As filed with the Securities and Exchange Commission on April , 2006
Registration No. 333-
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
LOUNSBERRY HOLDINGS III, INC.
(Name of Small Business Issuer in Its Charter)
Delaware 5122 51-0539830
(State or Other Jurisdiction (Primary Standard (IRS Employer
of Incorporation or Industrial Classification Identification No.)
Organization) Code Number)
51 Everett Drive; Suite A-20;West Windsor Professional Center,
Princeton Junction, NJ 08550 (609) 799-1889
(Address and telephone number of Principal Executive Offices)
51 Everett Drive; Suite A-20;West Windsor Professional Center,
Princeton Junction, NJ 08550
(Address of principal place of business)
Mr. Senshan Yang, CEO
Lounsberry Holdings III, Inc.
51 Everett Drive; Suite A-20; West Windsor Professional Center
Princeton Junction, NJ 08550
Telephone: (609)799-1889
Fax: (609)
(Name, address and telephone number of agent for service)
Please send a copy of all communications to:
Asher S. Levitsky P.C.
Katsky Korins LLP
605 Third Avenue
New York, NY 10158
Telephone: (212) 716-3239
Fax: (212) 716-3338
Approximate date of proposed sale to the public: As soon as practicable
after this Registration Statement becomes effective.
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering.[ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box. [ ]
CALCULATION OF REGISTRATION FEE
---------------------------- ----------------------- ------------------------ ------------------------ ------------------------
Proposed maximum Proposed maximum
Title of each class of Amount to be offering price per aggregate offering Amount of registration
securities to be registered registered unit (1) price(1) fee
---------------------------- ----------------------- ------------------------ ------------------------ ------------------------
Common Stock, par value 3,220,000 $ 1.25 $ 4,025,000.00 $ 430.68
$.0001 per share(2)
---------------------------- ----------------------- ------------------------ ------------------------ ------------------------
Common Stock, par value 7,389,476 2.125 15,702,636.50 1,680.18
$.0001 per share (3)
---------------------------- ----------------------- ------------------------ ------------------------ ------------------------
$2,110.86
---------------------------- ----------------------- ------------------------ ------------------------ ------------------------
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(a) promulgated under the Securities Act of 1933,
as amended. The 3,220,000 shares represent 100,000 outstanding shares
of common stock and 3,120,000 shares of common stock issuable upon
conversion of the series A convertible preferred stock. The proposed
maximum offering price is based on the purchase price of the preferred
stock, with no value being attributed to the warrants. The 7,389,476
are shares of common stock issuable upon exercise of common stock
purchase warrants, and the proposed maximum offering price is equal to
the average exercise price of the warrants.
(2) Represents 100,000 outstanding shares of common stock and 3,120,000
shares of common stock issuable upon conversion of the series A
convertible preferred stock.
(3) Represents 7,389,476 shares of common stock issuable upon exercise of
warrants at an average exercise price of $2.125 per share.
The Registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant shall
file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with section 8(a) of
the securities act of 1933 or until the registration statement shall become
effective on such date as the commission, acting pursuant to said section 8(a),
may determine.
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION DATED APRIL 13, 2006
PROSPECTUS
10,609,476 Shares
LOUNSBERRY HOLDINGS III, INC.
Common Stock
As of the date of this prospectus, there is no trading market in our
common stock, and we cannot assure you that a trading market will develop.
The selling stockholders may offer and sell from time to time up to an
aggregate of 10,609,476 shares of our common stock that they have acquired or
may acquire from us, including shares that they may acquire upon conversion of
series A preferred stock and exercise of warrants. For information concerning
the selling stockholders and the manner in which they may offer and sell shares
of our common stock, including limitation on the number of shares that may be
issued upon conversion of the series A preferred stock or certain of the
warrants, see "Selling Stockholders" and "Plan of Distribution" in this
prospectus.
We will not receive any proceeds from the sale by the selling stockholders
of their shares of common stock other than the exercise price of the outstanding
warrants if and when the warrants are exercised. We will pay the cost of the
preparation of this prospectus, which is estimated at $25,000.
Investing in shares of our common stock involves a high degree of risk.
You should purchase our common stock only if you can afford to lose your entire
investment. See "Risk Factors," which begins on page 6.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined whether
this prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The selling stockholders have not engaged any underwriter in connection
with the sale of their shares of common stock.
The date of this Prospectus is April 13, 2006
You should rely only on the information contained in this prospectus. We have
not authorized any dealer, salesperson or other person to provide you with
information concerning us, except for the information contained in this
prospectus. The information contained in this prospectus is complete and
accurate only as of the date on the front cover page of this prospectus,
regardless when the time of delivery of this prospectus or the sale of any
common stock. This prospectus is not an offer to sell, nor is it a solicitation
of an offer to buy, our common stock in any jurisdiction in which the offer or
sale is not permitted.
TABLE OF CONTENTS
Page
Prospectus Summary 3
Risk Factors 6
Forward-Looking Statements 18
Use of Proceeds 18
Selling Stockholders 19
Plan of Distribution 22
Market for Common Stock and Stockholder Matters 24
Management's Discussion and Analysis of Financial Condition and 24
Results of Operations 29
Business 32
Management 37
Principal Stockholders 40
Certain Relationships and Related Transactions 41
Description of Capital Stock 42
Experts 45
Legal Matters 45
How to Get More Information 46
Financial Statements F-1
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PROSPECTUS SUMMARY
This summary does not contain all of the information that is important to
you. You should read the entire prospectus, including the Risk Factors and our
consolidated financial statements and related notes appearing elsewhere in this
prospectus before making an investment decision.
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 other medicine companies. 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 sell us 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.
Prior to 2004, we did not engage in any research and development
activities. On October 8, 2003, we entered into an agreement to establish a
cooperative relationship with the Pharmaceutical Research Institute of Nanhua
University. Under the Agreement, we and Nanhua University jointly set up a new
medicine research facility - New Medicine Research Center of Konzern and Nanhua
University. We contribute 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.
Prior to July 25, 2000, our business was conducted as a state-owned
medicine company in Guangzhou, PRC. On July 25, 2000, we were privatized, in a
transaction by which our principal stockholders acquired the equity in our
company.
About Us
We are a Delaware corporation organized under the name Lounsberry Holdings
III, Inc. on February 10, 2005. Our board of directors has approved, subject to
stockholder approval, a change in our corporate name to China Medicine
Corporation.
On February 8, 2006, in a transaction characterized as a reverse
acquisition, we entered into an agreement pursuant to which we acquired all of
the equity of Guangzhou Konzern Medicine Co. Ltd., a Chinese company
("Konzern"), for 6,530,000 shares of common stock, representing approximately
88.5% of our outstanding common stock. The transaction by which we acquired the
stock of Konzern is referred to in this prospectus as the "reverse acquisition."
From and after February 8, 2006, our business was the business conducted by
Konzern prior to the reverse acquisition. The accounting rules for reverse
acquisitions require that beginning February 8, 2006, our balance sheet includes
the assets and liabilities of Konzern and our equity accounts were recapitalized
to reflect the net equity of Konzern. In addition, the 2005 and 2004 operating
results are those of Konzern.
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In connection with the acquisition of Konzern, we entered into:
o A preferred stock purchase agreement pursuant to which we issued 3,120,000
shares of Series A Preferred Stock and warrants to purchase an aggregate
of 7,389,476 shares of common stock for $3,900,000. The series A preferred
stock is convertible into 3,120,000 shares of common stock.
o A stock redemption agreement with Capital Markets Advisory Group, LLC
("Capital Markets"), which was then our principal stockholder, pursuant to
which we purchased 928,000 shares of common stock from Capital Markets for
$200,000, using the proceeds from the sale of the series A preferred
stock.
Our executive offices are located at 51 Everett Drive; Suite A-20; West
Windsor Professional Center, Princeton Junction, NJ 08550 (609) 799-1889. Our
website is www.chinamedicinecorp.com. Neither the information nor other
statements contained in our website nor the information contained in any other
Internet website is a part of this prospectus.
References in this prospectus to "we," "us," "our" and similar words refer
to Lounsberry Holdings III, Inc. and its subsidiaries, unless the context
indicates otherwise, and, prior to the effectiveness of the reverse acquisition,
these terms refer to Konzern.
Issuance of Securities to the Selling Stockholders
The selling stockholders acquired their shares in private placements 2005
and 2006.
In connection with our organization in February 2005, we issued 1,000,000
to Capital Markets and 20,000 shares to Mark Allen for nominal consideration. In
February 2006, in connection with the reverse acquisition, we purchased 928,000
shares from Capital Markets for $200,000.
In December 2005, we issued 8,000 shares of common stock for $2,000.
In February 2006, we issued to four of the selling stockholders 3,120,000
shares of Series A Preferred Stock and warrants to purchase an aggregate of
7,389,476 shares of common stock for $3,900,000. The series A preferred stock is
convertible into 3,120,000 shares of common stock
We are registering the 100,000 outstanding shares of common stock held by
selling stockholders, 3,120,000 shares of common stock which are issuable upon
conversion of the series A preferred stock, and 7,389,476 shares of common stock
issuable upon exercise of warrants.
THE OFFERING
Common Stock Offered: The selling stockholders are offering
a total of 10,609,476 shares of common
stock, of which 100,000 shares are
outstanding, 3,120,000 shares are
issuable upon conversion of the series
A preferred stock and 7,389,476 shares
are issuable upon exercise of warrants
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Limitation on Issuance of The holders of the series A preferred
Common Stock: stock and the holders of the warrants
cannot convert their shares of series
A preferred stock or exercise their
warrants to the extent that such
conversion and exercise would result
in the holders and their affiliates
owning more than 4.9% of our
outstanding common stock.
Outstanding Shares of 7,380,000 shares(1,2)
Common Stock:
Common Stock to be 17,889,476 shares(1)
Outstanding After Offering:
Use of Proceeds: We will receive no proceeds from the
sale of any shares by the selling
stockholders. In the event that any
selling stockholders exercise their
warrants, we would receive the
exercise price. If all warrants are
exercised, we would receive
approximately $16.5 million, all of
which, if and when received, would be
used for working capital and other
corporate purposes.
(1) Does not include a total of 1,575,000 shares are reserved for options,
stock grants or other equity-based incentives under our 2006 long-term
incentive plan.
(2) Does not include the shares of common stock issuable upon conversion of
the series A preferred stock or exercise of warrants held by the
selling stockholders.
SUMMARY FINANCIAL INFORMATION
(dollars in thousands)
The following information relating to Konzern as at December 31, 2005 and
for the years ended December 31, 2005 and 2004 has been derived from its audited
financial statements which appear elsewhere in this prospectus. Lounsberry
Holdings III, Inc. did not conduct any operations during 2005. Its separate
financial statements for the period February 10, 2005 through December 31, 2005
appear elsewhere in this prospectus.
Statement of Operations Information for Konzern:
Year Ended December 31,
2005 2004
------- -------
Revenues $12,791 $10,400
Gross profit 4,134 3,241
Income from operations 5,279 2,418
Income before income taxes 5,690 2,431
Net income 5,690 2,940
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Balance Sheet Information for Konzern:
December 31, 2005
-----------------
Working capital $ 4,429
Total assets 5,330
Total liabilities 571
Retained earnings 3,814
Stockholders' equity 4,759
RISK FACTORS
An investment in our securities involves a high degree of risk. In
determining whether to purchase our securities, you should carefully consider
all of the material risks described below, together with the other information
contained in this prospectus before making a decision to purchase our
securities. You should only purchase our securities if you can afford to suffer
the loss of your entire investment.
RISKS ASSOCIATED WITH COMPANIES CONDUCTING BUSINESS IN THE PRC
Because the scope of our business license is limited, we may need government
approval to expand our business.
We are a wholly-owned foreign enterprise, commonly known as a WOFE. The
scope of our business is narrowly defined for all businesses in China and the
WOFE can only conduct business within its approved business scope, which
ultimately appears on the business license. Our license permits us to operate as
a distributor of drugs. Any amendment to the scope of our business requires
further application and government approval. Inevitably, there is a negotiation
with the approval authorities to approve as broad a business scope as is
permitted, and we cannot assure you that we will be able to obtain the necessary
government approval for any change or expansion of our business.
If we are not be able to protect our intellectual property rights, our business
may be impaired.
We have developed proprietary products, which are based on formulation and
know-how developed by us, either by ourselves or pursuant to agreements with
others. All of our products are manufactured by others. The protection of
intellectual property in the PRC is weak, and we cannot give any assurance that
we will be able to protect our intellectual property rights. The value of our
proprietary products, and our ability to generate revenue from these products,
would be severely impaired if we are not able to protect our rights in these
products.
If the PRC enacts regulations which forbid or restrict foreign investment, our
ability to grow may be severely impaired.
We intend to expand our business both by increasing our product range and
making acquisitions of companies primarily in the pharmaceutical and related
industries. In addition, we may seek to manufacture our own products. Many of
the rules and regulations that we would face are not explicitly communicated,
and we may be subject to rules that would affect our ability to grow, either
internally or through acquisition of other Chinese or foreign companies. There
are also substantial uncertainties regarding the proper interpretation of
current laws and regulations of the PRC. New laws or regulations that forbid
foreign investment could severely impair our businesses and prospects.
Additionally, if the relevant authorities find us in violation of PRC laws or
regulations, they would have broad discretion in dealing with such a violation,
including, without limitation:
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o levying fines;
o revoking our business and other licenses;
o requiring that we restructure our ownership or operations; and
o requiring that we discontinue any portion or all of our Internet
related business.
Any deterioration of political relations between the United States and the PRC
could impair our operations.
The relationship between the United States and the PRC is subject to
sudden fluctuation and periodic tension. Changes in political conditions in the
PRC and changes in the state of Sino-U.S. relations are difficult to predict and
could adversely affect our operations or cause potential acquisition candidates
or their goods and services to become less attractive. Such a change could lead
to a decline in our profitability. Any weakening of relations between the United
States and the PRC could have a material adverse effect on our operations.
Our operations and assets in the PRC are subject to significant political and
economic uncertainties.
Under its current leadership, the government of the PRC has been pursuing
economic reform policies that encourage private economic activity and greater
economic decentralization. There is no assurance, however, that the government
of the PRC will continue to pursue these policies, or that it will not
significantly alter these policies from time to time without notice. In
addition, although the government of the PRC has in recent years implemented
measures emphasizing the reduction of state ownership of productive assets, a
substantial portion of productive assets in the PRC remains government-owned.
For instance, all lands are state owned and leased to business entities or
individuals through governmental granting of State-owned Land Use Rights. The
granting process is typically based on government policies at the time of
granting, which could be lengthy and complex. This process may adversely affect
our future expansion, especially if we seek to commence manufacturing
operations. The government of the PRC also exercises significant control over
China's economic growth through the allocation of resources, controlling payment
of foreign currency and providing preferential treatment to particular
industries or companies. Uncertainties may arise with changing of governmental
policies and measures. In addition, changes in laws and regulations, or their
interpretation, or the imposition of confiscatory taxation, restrictions on
currency conversion, imports and sources of supply, devaluations of currency or
the nationalization or other expropriation of private enterprises could have a
material adverse effect on our business, results of operations and financial
condition.
Our operations may not develop in the same way or at the same rate as might be
expected if the PRC economy were similar to the market-oriented economies of
OECD member countries.
The economy of the PRC has historically been a nationalistic, "planned
economy," meaning it functions and produces according to governmental plans and
pre-set targets or quotas. In certain aspects, the PRC's economy has been making
a transition to a more market-oriented economy, although the government may
impose price controls. However, we cannot predict the future direction of these
economic reforms or the effects these measures may have. The economy of the PRC
also differs from the economies of most countries belonging to the Organization
for Economic Cooperation and Development, an international group of member
countries sharing a commitment to democratic government and market economy. For
instance:
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o the level of state-owned enterprises in the PRC, as well as the level of
governmental control over the allocation of resources is greater than in
most of the countries belonging to the OECD;
o the level of capital reinvestment is lower in the PRC than in other
countries that are members of the OECD;
o the government of the PRC has a greater involvement in general in the
economy and the economic structure of industries within the PRC than other
countries belonging to the OECK; and
o the PRC has various impediments in place that make it difficult for
foreign firms to obtain local currency, as opposed to other countries
belonging to the OECD where exchange of currencies is generally free from
restriction.
As a result of these differences, our business may not develop in the same
way or at the same rate as might be expected if the economy of the PRC were
similar to those of the OECD member countries.
Because our directors and some of our officers reside outside of the United
States, it may be difficult for you to enforce your rights against them or
enforce United States court judgments against them in the PRC.
Our directors and our senior executive officers, including our chief
executive officer, chief operating officer and chief financial officer, reside
in the PRC and substantially all of our assets are located in the PRC. It may
therefore be difficult for United States investors to enforce their legal
rights, to effect service of process upon our directors or officers or to
enforce judgments of United States courts predicated upon civil liabilities and
criminal penalties of our directors and officers under federal securities laws.
Further, it is unclear if extradition treaties now in effect between the United
States and the PRC would permit effective enforcement of criminal penalties of
the federal securities laws.
We may have limited legal recourse under Chinese law if disputes arise under
contracts with third parties.
Almost all of our agreements with our employees and third parties,
including our supplier and customers, are governed by the laws of the PRC. The
legal system in the PRC is a civil law system based on written statutes. Unlike
common law systems, such as we have in the United States, it is a system in
which decided legal cases have little precedential value. The government of the
PRC has enacted some laws and regulations dealing with matters such as corporate
organization and governance, foreign investment, commerce, taxation and trade.
However, their experience in implementing, interpreting and enforcing these laws
and regulations is limited, and our ability to enforce commercial claims or to
resolve commercial disputes is unpredictable. The resolution of these matters
may be subject to the exercise of considerable discretion by agencies of the
PRC, and forces unrelated to the legal merits of a particular matter or dispute
may influence their determination. Any rights we may have to specific
performance or to seek an injunction under Chinese law are severely limited, and
without a means of recourse by virtue of the Chinese legal system, we may be
unable to prevent these situations from occurring. The occurrence of any such
events could have a material adverse effect on our business, financial condition
and results of operations.
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Failure to comply with the United States Foreign Corrupt Practices Act could
subject us to penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act, which
generally prohibits United States companies from engaging in bribery or other
prohibited payments to foreign officials for the purpose of obtaining or
retaining business. Foreign companies, including some that may compete with us,
are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs,
theft and other fraudulent practices occur from time-to-time in the PRC. We can
make no assurance, however, that our employees or other agents will not engage
in such conduct for which we might be held responsible. If our employees or
other agents are found to have engaged in such practices, we could suffer severe
penalties and other consequences that may have a material adverse effect on our
business, financial condition and results of operations.
If the United States imposes trade sanctions on the PRC due to its current
currency, export or other policies, our ability to succeed in the international
markets may be diminished.
The PRC currently "pegs" its currency to the United States dollar. This
means that each unit of Chinese currency has a set ratio for which it may be
exchanged for United States currency, as opposed to having a floating value like
other countries' currencies. This policy is currently under review by policy
makers in the United States. Trade groups in the United States have blamed the
cheap value of the Chinese currency for causing job losses in American
factories, giving exporters an unfair advantage and making its imports
expensive. There is increasing pressure for the PRC to change its currency
policies to provide for its currency to float freely on international markets.
As a result, Congress is considering the enacting legislation which could result
in the imposition of quotas and tariffs. If the PRC changes its existing
currency policies or if the United States or other countries enact laws to
penalize the PRC for its existing currency policies, our business may to be
adversely affected. Further, we cannot predict what action the PRC may take in
the event that the United States imposes tariffs, quotas or other sanctions on
Chinese products. Even though we do not sell products into the United States
market, it is possible that such action by the PRC may nonetheless affect our
business since we are a United States company.
Exchange controls that exist in the PRC may limit our ability to utilize our
cash flow effectively.
We are subject to the PRC's rules and regulations on currency conversion.
Although, as a WOFE, we are permitted to convert Chinese currency, the Renminbi
(People's currency) into United States dollars for remittance to our United
States parent, we cannot assure you that we will continue to have government
approval to remit United States dollars to our United States parent. Any
restrictions on currency exchanges may limit our ability to use our cash flow
for the distribution of dividends to our stockholders or to fund operations we
may have outside of the PRC. Conversion of Renminbi for capital account items,
including direct investment and loans, is subject to governmental approval in
the PRC, and companies are required to open and maintain separate foreign
exchange accounts for capital account items. We cannot be certain that the
regulatory authorities of the PRC will not impose more stringent restrictions on
the convertibility of the Renminbi, especially with respect to foreign exchange
transactions.
Fluctuations in the exchange rate could have a material adverse effect upon our
business.
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We conduct our business in the Renminbi. To the extent our future revenue
may be denominated in foreign currencies, we would be subject to increased risks
relating to foreign currency exchange rate fluctuations which could have a
material adverse affect on our financial condition and operating results. A
downturn in the economy of the PRC may slow our growth and profitability.
The growth of the Chinese economy has been uneven across geographic
regions and economic sectors. There can be no assurance that growth of the
Chinese economy will be steady or that any downturn will not have a negative
effect on our business.
Any recurrence of severe acute respiratory syndrome, or SARS, or another
widespread public health problem, such as bird flu, could adversely affect our
business.
A renewed outbreak of SARS or another widespread public health problem,
including bird flu, in China, where all of our revenues are derived, could have
a negative effect on our operations. Our operations may be impacted by a number
of health-related factors, including the following:
o quarantines or closures of some of our offices which would severely
disrupt our operations,
o the sickness or death of our key officers and employees, and
o a general slowdown in the economy of the PRC.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our business and results of operations.
If certain tax exemptions within the PRC regarding withholding taxes are
removed, we may be required to deduct corporate withholding taxes from any
dividends we may pay in the future.
Under the PRC's current tax laws, regulations and rulings, companies are
exempt from paying withholding taxes with respect dividends paid to stockholders
outside of the PRC. However, if the foregoing exemption is removed, we may be
required to deduct certain amounts from any dividends we pay to our
stockholders.
RISKS ASSOCIATED WITH OUR BUSINESS
Because we are dependent upon a small number of suppliers or customers, the loss
of a major supplier or customer could impair our ability to operate profitably.
Our five largest suppliers accounted for 74% of our purchases in each of
the years ended December 31, 2005 and 2004. 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. Our agreements with our suppliers
and customers generally have a term of not more than one-year. None of our
supply agreements has any minimum purchase requirements on our part. Our
contracts with our customers do not provide for minimum purchases, and our
customers are not restricted from purchasing competitive products from others.
As a result, the loss of any significant supplier or customer could materially
impair our ability to operate profitably.
We may face liability claims from users of our products.
As the distributor of drugs and other medical products, we may be subject
both to liability in the event that people who use our products suffer side
effects for the use of our products and to any government requirement that we
recall one or more of our products, either of which could result in expenses
that could result of our inability to operate profitably.
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As a result of the reverse acquisition, our expenses will increase
significantly.
As a result of the reverse acquisition, our ongoing expenses have
increased significantly, including expenses in compensation to our officers,
additional expenses relating to the anticipated hiring of a chief financial
officer, ongoing public company expenses, and obligations incurred in connection
with the reverse acquisition. Our failure to generate sufficient revenue and
gross profit could result in reduced profits of losses as a result of the
additional expenses.
Because we are dependent on our management, the loss of key executive officers
or a key consultant and the failure to hire additional qualified key personnel
could harm our business.
Our business is largely dependent upon the continued efforts of our chief
executive officer, Senshan Yang, and our executive vice president, Minhua Liu,
both of whom are also directors. We do not have a long-term contract with any of
our offices except other than Ms. Liu. The loss of either of these officers
could have a material adverse effect upon our ability to operate profitably.
We may not be able to continue to grow through acquisitions.
An important part of our growth strategy is to expand our business and to
acquire other businesses. Such acquisitions may be made with cash or our
securities or a combination of cash and securities. If our stock price is less
than the exercise price of the outstanding warrants, it is not likely that that
warrants will be exercised. To the extent that we require cash, we may have to
borrow the funds or sell equity securities. The issuance of equity, if
available, would result in dilution to our stockholders. We have no commitments
from any financing source and we may not be able to raise any cash necessary to
complete an acquisition. If we fail to make any acquisitions, our future growth
may be limited. As of the date of this prospectus, we do not have any agreement
or understanding, either formal or informal, as to any acquisition. Further, any
acquisition may be subject to government regulations and approval in the PRC.
If we make any acquisitions, they may disrupt or have a negative impact on our
business.
If we make acquisitions, we could have difficulty integrating the acquired
companies' personnel and operations with our own. In addition, the key personnel
of the acquired business may not be willing to work for us. We cannot predict
the affect expansion may have on our core business. Regardless of whether we are
successful in making an acquisition, the negotiations could disrupt our ongoing
business, distract our management and employees and increase our expenses. In
addition to the risks described above, acquisitions are accompanied by a number
of inherent risks, including, without limitation, the following:
o the difficulty of integrating acquired products, services or
operations;
o the potential disruption of the ongoing businesses and distraction of
our management and the management of acquired companies;
o the difficulty of incorporating acquired rights or products into our
existing business;
o difficulties in disposing of the excess or idle facilities of an
acquired company or business and expenses in maintaining such
facilities;
- 11 -
o difficulties in maintaining uniform standards, controls, procedures
and policies;
o the potential impairment of relationships with employees and customers
as a result of any integration of new management personnel;
o the potential inability or failure to achieve additional sales and
enhance our customer base through cross-marketing of the products to
new and existing customers;
o the effect of any government regulations which relate to the business
acquired;
o potential unknown liabilities associated with acquired businesses or
product lines, or the need to spend significant amounts to retool,
reposition or modify the marketing and sales of acquired products or
the defense of any litigation, whether of not successful, resulting
from actions of the acquired company prior to our acquisition.
Our business could be severely impaired if and to the extent that we are
unable to succeed in addressing any of these risks or other problems encountered
in connection with these acquisitions, many of which cannot be presently
identified, these risks and problems could disrupt our ongoing business,
distract our management and employees, increase our expenses and adversely
affect our results of operations.
Our operating results in future periods may vary from quarter to quarter, and,
as a result, we may fail to meet the expectations of our investors and analysts,
which may cause our stock price to fluctuate or decline.
Our revenue and operating results have fluctuated from quarter to quarter
significantly in the past. We expect that fluctuations in both revenue and net
income will continue due to a variety of factors, many of which are outside of
our control. Due to the risks discussed in this prospectus, you should not rely
on period-to-period comparisons of our results of operations as an indication of
future performance.
Certain of our stockholders control a significant amount of our common stock.
Approximately 88.5% of our outstanding common stock is owned by the former
owners of Konzern, including our chief executive officer and executive vice
president, both of whom are also directors, and they presently have the voting
power to elect all of the directors and approve any transaction requiring
stockholder approval.
Efforts to comply with recently enacted changes in securities laws and
regulations will increase our costs and require additional management resources,
and we still may fail to comply.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC
adopted rules requiring public companies to include a report of management on
the company's internal controls over financial reporting in their annual reports
on Form 10-KSB. In addition, the public accounting firm auditing the company's
financial statements must attest to and report on management's assessment of the
effectiveness of the company's internal controls over financial reporting. These
requirements are not presently applicable to us. If and when these regulations
become applicable to us, and if we are unable to conclude that we have effective
internal controls over financial reporting or if our independent auditors are
unable to provide us with an unqualified report as to the effectiveness of our
internal controls over financial reporting as required by Section 404 of the
Sarbanes-Oxley Act of 2002, investors could lose confidence in the reliability
of our financial statements, which could result in a decrease in the value of
our securities. We have not yet begun a formal process to evaluate our internal
controls over financial reporting. Given the status of our efforts, coupled with
the fact that guidance from regulatory authorities in the area of internal
controls continues to evolve, substantial uncertainty exists regarding our
ability to comply by applicable deadlines.
- 12 -
The terms on which we may raise additional capital may result in significant
dilution and may impair our stock price.
Because of both the absence of a public market for our common stock, the
terms of our recent private placement and the number of outstanding warrants and
the exercise price and other terms on which we may issued common stock upon
exercise of the warrants, it may be difficult for us to raise additional capital
if required for our present business and for any planned expansion. We cannot
assure you that we will be able to get additional financing on any terms, and,
if we are able to raise funds, it may be necessary for us to sell our securities
at a price which is at a significant discount from the market price and on other
terms which may be disadvantageous to us. In connection with any such financing,
we may be required to provide registration rights to the investors and pay
damages to the investor in the event that the registration statement is not
filed or declared effective by specified dates. The price and terms of any
financing which would be available to us could result in both the issuance of a
significant number of shares and significant downward pressure on our stock
price and could result in a reduction of the conversion price of the series A
preferred stock and exercise price of the warrants held by the investors in our
February 2006 private placement.
Because our board of directors does not have a majority of independent
directors, even if a market for our stock develops, we may be unable to generate
any interest in our common stock.
In general, investors, particularly institution investors, do not invest
in companies that do not have an independent board of directors, a view which is
more notable for companies whose stock is not traded on the Nasdaq Stock Market
or is listed on the New York or American Stock Exchange. Further, our failure to
have a board of directors with at least a majority of independent directors
within 60 days from the closing could result in our obligation to pay liquidated
damages under our agreement with the investors in the February 2006 private
placement.
If we fail to achieve certain financial results, we will be required to issue
more shares of common stock upon conversion of the series A preferred stock or
exercise of the warrants.
Both the series A preferred stock and the warrants issued in the February
2006 private placement have antidilution provisions which increase the number of
shares issuable upon conversion of the series A preferred stock and reduce the
exercise price of the warrants if we issue common stock at a price which is less
than the conversion price of the series A preferred stock or the exercise price
of the warrants or if we fail to meet full-diluted net income per share targets
set forth in the purchase agreement. If either or both of these adjustments are
triggered, the investors in the February 2006 private placement will receive, on
such exercise or conversion, a larger number of shares of common stock, which
will increase their percentage interest in our stock. We cannot assure you that
there will not be such an adjustment.
Because the purchasers of our series A preferred stock have a right of first
refusal for future offering of our stock, we may have difficulty in raising
additional funds if required for our business.
- 13 -
The selling stockholders who purchased their securities in our February
2006 private placement, have the right to participate in any future funding.
These provisions may prevent us from raising additional funds.
We may be required to pay liquidated damages if our board does not consist of a
majority of independent directors.
The purchase agreement relating to the February 2006 private placement
requires us to appoint, 45 days from the closing date, such number of
independent directors that would result in a majority of our directors being
independent directors, that the audit committee would be composed solely of
independent directors and the compensation committee would have a majority of
independent directors. Our failure to meet these requirements would results in
our payment of liquidated damages that payable by the issuance of additional
shares of series A preferred stock.
RISKS ASSOCIATED WITH INVESTING IN OUR COMMON STOCK
There is no trading market for our common stock.
Although our common stock is registered pursuant to the Securities
Exchange Act of 1934, there is no market for our common stock and we cannot give
any assurance that there will ever be a market for our common stock. We do not
anticipate that a market for our common stock will develop, if at all, until
after the registration statement of which this prospectus is a part has been
declared effective by the SEC. If a market for our common stock develops, there
is a significant risk that our stock price may fluctuate dramatically in the
future in response to any of the following factors, some of which are beyond our
control:
o variations in our quarterly operating results;
o announcements that our revenue or income are below analysts' expectations;
o general economic slowdowns;
o matters affecting the economy of the PRC and the relationship between the
United States and the PRC;
o changes in market valuations of both similar companies and companies whose
business is primarily or exclusively in the PRC;
o sales of large blocks of our common stock;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o fluctuations in stock market prices and volumes, which are particularly
common among highly volatile securities of internationally-based
companies.
o concern by potential investors that the large number of shares of common
stock which may be sold pursuant to this prospectus may have a downward
effect upon the market price of the stock.
o the effect of sales pursuant to this prospectus on the trading volume of
our common stock.
- 14 -
The rights of the holders of common stock may be impaired by the potential
issuance of preferred stock.
Our certificate of incorporation gives our board of directors the right to
create new series of preferred stock. As a result, the board of directors has
and in the future may, without stockholder approval, issue preferred stock with
voting, dividend, conversion, liquidation or other rights which could adversely
affect the voting power and equity interest of the holders of common stock.
Preferred stock, which could be issued with the right to more than one vote per
share, could be utilized as a method of discouraging, delaying or preventing a
change of control. The possible impact on takeover attempts could adversely
affect the price of our common stock. Although we have no present intention to
issue any additional shares of preferred stock or to create any new series of
preferred stock and the certificate of designation relating to the series A
restricts our ability to issue additional series of preferred stock, we may
issue such shares in the future.
Shares may be issued pursuant to our stock plans which may affect the market
price of our common stock.
We may issue stock upon the exercise of options or pursuant to stock
grants covering a total of 1,575,000 shares of common stock pursuant to our 2006
long-term incentive plan, under which options to purchase 430,000 shares of
common stock at $1.25 per share are outstanding. The exercise of these options
and the sale of the underlying shares of common stock and the sale of stock
issued pursuant to stock grants may have an adverse effect upon the price of our
stock.
Because we are not subject to compliance with rules requiring the adoption of
certain corporate governance measures, our stockholders have limited protections
against interested director transactions, conflicts of interest and similar
matters.
The Sarbanes-Oxley Act of 2002, as well as rule changes proposed and
enacted by the SEC, the New York and American Stock Exchanges and the Nasdaq
Stock Market as a result of Sarbanes-Oxley require the implementation of various
measures relating to corporate governance. These measures are designed to
enhance the integrity of corporate management and the securities markets and
apply to securities which are listed on those exchanges or the Nasdaq Stock
Market. Because we are not presently required to comply with many of the
corporate governance provisions and because we chose to avoid incurring the
substantial additional costs associated with such compliance any sooner than
necessary, we have not yet adopted all of these measures. Because none of our
present directors are independent directors, we do not have independent audit or
compensation committees. We also are not in compliance with requirements
relating to the distribution of annual and interim reports, the holding of
stockholders meetings and solicitation of proxies for such meeting and
requirements for stockholder approval for certain corporate actions. Until we
comply with such corporate governance measures, regardless of whether such
compliance is required, the absence of such standards of corporate governance
may leave our stockholders without protections against interested director
transactions, conflicts of interest and similar matters and investors may be
reluctant to provide us with funds necessary to expand our operations.
Failure to achieve and maintain effective internal controls in accordance with
Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on
our business and operating results and stockholders could lose confidence in our
financial reporting.
- 15 -
Effective internal controls are necessary for us to provide reliable
financial reports and effectively prevent fraud. If we cannot provide reliable
financial reports or prevent fraud, our operating results could be harmed. We
may be required to document and test our internal control procedures in order to
satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which
requires increased control over financial reporting requirements, including
annual management assessments of the effectiveness of such internal controls and
a report by our independent certified public accounting firm addressing these
assessments. Failure to achieve and maintain an effective internal control
environment, regardless of whether we are required to maintain such controls,
could also cause investors to lose confidence in our reported financial
information, which could have a material adverse effect on our stock price.
We do not anticipate paying dividends on our common stock.
We are prohibited from paying dividends on our common stock while the
series A preferred stock is outstanding.
Because we may be subject to the "penny stock" rules, you may have difficulty in
selling our common stock.
If a public market develops for our common stock and if our stock price is
less than $5.00 per share, our stock may be subject to the SEC's penny stock
rules, which impose additional sales practice requirements and restrictions on
broker-dealers that sell our stock to persons other than established customers
and institutional accredited investors. The application of these rules may
affect the ability of broker-dealers to sell our common stock and may affect
your ability to sell any common stock you may own.
According to the SEC, the market for penny stocks has suffered in recent
years from patterns of fraud and abuse. Such patterns include:
o Control of the market for the security by one or a few broker-dealers
that are often related to the promoter or issuer;
o Manipulation of prices through prearranged matching of purchases and
sales and false and misleading press releases;
o "Boiler room" practices involving high pressure sales tactics and
unrealistic price projections by inexperienced sales persons;
o Excessive and undisclosed bid-ask differentials and markups by selling
broker-dealers; and
o The wholesale dumping of the same securities by promoters and
broker-dealers after prices have been manipulated to a desired level,
along with the inevitable collapse of those prices with consequent
investor losses.
As an issuer of "penny stock" the protection provided by the federal securities
laws relating to forward looking statements does not apply to us.
Although the federal securities law provide a safe harbor for
forward-looking statements made by a public company that files reports under the
federal securities laws, this safe harbor is not available to issuers of penny
stocks. As a result, if we are a penny stock we will not have the benefit of
this safe harbor protection in the event of any based upon an claim that the
material provided by us, including this current report on Form 8-K, contained a
material misstatement of fact or was misleading in any material respect because
of our failure to include any statements necessary to make the statements not
misleading.
- 16 -
Fluctuations in our operating results and announcements and developments
concerning our business affect our stock price.
Historically, there has been volatility in the market price for common
stock of companies such as us. Our quarterly operating results, the number of
stockholders desiring to sell their shares, changes in general economic
conditions and the financial markets, the execution of new contracts and the
termination or expiration of existing license agreements and other developments
affecting us, could cause the market price of our common stock to fluctuate
substantially. Further, since a majority of our operating expenses, particularly
personnel and related costs, depreciation and rent, are relatively fixed in
advance of any particular quarter, the underutilization of our technical
personnel may cause significant variations in our operating results in any
particular quarter and could result in losses for the quarter.
We cannot predict when or whether an active market for our common stock will
develop.
In the absence of an active trading market, you may have difficulty buying
and selling or obtaining market quotations; the market visibility for our stock
may be limited, and the lack of visibility for our common stock may have a
depressive effect on the market price for our common stock.
Our stock price may be affected by our failure to meet projections and estimates
of earnings developed either by us or by independent securities analysts.
Although we do not make projections relating to our future operating
results, our operating results may fall below the expectations of securities
analysts and investors. In this event, the market price of our common stock
would likely be materially adversely affected.
The registration and potential sale by our stockholders of a significant number
of shares could encourage short sales by third parties.
Because there is no public market for our stock, there may be significant
downward pressure on our stock price caused by the sale or potential sale of a
significant number of shares pursuant to this prospectus, which could allow
short sellers of our stock an opportunity to take advantage of any decrease in
the value of our stock. The presence of short sellers in our common stock may
further depress the price of our common stock.
If the selling stockholders sell a significant number of shares of common
stock, the market price of our common stock may decline. Furthermore, the sale
or potential sale the offered shares and the depressive effect of such sales or
potential sales could make it difficult for us to raise funds from other
sources.
Because the purchasers of our series A preferred stock have a right of first
refusal for future offering of our stock, we may have difficulty in raising
additional funds if required for our business.
The selling stockholders who purchased their securities in our February
2006 private placement, have the right to participate in any future funding.
These provisions may prevent us from raising additional funds.
The issuance and sale of the registered common stock could result in a change of
control.
- 17 -
If we issue all of the 10,609,476 shares issuable upon conversion of the
series A preferred stock and exercise of the warrants, the 10,609,476 shares of
common stock offered by the selling stockholders would constitute 53% of our
then outstanding common stock. The percentage would increase to the extent that
we are required to issue any additional shares of common stock become upon
conversion of the series A preferred stock pursuant to the anti-dilution and
adjustment provisions. Any sale of all or a significant percentage of those
shares to a person or group could result in a change of control.
FORWARD-LOOKING STATEMENTS
Statements in this prospectus may be "forward-looking statements."
Forward-looking statements include, but are not limited to, statements that
express our intentions, beliefs, expectations, strategies, predictions or any
other statements relating to our future activities or other future events or
conditions. These statements are based on current expectations, estimates and
projections about our business based, in part, on assumptions made by
management. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may, and are likely to, differ materially
from what is expressed or forecasted in the forward-looking statements due to
numerous factors, including those described above and those risks discussed from
time to time in this prospectus, including the risks described under "Risk
Factors," and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in this prospectus and in other documents which we file
with the Securities and Exchange Commission. In addition, such statements could
be affected by risks and uncertainties related to product demand, our ability to
develop, obtain rights to or acquire new products and successfully market the
products, market and customer acceptance, our ability to raise any financing
which we may require for our operations, competition, government regulations and
requirements, particularly regulations and policies affecting the relationship
between the United State and the PRC, pricing and development difficulties, our
ability to make acquisitions and successfully integrate those acquisitions with
our business, as well as general industry and market conditions and growth
rates, and general economic conditions. Any forward-looking statements speak
only as of the date on which they are made, and we do not undertake any
obligation to update any forward-looking statement to reflect events or
circumstances after the date of this prospectus.
USE OF PROCEEDS
We will not receive any proceeds from the sale by the selling stockholders
of their common stock. If the selling stockholders exercise any warrants, we
will receive the amount of the exercise price. The maximum total exercise price
is approximately $15.7 million, which we would receive only if all of the
warrants were exercised at their present exercise price. Any proceeds which we
receive from the exercise of the warrants would be used for working capital and
general corporate purposes.
- 18 -
SELLING STOCKHOLDERS
The following table sets forth the names of the selling stockholders, the
number of shares of common stock owned beneficially by the selling stockholders
as of March 31, 2006, the number of shares of our common stock that may be
offered by the selling stockholders pursuant to this prospectus, the number of
shares owned by the selling stockholders after completion of the offering. No
selling stockholder will own any shares of our outstanding common stock upon
completion of the offering. The table and the other information contained under
the captions "Selling Stockholders" and "Plan of Distribution" has been prepared
based upon information furnished to us by or on behalf of the selling
stockholders.
Name Shares Beneficially Owned Shares Being Sold
----
Barron Partners, LP(1) 8,892,632 8,892,632
Ray and Amy Rivers, JTWOS 538,948 538,948
Steve Mazur 538,948 538,948
William M Denkin 538,948 538,948
Capital Markets Advisory
Group, LLC(2) 72,000 72,000
Mark Allen 20,000 20,000
Nelson Broms 200 200
Pearl Broms 200 200
CFO Managed Fund I, LLC(3) 200 200
Jeffrey Hicks 200 200
Anna Crawford 200 200
Christopher Toppin 200 200
James McKeever 200 200
Antonio A. Yenidjeian 200 200
Stephen Hieber 200 200
Susan Isley 200 200
Gina Pacific 200 200
Joanne Leftwich 200 200
Emilia P. Cantelio 200 200
Mary Ellen Schloth 200 200
Brenda Garzi 200 200
Joseph Garzi 200 200
Gabrielle Guttman 200 200
Brittany Moss 200 200
Jennifer Rasmussen 200 200
Brooke Rodgerson 200 200
John Rodgerson 200 200
Erika Magnussen 200 200
Zoe Hicks 200 200
Ellen Hicks 200 200
Carol Hicks 200 200
Bradley Hicks 200 200
Mary Hicks 200 200
Taylor Hicks 200 200
Jonathan Hicks 200 200
Lori Cipot 200 200
- 19 -
Tonya Toriari 200 200
Sarah Licata 200 200
Debra Case 200 200
Claire Byl 200 200
Kendall Byl 200 200
Tracy Byl 200 200
Michael Byl 200 200
Jean McKeever 200 200
Larry Ditkoff 200 200
Henry Sargent 200 200
----------
(1) Mr. Andrew B. Worden, president of the general partner of Barron Partners,
has sole voting and dispositive power over the shares beneficially owned by
Barron Partners.
(2) Mr. Stephen Hicks has sole voting and dispositive power over the shares
beneficially owned by Capital Markets.
(3) Mr. William Schloth has sole voting and dispositive power over the shares
beneficially owned by CFO Managed Fund I LLC.
The shares of common stock being offered by Barron Partners, Ray and Amy
Rivers, JTWOS, Steve Mazur and William M Denkin represent the shares of common
stock issuable upon conversion of the series A preferred stock and warrant that
were issued in the February 2006 private placement. See "Selling Stockholders -
February 2006 Private Placement" for information relating to the shares of
common stock issuable to them.
The purchase agreement, the certificate of designation relating to the
series A preferred stock and the warrants all provide that the preferred stock
cannot be converted and the warrant cannot be exercised to the extent that the
number of shares of common stock held by the selling stockholder and his
affiliates after such conversion or exercise would exceed 4.9% of the
outstanding common stock. Beneficial ownership is determined in the manner
provided in Section 13(d) of the Securities Exchange Act of 1934 and Regulation
13d-3 of the SEC thereunder. This provision, which cannot be modified, limits
the ability of the holders of the series A preferred stock and warrants to
convert their shares of series A preferred stock and exercise their warrants.
Based on our outstanding common stock on March 31, 2006, of 7,380,000 shares,
Barron Partners, Ray and Amy Rivers, Steve Mazur and William M Denkin would not
be able to convert series A preferred stock or exercise warrants for more than
361,620 shares of common stock. This limitation applies separately to each of
these selling stockholders. As the number of shares of common stock increases,
whether upon conversion of series A preferred stock, exercise or warrants or for
any other reason, the number of shares which could be issued under this
limitation will increase. In the event that any holder of the series A preferred
stock or the warrants issued in the February 2006 private placement transfers
its or his shares of series A preferred stock or warrants, the transferee, if it
is not an affiliate of the transferor, would be subject to a separate 4.9%
limitation.
None of the selling stockholders has, or within the past three years has
had, any position, office or material relationship with us or any of our
predecessors or affiliates, except that Capital Markets was our principal
stockholder and, in connection with the reverse acquisition, sold 928,000 shares
of commons stock to us for $200,000, which was paid from the proceeds of the
sale of the series A preferred stock.
- 20 -
February 2006 Private Placement
In February 2006, we issued to Barron Partners, Ray and Amy Rivers, JTWOS,
Steve Mazur and William M Denkin an aggregate of 3,120,000 shares of series A
preferred stock, and warrants to purchase an aggregate of 7,389,674 shares of
common stock. The following table sets forth, for each of the purchasers in the
February 2006 private placement, the number of shares of common stock issuable
upon conversion of the series A preferred stock, and upon exercise of the
warrants, together with the total number of shares of common stock issuable upon
conversion of the series A preferred stock and upon exercise of the warrants,
and the purchase price paid by the purchaser.
Preferred $1.75 Total
--------- ------ -----
Name Stock Warrants $2.50 Warrants Shares Investment
---- ----- -------- -------------- ------ ----------
Barron Partners 2,640,000 3,126,316 3,126,316 8,892,632 $3,300,000
Ray and Amy Rivers, JTWOS 160,000 189,474 189,474 538,948 $200,000
Steve Mazur 160,000 189,474 189,474 538,948 $200,000
William M Denkin 160,000 189,474 189,474 538,948 $200,000
Pursuant to the preferred stock purchase agreement relating to the
issuance of the series A preferred stock and warrants in the February 2006
private placement:
o We agreed that, within 70 days from the closing date, February 8,
2006, we will have appointed such number of independent directors that
would result in a majority of our directors being independent
directors, that our audit committee would be composed solely of
independent directors and our compensation committee would have a
majority of independent directors. Our failure to meet these
requirements would results in the payment of liquidated damages that
are to be paid by the issuance of additional shares of series A
preferred stock.
o We and the investors entered into a registration rights agreement
pursuant to which we agreed to file, within 60 days after the closing,
the registration statement of which this prospectus is a part. Since
the closing was on February 8, 2006, we were required to file the
registration statement by April 10, 2006 and have the registration
statement declared effective within 120 days thereafter. We will be
required to issue 1,025 shares of series A preferred stock for each
day of the delay in filing or and each date after the required
effective date. However, if the registration statement is declared
effective by the required effective date, no shares will be issued as
a result in the date in filing.
o The investors have the right to participate in any future financing.
o We are required to elect a chief financial officer who is familiar
with both the conduct of business in China and the SEC's rules and
regulations relating to accounting, financial statements and
accounting controls within fifteen days after closing. We are not in
compliance with this provision.
o With certain limited exceptions, if we issue stock at a purchase price
or warrants or convertible securities at an exercise or conversion
price which is less than the conversion price of the series A
preferred stock or the exercise price of the warrants, the conversion
price and exercise price will be reduced to such lower price.
- 21 -
o If our earnings before interest, taxes, depreciation and amortization
("EBITDA") for 2005 are less than $5,650,000, there would be a
reduction in the conversion price of the series A preferred stock and
the exercise price of the warrants. Since our EBITDA was greater than
that amount, no adjustment was required.
o If our pre-tax income per share for 2006 is less than $0.40, the
conversion price of the series A preferred stock and the exercise
price of the warrants is reduced proportionately by the percentage
shortfall, up to a maximum of 50%. Fully-diluted pre-tax income per
share is based on the number of outstanding shares of common stock
plus all shares of common stock issuable upon conversion of all
outstanding convertible securities and upon exercise of all
outstanding warrants, options and rights, regardless of whether (i)
such shares would be included in determining diluted earnings per
share and (ii) such convertible securities are subject to a
restriction or limitation on exercise.
PLAN OF DISTRIBUTION
The selling stockholders and any of their pledgees, donees, assignees and
successors-in-interest may, from time to time, sell any or all of their shares
of common stock on any stock exchange, market or trading facility on which the
shares are traded or in private transactions or by gift. These sales may be made
at fixed or negotiated prices. Our common stock is not presently traded on any
market, and none of our outstanding shares may be sold except pursuant to a
registration statement. As a result, it will be necessary for the selling
stockholders to sell a portion of their shares if a market is to be created. The
selling stockholders cannot predict the extent to which a market will develop
or, if a market develops, what the price of our common stock will be.
Because of the limitation whereby Barron Partners, Ray and Amy Rivers,
Steve Mazur and William M Denkin cannot hold more than 4.9% of our stock, there
is a limit on the number of shares that any of them may sell at any time.
Assuming a market for the common stock develops, the selling stockholders may
use any one or more of the following methods when selling or otherwise
transferring shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which a broker-dealer will attempt to sell the shares
as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
o sales to a broker-dealer as principal and the resale by the
broker-dealer of the shares for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions, including gifts;
o covering short sales made after the date of this prospectus.
o pursuant to an arrangement or agreement with a broker-dealer to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale; and
o any other method of sale permitted pursuant to applicable: law.
- 22 -
The selling stockholders may also sell shares pursuant to Rule 144 or Rule
144A under the Securities Act, if available, rather than pursuant to this
prospectus.
See "Selling Stockholders" for information concerning the restriction on
the right of the holders of the series A preferred stock and certain of the
warrants to convert the shares of series A preferred stock and to exercise
warrants if such conversion or exercise would result in the holder and his or
its affiliates beneficially owning more than 4.9% of our common stock.
Broker-dealers engaged by the selling stockholders may arrange for other
brokers dealers to participate in sales. Broker-dealers may receive commissions
or discounts from the selling stockholders (or, if any broker-dealer acts as
agent for the purchaser of shares, from the purchaser) in amounts to be
negotiated. The selling stockholders do not expect these commissions and
discounts to exceed what is customary in the types of transactions involved.
A selling stockholder may from time to time pledge or grant a security
interest in some or all of the shares or common stock or warrant owned by them
and, if the selling stockholder defaults in the performance of the secured
obligations, the pledgees or secured parties may offer and sell the shares of
common stock from time to time under this prospectus, or under an amendment to
this prospectus under Rule 424(b)(3) or other applicable provision of the
Securities Act of 1933 amending the list of selling stockholders to include the
pledgee, transferee or other successors in interest as selling stockholders
under this prospectus.
In connection with the sale of our common stock or interests therein, the
selling stockholders may enter into hedging transactions with broker-dealers or
other financial institutions which may in turn engage in short sales of our
common stock in the course of hedging the positions they assume. The selling
stockholders may, after the date of this prospectus, also sell shares of our
common stock short and deliver these securities to close out their short
positions, or loan or pledge their common stock to broker-dealers that in turn
may sell these securities. The selling stockholders may also enter into option
or other transactions with broker-dealers or other financial institutions or the
creation of one or more derivative securities which require the delivery to such
broker-dealer or other financial institution of shares offered by this
prospectus, which shares such broker-dealer or other financial institution may
resell pursuant to this prospectus (as supplemented or amended to reflect such
transaction).
The selling stockholders also may transfer the shares of common stock in
other circumstances, in which case the transferees, pledgees or other successors
in interest will be the selling beneficial owners for purposes of this
prospectus. In the event of a transfer by a selling stockholder of the series A
preferred stock, warrants or the common stock issuable upon conversion or
transfer the series A preferred stock or warrants other than a transfer pursuant
to this prospectus or Rule 144 of the SEC, we may be required to amend or
supplement this prospectus in order to name the transferee as a selling
stockholder.
The selling stockholders and any broker-dealers or agents that are
involved in selling the shares may be deemed to be "underwriters" within the
meaning of the Securities Act in connection with such sales. In such event, any
commissions received by such broker-dealers or agents and any profit on the
resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act. The selling stockholders have
informed us that they do not have any agreement or understanding, directly or
indirectly, with any person to distribute the common stock.
- 23 -
Because the selling stockholders may be deemed to be "underwriters" within
the meaning of the Securities Act, they will be subject to the prospectus
delivery requirements of the Securities Act. Federal securities laws, including
Regulation M, may restrict the timing of purchases and sales of our common stock
by the selling stockholders and any other persons who are involved in the
distribution of the shares of common stock pursuant to this prospectus.
We are required to pay all fees and expenses incident to the registration
of the shares. We have agreed to indemnify the selling stockholders against
certain losses, claims, damages and liabilities, including liabilities under the
Securities Act.
MARKET FOR COMMON STOCK AND STOCKHOLDER MATTERS
There is no market for our common stock
As of March 31, 2006, we had approximately 50 record holders of our common
stock.
We have not paid dividends on our common stock, and the terms of
certificate of designation relating to the creation of the series A preferred
stock prohibit us from paying dividends. We plan to retain future earnings, if
any, for use in our business. We do not anticipate paying dividends on our
common stock in the foreseeable future.
See "Selling Stockholders" for information relating to the issuance of
stock since our organization.
Equity Compensation Plan Information
The following table summarizes the equity compensation plans under which
our securities may be issued as of March 31, 2006.
Number of securities
Number of securities to Weighted-average remaining available
be issued upon exercise exercise price of for future issuance
of outstanding options outstanding options under equity
Plan Category and warrants and warrants compensation plans
------------- ----------------------- ------------------- ------------------
Equity compensation plans -0- -- --
approved by security holders
Equity compensation plan not 1,280,000 $1.25 295,000
approved by 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.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 prospectus. 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 "Forward Looking Statements."
- 24 -
Overview
Prior to July 25, 2000, our business was conducted as a state-owned
medicine company in Guangzhou Province, PRC. On July 25, 2000, Konzern was
privatized, in a transaction by which our principal stockholders acquired the
equity in Konzern. We are 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 a business license to operate as a
wholly-foreign owned enterprise, commonly known as a WFOE, and we own 100% of
Konzern and Konzern's business became our sole 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. 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. At December 31, 2005, we
have nationwide exclusive sales right from our suppliers for four of their
products.
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.
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 and may be affected by the relationship between the United States and the
PRC.
- 25 -
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 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."
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.
- 26 -
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
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 such as us that are small business corporations for interim
or annual periods beginning with the first fiscal year which commences after
December 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.
- 27 -
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.
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.
- 28 -
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 and 2004 in U.S. dollars and as a percentage of revenue:
Year Ended December 31,
2005 2004
---- ----
Revenue $12,791,031 100.00% $10,400,325 100.00%
Costs of goods sold 8,656,873 67.68% 7,159,107 68.84%
Gross profit 4,134,158 32.32% 3,241,218 31.16%
Other operating income 2,134,872 16.69% -- --
Research and development
expenses 478,590 3.74% 527,973 5.08%
Selling expenses 147,020 1.15% 80,843 0.78%
General and administrative
costs 364,150 2.85% 214,680 2.06%
Income from operations 5,279,270 41.27% 2,417,722 23.25%
Other income, net 410,900 3.21% 12,907 0.12%
Income before income taxes 5,690,170 44.49% 2,430,629 23.37%
(Credit) for income taxes -- -- (509,031) -4.89%
Net income 5,690,170 44.49% 2,939,660 28.27%
Other comprehensive income 101,132 0.79% - -
Comprehensive income 5,791,302 45.28% $2,939,660 28.27%
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.
- 29 -
Year Ended December 31,
2005 2004
---- ----
Traditional pharmaceutical
medicine $10,107,138 79.02% $7,828,188 75.27%
Traditional Chinese medicine 2,544,013 19.89% 2,255,672 21.69%
Chinese herbs 138,039 1.08% 307,508 2.96%
Nutritional products 1,841 0.01% 8,957 0.09%
Total $12,791,031 100.00% $10,400,325 100.00%
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 which we believe has 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.
Research and development expenses were approximately $478,590 for the year
ended December 31, 2005, a decrease of $49,383, or 9.4%, 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.
Selling expenses were approximately $147,020 for the year ended December
31, 2005, an increase of $66,177, or 81.9%, 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, or 69.6%, 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.
- 30 -
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 technology. We had
no comparable gain in the year ended December 31, 2004. The gain on an in-kind
distribution of approximately $74,828 for 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 $4.43
million. 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.
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, we acquired Konzern in a transaction accounted for as a
reverse acquisition. In connection with the reverse acquisition, an investor
group invested $3.9 million in the Company, from which the Company received net
proceeds of approximately $3.3 million. In connection with the sale of
securities to the investor group, we are obligated to register the shares of
common stock issuable upon conversion of the series A preferred stock and
exercisable upon exercise of the warrants.
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 net proceeds of 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.
- 31 -
BUSINESS
We are a distributor of medical products, including, traditional
pharmaceutical medicines, traditional Chinese medicine (finished medicine made
of Chinese herbs), Chinese herbs and nutritional supplements. These products
include both prescription drugs and over the counter drugs. We purchase our
products from Chinese drug manufacturers and other medicine companies, and we
sell our products to wholesale distributors, hospitals and retail drug stores.
Products
We sell more than 1,100 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 four products under development.
Traditional Pharmaceutical Medicines. Traditional pharmaceutical medicine
accounts for most of our sales, representing sales of approximately $10,107,138,
or 79% of revenue, for the year ended December 31, 2005, and $7.8 million, or
75.3% of revenue, for the year ended December 30, 2004. 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 PRC.
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.
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 in the PRC to any of these
products, except Lopamidol. 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, accounted for sales of
approximately $556,110.
- 32 -
o Qianbai biyan tablet, which is used for rhinitis, accounted for sales
of approximately $312,867.
o Qingre sanjie table, which is used for the common cold, accounted for
sales of approximately $265,319.
o Chuanbei piba gao, which is used for coughs, accounted for sales of
approximately $229,023.
o Zhachong shisanwei, which is used for the common cold, 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, and dietary supplements, which accounted for nominal sales.
Principal Suppliers
Our five largest suppliers, which were the same in both 2005 and 2004, accounted
for 74% of our purchases in each of 2005 and 2004. Among them, our two largest
suppliers, accounted for 59% of our purchases for 2005 and 53% of our purchases
for 2004. 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, which accounted for 32% of
our purchases, and Guangzhou Pharmaceutical Holdings Limited, which accounted
for 27% of our purchases. 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. 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 customers for
2005 are Guangdong Sanhong Medicine Co., Ltd., which accounted for 42% of
revenue, and Guangdong Saikang Medical Co., Ltd., which accounted for 30% of
revenue.
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Customer Support
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 support services, including
on-site visiting to the hospitals and contacting the medicine companies in order
to receive timely 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
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
anesthetic products, a right granted only to state-owned companies; however,
such state-owned companies do not have their own research and development
facilities, 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 to establish a cooperative
relationship with the Pharmaceutical Research Institute of Nanhua University.
Under the Agreement, we and Nanhua University jointly set up a new medical
research facility. We finance the research, which includes paying 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,
and we cannot assure you that we will generate a marketable product. We also
have an agreement with Guangzhou Laitai Pharmaceutical Co., Ltd.. Pursuant to
this agreement, we are financing the development by Laitai Pharmaceutical of new
drugs. If these drugs are approved by the State Food and Drug Administration, we
will have the exclusive distribution right for the drugs for a period of ten
years.
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Intellectual Property
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.
We hold the trademark "Konzem" in the PRC. 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 the name under which we conduct
business in the PRC. Trademarks issued in the PRC have an initial term of ten
years with the right to renew for an additional ten years. We have applied for
trademarks in the PRC for ten of our products, which are pending the approval
from the PRC Trademark Offices:
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 us 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.
- 35 -
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 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 good
supply practice 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 good supply practice conforms to the
distribution scope of the certificate for drug distribution.
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). 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 31, 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.
- 36 -
Risk of Loss and Liability
The standard contracts between with our 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.
We do 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.
Legal Proceedings
As of the date of this prospectus, we are not subject to any legal
proceedings.
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.
MANAGEMENT
Directors and Executive Officers
The following table sets forth certain information with respect to our directors
and executive officers.
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 and Secretary
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 since July 2000. For almost 20 years prior thereto, Mr. Yang
served as a manager associate for Guangdong Maoming Petroleum Corporation, a
state-owned company. Mr. Yang obtained his bachelor's degree from South China
University of Technology in 1981.
- 37 -
Ms. Minhua Lin has been our executive vice president and a director since
February 8, 2006 and a director since February 10, 2006. She has been vice
general manager of Konzern since July 2000. For two years prior thereto, she
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
Ms. Huizhen Yu has been our chief financial officer since February 10,
2006. She has been chief financial officer of Konzern since October 2002. From
2000 until 2002, Ms. Yu was an accountant for Shenzhen Liuge Bicycle Equipment
Co., Ltd., and from 1997 to 2000, she was an accountant for Guangzhou JoinWin
Consultancy Ltd. She received her bachelor's degree from Jinan University in
Guangzhou and middle level accountant certificate in China in 2002.
Ms. Meiyi Xia has been vice president since March 22, 2006, having served
as our president and from February 7, 2006 until March 21, 2006, and a director
from February 7 through February 10, 2006. Ms. Xia has been a partner of
Princeton Capital Group since December 2005 and a partner of Spring Asset
Management LLC since November 2003. From January 2004 to December 2005, Ms. Xia
was chief executive officer of AiDi Financial Investment LLC, an financial
consulting company working mainly with companies in the Peoples Republic of
China. From July 2002 until January 2004, 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.
Ms. Lin Li has been vice president and secretary since February 8, 2006.
Ms. Li has been a partner of Princeton Capital 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 Ecom
Corporation, a information technology company, and from 2000 to 2001 she was an
accountant for Genesis Health Ventures, a senior health care provider. Ms. Li
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.
Minhua Lin and Junhua Liu are sister and brother. There are no other
relationships among our officers, directors and principal stockholders.
Pursuant to the purchase agreement for the February 2006 private
placement, we agreed that, within 75 days from the closing date, February 8,
2006, we will have appointed such number of independent directors that would
result in a majority of our directors being independent directors, that the
audit committee would be composed solely of independent directors and the
compensation committee would have a majority of independent directors. Our
failure to meet these requirements would results in the payment of liquidated
damages that are to be paid by the issuance of additional shares of series A
preferred stock. We are in the process in seeking independent directors in order
to enable us to comply with this requirement.
Committees
Our board of directors has no separate committees and it acts as the audit
committee. We have no qualified financial expert at this time because we have
not been able to hire a qualified candidate. We intend to search for qualified
individuals to serve as independent directors and members of an audit and
compensation committee.
- 38 -
Section 16(a) Compliance
Section 16(a) of the Securities Exchange Act of 1934, requires our
directors, executive officers and persons who own more than 10% of our common
stock to file with the SEC initial reports of ownership and reports of changes
in ownership of common stock and other of our equity securities. To our
knowledge, during the calendar year ended December 31, 2005, the Forms 3 filed
on September 29, 2005 by Capital Markets Advisory Group and on September 26,
2005 by Allen Mark were filed late.
Compensation
Summary Compensation Table
The following table presents compensation information related to our chief
executive officer for 2005, 2004 and 2003. No other officer received
compensation in excess of $100,000 for those years.
Other
-----
Name and Position Year Salary Compensation
----------------- ---- ------ ------------
Senshan Yang, chief executive officer 2005 $25,488 $ -0-
2004 3,608 -0-
2003 5,562 -0-
Prior to February 8, 2006, Senshan Yang, Minhua Liu and Junhua Lin 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. These distributions were allocated to the equity holders in
proportion to their interest in Konzern -- 50% to Mr. Yang, 40% to Ms. Liu and
10% to Mr. Liu.
No bonuses were paid to any of the officers and no stock or other equity
compensation was provided to any of the officers.
Employment Agreements
We do not have employment agreements with any of our officers except Ms.
Minhua Liu, who has a five-year contract pursuant to which she serves as our
executive vice president in charge of sales and internal controls at an annual
salary of $7,650.
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 2006 Plan is to be administered by a
committee of not less than two directors each of which is to be an independent
directors. 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
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. Pursuant to this 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 at $1.25 per share.
The options are subject to stockholder approval of the 2006 Plan.
- 39 -
Options intended to be incentive stock options must be granted at an
exercise price per share which is not less than the fair market value of the
common stock on the date of grant and may have a term which is not longer than
ten years. If the option holder holds 10% of our common stock, the exercise
price must be at least 110% of the fair market value on the date of grant and
the term of the option cannot exceed five years.
Option holders do not recognize taxable income upon the grant of such
either incentive or non-qualified stock options. When employees exercise
incentive stock options, they will not recognize taxable income upon exercise of
the option, although the difference between the exercise price and the fair
market value of the common stock on the date of exercise is included in income
for purposes of computing their alternative minimum tax liability, if any. If
certain holding period requirements are met, their gain or loss on a subsequent
sale of the stock will be taxed at capital gain rates. Generally, long-term
capital gains rates will apply to their full gain at the time of the sale of the
stock, provided that they do not dispose of the stock made within two years from
the date of grant of the option or within one year after your acquisition of
such stock, and the option is exercised while they are employed by us or within
three months of the termination of their employment or one year in the event of
death or disability, as defined in the Internal Revenue Code.
In general, upon the exercise a non-qualified option, the option holders
will recognize ordinary income in an amount equal to the difference between the
exercise price of the option and the fair market value of the shares on the date
they exercise the option. Subject to certain limitations, we may deduct that
amount an expense for federal income tax purposes. In general, when the holders
of shares issued on exercise of a nonqualified stock option sell their shares,
any profit or loss is short-term or long-term capital gain or loss, depending
upon the holding period for the shares and their basis in the shares will be the
fair market value on the date of exercise.
No options were outstanding at December 31, 2005.
PRINCIPAL STOCKHOLDERS
The following table provides information at to shares of common stock
beneficially owned as of March 31, 2006 by:
o each director;
o each officer named in the summary compensation table;
o each person owning of record or known by us, based on information
provided to us by the persons named below, to own beneficially at
least 5% of our common stock; and
o all directors and executive officers as a group.
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Shares of Common Stock
Name Beneficially Owned Percentage
---- ------------------ ----------
Senshan Yang 3,265,000 44.2%
Room 702 Guangri Mansion No. 8,
South Wuyang Xin Chengsi,
Guangzhou, China
Minhua Liu 2,612,000 35.4%
Room 702 Guangri Mansion No. 8,
South Wuyang Xin Chengsi,
Guangzhou, China
Junhua Liu 653,000 8.9%
Room 702 Guangri Mansion No. 8,
South Wuyang Xin Chengsi,
Guangzhou, China
All officers and directors as a group
(four individuals) 6,064,500 82.2%
* Less than 1%.
Except as otherwise indicated each person has the sole power to vote and
dispose of all shares of common stock listed opposite his name. Each person is
deemed to own beneficially shares of common stock which are issuable upon
exercise or warrants or options or upon conversion of convertible securities if
they are exercisable or convertible within 60 days of March 31, 2006.
Barron Partners owns shares of series A preferred stock and 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 warrants may not be exercised if such conversion or
exercise would result in Barron Partners owning more than 4.9% of our
outstanding common stock. This limitation may not be waived.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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 preferred stock and warrants in the February 2006 private placement. At
the time of the purchase, Capital Markets owned approximately 97.3% of our
outstanding common stock..
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 from
January 2003 to December 2005.
Pursuant to the Exchange Agreement we issued the following shares in
exchange for all of the equity interest in Konzern.
- 41 -
Name Shares
---- ------
Senshan Yang 3,265,000
Minhua Liu 2,612,000
Junhua Liu 653,000
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.
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue 90,000,000 shares of common stock, par value
$.0001 per share, and 10,000,000 shares of preferred stock, par value $.0001 per
share. As of February 10, 2006, we had we 7,380,000 shares of common stock and
3,120,000 shares of series A preferred stock outstanding.
The following summary of certain provisions of our common stock, preferred
stock, certificate of incorporation and by-laws is not intended to be complete.
It is qualified by reference to the provisions of applicable law and to our
certificate of incorporation and by-laws.
Common Stock
Holders of common stock are entitled to one vote for each share held on
all matters submitted to a vote of stockholders and do not have cumulative
voting rights. Accordingly, holders of a majority of the shares of common stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of common stock are entitled to receive
proportionately any dividends as may be declared by our board of directors,
subject to any preferential dividend rights of outstanding preferred stock.
Pursuant to the certificate of designation relating to the series A preferred
stock, we are prohibited from paying dividends on our common stock while the
preferred stock is outstanding. Upon our liquidation, dissolution or winding up,
the holders of common stock are entitled to receive proportionately our net
assets available after the payment of all debts and other liabilities and
subject to the prior rights of any outstanding preferred stock. Holders of
common stock have no preemptive, subscription, redemption or conversion rights.
Our outstanding shares of common stock are fully paid and non-assessable. The
rights, preferences and privileges of holders of common stock are subject to,
and may be adversely affected by, the rights of the holders of shares of any
series of preferred stock that we may designate and issue in the future.
Preferred Stock
Our certificate of incorporation gives our board of directors the power to
issue shares of preferred stock in one or more series without stockholder
approval. Our board of directors has the discretion to determine the rights,
preferences, privileges and restrictions, including voting rights, dividend
rights, conversion rights, redemption privileges and liquidation preferences, of
each series of preferred stock. The purpose of authorizing our board of
directors to issue preferred stock and determine its rights and preferences is
to eliminate delays associated with a stockholder vote on specific issuances.
The issuance of preferred stock, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire, or could
discourage a third party from acquiring, a majority of our outstanding voting
stock. Except for the series A preferred stock, we have no present plans to
issue any shares of preferred stock.
- 42 -
Series A Preferred Stock
The certificate of designation for the series A preferred stock provides
that:
o Each share of series A preferred stock is convertible into one share
of common stock.
o If, while investors in the private placement own shares of series A
preferred stock, we issue common stock at a price, or options,
warrants or other convertible securities with a conversion or exercise
price less than the conversion price (initially $1.25), with certain
specified exceptions, the number of shares issuable upon conversion of
one share of series B preferred stock is adjusted to reflect a
conversion price equal to the lower price.
o If our earnings before interest, taxes, depreciation and amortization
for 2005, computed as provided in the agreement is less than
$5,350,000, the conversion price shall be reduced proportionately by
0% if the EBITDA is $5,350,000 and by 30% if EBITDA is $3,955,000 or
lower. Since our EBITDA for 2005 was in excess of $5,350,000, there
was no adjustment pursuant to this provision.
o If our fully-diluted pre-tax income, as defined in the agreement, for
2006 is less than $.40 per share, the conversion price shall be
reduced proportionately by 0% if the pre-tax income is $.40 or more
and by 50% if pre-tax income is $.20 per share or lower.
o No dividends are payable with respect to the series A preferred stock.
o While the series A preferred stock is outstanding, we may not pay
dividends on or redeem shares of common stock.
o Upon any voluntary or involuntary liquidation, dissolution or
winding-up, the holders of the series A preferred stock are entitled
to a preference of $1.25 per share before any distributions or
payments may be made with respect to the common stock or any other
class or series of capital stock which is junior to the series A
preferred stock upon voluntary or involuntary liquidation, dissolution
or winding-up.
o The holders of the series A preferred stock have no voting rights.
However, so long as any shares of series A preferred stock are
outstanding, we shall not, without the affirmative approval of the
holders of 75% of the outstanding shares of series A preferred stock
then outstanding, (a) alter or change adversely the powers,
preferences or rights given to the series A preferred stock or alter,
(b) authorize or create any class of stock ranking as to dividends or
distribution of assets upon liquidation senior to or otherwise pari
passu with the series A preferred stock, or any of preferred stock
possessing greater voting rights or the right to convert at a more
favorable price than the series A preferred stock, (c) amend its
certificate of incorporation or other charter documents in breach of
any of the provisions hereof, (d) increase the authorized number of
shares of series A preferred stock, or (e) enter into any agreement
with respect to the foregoing.
o The holders of the series A preferred stock may not convert the series
A preferred stock to the extent that such conversion would result in
the holders owning more than 4.9% of the outstanding Common Stock.
This limitation may not be amended or waived.
- 43 -
Pursuant to the preferred stock purchase agreement, our board of directors
approved, and authorized the submission to stockholders at the next annual or
special meeting, an amendment to our certificate of incorporation to add the
following provision:
"The terms and conditions of any rights, options and warrants approved by
the Board of Directors may provide that any or all of such terms and conditions
may be waived or amended only with the consent of the holders of a designated
percentage of a designated class or classes of capital stock of the Corporation
(or a designated group or groups of holders within such class or classes,
including but not limited to disinterested holders), and the applicable terms
and conditions of any such rights, options or warrants so conditioned may not be
waived or amended absent such consent."
Delaware Law and Certain Charter and By-law Provisions
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law statute. Section 203 prohibits a publicly-held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
A "business combination" includes mergers, asset sales and other transactions
resulting in a financial benefit to the interested stockholder. Subject to
certain exceptions, an "interested stockholder" is a person who, together with
affiliates and associates, owns, or within the prior three years did own, 15% or
more of the corporation's voting stock.
Our certificate of incorporation contains certain provisions permitted
under Delaware General Corporation Law relating to the liability of directors.
The provisions eliminate a director's liability for monetary damages for a
breach of fiduciary duty, except in certain circumstances where such liability
may not be eliminated under applicable law. Further, our certificate of
incorporation contains provisions to indemnify our directors and officers to the
fullest extent permitted by Delaware General Corporation Law.
Penny-Stock Rules
The SEC has adopted regulations which generally define a "penny stock" to
be any equity security that has a market price (as defined) of less than $5.00
per share, subject to certain exceptions, and is not listed on the a registered
stock exchange or the Nasdaq Stock Market (although the $5.00 per share
requirement may apply to Nasdaq listed securities) or has net tangible assets in
excess of $2,000,000, if the issuer has been in continuous operation for at
least three years, or $5,000,000, if the issuer has been in continuous operation
for less than three years; or has average revenue of at least $6,000,000 for the
last three years.
As a result, our common stock is 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 income 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 written consent to
the transaction prior to the purchase. Additionally, for any transaction
involving a penny stock, unless exempt, the rules require the delivery, prior to
the transaction, of a risk disclosure document mandated by the SEC relating to
the penny stock market. The broker-dealer must also disclose the commission
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 our securities
and may affect your ability to sell our securities in the secondary market and
the price at which you can sell our common stock.
- 44 -
According to the SEC, the market for penny stocks has suffered in recent
years from patterns of fraud and abuse. Such patterns include:
o Control of the market for the security by one or a few broker-dealers
that are often related to the promoter or issuer;
o Manipulation of prices through prearranged matching of purchases and
sales and false and misleading press releases;
o "Boiler room" practices involving high pressure sales tactics and
unrealistic price projections by inexperienced sales persons;
o Excessive and undisclosed bid-ask differentials and markups by selling
broker-dealers; and
The wholesale dumping of the same securities by promoters and
broker-dealers after prices have been manipulated to a desired level, along with
the inevitable collapse of those prices with consequent investor losses.
Purchasers of penny stocks may have certain legal remedies available to
them in the event the obligations of the broker-dealer from whom the penny stock
was purchased violates or fails to comply with the above obligations or in the
event that other state or federal securities laws are violated in connection
with the purchase and sale of such securities. Such rights include the right to
rescind the purchase of such securities and recover the purchase price paid for
them.
Because our stock is a "penny stock" we do not have the safe harbor
protection under federal securities laws with respect to forward-looking
statement.
EXPERTS
The financial statements of Konzern at December 31, 2005 and for the two
years in the period then ended, included in this prospectus to the extent and
for the periods indicated in its report, have been audited by Moore Stephens
Wurth Frazer and Torbet, LLP, independent registered public accountants, and are
included herein in reliance upon the authority of such firm as an expert in
accounting and auditing in giving such report.
The financial statements of Lounsberry Holdings III, Inc., at December 31,
2005 and for the period February 10, 2005 (inception) to December 31, 2005,
included in this prospectus to the extent and for the periods indicated in its
report, have been audited by Moore Stephens Wurth Frazer and Torbet, LLP,
independent registered public accountants, and are included herein in reliance
upon the authority of such firm as an expert in accounting and auditing in
giving such report.
LEGAL MATTERS
The validity of the shares of common stock offered through this prospectus
will be passed on by Katsky Korins LLP.
- 45 -
HOW TO GET MORE INFORMATION
We file annual, quarter and periodic reports, proxy statements and other
information with the Securities and Exchange Commission using the Commission's
EDGAR system. You may inspect these documents and copy information from them at
the Commission's offices at public reference room at 100 F Street, NE,
Washington, D.C. 20549. You may obtain information on the operation of the
public reference room by calling the SEC at 1-800-SEC-0330. The Commission
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission. The address of such site is http//www.sec.gov.
We have filed a registration statement with the Commission relating to the
offering of the shares. The registration statement contains information which is
not included in this prospectus. You may inspect or copy the registration
statement at the Commission's public reference facilities or its website.
You should rely only on the information contained in this prospectus. We
have not authorized any person to provide you with any information that is
different.
- 46 -
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
INDEX TO FINANCIAL STATEMENTS
Page
----------------------------------------------------------------------------------------------------------------- -------
Lounsberry Holdings III, Inc.
-------------------------------------------------------------------------------------------------------------------------
Report of Independent Registered Accounting Firm F-2
-------------------------------------------------------------------------------------------------------------------------
Balance Sheet at December 31, 2005 F-3
-------------------------------------------------------------------------------------------------------------------------
Statement of Operations for the Period from February 10, 2005 (inception) to December 31, 2005 F-4
-------------------------------------------------------------------------------------------------------------------------
Statements of Changes in Stockholders' Deficiency for the Period from February 10, 2005 F-5
(inception) to December 31, 2005
-------------------------------------------------------------------------------------------------------------------------
Statements of Changes in Stockholders' Deficiency for the Period from February 10, 2005 (inception) to F-6
December 31, 2005
-------------------------------------------------------------------------------------------------------------------------
Notes to Financial Statements F-7
-------------------------------------------------------------------------------------------------------------------------
Guangzhou Konzern Medicine Co., Ltd.
-------------------------------------------------------------------------------------------------------------------------
Report of Independent Registered Accounting Firm F-10
-------------------------------------------------------------------------------------------------------------------------
Balance Sheets at December 31, 2005 and 2004 F-11
-------------------------------------------------------------------------------------------------------------------------
Statements of Income and Other Comprehensive Income for the years ended December 31, 2005 and 2004 F-12
-------------------------------------------------------------------------------------------------------------------------
Statements of Shareholder's Equity for the years ended December 31, 2005 and 2004 F-13
-------------------------------------------------------------------------------------------------------------------------
Statements of Cash Flows for the years ended December 31, 2005 and 2004 F-14
-------------------------------------------------------------------------------------------------------------------------
Notes to Financial Statement F-15
-------------------------------------------------------------------------------------------------------------------------
F-1
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
Walnut, California
March 30, 2006
F-2
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.
F-3
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.
F-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
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.
F-5
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.
F-6
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
F-7
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
F-8
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
F-9
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
Walnut, California
March 24, 2006
F-10
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.
F-11
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.
F-12
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.
F-13
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.
F-14
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
F-15
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
F-16
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
F-17
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
F-18
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
F-19
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
F-20
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
F-21
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
F-22
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
F-23
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
F-24
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
F-25
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
F-26
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
F-27
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
F-28
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
F-29
Part II
INFORMATION NOT REQUIRED TO BE IN PROSPECTUS
Item 24. Indemnification of Officers and Directors
The Company's certificate of incorporation provide that the liability of
the directors of the corporation for monetary damages shall be eliminated to the
fullest extent permissible under Delaware law and provides for indemnification
to the extent permitted by Delaware law.
The Delaware General Corporation Law permits a corporation to provide in
its certificate of incorporation that a director of the corporation shall not be
personally liable to the corporation or its stockholders for monetary damages
for breach of fiduciary duty as a director, except for liability for any breach
of the director's duty of loyalty to the corporation or its stockholders; acts
or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law; payments of unlawful dividends or unlawful stock
repurchases or redemptions, or any transaction from which the director derived
an improper personal benefit.
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify directors and officers as well as other employees and
individuals against expenses including attorneys' fees, judgments, fines and
amounts paid in settlement in connection with various actions, suits or
proceedings, whether civil, criminal, administrative or investigative other than
an action by or in the right of the corporation, a derivative action, if they
acted in good faith and in a manner they reasonably believed to be in or not
opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, if they had no reasonable cause to believe their
conduct was unlawful. A similar standard is applicable in the case of derivative
actions, except that indemnification only extends to expenses including
attorneys' fees incurred in connection with the defense or settlement of such
actions, and the statute requires court approval before there can be any
indemnification where the person seeking indemnification has been found liable
to the corporation. The statute provides that it is not exclusive of other
indemnification that may be granted by a corporation's certificate of
incorporation, bylaws, agreement, a vote of stockholders or disinterested
directors or otherwise.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, offices or controlling persons of the
Company, pursuant to the foregoing provisions, or otherwise, the Company has
been advised that, in the opinion of the Securities and Exchange Commission,
such indemnification is against public policy as expressed in the Securities
Act, and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the Company
of expenses incurred or paid by a director, officer or controlling person of the
Company in the successful defense of any action, suit or proceeding) is asserted
by such director, officer or controlling person in connection with the
securities being registered hereunder, the Company will, unless in the opinion
of its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
II-1
Item 25. Other Expenses of Issuance and Distribution
The estimated expenses of the registration, all of which will be paid by the
Company, are as follows:
Item Amount
---- ------
SEC filing fee $2,110.84
Printing and filing *
Legal expenses, including blue sky *
Accounting expenses *
Miscellaneous *
Total *
* To be supplied by Amendment.
Item 26. Recent Sales of Unregistered Securities
In connection with our organization in February 2005, we issued 1,000,000
to Capital Markets and 20,000 shares to Mark Allen for nominal consideration. In
February 2006, in connection with the reverse acquisition, we purchased 928,000
shares from Capital Markets for $200,000.
In December 2005, we issued 8,000 shares of common stock for $2,000.
On February 8, 2006, we issued the following securities:
o Pursuant to the preferred stock purchase agreement, we sold to Barron
Partners, Ray and Amy Rivers, JTROS, Steve Mazur and William M. Denken
for an aggregate of $3.9 million, (i) 3,120,000 shares of series A
preferred stock, and (ii) warrants to purchase 7,389,476 shares of
common stock, of which warrants to purchase 3,694,738 shares have an
exercise price of $1.75 per share. We received net proceeds of
approximately $3.3 million. The shares and warrants were issued as
follows:
Investors Shares $1.75 Warrants $2.50 Warrants Investment
--------- ------ -------------- -------------- ----------
Barron Partners 2,640,000 3,126,316 3,126,316 $3,300,000
Ray and Amy Rivers, JTWOS 160,000 189,474 189,474 $200,000
Steve Mazur 160,000 189,474 189,474 $200,000
William M Denkin 160,000 189,474 189,474 $200,000
o Pursuant to an agreement with the holders of Konzern's capital stock,
we issued to the former stockholders of Konzern 6,530,000 shares of
common stock, as follows:
Name Shares
---- ------
Senshan Yang 3,265,000
Minhua Liu 2,612,000
Junhua Liu 653,000
o We issued an aggregate of 750,000 shares of common stock to the
following individuals for services.
Meiyi Xia 150,000
Lin Li 37,500
Qingsong Du 187,500
Xiao Duan 125,000
Yaru Du 125,000
Yinshing To 125,000
II-2
No broker was involved in connection with any of the foregoing
transactions, except that Crescent Fund, LLC received $78,000 and Britannia
Consulting Group received $39,000 in connection with the sale of securities in
the February 2006 private placement.
The foregoing issuances were exempt from registration pursuant to Section
4(2) of the Securities Act and Regulation D of the SEC thereunder.
During 2006, we issued shares of common stock and options to purchase
common stock to our officers and other key employees. The shares issuable upon
exercise of the options will be registered pursuant to the Securities Act on a
Form S-8.
Item 27. Exhibits
2.1 Exchange Agreement dated as of February 8, 2006, among the
Registrant and the former stockholders of Konzern(1)
3.1 Certificate of incorporation(2)
3.2 By-laws(2)
4.1 Certificate of Designation for the Series A Convertible Preferred
Stock(1)
4.2 Form of warrant issued to investors in the February 2006 private
placement(1)
5.1 Opinion of Katsky Korins LLP(3)
10.1 Preferred stock purchase agreement dated February 8, 2006, between
the Registrant and the investors in the February 2006 private
placement(1)
10.2 Registration rights agreement dated February 8, 2006, between the
Registrant and the investors in the February 2006 private
placement(1)
10.3 Registration rights provisions pursuant to the stock exchange
agreement(1)
10.4 2006 Long-term incentive plan(1)
21.1 List of Subsidiaries(4)
23.1 Consent of Katsky Korins LLP (included in Exhibit 5.1)
23.2 Consent of Moore Stephens Wurth Frazer and Torbet, LLP (Page II-6)
1 Filed as an exhibit to the Company's annual report on Form 8-K which was
filed with the Commission on February 14, 2006 and incorporated herein by
reference.
2 Filed as an exhibit to the Company's registration statement on Form 10-SB,
which was filed with the Commission on June 23, 2005 and incorporated
herein by reference.
3 To be filed by amendment.
4 Filed as an exhibit to the Company's annual report on Form 10-KSB, which
was filed with the Commission on March 31, 2006 and incorporated herein by
reference.
II-3
Item 28. Undertakings
(a) The undersigned Company hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to the Registration Statement to: (i)
include any prospectus required by Section 10(a)(3) of the
Securities Act; (ii) reflect in the prospectus any facts or events
arising after the effective date of the Registration Statement
which, individually or in the aggregate, represent a fundamental
change in the information set forth in the Registration Statement;
and notwithstanding the foregoing, any increase or decrease in
volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and
any deviation from the low or high end of the estimated maximum
offering range may be reelected in the form of a prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate,
the changes in volume and price represent no more than a 20 percent
change in the maximum aggregate offering price set forth in the
"Calculation of Registration" table in the effective registration
statement; and (iii) include any material information with respect
to the plan of distribution not previously disclosed in the
Registration Statement or any material change to such information in
the Registration Statement, provided however, that provisions (i)
and (ii) of this undertaking are inapplicable if the information to
be filed thereunder is contained in periodic reports filed by the
Company pursuant to the Exchange Act that are incorporated by
reference into the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of post-effective amendment any
of the securities being registered which remains unsold at the
termination of the offering.
(b) Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions, or otherwise, the Company has been advised
that in the opinion of the Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
director, officer or controlling person in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Company will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by the Company is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
II-4
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant certifies that it has reasonable grounds to believe that it meets
all the requirements for filing on Form SB-2 and has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Guangzhou in the People's Republic of China on
this 13th day of April 12th, 2006.
LOUNSBERRY HOLDINGS III, INC.
By: s/ Senshen Yang
------------------------
Senshen Yang
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed by the following persons on behalf
of the registrant and in the capacities and on the dates indicated. Each person
whose signature appears below hereby authorizes Senshen Yang as his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign any and all amendments (including post-effective amendments)
to this registration statement, and to file the same, with all exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission.
Signature Title Date
--------- ----- ----
s/ Senshen Yang Chief Executive Officer April 12, 2006
------------------------ and Director
Senshen Yang
(Principal Executive Officer)
s/ Huizhen Yu Chief Financial Officer April 12, 2006
------------------------
Huizhen Yu
(Principal Financial and
Accounting Officer)
s/ Minhua Lin Director April 12, 2006
------------------------
Minhua Lin
II-5
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S CONSENT
We consent to the use in this Registration Statement on Form SB-2, of our
report dated March 30, 2006 with respect to our audit of the financial
statements of Lounsberry Holdings III, Inc. at December 31, 2005 and for the
period February 10, 2005 (inception) to December 31, 2005, and our report dated
March 24, 2006 for Guangzhou Konzern Medicine Co., Ltd. at December 31, 2005 and
for the two years in the period then ended, and to the reference to our firm
under the heading "Experts" in the Prospectus.
Moore Stephens Wurth Frazer and Torbet, LLP
Certified Public Accountants
Walnut, California
April 13, 2006
II-6