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 þ
Non-accelerated
filer ¨ (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 $101,090,896 as of the last business day of the
registrant’s most recently completed second fiscal quarter.
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
27
ITEM 6.
SELECTED
FINANCIAL DATA
28
ITEM 7.
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
29
ITEM 7A.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
42
ITEM 8.
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
43
ITEM 9.
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
80
ITEM 9A.
CONTROLS
AND PROCEDURES
80
ITEM 9B.
OTHER
INFORMATION
83
Part III
ITEM 10.
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
84
ITEM 11.
EXECUTIVE
COMPENSATION
85
ITEM 12.
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
89
ITEM 13.
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
90
ITEM 14.
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
91
ITEM 15.
EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES
91
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)
- 2
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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 17 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 that
beneficially affect the host by improving its intestinal microbial
balance.
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 September 22, 2006, Growing State Limited established a
wholly-foreign owned enterprise, Growing Bioengineering (Shanghai) Company
Limited, in China.
- 3
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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. Since our net income
in fiscal year 2010 is below $60 million, the mandatory conversion will not be
implemented. 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 the 150-metric-ton-per-year manufacturing facility and for other
capital expenditures.
On
October 5, 2009, the Company closed an underwritten public offering of 4,600,000
shares of its common stock at a price of $15.00 per share. On October 26, 2009,
an additional 690,000 shares were sold pursuant to the exercise of an
over-allotment option at the same price. Net proceeds of the offering, including
the over-allotment, after deducting underwriting discounts, but excluding
estimated offering expenses, were approximately $74.9 million. The Company
expects to use the net proceeds from the offering for general corporate purposes
and may also use a portion of the net proceeds to acquire or invest in
businesses and products that are complementary to our own.
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 that beneficially affect the host by improving its intestinal
microbial balance.
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 currently our best-selling
product. Sales of Shining Essence represent approximately 29% of our
total sales for the year ended March 31, 2010, 40% for the year ended March 31,2009, and 48% for the year ended March 31, 2008. The Health Food
Association of China named Shining Essence as the best selling liver health
product in 2001.
We
currently have three patents for our production process, packaging design, and
packing equipment design. We have applied those technologies in the
manufacturing process of all products under the “Shining” brand. We also have a
patent for the production of one of our products, a blood cholesterol reduction
agent.
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 9001:2008 certification from TÜV Anlagentechnik GmbH
in respect of our production process for its leading product, Shining
Essence, which expires in January 2015. According to the American National
Standards Institute, ISO 9001:2008 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.
- 4
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·
ISO
14001. We obtained ISO 14001:2004 certification from TÜV Anlagentechnik
GmbH in respect of our production process for our Shining Essence product,
which expires in February 2013. 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.
·
GMP. We
obtained the Good Manufacturing Process (GMP) certification from the
Shanghai Food and Drug Administration (SHFDA) for our new production
facility in Qingpu Industrial Park, which expires on March 28,2013. GMP is a global quality assurance system that covers the
testing and manufacturing of food, pharmaceutical products, and medical
devices. GMP stipulates stringent approval guidelines on
various aspects of production based on evaluations of the factory and
equipment, materials, hygiene certificates, waste and recycling, and after
sales, among other things.
Products
We
manufacture and sell several health supplements under the “Shining” brand in
China 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 retail 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;
•
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.
- 5
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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.
In
February 2010, we commenced production at our new facility in Qingpu and began
producing bulk additives products, which are sold to institutional customers,
such as dairy manufacturers, animal feed manufacturers, pharmaceutical
companies, and food companies. 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 is 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 additives
business for institutional customers through our 150-ton capacity plant,
which commenced production in February 2010. We are focusing on two fast
growing industries: dairy and animal food in China. Management
believes our new facility will meet the industry requirements of quality
and scalability. Management estimates that Phase 1 of the project, which
involves constructing a facility capable of producing 150 tons of
probiotics per annum, will cost $28 million. Phase 2 of this project,
which commenced in December 2009, is expected to cost $18 million. The
construction cost of Phase 1 of the plant is being funded by cash received
from the sale of a convertible promissory note to Pope Investments II LLC
on December 11, 2007 as disclosed in “Business-History.” The construction
cost of Phase 2 of the plant is being funded by cash received from the
public offering of our common stock in October 2009 as disclosed in
“Business — History”;
- 6
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•
the geographical expansion of
its retail sales through direct sales and traditional sales
channels - We intend to expand the sale of our retail
products to the other metropolitan cities in China through a combination
of traditional distribution channels and dedicated Shining outlets. We
have a total of 111 outlets as of March 31, 2010. About three
quarters of these outlets are located in Shanghai, and the rest are
located in 12 other cities in China. With respect to our bulk
additives business, we have secured 31 bulk additives probiotics customers
nationwide in tier-one urban areas such as Beijing and Shanghai, as well
as inland provinces such as Qinghai and Inner Mongolia;
and
•
the improvement in research and
development of new products and services - 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. To further improve our competency in the
bulk additives market, we continue to improve our services to our
institutional clients by facilitating their lab testing and production
testing and providing customized technical support, among other
things.
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.
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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 July 19, 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.
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.
More use of probiotics in animal feed
industry. Antibiotics have been widely used in animal feed by Chinese
farmers. Human health has been indirectly impacted negatively by drinking milk
and eating meat produced by the farms using antibiotics added feed. With the
increasing public awareness of those issues, the government is encouraged to
set up stricter regulations to monitor the non-therapeutic use of
antibiotics in livestock feed to ensure food safety. (Please see the
article, “Call to keep
antibiotics out of the food chain” in China Daily at http://www.chinadaily.com.cn/china/2010-04/13/content_9719351.htm).
At the same time, organic food is getting more attention in Chinese daily
life. This creates a favorable trend of using more probiotics in
animal feed.
Business
strategies
Leveraging
on what 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, with a focus on fast growing
industries, including dairy and animal
feed;
•
the
geographic expansion of our retail sales through direct sales and
traditional sales channels; and
•
enhancement
in R&D to develop new products and provide value-added
services.
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 additives business for
functional foods through the completion of our 150-ton capacity plant, which
commenced commercial production in February 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 $28
million. Phase 2 of this project is expected to cost $18 million. The
construction cost of Phase 1 of the plant is being funded by cash received from
the sale of a convertible promissory note to Pope Investments II LLC on December11, 2007, as disclosed in “Business-History.” The construction cost of Phase 2
of the plant is being funded by cash received from the public offering of our
common stock in October 2009 as disclosed in “Business —
History.”
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Geographic
expansion and direct sales
We sell
our retail 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 retail products to other metropolitan cities in China
through a combination of 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, 2010, we
have opened 111 outlets in Shanghai and 12 other cities in China.
In
preparation for the opening of additional retail outlets, we have also been
actively recruiting and training retail sales staff. 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 111 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 retail products
In
connection with the opening of our first Shining outlet, we launched several new
retail products under the Shining brand. We currently have regulatory approval
to produce 41 retail 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 retail 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 retail products that 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 29
producers for use of our products as food additives.
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.
- 9
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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 required to
be 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 other manufacturing facility in China that can meet the demand for
probiotics if this requirement was imposed. We believe we are well positioned to
capture this significant new demand for probiotics.
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 50% to $81.3 million in
fiscal year 2010 from $54.2 million in fiscal year 2009, which was a 28%
increase from $42.3 million in fiscal year 2008. Income before taxes increased
from $22.5 million in fiscal year 2008 to $25.1 million in fiscal year 2009, and
decreased to $23.4 million in fiscal year 2010.
Production
We use
microecology 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 Microencapsulation 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;
·
Packaging
for Shining Essence (patent registration number ZL 01 3 01526.5);
and
In 2008
and 2009, we submitted eight applications for registration of patents regarding
the production of our products to the Intellectual Property Bureau of China. The
applications are all pending final approval and the issuance of formal
certificates.
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.
·
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 retail products primarily 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, 2010,
we had 27 distributors located in Shanghai, Jiangxu, Zhejiang, and Hong Kong. As
of March 31, 2010, we had 111 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.
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Customers
We have
two different types of customers: individual consumers and institutional
customers. Institutional customers include dairy manufacturers, animal feed
manufacturers, pharmaceutical companies, and food companies. Individual
consumers are primarily located in major metropolitan areas and they 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. As of March 31, 2010, we had 111 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 fiscal year ended March 31, 2010, we had one customer,
Beijing DBN Technology Group Co. Ltd, that accounted for 13.0% of our sales
revenue. For the fiscal year ended March 31, 2009, we had one
customer, Shanghai Lian Hua Quik Convenience Store Limited, that accounted for
11.5% of our sales revenue. For the fiscal 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 three
customers are independent third parties.
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 additives 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.
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Research
and Development
We have a
strong research and development team supported by a technical advisory board of
experts. At March 31, 2010, we have approximately 35 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 $3,665,380, $3,229,788 and $2,194,474 for the
fiscal years ended March 31, 2010, 2009 and 2008, 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.
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.
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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.
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.
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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.
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.
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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
expanding into the bulk additives business for functional foods through the
completion of our 150-ton capacity plant, which commenced production in February
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 $28 million. Phase 2 of this project, which commenced in December
2009, is expected to cost $18 million. The construction cost of Phase 1 of the
plant is being 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 construction cost of Phase 2 of the plant is
being funded by cash received from the public offering of our common stock
in October 2009 as disclosed in “Business — History.”
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 $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 the formal land use right certificate was issued. There are no
future lease payments under this land lease.
Employees
As of
March 31, 2010, we had 513 staff and employees. The following table
summarizes the functional distribution of our employees:
Department
Headcount
Management
and Administrative
27
Sales
and Marketing
73
Retail
Outlet
232
Research
and Development
35
Production
124
Finance
and Accounting
10
Engineering
12
Total
513
All of
these employees were full-time. We do not have any payment obligations for any
retirees and are not currently retaining any contractors.
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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.
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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
most of our revenue from the sale of our Shining Essence product. Sales of this
product represented approximately 29%, 40% and 48% of our total sales for the
year ended March 31, 2010, 2009, and 2008 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 2010,
2009 and 2008 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.
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.
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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 additives 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 additives 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 additives 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.
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.
- 19
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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, 2010, 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 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 (now known as ASC
740), the Group has reserved for the surcharges payable for fiscal year 2010 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 2010, 2009, and 2008.
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 one 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
six 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.
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. Cai, 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. Cai.
- 20
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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.
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:
- 21
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·
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.
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.
All
of our officers and directors, 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
our executive officers and directors 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.
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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.
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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
22,370,000 shares outstanding as of March 31, 2010, including
approximately 12,581,600 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
June 7, 2010, Mr. Song, our President and Chief Executive Officer
and a director, owned, directly and indirectly through his family,
approximately 37.1% of our issued and outstanding common stock on a fully
diluted basis. 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.
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.
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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.
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
1B. UNRESOLVED STAFF COMMENTS.
None.
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.
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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 $28 million. Phase 2 of this project, which commenced in
December 2009, is expected to cost $18 million. The construction cost of Phase 1
of the plant is being 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 construction cost of Phase 2 of the plant is being
funded by cash received from the public offering of our common stock in October
2009 as disclosed in “Business — History.”
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 $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. [REMOVED AND RESERVED]
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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.
As of
June 7, 2010 there were 22,370,000 shares our common stock outstanding held
by approximately 23
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
currently have an equity compensation plan. As of June 7, 2010, we have not
granted any stock options or other equity awards since our inception. Management
expects to implement an equity incentive plan at or before its next regularly
scheduled meeting of its board of directors and to seek stockholder approval of
the equity incentive plan at the 2010 Annual Meeting of
Stockholders.
Performance
Graph
The
following graph compares the cumulative 17-month total return of holders of
China-Biotics, Inc.'s common stock with the cumulative total returns of the
NASDAQ Composite index, and a customized peer group index consisting of
companies reporting under the Standard Industrial Classification Code 2833
(Medicinal Chemicals and Botanical Products), which are listed in footnote 1
below. The graph tracks the performance of a $100 investment in our common
stock, in the SIC Code Index, and the index (with the reinvestment of all
dividends) from 10/23/2008 to 3/31/2010.
(1) There
are twenty-four companies included in the SIC 2833 customized peer group which
are: Biodel Inc, Bond Laboratories Inc, Cambrex Corp., China Health Resource
Inc, China Holdings Inc, Cobalis Corp., Cyanotech Corp., Cybermesh International
Corp., Cytrx Corp., Entropin Inc, Four Star Holdings Inc, Geopharma Inc, Huifeng
Bio-Pharmaceutical Technology, Immunobiotics Inc, Life Nutrition Products Inc,
Nutraceutical International Corp., Optigenex Inc, Pacifichealth Laboratories
Inc, Rockwell Medical Technologies Inc, Soligenix Inc, Sunwin International
Neutraceuticals Inc, Synovics Pharmaceuticals Inc, Versatech Inc and Xelr8
Holdings Inc.
- 27
-
Oct-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
China-Biotics,
Inc.
100.00
82.46
73.98
93.99
139.25
134.64
155.87
NASDAQ
Composite
100.00
76.89
74.38
89.23
103.39
110.84
117.32
SIC
Code Index
100.00
112.09
93.46
136.32
169.00
154.88
156.82
The
stock price performance included in this graph is not necessarily indicative of
future stock price performance.
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 29 of this Form 10-K.
The
summary statement of operations data for each of the fiscal years ended March31, 2010, 2009 and 2008, and the summary balance sheet data as of March 31,2010, 2009 and 2008, are derived from our audited financial statements, which
are included in this Form 10-K.
2010
2009
2008
2007
2006
Statement
of Operations Data
Net
Sales
81,364
54,197
42,321
30,610
21,862
Cost
of goods sold
24,070
16,197
12,310
8,911
6,445
Gross
profit
57,294
38,000
30,011
21,699
15,417
Income
from operations
35,281
21,783
18,315
14,931
12,185
Net
income
15,648
19,967
17,542
10,905
8,354
Earnings
per share
Basic
and diluted
0.80
1.17
1.03
0.64
4.90
Balance
Sheet Data
Current
assets
181,953
87,370
79,979
41,897
31,833
Total
assets
232,935
120,804
93,791
44,580
33,427
Working
Capital
145,297
55,034
53,083
21,227
10,743
Non-current
liabilities
40,100
23,072
22,500
-
-
Total
Stockholder’s equity
156,179
65,396
44,395
23,910
12,337
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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 17 of this Form 10-K. See the cautionary note regarding
forward-looking statements at the beginning of Part I of this
Form 10-K.
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 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.
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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 primarily in the Chinese domestic
market.
Our
retail products are mainly sold to distributors, which then distribute them to
various retail outlets such as drug stores and supermarkets. During the year
ended March 31, 2010, over 84% of our sales revenue comprised amounts receivable
from the distributors for the sale of these products. Typically, 60 to 90 days’
credit is given to the distributors. Our bulk additives products are mainly sold
to institutional customers, such as dairy manufacturers, animal feed
manufacturers, pharmaceutical companies, and food companies.
Our first
retail product, Shining Essence, which was launched in April 2001, remains our
best-selling product. Sales of Shining Essence represented approximately 29%,
40% and 48% of our total sales for the years ended March 31, 2010, 2009 and
2008, respectively. In addition to Shining Essence, our research
and development team has successfully developed other new retail products,
such as Shining Probiotics Protein Powder. As of March 31, 2010, we have a
retail product portfolio of 41 products, and we are currently selling 11 of them
in the market. As we have released new products, the percentage contribution of
Shining Essence to our total retail sales has decreased.
As our
retail 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 bulk
products have a revenue contribution of 26.8% in fiscal year 2010 increased from
8.3% in fiscal year 2009. The significant increase reflects an increased focus
by management on the rapidly growing bulk additives business. In February 2010,
our new bulk production facility was ready for commercial production. The state
of art bulk additives production facility has a full capacity of 150 metric
tons. Management believes our new facility will help us to continue to meet the
increasing market demand for high quality and low cost products.
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 and health supplement products. As the
discretionary income and health-consciousness of the average Chinese
consumer increase, we expect the demand for functional foods and health
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 for both humans and animals. Moreover, the Chinese State
Food and Drug Administration has also acknowledged that probiotics are
beneficial for human health. Recently, the Ministry of Health in China
announced an expanded list of probiotics strains allowed to be used in the
food industry. The number of probiotics strains on the list has doubled.
It reflects Chinese government is encouraging wider uses of probiotics
products in the food industry, and it also demonstrates the rapidly
expanding probiotics market in
China.
·
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.
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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 additives
business through our 150-ton capacity plant, which commenced production in
February 2010. Government approval for the plant was received on November30, 2007. Management estimates that Phase 1 of the project, which involves
constructing a facility capable of producing 150-tons of probiotics per
annum, will cost $28 million. Phase 2 of this project, which commenced in
December 2009, is expected to cost $18 million. The construction cost of
Phase 1 of the plant is being funded by cash received from the sale of a
convertible promissory note to Pope Investments II LLC on December 11,2007 as disclosed in “Business — History.” The construction cost of Phase
2 of the plant is being funded by cash received from the public offering
of our common stock in October 2009 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 $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
111 Shining branded outlets in Shanghai and 12 other major Chinese cities
as of March 31, 2010. 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, which will have a capacity of 150-300
tons.
·
The development of new
products. With respect to our retail products, we plan to
continue to research and 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 to the market.
With respect to our bulk additives products, we will leverage our rich
bacteria strain library, the largest in China, to provide customized
products to meet the needs of our institutional
clients.
Our operation is generally not
labor-intensive. We employed 513 people as of March 31, 2010. With production
ramp up in the Phase 1 facility and the construction of Phase 2, we expect
significant increases in our number of employees 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 $15.6 million for the fiscal year ended March 31, 2010. This included
a $12.1 million deficit arising from the revaluation of the conversion feature
embedded in the convertible note issued in December 2007 as required by FAS133
(now known as ASC 815). The convertible note will expire in December 2010, and
will not have an impact on our net income after that date. Excluding this
revaluation deficit, our net income was $27.7 million, which was 63.9% above our
net income of $16.9 million (excluded $3.1 million revaluation surplus) for the
fiscal year ended March 31, 2009. Our growth in net income primarily resulted
from growth in our sales volume of in both our retail products and bulk
additives products. Shining Essence continued to be our best selling retail
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, bulk additives
product sales now account for 26.8% of our sales revenue during the year ended
March 31, 2010 (8.31% in the year ended March 31, 2009), the increase of which
is a result of the rapid growth in shipments to dairy and animal feed
customers.
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-
Our
results for 2010 and 2009 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 2010 and 2009 comprised the
following:
Net sales
of $81,363,973 for the fiscal year ended March 31, 2010 were 50.1% above the net
sales of $54,197,082 for the fiscal year ended March 31, 2009. The increase was
mainly attributable to increased sales volume in both retail products and bulk
additives products, and increases in average selling prices due to changes in
sales mix. Bulk additives products resulted in a revenue contribution of 26.8%
in the fiscal year ended March 31, 2010, increased from 8.3% in the fiscal year
ended March 31, 2009. The significant increase reflects an increased focus by
management on the rapidly growing bulk additives business.
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-
The
contributions of our products as a percentage of invoiced value on sales for the
year ended March 31, 2010 and 2009 respectively are summarized
below.
Cost of
sales for the year ended March 31, 2010 was $24,070,203 compared with
$16,197,267 for the year ended March 31, 2009. The increase in cost of sales was
primarily caused by increased packaging cost during the fiscal year
2010.
Unit
volume and unit costs comparatives for the year ended March 31, 2010 and 2009
are summarized below.
Percentage increase (decrease) from the prior year
Gross
profit increased by $19,293,955 from $37,999,815 for the 2009 fiscal year to
$57,293,770 for the 2010 fiscal year. This represents a 50.8% increase, which
primarily reflects increases in overall sales volume. Our gross profit margin
remained the same as last year at 70%.
Selling
expenses
Selling
expenses were $13,535,225 or 16.6% of net sales for the fiscal year ended March31, 2010, compared with $11,563,012 or 21.3% of net sales for the fiscal year
ended March 31, 2009. The operating costs of the retail outlets are included as
selling expenses. This increase in selling expenses was primarily caused by
increase of overall sales. As bulk
additives products account for a larger share of revenue and selling expense
associated with bulk additives products are smaller than that of retail products
in this fiscal year, the selling expenses as a percentage of revenue
decreased.
General
and administrative expenses
General
and administrative expenses were $8,538,058 or 10.5% of net sales for the year
ended March 31, 2010 compared with 6,246,482 or 11.5% of net sales for the year
ended March 31, 2009. The increase in general and administrative expenses was
due to increasing research costs of $3,665,379 related to the development
and launch of new products, and staff and administrative costs incurred in
connection with the construction of the new plant.
Other
Income
Other
income mainly comprised exchange gain of $60,178 for the fiscal year ended March31, 2010. For the fiscal year ended March 31, 2009, other income consisted of
exchange gain of $1.51 million.
Provision
for income taxes
Provision
for income taxes was $7.79 million and $5.16 million for the fiscal years ended
March 31, 2010 and 2009, respectively. The increase in income tax payable is
attributable to an increase in operating profit.
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-
Segment
reporting
We have
adopted the “products and services” approach for segment reporting. For fiscal
years 2010 and 2009, we had only one reporting segment—the probiotic products.
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.
Our net
income was $20 million for the fiscal year ended March 31, 2009. This included a
$3.1 million surplus arising from the revaluation of the conversion feature
embedded in the convertible note issued in December 2007, as required by FAS133
(now known as ASC 815). 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).
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.
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.
- 36
-
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.
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
a 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.
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Liquidity
and Capital Resources
We had
cash of $155.6 million and working capital of $145.3 million as of March 31,2010, and cash of $70.8 million and working capital of $55.0 million as of March31, 2009. Cash generated from operations was $28.2 million for the fiscal year
ended March 31, 2010, and $23.1 million for the fiscal year ended March 31,2009.
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 whom 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 $13.8 million for the year ended March 31, 2010,
primarily on building the new plant. We spent $17.5 million on fixed
assets in fiscal year 2009.
Our
current primary facility commenced operations in 2000 in Pudong, Shanghai. With
the increases in sales volume in the last couple of years, we are reaching our
production capacity. We are constructing a new plant with an overall project
size of $46 million in Qingpu, Shanghai. Phase 1 of the project involves
constructing a facility capable of producing 150 tons of probiotics per annum
and will cost approximately $28 million, $23 million of which was paid by
2010, and the balance is scheduled to be paid by the end of calendar year 2010.
All
equipment for production of Phase 1 is in place. The Phase 1 facility started
commercial production in February 2010. In Phase 1, there is research and
development equipment to be purchased, and some unfinished construction will be
done in calendar year 2010. Phase 1 is expected to be complete by December 2010.
Phase 2 commenced in December 2009 and is expected to cost $18 million, which is
scheduled to be paid in fiscal year 2011.
We had
net cash of $70 million generated from financing activities in fiscal year 2010.
We did not have cash generated from financing activities in fiscal year
2009. Details on our financing activities for the two fiscal years are as
follows:
NET
CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES
$
70,111,524
-
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
achieves a net income of $60 million in fiscal year 2010. Since our
net income in fiscal year 2010 is below $60 million, the mandatory conversion
will not be implemented. Net proceeds of the Note are being used to fund
the 150-metric-ton-per-year manufacturing facility.
On
October 5, 2009, the Company closed an underwritten public offering of 4,600,000
shares of its common stock at a price of $15.00 per share. On October 26, 2009,
an additional 690,000 shares were sold pursuant to the exercise of an
over-allotment option at the same price. Net proceeds of the offering, including
the over-allotment, after deducting underwriting discounts, and offering
expenses, were approximately $74.9 million. The Company expects to use the net
proceeds from the offering for general corporate purposes, and may also use a
portion of the net proceeds to acquire or invest in businesses and products that
are complementary to our own. Currently, the company keeps the net proceeds in
the form of cash or cash equivalents.
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-
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 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.
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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 $46
million. Phase 1 of the project involves constructing a facility capable of
producing 150 tons of probiotics per annum and is estimated to cost $28 million,
$23 million of which was paid by fiscal year 2010, and the balance is scheduled
to be paid by the end of calendar year 2010.
All
equipment for production of Phase 1 is in place. The Phase 1 facility started
commercial production in February 2010. In Phase 1, there is research and
development equipment to be purchased, and some unfinished construction will be
done in calander year 2010. Phase 1 is expected to be complete by December 2010.
Phase 2 commenced in December 2009 and is expected to cost $18 million, which is
scheduled to be paid in fiscal year 2011.
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
achieves a net income of $60 million in fiscal year 2010. Since our
net income in fiscal year 2010 is below $60 million, the
mandatory conversion will not be implemented. Net proceeds of the
Note are being used to fund the 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.
Inflation
We
believe that inflation has not had a material impact on our results of
operations for the fiscal years ended March 31, 2010 and 2009.
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-
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 additives 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, 2010.
(1)
See note 15 to our consolidated financial statements in this Annual
Report.
(2)
Estimated contractual purchases with suppliers as of March 31,2010.
(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, 2010, 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.
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 accounts has always been
zero. We had trade receivables totaling $21,008,664 as of March 31, 2010,
and $14,428,382 as of March 31, 2009, 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.
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-
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 that 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, 2010, 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 (now known as ASC 740), the
Group has reserved for the surcharges payable for the fiscal years 2010 and
2009. We consider it is more likely than not that the associated penalty will
not need to be paid.
Recent
Accounting Pronouncements
See
Note 3 of the March 31, 2010 Consolidated Financial Statements.
Other new pronouncements issued, but not yet effective until after March 31,2010, are not expected to have a significant effect on the Company’s
consolidated financial position or results of operations.
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.
- 42
-
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, 2010,
2009, and 2008
76
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and stockholders of
China-Biotics,
Inc.
We have
audited the accompanying consolidated balance sheets of China-Biotics, Inc. as
of March 31, 2010 and 2009, and the related consolidated statements of
operations, stockholders’ equity and cash flows for each of the three years in
the period ended March 31, 2010. In connection with our audits of the financial
statements, we have also audited the financial statement schedules listed in the
accompanying index. These financial statements and schedule 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. 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.
- 43
-
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, 2010 and 2009, and the results of its operations and its cash flows
for each of the three years in the period ended March 31, 2010, 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 consolidated financial statements taken as a whole, present fairly, in
all material respects, the information set forth therein.
We also
have audited, in accordance with the standards of the Public company Accounting
Oversight Board (United States), China-Biotics, Inc.’s internal control over
financial reporting as of March 31, 2010, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated June 14,2010 expressed an unqualified opinion thereon.
Convertible
note, net of discount of $2,853,094 as of March 31, 2010
17
$
22,146,906
-
Embedded
derivatives
17
$
14,797,000
-
Interest
payable
$
3,156,035
-
Total
current liabilities
$
76,755,753
$
32,336,105
Non-current
liabilities
Convertible
note, net of discount of $6,000,054 as of March 31,2009
17
$
-
$
18,999,946
Embedded
derivatives
17
-
2,660,000
Interest
payable
-
1,411,942
Total
non-current liabilities
$
-
$
23,071,888
Commitments and
contingencies
Stockholders'
equity:
Preferred
stock (par value of $0.01, 10,000,000 shares authorized, none
issued)
$
-
$
-
Common
stock (par value of $0.0001, 100,000,000 shares authorized, 41,461,004
shares issued and 17,080,000 outstanding as of March 31, 2009 and
46,751,004 shares issued and 22,370,000 outstanding as of March 31,2010)
4,675
4,146
Additional
paid-in capital
82,769,074
7,863,031
Retained
earnings
65,441,994
49,794,033
Treasury
stock at cost (24,381,004 shares)
11
(2,438
)
(2,438
)
Accumulated
other comprehensive income
4,939,830
4,711,788
Capital
and statutory reserves
12
3,025,794
3,025,794
Total
stockholders' equity
$
156,178,929
$
65,396,354
Total
liabilities and stockholders' equity
$
232,934,682
$
120,804,347
The
accompanying notes are an integral part of these financial
statements.
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 pay 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 a previous 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.
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 shares 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 China-Biotics, Inc. and its
subsidiaries for the years ended March 31, 2010 and 2009 and the three years in
the period ended March 31, 2010 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.
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 Financial Accounting
Standards Board (FASB) Accounting Standards Codification (ASC) Topic 830
“Foreign Currency Matters” (Formerly, Statement of Financial Accounting Standard
(“SFAS”) No. 52, “Foreign Currency Translation”). 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 ASC Topic 220 “Comprehensive Income” (Formerly, SFAS No. 130,
“Reporting Comprehensive Income”). ASC 220 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
We
record revenue when the criteria of Staff Accounting Bulletin No. 104
"Revenue
Recognition" (codified
in FASB Accounting Standards Codification ("ASC") Topic 605, "Revenue
Recognition") are
met. We recognize revenue from the sale of goods when all of the
following criteria are met: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the
sales price is fixed or determinable; and (4) collectibility is reasonably
assured. The customer takes title and assumes the risks and rewards of ownership
of the products upon delivery of the products, which generally occurs at
destination point. Sales are stated at invoiced value net of sales
tax under the caption Net Sales in these financial statements. The sales tax was
0.63%, 0.62%, and 0.64% of the invoiced value for years ended March 31, 2010,
2009, and 2008, respectively.
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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 is used 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 lands and classified as land
use rights. 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 assets. Such
costs include the costs of construction, equipment, interest, legal and direct
labor 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 ASC Topic 360, “Property, plant and equipment”
(Formerly, 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.
- 55
-
(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 ASC Topic 815, “Derivatives and Hedging” (Formerly, 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 ASC Topic 740 “Income
Taxes” (Formerly, 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 ASC 740-10 (Formerly, Financial
Accounting Standard Board (“FASB”) Interpretation No. 48, “Accounting for the
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, 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. ASC
740 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 ASC 740 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.
- 57
-
(s) Earnings Per
Share
Basic
earnings per share is computed in accordance with ASC Topic 260 “Earnings Per
Share” (Formerly, 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.
ASC Topic 280 “Segment Reporting” (Formerly, 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 a 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 February 2010, the FASB
issued Accounting Standards Update (ASU) No. 2010-08—Technical
Corrections to Various Topics. This update’s purpose is to eliminate GAAP
inconsistencies, update outdated provisions, and provide needed
clarifications. The adoption of ASU No. 2010-08 will not have a material impact
on the Company’s financial statements.
In February 2010, the FASB issued ASU
No. 2010-09, “Subsequent Events (Topics 855): Amendments to certain Recognition
and Disclosure Requirements.” An entity that is an SEC filer is not required to
disclose the date through which subsequent events have been evaluated. This
change alleviates potential conflicts between the ASC and the SEC’s
requirements. In addition, the scope of the “reissuance” disclosure requirements
is refined to include revised financial statements only. This update was
effective February 24, 2010. The adoption of ASU No. 2010-09 did not have a
material impact on the Company’s financial statements.
In January 2010, the FASB issued
Codification Accounting Standards Update No. 2010-06 (ASU No. 2010-06),
Improving Disclosure about Fair Value Measurements, under Topic 820, Fair value
Measurements and Disclosures, to improve and provide new disclosures for
recurring and nonrecurring fair value measurements under the three-level
hierarchy of inputs for transfers in and out of Levels 1 and 2, and activity in
Level 3. This update also clarifies existing disclosures of the level
of disaggregation for the classes of assets and liabilities and the disclosure
about inputs and valuation techniques. ASU No. 2010-06 new disclosures and
clarification of existing disclosure is effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements. Those disclosures are
effective for financial statements issued for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal
years. The adoption of ASU No. 2010-06 new disclosures and
clarification of existing disclosure did not have a material impact on our
consolidated financial statements. The Company is currently accessing the
impact, if any, of ASU No. 2010-06 disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements on our consolidated financial statements.
- 59
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In August 2009, the FASB issued
Accounting Standards Update (“ASU”) No. 2009-05, “Measuring Liabilities at Fair
Value,” which is codified as ASC 820, “Fair Value Measurements and Disclosures.”
This update provides amendments to ASC 820-10, Fair Value Measurements and
Disclosures–Overall, for the fair value measurement of liabilities. This update
provides clarification that in circumstances in which a quoted price in an
active market for the identical liability is not available, a reporting entity
is required to measure fair value using a valuation technique that uses the
quoted price of the identical liability when traded as an asset, quoted prices
for similar liabilities or similar liabilities when traded as assets, or that is
consistent with the principles of ASC 820. The amendments in this update also
clarify that when estimating the fair value of a liability, a reporting entity
is not required to include a separate input or adjustment to other inputs
relating to the existence of a restriction that prevents transfer of the
liability. The amendments in this update also clarify that both a quoted price
in an active market for the identical liability at the measurement date and the
quoted price for the identical liability when traded as an asset in an active
market when no adjustments to the quoted price of the assets are required are
Level 1 fair value measurements. The guidance provided in this update is
effective for the first reporting period (including interim periods) beginning
after August 28, 2009. The adoption of this update did not have a significant
impact to the Company’s consolidated financial statements.
In June 2009, the FASB issued SFAS No.
168, “The ‘FASB Accounting Standards Codification’ and the Hierarchy of
Generally Accepted Accounting Principles,” which is codified as ASC 105 (“ASC
105”). ASC 105 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
non-authoritative. ASC 105 is effective for financial statements
issued for interim and annual periods ending after September 15, 2009. The
Company has adopted ASC 105 for the year ended March 31, 2010. The adoption of
this Statement will not impact the results of operations or financial position,
as it only required disclosures. Beginning with this Annual Report on Form 10-K
for March 31, 2010, and in all filings thereafter, references to Financial
Accounting Standards that have been codified in the FASB Accounting Standards
Codification have been replaced with references to the appropriate guidance in
the Codification.
In May 2009, the FASB issued ASC
855-10, Subsequent Events (“ASC 855-10”). ASC 855-10 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.
ASC 855-10 is applicable for interim or annual periods after June 15,2009. The Company adopted this amended topic effective July 1,2009.
Basic
earnings per share is computed in accordance with SFAS No. 128 (now know as ASC
260), “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.
* The
effect of embedded derivatives was not included for the computation of diluted
earnings per share for the year ended March 31, 2010, 2009 and 2008 as inclusion
would be anti-dilutive.
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.
- 61
-
As of March 31, 2010 and 2009, the
Group had cash deposits of $155.58 million and $70.82 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, 2010 and 2009, all of the Group’s sales arose in the PRC.
In addition, all accounts receivable as at March 31, 2010 and 2009, also arose
in the PRC.
(c)
Concentration of Customers
A
substantial percentage of the Group’s sales are made to a small number of
customers that accounted for more than 10% of total gross sales. For the
year ended March 31, 2010, there is one customer that accounted for 13% of our
sales revenue. 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. As of March 31, 2010, there is one customer that
accounted for 15% of our accounts receivable. As of March 31, 2009,
there is no customer that accounted for more than 10% of our accounts
receivable.
As of
March 31, 2010, the amount due from a director, Mr. Song Jinan, represented
advances to him for the business interest of the Company. The amount was
unsecured, interest-free and will be returned to the Company on the expiration
of the business interest or no later than June 30, 2010.
As of
March 31, 2009, the amount due to a director, Mr. Song Jinan, represented
temporary advances to the Company which was unsecured, interest-free and
repayable on demand.
A
subsidiary of the Company operating in Shanghai, the PRC owns factory buildings
on certain state-owned land in the PRC and has been assigned the land use right
for a period of 50 years since January 15, 2008.
Amortization
expense amounted to $37,698, $46,427 and $0 for the years ended March 31, 2010,
2009, and 2008, respectively.
The land
use right was pledged to a bank as a credit guarantee for RMB30 million.
It is primarily a performance bond for a significant event in
Shanghai.
9. PROPERTY, PLANT AND
EQUIPMENT
Property,
plant and equipment, net, consisted of the following:
March 31, 2010
March 31, 2009
Plant
and machinery
16,718,856
7,510,635
Office
equipment
3,726,978
3,565,390
Motor
vehicles
341,773
245,989
Leasehold
improvements
2,932,937
2,422,575
$
23,720,544
$
13,744,589
Less:
Accumulated depreciation
(8,324,180
)
(6,413,927
)
15,396,364
7,330,662
Construction
in progress
33,489,713
23,916,961
$
48,886,077
$
31,247,623
Depreciation
expense amounted to $1,910,316, $1,721,700 and $999,148 for the years
ended March 31, 2010, 2009 and 2008, respectively.
The
construction in process consisted primarily of constructions of a
research and development center and other ancillary facilities in Qingpu, and an
office building, which will be used as our corporate headquarters. We expect the
office building for our corporate headquarters will be ready for use by the end
of September 2010.
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 taken 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, 2010 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. The Group has reserved for the surcharges payable for fiscal
year 2010, 2009 and 2008. 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
$
(13,801,657
)
$
2,371,750
$
2,352,418
(Loss)/income
in the British Virgin Islands before income taxes
(92,017
)
467,060
741,590
Income
in the PRC before income taxes
37,329,983
22,290,467
19,384,867
$
23,436,309
$
25,129,277
$
22,478,875
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-
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 2010, 2009 and 2008.
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% in
the years 2009 and 2008.
Another
newly set up PRC subsidiary of the Group, GBS, is located in Qingpu and has
a similar business and operation as Shining, but with a larger production
scale. GBS is 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, from 2010 to 2012. There is no financial effect from the
tax holiday as GBS did not generate any assessable profit in 2008, 2009 and
until its commencement of business in 2010.
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, 2010, the Company's PRC subsidiaries have incurred tax losses which
can be carried forward to a maximum of 5 years of approximately $1,248,724
(2009: $1,339,001, 2008: $1,202,649).
On March22, 2006, the Company repurchased 24,381,004 common stock of the Company with a
total cost of USD $2,438 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, 2010.
12. 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.
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-
13. ADVERTISING
COSTS
Advertising
costs, which were charged to expense, amounted to $2,792,656, $2,835,064 and
$2,647,140 for the years ended March 31, 2010, 2009 and 2008,
respectively.
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:
Rental
expense, which was charged to expense, amounted to $3,906,098, $3,363,300,
$990,300 for the years ended March 31, 2010, 2009 and 2008,
respectively.
GSL
entered into the agreements with the contractors to construct a plant consisting
of bulk manufacturing facilities in the Shanghai Qingpu Industrial Park
District. The amount of future payment were $2,931,822 which was contracted, but
not provided for as of March 31, 2010; 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 $6,444 which was contracted, but not
provided for as of March 31, 2010.
(c)
Purchase obligations
The Group
entered into the agreements with the suppliers to purchase raw materials and
packing materials. The amount of future payment is $20,629,531 which was
contracted, but not provided for as of March 31, 2010.
(d)
Other obligations
The Group
entered into an agreement with a university to perform research and development.
The amount of future payment is $645,480 which was contracted, but not provided
for as of March 31, 2010.
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. Since our net income in fiscal year 2010 is below $60 million,
the mandatory conversion will not be implemented. 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 being used to fund the construction of the
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 ASC Topic 820, “Fair Value Measurements and
Disclosures” (Formerly, SFAS No.157 “Fair Value Measurements”), which defines
fair value, establishes a framework for measuring fair value in GAAP, and
expands disclosures about fair value measurements. ASC 820 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 ASC 820
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 ASC 820, except as it applies to those non-financial assets and
non-financial liabilities for which the effective date has been delayed by one
year.
ASC 820
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 and 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, 2010, 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 ASC 820 at March 31, 2010:
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, 2009 to March 31, 2010:
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 as of March 31, 2010, 2009, and 2008 was
$14,797,000, $2,660,000, and $5,752,000, respectively. The change in the fair
value of the embedded derivatives amounted to $12,137,000, $3,092,000 and
$3,366,000 for the year ended March 31, 2010, 2009, and 2008 were
charged to the consolidated statement of operations.
For the
year ended March 31, 2010, 2009, and 2008 the Note interest amounted
to $11,727,789, $5,836,737, and $1,051,388 was capitalized under
construction in progress.
18.
SELECTED
QUARTERLY FINANCIAL DATA
(UNAUDITED)
A summary
of our quarterly consolidated financial results are as follows:
On
October 5, 2009, the Company closed an underwritten public offering of 4,600,000
shares of its common stock at a price of $15.00 per share. On October, 26, 2009,
an additional 690,000 shares were sold pursuant to the exercise of an
over-allotment option at the same price. Net proceeds of the offering, including
the over-allotment, after deducting underwriting discounts, and offering
expenses, were approximately $74.9 million. The Company expects to use the net
proceeds from the offering for general corporate purposes and may also use a
portion of the net proceeds to acquire or invest in businesses and products that
are complementary to our own. Currently, the Company keeps the net
proceeds in the form of cash or cash equivalents.
The
offering was made pursuant to an underwriting agreement, dated September 29,2009, by and between the Company and Roth Capital Partners, LLC, as sole manager
and representative of the underwriters named therein. The offering of the Shares
was registered under the Securities Act of 1933, as amended, pursuant to the
Company’s shelf registration statement on Form S-3, as amended by Amendment No.
1 and Amendment No. 2 to Form S-3 (File No. 333-160519).
20.
SUBSEQUENT
EVENTS
The
Company has evaluated events subsequent to the balance sheet date March 31, 2010
through the issue date of this Form 10-K and concluded that no subsequent events
have occurred that require recognition in the Financial Statements or disclosure
in the Notes to the Financial Statements.
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-
CHINA-BIOTICS,
INC.
SCHEDULE
I – CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
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 share capital
$
74,906,572
$
-
$
-
Proceeds
from issuance of convertible note
$
-
$
-
$
25,000,000
Interest
paid for convertible note
$
1,005,182
$
808,219
$
-
Capitalisation
of amortised convertible note discount and interest
$
5,891,053
$
4,785,349
$
1,051,388
The
accompanying notes are an integral part of these condensed financial
statements.
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.
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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, 2010. Based on this assessment, the
principal executive officer and principal financial officer believe that as of
March 31, 2010, the Company’s internal control over financial reporting was
effective based on criteria set forth by COSO in “Internal Control-Integrated
Framework.”
The
effectiveness of the Company’s internal control over financial reporting as of
March 31, 2010 has been audited by BDO Limited, the Company’s independent
registered public accounting firm, as stated in their report, which appears
herein.
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Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and shareholders of
China-Biotics,
Inc.
We have
audited China-Biotics, Inc.’s internal control over financial reporting as of
March 31, 2010, based on criteria established in Internal Control – Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (the
COSO criteria). China-Biotics, Inc.’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying “Item 9A, Management’s Annual Report on Internal
Control Over Financial Reporting”. Our responsibility is to express an opinion
on the Company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. 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 that the degree of compliance
with the policies or procedures may deteriorate.
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In our
opinion, China-Biotics, Inc. maintained, in all material respects,
effective internal control over financial reporting as of March 31, 2010, based
on the COSO criteria.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of
China-Biotics, Inc. as of March 31, 2010 and 2009, and the related consolidated
statements of operations, stockholders’ equity, and cash flows for each of the
three years in the period ended March 31, 2010 and our report dated June 14,2010 expressed an unqualified opinion thereon.
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.
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PART
III
ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
Directors,
Executive Officers, and Key Employees and Advisors
We seek
directors with established strong professional reputations and experience in
areas relevant to the strategy and operations of our businesses. We also seek
directors who possess the qualities of integrity and candor, personal and
professional ethics, commitment to understanding the Company's business,
industry knowledge and contacts, leadership, strong analytical skills, and the
willingness to engage management and each other in a constructive and
collaborative fashion. We also seek directors who have the ability and
commitment to devote significant time and energy to service on the board of
directors and its committees. We believe that all of our directors meet the
foregoing qualifications.
The
criteria described above are used as guidelines to evaluate the experience,
qualifications, skills and diversity of our current and potential board
members. With respect to diversity, certain of our directors have
strong scientific backgrounds that are relevant to our industry; another of our
directors has a background in accounting, finance, and management. We believe
that the backgrounds and skills of our directors bring a diverse range of
experience, opinion and perspectives to the board.
The
following is a summary of the business experience of our executive officers and
directors:
Mr. Song Jinan, age 48,
has been Chief Executive Officer, President, Treasurer and Secretary since March
2006, when he was also appointed to the board of directors. His current term as
director expires with 2010 annual meeting. 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.
Mr.
Song’s day-to-day leadership as our Chief Executive Officer provides him with
detailed knowledge of our business and operations. Among other professional
experiences, qualifications and skills, Mr. Song brings in-depth knowledge and
understanding of the probiotics industry, scientific expertise and management
skills that have been critical to formulating the Company’s short and long-term
strategies and to establishing the Company as a leading probiotics developer and
producer in China. As the Company’s largest shareholder, Mr. Song’s interest is
aligned with other China-Biotics shareholders interest in increasing the
long-term value of the Company.
Dr. Chin Ji Wei, age 53, has
been a director since January 2007 and his current term expires with the 2010
annual meeting. 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. Among
other professional experiences, qualifications and skills, Dr. Chin’s expertise
in the horticulture and agriculture industries, and in particular his focus on
food safety, provide scientific knowledge and expertise in the
regulatory aspects of food safety that are critical to the development and
distribution of the Company’s products.
Dr. Du Wen Min, age 42, has
been a director since January 2007 and his current term expires with the 2010
annual meeting. 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. Among
other professional experiences, qualifications and skills, Dr. Du’s experience
in the pharmaceutical industry and knowledge of food and drug safety issues are
critical to the development and distribution of the Company’s
products.
Mr. Simon Yick, age 52, has
been a director since January 2007 and his current term expires with the 2010
annual meeting. Mr. Yick has over 25 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 an independent non-executive director and chairman of the audit
committee for three Hong Kong listed companies and a fellow member of both the
Chartered Association of the Certified Accountants in UK and the Hong Kong
Institute of Certified Public Accountants. Among
other professional experiences, qualifications and skills, Mr. Yick’s knowledge
and understanding of the capital markets and his in-depth experience in
corporate finance, mergers and acquisitions, accounting and business management
provide knowledge and experience that are vital in formulating the Company’s
short and long-term business and growth strategies. Mr. Yick is also the
Company’s audit committee financial expert.
Mr. Travis Cai, age 38, has
been Chief Financial Officer since January 22, 2010. Mr. Cai previously served
as Vice President of Finance at A-Power Energy Generation Systems Ltd. (Nasdaq:
APWR) from 2009 to January 2010, Director of Finance and Assistant to President
at Vimicro Corp. (Nasdaq: VIMC) from 2007 to 2009, Director of Investment at
Tsing Capital in 2006, and Financial Analyst at Spinnaker Partners and WDC
Financial from 2001 to 2005. Mr. Cai holds a Master of Science degree in
Information Systems from the Stern School of Business at New York University and
a Bachelor of Science degree in Material Science & Engineering from Tsinghua
University in Beijing, China. Mr. Cai is also certified as a Financial Risk
Manager by the Global Association of Risk Professionals.
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:
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Ms. Yan
Yihong, age 47, 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.
Our board
of directors believes that Mr. Song's service as both Chairman of the Board and
Chief Executive Officer of the Company is in the best interest of the Company
and its stockholders. Mr. Song possesses detailed and in-depth knowledge of the
issues, opportunities and challenges facing the Company, its business and the
probiotics industry, and is thus best positioned to develop agendas that ensure
that our board's time and attention are focused on the most critical matters.
His combined role enables decisive leadership, ensures clear accountability, and
enhances the Company's ability to communicate its message and strategy clearly
and consistently to the Company's shareholders, employees, customers and
suppliers.
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.
Our board
of directors takes an active role, as a whole and also at the committee level,
in overseeing the material risks facing the Company, including operational,
financial, legal and regulatory, and strategic and reputational risks. Risks are
considered in virtually every business decision and as part of the Company's
overall business strategy. Our board committees also regularly engage
in risk assessment as a part of their regular function. The Audit
Committee discusses with management the Company's major financial risk exposures
and the steps management has taken to monitor and control such exposures. The
Compensation Committee is responsible for overseeing the management of risks
relating to the Company's executive compensation plans and arrangements. The
Nominating Committee manages risks associated with corporate governance,
including risks associated with the independence of the board and reviews risks
associated with potential conflicts of interest affecting directors and
executive officers of the Company. While each committee is responsible for
evaluating certain risks and overseeing the management of such risks, our entire
board of directors is regularly informed through committee reports about such
risks. The board of directors regularly engages in discussion of
financial, legal, technology, economic and other risks. Because overseeing risk
is an ongoing process that is inherent in the Company's strategic decisions, our
board of directors discusses risk throughout the year at other meetings in
relation to specific proposed actions. Additionally, our board of
directors exercises its risk oversight function in approving the annual budget
and quarterly forecasts and in reviewing the Company's long-range strategic and
financial plans with management.
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). To our knowledge, based solely on a review of the copies
of such reports furnished to us and written representations that no other
reports were required, during the fiscal year ended March 31, 2010, all
applicable Section 16(a) filing requirements were met, and that all such filings
were timely.
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 executive officer and 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.
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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 will use the Company’s
financial performance for fiscal year 2010 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 or adjust
executive compensation are currently under discussion by the Compensation
Committee but have not yet been formally approved.
Although
compensation for our executive officers has historically only included a base
salary, the Company is in the process of implementing an equity compensation
plan and expects to submit it to the Company’s stockholders for approval at the
2010 Annual Meeting of Stockholders. The Company believes that equity awards
will aid the long-term performance and create an ownership culture among our
executive officers, and will foster beneficial long-term performance by the
Company. The Company further believes that an equity compensation program will
provide our employees with incentives to help align their interests with the
interests of stockholders. The Compensation Committee believes that the use of
stock-based awards promotes our overall executive compensation objectives and
expects that stock options will become a significant source of compensation for
our executives.
In
keeping with the objectives described above, the Company agreed with Mr. Travis
Cai, our Chief Financial Officer, that, in addition to his base salary of
$150,000, he will receive options to purchase 150,000 shares of our common stock
after the Company has implemented an equity compensation program. The exercise
price, term and vesting schedule have not yet been determined. Mr. Cai’s
compensation was unanimously approved by the Compensation
Committee.
The
compensation of Mr. Travis Cai, our current Chief Financial Officer, and Mr.
Lewis Fan, our former Chief Financial Officer, were approved by our Compensation
Committee based on their respective salary histories, their respective
professional experience, their 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 Biogineering, Inc. and Shanghai Bright Dairy
& Food. In addition to American Oriental Bioengineering and Shanghai Bright
Dairy & Food, Tiens Biotech Group (USA), Inc. was also considered in setting
Mr. Cai’s salary. 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. Tiens Biotech Group is U.S-based, NYSE Alternext US-listed
company focused on developing and producing nutrition supplement products for
the Chinese and international market. The Compensation Committee will continue
to seek to identify additional companies in the future that are considered
comparable for the purposes of setting executive compensation. Any future
adjustments to Mr. Cai’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 Biogineering, Inc. and
Shanghai Bright Dairy & Food) and on company and individual
performance. Mr.
Song’s current salary, $78,162, was decreased from $129,586 at the request of
Mr. Song to lower general and administrative costs. The Compensation Committee
agreed with the Company’s decision to lower Mr. Song’s salary. His
salary will be subject to further review and adjustment by the Compensation
Committee based on the financial results for fiscal year 2010.
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.
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Board
Compensation
We have
not paid any compensation to directors of China-Biotics for the fiscal years
prior to 2008. The table below lists the compensation received by the
independent directors of China-Biotics for the fiscal year ended March 31, 2010,
2009 and 2008.
(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, 2010. 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, 2010.
Executive
Officer Compensation
The following table sets forth
information concerning compensation awarded to, earned by, or paid to
Mr. Song Jinan, the Chief Executive Officer of China-Biotics, Travis Cai,
the Chief Financial Officer of China-Biotics, and Mr. Raymond Li and Mr. Lewis
Fan, former Chief Financial Officers of China-Biotics. Mr. Song and Mr. Cai 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.
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Annual
Compensation
Name
Year
Salary(2)
Bonus
Option
Awards
Total
Song
Jinan
2010
$
78,162
-
-
$
78,162
CEO,
Treasurer,
2009
$
129,586
-
-
$
129,586
Secretary,
and
2008
$
139,020
-
-
$
139,020
Principal
Executive
Officer
of
SGI(1)
Tao
2010
$
28,571
-
150,000
(3)
$
28,571
(Travis)
Cai,
Chief
2009
-
-
-
-
Financial
Officer(1)
2008
-
-
-
-
Lewis
Fan,
2010
$
80,000
-
-
$
80,000
Former
Chief
2009
$
10,000
-
-
$
10,000
Financial
Officer
2008
-
-
-
-
Raymond
2010
-
-
-
-
Li,
Former
Chief
2009
$
79,419
-
-
$
79,419
Financial
Officer
2008
$
76,923
-
-
$
76,923
(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. Mr. Travis Cai became the
Chief Financial Officer on January 22, 2010.
(2)
Mr. Song was 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, 2010.
Includes social insurance contributions of US$7,463
(RMB52,164), US$6,553 (RMB45,809) and US$24,549 (RMB171,600) for Mr. Song
for the years ended March 31, 2010, 2009 and 2008, respectively.
(3) Mr. Cai will receive options
to purchase 150,000 shares of the Company’s common stock after the Company has
implemented an equity incentive plan.
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Equity
Compensation Plans and Awards
We have
not granted any stock options or other equity awards since our inception. The
Company expects to implement an equity incentive plan at or before its next
regularly scheduled meeting of its board of directors and to seek stockholder
approval of the equity incentive plan at the 2010 Annual Meeting of
Stockholders.
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 June 7, 2010, 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
22,370,000 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 June 7,2010.
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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
37.1
%
Chin
Ji Wei
-
-
Du
Wen Min
-
-
Simon
Yick (2)
221,000
.9
%
Raymond
Li
-
-
Lewis
Fan
-
-
Travis
Cai
-
-
Pope
Asset (3)
2,683,333
11.0
%
Tai
Kwok Leung, Alexander (4)
1,469,700
6.0
%
Yan
Yihong
503,370
2.1
%
Executive
officers and directors (3 persons)
9,788,400
40.0
%
(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 June 7, 2010. The
address for Pope Asset Management, LLC (“Pope Asset”) is 5100 Poplar Ave, Suite
512, Memphis, TN. Pope Asset is the investment advisor for Pope Investments, LLC
(“Pope Investments”) and Pope Investment II, LLC (“Pope Investments II”).
As of June 7, 2010, Pope Investments owned 500,000 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 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.
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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.
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, 2010 and 2009. 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 and
SEC filings for the fiscal years ended March 31, 2010 and 2009 were $356,000 and
$292,260, respectively.
Audit-Related
Fees
BDO
Limited did not render any audit-related services to us for the fiscal years
ended March 31, 2010 and 2009.
Tax
Fees
BDO
Limited did not render any tax services to us for the fiscal years ended March31, 2010 and 2009.
All
Other Fees
BDO
Limited did not render any other services to us for the fiscal years ended March31, 2010 and 2009.
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 June 14, 2010.
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 June 14, 2010.