method
$ -- $324,520
Less: Accumulated amortization -- 54,086
------------- -------------
Intangible assets, net $ -- $270,434
------------- -------------
Note 8 - Related party transactions
As of December 31, 2005 and 2004, the due from related parties amounted to $0
and $2,263, respectively. Those amounts were generated from making cash advances
to or from the shareholders for ordinary business expenses. These amounts are
unsecured, non interest bearing, and have no fixed terms of repayment.
Note 9 - Customer deposits
The Company requires their customers to deposit monies with the Company when
they place an order for their products. The Company does not pay interest on
these amounts. Customer deposits amounted to $37,292 and $694,493 as of December
31, 2005 and 2004, respectively.
Note 10 - Taxes payable
Income and other taxes payable
Taxes payable consisted of the following:
December 31, December 31,
2005 2004
-------- --------
Urban maintenance and
construction tax $ -- $ 1,535
Individual income tax 205 68
Value added tax 170,251 61,499
-------- --------
Totals $170,456 $ 63,102
======== ========
On October 15, 2004, the local Chinese tax authority waived the previously
accrued tax as accumulated prior to September 1, 2004 in the amount of $509,031
which was recorded as a credit during 2004 for previously accrued income taxes.
See report of independent registered public accounting firm
15
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 10 - Taxes payable, continued
Income and other taxes payable, (continued)
The credit for income taxes for the year ended December 31, 2004 consisted of
the following:
Year ended
December 31,
2004
--------
Credit for China income taxes $401,939
Deferred taxes 107,092
--------
Totals $509,031
========
Provision for income taxes
The following table reconciles the U.S. Statutory rates to the Company's
effective tax rate:
December 31, December 31,
2005 2004
------ ------
U.S. Statutory Rates 34.0 34.0
Foreign income not recognized in USA (34.0) (34.0)
China income taxes 33.0 33.0
Tax Exemption for China income taxes (33.0) (33.0)
------ ------
Totals - % - %
====== ======
In 2004, The Company became a Foreign JV enterprise. This economic region allows
foreign enterprises a two-year income tax exemption and a 50% income tax
reduction for the following three years. The Company was approved as a Foreign
JV enterprise in 2004. The Company has income tax exemption for years ending
December 31, 2004 and 2005 and 50% income tax reduction for the years ending
December 31, 2006, 2007 and 2008. The estimated tax savings due to this tax
exemption for the years ended December 31, 2005 and 2004 amounted to $1,877,756
and $802,108, respectively.
Note 11 - Short-term bank loan payable
Short-term bank loans payable represent amounts due to banks and are due on
demand or normally within one year. Short-term loans payable at December 31,
2005 consisted of the following:
Citic Industrial Bank due February 1, 2006,
annual interest at 5.22% $ 95,480
==========
See report of independent registered public accounting firm
16
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 12 - Commitments and contingencies
The Company leases its facilities under short-term and long-term, non-cancelable
operating lease agreements expiring through December 2006. The non-cancelable
operating lease agreement states that the Company pays certain operating
expenses applicable to the leased premises. Total rental expense for the years
ended December 31, 2005 and 2004 amounted to $31,282 and $39,535, respectively.
At December 31, 2005, the future minimum annual lease payments for the year
ending December 31, 2006 will be $23,213 and $0 for the years thereafter.
Note 13 - Other operating income
Other operating income represents revenues generated from sales contracts of
pharmaceutical or medical formulas and technologies the Company has internally
developed or purchased from outside. Other operating income for the year ended
December 31, 2005 and 2004 amounted to $2,134,872 and $0, respectively
Note 14 - Statutory reserves and dividend distribution
Statutory reserves
The Company is required to make appropriations to reserve funds, comprising the
statutory surplus reserve, statutory welfare fund and discretionary surplus
reserve, based on after-tax net income determined in accordance with generally
accepted accounting principles of the People's Republic of China (the "PRC
GAAP"). Appropriation to the statutory surplus reserve is required to be at
least 10% of the after tax net income determined in accordance with the PRC GAAP
until the reserve is equal to 50% of the entities' registered capital.
Appropriations to the statutory public welfare fund is required to be between 5%
to 10% of the after tax net income determined in accordance with the PRC GAAP.
Appropriations to the discretionary surplus reserve are made at the discretion
of the Board of Directors.
The statutory 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 statutory welfare reserve can only be utilized on capital items for the
collective benefit of the Company's employees, such as construction of
dormitories, cafeteria facilities, and other staff welfare facilities. This fund
is non-distributable other than upon liquidation. The transfer to this fund must
be made before distribution of any dividend to shareholders.
The discretionary surplus fund may be used to acquire fixed assets or to
increase the working capital to expend on production and operation of the
business. The Company's Board of Directors decided not to make appropriation to
this reserve.
See report of independent registered public accounting firm
17
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 14 - Statutory reserves and dividend distribution, continued
Statutory reserves, continued
According to the Company's articles, the Company should appropriate 10% of the
net profit as statutory surplus reserve and 6% as statutory public welfare. For
the year ended December 31, 2004, the Company appropriated to the statutory
surplus reserve and welfare reserve in the amount of $210,475 and $126,286,
respectively. As of December 31, 2005, the statutory reserve reached 50% of the
registered capital and no further statutory reserve is required thereafter.
Dividend distribution
Shareholders resolved on July 11 and September 30, 3005, and December 23, 2004
to distribute profits of the Company amounting to $3,111,477 and $2,557,832 for
the years ended December 31, 2005 and 2004, respectively. The distributions
consist of the following:
December 31, December 31,
2005 2004
---------- ----------
Cash distributions $1,892,422 $2,321,882
Dividend in-kind 1,219,055 235,950
---------- ----------
Total distributions $3,111,477 $2,557,832
========== ==========
The Company distributed inventory to the shareholders as part of their
distribution and in accordance with APB No. 29 "Accounting for nonmonetary
transactions", the Company recorded the inventory at its fair market value and
recognized a gain of $74,828 and $14,339 in the accompanying income statement
for the years ended December 31, 2005 and 2004, respectively.
Note 15 - Retirement benefit plans
Regulations in the PRC require the Company to contribute to a defined
contribution retirement plan for all permanent employees. The contribution is
based on a percentage required by the local government and the employees'
current compensation. The Company contributed $23,575 and $27,978 for the years
ended December 31, 2005 and 2004, respectively.
Note 16 - Bio-One Corporation joint venture agreement
On October 25, 2005, the Konzern shareholders and Bio-One entered into Stock
Transfer Agreements with the Company pursuant to which the Konzern Shareholders
agreed to sell all of their shares in Konzern to the Company for an aggregate
purchase price of RMB 24,280,000 and Bio-One agreed to sell all of its shares in
Konzern for RMB 1. Consummation of the forgoing transactions under the Stock
Transfer Agreements was conditioned upon Konzern's receiving an additional $
3,000,000 in funding on or before February 28, 2006. At that time, the Company
was a "shell" corporation with no operations or business.
On December 21, 2005, Bio-One Corporation submitted a letter to the Company to
have a mutual release from the Joint-Venture agreement dated July 19, 2004
between the Company and Bio-One Corporation. This letter confirmed that Bio-One
has no rights or obligations under either of the agreement and Bio-One has
released and discharged the Company of any liability under the joint venture
agreement. In consideration of this release by Bio-one, the Company has also
released and discharged Bio-One accordingly.
See report of independent registered public accounting firm
18
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 17 - Subsequent events
Capital stock exchange
On February 8, 2006, Lounsberry Holdings III, Inc., a Delaware corporation
("Lounsberry"), entered into a Stock Exchange Agreement ("Exchange Agreement")
with Guangzhou Konzern Medicine Co. Ltd. ("Konzern") and all of the stockholders
of all the issued and outstanding capital of Konzern ("Konzern Stockholders").
Under the Exchange Agreement, Lounsberry, at closing, acquired all of the
capital of Konzern from the Konzern Stockholders in exchange for 6,350,000
shares of Lounsberry's common stock.
Contemporaneously with the exchange with the Konzern Stockholders, Lounsberry
sold to an investor group 3,120,000 shares of Series A Convertible Preferred
Stock ("Series A Preferred Stock"), a newly-created series of preferred stock,
which are convertible into 3,120,000 shares of common stock, and warrants to
purchase an additional 3,694,738 shares of common stock at $1.75 per share and
3,694,738 shares of common stock at $2.50 per share. The warrants have a term of
five years and it also provides that, with certain exceptions, if Lounsberry
issues common stock at a price, or warrants or other convertible securities with
an exercise or conversion price which is less than the exercise price of the
warrants, the exercise price of the warrants will be reduced to the sales price,
exercise price or conversion price, as the case maybe, of such other securities.
The conversion rate of the Series A Preferred Stock and the exercise price of
the warrants are subject to adjustment in certain events, including the failure
to achieve specified levels of adjusted earnings before interest, taxes,
depreciation and amortization or fully diluted pre-tax income per share,
computed as set forth in the applicable agreements. Further, series A preferred
stock can not be converted and warrants can not be exercised if such conversion
or exercise would result in the holder and its affiliates of more than 4.9% of
the then outstanding number of shares of common stock on such date.
The gross proceeds from the sale of the preferred stock and warrants was $3.9
million, from which Lounsberry received net proceeds of approximately $3.4
million.
Lounsberry also purchased, for $200,000, 928,000 shares of common stock from its
then principal stockholder who is not affiliated with the Konzern Stockholders
or any member of the investor group.
See report of independent registered public accounting firm
19
GUANGZHOU KONZERN MEDICINE CO., LTD
NOTES TO FINANCIAL STATEMENTS
Note 17 - Subsequent events, continued
Other shares issued
Lounsberry issued 750,000 shares of common stock to individuals for services
performed and of which 187,500 shares were issued to Lounsberry's officers.
Long-term incentive plan
Lounsberry also set up 2006 long-term incentive plan (the "Plan") to enable
Lounsberry to attract, retain and reward employees of Lounsberry and its
subsidiaries and affiliates, and otters who provide services to Lounsberry and
its subsidiaries and affiliates, and strengthen the mutuality of interests
between such key employees and such other persons and Lounsberry's shareholders,
by offering interest or equity-based incentive in Lounsberry, as well as
performance-based incentives payable in cash. The total number of shares of
common stock reserved and available for distribution under the Plan shall be
1,575,000 shares of stock.
See report of independent registered public accounting firm