Securities
registered pursuant to Section 12(g) of the Act: None.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes þ No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§
229.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post
such files). Yes ¨ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,”“accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer ¨
Accelerated
filer ¨
Non-accelerated
filer þ (Do
not check if a smaller reporting company)
Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No þ
The
aggregate market value of voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold was approximately $67,843,790 as of the last business day of the
registrant’s most recently completed second fiscal quarter.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
22
Part
II
ITEM
5.
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES
23
ITEM
6.
SELECTED
FINANCIAL DATA
23
ITEM
7.
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
23
ITEM
7A.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
37
ITEM
8.
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
37
ITEM
9.
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
67
ITEM
9A.
CONTROLS
AND PROCEDURES
67
ITEM
9B.
OTHER
INFORMATION
68
Part
III
ITEM
10.
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
68
ITEM
11.
EXECUTIVE
COMPENSATION
69
ITEM
12.
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
70
ITEM
13.
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
71
ITEM
14.
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
71
ITEM
15.
EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
72
EX-31.1
(Certifications required under Section 302 of the Sarbanes-Oxley Act of
2002)
EX-31.2
(Certifications required under Section 302 of the Sarbanes-Oxley Act of
2002)
EX-32.1
(Certifications required under Section 906 of the Sarbanes-Oxley Act of
2002)
EX-32.2
(Certifications required under Section 906 of the Sarbanes-Oxley Act of
2002)
PART
I
The
information in this document contains forward-looking statements which involve
risks and uncertainties, including statements regarding our capital needs,
business strategy and expectations. Any statements contained herein that are not
statements of historical fact may be deemed to be forward-looking statements. In
some cases, you can identify forward-looking statements by terminology such as
“may,”“should,”“will,”“expect,”“plan,”“intend,”“anticipate,”“believe,”“estimate,”“predict,”“potential,”“forecast,”“project,” or “continue,” the
negative of such terms or other comparable terminology. You should not rely on
forward-looking statements as predictions of future events or results. Any or
all of our forward-looking statements may turn out to be wrong. They can be
affected by inaccurate assumptions, risks and uncertainties and other factors
which could cause actual events or results to be materially different from those
expressed or implied in the forward-looking statements.
In
evaluating these statements, you should consider various factors, including the
risks described in “Item 1A. Risk Factors” beginning on page 15 and
elsewhere in this Form 10-K. These factors may cause our actual results to
differ materially from any forward-looking statement. In addition, new factors
emerge from time to time and it is not possible for us to predict all factors
that may cause actual results to differ materially from those contained in any
forward-looking statements. We disclaim any obligation to publicly update any
forward-looking statements to reflect events or circumstances after the date of
this document, except as required by applicable law.
ITEM
1. BUSINESS
In this
document, references to the “company,”“we,”“us” and “our” refer to
China-Biotics, Inc. and our predecessors and subsidiaries, unless the context
otherwise requires.
History
We were
incorporated under the name Otish Resources, Inc. in Delaware in
February 2003. Prior to March 2006 we were a mineral exploration
stage company specializing in acquiring and consolidating mineral properties
with potential for commercial ore bodies. Although we conducted some preliminary
exploration work with respect to our mineral properties, we never achieved full
operations with respect to our mineral properties. We had never generated any
revenue from our mineral exploration operations.
On
March 22, 2006, we entered into and completed a securities exchange
agreement with Sinosmart Group Inc., or SGI, and the SGI shareholders pursuant
to which the SGI shareholders transferred all of the equity securities of SGI to
us in exchange for the issuance of shares of our common stock. We refer to
this transaction in this document as the share exchange. At the closing of the
share exchange, we issued to the SGI shareholders an aggregate of
15,980,000 shares of our common stock in exchange for their shares of
SGI, and SGI became our wholly-owned subsidiary. SGI owns all of the equity
securities of Shanghai Shining Biotechnology Co. Ltd., or Shining. As a result
of the share exchange, we are no longer a mineral exploration stage company, and
SGI’s business operations become our primary operations. We are currently
engaged in the research, development, production, marketing and distribution of
probiotics products. These products contain live microbial food supplements
which beneficially affect the host by improving its intestinal microbial
balance.
-2-
SGI was
incorporated in the British Virgin Islands on February 13, 2004. On
December 9, 2005, SGI incorporated a wholly-owned subsidiary, Growing State
Limited, in accordance with the laws of the British Virgin Islands. On September22, 2006, Growing State Limited established a wholly-foreign owned enterprise,
Growing Bioengineering (Shanghai) Company Limited, in China.
On
December 11, 2007, we sold a 4% Senior Convertible Promissory Note in the amount
of $25,000,000 (the “Note”) with a maturity date of December 11, 2010 to Pope
Investments II LLC, an affiliate of Pope Investments, LLC, in a private
placement. In connection with the sale, we entered into an Investment Agreement
and a Registration Rights Agreement. In addition, Mr. Song Jinan, the company’s
Chief Executive Officer, Chairman, and largest shareholder, entered into a
Guaranty Agreement and a Pledge Agreement, pursuant to which Mr. Song agreed to
guaranty the company’s obligations under the Note and to secure such guaranty
with a pledge of 4,000,000 shares of China-Biotics common stock owned by Mr.
Song. The principal amount of the Note is convertible into shares of our common
stock at an exercise price of $12.00 per share at any time until the maturity
date subject to adjustment for subdivision or combination of our common stock
and similar events. If the Note is not converted at maturity, we will
redeem the Note to provide Pope with a total yield of 10% per annum inclusive of
the annual interest. The Note also provides for mandatory conversion into common
stock if we achieve a net income of $60 million in fiscal year 2010. Pope
Investments II LLC may declare the outstanding principal amount and any accrued
but unpaid interest, calculated at a rate of 10% per annum, to be immediately
due and payable upon an event of default, including non-payment of obligations
under the Note, bankruptcy or insolvency, or failure to perform any covenant set
forth in the Note or Investment Agreement. Pursuant to the Investment Agreement
we have secured payment of our obligations under the Note with a pledge of
100% of the stock of our subsidiary, SGI, to Pope Investments II
LLC. Net proceeds of the Note are being used to fund the construction
of a proposed 150-metric-ton-per-year manufacturing facility and for other
capital expenditures.
Current
Operations
Overview
We are
engaged in the research, development, production, marketing and distribution of
probiotics products, which are products that contain live microbial food
supplements which beneficially affect the host by improving its intestinal
microbial balance.
-3-
Our first
product, Shining Essence, was approved by the Chinese Ministry of Health for
production and to market as a health product in August 2000. We launched Shining
Essence in Shanghai in April 2001, and it is currently our best-selling product,
representing approximately 61% of our total sales for the year ended
March 31, 2007, 48% for the year ended March 31, 2008 and 40% for the year
ended March 31, 2009. The Health Food Association of China named Shining Essence
as the best selling liver health product in 2001.
From
October to December 2001, we obtained three patents for our production process,
packaging design and packing equipment design. We applied those technologies in
manufacturing process of all products under the “Shining” brand. In June 2004,
we submitted an application for registration of a patent regarding the
production of one of our products to the Intellectual Property Bureau of China.
We have obtained approval for this patent, and obtained the formal certificate
by the authorities on February 11, 2009.
In
February 2002, we obtained the certifications below from TÜV
Rheinland/Berlin-Brandenburg Group of Companies. Management believes that our
Shanghai production plant was the first and the only production plant in China
for probiotics that obtained all four certifications.
ISO 9001. We obtained ISO
9001:2000 certification from TÜV Anlagentechnik GmbH in respect of our
production process for its leading product, Shining Essence and will expire in
January 2010. According to the American National Standards Institute, ISO
9001:2000 specifies requirements for a quality management system where an
organization needs to demonstrate its ability to consistently provide product
that meets customer and applicable regulatory requirements, and aims to enhance
customer satisfaction through the effective application of the system, including
processes for continual improvement of the system and the assurance of
conformity to customer and applicable regulatory requirements. All requirements
of this international standard are generic and are intended to be applicable to
all organizations, regardless of type, size and product provided.
ISO 14001. We obtained ISO
14001:1996 certification from TÜV Anlagentechnik GmbH in respect of our
production process for our Shining Essence product, which expires in
February 2010. According to the American National Standards Institute, ISO
14001:2004 specifies requirements for an environmental management system to
enable an organization to develop and implement a policy and objectives which
take into account legal requirements and other requirements to which the
organization subscribes, and information about significant environmental
aspects. It applies to those environmental aspects that the organization
identifies as those which it can control and influence. It does not itself state
specific environmental performance criteria.
OHSAS 18001. We obtained OHSAS
18001:1999 certification from TÜV Hong Kong Ltd in respect of our production
process for our Shining Essence product, which expires in June 2012.
According to BSI Management Systems - Asia, Occupational Health and Safety
Assessment Series specification relates to an entity’s occupational health and
safety management systems that enable organizations to control its occupational
health and safety risks and improve its performance. It does not state specific
occupational health and safety performance criteria, nor does it give detailed
specifications for the design of a management system. OHSAS 18001 is an
assessment specification developed in response to the need for
companies to meet their health and safety obligations in an efficient
manner.
HACCP. We obtained HACCP DS
3027 E:1997 certification from TÜV Anlagentechnik GmbH in respect of our
production process for our Shining Essence product, which expires in July 2012.
The term “HACCP” stands for Hazard Analysis Critical Control Point. The HACCP DS
3027 E:1997 standard was developed to ensure food safety among food
manufacturers and their suppliers in Denmark.
Products
We
manufacture and sell several health supplements under the “Shining” brand in the
Shanghai area as set forth below. All of these products have been approved by
the Ministry of Health in China and their content has been tested by the
Shanghai Preventative Medicine Research Institute, which found that our products
contain the quantities of bacteria specified by us. While management believes
these products to be effective, their effectiveness has not been conclusively
established.
Our four
major products are:
•
Shining Essence - Composed of
lactobacillus acidophilus and bifidobacterium bifidum, aimed at balancing
the microecology of the digestive system, enhancing intestinal health and
protecting and strengthening liver
function;
-4-
•
Shining Signal - Composed of
monascus rice and lactobacillus acidophilus, focused on reducing high
blood pressure, high blood sugar level and
hyperlipidemia;
•
Shining Golden Shield - Composed
of bifidobacterium adolescentis and lentinusedodes, focused on enhancing
the body’s immune system;
and
•
Shining Energy - Composed of
Vitamin C, L. Arginine, and other amino acids, aimed at promoting the
development of brain cells and enhancing alertness and
energy.
In
addition, in March 2006, we opened our first retail outlet in Shanghai and
launched the following products in the market:
•
Shining Beauty Essence - Composed
of soy bean isoflavones and pueraria lobata p extracts, aimed at
increasing bone mineral density of elderly people and reducing negative
health effects associated with the aging
process;
•
Shining Companion Bifidus Factor
Granule - Composed of bifidus, focused on enhancing the growth of bifidus
in the human body and enhancing intestinal
health;
•
Shining Stomach Protection
Capsules - Composed of lactobacillus acidophilus, aimed at protecting
stomach walls and improving the digestive
system;
•
Shining Sicanel Capsules -
Composed of lactobacillus acidophilus, focused on reducing hyperlipidemia,
or excess levels of fats in the blood;
and
•
Shining Golden Shield (kids
version) - Composed of bifido bacterium adolescentis and lentinusedodes,
focused on enhancing the body’s immune
system.
We intend
to continue to develop new products to strengthen our product pipeline so that
we may offer an array of products for sale in the market.
Business
prospects
Leveraging
on what our management believes are our technical competence, cost efficiencies
and highly recognized brand, our management expects to achieve significant
growth through:
•
the
introduction of bulk additives products - We are expanding into
the bulk additive business for functional foods through the completion of
our 150-ton capacity plant, which is scheduled to commence trial
production within the second quarter of fiscal year 2010. Management
estimates that Phase 1 of the project, which involves constructing a
facility capable of producing 150 tons of probiotics per annum will cost
$27.50 million, $25 million of which is expected to be paid
by the third quarter of calendar year 2009 and the balance by
the end of calendar year 2009. Phase 2 of this project will only commence
when demands for probiotics have exceeded the production capacity of the
Phase 1 facility. Phase 2 of this project is expected to
cost $18 million. The construction cost of Phase 1 of
the plant will be funded by cash received from the sale of
convertible promissory notes to Pope Investments II LLC on December 11,2007 as disclosed in
“Business-History”;
•
the
geographical expansion of its retail sales through direct sales and
traditional sales channels - We intend to expand the
sale of our products to the other metropolitan cities in China through a
combination of the traditional distribution channels and dedicated Shining
outlets. From March 2006, when we opened our first outlet in Shanghai, we
have a total of 106 outlets as of March 31, 2009. About three
quarters of these outlets are located in Shanghai and the rest are located
in 12 other cities in
China.
-5-
•
the
development of new products - We plan to continue to
develop new products aimed at improving the general health conditions of
humans, enhancing their immune system and reducing health problems. We are
also in the process of developing new products to strengthen our product
pipeline so that we may offer an array of products for sale in the Shining
outlets.
Industry
overview and market condition
Probiotics
We
manufacture and sell probiotics. Most probiotics are bacteria based and
naturally exist in the human body in the lower intestinal tract. The
introduction of “helpful” bacteria and other organisms may aid in preventative
fights against infection and improve digestion, especially with respect to dairy
products.
Probiotics
generally have a very short life-span. Water, acid and oxygen are harmful to
probiotics and most die or cease to function after a short period of time after
extraction from the source. A reduction of these naturally-occurring organisms
due to poor eating habits, stress, or the use of antibiotic drugs or other
factors may disrupt the natural equilibrium of the body and could lead to a
variety of abdominal ailments and an overall decrease in the function of the
immune system. Based on information available on the websitewww.usprobiotics.org,
a non-profit research and education website sponsored by the California Dairy Research
Foundation and Dairy & Food Culture Technologies, researchers are
also studying potential links between low probiotics microbial levels and
hypertension, certain types of cancer, high cholesterol, and allergies (to
access this information, click on the Section "Probiotics Basics," and then
click on the Section "Health Effects of Probiotics." Subsections of "Health
Effects of Probiotics" include "hypertension,""cancer,""elevated blood
cholesterol" and "allergy.")
China
market
China has very limited capacity to
produce probiotics. We believe that demand for probiotics and functional
foods in China will continue to increase in the foreseeable future. We believe
that China lacks manufacturing capabilities of bulk additives in a scale
necessary to support the functional foods industry. This has forced processed
food producers to either import most of their probiotics or produce finished
products abroad and re-import the final product. We believe this creates
significant inefficiencies in both cost and probiotics efficacy, as some
bacteria die during transport.
Demand for functional food products
is expected to grow significantly. As the discretionary income and
health-consciousness of the average Chinese consumer increase, we expect the
demand for functional foods and dietary supplements to increase. We believe that
the demand for functional foods and dietary supplements will be bolstered by the
stated commitment of the Chinese government to reduce the use of antibiotics and
promote the use of probiotics and other preventative measures.
Curtailment of the use of antibiotics
may stimulate demand for probiotics. According to two Chinese newspaper
articles entitled “80,000 people in China die from inappropriate use of
antibiotics each year, children suffer the most,” published in Xin Kuai Bao
dated December 12, 2003 available in Chinese at
http://info.china.alibaba.com/news/detail/v8-d5779326.html under
"News/Detail"), and “How many people die from inappropriate use of antibiotics
in China each year?,” published on 19 July 2005 by Bio Information Net
(available in Chinese at www.bio168.com/news/200507/46448F8BBO5D.html under
"Homepage/News/Main Text of the News"), China has the highest per capita
consumption of antibiotics in the world. In 2000, the World Health Organization
cautioned that “superdiseases” are being created by the overuse of antibiotics.
In order to stem the tide of these drug resistant strains, many nations have
taken steps to limit the use of antibiotic drugs. In July 2004, the Chinese
government took an active role in the fight against the overuse of antibiotics
by requiring prescriptions for these drugs. To further reduce the use of
antibiotics, the Chinese government has slashed the retail price of antibiotics
by 60%, so that it is no longer profitable for a large number of antibiotics
manufacturers to continue to manufacture such products. This resulted in a
marked increase in the use of other products to not only treat existing
infections but prevent infections from occurring. In addition, on May 20, 2005
(effective July 1, 2005) the State Food and Drug Administration (reference no.
Guo Shi Yao Jian Zhu (2005) no. 202) issued a notice acknowledging that
probiotics are beneficial for human health and also introduced guidelines for
regulating manufacturers of probiotics products and registration of probiotics
products with the State Food and Drug Administration.
-6-
Demand for dairy product additives is
expected to increase significantly. The demand for functional foods and
foods that use probiotic supplements is growing at a significant rate. According
to AC Nielsen (article available at
http://cn.en.acnielsen.com/news/20050916.shtml), yogurt and yogurt drinks are
the fastest growing products in the food products segment in China, with sales
increasing by 38% in 2004 alone. Sales of infant formula grew 23% in the same
year. Moreover, according to statements made by the Nutrition Development Centre
of National Development and Reform Commission in China, effective April 1, 2007,
probiotics will be added to baby milk powders produced in China. The relevant
regulations are expected to be announced at a later date. These factors
translate into significant growth in demands in China for live bacteria as food
addictives.
Business
strategies
Leveraging
on what our management believes are our technical competence, cost efficiencies
and highly recognized brand, our management expects to achieve significant
growth through:
•
the introduction of bulk
additives products;
•
the geographic expansion of our
retail sales through direct sales and traditional sales channels;
and
•
the development of new
products.
Bulk
market
Most
probiotics used for the manufacture of yogurt, milk powder products and food
preservatives are currently imported. However, we believe imported probiotics
are generally more expensive and are of lower quality as most bacteria die
during transport. In addition, according to statements made by the
Nutrition Development Centre of National Development and Reform Commission in
China, on April 1, 2007, probiotics must be added to baby milk powders and
other products produced in China. The relevant regulations will be implemented
at a later date. We are expanding into the bulk additive business for
functional foods through the completion of our 150-ton capacity plant, which is
scheduled to commence trial production within the second quarter of fiscal year
2010. Management estimates that Phase 1 of the project, which involves
constructing a facility capable of producing 150 tons of probiotics per year,
will cost $27.50 million, $25 million of which is expected to be
paid by the third quarter of calendar year 2009 and the
balance by the end of calendar year 2009. Phase 2 of this project will only
commence when demand for probiotics has exceeded the production capacity of the
Phase 1 facility. Phase 2 of this project is expected to cost $18
million. The construction cost of Phase 1 of the plant will be funded by cash
received from the sale of convertible promissory notes to Pope Investments II
LLC on December 11, 2007 as disclosed in “Business-History”.
Geographic
expansion and direct sales
We sell
our products mainly in Greater Shanghai through distributors. Over the past five
years, we believe we have firmly established ourselves in Shanghai as the
leading supplier and manufacturer of probiotics products. We are now expanding
the sale of our products to the other metropolitan cities in China through a
combination of the traditional distribution channels and dedicated Shining
outlets.
We opened
the first Shining retail outlet in Shanghai in March 2006. We have also
repackaged our products for sale in our outlets, and have introduced several new
products which are sold exclusively in our outlets. As at March 31, 2009, we
have opened 106 outlets in Shanghai and 12 other cities in China.
-7-
In
preparation for the opening of additional retail outlets, we have also been
actively recruiting and training retail sales staff since the beginning of 2006.
We have already successfully recruited a number of very experienced sales
professionals and have trained a pool of sales staff. We have also designed and
implemented control systems to manage this new business.
Currently,
we have a network of 106 outlets in China. We continue to survey cities in China
to assess and select suitable locations for new outlets.
As part
of our strategy, we will also consider licensing franchisees to operate retail
outlets in due course. We intend to finance the costs of our business expansion
by our internal working capital.
Introduction
of new products
In
connection with the opening of our first Shining outlet, we launched several new
products under the Shining brand. We currently have regulatory approval to
produce 24
products that can be marketed under the Shining brand. We plan to develop
new products to strengthen our product pipeline so that we may offer an array of
products for sale in the Shining outlets.
Our
Business Prospects
Growth
potential from geographic expansion leveraging on the Shining
brand.
We have
experienced rapid sales growth of our products are sold through retail sales in
the Greater Shanghai area under our “Shining” brand. Management believes that
the “Shining” brand is one of the most recognized health supplement brands in
Shanghai. We are expanding the sales of our retail products to the other major
metropolitan cities in China such as Changchun and Jilin. Given our high gross
margin and low overhead structure, management anticipates that distribution in
these areas could be profitable, assuming there is sufficient demand. Expansion
of retail sales is also a key component of the marketing of our food additives.
We intend to co-brand with food producers allowing consumers to identify food
products that use our additives as high quality and beneficial. We require our
“Shining” logo to be incorporated in the packaging of products manufactured by
food producers which contain probiotics additives supplied by us. We have
already entered into agreements with 3 food producers for use of our products as
food additives. These customers include Bright Dairy, the third largest dairy
company in China, and Holiland Group, a large bakery supplier with nationwide
retail coverage.
Significant
potential from the new bulk business (yogurt).
Live
bacteria are essential to the formulation of yogurt and yogurt -based drinks.
Yogurt and yogurt drinks were the fastest growing food product segments in China
in 2004 according to AC Nielsen. As a result, yogurt producers in China
currently import most of their probiotics additives. We believe that importation
of probiotics is costly and a portion of the effective ingredient (bacteria)
dies during transportation. Our new plant is intended for bulk manufacturing of
probiotics for use as food additives for foods such as yogurt and yogurt
drinks.
Significant
potential from the new bulk business (milk powder).
Manufacturers
have begun to add probiotics to infant formula and milk powders to facilitate
and improve digestion and absorption as well as strengthen the immune system of
infants. Currently, infant formula made in China by some multinational companies
such as Nestle and Mead Johnson already use imported probiotics produced by
Rodia SA and Chr. Hansen and other producers in their products. According to
statements made by the Nutrition Development Centre of National Development and
Reform Commission in China, effective April 1, 2007, probiotics are added to
baby milk powders produced in China. Relevant regulations are expected to be
announced at a later date. Currently, management believes there is no
manufacturing facility in China that can meet the demand for probiotics if this
requirement was imposed. Once our new plant is operating, we believe we will be
well positioned to capture this significant new demand for
probiotics.
In 2008,
milk samples (including samples of infant formula) from several Chinese dairy
companies, including the three largest producers, were found to have been
tainted with melamine, an industrial chemical. In September 2008, China’s State
Council, officiated by Premier Wen Jiabao, elected to take steps to conduct
comprehensive testing of dairy products and carry out other industry reforms.
Although sales of Chinese dairy products have fallen significantly as a result
of the melamine scandal, there has not been a significant impact on our business
to date as our current sales to the dairy industry are minimal. We believe that
the strengthening of product quality and testing standards in the dairy industry
are a positive development for domestic suppliers that operate to high
international standards. We are engaged in discussion and qualification
processes with several large global suppliers of infant formula and dairy
products to the China market, and believe that we are well-positioned to benefit
as more stringent requirements are implemented in the industry. We are also in
discussions with a number of suppliers of bakery, dairy and pharmaceutical
products in preparation for the opening of our new plant. Therefore, although
the full scope of the melamine problem remains unknown, we do not foresee that
it will have a material negative effect on our business and results of
operations.
We
believe our proprietary production technology gives the following competitive
advantages:
•
Product shelf
life - Our
proprietary technology helps to protect the live bacteria in probiotics
and allows a survival rate of 70% two years after
manufacture.
•
Concentration - The concentration of active
ingredients we produce is over 100 times that of the minimum governmental
standards in China.
•
Human
compatibility - The
probiotics we produce originate from organisms cultured from human
sources, reducing the risk that the active ingredients will be rejected by
the human body.
Strong
revenue and profit growth.
Our
probiotics products have generated strong sales and profit growth during the
past two years, and have generated sufficient cash flow to finance our
operations. Sales of our probiotics products increased 28% to $54.2 in fiscal
year 2009 from $42.3 million in fiscal year 2008 which was an 38%
increase from $30.6 million in fiscal year 2007. Similarly, income before
taxes increased from $15.1 million in fiscal year 2007 to $22.5 million in
fiscal year 2008 to $25.1 million in fiscal year 2009. Excluding the $3.4
million gain in 2008 and the $3.1 million gain in 2009 arising from the
revaluation of the conversion option embedded in the convertible notes issued in
December 2007 included in other income, income before taxes increased by 15.2%
from 2008 to 2009, and 26.5% from 2007 to 2008.
Production
We use
micro-ecology technologies to produce the live bacteria which are the active
ingredients of our probiotics. We use a multi-stage fermentation process under a
strictly controlled environment using our proprietary technology. Solid bacteria
are then extracted and stored using controlled freeze drying methods. Prior to
sale to our customers, we transform the solid bacteria into capsule form and
place it in sealed double aluminum packaging using our patented
equipment.
We have
registered the following patents in China:
•
High Quality Microecologics and
Micro-encapsulation Technology (patent registration number
ZL 01 1 09063.4), which increases the vitality rate,
maintaining large quantities of active
bacterium;
•
Nutrition Gas Injection
Capability and Double Aluminum Packaging Machine (patent registration
number ZL 01 2 04515.2), which enables the probiotics
bacterium to retain their vitality for two years and better resist gastric
acid; and
•
Packaging for Shining Essence
(patent registration number ZL 01 3
01526.5).
In June
2004, we submitted an application for registration of a patent regarding the
production of one of our products to the Intellectual Property Bureau of
China. We have obtained approval for this patent, and obtained the formal
certificate by the authorities on February 11, 2009.
Our
management believes that we enjoy the following competitive advantages in
utilizing such microecologics technology in our production process:
•
We use advanced fermentation,
bacteria extraction and micro-encapsulation technology to produce our
products, which increases our output and reduces our
costs.
-9-
•
Since probiotics are phobic to
water, acid and oxygen, their life span is extremely short. We use
technology that significantly extends the survival rate of the bacteria
and, as a result, our products have a survival rate of two years from
manufacturing at room
temperature.
•
According to rules governing live
bacteria products in China which took effect in 2001, such products need
to maintain out concentrations of live bacteria at a level of 10
6 /g within their stated effective
period. Our products maintain a 10 8 /g concentration of live
bacteria during their stated effective period. This concentration level is
also over 200 times higher than the current commonly accepted
international standard.
•
Most probiotic producers extract
their bacteria base from animals. The probiotics we produce originate from
organisms cultured from human sources to reduce the risk that the active
ingredients will be rejected by the human
body.
Distribution
We sell
our products mainly in the greater Shanghai area, mainly to large distributors
who then sell them through their networks to supermarkets, hypermarkets, such as
Wal-Mart, and drug stores. As of March 31, 2009, we had 18 distributors located
in Shanghai, Jiangxu, Zhejiang and Hong Kong. At March 2009, we had 106
Shining branded outlets in Shanghai and 12 other major cities in China. We
have been hiring consultants who have many years of experience in the direct
selling industry to facilitate the development of new Shining brand outlets. We
also are creating a “Community Network” through which we continuously provide
training and seminars to educate the public about becoming more health conscious
and about the benefits of probiotics and the Shining products. We believe that
this approach has many advantages:
•
The promotion and sale of
probiotics products has historically been most effective through
word-of-mouth marketing. We believe that the use of Community Network will
provide an additional channel to educate the public about the benefits of
probiotics and to provide advice on health related
matters.
•
We believe that the use of
Community Network to market and sell our products will be cost effective
compared with the traditional advertising and selling through
distributors, and that it should increase our profit
margin.
•
We believe that Community Network
will attract a group of health conscious individuals in the community who
can share health and product related experiences. This is expected to
enhance customer loyalty and encourage recurring
sales.
•
We expect that each Shining
outlet will employ a combination of employees and agents. The agents are
remunerated mainly on a commission basis, which will minimize our fixed
overhead costs.
•
We believe that the Shining brand
outlets and Community Network will increase brand awareness within the
community, which will facilitate the marketing of bulk additives products
using the Shining brand.
Customers
We have
two different types of customers, consumers and food product manufacturers. Food
product manufacturers include yogurt and milk powder producers and animal feed
manufacturers. Consumers are primarily individuals in major metropolitan areas
who are middle aged or above having middle to higher income levels. We believe
that these individuals are becoming increasingly health-conscious and as their
income levels increase, they spend more on health related products such as
probiotic products. We have historically reached consumers by selling our
products to large distributors, who then sell them through their networks to
supermarkets, hypermarkets, such as Wal-Mart, and drug stores, where they are
purchased by consumers. At March 31, 2009, we had 106 Shining branded
outlets in Shanghai and 12 other major cities in China where we sell our
products directly to the end users. We believe owning distribution channels and
having direct access to the end users will become a significant entry barrier in
the future. For the year ended March 31, 2009, there is one customer, Shanghai
Lian Hua Quik Convenience Store Limited, that accounted for 11.5% of our sales
revenue. For the year ended March 31, 2008, two of our customers, Shanghai Lian
Hua Quik Convenience Store Limited and Shanghai Sunrise Trading Limited,
accounted for 15.5% and 10.5% of our sales revenue. These two customers are
independent third parties. For the year ended March 31, 2007, no single customer
accounted for 10% of our total sales.
-10-
Backlog
We do not
have any material backlog. Due to our limited capacity, we sell our products on
a spot-basis as orders are made. We currently do not have any long-term sales
orders with our customers.
Seasonality
Typically,
60% of our sales take place in the second half of our fiscal year because many
of our customers purchase our products to give as gifts during the Chinese
festivals that occur during this time of the year. While it is still too early
to tell, we expect that our bulk additive sales will not be seasonal in nature
because the bulk products are purchased by food manufacturers consistently
throughout the year.
Marketing
and Advertising
We
promote our products through the media by placing advertisements in newspapers
and magazines and on television in China. From time to time, we also sponsor
charitable events to increase public awareness of the benefits of our health
products.
Competition
We
believe that we are well-positioned to compete in the Chinese pharmaceutical and
nutraceutical market with our proprietary technology, strong brand, diverse
product portfolio, research and development capabilities, established sales and
service network, and favorable cost structure. Other factors affecting
competitive conditions in the Chinese pharmaceutical and nutraceutical market
are managerial and technological expertise, the ability to identify and exploit
commercially viable products, time to market, patent position, product efficacy,
safety, convenience, reliability, availability and pricing.
Our
primary competitors in the Chinese domestic probiotics market are two Chinese
companies, Shanghai Jiaoda Onlly Co. Ltd. and Shanghai Pharmaceutical Group Co.
Ltd. – SINE Pharmaceutical Co. Ltd. and one Japanese company, Morishita Jintan
Co. Ltd. These competitors produce similar probiotics products and have similar
market share to ours in the Chinese domestic market. In addition to these
primary competitors, there are approximately four other domestic competitors
that compete with us in the Chinese market.
With
respect to the bulk additives market, we believe that our competition will come
mainly from large overseas producers and food importers that produce their own
supplements. Our management believes that we are well-positioned to compete in
the bulk additives market based on the high quality of our products, our
favorable cost structure, our time-to-market in the domestic market and our
established sales and service network. We are directing efforts toward
encouraging customers to switch from imported bacteria to our products as
additives for the production of yogurt, sour milk and other food
products.
Research
and Development
We have a
strong research and development team supported by a technical advisory board of
experts. At March 31, 2009, we have 30 staff members with Masters degrees
or PhDs. In addition to having advanced technology in bacteria culturing and
protection, we also conduct research and development into complimentary
technology, including genetically engineered drugs, drug delivery solutions and
Chinese medicine, in an effort to formulate solutions to address specific health
problems and expand our product line. We incurred research and development costs
of approximately $3,229,788, $2,194,474 and $497,817 for the years ended March31, 2009, 2008 and 2007, respectively. Such research and development costs
are mainly comprised of raw material costs, laboratory expenses and staff
salaries in the research and development division, which were included as part
of the production costs in our financial statements for such
periods.
Government
Regulation
Food
Business
Laws and
regulations governing our business include the following: the Law on the Food
Conditions of the PRC promulgated and enforced on October 30, 1995, the
Administrative Rules for Healthy Food promulgated by the Ministry of Health, or
MOH, on March 15, 1996 and enforced on June 1, 1996, the Notice of
Circulating the Appraisal Standard of Fungal and Good-Live-Bacterial Healthy
Food and its appendixes-Appraisal Standard of Fungal and
Good-Live-Bacterial Healthy Food, and List of Good-Live-Bacteria Applicable for
Healthy Food, which are promulgated by the MOH and enforced on March 23,2001, and the Administration Rules for the Registration of Healthy Food
(experimental) promulgated by the State Food and Drug Administration, or SFDA,
on April 30, 2005 and enforced on July 1, 2005.
-11-
The
previous governing authority of healthy food was the MOH. Since the General
Office of the State Council of the PRC promulgated the Regulations on the
Internal Organizations and Staff Schedule of the State Food and Drug
Administration on April 25, 2003, the responsibility of approving healthy food
of MOH has been assigned to the SFDA. The SFDA is a direct subordinate authority
under the State Council and its responsibilities are generally supervising the
safety control of food, healthy food and cosmetics, and supervising
drugs.
Pursuant
to the Law on the Food Conditions of the PRC, a food manufacturing or other
food-related enterprise may not engage in any food manufacturing or other
food-related business until it obtains a Health License issued by the competent
health administration. While using a new resource in manufacturing food, before
the formal production, the company must apply for an approval in accordance with
applicable standard food condition application procedures, and obtain a New Food
and Food-used Products Health Approval.
Pursuant
to the Administrative Rules for Healthy Food, the MOH applied an approval system
for healthy food. Any food claiming to have health care functions was required
to be inspected and confirmed by the MOH, which would issue a Certificate of
Healthy Food upon a successful inspection. After the Administration Rules for
the Registration of Healthy Food were enacted, SFDA will make an integral
appraisal and inspection of the safety, effectiveness, quality control and the
label and introduction of the healthy food. If permitted, the SFDA will issue an
Approval Certificate of Native Healthy Food, which is valid for five
years.
Pursuant
to the Appraisal Standard of Fungal and Good-Live-Bacterial Healthy Food, an
enterprise using good-live-bacteria in manufacturing healthy food must satisfy
the following requirements: form a Good Manufacturing Practice (GMP) and a
step-by-step Hazard Analysis Critical Control Point (HACCP) quality control
system; possess a pilot scale experiment manufacturing scale (at least 500 cubic
liters), and submit its pilot scale experiment products for approval; have
special plants or workshop, specific manufacturing equipment and devices, a
good-live-bacteria lab, special staffs looking after the bacteria under the
supervision of experts with at least middle level expert title, and specific
technical rules and procedures. In addition, these Rules require that
good-live-bacterial healthy food must maintain its active bacteria population at
more than 10 6 cfu/ml
during its storage term.
Pursuant
to the List of Good-Live-Bacteria Applicable for Healthy Food, nine
good-live-bacteria can be used in healthy food, including Bifidobacterium
bifidum, B.infantis, B.longum, B.breve, B.adolescentis,
Lactobacillus.bulgaricus, L.acidophilus, L.Casei subsp.casei, and Streptococcus
thermophilus.
Intellectual
Property
The
tables below set forth the trademarks and patents that we have registered in
China. The trademarks were granted by the Trademark Office of State
Administration of Industry and Commerce of the People’s Republic of China and
the patents were granted by the State Intellectual Property Administration
Office of the People’s Republic of China. Each of these trademarks and patents
is enforceable only within China.
Trademarks
Description
Registration No.
Class
Term
Logo
of Shanghai Shining Biotechnology Co. Ltd. and device
Pursuant
to the Patent Law of the PRC and its implementation rules amended on August 25,2000, Chinese laws protect the following three kinds of patents: patent for
invention, patent for utility model and patent for design. The State Bureau of
Intellectual Property is responsible for the management of patents in China,
accepting and reviewing patent applications and granting patents pursuant to
laws and regulations. Any invention or utility model for which patent right may
be granted must possess novelty, inventiveness and practical applicability. Any
design for which patent right may be granted must neither be identical with or
similar to any design which, before the date of filing, has been publicly
disclosed in publications in the country or abroad or has been publicly used in
the country, nor conflict with legal rights of any third party obtained before.
The protection period of patent for invention is 20 years and the protection
period of patent for utility model or design is 10 years, both calculating from
the application date.
Under the
Patent Law of the PRC, we may enforce our rights attached to the registered
patents against the infringer by applying to the relevant governing authorities
for an injunction. We may also apply to the People’s Court for an order of
specific performance which prohibits any third parties from using the registered
patents. The relevant governing authorities may also impose a fine up to three
times the profits made by the infringer from the unauthorized use of the
registered patents or a fixed fine up to RMB50,000 for cases which the infringer
has not earned any profits from such unauthorized uses.
Pursuant
to the Trademark Law of PRC and its implementation rules amended on October 27,2001, a registered capital may refer to a trademark registered with the
Trademark Bureau, including products, service trademark and collective
trademark, attest trademark; the trademark owner shall have exclusive rights of
using the trademark, under the protection of laws. The exclusive rights of using
the trademark is limited within the registered trademark and the registered
products on which the trademark can be used. The Trademark Bureau of the State
Administration for Industry and Commerce is responsible for managing the
trademark registration and administration throughout the PRC. The protection
period of registered trademark is ten years from the registration
date.
Taxation
and Local Governmental Support
Income
tax of a foreign-invested enterprise in China is principally governed by the Law
on the Income Tax of Foreign-invested Enterprises and Foreign Enterprises of the
PRC and its implementation rules promulgated and enforced on July 1, 1991.
Pursuant to those law and regulations, the corporate income tax rate of a
foreign-invested enterprise is 30%, and the local income tax rate is 3%.
However, foreign-invested enterprises which are located in certain areas or
satisfy certain qualifications are entitled to a corporate income tax exemption
or deduction. For instance, a manufacturing foreign-invested enterprise
established in Pudong District, Shanghai, is entitled to pay its corporate
income tax at a reduced tax rate of 15%. In addition, a manufacturing
foreign-invested enterprise, with a business term in excess of 10 years, is
entitled to a two-year corporate income tax exemption calculating from its first
profitable year, and for the following three years, such foreign-invested
enterprise is entitled to a half deduction of its applicable corporate income
tax rate. From January 1, 2008, the income tax rate is expected to gradually
increase to the standard rate of 25% over a five-year transition
period. The
five-year transitional rates for former tax rate that was 15% will be 18% in
2008, 20% in 2009, 22% in 2010, 24% in 2011, and 25% in 2012. Pursuant to PRC
laws and regulations, if an enterprise is qualified as “hi-tech” enterprise, it
would be entitled to the 15% preferential rate under the new CIT
regime.
Foreign
Exchange
Foreign
exchange in China is principally governed by the PRC Foreign Exchange Control
Regulations promulgated by the State Council and enforced on April 1, 1996, and
the Regulations on the Administration of Foreign Exchange Settlement, Sale and
Payment promulgated by the State Council and enforced on July 1, 1996. Under
these regulations, upon payment of the applicable taxes, foreign-invested
enterprises may convert the dividends they received in Renminbi into foreign
currencies and remit such amounts outside China through their foreign exchange
bank accounts.
-13-
If a
foreign-invested enterprise needs foreign exchange transaction services in
relation to the current account item, it may make such payment through its
foreign exchange account or make an exchange and payment at one of the
designated foreign exchange banks by providing applicable receipts and
certificates, and with an approval from the State Administration of Foreign
Exchange, or SAFE. If a foreign-invested enterprise distributes dividends to its
shareholders, it will be deemed as foreign exchange transaction services in
relation to the current account item, therefore, as long as it provides the
board resolutions and other documents authorizing the distribution of dividends,
it may make such payment through its foreign exchange account or make an
exchange and payment at one of the designated foreign exchange
banks.
Notwithstanding
the above, foreign exchange conversion matters under the capital account item
are still subject to regulatory restrictions, and a prior approval from SAFE or
its relevant branches is required before conversion between Renminbi and other
foreign currencies.
Facilities
We do not
own any real estate. We conduct our operations from a leased facility in Pudong,
Shanghai. Pursuant to our lease for this facility, which expires on October 19,2011, we pay annual rent of RMB507,532, payable in monthly installments of
RMB42,294. This facility, which includes a level 100,000 clean room and a level
10,000 clean room, houses our office space manufacturing facilities and
warehouse. The maximum current production capacity at this location is
approximately 3.5 million capsules per month. We have received ISO 9001,
ISO 14001, OHSAS 18001 and HACCP certifications for this facility. See “Business—Current
Operations—Overview” for further information with respect to these
certifications.
We are
constructing a bulk manufacturing facility that will have an initial capacity of
150 tons per year of bulk product with room for expansion to 300 tons per year
based on market demand. Management estimates that Phase 1 of the project, which
involves constructing a facility capable of producing 150 ton probiotics per
annum, will cost $27.5 million, $25 million of which is expected to be
paid by the third quarter of calendar year 2009 and the
balance by the end of calendar year 2009. Phase 2 of this project will only
commence when demand for probiotics has exceeded the production capacity of the
Phase 1 facility. Phase 2 of this project is expected to cost $18
million. The construction cost of Phase 1 of the plant will be funded by
cash received from the sale of convertible promissory notes to Pope Investments
II LLC on December 11, 2007 as disclosed in “Business-History”. On March 21,2006, Growing State, our subsidiary, entered into an agreement with Shanghai
Qingpu Industrial Park District Development (Group) Company Limited for the
lease of 73,157 square meters of land in the Shanghai Qingpu Industrial Park
District on which we are constructing this plant. The agreement provides for the
payment of leasing fees of approximately $2.1 million, 10% of which we paid on
April 11, 2006 as a deposit, to be refunded upon payment in full of the
aggregate lease amount. The Qingpu People’s Republic Government issued
its formal confirmation of the land use right necessary for the plant
construction on November 30, 2007 and confirmed the leasing fee of
$1,777,680 (reduced from $2.1 million because the size of the leased land was
reduced to 36,075 square meters) and a refundable land deposit of
$210,083. We paid the leasing fee on December 28, 2007. In
February 2009, the refundable land deposit was fully refunded and the
formal land use right certificate was issued. There are no future lease payments
under this land lease.
Employees
As at
March 31, 2009, we had 378 staff and employees. The following table
summarizes the functional distribution of our employees:
Department
Headcount
Management
and Administrative
9
Sales
and Marketing
28
Retail
Outlet
190
Research
and Development
30
Production
83
Finance
and Accounting
6
New
Plant
32
Total
378
All of
these employees were full-time. We do not have any payment obligations for any
retirees and are not currently retaining any contractors.
-14-
According
to Article 10, Trade Union Law of the People’s Republic of China an enterprise,
public institution or government organ with 25 or more members must establish a
basic-level trade union committee. However, a union is established only if it is
voluntarily formed by the employees. We currently do not have a trade
union.
Available
Information
We file
periodic reports with the SEC, including annual reports, on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K, and amendments to those
reports. All of our periodic reports may be inspected without charge at the
Public Reference Room maintained by the SEC at 100 F Street, NE, Washington,
D.C. 20549. You may obtain copies of the registration statement, including the
exhibits thereto, and all of our periodic reports after payment of the fees
prescribed by the SEC. For additional information regarding the operation of the
Public Reference Room, you may call the SEC at 1-800-SEC-0330. The SEC also
maintains a website which provides on-line access to reports and other
information regarding registrants that file electronically with the SEC at the
address: http://www.sec.gov.
We
maintain an internet website at http://www.chn-biotics.com.
Our website contains a link to the SEC’s website at http://www.sec.gov,
which provides free online access to our periodic reports. We will
also provide electronic or paper copies of our filings free of charge upon
request.
ITEM 1A. RISK
FACTORS.
Risks
Related to Our Business
We
depend on the services of our directors and key employees, the loss of which
could harm our business.
We
believe our success relies on the strategies, vision, efforts and technical
expertise of our directors and key management personnel, including Mr. Song
Jinan. The resignation or departure of any of these key people could have a
material adverse impact on our operations and future prospects. In addition, if
any of these key people join a competitor or form a competing company, we could
lose customers and incur additional expenses to recruit replacements and train
personnel. We have entered into standard form confidentiality agreements with
our technical employees with the exception of our directors and our key
executives, which contain non-competition clauses. We do not maintain key-man
life insurance for any of our key executives.
Failure
to attract and retain qualified employees may adversely affect our
business.
Our
continued success depends largely on our ability to attract and retain highly
skilled executive, managerial and technical employees. We may face difficulties
in recruiting skilled personnel in our industry due to its specialized nature.
If we are unable to attract and retain a sufficient number of suitably skilled
and qualified personnel, our business would be materially and adversely
affected. We may also have to pay substantial wages to attract sufficient
numbers of skilled employees and professionals, which may adversely affect our
operating margins.
We
are not insured against potential losses and could be seriously harmed by
natural disasters, catastrophes or acts of war.
Our
facilities and inventories could be materially damaged by hurricanes, floods and
other natural disasters, catastrophes, acts of war or other catastrophic
circumstances. We do not maintain insurance covering such events. If any of
these events occur, we could incur material losses and liabilities, which could
negatively affect our operating results.
We
may incur material product liability claims, which could increase our costs and
adversely affect our reputation, revenues and operating income.
As a
manufacturer of products designed for human consumption, we are subject to
product liability claims that the use of our products has resulted in injury.
Our products contain three types of live bacteria, lactobacillus acidophilus,
bifidobacterium bifidum and bifidobacterium adolescentis, which fall within the
nine types of “good” live bacteria that are approved for direct sale to the
public in China as health food. We obtain our bacteria from human sources.
Although we believe this reduces the risk that it will be rejected by the human
body, there can be no assurance that consumption of such bacteria could not
result in adverse health effects. We do not maintain any product liability
insurance. A product liability claim against us could result in costly
litigation and could adversely affect our reputation with our customers, which
in turn could adversely affect our revenues and operating income.
Our
revenues primarily depend on sales of one product and a decline in sales of this
product could cause our revenues to decrease.
We have
derived the majority of our revenue from the sale of our Shining Essence
product. Sales of this product represented approximately 61%, 48% and 40% of our
total sales for the year ended March 31, 2007, 2008 and 2009 respectively.
We expect that Shining Essence will continue to account for a large portion of
our revenues for the foreseeable future. Any factors adversely affecting the
pricing of, demand for or market acceptance of Shining Essence, including
increased competition, could cause our revenues to decline and our business and
future operating results to suffer.
We
are subject to concentrations of credit risk that could adversely affect our
operations.
Our
principal operations are in China and all of our sales during fiscal years 2007,
2008 and 2009 arose in China. A significant number of our financial instruments,
principally cash and accounts receivable, are located in China. These financial
instruments include:
·
cash deposits in China, which
includes the Special Administrative Region of Hong Kong, where there is
currently no rule or regulation in place for obligatory insurance of bank
accounts; and
·
accounts
receivable.
The
concentration of these financial instruments in China subjects us to
concentrations of credit risk that could adversely affect our operating
results.
-15-
If
our products fail to keep pace with advances in the industry, they may be
displaced by competitors’ newly developed products.
Other
companies in our industry may gain significant competitive advantages by
introducing new products to the market, delivering constant innovation in
products and techniques and offering competitive prices. Our future growth
partially depends on our ability to develop products that are more effective in
meeting consumer needs. In addition, we must be able to manufacture and
effectively market those products. The sales of our existing products may
decline if a competing product is introduced by other companies.
We
may have difficulty competing with larger and better financed companies in our
industry, which could require us, among other things, to lower our prices and
could result in the loss of our customers.
Some of
our existing and future competitors may have greater technical and financial
resources than we do and may use these resources to pursue a competitive
position that threatens our products. Our products could be rendered obsolete or
uneconomical by the development of new products to treat conditions addressed by
our products, as a result of technological advances affecting the cost of
production, or as a result of marketing or pricing action by one or more of our
competitors.
Additionally,
with China’s accession to the World Trade Organization, the Chinese government
has undertaken to open up the Chinese market to foreign companies. China reduced
its average import tariff rate overall to 11.50% in 2003 and has further reduced
it to 9.90% in 2005. As a result, foreign competitors may form alliances with or
acquire companies in our industry in China. Intensified competition from these
foreign competitors may lead to lower profit margins due to price competition,
loss of customers and slower than anticipated growth.
Unfavorable
publicity or research reports casting a negative light on our industry or our
products could change consumer perceptions and have an adverse affect on our
ability to market and sell our products.
We
believe that our industry is affected by media attention. Future research
reports or publicity about the quality of products in our industry generally, or
our products in particular, could have a material adverse effect on our
business. Scientific research to date is preliminary and there can be no
assurance that future scientific research or publicity will be favorable to our
industry or any particular product or consistent with earlier favorable research
or publicity. Adverse publicity could arise even if the adverse effects
associated with such products resulted from consumers’ failure to consume such
products appropriately. Given our dependence upon consumer perceptions, adverse
publicity, whether or not accurate, associated with illness or other adverse
effects resulting from the consumption of our products or any similar products
distributed by other companies could have a material adverse effect on our
business.
Our
planned expansion into the bulk additive business may not generate sufficient
revenues and the construction of our new facility to accommodate this business
may result in increased costs and losses.
We intend
to expand our operations into the bulk additive business through the supply of
high quality probiotics to be used as additives in dairy products to
manufacturers in China. We are constructing a new production plant with a
150-ton capacity which can accommodate our new bulk additive business. This will
expose us to many risks, including the following:
·
there
may not be sufficient market demand for bulk probiotics additives or our
products in particular;
·
we
may experience delays and cost overruns during construction of our new
facility which may result in losses;
and
·
we
may experience substantial start up losses when the plant is first
commissioned.
-16-
Our
plans to geographically expand our marketing and sales efforts and directly sell
our products directly to retail consumers may fail.
To date,
we have sold our products in the greater Shanghai area, Changchun, Longyan,
Jiaxing, Zhengzhou, Jilin and Hong Kong. We currently intend to expand our
marketing and sales efforts to the rest of China. There is no assurance that we
will receive the same level of public demand for our products in other parts of
China.
In
addition, we have been selling through distributors since our first product,
Shining Essence, was launched in the market in April 2001. We opened our first
retail outlet in March 2006. We intend to expand our operations by opening
additional new retail outlets to facilitate direct sales of our products to
customers. There is no assurance that we can successfully implement our direct
selling model.
As we
increase the geographic area of our selling efforts and implement a direct
selling model, there is a risk that our current systems may not be able to
accommodate the increased volume or the complexity of the future business. Our
short term operating results may be adversely affected as additional capital
investments will have to be made for system upgrades, replacements or
improvements.
We
face potential tax exposure.
Our
principal operations are in China. Business enterprises established in China are
subject to income taxes and value added taxes under Chinese tax laws and
regulations unless they have exemptions. In January 2006, we made tax
payments to the Chinese tax authorities for 2005 and we have made regular tax
payments to the Chinese tax authorities for subsequent periods. Our management
believes that our operations in China were exempted from income taxes and value
added taxes for all prior years because we had been recognized by the local
government as an advanced technology enterprise. However, we have never received
a written confirmation from the appropriate tax authorities for the tax
exemption status of our operations in China. As a result, there is no way to
ascertain the position which may be taken by the relevant Chinese tax
authorities in the future. Accordingly, our financial statements contain
full provisions for all applicable tax liabilities (other than potential tax
penalties), plus surcharge, for all prior calendar years for such taxes. Such
provisions for tax liabilities and surcharge will be reversed out of the
financial statements at the appropriate point in the future.
According
to PRC tax regulations, overdue tax liabilities in the PRC for the calendar
years prior to 2005 may be subject to potential penalties for the late payment
of taxes which is calculated on the basis of 0.5 times to five times the amount
of taxes payable, which amounts to from $4.9 million (if calculated based on 0.5
times of taxes payable) to $49 million (if calculated based on five times of the
amount of taxes payable) as of March 31, 2007, 2008 and 2009. The Group has
reserved for the payment of taxes that may be owed for calendar years prior to
2005 and any associated interest surcharges (which are calculated at 0.05% per
day on the accrued tax liabilities) in its financial statements until the
matter is fully resolved. Following the adoption of FIN48, the Group has
reserved for the surcharges payable for fiscal year 2008 and 2009. We
consider it more likely than not that the associated penalty will not need to be
paid.
In
addition, in connection with dividends paid to the Shining shareholders between
April 2003 to June 2005, Shining did not deduct a withholding tax at the rate of
20% as required by applicable Chinese laws and regulations. No provision for the
potential tax penalties with respect to this matter has been made in our
financial statements as our management believes that the possibility of having
to pay the penalties is unlikely. The Group has reserved for associated
surcharges for the fiscal year 2008 and 2009.
We
may not be able to protect our intellectual property against claims by other
parties or enforce our rights with respect to our intellectual
property.
We have
not purchased or applied for any patents other than three registered Chinese
patents in respect of the packaging processes and technologies we use in our
production process and a pending registration of a patent regarding the
production of one of our products, as we are of the view that it would not
be cost-effective to do so at this time. Without patents, we may have no legal
recourse in the event that our processes and technologies are replicated by
other parties. If our competitors are able to replicate our processes,
technologies and systems at lower costs, we may lose our competitive advantage
and our profitability will be adversely affected.
In
addition, we believe that over the last five years our “Shining” brand has
become a highly recognizable brand in our industry in Shanghai. To protect this
brand, which we consider important to our continued success, we have registered
four trademarks in China. If our competitors introduce products of inferior
qualities to the market using trademarks that are confusingly similar to the
“Shining” trademarks, our reputation and operating results will be adversely
affected.
-17-
From time
to time, we may have to resort to litigation to enforce our rights with respect
to our intellectual property. This type of litigation could result in
substantial costs and diversion of our resources, which would adversely affect
our results of operations.
Management
by a small team of officers may create conflicts of interests and impede the
successful implementation of our growth plans.
Mr.
Song and Mr. Fan, our only executive officers, are responsible for all
managerial functions of our company. We have been hiring additional employees to
complete our management team, but we cannot assure you that we can assemble a
management team that can tackle the expansion plans that we have. The
concentration of management could be disadvantageous to stockholders with
interests different from those of Mr. Song or Mr. Fan.
Risks
Related to Government Regulations
We
are subject to government regulation in China, and changes in Chinese
regulations may substantially increase the cost of manufacturing and selling our
products.
The
manufacturing and marketing of our products are subject to various governmental
regulations in China. Government regulation includes inspection of and controls
over manufacturing, safety and environmental controls, efficacy, labeling and
the sale and distribution of wellness products.
As a
company which produces probiotics supplements, we are subject to the Law on the
Food Conditions of the PRC which became effective on October 30, 1995, the
Administrative Rules for Healthy Food promulgated by the Ministry of Health on
March 15, 1996 which became effective on June 1, 1996, the Notice of Circulating
the Appraisal Standard of Fungal and Good-Live-Bacterial Healthy Food and its
appendixes-Appraisal Standard of Fungal and Good-Live-Bacterial Healthy Food,
and List of Good-Live-Bacteria Applicable for Healthy Food, promulgated by the
Ministry of Health which became effective on March 23, 2001, the Administration
Rules for the Registration of Healthy Food (experimental) promulgated by the
State Food and Drug Administration on April 30, 2005 which became effective on
July 1, 2005, and other relevant rules and regulations issued by the Ministry of
Health and the State Food and Drug Administration. In addition, Shining is a
Chinese corporation and therefore is subject to the Company Law of China and
more specifically to the Foreign Company provisions of the Company Law and the
Law on Foreign Capital Enterprises of China.
Our
industry is relatively new in China, and the manner and extent to which it is
regulated is evolving. Changes in existing laws or new interpretations of such
laws may have a significant impact on our methods and costs of doing business.
For example, new legislative proposals that affect our product pricing,
reimbursement levels, approval criteria and manufacturing requirements may be
proposed and adopted.
The costs
of compliance with current or future legislation or regulatory requirements may
be significant, and could force us to curtail our operations or otherwise have a
material adverse effect on our financial condition, results of operations or
cash flows. For example, we have obtained three licenses and permits which are
required for us to operate our business in China. If the regulations regarding
these licenses and permits are changed, it may be materially burdensome for us
to obtain or renew these licenses and permits or they may be otherwise
unavailable.
Government
regulation of our retail prices and advertising methods may adversely affect our
results of operations.
We are
subject to government regulations with respect to the prices we charge, the
rebates we may offer to customers and our marketing methods. In addition, we are
required to obtain approval from Chinese government authorities regarding the
contents of advertisements related to our products before they can be published.
If the Chinese government requires that we set our retail prices at
undesirable prices or significantly limits our ability to advertise our
products, it could have a material adverse effect on our results of
operations.
-18-
We
may not be able to obtain regulatory approvals for our products or reimbursement
from the sale of our products.
The
manufacture and sale of our products in China is highly regulated by a number of
state, regional and local authorities. These regulations significantly increase
the difficulty and costs involved in obtaining and maintaining regulatory
approval for marketing new and existing products. In addition, our future growth
and profitability are, to a significant extent, dependent upon our ability to
obtain timely regulatory approvals from the relevant authorities.
Risks
Related to Doing Business in China
Adverse
changes in China’s economic, political and social conditions and government
policies could have a material adverse effect on the overall economic growth of
China, which could adversely affect our results of operations and financial
condition.
We
currently conduct our business solely in China. Changes in the economic and
political situation in China and the economic, financial, fiscal and other
policies adopted by the Chinese government may affect our operations,
performance and profitability. The economy of China differs from the economies
of most developed countries in many respects, including:
·
structure;
·
extent
of government involvement;
·
level
of development;
·
growth
rate;
·
control
of foreign exchange; and
·
allocation
of resources.
China’s
economy has traditionally been subject to central planning, with a series of
economic plans promulgated and implemented by the Chinese government. Over the
past 25 years, the Chinese government has been reforming the economic and
political systems in China in an attempt to achieve economic and social
advancements. Many of these reforms were unprecedented and are expected to
continue while political, economic and social factors may also lead to further
adjustments to China’s reform measures. These reforms and adjustments may not
always have a positive effect on our operations. Accordingly, we cannot assure
you that our performance and profitability will not be adversely affected from
these measures. In addition, there is no assurance that the Chinese government
will continue to pursue economic liberalization and other reforms.
Macroeconomic
measures taken by the Chinese government may cause the Chinese economy to slow
down.
In
response to concerns relating to China’s high rate of growth in industrial
production, bank credit, fixed investment and money supply and growing
inflationary pressures, the Chinese government has taken measures to slow
economic growth to a more manageable level. Among the measures that the Chinese
government has taken are restrictions on bank loans in certain sectors and the
increase of interest rates. We cannot assure you that those measures will not
result in a slowdown in economic growth and hence a reduction in demand for
consumer products in China. These measures and any additional measures could
contribute to a slowdown in the Chinese economy and could potentially cause the
economy to enter a recession, which could have an adverse impact on demand for a
wide range of products in China, including our products.
There
are uncertainties regarding interpretation and enforcement of Chinese laws and
regulations.
China’s
legal system is a civil law system based on statutory law. Prior legal decisions
and judgments have little precedential value. China is still in the process of
developing a comprehensive statutory framework and its legal system is still
considered to be underdeveloped in comparison with the legal systems in some
western countries. Since 1979, the Chinese government has formulated and enacted
a large number of laws and regulations governing economic matters, securities
activities and foreign investments.
-19-
Despite
significant development in its legal system, China does not have a comprehensive
system of laws. The interpretation of Chinese law by courts and tribunals may be
inconsistent and influenced by government policies and other considerations. In
addition, the enforcement of existing laws and regulations can be uncertain and
unpredictable. Judgments and arbitration rulings may be unenforceable. The
promulgation of new laws, changes to existing laws and inconsistent
interpretation of laws could have a negative impact on our
business.
Key
members of our management, and substantially all of our assets, are located in
China, thus it may be extremely difficult to acquire jurisdiction and enforce
liabilities against our management and our assets.
Because
key members of our management are Chinese citizens it may be difficult, if not
impossible, to acquire jurisdiction over them in the event a lawsuit is
initiated against us or our management by a stockholder or group of stockholders
in the United States. We anticipate that future members of our management will
also be Chinese citizens. Because the majority of our assets are located in
China, it would also be extremely difficult to access those assets to satisfy an
award entered against us in U.S. court.
Restrictions
on currency exchange may limit our ability to receive and use our revenues
effectively.
Since
almost all of our future revenues may be in the form of Renminbi, any future
restrictions on currency exchanges may limit our ability to use revenue
generated in Renminbi to fund any future business activities outside China or to
make dividend or other payments in U.S. dollars. There are significant
restrictions on convertibility of the Renminbi for current account
transactions, including primarily the restriction that foreign invested
enterprises may only buy, sell or remit foreign currencies, after providing
valid commercial documents, at those banks authorized to conduct foreign
exchange business. In addition, conversion of Renminbi for capital account
items, including direct investment and loans, is subject to governmental
approval in China, and companies are required to open and maintain separate
foreign exchange accounts for capital account items. We cannot be certain that
the Chinese regulatory authorities will not impose more stringent restrictions
on the convertibility of the Renminbi, especially with respect to foreign
exchange transactions.
Failure
to comply with the United States Foreign Corrupt Practices Act could subject us
to penalties and other adverse consequences.
As our
ultimate holding company is a Delaware corporation, we are subject to the United
States Foreign Corrupt Practices Act, which generally prohibits United States
companies from engaging in bribery or other prohibited payments to foreign
officials for the purpose of obtaining or retaining business. Foreign companies,
including some that may compete with our company, are not subject to these
prohibitions. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices may occur from time-to-time in the PRC. We can make no
assurance, however, that our employees or other agents will not engage in such
conduct for which we might be held responsible. If our employees or other agents
are found to have engaged in such practices, we could suffer severe penalties
and other consequences that may have a material adverse effect on our business,
financial condition and results of operations.
Because
our funds are held in banks in the PRC that do not provide insurance, the
failure of any bank in which we deposit our funds could affect our ability to
continue in business.
Banks and
other financial institutions in the PRC do not provide insurance for funds held
on deposit. A significant portion of our assets are in the form of cash
deposited with banks in the PRC, and in the event of a bank failure, we may not
have access to our funds on deposit. Depending upon the amount of money we
maintain in a bank that fails, our inability to have access to our cash could
impair our operations, and, if we are not able to access funds to pay our
suppliers, employees and other creditors, we may be unable to continue in
business.
Any
outbreak of the Swine Flu (H1N1), severe acute respiratory syndrome, or SARS,
the Avian Flu, or another widespread public health problem in the PRC could
adversely affect our operations.
There
have been recent outbreaks of the highly pathogenic Swine Flu, caused by the
H1N1 virus, in certain regions of the world, including parts of China, where all
of our manufacturing facilities are located and where all of our sales occur.
Our business is dependent upon our ability to continue to manufacture and
distribute our products, and an outbreak of the Swine Flu, or a renewed outbreak
of SARS, the Avian Flu, or another widespread public health problem in China,
could have a negative effect on our operations. Any such outbreak could have an
impact on our operations as a result of:
·
quarantines
or closures of our manufacturing or distribution facilities or the retail
outlets, which would severely disrupt our
operations,
·
the
sickness or death of our key officers and employees,
and
·
a
general slowdown in the Chinese
economy.
Any of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect our operations.
Risks
Related to our Common Stock
Shares
of our common stock which are eligible for immediate sale by our stockholders
may decrease the market price of our common stock.
We had
17,080,000 shares outstanding as of March 31, 2009, including
approximately 6,968,028 shares which are free trading and may be sold
immediately by our stockholders. An additional 2,083,333 shares, subject to
adjustment for subdivision or combination of our stock and similar events, may
be issued upon conversion of a 4% convertible promissory note issued to
Pope Investments II LLC in the amount of $25 million, as further described
in “Business-History”. If our stockholders sell substantial amounts of our
common stock, or there is a perception in the market that such sales may occur,
then the market price of our common stock could decrease.
Concentration
of our ownership by our President and Chief Executive Officer
and a director and his family may dissuade new investors from
purchasing our securities which could result in a lower trading price for our
securities than if our ownership was less concentrated.
As of
March 31, 2009, Mr. Song, our President and Chief Executive Officer
and a director, owned, directly and indirectly through his family,
approximately 54.5% of our issued and outstanding common stock. As a result,
Mr. Song has the ability to exert substantial influence or absolute control
over all matters requiring approval by our stockholders, including the election
and removal of directors, any proposed merger, consolidation or sale of all or
substantially all of our assets and other corporate transactions. This
concentration of control could be disadvantageous to other stockholders with
interests different from those of Mr. Song. For example, Mr. Song
could delay or prevent an acquisition or merger even if the transaction would
benefit other stockholders. In addition, this concentration of share ownership
may adversely affect the trading price for our common stock because investors
often perceive disadvantages in owning stock in companies with a significant
concentration of ownership among a limited number of stockholders.
-20-
Our
common stock price has been volatile, and you may not be able to sell
your shares at or above the price that you pay for
the shares.
The price
of our common stock has historically been volatile and our investors experience
wide fluctuations in the market price of our securities. Although our common
stock is currently traded on the Nasdaq Global Market, it was previously quoted
on the OTC Bulletin Board. Securities quoted on the OTC Bulletin Board tend to
be highly illiquid, in part because there is no national quotation system by
which potential investors can track the market price of shares except through
information received or generated by a limited number of broker-dealers that
make markets in particular stocks.
The
volatility in the price of our common stock may be caused by a variety of
factors including:
·
lower trading
volume;
·
market
conditions;
·
the lack of readily available
price quotations; and
·
the absence of consistent
administrative supervision of “bid” and “ask”
quotations.
The
fluctuations in the price of our common stock may have an extremely negative
effect on the market price of our securities and may prevent you from obtaining
a market price equal to your purchase price when you attempt to sell our
securities in the open market. In these situations, you may be required to
either sell our securities at a market price which is lower than your purchase
price, or to hold our securities for a longer period of time than you
planned.
Volatility
in the price of our common stock may cause it to be classified as penny stock
which will result in limits on trading and our stock price could
decline.
Because
our common stock is volatile, it may in the future fall under the SEC definition
of “penny stock”, if our common stock is classified as “penny stock” we expect
trading in our common stock, if any, to be limited because broker-dealers are
required to provide their customers with disclosure documents prior to allowing
them to participate in transactions involving our common stock. These disclosure
requirements are burdensome to broker-dealers and may discourage them from
allowing their customers to participate in transactions involving our common
stock.
Rules
promulgated by the SEC under Section 15(g) of the U.S. Securities Exchange
Act of 1934, or Exchange Act, require broker-dealers engaging in transactions in
penny stocks, to first provide to their customers a series of disclosures and
documents, including:
·
a
standardized risk disclosure document identifying the risks inherent in
investment in penny stocks;
·
all
compensation received by the broker-dealer in connection with the
transaction;
·
current
quotation prices and other relevant market data;
and
·
monthly
account statements reflecting the fair market value of the
securities.
In
addition, these rules require that a broker-dealer obtain financial and other
information from a customer, determine that transactions in penny stocks are
suitable for such customer and deliver a written statement to such customer
setting forth the basis for this determination.
-21-
Our
preferred stock may make a third-party acquisition of our company more difficult
which in turn would make a purchase of our shares less desirable, thereby
potentially reducing our stock price or the liquidity of
our shares.
Our
certificate of incorporation authorizes our board of directors to issue up to
10,000,000 shares of preferred stock having such rights as may be
designated by our board of directors, without stockholder approval. The issuance
of preferred stock could inhibit a change in our control by making it more
difficult to acquire the majority of our voting stock and thereby making the
purchase of our shares by new investors less likely. A lesser interest in
the purchase of our shares could reduce our market price or make it more
difficult for stockholders to sell their shares. No shares of
preferred stock are currently outstanding.
We
do not anticipate paying dividends.
We do not
anticipate paying dividends in the foreseeable future. Any dividends which we
may pay in the future will be at the discretion of our board of directors and
will depend on our future earnings, any applicable regulatory considerations,
our financial requirements and other similarly unpredictable factors. For the
foreseeable future, we anticipate that we will retain any earnings which we may
generate from our operations to finance and develop our growth.
ITEM
2. PROPERTIES.
We
do not own any real estate. We conduct our operations from a leased facility in
Pudong, Shanghai. Pursuant to our lease for this facility, which expires on
October 19, 2011, we pay annual rent of RMB507,532, payable in monthly
installments of RMB42,294. This facility, which includes a level 100,000 clean
room and a level 10,000 clean room, houses our office space manufacturing
facilities and warehouse. The maximum current production capacity at this
location is approximately 3.5 million capsules per month. We have received
ISO 9001, ISO 14001, OHSAS 18001 and HACCP certifications for this facility.
See
“Business—Current Operations—Overview” for further information with respect to
these certifications.
We are
constructing a bulk manufacturing facility that will have an initial capacity of
150 tons per year of bulk product with room for expansion to 300 tons per year
based on market demand. Management estimates that Phase 1 of the project, which
involves constructing a facility capable of producing 150 ton probiotics per
annum, will cost $27.5 million, $25 million of which is expected to be
paid by the third quarter of calendar year 2009 and the
balance by the end of calendar year 2009. Phase 2 of this project will only
commence when demand for probiotics has exceeded the production capacity of the
Phase 1 facility. Phase 2 of this project is expected to cost $18
million. The construction cost of Phase 1 of the plant will be funded by
cash received from the sale of convertible promissory notes to Pope Investments
II LLC on December 11, 2007 as disclosed in “Business-History”. On March 21,2006, Growing State, our subsidiary, entered into an agreement with Shanghai
Qingpu Industrial Park District Development (Group) Company Limited for the
lease of 73,157 square meters of land in the Shanghai Qingpu Industrial Park
District on which we are constructing this plant. The agreement provides for the
payment of leasing fees of approximately $2.1 million, 10% of which we paid on
April 11, 2006 as a deposit, to be refunded upon payment in full of the
aggregate lease amount. The Qingpu People’s Republic Government issued
its formal confirmation of the land use right necessary for the plant
construction on November 30, 2007 and confirmed the leasing fee of
$1,777,680 (reduced from $2.1 million because the size of the leased land was
reduced to 36,075 square meters) and a refundable land deposit of
$210,083. We paid the leasing fee on December 28, 2007. In February
2009, the refundable land deposit was fully refunded and the formal land use
right certificate was issued. There are no future lease payments under this land
lease.
ITEM
3. LEGAL PROCEEDINGS
We have
not been involved in any material litigation or claims arising from our ordinary
course of business. We are not aware of any material potential litigation or
claims against us which would have a material adverse effect upon our results of
operations or financial condition.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-22-
PART
II
ITEM
5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Market
Information
Our
common stock has been traded on the Nasdaq Global Market since October 23, 2008
under the symbol “CHBT”. Prior to listing on the Nasdaq Global Market, our
common stock was quoted on the OTC Bulletin Board. We have generally had very
low trading volume for our common stock. Set forth below is information with
respect to the high and low sales prices of our common stock for the periods
indicated.
At July13, 2009 there were 17,080,000 shares our common stock outstanding held by
approximately 29 stockholders of record. An additional 2,083,333
shares, subject to adjustment for subdivision or combination of our stock and
similar events, may be issued upon conversion of a 4% convertible promissory
note issued to Pope Investments II LLC in the amount of $25 million, as further
described in "Business - History".
Dividend
Policy
We have
not historically paid any cash dividends and do not intend to pay any dividends
in the foreseeable future. We plan to use retained earnings, if any, to finance
our growth. The declaration and payment of dividends in the future will be
determined by our board of directors in light of conditions then existing,
including our financial condition, capital requirements and restrictions in our
financing agreements.
Equity
Compensation Plans
We do not
have any equity compensation plans. We have not granted any stock options or
other equity awards since our inception.
Performance
Graph
The
following chart compares the cumulative total stockholder return on the
Company’s shares of common stock with the cumulative total stockholder return of
(i) the NASDAQ Market index and (ii) a peer group index consisting of
companies reporting under the Standard Industrial Classification Code 2833
(Medicinal Chemicals and Botanical Products). The chart compares the cumulative
total stockholder return on a monthly basis, and the measurement period covered
by this comparison starts from October 23, 2008, which is when the Company’s
common shares were listed on the NASDAQ Global Market.
COMPARISON
OF CUMULATIVE TOTAL RETURN
AMONG
CHINA-BIOTICS, INC.,
NASDAQ
MARKET INDEX AND SIC CODE INDEX
CUMULATIVE
VALUE OF $100 INVESTMENT
YEAR
ENDING
COMPANY/INDEX/MARKET
10/23/2008
11/28/2008
12/31/2008
1/30/2009
2/27/2009
3/31/2009
4/30/2009
5/29/2009
6/30/2009
China-Biotics,
Inc.
100.00
60.92
82.42
73.54
60.92
73.98
73.98
90.95
93.99
Medicinal
Chemicals and Botanical Products
100.00
97.76
94.09
93.44
91.74
89.31
93.11
107.79
110.21
NASDAQ
Market Index
100.00
95.74
98.32
92.05
85.91
95.30
107.07
110.63
114.41
ITEM
6. SELECTED FINANCIAL DATA
The
tables below present our summary selected consolidated financial data (in
thousands, except for per share data) prepared in accordance with accounting
principles generally accepted in the United States of America. This information
should be read in conjunction with our audited consolidated financial statements
and related notes thereto which are included in this Form 10-K and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” on
page 23 of this Form 10-K.
The
summary statement of operations data for each of the fiscal years ended March31, 2009, 2008 and 2007 and the summary balance sheet data as of March 31, 2009,
2008 and 2007 are derived from our audited financial statements, which are
included in this Form 10-K.
The scope
of our current business is substantially different from that conducted by us
prior to March 22, 2006. You should not view our historical consolidated
financial statements or the financial data derived therefrom as predictive of
our future financial position or results of operations.
2009
2008
2007
2006
Unaudited
2005
(1)
Statement
of Operations Data
Net
Sales
54,197
42,321
30,610
21,862
-
Cost
of goods sold
16,197
12,310
8,911
6,445
-
Gross
profit
38,000
30,011
21,699
15,417
-
Income
from operations
21,783
18,315
14,931
12,185
(12,643
)
Net
income
19,967
17,542
10,905
8,354
(12,643
)
Earnings
per share
Basic
and diluted
1.17
1.03
0.64
4.90
-
Shares
used in per share calculation
Basic
17,080,000
17,080,000
17,080,000
1,705,242
26,481,004
Balance
Sheet Data
Current
assets
87,370
79,979
41,897
31,833
2,215
Total
assets
120,804
93,791
44,580
33,427
2,215
Working
Capital
55,034
53,083
21,227
10,743
2,215
Non-current
liabilities
23,072
22,500
-
-
-
Total
Stockholder’s equity
65,396
44,395
23,910
12,337
2,215
(1)
Fiscal
year ended August 31 (Unaudited).
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
The
following discussion should be read in conjunction with the financial statements
and the notes thereto appearing elsewhere in this Form 10-K. The following
discussion contains forward-looking statements reflecting our plans, estimates
and beliefs. Our actual results could differ materially from those discussed in
the forward-looking statements. You are also urged to carefully review and
consider our discussions regarding the various factors which affect our
business, including the information provided in the risk factors discussion
beginning on page 15 of this Form 10-K. See the cautionary note regarding
forward-looking statements at the beginning of Part I of this Form
10-K.
-23-
General
We were
incorporated under the name Otish Resources, Inc. in Delaware in
February 2003. Until March 2006 we were a mineral exploration stage company
specializing in acquiring and consolidating mineral properties with potential
for commercial ore bodies. Although we conducted some preliminary exploration
work with respect to our mineral properties, we never achieved full operations
with respect to our mineral properties. We had never generated any revenue from
our mineral exploration operations. We incurred a total of expenses of $257,914
from inception to February 28, 2006.
On March22, 2006, we entered into and completed a securities exchange transaction with
SGI and the shareholders of SGI, pursuant to which the SGI shareholders
transferred all of the equity securities of SGI to us in exchange for an
aggregate of 15,980,000 shares of our common stock. At the closing of the
share exchange, SGI became our wholly-owned subsidiary. Immediately after the
share exchange and related transactions described elsewhere in this document,
the former SGI shareholders and their designees collectively owned 98.7% of our
common stock. As a result of the share exchange, we are no longer a mineral
exploration stage company, and SGI’s business operations become our primary
operations. We are currently engaged in the research, development, production,
marketing and distribution of probiotics products. These products contain live
microbial food supplements which beneficially affect the host by improving its
intestinal microbial balance. See “Business - History”.
We
accounted for the share exchange as a recapitalization whereby the historical
financial statements and operations of the SGI become our historical financial
statements, with no adjustment to the carrying value of the assets and
liabilities. Our issued and outstanding common stock immediate prior to the
share exchange is accounted for at the net book value at the time of the
transaction.
Upon
consummation of the share exchange, we changed our fiscal year end from August
31 to March 31 to conform to the year end date of SGI. We filed a quarterly
report on Form 10-QSB on April 14, 2006 for quarter ended February 28,2006. This quarterly report was our last filing under our previous fiscal year
end date of August 31, and as a mineral exploration stage company. In our
future filings with the SEC, we will report our business activities as a
manufacturer and distributor of probiotics products based on our new fiscal year
end date of March 31. SGI’s historical financial statements will become our
historical financial statements.
The
results of operations related to Otish Resources, Inc., as a mineral exploration
stage company, are not material and are therefore not included in the discussion
below. Unless otherwise noted, all references to the “company,”“we,”“us” and
“our” hereafter in this section refer to the current business of China-Biotics,
Inc. or the historical business of SGI and its subsidiaries, as
applicable.
In this
document, we use the “Current rate method” to translate the financial statements
of SGI from HKD into U.S. Dollars, and to translate the financial statements of
Shining from RMB into U.S. Dollars, as required under the Statement of Financial
Accounting Standards No. 52, “Foreign Currency Translation” issued by the
Financial Accounting Standards Board. The assets and liabilities of SGI and
Shining, except for the paid-up capital, are translated into U.S. Dollars using
the rate of exchange prevailing at the balance sheet date. The paid-up capital
is translated at the historical rate. Adjustments resulting from the translation
of SGI’s and Shining’s balance sheets from HKD and RMB into U.S. Dollars are
recorded in shareholders’ equity as part of accumulated comprehensive income.
The statement of operations is translated at average rates during the reporting
period. Gains or losses resulting from transactions in currencies other than the
functional currencies are reflected in the statement of operations for the
reporting periods. The statement of cash flows is translated at average rates
during the reporting period, with the exception of issue of share and payment of
dividends which are translated at the historical rates. Due to the use of
different rates for translation, the figures in the statement of changes in cash
flows may not agree with the differences between the year end balances as shown
in the balance sheets.
-24-
Overview
We
manufacture and sell probiotics products. Probiotics comprise mainly live
bacteria, which we produce using advanced proprietary fermentation technology.
Currently, our products are sold mainly in the Greater Shanghai
region.
The
products are mainly sold to distributors, which then distribute them to various
retail outlets such as drug stores and supermarkets. During the year ended March31, 2009, over 65% of our sales revenue comprised amounts receivable from the
distributors for the sale of these products. Typically, 60 to 90 days’ credits
are given to the distributors.
Our first
product, Shining Essence, which was launched in April 2001, remains our
best-selling product. Sales of Shining Essence represented approximately 61%,
48% and 40% of our total sales for the years ended March 31, 2007, 2008 and
2009, respectively. In addition to Shining Essence, we have successfully created
other new products, such as Shining Probiotics Protein Powder. As we have
released new products, the percentage contribution of Shining Essence to our
total sales has decreased.
As our
products comprise mainly live bacteria, which are reproduced by fermentation, we
have historically had a low cost of production of which packaging costs
represent the largest cost item.
Our
management believes that the following trends in China will have an important
impact on, and present significant opportunities for, our business:
•
Increasing
demand for functional food products. As the discretionary income and
health-consciousness of the average Chinese consumer increase, we expect
the demand for functional foods and dietary supplements to
increase.
•
Curtailment of
the use of antibiotics and preservatives and government support for
probiotics. China
has the highest per capita consumption of antibiotics in the world. To
curtail the overuse of antibiotics, the Chinese government has taken steps
to limit the use of antibiotic drugs and preservatives. Moreover, the
Chinese State Food and Drug Administration has also acknowledged that
probiotics are beneficial for human
health.
•
Increasing
demand for dairy product additives. The demand for functional foods
and foods that use probiotic supplements is growing at a significant rate
and our management believes that it will continue to do so. According to
statements made by the Nutrition Development Centre of National
Development and Reform Commission in China, effective April 1, 2007,
probiotics will be added to baby milk powders produced in
China.
Our
management expects to capitalize on the opportunities created by these trends to
achieve significant growth through:
•
The introduction of bulk
additives products. We are expanding into the bulk additive
business for functional foods through the completion of our 150-ton
capacity plant, which is scheduled to commence trial production within the
second quarter of fiscal year 2010. Management estimates that Phase 1 of
the project, which involves constructing a facility capable of producing
150 tons of probiotics per annum will cost $27.5 million, $25 million of
which is expected to be paid by the third quarter of calendar year 2009
and the balance by the end of calendar year 2009. Phase 2 of this project
will only commence when demand for probiotics has exceeded the production
capacity of the Phase 1 facility. Phase 2 of this project is expected to
cost $18 million. The construction cost of Phase I of the plant will be
funded by cash received from the sale of convertible promissory notes to
Pope Investments II LLC on December 11, 2007 as disclosed in “Business —
History”.
-25-
On March21, 2006, Growing State, our subsidiary, entered into an agreement with Shanghai
Qingpu Industrial Park District Development (Group) Company Limited for the
lease of 73,157 square meters of land in the Shanghai Qingpu Industrial Park
District on which we are constructing this plant. The agreement provides for the
payment of leasing fees of approximately $1.89 million. The Qingpu
People’s Republic Government issued its formal confirmation of the land use
right necessary for the plant construction on November 30, 2007 and confirmed
the leasing fee of $1,777,680 (reduced from $2.1 million because the size of the
leased land was reduced to 36,075 square meters) and a refundable land deposit
of $210,083. We paid the leasing fee on December 28, 2007. In
February 2009, the refundable land deposit was fully refunded and the
formal land use right certificate was issued. There are no future lease payments
under this land lease.
•
The
geographical expansion of retail sales through direct sales and
traditional sales channels. We intend to expand our sales to
other cities in China through a combination of distributors and our own
outlets. In this regard, we had 106 Shining branded outlets in Shanghai
and 12 other major Chinese cities at March 31, 2009. We expect that the
additional demands from opening new outlets will be met initially by
increasing production from our existing plant, which currently has the
necessary capacity, and in the future from our new plant that will have a
capacity of 150-300 tons. The initial, 150-ton phase of our new plant is
scheduled to commence trial production within the second quarter of fiscal
year 2010.
•
The
development of new products. We have introduced
several new products which are sold exclusively in our outlets. We plan to
continue to develop new products aimed at improving the general health
conditions of humans, enhancing their immune system and reducing health
problems. The new products will strengthen our product pipeline so that we
may offer a wider array of products for sale in the Shining
outlets.
Our
operation is generally not labor-intensive. We employed 378 people as of March31, 2009. The construction of our new plant and the creation of the new direct
sales network will result in significant increases in our number of employees as
we expect our staff and employees will increase to 1,000 staff over the next two
years. We have been recruiting senior executives to strengthen our management
team. However, as wages in China are relatively inexpensive, we expect that
labor costs will remain insignificant.
Our net
income was $20 million for the fiscal year ended March 31, 2009. This included
$3.1 million surplus arising from the revaluation of the conversion feature
embedded in the convertible notes issued in December 2007 as required by FAS133.
Excluding this revaluation surplus, our net income was $16.9 million, which was
19.9% above our net income of $14.1 million (excluded $3.4 million revaluation
surplus) for the fiscal year ended March 31, 2008. Our growth in net income
primarily resulted from growth in our sales volume of our products. Shining
Essence continued to be our best selling product. We have enjoyed strong growth
in demand for many products such as Shining Essence Stomach
Protection and Shining Probiotics Protein Powder which outpaced
that of Shining Essence. In addition, new product sales now account for 18.5% of
our sales revenue during the year ended March 31, 2009 (15.6% in the year ended
March 31, 2008). As a result, the percentage of sales revenue attributable to
Shining Essence has been diluted to only 40% of our total sales revenue in the
year ended March 31, 2009 (49% in the year ended March 31, 2008).
-26-
Our
results for 2009 and 2008 are summarized below:
Net sales
in our financial statements are stated at invoiced value less sales discount and
sales tax. Our net sales for the fiscal years 2009 and 2008 comprised the
following:
Net sales
of $54,197,082 for the fiscal year ended March 31, 2009 were 28.1% above the net
sales of $42,321,111 for the fiscal year ended March 31, 2008. The increase was
mainly attributable to increased sales volume and increases in average selling
prices due to changes in sales mix.
The
contributions of each product as a percentage of invoiced value on sales for the
year ended March 31, 2009 and 2008 respectively are summarized below. New
product sales (including Stomach Protection, Protein Powder and others) now
account for 18.5% of our sales revenue for the year ended March 31, 2009. While
the sales revenues of Essence and Signal capsules have remained stable, their
percentage contributions to our sales revenue have been diluted by increases in
new product sales.
Unit
volume and unit prices comparatives (on the invoiced value of sales) for 2009
and 2008 are summarized below. The increase in selling prices of Golden Shield
and Energy capsules primarily reflect a combination of price increase and
changes in sales mix with more sales of packages with higher selling
prices.
-27-
Percentages increase (decrease) from the prior year
Cost of
sales for the year ended March 31, 2009 was $16,197,267 compared with
$12,310,092 for the year ended March 31, 2008. The increase in cost of sales was
primarily caused by increased packaging cost during the fiscal year
2009.
Unit
volume and unit costs comparatives for the year ended March 31, 2009 and 2008
are summarized below.
Percentages increase (decrease) from the prior year
Gross
profit increased by $7,988,796 from $30,011,019 for the 2008 fiscal year to
$37,999,815 for the 2009 fiscal year. This represents a 26.6% increase, which
reflects primarily increases in sales volume. Our gross profit margin remained
the same as last year at 70%.
Selling
expenses
Selling
expenses were $11,563,012 or 21.3% of net sales for the fiscal year ended March31, 2009 compared with $6,869,109 or 16.2% of net sales for the fiscal year
ended March 31, 2008. The operating costs of the retail outlets are included as
selling expenses. This increase in selling expenses was primarily caused by the
roll out of retail outlets. As of March 31, 2009, we had a total of 106 retail
outlets in operation (as of March 31, 2008, we had 60 retail
outlets).
General
and administrative expenses
General
and administrative expenses were $6,246,482 or 11.5% of net sales for the year
ended March 31, 2009 compared with 4,826,473 or 11.4% of net sales for the year
ended March 31, 2008. The increase in general and administrative expenses was
due to additional research costs of $1,035,314 related to the development and
launching of new products, and staff and administrative costs incurred in
connection with the construction of the new plant.
-28-
Other
Income
Other
income mainly comprised exchange gain of $1.51 million for the fiscal year ended
March 31, 2009. For the fiscal year ended March 31, 2008, other income consisted
of exchange gain of $0.4 million.
Provision
for income taxes
Provision
for income taxes was $5.16 million and $4.94 million for the fiscal years ended
March 31, 2009 and 2008, respectively. The increase in income tax payable is
attributable to an increase in operating profit.
Segment
reporting
We have
adopted the “products and services” approach for segment reporting. For fiscal
years 2009 and 2008, we had only one reporting segment—the probiotic products as
health supplement. We manufactured and sold the probiotic products solely in
China and delivered all shipments to destinations within China, and all of our
long-lived assets were physically located in China. We made all sales to
external customers.
Liquidity
and Capital Resources
We had
cash of $70.8 million and working capital of $55.0 million as of March 31, 2009,
and cash of $64.3 million and working capital of $53.1 million as of March 31,2008. Cash generated from operations was $23.1 million for the fiscal year ended
March 31, 2009 and $19.4 million for the fiscal year ended March 31,2008.
Our
business is not capital or labor intensive. Typically, 60% of our sales take
place in the second half of the fiscal year. Since our customers have
historically been large distributors with which we have done business for a
number of years, our cash flows from our existing business have been, and we
expect them to continue to be, fairly reliable.
We had
capital expenditures totaling $17.5 million for the year ended March 31, 2009,
primarily on building the new plant. We spent $10.3 million on fixed
assets in fiscal year 2008.
Our
current facility commenced operations in 2000. With the increases in sales
volume in the last couple of years, we are reaching our production capacity. We
have started to construct a new plant with an overall project size of $45.5
million. Phase 1 of the project involves constructing a facility capable of
producing 150 tons of probiotics per annum and is estimated to cost $27.50
million, $25 million of which is expected to be paid in the third quarter of
calendar year 2009 and the balance by the end of calendar year 2009. Subsequent
phases of this project will only commence when demands for probiotics have
exceeded the production capacity of the Phase 1 facility.
-29-
We did
not have cash generated from financing activities in fiscal year 2009. We had
net cash of $25 million generated from financing activities in fiscal year
2008. Details on our financing activities for the two fiscal years are as
follows:
NET
CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES
-
25
On
December 11, 2007, we issued a 4% Senior Convertible Promissory Note in the
amount of $25,000,000 (the “Note”) with a maturity date of December 11, 2010.
The principal amount of the Note is convertible into shares of our common stock
at an exercise price of $12.00 per share at any time until the maturity date. If
the Note is not converted at maturity, we will redeem the Note at a price that
gives a total yield of 10% per annum inclusive of the annual interest. The Note
also provides for mandatory conversion into common stock if the Group
achieve a net income of $60 million in fiscal year 2010. Net proceeds of the
Note are expected to be used to fund the construction of a proposed
150-metric-ton-per-year manufacturing facility.
Taking
into account our current cash position and our anticipated cash flows from
operations, we expect we will be able to meet all our funding needs in the next
twelve months, including payments required to settle our contractual obligations
and for our construction of our new plant. No assurance, however, can be given
that our business plan will succeed. In the event that our business plan does
not materialize as predicted, we may need to seek for external financing to fund
our expansion plan. There can be no assurance that we will be able to raise
needed capital on favorable terms, if at all. In addition, there is no assurance
that our estimate of our liquidity needs is accurate or that new business
development or other unforeseen events will not occur, resulting in the need to
raise additional funds.
Our net
income was $17.5 million for the fiscal year ended March 31, 2008. This included
$3.4 million surplus arising from the revaluation of the conversion feature
embedded in the convertible notes issued in December 2007 as required by FAS133.
Excluding this revaluation surplus, our net income was $14.1 million, which was
29.4% above our net income of $10.9 million for the fiscal year ended March 31,2007. Our growth in net income primarily resulted from growth in our sales
volume of our products. Shining Essence continued to be our best selling
product. We have enjoyed strong growth in demands for many products such as
Shining Golden Shield and Shining Energy which outpaced that of Shining Essence.
In addition, new product sales now account for 13.6% of our sales revenue during
the year ended March 31, 2008 (1.9% in the year ended March 31, 2007). As a
result, the percentage of sales revenue attributable to Shining Essence has been
diluted to only 48% of our total sales revenue in the year ended March 31, 2008
(61% in the year ended March 31, 2007).
-30-
Our
results for 2008 and 2007 are summarized below:
Net sales
in our financial statements are stated at invoiced value less sales discount and
sales tax. Our net sales for the past fiscal years 2008 and 2007 comprised of
the following:
Net sales
of $42,321,111 for the fiscal year ended March 31, 2008 were 38.3% above the net
sales of $30,609,941 for the fiscal year ended March 31, 2007. The increase was
mainly attributable to increased sales volume and increases in average selling
prices due to changes in sales mix.
The
contributions of each product as a percentage of invoiced value on sales for the
year ended March 31, 2008 and 2007 respectively are summarized below. New
product sales (including Energy, Stomach Protection and others) now account for
13.6% of our sales revenue for the year ended March 31, 2008. While the sales
revenues of Essence and Signal capsules have remained stable, their percentage
contributions to our sales revenue have been diluted by increases in new product
sales.
Unit
volume and unit prices comparatives (on the invoiced value of sales) for 2008
and 2007 are summarized below. The increase in selling prices of Golden Shield
and Energy capsules primarily reflect a combination of price increase and
changes in sales mix with more sales of packages with higher selling
prices.
-31-
Percentages increase (decrease)
from the prior year
Cost of
sales for the year ended March 31, 2008 was $12,310,092 compared with $8,910,633
for the year ended March 31, 2007. The increase in cost of sales was primarily
caused by increased sales volume.
Unit
volume and unit costs comparatives for the year ended March 31, 2008 and 2007
are summarized below. The increase in unit costs of Golden Shield and Energy
capsules primarily reflect changes in sales mix with more sales of packages with
higher unit costs.
Percentages increase (decrease)
from the prior year
Gross
profit increased by $8,311,711 from $21,699,308 for the 2007 fiscal year to
$30,011,019 for the 2008 fiscal year. This represents a 38.3% increase, which
reflects primarily increases in sales volume. Our gross profit margin remained
the same as last year at 70.9%. In the fourth quarter of fiscal year 2008, the
cost of packaging increased significantly due to increases in pulp and paper
costs which reduced our gross profit margin for the fourth quarter to 66.6% from
73.3% in the third quarter. Management is taking action to bring down the
packaging costs going forward.
Selling
expenses
Selling
expenses were $6,869,109 or 16.2% of net sales for the fiscal year ended March31, 2008 compared with $4,502,687 or 14.7% of net sales for the fiscal year
ended March 31, 2007. The operating costs of the retail outlets are included as
selling expenses. This increase in selling expenses was primarily caused by the
roll out of retail outlets. As of March 31, 2008, we had a total of 60 retail
outlets in operation (as of March 31, 2007, we had 9 retail
outlets).
General
and administrative expenses
General
and administrative expenses were $4,826,473 or 11.4% of net sales for the year
ended March 31, 2008 compared with 2,265,220 or 7.4% of net sales for the year
ended March 31, 2007. The increase in general and administrative expenses was
due to additional research costs of $1,696,657 related to the development and
launching of new products, and staff and administrative costs incurred in
connection with the construction of the new plant.
-32-
Other
Income
Other
income comprised exchange gain of $0.4 million in the year ended March 31,2008.
Provision
for income taxes
Provision
for income taxes was $4.94 million and $4.19 million for the fiscal years ended
March 31, 2008 and 2007, respectively. Excluding the $3.37 million surplus on
revaluation of the convertible note, income before taxes was $22.5 million for
fiscal year 2008 compared with $15.1 million for 2007. The increase in income
tax payable is attributable to an increase in operating profit.
Segment
reporting
We have
adopted the “products and services” approach for segment reporting. For fiscal
years 2008 and 2007, we had only one reporting segment—the probiotic products as
health supplement. We manufactured and sold the probiotic products solely in
China and delivered all shipments to destinations within China, and all of our
long-lived assets were physically located in China. We made all sales to
external customers.
Liquidity
and Capital Resources
We had
cash of $64.31 million and working capital of $53.08 million as of March 31,2008, and cash of $26.99 million and working capital of $21.23 million as of
March 31, 2007. Cash generated from operations was $19.36 million for the fiscal
year ended March 31, 2008 and $10.01 million for the fiscal year ended March 31,2007.
Our
business is not capital or labor intensive. Typically, 60% of our sales take
place in the second half of the fiscal year. Since our customers have
historically been large distributors with which we have done business for a
number of years, our cash flows from our existing business have been, and we
expect them to continue to be, fairly reliable.
We had
capital expenditures totaling $10.30 million for the year ended March 31, 2008,
primarily on improvements to production and research facilities. We spent
$1.49 million on fixed assets in fiscal year 2007.
Our
current facility commenced operations in 2000. With the increases in sales
volume in the last couple of years, we are reaching our production capacity. We
have started to construct a new plant with an overall project size of $45.5
million. Phase 1 of the project involves constructing a facility capable of
producing 150 tons of probiotics per annum and is estimated to cost $27.50
million, $25 million of which is expected to be paid in the fourth quarter of
calendar year 2008 and the balance by the end of second quarter of calendar year
2009. Subsequent phases of this project will only commence when demands for
probiotics have exceeded the production capacity of the Phase 1
facility.
We are
expanding our sales to other cities in China through a combination of
distributors and our own outlets. In this regard, we have opened 60 stores in
Shanghai and 5 other cities in China at March 31, 2008. In preparation for the
opening of our retail outlets, we have repackaged a number of our existing
products for sale in our outlets, and have introduced several new products which
are available exclusively in our outlets. The costs of repackaging the existing
products and releasing the new products are minimal and have been included in
our cost of sales and selling and administrative expenses. We will continue to
develop new products to strengthen our product pipeline and add to our retail
outlet offerings. As our development costs mainly comprise staff costs, we do
not expect that such costs will be significant.
-33-
We had
net cash of $25 million generated from financing activities in fiscal year 2008.
We had $2.28 million of cash flows used in financing activities for
the year ended March 31, 2007. Details on our financing
activities for the two fiscal years are as follows:
Loan
from shareholders / (repayment on loan from shareholders)
-
(2.28
)
NET
CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES
25
(2.28
)
On
December 11, 2007, we issued a 4% Senior Convertible Promissory Note in the
amount of $25,000,000 (the “Note”) with a maturity date of December 11, 2010.
The principal amount of the Note is convertible into shares of our common stock
at an exercise price of $12.00 per share at any time until the maturity date. If
the Note is not converted at maturity, we will redeem the Note at a price that
gives a total yield of 10% per annum inclusive of the annual interest. The Note
also provides for mandatory conversion into common stock if the Group
achieve a net income of $60 million in fiscal year 2010. Net proceeds of the
Note are expected to be used to fund the construction of a proposed
150-metric-ton-per-year manufacturing facility and for other capital
expenditures.
Taking
into account our current cash position and our anticipated cash flows from
operations, we expect we will be able to meet all our funding needs in the next
twelve months, including payments required to settle our contractual obligations
and for our construction of our new plant. No assurance, however, can be given
that our business plan will succeed. In the event that our business plan does
not materialize as predicted, we may need to seek for external financing to fund
our expansion plan. There can be no assurance that we will be able to raise
needed capital on favorable terms, if at all. In addition, there is no assurance
that our estimate of our liquidity needs is accurate or that new business
development or other unforeseen events will not occur, resulting in the need to
raise additional funds.
Inflation
We
believe that inflation has not had a material impact on our results of
operations for the fiscal years ended March 31, 2007, 2008 and
2009.
Seasonality
Typically,
60% of our sales take place in the second half of the fiscal year because many
of our customers purchase our products to give as gifts during the Chinese
festivals that occur during this time of the year. While it is still too early
to tell, we expect that our bulk additive sales will not be seasonal
in nature because the bulk products are purchased by food manufacturers
consistently over the year.
Off-Balance
Sheet Arrangements
We do not
have any off-balance sheet arrangements.
Contractual
Obligations
The
following table summarizes our principal contractual obligations and commercial
commitments over various future periods as of March 31, 2009.
(1)
See
note 15 to our consolidated financial statements in this Annual
Report.
(2)
Estimated
contractual purchases with suppliers as of March 31, 2009.
(3)
See
note 17 to our consolidated financial statement in this Annual
Report.
Critical
Accounting Policies
This
MD&A discusses our consolidated financial statements for the fiscal years
ended March 31, 2007, 2008 and 2009. These financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States. In preparing these financial statements, we are required to make
estimates and assumptions affecting the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, we evaluate our estimates and
judgments. We base our estimates and judgments on historical experience and on
various other factors we believe are reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
-34-
We
consider accounting policies related to (a) allowance for doubtful accounts, and
(b) use of estimates as applied to potential penalties for the late payment of
taxes, to be critical accounting policies due to the estimation process involved
in each.
Allowance
for doubtful accounts
We
maintain an allowance for doubtful accounts for estimated losses that may result
from the inability of our customers to make required payments. Such allowances
are based upon several factors including, but not limited to, historical
experience and the current and projected financial condition of specific
customers. Since our inception of business, we have never experienced any
unrecoverable receivables. We also have never experienced situations
causing us to cast doubt on the ability of our customers to make required
payments. The balance of our allowance for doubtful account has always been
zero. We had trade receivables totaling $14,428,382 as of March 31, 2009
and $13,214,531 as of March 31, 2008, and a zero balance for allowance for
doubtful accounts. We have considered all relevant factors, including the
financial conditions, affecting the payment abilities of customers comprising
these receivables up to the date of this 10-K and we believe these
customers are able to make required payments. We, however, cannot give assurance
that these factors, including the financial conditions of these customers, will
not change adversely in the future. We will continue to evaluate the ability of
all our customers to make required payments. Were the financial condition of a
customer to deteriorate, resulting in an impairment of its ability to make
payments, allowances may be required.
Use
of estimates as applied to potential penalties for the late payment of
taxes
Our
principal operations are in the PRC. Business enterprises established in the PRC
are subject to income taxes and value added taxes under PRC tax laws and
regulations unless they have exemptions. We have made tax payments to the PRC
tax authorities since 2005. We believe that our operations in the PRC were
exempted from income taxes and value added taxes for all prior years because we
had been recognized by the local government as an advanced technology
enterprise. However, we have never received a written confirmation from the
appropriate tax authorities for the tax exemption status of our operations in
the PRC. As a result, there is no way to ascertain the position which may be
taken by the relevant PRC tax authorities in the future. Accordingly, our
financial statements contain full provisions for all applicable tax liabilities
for all prior calendar years. Such provisions for tax liabilities will be
reversed out of the financial statements at the appropriate point in the
future.
According
to PRC tax regulations, our overdue tax liabilities in the PRC for the calendar
years prior to 2005 may be subject to potential penalties for the late payment
of taxes which is calculated on the basis of 0.5 times to five times the amount
of taxes payable, which amounts to from $4.9 million (if calculated based on 0.5
times of taxes payable) to $49 million (if calculated based on five times of the
amount of taxes payable) as of March 31, 2009 and 2008. The Group has
reserved for the payment of taxes that may be owed for calendar years prior to
2005 and any associated surcharges (which are calculated at 0.05% per day on the
accrued tax liabilities) in its financial statements until the matter is fully
resolved. Following the adoption of FIN48, the Group has reserved for the
surcharges payable for the fiscal years 2009 and 2008. We consider it is
more likely than not that the associated penalty will not need to be
paid.
Recent Accounting
Pronouncement
In June
2009, the FASB issued SFAS No. 168, “The ‘FASB Accounting Standards
Codification’ and the Hierarchy of Generally Accepted Accounting Principles”
(“SFAS 168”). SFAS 168 establishes the “FASB Accounting Standards
Codification” (“Codification”), which officially launched July 1, 2009, to
become the source of authoritative U.S. generally accepted accounting principles
(“GAAP”) recognized by the FASB to be applied by nongovernmental
entities. Rules and interpretive releases of the Securities and
Exchange Commission (“SEC”) under authority of federal securities laws are also
sources of authoritative U.S. GAAP for SEC registrants. The
subsequent issuances of new standards will be in the form of Accounting
Standards Updates that will be included in the
Codification. Generally, the Codification is not expected to change
U.S. GAAP. All other accounting literature excluded from the
Codification will be considered nonauthoritative. SFAS 168 is
effective for financial statements issued for interim and annual periods ending
after September 15, 2009. We will adopt SFAS 168 for our quarter
ending September 30, 2009. We are currently evaluating the effect on
our financial statement disclosures as all future references to authoritative
accounting literature will be references in accordance with the
Codification.
In June
2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation
No. 46(R) (“SFAS No. 167”). SFAS No. 167
seeks to improve financial reporting by enterprises involved with variable
interest entities. SFAS No. 167 is applicable for annual periods after November15, 2009 and interim periods therein and thereafter. Management does not
anticipate that the provisions of SFAS No. 167 will have an impact on the
Company’s consolidated results of operations or consolidated financial
position.
In June
2009, the FASB issued SFAS No. 166, Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No.
140 (SFAS No. 166”). SFAS No. 166
seeks to improve the relevance, representational faithfulness, and comparability
of the information that a reporting entity provides in its financial statements
about a transfer of financial assets; the effects of a transfer on its financial
position, financial performance, and cash flows; and a transferor’s continuing
involvement, if any, in transferred financial assets. SFAS No. 166 is applicable
for annual periods after November 15, 2009 and interim periods therein and
thereafter. The Company is currently evaluating the effect, if any, the adoption
of SFAS No. 166 will have on its results of operations, financial position or
cash flows.
In May
2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS No. 165”). SFAS No. 165
provides general standards of accounting for and disclosure of events that occur
after the balance sheet date but before financial statements are issued or are
available to be issued. SFAS No. 165 is applicable for interim or annual periods
after June 15, 2009. The Company is currently evaluating the effect, if any, the
adoption of SFAS No. 165 will have on its results of operations, financial
position or cash flows.
In April
2009, the FASB issued FSP SFAS No. 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.” FSP SFAS
No. 157-4 provides factors to determine whether there has been a
significant decrease in the volume and level of activity for the asset or
liability and circumstances that may indicate that a transaction is not orderly.
In those instances, adjustments to the transactions or quoted prices may be
necessary to estimate fair value with SFAS No. 157. This FSP does not apply
to Level 1 inputs. FSP SFAS No. 157 also requires additional disclosures,
including inputs and valuation techniques used, and changes thereof, to measure
the fair value. FSP SFAS No. 157-4 is effective for interim and annual
reporting periods ending after June 15, 2009. Early adoption is permitted
for periods ending after March 15, 2009. Management of the Company is in
the process of evaluating the impact of FSP SFAS No. 157-4 and will adopt
this FSP, effective on July 1, 2009.
-35-
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB No. 51.” SFAS No. 160
amends ARB No. 51 to establish accounting and reporting standards for
noncontrolling interests in subsidiaries and for the deconsolidation of
subsidiaries. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest that should be reported as equity in the consolidated
financial statements. The provisions of SFAS No. 160 are effective for fiscal
years beginning on or after December 15, 2008, and interim periods within those
fiscal years on a prospective basis except for the presentation and disclosure
requirements which apply retrospectively. Earlier application of SFAS No. 160 is
prohibited. SFAS No. 160 is effective for the Company’s fiscal year that begins
on April 1, 2009. Management is currently evaluating the potential impact, if
any, on the Company’s consolidated financial statements.
In
December 2007, the FASB amended SFAS No. 141 (revised 2007), “Business
Combinations.” SFAS No. 141R, establishes principles and requirements for how an
acquirer recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. SFAS No. 141R applies prospectively to business combinations for which
the acquisition date is on or after the beginning of the first reporting period
for fiscal years beginning on or after December 15, 2008. Earlier application of
SFAS 141R is prohibited. SFAS No. 141R is effective for the Company’s fiscal
year that begins on April 1, 2009 and will be applied to future
acquisitions.
-36-
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
We are
exposed to various market risks, including changes in foreign currency exchange
rates and fair value. We do not enter into derivatives or other financial
instruments for trading or speculative purposes in the normal course of
business.
Foreign
Currency Exchange Rate Risk
Our
operations are conducted mainly in the People’s Republic of China. As such, our
earnings are subject to movements in foreign currency exchange rates when
transactions are denominated in RMB, which is our functional
currency.
Therefore,
changes in the rate of exchange between the U.S. dollar and the RMB, in which
the financial statements of our operations are maintained, affect our results of
operations and financial position as reported in our consolidated financial
statements. We have consolidated the balance sheets of our RMB-denominated
operations into U.S. dollars at the exchange rates prevailing at the balance
sheet date. Revenues and expenses are translated at the average exchange rates
for the period.
These
changes result in cumulative translation adjustments, which are included in
“Accumulated other comprehensive income”, and potentially result in transaction
gains or losses, which are included in our earnings.
Fair
Value Risk
We record
an adjustment on our convertible notes adjusting the fair value of the embedded
conversion options. The change in the value of these instruments is primarily
impacted by the price of our stock at the end of each reporting period. This
adjustment creates a non-cash effect on our statement of operations which may
have a significant impact.
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Schedule
I - Condensed Parent Company Financial Statements as of March 31, 2009,
2008 and 2007
62
-37-
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and shareholders of
China-Biotics,
Inc.
We have
audited the accompanying consolidated balance sheets of China-Biotics, Inc. as
of March 31, 2009 and 2008 and the related consolidated statements of
operations, stockholders’ equity and cash flows for each of the three years in
the period ended March 31, 2009. Our audits also included the financial
statement schedules listed in the accompanying index. These financial statements
and schedules are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China-Biotics, Inc. as of
March 31, 2009 and 2008 and the results of its operations and cash flows for
each of the three years in the period ended March 31, 2009, in conformity with
accounting principles generally accepted in the United States of
America.
Also, in
our opinion, the financial statement schedules, when considered in relation to
the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
China-Biotics,
Inc. (the “Company” or “China-Biotics”) was incorporated under the name Otish
Resources, Inc. in Delaware in February 2003. Until March 2006 the Company was a
mineral exploration stage company specializing in acquiring and consolidating
mineral properties with potential for commercial ore bodies. Although the
Company conducted some preliminary exploration work with respect to its mineral
properties, it never achieved full operations with respect to its mineral
properties. The Company had never generated any revenue from its mineral
exploration operations.
On March22, 2006, the Company entered into an agreement and completed a securities
exchange transaction with Sinosmart Group Inc. (“SGI”) and the shareholders of
SGI. The key terms of this agreement are: (i) SGI’s shareholders would
collectively sell, transfer and deliver 14,287 SGI ordinary shares representing
all SGI ordinary share issued and outstanding as of March 22, 2006, to the
Company on March 22, 2006, and (ii) in exchange for the 14,287 SGI ordinary
shares, the Company would issue to the SGI shareholders (and their designees) an
aggregate of 15,980,000 shares of newly issued common stock on March 22, 2006.
This transaction is hereafter referred to as the “share exchange”. As a result
of the share exchange, the Company is no longer a mineral exploration stage
company, and SGI’s business operations become the Company’s primary operations.
SGI, through its wholly owned subsidiaries which are described below, is
currently engaged in the research, development, production, marketing and
distribution of probiotics products. These products contain live microbial food
supplements which beneficially affect the host by improving its intestinal
microbial balance.
In
conjunction with the share exchange, the Company entered into an agreement to
acquire 20,000,000 shares of its common stock from its former President, Mr.
Stan Ford (the “Stan Ford Agreement”). The key terms of this agreement are: (i)
Mr. Stan Ford would transfer 20,000,000 shares of the Company’s common stock he
owned to the Company, and (ii) in exchange for these 20,0000,000 shares of the
Company’s common stock, the Company would paid Mr. Stan Ford a sum of $5,000,
and transfer to Mr. Ford all right, title and interest of the Company in and to
726 shares of common stock issued by Diadem Resources Ltd. The value of
investment in these 726 shares of Diadem Resources Ltd. common stock had been
fully written off by the Company in its books and records in prior year. These
securities had a market value of $363 at the time the Stan Ford Agreement was
executed. Because the Company’s management believed that Mr. Stan Ford would not
have entered into the Stan Ford Agreement in the absence of the execution of the
agreement for the share exchange, this transaction was considered as an integral
part of the share exchange for the accounting purposes (also see Note
4).
SGI
was incorporated in the British Virgin Islands on February 13, 2004. SGI’s
original shareholders were Mr. Song Jinan, Ms. Yan Li, Mr. Huang Weida and Ms.
Yan Yihong (the “Original SGI Shareholders”). Ms. Kwok Kin Kwok became the sole
shareholder of SGI on March 11, 2005 when she purchased 1000 shares of SGI (100%
of the outstanding shares of SGI) from the Original SGI Shareholders. The SGI
shares were sold to Ms. Kwok in order to comply with Chinese government
regulation and to facilitate the future listing of China-Biotics stock outside
of China. The temporary transfer of stock to a third party in this manner is a
common practice in China.
Until
August 2005, the Original SGI Shareholders owned 99.5% of the outstanding stock
of Shanghai Shining Biotechnology Co. Ltd. (“Shining”), with Shanghai Shengyuan
Property Co., Ltd. (“Shengyuan”) owning the remaining 0.5% of the Shining
equity. Shengyuan became a shareholder of Shining in 2002 when Shining became a
joint stock limited company in order to comply with a Chinese law requiring that
joint stock limited companies have a minimum of five shareholders.
On August11, 2005, SGI entered into an agreement to acquire 100% of the outstanding
Shining shares from the Original SGI Shareholders and Shengyuan in exchange for
a total cash consideration of $2.27 million (RMB 18.35 million). Under the terms
of this agreement, SGI agreed to make full payment of the consideration within
three months after the transaction was approved by the relevant government
authorities in the People’s Republic of China (“PRC”). On August 19, 2005, the
transaction was approved by the Economic and Trade Bureau of the Pudong New
District, Shanghai, PRC and in October 2005, SGI made full payment of $2.27
million to the Original SGI Shareholders. In December 2005, SGI’s acquisition of
Shining was consummated when a revised business license was issued to Shining as
a Wholly Owned Foreign Corporation, signifying the formal recognition of SGI as
Shining’s sole shareholder by the Chinese government authorities.
Also on
August 11, 2005, SGI and the Original SGI Shareholders entered into a
supplemental agreement granting the Original SGI Shareholders the option to
purchase an aggregate of 9,000 share of SGI for $1.00 per share. No
consideration was paid by the Original SGI Shareholders in exchange for the
option. On October 25, 2005, the Original SGI Shareholders exercised the option
and purchased 9,000 shares of SGI for an aggregate of $9,000. After exercise of
the option, the Original SGI Shareholders owned 9,000 shares of SGI (90% of the
outstanding SGI equity) and Ms. Kwok owned 1,000 shares of SGI (10% of the
outstanding SGI equity).
In the
share exchange, the Original SGI Shareholders exchanged their 9,000 SGI shares
for 10,067,400 shares of Company common stock, which represented 63% of the
total of 15,980,000 shares received by all SGI shareholders in this transaction.
Ms. Kwok’s shares of SGI stock were exchanged for 1,118,600 shares of Company
common stock issued in the name of Bright Treasure Group Ltd., an entity that is
beneficially-owned by Ms. Kwok.
On
December 9, 2005, SGI incorporated a wholly-owned subsidiary, Growing State
Limited (“GSL”), in accordance with the laws of the British Virgin Islands. On
September 22, 2006, GSL established a wholly-foreign owned enterprise, Growing
Bioengineering (Shanghai) Company Limited (“GBS”) in the PRC.
Shining
is a manufacturer and distributor of probiotics products in the
PRC.
Shining
had a registered capital of RMB 1,000,000 when it was established as a domestic
limited liability company in 1999. In 2002, its registered capital was first
increased to RMB 10,000,000, and then to RMB 20,480,000 when it became a
joint-stock limited company.
2. BASIS OF PRESENTATION AND PRINCIPLES
OF CONSOLIDATION
The share
exchange between the Company and SGI’s shareholders as disclosed in Note 1 has
been accounted for in accordance with the accounting and financial reporting
interpretations and accounting principles generally accepted in the United
States ("US GAAP"). The share exchange was treated as a recapitalization of SGI,
accompanied by a reverse acquisition of the Company with SGI as the accounting
acquirer, on the basis that:
i.
the company was a non-operating
reporting public shell company with nominal net
assets;
ii.
SGI is a operating private
company;
iii.
SGI’s former shareholders
collectively become the Company’s majority shareholders after the share
exchange;
iv.
SGI’s former shareholders have
actual and effective operating control over the combined company after the
share exchange; and
v.
Shareholders who owned the
Company’s shares immediate prior to the share exchange become passive
investors after the share
exchange.
Under the
accounting for reverse acquisition, a distinction is made between the legal
acquirer and the accounting acquirer. The legal acquirer is the entity which
issues new shares to acquire a majority equity interest in another legal entity.
The entity being acquired is a subsidiary of the legal acquirer legally. Under
the accounting for reverse acquisition, the legal aspect of the transaction is
disregarded and the entity being acquired legally is treated as the accounting
acquirer with the following accounting treatments and financial statement
presentations:
(a)
the historical financial
statements of the accounting acquirer prior to the date of the reverse
acquisition is completed become those of the legal
acquirer;
the shares issued by the legal
acquirer in connection with the reverse acquisition are treated as the
historical issued shares of the accounting acquirer, and the accounting
acquirer’s historical paid-in capital is restated, after giving effect to
any difference in par value of the shares of the legal acquirer and the
accounting acquirer’s historical financial
statements;
(c)
the legal acquirer’s shares in
issue immediately prior to the completion of the reverse acquisition are
treated as if they were issued in exchange for the legal acquirer’s net
assets or net liabilities as of the completion date;
and
(d)
the operating results of the
legal acquirer and the accounting acquirer are consolidated with effect
from the completion date.
The
consolidated financial statements for SGI and its subsidiaries for the years
ended March 31, 2005 and 2006 are prepared in accordance with generally accepted
accounting principles in the United States of America and include the accounts
of SGI, Shining, GSL and GBS.
In
preparing the consolidated financial statements presented herewith, all
significant intercompany balances and transactions have been eliminated on
consolidation
The term
“Group”, as used in these financial statements, refers to a group of companies
comprising China-Biotics, SGI, Shining, GSL and GBS from March 23, 2006 and
onward.
Prior to
the share exchange as described in Note 1, the Company had a fiscal year end
date of August 31. Upon consummation of the share exchange, the Company changed
its fiscal year end from August 31 to March 31 to conform to the year end date
of SGI.
(b) Use of Estimates
The
preparation of the consolidated 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, the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Accordingly, actual results
could differ from those estimates.
(c) Foreign Currency Translations and
Transactions
The Group
uses the United States dollar ("U.S. dollars") for financial reporting
purposes.
SGI
maintains its books and accounting records in Hong Kong Dollars ("HKD"), being
the functional currency. HKD, the local currency of the Hong Kong Special
Administrative Region, is the primary currency of the economic environment in
which the operations of SGI are conducted. The HKD is therefore considered as
SGI’s “functional currency”.
SGI’s
wholly-owned subsidiaries, Shining, GSL and GSL’s wholly-owned subsidiary, GBS,
maintain theirs books and accounting records in Renminbi ("RMB"), being the
functional currency. RMB, the national currency of the PRC, is the primary
currency of the economic environment in which the operations of Shining, GSL
and GBS are conducted currently or to be conducted in the future. The RMB
is therefore considered as the “functional currency” of Shining, GSL and
GBS.
SGI uses
the “Current rate method” to translate its financial statements from HKD into
U.S. Dollars, and to translate Shining ’s, GSL’s and GBS’s financial statements
from RMB into U.S. Dollars, as required under the Statement of Financial
Accounting Standard (“SFAS”) No. 52, "Foreign Currency Translation" issued by
the Financial Accounting Standard Board (“FASB”). The assets and liabilities of
SGI, Shining, GSL and GBS, except for the paid-up capital, are translated into
U.S. Dollars using the rate of exchange prevailing at the balance sheet date.
The paid-up capital is translated at the historical rate. Adjustments resulting
from the translation of the balance sheets of SGI, Shining GSL and GBS from HKD
and RMB into U.S. Dollars are recorded in stockholders' equity as part of
accumulated comprehensive income. The statement of operations is translated at
average rates during the reporting period. Gains or losses resulting from
transactions in currencies other than the functional currencies are reflected in
the statement of operations for the reporting periods. The statement of cash
flows is translated at average rates during the reporting period, with the
exception of issue of share and payment of dividends which are translated at the
historical rates. Due to the use of different rates for translation, the figures
in the statement of changes in cash flows may not agree with the differences
between the year end balances as shown in the balance sheets.
(d) Comprehensive
Income
The Group
has adopted SFAS No. 130, "Reporting Comprehensive Income, issued by the FASB.
SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general-purpose
financial statements. The Group has chosen to report comprehensive income in the
statements of changes in stockholders’ equity. Comprehensive income comprised
net income and all changes to stockholders' equity except those due to
investments by owners and distributions to owners.
(e) Revenue
Recognition
Sale
of goods
Revenue
from the sale of goods is recognized on the transfer of risks and rewards of
ownership, which generally coincides with the time when the goods are delivered
to customers and title has passed. Sales are stated at invoiced value net of
sales tax under the caption Net Sales in these financial statements. The sales
tax were 0.66%, 0.64% and 0.62% of the invoiced value for years ended March 31,2007, 2008 and 2009, respectively.
Interest
income
Interest
income is recognized on a time proportion basis, taking into account the
principal amounts outstanding and the interest rates applicable.
(f) Cash and cash
equivalents
Cash and
cash equivalents include all highly liquid investments with an original maturity
of three months or less.
(g) Allowance for Doubtful
Accounts
The Group
maintains allowances for doubtful accounts for estimated losses that may result
from the inability of its customers to make required payments. Such allowances
are based upon several factors including, but not limited to, historical
experience and the current and projected financial condition of specific
customers. Were the financial condition of a customer to deteriorate, resulting
in an impairment of its ability to make payments, initial or additional
allowances may be required.
(h) Property, plant and equipment and
land use right
Property,
plant and equipment and land use rights are recorded at cost and are stated net
of accumulated depreciation. Gains or losses on disposals are reflected as gain
or loss in the year of disposal. The cost of improvements that extend the life
of plant and equipment are capitalized. These capitalized costs may include
structural improvements, equipment, and fixtures. All ordinary repair and
maintenance costs are expensed as incurred.
Plant and
equipment are depreciated at rates sufficient to write off their cost over their
estimated useful lives on a straight-line basis. Leasehold improvements are
depreciated over the lease term of the related leased properties. Depreciation
relating to property, plant and equipment used in production in our
determination of gross profit. Land in the PRC is owned by the PRC
government. The government in the PRC, according to PRC law, may sell the right
to use the land for a specified period of time. Thus, all of the Group’s land
purchases in the PRC are considered to be leasehold land and classifies as land
use right. They are amortized on a straight-line basis over the respective term
of the right to use the land. The estimated useful lives of the assets are as
follows:
Land use right
50 years
Plant and machinery
10 years
Office equipment
5 years
Motor vehicles
5 years
Leasehold improvements
Lease term of related leased properties
Construction
in progress includes project costs paid to third parties that are clearly
associated with the acquisition, development, and construction of an asset and
are capitalized as a cost of that project prior to the use of the assest. Such
costs include the costs of construction, equipment, interest, legal, and direct
labour costs. These capitalized project costs are not subject to depreciation
until the assets to which they are related are placed into
production.
(i) Impairment of Long-Lived
Assets
In
accordance with the provisions of SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets", the Group's policy is to record an impairment
loss against the balance of a long-lived asset in the period when it is
determined that the carrying amount of the asset may not be recoverable. This
determination is based on an evaluation of such factors as the occurrence of a
significant event, a significant change in the environment in which the business
assets operate or if the expected future non-discounted cash flows of the
business is determined to be less than the carrying value of the assets. If
impairment is deemed to exist, the assets will be written down to fair value.
Management also evaluates events and circumstances to determine whether revised
estimates of useful lives are warranted. There was no impairment of long-lived
assets for the periods presented in these financial statements.
(j) Inventories
Inventories
are stated at the lower of cost or market. Cost, which is calculated using the
weighted average method, comprises all costs of purchases, costs of conversion
and other costs incurred in bringing the inventories to their present location
and condition. Market value is determined by reference to the sales proceeds of
items sold in the ordinary course of business after the balance sheet
date.
(k)
Embedded derivatives
On
December 11, 2007, the Company issued a 4% Senior Convertible Promissory Note in
an amount of $25,000,000 (the “Note”) which is due on December 11, 2010.
Pursuant to SFAS No. 133 “Accounting For Derivatives Instruments And Hedging
Activities” and EITF Issue No. 00-19 “Accounting For Derivatives Financial
Instruments Indexed To And Potentially Settled In A Company’s Own Stock”, the
Company bifurcates the conversion options with a mandatory conversion feature
(“embedded derivatives”) from the Note as the embedded derivatives are
determined to be not clearly and closely related to the host contract. The
embedded derivatives are recorded at fair value, mark-to-market at each
reporting period, and are carried on a separate line in the balance
sheet.
(l) Treasury Stock
The Group
treated common stock repurchased but not yet canceled as treasury stock.
Treasury stock is reported in the balance sheets and statements of changes in
stockholders’ equity with its par value charged to common stock, and with the
excess of the purchase price over par, if any, first charged against any
available additional paid-in capital and the balance charged to retained
earnings.
(m) Transaction costs related to the
Share Exchange transaction
The
transaction costs incurred in relation to the Share Exchange transaction as
described in Note 1 are expensed as incurred.
(n) Advertising costs
All
advertising costs incurred in the promotion of the Group’s products are expensed
as incurred.
(o) Income Tax
The Group
accounts for income tax under the provisions of SFAS No. 109, “Accounting for
Income Taxes”, which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the tax and financial reporting basis of assets and liabilities and for
loss and credit carryforward. Deferred income taxes are provided using the
liability method. Under the liability method, deferred income taxes are
recognized for all significant temporary differences between the tax and
financial statement bases of assets and liabilities. In addition, the Group is
required to record all deferred tax assets, including future tax benefits of
capital losses carried forward, and to record a "valuation allowance" for any
deferred tax assets where it is more likely than not that the asset will not be
realized.
Effective
April 1, 2007, the Group adopted the Financial Accounting Standard Board
(“FASB”) Interpretation No. 48, “Accounting for the Uncertainty in Income Taxes
- an interpretation of FASB Statement No. 109 (“FIN48”), which clarifies the
accounting for uncertainty income taxes recognized in an enterprise’s financial
statements. The interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides accounting guidance on de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. The Group
classifies interest and/or penalties related to unrecognized tax benefits as a
component of income tax provisions. There is no material impact of FIN 48
on the Group’s consolidated financial statements.
(p) Research and Development
Costs
Research
and development costs are charged to expense when incurred and are included in
operating expenses.
(q) Retirement Costs
Retirement
costs are charged to expense at certain percentage of the payroll costs which is
required under the PRC regulations.
(r) Operating Leases
Operating
leases represent those leases under which substantially all risks and rewards of
ownership of the leased assets remain with the lessors. Rental payment under
operating leases are charged to expense as incurred over the lease
periods.
(s) Earnings Per
Share
Basic
earnings per share is computed in accordance with SFAS No.128, “Earnings Per
Share”, by dividing the net income by the weighted average number of outstanding
common stock during the period. The diluted earnings per share calculation
includes the impact of dilutive convertible securities, if applicable. The
weighted average number of outstanding common stock is determined by relating
the portion of time within a reporting period that a particular number of common
stock has been outstanding to the total time in that period.
(t) Related Parties
Parties
are considered to be related if one party has the ability, directly or
indirectly, to control the other party or exercise significant influence over
the other party in making financial and operational decisions. Parties are also
considered to be related if they are subject to common control or common
significant influence. Related parties may be individuals or corporate
entities.
SFAS No.
131, “Disclosure about Segments of an Enterprise and Related Information”,
requires use of the “management approach” model for segment reporting. The
management approach model is based on the way a company’s management organizes
segments within the company for making operating decisions and assessing
performance. Reportable segments are based on one of the followings: (a)
products and services, (b) geographical areas, (c) legal structure, (d)
management structure, or (e) any other manner in which management disaggregates
a company. The Group’s management has adopted the “products and services”
approach for segment reporting.
The
Group’s management has adopted the “products and services” approach for segment
reporting. For all periods covered by these financial statements, the
Group:
(a)
had only one reportable segment -
the probiotic products as health
supplement;
(b)
manufactured and sold the
probiotic products in a single geographical area - the
PRC;
(c)
delivered all its shipments to
destinations within the PRC;
and
(d)
had all its long-lived assets
physically located in the
PRC.
(v) Recent Accounting
Pronouncements
In June
2009, the FASB issued SFAS No. 168, “The ‘FASB Accounting Standards
Codification’ and the Hierarchy of Generally Accepted Accounting Principles”
(“SFAS 168”). SFAS 168 establishes the “FASB Accounting Standards
Codification” (“Codification”), which officially launched July 1, 2009, to
become the source of authoritative U.S. generally accepted accounting principles
(“GAAP”) recognized by the FASB to be applied by nongovernmental
entities. Rules and interpretive releases of the Securities and
Exchange Commission (“SEC”) under authority of federal securities laws are also
sources of authoritative U.S. GAAP for SEC registrants. The
subsequent issuances of new standards will be in the form of Accounting
Standards Updates that will be included in the
Codification. Generally, the Codification is not expected to change
U.S. GAAP. All other accounting literature excluded from the
Codification will be considered nonauthoritative. SFAS 168 is
effective for financial statements issued for interim and annual periods ending
after September 15, 2009. We will adopt SFAS 168 for our quarter
ending September 30, 2009. We are currently evaluating the effect on
our financial statement disclosures as all future references to authoritative
accounting literature will be references in accordance with the
Codification.
In
June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation
No. 46(R) (“SFAS No. 167”). SFAS No. 167
seeks to improve financial reporting by enterprises involved with variable
interest entities. SFAS No. 167 is applicable for annual periods after November15, 2009 and interim periods therein and thereafter. Management does not
anticipate that the provisions of SFAS No. 167 will have an impact on the
Company’s consolidated results of operations or consolidated financial
position.
In June
2009, the FASB issued SFAS No. 166, Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No.
140 (SFAS No. 166”). SFAS No. 166
seeks to improve the relevance, representational faithfulness, and comparability
of the information that a reporting entity provides in its financial statements
about a transfer of financial assets; the effects of a transfer on its financial
position, financial performance, and cash flows; and a transferor’s continuing
involvement, if any, in transferred financial assets. SFAS No. 166 is applicable
for annual periods after November 15, 2009 and interim periods therein and
thereafter. The Company is currently evaluating the effect, if any, the adoption
of SFAS No. 166 will have on its results of operations, financial position or
cash flows.
In May
2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS No. 165”). SFAS No. 165
provides general standards of accounting for and disclosure of events that occur
after the balance sheet date but before financial statements are issued or are
available to be issued. SFAS No. 165 is applicable for interim or annual periods
after June 15, 2009. The Company is currently evaluating the effect, if any, the
adoption of SFAS No. 165 will have on its results of operations, financial
position or cash flows.
In April
2009, the FASB issued FSP SFAS No. 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.” FSP SFAS
No. 157-4 provides factors to determine whether there has been a
significant decrease in the volume and level of activity for the asset or
liability and circumstances that may indicate that a transaction is not orderly.
In those instances, adjustments to the transactions or quoted prices may be
necessary to estimate fair value with SFAS No. 157. This FSP does not apply
to Level 1 inputs. FSP SFAS No. 157 also requires additional disclosures,
including inputs and valuation techniques used, and changes thereof, to measure
the fair value. FSP SFAS No. 157-4 is effective for interim and annual
reporting periods ending after June 15, 2009. Early adoption is permitted
for periods ending after March 15, 2009. Management of the Company is in
the process of evaluating the impact of FSP SFAS No. 157-4 and will adopt
this FSP, effective on July 1, 2009.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB No. 51.” SFAS No. 160
amends ARB No. 51 to establish accounting and reporting standards for
noncontrolling interests in subsidiaries and for the deconsolidation of
subsidiaries. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest that should be reported as equity in the consolidated
financial statements. The provisions of SFAS No. 160 are effective for fiscal
years beginning on or after December 15, 2008, and interim periods within those
fiscal years on a prospective basis except for the presentation and disclosure
requirements which apply retrospectively. Earlier application of SFAS No. 160 is
prohibited. SFAS No. 160 is effective for the Company’s fiscal year that begins
on April 1, 2009. Management is currently evaluating the potential impact, if
any, on the Company’s consolidated financial statements.
In
December 2007, the FASB amended SFAS No. 141 (revised 2007), “Business
Combinations.” SFAS No. 141R, establishes principles and requirements for how an
acquirer recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. SFAS No. 141R applies prospectively to business combinations for which
the acquisition date is on or after the beginning of the first reporting period
for fiscal years beginning on or after December 15, 2008. Earlier application of
SFAS 141R is prohibited. SFAS No. 141R is effective for the Company’s fiscal
year that begins on April 1, 2009 and will be applied to future
acquisitions.
For the
years ended March 31, 2009 and 2008, potential common stock of 2,083,000 shares
related to the convertible note at the exercise price of $12 per share are
excluded from the computation of diluted earnings per share as the exercise
price was higher than the average market price.
5.
RISKS, UNCERTAINTIES, AND CONCENTRATIONS
(a)
Nature of Operations
Substantially
all of the Group’s operations are conducted in the PRC and are subject to
various political, economic, and other risks and uncertainties inherent in this
country. Among other risks, the Group’s operations are subject to the risks of
restrictions on transfer of funds; export duties, quotas and embargoes; domestic
and international customs and tariffs; changing taxation policies; foreign
exchange restrictions; and political conditions and governmental
regulations.
(b)
Concentration of Credit Risk
Financial
instruments that potentially subject the Group to concentrations of credit risk
consist principally of cash and accounts receivable.
As of
March 31, 2009 and 2008, the Group had cash deposits of $70.82 million
and $64.31 million placed with several banks in the PRC, which includes the
Special Administrative Region of Hong Kong, where there is currently no rule or
regulation in place for obligatory insurance of bank accounts.
For the
years ended March 31, 2009 and 2008, all of the Group’s sales arose in the PRC.
In addition, all accounts receivable as at March 31, 2009 and 2008 also arose in
the PRC.
(c)
Concentration of Customers
For the
year ended March 31, 2009, there is one customer that accounted for 11.5% of our
sales revenue. For the year ended March 31, 2008, there are two customers that
accounted for 15.5% and 10.5% of our sales revenue. For the year ended March 31,2007, no single customer accounted for 10% of our total sales.
8. PROPERTY, PLANT AND EQUIPMENT AND
LAND USE RIGHT
The
Group's property, plant and equipment and land use right as of the balance
sheet dates as presented in these financial statements are summarized as
follows:
Pursuant
to the Provisional Regulation of PRC on Value Added Tax, or VAT, and their
implementing rules, all entities and individuals that are engaged in the sale of
goods are generally required to pay VAT at a rate of 17% of the gross sales
proceeds received, less any deductible VAT already paid or borne by the
taxpayer.
The Group
has its principal operations in the PRC. Business enterprises are subject to
income taxes and VAT under PRC tax laws and regulations unless they have
exemptions. It has been the belief of the Group’s management that its PRC
operations from 1999 to 2004 were exempted from income taxes and VAT as these
operations were considered by the local government as "high technology" company.
The Group, however, has never received a written confirmation from the
appropriate tax authorities for the tax exemption status of its PRC operations.
The Group has took the initiative to make tax payments to the PRC authorities
for the calendar year 2005 and subsequent years and accrued for all applicable
tax liabilities.
According
to PRC tax regulations, overdue tax liabilities in the
PRC for the calendar years prior to 2005 may be subject to potential
penalties for the late payment of taxes, which is calculated on the basis of 0.5
times to five times the amount of overdue tax liabilities. This amounts to $4.9
million (if calculated based on 0.5 times the taxes payable) to $49 million (if
calculated based on five times the amount of taxes payable) as of March 31, 2008
and 2009. The Group has reserved for the payment of taxes that may be owed for
calendar years prior to 2005 and any associated interest surcharges (which are
calculated at 0.05% per day on the accrued tax liabilities) in its
financial statements until the matter is fully resolved. Following the adoption
of FIN48, the Group has reserved for the surcharges payable for fiscal year
2007, 2008 and 2009. We consider it more likely than not that the
associated penalty will not need to be paid.
The
income/(loss) generated in the United States, the British Virgin Islands and the
PRC before income taxes during the periods as presented in these financial
statements are summarized as follows:
(Loss)/income
in the United States before income taxes
$
2,371,750
$
2,352,418
$
(453,543
)
(Loss)/income
in the British Virgin Islands before income taxes
467,060
741,590
(91,627
)
Income
in the PRC before income taxes
22,290,467
19,384,867
15,637,024
$
25,129,277
$
22,478,875
$
15,091,854
The
Company, which is incorporated in the United States, is subject to U.S. tax
law. Other than legal and professional expenses for the daily
operations of the Company, the (loss)/income generated from the United States is
the change in the fair value of the embedded derivatives of the 4% Senior
Convertible Promissory Note issued on December 11, 2007.
There is
no income tax for companies not carrying out business activities in
the British Virgin Islands. Accordingly, the Company's financial statements do
not present any income tax provisions/credits related to the British Virgin
Islands tax jurisdiction.
The
Group has its principal operations in the PRC and is subject to a PRC Enterprise
Income Tax rate of 25% in calendar years 2009 and 2008 and 33% in calendar
2007.
However,
one of the PRC subsidiaries of the Group, Shining located in the Shanghai
Jinqiao special economic zone is awarded the status of “high technology”
enterprise for the calendar year 2007 till 2010. Hence Shining enjoys
a preferential income tax of 15%, which represents a tax concession of 10% , 10%
and 18% in the year 2009, 2008 and 2007.
Another
newly set up PRC subsidiary of the Group, GBS, is located in Qingpu, will have
the same business and operation as Shining but with a larger production scale,
is believed by the management to be qualified for the application for the status
of being a “high technology” enterprise once operation is
commenced. If the “high technology” status is awarded, GBS would then
be fully exempted from PRC Enterprise Income Tax for two years starting from
calendar year 2008, followed by 50% tax exemption for the next three calendar
years, period from 2010 to 2012. There is no financial effect from the tax
holiday as GBS did not generate any assessable profit in 2009, 2008 and
2007.
The
principal reconciling items from income tax computed at the statutory rates and
at the effective income tax rates are as follows:
As
at March 31, 2009, the Company's PRC subsidiaries have incurred tax losses which
can be carried forward to a maximum of 5 years of approximately $1,339,001
(2008: $1,202,649, 2007: $134,849).
Deferred
tax assets were primarily raised from the tax losses carry forwards, and a
valuation allowance has been established for the entire deferred tax assets
since the management believes that the US Company would not generate future
taxable income to utilize the deferred tax assets.
10. TREASURY STOCK
On March22, 2006, the Company repurchased 24,381,004 common stock of the Company with a
total cost of USD2,438 under the approval of the Board of Directors. The Company
recorded the entire purchase price of the treasury stock as a reduction of
equity. The Company has made no additional purchases of common stock during the
year ended March 31, 2009.
11. CAPITAL AND STATUTORY
RESERVES
The
Company’s PRC subsidiary, Shining, is required to make appropriations to reserve
funds, comprising the statutory surplus reserve, statutory public welfare fund
and discretionary surplus reserve, based on after-tax net income determined in
accordance with generally accepted accounting principles of the PRC (the “PRC
GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of
the after tax net income determined in accordance with the PRC GAAP until the
reserve is equal to 50% of the subsidiary’s registered capital. Appropriations
to the statutory public welfare fund are at 5% to 10% of the after tax net
income determined in accordance with the PRC GAAP. Appropriations to the
discretionary surplus reserve are made at the discretion of the Board of
Directors. The statutory public welfare fund is established for the purpose of
providing employee facilities and other collective benefits to the employees and
is non-distributable other than in liquidation. The statutory surplus reserve
and discretionary surplus reserve can be used to make good losses or to increase
the capital of the relevant company.
12. ADVERTISING COSTS
The
Group's advertising costs charged to expense as incurred during the periods as
presented in these financial statements are summarized as follows:
13. RESEARCH AND DEVELOPMENT COSTS
CHARGED TO EXPENSE AS INCURRED
The
Group's research and development costs, which typically consist of salaries and
other direct costs, charged to expense as incurred during the periods as
presented in these financial statements are summarized as follows:
14. RETIREMENT COSTS CHARGED TO EXPENSE
AS INCURRED
The
Group’s employees are required to participate in a central pension scheme
operated by the local municipal government. The Group is required to contribute
a certain percentage of their payroll costs to the central pension scheme. The
contributions are charged to the income statement as they become payable in
accordance with the rules of the central pension scheme. Non forfeited
contribution is available to reduce the contribution payable in the future
years. The Group’s retirement costs charged to expense as incurred during the
periods as presented in these financial statements are summarized as
follows:
The Group
leases office space, warehouse facilities and retail outlets under
non-cancelable operating agreements that expire at various
dates from 2009 through 2010. The charges incurred by the Group in
relation to the above-mentioned operating leases during the periods as presented
in these financial statements are summarized as follows:
As of the
balance sheet dates as presented in these financial statements, the amount of
future minimum lease payment under the above-mentioned operating leases were as
follows:
On March21, 2006, the Company's wholly-owned subsidiary, GSL, entered into an agreement
with Shanghai Qingpu Industrial Park District Development (Group) Company
Limited for the lease of 73,157 square meters of land in the Shanghai Qingpu
Industrial Park District on which the Company will construct a plant consisting
bulk manufacturing facilities that will have an initial capacity of 150 tons per
year of bulk product with room for expansion to 300 tons per
year. This agreement contemplates a one-time leasing fee of
$2,100,828. The leasing fee was later reduced to $1,777,860 because
the size of the leased land was reduced to 36,075 square meters. 10%
of the leasing fee was due and paid on April 5, 2006 as a refundable deposit.
The $1,777,680 leasing fee was paid on December 28, 2007. In February 2009, the
deposit was refunded and the approval documents for the land lease were issued
by the Shanghai Qingpu local government authorities. There are no future lease
payments under this land lease.
(c) Capital
commitments
During
the year ended of March 31, 2009, GSL entered into the agreements with the
contractors to construct a plant consisting bulk manufacturing facilities in the
Shanghai Qingpu Industrial Park District. The amount of future payment were
$3,912,138 (2008 : $14,517,210) which was contracted, but not provided for as of
March 31, 2009; Shining also entered into the agreement with the contractors to
renovate the existing R&D facility in Shanghai Qinqiao, the amount of future
payment were $474,706 (2008 : nil) which was contracted, but not provided for as
of March 31, 2009.
16. RELATED PARTY
TRANSACTIONS
(a)
Shining, before it became the Company’s wholly-owned subsidiary, declared
dividends amounting to $16.73 million during the period from April 2003 to June
2005. The full amount of dividends was paid in cash to the Shining equity
holders without deducting a withholding tax at the rate of 20% as required by
the applicable laws and regulations in the PRC. These equity holders, except one
of them, collectively became a majority shareholder of the Company in March 2006
as a result of the share exchange. The amount of dividend withholding taxes not
withheld by Shining totaled $3.34 million was repaid to Shining in March 2006 by
these former Shining equity holders.
(b)
As disclosed in Note 1, on August 11, 2005, SGI entered into the Equity
Transfer Agreement to acquire 100% of the equity of Shining from the Original
Shining Equity Holders, who are former majority shareholders of SGI, and a third
party for a total cash consideration of $2.27 million (RMB 18.35 million). At
the time of this transaction, SGI and the Original Shining Equity Holders also
entered into the Supplemental Agreement to grant the right to the Original
Shining Equity Holders to re-establish a majority ownership in SGI within three
months after the consummation of SGI’s acquisition of 100% equity in Shining. In
October 2005, the Original Shining Equity Holders exercised their right under
the Supplemental Agreement and executed subscription agreements to acquire 9,000
new shares issued by SGI for a total consideration of $9,000, representing a 90%
ownership in SGI. SGI received the subscription money in full in March 2006. As
disclosed in Note 4, these 9,000 SGI ordinary shares were exchanged into
10,067,400 shares of the Company’s common stock in the share exchange, which
represented 63% of the total of 15,980,000 shares received by all SGI
shareholders in this transaction.
(c) In September22, 2005, SGI entered into an agreement and issued a Hong Kong Dollar
denominated convertible bond for cash in the face amount of $2,580,000
(HKD20,000,000) to an independent third party, Charming Leader Group Ltd., which
is a British Virgin Islands company beneficially wholly-owned by Mr. Alexander
Tai Kwok Leung. A s a condition precedent to the completion of the transaction
contemplated in this agreement, the Original Shining Equity Holders, comprising
the individuals as shown below, have to execute an agreement with Shining under
which they collectively committee to advance a RMB denominated loan of
$2,290,230 (RMB 18,351,200) to Shining upon the serving of a notice by Shining
in the following proportion:
On
September 22, 2005,the Original Shining Equity Holders entered into an agreement
with Shining with the following key terms: (a) the Original Shining Equity
Holders agree to lend a RMB denominated loan of US$2,290,230 (RMB 18,351,200) to
Shining (in proportion as shown above), (b) Shining has the right to draw down
the full amount of loan upon serving a 7 days notice to the Original Shining
Equity Holders, after the fulfillment of certain conditions precedent, (c)
Shining agrees to use the loan proceeds only for daily operations unless a
written consent for other uses is granted by the Original Shining Equity
Holders, (d) the loan is repayable one year from the date of draw-down, and (e)
the loan is interest free.
In March,
2006, Shining made notice to the Original Equity Holders and received the full
loan amount of US$2,290,230 (RMB 18,351,200). In March 2007, this loan was fully
repaid by Shining.
(d)
On December 11, 2007, the Company entered into definitive agreements
concerning the sale of a 4% Senior Convertible Promissory Note in the amount of
$25,000,000 to Pope Investments II LLC in a private placement. In connection
with the private placement, Mr. Song Jinan, the Company’s Chief Executive
Officer, Chairman, and largest shareholder, entered into a Guaranty Agreement
and a Pledge Agreement, pursuant to which Mr. Song agreed to guaranty the
Company’s obligations under the Note and to secure such guaranty with a pledge
of 4,000,000 shares of the Company’s common stock.
17. CONVERTIBLE NOTES
On
December 11, 2007, the Company sold a 4% Senior Convertible Promissory Note in
the amount of $25,000,000 (the “Note”) with a maturity date of December 11, 2010
to Pope Investments II LLC, an affiliate of Pope Investments, LLC, in a private
placement. In connection with the sale, the Company entered into an Investment
Agreement and a Registration Rights Agreement. In addition, Mr. Song Jinan, the
Company’s Chief Executive Officer, Chairman, and largest stockholder, entered
into a Guaranty Agreement and a Pledge Agreement pursuant to which Mr. Song
agreed to guaranty the Company’s obligations under the Note and to secure such
guaranty with a pledge of 4,000,000 shares of China-Biotics common stock owned
by Mr. Song. The principal amount of the Note is convertible into shares of the
Company’s common stock at an exercise price of $12.00 per share at any time
until the maturity date subject to adjustment for subdivision or combination of
the Company’s common stock and similar events. If the Note is not converted at
maturity, the Company will redeem the Note to provide Pope Investments II LLC
with a total yield of 10% per annum inclusive of the annual interest. The Note
also provides for mandatory conversion into the Company’s common stock if the
Group achieves a net income of $60 million in fiscal year 2010. Pope Investments
II LLC may declare the outstanding principal amount and any accrued but unpaid
interest, calculated at a rate of 10% per annum, to be immediately due and
payable upon an event of default, including non-payment of obligations under the
Note, bankruptcy or insolvency, or failure to perform any covenant set forth in
the Note or Investment Agreement. Pursuant to the Investment Agreement the
Company has secured payment of obligations under the Note with a pledge of 100%
of the stock of SGI to Pope Investments II LLC.
Net
proceeds of the note are expected to be used to fund the construction of a
proposed 150-metric-ton-per-year manufacturing facility and for other capital
expenditures.
The
Company accounted for the net proceeds from the issuance of the Note as two
separate components: an embedded derivative component (conversion option with
mandatory conversion feature) and a debt component. The Company determined the
initial carrying value of the debt component by subtracting the fair value of
embedded derivatives amounting to $9,118,000 from the net proceeds received from
the issuance of the Note. This resulted in a $15,882,000 initial carrying amount
of the debt component.
On April1, 2008, the Company adopted SFAS No.157, “Fair Value Measurements”, (“SFAS
157”) which defines fair value, establishes a framework for measuring fair value
in GAAP, and expands disclosures about fair value measurements. SFAS 157 does
not require any new fair value measurements, but provides guidance on how to
measure fair value by providing a fair value hierarchy used to classify the
source of the information. In February 2008, the FASB deferred the effective
date of SFAS 157 by one year for certain non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). The Company
adopted the provisions of SFAS 157, except as it applies to those non-financial
assets and non-financial liabilities for which the effective date has been
delayed by one year.
SFAS 157
establishes a three-level valuation hierarchy of valuation techniques based on
observable and unobservable inputs, which may be used to measure fair value and
include the following:
Level 1 -
Quoted prices in active markets for identical assets or
liabilities.
Level 2 -
Inputs other than Level 1 that are observable, either directly or indirectly,
such as quoted prices for similar assets or liabilities; quoted prices in
markets that are not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities.
Level 3 -
Unobservable inputs that are supported by little or no market activity an that
are significant to the fair value of the assets or liabilities.
Classification
within the hierarchy is determined based on the lowest level of input that is
significant to the fair value measurement.
As of
March 31, 2009, the Company held certain assets and liabilities that are
required to be measured at fair value on a recurring basis, including the
embedded derivatives related to the Note issued in 2007. The fair value of the
embedded derivatives was determined using the following inputs in accordance
with SFAS 157 at March 31, 2009:
The
following table presents a reconciliation of the assets and liabilities measured
at fair value on a recurring basis using significant unobservable inputs (Level
3) from April 1, 2008 to March 31, 2009:
The
embedded derivatives are revalued at the end of each reporting period and the
resulting difference is included in the results of operations. The estimated
fair value of the embedded derivatives at the time of issuance at December 11,2007, as of March 31, 2008 and March 31, 2009 was $9,118,000, $5,752,000
and 2,660,000, respectively. The change in the fair value of the embedded
derivatives amounted to $3,366,000 and 3,092,000 for the year ended March 31,2008 and 2009 were charged to the consolidated statement of
operations.
Net
increase in cash and cash equivalents balances
$
-
$
-
$
-
Cash
and cash equivalents balances at beginning of year
-
-
-
Cash
and cash equivalents balances at end of year
$
-
$
-
$
-
Supplemental
disclosure of non-cash information:
Cash
transactions received or paid on behalf by a subsidiary
Proceeds
from issuance of convertible note
$
-
$
25,000,000
$
-
Interest
paid for convertible note
$
808,219
$
-
$
-
Capitalisation
of amortised convertible note discount on
$
4,785,349
$
1,051,388
$
-
The
accompanying notes are an integral part of these condensed financial
statements.
-65-
CHINA-BIOTICS,
INC.
SCHEDULE
I - CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
NOTES
TO CONDENSED FINANCIAL STATEMENTS
1
These
condensed parent company only financial statements should be read in
connection with the consolidated financial statements and notes
thereto.
-66-
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM
9A. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
An
evaluation was performed under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, of the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934) as of the end of the period covered by this Annual Report on Form 10-K.
Based on that evaluation, our management, including our principal executive
officer and principal financial officer, concluded that our disclosure controls
and procedures are effective to ensure that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms and such information is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, to allow timely decisions
regarding required disclosure.
Management’s
Annual Report on Internal Control over Financial Reporting
The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act). The Company’s internal control
over financial reporting is designed to provide reasonable assurance regarding
the reliability of its financial reporting and the preparation of published
financial statements in accordance with generally accepted accounting
principles.
However,
because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or the degree
of compliance with policies may deteriorate.
Management
conducted its evaluation of the effectiveness of its internal control over
financial reporting based on the framework in “Internal Control-Integrated
Framework” issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) as of March 31, 2009.
Based on
this assessment, the principal executive officer and principal financial officer
believe that as of March 31, 2009, the Company’s internal control over financial
reporting was effective based on criteria set forth by COSO in “Internal
Control-Integrated Framework.”
This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management’s report
in this Annual Report on Form 10-K.
-67-
Changes
in Internal Controls over Financial Reporting
There
were no changes in the Company’s internal control over financial reporting
identified in connection with the evaluation required by paragraph (d) of Rules
13a-15 and 15d-15 of the Exchange Act that occurred during the Company’s most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
ITEM
9B. OTHER INFORMATION
None.
PART
III
ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
Directors,
Executive Officers and Key Employees and Advisors
The
following is a summary of the business experience of our executive officers and
directors:
Mr. Song Jinan, age 47,
Chief Executive Officer, President, Director, Treasurer and Secretary since
March 2006 -
Mr. Song was one of the founders of Shining in 1999, and has been the
principal executive officer of Shining since inception. Prior to founding
Shining, Mr. Song served as the chief engineer of Sai Bao Bio-Chemical
Manufacturing Corporation. Mr. Song received his Bachelor’s Degree in
Polymers from the University of Hei Long Jiang and his Master’s degree in
Politics and Economics from Habin Industrial University.
Dr. Chin Ji Wei, age 52,
Director since January 2007 - Dr. Chin has over 20 years of academic experience
as a lecturer and researcher in the field of horticulture, where he has been
focused on the areas of efficient agriculture industry and food safety. Dr. Chin
has served as a Vice Principal, professor, and lecturer at Northeast
Agricultural University in China since 1999. From 1985 to 1995, Dr. Chin
served as a Researcher at the Northeast Agricultural University and the
Northeast Agricultural Institute. Dr. Chin has Bachelors, Masters, and Doctorate
degrees, all from Northeast Agricultural University.
Dr. Du Wen Min, age 41,
Director since January 2007 - Dr. Du has served as the Deputy Director in charge
of the Centre for Adverse Drug Reactions in Shanghai since 2001. The centre was
established in June 2001 as a technology unit governed by The Shanghai Food and
Drug Authority. Dr. Du has also served as the Vice Chairman of Evaluation of
Pharmacology & Clinical Pharmacy in Shanghai, China, and the Vice Chairman
at the Centre for the Study of Liver Disease in Shanghai, China since 2006. Dr.
Du has Bachelors and Masters degrees from Shanxi Medical University and a
Doctorate in Medicine from Fudan University.
Mr. Simon Yick, age 51,
Director since January 2007 - Mr. Yick has over 20 years experience in corporate
finance, direct investment and auditing. From March 2002 to January 2004, Mr.
Yick worked as an Executive Director of Kingsway Capital Ltd. Mr. Yick
has served as the managing director at Sinovest Capital Ltd., which makes direct
investments, is involved with merger & acquisition activities, and operates
a full service consultancy business for both Hong Kong and PRC enterprises,
since 2004. His experience includes working for Ernst & Young in London and
Hong Kong, in addition to holding senior positions at multiple U.S., Taiwan, and
Hong Kong based investment banking firms in Hong Kong. In addition, he is
currently a non-executive director and chairman of the audit committee for three
Hong Kong listed companies and an independent non-executive director of a PRC
(Shenzhen Stock Exchange) listed company and a member of both the Chartered
Association of the Certified Accountants in UK and the Hong Kong Institute of
Certified Public Accountants.
Mr. Lewis Fan, age 39, has
been Chief Financial Officer since March 2009. Mr. Fan served as Vice
President and Senior Analyst in equity research at Brean Murray, Carret & Co
from 2008 to 2009, Assistant Vice President of investor relations at The Ruth
Group from 2007-2008, Senior Analyst at GFI Securities, Inc. in 2007, Associate
Analyst in equity research at UBS Securities in 2007, and Associate in emerging
markets strategy at Deutsche Bank from 2003 to 2007. Mr. Fan has a
master of business administration degree in finance from New York
University, a master of science degree in medicinal chemistry from the
University of Michigan, and a bachelor of arts degree in biology and
chemistry from Luther College.
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In
addition, we have a strong management team with significant experience in our
industry. We also have a technical advisory panel comprising a group of experts
from different fields of live sciences, including genetics, microecologics,
biochemistry and molecular materials, to advise on our product research and
development. Mr. Song Jinan is a member of the technical advisory panel.
Biographical details of the other key employee not included above are set out
below:
Ms. Yan Yihong, age 46, is
the chief administration officer (assistant to the general manager) of Shining.
Ms. Yan has served as a director of Shining since 1999. She was appointed as the
chief administration officer in 2004. During the past five years, Ms. Yan has
been an employee of Shining in various capacities and has, among other things,
participated in formulating the company’s development plans, implemented the
company’s internal control procedures and represented the company in business
negotiations with relevant government authorities and other external
parties.
Board Structure and Composition;
Committees
Our board
of directors currently consists of four members: Mr. Song Jinan, Dr. Chin
Ji Wei, Dr. Du Wen Min and Mr. Simon Yick. Dr. Chin Ji Wei, Dr. Du Wen Min and
Mr. Simon Yick are independent directors under the independence definitions
established by the SEC, the American Stock Exchange and NASDAQ.
On May28, 2008, we established an audit committee of the board of directors (the
“Audit Committee”). The initial members of the Audit Committee are Dr. Chin Ji
Wei, Dr. Du Wen Min and Mr. Simon Yick. Mr. Simon Yick serves as the initial
chairperson of the Audit Committee. Our board of directors has determined that
Mr. Simon Yick qualifies as an audit committee financial expert and is an
independent director under the independence definitions established by the SEC,
the American Stock Exchange and NASDAQ.
On May28, 2008, we also established a nominating committee (the “Nominating
Committee”) and a compensation committee (the “Compensation Committee”) of the
board of directors. The initial members of the Nominating Committee are Mr. Song
Jinan, Dr. Chin Ji Wei and Dr. Du Wen Min. Mr. Song serves as the initial
chairperson of the Nominating Committee. The initial members of the Compensation
Committee are Dr. Chin Ji Wei, Dr. Du Wen Min and Mr. Simon Yick. Dr. Du Wen Min
serves as the initial chairperson of the Compensation Committee.
On
October 23, 2008, our common shares became registered under the Securities
Exchange Act of 1934, as amended, as of which time the Company's officers,
directors and any 10% shareholders became subject to the reporting requirements
of Section 16(a). Mr. Lewis Fan became the Chief Financial Officer of
the Company on March 6, 2009. On April 6, 2009, he filed his Initial Statement
of Beneficial Ownership of Securities on Form 3, on which he reported that he
owns no shares of the Company, on an untimely basis.
Code
of Business Conduct and Ethics
Our board
of directors has adopted a code of business conduct and ethics applicable to our
directors, executive officers, including our chief financial officer and other
of our senior financial officers, and employees.
ITEM
11. EXECUTIVE COMPENSATION
Compensation
Discussion and Analysis
Our
compensation program is designed to attract and retain employees and reward them
for their efforts toward helping us achieve both long-term and short-term goals.
Currently, compensation for our executive officers consists solely of base
salary, which is set based on relevant factors, such as:
·
The
short-term and long-term performance of the
company;
·
The
performance of the executive officers in light of relevant corporate goals
and objectives;
·
Executive
compensation levels at comparable companies;
and
·
The
recommendations of our Chief Executive
Officer.
Base
salaries are reviewed annually and adjustments are made to reflect
performance-based factors, such as the individual performance of the executive
officer and the financial performance of the Company, as well as competitive
conditions in the industry. The Compensation Committee has adopted a policy that
it will use the Company’s financial performance for fiscal year 2009 as a
baseline to determine its executive officers’ future compensation, including any
adjustments to their current salaries in the annual review process. Other
specific performance goals and specific corporate goals and objectives that may
be used to set and adjust executive compensation are currently under discussion
by the Compensation Committee but have not yet been formally
approved.
Other
elements of compensation, such as options or other awards of equity-based
compensation, are not currently a part of the Company’s compensation program. It
is likely that the Company’s Compensation Committee will consider whether to
include other forms of compensation, such as options or other equity-based
compensation, to its executive officers as it continues to review the Company’s
compensation program.
The
compensation of Mr. Lewis Fan, our Chief Financial Officer, was approved by our
Compensation Committee based on Mr. Fan’s salary history, his professional
experience, his personal attributes and experience, an analysis of the
compensation levels of U.S.-based chief financial officers of comparable
companies and on the recommendation of our Chief Executive Officer. The two
companies that were identified as comparable for purposes of setting Mr. Fan’s
compensation were American Oriental Bioengineering, Inc. and Shanghai Bright
Dairy & Food. American Oriental Bioengineering is a New York
Stock Exchange listed, U.S.-based company focused on producing pharmaceutical
and neutraceutical products for the Chinese market. Shanghai Bright Dairy &
Food is a Shanghai Stock Exchange listed company that produces dairy products
for the Chinese market. The Compensation Committee will seek to identify
additional companies in the future that are considered comparable for the
purposes of setting executive compensation. Any future adjustments to Mr. Fan’s
compensation will take into account the factors described above, his future
performance, the Company’s future financial performance, and any additional
factors the Compensation Committee considers appropriate at that
time.
Prior to
the formation of the Compensation Committee, the compensation of our executive
officers (including the current compensation of Mr. Song, our Chief Executive
Officer) was set by the board of directors based on review of compensation
levels at comparable companies (such as American Oriental Bioengineering, Inc.
and Shanghai Bright Dairy & Food) and on company and individual performance.
Mr. Song’s current compensation was considered and confirmed without adjustment
by the Compensation Committee in May 2009. His salary will be subject to further
review and adjustment by the Compensation Committee after the financial results
for fiscal year 2009 are released.
Our
Compensation Committee was formed on May 28, 2008. The Compensation
Committee is responsible for advising and assisting the Board in its
responsibilities related to compensation of the Company’s executives, and
ensuring that compensation plans are appropriate and competitive and properly
reflect the objectives and performance of our management and the
company.
Board
Compensation
We have
not paid any compensation to directors of China-Biotics for the fiscal years
ended March 31, 2007, 2006, or 2005. The table below lists the compensation
received by the independent directors of China-Biotics for the fiscal year ended
March 31, 2009 and 2008.
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Annual Compensation
Name of independent
directors
Year
Salary (1)
Bonus
Other Annual
Compensation
Dr.
Chin Ji Wei
2009
$
—
2008
$
5,722
—
—
Dr.
Du Wen Min
2009
$
—
2008
$
5,722
—
—
Mr.
Simon Yick
2009
$
30,968
2008
$
18,273
—
—
(1) Chin
Ji Wei and Dr. Du Wen Min were paid in RMB; the US dollar amounts were
calculated using an exchange rate of RMB6.99 to US$1, the prevailing rate as of
March 31, 2008. Mr. Simon Yick was paid in Hong Kong dollars; the US
dollar amount was calculated using an exchange rate of HK$7.75 to US$1, the
prevailing rate as of March 31, 2009.
Executive
Officer Compensation
The table
below lists the compensation received by Mr. Song Jinan, the Chief
Executive Officer of China-Biotics, and Mr. Raymond Li and Mr. Lewis Fan, the
former and current Chief Financial Officers of China-Biotics. Mr. Song and Mr.
Fan are currently the only executive officers of China-biotics. No other officer
of China-Biotics or SGI received compensation in excess of $100,000 for these
years.
Annual Compensation
Name and Principal
Position(1)
Year
Salary
(2)(3)
Bonus
Other Annual
Compensation
Song
Jinan, Chief Executive Officer,
2009
$
129,586
—
—
Treasurer
and Secretary and
2008
139,020
—
—
Principal
Executive Officer of SGI
2007
90,032
—
—
Lewis
Fan, Chief Financial Officer
2009
$
10,000
—
—
Raymond
Li, Former Chief Financial
2009
$
79,419
—
—
Officer
2008
76,923
—
—
2007
79,189
—
—
(1)
Mr. Song became our Chief Executive Officer, Chief Financial
Officer, Treasurer and Secretary as of March 22, 2006. He was the sole
executive officer of China-Biotics prior to November 2006 and the principal
executive officer of SGI for the periods indicated. On November 13,2006 Mr. Song resigned from the office of Chief Financial Officer, and appointed
Mr. Raymond Li to serve as the Chief Financial Officer. Mr. Lewis Fan
replaced Mr. Li as the Chief Financial Officer as of March 6, 2009.
(2)
Mr. Song and Mr. Li were paid in RMB. The US dollar amounts were
calculated using an exchange rate of RMB6.99 to US$1, the prevailing rate as of
March 31, 2009. Includes social insurance contributions of US$6,553
(RMB45,809), US$24,549 (RMB171,600) and US$54,121 (RMB371,750) for Mr. Song for
the years ended March 31, 2009, 2008 and 2007, respectively.
Equity
Compensation Plans and Awards
We do not
have any equity compensation plans. We have not granted any stock options or
other equity awards since our inception.
Compensation
Committee Interlocks and Insider Participation
Prior to
establishing the Compensation Committee, our Board of Directors as a whole
performed the functions delegated to the Compensation Committee. None of the
members of our Compensation Committee has ever been one of our officers or
employees. None of our executive officers currently serves, or has served, as a
member of the Board of Directors or Compensation Committee of any entity that
has one or more executive officers serving as a member of our Board of Directors
or Compensation Committee.
Compensation
Committee Report
The Compensation Committee Report is
not to be deemed to be “soliciting material” or to be “filed” with the SEC or
subject to Regulation 14A or 14C or to the liabilities of Section 18
of the Exchange Act, except to the extent that the Company specifically requests
that such information be treated as soliciting material or specifically incorporates
it by reference into any filing under the Securities Act of 1933, as amended
(the “Securities
Act”) or the Exchange
Act.
The
Compensation Committee has reviewed and discussed the Compensation Discussion
and Analysis required by Item 402(b) of Regulation S-K with management. Based on
this review and discussion, the Compensation Committee has recommended to the
Company’s Board of Directors that the Compensation Discussion and Analysis be
included in this Annual Report on Form 10-K.
Compensation
Committee
Dr. Chin
Ji Wei
Dr. Du
Wen Min
Mr. Simon
Yick
ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The
following table sets forth information with respect to the beneficial ownership
of our common stock as of July 13, 2009, including shares which the listed
beneficial owner has the right to acquire within 60 days from such date
from options, warrants, rights, conversion privileges or similar obligations,
by:
•
each
holder of more than 5% of our common
stock;
•
each
of our executive officers and directors;
and
•
our
executive officers and directors as a
group.
Unless
otherwise noted below, the addresses of each beneficial owner set forth below is
No. 999 Ningqiao Road, Jinqiao Export Processing Zone, Pudong, Shanghai
201206, People’s Republic of China. The numbers and percentages are based on
17,080,000 shares of our common stock and a note convertible into 2,083,333
shares of our common stock (subject to adjustment for subdivision or combination
of our stock and similar events) outstanding as of July 13,2009.
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Name and Address of Beneficial Owner
Number of
Shares of
Common Stock
Owned
Percent of
Common
Stock Owned
Song
Jinan (1)
9,064,030
47.3
%
Chin
Ji Wei
0
-
Du
Wen Min
0
-
Simon
Yick (2)
221,000
2
%
Raymond
Li
0
-
Lewis
Fan
0
-
Pope
Asset (3)
3,066,752
16.0
%
Tai
Kwok Leung, Alexander (4)
1,469,700
7.7
%
Executive
officers and directors (5 persons)
9,535,030
48.5
%
(1)
Includes 3,979,993 shares held by Ms. Yan Li. Ms. Yan is the spouse of Mr. Song,
a director and our President and Chief Executive Officer.
(2) Each
of Mr. Yick and his spouse owns 50% of Master Talent Group Limited, which owns
221,000 shares of our common stock.
(3) Based on
a shareholder list provided by our transfer agent on July 13, 2009. The address
for Pope Asset Management, LLC (“Pope Asset”) is 5100 Poplar Ave, Suite 512,
Memphis, TN. Pope Asset is the investment advisor for Halter/Pope USX China Fund
(“Halter/Pope”), Pope Investments, LLC (“Pope Investments”) and Pope Investment
II, LLC (“Pope Investments II”). As of July 13, 2009, Halter/Pope owned 36,900
shares of our common stock, Pope Investments owned 846,519 shares of our
common stock and Pope Investments II owned 100,000 shares of our common stock.
Pope Investments II also holds our 4% convertible promissory note, which is
convertible into 2,083,333 shares of our common stock. William P. Wells is chief
manager of Pope Asset. Mr. Wells may be deemed to beneficially own the shares
reported as held by Halter/Pope, Pope Investments and Pope Investments
II.
(4) Tai
Kwok Leung, Alexander, is the sole shareholder of Fascinating Gain Investments
Limited and Charming Leader Group Limited, each of which holds 734,850 shares of
our common stock. Mr. Tai may be deemed to beneficially own these shares. The
address for Mr. Tai, Fascinating Gain Investments Limited and Charming Leader
Group Limited is 8th Floor, No. 313 Lockhart Road, Wanchai, Hong
Kong.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
On
December 11, 2007, China-Biotics, Inc. (the “Company”) entered into definitive
agreements concerning the sale of a 4% Senior Convertible Promissory Note in the
amount of $25,000,000 to Pope Investments II LLC in a private placement. In
connection with the private placement, Mr. Song Jinan, the Company’s Chief
Executive Officer, Chairman, and largest shareholder, entered into a Guaranty
Agreement and a Pledge Agreement, pursuant to which Mr. Song agreed to guaranty
the Company’s obligations under the Note and to secure such guaranty with a
pledge of 4,000,000 shares of the Company’s common stock. The transaction
described above was approved by our board of directors. We believe that the
transaction was made on terms no less favorable to us than could have been
obtained from unaffiliated third parties.
On
January 21, 2009 and on May 19, 2009, Ms. Yan Li sold 250,000 shares and
250,000, respectively, of our common stock in private sale transactions pursuant
to purchase agreements among Ms. Yan, China-Biotics and certain purchasers.
Under the terms of each purchase agreements, China-Biotics agreed to use its
reasonable best efforts to prepare and file with the Securities and Exchange
Commission a registration statement (or to include in an existing registration
statement through the use of an amendment to such registration statement),
including the prospectus, for an offering to be made on a continuous basis
pursuant to Rule 415 of the Securities Act by the 30th day
following the closing date covering the resale by the purchasers of the shares
and naming the purchasers as selling stockholders. Ms. Yan is the spouse of Mr.
Song, a director and the President and Chief Executive Officer of China-Biotics.
This transaction was reviewed by our audit committee and approved by a majority
of our independent directors.
In May
2008, we established an audit committee of the board composed solely of
directors who meet the independence requirements of the SEC, the American Stock
Exchange and NASDAQ. Any transaction we enter into in the future with any
related party will be made on terms no less favorable to us than could have been
obtained from unaffiliated third parties and the terms of any such transaction
will be reviewed by our audit committee and approved by a majority of our
independent directors. Our board of directors currently consists of four
members: Mr. Song Jinan, Dr. Chin Ji Wei, Dr. Du Wen Min and Mr. Simon Yick. Dr.
Chin Ji Wei, Dr. Du Wen Min and Mr. Simon Yick are independent directors under
the independence definitions established by the SEC, the American Stock Exchange
and NASDAQ.
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Set forth
below is a summary of the fees we paid our principal auditor for professional
services rendered for the years ended March 31, 2009 and 2008. All of the
audit fees were approved by the board of directors acting as the company's audit
committee.
Audit
Fees
The
aggregate fees billed for professional services rendered by BDO Limited for the
audit of our annual financial statements and review of financial statements for
the fiscal years ended March 31, 2009 and 2008 were $292,260 and $165,430,
respectively.
Audit-Related
Fees
BDO
Limited did not render any audit-related services to us for the fiscal years
ended March 31, 2009 and 2008.
Tax
Fees
BDO
Limited did not render any tax services to us for the fiscal years ended March31, 2009 and 2008.
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All
Other Fees
BDO
Limited did not render any other services to us for the fiscal years ended March31, 2009 and 2008.
Policy
on Audit Committee Pre-Approval of Audit and Audit-Related Services of
Independent Auditors
Our Audit
Committee pre-approves all audit and audit-related services provided by the
independent auditors. On an ongoing basis, management communicates specific
projects and categories of services for which advance approval of the board of
directors is requested. The Audit Committee reviews these requests and makes a
recommendation to the board of directors. The board of directors then advises
management whether it has approved the engagement of the independent auditors
for specific projects.
ITEM
15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(1) Financial
Statements.
Report
of Independent Registered Public Accounting Firm
4%
Senior Convertible Promissory Note dated December 11, 2007 (incorporated
by reference to Exhibit 10.3 to China-Biotics, Inc.’s Form 8-K filed on
December 12, 2007).
Letter
dated April 13, 2006 from Malone & Bailey PC to the United States
Securities and Exchange Commission (incorporated by reference to Exhibit
16.1 to China-Biotics, Inc.'s Form 8-K filed on May 31,2006).
Certification
of CEO pursuant to Rule 13a-14(a)/15(d)-14(a).
31.2
Certification
of CFO pursuant to Rule 13a-14(a)/15(d)-14(a).
32.1
Certification
of CEO pursuant to Section 1350.
32.2
Certification
of CFO pursuant to Section 1350.
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SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on July 14, 2009.
Pursuant
to the requirements of Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities indicated on July 14, 2009.
