Item 1. Business.
Corporate History
Lid Hair Studios International, Inc. was established on April 20, 2005 in the state of Nevada. The company was originally incorporated under the name Belford Enterprises, Inc. and changed its name to Lid Hair Studios International Inc. on August 15, 2005. Our operating subsidiary Belford Enterprises B.C. Ltd., doing business as Lid Hair Studio, was established June 7, 2005, in the City of Vancouver, British Columbia, Canada. There are no bankruptcies, receivership, or similar proceedings against the parent or operating subsidiary.
On June 18, 2005, the company purchased hair salon equipment and the rights to an office lease from Farideh Jafari in the amount of approximately $39,150US ($45,000CDN).
The Merger Transaction
On September 30, 2009, we acquired China Children Pharmaceuticals, a Hong Kong based pharmaceutical manufacturer and distributor company in accordance with a Share Exchange Agreement (“Exchange Agreement”) entered into by and among the Company, Eric Anderson, the Company’s then-principal shareholder, and Asia-Pharm, a company incorporated in the British Virgin Islands, the sole shareholder of China Children Pharmaceuticals.
In exchange for the 100% equity interest in China Children Pharmaceuticals, the Company issued 7,000,000 shares of common stock to the shareholders of Asia-Pharm. As a result of the share exchange transaction, Shaanxi Jiali became our operating entity and our operations have been headquartered in Xi’an, Shaanxi Province, China.
In connection with the share exchange agreement of September 30, 2009, Eric Anderson transferred 5,000,000 shares of common stock of Lid Hair Studios to Lid Hair Studios for cancellation and forgave the outstanding shareholder’s loan to the company in the amount of $86,173 in exchange for 100% of the issued and outstanding shares of Lid Hair Studios’ wholly-owned subsidiary, Belford Enterprises B.C. Ltd., d/b/a Lid Hair Studio. Lid Hair Studios cancelled the shares of common stock received from Eric Anderson prior to affecting the reverse stock split which reduced the amount of common stock then issued and outstanding.
Effective October 9, 2009, the Company changed its name from Lid Hair Studios International Inc. to China Pediatric Pharmaceuticals, Inc. (the “Name Change Transaction”). The name change was effected through a parent/subsidiary merger of our wholly-owned subsidiary, China Pediatric Pharmaceuticals, Inc., with and into the Company, with the Company as the surviving corporation. To effectuate the merger, the Company filed its Articles of Merger with the Nevada Secretary of State and the merger became effective on October 9, 2009. The Company’s board of directors approved the merger which resulted in the name change on October 9, 2009. In accordance with Section 92A.180 of the Nevada Revised Statutes , shareholder approval of the merger was not required.
Background of Shaanxi Jiali
Shaanxi Jiali, our operating entity, was incorporated in the PRC under the name Shaanxi Jiali Technologies Co, Ltd. on July 1, 1998. Shaanxi Jiali is our operating company and is in the business of manufacturing, marketing and sales of pharmaceuticals in China with pediatric medicine as its focus. In October 2000, Shaanxi Jiali Technologies changed its name to Shaanxi Jiali Pharmaceutical Co. Ltd.
Asia-Pharm was incorporated in British Virgin Islands on June 20, 2008. As described below, on August 4, 2008, Asia-Pharm, through its wholly owned subsidiary China Children Pharmaceuticals, became the indirect holding company for Shaanxi Jiali, a medical and pharmaceutical developer, manufacturer and marketer in the PRC.
China Children Pharmaceuticals was incorporated in Hong Kong on June 27, 2008. China Children is a wholly owned subsidiary of Asia-Pharm.
Xi’an Coova is a “wholly owned foreign enterprise” incorporated in the PRC on July 25, 2008. Xi’an Coova is a wholly owned subsidiary of China Children Pharmaceuticals.
As described below, on August 4, 2008, an Management Entrustment Agreement (was entered into between Xi’an Coova and Shaanxi Jiali, which effectively gives China Children Pharmaceuticals, by way of Xi’an Coova, control over the operations and business of Shaanxi Jiali through Xi’an Coova. Pursuant to the Entrustment Management Agreement, China Children Pharmaceuticals shall receive all net profits and assume all operational losses of Shaanxi Jiali through Xi’an Coova.
Xi’an Coova entered into a Management Entrustment Agreement with Shaanxi Jiali and the shareholders of Shaanxi Jiali, in which Shaanxi Jiali and its shareholders agreed to transfer control, or entrust, the operations and management of its business to Xi’an Coova. Under the agreement, Xi’an Coova manages the operations and assets of Shaanxi Jiali, controls all of the cash flows of Shaanxi Jiali through a bank account controlled by Xi’an Coova, is entitled to 100% of earnings before tax of Shaanxi Jiali, a management fee, and is obligated to pay all payables and loan payments of Shaanxi Jiali. In addition, under the terms of the Management Entrustment Agreement, Xi’an Coova has been granted certain rights which include, in part, the right to appoint and terminate members of Shaanxi Jiali’s Board of Directors, hire management and administrative personnel and control decisions relating to entering and performing customer contracts and other instruments. We anticipate that Shaanxi Jiali will continue to be the contracting party under its customer contracts, bank loans and certain other instruments unless Xi’an Coova exercises its option. The agreement does not terminate unless the business of Shaanxi Jiali is terminated or Xi’an Coova exercises its option to acquire all of the assets or equity of Shaanxi Jiali under the terms of the Exclusive Option Agreement as more fully described below and completes the acquisition of Shaanxi Jiali.
In order to induce Shaanxi Jiali to enter into the Management Entrustment Agreement, Xi’an Coova, through its parent company Asia-Pharm, issued an aggregate of 12,000,000 shares of Asia-Pharm’s common stock to the shareholders of Shaanxi Jiali which was allocated based on their respective pro rata ownership of Shaanxi Jiali.
In order to give Xi’an Coova further control over Shaanxi Jiali, the Shaanxi Jiali shareholders and Xi’an Coova, a wholly owned subsidiary of China Children in the PRC, entered into a shareholders’ Voting Proxy Agreement (the “Voting Proxy Agreement”) whereby the Shaanxi Jiali shareholders irrevocably and exclusively appointed the members of Xi’an Coova’s board of directors, as their proxies to vote on all matters that require Shaanxi Jiali shareholder approval, including, without limitation, the right to appoint members of the board of directors of Shaanxi Jiali. The agreement further provides that Shaanxi Jiali will appoint all of the board of directors of Xi’an Coova as its board of directors and if Xi’an Coova’s board of directors undergoes any changes, Shaanxi Jiali must remove and appoint the same members to its board. The agreement terminates upon the exercise of the option by Xi’an Coova to purchase the shares of Shaanxi Jiali as described below and is governed by the laws of the PRC.
In order to permit Shaanxi Jiali to become an indirectly wholly owned subsidiary of China Children when permitted under PRC law, Xi’an Coova, Shaanxi Jiali and the Shaanxi Jiali shareholders entered into an exclusive option agreement (the “Exclusive Option Agreement”) whereby the Shaanxi Jiali shareholders granted Xi’an Coova an irrevocable and exclusive purchase option (the “Option”) to acquire Shaanxi Jiali’s equity and/or remaining assets, but only to the extent that the acquisition does not violate limitations imposed by PRC law on such transactions. Current PRC law does not specifically provide for the equity of a non-PRC entity to be used as consideration for the purchase of a PRC entity’s assets or equity unless the value of the shares are equal to or greater than the value of the enterprise acquired. In addition, there is a lengthy appraisal process which must be approved by the provincial PRC government entities. The consideration for the exercise of the Option is to be determined by the parties and memorialized in future definitive agreements setting forth the kind and value of such consideration. Accordingly, we will consider exercising the Option under such circumstances we believe will be in our best interests and our shareholders and the Exclusive Option Agreement has been drafted to give us such flexibility. In considering whether or not we will exercise the Option we may consider such factors as (1) if the exercise price can be lower than the appraised value under current PRC law (2) availability of funds, (3) any relevant tax considerations at the time, (4) any other relevant PRC laws that may exist at the time, (5) the value of our shares that were previously paid to shareholders of Shaanxi Jiali, and (6) whether or not the exercise of the Option will provide any other additional benefits to us or our shareholders. Upon exercise of the Option, the parties will prepare transfer documents to be submitted for governmental approval and work together to obtain all approvals and permits. The agreement may be terminated by agreement of all parties or by with 30 days notice and is governed by the laws of the PRC.
In order to further solidify China Children’s rights, benefits and control of Shaanxi Jiali through its ownership of Xi’an Coova under the Entrusted Management Agreement, Voting Proxy Agreement and Exclusive Option Agreement, Xi’an Coova and the Shaanxi Jiali shareholders entered into a share pledge agreement (the “Share Pledge Agreement”) whereby the Shaanxi Jiali shareholders pledged all of their equity interests in Shaanxi Jiali, including the proceeds thereof, to guarantee the performance by the shareholders of all of the agreements they entered into with Xi’an Coova. Upon breach by any of the shareholders of any of the Management Entrustment Agreement, Voting Proxy Agreement, the Exclusive Option Agreement or the Share Pledge Agreement, Xi’an Coova is entitled by operation of law to become the beneficial owner of the shares of Shaanxi Jiali. Prior to termination of the Share Pledge Agreement, the pledged equity interests of Shaanxi Jiali cannot be transferred without Xi’an Coova’s prior written consent. The provisions of the Share Pledge Agreement and the Voting Proxy Agreement work together to give the board of directors of Xi’an Coova control over transfers by the shareholders of Shaanxi Jiali . The agreement will not terminate until agreed to by all of the parties in writing and is governed by the laws of the PRC.
Reorganization and Revised Structure
The organization and ownership structure of the Company subsequent to the consummation of the August 2008 Management Entrustment Agreement and related agreements as summarized in the paragraphs above was as follows:
The following diagram sets forth the current corporate structure of China Pediatric Pharmaceuticals, Inc., giving effect to the merger transaction consummated on September 30, 2009 and the Name Change Transaction consummated on October 9, 2009:
Subsidiaries
As a result of the Merger Transaction, China Children and Xi’an Coova are our wholly-owned subsidiaries. Shaanxi Jiali, the entity through which we operate our business, currently has no subsidiaries, either wholly-owned or partially-owned.
Our Business
Our operations are headquartered in Xi’an, Shaanxi Province, China. Through our operating entity, Shaanxi Jiali, we are a profitable, mid-sized Chinese pharmaceutical company that identifies, discovers, develops manufactures and distributes both prescription and over-the counter drugs (including conventional Western medicines as well asTCMs) primarily for the treatment of some of the most common children’s ailments and diseases. Approximately 81% of our products are intended for children’s use and approximately 19% of our products are intended for adult use.
Our operating company, Shaanxi Jiali, has its own manufacturing facility located in Baoji, Shaanxi Province. Our manufacturing facility was issued a Good Manufacturing Practices (“GMP”) certification by the State Food and Drug Administration (“SFDA”) in 2004, which has been approved for renewal as of April 2010. The Chinese government agency, SFDA, is analogous to the Food and Drug Administration (“FDA”) in the United States. Unlike the FDA, however, the SFDA provides intellectual property and competitive protection to certain classes of approved drugs.
GMP is an internationally-recognized standard for pharmaceutical plant design and construction. GMP has been defined as “that part of quality assurance which ensures that products are consistently produced and controlled to the quality standards appropriate for their intended use and as required by the marketing authorization” (World Health Organization). GMP covers all aspects of the manufacturing process: defined manufacturing process; validated critical manufacturing steps; suitable premises, storage, transport; qualified and trained production and quality control personnel; adequate laboratory facilities; approved written procedures and instructions; records to show all steps of defined procedures taken; full traceability of a product through batch processing records and distribution records; and systems for recall and investigation of complaints.
We were awarded the National High-tech Enterprise Award by the Shaanxi Technology Administration in 2006. As a result of receiving the National High-tech Award Shaanxi Jiali is entitled to the “Two exemption Three half” tax holiday based on the local government’s policy to encourage outside investment into the locality. According to PRC tax laws, “Two exemption Three half” policy means foreign investment enterprises including Shaanxi Jiali may enjoy an exemption from corporate income tax for 2 years starting from its first profitable year, followed by 3 years at a rate that is one half of the regular rate for corporate income tax. The Company enjoyed this benefit through fiscal year 2010 and for fiscal year 2011, the tax rate will return to the regular rate.
We distribute our high value, branded medicines, both OTC and prescription, through exclusive territory agents who sell our products directly to local pharmacies who in turn sell them to their retail customers.
Principal Products
In the fiscal year ended December 31, 2010, our revenues were principally derived from sales of 26 products listed below, of which 7 products are adult Western medicine products and 19 are finished pediatric TCM products. We have SFDA approval for all medicines that we market. Detailed information is provided in the table of products below.
We currently have 26 products that are manufactured by both our in-house production facility and through third-party manufacturers (“OEM Companies”). Of these products, 13 are produced in-house at our production plant:
Table of Products Manufactured by Shaanxi Jiali
The table below represents our 13 of our medicines that are produced by OEM Companies.
Table of Products Manufactured by OEM Companies
We currently market our products under three brands:
Cooers Brand Products
The Cooers Brand product line is focused on the pediatric medicine market. The product line includes both prescription and over-the-counter pharmaceutical products, including both conventional and traditional Chinese medicines. The Cooers product line has 15 products that address numerous ailments including, but not limited, to pain relief, anti-inflammatory, anti-bacteria, infection, digestion, respiratory tract infections, gangrene, diarrhea and fever, cold and cough remedies and vitamins.
Qingsongling Brand Products
The Qingsongling product line is focused on the adult market. This product line includes both prescription and over -the-counter pharmaceutical products including both conventional and traditional Chinese medicines. The Qingsongling product line has 8 products for treatment of numerous ailments, including but not limited to, treatments for heart disease and angina, respiratory tract infection, influenza, gangrene, anti-inflammatory pain relief, cold and fever remedies and vitamins.
Xianzhi Brand Product
The Xianzhi product line is focused on the adult medicine market. Xianzhi series includes one product which is prescription medicine (TCM). The Xianzhi product line has one product for treatment for chronic bronchitis and asthma.
Marketing and Sales
Shaanxi Jiali’s high value branded prescription and OTC medicines are distributed through the following distribution channel: Pharmaceutical Manufacturer (Shaanxi Jiali) - Exclusive Agents - Pharmacies - Patients.
Shaanxi Jiali currently sells its products through 17 exclusive territory agents in 9 provinces throughout China. The exclusive territory agents sell the Company’s products directly to local pharmacies in their assigned territory. This method of distribution minimizes the Company’s need to maintain a large direct sales force.
Exclusive Territory Agents
Shaanxi Jiali has entered into contracts with Exclusive Territory Agents for the sale and distribution of our products to local pharmacies in the agent’s respective exclusive territory, whereby the agent receives approximately 10% commission as consideration for serving as the Company’s exclusive agent in that territory. In 2008, we signed six Exclusive Territory Agent contracts, and as of December 31, 2009 we have increased our number of contracts to a total of fifteen. As of December 31, 2010, we have increased our number of contracts to a total of 17. These contracts are typically for a period of one year. Neither party may transfer their rights under the agreement without the prior consent of the other party, or else the breaching party will incur damages of RMB50,000. As the Company expands into new markets and gains more access to additional capital, we expect to increase the number of contracts with Exclusive Territory Agents. Due to the favorable pricing terms we offer, we have not experienced any difficulties with finding new Exclusive Territory Agents should we terminate our relationships with existing agents.
Special Marketing Initiatives
Cooers Brand Initiative. Shaanxi Jiali intends to further develop the series of products based on the Cooers Brand and designed to target the pediatric medicine market. These products will continue be sold through agents who in turn distribute to local pharmacies in their assigned territories. In addition, we are planning to enlarge our own sales team and promote our Cooer brand.
Regional Expansion Initiative. Shaanxi Jiali intends to further expand its distribution channels by increasing the number of exclusive territory agents. These additional exclusive territory agents will be contracted to distribute Shaanxi Jiali products to local pharmacies in several additional provinces or regions throughout China.
Status of Publicly Announced New Products
We expect that the following products in our development pipeline will generate growth in our revenue in the next few years. We expect to launch commercial production for the five products for which we have applied for SFDA approval.
Development Status of Key Products in our Pipeline as of December 31, 2010 :
During the years ended December 31, 2010 and 2009, we spent approximately $2.46 million and $2.97 million on marketing, respectively.
Quality Control
Our production facilities are designed and maintained with a view towards conforming with good practice standards. To comply with GMP operational requirements, we have implemented a quality assurance plan setting forth our quality assurance procedures. Our Quality Control department is responsible for maintaining quality standards throughout the production process. Quality Control executes the following functions:
●
setting internal controls and regulations for semi-finished and finished products;
●
implementing sampling systems and sample files;
●
maintaining quality of equipment, instruments, reagents, test solutions, volumetric solutions, culture media and laboratory animals;
●
auditing production records to ensure delivery of quality products;
●
monitoring the number of dust particles and microbes in the clean areas;
●
evaluating stability of raw materials, semi-finished products and finished products in order to generate accurate statistics on storage duration and shelf life;
●
articulating the responsibilities of Quality Control staff; and
●
on-site evaluation of supplier quality control systems.
Competition
Company research indicates that there are primarily two competitors in the pediatric pharmaceutical market that are comparable in R&D, manufacturing scale and brand awareness. They are BMP Sunstone Corp. (“BMP Sunstone”), which manufactures pediatric and gynecological medicine under the brand “Good Baby” and “Confort”, and China venture capital market listed company Hainan Honz Pharmaceuticals Co., Ltd.(“Honz Pharma”), which manufactures pediatric prescription medicines. A comparison of these two companies to China Pediatric is provided below:
Comparison of Primary Competitors
*Data with respect to BMP Sunstone Corp and Hainan Honz Pharmaceuticals Co., Ltd. is derived from such companies' corporate website and, with respect to BMP Sunstone Corp, the company's publlic filing with the SEC.
Notwithstanding the above, we have been actively developing our business to build the following competitive advantages:
1. Positioning in the pediatric medicines market: Shaanxi Jiali has positioned itself as an early entrant in the developing pediatric segment of the pharmaceutical market, focusing on the research and development, manufacture and sales of pediatric medicine.
Despite the heavy requirements it places on its participants, the PRC pediatric medicine market and is growing at a steady rate. According to data from the Southern Medicine Economic Institute, a PRC research institute which is affiliated with the SFDA, among the 7145 pharmaceutical preparations in 2008 that were authorized and marketed in the PRC (including generic names and formulations), there were only 500 pediatric drugs (including 320 TCMs), or approximately 7%, that provided clearly specified dosages and usage applications for children/infants. The pediatric market provides a greater opportunity for growth than the adult pharmaceutical market and, according to the Southern Medicine Economic Institute, it has kept a steady 11.64% average annual growth rate over the past 6 years.
Based on Shaanxi Jiali’s as well as general industry experience, we estimate that a drug (be it for adult or pediatric use) generally takes at least five years to from product development to commercial launch, as the drug must be developed, undergo clinical trials, and clear the SFDA approval process before it is ready to enter the market. Due to the special considerations of the child consumer, the manufacture and sale of pediatric pharmaceuticals are more heavily regulated due to greater concerns about safety and dosage effectiveness in children/infants than adults. Additionally, these products must first be tested before they are marketed, and it is more difficult to find child/infant test subjects to conduct clinical trials. According to the data from the Southern Medicine Economic Institute, which is affiliated with the SFDA, a new drug generally takes at least five years to research and develop and obtain the SFDA approval. As such, due to the substantial resources and time inputs that are required to develop new drugs and the current size of the pediatric market, established manufacturers who have enjoyed their market share in the larger adult pharmaceutical industry may not feel the need to expand into the more limited pediatric market and will require professional research teams with long-term expertise to do so.
2. Diversity of products: After long-term efforts, the company's competitive line of “Cooer” products includes a total of 26 products spanning six product categories (as grouped by treatment type, such as Anticold, Antidiarrheal, Nutritional supplements, Digestion, Antibiotics, Antitussive (cough suppressants)), and the clinical effects of our products have been recognized by our customers and have been well-received at pharmaceutical sales conferences and exhibitions. The distinguishing feature of our Cooer products is the comprehensive coverage that our products span the entire conventional pediatric medicine market in China. Although our competitors also produce a number of pediatric drugs, their product range is not as diverse and do not span all six product categories described above. We believe that we dominate the pediatric medicine industry in terms of our marketing capability, concentration and expertise in the pediatric sector. Our other competitors either act as OEM manufacturers for other companies or produce but do not specialize in the pediatric field of pharmaceuticals.
In the short term, we believe that our competitive advantages will be difficult to be surpassed: unlike our competitors, we concentrate the majority of our R&D, sales, and manufacturing efforts on the pediatric pharmaceutical market. What’s more, as a managing director of Shaanxi Pharmaceutical Association in China, we can make full use of the R&D resources of Shaanxi province and have done so by teaming with reputable R&D partners, such as the Shaanxi Research Institution of Chinese Traditional Medicines. We believe that we have strong manufacturing capabilities, both through our in-house production and utilization of OEM partners to fulfill our manufacturing requirements. We have also established strategic partnerships with 15 exclusive distribution agents in 2009, we increased our strategic partnerships to 17 exclusive distribution agents in 2010, which we believe have given our products a competitive edge in the pediatric pharmaceuticals market.
Our Future Goals and Plans for Expansion
There are certain opportunities for growth that we intend to seize by employing the following growth strategies:
Rapidly growing Chinese pharmaceutical market. With approximately one-fifth of the world’s population and a fast-growing gross domestic product, China represents a significant potential market for the pharmaceutical industry. We believe the significant expected growth of the pharmaceutical market in China is due to factors such as robust economic growth and increased pharmaceutical expenditure, aging population and increased lifestyle-related diseases, government support of the pharmaceutical industry, the relatively low research and development and clinical trial costs in China as compared to developed countries, as well as the increased availability of funding for medical insurance and industry consolidation in China.
Currently China has about 3,500 drug companies, falling from more than 5,000 in 2004, according to the National Development & Reform Commission of China. The number is expected to drop further. The domestic companies compete in the $10 billion market (according to the National Development & Reform Commission of China) without a dominant leader. Most often cited adverse factors include a lack of protection of intellectual property rights, a lack of visibility for drug approval procedures, a lack of effective governmental incentives, poor corporate support for drug research and differences in the treatment in China accorded to local and foreign firms. The profile of the pharmaceutical industry in China remains very low. According to the National Development & Reform Commission of China, China accounts for approximately 20% of the world’s population but only 1.5% of the global drug market. In addition, according to the National Development & Reform Commission of China, as of 2008, China was the world's eighth largest drug market.
New Product Development. We will continue to evaluate and develop additional product candidates, both through our in-house research and development department and working with our research and development partners, to expand our pipeline where we perceive an unmet need and commercial potential. We will face the risk that in developing new products we may spend substantial sums of money and the new products developed may not effectively meet the perceived need or may not be successfully commercialized.
Focus on brand development. With intense price competition among many similar or identical products in the industry, we believe that building brand equity is the primary means to generate and sustain profitable growth in the future. The company intends to focus its brand development efforts on building the Cooers brand name with the intent on it becoming a leading pediatric medicine brand in China.
Marketing and Sales Function. We intend to grow our internal marketing and sales function and increase our relationships with other exclusive territory distributors to expand the distribution and presence of our pharmaceutical products. In expanding market share of our products, we intend to take advantage of our large manufacturing scale and reasonable cost control mechanisms, and our strong sales network. In addition, our goal is to establish our products as a preferred choice for children’s medicines in local pharmacies. We hope to add other pharmaceutical products into this channel over the next few years. We may face risks in obtaining adequate quantities of raw materials at reasonable prices in order to meet increased demand for our products that result from any growth. In seeking additional employees, sales representatives, and exclusive territory agents, we will compete with many other established pharmaceutical manufacturers that may have greater resources than we do.
Low cost producer. We benefit from focusing on a specialized division of the pharmaceuticals market, i.e., by focusing on pediatric medicine, and investing efforts into research and development of new pediatric drugs. We also plan to build about our specialty and early market entry advantage by building better facilities and equipment to increasingly automate our manufacturing process. We believe that these efforts will lower our production costs in the following respects:
1. Research and Development. As an early market entrant, we have accumulated a large amount of confidential data from our experiences in the industry and our prior research and development efforts that we believe (it is a matter of opinion and not of fact) enables to have first access and lead-time advantages to the pediatric market. Pediatric medicine has a long R&D term with high costs and risks. Challenges to effective R&D include the difficulty of employing accurate methods to monitor trial dosages and finding suitable child test subjects who adhere to testing requirements. Such challenges have served as a deterrent for many companies who have eyed the pediatric pharmaceutical market. Since Shaanxi Jiali focused on the pediatric field early on, it has already passed the difficult initial stage and no longer incurs the large up-front costs that a new entrant would require.
2. Manufacturing. We are continually optimizing and technologically upgrading production lines to make them suit the nature of pediatric medicine, including improvements to our granule packaging line in order to improve the safety of our products.
Standard packing bags for granules have three layers: (1) the first packing layer (the outermost layer); (2) the second protective layer (the middle layer, which is the thickest layer and mainly plays a protective role in providing structure and resisting moisture, pressure and gas leakage; and (3) the innermost layer which is in direct contact with the medicine. Currently pediatric pharmaceutical manufacturers generally make the first and third layers of the same materials and most manufacturers make the second layer out of the blend of aluminum and plastic.
In order to meet and improve upon the more stringent safety requirements of pediatric medicine, the second layer of our granule bags are made out of pure aluminum, which enhances the airtightness of the package and improves the safety of the medicine. To do so, we purchased a DXDB80 granule bag packing machine in 2007 to deal with the deficiency that our older machines could not package our granule products with the pure aluminum packaging materials. We also required our OEM factories, Xi’an KeLi Pharmaceuticals Co. Ltd, and Sichuan Nanchong Pharmaceutical Factory, to purchase the same granule bag packing machines, so that the production lines of all our OEM factories can meet our internal quality control standards.
Given the special considerations involved in manufacturing pediatric medicine, it is difficult for larger, more established pharmaceutical manufacturers to produce pediatric medicine on a general product line, while up-and-coming companies encounter high cost barriers in recruiting the talent and expertise need to construct product lines suitable for pediatric pharmaceutical products. We also currently have partially automated production lines and plan to advance our technology towards full automation, which will help in the long term to lower our production costs.
3. Acquisitions. We are considering expanding our production capacity by acquiring existing pharmaceutical facilities or manufacturing entities. We believe this will be a quick and efficient way of increasing and diversifying our capabilities.
4. Human Resources. We are continually striving to reduce human resources costs by improving our management oversight and training of our manufacturing department employees to enhance the capability and productivity of our workers.
We plan to enhance the quality of our products to ensure that we remain in compliance with the PRC’s higher thresholds and intend to broaden our national market share of our Cooer series of products. We may also decide to acquire other small and medium enterprises that process certain competitive advantages to assist us in our goal of becoming the No. 1 brand for Chinese pediatric pharmaceuticals.
We also intend to capitalize on the opportunities granted from any integration of the distribution of pharmaceuticals by establishing strategic and cooperative relationships with more distributors that will secure reliable agents, extend the reach of our distribution networks, and improve turnover of goods.
Customers
Shaanxi Jiali has entered into contracts with Exclusive Territory Agents for the sale and distribution of our products to local pharmacies in the agent’s respective exclusive territory, whereby the agent receives approximately 10% commission as consideration for serving as the Company’s exclusive agent in that territory. These agents serve as our primary customers for our products. In 2009, we signed 15 Exclusive Territory Agent contracts and in 2010, we signed 17 Exclusive Territory Agent contracts. These contracts are typically for a period of one year.
The five largest customers of Shaanxi Jiali in the fiscal year ended December 31, 2010 are as follows:
The five largest customers of Shaanxi Jiali in the fiscal year ended December 31, 2009 are as follows:
Raw Materials and Principal Suppliers
The primary raw materials used to manufacture our products include various medicinal herbs, which we obtain from numerous qualified suppliers with national qualifications. We also enter into supply agreements for many other materials used to manufacture and package our products. Shaanxi Jiali has written agreements with substantially all of its suppliers. These agreements typically take the form of one-time purchase orders with requirements for one-time delivery and one-time payments. The agreements give the Company the right to inspect the materials purchased for quality and quantity compliance.
The five largest suppliers of Shaanxi Jiali in the fiscal year ended December 31, 2010 are as follows:
The five largest suppliers of Shaanxi Jiali in the fiscal year ended December 31, 2009 are as follows:
Intellectual Property
We regard our service marks, trademarks, trade secrets, patents and similar intellectual property as critical factors to our success. We rely on patent, trademark and trade secret law, as well as confidentiality and license agreements with certain of our employees, customers and others to protect our proprietary rights.
Patents
Because the concept and implementation of intellectual property protection is somewhat new in the PRC, the PRC government offers two types of IP protection for manufacturers of pharmaceutical products: the medicine production technique patent and medicine invention formula patent. A company can obtain “legal” protection for the manufacture of its proprietary products by applying for a patent with the State Patent Bureau. This patent will apply not only to the particular formulation for the medicine, but also the production technique and/or dosage form or type for such medicine. A state-issued patent is afforded a period of 20 years of protection.
Separately, certain over-the-counter TCM products which have received SFDA approval are afforded certain intellectual property rights. A company can apply for “administrative” IP protection for the production technique of its SFDA-approved product with the SFDA. The SFDA administrative protection lasts for 8 years and only covers the production technique for the particular dosage type. In PRC, illegal infringements of production technique patents are widespread. A tiny modification to a filed medicine production technique might be construed as a new one and argued as not violating the patent laws. Invention formula patents are as easily imitated as production technique patents. However, since only one SFDA production certificate can be issued on new branded medicine based on the major pharmaceutical ingredients used, a minor modification to the formula would not warrant a new SFDA production certificate. This means that, even if another manufacturer gets to know a patented formula, it would not be able to produce it in the PRC without the proper SFDA production certificate.
Once the SFDA protection has expired, it cannot be renewed, except under special circumstances as to be determined at the SFDA’s discretion. Once the SFDA protection period has expired, a company may apply for patent protection.
To a large extent, we rely on SFDA protection regulation to protect our intellectual property rights with respect to our products. Except for the two patents that we have received and described further below, all other products are protected under the SFDA.
Two types of medicine-related patents exist in PRC: the medicine production technique patent and medicine invention formula patent.
Shaanxi Jiali currently holds two patents: ZL03 1 08011.1 for the treatment of chronic bronchitis and ZL 03 1 08012.X and for the treatment of dermatosis. Only one patented medicine, ZL03 1 08011.1, is currently being produced.
Trademarks
Shaanxi Jiali currently holds nine registered trade names for the following medicine names and logos: Sanseqi (logo), Cooer, Tailaishi, Qingsongling, Beishiting, Zhiben, Xianzhi, Chugan, Yunlaitongjingbao and has filed trademark applications, the approvals of which are pending, for 3 other medicine names or general trademarks.
The Sanseqi logo for which we have obtained a trademark appears below:
Research and Development
We develop new products through an arrangement with the Shaanxi Research Institution of Chinese Traditional Medicines, in Xi’an. We expect to continue to develop additional new drugs under this method.
Shaanxi Jiali’s in-house Research & Development department coordinates and supervises the contract based outsourced R&D processes. Shaanxi Jiali’s Research & Development had a staff of five during the years ended December 31, 2009 and 2010.
Shaanxi Jiali entered into a Medicine Research and Development Agreement with the Shaanxi Research Institute of Chinese Traditional Medicines (“SRICTM”) on December 10, 2007. Under the terms of the Medicine Research and Development Agreement the Shaanxi Research Institute of Chinese Traditional Medicines was contracted for the research and development and for the application of productional approval of five new “pediatric cold treatment medicines”: Cooer Xiaoer Fuxiening Granules; Cooer Xiaoer Kechuanling Granule; Cooer Xiaoer Kangganjiedu Granules; Cooer Xiaoer Digesting Tablet, and Cooer Xiaoer Jianpibuxue Granules. Under the terms of the research and development agreement Shaanxi Jiali is committed to paying the Shaanxi Research Institute of Chinese Traditional Medicines $293,000 for each of the five new products contracted for development. Under the terms of the research and development agreement Shaanxi Jiali owns the Intellectual Property rights for the five new pharmaceutical products developed by the Shaanxi Research Institute of Chinese Traditional Medicines.
If approved by SFDA, we will be authorized to commence manufacturing of these new products. Management has estimated that all new products would enter the market and generate net cash inflows from these projects would be expected to commence within six months of receiving approval.
Pursuant to the terms of Medicine Research and Development Agreement, at this stage of completion, we have prepaid all R&D expenses to SRICTM. Should the applications be rejected by the SFDA due to a technology-related error or any error of SRICTM, SCRICTM is contractually obligated under Sections 5.3, 7.3 and 10.1 of the agreement to refund all fees already paid under the terms of the Medicine Research and Development Agreement and Supplemental Agreement of Medicine Research and Development Agreement. Therefore, the Company recorded it as prepaid expense.
We did not obtain any certificates or approvals of drug production for any new drug batches during the fiscal year ended December 31, 2010. However, we expect to develop additional new drugs in 2011.
Government Regulation of Pharmaceuticals
The testing, approval, manufacturing, labeling, advertising and marketing, post-approval safety reporting, of our products or product candidates are extensively regulated by governmental authorities in the PRC. Our sole sales market is presently in China. We are subject to the Drug Administration Law of China, which governs the licensing, manufacturing, marketing and distribution of pharmaceutical products in China and sets penalties for violations of the law. Additionally, we are subject to various regulations and permit systems by the Chinese government. These regulations and their impact on the business of Shaanxi Jiali are set forth in more detail below.
●
Drug Administration Law of the PRC was promulgated by the Standing Committee of National People’s Congress on February 28, 2001 and effective as of December 1, 2001, and its implemental rules were promulgated by the State Council on August 4, 2004 and effective as of September 15, 2002. According to Drug Administration Law of the PRC and its implemental rules, a pharmaceutical manufacturer is to obtain a Pharmaceutical Manufacturing Permit and the Drug Approval Number for each manufactured medicine from relevant SFDA’s provincial branch, which are valid for five years and are renewable upon application before expiration. Shaanxi Jiali is required to file for these approvals for each of its medicines and renew them prior to expiration.
●
Administration Regulations for Drug Registration was promulgated by the SFDA on July 10, 2007, and was effective as of October 1, 2007. Administration Regulations for Drug Registration specifies the requirements and procedures of obtaining a Drug Approval Number for new drugs, including the requirements for clinical trial of new drugs, procedures of registering imported medicines and report and approval procedures of generic medicines . The Drug Approval Number is valid for five years and can be re-registered upon expiration. Shaanxi Jiali is required to obtain a Drug Approval Number for each of its new drugs and reapply prior to the expiration date.
●
Good Manufacturing Practices (GMP) for Pharmaceutical Products , as revised in 1998 was promulgated by the SFDA on June 18, 1999 and became effective as of August 1, 1999, and the Authentication Regulations for Drug GMP was promulgated by the SFDA on September 7, 2005 and became effective on of October1, 2005. A pharmaceutical manufacturer must meet the GMP standards and obtain the GMP Certificate with a five-year validity period from SFDA. Before the GMP Certification expires, the pharmaceutical manufacturer must apply again and complete the relevant procedures, which may take about 120 working days, to obtain a new GMP Certificate. On October 24, 2007, the SFDA issued the new guideline for authentication standards of GMP, effective as of January 1, 2008. The new guideline may result in a rise of cost for a pharmaceutical manufacturer to meet the new standards so as to maintain the GMP qualification. If a pharmaceutical manufacturer fails to obtain or maintain GMP Certification and still carry on its production, it will be fined and the Pharmaceutical Manufacturing Permit may be revoked under serious circumstances. Shaanxi Jiali received its first GMP certificate in November 2004 and has received approval for its renewal as of April 2010 after a temporary suspension of production between November 2009 and April 2010 while the renewal application was being processed.
Our GMP certificate expired on November 2, 2009. It is not uncommon for companies in the pharmaceutical industry to suspend production while they are in application for a renewed permit in order to prepare for and accommodate GMP inspection. We applied to renew our GMP certificate prior to November 2, 2009, and as such we did not experience any penalties or delays in the processing of our application. Because, however, we experienced an increase in customer orders toward the end of the calendar year, we continued production until November 2, 2009 in order to meet all of our customers’ needs.
The SFDA generally takes about three to four months to review GMP renewal applications and as a result, we did not receive preliminary approval for the renewed certificate until April 2010. Between November 2009 and April 2010, while our application for renewal was being processed and our facilities underwent standard GMP review and inspection, we temporarily suspended production during the application period. During this time, we worked with our OEM partners to meet our manufacturing needs. We also experienced a lower demand for our products during this period due to China’s Spring Festival holiday in the month of February. As such, we continued to have sales between November 2009 and April 2010 even though we did not manufacture any products in-house and were able to use our OEM manufacturers to meet all of our customers’ needs. Since April 2010, when we were notified that the SFDA had approved our application, we have resumed regular production.
●
Administration Regulations for Drug Call-back was promulgated by the SFDA on December 10, 2007 and effective on the same day. According to the Administration Regulations for Drug Call-back, the pharmaceutical manufacturer should establish a drug call-back system and collect information regarding the drug safety. If a manufacturer discovers any unreasonable danger of drug that threatens people’s safety and health, it should immediately stop the manufacturing and sale of such drug, notify the distributors and report to the branch of the SFDA. This regulation also stipulates the procedures of drug call-back and danger valuation standards established and maintain a drug call back system in conformance the regulations.
●
Administration Regulations for Drug Instructions and Labels was promulgated by the SFDA on March 15, 2006 and was effective as of June 1, 2006. According to Administration Regulations for Drug Instructions and Labels, the contents of instructions and labels of each drug must be approved by the SFDA, and the smallest packing unit of drug shall be attached with instructions. Shaanxi Jiali received approval and maintains drug labeling in conformance with the regulations for its existing products and must do so for new products.
●
Supervision Administration Regulations for Drug Distribution was promulgated by the SFDA on January 31, 2007 and effective as of May 1, 2007. According to Supervision Administration Regulations for Drug Distribution, a pharmaceutical manufacturer can only sell drugs produced by itself, and it shall not sell drugs produced by other manufacturers or produced by itself but for commissioning manufacturing purpose. Shaanxi Jiali does not resell any other pharmaceutical manufacturers drugs.
●
Regulations for Drug Advertisement Censoring was promulgated by the SFDA and State Administration for Industry and Commerce (the “ SAIC ”) on March 13, 2007 and effective as of May 1, 2007. Standards for Drug Advertisement Censoring and Publication promulgated by the SFDA and the SAIC on March 3, 2007 and effective as of May 1, 2007. According to Regulations for Drug Advertisement Censoring, a pharmaceutical manufacturer must obtain a Drug Advertisement Approval Number from the provincial branch of the SFDA which is valid period of one year if the drug advertisement describes the functions or benefits of a drug. However, if an over the counter drug advertisement in any media, or a prescription drug advertisement in professional medical magazine, only refers to the name of the drug, including the general name and commercial name, without any other addition promotional information, the advertisement does not need to be censored or approved. Shaanxi Jiali obtained a Drug Advertisement Approval Number and reviews all of its over the counter and prescription drug advertisements so that it is in conformance with the regulations relating to advertising its products.
The application and approval procedure in China for a newly developed drug product has numerous steps. New drug applicants prepare the documentation of pharmacological study, toxicity study and pharmacokinetics and drug metabolism (PKDM) study and new drug samples. Documentation and samples are then submitted to provincial food and drug administration (“provincial FDA”). The provincial FDA sends its officials to the applicant to check the applicant’s research and development facilities and to arrange new drug examination committee meeting for approval deliberations. This process usually takes three months. After the documentation and samples are approved by the provincial FDA, the provincial FDA will submit the approved documentation and samples to SFDA. SFDA examines the documentation and tests the samples and arranges new drug examination committee meeting for approval deliberations. If the application is approved by SFDA, SFDA will issue a clinical trial license to the applicant for clinical trials. The clinical trial license approval typically takes one year. The applicant completes the clinical trial process and prepares documentation and files that are submitted to SFDA for new drug approval. The clinical trial process usually takes one year or two depending on the category and class of the new drug. SFDA examines the documentation and gives final approval for the new drug and issues the new drug license to the applicant. This process usually takes eight months. The whole process for new drug approval usually takes three to four years.
The SFDA and China Traditional Medicine Administration Bureau regulate the process for new drug approval and licensing in China, which can involve many layers of authority, lacks transparency, and presents one of the greatest obstacles for companies in introducing new drugs into the market. One of the preliminary aspects of the application process involves a review of the Chinese market’s need for a particular drug. If the SFDA determines that the market niche for a particular drug is saturated, the drug will not receive further consideration and the licensing application will be denied. According to industry analysts, eighty-five percent of the applications for new drugs licensing are determined by SFDA to be in saturated markets and thus are not considered for approval. Only fifteen percent of new-to-market drug applications are considered for approval by the SFDA.
Shaanxi Jiali's receipt of the GMP certificate and approval by the SFDA of its prescription and OTC drugs represents a significant competitive advantage as these approvals present a significant barrier to entry by new companies. Any new products may not pass the clinical review and testing process which can negatively affect cash flow and income.
Compliance with Environmental Law
We comply with the Environmental Protection Law of PRC as well as applicable local regulations. In addition to statutory and regulatory compliance, we actively ensure the environmental sustainability of our operations. Penalties would be levied upon us if we fail to adhere to and maintain certain standards. Such failure has not occurred in the past, and we generally do not anticipate that it will occur in the future, but no assurance can be given in this regard.
Environmental Regulation
We comply with the Environmental Protection Law of PRC as well as applicable local regulations. In addition to statutory and regulatory compliance, we actively ensure the environmental sustainability of our operations. Penalties would be levied upon us if we fail to adhere to and maintain certain standards. Such failure has not occurred in the past, and we generally do not anticipate that it will occur in the future, but no assurance can be given in this regard.
China Pediatric Pharmaceuticals’ operation and facilities are subject to environmental laws and regulations stipulated by the national and the local environment protection bureaus in China. Relevant laws and regulations include provisions governing air emissions, water discharges and the management and disposal of hazardous substances and wastes. The PRC regulatory authorities require pharmaceutical companies to carry out environmental impact studies before engaging in new construction projects to ensure that their production processes meet the required environmental standards.
China Pediatric Pharmaceuticals maintains controls at its production facilities to facilitate compliance with environmental rules and regulations. China Pediatric Pharmaceuticals is not aware of any investigations, prosecutions, disputes, claims or other proceedings in respect of environmental protection, nor has it been subject to any action made by any environmental administration authorities of the PRC. To management’s knowledge, China Pediatric Pharmaceuticals’ operation meets or exceeds the existing requirements of the PRC.
Advertising Laws
Advertisement Law of the People’s Republic of China and Rules of Medicine Advertisements Management from State Admission for Industry and Commerce, Regulations on Control of Advertisements (tentative) from State Council provide guidelines for advertising prescription and OTC drugs and nutrients made by Shaanxi Jiali. The rules limit where advertisements may be place and govern the claims that may be made by the manufacturer.
Price Controls
The prices of approximately 1,500 pharmaceuticals are presently set by the Chinese government. These constitute approximately 10% of all distributing drugs. The prices for the other 90%, or 12,000 pharmaceuticals, are established by the market (by the companies themselves). Corporations typically establish these prices based on operating costs, and market supply and demand. The Supervision Department of the Chinese government will intervene only if there is a significant fluctuation in prices or a monopoly develops in a particular drug. We have not had any products subject to specific pricing control and production and trading of none of our pharmaceutical products constitutes a monopoly.
Employees
We have approximately 206 full-time employees, including 28 in management and administration, 106 in sales, marketing and distribution, 67 in production and quality control, and five in research and development. Our employees are neither unionized nor represented by a labor group for purposes of collective bargaining. We have good employee relations with little turnover in staff.
Item 1A.
Item 1A. Risk Factors.
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information contained in this report before deciding to invest in our common stock.
Risks Relating to Our Business
Our operating history may not serve as an adequate basis to judge our future prospects and results of operations.
Shaanxi Jiali commenced its current line of business operations on July 1, 1998 and received its Good Manufacturing Practices (“GMP”) certifications in November 2004. These certifications must be renewed every five years for Shaanxi Jiali to stay in business. We have applied for renewal of all of our necessary GMP certifications, underwent routine review and inspection, and have received approval for these renewals in April 2010, with the renewed GMP certificate expected to be issued in early July 2010. Notwithstanding the above, Shaanxi Jiali’s operating history may not provide a meaningful basis on which to evaluate its business. We cannot assure you that Shaanxi Jiali will maintain GMP approval for its products, maintain its profitability, or assure you that we will not incur net losses in the future. Pursuant to SFDA regulation, if there is a gap at any time in the validity of a company’s GMP certificate, it must suspend production or faces stiff fines and the risk that its authorization for production may be permanently revoked. We expect that Shaanxi Jiali’s operating expenses will increase as it expands. Any significant failure to realize anticipated revenue growth could result in significant operating losses. We will continue to encounter risks and difficulties frequently experienced by companies at a similar stage of development, including our potential failure to:
●
raise adequate capital for expansion and operations;
●
implement our business model and strategy and adapt and modify them as needed;
●
increase awareness of our brand name, protect our reputation and develop customer loyalty;
●
manage our expanding operations and service offerings, including the integration of any future acquisitions;
●
maintain adequate control of our expenses;
●
anticipate and adapt to changing conditions in the medical over the counter, pharmaceutical and nutritional supplement markets in which we operate as well as the impact of any changes in government regulations, mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics
If we are not successful in addressing any or all of these risks, our business may be materially and adversely affected.
The loss of Shaanxi Jiali as our operating business would have a material adverse effect on our business and the price of our common stock.
We have no equity ownership interest in Shaanxi Jiali. Our ability to control Shaanxi Jiali and consolidate its financial results is through a series of contractual agreements between Shaanxi Jiali and our wholly-owned subsidiary Xi’an Coova. The management of Shaanxi Jiali is an affiliate of us and of Xi’an Coova and the stockholders of Shaanxi Jiali are also our shareholders. Thus the Management Entrustment Agreement was not entered into as a result of arms’ length negotiations because the parties to the agreement are under common control. Mr. Xia, our CEO and Chairman, holds approximately 35% of the shares of Shaanxi Jiali and approximately 21.44% of our common stock. The Management Entrustment Agreement may be terminated upon the termination of the business of Shaanxi Jiali or upon the date upon which Xi’an Coova completes the acquisition of Shaanxi Jiali. Any other termination would be a breach of the agreement. While the Company has been advised by its PRC counsel that the Management Entrustment Agreement is legal and enforceable under PRC law, these affiliates control the parties to the Management Entrustment Agreement and it could be possible for them to cause Shaanxi Jiali to breach the Management Entrustment Agreement and our unaffiliated investors would have little or no recourse because of the inherent difficulties in enforcing their rights since all our assets are located in the PRC. (See, Risk Factor “The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may harm its business.”) In the event that management of Shaanxi Jiali decides to breach the Management Entrustment Agreement, the risk of loss of the affiliated shareholders of Shaanxi Jiali could be lower than unaffiliated investors and the interests of the management and shareholders of Shaanxi Jiali would be in conflict with the interest of our other stockholders.
Shaanxi Jiali’s failure to compete effectively may adversely affect our ability to generate revenue.
Shaanxi Jiali competes with other companies, many of whom are developing or can be expected to develop products similar to Shaanxi Jiali. Shaanxi Jiali’s market is a large market with many competitors. Many of its competitors are more established than Shaanxi Jiali is, and have significantly greater financial, technical, marketing and other resources than it presently possess. Some of Shaanxi Jiali’s competitors have greater name recognition and a larger customer base. These competitors may be able to respond more quickly to new or changing opportunities and customer requirements and may be able to undertake more extensive promotional activities, offer more attractive terms to customers, and adopt more aggressive pricing policies. We cannot assure you that Shaanxi Jiali will be able to compete effectively with current or future competitors or that the competitive pressures it faces will not harm it business.
We may not be able to effectively control and manage the growth of Shaanxi Jiali.
If Shaanxi Jiali’s business and markets grow and develop, it will be necessary for us to finance and manage expansion in an orderly fashion. An expansion would increase demands on existing management, workforce and facilities. Failure to satisfy such increased demands could interrupt or adversely affect its operations and cause delay in production and delivery of its pharmaceutical prescription, over the counter and medical nutrient products as well as administrative inefficiencies.
We may require additional financing in the future and a failure to obtain such required financing will inhibit Shaanxi Jiali’s ability to grow.
The continued growth of Shaanxi Jiali’s business may require additional funding from time to time, which we expect to raise in private placements of our equity or debt securities with accredited investors or by offering our securities for sale pursuant to an effective registration statement on a market where our common stock is traded. The proceeds of these funding would be forwarded to Shaanxi Jiali and accounted for as a loan to Shaanxi Jiali and eliminated during consolidation. The proceeds would be used for general corporate purposes of Shaanxi Jiali, which could include acquisitions, investments, repayment of debt and capital expenditures among other things. We may also use the proceeds to repurchase our capital stock or for our corporate overhead expenses. If we borrow funds we expect to be the primary obligor on any debt. Obtaining additional funding would be subject to a number of factors including market conditions, operating performance and investor sentiment, many of which are outside of our control. These factors could make the timing, amount, terms and conditions of additional funding unattractive or unavailable to us. Our management believes that we currently have sufficient funds from working capital to meet our current operating costs over the next 12 months.
The terms of any future financing may adversely affect your interest as stockholders.
If we require additional financing in the future, we may be required to incur indebtedness or issue equity securities, the terms of which may adversely affect your interests in us. For example, the issuance of additional indebtedness may be senior in right of payment to your shares upon our liquidation. In addition, indebtedness may be under terms that make the operation of Shaanxi Jiali’s business more difficult because the lender's consent could be required before we take certain actions. Similarly the terms of any equity securities we issue may be senior in right of payment of dividends to your common stock and may contain superior rights and other rights as compared to your common stock. Further, any such issuance of equity securities may dilute your interest in us.
We, through our subsidiaries/affiliated companies China Pediatric, Xi’an Coova or Shaanxi Jiali, may engage in future acquisitions that could dilute the ownership interests of our stockholders, cause us to incur debt and assume contingent liabilities.
We, through our subsidiaries/affiliated companies China Children, Xi’an Coova or Shaanxi Jiali, may review acquisition and strategic investment prospects that we believe would complement the current product offerings of Shaanxi Jiali, augment its market coverage or enhance its technical capabilities, or otherwise offer growth opportunities. From time to time Shaanxi Jiali reviews investments in new businesses and we, through our subsidiaries/affiliated companies China Children, Xi’an Coova or Shaanxi Jiali, expect to make investments in, and to acquire, businesses, products, or technologies in the future. We expect that when we raise funds from investors for any of these purposes we will be either the issuer or the primary obligor while the proceeds will be forwarded to Shaanxi Jiali and accounted for as a loan to Shaanxi Jiali and eliminated during consolidation. In the event of any future acquisitions, we could:
●
issue equity securities which would dilute current stockholders’ percentage ownership;
●
incur substantial debt;
●
assume contingent liabilities; or
●
expend significant cash.
These actions could have a material adverse effect on our operating results or the price of our common stock. Moreover, even if through our subsidiaries/affiliated companies, China Children, Xi’an Coova, or Shaanxi Jiali, we do obtain benefits in the form of increased sales and earnings, there may be a lag between the time when the expenses associated with an acquisition are incurred and the time when we recognize such benefits. Acquisitions and investment activities also entail numerous risks, including:
●
difficulties in the assimilation of acquired operations, technologies and/or products;
●
unanticipated costs associated with the acquisition or investment transaction;
Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.
We are constantly striving to improve our internal accounting controls. We expect to continue to improve our internal accounting control for budgeting, forecasting, managing and allocating our funds and to better account for them as we grow. There is no guarantee that such improvements will be adequate or successful or that such improvements will be carried out on a timely basis. If we do not have adequate internal accounting controls, we may not be able to appropriately budget, forecast and manage our funds, we may also be unable to prepare accurate accounts on a timely basis to meet our continuing financial reporting obligations and we may not be able to satisfy our obligations under US securities laws.
Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of U.S. public companies’ internal control over financial reporting, and attestation of this assessment by their independent registered public accountants. While the Dodd-Frank Wall Street Reform and Consumer Protection Act exempts smaller reporting companies with respect to the attestation by their independent registered public accountants as to our financial controls, this exception does not affect the requirement that we include a report of management on our intenal controls over financial reporting and will not affect the requirement to include the auditor's attestation if our public float exceeds $75 million and we cease to be smaller reporting company. Existing standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. While there has not been any detected significant deficiency or material weakness in our internal control and with respect to the assessment of the internal control for the year ended December 31, 2010, we cannot guarantee the implementation of controls and procedures in future years to be without any significant deficiency or material weakness.
We are dependent on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.
Our success is, to a certain extent, attributable to the management, sales and marketing, and pharmaceutical factory operational expertise of key personnel. Jun Xia, our Chief Executive Officer and Chairman of the Board perform key functions in the operation of our and Shaanxi Jiali’s business. There can be no assurance that Shaanxi Jiali will be able to retain Mr. Xia after the term of their employment contracts expire. The loss of Mr. Xia could have a material adverse effect upon our business, financial condition, and results of operations. Shaanxi Jiali must attract, recruit and retain a sizeable workforce of technically competent employees. We do not carry key man life insurance for any of our key personnel or personnel nor do we foresee purchasing such insurance to protect against a loss of key personnel and the key personnel.
We are dependent upon the services of Mr. Xia for the continued growth and operation of our company because of his experience in the industry and his personal and business contacts in the PRC. Although we have entered into two-year employment agreements with Mr. Xia and we have no reason to believe that he will discontinue their services with the Company or Shaanxi Jiali, the interruption or loss of his services would adversely affect our ability to effectively run our business and pursue our business strategy as well as our results of operations.
We may not be able to hire and retain qualified personnel to support its growth and if it is unable to retain or hire these personnel in the future, its ability to improve its products and implement its business objectives could be adversely affected.
Competition for senior management and senior personnel in the PRC is intense, the pool of qualified candidates in the PRC is very limited, and we may not be able to retain the services of our senior executives or senior personnel, or attract and retain high-quality senior executives or senior personnel in the future. This failure could materially and adversely affect our future growth and financial condition. We expect to hire additional sales and plant personnel throughout fiscal year 2010 in order to accommodate its growth.
If we fail to increase our brand recognition, we may face difficulty in obtaining new customers and business partners.
We believe that establishing, maintaining and enhancing our brand in a cost-effective manner is critical to achieving widespread acceptance of our current and future products and services and is an important element in our effort to increase our customer base and obtain new business partners. We believe that the importance of brand recognition will increase as competition in our market develops. Some of our potential competitors already have well-established brands in the pharmaceutical promotion and distribution industry. Successful promotion of our brand will depend largely on our ability to maintain a sizeable and active customer base, our marketing efforts and ability to provide reliable and useful products and services at competitive prices. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we will incur in building our brand. If we fail to successfully promote and maintain our brand, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract enough new customers or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts, in which case our business, operating results and financial condition, would be materially adversely affected.
Our operating results may fluctuate as a result of factors beyond our control.
Our operating results may fluctuate significantly in the future as a result of a variety of factors, many of which are beyond our control. These factors include:
●
the costs of pharmaceutical products and development;
●
the relative speed and success with which we can obtain and maintain customers, merchants and vendors for our products;
●
capital expenditure for equipment;
●
marketing and promotional activities and other costs;
●
changes in our pricing policies, suppliers and competitors;
●
the ability of our suppliers to provide products in a timely manner to their customers;
●
changes in operating expenses;
●
increased competition in the pharmaceutical markets; and
●
other general economic and seasonal factors.
We face risks related to product liability claims.
We presently do not maintain product liability insurance. We face the risk of loss because of adverse publicity associated with product liability lawsuits, whether or not such claims are valid. We may not be able to avoid such claims. Although product liability lawsuits in the PRC are rare, and we have not, to date, experienced significant failure of our products, there is no guarantee that we will not face such liability in the future. This liability could be substantial and the occurrence of such loss or liability may have a material adverse effect on our business, financial condition and prospects.
We face marketing risks.
Newly developed drugs and technology may not be compatible with market needs. Because markets for drugs differentiate geographically inside the PRC, we must develop and manufacture our products to accurately target specific markets to ensure product sales. We have spent approximately $28,478 and $16,616 on market research during the years ended December 31, 2010 and 2009, which account for 0.1% of net sales in both years. If we fail to invest in extensive market research to understand the health needs of consumers in different geographic areas, we may face limited market acceptance of our products, which could have material adverse effect on our sales and earnings.
We face risks relating to difficulty in defending intellectual property rights from infringement.
Our success depends on protection of our current and future technology and products and our ability to defend our intellectual property rights. Shaanxi Jiali currently holds 2 patents and 9 trademarks and has filed for trademark protection for additional names and brands of its products sold in the PRC. We also have certain limited administrative SFDA protection for our non-patented products. However, it is possible for its competitors to develop similar competitive products even though we have taken steps to protect our intellectual property. If we fail to protect Shaanxi Jiali’s intellectual property adequately, competitors may manufacture and market products similar to Shaanxi Jiali.
Presently, we sell our products mainly in PRC. To date, no trademark or patent filings have been made other than in PRC. To the extent that we market our products in other countries, we may have to take additional action to protect our intellectual property. The measures we take to protect our proprietary rights may be inadequate and we cannot give you any assurance that our competitors will not independently develop formulations and processes that are substantially equivalent or superior to our own or copy our products.
We expect to file additional patent applications seeking to protect newly developed technology and products in various countries, including the PRC. Some patent applications in the PRC are maintained in secrecy until the patent is issued. Because the publication of discoveries tends to follow their actual discovery by many months, we may not be the first to invent, or file patent applications on any of our discoveries. Patents may not be issued with respect to any of our patent applications and existing or future patents issued to or licensed by us may not provide competitive advantages for our products. Patents that are issued may be challenged, invalidated or circumvented by our competitors. Furthermore, our patent rights may not prevent our competitors from developing, using or commercializing products that are similar or functionally equivalent to our products.
Currently, the SFDA does not automatically stay drug registration approval upon initiation of an infringement lawsuit by a third party. At present, we must wait until a copycat manufacturer has received marketing approval from SFDA before we can bring an infringement lawsuit. Furthermore, PRC courts have been hesitant to issue preliminary injunctions to suspend sales until a final judgment is issued in the lawsuit. Our sales could be lowered were a competitor to infringe our intellectual property rights by marketing one or more versions of SFDA-approved drugs proprietary to us until we can curtail such infringement through legal action. Pursuing infringement lawsuits would require us to devote financial and management resources that could impact the results of our operations.
We also rely on trade secrets, non-patented proprietary expertise and continuing technological innovation that we shall seek to protect, in part, by entering into confidentiality agreements with licensees, suppliers, employees and consultants. These agreements may be breached and there may not be adequate remedies in the event of a breach. Disputes may arise concerning the ownership of intellectual property or the applicability of confidentiality agreements. Moreover, our trade secrets and proprietary technology may otherwise become known or be independently developed by our competitors. If patents are not issued with respect to products arising from research, we may not be able to maintain the confidentiality of information relating to these products.
We face risks relating to third parties that may claim that we infringe on their proprietary rights and may prevent us from manufacturing and selling certain of our products.
There has been substantial litigation in the pharmaceutical industry with respect to the manufacturing, use and sale of new products. These lawsuits relate to the validity and infringement of patents or proprietary rights of third parties. We are not aware of any infringement claims that have been filed against us by third parties. However, we may be required to commence or defend against charges relating to the infringement of patents or proprietary rights. Any such litigation could:
●
require us to incur substantial expense, even if covered by insurance or are successful in the litigation;
●
require us to divert significant time and effort of our technical and management personnel;
●
result in the loss of our rights to develop or make certain products; and
●
require us to pay substantial monetary damages or royalties in order to license proprietary rights from third parties.
Although intellectual property disputes within the pharmaceutical industry have often been settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include the long-term payment of royalties. These arrangements may be investigated by regulatory agencies and, if improper, may be invalidated. Furthermore, the required licenses may not be made available to us on acceptable terms. Accordingly, an adverse determination in a judicial or administrative proceeding or a failure to obtain necessary licenses could prevent us from manufacturing and selling some of our products or increase our costs to market these products.
In addition, when seeking regulatory approval for some of our products, we may be required to certify to regulatory authorities, including the SFDA, that such products do not infringe upon third party patent rights. Filing a certification against a patent gives the patent holder the right to bring a patent infringement lawsuit against us. Any lawsuit would delay the receipt of regulatory approvals. A claim of infringement and the resulting delay could result in substantial expenses and even prevent us from manufacturing and selling certain of our products.
Our launch of a product prior to a final court decision or the expiration of a patent held by a third party may result in substantial damages to us. If we are found to infringe a patent held by a third party and become subject to such damages, these damages could have a material adverse effect on the results of our operations and financial condition.
We face risks related to research and the ability to develop new drugs.
Our growth and survival depends on our ability to consistently discover, develop and commercialize new products and find new and improve on existing technology and platforms. During the year ended December 31, 2007, we spent $35,500 on research and development expenses, which amounted to 0.3% of our net sales. During the years ended December 31, 2009 and December 31, 2008, we have prepaid $955,900 and $808,800, respectively, of research and development expenses which amounted to 5.7% and 5.5%, respectively, of our net sales. We spent $49,242 on research and development in 2010. We prepaid these expenses to Shaanxi Research Institution of Chinese Traditional Medicines (“SRICTM”), which develops certain drugs on our behalf. Should the applications for these drugs be rejected by the SFDA due to a technology-related error or any error of SRICTM, SRICTM is contractually obligated under Sections 5.3, 7.3 and 10.1 of the agreement to refund all fees already paid by the Company under the terms of the Medicine Research and Development Agreement and Supplemental Agreement of Medicine Research and Development Agreement. If we fail to make sufficient investments in research, be attentive to consumer needs or does not focus on the most advanced technology, our current and future products could be surpassed by more effective or advanced products of other companies.
Risk Related To the Pharmaceutical Industry
Our certificates, permits, and licenses related to our pharmaceutical operations are subject to governmental control and renewal and failure to obtain renewal will cause all or part of our operations to be terminated.
Shaanxi Jiali is subject to various PRC laws and regulations pertaining to the pharmaceutical industry. Shaanxi Jiali has attained certificates, permits, and licenses required for the operation of a pharmaceutical enterprise and the manufacturing of pharmaceutical products in the PRC.
In 1998, the SFDA introduced the GMP Certificate in order to promote quality and safety of pharmaceutical production. The Good Manufacturing Practices were revised in July and October 2004. We and our competitors are required to meet GMP standards in order to continue manufacturing pharmaceutical products and health foods. For each new product, Shaanxi Jiali prepares documentation of pharmacological, toxicity, pharmacokinetics and drug metabolism studies in addition to providing samples of the drug. The documentation and samples are then submitted to provincial food and drug administration. This process typically takes approximately three months. After the documentation and samples have been approved by the provincial food and drug administration, the provincial administration submits the approved documentation and samples to the SFDA. The SFDA examines the documentation, tests the samples and presents the findings to the New Drug Examination Committee for approval. If the application is approved by the SFDA, the SFDA will issue a clinical trial license to the applicant for clinical trials. This clinical trial license approval typically takes one year, followed by approximately two years of trials, depending on the category and class of the new drug. The SFDA then examines the documentation from the trial and, if approved, issues the new drug license to the applicant. This process usually takes eight months. The entire process takes anywhere from three to four years.
Shaanxi Jiali initially obtained pharmaceutical products permits by submitting its manufacturing processes and product tests to the SFDA who verified that its production processes and products met the standards by onsite inspections, review of test results and a determination that the market was not saturated by its products. The production permits are permanent once issued as long as they are renewed by the expiration date. The GMP certificate is valid for a term of five years, and each must be renewed before its expiration, if applicable. Pursuant to SFDA regulation, if there is a gap at any time in the validity of a company’s GMP certificate, it must suspend production or face stiff fines and the risk that its authorization for production may be permanently revoked.
We own one facility in Baoji, Shaanxi Province, China. This facility is in compliance with Good Manufacturing Practice (GMP) standards and we received our initial GMP certificate on November 3, 2004. (Certificate No. Shaan for Baoji Production Base). We satisfied SFDA’s 5-year-test and got our new GMP certificate dated September 19, 2010 (Certificate No. Shaan L0411)
According to Drug Administration Law of the PRC and its implementing rules, the SFDA approvals, including Pharmaceutical Manufacturing Permit and Drug Approval Numbers, may be suspended or revoked prior to the expiration date under circumstances that include:
●
producing counterfeit medicine;
●
producing inferior quality products;
●
failing to meet the drug GMP standards;
●
purchasing medical ingredients used in the production of products sources that do not have Pharmaceutical Manufacturing Permit or Pharmaceutical Trade Permit;
●
fraudulent reporting of results or product samples in application process;
●
failing to meet drug labeling and direction standards;
●
bribing doctors or hospital personnel to entice them to use products,
●
producing pharmaceuticals for use or resale by companies that are not approved by the SFDA, or
●
The approved drug has a serious side effect.
If our pharmaceutical products fail to receive regulatory approval or are severely limited in these products' scope of use, we may be unable to recoup considerable research and development expenditures.
Our research and development of pharmaceutical products is subject to the regulatory approval of the SFDA in the PRC. The regulatory approval procedure for pharmaceuticals can be quite lengthy, costly, and uncertain. Depending upon the discretion of the SFDA, the approval process may be significantly delayed by additional clinical testing and require the expenditure of resources not currently available; in such an event, it may be necessary for us to abandon our application. Even where approval of the product is granted, it may contain significant limitations in the form of narrow indications, warnings, precautions, or contra-indications with respect to conditions of use. If approval of our product is denied, abandoned, or severely limited in terms of the scope of products use, it may result in the inability to recoup considerable research and development expenditures. If we do not receive timely approval for any of these drugs, then production will be delayed and sales of the products cannot be planned for.
Price control regulations may decrease our profitability.
The laws of the PRC provide for the government to fix and adjust prices. The prices of certain medicines we distribute, including those listed in the Chinese government's catalogue of medications that are reimbursable under the PRC’s social insurance program, or the Insurance Catalogue, are subject to control by the relevant state or provincial price administration authorities. The PRC establishes price levels for products based on market conditions, average industry cost, supply and demand and social responsibility. In practice, price control with respect to these medicines sets a ceiling on their retail price. The actual price of such medicines set by manufacturers, wholesalers and retailers cannot historically exceed the price ceiling imposed by applicable government price control regulations. Although, as a general matter, government price control regulations have resulted in drug prices tending to decline over time, there has been no predictable pattern for such decreases.
For the years ended December 31, 2010 and December 31, 2009, we have not had any products subject to specific pricing control and production and trading of none of our pharmaceutical products constitutes a monopoly. However, it is possible that our products may be subject to price control in the future. To the extent that our products 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 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.
If the medicines we produce are replaced by other medicines or are removed from the PRC's insurance catalogue in the future, our revenue may suffer.
Under PRC regulations, patients purchasing medicine listed by the PRC's state and/or provincial governments in the Insurance Catalogue may be reimbursed, in part or in whole, by a social medicine fund. Accordingly, pharmaceutical distributors prefer to engage in the distribution of medicine listed in the Insurance Catalogue. Currently, our main prescription products are listed in the Insurance Catalogue. The content of the Insurance Catalogue is subject to change by the PRC Ministry of Labor and Social Security, and new medicine may be added to the Insurance Catalogue by provincial level authorities as part of their limited ability to change certain medicines listed in the Insurance Catalogue. If the medicine we produce are replaced by other medicines or removed from the Insurance Catalogue in the future, our revenue may suffer.
Adverse publicity associated with our products, ingredients or network marketing program, or those of similar companies, could harm our financial condition and operating results.
The results of our operations may be significantly affected by the public's perception of our product and similar companies. This perception is dependent upon opinions concerning:
●
The safety and quality of our products and ingredients;
●
The safety and quality of similar products and ingredients distributed by other companies; and
●
Our sales force.
Adverse publicity concerning any actual or purported failure to comply with applicable laws and regulations regarding product claims and advertising, good manufacturing practices, or other aspects of our business, whether or not resulting in enforcement actions or the imposition of penalties, could have an adverse affect on our goodwill and could negatively affect our sales and ability to generate revenue.
In addition, our consumers' perception of the safety and quality of products and ingredients as well as similar products and ingredients distributed by other companies can be significantly influenced by media attention, publicized scientific research or findings, widespread product liability claims and other publicity concerning our products or ingredients or similar products and ingredients distributed by other companies. Adverse publicity, whether or not accurate or resulting from consumers' use or misuse of our products, that associates consumption of our products or ingredients or any similar products or ingredients with illness or other adverse effects, questions the benefits of our or similar products or claims that any such products are ineffective, inappropriately labeled or have inaccurate instructions as to their use, could negatively impact our reputation or the market demand for our products.
If we fail to develop new products with high profit margins, and our high profit margin products are substituted by competitor's products, our gross and net profit margins will be adversely affected.
There is no assurance that we will be able to sustain our profit margins in the future. The pharmaceutical industry is very competitive, and there may be pressure to reduce sale prices of products without a corresponding decrease in the price of raw materials. In addition, the medical industry in the PRC is highly competitive and new products are constantly being introduced to the market. In order to increase our sales and expand our market share, we may be forced to reduce prices in the future, leading to a decrease in gross profit margin. The research and development of new products and technology is costly and time consuming, and there are no assurances that our research and development of new products will either be successful or completed within the anticipated timeframe, if ever at all. There is no assurance that our competitors' new products, technology, and processes will not render our existing products obsolete or non-competitive. To the extent that we fail to develop new products with high profit margins and our high profit margin products are substituted by competitors' products, our gross profit margins will be adversely affected.
The commercial success of our products depends upon the degree of market acceptance among the medical community and failure to attain market acceptance among the medical community may have an adverse impact on our operations and profitability.
The commercial success of our products depends upon the degree of market acceptance among the medical community, such as hospitals and physicians. Even if our products are approved by the SFDA, there is no assurance that physicians will prescribe or recommend our products to patients. Furthermore, a product's prevalence and use at hospitals may be contingent upon its relationship with the medical community, particularly products that are only available by medical prescription. The acceptance of our products among the medical community may depend upon several factors, including but not limited to, the product's acceptance by physicians and patients as a safe and effective treatment, cost effectiveness, potential advantages over alternative treatments, and the prevalence and severity of side effects. Failure to attain market acceptance among the medical community may have an adverse impact on our operations and profitability.
We enjoyed certain preferential tax concessions that ended at December 31, 2010, and loss of these preferential tax concessions will cause our tax liabilities to increase and our profitability to decline.
Shaanxi Jiali enjoyed preferential tax concessions wereby it was granted a reduction in its income tax rate under which it paid no income taxes from January 1, 2006 to December 31, 2007 and had had an income tax rate of 15% between January 1, 2008 and December 31, 2010, which is a 50% reduction on the current effective income tax rate. This favorable 50% tax exemption treatment expired on December 31, 2010. As a result, Shannxi Jiali’s tax liabilities will increase and its profits may accordingly decline. Additionally, the PRC Enterprise Income Tax Law (the "EIT Law") was enacted on March 16, 2007. Under the EIT Law, effective January 1, 2008, the PRC will adopt a uniform tax rate of 25.0% for all enterprises (including foreign-invested enterprises) and cancel several tax incentives enjoyed by foreign-invested enterprises. However, for foreign-invested enterprises established before the promulgation of the EIT Law, a five-year transition period is provided during which reduced rates will apply but gradually be phased out. Since the PRC government has not announced implementation measures for the transitional policy with regards to such preferential tax rates, we cannot reasonably estimate the financial impact of the new tax law to Shaanxi Jiali at this time. Further, any future increase in the enterprise income tax rate applicable to it or other adverse tax treatments, such as the discontinuation of preferential tax treatments for high and new technology enterprises, would have a material adverse effect on its results of operations and financial condition.
Risks Related to Doing Business in the PRC
Changes in the policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and the profitability of such business .
Our business operations may be adversely affected by the current and future political environment in the PRC. The PRC has operated as a socialist state since the mid-1900s and is controlled by the PRC’s Communist Party. The Chinese government exerts substantial influence and control over the manner in which we and it must conduct our business activities. The PRC has only permitted provincial and local economic autonomy and private economic activities since 1988. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy, particularly the pharmaceutical industry, through regulation and state ownership. Our ability to operate in the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
The PRC's economy is in a transition from a planned economy to a market oriented economy subject to five-year and annual plans adopted by the government that set national economic development goals. Policies of the PRC government can have significant effects on the economic conditions of the PRC. The PRC government has confirmed that economic development will follow the model of a market economy. Under this direction, we believe that the PRC will continue to strengthen its economic and trading relationships with foreign countries and business development in the PRC will follow market forces. While we believe that this trend will continue, there can be no assurance that this will be the case.
A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. Although the PRC government has been pursuing economic reform policies for more than two decades, there is no assurance that the 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 other circumstances affecting the PRC's political, economic and social life.
The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may harm its business.
The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. The PRC’s legal system is a civil law system based on written statutes, in which system decided legal cases have little value as precedents unlike the common law system prevalent in the United States. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We are considered a foreign persons or foreign funded enterprises under PRC laws, and as a result, we are required to comply with PRC laws and regulations. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on its businesses. If the relevant authorities find that we are in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation:
●
levying fines;
●
revoking Shaanxi Jiali’s business and other licenses;
●
requiring that we restructure our ownership or operations; and
●
requiring that we discontinue any portion or all of our business.
Among the material laws that we are subject to are the Medicine Management Law, governing the management of pharmaceutical companies, medicine production procedure, packaging, prices, Advertisement Law of the People’s Republic of China and Rules of Medicine Advertisements Management from State Admission for Industry and Commerce, Regulations on Control of Advertisements from State Council, governing rules on advertising, Standardization of the Management on the Quality of Medicine Production issued by SFDA, providing standards for staff, plants, equipment, materials, environment, production management, products laws, and the Price Law of The People’s Republic of China, Measurement Law of The People’s Republic of China, Tax Law, Environmental Protection Law, Contract Law, Patent Law, Accounting Laws and Labor Law.
A slowdown, inflation or other adverse developments in the PRC economy may harm our customers and the demand for our services and products.
All of our operations are conducted in the PRC and all of our revenue is generated from sales in the PRC. Although the PRC economy has grown significantly in recent years, we cannot assure you that this growth will continue. A slowdown in overall economic growth, an economic downturn, a recession or other adverse economic developments in the PRC could significantly reduce the demand for our products and harm our business.
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth could lead to growth in the money supply and rising inflation. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may harm our profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credit, limits on loans for fixed assets and restrictions on state bank lending. Such an austere policy can lead to a slowing of economic growth. In October 2004, the People's Bank of China, the PRC's central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the Chinese economy. Repeated rises in interest rates by the central bank would likely slow economic activity in the PRC which could, in turn, materially increase its costs and also reduce demand for its products.
Governmental control of currency conversion may affect the value of your investment.
The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. We receive substantially all of our revenue in Renminbi, which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi is to be converted into foreign currency and remitted out of the PRC to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.
The PRC government may also in the future restrict access to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain of our expenses as they come due.
The fluctuation of the Renminbi may harm your investment.
The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC's political and economic conditions. According to the currency website www.xe.com, as of December 31, 2010, $1 = 6.61 Renminbi. As we rely entirely on revenue earned in the PRC, any significant revaluation of the Renminbi may materially and adversely affect our cash flows, revenue and financial condition. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into Renminbi for Shaanxi Jiali’s operations, appreciation of the Renminbi against the U.S. dollar would diminish the value of the proceeds of the offering and this could harm Shaanxi Jiali’s business, financial condition and results of operations because it would reduce the proceeds available to us for capital investment in proportion to the appreciation of the Renminbi. Thus if we raise 1,000,000 dollars and the Renminbi appreciates against the U.S. dollar by 15%, then the proceeds will be worth only RMB 5,602,350 as opposed to RMB 6,591,000 prior to the appreciation. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our common shares or for other business purposes and the U.S. dollar appreciates against the Renminbi; the U.S. dollar equivalent of the Renminbi we convert would be reduced in proportion to the amount the U.S. dollar appreciates. In addition, the depreciation of significant RMB denominated assets could result in a charge to our income statement and a reduction in the dollar value of these assets. Thus if Shaanxi Jiali has RMB 1,000,000 in assets and Renminbi is depreciated against the U.S. dollar by 15%, then the assets will be valued at $128,963 as opposed to $151,722 prior to the depreciation.
On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 17.5% appreciation of the Renminbi against the U.S. dollar as of December 31, 2009. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar.
PRC state administration of foreign exchange ("SAFE") regulations regarding offshore financing activities by PRC residents which may increase the administrative burden we face. The failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.
SAFE issued a public notice ("SAFE #75") effective from November 1, 2005, which requires registration with SAFE by the PRC resident shareholders of any foreign holding company of a PRC entity. Without registration, the PRC entity cannot remit any of its profits out of the PRC as dividends or otherwise.
In October 2005, SAFE issued a public notice, the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, or the SAFE notice, which requires PRC residents, including both legal persons and natural persons, to register with the competent local SAFE branch before establishing or controlling any company outside of the PRC, referred to as an "offshore special purpose company," for the purpose of overseas equity financing involving onshore assets or equity interests held by them. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in the PRC. Moreover, if the offshore special purpose company was established and owned the onshore assets or equity interests before the implementation date of the SAFE notice, a retroactive SAFE registration is required to have been completed before March 31, 2006. If any PRC shareholder of any offshore special purpose company fails to make the required SAFE registration and amendment, the PRC subsidiaries of that offshore special purpose company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the offshore special purpose company. Moreover, failure to comply with the SAFE registration and amendment requirements described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.
It is unclear whether our PRC resident shareholders must make disclosure to SAFE. While our PRC counsel has advised us that only PRC resident shareholders who receive ownership of the foreign holding company in exchange for ownership in the PRC operating company are subject to SAFE #75, there can be no assurance that SAFE will not require our other PRC resident shareholders to register and make the applicable disclosure. In addition, SAFE #75 requires that any monies remitted to PRC residents outside of the PRC be returned within 180 days; however, there is no indication of what the penalty will be for failure to comply or if shareholder non-compliance will be considered to be a violation of SAFE #75 by us or otherwise affect us.
In the event that the proper procedures are not followed under SAFE #75, Xi’an Coova could lose the ability to remit monies outside of the PRC and would therefore be unable to pay dividends or make other distributions. Our PRC resident shareholders could be subject to fines, other sanctions and even criminal liabilities under the PRC Foreign Exchange Administrative Regulations promulgated January 29, 1996, as amended.
The PRC's legal and judicial system may not adequately protect our business and operations and the rights of foreign investors.
The PRC legal and judicial system may negatively impact foreign investors. In 1982, the National People's Congress amended the Constitution of the PRC to authorize foreign investment and guarantee the "lawful rights and interests" of foreign investors in the PRC. However, the PRC's system of laws is not yet comprehensive. The legal and judicial systems in the PRC are still rudimentary, and enforcement of existing laws is inconsistent. Many judges in the PRC lack the depth of legal training and experience that would be expected of a judge in a more developed country. Because the PRC judiciary is relatively inexperienced in enforcing the laws that do exist, anticipation of judicial decision-making is more uncertain than would be expected in a more developed country. It may be impossible to obtain swift and equitable enforcement of laws that do exist, or to obtain enforcement of the judgment of one court by a court of another jurisdiction. The PRC's legal system is based on the civil law regime, that is, it is based on written statutes; a decision by one judge does not set a legal precedent that is required to be followed by judges in other cases. In addition, the interpretation of Chinese laws may be varied to reflect domestic political changes.
The promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors. However, the trend of legislation over the last 20 years has significantly enhanced the protection of foreign investment and allowed for more control by foreign parties of their investments in Chinese enterprises. There can be no assurance that a change in leadership, social or political disruption, or unforeseen circumstances affecting the PRC's political, economic or social life, will not affect the PRC government's ability to continue to support and pursue these reforms. Such a shift could have a material adverse effect on our business and prospects.
The practical effect of the PRC legal system on our business operations in the PRC can be viewed from two separate but intertwined considerations. First, as a matter of substantive law, the Foreign Invested Enterprise laws provide significant protection from government interference. In addition, these laws guarantee the full enjoyment of the benefits of corporate Articles and contracts to Foreign Invested Enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are qualitatively different from the general corporation laws of the United States. Similarly, the PRC accounting laws mandate accounting practices, which are not consistent with U.S. generally accepted accounting principles. PRC's accounting laws require that an annual "statutory audit" be performed in accordance with PRC accounting standards and that the books of account of Foreign Invested Enterprises are maintained in accordance with Chinese accounting laws. Article 14 of the People's Republic of China Wholly Foreign-Owned Enterprise Law requires a wholly foreign-owned enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities, at the risk of business license revocation. While the enforcement of substantive rights may appear less clear than United States procedures, the Foreign Invested Enterprises and Wholly Foreign-Owned Enterprises are Chinese registered companies, which enjoy the same status as other Chinese registered companies in business-to-business dispute resolution. Any award rendered by an arbitration tribunal is enforceable in accordance with the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958). Therefore, as a practical matter, although no assurances can be given, the Chinese legal infrastructure, while different in operation from its United States counterpart, should not present any significant impediment to the operation of Foreign Invested Enterprises.
Any recurrence of severe acute respiratory syndrome, or SARS, or another widespread public health problem, could harm our operations.
A renewed outbreak of SARS or another widespread public health problem (such as bird flu) in the PRC, where all of our revenue is derived, could significantly harm our operations. Our operations may be impacted by a number of health-related factors, including quarantines or closures of some of our offices that would adversely disrupt our operations. Any of the foregoing events or other unforeseen consequences of public health problems could significantly harm our operations.
Because our principal assets are located outside of the United States and most of our directors and all of our officers reside outside of the United States, it may be difficult for you to enforce your rights based on U.S. Federal Securities Laws against us and our officers or to enforce U.S. Court Judgments against us or them in the PRC.
Most of our directors and all of our officers reside outside of the United States. In addition, our operating company is located in the PRC and substantially all of our assets are located outside of the United States. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the U.S. Federal securities laws against us in the courts of either the U.S. or the PRC and, even if civil judgments are obtained in U.S. courts, to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties, under the U.S. Federal securities laws or otherwise.
The relative lack of public company experience of our management team may put us at a competitive disadvantage.
Our management team lacks public company experience, which could impair our ability to comply with legal and regulatory requirements such as those imposed by Sarbanes-Oxley Act of 2002. The individuals who now constitute our senior management have never had responsibility for managing a publicly traded company. Such responsibilities include complying with federal securities laws and making required disclosures on a timely basis. Our senior management may not be able to implement programs and policies in an effective and timely manner that adequately responds to such increased legal, regulatory compliance and reporting requirements. Our failure to comply with all applicable requirements could lead to the imposition of fines and penalties and distract our management from attending to the growth of our business.
Risks Related to our Common Stock
We are not likely to pay cash dividends in the foreseeable future.
We intend to retain any future earnings for use in the operation and expansion of our business. We do not expect to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate. Should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions.
There is a limited market for our common stock, which may make it difficult for you to sell your stock.
Our common stock trades on the OTCBB under the symbol “CPDU.OB.” There is a limited trading market for our common stock. Accordingly, there can be no assurance as to the liquidity of any markets that may develop for our common stock, the ability of holders of our common stock to sell our common stock, or the prices at which holders may be able to sell our common stock.
Our shares are subject to the U.S. “Penny Stock” Rules and investors who purchase our shares may have difficulty re-selling their shares as the liquidity of the market for our shares may be adversely affected by the impact of the “Penny Stock” Rules.
Our stock is subject to U.S. "Penny Stock" rules, which may make the stock more difficult to trade on the open market. Our common shares currently trade on the OTCBB. A "penny stock" is generally defined by regulations of the U.S. Securities and Exchange Commission ("SEC") as an equity security with a market price of less than US$5.00 per share. However, an equity security with a market price under US$5.00 will not be considered a penny stock if it fits within any of the following exceptions:
(i)
the equity security is listed on AMEX or a national securities exchange;
(ii)
the issuer of the equity security has been in continuous operation for less than three years, and either has (a) net tangible assets of at least US$5,000,000, or (b) average annual revenue of at least US$6,000,000; or
(iii)
the issuer of the equity security has been in continuous operation for more than three years, and has net tangible assets of at least US$2,000,000.
Our common stock does not currently fit into any of the above exceptions.
If an investor buys or sells a penny stock, SEC regulations require that the investor receive, prior to the transaction, a disclosure explaining the penny stock market and associated risks. Furthermore, trading in our common stock is currently subject to Rule 15g-9 of the Securities Exchange Act of 1934 (the “Exchange Act”), which relates to non-NASDAQ and non-exchange listed securities. Under this rule, broker/dealers who recommend our securities to persons other than established customers and accredited investors must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to a transaction prior to sale. Securities are exempt from this rule if their market price is at least $5.00 per share.
Since our common stock is currently deemed a penny stock, it will be subject to penny stock regulations, which may reduce market liquidity of our common stock, because they limit the broker/dealers' ability to trade, and a purchaser's ability to sell, the stock in the secondary market.
The low price of our common stock has a negative effect on the amount and percentage of transaction costs paid by individual shareholders. The low price of our common stock also limits our ability to raise additional capital by issuing additional shares. There are several reasons for these effects. First, the internal policies of certain institutional investors prohibit the purchase of low-priced stocks. Second, many brokerage houses do not permit low-priced stocks to be used as collateral for margin accounts or to be purchased on margin. Third, some brokerage house policies and practices tend to discourage individual brokers from dealing in low-priced stocks. Finally, broker's commissions on low-priced stocks usually represent a higher percentage of the stock price than commissions on higher priced stocks. As a result, our shareholders may pay transaction costs that are a higher percentage of their total share value than if our share price were substantially higher.
As an issuer of “penny stock” the protection provided by the federal securities laws relating to forward-looking statements does not apply to us and as a result we could be subject to legal action.
Forward-looking statements are based on current expectations, estimates, forecasts and projections about the Company, us, our future performance, our beliefs and our Management’s assumptions. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Forward-looking statements involve risks and uncertainties. Forward-looking statements include statements regarding, among other things, (a) projected sales, profitability, and cash flows, (b) growth strategies, (c) anticipated trends, (d) future financing plans and (e) anticipated needs for working capital. They are generally identifiable by use of the words “may,” “will,” “should,” “anticipates,” “estimate,” “plans,” “potential,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend,” or the negative of these words or other variations on these words or comparable terminology. These statements may be found under “Management’s Discussion and Analysis of Financial Condition and Plan of Operation” and “Business,” as well as in this prospectus generally. In particular, these include statements relating to future actions, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, the outcome of contingencies such as legal proceedings, and financial results.
These forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions that we cannot predict. Any assumptions, upon which they are based, are made in good faith and reflect our current judgment regarding the direction of our business. However, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested in this prospectus. We assume no obligation to update forward-looking statements, except as otherwise required under the applicable federal securities laws.
Although federal securities laws 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 stock. 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 legal action based upon a claim that 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. Such an action could hurt our financial condition.
For more information about penny stocks, contact the Office of Filings, Information and Consumer Services of the U.S. Securities and Exchange Commission, 100 F Street, N.E., Washington, D.C. 20549, or by telephone at 1-800-732-0330.
A large number of shares will be eligible for future sale and may depress our stock price.
We may be required, under terms of future financing arrangements, to offer a large number of common shares to the public, or to register for sale by future private investors a large number of shares sold in private sales to them.
Sales of substantial amounts of common stock, or a perception that such sales could occur, and the existence of options or warrants to purchase shares of common stock at prices that may be below the then-current market price of our common stock, could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of our equity securities, either of which would decrease the value of any earlier investment in our common stock.
Investors may experience immediate and substantial dilution in net tangible book value per share of our common stock if they elect to exercise the warrants.
Investors may experience immediate and substantial dilution in net tangible book value per share of our common stock if they elect to exercise the Warrants. The exercise price of the Warrants may be substantially higher than the net tangible book value per share. Accordingly, if the selling stockholders exercise the Warrants, they will likely experience immediate and substantial dilution in the net tangible book value per share and further dilution if we issue shares of our common stock in the future. As a result of this dilution, in the event of our subsequent liquidation, the selling stockholders exercising their Warrants may receive significantly less than the full exercise price that they paid for the shares of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not required under Regulation S-K for “smaller reporting companies.”
Item 2.
Item 2. Properties.
Our properties are located in Baoji and Xi'an, which is the capital of the Shaanxi province in the People's Republic of China and a sub-provincial city. As one of the oldest cities in Chinese history, Xi'an is one of the Four Great Ancient Capitals of China because it has been the capital of some of the most important dynasties in Chinese history, including the Zhou, Qin, Han, the Sui, and Tang dynasties. Xi'an is the eastern terminus of the Silk Road and known as the site of the Terracotta Army, made during the Qin Dynasty. The city has more than 3,100 years of history, and was known as Chang'an before the Ming Dynasty. Since the 1990s, as part of the economic revival of interior China especially for the central and northwest regions, the city of Xi'an has re-emerged as an important cultural, industrial and educational center of the central-northwest region, with facilities for research and development, national security and China's space exploration program.
Headquarters and Administration Offices
Shaanxi Jiali leases approximately 2,200 square feet of premium office space at the 9 th Floor of the China Construction Bank Building, No. 29 Nanxin Street, Xi’an, Shaanxi, PRC, for the purposes of accommodating the company’s executive and administration staff. The annual lease expense is RMB 156,240.which equals approximately USD22, 900.
Production Plant
Shaanxi Jiali owns the land use rights to approximately 54,000 square meters of land in Shaanxi province. The location of our 28,500 square meter manufacturing facility is located at No. 48 Xibao Road, Weibin District, City of Baoji , Shaanxi Province, P.R.C. We have a Certificate of House Ownership and Appendix Permit Certificate of State-owned Land Usufruct.
All land in the PRC is owned by the government and cannot be sold to any individual or entity. Instead, the government grants landholders a "land use right" after a purchase price for such "land use right" is paid to the government. The "land use right" allows the holder the right to use the land for a specified long-term period of time and enjoys all the incidents of ownership of the land. Our Baoji production base covers an area of 54,000 square meters with building area of 28,500 square meters. The land use rights for the Baoji production base expires on June 18, 2050.
Item 3.
Item 3. Legal Proceedings.
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results.
Item 4.
Item 4. (Removed and Reserved).
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock, having $.001 par value per share, is traded on the Over-The-Counter Bulletin Board ("OTCBB") under the symbol "CPDU". Prior to December 14, 2009, the Company traded under the symbol “LHSI.” Although our stock is traded on the OTCBB, the market for our stock, particularly prior to September 30, 2009, has been relatively inactive.
The range of high and low bid quotations by quarter from January 1, 2009 through December 31, 2010 is listed below. The quotations are taken from the OTC Bulletin Board. They reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
On March 30, 2011, the closing sale price of our common stock, as reported by the Over-the-Counter Bulletin Board, was $2.00 per share. On March 31, 2011, there were 12,730,288 holders of record of our common stock.
Dividends
We have never paid any cash dividends on our capital stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We intend to retain future earnings to fund ongoing operations and future capital requirements of our business. Any future determination to pay cash dividends will be at the discretion of the Board and will be dependent upon our financial condition, results of operations, capital requirements and such other factors as the Board deems relevant.
Penny Stock Regulations
The SEC has adopted regulations which generally define "penny stock" to be an equity security that has a market price of less than $5.00 per share. Our common stock, falls within the definition of penny stock and subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000, or annual incomes exceeding $200,000 or $300,000, together with their spouse).
For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser's prior written consent to the transaction. Additionally, for any transaction, other than exempt transactions, involving a penny stock, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the "penny stock" rules may restrict the ability of broker-dealers to sell our common stock and may affect the ability of investors to sell their common stock in the secondary market.
Recent Sales of Unregistered Securities
On October 15, 2010, the board of directors approved the issuance of an aggregate of 1,470,000 shares of common stock to be issued to 4 individuals, Hongtao Wang, Guiping Zhang, Weibing Lu, and Jun Pu, as consideration for certain consulting services to be provided to the Company’s indirect wholly-owned subsidiary, Coova Children Pharmaceuticals Technology (Xi’an) Co. Ltd. Such consulting services shall include, but not be limited to, matters related to mergers and acquisitions, management buy-outs, restructuring, asset management, investment, and financing.
The issuance of shares of common stock pursuant to the Agreement are exempt from registration in reliance upon Regulation S and Section 4(2) of the Securities Act of 1933, as amended. The consultants issued the above-mentioned shares are non-U.S. persons, as defined in Rule 902(k) of Regulation S. In addition, the Company’s shares will be issued without registration under Section 5 of the Securities Act in reliance on the exemption from registration contained in Section 4(2) of the Securities Act. Specifically, (1) the Company had determined that subject individuals were knowledgeable and experienced in finance and business matters and thus they are able to evaluate the risks and merits of acquiring our securities; (2) they had advised the Company that they were able to bear the economic risk of purchasing the Company’s common stock; (3) the Company had provided them with access to the type of information normally provided in a prospectus; and (4) the Company did not use any form of public solicitation or general advertising in connection with the issuance of the shares.
Equity Compensation Plan Information
None.
Item 6.
Item 6. Selected Financial Data
Not required under Regulation S-K for “smaller reporting companies.”
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of financial condition and results of operation of the Company for the years ended December 31, 2010, and 2009, should be read in conjunction with the consolidated financial statements and the notes to those statements are included elsewhere in this Annual Report.
Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K (“Report”) contains forward-looking statements. For this purpose, any statements contained in this Report that are not statements of historical fact may be deemed to be forward-looking statements, including any statements relating to future actions and outcomes including but not limited to prospective products, future performance or results of current or anticipated products, sales and marketing efforts, costs and expense trends, future interest rates, outcome of contingencies and their future impact on financial condition, results of operations, liquidity, business strategies, cost savings, objectives of management, and other matters. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “contemplates,” “predicts,” “potential,” or “continue” or variations and/or the negative of these similar terms. Forward-looking statements are based on current expectations, estimates, forecasts and projections about the Company, us, our future performance, our beliefs and our Management’s assumptions. All forward-looking statements made in this Report, including any future written or oral statements made by us or on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.
These forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions that we cannot predict. Any assumptions, upon which they are based, are made in good faith and reflect our current judgment regarding the direction of our business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested in this Report. Therefore, actual outcomes and results may differ materially from what is expressed or forecast in such forward-looking statements. In evaluating these forward-looking statements, you should consider various factors, including the following: (a) those risks and uncertainties related to general economic conditions, (b) whether we are able to manage our planned growth efficiently and operate profitable operations, (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations, (d) whether we are able to successfully fulfill our primary requirements for cash. Please refer to Part II, Item 7 under “Liquidity and Capital Resources” and Part I, Item 1A under “Risk Factors” contained in this Report for additional discussion. Please also refer to our other filings with the Securities and Exchange Commission. We assume no obligation to update forward-looking statements, except as otherwise required under the applicable federal securities laws.
Results of Operations for the Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
NET SALES
Total net sales for the years ended December 31, 2010 increased by $9,699,817 or approximately 66% compared to the same period of 2009. This was mainly due to increases in sales of "Cooer" Series by 86% in 2010, as a result of the intensive promotion in 2009 and 2010.
COST OF SALES
Compared to last period, cost of sales increased $4,504,226 or 64% in the year ended December 31, 2010. This was primarily resulting from the increase in product net sales. The increase in average unit costs was mainly caused by the general increase in costs of raw material in China in the year 2010 and increase in wages of workers due to statutory minimum wages increases.
GROSS PROFIT
The gross profit for the year ended December 31, 2010 increased by $5,195,591, or approximately 67%, compared to the same period of 2009.
As a result of GMP inspection, production had been temporarily suspended in 2010 Q1. Raw materials on hand for production become excessive. The Company therefore sold all the excessive raw materials of carrying value amounted to $1,147,337 included in “Others” back to the suppliers of $991,199 (i.e. of a discount around 86% of the original costs $1,147,337). However, gross profit ratio remains 53% ,which is constant compared with the same period in 2009.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
In 2010, increases in selling, general and administrative expenses in absolute dollars of $2,284,530. It was mainly due to the increase in stock based compensation cost of around $2.7 million. Under this circumstance, the selling, general and administrative expenses were increased by 58%. But compare with 2009, the percentage of total net sales was slightly decrease.
PROVISION FOR INCOME TAXES
The amount of Enterprise Income Tax payable is computed on the basis of the taxable income and by applying the tax rate of 25%. We enjoyed a reduced rate of 15% from the Enterprises Income Tax in 2009 and 2010 because we were a "High Technology Business" under PRC Income Tax Laws.
In 2010, the operating income before tax for the year ended December 31, 2010 was increased by approximately $3 million, therefore the assessable income was increased significantly.
NET INCOME
As a result of the above, in the year ended December 31, 2010, the net income was $5,971,619 compared to a net loss of $2,792,672 for the year ended December 31, 2009.
LIQUIDITY AND CAPITAL RESOURCES AND RESULTS OF OPERATIONS AS OF DECEMBER 31, 2010 AND 2009 AND FOR THE YEARS THEN ENDED
As of December 31, 2010, we had cash and cash equivalents of approximately $11 million. We believe our existing cash and cash equivalents will be sufficient to maintain our operations at present level for at least the next twelve months. We plan to review acquisition opportunities as a strategy for further growth.
Net cash provided by operating activities for the year ended December 31, 2010 was $2,948,989. This was primarily due to the net income of $5,971,619, adjusted by non-cash related expenses including depreciation and amortization of $416,248, derivative income of $187,500 and stock based compensation cost of $2,704,800 offset by a net decrease in working capital items of $5,956,178. The net decrease in working capital items was mainly due to increase in accounts receivable which resulted from the significant increase in revenues during the year ended December 31, 2010 and the longer credit term provided to customers as part of sales promotion, increase in prepayments to suppliers, increase in inventories to prepare for the ongoing sales promotion, and decrease in accrued expenses. The net decrease in working capital items was partially offset by the increase in receipt in advance, accounts payable and increase in income tax payable.
Net cash used in operating activities for the year ended December 31, 2009 was $498,180. This was primarily due to the net loss of $2,792,672, adjusted by non-cash related expenses including depreciation and amortization of $435,724, derivative expense of $5,950,000 and stock based compensation cost of $16,087 offset by a net decrease in working capital items of $4,107,319. The net decrease in working capital items was mainly due to increase in accounts receivable which resulted from the significant increase in revenues during the year ended December 31, 2009 and the longer credit term provided to customers as part of sales promotion, increase in prepayments to suppliers, and increase in inventories to prepare for the ongoing sales promotion, decrease in accounts payable, decrease in income tax payable. The net decrease in working capital items was partially offset by the increase in accrued expenses.
Net cash used in investing activities for the years ended December 31, 2010 and 2009 was $1,254 and $Nil.
Net cash generated from financing activities for the year ended December 31, 2010 was $6,860,000 due to the issue of common stock and increase in additional paid-in-capital. Net cash generated from financing activities for the year ended December 31, 2009 was $438,553. This was due to the inception of new bank loans of $438,540 and subscription received of $13.
Short-Term Loans
As of December 31, 2010, the Company had short-term debt as follows:
The Company uses these loans for working capital purposes. The loan is secured by the land use rights of Shaanxi Jiali's Baoji production base.
Our anticipated needs for the future are to be negotiated in accordance with manufacturing and operation needs, and market conditions of next year.
Critical Accounting Policies and Estimates
Our financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States ("US GAAP"). US GAAP requires the use of estimates; assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenues and expenses amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently and conservatively applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements
We believe the following is among the most critical accounting policies that impact our consolidated financial statements. We suggest that our significant accounting policies, as described in our condensed consolidated financial statements in the Summary of Significant Accounting Policies, be read in conjunction with this Management's Discussion and Analysis of Financial Condition and Results of Operations. See also Note 2 to our consolidated financial statements for further discussion of our accounting policies.
Revenue Recognition
The Company's revenue recognition policies are in compliance with Staff Accounting Bulletin ("SAB") 104, "Revenue Recognition." Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.
Allowance for Doubtful Accounts
The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Reserves are recorded primarily on a specific identification basis.
The following table sets out the aging of our accounts receivable for each balance sheet periods presented.
The following presents the days sales outstanding calculated based on sales and accounts receivables in RMB term for each income statement periods presented.
Inventory
Management compares the cost of inventories with the market value. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand, future pricing and market conditions.
Property, plant and Equipment
Property, plant and equipment are stated at historical cost less accumulated depreciation and amortization. Expenditures for maintenance and repairs are charged to earnings as incurred, additions, renewals and betterments are capitalised. When property and equipment are retired or otherwise disposal of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss in included in operations. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Judgment is required to determine the estimated useful lives of assets, especially for plant and equipment and transportation equipment, including determining how long existing equipment can function and when new technologies will be introduced at cost-effective price points to replace existing equipment. Changes in these estimates and assumptions could materially impact the financial position and results of operations.
Accounting for Stock-Based Compensation
The account for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", as amended by the Financial Accounting Standards Board Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation." Accounting Principles Board Opinion No. 25 and Financial Accounting Standards Board Interpretation No. 44 state that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the company’s common stock on the grant date. We adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" which requires compensation expense to be disclosed based on the fair value of the options granted at the date of the grant.
In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment, an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires companies to recognize in the statement of operations the grant date fair value of stock options and other equity-based compensation issued to employees. FAS No. 123R is effective beginning in the first quarter of fiscal 2006.
We did not issue any stock options to employees during the year ended December 31, 2010, therefore pro forma disclosures are not required.
Accounting for Defined Benefit Pensions and Other Postretirement Plans
In September 2006, FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). SFAS No. 158 improves financial reporting by requiring an employer to recognize the over funded or under funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded statues in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. An employer without publicly traded equity securities is required to recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after June 15, 2007. However, an employer without publicly traded equity securities is required to disclose the following information in the notes to financial statements for a fiscal year ending after December 15, 2006, but before June 16, 2007, unless it has applied the recognition provisions of this Statement in preparing those financial statements.
a.
A brief description of the provisions of this Statement
b.
The date that adoption is required
c.
The date the employer plans to adopt the recognition provisions of this Statement, if earlier.
The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008.
The adoption of this new standard did not have a material impact on the Company’s financial position, results of operations or cash flows.
Valuation of Intangibles
From time to time, we acquire intangible assets that are beneficial to our product development processes. Management periodically evaluates the carrying value of intangibles, including the related amortization periods. In evaluating acquired intangible assets, management determines whether there has been impairment by comparing the anticipated undiscounted cash flows from the operation and eventual disposition of the product line with its carrying value. If the undiscounted cash flows are less than the carrying value, the amount of the impairment, if any, will be determined by comparing the carrying value of each intangible asset with its fair value. Fair value is generally based on either a discounted cash flows analysis or market analysis. Future operating income is based on various assumptions, including regulatory approvals, patents being granted, and the type and nature of competing products. If regulatory approvals or patents are not obtained or are substantially delayed, or other competing technologies are developed and obtain general market acceptance or market conditions otherwise change, our intangibles may have a substantially reduced value, which could be material.
In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, “Determination of the Useful Life of Intangible Assets,” which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets.” This Staff Position is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The adoption of this new FSP did not have a material impact on the Company’s financial position, results of operations or cash flows.
The Fair Value Option for Financial Assets and Financial Liabilities
In February, 2007, FASB issued SFAS 159, ‘The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.” This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. This Statement is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The adoption of this new standard did not have a material impact on the Company’s financial position, results of operations or cash flows.
Income Taxes
The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
In July 2006, the FASB issued Interpretation No. 48 (FIN 48), "Accounting for uncertainty in Income Taxes." FIN 48 clarifies the accounting for Income Taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition and clearly scopes income taxes out of SFAS 5, "Accounting for Contingencies." FIN 48 is effective for fiscal years beginning after December 15, 2006. As a result of implementing FIN 48, there have been no adjustments to the Company's financial statements.
Pursuant to the PRC Income Tax Laws, the Enterprise Income Tax ("EIT") through December 31, 2007 is at a statutory rate of 33%, which is comprised of 30% national income tax and 3% local income tax. As of January 1, 2008, the EIT is at a statutory rate of 25%. The Company is a high technology business and under PRC Income Tax Laws, it is entitled to a two-year tax exemption for 2006 through 2007. Starting from January 1, 2008, the EIT is at a reduced rate of 15% to the Company.
Foreign Currency
Our functional currency is the U.S. dollar and our subsidiary and our operating company in China use their respective local currencies as their functional currencies, i.e. the Chinese Yuan Renminbi (CNY). An entity's functional currency is the currency of the primary economic environment in which the entity operates. Management must use judgment in determining an entity's functional currency, assessing economic factors including cash flow, sales price, sales market, expense, financing and inter-company transactions and arrangements. Impact from exchange rate changes related to transactions denominated in currencies other than the functional currency is recorded as a gain and loss in the statements of operations, while impact from
exchange rate changes related to translating a foreign entity's financial statements from the functional currency to its reporting currency, the U.S. dollar, is disclosed and accumulated in a separate component under the equity section of the balance sheets. Different judgments or assumptions resulting in a change of functional currency may materially impact our financial position and results of operations.
STATUTORY RESERVE
In accordance with the laws and regulations of the PRC, a wholly-owned Foreign Invested Enterprises income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public welfare fund. Prior to January 1, 2006 the proportion of allocation for reserve was 10 percent of the profit after tax to the surplus reserve fund and additional 5-10 percent to the public affair fund. The public welfare fund reserve was limited to 50 percent of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve is 10 percent of income after tax, not to exceed 50 percent of registered capital.
Statutory Reserve funds are restricted for set off against losses, expansion of production and operation or increase in register capital of the respective company. Statutory public welfare fund is restricted to the capital expenditures for the collective welfare of employees. These reserves are not transferable to the Company in the form of cash dividends, loans or advances. These reserves are therefore not available for distribution except in liquidation. As of December 31, 2010 and2009, the Company had allocated $810,540 and $810,540, respectively, to these non-distributable reserve funds.
INFLATION
Inflation in recent years have affected the business results of the Company. First of all, on the global economic expansion, supply has been restricted and coupled with the fact that USA has adopted a relaxed currency policy etc., these increase inflation risks. Secondly, GNP increases in China also elevates consumption ability and production cost, prices increase as a natural tendency. Finally, as a result of the macro economic trend, prices increase, the Company’s procurement prices are also affected resulting in increase in cost of sales.
The Company operates in China and as such, the Company’s business activities, financial position and operational results will be affected by PRC politics, economic and legal environments and also affected by the overall economic situation of China. The business of the Company may be affected by the relevant laws, regulations, anti-inflation measures, currency conversion and overseas remittance and exchange rates issues etc that are related to China politics.
RECENT ACCOUNTING PRONOUNCEMENTS
No new accounting pronouncements issued or effective during the fiscal year has had, or is expected to have a material impact on these consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not required under Regulation S-K for “smaller reporting companies.”
Item 8.
Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
China Pediatric Pharmaceuticals Co. Ltd.
We have audited the accompanying consolidated balance sheets of China Pediatric Pharmaceuticals Co. Ltd. (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity and cash flows for the two years ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that out audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Pediatric Pharmaceuticals Co. Ltd. as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/S/ ACQUAVELLA, CHIARELLI, SHUSTER, BERKOWER & CO., LLP
New York, New York
March 31, 2011
New York · New Jersey · San Francisco · Los Angeles · Cayman Islands
F - 1
The accompanying notes are an integral part of these financial statements.
F - 2
The accompanying notes are an integral part of these financial statements.
F - 3
The accompanying notes are an integral part of these financial statements.
F - 4
CHINA PEDIATRIC PHARMACEUTICALS INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31,2010 AND 2009
The accompanying notes are an integral part of these financial statements
F - 5
CHINA PEDIATRIC PHARMACEUTICALS CO. LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 1 - ORGANIZATION
China Pediatric Pharmaceuticals, Inc. ("the Company") was incorporated on April 20, 2005 in the state of Nevada. The Company was originally incorporated under the name Belford Enterprises, Inc. and changed its name to Lid Hair Studios International Inc. on August 15, 2005. Asia-Pharm Holding Inc. ("Asia-Pharm") was incorporated in British Virgin Islands on June 20, 2008. China Children Pharmaceuticals Co. Limited ("China Children") a wholly owned subsidiary of Asia-Pharm Holdings Inc. was formed on June 27, 2008 under the laws of Hong Kong. Xi'an Coova Children Pharmaceuticals Co., Ltd. ("Xi'an Coova" or "WOFE") is a "wholly owned foreign enterprise" incorporated in People's Republic of China ("PRC"). Xi'an Coova is a wholly owned subsidiary of China Children.
On September 30, 2009 the Company completed its merger with China Children, a Hong Kong based pharmaceutical manufacturer company in accordance with the Share Exchange Agreement. The Share Exchange Transaction is being accounted for as a reverse acquisition. In accordance with the Accounting and Financial Reporting Interpretations and Guidance prepared by the staff of the U.S. Securities and Exchange Commission, the Company (the legal acquirer) is considered the accounting acquiree and China Children (the legal acquiree) is considered the accounting acquirer for accounting purposes The assets, liabilities and historical operations prior to the share exchange transaction will be those of China Children. Subsequent to the date of Share Exchange Transaction, China Children is deemed to be a continuation of the business of the Company. Therefore post exchange financial statements will include the combined balance sheet of the Company and China Children, the historical operations of China Children and the operations of the Company and China Children from the closing date of the Share Exchange Transaction forward.
On August 4, 2008, an Entrustment Management Agreement was entered into between Xi'an Coova and Shaanxi Jiali Pharmaceuticals Co., Ltd. ("Shaanxi Jiali") to which China Children exercises control over the operations and business of Shaanxi Jiali through Xi'an Coova. Pursuant to the Entrustment Management Agreement, China Children receives all net profits and assume all operational losses of Shaanxi Jiali through Xi'an Coova.
Xi'an Coova entered into a Management Entrustment Agreement with Shaanxi Jiali and the shareholders of Shaanxi Jiali (the "Management Entrustment Agreement"), in which Shaanxi Jiali and its shareholders agreed to transfer control, or entrust, the operations and management of its business to Xi'an Coova. Under the agreement, Xi'an Coova manages the operations and assets of Shaanxi Jiali, controls all of the cash flows of Shaanxi Jiali through a bank account controlled by Xi'an Coova, is entitled to 100% of earnings of Shaanxi Jiali and, a management fee before tax, and is obligated to pay all payables and loan payments of Shaanxi Jiali. In addition, under the terms of the Management Entrustment Agreement, Xi'an Coova has been granted certain rights which include, in part, the right to appoint and terminate members of Shaanxi Jiali's Board of Directors, hire management and administrative personnel and control decisions relating to entering and performing customer contracts and other instruments. We anticipate that Shaanxi Jiali will continue to be the contracting party under its customer contracts, bank loans and certain other instruments unless Xi'an Coova exercises its option. The agreement does not terminate unless the business of Shaanxi Jiali is terminated or Xi'an Coova exercises its option to acquire all of the assets or equity of Shaanxi Jiali under the terms of the Exclusive Option Agreement.
The contractual arrangements completed on August 4, 2008 provide that Xi'an Coova has controlling interest in Shaanxi Jiali as defined by FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN 46R"), an Interpretation of Accounting Research Bulletin No. 51, which requires Xi'an Coova to consolidate the financial statements of Shaanxi Jiali and ultimately consolidate with its parent company, China Children since that date.
The outstanding stock of the Company prior to the Share Exchange Transaction will be accounted for at their net book value and no goodwill will be recognized. Details of the shares outstanding upon completion of the Merger are as follows:
The Company, through its subsidiary, and exclusive contractual arrangement with Shaanxi Jiali, is engaged in the business of manufacturing and marketing over-the-counter ("OTC") and prescription pharmaceutical products for the Chinese marketplace as treatment for a variety of diseases and conditions.
F - 6
CHINA PEDIATRIC PHARMACEUTICALS CO. LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America. The Company's functional currency is the Chinese Renminbi, however the accompanying consolidated financial statements have been translated and presented in United States Dollars.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, its subsidiary and variable interest entity (“VIE”) for which the Company is the primary beneficiary. All inter-company accounts and transactions have been eliminated in consolidation. The Company has adopted the Consolidation Topic of the FASB Accounting Standards Codification (“ASC 810”) which requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns.
In determining Shaanxi Jiali is the VIE of Xi’an Coova., the Company considered the following indicators, among others:
●
Xi’an Coova has the full right to control and administrate the financial affairs and daily operation of Shaanxi Jiali and has the right to manage and control all assets of Shaanxi Jiali. The equity holders of Shaanxi Jiali as a group have no right to make any decision about Shaanxi Jiali’s activities without the consent of Xi’an Coova.
●
Xi’an Coova was assigned all voting rights of Shaanxi Jiali and has the right to appoint all directors and senior management personnel of Shaanxi Jiali. The equity holders of Shaanxi Jiali possess no substantive voting rights.
●
Xi’an Coova will provide financial support if Shaanxi Jiali requires additional funds to maintain its operations and to repay its debts.
●
Xi’an Coova should be paid a management fee equal to Shaanxi Jiali’s earnings before taxes. If there are no earnings before taxes and other cash expenses, then no fee shall be paid. If Shaanxi Jiali sustains losses, they will be carried over to the next period and deducted from the next management fee. Xi’an Coova should assume all operation risks of Shaanxi Jiali and bear all losses of Shaanxi Jiali. Therefore, Xi’an Coova is the primary beneficiary of Shaanxi Jiali.
Foreign Currency Translation
The Company’s reporting currency is the U.S. dollar. The Company’s operation in China uses Chinese Yuan Renminbi (CNY) as its functional currency. The financial statements of the subsidiary are translated into U.S. Dollars (USD) in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, “Foreign Currency Translation”, included in the Codification as ASC 830, Foreign Currency Matters. According to the Statement, all assets and liabilities were translated at the current exchange rate, stockholders’ equity are translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with SFAS No. 130, “Reporting Comprehensive Income,” as a component of shareholders’ equity, included in the Codification as ASC 220, Comprehensive Income. Foreign exchange transaction gains and losses are reflected in the income statement. For the years ended December 31, 2010 and 2009, the foreign currency translation adjustment to the Company’s comprehensive income was $1,093,784 and $15,138 respectively.
The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US dollars at the rates used in translation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
F - 7
CHINA PEDIATRIC PHARMACEUTICALS CO. LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Comprehensive Income
Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and distributions to owners. For the Company, comprehensive income for the periods presented includes net income and foreign currency translation adjustments.
Contingencies
Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material would be disclosed.
Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantees, in which case the guarantee would be disclosed.
There were no contingencies at December 31, 2010 and 2009.
Cash and Cash Equivalents
Cash and cash equivalents include cash in hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.
Accounts Receivable
The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. There are no allowances for doubtful accounts as of December 31, 2010 and 2009.
Prepaid Expenses and Other prepaid expenses
Prepaid account is primarily comprised of two factors: advance payments suppliers for goods purchased, and advance payments to R&D organizations for licensing of - new medicines to be developed and purchased.
In December 2007, the Company signed a Medicine Research and Development Agreement with Shaanxi Research Institution of Chinese Traditional Medicine (SRICTM). Pursuant to the terms of the agreement and Supplemental Agreement between the Company and SRICTM, SRICTM must successfully develop and obtain governmental approval for production of five new pediatric medicines, otherwise, the Company is entitled to a full refund of fees. Therefore, the costs paid in connection with these services were not classified as research and development costs, but rather as prepaid expenses. Such advance payments will be refundable if we do not receive the desired results from SRICTM.
We submitted our SFDA application for four new medicines on November 28 .2007 and one new medicine on April 29.2008.We Received first round of comments from SFDA in June 2010. Approval is not expected before 2012.
F - 8
CHINA PEDIATRIC PHARMACEUTICALS CO. LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
A table of the outstanding prepaid expenses as of December 31, 2010 and 2009 are as follows:
Inventories
Inventories are valued at the lower of cost (determined on a weighted average basis) or market. The Management compares the cost of inventories with the market value and allowance is made for writing down their inventories to market value, if lower. As of December 31, 2010 and 2009, inventories consist of the following:
Property, Plant & Equipment
Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in other income or expense. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:
As of December 31, 2010 and 2009, Property, Plant & Equipment consist of the following:
Depreciation expense for the years ended December 31, 2010 and 2009 were $87,093 and $103,067, respectively.
F - 9
CHINA PEDIATRIC PHARMACEUTICALS CO. LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Goodwill
Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. In accordance with the Intangibles, Goodwill and other topic of the FASB Accounting Standard Codification (“ASC 350”), indefinite-life identifiable intangible assets and goodwill are not amortized. Under the provisions of ASC 350, we are required to perform an annual impairment test of our goodwill. Goodwill impairment is determined using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit, which we define as our business segments, with its net book value or carrying amount including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The fair value of the reporting unit is allocated to all of the assets and liabilities of that unit including any unrecognized intangible assets as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. Goodwill as of December 31, 2010 and 2009 is $ 612,745. The goodwill was arisen from acquisition of assets and liabilities of Baoji facility in fisical year 2000
Intangible Assets
The Company has four proprietary technologies: propriety technology for antioxidant technique, proprietary technology for “liren” capsule, patent-Chinese medicine and production method for skin and gynecology disease and patent: Chinese medicine and production method for tracheitis. Propriety technology for antioxidant technique was contributed by a shareholder in exchange for shares of the Company’s common stock. Proprietary technology for “liren” capsule was purchased from third party at the price agreed by the Company and the third party. Two patents were purchase from the shareholders at the prices determined by an independent appraiser. These proprietary technologies were acquired for the future use of the Company. We capitalized them as intangible assets as acquired
Intangible assets are amortized using the straight-line method over their estimated period of benefit, ranging from ten to fifty years. Management evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. No impairments of intangible assets have been identified during any of the periods presented. The land use rights will expire in 2056 and 2058. All of the Company’s intangible assets are subject to amortization with estimated lives of:
Land use right
50 years
Proprietary technologies
10 years
The components of finite-lived intangible assets are as follows:
Amortization expense for the years ended December 31, 2010 and 2009 were $329,155 and $332,657, respectively.
The estimated future amortization expenses related to intangible asset as of December 31, 2010 are as follows:-
F - 10
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Long-Lived Assets
The Company accounts for long-lived assets in accordance with Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144), included in the Codification as ASC 360, Property, Plant, and Equipment, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations for a Disposal of a Segment of a Business”, included in the Codification as ASC 225, Income Statement. The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with ASC 360. ASC 360requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on its review, the Company believes that, as of December 31, 2010 and 2009, there were no significant impairments of its long-lived assets.
Fair Value of Financial Instruments
In accordance with FASB ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.
In determining fair value, the Company uses various valuation approaches. In accordance with GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Fund. Unobservable inputs reflect the Fund’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy is categorized into three levels based on the inputs as follows:
·
Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in
active markets.
·
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active
markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full
term of the financial instruments.
·
Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value.
As of December 31, 2010 and December 31, 2009, the derivative liabilities amounted to$5,762,500 and $5,950,000. In accordance with the accounting standards the Company determined that the carrying value of these derivatives approximated the fair value using the level 2 inputs.
F - 11
CHINA PEDIATRIC PHARMACEUTICALS CO. LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Derivative Financial Instruments
Derivative financial instruments, as defined in Financial Accounting Standard, consist of financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets. The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. the Company issued warrants in connection with the September 2009 share exchange agreement and determined that the warrants did not qualify for a scope exception under ASC 815 as they were determined to not be indexed to the Company’s stock as prescribed by ASC 815. Under ASC 815, the warrants will be carried at fair value as derivative liability and mark to market at each reporting period.
Accordingly, the Company adjusts the fair value of these derivative components at each reporting period through a charge to income until such time as the instruments acquire classification in stockholders’ equity.
Value Added Tax Payable
The Company is subject to a value added tax rate of 17% on product sales by the People’s Republic of China. Value added tax payable is computed net of value added tax paid on purchases for all sales in the People’s Republic of China.
Revenue Recognition
The Company’s revenue recognition policies are in compliance with staff accounting bulletin (SAB) 104. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.
Advertising
Advertising expenses consist primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses all advertising costs as incurred. Advertising costs for the years ended December 31, 2010 and 2009 were $421,907 and $1,487,000, respectively.
Customer rebates
Rebates are paid to customers every quarter and we recorded customer rebates as customers earned. They are classified as a reduction of revenue according to ASC 605-55-64. The Company paid rebates to customers for the years ended December 31, 2010 and 2009 were $3,010,861 and $1,966,224 respectively.
Income Taxes
The Company utilizes SFAS No. 109, “Accounting for Income Taxes”, included in the Codification as ASC 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
On January 1, 2007 the Company adopted the provisions of FASB issued Interpretation No. 48 (FIN 48), “Accounting for uncertainty in Income Taxes”, included in the Codification as ASC 740, Income Taxes. The topic addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.
F - 12
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Statement of Cash Flows
In accordance with SFAS No. 95, “Statement of Cash Flows”, included in the Codification as ASC 230, Statement of Cash Flows, cash flows from the Company’s operations are based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
Basic and Diluted Earnings Per Share (EPS)
Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is similarly computed, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Diluted net earnings per share are based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to have been exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
Segment Reporting
FASB ASC 280-10-50, “Disclosure about Segments of an Enterprise and Related Information” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company operates in one segment during the year ended December 31, 2010 and 2009 .
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, most of which are in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.
Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued ASU 2010-06, “Value Measurements and Disclosures - Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), that amends ASC Subtopic 820-10, “Fair Value Measurements and Disclosures - Overall”, and requires reporting entities to disclose (1) the amount of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and (2) separate information about purchases, sales, issuance and settlements in the reconciliation of fair value measurements using significant unobservable inputs (Level 3). ASU 2010-06 also requires reporting entities to provide fair value measurement disclosures for each class of assets and liabilities and disclose the inputs and valuation techniques for fair value measurements that fall within Levels 2 and 3 of the fair value hierarchy. These disclosures and clarification are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuance, and settlements in the rollforward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted the provisions of ASU 2010-06 and the provisions of ASU 2010-06 and the adoption of these provisions does not have a material impact on its consolidated financial statements.
F - 13
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations” (“ASU 2010-29”), an amendment to the disclosure of supplementary pro forma information for business combinations. The amendment specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company will adopt this guidance in the event it consummates a business acquisition in the future.
In December 2010, the FASB issued ASU 2010-28, “Intangibles - Goodwill and Other” (“ASU 2010-28”), an amendment to goodwill impairment testing. The amendment modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The Company does not anticipate any impact from the adoption of this guidance since it does not have any reporting units with zero or negative carrying amounts at December 31, 2010.
Note 3 - OTHER RECEIVABLES
Other receivables consist of cash advances to employees. As of December 31, 2010 and 2009, other receivables were $69,257 and $43,305, respectively.
Note 4 - COMPENSATED ABSENCES
Regulation 45 of the local labour law of the People’s Republic of China (“PRC”) entitles employees to annual vacation leave after 1 year of service. In general, all leave must be utilized annually, with proper notification. Any unutilized leave is cancelled.
Note 5 - SHORT-TERM BANK LOAN
As of December 31, 2010, the Company had debt as follows:
The Company uses these loans for working capital purposes. The loan is secured by the factory building of Shaanxi Jiali's Baoji production base. Our anticipated needs for the future are to be negotiated in accordance with manufacturing and operation needs, and market conditions of next year.
F - 14
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 6 - INCOME TAXES
The Company’s effective tax rate reflected the combined results for both . The following table reconciles the Company’s . statutory tax rates to its effective tax rate for the years ended December 31, 2010 and 2009.
Note 7 - COMMON STOCK AND WARRANTS
Common stock and stock-based compensation
On February 11, 2010, the Company closed a private placement issued 375,000 shares common stock at $4 per share to several investors for total cash consideration of $1,500,000.
On April 29, 2010, the Company issued 1,200,000 shares common stock at $2 per share to several investors for total cash consideration of $2,400,000.
On June 23, 2010, the Company issued 300,000 shares common stock at $2 per share to several investors for total cash consideration of $600,000.
On September 8, 2010, the Company issued 100,000 shares common stock at $2.2 per share to an investor for cash consideration of $220,000.
On October 9, 2010, the Company entered into consultancy service agreements with four individuals as consultants to the Company to identify and refer a target company to the Company to consummate an acquisition within the contract period of 6 months. In consideration for the services provided by these four individuals, on October 15, 2010, the Company approved the issue of 1,470,000 shares common stock to individuals in aggregate for the services provided at total price of $5,409,600 or $3.68 per share, which was 80% of the closing price of common stock of the Company on that date. The total consideration $5,409,600 was recognized , as stock-based compensation expense $2,704,800 in 2010 and the balance in 2011.
On November 12, 2010, the Company issued 200,000 shares common stock at $2.2 per share to several investors for cash consideration of $440,000.
On December 31, 2010, the Company issued 680,000 shares common stock at $2.5 per share to an investor for cash consideration of $1.700,000.
F - 15
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 7 - COMMON STOCK AND WARRANTS
Warrants
On August 15, 2009, Kang Xiulan referred a public shell company（Lid Hair Studios International, Inc.）to China Children Pharmaceutical Inc. China Children Pharmaceutical Inc. came to be quoted on the OTCBB successfully through the reverse merger with Lid Hair Studios International, Inc. on September 30, 2009 and changed its name into China Pediatric Pharmaceuticals, Inc. As consideration for the services provided by Kang Xiulan (and in accordance with a warrant placement agreement dated September 30, 2009 between the Company and Kang Xiulan), the Company agreed to issue to Kang Xiulan warrants to acquire 250,000 shares of the Company’s common stock with an exercise price of $3.00 with piggyback warrants to purchase 250,000 shares of the Company’s common stock with an exercise price of $5.00. The warrants will expire on September 30, 2011 and September 30, 2012, respectively.
During the above-mentioned reverse merger process, the Company obtained certain consulting services from IFG Investments Services, Inc., including advising on a merger/acquisition transaction and regulatory filings, and other services and support as requested from IFG. In consideration for the consulting services to be performed by IFG (and in accordance with a warrant placement agreement dated September 30, 2009 between the Company and IFG), the Company agreed to issue to IFG warrants to acquire 600,000 shares of the Company’s common stock with an exercise price of $3.00 with piggyback warrants to purchase 600,000 shares of the Company’s comment stock with an exercise price of $5.00. The warrants will expire on September 30, 2011 and September 30, 2012, respectively
The Company also obtained certain public company sector services, including investor relations advisory services. In consideration for the investor relation services provided by China National Information Network (and in accordance with a warrant placement agreement dated September 30, 2009 between the Company and China National Information Network), the Company agreed to issue to China National Information Network the warrants to acquire 400,000 shares of the Company’s common stock with an exercise price of $3.00 with piggyback warrants to purchase 400,000 shares of the Company’s comment stock with an exercise price of $5.00. The warrants will expire on September 30, 2011 and September 30, 2012, respectively
Note 8 - DERIVATIVE FINANCIAL INSTRUMENTS
The balance sheet caption derivative liabilities consist of the Warrants, issued in to consultants and investor relations in connection with the merger agreements. These derivative financial instruments are indexed to an aggregate of 2,500,000 shares of the Company's common stock as of December 31, 2010 and 2009, respectively, and are carried at fair value. The following tabular presentations set forth information about the derivative instruments for the years ended December 31, 2010 and 2009:
Freestanding derivative instruments, consisting of warrants are valued using the Black-Scholes-Merton valuation methodology because that model embodies all of the relevant assumptions that address the features underlying these instruments. Significant assumptions used in the Black Scholes models included: conversion or strike prices ranging from $3.00 - $5.00; volatility 105.1 - 128.3% based upon forward terms of instruments; terms-remaining of 0.75 and 1.75 life at December 31, 2010 and 1.75 and 2.75 Life at December 31, 2009; and a risk free rate ranging from 1.61%.
F - 16
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 9 - STATUTORY RESERVE
In accordance with the laws and regulations of the PRC, a wholly-owned Foreign Invested Enterprises income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public welfare fund. Prior to January 1, 2006 the proportion of allocation for reserve was 10 percent of the profit after tax to the surplus reserve fund and additional 5-10 percent to the public affair fund. The public welfare fund reserve was limited to 50 percent of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve is 10 percent of income after tax, not to exceed 50 percent of registered capital.
Statutory Reserve funds are restricted for set off against losses, expansion of production and operation or increase in register capital of the respective company. Statutory public welfare fund is restricted to the capital expenditures for the collective welfare of employees. These reserves are not transferable to the Company in the form of cash dividends, loans or advances. These reserves are therefore not available for distribution except in liquidation. As of December 31, 2010 and 2009, the Company had allocated $810,540 to these non-distributable reserve funds.
Note 10 - NET INCOME PER SHARE
In accordance with FASB ASC Topic 260-1-50, “Earnings per Share”, and SEC Staff Accounting Bulletin No. 98, basic net income or loss per common share is computed by dividing net income or loss for the period by the weighted - average number of common shares outstanding during the period. Under FASB ASC 260-10-50, diluted income or loss per share is computed by dividing net income or loss for the period by the weighted - average number of common and common equivalent shares, such as stock options, warrants and convertible securities outstanding during the period.
The following table sets forth the computation of basic and diluted earnings per share of common stock:
F - 17
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 11 - OTHER COMPREHENSIVE INCOME
Balances of related after-tax components comprising accumulated other comprehensive income, included in stockholders’ equity, at of December 31, 2010, are as follows:
Note 12 - CURRENT VULNERABILITY DUE TO CERTAIN RISK FACTORS
The Company’s major operations are carried out in the PRC; therefore the Company is subject to the risks not typically associated with entities operating in the United States of America. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, by the general state of the PRC's economy. All of the following risks may impair the Company’s business operations. If any of the following risks actually occurs, the Company’s business, financial condition or results of operations could be materially adversely affected. In such case, investor may lose all or part of the investment. Additional risks include:
l
The Company may not be able to adequately protect and maintain its intellectual property.
l
The Company may not be able to obtain regulatory approvals for its products.
l
The Company may have difficulty competing with larger and better financed companies in the same sector. New legislative or regulatory requirements may adversely affect the Company's business and operations. The Company is dependent on certain key existing and future personnel.
l
The Company's growth is dependent on its ability to successfully develop, market, or acquire new drugs. The Company may be subject to product liability claims in the future.
l
Changes in the laws and regulations in the PRC may adversely affect the Company's ability to conduct its business.
l
The Company may experience barriers to conducting business due to governmental policy.
l
Capital outflow policies in the PRC may hamper the Company's ability to remit income to the United States.
l
Fluctuation of the Renminbi could materially affect the Company's financial condition and results of operations.
l
The Company may face obstacles from the communist system in the PRC.
l
The Company may have difficulty establishing adequate management, legal and financial controls in the PRC.
l
Trade barriers and taxes may have an adverse affect on the Company's business and operations.
l
There may not be sufficient liquidity in the market for the Company's securities in order for investors to sell their securities.
Note 13 - MAJOR CUSTOMERS AND CREDIT RISK
No customer accounted for more than 10% of accounts receivable at December 31, 2010. Five customers accounted for more than 10% of accounts receivable at December 31, 2009 totalling 61%. As of December 31, 2010 and 2009, two and three vendors were greater than 10% of accounts payable, totalling 25% and 63%, respectively.
Three and two customer(s) accounted for 25% and 23% of sales for the years ended December 31, 2010 and 2009, respectively. Four and five vendors accounted for 52% and 84% of purchases for the years ended December 31, 2010 and 2009, respectively.
F - 18
CHINA PEDIATRIC PHARMACEUTICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 14 - Employment Agreements
On September 30, 2009, we entered into a two year Employment Agreement with Jun Xia to serve as our Chief Executive Officer. The agreement provides for an annual salary of USD$10,553 and an annual bonus of up to 50% of the executive’s annual salary.
On September 1, 2010 , we entered into a one year Employment Agreement with Minggang Xiao to serve as our Chief Financial Officer. The agreement provides for an annual salary of USD$7,036 and an annual bonus of up to 50% of the executive’s annual salary.
Note 15 - RESTATEMENT
The accompanying consolidated balance sheet and statement of stockholders’ equity for December 31, 2009 have been restated for the following matter:
(i)
We have restated our financial statements to treat the warrants issued as a derivative liability, see note 9. We previously accounted for the warrants as a component of equity. This restatement had the effect of decreasing our net income by $5,308,274 or $(0.65) per common share.
The following table illustrates the restatement.
Note 16 - SUBSEQUENT EVENT
For the year ended December 31, 2010, the Company has evaluated subsequent events for potential recognition and disclosure. Except for the following, no significant events occurred subsequent to the end of the reporting period but prior to the filing of this report that would have a material impact on our consolidated financial statements.
Subsequent to December 31, 2010, the Company granted 50,000 shares common stock to a consulting company in consideration for providing the Company and its affiliates consulting services within one year.
Subsequent to December 31, 2010, the Company granted 50,000 shares common stock to a employee in consideration for work for sharing with the employee's experience and resources in investment market.
F - 19
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures.
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on management’s evaluation, our chief executive officer and chief financial officer concluded that, as a result of the material weaknesses described below, as of December 31, 2010, our disclosure controls and procedures are not designed at a reasonable assurance level and are ineffective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. The material weaknesses, which relate to internal control over financial reporting, that were identified are:
a)
We did not maintain sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements. We have limited experience in the areas of financial reporting and disclosure controls and procedures. As a result, there is a lack of monitoring of the financial reporting process and there is a reasonable possibility that material misstatements of the consolidated financial statements, including disclosures, will not be prevented or detected on a timely basis; and
b)
Due to our small size, we do not have a proper segregation of duties in certain areas of our financial reporting process. The areas where we have a lack of segregation of duties include cash receipts and disbursements, approval of purchases and approval of accounts payable invoices for payment. This control deficiency, which is pervasive in nature, results in a reasonable possibility that material misstatements of the consolidated financial statements will not be prevented or detected on a timely basis.
We are committed to improving our financial organization. As part of this commitment, we will look to increase our personnel resources and technical accounting expertise within the accounting function by the end of 2011 to resolve non-routine or complex accounting matters. In addition, when funds are available, which we expect to occur by the end of 2011, we will take the following action to enhance our internal controls: Hiring additional knowledgeable personnel with technical accounting expertise to further support our current accounting personnel. As necessary, we will engage consultants or an outside accounting firm in order to ensure proper accounting for our consolidated financial statements.
Management believes that hiring additional knowledgeable personnel with technical accounting expertise will remedy the following material weakness: insufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements.
Management believes that the hiring of additional personnel who have the technical expertise and knowledge with the non-routine or technical issues we have encountered in the past will result in both proper recording of these transactions and a much more knowledgeable finance department as a whole. Due to the fact that our internal accounting staff consists of only a small number of people, additional personnel will also ensure the proper segregation of duties and provide more checks and balances within the department. Additional personnel will also provide the cross training needed to support us if personnel turn over issues within the department occur. We believe this will greatly decrease any control and procedure issues we may encounter in the future.
(b) Changes in internal control over financial reporting.
We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes. There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
(c) Management’s report on internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2010. The effectiveness of our internal control over financial reporting as of December 31, 2010 has not been audited by Acquavella, Chiarelli, Shuster, Berkower & Co., LLP, our independent registered public accounting firm. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, smaller reporting companies, like us, are exempt from the requirement that management’s report be subject to an audit by an independent registered public accounting firm.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The names of our directors and executive officers and their ages, titles, and biographies as of December 31, 2010 are set forth below:
Our directors hold office until the next annual meeting of our shareholders and until their successors have been qualified after being elected or appointed. Our officers serve at the discretion of our Board of Directors.
Set forth below is biographical information about our current directors and executive officers:
Jun Xia, Chairman, Chief Executive Officer and President, became our Chairman, Chief Executive Officer and President upon the closing of the Share Exchange transaction on September 30, 2009. Mr. Xia founded Shaanxi Jiali on July 1, 1998. Prior to founding Shaanxi Jiali, Mr. Xia founded Shaanxi Jiali Broadcasting Co., Ltd in the year 1996 which provided advertising marketing promotion and brand management strategies to clients that included Volkswagon AG and major drink manufacture Wahaha. Mr. Xia is the Standing Director of Shaanxi Pharmaceuticals Association and Vice Chairman of Biomedical Branch of Shaanxi Scientific and Research Association of Chinese Traditional Medicines. In 2001, Mr. Xia was named “Youngest Entrepreneur in Shaanxi Province” by Xi’an National Hi-Tech Industrial Development Zone. Mr. Jun Xia, graduated from Economy Management School of Northwest University, in 1995. Mr. Xia also attended the Fudan University in Shaanhai.
Minggang Xiao, Director & Chief Financial Officer, became our director and Chief Financial Officer upon the closing of the Share Exchange transaction on September 30, 2009. Mr. Xiao has been with Shaanxi Jiali since 2006. Mr. Xiao manages the day-to-day operations of the Shaanxi Jiali’s Finance Department. Prior to joining Shaanxi Jiali, Mr. Xiao was the Finance Manager at Shaanxi Xinchuang Management Co. Ltd. in Xi’an from 2005 to 2006. From 2004 to 2005, Mr. Xiao was an Accountant with Financial Bureau of Baoji City, Shaanxi. Mr. Xiao holds the professional designation of Accountant. Mr. Xiao graduated from Xi’an Industrial University with his Bachelor of Accounting Degree in 2004.
Wanxiang Li, Independent Director, became an Independent Director upon the closing of the Share Exchange transaction on September 30, 2009. Ms. Li has been a Professor of Accounting at the School of Finance and Economy at Xi’an Jiaotong University in Xi'an since 1984. From 1969 to 1984, Ms. Li was an Accountant in the Finance Department of the Science and Technology Management Bureau of Government Shaanxi in Xi’an. Ms. Li holds the professional designation of Senior Accountant. Ms Li graduated from the Economy Management School of China Agricultural University in Xi’an with her Master’s Degree in Accounting in 1964.
Nanjing Lin, Independent Director, became an Independent Director upon the closing of the Share Exchange transaction on September 30, 2009. Mr. Lin has been Committee Chief of Government Consulting & Policies Management in Shaanxi province in Xi’an since 1993, after joining in 1986. From 1964 to 1986, Mr. Lin was Department Head, Finance, at Shayuan Farm of Agr-cultivation Bureau of Shaanxi province in Xi’an. Mr. Lin holds the professional designation of Senior Accountant. Mr. Lin graduated from the Economy Management School of Shaanxi Finance and Economy University where he earned his Bachelor’s degree of Accounting in the year 1964.
Xiaoying Zhang, Independent Director, became an Independent Director upon the closing of the Share Exchange transaction on September 30, 2009. Ms. Zhang has been Accountant Supervisor with Shaanxi Deli Energy Science and Technology Co., Ltd. in Xi’an since 2007. Prior to her employment with Shaanxia Deli Energy Ms. Zhang was employed as an Accountant with the Department of Finance of Xi’an Instrument Group Ltd. Co. in Xi’an from 2003 until 2007. Ms. Zhang holds the professional designation of Accountant. Ms. Zhang graduated from the Xi’an International University, in Xi’an in 2003 and earned her Bachelor’s Degree of Accounting.
Director Experience
The Board believes that each of the Company’s directors should possess the highest personal and professional ethics, integrity and values, and be committed to representing the long-term interests of the Company’s shareholders. When evaluating candidates for election to the Board, the Corporate Governance and Nominating Committee seeks candidates with certain qualities that it believes are important, including integrity, an objective perspective, good judgment, and leadership skills. The Board has also considered the fact that all of our directors have worked for, or served on the boards of directors of, a variety of companies in a range of industries. The Board believes that through their varying backgrounds, the Company’s directors bring a wealth of experiences, new ideas and solutions to the Board. Specifically, the Board has noted that our directors have the following skills and qualifications that, among others, have made them particularly suited to serve as a director of China Pharmaceuticals:
●
Mr. Jun Xia has significant business management experience, entrepreneurial vision, and extensive knowledge of the pharmaceuticals industry and has served in various leadership positions in the Shaanxi pharmaceutical community since 2007.
●
Mr. Minggang Xiao has significant financial experience, and in 2008 was awarded the designation of accountant by the PRC Department of Treasury.
●
Ms. Wanxiang Li processes an extensive knowledge of accounting principles, having served as both a practicing accountant and as a professor of accounting for each of 15 years, respectively.
●
Mr. Nanjing Lin is an “audit committee financial expert” with over 20 years of financial and accounting experience in the PRC.
●
Ms. Xiaoying Zhang has significant accounting experience and served as supervisor to the accounting operations of a PRC technology company since 2007.
Committees of the Board of Directors
We have appointed the follow committees of the Board of Directors with membership as follows:
Audit Committee and Audit Committee Financial Expert
Our board of directors established an audit committee on September 30, 2009. The audit committee is comprised of the following three independent board members:
●
Nanjing Lin, Chair, Committee Chief of Government Consulting & Policies Management in Shaanxi province
●
Wanxiang Li, Member, Professor of Accounting at the School of Finance and Economy at Xi’an Jiaotong University
●
Xiaoying Zhang, Member, Accountant Supervisor with Shaanxi Deli Energy Science and Technology Co., Ltd.
The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:
●
selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;
●
reviewing with our independent auditors any audit problems or difficulties and management’s response;
●
reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K under the Securities Act;
●
discussing the annual audited financial statements with management and our independent auditors;
●
reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of material control deficiencies;
●
annually reviewing and reassessing the adequacy of our audit committee charter;
●
such other matters that are specifically delegated to our audit committee by our board of directors from time to time;
●
meeting separately and periodically with management and our internal and independent auditors; and
●
reporting regularly to the full board of directors.
Our board of directors has determined that it has an "audit committee financial expert" as defined by Item 401(h) of Regulation S-K as promulgated by the Securities and Exchange Commission. Our audit committee financial expert is Nanjing Lin. The directors who serve on the audit committee are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers. Our Board of Directors has adopted a written charter for the Audit Committee.
Compensation Committee
Our board of directors established a compensation committee on September 30, 2009.
The compensation committee of the board of directors is comprised of the following three independent board members:
●
Wanxiang Li, Chair, Professor of Accounting at the School of Finance and Economy at Xi’an Jiaotong University
●
Nanjing Lin, Member, Committee Chief of Government Consulting & Policies Management in Shaanxi province
●
Xiaoying Zhang, Member, Accountant Supervisor with Shaanxi Deli Energy Science and Technology Co., Ltd.
Our compensation committee assists the board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Members of the compensation committee are not prohibited from direct involvement in determining their own compensation. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The compensation committee is responsible for, among other things:
●
approving and overseeing the compensation package for our executive officers;
●
reviewing and making recommendations to the board with respect to the compensation of our directors;
●
reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and
●
Reviewing periodically and making recommendations to the board regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.
Our board of directors has adopted a written compensation committee charter. The directors who serve on the compensation committee are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers.
Corporate Governance and Nominating Committee
Our board of directors established a corporate governance and nominating committee on September 30, 2009.
The Company’s corporate governance and nominating committee is comprised of the following three independent board members:
●
Wanxiang Li, Chair, Professor of Accounting at the School of Finance and Economy at Xi’an Jiaotong University
●
Nanjing Lin, Member, Committee Chief of Government Consulting & Policies Management in Shaanxi province
●
Xiaoying Zhang, Member, Accountant Supervisor with Shaanxi Deli Energy Science and Technology Co., Ltd.
Our corporate governance and nominating committee consists of our independent directors Ms. Lin, Mr. Li and Ms Zhang. The corporate governance and nominating committee assists the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee is responsible for, among other things:
●
identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy;
●
Reviewing annually with the board the current composition of the board in light of the characteristics of independence, age, skills, experience and availability of service to us;
●
identifying and recommending to the board the directors to serve as members of the board’s committees;
●
advising the board periodically with respect to significant developments in the law and practice of corporate governance as well as our compliance with applicable laws and regulations, and making recommendations to the board on all matters of corporate governance and on any corrective action to be taken; and
●
monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.
The directors who serve on the nominating committee are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers. The nominating committee has a written charter.
At this time, no additional specific procedures to propose a candidate for consideration by the nominating committee, nor any minimum criteria for consideration of a proposed nomination to the board, have been adopted. The committee does not currently consider diversity in identifying nominees for our Board of Directors.
To the best of our knowledge, none of the following ever occurred to any of our directors and officers:
(1) Any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time;
(2) Any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
(3) Being subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; or
(4) Being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated.
Code of Ethics
On September 30, 2009, we adopted a code of ethics to apply to all of our executive officers, including our principal executive, financial and accounting officers, our directors, our financial managers and all employees are expected to adhere and promote regarding individual and peer responsibilities, and responsibilities to other employees, the Company, the public and other stakeholders.
Board Leadership and Risk Oversight
Our Chief Executive Officer also serves as Chairman of the Board. We have four other directors, three of whom are independent. Nanjing Lin, the chairman of the Audit Committee, is our lead independent director. The Board has three standing committees, each of which is comprised solely of independent directors with a committee chair. We believe that this leadership structure has served the Company well. The Board believes that the Company’s Chief Executive Officer is best situated to serve as Chairman of the Board because he is the director most familiar with our business and industry and the director most capable of identifying strategic priorities and executing our business strategy. In addition, having one person serve as both Chairman and Chief Executive Officer eliminates potential for confusion and demonstrates to our employees, suppliers, customers, shareholders and other stakeholders that China Pediatric Pharmaceuticals has clear leadership with a single person setting the tone and managing our operations. The Board has delegated responsibility for the oversight of specific risks to Board committees as follows:
●
appointing, retaining and overseeing the work of the independent auditors, including resolving disagreements between the management and the independent auditors relating to financial reporting;
●
Approving all auditing and non-auditing services permitted to be performed by the independent auditors;
●
Reviewing annually the independence and quality control procedures of the independent auditors;
●
Reviewing, approving, and overseeing risks arising from proposed related party transactions;
●
discussing the annual audited financial statements with the management;
●
meeting separately with the independent auditors to discuss critical accounting policies, management letters, recommendations on internal controls, the auditor’s engagement letter and independence letter and other material written communications between the independent auditors and the management; and
●
monitoring the risks associated with management resources, structure, succession planning, development and selection processes, including evaluating the effect the compensation structure may have on risk decisions.
The board and its committees held the following number of meetings during the fiscal year of 2010:
Board of Directors
Audit Committee
Compensation Committee
Corporate Governance and Nominating Committee
The meetings include meetings that were held by means of a conference telephone call, but do not include actions taken by unanimous written consent.
Each director attended at least 75% of the total number of meetings of the board and those committees on which he served during the year. Our non-management directors did not meet in executive session during 2010.
Conflicts of Interest
With respect to transactions involving real or apparent conflicts of interest, we have adopted policies and procedures which require that: (i) the fact of the relationship or interest giving rise to the potential conflict be disclosed or known to the directors who authorize or approve the transaction prior to such authorization or approval, (ii) the transaction be approved by a majority of our disinterested outside directors, and (iii) the transaction be fair and reasonable to us at the time it is authorized or approved by our directors.
Litigation
Neither we, nor any of our controlled affiliates, are involved in any lawsuit outside the ordinary course of business, the disposition of which would have a material effect upon either our results of operations, financial position, or cash flows.
Shareholder Communications
Shareholders requesting communication with Directors can do so by writing to China Pediatric Pharmaceuticals, Inc., c/o Corporate Secretary, 9th Floor, No. 29 Nanxin Street, Xi'an, Shaanxi Province, People’s Republic of China 710004 or emailing to office@jialipharma.com. At this time we do not screen communications received and would forward any requests directly to the named Director. If no Director was named in a general inquiry, the Secretary would contact either the Chairman or the Chairman of a particular committee, as appropriate. We do not provide the physical address, email address, or phone numbers of Directors to outside parties without a Director's permission.
Compliance with Section 16(a) of the Securities Act of 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers and directors and persons who own more than 10% of a registered class of our equity securities to file with the Securities and Exchange Commission initial statements of beneficial ownership, reports of changes in ownership and annual reports concerning their ownership of the our common stock and other equity securities, on Form 3, 4 and 5 respectively. Executive officers, directors and greater than 10% shareholders are required by the Securities and Exchange Commission regulations to furnish our company with copies of all Section 16(a) reports they file.
Based solely on our review of the copies of such reports received by us, and on written representations by our officers and directors regarding their compliance with the applicable reporting requirements under Section 16(a) of the Exchange Act, we believe that, with respect to the fiscal year ended December 31, 2010, our officers and directors, and all of the persons known to us to own more than 10% of our common stock, filed all required reports on a timely basis.
Item 11.
Item 11. Executive Compensation.
The following summary compensation table indicates the cash and non-cash compensation earned during the years ended December 31, 2010 and 2009 by each person who served as chief executive officer during 2010 and 2009. No officer received compensation of $100,000 or more during 2010 or 2009.
(1)
Jun Xia was appointed as our Chief Executive Officer on September 30, 2009.
(2)
Eric Anderson resigned as our Chairman, Chief Executive Officer, President and Chief Financial Officer on September 30, 2009.
Employment Agreements
On September 30, 2009, we entered into a two year Employment Agreement with Jun Xia to serve as our Chief Executive Officer. The agreement provides for an annual salary of USD$10,553 and an annual bonus of up to 50% of the executive’s annual salary.
Compensation Discussion and Analysis
We strive to provide our named executive officers (as defined in Item 402 of Regulation S-K) with a competitive base salary that is in line with their roles and responsibilities when compared to peer companies of comparable size in similar locations.
We plan to implement a more comprehensive compensation program, which takes into account other elements of compensation, including, without limitation, short and long term compensation, cash and non-cash, and other equity-based compensation such as stock options. We expect that this compensation program will be comparable to the programs of our peer companies and aimed to retain and attract talented individuals.
Our compensation committee oversees the compensation of our named executive officers.
Compensation of Directors
As of the date of this report, our directors have received no compensation for their service on the board of directors. We plan to implement a compensation program for our independent directors, which we anticipate will include such elements as an annual retainer, meeting attendance fees and stock options. The details of that compensation program will be negotiated with each independent director.
Outstanding Equity Awards at Fiscal Year-End
There were no option exercises or options outstanding in fiscal year of 2010.
Pension and Retirement Plans
Currently, we do not offer any annuity, pension or retirement benefits to be paid to any of our officers, directors or employees. There are also no compensatory plans or arrangements with respect to any individual named above which results or will result from the resignation, retirement or any other termination of employment with our company, or from a change in our control.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table sets forth certain information with respect to the beneficial ownership of our voting securities by (i) any person or group owning more than 5% of any class of voting securities, (ii) each director, (iii) our Chief Executive Officer, President and Chief Financial Officer, and (iv) all executive officers and directors as a group as of March 31, 2011.
Amount and Nature of Beneficial Ownership
*Represents less than 1% of the issued and outstanding shares of the Company’s common stock.
(1) Except as otherwise indicated, the address of each beneficial owner is c/o China Pediatric Pharmaceuticals, Inc., 9th Floor, No. 29 Nanxin Street, Xi’an, Shaanxi Province P.R.C., 710004.
(2) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable or convertible, or exercisable or convertible within 60 days of March 31, 2011 are deemed outstanding for computing the percentage of the person holding such option or warrant but are not deemed outstanding for computing the percentage of any other person.
(3) Percentage based on 12,730,288 shares of common stock outstanding.
(4) Bo Chen, the chief executive officer of Yangling Bodisen Biotech Development, Inc., has sole power to vote and dispose of the shares held by Yangling Bodisen Biotech Development, Inc.
(5) The shares deemed to be beneficially owned by IFG Investments Services, Inc. represent shares of common stock underlying a $3.00 warrant to purchase 600,000 shares of common stock and a $5.00 warrant to purchase 600,000 shares of common stock, each expiring September 30, 2012. Daniel MacMullin, the President and beneficial owner of IFG Investments Services, Inc., has sole power to vote and dispose of the shares held by IFG Investments Services, Inc.
(6) The shares deemed to be beneficially owned by China National Information Network Trust represent shares of common stock underlying a $3.00 warrant to purchase 400,000 shares of common stock and a $5.00 warrant to purchase 400,000 shares of common stock, each expiring September 30, 2012. Clare Donahue, the beneficial owner of China National Information Network Trust, has sole power to vote and dispose of the shares held by China National Information Network Trust.
(7) The shares deemed to be beneficially owned by Jun Xia, the Company’s chief executive officer, include 2,450,000 shares of common stock held by Mr. Xia and 280,000 shares of common stock held by Tianqiu Xia, Mr. Xia’s father.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
On September 30, 2009, the Company entered into a Share Exchange Agreement with Eric Anderson and Asia-Pharm, pursuant to which the Company acquired all of the outstanding capital stock an ownership interest of China Children from Asia-Pharm. In exchange for the equity interest in China Children, the Company issued 7,000,000 (post-split) shares of common stock to the shareholders of Asia-Pharm.
Immediately after the closing of the Share Exchange Agreement, the Company had a total of 8,305,288 shares of common stock outstanding, with all of the Asia-Pharm shareholders owning approximately 84.28% of the Company’s outstanding common stock. In addition, pursuant to an agreement dated September 30, 2009, Eric Anderson transferred 1,428,571(post-split) shares of the Company’s common stock for cancellation and forgave his outstanding loan to the company in the amount of $86,173 in exchange for 100% of the issued and outstanding shares of Lid Hair Studios’ wholly-owned subsidiary, Belford Enterprises B.C. Ltd., d/b/a Lid Hair Studio.
Concurrent with the Share Exchange Agreement on September 30, 2009, we issued to certain consultants two year warrants to purchase an aggregate of 1,250,000 shares of our common stock at an exercise price of $3.00 per share with three year piggyback warrants to purchase an aggregate of 1,250,000 shares of our common stock at an exercise price of $5.00 per share (collectively, the “Warrants”). Specifically, we issued to IFG Investments Services, Inc. a $3.00 warrant to purchase 600,000 shares of common stock and a $5.00 warrant to purchase 600,000 shares of common stock as consideration for certain professional consulting services rendered, including merger/acquisition support, NASDAQ and/or Hong Kong listing support. We also issued to Kang Xiulan, an individual who assisted us in the share exchange transaction, a $3.00 warrant to purchase 250,000 shares of common stock and a $5.00 warrant to purchase 250,000 shares of common stock as consideration for certain “shell” company referral services rendered in connection with the Merger Transaction. The referral services rendered included an introduction by Kang Xiulan of the OTCBB shell company, Lid Hair Studios International, Inc., as a potential merger partner to Shaanxi Jiali Pharmaceutical Co. Ltd. for the purposes of a merger. On account of Mr. Kang’s involvement with the Company’s restructuring and reverse acquisition transaction, we determined him to be a related person.
The exercise price and number of shares of Common Stock to be received upon the exercise of the Warrants are subject to adjustment upon the occurrence of certain events, such as stock splits, stock dividends or our recapitalization. In the event of our liquidation, dissolution or winding up, the holders of the Warrants will not be entitled to participate in the distribution of our assets. If the Company shall make any dividend or other distribution of assets to holders of its common stock (a “Distribution”), then the Exercise Price shall be reduced by multiplying such Exercise Price by a fraction of which (i) the numerator shall be the closing bid price of the shares of common stock on the trading day immediately preceding such record date minus the value of the Distribution applicable to one share of common stock, and (ii) the denominator shall be the closing bid price of the shares of common stock on the trading day immediately preceding such record date. Additionally, the number of shares underlying the Warrant shall be increased to a number of shares of common stock obtainable immediately prior to the close of business on the record date fixed for determining holders of shares entitled to receive the Distribution multiplied by the reciprocal of the fraction set forth above. Holders of the Warrants will have no voting, pre-emptive, subscription or other rights of shareholders in respect of the Warrants, nor shall the Holders be entitled to receive dividends.
Other than as disclosed above, there have been no other transactions since the beginning of the fiscal year preceding our last fiscal year or any currently proposed transactions in which we are, or plan to be, a participant and the amount involved exceeds $120,000 or one percent of the average of our total assets at year end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest.
Procedures for Approval of Related Party Transactions
Our Board of Directors and audit committee is charged with reviewing and approving all potential related party transactions. All such related party transactions must then be reported under applicable SEC rules. We have not adopted other procedures for review, or standards for approval, of such transactions, but instead review them on a case-by-case basis.
Director Independence
The Company currently has three independent directors, Wanxiang Li, Nanjing Lin, and Xiaoying Zhang, as that term is defined under the National Association of Securities Dealers Automated Quotation system.
Item 14.
Item 14. Principal Accounting Fees and Services
Audit Fees. The aggregate fees billed by our independent auditors, for professional services rendered for the audit of our annual financial statements for the years ended December 31, 2010 and 2009, and for the reviews of the financial statements included in our Quarterly Reports on Form 10-Q during the fiscal years were $61,900 and $60,900, respectively.
Audit Related Fees. We incurred $3,365 to our independent auditors for involving in response of SEC’s comments during the fiscal years ended December 31, 2010..We did not incur fees to our independent auditors for audit related fees during the fiscal years ended December 31, 2009.
Tax and Other Fees. We did not incur fees to our independent auditors for tax compliance services during the fiscal years ended December 31, 2010 and 2009.
Consistent with SEC policies and guidelines regarding audit independence, the Audit Committee is responsible for the pre-approval of all audit and permissible non-audit services provided by our principal accountants on a case-by-case basis. Our Audit Committee has established a policy regarding approval of all audit and permissible non-audit services provided by our principal accountants. Our Audit Committee pre-approves these services by category and service. Our Audit Committee has pre-approved all of the services provided by our principal accountants.
PART IV
Item 15.
Item 15. Exhibits, Financial Statements Schedules
*Filed Herewith.
(1)
Incorporated by reference to the exhibit to our Current Report on Form 8-K filed with the SEC on October 6, 2009.
(2)
Incorporated by reference to the exhibit to Amendment No. 1 to our Current Report on Form 8-K/A filed with the SEC on October 14, 2009.
(3)
Incorporated by reference to the exhibit to our Annual Report on Form 10-K filed with the SEC on March 31, 2010.
(4)
Incorporated by reference to the exhibit to our Registration Statement on Form S-1/A (File No. 333-164562) filed with the SEC on July 12, 2010.
(5)
Incorporated by reference to the exhibit to our Registration Statement on Form S-1/A (File No. 333-164562) filed with the SEC on September 7, 2010.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2011
In accordance with the Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ Jun Xia
Chief Executive Officer and Director (principal executive officer)
March 31, 2011
Jun Xia
/s/ Minggang Xiao
Chief Financial Officer (principal financial and accounting officer)
March 31, 2011
Minggang Xiao
/s/ Wanxiang Li
Director
March 31, 2011
Wanxiang Li
/s/ Nanjing Lin
Director
March 31, 2011
Nanjing Lin
/s/ Xiaoying Zhang
Director
March 31, 2011
Xiaoying Zhang