UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB/A
Amendment No.1
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006 OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO
__________
COMMISSION FILE NUMBER: 000-23889
---------------
CHINA MEDICINE CORPORATION
-------------------------------------------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
DELAWARE 51-0539830
-------------------------------- -----------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION
24A Jefferson Plaza
Princeton, NJ 08540
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
ISSUER 'S TELEPHONE NUMBER, INCLUDING AREA CODE: (732) 4388866
-------------------------------------------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 |X| No |_|.
-----------
The number of shares of Common Stock of the Registrant, par value $.0001
per share, outstanding at April 30, 2006 was 7,380,000.
Transitional Small business Disclosure Format (Check one):
Yes |_|; No |X|.
CHINA MEDICINE CORPORATION
INDEX TO MARCH 31, 2006 FORM 10-QSB/A
Page
---------
Part I - Financial Information 3
Item 1 - Financial Statements (unaudited) F-1
Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005 F-1
Consolidated Statements of Income and Other Comprehensive Income for the Three
Months ended March 31, 2006 and March 31, 2005 F-2
Consolidated Statements of Shareholders' Equity for the Three Months ended March
31, 2006 and March 31, 2005 F-3
Consolidated Statements of Cash Flows for the three months ended March 31, 2006
and March 31, 2005 Consolidated Notes to the Consolidated Financial Statements F-4
Condensed Notes to the Consolidated Financial Statements F-5
Item 2 - Management's Discussion and Analysis of Results of Operations and Financial Condition 4
Item 3 - Controls and Procedures 9
Part II - Other Information 9
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 9
Item 6 - Exhibits 9
Signature Page 11
2
This quarterly report on Form 10-QSB/A ("Form 10-QSB/A") is being filed to
amend our quarterly report on Form 10-QSB for the quarter ended March 31, 2006
(the "Original Form 10-QSB") which was filed with the Securities and Exchange
Commission ("SEC") on May 22, 2006 to reflect changes in the financial
statements consistent with changes in the financial statements for the six
months ended June 30, 2006 that were made in Amendment No. 3 to our Registration
Statement on Form SB-2. Pursuant to Rule 12b-15 under the Securities Exchange
Act of 1934, as amended, the Form 10-QSB/A contains current dated certifications
from the principal executive officer and the principal financial officer. We
have not updated the information contained herein for events occurring
subsequent to May 22, 2006, the filing date of the Original Form 10-QSB.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
3
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2006 AND DECEMBER 31, 2005
ASSETS
March 31, December 31,
2006 2005
------------ ------------
(Unaudited)
------------ ------------
CURRENT ASSETS:
Cash $ 1,758,279 $ 91,964
Accounts receivable, trade, net of allowance for doubtful accounts
of $12,412 and $12,333 as of March 31, 2006 and
December 31, 2005, respectively 3,323,205 2,410,824
Inventories 2,253,491 1,382,929
Other receivables 114,006 38,301
Other receivables - related parties 60,695 --
Advances to suppliers 2,084,331 1,075,546
------------ ------------
Total current assets 9,594,007 4,999,564
------------ ------------
EQUIPMENT, net 778,234 330,015
------------ ------------
Total assets $ 10,372,241 $ 5,329,579
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable, trade $ 1,041,302 $ 170,196
Short-term loans -- 95,480
Other payables and accrued liabilities 3,220 97,449
Customer deposits 43,520 37,292
Taxes payable 367,402 170,456
------------ ------------
Total current liabilities 1,455,444 570,873
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $0.0001 par value; 10,000,000 shares
authorized, 3,120,000 shares issued and outstanding 312 --
Common stock, $0.0001 par value; $90,000,000 shares
authorized, 7,380,000 shares issued and outstanding 738 653
Paid-in capital 4,332,842 120,347
Statutory reserves 722,909 722,909
Retained earnings 3,714,024 3,813,665
Accumulated other comprehensive income 145,972 101,132
------------ ------------
Total shareholders' equity 8,916,797 4,758,706
------------ ------------
Total liabilities and shareholders' equity $ 10,372,241 $ 5,329,579
============ ============
The accompanying notes are an integral part of this statement.
F-1
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
2006 2005
------------- -------------
Unaudited Unaudited
------------- -------------
REVENUES $ 3,511,979 $ 2,728,586
COST OF GOOD SOLD 2,459,550 1,828,997
------------- -------------
GROSS PROFIT 1,052,429 899,589
------------- -------------
OTHER OPERATING INCOME 296,103 424,628
------------- -------------
OPERATING EXPENSES
Research and development expenses 54,664 159
Selling expenses 100,102 39,429
General and administrative expenses 187,064 58,288
------------- -------------
Total operating expenses 341,830 97,876
------------- -------------
INCOME FROM OPERATIONS 1,006,702 1,226,341
ACQUISITION TRANSACTION EXPENSE 931,270 --
OTHER (EXPENSE) INCOME (9,492) 178
------------- -------------
INCOME BEFORE INCOME TAXES 65,940 1,226,519
PROVISION FOR INCOME TAXES 165,581 --
------------- -------------
NET (LOSS) INCOME (99,641) 1,226,519
OTHER COMPREHENSIVE INCOME :
Foreign currency translation adjustment 44,840 --
------------- -------------
COMPREHENSIVE INCOME $ (54,801) $ 1,226,519
============= =============
Earning per share - basic $ (0.01) $ 0.19
============= =============
Earning per share - diluted $ (0.01) $ 0.19
============= =============
Weighted average number of shares outstanding - basic 6,992,778 6,530,000
============= =============
Weighted average number of share outstanding - diluted 7,193,678 6,530,000
============= =============
The accompanying notes are an integral part of this statement.
F-2
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
Common Stock Preferred Stock
--------------------------- -------------------------- Paid-in
Shares Par Value Shares Par Value capital
------------- ---------- ------------ ----------- -------------
BALANCE, December 31, 2004 6,530,000 $ 653 - $ - $ 120,347
Net income
------------- ---------- ------------ ----------- -------------
BALANCE, March 31, 2005 (Unaudited) 6,530,000 653 - - 120,347
Net income
Distributions
Foreign currency translation adjustments
------------- ---------- ------------ ----------- -------------
BALANCE, December 31, 2005 6,530,000 653 - - 120,347
Net income
Reverse acquisition, February 8, 2006 1,028,000 103 (32,501)
Shares redeemed in connection with
reverse acquisition (928,000) (93) (167,509)
Shares issued for acquisition services 750,000 75 607,425
Issuance of preferred stock 3,120,000 312 2,401,303
Issuance of common stock A warrants 815,268
Issuance of common stock B warrants 566,117
Stock option granted 22,392
Foreign currency translation adjustments
------------- ---------- ------------ ----------- -------------
BALANCE, March 31, 2006 (Unaudited) 7,380,000 $ 738 3,120,000 $ 312 $ 4,332,842
============= ========== ============ =========== =============
Accumulated
other
Statutory Retained comprehensive
reserves earnings income Totals
-------------- ---------------- -------------- ----------------
BALANCE, December 31, 2004 $ 722,909 $ 1,234,972 $ - $ 2,078,881
Net income 1,226,519 1,226,519
-------------- ---------------- -------------- ----------------
BALANCE, March 31, 2005 (Unaudited) 722,909 2,461,491 - 3,305,400
Net income 4,463,651 4,463,651
Distributions (3,111,477) (3,111,477)
Foreign currency translation adjustments 101,132 101,132
-------------- ---------------- -------------- ----------------
BALANCE, December 31, 2005 722,909 3,813,665 101,132 4,758,706
Net income (99,641) (99,641)
Reverse acquisition, February 8, 2006 (32,398)
Shares redeemed in connection with
reverse acquisition (167,602)
Shares issued for acquisition services 607,500
Issuance of preferred stock 2,401,615
Issuance of common stock A warrants 815,268
Issuance of common stock B warrants 566,117
Stock option granted 22,392
Foreign currency translation adjustments 44,840 44,840
-------------- ---------------- -------------- ----------------
BALANCE, March 31, 2006 (Unaudited) $ 722,909 3,714,024 $ 145,972 $ 8,916,797
============== ================ ============== ================
The accompanying notes are an integral part of this statement.
F-3
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
2006 2005
------------ ------------
Unaudited Unaudited
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (99,641) $ 1,226,519
Adjustments to reconcile net income to cash
used in operating activities:
Depreciation 21,478 25,794
Gain on sale of intangible assets 15,570 --
Stock issued for services 607,500 --
Stock option granted 22,392 --
Change in operating assets and liabilities:
(Increase) decrease in assets:
Accounts receivable, trade (893,091) 171,033
Inventories (858,049) (492,890)
Other receivables (75,143) (36,003)
Other receivables - related parties (60,442) (40,387)
Advances to suppliers (997,672) (679,741)
Increase (decrease) in liabilities:
Accounts payable, trade 833,982 314,548
Other payables and accrued liabilities (94,462) 6,600
Customer deposits 5,962 (585,644)
Taxes payable 195,031 (17,760)
------------ ------------
Net cash used in operating activities (1,376,585) (107,931)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (483,292) (18,968)
------------ ------------
Net cash provided by (used in) investing activities (483,292) (18,968)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term loan (95,696) --
Proceeds from issuance of preferred stock 3,783,000 --
Cash paid on shares redeemed (167,602) --
------------ ------------
Net cash used in financing activities 3,519,702 --
------------ ------------
EFFECT OF EXCHANGE RATE ON CASH 6,490 --
------------ ------------
INCREASE (DECREASE) IN CASH 1,666,315 (126,899)
CASH, beginning of period 91,964 243,520
------------ ------------
CASH, end of period $ 1,758,279 $ 116,621
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ -- $ --
============ ============
Cash paid for interest expense $ 1,582 $ --
============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTION:
Stock issued for services $ 607,500 $ --
============ ============
Stock option granted $ 22,392 $ --
============ ============
The accompanying notes are an integral part of this statement.
F-4
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization
Organization
China Medicine Corporation (the "Company") is a Delaware corporation,
incorporated on February 10, 2005 under the name Lounsberry Holdings III, Inc,
for the purpose of acquiring, or merging with, an operating business. On May 10,
2006, the Company changed its corporate name to China Medicine Corporation.
Effective February 8, 2006, the Company entered into a Stock Exchange Agreement
("Exchange Agreement") with Guangzhou Konzern Medicine Co., Ltd. ("Konzern").
Pursuant to the Exchange Agreement, the Company, at closing, acquired all of the
capital of Konzern from Konzern Stockholders in exchange for 6,530,000 shares of
the Company's common stock. For accounting purposes, the acquisition of Konzern
has been treated as a recapitalization of Konzern with Konzern as the acquirer.
The historical financial statements prior to February 8, 2006 are those of
Konzern. Contemporaneously with the reverse acquisition, the Company redeemed
928,000 shares of common stock from its then principal stockholder who is not
affiliated with the Konzern Stockholders or any member of the investor group for
$167,602 and paid off loans from related party for $32,398. The 928,000 shares
purchased constituted approximately 90.3% of the 1,028,000 shares of common
stock outstanding prior to the issuance of the shares of common stock pursuant
to the Exchange Agreement and the 750,000 shares issued as disclosed in Note 15.
Konzern was privatized from a state-owned medicine company on July 25, 2000 in
Guangzhou, People's Republic of China (PRC). The registered capital was
$121,000. The Company has increased Konzern's registered capital by $2,300,000
with the proceeds received from the sale of preferred stock (see Note 15). The
business license provides for a 24 years term and will end on September 2, 2024.
Konzern is a distributor of medical products, including traditional
pharmaceutical medicines, traditional Chinese medicines (finished medicines made
of Chinese herbs), Chinese herbs and dietary supplements. These products include
both prescription drugs and over-the-counter drugs. The Company purchases its
products from Chinese drug manufacturers and other medicine companies.
Note 2 - Summary of significant accounting policies
Basis of presentation
The consolidated financial statements of the Company reflected the activities of
100% ownership of Konzern that locates in PRC. The consolidated financial
statements have been presented as if the equity Exchange Agreement of the
subsidiary occurred during the year of 2004 due to common management and
ownership.
F-5
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Basis of presentation, (continued)
The accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
accompanying consolidated financial statements include the accounts of Konzern
and the Company. All material transactions and balances have been eliminated in
the consolidation.
Use of estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reported period. Actual results could differ
from those estimates.
Cash and cash equivalents
For purposes of the cash flow statements, the Company considers all highly
liquid investments with original maturities of three months or less at the time
of purchase to be cash equivalents. Cash includes cash on hand and demand
deposits in accounts maintained with state owned banks within PRC and the United
States.
The Company's operations may be adversely affected by significant political,
economic and social uncertainties in China. Although the Chinese government has
pursued economic reform policies in the past, there is no assurance that the
Chinese government will continue to pursue such policies or that such policies
may not be significantly altered, especially in the event of a change in
leadership, social or political disruption or unforeseen circumstances affect
China's political, economic and social conditions. There is also no guarantee
that the Chinese government's pursuit of economic reforms will be consistent or
effective.
Concentration of credit risk
Financial instruments, which subject the Company to concentration of credit
risk, consist of cash. The Company maintains balances at financial institutions
which, from time to time, may exceed Federal Deposit Insurance Corporation
insured limits for the bank that is located in the Unites States, no deposits
with the state owned banks within PRC are covered by insurance. As of March 31,
2006 and December 31, 2005, the Company had deposits in excess of federally
insured limits total of $1,900,350 and $78,319, respectively. The Company has
not experienced any losses in such accounts and believes it is not exposed to
any significant risks on its cash in bank accounts.
F-6
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Accounts receivable, trade
The Company conducts its business operations in PRC. During the normal course of
business, the Company extends unsecured credit to its customers. Management
reviews its accounts receivable on a regular basis to determine if the bad debt
allowance is adequate. However, the Company records a provision for accounts
receivable trade that ranges from 0.3% to 1.0% of the outstanding accounts
receivable balance in accordance with generally accepted accounting principles
in the PRC. The allowance for doubtful accounts as of March 31, 2006 and
December 31, 2005 amounted to $12,412 and $12,333, respectively.
Inventories
Inventories are stated at the lower of cost or market value, cost is determined
using the weighted average method.
Plant and equipment
Plant and equipment are stated at the actual cost of acquisition less
accumulated depreciation and amortization. Depreciation and amortization are
provided for in amounts sufficient to relate the cost of depreciation of assets
to operations over their estimated service lives, principally on a straight-line
basis. The estimated lives used in determining depreciation are:
Furniture 3 - 5 years
Office equipment 3 - 5 years
Motor vehicles 4 - 10 years
The residual value is estimated to be 5% of the actual cost.
The cost and related accumulated depreciation of assets sold or otherwise
retired are eliminated from the accounts and any gain or loss is include in the
statement of operations. Maintenance, repairs and minor renewals are charged
directly to expenses as incurred.
Intangibles
Under the Statement of Accounting Standards ("SFAS") No.142, "Goodwill and Other
Intangible Assets", all goodwill and certain intangible assets determined to
have indefinite lives will not be amortized but will be tested for impairment at
least annually. Intangible assets other than goodwill will be amortized over
their useful lives and reviewed for impairment in accordance with SFAS No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets".
F-7
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Impairment of long-lived assets
Per SFAS No. 144, long-lived assets will be analyzed for indications of
impairment. Impairment of long-lived assets is assessed by the Company whenever
there is an indication that the carrying amount of the asset may not be
recovered. Recoverability of these assets is determined by comparing the
forecasted undiscounted cash flows generated by those assets to the assets' net
carrying value. The amount of impairment loss, if any, is measured as the
difference between the net book value of the assets and the estimated fair value
of the related assets.
The Company evaluates the recoverability of long-lived assets by measuring the
carrying amount of the assets against the estimated undiscounted future cash
flows associated with them. At the time such flows of certain long-lived assets
are not sufficient to recover the carrying value of such assets, the assets are
adjusted to their fair values.
Revenue recognition
The Company recognizes revenue when all four of the following criteria are met:
(1) persuasive evidence has been received that an arrangement exists; (2)
delivery of the products and/or services has occurred; (3) the selling price is
fixed or determinable; and (4) collectibility is reasonably assured. The Company
follows the provisions of SAB No. 104 which sets forth guidelines in the timing
of revenue recognition based upon factors such as passage of title,
installation, payments and customer acceptance. Any amounts received prior to
satisfying the Company's revenue recognition criteria is recorded as deferred
revenue.
Sales revenue represents the invoiced value of goods, net of a value-added tax
(VAT). All of the Company's products that are sold in the PRC are subject to a
Chinese value-added tax at a rate of 13% to 17% of the gross sales price. This
VAT may be offset by VAT paid by the Company on raw materials and other
materials included in the cost of producing their finished product.
Research and development costs
Research and development costs are expensed as incurred. The costs of material
and equipment that are acquired or constructed for research and development
activities, and have alternative future uses, either in research and
development, marketing, or sales, are classified as property and equipment or
depreciated over their estimated useful lives.
F-8
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Foreign currency translation
The functional currency of Konzern is the Chinese Renminbi. The financial
statements of Konzern are translated to United Stated dollars using year-end
exchange rates as to assets and liabilities and average exchange rates as to
revenues and expenses. Capital accounts are translated at their historical
exchange rates when the capital transaction occurred. Net gains and losses
resulting from foreign exchange translations are included in the statements of
operations and stockholders' equity as other comprehensive income.
This quotation of the exchange rates does not imply free convertibility of RMB
to other foreign currencies. All foreign exchange transactions continue to take
place either through the People's Bank of China or other banks authorized to buy
and sell foreign currencies at the exchange rate quoted by PRC.
Approval of foreign currency payments by the Bank of China or other institutions
requires submitting a payment application form together with invoices, shipping
documents and signed contracts.
Translation adjustments resulting from this process are included in accumulated
other comprehensive income in the consolidated statement of shareholders' equity
and amounted to $44,840 and $0 for the three months ended March 31, 2006 and
2005, respectively. The balance sheet amounts with the exception of equity at
March 31, 2006 were translated at 8.01 RMB to $1.00 USD as compared to 8.26 RMB
at March 31, 2005. The equity accounts were stated at their historical rate. The
average translation rate of 8.04 RMB for the three months ended March 31, 2006
was applied to income statement accounts.
Income taxes
The Company has adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). SFAS 109 requires the recognition of
deferred income tax liabilities and assets for the expected future tax
consequences of temporary differences between income tax basis and financial
reporting basis of assets and liabilities. Provision for income taxes consist of
taxes currently due plus deferred taxes. There are no deferred tax amounts at
March 31, 2006 and December 31, 2005.
The Charge for taxation is based on the results for the year as adjusted for
items, which are non-assessable or disallowed. It is calculated using tax rates
that have been enacted or substantially enacted by the balance sheet date.
F-9
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Income taxes, (continued)
Deferred tax is accounted for using the balance sheet liability method is
respect of temporary differences arising from differences between the carrying
amount of assets and liabilities in the financial statements and the
corresponding tax basis used in the computation of assessable tax profit. In
principle, deferred tax liabilities are recognized for all taxable temporary
differences, and deferred tax assets are recognized to the extent that it is
probably that taxable profit will be available against which deductible
temporary differences can be utilized.
Deferred tax is calculated at the tax rates that are expected to apply to the
period when the asset is realized or the liability is settled. Deferred tax is
charged or credited in the income statement, except when it related to items
credited or charged directly to equity, in which case the deferred tax is also
dealt with in equity.
Deferred tax assets and liabilities are offset when they relate to income taxes
levied by the same taxation authority and the Company intends to settle its
current tax assets and liabilities on a net basis.
The Company is organized in the United States and no tax benefit is expected
from tax credits in the future. The Company has located its subsidiary, Konzern
in a special economic region in China. This economic region allows foreign
enterprises a two-year income tax exemption and a 50% income tax reduction for
the following three years. Konzern was approved as a foreign Joint-venture
enterprise in 2004 and as a wholly-owned foreign enterprise in 2006. Konzern has
an income tax exemption for 2004 and 2005 and a 50% reduction the income tax
rate for 2006, 2007 and 2008.
The estimated tax savings for the period ending March 31, 2006 and 2005 amounted
to $165,581 and $404,751, respectively. The net effect on earnings per share if
the income tax had been applied would decrease earnings (losses) per share from
$0.01 to ($0.04) for 2006 and $0.19 to $0.13 for 2005, respectively.
The provision for income taxes at March 31 consisted of the following:
2006 2005
--------------- ---------------
Unaudited Unaudited
--------------- ---------------
Provision for China Income Tax $ 165,581 $ --
Provision for Local Tax -- --
--------------- ---------------
Totals $ 165,581 $ --
=============== ===============
F-10
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Income taxes, (continued)
The following table reconciles the U.S. statutory rates to the Company's
effective tax rate for the three months ended March 31:
2006 2005
--------------- ---------------
U.S. Statutory rates 34.0 % 34.0 %
Foreign income not reognized in USA (34.0) (34.0)
China income taxes 33.0 --
50% tax reduction (16.5) --
--------------- ---------------
Effective income tax rate 16.5 % - %
=============== ===============
Value added tax
Enterprises or individuals who sell commodities are subject to a value added tax
in accordance with Chinese laws. The value added tax standard rate is 17% of the
gross sales price. A credit is available whereby VAT paid on the purchase of
semi-finished products or raw materials used in production of the Company's
finished products can be used to offset the VAT due on sales of the finished
product.
Fair value of financial instruments
The carrying amounts of the Company's financial instruments (including accounts
receivable, shareholder loans and notes payable) approximate fair value due to
the relatively short period to maturity of these instruments.
Stock-based compensation
Effective January 1, 2006, the Company adopted the Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payments,"
("FAS123R"), which established standards for the accounting for transactions in
which an entity exchange its equity instruments for goods or services. This
statement require a public entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award.
F-11
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Stock-based compensation, (continued)
On February 8, 2006, contemporaneously with the reverse acquisition, the Company
granted options to purchase 430,000 of common stock of which options to purchase
390,000 shares were granted to officers and other key employees of Konzern. On
March 22, 2006, the Company granted options to purchase an additional 850,000
shares of common stock to two officers. The options all have an exercise price
of $1.25, which was the conversion price of the series A preferred stock and not
less than the fair market value on the date of grant, and were granted pursuant
to the Company's 2006 Long-Term Incentive Plan. The 2006 Long-Term Incentive
Plan, which covers 1,575,000 shares of common stock, and all options granted
under the plan are subject to stockholder approval of the plan. The Company
estimated that the value of the options is between $0.17 to 0.23 per shares
subject to the options The plan has been approved by the stockholders of the
Company in July 2006.
SFAS No. 123 requires that compensation expense related to options granted be
calculated based on the fair value of the options as of the date of grant. The
fair value calculations take into account the exercise prices and expected lives
of the options, the current price of the underlying stock, its expected
volatility, the expected dividends on the stock, and the current risk-free
interest rate for the expected life of the option. Because there is no trading
market for the Company's common stock, no historical data on which to base an
estimate of volatility. The Company have considered the volatility that might be
expected to occur for companies comparable to the Company and, selected three
publicly-traded companies whose business is similar to the Company's and who are
classified in the same SIC code as the Company, have assumed a volatility of 50%
as being reasonably representative of the volatility that could be expected to
occur in the future over the relevant periods. The risk-free rates used are
based on Treasury Constant Maturity rates, published by the U.S. Federal
Reserve. The weighted average risk-free rate was 4.65%. Since the Company does
not have a history of employee stock options, the estimated life is based on one
half of the sum of the vesting period and the contractual life of the option.
The Company used the Cox-Ross-Rubinstein binomial model to value the Warrants
and the embedded conversion option of the the Series A Preferred Stock. The
following assumptions were used in the preparation of the above valuations at
inception:
Assumption Preferred Stock Warrants A Warrants B Stock options
---------- --------------- ---------- ---------- -------------
Common stock - fair value $ 0.81 $ 0.81 $ 0.81 $ 0.81
Expected life Perpetual 5 years 5 years 2.5 years
Volatility 50% 50% 50%
Risk-free rate 4.55% 4.55% 4.65%
F-12
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of significant accounting policies, (continued)
Major suppliers
For the three months ended March 31, 2006 and the year ended December 31, 2005,
five suppliers accounted for approximately 54% and 74%, respectively, of the
Company's purchases.
Major customers
For the three months ended March 31, 2006 and the year ended December 31, 2005,
five customers accounted for approximately 67% and 65%, respectively, of the
Company's sales.
Recently issued accounting pronouncements
In July 2005, the Financial Accounting Standards Board (FASB) issued an Exposure
Draft of a proposed Interpretation "Accounting for Uncertain Tax Positions--an
interpretation of FASB Statement No. 109." Under the proposed Interpretation, a
company would recognize in its financial statements its best estimate of the
benefit of a tax position, only if the tax position is considered probable of
being sustained on audit based solely on the technical merits of the tax
position. In evaluating whether the probable recognition threshold has been met,
the proposed Interpretation would require the presumption that the tax position
will be evaluated during an audit by taxing authorities. The proposed
Interpretation would be effective as of the end of the first fiscal year ending
after December 15, 2005, with a cumulative effect of a change in accounting
principle to be recorded upon the initial adoption. The proposed Interpretation
would apply to all tax positions and only benefits from tax positions that meet
the probable recognition threshold at or after the effective date would be
recognized.
The Company is currently analyzing the proposed Interpretation and has not
determined its potential impact on our Consolidated Financial Statements. While
we cannot predict with certainty the rules in the final Interpretation, there is
risk that the final Interpretation could result in a cumulative effect charge to
earnings upon adoption, increases in future effective tax rates, and/or
increases in future interperiod effective tax rate volatility.
Note 3 - Consolidated financial statements and condensed footnotes
The interim consolidated financial statements presented herein have been
prepared by the Company and include the unaudited accounts of the Company and
its subsidiaries. All significant inter-company accounts and transactions have
been eliminated in the consolidation.
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States for interim
financial information and the instructions for Form 10-QSB and Item 310 of
Regulation S-B.
F-13
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Consolidated financial statements and condensed footnotes
Certain information and footnote disclosures that are normally included in
financial statements presented in accordance with generally accepted accounting
principles have been condensed or omitted. Management of the Company believes
the disclosures made are adequate to make the information presented not
misleading.
In the opinion of management, the unaudited consolidated financial statements
reflect all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position of the Company as of March
31, 2006 and December 31, 2005, and the results of operations, changes in
shareholders' equity and cash flows for the three months ended March 31,2006 and
2005. Interim results are not necessarily indicative of a full year's
performance because of the impact of seasonal and short-term variations.
Note 4 - Earnings per share
The Company reports earnings per share in accordance with the provisions of SFAS
No. 128, "Earnings Per Share." SFAS No. 128 requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share. Basic earnings per share excludes
dilution and is computed by dividing income available to common stockholders by
the weighted average common shares outstanding during the period. Diluted
earnings per share takes into account the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and converted
into common stock.
The following is a reconciliation of the basic and diluted earnings per share
computations for the three months ended March 31, 2006 and 2005:
2006 2005
----------- -----------
Unaudited Unaudited
----------- -----------
Net income for basic earnings per share $ (99,641) $ 1,226,519
=========== ===========
Shares of common stock and common
stock equivalents:
Weighted average shares used in basic computation 6,992,778 6,530,000
===========
Diluted effect of convertible preferred stock 200,900
-----------
Weighted average shares used in diluted computation 7,193,678
===========
Earnings per share:
Basic $ (0.01) $ 0.19
=========== ===========
Diluted $ (0.01)
===========
F-14
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 5 - Accounts receivable, trade
Accounts receivable, trade as of March 31, 2006 and December 31, 2005 consisted
of the following:
March 31, December 31,
2006 2005
----------- -----------
Unaudited Audited
----------- -----------
Accounts receivable $ 3,335,617 $ 2,423,157
Less: allowance for
doubtful accounts 12,412 12,333
----------- -----------
Totals $ 3,323,205 $ 2,410,824
=========== ===========
Note 6 - Inventories
Inventories consisted of the following:
March 31, December 31,
2006 2005
----------- -----------
Unaudited Audited
----------- -----------
Chemical medicine $ 2,253,257 $ 1,382,929
Traditional Chinese Medicine 234 --
----------- -----------
Totals $ 2,253,491 $ 1,382,929
=========== ===========
Note 7 - Advances to suppliers
Advances to suppliers as of March 31, 2006 and December 31, 2005 amounted to
$2,084,332 and $1,075,546, respectively. They represent advances to suppliers on
inventory purchases.
F-15
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - Equipment
Equipment is summarized as follows:
March 31, December 31,
2006 2005
-------------- --------------
Unaudited Audited
-------------- --------------
Furniture and fixtures $ 59,982 $ 160,081
Office equipment 668,483 369,459
Motor vehicles 196,685 132,804
-------------- --------------
Total 925,150 662,344
Less accumulated depreciation 146,916 332,329
-------------- --------------
Equipment, net $ 778,234 $ 330,015
============== ==============
Depreciation expense for the three months ended March 3, 2006 and 2005 amounted
to $21,478 and $25,794 respectively.
Note 9 - Customer deposits
The Company requires their customers to deposit monies with the Company when
they place an order for their products. The Company does not pay interest on
these amounts. Customer deposits amounted to $43,520 and $37,292 as of March 31,
2006 and December 31, 2005, respectively.
Note 10 - Taxes payable
Taxes payable consisted of the following:
March 31, December 31,
2006 2005
----------- -----------
Unaudited Audited
----------- -----------
Income taxes payable $ 166,273 $ --
Individual income tax 380 205
Value added tax 200,749 170,251
----------- -----------
Totals $ 367,402 $ 170,456
=========== ===========
Note 11 - Short-term bank loan payable
In January 2006, the Company repaid $95,696 in short term loans to CITIC
Industrial Bank including interest of $1,582.
March 31, December 31,
2006 2005
------------ ------------
Unaudited Audited
------------ ------------
Citic Industrial Bank due February 1, 2006,
annual interest rate at 5.22% $ -- $ 95,480
============ ============
F-16
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Commitments and contingencies
Operating lease
The Company leases its facilities under short-term and long-term, non-cancelable
operating lease agreements expiring through August 2006. The non-cancelable
operating lease agreement states that the Company pays certain operating
expenses applicable to the leased premises.
Total rental expense for the three months ended March 31, 2006 and the year
ended December 31, 2005 amounted to $11,583 and $31,282, respectively.
As of March 31, 2006, the future minimum annual lease payments required are as
follows:
Year Ending December 31,
------------------------
2006 $36,985
2007 and thereafter --
Note 13 - Statutory reserves
The Company's subsidiary, Konzern, is required to make appropriations to reserve
funds, comprising the statutory surplus reserve, statutory welfare fund and
discretionary surplus reserve, based on after-tax net income determined in
accordance with generally accepted accounting principles of People's Republic of
China ("PRC GAAP"). Appropriation to the statutory surplus reserve is required
to be at least 10% of the after tax net income determined in accordance with the
PRC GAAP until the reserve is equal to 50% of the entities' registered capital.
Appropriations to the statutory public welfare fund is required to be between 5%
to 10% of the after tax net income determined in accordance with the PRC GAAP.
Appropriations to the discretionary surplus reserve are made at the discretion
of the Board of Directors.
The statutory surplus reserve fund is non-distributable other than during
liquidation and can be used to fund previous years' losses, if any, and may be
utilized for business expansion or converted into share capital by issuing new
shares to existing shareholders in proportion to their shareholding or by
increasing the par value of the shares currently held by them, provided that the
remaining reserve balance after such issue is not less than 25% of the
registered capital.
The statutory welfare reserve can only be utilized on capital items for the
collective benefit of the Company's employees, such as construction of
dormitories, cafeteria facilities, and other staff welfare facilities. This fund
is non-distributable other than upon liquidation. The transfer to this fund must
be made before distribution of any dividend to shareholders.
F-17
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 13 - Statutory reserves, (continued)
The discretionary surplus fund may be used to acquire fixed assets or to
increase the working capital to expend on production and operation of the
business. The Company's Board of Directors decided not to make appropriation to
this reserve. According to Konzern's articles, Konzern should appropriate 10% of
the net profit as statutory surplus reserve and 6% as statutory public welfare.
As of March 31, 2006, Konzern's statutory reserve did not reach 50% of Konzern's
registered capital due to the increase in registered capital of $2.3 millions
and reserve will be made at the end of 2006.
Note 14 - Retirement benefit plans
Regulations in the PRC require the Company to contribute to a defined
contribution retirement plan for all permanent employees. The contribution is
based on a percentage required by the local government and the employees'
current compensation. The Company contributed $17,947 and $23,575 during the
three months ended March 31, 2006 and the year ended December 31, 2005,
respectively.
Note 15 - Stockholders' equity
Sale of preferred stock
Contemporaneously with the reverse acquisition, the Company entered into a
Preferred Stock Purchase Agreement, dated February 8, 2006, with Barron Partners
L.P., Ray and Amy Rivers, JTROS, Steve Mazur and William Denkin pursuant to
which the Company issued and sold an aggregate of 3,120,000 shares of its Series
A Convertible Preferred Stock, a newly-created series of preferred stock, and
warrants to purchase 3,694,738 shares of common stock at $1.75 per share and
3,694,738 shares of common stock at $2.50 per share.
The Series A Convertible Preferred Stock is convertible, at the option of the
holder and at any time, into 3,120,000 shares of common stock. No dividends are
payable on the preferred stock and dividends may not be paid on the common stock
while the preferred stock is outstanding. The preferred stock is not redeemable
but has a liquidation preference of $1.25 per share. Holders of the preferred
stock are not entitled to vote, except on matters that would adversely affect
their rights.
The warrants have a term of five years and are exercisable by the holder at any
time. With certain exceptions, if the Company issues common stock at a price, or
warrants or other convertible securities with an exercise or conversion price,
which is less than the exercise price of the warrants, the exercise price of the
warrants will be reduced to the sales price, exercise price or conversion price,
as the case maybe, of such other securities. However, in such circumstances, the
number of shares obtainable on exercise of the warrants is not changed.
F-18
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Stockholders' equity, (continued)
Sale of preferred stock, (continued)
The conversion rate of the Series A Preferred Stock and the exercise price of
the warrants (but not the number of shares obtainable on exercise) are subject
to adjustment in certain events, including the failure to achieve specified
levels of adjusted earnings before interest, taxes, depreciation and
amortization or fully diluted pre-tax income per share, computed as set forth in
the applicable agreements. Further, the Series A Preferred Stock can not be
converted and the warrants can not be exercised if such conversion or exercise
would result in the holder and its affiliates owning more than 4.9% of the then
outstanding number of shares of common stock.
The Company valued the warrants at the time they were issued using the
Cox-Ross-Rubinstein binomial model, based on the exercise price and term of the
warrants and the following assumptions: fair value of common stock - $0.81;
volatility - 50%; interest rate - 4.55%. Because there is currently no public
market for the Company's common stock, the Company estimated the expected
volatility of the Company's common stock over the term of the warrants based on
a review of the historical volatility of other publically-traded companies
considered by management to be comparable to the Company. The fair value of the
common stock and the Series A Preferred Stock was estimated based on the
implicit value paid by the investors. As a result, based on these factors, the
Series A Preferred Stock was valued at $2,518,615 and the warrants were valued
at $1,381,385, reflecting the aggregate gross proceeds paid by the investors of
$3,900,000.
Under a registration rights agreement with the investors, the Company is
required to file a registration statement registering the common stock issuable
upon conversion of the preferred stock and exercise of the warrants. The
registration statement was filed on April 13, 2006 but has not yet become
effective. The registration rights agreement requires the registration statement
to be filed by April 9, 2006 and be declared effective by August 8, 2006. The
Company filed the registration statement on April 13, 2006. The Company is
required to pay to the investors liquidated damages of 1,025 shares of preferred
stock each day (i) after April 8, 2006 until the registratin statement is filed,
(ii) after August 8, 2006 until the registration statement is effective, and
(iii) after the registration statement becomes effective, subject to certain
limitation, for each day that the registration statement ceases to be current
and effective until the expiration of two years after the date of the agreement
or until the investors hold less than 10% of the registerable securities. The
agreement also provides that the liquidated damages resulting from a failure to
file on time will be waived if the registration statement is declared effective
by the required date. As of March 31, 2006, the Company had not accrued any
liquidated damages under this agreement.
F-19
CHINA MEDICINE CORPORATION AND SUBSIDIARY
(FORMERLY KNOWN AS LOUNSBERRY HOLDINGS III, INC)
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Stockholders' equity, (continued)
Sale of preferred stock, (continued)
The Company reviewed the terms of the Series A Preferred Stock and the Warrants,
in accordance with FAS 133 and EITF Issue 00-19. The conversion option related
to the Series A Preferred Stock is an embedded derivative instrument but the
risks and rewards of that embedded derivative are considered to be clearly and
closely related to the risks and rewards of the host instrument and,
accordingly, the embedded derivative instrument has not been bifurcated. The
Company has reviewed the requirements of EITF Issue 00-19 and concluded that the
Warrants should be accounted for as equity instruments. Accordingly, the net
proceeds from the sale of the preferred stock and warrants of $3,783,000,
representing the gross proceeds received of $3,900,000, net of $117,000 of
commissions, has been credited to additional paid-in capital.
Common stock
The Company issued 750,000 shares of common stock to individuals for services
performed and of which 150,000 shares were issued to Ms. Mary Xia and 37,500
shares were issued to Ms. Lin Li. There is no established market for the
Company's common stock. Accordingly, the fair value of the common stock of $0.81
has been estimated by determining the fair value that would equate the aggregate
fair values of the Series A Preferred Stock and the Warrants to the gross cash
proceeds received from the third-party investors, keeping all other valuation
factors constant. Therefore, the Company valued the common stock at $0.81 per
share for a total of $607,500 for the 750,000 shares issued. The total amount
was charged to income in the period ended March 31, 2006.
F-20
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
FORWARD-LOOKING INFORMATION - Management's Discussion and Analysis of
Financial Condition and Results of Operations ("MD&A") includes "forward-looking
statements". All statements, other than statements of historical facts, included
in this MD&A regarding the Company's financial position, business strategy and
plans and objectives of management of the Company for future operations are
forward-looking statements. These forward-looking statements rely on a number of
assumptions concerning future events and are subject to a number of
uncertainties and other factors, many of which are outside of the Company's
control, that could cause actual results to materially differ from such
statements. While the Company believes that the assumptions concerning future
events are reasonable, it cautions that there are inherent difficulties in
predicting certain important factors, especially, the prospects for future
acquisitions; the possibility that a current customer could be acquired or
otherwise be affected by a future event that would diminish their medicine
products requirements; the competition in the medical product market and
governmental price policy on medical products and the impact of such factors on
pricing, revenues and margins; and the cost of attracting and retaining highly
skilled personnel.
Overview
We are the holding company, and our business is conducted through our
wholly owned subsidiary, Guangzhou Konzern Medicine Co., Ltd. ("Konzern"), which
is organized under the laws of the People's Republic of China (the "PRC", or
"China"). Through Konzern, we distribute medical products, including traditional
Chinese medicine (finished medicine made of Chinese herbs) and Chinese herbs and
nutritional supplements in the PRC. We acquired all the outstanding equity of
Konzern in February 2006. In connection therewith, we raised an aggregate of
$3,900,000 in gross proceeds in a private equity financing by certain
non-affiliated accredited investors in February 2006.
We distribute 1,100 medicine products in China, including traditional
pharmaceutical medicines, traditional Chinese medicines (finished medicines made
of Chinese herbs), Chinese herbs and dietary supplements. These products include
both prescription drugs and over-the-counter drugs. Our network reaches 28
provinces in China, over 300 hospitals, 500 medicine companies and 1700 drug
stores. Our business is dependent upon our ability both to acquire our products
and distribute our products in the Chinese markets. We purchase our products
from Chinese drug manufacturers, and we are the manufacturer's sole distributor
in the PRC for our five largest suppliers. Our five largest suppliers, which
were the same in each period, accounted for 54% and 57% of our purchases in the
three months ended March 31, 2006, and March 31, 2005, respectively. Our
agreements with our suppliers generally have a term of one year and provide that
the suppliers will provide us with the products we order. None of our supply
agreements has any minimum purchase requirements on our part. However, we are
frequently required to make a significant down-payment when we place an order,
and, at March 31, 2006, our advances to our suppliers were approximately $2.1
million. These down payments are made pursuant to contracts with the suppliers,
and, to the extent that we reduce the size of the order, we will receive a
credit from the supplier. To date, all of our down payments have been applied to
our orders. As of March 31, 2006, we have nationwide exclusive sales right from
our suppliers for six products they produce, which accounted for $1,596,938, or
45% of revenue in the quarter ended March 31, 2006, and $683,772, or 24% of
revenue in the comparable quarter of 2005.
Our customers are typically wholesale medical products companies,
hospitals and retail drug stores. Our five largest customers accounted for 67%
and 60% of our revenue for the three months ended March 31, 2006 and March 31,
2005, respectively.
Since 2003, we started to conduct medical research and development through
Konzern's R&D center. We have four new medicines currently under development by
Konzern: Yutian Capsule a traditional Chinese medicine which is used in the
treatment of lung cancer, Dioscorea Collettii Hook F Extraction for high blood
pressure treatment, EGFR Test kit for lung cancer testing, Multi Functional
Peptide Derivative for intestine cancer treatment. We have been focusing on the
pre-clinical study of Yutian capsule in the first quarter of 2006. These
products are designed for marketing in the PRC in compliance with PRC regulatory
requirements. None of the claims with respect to these medications would be
permissible in the United States or any other western country.
4
Under certain regulations in the form of public notices issued by the PRC
State Administration of Foreign Exchange, or SAFE, our shareholders who are PRC
resident entities or individuals are subject to certain registration
requirements. These regulations would prohibit Konzern from distributing
dividends or profits to us unless the registration requirements are complied
with. As of March 31, 2006, our PRC shareholders have not complied with the
registration requirements under the SAFE regulations. The Company currently does
not have any present plans to pay dividends, and we are prohibited from paying
dividends under the terms of the purchase agreement relating to the series A
preferred stock. The PRC shareholders have advised us that they will comply with
relevant SAFE regulations.
As a result of the reverse acquisition, we became a reporting company in
February 2006. As a result, our general and administrative expenses increased to
reflect the establishment of a United States office and additional legal,
accounting and other expenses relating to our status as a public company and
compliance with the reporting requirements of the federal securities laws and
our obligations under the agreement pursuant to which we sold preferred stock to
our investors.
Results of Operations
The following table sets forth our statements of operations for the three
months ended March 31, 2006 and 2005, and the year ended December 31, 2005, in
U.S. dollars:
5
12 Months Ended
Three Months Ended March 31, December 31,
---------------------------- ------------
2006 2005 2005
----------- ----------- -----------
Revenue $ 3,511,979 $ 2,728,586 $12,791,031
Costs of goods sold 2,459,550 1,828,997 8,656,873
Gross profit 1,052,429 899,589 4,134,158
Other operating income 296,103 424,628 2,134,872
R&D expenses 54,664 159 478,590
Selling expenses 100,102 39,429 147,020
General and administrative costs 187,064 58,288 364,150
Income from operations 1,006,702 1,226,341 5,279,270
Reverse acquisition expenses 931,270 0 0
Other income, net (9,492) 178 410,900
Income before income taxes 65,940 1,226,519 5,690,170
Provision for income taxes 165,581 0 0
Net (loss) income (99,641) 1,226,519 5,690,170
Other comprehensive income 44,840 0 101,132
Comprehensive income $ (54,801) $ 1,226,519 $ 5,748,501
Our revenue is derived primarily from the sale of traditional
pharmaceutical medicines, traditional Chinese medicines, which are medicines
derived from Chinese herbs and nutritional products. The following table sets
forth the revenue and percentage of revenue derived from each of these types of
products.
Year Ended December 31, Three Months Ended March 31,
----------------------- ---------------------------------------------
2005 2005 2006
----------- ----------- -----------
Traditional
Pharmaceutical Medicine $10,107,138 79% $ 1,973,275 72% $ 2,477,138 70.53%
Traditional Chinese
Medicine 2,545,854 20% 709,695 26% 1,031,874 29.38%
Chinese Herbs 138,039 1% 45,616 2% 2,968 0.08%
Total $12,791,031 100% $ 2,728,586 100% $ 3,511,979 100%
Revenues for quarter ended March 31, 2006 were $3,511,979, an increase of
$783,393, or 29%, from the revenue of $2,728,586 for the comparable period in
2005. We obtained the distribution rights for three new products in the second
half of 2005, which generated significant additional revenues for us.
Cost of revenue for the quarter ended March 31, 2006 was $2,459,505, an
increase of $630,553, or 34%, from $1,828,997 for the comparable period in 2005.
Gross profit for the quarter ended March 31, 2006 was $1,052,429, an increase of
$152,840, or 17%, from $899,589 for the comparable period of 2005. Our gross
margin for the quarter ended March 31, 2006 was 30% as compared with 33% for the
quarter ended March 31, 2005. The drop in our gross margin was due to the
decrease of the medicine prices which was adjusted by the Chinese government.
6
Other operating income of $296,103 and $424,628 for the quarter ended
March 31, 2006 and 2005, respectively, represented the proceeds from the sale of
certain technology and know-how on the production of medicines to certain
nonaffiliated drug manufacturers. We bought the technology in its preliminary
stage from other companies and then sold the improved technology to other
pharmaceutical companies.
Research and development expenses were $54,664 for the quarter ended March
31, 2006 which was for the pre-clinical study of Yutian capsule. The Research
and development expense for the first quarter of 2005 was nominal. Our research
and development for that period was performed pursuant to an agreement with
Nanhua University, and, during the first quarter of 2005, Nanhua University did
not perform any significant services for us.
Selling expenses were $100,102 for the quarter ended March 31, 2006, an
increase of $60,673 from $39,429 for the comparable period in 2005. The increase
of selling expenses was mainly due to the increase of transportation expenses,
advertising and marketing expenses.
General and administrative expenses were $187,064 for the quarter ended
March 31, 2006, an increase of $128,776 from $58,288 for the comparable period
in 2005. The increase mainly reflected additional expenses associated with our
status as a reporting company, including the establishment of a United States
office and additional legal, accounting and other expenses relating to our
status as a public company and compliance with the reporting requirements of the
federal securities laws and our obligations under the agreement pursuant to
which we sold preferred stock to our investors.
Reverse acquisition expenses were $931,270 in the first quarter ended
March 31, 2006. These expenses were one-time expenses which include the value of
stock issued to employees, including two of our officers, and a service
provider; warrants issued to investors, and legal, accounting and investment
banking fees paid during the first quarter of 2006.
Provision for income taxes was $165,581 for the first quarter of 2006
compared with zero taxes for the first quarter of 2005. As a foreign invested
company in China, our subsidiary Guangzhou Konzern Medicine Co., Ltd has an
income tax exemption for 2004 and 2005 and a 50% reduction income tax rate for
2006, 2007 and 2008.
Comprehensive income for the quarter ended March 31, 2006 was (54,801), a
decrease of $1,281,320 from $1,226,519 for the comparable period in 2005. The
decrease was mainly due to the increase on selling expenses, G&A expenses,
reverse acquisition expenses and income taxes.
Liquidity and Capital Resources
Prior to February 2006, we financed our operation and met capital
expenditure requirements primarily through short-term bank loans, trade credit
and equity financing. As of March 31, 2006, as a result of the sale of preferred
stock and warrants, from which we received net proceeds of approximately $3.8
million, we had working capital of $8,138,564, an increase of $3,709,873 from
$4,428,691 from December 31, 2005.
We used cash of $1,376,510 in our operations for the first quarter of
2006, an increase of $1,268,579 from the cash required for the comparable period
of 2005. The increase in net cash used in operations was largely due to the
increase in the accounts receivables and inventories.
7
In January 2006, we repaid $95,696 short term loans to CITIC Industrial
Bank with $1,582 interest payment. As of March 31, 2006, the Company did not
have long-term debt.
We intend to use our available funds to accelerate the development and
testing of new drugs and we may establish our own production facilities to
manufacture our own products. We believe that our available funds will provide
us with sufficient capital for at least the next twelve months; however, to the
extent that we make acquisitions or establish our own production facilities, we
may require additional capital for the acquisition or for the operation of the
combined companies. We cannot assure that such funding will be available.
Critical Accounting Policies and Estimates
We have disclosed in Note 2 to our financial statements those accounting
policies that we consider to be significant in determining our results of
operations and our financial position which are incorporated by reference
herein.
Management's discussion and analysis of its financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. Our financial statements reflect the selection
and application of accounting policies which require management to make
significant estimates and judgments. See note 2 to our consolidated financial
statements, "Summary of Significant Accounting Policies." Management bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. We believe that
the following reflect the more critical accounting policies that currently
affect our financial condition and results of operations. The significant
accounting policies which we believe are the most critical to aid in fully
understanding and evaluating our reported financial results include the
following: Revenue recognition
The Company recognizes revenue when all four of the following criteria are
met: (1) persuasive evidence has been received that an arrangement exists; (2)
delivery of the products and/or services has occurred; (3) the selling price is
fixed or determinable; and (4) collectibility is reasonably assured. The Company
follows the provisions of SAB No. 104 which sets forth guidelines in the timing
of revenue recognition based upon factors such as passage of title,
installation, payments and customer acceptance. Any amounts received prior to
satisfying the Company's revenue recognition criteria is recorded as deferred
revenue.
Sales revenue represents the invoiced value of goods, net of a value-added
tax (VAT). All of the Company's products, which are sold exclusively in the PRC,
are subject to a Chinese value-added tax at a rate of 13% to 17% of the gross
sales price. This VAT may be offset by VAT paid by the Company on raw materials
and other materials included in the cost of producing their finished product.
Research and development costs
Research and development costs are expensed as incurred. To the extent
that research and development services are performed for us by third parties,
these costs are expenses when the services are performed by the third party. The
costs of material and equipment that are acquired or constructed for research
and development activities, and have alternative future uses, either in research
and development, marketing, or sales, are classified as property and equipment
or depreciated over their estimated useful lives.
Use of estimates
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The preparation of financial statements in conformity with generally
accepted accounting principles of the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the combined financial statements and accompanying notes. Management believes
that the estimates utilized in preparing its financial statements are reasonable
and prudent. Actual results could differ from these estimates.
Inventories
We record reserves against our inventory to provide for estimated obsolete
or unsalable inventory based on assumptions about future demand for its products
and market conditions. If future demand and market conditions are less favorable
than management's assumptions, additional reserve could be required. Likewise,
favorable future demand and market conditions could positively impact future
operating results if previously reserved for inventory is sold.
Item 3. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Our chief executive
officer and our chief financial officer, after evaluating the effectiveness of
the company's "disclosure controls and procedures" (as defined in the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), Rules 13a-15e and
15d-15e) as of the end of the period covered by this report (the "Evaluation
Date"), have concluded that, as of the Evaluation Date, our disclosure controls
and procedures were effective and that information required to be disclosed in
the reports that we file or submit under the Exchange Act is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, to allow timely decisions regarding required disclosure.
(b) Changes in internal controls. During the fiscal quarter covered by
this quarterly report, there was no change in our internal control over
financial reporting that has materially affected, or is reasonably likely to
materially affect our internal control over financial reporting.
PART II
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On February 8, 2006, the Company issued 6,530,000 shares of its common
stock in exchange for all the outstanding equity of Kozern and issued an
aggregate of 3,120,000 shares of a newly-created series of preferred stock,
designated as the Series A Convertible Preferred Stock, and warrants to purchase
an aggregate of 7,389,476 shares of common stock of the Company. Subject to
certain restrictions and adjustments, one share of Series A Convertible
Preferred Stock is initially convertible into one share of the Company's common
stock. Contemporaneously with the February 2006 private placement, the Company
issued an aggregate of 750,000 shares of common stock for services including
150,000 shares to Meiyi Xia and 37,500 shares to Lin Li.The Company reported
these transactions on the Company's Current Report on Form 8-K filed with the
Commission on February 14, 2006.
Item 6. Exhibits
(a) Exhibits
3.1 - Certificate of Incorporation, as filed with the Delaware Secretary
of State on February 10, 2005. (1)
3.2 - Amendment to the Certificate of Incorporation, as filed with the
Delaware Secretary of State on May 10, 2006. (1)
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3.3 - Certificate of Correction, as filed with the Delaware Secretary of
State on February 8, 2006.(1)
31.1 - Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 - Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 - Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(1) Incorporate by reference to the Original 10-QSB filed with the SEC on May
22, 2006.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned there
unto duly authorized.
CHINA MEDICINE CORPORATION
Date: September 20, 2006. BY: /s/ Senshan Yang
-----------------------
Senshan Yang
Chief Executive Officer
BY: /s/ Huizhen Yu
-----------------------
Huizhen Yu
Chief Financial Officer
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