UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-KSB
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(Mark one)
[X] Annual Report Under Section 13 or 15(d) of The Securities Exchange Act of
1934 for the fiscal year ended December 31, 2006
[ ] Transition Report Under Section 13 or 15(d) of The Securities Exchange Act
of 1934
For the transition period from ______________ to _____________
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Commission file number: 000-29523
China Pharma Holdings, Inc.
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(Exact name of small business issuer as specified in its charter)
Delaware 73-1564807
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(State or Other Jurisdiction (I.R.S. Employer I.D. No.)
incorporation or organization)
2nd Floor, No. 17, Jinpan Road, 570216
Haikou, Hainan Province, China
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number 0086-898-66811730 (China)
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Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) ofthe Exchange Act:
Common stock, $0.001 par value
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Check whether the issuer has (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period the Company was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of Company's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X ].
The issuer's revenue for the fiscal year ended December 31, 2006 was
$21,843,262.
11,950,553 shares held by non-affiliates had an aggregate market value of $
21,391,489.87 as of March 26, 2007, Shares of common stock held by any executive
officer or director of the issuer and any person who beneficially owns 10% or
more of the outstanding common stock have been excluded from this computation
because such persons may be deemed to be affiliates. This determination of
affiliate status is not a conclusive determination for other purpose.
As of March 26, 2007, there were 37,228,938 shares of Common Stock issued
and outstanding.
DOCUMENT INCORPORATED BY REFERENCE
EXHIBITS incorporates by reference certain information which has been filed with
the Securities and Exchange Commission.
Transitional Small Business Disclosure Format: Yes No X
2
China Pharma Holdings, Inc.
Table of Contents
Page Number
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Part I
Item 1 Description of Business 4
Item 2 Description of Property 35
Item 3 Legal Proceedings 35
Item 4 Submission of Matters to a Vote of Security Holders 36
Part II
Item 5 Market for Company's Common Stock and Related Stockholders Matters 36
Item 6 Management's Discussion and Analysis or Plan of Operation 37
Item 7 Financial Statements 51
Item 8 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures 51
Item 8A Controls and Procedures 51
Part III
Item 9 Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 51
Item 10 Executive Compensation 54
Item 11 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 56
Item 12 Certain Relationships and Related Transactions 56
Item 13 Exhibits 57
Item 14 Principal Accountant Fees and Services Signatures 58
FINANCIAL STATEMENTS F-1
EXHIBITS
3
PART I
Certain statements in this Form 10-KSB constitute "forward-looking statements."
These forward-looking statements involve known and unknown risks, uncertainties,
and other factors that may cause our actual results, performance or achievements
to be materially different from any future results, performance or achievements
expressed or implied by the forward-looking statements. The forward-looking
statements in this Form 10-KSB are identified by words such as "believes",
"anticipates", "expects", "intends", "may", "will", "estimate", "continue" and
other similar expressions regarding our intent, belief and current expectations.
However, these words are not the exclusive means of identifying such statements.
In addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances and statements made in the
future tense are forward-looking statements. Actual results may differ
materially from those projected in the forward-looking statements as a result of
various factors, many of which are beyond our control. We undertake no
obligation to publicly release the results of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
occurring subsequent to the filing of this Form 10-KSB with the Securities and
Exchange Commission. Readers are urged to carefully review and consider the
various disclosures made by us in this Form 10-KSB, including those set forth
under "Risk Factors".
Item 1 - Description of Business
Overview
China Pharma Holdings, Inc. (formerly, TS Electronics, Inc. and prior thereto,
Softstone, Inc.) was incorporated on January 28, 1999, pursuant to the
provisions of the General Corporation Act of the State of Delaware. On May 31,
1999, we merged with Soft Stone Building Products, Inc., an Oklahoma corporation
that was a predecessor to our Company's business. Our initial business
operations were conducted at 620 Dallas Drive, Denton TX, 76205. On February 1,
2000, we moved our offices and facilities to Ardmore, OK. In June 2002, we moved
our office facilities to Pottsboro, TX. On August 13, 2003, we changed our name
to TS Electronics, Inc. On March 15, 2006, we changed our name from TS
Electronics, Inc. to China Pharma Holdings, Inc.
Our focus initially was solely on realizing the commercial benefits of a process
developed and patented by our first president, Frederick Parker. This process
converted waste tires into useful products. We were not successful in promoting
this business, wrote off all assets associated with the business and shifted our
attention to the commercial possibilities of a then, newly discovered
devulcanization process to which we acquired a 5.5 year exclusive license for
the Western Hemisphere. In addition, we entered into the business of importing
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hard-to-find and specialty crumb rubber. We were also not successful in these
endeavors and have abandoned all efforts regarding these pursuits.
Effective August 11, 2004, the Company entered into a Stock Exchange Agreement
with Hou Xiao, the sole stockholder of China ESCO Holdings Limited ("China
ESCO"), a company organized in the Hong Kong Special Administration Region in
the People's Republic of China (the "PRC") and its wholly owned operating
subsidiary, AsiaNet PE Systems Limited. China ESCO was engaged in the
development and manufacturing of electrical energy saving systems and products
in the PRC.
The consummation of the transaction with China ESCO was subject to a number of
conditions, including receipt by us of financial statements of China ESCO as
required under applicable regulations, and satisfaction of all applicable
regulatory requirements. In January 2005, we declared China ESCO to be in
material breach of the agreement and rescinded the agreement.
Effective February 8, 2005, we executed a Letter of Intent with Osage Energy
Company, LLC ("Osage") whereby Osage would acquire 90% of the equity interests
of the Company. This transaction was never consummated by the parties. The
Company had no operations or significant assets from the quarter ended December
31, 2004 until May 2005.
On May 11, 2005, we sold to Halter Financial Group, Inc., in a private
placement, 1,875,045 shares of common stock at a purchase price of $0.1066641
per share, pursuant to the terms of a Stock Purchase Agreement (the "Purchase
Agreement"). The private placement was exempt from the registration requirements
of the Securities Act, in reliance upon Section 4(2) thereunder. As a result of
the purchase, Halter Financial Group, Inc. became our controlling stockholder,
owning approximately 75% of our issued and outstanding shares of common stock.
Immediately subsequent to, and as a result of, the closing of the transactions
contemplated by the Purchase Agreement, Gene F. Boyd, Keith P. Boyd, Fredrick W.
Parker and Leo G. Templer resigned as officers and directors, as applicable, of
the Company. Timothy P. Halter was concurrently appointed as a member of the
Board of Directors, and Mr. Halter was elected as President, Chief Accounting
Officer and Secretary of the Company.
On October 19, 2005 we entered into a Securities Exchange Agreement (the
"Exchange Agreement") with Onny Investment Limited, a British Virgin Islands
company, and its original stockholders pursuant to which we acquired all of the
issued and outstanding shares of Onny from said stockholders in exchange for
27,499,940 shares of our common stock. Upon the closing of the exchange
transaction (the "Exchange Transaction"), Onny became the wholly owned
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subsidiary of our Company. The Exchange Agreement also provides that, upon the
effectiveness of an amendment to the Company's Certificate of Incorporation to
increase its authorized capital stock, the Company shall issue to Heung Mei
Tsui, the principal stockholder of Onny, an additional 4,723,056 shares of
common stock (the "Post Closing Shares") to which she would otherwise have been
entitled if the Company had enough authorized shares as of the closing of the
Exchange Transaction.
Immediately prior to the closing of the Exchange Transaction, Onny completed a
private placement (the "Onny Offering") of its convertible preferred stock to 46
accredited investors. The Onny Offering raised gross proceeds of $5,000,000.
Additionally, immediately prior to the Exchange Transaction, participants in the
Onny Offering exchanged their preferred shares for an aggregate of 10,000 shares
of Onny's common stock. Participants in the Onny Offering then participated in
the Exchange Transaction by exchanging such 10,000 shares of common stock for
6,944,619 shares of our common stock.
On March 15, 2006, the Company amended its Certificate of Incorporation to
increase its authorized capital stock from 30,000,000 to 60,000,000 shares and
filed the Information Statement in accordance with Section 14 of the Exchange
Act. On May 16, 2006, the Company issued to Heung Mei Tsui an additional
4,723,056 shares of common stock as provided in the Exchange Agreement. Upon the
issuance of the Post Closing Shares, Ms. Tsui holds 25,278,385 shares or
approximately 72.8% of the issued and outstanding common stock of the Company.
On July 24, 2006, Zhilin Li, Heung Mei Tsui and the Company entered into that
certain Stock Transfer Agreement, as amended on November 24, 2006, pursuant to
which Heung Mei Tsui transferred 10,000,000 shares of her personal holdings of
the Company's common stock to Zhilin Li in exchange for a sublicense to a patent
held by a third party, which is licensed to Ms. Li. After the aforementioned
stock transfer, Ms. Tsui holds 15,278,385 shares or 44% of the total outstanding
shares of our common stock. Ms. Li holds 10,000,000 shares or 28.8% of the total
outstanding shares of our common stock.
On February 1, 2007, we completed an offering pursuant to a Subscription and
Registration Rights Agreement ("Agreement") with 17 accredited investors
("Investors") in connection with a private placement of 2,505,882 shares of the
Company's common stock at $1.7 per share (the "Private Placement"). Pursuant to
the Agreement, the Investors also received three-year warrants to purchase an
aggregate of 1,252,941 shares of Company's common stock at $2.38 per share.
Pursuant to the transaction on February 1, 2007, we received the subscription
proceeds in the aggregate amount of $4,259,899.90. The net proceeds, after
deduction of related expenses, amounted to $3,814,642.34.
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Onny
Onny Investment Limited ("Onny") was incorporated on January 12, 2005 under the
laws of the British Virgin Islands. At the time of incorporation, Onny's
authorized capital was $50,000 and there were 50,000 shares of one class and one
series of capital stock, $1.00 par value, issued and outstanding. Heung Mei Tsui
was, at the time of incorporation, the sole stockholder and director of Onny. On
July 6, 2005, Onny adopted a sole stockholder's resolution and a sole director's
resolution that resolved to change Onny's authorized capital to $50,000 divided
into 4,000,000 ordinary shares of capital stock, $0.01 par value, and 100
preferred shares of capital stock, $100 par value. On August 18, 2005, Onny
increased its authorized capital to $5,000,000 divided into 40,000 ordinary
shares of capital stock, $100.00 par value, and 10,000 preferred shares, $100.00
par value. As of the date of this Form 10-KSB, there are 39,700 ordinary shares
issued and outstanding, all of which are held by the Company. No preferred
shares of Onny are currently issued and outstanding.
On May 25, 2005, Onny acquired all the equity interests in Hainan Helpson
Medicine and Bio-Technology Co. Ltd. in exchange for the assumption of
obligations to make cash payments to the Helpson shareholders in the form of
common stock dividends from Helpson of $4,154,041, the assumption of $4,646,409
of other liabilities and the issuance of non-interest bearing promissory notes
totaling $3,413,265 payable three months after Helpson obtains a business
license in the PRC as a wholly foreign owned entity. Effective as of June 21,
2005, Onny became the sole stockholder of Helpson, and Helpson became a wholly
foreign-owned enterprise as defined by PRC law.
On October 19, 2005, Onny completed the Onny Offering. Under the terms of the
Onny Offering, Heung Mei Tsui agreed to escrow 6,944,611 shares of the Company's
common stock that she received as a result of the Exchange Transaction. These
shares represent 20% of the Company's issued and outstanding common stock
immediately following the closing of the Exchange Transaction (the "Make Good
Shares"), so that in the event that actual net income set forth in the
consolidated financial statements of the Company for the fiscal year ending
December 31, 2006 ("NI") does not reflect $8 million of net income (the
"Guaranteed NI"), the Make Good Shares can be distributed on a pro rata basis to
the participants of the Onny Offering in accordance with the following formula:
Make Good Shares = ((Guaranteed NI - NI) / $8m) X Make Good Pool
If required, the Make Good Shares will be delivered to participants in the Onny
Offering within ten (10) business days of the date the audit report for the
period is filed with the SEC.
Additionally, in connection with the Onny Offering, Heung Mei Tsui escrowed
277,785 shares of the Company's common stock that she received as a result of
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the Exchange Transaction, which shares represent 0.8% of the Company's issued
and outstanding common stock immediately following the closing of the Exchange
Transaction (the "HFG Make Good Pool"), so that in the event the Company does
not achieve the Guaranteed NI, the HFG Make Good Shares will be distributed to
HFG International, Limited, an affiliate of Halter Financial Group, Inc., in
accordance with the following formula:
HFG Make Good Shares = ((Guaranteed NI - NI) / $8m) X HFG Make Good Pool
If required, the HFG Make Good Shares will be delivered within ten (10) business
days of the date the audit report for the period is filed with the SEC.
Helpson
Hainan Helpson Medicine and Bio-Technology Co. Ltd. ("Helpson") is a
foreign-invested enterprise established in Haikou, Hainan Province, PRC on
February 25, 1993. Initially, its name was Hainan Fulin Biomedical Co., Ltd. and
it changed to "Helpson" in 1999. The company was originally an "equity joint
venture" as defined by China's laws on foreign invested enterprises. The two
joint venturers were Haikou Biomedical Engineering Co., Ltd. ("Haikou
Biomedical"), a PRC company, and Hong Kong Fudao Development Co., Ltd.
("Fudao"), a Hong Kong company. Haikou Biomedical invested RMB 2,100,000 for a
70% share of Helpson, and Fudao invested $150,000 for a 30% share of Helpson.
On June 16, 2001, Fudao entered into an Equity Interest Transfer Agreement with
Hainan Kaidi Science and Technology Co., Ltd., a PRC company ("Kaidi"). In
accordance with the Equity Interest Transfer Agreement, Fudao transferred all of
its 30% capital contribution in Helpson to Kaidi in consideration of RMB
2,780,000. As a result of the transfer, Haikou Biomedical continued to hold a
70% equity interest in Helpson, while Kaidi had a 30% equity interest in
Helpson. Therefore, Helpson became a PRC domestic company, rather than a
foreign-invested company.
Effective on December 26, 2003, Helpson issued new capital stock to Chengdu
Huineng Biomedical Co., Ltd. ("Chengdu Bio") and Chongqing Chemical Medicine
Holding Group ("Chongqing Chemical"). Chengdu Bio contributed RMB 3,000,000 for
a 10.71% equity interest in Helpson and an additional RMB 3,000,000 for
Helpson's capital common reserve fund, and Chongqing Chemical contributed RMB
5,000,000 for a 17.86% equity interest in Helpson and an additional RMB
5,000,000 for Helpson's capital common reserve fund. After the issuance of
shares, Helpson had four equity holders: Haikou Biomedical, a 50% equity
interest; Kaidi, a 21.43% interest; Chengdu Bio, a 10.71% interest; and
Chongqing Chemical, a 17.86% interest.
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On March 8, 2005, Chongqing Chemical entered into an equity interest transfer
agreement with Haikou Biomedical to transfer all of its equity interest in
Helpson to Haikou Biomedical. Upon completion of the transfer, there remained
only three equity holders of Helpson: Haikou Biomedical, which held a 67.86%
equity interest; Kaidi, which held a 21.43% equity interest, and Chengdu Bio,
which held a 10.71% equity interest.
As set forth above, on May 25, 2005, Haikou Biomedical, Kaidi and Chengdu Bio
entered into an equity interest transfer agreement with Onny to transfer all
their equity interests in Helpson to Onny. Effective as of June 21, 2005, Onny
became the sole stockholder of Helpson, and Helpson became a wholly
foreign-owned enterprise as defined by PRC law.
Upon the closing of the Exchange Transaction on October 19, 2005, we acquired
all of the issued and outstanding shares of Onny in exchange for 27,499,940
shares of our common stock and became Onny's sole stockholder. As a result, as
of October 19, 2005, Helpson became our wholly owned subsidiary.
As of July 4, 2006, Helpson increased its registered capital from RMB 28,000,000
to RMB 60,000,000 and changed its registered address from Unit 8, D Area, Office
Hall, Haikou Bonded Zone, Haikou, Hainan Province, China to C09-2, Haikou Bonded
Zone, Haikou, Hainan Province, PRC.
Since its establishment, Helpson has positioned itself in the research,
development, manufacturing, and sales of a series of bio-pharmaceutical
products. Helpson's products focus primarily on genetic engineering,
bioengineering and peptidergic medicine, as well as chemical medicinal products.
Principal Products and Services
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Helpson's primary business is the manufacturing, marketing and sales of
pharmaceuticals. Helpson manufactures and markets products in three major
categories: cardiovascular and cerebrovascular medicine, raw materials for
surface wound, and anti-infection medicine.
At present, Helpson is manufacturing a total of 17 drugs, among which the
following four kinds of medicines have received new drug certifications:
* Buflomedil Hydrocholoride tablets, Buflomedil Hydrocholoride for
injections, Buflomedil Hydrocholoride injections, Buflomedil frozen powder
aricula and raw materials: Buflomedil Hydrochloride: Used in peripheral
blood vessel disease, intermission walk lamely Renaud syndrome, blood
vessel convulsion, etc., vascular dementia
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* Naprooxen Sodium and Pseudophedrine Hydrochloride Sustained Release
Tablets: anti-flu medicine in the market mixed with pseudoephederine
hydrochloride with a non-drowsy formula and a runny nose suppressant which
temporarily relieves cold, sinus and flu symptoms.
* Roxithramycin dispersible tablets: Pharyngitis and tonsillitis caused by
the suppurative chain coccus, nasal sinusitis, otitis media, acute
bronchitis, chronic bronchitis due to the acute sensitive funguses break
out, pneumonia mycoplasma or pneumonia due to the original body of
pneumonia chlamyiae; Urethritis that the original body of chlamyiae of
trachoma causes and palace neck inflammation; bacterial infection of the
soft tissue of skin.
* Cefaclor dispersible tablets: Used in otitis media, when the airway is
infected, the urethra is infected, or skin and skin tissue are infected.
In addition to the above new medicines, Helpson is manufacturing the following
medicines:
* Gastrodin Injection: Used in neurasthenia, neurasthenia syndrome and
traumatic syndrome of the brain; Vertigo; Neuralgia; Headache; etc.
* Hepatocyte Growth-promoting Factor for Injection: Used to assist and treat
various heavy-duty virus hepatitis (acute, subnormal temperature, and
chronic serious disease in the early or middle stage of hepatitis)
* Propylgallate for Injection: Used for preventing and treating cerebral
thrombosis, coronary heart disease, and complication after the surgery -
thrombus deep phlebitis, etc.
* Ozagrel Sodium for Injection: Used to treat acute cerebral infarction and
kinesipathy accompanied by cerebral infarction.
* Alginic Sodium Diester Injection: Used in ischemic heart, cerebrovascular
diseases (cerebral thrombosis, cerebral embolism, coronary heart
disease,etc.) and high lipoprotein blood disease
* Granisetron Hydrochloride Injection: Post-Operative Nausea and Vomiting,
Prevention of Cancer Chemotherapy-Induced Nausea and Vomiting, Prevention
of Post-Operative Nausea and Vomiting
* Cerebroprotein Hydroloysate Injection: For the improvement of the symptom
of sequela of craniocerebral traumatism and cerebrovascular diseases
accompanied by memory decline and attention deficit disorder.
* Cefaclor dispersible tablets: Used in otitis media, when the airway is
infected, the urethra is infected, or skin and skin tissue are infected.
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* Clarthromycin Granules and Clarthromycin Capsules: Suitable for nasopharynx
that is infected by one carat of mould plain sensitive mushrooms, airway
infection, soft skin tissue infection, otitis media acuta, primary atypical
pneumonia, urethritis and cervicitis caused by chlamydia trachomatis,. Used
in legion fungus infections or is jointly used in the treatment of the
bacillus of mycobacterium avium was infected, spiral shell's bacillus of
pylorus infected with other medicines.
* Chuanxinlian Tablets: Clears away heat and detoxifies, is antibacterial and
diminishes inflammation. Used in upper airway infection, bacillary
dysentery.
* Thymopolypetides Injection: Use for treating various primary or secondary T
cell defective disease, immune system diseases, assists and treats the
diseases and tumors of various cells with low immunological function.
* Cefalexin Capsules: Suitable for acute tonsillitis due to the sensitive
funguses, airway infection, urine infections, or infections of the angina,
otitis media, nasal sinusitis, bronchitis, pneumonia, etc. and when the
skin soft tissue is infected
* Haizhu Oral Liquid: Chinese traditional medicine used in supplementary
treatment of high lipoprotein blood disease.
In addition, Helpson's products include a Recombinant Human Ciliary Neuotrophic
Factor, which is used as a raw material for cosmetics and has the function of
wound repairing, including damages caused by ultraviolet ray, acne, analeptic
organized by the skin, or citric acid.
There are 20 drugs undergoing research and development including Hugan Keli,
Troxerutin and Cerebroprotein Hydrolysate for Injection,Yimaikang Capsule,
Bumetnide for Injection, Tiopronin, Omeprazole for Injection, Ceftriaxone Sodium
and Tazobactam Sodium, Donepezil Dispersible Tablets, Mycophenolate Mofetil
Granules, Cattle Encephalon Glycoside and Ignotin, ClindamycinPhosphate for
Injection, Thymopetidum for Injection, Compand Diclofenac Sodium Injection,
ShengQing Pian, rhCNTF, Pioglitazone HCL + metformin HCL, ACTOplus, Xinlin
Tablets, Xinlin Oral Solution, rhaFGF and Cefprozil Tablets.
Due to the nature of the biotechnology and pharmaceutical industries, the
Company continually strives to change its product portfolio to respond to
changes in market demand. Helpson traditionally focused on R&D and marketing of
cardiovascular and cerebrovascular medicine medicines. Recently, Helpson
launched PuSenOK, an anti-flu medicine in the market mixed with pseudoephederine
hydrochloride that has a non-drowsy formula and a runny nose suppressant.
Helpson's PuSenOK has passed clinical experiments and entered the trial
production stage, and has been awarded the new medicine certificate.
Helpson also plans to expand its biotechnology product series. Based upon the
foundation established by Helpson's Neurotrophicpeptide, Helpson will launch
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several additional biological medicines, including brain peptide injections, and
injected Hepatocyte Growth-promoting Factors.
Helpson adjusts the delivery system and marketing for each of its products based
on the product's target patient group. Maintaining a variety of delivery systems
(e.g. tablet, injection, powder, etc.) targeted for different groups enhances
Helpson's competitive position in the market. Helpson's present types of
delivery include covered tablet, capsule, troche, oral fluid, injection, frozen
powder, acicula, and germ-free powder acicula.
Principal Markets
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The principal markets of Helpson lie within China. China has the world's largest
population of nearly 1.3 billion people. The pharmaceutical industry accounts
for approximately 3% of China's annual GDP
(Source:http://www.chinability.com/2004%20economic%20performance.htm). In 2004,
PRC's pharmaceutical industry realized sales of RMB347.6 billion ($44.56
billion) and net profits of RMB30.64 billion ($3.93 billion); a 17.44% increase
in realized sales and 11.74% increase in net profits from the previous year
(Source:http://www.chinapharm.com.cn). According to a Chinese government report,
China's pharmaceutical sales in 2005 are expected to be approximately RMB
376.6billion ($ 48.28 billion), growing 17% from the previous year
(Source:http://www.biotech.org.cn/news/news/show.php ?id=21470). It is estimated
that China's pharmaceutical industry will maintain at least a 12%-15% growth
rate through the year 2010 (Source: http://www.511511.
com/A1/200501/A100000391720050104093750375.shtml).
The predicted growth is based upon the relaxation of trade barriers following
China's accession to the World Trade Organization,advances in China's economy,
and China's large, aging population.
Detailed Market Sectors
-----------------------
Reepitheliazation/Wound rehabilitation medications: These products belong to a
new and advanced classification of drugs used to speed the rehabilitation of a
wide variety of wounds ranging from lacerations and burns to injuries sustained
during childbirth and surgery. Cardiovascular & Cerebrovascular Disease
medications: Cardiovascular & cerebrovascular diseases have become increasingly
common and have a serious impact on people's health. The SFDA estimated the
market share in 2003 of these two medicines in the PRC to be 14.36% of the $5.1
billion (RMB42.2 billion) market. (Source:
http://www.specc.com.cn/hydt/ShowHydt.aspx?id=121 )
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Over-the-Counter Cold & Flu medicines: In 2003, the OTC medicine market capacity
in the PRC was approximately US$3.6 billion, (Source:
http://www.cnm21.com/xinwen2/ 041028_007.htm) with cold & flu medicines having a
market of RMB2.5billion (Source:
http://www.fx120.net/ypsj/ypsc/scfx/200406101631184449.htm ). The sales of such
medicines make up 8.3% of total Over-the-Counter medicine retail sales.
Anti-infection medicines: In the past few years, Anti-bacterial medicines have
become the best selling drugs within the PRC while also maintaining a growth
rate of 20%. In 2001, the sales reached roughly RMB30 billion (approximately
$3.85 billion); in 2003, the sales reached more than RMB40 billion
(approximately $5.13 billion), achieving a 30% market share. (Source: SFDA
Prospectus of Zhejiang Jingxin Pharmaceutical Co., Ltd.).
Distribution
------------
As of December 31, 2006, Helpson's products were sold in 29 provinces,
sovereignties, and autonomous regions. Helpson has 16 sales offices and
approximately 550 proxy agents in China.
Helpson uses a flat distribution channel system of independent regional
distributors. In a typical distribution contract, a distributor will be provided
with certain sales targets for a particular period according to a set retail
price. If the distributor completes the sales task within the prescribed period,
the agent distributor will be given greater economic incentives and future
distribution opportunities. If the distributor fails to complete the sales task
within the prescribed period, Helpson will cancel its contract with the
distributor and sign with other competent distributors. Helpson also signs
reselling contracts with franchise drug companies for the distribution of its
products. The franchise drug company, as a reseller, resells the Company's
products to local hospitals, drug stores, and other channel distributors. In
addition, Helpson sells its products directly to hospitals and retail
drugstores.
Industry Background and Competition
The pharmaceutical industry accounts for approximately 3% of China's GDP.
(Source: http://blog.fh21.com.cn/post/65/106). The industry's primary categories
include chemical medicine, traditional Chinese medicinal material, traditional
Chinese medicinal film, prepared Chinese herbal medicine, antibiotics,
biological products, biological medicine, radioactive medicine, medical
appliances, sanitation materials, pharmaceutical machinery, medical packaging,
and trading.
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The pharmaceutical industry in China is fragmented with many drug manufacturers.
According to the SFDA-reported statistics, in July of 2004, there were 5071
manufacturing pharmaceutical companies (not including companies producing
traditional Chinese medicinal film, medical oxygen, reagent of in-vitro
diagnosis or supplementary materials). The total market share of the top 10
biggest companies was about 42%, compared to 66% in the US. (Source: SFDA
(pound) Prospectus of Zhejiang Jingxin Pharmaceutical Co., Ltd.)
Competition in the pharmaceutical industry is reduced by barriers to entry. A
company wishing to enter the industry must comply with the standards and
regulations set forth by the government. In the PRC, the SFDA is the authority
that monitors and supervises the administration of the pharmaceutical industry
including pharmaceutical products, medical appliances, and equipment.
Pharmaceutical manufacturing enterprises must obtain a Pharmaceutical
Manufacturing Enterprise Permit issued by the relevant pharmaceutical
administrative authorities and relevant health departments at the provincial
level where the enterprise is located. Furthermore, all pharmaceutical products
produced in the PRC, with the exception of Chinese herbal medicines in soluble
form, must bear a registered number approved by the appropriate governmental
authorities in the PRC. Lastly, in accordance with the World Health
Organization, the PRC now requires compliance with GMP standards in
pharmaceutical production in order to minimize the risks involved in any
pharmaceutical production that cannot be eliminated through testing final
products. As the regulatory approval process becomes more stringent, it also
increases the barriers to entering the market.
Due to the variety of consumer demands within the pharmaceutical market,
pharmaceutical companies have relatively dispersed product lines. We have
identified, however, two primary strategies we must adopt in order to stay
competitive. In expanding market share of common traditional medicine, we must
take advantage of 1) our large manufacturing scale and reasonable cost control
mechanisms, and 2) our strong sales network.
Employees
As of December 31, 2006, The Company had 123 regular employees. Helpson was also
aided by the efforts of a 54 member outside sales and marketing team.
Risk Factors
14
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
WE MAY NEED TO RAISE ADDITIONAL CAPITAL WITHIN THE NEXT TWELVE MONTHS TO FUND
OUR OPERATIONS AND FAILURE TO RAISE ADDITIONAL CAPITAL MAY FORCE US TO DELAY,
REDUCE, OR ELMINATE OUR PRODUCT DEVELOPMENT PROGRAMS
Due to the large amount of funds required for research and development and the
subsequent marketing of products, the pharmaceutical industry is very capital
intensive. The industry is characterized by large and slow receivable turnovers,
which signifies that we will need more working capital as our revenues increase.
We have traditionally been committed to biomedical R&D, and are now developing
traditional chemical medicines within specific market segments such as those of
anti-flu and anti-infection. It is likely that we will need to raise additional
capital within the next twelve months. Additional capital may be needed for the
development of new products or product lines, financing of general and
administrative expenses, licensing or acquisition of additional technologies,
and marketing of new or existing products. There are no assurances that we will
be able to raise the appropriate amount of capital needed for our future
operations. Failure to obtain funding when needed may force us to delay, reduce,
or eliminate our product development programs and have a material adverse effect
on our profitability.
WE RELY ON A FEW SUPPLIERS AND ANY DISRUPTION WITH OUR SUPPLIERS COULD DELAY
PRODUCT SHIPMENTS AND MATERIALLY ADVERSELY AFFECT OUR BUSINESS OPERATIONS AND
PROFITABILITY
We have developed relationships with a single or limited number of suppliers for
materials that are otherwise generally available. Purchases from our largest
supplier, Hainan Xinxin Biotechnology Company, as of December 31, 2006,
accounted for approximately 44.42% of the total purchases of our Company.
Purchases from our second-to-largest supplier, Sichuang Chengxin Pharmaceutical
Company, December 31, 2006, accounted for approximately 33.65% of our total
purchases. Although we believe that alternative suppliers are available to
supply materials, should either of these suppliers terminate their business
arrangements with us or increase their prices of materials supplied, it could
delay product shipments and materially adversely affect our business operations
and profitability.
IF ALL OR A SIGNIFICANT PORTION OF OUR TRADE RECIEVABLES ARE NOT COLLECTED OR
COLLECTION IS DELAYED, OUR NET INCOME WILL DECREASE AND OUR PROFITABILITY WILL
BE MATERIALLY ADVERSELY AFFECTED
15
Our Company had trade receivables, net of allowance for doubtful accounts, of
approximately $5,709,762 ($1,412,353 for doubtful accounts) and $12,101,979
($1,562,494 for doubtful accounts) as of December 31, 2005 and 2006,
respectively. During the years ending December 31, 2005 and 2006, our customers'
turnover periods were approximately 116 days and 199, respectively.
It is usual commercial practice that certain customers may repay their debts
beyond credit periods granted or may repay slowly when transaction volume
increases. There is no assurance that our trade receivables will be fully repaid
on a timely basis. The percentage of a trade receivable that is deemed doubtful
is as follows: 100% after 720 days; 50 % after 360 days; and 7.5% up to 360
days.
If all or a significant portion of our customers with trade receivables fail to
pay all or part of the trade receivables or delay the payment due to us for
whatever reason, our net profit will decrease and our profitability will be
materially adversely affected.
WE MAY UNDERTAKE ACQUISITIONS IN THE FUTURE, AND ANY DIFFICULTIES IN INTEGRATING
THESE ACQUISITIONS MAY DAMAGE OUR PROFITABILITY
In the future, we may acquire additional businesses or products that complement
our existing business and expand our business scale. The integration of new
businesses and products may prove to be an expensive and time consuming
procedure. We can offer no assurance that we will be able to successfully
integrate the newly acquired businesses and products or operate the acquired
business in a profitable manner. Failure to locate an appropriate acquisition
target or failure to successfully integrate and operate acquired businesses and
products may materially adversely impact our operations and profits.
THE FAILURE TO MANAGE GROWTH EFFECTIVELY COULD HAVE AN ADVERSE EFFECT ON OUR
BUSINESS, FINANCIAL CONDITION, AND RESULTS OF OUR OPERATIONS
The rapid market growth of our pharmaceutical products may require our Company
to expand our employee base for managerial, operational, financial, and other
purposes. As of December 31, 2006, we had 123 regular employees. The continued
future growth will impose significant added responsibilities upon the members of
management to identify, recruit, maintain, integrate, and motivate new
employees. Aside from increased difficulties in the management of human
resources, we may also encounter working capital issues, as we need increased
liquidity to finance the purchases of raw materials and supplies, research and
development of new products, acquisition of new businesses and technologies, and
the hiring of additional employees. For effective growth management, we will be
required to continue improving our operations, management, and financial systems
16
and control. Our failure to manage growth effectively may lead to operational
and financial inefficiencies that will have a negative effect on the Company's
profitability.
WE ARE DEPENDENT ON CERTAIN KEY PERSONNEL AND LOSS OF THESE KEY PERSONNEL COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FIANANCIAL CONDITION AND RESULTS
OF OPERATIONS
Our Company's success is, to a certain extent, attributable to the management,
sales and marketing, and pharmaceutical factory operational expertise of key
personnel. Zhilin Li, Heqi Cai, and Yao Huang perform key functions in the
operation of our Company. Ms. Li entered into an Employment Agreement with
Helpson, which provides that she shall act as its CEO. The term of her
Employment Agreement is from July 1, 2005, to June 30, 2010. Mr. Cai entered
into an Employment Agreement with Helpson to act as its Director of Development
Department for a term from July 1, 2005, to June 30, 2010. Ms. Huang entered
into an Employment Agreement with Helpson to act as its Head of Pharmaceutical
Plant for a term from July 1, 2005, to June 30, 2010. There can be no assurance
that we will be able to retain these officers after the term of their employment
or after their contracts expire. The loss of officers could have a material
adverse effect upon our business, financial condition, and results of
operations. We must attract, recruit and retain a sizeable workforce of
technically competent employees. Our ability to effectively implement our
business strategy will depend upon, among other factors, the successful
recruitment and retention of additional highly skilled, experienced management
and other key personnel. We cannot assure that we will be able to hire or retain
such employees.
IF WE FAIL TO DEVELOP NEW PRODUCTS WITH HIGH PROFIT MARGINS AND OUR HIGH PROFIT
MARGIN PRODUCTS ARE REPLACED BY COMPETITOR'S PRODUCTS, THEN OUR GROSS AND NET
PROFIT MARGINS WILL BE ADVERSELY AFFECTED
In the years ended December 31, 2005 and 2006, the gross profit margin for our
Company was 51.9% and 46.2% respectively. However, there is no assurance that we
will be able to sustain such profit margins in the future. The pharmaceutical
market in the PRC is very competitive, and there may be pressure to reduce sale
prices of products without a corresponding decrease in the price of raw
materials. 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, gross profit margins will be adversely affected.
WE FACE COMPETITION IN THE PHARMACEUTICAL MARKET IN THE PRC AND SUCH COMPETITION
COULD CAUSE OUR SALES REVENUE AND PROFITS TO DECLINE
17
According to the State Food and Drug Administration of China (the "SFDA"), there
were approximately 5,071 pharmaceutical manufacturing companies in the PRC as of
the end of June 2004, of which approximately 3,237 manufacturers obtained
certificates of Good Manufacturing Practices certification ("GMP
certification"). After GMP certification became a mandatory requirement on July
1, 2004, approximately 1,834 pharmaceutical manufacturers were forced to cease
production. Only the 3,237 pharmaceutical manufacturers with GMP certifications
may continue their manufacturing operations. The certificates, permits, and
licenses required for pharmaceutical operation in the PRC create a potentially
significant barrier for new competitors seeking entrance into the market.
Despite these obstacles, we face competitors that will attempt to create, or are
already marketing, products in the PRC that are similar to ours. There can be no
assurance that our products will be either more effective in their therapeutic
abilities and/or be able to compete in price with that of our competitors.
Failure to do either of these may result in decreased profits for our Company.
OUR SUCCESS IS HIGHLY DEPENDENT ON CONTINUALLY DEVELOPING NEW AND ADVANCED
PRODUCTS, TECHNOLOGIES, AND PROCESSES AND FAILURE TO DO SO MAY CAUSE US TO LOSE
OUR COMPETITIVENESS IN THE PHARMACEUTICAL INDUSTRY AND MAY CAUSE OUR PROFITS TO
DECLINE
To remain competitive in the pharmaceutical industry, it is important to
continually develop new and advanced products, technologies and processes. There
is no assurance that our competitors' new products, technologies and processes
will not render our Company's existing products obsolete or non-competitive. Our
Company's competitiveness in the pharmaceutical market therefore relies upon our
ability to enhance our current products, introduce new products, and develop and
implement new technologies and processes. Our Company's failure to
technologically evolve and/or develop new or enhanced products may cause us to
lose our competitiveness in the pharmaceutical industry and may cause our
profits to decline.
18
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 COMMUNICTY 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. 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 our relationship with the medical community. 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.
THE DISCONTINUATION OF ANY PREFERENTIAL TAX TREATMENTS OR OTHER INCENTIVES
CURRENTLY AVAILABLE TO US IN THE PRC COULD MATERIALLY AND ADVERSELY AFFECT OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Pursuant to the Income Tax Law of the PRC for Enterprises with Foreign
Investment and Foreign Enterprises promulgated in April, 1991 (the "Income Tax
Law"), a foreign invested enterprise as defined under PRC laws shall pay 30%
corporate income tax and 3% local income tax. Pursuant to the State Council's
Regulations on Encouraging Investment in and Development of Hainan Island
promulgated in May, 1988, the corporate income tax for all companies
incorporated in Hainan Province is reduced to 15%. As a foreign invested company
incorporated in Hainan Province, currently, Helpson's corporate income tax
liability is 15%. Pursuant to the Regulations on Foreign Investment in Hainan
Special Economic Zone promulgated by Hainan Province in March, 1991 (the
"Regulation on Foreign Investment"), all foreign invested enterprises
incorporated in Hainan Province are exempted from paying the local income tax,
which normally is 3% of the taxable income. Therefore, Helpson is completely
exempted from paying any local income tax. Thus, the corporate income tax
liability of Helpson is 15%.
According to the stipulation of Income Tax Law and Regulation on Foreign
Investment, an enterprise with foreign investment of a production nature
scheduled to operate for a period of not less than ten years shall, from the
year of making profits, be exempt from corporate income tax in the first and
second years and allowed a fifty percent reduction in the third to fifth years.
19
Helpson has obtained the approval for preferential corporate income tax
treatment from Hainan State Administration of Taxation at the end of 2006 and
has began to enjoy the preferential tax treatment. Therefore, Helpson shall be
exempted from corporate income tax in the first and second years after it begins
to make profit. Because the corporate income tax for all companies incorporated
in Hainan province is reduced to 15% from the normal corporate income tax rate
of 30%, Helpson, from the third to the fifth year after it begins to make
profit, shall pay corporate income tax at the rate of half of 15%, or 7.5%.
However, on March 16, 2007, China's national congress approved Income Tax Law of
the PRC for Enterprises ("New Income Tax Law"), which will be implemented on
January 1, 2008. The New Income Tax Law unifies the enterprise income tax rate,
cost deduction and tax incentive policies for both domestic and foreign invested
enterprises. This new unified income tax law will increase tax rates on foreign
invested enterprises and lower Chinese enterprises' rates to 25%. For current
foreign invested enterprise, like us, the applicable tax rate will be moved up
to 25% over a five-year grandfather period. We expect the measures to implement
this grandfather period to be enacted by the PRC government in the coming months
and we will make an assessment of what the impact of the New Income Tax Law is
expected to be in the grandfather period. The discontinuation of any such
special or preferential tax treatment or other incentives could have an adverse
affect our business, financial condition and results of operations.
WE MAY BE SUBJECT TO THE PRC'S PRICE CONTROL OF DRUGS WHICH MAY LIMIT OUR
PROFITABILITY AND EVEN CAUSE US TO STOP MANUFACTURING CERTAIN PRODUCTS
The State Development and Reform Commission ("SDRC") of the PRC and the price
administration bureaus of the relevant provinces of the PRC in which the
pharmaceutical products are manufactured are responsible for the retail price
control over our pharmaceutical products. The SDRC sets the price ceilings for
certain pharmaceutical products in the PRC. Although our products have not been
subject to such price controls as of the date of this Form 10-KSB, there is no
assurance that our products will remain unaffected by it. Where our products are
subject to a price ceiling, we will need to adjust the product price to meet the
requirement and to accommodate for the pricing of competitors in the competition
for market shares. The price ceilings set by the SDRC may limit our
profitability, and in some instances, such as where the price ceiling is below
production costs, may cause us to stop manufacturing certain products which may
adversely affect our results of operations.
OUR CERTIFICATES, PERMITS, AND LICENSES ARE SUBJECT TO GOVERNMENTAL CONTROL AND
RENEWAL, AND THE FAILURE TO OBTAIN RENEWAL WOULD CAUSE ALL OR PART OF OUR
20
OPERATIONS TO BE SUSPENDED AND HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL
CONDITION
Our Company is subject to various PRC laws and regulations pertaining to the
pharmaceutical industry. Our Company has attained certain certificates, permits,
and licenses required for the operation of a pharmaceutical enterprise and the
manufacturing of pharmaceutical products in the PRC. We obtained the Medicine
Production Permit in December 2005, which is valid through December 31, 2010. We
also obtained three GMP certificates which are effective through July 17, 2008,
December 2, 2009, February 2, 2010 and April 17, 2011, respectively. The
pharmaceutical production permits and GMP certificates are each valid for a term
of five years and must be renewed before their expiration. During the renewal
process, we will be re-evaluated by the appropriate governmental authorities and
must comply with the prevailing standards and regulations, which may change from
time to time. In the event that we are not able to renew the certificates,
permits and licenses, all or part of our operations may be suspended by the
government, which would have a material adverse affect on our financial
condition. Furthermore, if escalating compliance costs associated with
governmental standards and regulations restrict or prohibit any part of our
operations, it may adversely affect our results of operations and profitability.
IF OUR PRODUCTS FAIL TO RECEIVE REGULATORY APPROVAL OR ARE SEVERELY LIMITED IN
THE PRODUCTS SCOPE OF USE, THEN WE MAY BE UNABLE TO RECOUP CONSIDERABLE RESEARCH
AND DEVELOPMENT EXPENDITURES ALREADY INCURRED
Our products that are approved to be manufactured as of December 31, 2006
include 17 medicines. There are 20 products in the stage of research and
development as of December 31, 2006. The production of our pharmaceutical
products is subject to the regulatory approval of the SFDA. 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 already incurred.
OUR RESEARCH AND DEVELOPMENT MAY BE COSTLY AND/OR UNTIMELY, AND THERE ARE NO
ASSURANCES THAT OUR RESEARCH AND DEVELOPMENT WILL EITHER BE SUCCESSFUL OR
21
COMPLETED WITHIN THE ANTICIPATED TIMEFRAME, IF EVER AT ALL
The research and development of our new and existing products and their
subsequent commercialization plays an important role in our success. As of
December 31, 2006, there are 20 products under research and development,
including Hugan Keli, Troxerutin and Cerebroprotein Hydrolysate for
Injection,Yimaikang Capsule, Bumetnide for Injection, Tiopronin, Omeprazole for
Injection, Ceftriaxone Sodium and Tazobactam Sodium, Donepezil Dispersible
Tablets, Mycophenolate Mofetil Granules, Cattle Encephalon Glycoside and
Ignotin, ClindamycinPhosphate for Injection, Thymopetidum for Injection, Compand
Diclofenac Sodium Injection, ShengQing Pian, rhCNTF, Pioglitazone HCL +
metformin HCL, ACTOplus, Xinlin Tablets, Xinlin Oral Solution, rh_aFGF and
Cefprozil Tablets. The research and development of new products 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 time
frame, if ever at all. There are also no assurances that if the product is
developed, that it will lead to successful commercialization.
WE CANNOT GUARANTEE THE PROTECTION OF OUR INTELLECTUAL PROPERTY RIGHTS, AND IF
INFRINGEMENT OR COUNTERFEITING OF OUR INTELLECTUAL PROPERTY RIGHTS OCCURS, THEN
OUR REPUTATION AND BUSINESS MAY BE ADVERSELY AFFECTED
To protect the brand names of our products, we have registered and applied for
registration of our trademarks in the PRC, where we have a major business
presence.
All of our products are sold under these trademarks. As of the date of this Form
10-KSB, we have not experienced any infringements of such trademarks for sales
of pharmaceutical products, and as of the date of this Form 10-KSB, we were not
aware of any infringement of our intellectual property rights. However, there is
no assurance that there will not be any infringement of our brand name or other
registered trademarks or counterfeiting of our products in the future. Should
any such infringement or counterfeiting occur, our reputation and business may
be adversely affected. We may also incur significant expenses and substantial
amounts of time and effort to enforce our intellectual property rights in the
future. Such diversion of our resources may adversely affect our existing
business and future expansion plans.
OUR REPUTATION AND BUSINESS MAY BE ADVERSELY AFFECTED AS A RESULT OF PRODUCT
LIABILITY OR DEFECTIVE PRODUCTS
We may produce products which inadvertently have an adverse pharmaceutical
effect on the health of individuals despite proper testing. Existing PRC laws
22
and regulations do not require us to maintain third party liability insurance to
cover product liability claims. However, if a product liability claim is brought
against us, it may, regardless of merit or eventual outcome, result in damage to
our reputation, breach of contract with our customers, decreased demand for our
products, costly litigation, product recalls, loss of revenue, and the inability
to commercialize some products. We currently are not aware of any existing or
anticipated product liability claims with respect to our products.
WE RELY ON THE COOPERATION WITH CERTAIN RESEARCH LABORATORIES, PHARMACEUTICAL
INSITITUIONS, AND UNIVERSITIES, AND IF THESE INSTITUTIONS CEASE TO COOPERATE
WITH US AND WE CANNOT FIND OTHER SUITABLE SUBSTITUTE RESEARCH AND DEVELOPMENT
PARTNERS, THEN OUR ABILITY TO DEVELOP NEW PRODUCTS MAY BE HINDERED AND OUR
BUSINESS MAY BE ADVERSELY AFFECTED
Helpson cooperates with several research institutions including the Chinese
Academy of Medical Sciences, China University of Pharmaceuticals, the Academy of
Military Medical Science, the Chongqing Medical Industry Institute and China
Sichuan University. Helpson relies to a certain extent on these institutions for
its development of new products. There is no assurance that these institutions
will continue cooperating with Helpson to develop new products. In the event
that these institutions cease to cooperate with Helpson and Helpson cannot find
other suitable substitute research and development partners, our ability to
develop new products may be hindered and our business may be adversely affected.
RISKS RELATED TO DOING BUSINESS IN CHINA
Helpson operates from facilities that are located in China. Accordingly, its
operations must conform to governmental regulations and rules of the PRC.
THE PRC LEGAL SYSTEM HAS INHERENT UNCERTAINTIES THAT COULD LIMIT THE LEGAL
PROTECTIONS AVAILABLE TO US
The PRC legal system is a civil law system based on written statutes. Unlike
common law systems, it is a system in which decided legal cases have little
precedential value. In the late 1970s, the PRC government began to promulgate a
comprehensive system of laws and regulations governing commercial matters. The
overall effect of legislation enacted over the past 20 years has significantly
enhanced the protections afforded to foreign-invested enterprises in China.
However, these laws, regulations, and legal requirements are relatively recent
and are evolving rapidly, and their interpretation and enforcement involve
uncertainties. These uncertainties could limit the legal protections available
to foreign investors.
23
The practical effect of the PRC's legal system on our business operations in
China 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 benefit of corporate articles and contracts to Foreign
Invested Enterprise participants. These laws, however, do impose standards
concerning corporate formation and governance, which are not qualitatively
different from the corporation laws found in the United States. Similarly, PRC
accounting laws mandate accounting practices which may not be consistent with
the U.S. Generally Accepted Accounting Principles. China accounting laws require
that an annual "statutory audit" be performed in accordance with PRC accounting
standards and that the books of account of a Foreign Invested Enterprise be
maintained in accordance with PRC accounting laws. Article 14 of the PRC 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.
Second, while the enforcement of substantive rights may appear less clear than
United States procedures, Foreign Invested Enterprises and Wholly Foreign-Owned
Enterprises are PRC registered companies which enjoy the same status as other
PRC registered companies in business-to-business dispute resolutions. The PRC
legal infrastructure, however, is significantly different in operation from its
United States counterpart, and may present a significant impediment to the
operation of a Foreign Invested Enterprise.
PRC ECONOMIC REFORM POLICIES OR NATIONALIZATION COULD RESULT IN A TOTAL
INVESTMENT LOSS IN OUR COMMON STOCK
Since 1979, the PRC government has reformed its economic policies. Because many
reforms are unprecedented or experimental, they are expected to be refined and
improved. Other political, economic and social factors, such as political
changes, changes in the rates of economic growth, unemployment or inflation, or
in the disparities in per capita wealth between regions within China, could lead
to further readjustment of the reform measures. This refining and readjustment
process may negatively affect our operations.
Although the PRC government owns the majority of productive assets in China, in
the past several years the government has implemented economic reform measures
that emphasize decentralization and encourage private economic activity. Because
these economic reform measures may be inconsistent or ineffectual, there are no
assurances that:
- We will be able to capitalize on economic reforms;
- The Chinese government will continue its pursuit of economic reform
policies; - The economic policies, even if pursued, will be
24
successful; - Economic policies will not be significantly altered from
time to time; or
- Business operations in China will not become subject to the risk of
nationalization.
Over the last few years, China's economy has registered high growth rates.
Recently, there have been indications that rates of inflation have increased. In
response, the Chinese government recently has taken measures to curb this
excessively expansive economy. These measures have included restrictions on the
availability of domestic credit, reducing the purchasing capability of some of
its customers, and limited recentralization of the approval process for
purchases of certain foreign products. These austere measures alone may not
succeed in slowing down the economy's excessive expansion or control inflation,
and may result in severe dislocations in the Chinese economy. The PRC government
may adopt additional measures to further combat inflation, including the
establishment of freezes or restraints on certain projects or markets. These
measures may adversely affect our operations.
There can be no assurance that the reforms to China's economic system will
continue or that we will not be adversely affected by changes in China's
political, economic, and social conditions and by changes in policies of the PRC
government, such as changes in laws and regulations, measures which may be
introduced to control inflation, changes in the rate or method of taxation,
imposition of additional restrictions on currency conversion and remittance
abroad, and reduction in tariff protection and other import restrictions.
YOU MAY EXPERIENCE DIFFICULTIES IN EFFECTING SERVICE OF LEGAL PROCESS, ENFORCING
FOREIGN JUDGMENTS OR BRINGING ORIGINAL ACTIONS IN THE PRC BASED ON U.S. OR OTHER
FOREIGN LAWS AGAINST THE COMPANY OR OUR MANAGEMENT
Helpson, our operating company, is incorporated under the laws of the PRC, and
substantially all of our assets are located in the PRC. In addition, many of our
directors, managers, and executive officers reside within the PRC, and
substantially all of the assets of these persons are located within the PRC. As
a result, it may not be possible to effect service of process within the United
States or elsewhere outside the PRC upon certain of our directors, supervisors
or executive officers, including with respect to matters arising under U.S.
federal securities laws or applicable state securities laws. Moreover, the PRC
does not have treaties providing for the reciprocal recognition and enforcement
of judgments of courts with the United States, the United Kingdom, Japan or many
other countries. As a result, recognition and enforcement in the PRC of
judgments of a court in the United States and any of the other jurisdictions
mentioned above in relation to any matter may be difficult or impossible.
Furthermore, an original action may be brought in the PRC against us, our
25
directors, managers, or executive officers only if the actions are not required
to be arbitrated by PRC law and Helpson's articles of association, and only if
the facts alleged in the complaint give rise to a cause of action under PRC law.
In connection with any such original action, a PRC court may impose civil
liability, including monetary damages.
BECAUSE WE RECEIVE SUBSTANTIALLY ALL OF OUR REVENUE IN RENMINBI, WHICH CURRENTLY
IS NOT A FREELY CONVERTIBLE CURRENCY, AND THE PRC GOVERNMENT CONTROLS THE
CURRENCY CONVERSION AND THE FLUCTUATION OF THE RENMINBI, WE ARE SUBJECT TO
CHANGES IN THE PRCS' POLITICAL AND ECONOMIC DECISIONS
We receive substantially all of our revenues in Renminbi, which currently is not
a freely convertible currency. The PRC government may, at its discretion,
restrict access in the future to foreign currencies for current account
transactions.
The value of the Renminbi against the U.S. dollar and other currencies
fluctuates and is affected by, among other things, changes in the PRC's
political and economic conditions. Since 1994, the conversion of Renminbi into
foreign currencies, including Hong Kong and U.S. dollars, has been based on
rates set by the People's Bank of China, which are set daily based on the
previous day's inter-bank foreign exchange market rates and current exchange
rates on the world financial markets. Since 1994, the official exchange rate for
the conversion of Renminbi to U.S. Dollars generally has been stable. Any
devaluation of the Renminbi, however, may materially and adversely affect the
value of, and any dividends payable on, our shares in foreign currency terms,
since we will receive substantially all of our revenues, and express our
profits, in Renminbi. Our financial condition and results of operations also may
be affected by changes in the value of certain currencies other than the
Renminbi. Our results of operation may be adversely affected by changes in the
political and social conditions in the PRC, and changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among other
things.
The official exchange rate of the Renminbi to the U.S. Dollar had remained
nearly fixed until July 21, 2005. On this date, the PRC government changed its
policy of tying the value of the RMB 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. For nearly one and a half years since
the implementation of this revaluation policy, there has been an approximately
5.79% appreciation of the Renminbi against the U.S. dollar. While the
international reaction to the Renminbi revaluation generally has 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 due to certain
26
factors including a U.S. current (trade) account deficit with China. This
floating exchange rate, and any further appreciation of the Renminbi that may
result from such rate, could have various effects on the Company's financial
statements. It is not possible to predict if the net effects of the further
appreciation of the Renminbi, if it occurred, would be positive or negative for
the Company.
THE GROWTH OF THE CHINESE ECONOMY HAS BEEN UNEVEN ACROSS GEOGRAPHIC REGIONS AND
ECONOMIC SECTORS, AND A DOWNTURN IN CERTAIN REGIONS IN WHICH WE DO BUSINESS OR
IN OUR ECONOMIC SECTOR WOULD SLOW DOWN OUR GROWTH AND PROFITABILITY
The growth of the Chinese economy has been uneven across geographic regions and
economic sectors. For example, during the years between 1978 and 2000, the per
capital GDP growth rate of Fujian Province in Southeastern China was 12% while
that of Gansu Province in Northwestern China was 5.3% (Source: New China
Statistical Materials Compilation for 50 Years and 2001 China Annual
Statistics). There can be no assurance that growth of the Chinese economy will
be steady or that any downturn will not have a negative effect on our business.
Our profitability may decrease due to a downturn in the Chinese economy. More
specifically, the expansion of our sales area in the less economically developed
central and western provinces of China will depend on those provinces achieving
certain income levels.
ANY OCCURRENCE OF SERIOUS INFECTIOUS DISEASES, SUCH AS RECURRENCE OF SEVERE
ACUTE RESPIRATORY SYNDROME (SARS) CAUSING WIDESPREAD PUBLIC HEALTH PROBLEMS,
COULD ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS
A renewed outbreak of SARS or other widespread public health problems in China,
where all of our revenue is derived, and in Hainan, where our operations are
headquartered, could have a negative effect on our operations. Our operations
may be impacted by a number of public health-related factors, including the
following:
o quarantines or closures of our factories or subsidiaries which would
severely disrupt its operations;
o the sickness or death of key officers and employees; and
o general slowdown in the Chinese economy.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our business and results of operations.
27
WE ARE SUBJECT TO THE ENVIRONMENTAL PROTECTION LAWS OF THE PRC
Our manufacturing process may produce by-products such as effluent, gases and
noise, which are harmful to the environment. We are subject to multiple laws
governing environmental protection, such as "The Law on Environmental Protection
in the PRC" and "The Law on Prevention of Effluent Pollution in the PRC," as
well as standards set by the relevant governmental bodies determining the
classification of different wastes and proper disposal. We have properly
attained a waste disposal permit for our manufacturing facility, which details
the types and concentration of effluents and gases allowed for disposal. The
temporary waste disposal permit will expire on September 28, 2009. We are
responsible for the renewal of the waste disposal permit. There is no assurance
that we will obtain the renewal of the waste disposal permit when the current
permit expires.
China is experiencing substantial problems with environmental pollution.
Accordingly, it is likely that the national, provincial and local governmental
agencies will adopt stricter pollution controls. There can be no assurance that
future changes in environmental laws and regulations will not impose costly
compliance requirements on us or otherwise subject us to future liabilities. Our
business's profitability may be adversely affected if additional or modified
environmental control regulations are imposed upon us.
RECENT PRC REGULATIONS RELATING TO ACQUISITIONS OF PRC COMPANIES BY FOREIGN
ENTITIES MAY LIMIT OUR ABILITY TO ACQUIRE PRC COMPANIES AND ADVERSELY AFFECT THE
IMPLEMENTATION OF OUR STRATEGY AS WELL AS OUR BUSINESS AND PROSPECTS
The PRC State Administration of Foreign Exchange, or SAFE, issued a public
notice in January 2005 concerning foreign exchange regulations on mergers and
acquisitions in China ("January Notice"). The January Notice states that if an
offshore company controlled by PRC residents intends to acquire a PRC company,
such acquisition will be subject to strict examination by the relevant foreign
exchange authorities. The public notice also states that the approval of the
relevant foreign exchange authorities is required for any sale or transfer by
the PRC residents of a PRC company's assets or equity interests to foreign
entities, such as us, for equity interests or assets of the foreign entities.
In April 2005, SAFE issued another public notice (the "April Notice") further
explaining the January Notice. In accordance with the April Notice, if an
acquisition of a PRC company by an offshore company controlled by PRC residents
has been confirmed by a Foreign Investment Enterprise Certificate prior to the
promulgation of the January Notice, the PRC residents must each submit a
registration form to the local SAFE branch with respect to their respective
28
ownership interests in the offshore company, and must also file an amendment to
such registration if the offshore company experiences material events, such as
changes in the share capital, share transfer, mergers and acquisitions, spin-off
transactions or use of assets in China to guarantee offshore obligations. The
April Notice also provides that failure to comply with the registration
procedures set forth therein may result in a restriction on the PRC company's
ability to distribute profits to its offshore parent company. Pending the
promulgation of detailed implementation rules, the relevant government
authorities are reluctant to commence processing any registration or application
for approval required under the SAFE notices.
In October 2005, SAFE promulgated another notice ("Decree No. 75") which
repealed the above January Notice and April Notice. Decree No. 75 requires PRC
residents and PRC corporate entities to register with and obtain approvals from
relevant PRC governmental authorities in connection with their direct or
indirect offshore investment activities.
Decree No. 75 requires registration by March 31, 2006 of direct or indirect
investments previously made by PRC residents in offshore companies prior to the
implementation of Decree No. 75 on November 1, 2005. If a PRC shareholder with a
direct or indirect stake in an offshore parent company fails to make the
required SAFE registration, the PRC subsidiaries of such offshore parent company
may be prohibited from making distributions of profit to the offshore parent and
from paying the offshore parent proceeds from any reduction in capital, share
transfer or liquidation in respect of the PRC subsidiaries. Furthermore, failure
to comply with the various SAFE registration requirements described above could
result in liability under PRC law for foreign exchange evasion.
As it is uncertain how Decree No. 75 will be interpreted or implemented, we
cannot predict how it will affect our business operations or future strategy.
For example, we may be subject to more stringent review and approval process
with respect to our foreign exchange activities, such as remittance of dividends
and foreign-currency-denominated borrowings, which may adversely affect our
results of operation and financial condition. In addition, if we decide to
acquire a PRC company through the issuance of our capital stock, we cannot
assure that the owners of the target company will be able to complete the
necessary approval, filings and registrations for the acquisition. This may
restrict our ability to implement our acquisition strategy and adversely affect
our business and prospects.
On August 8, 2006, six PRC regulatory agencies, including the Chinese Securities
Regulatory Commission, or CSRC, promulgated a regulation (the "M&A Regulation")
that became effective on September 8, 2006. This regulation, among other things,
has some provisions that purport to require that an offshore special purpose
vehicle, or SPV, formed for listing purposes and controlled directly or
29
indirectly by PRC companies or individuals shall obtain the approval of the CSRC
prior to the listing and trading of such SPV's securities on an overseas stock
exchange.
Because the M&A Regulation became effective very recently, it remains uncertain
how the M&A Regulation will be interpreted and enforced by the Chinese
governmental authority such as the CSRC and the Ministry of Commerce. We cannot
predict how the M&A Regulation will affect our business operations or future
strategy. If the CSRC requires that we obtain its approval, we may be unable to
obtain a waiver of the CSRC approval requirements, if and when procedures are
established to obtain such a waiver. Any uncertainties and/or negative publicity
regarding this CSRC approval requirement could have a material adverse effect on
the trading price of our common stocks.
OUR BUSINESS MAY BE ADVERSELY AFFECTED AS A RESULT OF CHINA'S ENTRY INTO THE
WORLD TRADE ORGANIZATION ("WTO") BECAUSE THE PREFERENTIAL TAX TREATMENTS
AVAILABLE TO US MAY BE DISCONTINUED AND FOREIGN PHARMACEUTICAL MANUFACTURERS MAY
COMPETE WITH US IN THE PRC PHARMACEUTIAL INDUSTRY
The PRC became a member of the WTO on December 11, 2001. The current tax
benefits enjoyed by our Company may be regarded as unfair treatment by other
members of the WTO. Accordingly, the preferential tax treatments available to us
may be discontinued. In such circumstances, our profitability may be adversely
affected. In addition, we may face additional competition from foreign
pharmaceutical manufacturers if they set up their production facilities in the
PRC or form Sino-foreign joint ventures with our competitors in the PRC. In the
event that we fail to maintain our competitiveness against these competitors,
our profitability may be adversely affected.
RISKS RELATED TO OUR COMMON STOCK
THE MARKET PRICE FOR OUR COMMON STOCK MAY BE VOLATILE WHICH COULD RESULT IN A
COMPLETE LOSS OF YOUR INVESTMENT
The market price for our common stock is likely to be highly volatile and
subject to wide fluctuations in response to factors including the following:
o actual or anticipated fluctuations in our quarterly operating results,
o announcements of new products by us or our competitors,
o changes in financial estimates by securities analysts,
30
o conditions in the pharmaceutical market,
o changes in the economic performance or market valuations of other
companies involved in pharmaceutical production,
o announcements by our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments,
o additions or departures of key personnel, or
o potential litigation,
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are not related to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
WE MAY ISSUE ADDITIONAL SHARES OF OUR CAPITAL STOCK TO RAISE ADDITIONAL CASH FOR
WORKING CAPITAL; IF WE ISSUE ADDITIONAL SHARES OF OUR CAPITAL STOCK, OUR
STOCKHOLDERS WILL EXPERIENCE DILUTION IN THEIR RESPECTIVE PERCENTAGE OWNERSHIP
IN US THE COMPANY
We may issue additional shares of our capital stock to raise additional cash for
working capital. Although the Warrants issued in this Offering will have
anti-dilution protection, there are no anti-dilution protection or preemptive
rights in connection with our common stock. Thus, the percentage ownership of
existing holders of common stock, including the Shares issued in this Offering,
may be diluted in their respective percentage ownership in us if we issue
additional shares of our capital stock.
A LARGE PORTION OF OUR COMMON STOCK IS CONTROLLED BY A SMALL NUMBER OF
STOCKHOLDERS AND AS A RESULT, THESE STOCKHOLDERS ARE ABLE TO INFLUENCE AND
ULTIMATELY CONTROL THE OUTCOME OF STOCKHOLDER VOTES ON VARIOUS MATTERS
A large portion of our common stock is held by a small number of stockholders.
For instance, Heung Mei Tsui holds 41.04% and Zhilin Li holds 26.86% of the
Company's common stock, respectively, as of the date of this Form 10-KSB. As a
result, these two stockholders are able to influence and ultimately control the
outcome of stockholder votes on various matters, including the election of
directors and other corporate transactions including business combinations. In
addition, the occurrence of sales of a large number of shares of our common
stock, or the perception that these sales could occur, may affect our stock
price and could impair our ability to obtain capital through an offering of
equity securities. Furthermore, the current ratios of ownership of our common
stock reduce the public float and liquidity of our common stock which can in
turn affect the market price of our common stock.
31
THERE IS CURRENTLY A LIMITED TRADING MARKET FOR OUR COMMON STOCK WHICH MAY MAKE
IT DIFFICULT TO SELL SHARES OF OUR COMMON STOCK
Our common stock is currently traded in the over-the-counter market through the
Over-the-Counter Bulletin Board (OTC Bulletin Board). The quotation of our
shares on the OTC Bulletin Board may result in a less liquid market available
for our existing and potential stockholders to trade shares of our common stock,
could depress the trading price of our common stock and could have a long-term
adverse impact on our ability to raise capital in the future. While there is an
active trading market for our common stock, it is small. Further, there can be
no assurance that an active trading market will be maintained. We cannot assure
you that our common stock will ever be included for trading on any stock
exchange or through any other quotation system (including, without limitation,
the NASDAQ Stock Market).
WE ARE LIKELY TO REMAIN SUBJECT TO "PENNY STOCK" REGULATIONS AND AS A
CONSEQUENCE THERE ARE ADDITIONAL SALES PRACTICE REQUIREMENTS AND ADDITIONAL
WARNINGS ISSUED BY THE SEC
As long as the trading price of our common stock is below $5.00 per share, the
open-market trading of our common stock will be subject to the "penny stock"
rules of the SEC. The "penny stock" rules impose additional sales practice
requirements on broker-dealers who sell securities to persons other than
established customers and accredited investors (generally those with assets in
excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with their spouse). For transactions covered by these rules, the broker-dealer
must make a special suitability determination for the purchase of securities and
have received the purchaser's written consent to the transaction before the
purchase. Additionally, for any transaction involving a penny stock, unless
exempt, the broker-dealer must deliver, before the transaction, a disclosure
schedule prescribed 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 and current quotations for the
securities. Finally, monthly statements must be sent disclosing recent price
information on the limited market in penny stocks. These additional burdens
imposed on broker-dealers may restrict the ability of broker-dealers to sell the
common stock and may affect a stockholder's ability to resell the common stock.
There can be no assurance that our common stock will qualify for exemption from
the "penny stock" rules. In any event, even if our common stock is exempt from
such rules from such rules, we would remain subject to Section 15(b)(6) of the
Exchange Act, which gives the SEC the authority to restrict any person from
32
participating in a distribution of a "penny stock" if the SEC finds that such a
restriction would be in the public interest.
Stockholders should be aware that, according to SEC Release No. 34-29093, the
market for penny stocks has suffered in recent years from patterns of fraud and
abuse. Such patterns include (i) control of the market for the security by one
or a few broker-dealers that are often related to the promoter or issuer; (ii)
manipulation of prices through prearranged matching of purchases and sales and
false and misleading press releases; (iii) boiler room practices involving
high-pressure sales tactics and unrealistic price projections by inexperienced
sales persons; (iv) excessive and undisclosed bid-ask differential and markups
by selling broker-dealers; and (v) the wholesale dumping of the same securities
by promoters and broker-dealers after prices have been manipulated to a desired
level, along with the resulting inevitable collapse of those prices and with
consequent investor losses. Our management is aware of the abuses that have
occurred historically in the penny stock market.
WE ARE RESPONSIBLE FOR THE INDEMNIFICATION OF OUR OFFICERS AND DIRECTORS UNDER
CERTAIN CIRCUMSTANCES WHICH COULD RESULT IN SUBSTANTIAL EXPENDITURES, WHICH WE
MAY BE UNABLE TO RECOUP
Our bylaws provide for the indemnification of our directors, officers,
employees, and agents, under certain circumstances, against attorney's fees and
other expenses incurred by them in any litigation to which they become a party
arising from their association with or activities on behalf of us. This
indemnification policy could result in substantial expenditures, which we may be
unable to recoup.
COMPLIANCE WITH THE SARBANES-OXLEY ACT COULD COST HUNDREDS OF THOUSANDS OF
DOLLARS, REQUIRE ADDITIONAL PERSONNEL AND REQUIRE HUNDREDS OF MAN HOURS OF
EFFORT, AND THERE CAN BE NO ASSURANCE THAT WE WILL HAVE THE PERSONNEL, FINANCIAL
RESOURCES OR EXPERTISE TO COMPLY WITH THESE REGULATIONS
The Public Company Accounting Reform and Investor Protection Act of 2002, better
known as Sarbanes-Oxley, is the most sweeping legislation to affect U.S.
publicly traded companies in the last 70 years. Sarbanes-Oxley created a set of
complex and burdensome regulations upon publicly traded companies. Compliance
with such regulations requires hundreds of thousands of dollars, additional
personnel and hundreds of man hours of effort. There can be no assurance that we
will have the personnel, financial resources or expertise to comply with these
regulations.
Section 404 of the Sarbanes-Oxley Act of 2002 requires management to assess its
internal controls over financial reporting and requires auditors to attest to
33
that assessment. Current regulations of the SEC will require us to include this
assessment and attestation in our Annual Report on Form 10-KSB commencing with
the annual report for our fiscal year ended December 31, 2007.
We will incur significant increased costs in implementing and responding to
these requirements. In particular, the rules governing the standards that must
be met for management to assess its internal controls over financial reporting
under Section 404 are complex and require significant documentation, testing
and, if necessary, possible remediation. Our process of reviewing, documenting
and testing our internal controls over financial reporting may cause a
significant strain on our management, information systems and resources. We may
have to invest in additional accounting and software systems. We may be required
to hire additional personnel and to use outside legal, accounting, and advisory
services. In addition, we will incur additional fees from our auditors as they
perform the additional services necessary for them to provide their attestation.
If we are unable to favorably assess the effectiveness of our internal controls
over financial reporting when we are required to, or if our independent auditors
are unable to provide an unqualified attestation report on such assessment, then
we may be required to change our internal controls over financial reporting to
remediate deficiencies. In addition, investors may lose confidence in the
reliability of our financial statements, causing our stock price to decline.
OUR HOLDING COMPANY STRUCTURE MAY LIMIT THE PAYMENT OF DIVIDENDS
We have no direct business operations, other than our ownership of our
subsidiaries. While we have no current intention of paying dividends, 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 and other holdings and
investments. In addition, our operating subsidiaries, from time to time, may be
subject to restrictions on their ability to make distributions to us, including
as a result of restrictive covenants in loan agreements, restrictions on the
conversion of local currency into U.S. dollars or other hard currency and other
regulatory restrictions as discussed below. PRC regulations currently permit the
payment of dividends only out of accumulated profits as determined in accordance
with PRC accounting standards and regulations. Our subsidiaries in China are
also required to set aside a portion of their after tax profits according to PRC
accounting standards and regulations to fund certain reserve funds. Currently,
our subsidiaries in China are the only sources of revenues or investment
holdings for the payment of dividends. If they do not accumulate sufficient
profits under PRC accounting standards and regulations to first fund certain
reserve funds as required by PRC accounting standards, we will be unable to pay
any dividends.
Item 2 - Description of Property
34
Helpson owns a factory with a floor area of 663.94 square meters located at the
East Wing, 6/F, 5 Jianshe Road, Jinpan Industrial Development Zone, Haikou.
Helpson also owns the land use rights to another 31,050 square meters located at
plot C09-2, Hainan Bonded Zone, Haikou. Helpson built a factory with a floor
area of approximately 7,300 square meters on this parcel.
In addition, Helpson entered into a lease agreement with Hainan Zhongfu
Going-abroad Personnel Service Center ("Zhongfu"), under which Helpson rented
the offices located at 2/F, Jiahai Building owned by Zhongfu as its principal
executive offices. The term of the lease is 10 years, from November 21, 2000 to
November 20, 2010. The rent from November 21, 2000 to November 20, 2005 is
RMB3,600 per month. The rent from November 21, 2005 to November 20, 2010 may be
adjusted within 5% of the original rent.
Intellectual Property
Helpson owns 13 registered trademarks and logos used in connection with western
medicine, raw material medicine, Chinese herbal medicine and medicine
injections, which are: Funalin, Fukexing, Helspon, Beisha, Shiduotai, Xinuo and
the HPS logo, as well as five other logos as listed in the Schedule 4.6 of the
current report filed as of October 20, 2005; one logo used in connection with
bathing cosmetics, shampoo, hair stimulating shampoo, facials, nail polish,
cosmetics, perfume, perfume essence oils, skin care toner, and cosmetics
cleansers; one registered trademark, Helpson; and one logo, used in connection
with medical appliances and equipment, surgical implants, surgical implanted
artificial eyes, surgical artificial crystalline lens, surgical artificial skin,
and artificial eyes. In addition, Helpson is applying for registration of nine
other trade marks used in connection with western medicine, raw material
medicine, Chinese herbal medicine and medicine injections.
Helpson owns the intellectual property rights of its genetic engineering
technology for rh-CNTF and rh-aFGA, and fungi form engineering and production
techniques.
Item 3 - Legal Proceedings
We have no pending legal proceedings. From time to time, we may be involved in
various claims, lawsuits, disputes with third parties, actions involving
allegations of discrimination or breach of contract actions incidental to the
normal operations of the business.
Item 4 - Submission of Matters to a Vote of Security Holders
None.
35
PART II
Item 5 - Market for Company's Common Stock and Related Stockholder Matters
Our common stock is traded on the OTCBB under the symbol "CPHI.OB". The
following table sets forth the price representing the range of high and low
closing sale prices for our common stock as reported during the fiscal years
ended December 31, 2005 and 2006.
Quarter Ended High Low
------------------------ --------------- -------------
2006
------------------------ --------------- -------------
4th Quarter $2.35 $1.30
------------------------ --------------- -------------
3rd Quarter $1.60 $1.07
------------------------ --------------- -------------
2nd Quarter $1.70 $1.15
------------------------ --------------- -------------
1st Quarter $2.05 $1.05
2005
------------------------
4th Quarter $2.65 $1.70
------------------------ --------------- -------------
3rd Quarter $2.25 $1.05
------------------------ --------------- -------------
2nd Quarter $2.00 $0.40
------------------------ --------------- -------------
1st Quarter $0.55 $0.35
------------------------ --------------- -------------
As of March 26, 2007, the closing price of our common stock on the OTCBB was
$1.79. As of March 26, 2007, the stockholders' list for our common stock showed
204 registered shareholders of record, which figure does not take into account
those stockholders whose certificates are held in the name of broker-dealers or
other nominees and 37,228,938 shares of common stock issued and outstanding.
Dividend Policy
Since inception, we have not paid, nor declared, any dividends and we do not
intend to declare any such dividends in the foreseeable future. Our ability to
pay dividends is subject to limitations imposed by Delaware law and the laws of
the PRC.
Transfer Agent
The Transfer Agent and Registrar for our common stock is Securities Transfer
Corporation, 2591 Dallas Parkway, Suite 102, Frisco, Texas 75234 and its
telephone number is 469.633.0100.
36
Item 6 - Management's Discussion and Analysis or Plan of Operation
FORWARD-LOOKING STATEMENTS
The following discussion of China Pharma Holdings, Inc.'s ("China Pharma")
financial condition and results of operations should be read in conjunction with
its financial statements and the related notes, and the other financial
information included elsewhere in this Current Report on Form 10-KSB.
This filing contains forward-looking statements. The words "anticipated,"
"believe," "expect", "plan," "intend," "seek," "estimate," "project," "could,"
"may," and similar expressions are intended to identify forward-looking
statements. These statements include, among others, information regarding future
operations, future capital expenditures, and future net cash flow. Such
statements reflect China Pharma management's current views with respect to
future events and financial performance and involve risks and uncertainties,
including, without limitation, general economic and business conditions, changes
in foreign, political, social, and economic conditions, regulatory initiatives
and compliance with governmental regulations, the ability to achieve further
market penetration and additional customers, and various other matters, many of
which are beyond China Pharma's control. Should one or more of these risks or
uncertainties occur, or should underlying assumptions prove to be incorrect,
actual results may vary materially and adversely from those anticipated,
believed, estimated or otherwise indicated. Consequently, all of the
forward-looking statements made in this filing are qualified by these cautionary
statements and there can be no assurance of the actual results or developments.
I. The year 2006 in brief.
2006 saw another year of sound growth and outstanding financial performance at
China Pharma. The Company's whole revenue increased by over 150% to a historical
record high of $21.84 million in US dollars. This fast growth has all been built
on an organic basis since the inception of Company in January, 2005;
particularly, in addition to some traditionally classical products, the growth
of sales was primarily attributed to the development of new products for the
fiscal year 2006. China Pharma maintained its orientation of launching new
products in an increasingly competitive market and explored potential markets in
a wide domestic base.
The financial performance in year 2006 improved significantly compared to years
before. Gross profit grew dramatically by 125% to US $10 million and the net
income, without consideration of foreign currency translation adjustment, has
been doubled to US $8.59 million. Major outlays have been placed on the
37
development of new product pipelines and the construction of new marketing
activities. Considering the newly fulfilled fund-raising activities, there was a
slight decrease in the basic and diluted earnings per common shares to US$0.25,
however, weighted-average common shares outstanding has grown three times to
34.72 million, in an anticipation of sustainable profit generation.
China Pharma has built up intense cooperation among biological, chemical and
medical institutions to deliver more functional products tailored to the demand
of particular populations of the end-user. According to management's goals, our
company is dedicated to achieve stable profits growth. We operate the business
by relevant strategic principles, which have been proven successful. Thoroughly
exploring the potential in the pharmaceutical field is the key to our success.
Further, we also are concerned with corporate governance as a modern enterprise.
In the near future, we will establish a more systematic and long lasting process
of internal controls for prospective development and to the benefit of our
shareholders.
II. Business Overview
China Pharma is primarily engaged in the research, development, manufacture, and
marketing of pharmaceutical and nutritional supplements. Especially, we have
launched an anti-flu product named PuSenOK in 2005, which is the only anti flu
medicine in the market mixed with pseudo ephedrine hydrochloride, a non-drowsy
formula with a runny nose suppressant. We plan to expand our biotechnology
product series. Based on the foundation established by some of Helpson's widely
recognized medicine labels such as Neurotrophicpeptide, we have been and will
continue to launch a variety of biological medicines, including the brain
peptide injection, injected hepatocyte growth-promoting factors, as well as new
genetic medicines, rh-CNTF and rh-AFGF, which are expected to fuel us a new
growth following that of Neurotrophicpeptide.
The product of Buflomedil Hydrochloride (including raw material, injection and
troche) has been:
o Designated as the key technology project in Hainan in 2003 by Hai'kou
Municipality.
o Received the best technology commercialization award in Hainan in 2004 by
Hainan Scientific and Technological Result Examination Committee.
o Awarded the national key new products certificate in 2003 by the State
Science and Technology Department, State Taxation Bureau, Ministry of
Commerce, State Bureau of Quality Supervision, Inspection and Quarantine,
and State Environmental Protection Bureau.
Since the year 2003 Helpson attained GMP authentication and the prize as the
"best enterprise for supporting SARS medicine" awarded by Hainan Food and Drug
Administration, we have been keeping forward to the frontier market. In the year
38
of 2006, our products have been distributed to more than 29 provinces,
sovereignties, and autonomous regions around China. Our sales network covers
approximately 16 sales offices and approximately 550 proxy agents. The main
channels we use to deliver our products include: (1) Distribution system (Proxy
Agency); (2) Direct sale system to hospitals; (3) Direct representation in
clinic hospitals through medical representatives; and (4) Distribution of
products to local medical companies through logistics companies.
Retrospectively, on June 16, 2005, Onny Investment Limited ("Onny") acquired all
the outstanding shares in Hainan Helpson Medicine and Bio-Technology Co. Ltd.
("Helpson"), a private Chinese company, in exchange for the assumption of
obligations to make cash payments to the Helpson's shareholders in a form of
common stock dividend from Helpson of $4,154,041, the assumption of $4,646,409
of other liabilities and the issuance of non-interest bearing promissory notes
totaling $3,413,265 payable three months after Helpson obtained a business
license in the PRC as a wholly foreign owned entity. The acquisition of Helpson
was recognized as a business combination.
Then after, on October 19, 2005, Onny issued 10,000 preferred shares in exchange
for $4,313,000 in cash, net of offering costs and estimated registration costs,
and on that same date, those preferred shares were converted into 10,000 Onny
common shares. Also on October 19, 2005, Onny was reorganized as a wholly-owned
subsidiary of the Company. The reorganization was accomplished by the original
Onny common shareholder exchanging her 29,700 Onny common shares for 20,555,329
common shares of China Pharma and for the commitment by China Pharma to issue
the original Onny common shareholder 4,723,056 common shares following an
amendment of the China Pharma articles of incorporation increasing the number of
common shares authorized to 60,000,000 shares from 30,000,000 shares. In
addition, the prior Onny preferred shareholders exchanged their 10,000 Onny
common shares for 6,944,611 common shares of China Pharma.
Additionally, on February 1, 2007, China Pharma fulfilled an offering of Units
priced at $1.70 per Unit consisting of one share of Company common stock and a
warrant to purchase one-half of a share of Company common stock at an exercise
price of $2.38 per share. China Pharma received gross proceeds in the aggregate
amount of $4,259,900; and the net proceeds, after deducting the related offering
expenses of $445,258, amounted to $3,814,741. Totally, it issued an aggregate of
2,505,882 shares of common stock and issued three-year warrants to purchase an
aggregate of 1,252,941 shares of Company's common stock to 17 accredited
investors.
III. Trend in the Market.
Studies show that, with the world's expanding population, not only larger but
39
older, ever growing numbers of people have diseases of aging, such as cancers,
Alzheimer's disease, diabetes and rheumatoid arthritis, which have already
becoming prevalent, especially in developed areas. In a growing and aging
population, people need to find more effective methods of treatment.
In addition, patient empowerment has been another factor in high-quality
healthcare. Many are better informed about the importance of health issues and
medical advancement. Naturally, people today are demanding greater care and
access to the latest medical procedures and medicines.
Helpson regards this market trend as an opportunity. However, the best way to
develop it is to find our business risks beforehand, with a hope of alleviating
or eliminating these potential side-effects. Generally speaking, there are three
aspects of risks.
o External Risk
In recent years, Chinese medical system reform has been occurring, resulting in
the State Department establishment of a basic medical insurance system for the
workers in cities and towns. Considering the social environment and the
governmental policy in pharmaceutical industry in PRC, a high speed growth of
sales can be expected due to a kind of regional protectionism in the industry.
Competition will also be intensive across the industry overall. Currently,
company's existing products are competitive in the market and possess potential
growth power in its existing products and topic selection, however, from a
long-term perspective, some major western medicine producers are also seeking
Chinese market share. This will make the company face intensive competition in
this natural herb product market.
o Operation Risk
One of the major uncertainties in the Company is the purchase of raw materials.
Raw material is primarily affected by the geographical environment in Hainan
Province. As it is a long way for transportation, in order for the need of
production, the Company has to store large amounts of inventory according
inventory budget. In addition, partial raw material need to be specifically
ordered, with higher storage needs. Meanwhile, since the increasing volume in
sales, the Company needs to store large volume of packaging material, to meet
the needs of production and sales.
o Foreign Currency Risk
Substantially all of our operations are conducted in the PRC. Our sales and
purchases are conducted within the PRC in Chinese Renminbi. As a result, the
effect of exchange rate fluctuation would inevitably to be considered to be
material to our business operations.
40
All of our revenues and expenses are denominated in Renminbi. But we use the
United States dollar for financial reporting purposes. Conversion of Renminbi
into foreign currencies is regulated by the People's Bank of China through a
unified floating exchange rate system. Although the PRC government has stated
its intention to support the value of the Renminbi, there could be no assurance
that such exchange rate will not again become volatile or that the Renminbi will
not devalue significantly against the U.S. dollar. Exchange rate fluctuations
may adversely affect the value, in U.S.dollar terms, of our net assets and
income derived from its operations in the PRC.
IV. Critical Accounting Policies and Estimates
The overall discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. We believe the following are the critical accounting policies
that impact the financial statements, some of which are based on management's
best estimates available at the time of preparation. Actual experience may
differ from these estimates.
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates.
Accounts Receivable - During the normal course of business, we keep unsecured
credit to our customers and review our accounts receivable on a regular basis to
determine if the bad debt allowance is adequate at the end of the period. We
record an allowance for bad debts based on age of outstanding accounts
receivables at the end of the period in accordance with generally accepted
accounting principles in the PRC. The percentage of a trade receivable that is
deemed doubtful is as follows: 100% after 720 days; 50 % after 360 days; and
7.5% up to 360 days.
Intangibles- Under the Statement of Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," all goodwill and certain intangible
assets determined to have indefinite lives are not amortized, but are tested for
impairment at least annually. Other intangible assets are amortized over their
useful lives and reviewed for impairment in accordance with SFAS No. 144
"Accounting for Impairment or Disposal of Long-Lived Assets."
Revenue Recognition- We recognize revenue when all four of the following
criteria are met :( i) persuasive evidence has been received that there is an
enforceable agreement; (ii) the products have been delivered or the services
41
have been performed; (iii) the selling price is fixed or determinable; and (iv)
collectibility is reasonably assured.
Concentrations and Credit Risks - As all of the Company's operations are
conducted in the PRC, and therefore our operations may be adversely affected by
significant political, economic and social uncertainties in the PRC. Although
the Chinese government has pursued economic reform policies in the past, we
cannot assure you that the Chinese government will continue to pursue such
policies or that such policies will not be significantly altered, especially in
the event of a change in leadership, social or political disruption or
unforeseen circumstances affect China's political, economic and social
conditions.
The Company's revenue are denominated in the PRC's currency of Renminbi ("CNY"
or "(Y)"), which must be converted into other currencies before remittance out
of the PRC. Both the conversion of CNY into foreign currencies and the
remittance of foreign currencies abroad require approval of the PRC government.
We could give no assurance that the Chinese government's pursuit of economic
reforms will be consistent or effective.
In addition, as a common practice in the Industry, some customers may not repay
their debts under the credit periods granted or may repay slowly as the volume
of purchase increase. In this regard, there is no assurance that trade
receivables could be repaid completely as due on a timely basis.
Research and Development Costs- Research and development costs are expensed as
incurred. The costs of material and equipment acquired or constructed for
research and development and having alternative future uses are classified as
property and equipment and depreciated over their estimated useful lives.
Foreign Currency Translation- Our functional currency is the Chinese Yuan. Our
financial statements are translated into United States dollars, using the
exchange rates at the end of the period as to assets and liabilities and average
exchange rates as to revenue and expenses. Capital accounts are translated at
their historical exchange rates when the transaction occurred. Net gains and
losses resulting from foreign exchange translations are included in the
statements of operations and stockholders' equity as other comprehensive income.
The quotation of the exchange rates does not imply free convertibility. All
foreign exchange transactions continue to take place either through the People's
Bank of China or other banks authorized to buy and sell foreign currencies at
the exchange rate quoted by the People's Bank of China. Approval by the People's
Bank of China or other institutions requires us to submit a payment application
form together with invoices, shipping documents and signed contracts.
42
V. Analysis to the financial performance
The following chart sets forth our statements of operations for the twelve
months ended December 31, 2006, and for the period from January 12, 2005 (date
of inception) through December 31, 2005. Both are dominated in U.S. dollars.
Figure 1:
------------------------------------------------------------------------------------------------------------------
CHINA PHARMA HOLDING, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Period from January
For the year ended 12, 2005 (Date of Inception)
December 31, 2006 through December 31, 2005
------------------------ --------------------------------
Revenue $ 21,843,262 $ 8,657,813
Cost of Revenue 11,745,815 4,166,965
------------------------ --------------------------------
Gross Profit 10,097,447 4,490,848
------------------------ --------------------------------
Operating expenses:
Selling expenses 260,128 106,129
General and administrative 1,213,828 140,903
------------------------ --------------------------------
Total Operating Expenses 1,473,956 247,032
------------------------ --------------------------------
Income from Operations 8,623,491 4,243,816
------------------------ --------------------------------
Non-operating income(expenses):
Interest income 991 769
Interest expense (145,881) (186,452)
Other Income (Expense) 108,485 (6,482)
------------------------ --------------------------------
Total Non-operating Income (Expense) (36,405) (192,165)
------------------------ --------------------------------
Income Before Taxes 8,587,086 4,051,651
Income tax expense - 252,101
------------------------ --------------------------------
Net Income $ 8,587,086 $ 3,799,550
------------------------ --------------------------------
Comprehensive income-foreign currency 563,945 99,926
translation adjustments
------------------------ --------------------------------
Comprehensive income $ 9,151,031 $ 3,899,476
------------------------ --------------------------------
Basic and Diluted Earnings per Common
Share $ 0.25 $ 0.34
------------------------ --------------------------------
Weighted-average Common Shares
Outstanding 34,723,056 11,289,480
--------------------------------------------------------------------------------
43
Figure 2:
------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Period
from January
12, 2005 (Date
For the year As a of Inception) As a
ended December percentage of through percentage of Comparative
31, 2006 Revenue December 31, Revenue Variance %
-------------- ------------- ------------- ------------- -----------
2005.
Revenue $21,843,262 8,657,813 152%
Cost of Revenue 11,745,815 54% 4,166,965 48% 182%
Gross Profit 10,097,447 46% 4,490,848 52% 125%
Operating expenses
Selling expenses 260,128 1.2% 106,129 1.2% 145%
General and administrative 1,213,828 5.56% 140,903 1.6% 761%
Total Operating Expenses 1,473,956 7% 247,032 3% 497%
Income from Operations 8,623,491 39% 4,243,816 49% 103%
Non-operating income(expenses):
Interest income 991 0.0% 769 0.0% 29%
Interest expense -145,881 0.7$ -186,452 2.2% -22%
Other Income (Expense) 108,485 0.5% -6,482 0.1% 1,774%
Total Non-operating Income
(Expense) -36,405 (0.2%) -192,165 (2.2%) -81%
Income Before Taxes 8,587,086 39.3% 4,051,651 46.8% 112%
Income tax expense -- 252,101 2.9% -100%
Net Income $ 8,587,086 39.3% 3,799,550 43.9% 126%
Comprehensive
income-foreign currency
translation adjustments 563,945 2.6% 99,926 1.2% 464%
Comprehensive income $ 9,151,031 41.9% 3,899,476 45.0% 135%
44
Revenue: Revenue for the twelve months ended December 31, 2006 was $ 21,843,262,
a dramatic increase of $13,185,449, around 152.30%, from the revenue of
$8,657,813 for the period ended December 31, 2005. One of the major driving
forces was derived from a launch of new products and enhancement of some
existing products this year. For example, the products of AFGF, Roxithromycin
dispersible tablets and Gastrodin Injection all had predominant performance to
the overall sales. Meanwhile, a distribution network has spread over a majority
of the provinces in China, about 29 provinces or regions. Further, with the
improvement of production capacity, a significant improvement in sales has also
been guaranteed by an increased yield capacity, both in new and existing
products.
Cost of Revenue: Compared to the corresponding figure last year, cost of sales
has increased as well, about 181.90% from $4,166,965 for the period as of
December 31, 2005 to the amount of $11,745,815 for the year as of December 31,
2006. As a percentage of revenues, the cost of sales increased from 48% for the
period as of December 31, 2005 to that of 54% for the period as of December 31,
2006. The increased cost of sales was primarily as a result of the increased
revenue during the fiscal year 2006.
Gross Margin: There was an increase in gross margin to $10,097,447 for the
period as of December 31, 2006 from that of $4,490,848 for the period as of
December 31, 2005. As a percentage of revenue, it was correspondingly from 52%
to 46%. The decreased gross margin was mainly due to an increase in cost of
sales rather than the growth of overall operation revenue.
Selling Expenses: Selling expense has also increased at the same time, primarily
for the purpose of distribution. Relative to the total operating expenses,
selling expenses approximately accounted for 18% for the year ended December 31,
2006. It was a dramatic decrease due to good management of distribution,
compared to 43% of operating expenses for the year ended December 31, 2005.
45
General & Administrative Expenses: There was an increase in general and
administrative expense for the year ended December 31, 2006 to $1,213,828 from
corresponding amount of $140,903 for the year ended December 31 2005. There were
two major reasons, due to the specific nature of pharmaceutical industry in
China, most of the sales will be realized through receivables. Accordingly, an
increased bad debt provision has been accrued. However, another important reason
was due to an increase in R&D, up 281.23%.
For the fiscal years ended December 31, 2006 and December 31, 2005, R&D expense
has covered a variety of pharmaceutical products such as Cardiovascular and
Cerebrovascular drugs, Natural Herb drugs, Diuretics drugs, Liver protecting
drugs, inhibitor drugs and others. In the next 2-3 years, our company will
continue focusing on R&D, for sustainable development of product varieties. The
outlay for R&D is expected to be around 5-10% as a percentage of total revenue
for each respective year.
Thus, as a percentage of revenues, the total operating expenses has grown to 7%
for the period as of December 31, 2006, from a 3% for that of fiscal year 2005.
Income from Operations: With the large increase in sales, although there was a
relative decrease in income from operations against revenue, from 49% for the
period as of December 31, 2005 to 39% for the period as of December 31, 2006, it
can be seen an absolute increase from $4,243,816 to the amount of $8,623,491 for
the corresponding fiscal years.
Financial Cost: Interest income and expense has stayed stable from last year,
with a net interest expense $144,890 ended December 31, 2006 from a net amount
of $185,683 for period as of December 31, 2005. In addition, government grants
including `Purchase of domestically made machinery refund' and other tax refunds
have been credited for business support this year, which resulted in the
increase in Other Income amounting to $108,485 for the year ended December 31,
2006.
Income Tax: During the year, the Company qualified for a preferential income tax
policy in China, i.e., "two-year free; third-fifth year half" for
profit-realized foreign invested company (FIE). Therefore, there was no
enterprise income tax this year as the company has been recognized as a FIE this
year.
Net Income: Net income, without consideration of foreign currency translation
factor, was $ 8,587,086 for the year ended December 31, 2006. It was more than
126% higher than the net income for the period ended December 31, 2005 which was
$3,799,550. As a percentage of revenue, there was a decrease from 44% to 39% for
the fiscal years respectively. Moreover, given the foreign currency translation
influence, comprehensive income is $9,151,031 for the year ended December 31,
2006, a 134.7% increase compared to $3,899,476 for last year ended December 31,
2005. The comparative result of operation has shown an organic growth of
business in sales, with a dramatic increase in sales and slight decrease in the
cost of sales and related expenses as a percentage of sales in total.
46
VI.Analysis to the financial position: Liquidity and Capital Resource
As of December 31, 2006, cash and cash equivalents were $656,441, which has also
increased by 42.3% compared to the ending balance as of December 31, 2005 at
$461,220. Meanwhile, during the year, the Company has borrowed short-term loans
of $6,533,649 as of December 31, 2006. It was primarily for working capital.
Figure 3:
-----------------------------------------------------------------------------------------------------
Summary of Cash Flow
-----------------------------------------------------------------------------------------------------
-----------------------------------
$,000 Years Ended December,31
-----------------------------------
2006 2005
------------------ ----------------
In thousands
Net cash provided by (used in) operating activities (1,736.33) (449.10)
----------------------------------------------------------------- ------------------ ----------------
Net cash provided by (used in) investing activities (192.00) (341.52)
----------------------------------------------------------------- ------------------ ----------------
Net cash provided by (used in) financing activities 2,105.43 1,248.73
----------------------------------------------------------------- ------------------ ----------------
Effect of Foreign Exchange translation 18.13 3.11
----------------------------------------------------------------- ------------------ ----------------
Net cash Flow 195.22 461.22
----------------------------------------------------------------- ------------------ ----------------
Net cash used in operating activities was $1,736,333 for the year ended at
December 31, 2006, nearly three times more compared to $ 449,095 for the period
ended at December 31, 2005. One of the significant reasons for this large
increase was due to the increase in trade account receivables and inventory.
Confidence can be seen from the stable improvement of trade capability in the
Company.
Net cash used in investing activities, for purchase of property, equipment and
that of intangible assets have been lowered to $182, 346 and $9,657 respectively
at the year end of December 31, 2006. There was not any cash generated from the
purchased of entity in the year 2006, compared to that of $131,336 in the year
2005.
Net cash proceed for financing activities has grown up to $2, 105,430 as of
December 31, 2006, 68% higher relative to the proceeds of $1,248,727 for the
period as of December 31, 2005. As analyzed above, the increase was primarily
because of the proceeds from note payables and loans from shareholders. For the
fiscal year as of December 31 2006, a $2,140,943 bank loan was borrowed for
working capital purpose.
47
Capital expenditures: For the past three fiscal years ended December 31, 2006,
there have been capital expenditures of $1,157,126, primarily for GMP Plant
Construction, purchase of equipment and intangible assets. As of December 31,
2006, there was no material commitments for capital expenditures other than for
those expenditures incurred in an ordinary course of business.
VII. Off-Balance Sheet Arrangements
There was no off-balance sheet arrangement in the Company.
VIII. Commitments
In January 2006, the Company converted its dividend payable of $4,304,371 into
short-term note bearing interest at the rate of 2.25% per annum.
IX. New Accounting Pronouncements
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3 ("SFAS
154"). This Statement replaces APB Opinion No. 20, Accounting Changes, and FASB
Statement No. 3, Reporting Accounting Changes in Interim Financial Statements,
and changes the requirements for the accounting for and reporting of a change in
accounting principle. SFAS 154 requires retrospective application to prior
period financial statements of a voluntary change in accounting principle unless
it is impractical to determine period specific changes. This statement is
effective for fiscal periods beginning after December 15, 2005 and is not
expected to have a significant impact on the Company's financial statements.
In November 2004, the Financial Accounting Standards Board, or FASB, issued FASB
Statement No. 151 "Inventory Costs, an Amendment of ARB No. 43 Chapter 4" ("FAS
151"). FAS 151 is applicable for Inventory costs incurred during fiscal years
beginning after June 15, 2005. FAS 151 requires that items such as idle facility
expense, excessive spoilage, double freight, and remanding be recognized as
current-period charges rather than being included in inventory regardless of
whether the costs meet the criterion of abnormal as defined in ARB 43. The
Company does not believe the adoption of the standard will have a material
impact on the Company upon adoption in 2006 as the Company has historically
expensed such costs as incurred.
X. Conclusion
48
The overall performance in year 2006 was outstanding. As a public Company
orientated at pharmaceutical industry, we put effort to product innovation. We
understand, without sustainable R&D, the medical progress and accessibility to
end-user can not fully be realized. In this regard, China Pharma will continue
to actively engage with the development and distribution of high-quality
products to the market.
Item 7 - Index to Financial Statements
The Financial Statements required by this Item begins at page F-1 hereof.
Item 8 - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None.
Item 8A - Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in Company reports
filed or submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed in Company reports filed under the Exchange Act is
accumulated and communicated to management, including the Company's Chief
Executive and Chief Financial Officer as appropriate, to allow timely decisions
regarding required disclosure.
Currently, we are in the process of revising the internal control and
procedures.
Item 8B - Other Information
None.
PART III
Item 9 - Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
The following table sets forth the names of all of our current directors and
executive officers to be appointed. The directors will serve until the next
annual meeting of the stockholders or until their successors are elected or
appointed and qualified. Executive officers will serve at the board's
discretion.
49
--------------------------------------------------------------------------------
Name Age Position
--------------------------------------------------------------------------------
Heung Mei TSUI 50 Director
--------------------------------------------------------------------------------
Zhilin LI 54 Director, President and Chief Executive Officer
--------------------------------------------------------------------------------
Xinhua WU 44 Director and Chief Financial Officer
--------------------------------------------------------------------------------
Jian YANG 52 Secretary
--------------------------------------------------------------------------------
Ms. Heung Mei TSUI. Ms. Tsui is director of the Company since October 19, 2005.
She is a self-employed business woman engaged in the re-export business,
including chemical products trade and electromechanical products trade. She is
also Toyota automobile's agent in Hainan province. She graduated from Huhan
Financial & Economic College in 1982.
Ms. Zhilin LI: Ms. Li is director, President and Chief Executive Officer of the
Company. She is a founder of Helpson, and has served as chairman and CEO of
Helpson since 1993. Ms. Li was formerly the president of Haikou Bio-engineering
institute, and the vice president of the Sichuan Institute of Biology . She
graduated from Sichuan University, where she majored in biology, and later
became an instructor.
Mr. Xinhua WU: Mr. Wu is director and Chief Financial Officer of the Company. He
has acted as CFO of Helpson since his hiring in 1999. Mr. Wu served as CFO and
assistant to the CEO at Hainan Guobang Enterprises Inc., where he was employed
from 1992 to 1999. Mr. Wu graduated from the University of Wales with an MBA
degree and Jiangxi Financial college with a Bachelor of Science degree in
Finance.
Ms. Jian YANG: Ms. Yang is Secretary of the Company since October 19, 2005. She
is a founder and director of Helpson. Ms. Yang was a technician at the Sichuan
Institute of Biology in 1990 and vice president of Haikou Biomedicine
Enginerring Co., Ltd. in 1991 Ms. Yang earned her MBA at the University of
Wales, England.
Board Composition and Committees
The board of directors are currently composed of Heung Mei Tsui, Zhilin Li and
Xinhua Wu. All board actions require the approval of a majority of the directors
in attendance at a meeting at which a quorum is present.
50
We currently have no committees of Audit, Compensation, or any other committees;
therefore, the board will act in the capacity of the absent committees.
Disclosure of Commission Position of Indemnification for Securities and
Liabilities
Our Amended and Restated Certificate of Incorporation, with certain exceptions,
eliminates any personal liability of directors or officers to us or our
stockholders for monetary damages for the breach of such person's fiduciary duty
to the extent permitted by law. We have also adopted by-laws which provide for
indemnification to the full extent permitted under the law which includes all
liability, damages, costs, or expenses arising from or in connection with
service for, employment by, or other affiliation with us to the maximum extent
and under all circumstances permitted by law.
There are presently no material pending legal proceeding to which a director,
officer, or employee of ours is a party. There is no pending litigation or legal
proceeding involving one of our directors, officers, employees or other agents
as to which indemnification is being sought, and we are not aware of any pending
or threatened litigation that may result in claims for indemnification by any
director, officer, employee or other agent.
To the extent provisions of our Amended and Restated Certificate of
Incorporation provide for indemnification of directors for liabilities arising
under the Securities Act or the Exchange Act, those provisions are, in the
opinion of the Securities and Exchange Commission, against public policy and
therefore are unenforceable.
Code of Ethics
We do not yet have a code of ethics. Due to the recent completion of the Private
Placement, the board of directors has decided to postpone the adoption of a code
of ethics until we are able to focus our business plan and develop a greater
infrastructure. Once we have adopted a Code of Ethics, a copy may be obtained by
sending a written request to our corporate Secretary.
Director Compensation
No cash compensation was paid to our director for services as a director during
the fiscal year ended December 31, 2006. We have no standard arrangement
pursuant to which our board of directors are compensated for their services in
their capacity as directors. The board of directors may award special
remuneration to any director undertaking any special services on behalf of our
company other than services ordinarily required of a director. All authorized
51
out-of-pocket expenses incurred by a director on our behalf will be subject to
reimbursement upon our receipt of required supporting document of such expenses.
No director received and/or accrued any compensation for his services as a
director, including committee participation and/or special assignments.
Section 16(a) Beneficial Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our
officers and directors, and persons who own more than ten percent of a class of
our capital stock, to file reports of ownership and changes in their ownership
with the Securities and Exchange Commission. These persons are required to
furnish us with copies of all Section 16(a) forms they file. Based solely on a
review of the copies of such forms received by us, we believe that during the
year ended December 31, 2006, all persons subject to Section 16(a) filing
requirements have filed on a timely basis reports required to be filed by
Section 16(a) of the Exchange Act.
Item 10 - Executive Compensation
No cash compensation was paid to our director for services as a director during
the fiscal year ended December 31, 2006. We have no standard arrangement
pursuant to which our board of directors is compensated for their services in
their capacity as directors. The board of directors may award special
remuneration to any director undertaking any special services on behalf of our
Company other than those services ordinarily required of a director. All
authorized out-of-pocket expenses incurred by a director on our behalf will be
subject to reimbursement upon our receipt of required supporting document of
such expenses. No director received and/or accrued any compensation for his
services as a director, including committee participation and/or special
assignments.
The following table provides compensation information for the period indicated
with respect to the person who served as our president for the years ended
December 31, 2006, 2005 and 2004, and all other of our executive officers
receiving total salary and bonus in excess of $100,000 during the years ended
December 31, 2006, 2005 and 2004 (collectively, the "Named Executive Officers"):
52
SUMMARY COMPENSATION TABLE
---------------------------------------------------------------- ---------------------------------- ---------
Long Term Compensation
---------------------------------------------------------------- ---------------------------------- ---------
Annual Compensation Awards Payouts
------------------------- -------- ---------- ----- ------------ ---------- --------------- ------- ---------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Name and Principal Year Salary($) Bonus Other Annual Restricted Securities LTIP All Other
Position ($) Compensa- Stock Under-lying Payouts Compen-
tion Awards($) Options/ SARs ($) sation ($)
(#)
------------------------- -------- ---------- ----- ------------ ---------- --------------- ------- ---------
(1) Zhilin LI 2006 0 0 0 0 0 0 0
Director, CEO and 2005 18,007 0 0 0 0 0 0
President
------------------------- -------- ---------- ----- ------------ ---------- ----------- ------- ---------
(2) Keith P. Boyd CEO,
CFO & President 2005 0 0 0 0 0 0 0
2004 0 0 0 0 0 0 0
------------------------- -------- ---------- ----- ------------ ---------- ----------- ------- ---------
(2) Tim Halter President,
CEO, CAO, Treasurer and 2005 0 0 0 0 0 0 0
Secretary
------------------------- -------- ---------- ----- ------------ ---------- --------------- ------- ---------
(1) Zhilin LI has been our CEO and president since October 20, 2005 and her
salary was paid in RMB. As of January 20, 2006, Zhilin LI was elected as the
director of the Company. Her salary in the fiscal year ended December 31, 2006
has not been paid until the date of this Form 10-KSB.
(2) Prior to October 20, 2005, Keith P. Boyd and Tim Halter did not spend any
material time working since we had no material business then. Accordingly, we
did not compensate any officer or director during this time period.
Stock Option Grants and Exercises
We currently have no option, retirement, pension or profit sharing programs for
the benefit of the directors, officers or other employees, but the board of
directors may recommend adoption of one or more such programs in the future.
Employment, Severance and Change of Control Agreements
Ms. Zhilin Li entered into an Employment Agreement with Helpson, which provides
that Ms. Li is employed by Helpson to perform executive management. The term of
her employment is from July 1, 2005 to June 30, 2010. Her annual salary is
RMB800,000 or approximately $100,000. Mr. Xinhua Wu was employed by Helpson to
act as its CFO. The term of his employment is from July 1, 2005 to June 30,
2010. His annual salary is RMB500,000 or approximately $62,500. Ms. Jian Yang
was employed by Helpson to act as its Deputy General Manager. The term of her
employment is from July 1, 2005 to June 30, 2010. Her annual salary is
RMB500,000 or approximately $62,500. Ms. Zhilin Li was paid RMB 150,000
(approximately US$18,007) as the compensation for acting as the Company's
53
director, CEO and president during the fiscal year ended June 30, 2005. Mr.
Xinhua Wu and Ms. Jian Yang received no compensation for acting as officers
during the fiscal year ended June 30, 2005. Ms. Zhilin Li ,Mr. Xinhua Wu and Ms.
Jian Yang has not received any compensation for acting as officers during the
fiscal year ended December 31, 2006 until the date of this Form 10-KSB.
Item 11 - Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information known to us with respect to
the beneficial ownership of our common stock as of March 27, 2006 and (i) all
persons who are known to us to be beneficial owners of five percent or more of
the common stock, (ii) each of our Directors, and (iii) all current Directors
and executive officers as a group.
NAME AND ADDRESS OF SHARES BENEFICIALLY
BENEFICIAL OWNER (1) OWNED % OF CLASS OWNED
Heung Mei Tsui 15,278,385 41.04
Zhilin Li 10,000,000 26.86
All Directors and Executive 25,278,385 67.9
Officers as a Group
(1) Unless otherwise stated, the address of all persons in the table is 2nd
Floor,No.17, Jinpan Road, Kaikou, Hainan Province, China.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power with
respect to the securities. Unless otherwise indicated, the address for each of
the individuals listed in the table is care of Hainan Helpson Bio-Pharmaceutical
Co. Ltd, Unit 8, D Area, Office Hall, Haikou Bonded Zone, Haikou, Hainan
Province, China.
Unless otherwise indicated by footnote, the persons named in the table have sole
voting and sole investment power with respect to all shares of common stock
shown as beneficially owned by them, subject to applicable community property
laws. Percentage of beneficial ownership is based on 37,228,938 shares of our
common stock outstanding as of March 23, 2007.
Item 12 - Certain Relationships and Related Transactions
None.
54
Item 13 - Exhibits
(1) Our audited financial statements are included in this Annual Report on Form
10-KSB.
(2) EXHIBITS
----------- --------------------------------------------------------------------
Exhibit No. Description
----------- --------------------------------------------------------------------
2.1 Securities Exchange Agreement by and among Onny Investment
Limited dated October 19, 2005. (3)
----------- --------------------------------------------------------------------
3.1 Memorandum and Articles of Association. (4)
----------- --------------------------------------------------------------------
3.2 Articles of Association of Helpson Medical Biotechnology Co. (3)
----------- --------------------------------------------------------------------
10.1 Stock Purchase Agreement by and among Halter Financial Group Inc.
dated May 11, 2005 filed on May 11, 2005. (1)
----------- --------------------------------------------------------------------
10.2 Subscription Agreement by and among Onny Investment Limited
stockholders. (3)
----------- --------------------------------------------------------------------
10.3 Employment Contract by and among Zhilin LI dated July 1, 2005.
(5)
----------- --------------------------------------------------------------------
10.4 Employment Contract by and among Xinhua WU dated July 1, 2005.
(5)
----------- --------------------------------------------------------------------
10.5 Employment Contract by and among Jian YANG dated July 1, 2005 (5)
----------- --------------------------------------------------------------------
10.6 Subscription and Registration Rights Agreement among China Pharma
and 17 investors (6)
----------- --------------------------------------------------------------------
10.7 Form of Warrant(6)
----------- --------------------------------------------------------------------
10.8* Supply Agreement entered into by Hainan Helpson Medicine and
Bio-Technology Co. Ltd. and Sichuang Chengxin Pharmaceutical
Company
----------- --------------------------------------------------------------------
10.9* Supply Agreement entered into by Hainan Helpson Medicine and
Bio-Technology Co. Ltd. and Hainan Xinxin Biotechnology Company
----------- --------------------------------------------------------------------
10.10* Sales Contract entered into by Hainan Helpson Medicine and
Bio-Technology Co. Ltd. and Hainna xinglin Medicine company
----------- --------------------------------------------------------------------
10.11* Supply Agreement entered into by Hainan Helpson Medicine and
Bio-Technology Co. Ltd. and Hainan liang bishi huangzhuang pin
company
----------- --------------------------------------------------------------------
16.1 Letter regarding Change in certifying Accountant dated August 15.
(2)
----------- --------------------------------------------------------------------
21 Subsidiaries of China Pharma Holdings, Inc. filed on October 20,
2005. (4)
----------- --------------------------------------------------------------------
31.1* Certification of Chief Executive Officer pursuant to Rule 13a-14
and Rule 15d-14(a) of the Exchange Act.
----------- --------------------------------------------------------------------
31.2* Certification of Chief Financial Officer pursuant to Rule 13a-14
and Rule 15d-14(a) of the Exchange Act.
----------- --------------------------------------------------------------------
32.1* Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
----------- --------------------------------------------------------------------
55
---------- ---------------------------------------------------------------------
32.2* Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
---------- ---------------------------------------------------------------------
*Filed herewithin
(1) Previously filed as an exhibit to our report on Form 8-K (Commission File
Number: 000-29523) filed with the Commission on May 11, 2005.
(2) Previously filed as an exhibit to our report on Form 8-K (Commission File
Number: 000-29523) filed with the Commission on August 18, 2005.
(3) Previously filed as an exhibit to our report on Form SB-2 (Commission File
Number: 333-129161) filed with the Commission on October 20, 2005.
(4) Previously filed as an exhibit to our report on Form SB-2 (Commission File
Number: 333-129161) filed with the Commission on December 23, 2005.
(5) Previously filed as an exhibit to our report on Form 10-QSB (Commission
File Number: 000-29523) filed with the Commission on November 16, 2006.
(6) Previously filed as an exhibit to our report on Form 8-K (Commission File
Number: 000-29523) filed with the Commission on February 6, 2007.
Item 14. Principal Accountant Fees and Services
Our independent accountant for the year ended December 31, 2006 were Hansen,
Barnett & Maxwell ("HBM").
FISCAL 2005 FISCAL 2006
----------- -----------
-------------------------------------------------------------------------------
Audit Fees (1) $ 108,000 $ 124,064
--------------------------------------------------------------------------------
Audit-Related Fees(2) $ 0 $ 0
--------------------------------------------------------------------------------
Tax Fees(3) $ 0 $ 0
--------------------------------------------------------------------------------
All Other Fees(4) $ 0 $ 2,286
--------------------------------------------------------------------------------
Total $108,000 $ 126,350
--------------------------------------------------------------------------------
(1) During the fiscal year ended December 31, 2005, our principal accountant,
HBM, billed us $50,500 in fees for professional services for the audit of
our annual financial statements, review of financial statements included in
our Form 10-QSB quarterly reports. In addition, we also paid $57,500 to
56
Baker Tilly China for their involvements in the auditing and reviews under
the supervision of HBM. During the fiscal year ended December 31, 2006, HBM
billed us $66,000 in fees for professional services for the audit of our
annual financial statements, review of financial statements included in our
Form 10-QSB quarterly reports. We paid $58,064 to Baker Tilly China for
their involvements in the auditing and reviews under the supervision of
HBM.
(2) During the fiscal year ended December 31, 2005 and 2006, HBM billed us $0
in fees for assurance and related services related to the performance of
the audit and review of the Company's financial statement.
(3) During the fiscal year ended December 31, 2005 and 2006, HBM billed us $0
in fees for professional services for tax planning and preparation.
(4) During the fiscal year ended December 31, 2005, HBM billed us $0 in fees
for professional services for other fees. During the fiscal year ended
December 31, 2006, HBM billed us $2,286 in fees for traveling.
(5) The percentage of hours expended on the principal accountant's engagement
to audit our financial statements for the most recent fiscal year that were
attributed to work performed by persons other than the principal
accountant's full time, permanent employees was 65%.
57
SIGNATURES
In accord with Section 13 or 15(d) of the Securities Act of 1933, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereto duly authorized.
China Pharma Holdings, Inc.
Dated: March 26, 2007 By: /s/ Zhilin Li
--------------- ----------------------------------
Zhilin Li,
Director, Chief Executive Officer,
President and Director
Dated: March 26, 2007 By: /s/ Xinhua Wu
--------------- -------------------------------
Xinhua Wu
Director and
Chief Financial Officer
In accordance with the Securities Exchange Act of 1934, as amended, this report
has been signed below by the following persons on behalf of registrant and in
the capacities and on the date as indicated.
Dated: March 26, 2007 By: /s/ Zhilin Li
--------------- ----------------------------------
Zhilin Li,
Director, Chief Executive Officer,
President and Director
Dated: March 26, 2007 By: /s/ Xinhua Wu
--------------- ----------------------------------
Xinhua Wu
Director and
Chief Financial Officer
58
F-1
CHINA PHARMA HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm......................F-2
Consolidated Balance Sheets..................................................F-3
Consolidated Statements of Operations........................................F-4
Consolidated Statements of Stockholders' Equity..............................F-5
Consolidated Statements of Cash Flows........................................F-6
Notes to the Consolidated Financial Statements...............................F-7
F-1
HANSEN, BARNETT & MAXWELL, P.C.
A Professional Corporation
CERTIFIED PUBLIC ACCOUNTANTS
5 Triad Center, Suite 750
Salt Lake City, UT 84180-1128
Phone: (801) 532-2200
Fax: (801) 532-7944
www.hbmcpas.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and the Shareholders
China Pharma Holdings, Inc.
We have audited the accompanying consolidated balance sheets of China Pharma
Holdings, Inc. as of December 31, 2006 and 2005, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the year
ended December 31, 2006 and for the period from January 12, 2005 (date of
inception) through December 31, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of China
Pharma Holdings, Inc. and the results of their operations and their cash flows
for the year ended December 31, 2006 and for the period from January 12, 2005
(date of inception) through December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America.
HANSEN, BARNETT & MAXWELL, P.C.
Salt Lake City, Utah
March 21, 2007
F-2
CHINA PHARMA HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2006 2005
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 656,441 $ 461,220
Trade accounts receivable, less allowance for doubtful
accounts of $1,562,494 and $1,412,353, respectively 12,101,979 5,709,762
Other receivables, less allowance for doubtful
accounts of $27,517 and $111,029, respectively 355,554 385,957
Deferred offering costs 59,390 -
Advances to suppliers 2,255,877 2,123,729
Inventory 10,277,887 5,785,196
------------ ------------
Total Current Assets 25,707,128 14,465,864
------------ ------------
Non-current Assets:
Property and equipment, net of accumulated depreciation of
$619,645 and $250,184, respectively 2,725,173 2,808,342
Intangible assets, net of accumulated amortization of
$184,175 and $135,656, respectively 65,344 96,406
Deferred tax assets 16,736 130,458
------------ ------------
Total Non-current Assets 2,807,253 3,035,206
------------ ------------
TOTAL ASSETS $ 28,514,381 $ 17,501,070
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Trade accounts payable $ 477,291 $ 679,104
Accrued expenses 104,216 15,625
Accrued taxes payable 167,419 565,236
Other payables 185,096 250,317
Advances from customers 141,871 50,755
Accounts payable -related parties 22,650 -
Short-term notes payable 6,533,649 -
Dividends payable - 4,209,889
------------ ------------
Total Current Liabilities 7,632,192 5,770,926
------------ ------------
Research and development commitments 31,980 30,966
------------ ------------
Total Liabilities 7,664,172 5,801,892
------------ ------------
Stockholders' Equity:
Common stock, $0.001 par value, 60,000,000 shares
authorized, 34,723,056 shares issued and outstanding 34,723 34,723
Additional paid-in capital 7,764,979 7,764,979
Foreign currency translation adjustment 663,871 99,926
Retained earnings 12,386,636 3,799,550
------------ ------------
Total Stockholders' Equity 20,850,209 11,699,178
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 28,514,381 $ 17,501,070
============ ============
The accompanying notes are integral part of these consolidated financial
statements
F-3
CHINA PHARMA HOLDINGS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
For the period
from January 12,
2005 (Date of
For the year Inception)
ended through
December 31, December 31,
2006 2005
----------------- -----------------
Revenue $ 21,843,262 $ 8,657,813
Cost of Revenue 11,745,815 4,166,965
----------------- -----------------
Gross Profit 10,097,447 4,490,848
----------------- -----------------
Operating expenses:
Selling expenses 260,128 106,129
General and administrative 1,213,828 140,903
----------------- -----------------
Total Operating Expenses 1,473,956 247,032
----------------- -----------------
Income from Operations 8,623,491 4,243,816
----------------- -----------------
Non-operating income (expenses):
Interest income 991 769
Interest expense (145,881) (186,452)
Other income (expense) 108,485 (6,482)
----------------- -----------------
Total Non-operating Income (Expense) (36,405) (192,165)
----------------- -----------------
Income Before Taxes 8,587,086 4,051,651
Income tax expense - 252,101
Net Income $ 8,587,086 $ 3,799,550
================= ==================
Comprehensive income -
foreign currency translation adjustments 563,945 99,926
----------------- -----------------
Comprehensive Income $ 9,151,031 $ 3,899,476
================= ==================
Basic and Diluted Earnings per Common Share $ 0.25 $ 0.34
================= ==================
Weighted-average Common Shares Outstanding 34,723,056 11,289,480
================= ==================
The accompanying notes are integral part of these consolidated financial
statements
F-4
CHINA PHARMA HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Additional Other Total
Common Stock Paid-in Comprehensive Retained Shareholders'
Shares Amount Capital Income Earnings Equity
------------ ------------ ------------ ------------ ------------ ------------
Balance, January 12, 2005
(Date of Inception) - $ - $ - $ - $ - $ -
Shares issued for cash,
April 12, 2005 85,112 85 (84) - - 1
Shares issued for cash,
August 16, 2005 25,193,273 25,193 3,465,981 - - 3,491,174
Shares issued for cash, net
October 20, 2005 6,944,611 6,945 4,306,055 - - 4,313,000
Shares issued to acquire China
Pharma Holdings, Inc.,
recorded as a purchase 2,500,060 2,500 (6,973) - - (4,473)
Net income for the year - - - - 3,799,550 3,799,550
Foreign currency translation
adjustment - - - 99,926 - 99,926
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2005 34,723,056 34,723 7,764,979 99,926 3,799,550 11,699,178
Net income for the year - - - 8,587,086 8,587,086
Foreign currency translation
adjustment - - - 563,945 - 563,945
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2006 34,723,056 $ 34,723 $ 7,764,979 $ 663,871 $ 12,386,636 $ 20,850,209
============ ============ ============ ============ ============ =============
The accompanying notes are integral part of these consolidated financial
statements
F-5
CHINA PHARMA HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the period
from January 12,
2005 (Date of
For the year Inception)
ended through
December 31, December 31,
2006 2005
---------------- ----------------
Cash Flows from Operating Activities:
Net income $ 8,587,086 $ 3,799,550
Depreciation and amortization 397,001 250,184
Accretion of discount on notes payable - 86,060
Changes in assets and liabilities:
Trade accounts receivable (6,077,526) (1,198,199)
Other receivables 42,642 80,164
Advances to suppliers (61,345) (916,792)
Inventory (4,214,702) (2,395,393)
Deferred tax assets 115,564 (89,763)
Trade accounts payable (219,427) 383,188
Accrued expenses 86,265 11,330
Accrued taxes payable (407,744) 356,187
Other payables (71,759) (588,748)
Advances from customers 87,612 (226,863)
---------------- ----------------
Net Cash Used in Operating Activities (1,736,333) (449,095)
---------------- ----------------
Cash Flows from Investing Activities:
Purchase of property and equipment (182,346) (433,524)
Purchase of intangible assets (9,657) (50,611)
Notes receivable - 11,277
Net cash received in purchase of Helpson - 131,336
---------------- ----------------
Net Cash (Used) by Investing Activities (192,003) (341,522)
---------------- ----------------
Cash Flows from Financing Activities:
Payment of dividend payable - (237,599)
Payment of note payable - (6,317,849)
Proceeds from note payable 2,140,943 -
Proceeds from loan from shareholder 22,650 -
Proceeds from issuance of common stock - 7,804,175
Payment of offering costs (58,167) -
---------------- ----------------
Net Cash Proceeds from Financing Activities 2,105,426 1,248,727
---------------- ----------------
Effect of Exchange Rate Changes on Cash 18,131 3,110
---------------- ----------------
Net Change in Cash 195,221 461,220
---------------- ----------------
Cash and Cash Equivalents at Beginning of Period 461,220 -
---------------- ----------------
Cash and Cash Equivalents at End of Period $ 656,441 $ 461,220
================ ================
The accompanying notes are integral part of these consolidated financial
statements
F-6
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization - Onny Investment Limited ("Onny") was incorporated in the British
Virgin Islands on January 12, 2005 and was a development stage enterprise
through June 15, 2005. On June 16, 2005, Onny acquired all of the outstanding
shares of Hainan Helpson Medical & Biotechnology Co., Ltd, a privately held
Chinese joint venture ("Helpson") and emerged from the development stage.
On October 19, 2005, Onny was reorganized as a wholly owned subsidiary of China
Pharma Holdings, Inc., formerly TS Electronics, (the Company"). The
reorganization was accomplished by an exchange of Onny's common shares for
25,278,385 shares of the Company's common stock resulting in a 851-for-1
exchange ratio. In addition, the prior Onny convertible preferred shareholders
exchanged their shares for 6,944,611 shares of the Company's common stock
resulting in a 694-for-1 exchange ratio. The reorganization of Onny into the
Company was recognized as a stock split of the common stock of Onny and the
effective issuance by Onny of 2,500,060 shares of the Company's common stock in
exchange and the assumption of $4,473 in liabilities. This transaction was
accounted for as a reverse acquisition of the Company and was recognized as a
non-monetary exchange.
Nature of Operations - Helpson manufactures and markets several Western and
Chinese medicines sold mainly to hospitals and private retailers in The People's
Republic of China (PRC), through its marketing department located in Hainan
Province. There are also nine other offices, with sales representatives in other
provinces and cities throughout the PRC. Helpson's other operating activities
include biochemical products, health products, and cosmetics.
Accounting Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosures of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
Consolidation and Basis of Presentation - The accompanying financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The functional currency of the operating
subsidiaries in the PRC is the Chinese Yuan Renminbi (CNY); however, the
accompanying financial statements have been expressed in United States Dollars
("USD"). The accompanying consolidated balance sheets have been translated into
USD at the exchange rates prevailing at each balance sheet date. The
accompanying consolidated statements of operations have been translated using
the average exchange rates prevailing during the periods of each statement. See
Note 9.
The accompanying consolidated financial statements include the accounts and
operations of Onny from the date of its inception on January 12, 2005 and the
accounts and operations of Helpson from the date of its acquisition on June 16,
2005. The accompanying consolidated financial statements have been restated on a
retroactive basis for the effects of the stock split resulting from the
reorganization of Onny into the Company. All significant inter-company balances
F-7
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
and transactions have been eliminated in consolidation.
Fair Values of Financial Instruments - Based on the borrowing rates currently
available to the Company for bank loans with similar terms and average
maturities, the carrying amounts of notes payable that were outstanding during
the current period approximated fair value because of either the immediate or
short-term maturity of these financial instruments or because the underlying
instruments are at interest rates which approximated current market rates.
Cash and cash equivalents - Cash and cash equivalents include interest bearing
and non-interest bearing bank deposits, money market accounts, and short-term
certificates of deposit with original maturities of three months or less. Cash
deposits are held at financial institutions in The Peoples Republic of China and
are not insured by the FDIC.
Trade receivables and allowance for doubtful accounts - Trade receivables are
carried at original invoiced amounts less an allowance for doubtful accounts.
The allowances for doubtful accounts are calculated based on detailed review of
certain individual customer accounts and an estimation of the overall economic
conditions affecting the Company's customer base. The Company reviews a
customer's credit history before extending credit. If the financial condition of
its customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required. A provision is made
against accounts receivable to the extent they are considered unlikely to be
collected. It is common practice in China for receivables to extend beyond one
year. Included in trade receivables is approximately $1,265,079 that occurred
more than one year from December 31, 2006, but is estimated to still be
collectable.
Inventory - Inventories are stated at the lower of cost or net realizable value,
on an average cost basis. The method of determining inventory costs is used
consistently from year to year. Allowance for inventory obsolescence is provided
when the market value of certain inventory items are lower than the cost.
Valuation of Long-lived Assets - The carrying values of the Company's long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that they may not be recoverable. Should such an event occur, the
Company would project undiscounted cash flows to be generated from the use of
the asset and its eventual disposition over the remaining life of the asset. If
projections indicate that the carrying value of the long-lived asset will not be
recovered, the carrying value is reduced by the estimated excess of the carrying
value over the projected discounted cash flows.
Property and Equipment - Property and equipment are stated at cost. Maintenance
and repairs are charged to expense as incurred and major improvements are
capitalized. Gains or losses on sales or retirements are included in the
statement of operations in the period of disposition.
Intangible Assets - Acquisition costs on patents, trademarks, licenses,
techniques, formulas and other intangibles are capitalized and amortized using
the straight-line method over their useful lives. For those intangible assets,
such as patents, with legal protection over a period, their useful life is the
protected period. Others that do not have legal protection periods are amortized
F-8
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
generally over 5 to 10 years. The Company does not capitalize internally
generated intangible assets. The Company's intangible assets consist of
techniques for medicines.
Advances to Suppliers and Advances from Customers - The Company, as is the
common practice in the PRC, will often pay advanced payments to suppliers for
materials and receive from customers advances for finished products. As of
December 31, 2006 and 2005, the advances to suppliers were $2,255,877 and
$2,123,729, respectively, and the advances from customers were $141,871 and
$50,755, respectively.
Revenue Recognition - The Company recognizes revenue when it is realized and
earned. The Company considers revenue realized or realizable and earned when (1)
it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the
sales price is fixed or determinable, and (4) collectibility is reasonably
assured. Delivery does not occur until products have been shipped to the client,
risk of loss has transferred to the client and client acceptance has been
obtained, client acceptance provisions have lapsed, or the Company has objective
evidence that the criteria specified in client acceptance provisions have been
satisfied. The sales price is not considered to be fixed or determinable until
all contingencies related to the sale have been resolved.
Cost of Revenues - Cost of revenues includes wages, materials, handling charges,
and other expenses associated with the manufacture and delivery of product.
Research and Development - Research and development expenditures are recorded as
expenses in the period in which they occur.
Retirement Benefit Plans - The Company contributes to various employee
retirement benefit plans organized by provincial governments under which it is
required to make monthly contributions to these plans at rates prescribed by the
related provincial governments. The provincial governments undertake to assume
the retirement benefit obligations of all existing and future retired employees
of the Company. Contributions to these plans are charged to expense as incurred.
Advertising Costs - Advertising costs are expensed when incurred.
Basic and Diluted Earnings per Common Share - Basic earnings per common share is
computed by dividing net income by the weighted-average number of common shares
outstanding. Diluted earnings per common share are calculated to give effect to
potentially issuable dilutive common shares. There were no potentially issuable
common shares outstanding at December 31, 2005 and 2006.
Credit risk - The carrying amounts of accounts receivable included in the
balance sheet represent the Company's exposure to credit risk in relation to its
financial assets. No other financial assets carry a significant exposure to
credit risk. The Company performs ongoing credit evaluations of each customer's
financial condition. It maintains allowances for doubtful accounts and such
allowances in the aggregate have not exceeded management's estimations.
Interest rate risk - The Company is exposed to the risk arising from changing
F-9
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
interest rates, which may affect the ability of repayment of existing debts and
viability of securing future debt instruments within the PRC.
New Accounting Standards - In December 2004, FASB issued Statements of Financial
Accounting Standards (SFAS) 123R, "Share-Based Payment" (SFAS 123R). SFAS No.
123R revises FASB Statement No. 123, "Accounting for Stock-Based Compensation,"
and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees."
SFAS 123R focuses primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions. SFAS 123R
requires companies to recognize in the statement of operations the cost of
employee services received in exchange for awards of equity instruments based on
the grant-date fair value of such awards (with limited exceptions). SFAS 123R is
effective as of the first reporting period beginning after December 15, 2005.
The Company has not yet quantified the effects of the adoption of SFAS 123R, but
it is expected that the new standard will result in significant stock-based
compensation expense. The pro forma effects on net loss and loss per share if
the Company had applied the fair value recognition provisions of the original
SFAS 123R on stock compensation awards (rather than applying the intrinsic value
measurement provisions of APB 25) are disclosed above in stock-based
compensation. Although such pro forma effects of applying the original SFAS 123
may be indicative of the effects of adopting SFAS 123R, these provisions differ
in some important respects.
In December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of
Non-monetary Assets-an amendment of APB Opinion No. 29" (SFAS 153). The Company
adopted the provisions of SFAS 153 in January 2006. The adoption of SFAS 153 did
not have a material impact on the Company's consolidated financial statements.
In May, 2005, the FASB issued SFAS No. 154, "Accounting Changes and Errors
Corrections-an amendment to APB Opinion No. 20 and Statement of Financial
Accounting Standards No. 3" (SFAS 154). The Company adopted the provisions of
SFAS 154 in January 2006. The adoption of SFAS 154 did not have a material
impact on the Company's consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments -- an amendment of FASB Statements No. 133 and 140 (SFAS
155). SFAS 155 eliminates the prohibition on a qualifying special-purpose entity
from holding a derivative financial instrument that pertains to a beneficial
interest other than another derivative financial instrument. SFAS 155 is
effective for the Company for all financial instruments acquired or issued
beginning January 1, 2007. The impact of SFAS No. 155 will depend on the nature
and extent of any new derivative instruments entered into after the effective
date.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140 (SFAS 156). SFAS 156
amends SFAS 140 requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a financial asset. It
also requires all separately recognized servicing assets and servicing
liabilities to be initially measured at fair value, if practicable. SFAS 156
permits an entity to use either the amortization method or the fair value
measurement method for each class of separately recognized servicing assets and
F-10
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
servicing liabilities. SFAS 156 is effective for the Company as of January 1,
2007. The impact of adoption of this statement on the Company's consolidated
financial statements, if any, has not yet been determined.
In July 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes" (FIN 48), which attempts to set out a consistent framework for
preparers to use to determine the appropriate level of tax reserves to maintain
for uncertain tax positions. This interpretation of FASB Statement No. 109 uses
a two-step approach wherein a tax benefit is recognized if a position is
more-likely-than-not to be sustained. The amount of the benefit is then measured
to be the highest tax benefit which is greater than fifty percent likely to be
realized. FIN 48 also sets out disclosure requirements to enhance transparency
of an entity's tax reserves. The Company will be required to adopt this
Interpretation as of January 1, 2007. The Company is still evaluating the impact
of the adoption of FIN 48.
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, "Fair Value Measurements" (SFAS 157), which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles and requires additional disclosures about fair value
measurements. SFAS 157 aims to improve the consistency and comparability of fair
value measurements by creating a single definition of fair value. The Statement
emphasizes that fair value is not entity-specific, but instead is a market-based
measurement of an asset or liability. SFAS 157 upholds the requirements of
previously issued pronouncements concerning fair value measurements and expands
the required disclosures. This Statement is effective for financial statements
issued for fiscal years beginning after November 15, 2007, however earlier
application is permitted provided the reporting entity has not yet issued
financial statements for that fiscal year. The Company does not believe that the
adoption of SFAS 157 will have a material effect on its consolidated financial
statements.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108 (SAB 108). SAB 108 was issued to provide
interpretive guidance on how the effects of the carryover reversal of prior year
misstatements should be considered in quantifying a current year misstatement.
The provisions of SAB 108 are effective for the Company for its December 31,
2006 year-end. The adoption of SAB 108 had no impact on the Company's
consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities", including an amendment of FASB
Statement No. 115 SFAS 159. This pronouncement permits entities to choose to
measure many financial instruments and certain other items at fair value that
are not currently required to be measured at fair value. SFAS 159 is effective
as of the beginning of an entity's first fiscal year that begins after November
15, 2007. The impact of adopting SFAS 159 on the Company's consolidated
financial statements, if any, has not yet been determined.
NOTE 2 - ACQUISITION
On May 25, 2005, the Company entered into an agreement with the shareholders of
Helpson, in which the Company agreed to acquire, and the shareholders of Helpson
agreed to sell, all of the outstanding shares of Helpson in exchange for the
assumption of obligations to make cash payments to the Helpson shareholders in
F-11
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
the form of common stock dividends from Helpson of $4,154,041, the assumption of
$4,646,409 of other liabilities and the issuance of non-interest bearing
promissory notes totaling $3,413,265 payable three months after Helpson obtained
a business license in the PRC as a wholly foreign owned entity. Helpson obtained
such license on June 16, 2005 and the shares of Helpson were transferred to the
Company on that date. Since June 16, 2005 was recognized as the date of the
acquisition, the promissory notes became due September 16, 2005.
Since Helpson is an operating company and control of Helpson changed upon the
closing of the acquisition agreement, the Company is the accounting acquirer and
has recognized the acquisition of Helpson as a business combination in
accordance with Statements of Financial Accounting Standards No. 141, Business
Combinations. On April 25, 2005, Helpson declared a dividend to the selling
shareholders of $4,154,041 which equaled Helpson's retained earnings at March
31, 2005 less deferred income tax assets of $86,985 that are not considered part
of distributable profits under PRC law. The fair value of the net assets of
Helpson was determined by appraisal and exceeded the purchase price of the net
assets acquired. That excess was allocated as a pro rata reduction of the
amounts that otherwise would have been assigned to the non-current assets
acquired.
At June 16, 2005, the purchase price was allocated to the assets acquired and
liabilities assumed as follows:
Current assets $ 9,570,918
Property and equipment 2,555,565
Intangible 71,210
------------------
Total Assets Acquired 12,197,693
------------------
Current liabilities 7,864,066
Long-term liabilities 1,005,694
------------------
Total Liabilities Assumed 8,869,760
------------------
Net Assets Acquired $ 3,327,933
==================
Intangible assets consist of registered patents, trademarks, licenses,
techniques and formulas related to several Western and Chinese medicines,
biochemical products, health products, and cosmetics. These intangible assets
have a weighted-average useful life of approximately 5 years.
The following pro forma information is presented to reflect the operations of
the Company for the year ended December 31, 2005, as though the acquisition of
Helpson had been completed on January 12, 2005, and the operations of the
Company and Helpson are combined for the entire year. The pro forma information
is only illustrative of the effects of the acquisition and does not necessarily
reflect the results of operations that would have resulted had the acquisition
actually occurred on that date.
F-12
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
For the Year Ended
December 31, 2005
(proforma)
--------------------
(unaudited)
Revenue $ 14,075,521
Net Income 5,778,901
------------------
Basic and diluted earnings perr common share $ 0.17
------------------
Pro forma net income for the twelve months ended December 31, 2005 includes
nonrecurring interest expense of $85,332 resulting from the amortization of the
discount on the $3,413,265 promissory notes payable to the former Helpson
shareholders, which discount was computed based upon an imputed interest rate of
10% per annum.
The reorganization was recognized as a stock split of the common stock of Onny
and the effective issuance by Onny of the 2,500,060 shares of common stock of
the Company that remained outstanding in exchange for the assumption of $4,473
of liabilities. The acquisition of the Company was recognized as a non-monetary
exchange.
NOTE 3 - INVENTORY
Inventory consisted of the following at December 31, 2006 and 2005:
December 31,
------------
2006 2005
---- ----
Raw materials $ 8,458,210 $ 4,673,352
Work in progress 1,679,952 819,146
Finished goods 139,725 292,698
----------- -----------
Total Inventory $10,277,887 $ 5,785,196
=========== ===========
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2006 and 2005:
F-13
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31,
------------
2006 2005
---- ----
Permit of land use $ 360,304 $ 348,884
Building 1,640,629 1,123,144
Plant, machinery and equipment 1,253,572 1,120,289
Motor vehicle 14,763 14,295
Office equipment 75,550 62,211
Construction in progress - 389,703
--------- ---------
Total 3,344,818 3,058,526
Less: accumulated depreciation (619,645) (250,184)
--------- ---------
Property and Equipment, net $ 2,725,173 $ 2,808,342
=========== ===========
Depreciation is computed on a straight-line basis over the estimated useful
lives of the assets as follows:
Asset Life - years
------------------------- ------------------
Permit of land use 40 - 70
Building 20 - 35
Plant, machinery and equipment 10
Motor vehicle 5 - 10
Office equipment 5
For the year ended December 31, 2006, depreciation expense was $353,831. For the
period from January 12, 2005 (Date of Inception) through December 31, 2005
depreciation expense was $213,696.
NOTE 5 - INTANGIBLE ASSETS
Intangible assets represent the costs on patents, trademarks, licenses,
techniques and formulas. Intangible assets have a weighted-average remaining
useful life of approximately three years. Amortization of intangible assets was
$43,170 for the year ended December 31, 2006, and $36,488 for the period from
January 12, 2005 through December 31, 2005.
The estimated aggregate amortization expense for the next three years follows:
Year Amount
------------ ------------------
2007 $ 27,869
2008 19,200
2009 18,275
------------------
Total $ 65,344
------------------
NOTE 6 - DEBT
During 2006, the Company borrowed approximately $2,174,608 from the
Communication Bank of China in three installments. The first two installments
F-14
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
totaled approximately $1,535,018 and were borrowed in July 2006 at a interest
rate of 6.1425%. The final installment was for approximately $639,591 and was
borrowed in August 2006 at a rate of 6.4260%. The loan is due in one year from
borrowing and is collateralized with equipment and machinery valued at
$4,657,400. At December 31, 2006 the company also had a note payable due to the
former shareholders of Helpson, see Note 10. The value of the note at year end
was $4,359,041.
NOTE 7 - INCOME TAXES
The Company accounts for its income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, which requires recognition of
deferred tax assets and liabilities and their respective tax bases and any tax
credit carry forwards available. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
According to federal law in the Peoples Republic of China (PRC), enterprises
with foreign investment and foreign enterprises doing business in the PRC are
generally subject to federal enterprise income tax at a rate of 30%. Effective
at the beginning of 2006 and extending through 2007, Peoples Republic of China
granted the company a "tax holiday" that allows the Company to be exempt from
income taxes for the first two profitable years. This "tax holiday" further
allows the Company to be exempt from 50% of income taxes during the third
through the fifth years. The reduced tax rate for 2008 through 2010 is 15%.
Additionally, Hainan province is considered a `developing economic region' which
has a reduced statutory tax rate of 15%, which results in a tax holiday rate of
7.5% during the third through the fifth years of profitability.
Following is a reconciliation of income taxes calculated at the United States'
federal statutory rates to actual income tax expense:
December 31,
------------
2006 2005
---- ----
Tax at US Federal statutory rates (34%) $ 2,919,609 $ 1,377,561
Non-deductible expenses 27,559 137,458
Change in temporary differences (22,654) (114,254)
Effect of lower foreign tax rates (2,924,514) (1,148,664)
------------ ------------
Income tax provision $ - $ 252,101
------------ ------------
The company has a deferred tax asset based upon the temporary differences from
the allowance for bad debt that equaled $540,604 at December 31, 2006 and
$130,458 at December 31, 2005. The Company has also incurred various other
taxes, comprised primarily of business taxes, value-added taxes, urban
construction taxes, education surcharges and others. Any unpaid amounts are
reflected on the balance sheets as accrued taxes payable.
NOTE 8 - STOCKHOLDERS' EQUITY
On April 12, 2005, Onny was incorporated and issued 85,112 shares for $1. On
F-15
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
August 16, 2005, the shareholder of Onny made capital investments of cash into
Onny of $3,491,174 in exchange for the issuance of 25,193,273 shares of common
stock. On October 19, 2005 Onny issued shares of convertible preferred stock for
$4,313,000 (net of offering costs of $687,000). In conjunction with the
reorganization of Onny into the Company, which also occurred on October 19,
2005, these preferred shares were converted into 6,944,611 shares of common
stock. The reorganization of Onny into the Company on October 19, 2005, is
reflected in these consolidated financial statements by the issuance of
2,500,060 shares of common stock and the assumption of $4,473 of liabilities.
See Note 2. In 2006, the stockholders approved increasing the shares of common
stock authorized by 30,000,000 shares for a total of 60,000,000 shares
authorized.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Economic environment - Significantly all of the Company's operations are
conducted in the PRC, and therefore the Company is subject to special
considerations and significant risks not typically associated with entities
operating in the United States of America. These risks include, among others,
the political, economic and legal environments and foreign currency exchange.
The Company's results may be adversely affected by changes in the political and
social conditions in the PRC, and by changes in governmental policies with
respect to laws and regulations, anti-inflationary measures, currency conversion
and remittance abroad, and rates and methods of taxation, among other things.
In addition, all of the Company's revenue is denominated in the PRC's currency,
CNY, which must be converted into other currencies before remittance out of the
PRC. Both the conversion of CNY into foreign currencies and the remittance of
foreign currencies abroad require approval of the PRC government.
NOTE 10 - RELATED PARTY TRANSACTIONS
Dividends payable - The terms of a $4,154,041 dividend declared on April 25,
2005 require that if such dividend had not been paid by December 31, 2005, it
should be transferred and reflected as a loan payable accruing interest at 2.25%
per year to the former shareholders of Helpson. Inasmuch as the dividend was not
paid by December 31, 2005 and has still not been paid, this amount is reflected
on the accompanying consolidated financial statements as a current liability
(adjusted for foreign currency translations as of the balance sheet dates) and
is due upon demand.
NOTE 11 - CONCENTRATIONS
For the year ended December 31, 2006, three customers accounted for 17%, 11% and
10% of sales, respectively. In 2005, four customers accounted for 20%, 16%, 14%
and 14% of sales, respectively. In addition, two customers made up 18% and 14%
of accounts receivable in 2006 and two customers made up 19% and 14% of accounts
receivable in 2005. Finally, purchases from two suppliers accounted for 44% and
34% of raw material purchases in the year ended December 31, 2006 and 46% and
42% of raw material purchases in the year ended December 31, 2005.
NOTE 12 - SUBSEQUENT EVENT
F-16
CHINA PHARMA HOLDINGS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
On February 1, 2007, the Company completed an offering of Units priced at $1.70
per Unit consisting of one share of Company common stock and a warrant to
purchase one-half of a share of Company common stock at an exercise price of
$2.38 per share. The Company received gross proceeds in the aggregate amount of
$4,259,900. The net proceeds, after deduction of related offering expenses of
$445,258, amounted to $3,814,642. The Company issued an aggregate of 2,505,882
shares of common stock and issued three-year warrants to purchase an aggregate
of 1,252,941 shares of Company's common stock to 17 accredited investors. The
proceeds were allocated to the warrants based upon their fair value or
$2,010,219, and the balance of the proceeds was allocated to the shares of
common stock. The fair value of the warrants, determined using the Black-Scholes
Option Pricing Model, was calculated using the following assumptions: risk free
interest rate of 4.80%, expected dividend yield of 0%, expected volatility of
124.39% and an expected life of 3 years.
The common shares and the shares underlying the warrants have registration
rights, and the Company is required to file a registration statement including
said shares with the Securities and Exchange Commission. In the event that the
Company does not file a registration statement within 60 days of the completion
of the offering, the Company will be required to pay a penalty to each investor
equal to one percent (1%) of the purchase price of the common stock and the
warrants and an additional one percent (1%) for each additional 30-day period
during which such registration statement is not filed. The Company estimates
that the probability of not filing the registration statement within the allowed
time period is remote; therefore no accrual has been made for these potential
penalties.
F-17