As filed with the Securities and Exchange Commission on July 13, 2006
Registration No. 333-133283
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT No. 1
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
CHINA MEDICINE CORPORATION
(Name of Small Business Issuer in Its Charter)
Delaware 5122 51-0539830
(State or Other Jurisdiction of (Primary Standard Industrial (IRS Employer
Incorporation or Organization) Classification Code Number) Identification No.)
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
China Medicine Corporation
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.
Sichenzia Ross Friedman Ference LLP
1065 Avenue of the Americas
New York, NY 10018
Telephone: (212) 981-6767
Fax: (212) 930-9725
Approximate date of proposed sale to the public: As soon as practicable
after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [X]
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. I ]
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 $2.75 $ 8,855,000.00 $ 947.49
$.0001 per share(2)
Common Stock, par value 7,389,476 2.125 15,702,636.50 1,680.18
$.0001 per share (3)
--------------------------- ------------- ------------------ ------------------ ----------------------
2,627.67*
*of which $2,110.86 has been paid.
(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 estimated high end of the range
at which the common stock will initially be sold. 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 JULY 13, 2006
PROSPECTUS
10,609,476 Shares
CHINA MEDICINE CORPORATION
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. Because there is no trading
market in our common stock as of the date of this prospectus, the selling
stockholders intend to sell any shares in the public market at prices ranging
from $2.00 to $2.75 per share until a public market develops for the common
stock. Once a public market develops for the common stock, the selling
stockholders may sell their shares of common stock in the public market based on
the market price at the time of sale or at negotiated prices. The selling
stockholders may also sell their shares in transaction that are not in the
public market in the manner set forth under "Plan of Distribution."
The date of this Prospectus is , 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 19
Use of Proceeds 20
Selling Stockholders 20
Plan of Distribution 24
Market for Common Stock and Stockholder Matters 26
Management's Discussion and Analysis of Financial Condition and
Results of Operations 27
Business 37
Management 44
Principal Stockholders 48
Certain Relationships and Related Transactions 49
Description of Capital Stock 49
Experts 53
Legal Matters 53
How to Get More Information 53
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. These down
payments are made pursuant to contracts with the suppliers, and, to the extent
that we reduce the size of the order, we will receive a credit from the
supplier. To date, all of our down payments have been applied to our orders. 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 a research and development
agreement with the with the Pharmaceutical Research Institute of Nanhua
University to establish a research and development center at Nanhua University.
Under the Agreement, we contribute the funds necessary to support the project,
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, Peoples Republic of China ("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, and on May 10, 2006, our corporate name
was changed 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 $167,602, and paid $32,398 of debt to Capital Markets,
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 China Medicine Corporation and its subsidiaries, unless the context
indicates otherwise, and, prior to the effectiveness of the reverse acquisition,
these terms refer to Konzern. References to "Lounsberry" relate to Lounsberry
Holdings III, Inc. prior to the reverse acquisition.
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 $167,602.
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 Common Stock: The holders of the series A preferred 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
Common Stock: 7,380,000 shares(1,2)
Common Stock to be
Outstanding After of
Investor Warrants: 17,889,476 shares(1)
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 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 at December 31, 2005 and for the years ended
December 31, 2005 and 2004 has been derived from our audited financial
statements which appear elsewhere in this prospectus. The information at March
31, 2006 and for the three months ended March 31, 2006 and 2005 has been derived
from our unaudited financial statements which appear elsewhere in this
prospectus.
Statement of Operations Information:
Three Months Year Ended
Ended March 31, December 31,
----------------- -----------------
2006 2005 2005 2004
------- ------- ------- -------
Revenues $ 3,512 $ 2,729 $12,791 $10,400
Gross profit 1,052 900 4,134 3,241
Income from operations 467 1,226 5,279 2,418
Income before income taxes 457 1,227 5,690 2,431
Net income 292 1,227 5,690 2,940
Comprehensive income 336 1,227 5,791 2,940
Earnings per share (basic) $ .04 $ .19 $ .89 $ .45
Weighted average shares of common stock 6,993 6,530 6,530 6,530
outstanding (basic)
Earnings per share (diluted) $ .04 $ .19 $ .89 $ .45
Weighted average shares of common stock 7,194 6,530 6,530 6,530
outstanding (diluted)
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Balance Sheet Information:
March 31, 2006 December 31, 2005
-------------- -----------------
Working capital $ 8,139 $ 4,429
Total assets 10,372 5,330
Total liabilities 1,455 571
Retained earnings 4,105 3,814
Stockholders' equity 8,917 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 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.
Although the government of the PRC has been pursuing economic reform
policies, government policies are subject to rapid change and the government may
adopt policies which have the effect of hindering private economic activity and
greater economic decentralization. There is no assurance that the government of
the PRC will not significantly alter its policies from time to time without
notice in a manner with reduces or eliminates any benefits from its present
policies of economic reform. In addition, 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.
Price controls may affect both our revenues and net income.
The laws of the PRC provide for the government to fix and adjust
prices. During 2006, some of our products became subject to price controls which
affected our gross profit, gross margin and net income for the three months
ended March 31, 2006. It is possible that additional products may be subject to
price control. To the extent that we are subject to price control, our revenue,
gross profit, gross margin and net income will be affected since the revenue we
derive from our sales will be limited and we may face no limitation on our
costs. Further, if price controls affect both our revenue and our costs, our
ability to be profitable and the extent of our profitability will be effectively
subject to determination by the applicable regulatory authorities in the PRC.
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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 and price controls. 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:
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 OECD;
o the government of the PRC imposes price controls on certain products
and our products may become subject to additional price controls;
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 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.
-8-
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.
Because we may not be able to obtain business insurance in the PRC, we may not
be protected from risks that are customarily covered by insurance in the United
States.
Business insurance is not readily available in the PRC. To the extent
that we suffer a loss of a type which would normally be covered by insurance in
the United States, such as product liability and general liability insurance, we
would incur significant expenses in both defending any action and in paying any
claims that result from a settlement or judgment. Since our products are taken
as medicine, any damages which we sustain could be material to our assets and
earnings. If the nature or amount of any uninsured loss is significant, we may
be unable to continue in business.
Because our funds are held in banks which do not provide insurance, the failure
of any bank in which we deposit our funds could affect our ability to continue
in business.
Banks and other financial institutions in the PRC do not provide
insurance for funds held on deposit. As a result, in the event of a bank
failure, we may not have access to funds on deposit. Depending upon the amount
of money we maintain in a bank that fails, our inability to have access to our
cash could impair our operations, and, if we are not able to access funds to pay
our suppliers, employees and other creditors, we may be unable to continue in
business.
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.
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The PRC currently "pegs" its currency to the a basket of currencies,
including 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 be adversely affected, even though we do not sell outside of the
PRC. 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, although we cannot predict the nature or
extent thereof.
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.
We conduct our business in the Renminbi. To the extent our future
revenue are denominated in currencies other the United States dollars, 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 since our operating results are reported in
United States dollars and significant changes in the exchange rate could
materially impact our reported earnings.
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 especially if it results in either a decreased use of
products such as ours or in pressure on us to lower our prices.
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:
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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.
Because a significant portion of the accounts receivable are generated by a
small number of customers, the failure of one of these customers could impair
our financial condition.
Because a substantial portion of our sales are made to a small number
of customers, our accounts receivable from a small number of customers may
represent a large percentage of our accounts receivable and assets. Our largest
account receivable at March 31, 2006 was approximately $668,000, representing
approximately 12.5% of our total assets and approximately 15.1% of our working
capital, and our three largest accounts receivable were approximately $1.1
million, representing approximately 21.5% of our total assets and approximately
25.9% of our working capital. This concentration of accounts receivable
represents a significant credit risk. The failure of any of these customers to
pay their obligations to us in a timely manner could have a material adverse
effect upon our financial condition.
Because of the long period that our receivable are outstanding and the payment
requirements of our suppliers, we may require additional cash for our business,
regardless of whether our sales increase.
-11-
The collection period for our accounts receivable typically range from
three months to one year, and we are required to pay our suppliers in advance
for a significant portion of the purchase price and we have to maintain deposits
with some of our suppliers. Further, it generally takes our supplies one to two
months to deliver products pursuant to our purchase orders. As a result, our
business is very cash intensive. We do not have an account receivable or
inventory based credit facility. To the extent that we continue to experience a
long collection period and our suppliers require advance payments, we may not
have sufficient cash to enable up to carry our receivable and pay our suppliers.
To the extent that we cannot satisfy our cash needs, whether from operations or
from a financing source, our business would be impaired in that it may be
difficult for us to obtain products which could, in turn, impair our ability to
generate sales.
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.
The increased expenses resulting from our status as a public company may impair
our ability to operate profitably.
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 who is familiar with United States GAAP, ongoing public company
expenses, including increased legal and accounting expenses as a result of our
status as a reporting company and the requirement that we register the shares of
common stock covered by this prospectus, expenses incurred in complying with the
internal controls requirements of the Sarbanes-Oxley Act, and obligations
incurred in connection with the reverse acquisition. Our failure to generate
sufficient revenue and gross profit could result in reduced profits 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 officers 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.
-12-
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 effect that expansion may have on our core business. 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;
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, and include factors which are described in these Risk
Factors, including the needs of our customers, competitive products offered by
others, consumer preferences for medical products and the extent of our research
and development activities. 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.
-13-
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. Senshan Yang, our chief executive officer and a
director, owns 44.2% of our stock, Minhua Liu, our executive vice president and
a director, owns 35.4%, and Junhua Liu, the brother of Minhua Liu, owns 8.9%.
They presently have the voting power to elect all of the directors and approve
any transaction requiring stockholder approval and can take action by
stockholder consent without a stockholders' meeting.
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.
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 issue 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. The conversion price of the series A preferred
stock refers to the purchase price of the series A preferred stock ($3,900,000)
divided by the number shares of common stock issuable upon conversion of the
preferred stock, which is initially and as of the date of this prospectus,
3,120,000, and the conversion price is $1.25. The conversion rate is the number
of shares of common stock issuable upon conversion of each share of series A
preferred stock, which is initially and as of the date of this prospecus, one.
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.
-14-
Both the series A preferred stock and the warrants issued in the
February 2006 private placement have anti-dilution 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. The target for pre-tax income
for 2006 is $.40 per share, representing an increase of $.103 per share more
than the pre-tax income, computed as provided in the purchase agreement. If this
adjustment is 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. The maximum
adjustment would result in (i) the issuance of 3,120,000 additional shares of
common stock upon conversion of the series A preferred stock, thereby increasing
the total number of shares of common stock issuable upon such conversion from
3,120,000 shares to 6,240,000 shares, (ii) a reduction of the exercise price of
the $1.75 warrant from $1.75 to $.875, and (iii) a reduction in the exercise
price of the $2.50 warrant from $2.50 to $1.25.
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.
We may be required to pay liquidated damages if we do not maintain a board
consisting of a majority of independent directors.
The purchase agreement relating to the February 2006 private placement
requires us to maintain a board of directors on which a majority of directors
are 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 continue to meet these requirements could
result in our payment of liquidated damages that could be 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;
-15-
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.
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. If we issue all of the shares of common stock issuable pursuant to the
plan, these shares will represent approximately 17.6% of the outstanding common
stock, based on the presently outstanding shares of common stock and
approximately 13.0% of the outstanding common stock, based on the presently
outstanding common stock plus the shares issuable upon conversion of the series
A preferred stock, with a related dilution to the other holders of our common
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.
-16-
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. 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.
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.
Because of our cash requirements and restrictions in our preferred stock
purchase agreement we may be unable to pay dividends.
We expect to retain any earnings to finance the growth of our business.
Further, 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:
-17-
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 claim based upon the material
provided by us 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.
Fluctuations in our operating results and announcements and developments
concerning our business affect our stock price.
The success of our business is based upon our ability to offer products
to meet the perceived medical needs in China. To this end, we market a broad
range of existing products and are engaged in the development of new products.
Further, we may also establish our own manufacturing facilities. Our major
customers are wholesale drug companies. Our operating results are subject to
numerous factors, including purchasing policies and requirements of our
customers, our research and development and product development activities, the
effects of price controls on our revenues and costs, and any expenses and
capital expenditure which we incur in manufacturing products. These factors,
along with other factors described under "Risk Factors" may affect our operating
results and may result in fluctuations in our quarterly results all of which
could affect our stock price or could result in volatility in our stock price.
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.
-18-
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.
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.
-19-
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 prices, which are
$1.75 per share as to warrants to purchase 3,694,738 shares of common stock and
$2.50 per share as to warrants to purchase an additional 3,694,738 shares of
common stock. Any proceeds which we receive from the exercise of the warrants
would be used for working capital and general corporate purposes. In the event
that the exercise price of the warrants is reduced as a result of our failure to
meet the required level of pre-tax income per share, the total proceeds from the
exercise of the warrants could be reduced by up to 50%, with the result that the
total proceeds would be reduced by up to $7.85 million. We cannot assure you
that any of the warrants will be exercised.
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 June 30, 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.
Shares Shares
Name Beneficially Owned 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
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(4) 200 200
Jean McKeever 200 200
Larry Ditkoff 200 200
Henry Sargent 200 200
-20-
----------
(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. Although Capital Markets is not a
broker-dealer, it is an affiliate of a broker dealer in that Mr. Hicks has
a voting and dispositive control of securities owned by Capital Markets
and Southridge Investment Group, LLC, a broker-dealer.
(3) Mr. William Schloth has sole voting and dispositive power over the shares
beneficially owned by CFO Managed Fund I LLC.
(4) Mr. Byl is president of Southridge Investment Group, LLC, a broker-dealer.
The selling stockholders acquired their shares in private placements in
2005 and 2006.
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 as follows: In connection with our
organization in February 2005, we issued 1,000,000 shares of common stock to
Capital Markets and 20,000 shares of common stock to Mark Allen for nominal
consideration. In February 2006, in connection with the reverse acquisition, we
purchased 928,000 shares of common stock from Capital Markets for $167,602, and
paid $32,398 of debt due to Capital Markets. Mr. Allen was president and
director of Lounsberry from its organization until the reverse acquisition in
February 2006.
-21-
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 an
exercise of the warrants 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.
None of the selling stockholders are broker-dealers except for Capital
Markets and Mr. Byl, who are affiliates of broker-dealers. Capital Markets
purchased its shares in connection with the organization of Lounsberry and Mr.
Byl acquired his shares in the normal course of his business. At the time of
their purchase neither Capital Markets nor Mr. Byl had any agreement or
understanding, directly or indirectly, with any person to distribute the
securities.
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.
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 $2.50 Total
Name Stock Warrants 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:
-22-
o We agreed that we will have appointed and maintain a board
consisting of 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 believe
that we are in compliance with this provision. The agreement does
not include any liquidated damages provision with respect to our
failure to comply witf this requirement.
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
ratio. The initial conversion price of the series A preferred stock
is $1.25 and the initial conversion ratio is one share of common
stock for each share of series A preferred stock. Any change in the
conversion price will automatically result in an adjustment in the
conversion ratio of the series A preferred stock.
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 fully-diluted 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%. Our fully-diluted
pre-tax income per share for 2005, computed in the manner provided
in the agreement, was $0.297. 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.
-23-
o The following table sets forth the initial conversion price of the
series A preferred stock and the exercise price of the $1.75
warrants and the $2.50 warrants and the adjusted numbers if (a) the
pre-tax income per share for 2006 were $0.30 per share, which is 25%
below the target (a "25% shortfall") and (b) the pre-tax income per
share for 2006 were $0.20 or less per share, which is 50% or more
below the target (a "50% shortfall"). The number of shares reflects
the number of shares of common stock issuable upon conversion of the
series A preferred stock, and is based on the assumption that no
shares of series A preferred stock are converted into common stock
until the adjustment has been made for 2006. There is no adjustment
in the number of shares issuable upon exercise of the warrants.
Conversion Price/ $1.75 Warrant $2.50 Warrant
Conversion Ratio Number of Shares Exercise Price Exercise Price
---------------- ---------------- -------------- --------------
Unadjusted $1.25/1:1 3,120,000 $1.75 $2.50
25% shortfall $.9375/1.3333:1 4,160,000 $1.3125 $1.875
50% shortfall $.625/2:1 6,240,000 $.875 $1.25
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. 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 there is no trading market in our
common stock as of the date of this prospectus, the selling stockholders intend
to sell any shares in the public market at prices ranging from $2.00 to $2.75
per share until a public market develops for the common stock. Once a public
market develops for the common stock, the selling stockholders may sell their
shares of common stock in the public market based on the market price at the
time of sale or at negotiated prices. Subject to the foregoing, 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.
-24-
The selling stockholders who acquired their shares pursuant to the
preferred stock purchase agreement (Barron Partners, Ray and Amy Rivers, JTWOS,
Steve Mazur and William M. Denkin), may also sell shares pursuant to Rule 144 or
Rule 144A under the Securities Act, if available, rather than pursuant to this
prospectus. Since the other selling stockholders acquired their shares at a time
that we were a so-called blank-check shell corporation, they are unable to sell
their shares pursuant to Rule 144 or 144A and must sell their shares 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. 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.
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
pledgees, transferees 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.
-25-
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 June 30, 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. Prior to the reverse acquisition, we
made distributions to our stockholders, including, in 2006, a cash distribution
of $1.9 million and a distribution of $1.2 million of inventory. At the time of
the distribution, we were a privately-owned Chinese entity similar to a limited
liability company, with our income being taxed to our stockholders. The
distribution was made partly in inventory in order to maintain cash in the
business.
As of June 30, 2006, there were reserved for issuance a total of
12,084,476 shares, of which 3,120,000 were issuable upon conversion of the
series A preferred stock, 7,389,476 shares were reserved for issuance upon
exercise of the warrants and 1,575,000 shares are reserved for issuance pursuant
to the 2006 long-term incentive plan. The 3,120,000 shares issuable upon
conversion of the series A preferred stock and the 7,389,476 shares reserved for
issuance upon exercise of the warrants are being offered by the selling
stockholders pursuant to this prospectus. No shares are available for sale
pursuant to Rule 144 as of the date of this prospectus.
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 June 30, 2006.
-26-
Number of securities to be Weighted-average Number of securities
issued upon exercise of exercise price of remaining available for
(I) Plan Category outstanding options and outstanding options and future issuance under
------------- warrants warrants equity compensation plans
-------------------------- ----------------------- -------------------------
Equity compensation plans 1,280,000 $1.25 295,000
approved by security holders
Equity compensation plan not -0- -- --
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 stockholders approved the plan
on June 20, 2006, and such approval becomes effective 20 days after an
information statement describing such action has been sent to the stockholders.
The information statement was mailed to stockholders on June 26, 2006 and the
stockholder approval will become effective on July 15, 2006.
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."
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.
-27-
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.
Our typical collection period ranges from three months to one year. In
addition, because we generally need one to two months to receive products from
our suppliers, we have been increasing our inventory in order to have product
available to meet anticipated orders, and we must pay our suppliers in advance,
and in some cases we must maintain funds on deposit with the supplier. These
factors require us to use significant cash in our operations.
Because a substantial portion of our sales are made to a small number
of customers, our accounts receivable from a small number of customers may
represent a large percentage of our accounts receivable and assets. Our largest
account receivable at March 31, 2006 was approximately $668,000, representing
approximately 12.5% of our total assets and approximately 15.1% of our working
capital, and our three largest accounts receivable were approximately $1.1
million, representing approximately 21.5% of our total assets and approximately
25.9% of our working capital. This concentration of accounts receivable
represents a significant credit risk.
Prior to 2004, we did not engage in any research and development
activities. Pursuant to a five-year research and development agreement dated
October 8, 2003, with the Pharmaceutical Research Institute of Nanhua
University, we agreed to contribute the funds necessary to support the project,
including the salaries of the research personnel, who are mainly professors at
Nanhua University, in return for which we obtain the ownership of the new
medicines developed. All expenses of this project have been recorded as research
and development expenses, and are expensed as incurred.
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.
Under the law of the PRC, we are required to make appropriations to
reserve funds, comprising the statutory surplus reserve, statutory welfare fund
and discretionary surplus reserve, based on our after-tax net income determined
in accordance with generally accepted accounting principles of PRC. The
appropriation to the statutory surplus reserve is required to be at least 10% of
the after tax net income until the reserve is equal to 50% of our registered
capital. At March 31, 2006, the registered capital was $2.3 million.
Appropriations to the statutory public welfare fund is required to be between 5%
and 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 allocations to these reserve funds are treated as
a component of stockholders' equity. 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. Our board of directors decided not to
make appropriation to this reserve.
-28-
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, of which $1.9 million was cash and $1.2 million was inventory, and $2.6
million for the year ended December 31, 2004, all of which was cash.
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.
-29-
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.
-30-
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.
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.
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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.
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
three months ended March 31, 2006 and 2005 and the years ended December 31, 2005
and 2004 in U.S. dollars and as a percentage of revenue:
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(Dollars in thousands)
Three Months Ended March 31, Year Ended December 31,
2006 2005 2005 2004
---- ---- ---- ----
Revenue $ 3,512 100.00% $ 2,729 100.00% $ 12,791 100.00% $ 10,400 100.00%
Costs of goods sold 2,460 70.05% 1,829 67.02% 8,657 67.68% 7,159 68.84%
Gross profit 1,052 29.95% 900 32.98% 4,134 32.32% 3,241 31.16%
Other operating 296 8.43% 425 15.57% 2,135 16.69% -- --
income
Research and 55 1.57% -- -- 479 3.74% 528 5.08%
development
expenses
Selling expenses 100 2.85% 39 1.43% 147 1.15% 81 0.78%
General and 728 20.73% 58 2.13% 364 2.85% 215 2.06%
administrative costs
Income from 467 13.30% 1,226 44.92% 5,279 41.27% 2,418 23.25%
operations
Other income, net (9) -0.26% -- -- 411 3.21% 13 0.12%
Income before 457 13.01% 1,227 44.96% 5,690 44.49% 2,431 23.37%
income taxes
(Credit) for income 166 4.73% -- -- -- -- (509) -4.89%
taxes
Net income 292 8.31% 1,227 44.96% 5,690 44.49% 2,940 28.27%
Other comprehensive 45 1.28% -- -- 101 0.79% -- --
income
Comprehensive income $ 336 9.57% $ 1,227 44.96% 5,791 45.28% $ 2,940 28.27%
Our revenue is derived primarily from the sale of traditional
pharmaceutical medicines, which are medicines of the type that might be sold in
drug stores in the United States, traditional Chinese medicines, which are
medicines derived from Chinese herbs, and Chinese herbs. Nutritional products
accounted for less than 0.1% of revenue in each period. The following table sets
forth the revenue and percentage of revenue derived from each of these types of
products.
(Dollars in thousands)
Three Months Ended March 31, Year Ended December 31,
2006 2005 2005 2004
---- ---- ---- ----
Traditional $2,477 70.53% $1,973 72% $10,107 79.02% $ 7,828 75.27%
pharmaceutical
medicine
Traditional 1,032 29.38% 710 26% 2,544 19.89% 2,256 21.69%
Chinese medicine
Chinese herbs 3 0.08% 46 2% 138 1.08% 308 2.96%
Total $3,512 100% $2,729 100% $12,791 100.00% $10,400 100.00%
Three Months Ended March 31, 2006 and 2005
Revenues for quarter ended March 31, 2006 were $3,511,979, an increase
of $783,393, or 29%, from the revenue of $2,728,586 for the comparable period in
2005. We obtained the distribution rights for three new products in the second
half of 2005, which generated significant additional revenues for us.
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Cost of revenue for the quarter ended March 31, 2006 was $2,459,505, an
increase of $630,553, or 34%, from $1,828,997 for the comparable period in 2005.
Gross profit for the quarter ended March 31, 2006 was $1,052,429, an increase of
$152,840, or 17%, from $899,589 for the comparable period of 2005. Our gross
margin for the quarter ended March 31, 2006 was 30% as compared with 33% for the
quarter ended March 31, 2005. The drop in our gross margin was due to the
decrease of the medicine prices which was adjusted by the Chinese government
pursuant to its price control regulations.
Other operating income of $296,103 and $424,628 for the quarter ended
March 31, 2006 and 2005, respectively, represented the proceeds from the sale of
certain technology and know-how on the production of medicines to certain
nonaffiliated drug manufacturers. We bought the technology in its preliminary
stage from other companies and then sold the improved technology to other
pharmaceutical companies.
Research and development expenses were $54,664 for the quarter ended
March 31, 2006 which was for the pre-clinical study of Yutian capsule. The
research and development expense for the first quarter of 2005 was nominal. Our
research and development was performed pursuant to our agreement with Nanhua
University, and, during the first quarter of 2005, Nanhua University did not
perform any significant services for us. Most of our research and development
projects had been substantially expensed at the end of 2005, and, as a result,
our research and development expenses declined in the first quarter of 2006 from
the rate that we were incurring such expenses in the second half of 2005.
Selling expenses were $100,102 for the quarter ended March 31, 2006, an
increase of $60,673 from $39,429 for the comparable period in 2005. The increase
of selling expenses was mainly due to the increase of transportation expenses,
advertising and marketing expenses.
General and administrative expenses were $727,136 for the quarter ended
March 31, 2006, an increase of $668,848 from $58,288 for the comparable period
in 2005. The increase mainly included $358,770 one time expenses associated with
the reverse merger, and the increase of general and administrative expenses also
reflects additional expenses associated with our status as a reporting company,
including the establishment of a United States office and additional legal,
accounting and other expenses relating to our status as a public company and
compliance with the reporting requirements of the federal securities laws and
our obligations under the agreement pursuant to which we sold preferred stock to
our investors.
Provision for income taxes was $165,581 for the first quarter of 2006
compared with no taxes for the first quarter of 2005. As a foreign invested
company in China, we have an exemption from Chinese income tax for 2004 and 2005
and a 50% reduction income tax rate for 2006, 2007 and 2008.
Comprehensive income for the quarter ended March 31, 2006 was 336,322,
a decrease of $890,197 from $1,226,519 for the comparable period in 2005. The
decrease was mainly due to the increase on selling expenses, general and
administrative expenses and income taxes.
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.
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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 traditional pharmaceutical medicines 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 decline in research and development
expenses resulted from the nature of the projects. Our research and development
activities in 2004 related to projects which were close to completion at the end
of 2004 and were completed in early 2005. There was a slowdown in our research
and development activities at the beginning of 2005 following completion of
those projects and before new projects were commenced.
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.
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 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. The waiver, which is granted in
accordance with the applicable provision of Chinese law, provided for a two-year
tax abatement and a 50% income tax reduction for the following three years.
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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
Prior to February 2006, we financed our operation and met capital
expenditure requirements primarily through short-term bank loans, trade credit
and equity financing. As of March 31, 2006, as a result of the sale of preferred
stock and warrants, from which we received net proceeds of approximately $3.8
million, we had working capital of $8.1 million, an increase of $3.7 million
from $4.4 million at December 31, 2005. We had no long-term debt at March 31,
2006.
The gross proceeds from the February private placement were $3.9
million, from which we received net proceeds of approximately $3.8 million after
deducting finders' fees of $117,000. In connection with the private placement,
we also paid $167,602 to Capital Markets to purchase 928,000 shares of common
stock and $32,398 to pay debt to Capital Markets, and incurred legal and
accounting expenses of $120,000, a $50,000 due diligence fee payable to Barron
Partners and an investment banking fee of approximately $102,000, with the
result that the total cash received by us was approximately $3.3 million.
We used cash of $1,376,510 in our operations for the first quarter of
2006, an increase of $1,268,579 from the cash required for the comparable period
of 2005. The increase in net cash used in operations was largely due to the
increase of our general and administrative expenses to $727,136 from $58,447 for
the comparable period in 2005. 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. We made the
distribution of inventory in order to preserve our cash position.
The following table sets forth the changes in certain balance sheet
items, in dollars and percentages, from December 31, 2004 to December 31, 2005
to March 31, 2006 (dollars in thousands).
Change in dollars Percentage Change Change in dollars Percentage Change
Balance Sheet Caption 12/31/04 to 12/31/05 12/31/04 to 12/31/05 12/31/05 to 3/31/06 12/31/05 to 3/31/06
--------------------- -------------------- -------------------- ------------------- -------------------
Accounts receivable $1,050 23% $912 38%
Inventories 620 81% 871 63%
Advances to suppliers 637 145% 1,009 94%
Accounts payable 307 64% 871 512%
Customer deposits 657 64% 6 17%
The change in these balance sheet captions reflects the nature of the
cash requirements of our business. The increase in accounts receivable reflected
the increase in sales. Because the collection period typically runs from three
months to one year, the increase in accounts receivable reflects not only the
increase in sales but also the long collection period. Since we require one to
two months to receive products we order, we have been increasing our inventories
in order to enable us to meet anticipated increases in sales. In addition, our
payment cycle is considerably shorter than our receivable cycle, since we
typically pay our suppliers all or a portion of the purchase price in advance
and for some suppliers we must maintain a deposit for future orders. Our payable
decreased as we paid our suppliers more rapidly that we received payments from
our customers. In addition, our customer deposits declined December 31, 2005 to
March 31, 2006. We require our customers are to pay certain percentage of the
sales price as deposit before we ship products to the customers. The percentage
varies from customer to customer. During the course of business, we reduce the
deposit requirement for some customers with good credit. To the extent that we
cannot satisfy our cash needs, whether from operations or from a financing
source, our business would be impaired in that it may be difficult for us to
obtain products which could, in turn, impair our ability to generate sales.
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We believe that our available funds will provide us with sufficient
capital for at least the next twelve months; however, to the extent that we make
acquisitions or establish our own production facilities, we may require
additional capital for the acquisition or for the operation of the combined
companies. As of the date of this prospectus, we have no material commitments
for capital expenditures. We cannot assure that such funding will be available.
In the course of our business, we must make significant deposits to our
suppliers when we place an order. At March 31, 2006, our advance payments to our
suppliers totaled approximately $2.1 million. At May 31, 2006, our cash balance
was approximately $598,000.
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
$2.0 million, or 72% of revenue, for the three months ended March 31, 2006,
approximately $10.1 million, 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 31,
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
three months ended March 31, 2006, together with the sales volume for the
period, are:
o Lopamidol 370, a liquid medication which is used for stomach
radiography, accounted for sales of $417,000.
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o Lopamidol 300, a liquid medication which is used for stomach
radiography, accounted for sales of $402,000.
o An Ting, a contraceptive medicine which accounted for sales of
$302,000.
o Cinepazide maleate injection, which is used in the treatment of
vascular sclerosis, accounted for sales of $165,000.
o SonoVue, which is used in ultrasound radiography, accounted for
sales of $133,333.
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, which accounted for sales of $3.4 million.
o Levocarnitine, which is used for cardiac muscle disease, bone
problem and high blood lipid and is given by injection, which
accounted for sales of approximately $1million.
o SonoVue, which accounted for sales of $625,000.
o Cinepazide maleate injection, which accounted for sales of $314,000.
o Sodium Ozagrel injection, which is used in the treatment of stroke,
accounted for sales of $250,000.
We have the exclusive distribution rights in the PRC to Lopamidol,
Levocarnitine and Ozargel. 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 three months ended March 31, 2006, together with the
sales volume for the period, are:
o Shedan chuanbei piba gao, which is used for coughs, accounted for
sales of $317,000.
o Milian chuanbei piba gao, which is used for coughs, accounted for
sales of $163,000.
o Xue shuan tong, which is used for stroke, accounted for sales of
$88,000.
o Qianbai biyan tablet, which is used for rhinitis, accounted for
sales of $56,000.
o Tianhuang houzao powder, which is used for cold, accounted for sales
of $47,000.
Our five largest selling traditional Chinese medicines for the year
ended December 31, 2005 with the sales volume for the period, are:
o Xue shuan tong, which accounted for sales of approximately $556,000.
o Qianbai biyan tablet, which accounted for sales of approximately
$313,000.
o Qingre sanjie table, which is used for the common cold, accounted
for sales of approximately $265,000.
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o Chuanbei piba gao, which is used for coughs, accounted for sales of
approximately $229,000.
o Zhachong shisanwei, which is used for the common cold, accounted for
sales of approximately $191,000.
Herbs and Dietary Supplements. We also sell a range of Chinese herbs,
which accounted for nominal sales for the three months ended March 31, 2006 and
approximately $138,000 for the year ended December 31, 2005, and dietary
supplements, which accounted for nominal sales.
Principal Suppliers
Our five largest suppliers in the three months ended March 31, 2006 are
Shanghai Bracco Sine Pharmaceutical Corporation, Guangzhou Pharmaceutical
Holdings Limited, Guangzhou Qixing Pharmaceutical Co., Ltd., Guangzhou
Pangaoshou Medicine Co., Ltd and Guangzhou Jingxiutang Medicine Co., Ltd, which
accounted for 54.3% of our total purchases in the three months ended March 31,
2006. Among them, our two largest suppliers are accounted for 33.8% of our
purchases in the three month period.
Our five largest suppliers in 2005 and 2004 were 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.. These suppliers accounted
for 74% of our purchases in each of these years. Among them, our two largest
suppliers, accounted for 59% of our purchases for 2005 and 53% of our purchases
for 2004.
Our agreements with our suppliers generally have a term of one year and
provide that the suppliers will provide us with the products we order. None of
our supply agreements has any minimum purchase requirements on our part;
however, we are frequently required to make a significant down payment, in the
amount of $150,000 to $250,000, for one year's purchase with our large suppliers
when we place an order at the beginning of each year. 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 67% of our revenue for the three months
ended March 31, 2006, 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 49% of our revenue for the three months ended
March 31, 2006, 72% and 25% of our revenue for the years ended December 31, 2005
and 2004. Our two largest customers for the three months ended March 31, 2006
and the year 2005 are Guangdong Sanhong Medicine Co., Ltd., which accounted for
33% and 42% of revenue for the three months ended March 31, 2006 and the year
2005, and Guangdong Saikang Medical Co., Ltd., which accounted for 16% and 30%
of revenue for the three months ended March 31, 2006 and the year 2005.
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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
medicine companies and hospitals typically buy some inventory which they deem
useful 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 and because of the larger
purchases made at the end of the previous year.
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 in China with respect to certain
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 a five-year 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.
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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. However, commencing in
2006 some of our products became subject to price controls, which affected our
gross margin for the three months ended March 31, 2006. It is possible that
additional products may become subject to price controls. 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.
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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.
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.
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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
Robert Adler(1) 71 Director
Dr. Rachel Gong(1), (2) 38 Director
Dr. Yanfang Chen(2) 42 Director
----------
(1) Member of the audit committee.
(2) Member of the compensation committee.
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.
Ms. Minhua Liu 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, a financial
consulting company working mainly with companies in the PRC. 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.
-44-
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.
Mr. Robert Adler is a private investor. During the past five years, Mr.
Adler has been an investment adviser with UBS Financial Services and most
recently he taught financial English for a semester in Shanghai University of
Finance and Economics. Mr. Adler's prior experience includes terms as a managing
director for ING Furman Selz Asset Management, Vice President and Senior
Investment Officer of BHF Securities Corp and DG Bank, New York Branch and Vice
President of Kuhn, Loeb & Co. Mr. Adler obtained a B.A. degree from Swarthmore
College and studied at NYU School of Business Administration. Mr. Adler is a
member of Institute of Chartered Financial Analysts.
Dr. Rachel Gong is an investment principal of Morningside, an
international investment group based in Hong Kong and has served in that
position since 2004. Prior to that, Dr. Gong served as an investment banker for
RBC Capital Markets from 2001 to 2004 and a senior auditor for
PricewaterhouseCoopers from 1999 to 2001. Dr. Gong obtained a Ph.D. in Medical
Science (Biochemistry and Molecular Biology) from University of South Florida
College of Medicine and an MBA from Johnson Graduate School of Management of
Cornell University.
Dr. Yanfang Chen is currently an assistant professor, of Department of
Pharmacology & Toxicology, Wright State University Boonshoft School of Medicine.
During the past five years, he has been research associate, senior research
associate and research assistant professor at the Department of Pharmacology &
Toxicology, Wright State University Boonshoft School of Medicine. He obtained a
Ph.D. from Medical Science Center, Peking University in China in 1995 and worked
for Guangdong Provincial People's Hospital from 1995 to 1999. Dr. Chen is a
professional member of American Heart Association and American Stroke
Association, and a member of American Society for Pharmacology and Experimental
Therapeutics. He has numerous publications in his field of research.
Minhua Liu and Junhua Liu are sister and brother. There are no other
relationships among our officers, directors and principal stockholders.
Directors are elected for a term of one year.
Committees
Our business, property and affairs are managed by or under the
direction of the board of directors. Members of the board are kept informed of
our business through discussion with the chief executive and financial officers
and other officers, by reviewing materials provided to them and by participating
at meetings of the board and its committees.
-45-
Since May 9, 2006, when our independent directors were elected, our
board of directors has had two committees - the audit committee and the
compensation committee. Dr. Rachel Gong and Robert Adler were named to the audit
committee, with Dr. Gong as chairperson, and Dr. Yanfang Chen and Dr. Gong were
named to the compensation committee, with Dr. Chen as chairman.
Our audit committee will be involved in discussions with our
independent auditor with respect to the scope and results of our year-end audit,
our quarterly results of operations, our internal accounting controls and the
professional services furnished by the independent auditor. Our board of
directors has adopted a written charter for the audit committee which the audit
committee reviews and reassesses for adequacy on an annual basis.
The compensation committee serves as the stock option committee for our
stock option plan, and it reviews and approves any employment agreements with
management and changes in compensation for our executive officers.
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.
Directors' Compensation
Each independent director receives an annual directors' fee of $10,000.
In addition, pursuant to the 2006 long-term incentive plan, each newly-elected
independent director receives at the time of his or her election, a five-year
option to purchase 30,000 shares of common stock at the market price on the date
of his or her election. In addition, the plan provides for the annual grant to
each independent director of an option to purchase 5,000 shares of common stock
on first trading day in April of each calendar year, commencing in 2007.
Pursuant to these provisions, each of the three independent directors received a
stock option to purchase 30,000 shares of common stock at an exercise price of
$1.25 per share, subject to stockholder approval of the plan.
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.
Name and Position Year Salary Other Compensation
----------------- ---- ------ ------------------
Senshan Yang, chief executive officer 2005 $25,488 $ -0-
2004 3,608 -0-
2003 5,562 -0-
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Prior to February 8, 2006, Senshan Yang, Minhua Liu and Junhua Liu were
the owners of all of the equity of Konzern. During 2005, Konzern made
distributions to its stockholders in the amount of approximately $3.1 million
consisting of $1.9 million in cash and $1.2 million in inventory. Konzern made
distributions with respect to the year ended December 31, 2004 in the amount of
$2.6 million. 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. We distributed inventory of $1.2 million in 2006 in order to
preserve our cash position. The former stockholders of Konzern have no agreement
or understanding with us with respect to the inventory.
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 whom is to be an independent
director. 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.
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.
-47-
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 as to shares of common stock
beneficially owned as of June 30, 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.
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 6,064,500 82.2%
individuals)
* 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 June 30, 2006.
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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
During the period from February 2005 through the completion of the
reverse acquisition on February 8, 2006, the operations of Capital Markets
advanced money to Lounsberry to fund its operations. As of February 8, 2006, the
amount due Capital Markets was $32,398. On February 8, 2006, we purchased
928,000 shares of common stock from Capital Markets for $167,602, and paid debt
of $32,398 due to Capital Markets in respect of its advances. 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.
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.
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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.
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 A 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 $0.40 or more
and by 50% if pre-tax income is $0.20 per share or lower.
o No dividends are payable with respect to the series A preferred
stock.
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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.
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."
Common Stock Purchase Warrants
In connection with our February 2006 private placement, we issued
warrants to purchase 3,694,738 shares of common stock at an exercise price of
$1.75 per share and 3,694,738 shares of common stock at an exercise price of
$2.50 per share. The warrants issued to the investors have a term of five years.
The warrants provide for adjustments if the Company does not meet certain
financial targets. In the event that our earnings before interest, taxes,
depreciation and amortization for the year ended December 31, 2005 is less than
$5,650,000, the exercise price of the warrant is reduced by the percentage
shortfall, up to a maximum of 30%. No adjustment was made as a result of our
operations in 2005. In the event our pre-tax income, as defined, per share of
common stock for 2006, is less than $0.40 per share, the exercise price shall be
reduced proportionately by up to 50%. The exercise price will be reduced by 50%
if pre-tax income per share $0.20 per share or lower.
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The warrants also provide 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 may be, of such other
securities. The holders of the warrants have certain cashless exercise rights,
commencing in August 2006, if we the underlying shares of common stock are not
subject to a current and effective registration statement.
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.
Although we do not believe that we are subject to the penny-stock
rules, it is possible that in the future our common stock may be subject to
rules that impose additional sales practice requirements on broker-dealers who
sell such securities to persons other than established customers and accredited
investors (generally those with assets in excess of $1,000,000 or annual 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.
-52-
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 China Medicine Corporation 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.
LEGAL MATTERS
The validity of the shares of common stock offered through this
prospectus will be passed on by Sichenzia Ross Friedman Ference LLP.
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.
-53-
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.
-54-
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
CHINA MEDICAL CORPORATION
INDEX TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Years Ended December 31, 2005 and 2004 Page
--------------------------------------------------------------------------------
Report of Independent Registered Accounting Firm F-2
Balance Sheet at December 31, 2005 F-3
Statement of Income and Other Comprehensive Income for the
years ended December 31, 2005 and 2004 F-4
Statements of Changes in Stockholders' Equity for the Period
from February 10, 2005 (inception) to December 31, 2005 F-5
Statements of Cash Flows for the years ended December 31, 2005
and 2004 F-6
Notes to Financial Statements F-7 - F-20
--------------------------------------------------------------------------------
Three Months Ended March 31, 2006 and 2005 (unaudited)
--------------------------------------------------------------------------------
Balance Sheet at March 31, 2006 F-21
Statements of Income and Other Comprehensive Income for the
three months ended March 31, 2006 and 2005 F-22
Statements of Stockholder's Equity for the three months
ended March 31, 2006 and 2005 F-23
Statements of Cash Flows for the three months ended
March 31, 2006 and 2005 F-24
Notes to Financial Statement F-25 - F-39
F-1
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
July , 2006
F-2
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2005 AND 2004
ASSETS
2005 2004
---------- ----------
CURRENT ASSETS:
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:
Common stock, $0.0001 par value, $90,000,000 shares authorized,
6,530,000 shares issued and outstanding 653 653
Paid-in capital 120,347 120,347
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-3
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED 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
============ ============
Earnings per share - basic and diluted $ 0.89 $ 0.45
============ ============
Weighted average number of shares outstanding-basic and diluted 6,530,000 6,630,000
============ ============
See report of independent registered public accounting firm.
The accompanying notes are an integral part of this statement.
F-4
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Accumulated
Common Stock other
--------------------- Paid-in Statutory Retained comprehensive
Shares Par Value capital reserves earnings income Totals
--------- --------- --------- --------- ----------- --------- -----------
BALANCE, December 31, 2003 6,530,000 $ 653 $ 120,347 $ 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 6,530,000 653 120,347 722,909 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 6,530,000 $ 653 $ 120,347 $ 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-5
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED 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-6
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 1 - Organization
Organization
China Medicine Corporation (the "Company") is a Delaware corporation,
incorporated on February 10, 2005 under the name Lounsberry Holdings III, Inc,
for the purpose of acquiring, or merging with, an operating business. On May 10,
2006, the Company changed its corporate name to China Medicine Corporation.
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"). Pursuant to the Exchange Agreement, the Company, at
closing, acquired all of the capital of Konzern from Konzern Stockholders in
exchange for 6,530,000 shares of the Company's common stock. For accounting
purposes, the acquisition of Konzern has been treated as a recapitalization of
Konzern with Konzern as the acquirer. The historical financial statements for
periods prior to February 8, 2006 are those of Konzern, except that the equity
section and earnings per share have been retroactively restated to reflect the
reverse acquisition. Contemporaneously with the reverse acquisition, the Company
redeemed 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 for $167,602 and paid off loans from related party for $32,398. The
928,000 shares purchased constituted approximately 90.3% of the 1,028,000 shares
of common stock outstanding prior to the issuance of the shares of common stock
pursuant to the Exchange Agreement.
Konzern was privatized from a state-owned medicine company on July 25, 2000 in
Guangzhou, People's Republic of China (PRC). The business license provides for a
24 years term and will end on September 2, 2024.
Konzern is 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. The Company purchases its
products from Chinese drug manufacturers and other medicine companies.
Activities
The Company's business operations consist of the purchase of traditional
pharmaceutical medicines, 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-7
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies
Basis of preparation
The consolidated financial statements of the Company reflected the activities of
100% ownership of Konzern that locates in PRC. The consolidated financial
statements have been presented as if the exchange of shares provided in the
Exchange Agreement occurred on January 1, 2004, as a result of the reverse
acquisition whereby the Konzern Shareholders acquired voting control and
operational management of the Company.
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, and the residual value is estimated to be 5% of cost. The
estimated lives used in determining depreciation are:
Furniture 3 - 5 years
Office equipment 3 - 5 years
Motor vehicles 4 - 10 years
See report of independent registered public accounting firm
F-8
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
See report of independent registered public accounting firm
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-9
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
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-10
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
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-11
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
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-12
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
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.
See report of independent registered public accounting firm
F-13
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, continued
Recently issued accounting pronouncements, continued
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.
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.
See report of independent registered public accounting firm
F-14
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 3 - Earnings per share
The Company reports earnings per share in accordance with the provisions of SFAS
No. 128, "Earnings Per Share." SFAS No. 128 requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share. Basic earnings per share excludes
dilution and is computed by dividing income available to common stockholders by
the weighted average common shares outstanding during the period. Diluted
earnings per share takes into account the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and converted
into common stock. Earnings per share have been retroactively restated to
reflect the reverse acquisition and earnings per share for the years ended
December 2005 and 2004 are $0.89 and $0.45, respectively.
Note 4 - 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
========== ==========
Note 5 - Inventories
Inventories consisted of the following:
December 31, December 31,
2005 2004
---------- ----------
Traditional Pharmaceutical Medicine $1,382,929 $ 755,965
Traditional Chinese Medicine -- 7,423
---------- ----------
Totals $1,382,929 $ 763,388
========== ==========
Note 6 - 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.
See report of independent registered public accounting firm
F-15
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 7 - 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 8 - 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.
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 9 - 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.
See report of independent registered public accounting firm
F-16
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 10 - 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 11 - 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.
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:
See report of independent registered public accounting firm
F-17
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 11 - Taxes payable, continued
Provision for income taxes, (continued)
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 12 - 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
========
Note 13 - 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.
See report of independent registered public accounting firm
F-18
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 14 - 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
The cost of purchase and development of those technologies had been booked as
research and development expenses in 2004 since all purchase and development
activities occurred in 2004. The Company sold these technologies in 2005 and
recognized $2,134,872 as other operating income.
Note 15 - 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-19
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 15 - 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
the difference between its fair market value and cost is recognized as gain of
$74,828 and $14,339 in the accompanying income statement for the years ended
December 31, 2005 and 2004, respectively. The shareholders received inventory
distribution in order to retain cash in the business for operating purpose.
Note 16 - 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 17 - 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.
See report of independent registered public accounting firm
F-20
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO FINANCIAL STATEMENTS
Note 17 - Bio-One Corporation joint venture agreement, continued
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.
Note 18 - Subsequent events
Sale of preferred stock and warrants
Contemporaneously with the exchange with 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.
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.
Each Series A Preferred Stock is convertible into one share of common stock,
reflecting a conversion price of $1.25 per common stock. The Company determined
that the fair market value of common stock at the time of issuance of the
preferred stock is $0.32 per share; therefore, the conversion features are
out-the-money. Under the guidance of Accounting Principles Board Opinion (APB)
No.14, no portion of the proceeds from the issuance was allocated to the
conversion features.
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 $3.78
million.
Other shares issued
The Company issued 750,000 shares of common stock to individuals for services
performed and of which 187,500 shares were issued to officers.
Long-term incentive plan
The Company also adopted, subject to stockholder approval, the 2006 long-term
incentive plan (the "Plan") to enable the Company and its subsidiaries and
affiliates to attract, retain and reward employees and consultants.
See report of independent registered public accounting firm
F-21
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2006 AND DECEMBER 31, 2005
ASSETS
March 31, December 31,
2006 2005
----------- -----------
(Unaudited) (Audited)
----------- -----------
CURRENT ASSETS:
Cash $ 1,758,279 $ 91,964
Accounts receivable, trade, net of allowance for doubtful accounts
of $12,412 and $12,333 as of March 31, 2006 and
December 31, 2005, respectively 3,323,205 2,410,824
Inventories 2,253,491 1,382,929
Other receivables 114,006 38,301
Other receivables - related parties 60,695 --
Advances to suppliers 2,084,331 1,075,546
----------- -----------
Total current assets 9,594,007 4,999,564
----------- -----------
EQUIPMENT, net 778,234 330,015
----------- -----------
Total assets $10,372,241 $ 5,329,579
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable, trade $ 1,041,302 $ 170,196
Short-term loans -- 95,480
Other payables and accrued liabilities 3,220 97,449
Customer deposits 43,520 37,292
Taxes payable 367,402 170,456
----------- -----------
Total current liabilities 1,455,444 570,873
----------- -----------
SHAREHOLDERS' EQUITY:
Preferred stock, $0.0001 par value; 10,000,000 shares
authorized, 3,120,000 shares issued and outstanding 312 --
Common stock, $0.0001 par value; $90,000,000 shares
authorized, 7,380,000 shares issued and outstanding 738 653
Paid-in capital 3,941,719 120,347
Statutory reserves 722,909 722,909
Retained earnings 4,105,222 3,813,665
Accumulated other comprehensive income 145,897 101,132
----------- -----------
Total shareholders' equity 8,916,797 4,758,706
----------- -----------
Total liabilities and shareholders' equity $10,372,241 $ 5,329,579
=========== ===========
The accompanying notes are an initegral part of this statement.
F-22
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
2006 2005
----------- -----------
Unaudited Unaudited
----------- -----------
REVENUES $ 3,511,979 $ 2,728,586
COST OF GOOD SOLD 2,459,550 1,828,997
----------- -----------
GROSS PROFIT 1,052,429 899,589
----------- -----------
OTHER OPERATING INCOME 296,103 424,628
----------- -----------
OPERATING EXPENSES
Research and development expenses 54,664 159
Selling expenses 100,102 39,429
General and administrative expenses 403,366 58,288
----------- -----------
Total operating expenses 558,132 97,876
----------- -----------
INCOME FROM OPERATIONS 790,400 1,226,341
ACQUISITION TRANSACTION EXPENSE 323,770 --
OTHER (EXPENSE) INCOME (9,492) 178
----------- -----------
INCOME BEFORE INCOME TAXES 457,138 1,226,519
PROVISION FOR INCOME TAXES 165,581 --
----------- -----------
NET INCOME 291,557 1,226,519
OTHER COMPREHENSIVE INCOME :
Foreign currency translation adjustment 44,765 --
----------- -----------
COMPREHENSIVE INCOME $ 336,322 $ 1,226,519
=========== ===========
Earning per share - basic $ 0.04 $ 0.19
=========== ===========
Earning per share - diluted $ 0.04 $ 0.19
=========== ===========
Weighted average number of shares outstanding - basic 6,992,778 6,530,000
=========== ===========
Weighted average number of share outstanding - diluted 7,193,678 6,530,000
=========== ===========
The accompanying notes are an initegral part of this statement.
F-23
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
Common Stock Preferred Stock
---------------------- ---------------------- Paid-in Statutory
Shares Par Value Shares Par Value capital reserves
--------- ------- --------- ------- ----------- --------
BALANCE, December 31, 2004 6,530,000 $ 653 -- $ -- $ 120,347 $722,909
Net income
--------- ------- --------- ------- ----------- --------
BALANCE, March 31, 2005 (Unaudited) 6,530,000 653 -- -- 120,347 722,909
Net income
Distributions
Foreign currency translation adjustments
--------- ------- --------- ------- ----------- --------
BALANCE, December 31, 2005 6,530,000 653 -- -- 120,347 722,909
Net income
Reverse acquisition, February 8, 2006 1,028,000 103 (32,501)
Shares redeemed in connection with
reverse Acquisition (928,000) (93) (167,509)
Shares issued for acquisition services 750,000 75 238,694
Issuance of preferred stock 3,120,000 312 3,782,688
Foreign currency translation adjustments
--------- ------- --------- ------- ----------- --------
BALANCE, March 31, 2006 (Unaudited) 7,380,000 $ 738 3,120,000 $ 312 $ 3,941,719 $722,909
========= ======= ========= ======= =========== ========
Accumulated
other
Retained comprehensive
earnings income Totals
----------- -------- -----------
BALANCE, December 31, 2004 $ 1,234,972 $ -- $ 2,078,881
Net income 1,226,519 1,226,519
----------- -------- -----------
BALANCE, March 31, 2005 (Unaudited) 2,461,491 -- 3,305,400
Net income 4,463,651 4,463,651
Distributions (3,111,477) (3,111,477)
Foreign currency translation adjustments 101,132 101,132
----------- -------- -----------
BALANCE, December 31, 2005 3,813,665 101,132 4,758,706
Net income 615,327 615,327
Reverse acquisition, February 8, 2006 (32,398)
Shares redeemed in connection with
reverse acquisition (167,602)
Shares issued for acquisition services 238,769
Issuance of preferred stock 3,783,000
Foreign currency translation adjustments 44,765 44,765
----------- -------- -----------
BALANCE, March 31, 2006 (Unaudited) 4,428,992 $145,897 $ 9,240,567
=========== ======== ===========
The accompanying notes are an initegral part of this statement.
F-24
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
2006 2005
----------- -----------
Unaudited Unaudited
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 291,557 $ 1,226,519
Adjustments to reconcile net income to cash
used in operating activities:
Depreciation 21,478 25,794
Gain on sale of intangible assets 15,570 --
Stock issued for services 238,769 --
Change in operating assets and liabilities:
(Increase) decrease in assets:
Accounts receivable, trade (893,091) 171,033
Inventories (858,049) (492,890)
Other receivables (75,143) (36,003)
Other receivables - related parties (60,442) (40,387)
Advances to suppliers (997,672) (679,741)
Increase (decrease) in liabilities:
Accounts payable, trade 833,982 314,548
Other payables and accrued liabilities (94,462) 6,600
Customer deposits 5,962 (585,644)
Taxes payable 195,031 (17,760)
----------- -----------
Net cash used in operating activities (1,376,510) (107,931)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (483,292) (18,968)
----------- -----------
Net cash provided by (used in) investing activities (483,292) (18,968)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term loan (95,696) --
Proceeds from issuance of preferred stock 3,783,000 --
Cash paid on shares redeemed (167,602) --
----------- -----------
Net cash used in financing activities 3,519,702 --
----------- -----------
EFFECT OF EXCHANGE RATE ON CASH 6,415 --
----------- -----------
INCREASE (DECREASE) IN CASH 1,666,315 (126,899)
CASH, beginning of period 91,964 243,520
----------- -----------
CASH, end of period $ 1,758,279 $ 116,621
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ -- $ --
=========== ===========
Cash paid for interest expense $ 1,582 $ --
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTION:
Stock issued for services $ 238,769 $ --
=========== ===========
The accompanying notes are an initegral part of this statement.
F-25
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 1 - Organization
Organization
China Medicine Corporation (the "Company") is a Delaware corporation,
incorporated on February 10, 2005 under the name Lounsberry Holdings III, Inc,
for the purpose of acquiring, or merging with, an operating business. On May 10,
2006, the Company changed its corporate name to China Medicine Corporation.
On February 8, 2006, the Company entered into a Stock Exchange Agreement
("Exchange Agreement") with Guangzhou Konzern Medicine Co., Ltd. ("Konzern").
Pursuant to the Exchange Agreement, the Company, at closing, acquired all of the
capital of Konzern from Konzern Stockholders in exchange for 6,530,000 shares of
the Company's common stock. For accounting purposes, the acquisition of Konzern
has been treated as a recapitalization of Konzern with Konzern as the acquirer.
The historical financial statements for periods prior to February 8, 2006 are
those of Konzern, except that the equity section and earnings per share have
been retroactively restated to reflect exchange ratio in the reverse
acquisition. Contemporaneously with the reverse acquisition, the Company
redeemed 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 for $167,602 and paid off loans from related party for $32,398. The
928,000 shares purchased constituted approximately 90.3% of the 1,028,000 shares
of common stock outstanding prior to the issuance of the shares of common stock
pursuant to the Exchange Agreement and the 750,000 shares issued as disclosed in
Note 15.
Konzern was privatized from a state-owned medicine company on July 25, 2000 in
Guangzhou, People's Republic of China (PRC). The business license provides for a
24 years term and will end on September 2, 2024.
Konzern is 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. The Company purchases its
products from Chinese drug manufacturers and other medicine companies.
Note 2 - Summary of significant accounting policies
Basis of presentation
The consolidated financial statements of the Company reflected the activities of
100% ownership of Konzern that locates in PRC. The consolidated financial
statements have been presented as if the exchange of shares provided in the
Exchange Agreement occurred on January 1, 2004, as a result of the reverse
acquisition whereby the Konzern Shareholders acquired voting control and
operational management of the Company.
F-26
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Basis of presentation, (continued)
The accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
accompanying consolidated financial statements include the accounts of Konzern
and the Company. All material transactions and balances have been eliminated in
the consolidation.
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
The Company considers all highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents. Cash
includes cash on hand and demand deposits in accounts maintained with state
owned banks within PRC and banks in the United States.
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 that
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.
Concentration of credit risk
Financial instruments, which subject the Company to concentration of credit
risk, consist of cash. The Company maintains balances at financial institutions
which, from time to time, may exceed Federal Deposit Insurance Corporation
insured limits for the bank that is located in the Unites States, no deposits
with the state owned banks within PRC are covered by insurance. As of March 31,
2006 and December 31, 2005, the Company had deposits in excess of federally
insured limits total of $1,900,350 and $78,319, respectively. These deposit were
held in United States banks at March 31, 2006.The Company has not experienced
any losses in such accounts and believes it is not exposed to any significant
risks on its cash in bank accounts.
F-27
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Accounts receivable, trade
The Company conducts its business operations in PRC. 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. However, 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 March 31, 2006 and
December 31, 2005 amounted to $12,412 and $12,333, respectively.
Inventories
Inventories are stated at the lower of cost or market value, cost is determined
using the weighted average method.
Plant and equipment
Plant and equipment are stated at the actual cost of acquisition less
accumulated depreciation and amortization. Depreciation and amortization are
provided for in amounts sufficient to relate the cost of depreciation of assets
to operations 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 the actual cost.
The cost and related accumulated depreciation of assets sold or otherwise
retired are eliminated from the accounts and any gain or loss is include in the
statement of operations. Maintenance, repairs and minor renewals are charged
directly to expenses as incurred.
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".
F-28
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Impairment of long-lived assets
Per SFAS No. 144, long-lived assets will be analyzed 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 undiscounted future cash
flows associated with them. At the time such 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 the 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.
F-29
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Foreign currency translation
The functional currency of Konzern is the Chinese Renminbi. The financial
statements of Konzern 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 PRC.
Approval of foreign currency payments by the Bank of China or other institutions
requires submitting a payment application form together with invoices, shipping
documents and signed contracts.
Translation adjustments resulting from this process are included in accumulated
other comprehensive income in the consolidated statement of shareholders' equity
and amounted to $44,765 and $0 for the three months ended March 31, 2006 and
2005, respectively. The balance sheet amounts with the exception of equity at
March 31, 2006 were translated at 8.01 RMB to $1.00 USD as compared to 8.26 RMB
at March 31, 2005. The equity accounts were stated at their historical rate. The
average translation rate of 8.04 RMB for the three months ended March 31, 2006
was applied to income statement accounts.
Income taxes
The Company has adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). SFAS 109 requires the recognition of
deferred income tax liabilities and assets for the expected future tax
consequences of temporary differences between income tax basis and financial
reporting basis of assets and liabilities. Provision for income taxes consist of
taxes currently due plus deferred taxes. There are no deferred tax amounts at
March 31, 2006 and December 31, 2005.
The Charge for taxation is based on the results for the year as adjusted for
items, which are non-assessable or disallowed. It is calculated using tax rates
that have been enacted or substantially enacted by the balance sheet date.
F-30
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Income taxes, (continued)
Deferred tax is accounted for using the balance sheet liability method is
respect of temporary differences arising from differences between the carrying
amount of assets and liabilities in the financial statements and the
corresponding tax basis used in the computation of assessable tax profit. In
principle, deferred tax liabilities are recognized for all taxable temporary
differences, and deferred tax assets are recognized to the extent that it is
probably that taxable profit will be available against which deductible
temporary differences can be utilized.
Deferred tax is calculated at the tax rates that are expected to apply to the
period when the asset is realized or the liability is settled. Deferred tax is
charged or credited in the income statement, except when it related to items
credited or charged directly to equity, in which case the deferred tax is also
dealt with in equity.
Deferred tax assets and liabilities are offset when they relate to income taxes
levied by the same taxation authority and the Company intends to settle its
current tax assets and liabilities on a net basis.
The Company is organized in the United States and no tax benefit is expected
from tax credits in the future. The Company has located its subsidiary, Konzern
in a special economic region in China. This economic region allows foreign
enterprises a two-year income tax exemption and a 50% income tax reduction for
the following three years. Konzern was approved as a foreign Joint-venture
enterprise in 2004 and as a wholly-owned foreign enterprise in 2006. Konzern has
an income tax exemption for 2004 and 2005 and a 50% reduction the income tax
rate for 2006, 2007 and 2008.
The estimated tax savings for the period ending March 31, 2006 and 2005 amounted
to $165,581 and $404,751, respectively. The net effect on earnings per share if
the income tax had been applied would decrease earnings per share from $0.04 to
$0.01 for 2006 and $0.19 to $0.13 for 2005, respectively.
The provision for income taxes at March 31 consisted of the following:
2006 2005
-------- ----------
Unaudited Unaudited
-------- ----------
Provision for China Income Tax $165,581 $ --
Provision for Local Tax -- --
-------- ----------
Totals $165,581 $ --
======== ==========
F-31
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Income taxes, (continued)
The following table reconciles the U.S. statutory rates to the Company's
effective tax rate for the three months ended March 31:
2006 2005
------ ------
U.S. Statutory rates 34.0 % 34.0 %
Foreign income not reognized in USA (34.0) (34.0)
China income taxes 33.0 --
50% tax reduction (16.5) --
------ ------
Effective income tax rate 16.5 % -- %
====== ======
Value added tax
Enterprises or individuals who sell commodities are subject to a value added tax
in accordance with Chinese laws. The value added tax standard rate is 17% of the
gross sales price. A credit is available whereby VAT paid on the purchase of
semi-finished products or raw materials used in production of the Company's
finished products can be used to offset the VAT due on sales of the finished
product.
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.
Stock-based compensation
Effective January 1, 2006, the Company adopted the Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payments,"
("FAS123R"), which established standards for the accounting for transactions in
which an entity exchange its equity instruments for goods or services. This
statement require a public entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award.
F-32
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Stock-based compensation, (continued)
On February 8, 2006, contemporaneously with the reverse acquisition, the Company
granted options to purchase 430,000 of common stock of which options to purchase
390,000 shares were granted to officers and other key employees of Konzern. On
March 22, 2006, the Company granted options to purchase an additional 850,000
shares of common stock to two officers. The options all have an exercise price
of $1.25, which was the conversion price of the series A preferred stock and not
less than the fair market value on the date of grant, and were granted pursuant
to the Company's 2006 Long-Term Incentive Plan. The 2006 Long-Term Incentive
Plan, which covers 1,575,000 shares of common stock, and all options granted
under the plan are subject to stockholder approval of the plan. The Company
estimated that the value of the options is $.10 per share of common stock
subject to the options. The Company intends to seek stockholder approval of the
plan during the second quarter of 2006.
Major suppliers
For the three months ended March 31, 2006 and the year ended December 31, 2005,
five suppliers accounted for approximately 54% and 74%, respectively, of the
Company's purchases.
Major customers
For the three months ended March 31, 2006 and the year ended December 31, 2005,
five customers accounted for approximately 67% and 65%, respectively, of the
Company's sales.
Recently issued accounting pronouncements
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.
F-33
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 2 - Summary of significant accounting policies, (continued)
Recently issued accounting pronouncements, (continued)
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.
Note 3 - Consolidated financial statements and condensed footnotes
The interim consolidated financial statements presented herein have been
prepared by the Company and include the unaudited accounts of the Company and
its subsidiaries. All significant inter-company accounts and transactions have
been eliminated in the consolidation.
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States for interim
financial information and the instructions for Form 10-QSB and Item 310 of
Regulation S-B.
Certain information and footnote disclosures that are normally included in
financial statements presented in accordance with generally accepted accounting
principles have been condensed or omitted. Management of the Company believes
the disclosures made are adequate to make the information presented not
misleading.
In the opinion of management, the unaudited consolidated financial statements
reflect all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position of the Company as of March
31, 2006 and the results of operations, changes in shareholders' equity and cash
flows for the three months ended March 31,2006 and 2005. Interim results are not
necessarily indicative of a full year's performance.
Note 4 - Earnings per share
The Company reports earnings per share in accordance with the provisions of SFAS
No. 128, "Earnings Per Share." SFAS No. 128 requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share. Basic earnings per share excludes
dilution and is computed by dividing income available to common stockholders by
the weighted average common shares outstanding during the period. Diluted
earnings per share takes into account the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and converted
into common stock.
F-34
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 4 - Earnings per share, (continued)
The following is a reconciliation of the basic and diluted earnings per share
computations for the three months ended March 31, 2006 and 2005:
2006 2005
---------- ----------
Unaudited Unaudited
---------- ----------
Net income for basic earnings per share $ 256,557 $1,226,519
========== ==========
Shares of common stock and common
stock equivalents:
Weighted average shares used in basic computation 6,992,778 6,530,000
==========
Diluted effect of convertible preferred stock 200,900
----------
Weighted average shares used in diluted computation 7,193,678
==========
Earnings per share:
Basic $ 0.04 $ 0.19
========== ==========
Diluted $ 0.04
==========
Note 5 - Accounts receivable, trade
Accounts receivable, trade as of March 31, 2006 and December 31, 2005 consisted
of the following:
March 31, December 31,
2006 2005
---------- ----------
Unaudited Audited
---------- ----------
Accounts receivable $3,335,617 $2,423,157
Less: allowance for
doubtful accounts 12,412 12,333
---------- ----------
Totals $3,323,205 $2,410,824
========== ==========
Note 6 - Inventories
Inventories consisted of the following:
March 31, December 31,
2006 2005
--------- ----------
Unaudited Audited
--------- ----------
Traditional Pharmaceutical Medicine 2,253,257 $1,382,929
Traditional Chinese Medicine 234 --
---------
Totals 2,253,491 $1,382,929
=========
F-35
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 7 - Advances to suppliers
Advances to suppliers as of March 31, 2006 and December 31, 2005 amounted to
$2,084,332 and $1,075,546, respectively. They represent advances to suppliers on
inventory purchases and are fully credited against the purchase price of the
inventory.
Note 8 - Equipment
Equipment is summarized as follows:
March 31, December 31,
2006 2005
-------- --------
Unaudited Audited
-------- --------
Furniture and fixtures $ 59,982 $160,081
Office equipment 668,483 369,459
Motor vehicles 196,685 132,804
-------- --------
Total 925,150 662,344
Less accumulated depreciation 146,916 332,329
-------- --------
Equipment, net $778,234 $330,015
======== ========
Depreciation expense for the three months ended March 3, 2006
and 2005 amounted to $21,478 and $25,794 respectively.
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 $43,520 and $37,292 as of March 31,
2006 and December 31, 2005, respectively.
Note 10 - Taxes payable
Taxes payable consisted of the following:
March 31, December 31,
2006 2005
-------- --------
Unaudited Audited
-------- --------
Income taxes payable $166,273 $ --
Individual income tax 380 205
Value added tax 200,749 170,251
-------- --------
Totals $367,402 $170,456
======== ========
F-36
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 11 - Short-term bank loan payable
In January 2006, the Company repaid $95,696 in short term loans to CITIC
Industrial Bank including interest of $1,582.
March 31, December 31,
2006 2005
--------- -------
Unaudited Audited
--------- -------
Citic Industrial Bank due February 1, 2006,
annual interest rate at 5.22% $ -- $95,480
========= =======
Note 12 - Commitments and contingencies
Operating lease
The Company leases its facilities under non-cancelable operating lease
agreements expiring through August 2006. The lease agreement states that the
Company pays certain operating expenses applicable to the leased premises.
Total rental expense for the three months ended March 31, 2006 and 2005 amounted
to $11,583, and $6,377, respectively.
As of March 31, 2006, the future minimum annual lease payments required are as
follows:
Year Ending December 31,
------------------------
2006 $36,985
2007 and thereafter --
Note 13 - Statutory reserves
The Company's subsidiary, Konzern, 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 PRC ("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 entity's registered capital. Konzern's registered
capital was $2.3 million at March 31, 2006 and $ 121,000 at December 31, 2005.
Appropriations to the statutory public welfare fund is required to be between 5%
and 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 reserves have been reflected in the
financial statements under shareholders' equity.
F-37
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Note 13 - Statutory reserves, (continued)
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 with respect to 2006. According to Konzern's articles, Konzern
should appropriate 10% of the net profit as statutory surplus reserve and 6% as
statutory public welfare. As of March 31, 2006, Konzern's statutory reserve did
not reach 50% of Konzern's registered capital due to the increase in registered
capital of $2.3 million and the reserve will be made at the end of 2006.
Note 14 - 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 $17,947 and $6,354 during the
three months ended March 31, 2006 and 2005, respectively.
Note 15 - Stockholders' equity
Sale of preferred stock
Contemporarily with the reverse acquisition, the Company, on February 8, 2006,
entered into a Preferred Stock Purchase Agreement, dated February 8, 2006, with
Barron Partners L.P., Ray and Amy Rivers, JTROS, Steve Mazur and William Denkin
pursuant to which the Company issued and sold an aggregate of 3,120,000 shares
of its Series A Convertible 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. The warrants 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.
F-38
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(for the three months ended March 31, 2006 and 2005 (unaudited)
Sale of preferred stock , (continued)
Each share of Series A Convertible Preferred Stock is convertible into one share
of common stock, based on a conversion price of $1.25 per share of common stock.
The Company determined that the fair market value of common stock at the time of
issuance of the preferred stock is $.32 per share; therefore, the conversion
features are out-the-money. Under the guidance of Accounting Principles Board
Opinion (APB) No.14, no portion of the proceeds from the issuance was allocated
to the conversion features.
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 for 2005 or fully diluted pre-tax income per
share, computed as set forth in the applicable agreements for 2006. No
adjustment was required with respect to the 2005 requirement. 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 were $3.9 million,
from which the Company received $3,783,000 net of $117,000 commissions.
Common stock
The Company issued 750,000 shares of common stock to individuals for services
performed and of which 150,000 shares were issued to Ms. Mary Xia and 37,500
shares were issued to Ms. Lin Li. The Company valued the common stock at $0.32
per share for a total of $238,769 for the 750,000 shares issued.
F-39
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.
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:
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Item Amount
---- ------
SEC filing fee $2,627.67
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 $102. Both
purchasers are "accredited investors" and they represented in writing that they
acquired the securities for their own accounts. In February 2006, in connection
with the reverse acquisition, we purchased 928,000 shares from Capital Markets
for $167,602, and paid $32,398 of debt due to Capital Markets.
In December 2005, we issued 8,000 shares of common stock for $2,000.
The sales were made directly by the Company to persons known by the Company. One
of the investors, Michael Byl, is president of Southridge Investment Group, LLC,
an NASD registered broker-dealer formerly known as Greenfield Capital Partners
LLC ("Southridge"). Southridge is affiliated by common ownership with Capital
Markets in that both are controlled by a family limited partnership in which
Steve Hicks has voting and disposition control. Of the remaining 39 investors,
one is an employee, but not an affiliate of, Southridge, 16 are employees of
entities that are related to Southridge, but are not broker-dealers, ten have a
family relationship with Steve Hicks, and twelve are not affiliated with the
Company or Capital Markets. No broker or underwriter was involved in the sale of
the shares and no brokerage or underwriting commission was paid. The purchasers
acquired the shares for their own accounts and not with a view to the sale or
distribution thereof. The stock certificates representing the shares bear a
restrictive legend.
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. 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
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o We issued an aggregate of 750,000 shares of common stock to the
following individuals for services. The Company valued the common
stock at $0.32 per share for a total of $238,769 for the 750,000
shares issued.
Meiyi Xia 150,000
Lin Li 37,500
Qingsong Du 187,500
Xiao Duan 125,000
Yaru Du 125,000
Yinshing To 125,000
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.
All of the persons who acquired shares in the foregoing transactions
acquired the shares for investment and not with a view to the sale or
distribution thereof and the stock certificates bear a restrictive legend.
All of 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. Such shares were acquired
for investment and not with a view to the sale of distribution thereof. 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)
4.3 Form of common stock certificate(5)
5.1 Form of opinion of Sichenzia Ross Friedman Ference LLP(5,3)
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)
10.5 Agreement dated October 8, 2003, between the Company and Medicine
and Pharmacology Institute of Nanhua University (English
translation) (5).
10.6 Tax waiver (English translation) (5)
21.1 List of Subsidiaries(4)
23.1 Consent of Sichenzia Ross Friedman Ference LLP (included in Exhibit
5.1)
23.2 Consent of Moore Stephens Wurth Frazer and Torbet, LLP (Page II-6)
II-3
(1) Filed as an exhibit to the Company's current 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) Exhibit 5.1, as signed, will 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.
(5) Filed herewith.
Item 28. Undertakings
The undersigned registrant hereby undertakes:
1. To file, during any period in which it offers or sells
securities, a post-effective amendment to this 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 which,
individually or together, represent a fundamental change
in the information in the registration statement; and
Notwithstanding the forgoing, 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
reflected in the form of prospects filed with the
Commission pursuant to Rule 424(b) if, in the aggregate,
the changes in the volume and price represent no more
than a 20% change in the maximum aggregate offering
price set forth in the "Calculation of Registration Fee"
table in the effective registration statement.
iii. include any additional or changed material information
on the plan of distribution.
2. For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of
the securities offered, and the offering of the securities at
that time to be the initial bona fide offering.
3. File a post-effective amendment to remove from registration
any of the securities that remain unsold at the end of the
offering.
4. For determining liability of the undersigned small business
issuer under the Securities Act to any purchaser in the
initial distribution of the securities, the undersigned small
business issuer undertakes that in a primary offering of
securities of the undersigned small business issuer pursuant
to this registration statement, regardless of the underwriting
method used to sell the securities to the purchaser, if the
securities are offered or sold to such purchaser by means of
any of the following communications, the undersigned small
business issuer will be a seller to the purchaser and will be
considered to offer or sell such securities to such purchaser:
II-4
i. Any preliminary prospectus or prospectus of the
undersigned small business issuer relating to the
offering required to be filed pursuant to Rule 424;
ii. Any free writing prospectus relating to the offering
prepared by or on behalf of the undersigned small
business issuer or used or referred to by the
undersigned small business issuer;
iii. The portion of any other free writing prospectus
relating to the offering containing material information
about the undersigned small business issuer or its
securities provided by or on behalf of the undersigned
small business issuer; and
iv. Any other communication that is an offer in the offering
made by the undersigned small business issuer to the
purchaser.
(b) For determining any liability under the Securities Act, treat the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the small business issuer under Rule 424(b)(1), or (4) or
497(h) under the Securities Act as part of this registration statement as of the
time the Commission declared it effective.
(c) For determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of prospectus as a new
registration statement for the securities offered in the registration statement,
and that offering of the securities at that time as the initial bona fide
offering of those securities.
(d) Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the small business issuer pursuant to the foregoing provisions, or
otherwise, the small business issuer has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the small business issuer of expenses incurred or paid by a director, officer or
controlling person of the small business issuer 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 small business
issuer 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-5
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 Amendment
to 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 11th day of July, 2006.
CHINA MEDICINE CORPORATION
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 July 11, 2006
------------------------------------ and Director
Senshen Yang.
(Principal Executive Officer)
s/ Huizhen Yu Chief Financial Officer July 11, 2006
-----------------------------------
Huizhen Yu
(Principal Financial and Accounting Officer)
s/ Minhua Liu Director July 11, 2006
-----------------------------------
Minhua Liu
s/ Robert Adler Director July 11, 2006
-----------------------------------
Robert Adler
Director July __, 2006
-----------------------------------
Rachel Gong
s/ Yanfang Chen Director July 11, 2006
-----------------------------------
Yanfang Chen
II-6