SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Amendment No. 1
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: March 31, 2012 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: 0-53600
CHINA YCT INTERNATIONAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Issuer's telephone number: 406-282-3188
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 406 of the Securities Act. Yes ¨ No x
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 x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 x 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 (§232.405 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 x
Indicate by check mark disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) 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. x
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. (Check One)
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Small reporting company x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of September 30, 2011, the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon close sale price of such shares as reported on the OTCQB Marketplace, was $1,848,118.
The number of shares outstanding of the issuer’s common stock, as of June 29, 2012, was 73,868,110.
EXPLANATORY NOTE – AMENDMENT
The sole purpose of this amendment is to clarify that the total number of authorized shares of Common Stock at March 31, 2012 was 100,000,000. At the time the Company filed preliminary proxy materials with the Securities and Exchange Commission on February 22, 2012, the Company anticipated increasing the number of authorized shares of Common Stock to 500,000,000 as the Company was preparing for a proposed financing of a minimum of $20,000,0000. The Company did not circulate definitive proxy materials or amend its articles of incorporation to increase the number of authorized shares when the financing became unlikely to be completed There are no other changes to the Annual Report on Form 10-K. .
CHINA YCT INTERNATIONAL GROUP, INC.
For the Fiscal Year Ended March 31, 2012
TABLE OF CONTENTS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Report contains certain forward-looking statements regarding China YCT International Group, Inc., its business and its financial prospects. These statements represent Management’s present intentions and its present belief regarding the Company’s future. Nevertheless, there are numerous risks and uncertainties that could cause our actual results to differ from the results suggested in this Report. A number of those risks are set forth in the section of this report titled “Risk Factors”.
Because these and other risks may cause China YCT International Group’s actual results to differ from those anticipated by Management, the reader should not place undue reliance on any forward-looking statements that appear in this Report. Readers should also take note that China YCT International Group will not necessarily make any public announcement of changes affecting these forward-looking statements, which should be considered accurate on this date only.
ITEM 1. BUSINESS
The Structure of our Business
China YCT International Group (“CYIG” or “the Company”), through its wholly-owned subsidiary, Landway Nano Bio-Tech Group, Inc., owns 100% of the registered capital of Shandong Spring Pharmaceutical Co., Ltd. (“Shandong Spring Pharmaceutical”), a corporation organized in 2005 under the laws of the People’s Republic of China. Shandong Spring Pharmaceutical is engaged in the business of developing, manufacturing and marketing gingko products in the People’s Republic of China.
From January 2006 until January 2007 management of Shandong Spring Pharmaceutical was engaged in developing the company’s manufacturing facility and distribution network. In January 2007, Shandong Spring Pharmaceutical commenced revenue-producing activities, specifically distributing products manufactured by Shandong Yong Chun Tang Bioengineering Co., Ltd. (“Shandong YCT”).
Shandong Spring Pharmaceutical was originally organized as a subsidiary of Shandong YCT for the purpose of focusing on advanced technology related to the use of gingko as an aide to health. Shandong YCT later transferred ownership of Shandong Spring Pharmaceutical to its equity-holders. Shandong Spring Pharmaceutical served solely as a distributor for Shandong YCT through the end of its fiscal year on March 31, 2009, pursuant to a distribution agreement that fixed the resale profit that would be earned by Shandong Spring Pharmaceutical. On February 19, 2010, we renewed the Purchase and Sale Contract with Shandong YCT, for a term of five years ending on February 28, 2015. Pursuant to the renewed agreement, we can purchase 10 products from Shandong YCT at a fixed price, which were selected according to their sales and profits. Mr. Yan Tinghe, our founder and Chief Executive Officer, was the principal shareholder of Shandong YCT until he sold all of his shares of Shandong YCT to an unrelated party on Dec 16, 2009.
In March 2010, the Company purchased a patent from Shandong YCT for US$6.74 million, which enabled the Company to manufacture and distribute medicine products for cardio cerebral vascular disease, cosmetics and healthcare products. The purchase price for the patent was determined through negotiations between the Comany and Shandong YCT based on a valuation price of US$11.14 million. The patent for the manufacturing method of deeply extracting ginkgo flavonoids that the Company acquired from Shandong YCT, was assessed by Beijing Beifang Yashi Asset Evaluation Company. The Company received the independent assessment, based on the current income value method, that the patent had a fair value of US$11.14 million. Shandong YCT sold the patent to the Company at a discount from the assessed value because Shandong YCT retained a license to produce certain products based on the patent technology. The patent is for an aglycone type and purification method of biotransformation in gingko product manufacturing process, with a remaining legal life of 16.5 years.
Conducting clinical studies in China via Shandong Spring will save substantial R&D expenses compared to conducting such studies in the United States. According to the August 18, 2007 issue of World Journal, the average cost of the research and development for a new chemical drug is $980 million US dollars, of which 70 % will be used for clinical studies, and the average time of developing a new drug was 14.2 years in 2007. CYIG could not afford such cost. In 2004, US FDA released Guidance for industry Botanical drug products. According to this guidance, presentation of the prior use of the herbal drugs in foreign countries will help the approval of the application for the production permit. Following the guidance, CYIG intends to prepare and submit a report of the historical use of Ban Lan Gen (“BLG”), an herbal anti- biotic, used to cool and clear skin irritations and reduce fevers and sore throats, or pure Ban Lan Gen (“PBLG”) in China to the US FDA, which we expect will accelerate the process of FDA approval. In the future, CYIG hopes to raise more capital for the research and development of the drug through offerings of debt or equity, but there can be no assurance such offerings will be successful. Simultaneously, CYIG will conduct the clinical studies following the standards of the US FDA in China, where the cost of conducting clinical trials is lower than in the United States. The conduct of clinical studies in foreign countries following the standards of the US FDA is permitted by the US FDA, and we believe that obtaining approval for an herbal drug from the FDA is easier than the approval of a chemical drug. In addition, CYIG would submit an application to China’s SFDA for the drug as an over the counter drug, which is permitted for sale in China.
The profits from our health and medical products are adequate to fund our ongoing operations. In order to fully implement its business plan, however, Shandong Spring Pharmaceutical will require a capital infusion to finance the creation of state-of-the-art facilities for the extraction of compounds from gingko, the formulation of products based on those compounds and the obtaining and development of Patents.
The Market for Gingko
Traditional Chinese medicine recommends consumption of gingko tea to improve circulation and pulmonary function. Although scientific testing of the health benefits traditionally attributed to gingko has been inconclusive to date, there remains a widespread belief in the benefits of a regimen of gingko consumption. In particular, the potential use of gingko to alleviate symptoms of Alzheimer’s disease has attracted attention. Various research articles, including an article published by the Shandong Traditional Chinese Medical University in 2010, has reported research results on the use of gingko to alleviate symptoms of Alzheimer’s disease. The flavonoid aglycone, a compound derived from the gingko plant, is widely used in pharmaceutical formulations as well as in food and cosmetic products. The flavonoid aglycone is listed as a dual food/drug product by the Ministry of Health of China. Our cosmetic flavonoid aglycone product, YCT Ginkgo Freckle Cream has received Cosmetic Product Certificate issued by the Ministry of Health of China.
According to data issued by Chinese Association (Wutai) of Market Information and Research, the annual worldwide consumption of various gingko extracts exceeded 460 tons in 2007, of which over 80% was produced in China. A large portion of the Chinese production, however, is extracted from gingko biloba, and lacks aglycone. The primary sources of aglycone-rich extracts are France, Germany, and the US. We compete directly with these international competitors. We believe that our competitive advantages will be a substantially lower cost of production and advanced extraction technology.
Research and Development: Our Products
Our goal is to utilize advanced biological technology to isolate and extract the beneficial compounds in plants that have traditionally been known to have medicinal benefits, primarily gingko. We have a staff of 25 employees engaged in research and development of new technologies and resulting products. In addition we maintain close ties to the research staffs at Tsinghua University, China Agriculture University, Shandong Herbal Medicine University, and the Shandong Herbal Medicine Research Institute. We entered into a written R&D Cooperation Agreement with Nanjing Forestry University, pursuant to which we will invest on a national ginkgo R&D center with Nanjing Forestry University and have the right of first refusal on the transfer and use of Nanjing Forestry University’s ginkgo related technologies. We also entered into an R&D Cooperation Agreement with Shandong University on April 26, 2011, which is effective until April 25, 2014. Pursuant to the agreement with Shandong University, we invested RMB 300,000 (approximately USD45,000) in R&D projects and will be the co-owner of the resulting technologies. We were also committed to make further investments equal to 10% of our profits arising from Shandong University’s technologies.
On October 26, 2010, Shandong Spring Pharmaceutical signed an agreement to purchase three patents relating to Chinese herbal formulas from Jining Tianruitong Technology Development Limited Company for $15,557,318, which agreement was subsequently amended and restated on March 14, 2011. We received an independent assessment of the value of the patents which supported the purchase price. Subsequent to March 31, 2011, $10,050,910 of the total purchase price was returned to us by the owner of the patents because certain governmental approvals for the transfer of one of the patents were not completed and the patents are being purchased as a group. In October 2011, two of the patents were transferred to the Company. The two patents are “Treatment to ischemic encephalopathy and its preparation method” (ZL200510045001.9) and “Chinese herbal medicine compound to treat renal insufficiency and its preparation” (ZL200710013301.8), with remaining legal lives of 13.75 years and 14.95 years, respectively. As of March 31, 2012, all the prepayment related to the patent acquisition has been returned. Approval from the State Intellectual Property Office of the PRC is required for the transfer of the patent and we are waiting for governmental approvals for the transfer of the patent.
During the year ended March 31, 2012, we spent $848,753 in research and development. Our R&D expenses were primarily used for acquiring and testing raw material, and also the ordinary maintenance expense for our research equipment. We also made progress in bringing the patented technology into mass production. The Aglycone flavonoids patented technology has been successfully tested and the production process has been established. Continued development is ongoing to increase extraction yield, improve consistency, and to find the most energy-saving and environmentally friendly production process. Further development includes scaling up production and applying the technology to food, medicines, cosmetic products and other relevant areas by conducting further market analysis and research.
The herbal formula and production process based on the patent, “Chinese herbal medicine compound to treat renal insufficiency and its preparation”, have been confirmed. Samples have been produced and will be used for animal trials.
The technology based on the patent, “Treatment to ischemic encephalopathy and its preparation method”, is fairly mature. We concluded the first round of animal trial with the second round in planning. Currently, we are in the process of summarizing and evaluating the research and production results.
Our new product, Huoliyuan Capsule.
In January 2007, the company purchased from Beijing Boya Research Institution, Ltd., a patent for RMB400,000 (approximately USD$58,000) for the Huoliyuan Capsule. In 2010, the Company started to manufacture and distribute our new product, Huoliyuan Capsule. In the year ended March 31, 2012, the Company produced approximately 8.0 million boxes of (1*3 pack) and 1 million boxes of (1*2 pack) of Huoliyuan Capsule with a retail price of RMB20 Yuan and RMB16 Yuan per box, respectively.
Huoliyuan Capsule is approved by the State Food and Drug Administration (the “SFDA”) of China. The Huoliyuan capsule is manufactured according to the traditional Chinese medicine concepts. The main ingredients of Huoliyuan are: Panax Ginseng Leaves Extract, Radix Astragali, Radix Ophiopogonis, Schisandra Chinensis and Monkshood; all are traditional Chinese herbal medicines. Huoliyuan capsule is formulated for slow release and used for daily use. The therapeutic effect of Huoliyuan was tested by independent analysts, the Jining Institute for Drug Control in 2003. The test primarily consists of a Character Test, Identification Test, Water Index, Load Difference, Disintegration Time and Microbial Limit. The test concluded that Houliyuan was beneficial for the human cardiovascular system and as an aid in the treatment of chronic hepatitis, diabetes, insomnia, memory loss, menopause syndrome, and other maladies.
Property and Facilities
As of March 31, 2012, we completed a new manufacturing factory and moved our plant and equipment into the new factory, which is mainly used to facilitate the full production of ginkgo aglycone flavonoids. Our new factory includes a powder injection production line and cleaning and purifying equipment. The factory also includes a pin powder workshop, and a solid manufacturing workshop. Huoliyuan is manufactured in a dedicated workshop, and the second workshop will be used as our research facility. The designated annual production capacity of the Huoliyuan Capsule manufacturing factory is 11 million boxes per year; sales of which reached 72.79% of our total annual sales. The Company has no immediate plan to build more workshops or factories.
After the manufacturing factory is completed, we plan to develop an art enzyme extraction facility for the utilization of gingko compounds. Achievement of that goal will depend on our ability to obtain substantial additional funds and there can be no assurances that such funds can be raised and/or that the facility can be constructed.
Shandong Spring Pharmaceutical operates on a property of approximately 1,700 acres that is owned by the rural collective economic organization in Sishui, Shandong. Shandong Spring Pharmaceutical has reached a cooperative agreement with the rural collective economic organization of gingko growers, which will expire in December 2016. Under the cooperative agreement, the rural collective economic organization granted us a right to occupy the property. Pursuant to the cooperative agreement, we shall provide the ginkgo growers, who control approximately 33,000 acres of land, guidance to plant gingko; and in exchange, we have a preemptive right to purchase their ginkgo leaves at the most-favored local price. Besides housing our executive offices, the property is home to a manufacturing facility measuring 17,200 square meters and a research facility measuring 3,000 square meters. The greater portion of the property, 1,647 acres, is dedicated to agricultural use, primarily the production of gingko.
The manufacturing facility developed by Shandong Spring Pharmaceutical has received GMP (good manufacturing practices) certification by the Chinese government. The company has also achieved ISO9000 certification of its management processes. GMP is the only certified manufacturing standard certificate that is authorized by the Chinese government. Only companies that pass GMP standards and obtain the certificate that issued by Chinese government are able to manufacture medicine and related products.
The farm operated by Shandong Spring Pharmaceutical is operated in a manner consistent with the requirements for organic certification set up by the Organic Foods Development Center. The farm has been certified as “green” by the Chinese Ministry of Agriculture, which reflects the company’s dedication to organic agricultural methods.
We distribute products of Shandong YCT pursuant to a Purchase and Sale Contract executed on December 26, 2006. The contract sets forth the wholesale prices at which we purchase products from Shandong YCT. On February 19, 2010, we renewed the Purchase and Sale Contract with Shandong YCT, for a term of five years ending on February 28, 2015. Pursuant to the renewed agreement, we can purchase 10 products from Shandong YCT on a fixed price, which were selected according to their sales volume and profits.
Our in-house marketing staff supervises independent primary dealers, who sub-distribute through networks of supermarkets, beauty parlors and other retail sites. This network allows us to accomplish broad geographic distribution with a marketing staff of only eight people, thus keeping our overhead low.
When we commence marketing our proprietary gingko products, we intend to use our distribution network as the source for a multi-dimensional marketing program. The key overlay onto our established marketing network will be an Internet distribution program designed to both promote local sales by our distribution network and enable customers to purchase our products online. Our goal will be to establish worldwide online distribution of our products. Towards that end we have established a strategic distribution agreement with China National Post Logistics, a subsidiary of China Post, which has 31 provincial offices located throughout China.
Shandong Spring Pharmaceutical currently employs 283 individuals, each on a full-time basis. 18 employees are involved in administration; 8 are dedicated to marketing, and 25 to research and development. The remainder of our employees is involved in manufacturing. We believe that we have a good relationship with our employees.
On February 28, 2011, the Company acquired U.S. patent No. 6,475,531 B1 titled “Safe Botanical Drug for Treatment and Prevention of Influenza and Increasing Immune Function” (the “Influenza Patent”) through a purchase agreement with L.Y. Research Corp. and its subsidiary, and LY. (HK) Biotech Limited,. as amended as of August 15, 2011 (the “Acquisition Agreement.”) In consideration for the purchase of the patent, CYIG issued LY Holding Limited, an affiliate of LY Research Corp., 44,254,952 shares of common stock, which consideration may increase to a maximum of 75,865,631 shares of CYIG common stock pursuant to the Acquisition Agreement. The total value of the consideration on the acquisition date is $32,748,665 which is calculated by the total issuing shares, multiplying CYIG’s quoted stock price $0.74 per share on February 28, 2011.
On October 21, 2011, the Company entered into an Amendment Agreement with L.Y. Research to amend the purchase agreement, dated as of February 28, 2011, and amended and restated as of August 15, 2011 (the “Purchase Agreement”) with respect to the acquisition of U.S. Patent #6,475,531B titled “Safe Botanical Drug for Treatment and Prevention of Influenza and Increasing Immune Function” (the “LY Patent”).
The Amendment Agreement added the following terms:
Management has determined that it is more likely than not that the Company will not be able to, by October 21, 2012, meet the conditions under the Amendment Agreement to (i) raise a minimum of $20M in gross proceeds from a debt or equity financing, or a series of debt and/or equity financings, or (ii) list its common stock on NASDAQ or a major foreign stock exchange. Therefore, pursuant to the Amendment Agreement, on October 21, 2012, the shares issued pursuant to the Purchase Agreement are expected to be returned to the Company and the LY Patent will be returned to LY Research and the Purchase Agreement, as amended, will be cancelled and of no further force or effect. As of March 31, 2012, the Company reviewed the LY patent for impairment and determined that the undiscounted cash flow expected to result from the use and eventual disposition of the U.S. Patent was zero as of March 31, 2012. Therefore, the fair value of the LY Patent was zero as of March 31, 2012 as calculated by the net present value of the cash flow. The carrying value of the patent was written off as impairment.
ITEM 1A RISK FACTORS
You should carefully consider the risks described below before buying our common stock. If any of the risks described below actually occurs, that event could cause the trading price of our common stock to decline, and you could lose all or part of your investment.
Because we have not yet commenced our gingko production operations, unexpected factors may hamper our efforts to implement our business plan.
Our business plan contemplates that we will become a fully-integrated grower, manufacturer and marketer of products derived from gingko. We commenced manufacture of Huoliyuan Capsules in 2010; and our business shifted from largely distributing health and beauty aids manufactured by Shandong YCT, to manufacturing and marketing Huoliyuan Capsules. In order to fully implement our business plan, we will have to successfully complete the development of an agricultural facility and an industrial facility. The complexity of this undertaking means that we are likely to face many challenges, some of which are not yet foreseeable. Problems may occur with our raw material production and with the roll-out of efficient manufacturing processes. If we are not able to minimize the costs and delays that result, our business plan may fall short of its goals, and the current profitability or our distribution activities may be offset by losses from the new gingko business.
One supplier accounts for most of our productss.
Since January 2007, the exclusive business activity of Shandong Spring Pharmaceutical has been the distribution of products manufactured by its affiliate company Shandong YCT. The Company purchases the majority of its products from Shandong YCT. For the year ended March 31, 2009, Shandong YCT was the sole vendor to the Company. For the year ended March 31, 2012, the amount purchased from Shandong YCT was amounted to US$6,548,216, and the purchase from the three major vendors (including Shandong YCT) was $17,315,268, representing over 99% of the Company’s annual total purchases. In the event we lose Shandong YCT or its business suffer adverse developments, our financial condition will be materially and adversely affected.
The capital investments that we plan may result in dilution of the equity of our present shareholders.
Our business plan contemplates that we will invest approximately $40 million in capital improvements during the next five years. We estimate that we will be unable to achieve profitable operations as an independent producer of gingko products unless we invest over $10 million in our facility. We intend to raise the largest portion of the necessary funds by selling equity. At present we have no commitment from any source for those funds. We cannot determine, therefore, the terms on which we will be able to raise the necessary funds. It is possible that we will be required to dilute the value of our current shareholders’ equity in order to obtain the funds. If, however, we are unable to raise the necessary funds, our growth will be limited, as will our ability to compete effectively.
We are subject to the risk of natural disasters.
We intend to produce the greater portion of our raw materials. In particular, we intend to produce our own gingko. Gingko is a very sensitive crop, which can be readily damaged by harsh weather, by disease, and by pests. If our crops are destroyed by drought, flood, storm, blight, or the other woes of farming, we will not be able to meet the demands of our manufacturing facility, which will then become inefficient and unprofitable. In addition, if we are unable to produce sufficient products to meet demand, our distribution network is likely to atrophy. This could have a long-term negative effect on our ability to grow our business, in addition to the near-term loss of income.
If we lost control of our distribution network, our business would fail.
We depend on our distribution network for the success of our business. Competitors may seek to pull our distribution network away from us. In addition, if dominant members of our distribution network become dissatisfied with their relationship with Shandong Spring Pharmaceutical, a concerted effort by the distribution network could force us to accept less favorable financial terms from the distribution network. Any one of these possibilities, if realized, would have an adverse effect on our business.
Increased government regulation of our production and/or marketing operations could diminish our profits.
At present, there is no significant government regulation of the health claims that participants in our industry make regarding their products. In addition, there is only limited government regulation of the conditions under which we will manufacture our products. Other developed countries, such as the United States and in particular, members of the European Community, have far more extensive regulation of the operations of nutraceuticals and plant-based cosmetics, including strict limitations on the health-related claims that can be made without scientifically-tested evidence. It is likely, therefore, that China will increase its regulation of our activities in the future. To the extent that new regulations require us to conduct a regimen of scientific tests of the efficacy of our products, the expense of such testing would reduce our profitability. In addition, to the extent that the health benefits of some of our products could not be fully supported by scientific evidence, our sales might be reduced.
Our business and growth will suffer if we are unable to hire and retain key personnel that are in high demand.
Our future success depends on our ability to attract and retain highly skilled agronomists, biologists, chemists, industrial technicians, production supervisors, and marketing personnel. In general, qualified individuals are in high demand in China, and there are insufficient experienced personnel to fill the demand. In a specialized scientific field, such as ours, the demand for qualified individuals is even greater. If we are unable to successfully attract or retain the personnel we need to succeed, we will be unable to implement our business plan.
We may have difficulty establishing adequate management and financial controls in China.
The People’s Republic of China has only recently begun to adopt the management and financial reporting concepts and practices that investors in the United States are familiar with. We may have difficulty in hiring and retaining employees in China who have the experience necessary to implement the kind of management and financial controls that are expected for a United States public company. If we cannot establish such controls, we may experience difficulty in collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet U.S. standards.
Our success depends on collaborative partner, licensees and other third parties over whom we have limited control.
Due to the complexity of the process of developing pharmaceuticals, our core business depends on arrangements with pharmaceutical institutes, corporate and academic collaborators, licensors, licensees and others for the research, development, clinical testing, technology rights, manufacturing, marketing and commercialization of our products. Our license agreements could obligate the parties to diligently bring potential products to market, make milestone payments and royalties that, in some instances, could be substantial, and incur the costs of filing and prosecuting patent applications. There are no assurances that we will be able to establish or maintain collaborations that are important to our business on favorable terms, or at all.
A number of risks arise from the Company’s dependence on collaborative agreements with third parties. Product development and commercialization efforts could be adversely affected if any collaborative partner:
Our collaborative partners could pursue other technologies or develop alternative products that could compete with the products we are developing.
If we fail to maintain the adequacy of our internal controls, our ability to provide accurate financial statements and comply with the requirements of the Sarbanes-Oxley Act of 2002 could be impaired, which could cause our stock price to decrease substantially.
We have committed limited personnel and resources to the development of the external reporting and compliance obligations that would be required for a public company. Recently, we have taken measures to address and improve our financial reporting and compliance capabilities and we are in the process of instituting changes to satisfy our obligations in connection with joining a public company, when and as such requirements become applicable to us. Prior to taking these measures, we did not believe we had the resources and capabilities to do so. We plan to obtain additional financial and accounting resources to support and enhance our ability to meet the requirements of being a public company. We will need to continue to improve our financial and managerial controls, reporting systems and procedures, and documentation thereof. If our financial and managerial controls, reporting systems or procedures fail, we may not be able to provide accurate financial statements on a timely basis or comply with the Sarbanes-Oxley Act of 2002 as it applies to us. Any failure of our internal controls or our ability to provide accurate financial statements could cause the trading price of our common stock to decrease substantially. We have implemented, or plan to implement, the measures described below under the supervision and guidance of our management to remediate the above control deficiencies and to strengthen our internal controls over financial reporting. Key elements of the remediation effort include, but are not limited to, the following initiatives, which have been implemented, or are in the process of implementation, as of the date of filing of this Annual Report:
If our financial and managerial controls, reporting systems or procedures fail, we may not be able to provide accurate financial statements on a timely basis or comply with the Sarbanes-Oxley Act of 2002 as it applies to us. Any failure of our internal controls or our ability to provide accurate financial statements could cause the trading price of our common stock to decrease substantially.
The profitability of our products will depend in part on our ability to protect proprietary rights and operate without infringing the proprietary rights of others.
The profitability of our products will depend in part on our ability to obtain and maintain manufacturing rights and preserve trade secrets, and the period our intellectual property remains protected. We must also operate without infringing the proprietary rights of third parties and without third parties circumventing its rights. The patent positions of pharmaceutical and biotechnology enterprises, including us, are uncertain and involve complex legal and factual questions for which important legal principles are largely unresolved. The biotechnology patent situation outside the U.S. is uncertain, is currently undergoing review and revision in many countries, and may not protect the Company’s intellectual property rights to the same extent as the laws of the U.S. Because patent applications are maintained in secrecy in some cases, we cannot be certain that it or its licensors are the first creators of inventions described in our pending patent applications or patents or the first to file patent applications for such inventions.
Other companies may independently develop similar products and design around any patented products we develop. We cannot assure that:
There are no assurances that we will be able to meaningfully protect our trade secrets. We cannot assure that any of our existing confidentiality agreements with employees, consultants, advisors or collaborators will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure. Collaborators, advisors or consultants may dispute the ownership of proprietary rights to our products, for example, by asserting that they developed the product independently.
We may not be able to obtain the regulatory approvals or clearances that are necessary to commercialize the products.
The PRC imposes significant statutory and regulatory obligations upon the manufacture and sale of pharmaceutical products. It typically has a lengthy approval process in which it examines pre-clinical and clinical data and the facilities in which the product is manufactured. Regulatory submissions must meet complex criteria to demonstrate the safety and efficacy of the ultimate products. Addressing these criteria requires considerable data collection, verification and analysis. We may spend time and money preparing regulatory submissions or applications without assurances as to whether they will be approved on a timely basis or at all.
Governmental and regulatory authorities may approve a product candidate for fewer indications or narrower circumstances than requested or may conditionally approve the performance of post-marketing studies for a product candidate. Even if a product receives regulatory approval and clearance, it may later exhibit adverse side effects that limit or prevent its widespread use or that force us to withdraw the product from the market.
Any marketed product and its manufacturer will continue to be subject to strict regulation after approval. Results of post-marketing programs may limit or expand the further marketing of products. Unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including its withdrawal from the market and possible civil actions.
Manufacturing our products requires compliance with applicable good manufacturing practices regulations, which include requirements relating to quality control and quality assurance, as well as the maintenance of records and documentation. If we cannot comply with regulatory requirements, including applicable good manufacturing practices requirements, we may not be allowed to develop or market the product candidates. If we fail to comply with applicable regulatory requirements at any stage during the regulatory process, it may be subject to sanctions, including fines, product recalls or seizures, injunctions, refusal of regulatory agencies to review pending market approval applications or supplements to approve applications, total or partial suspension of production, civil penalties, withdrawals of previously approved marketing applications and criminal prosecution.
Competitors may develop and market pharmaceutical products that are less expensive, more effective or safer, making our products obsolete or uncompetitive.
Some of our competitors and potential competitors have greater product development capabilities and financial, scientific, marketing and human resources than we do. Technological competition from pharmaceutical companies and biotechnology companies is intense and is expected to increase. Other companies have developed technologies that could be the basis for competitive products. Some of these products have an entirely different approach or means of accomplishing the desired curative effect than products we are developing. Alternative products may be developed that are more effective, work faster and are less costly than our products. Competitors may succeed in developing products earlier than us, obtaining approvals and clearances for such products more rapidly than us, or developing products that are more effective than those of our company. In addition, other forms of treatment may be competitive with our company’s products. Over time, our products may become obsolete or uncompetitive.
If we were successfully sued for product liability, we could face substantial liabilities that may exceed our resources.
We may be held liable if any product we or our supplier develop, causes injury or is found unsuitable during product testing, manufacturing, marketing, sale or use. These risks are inherent in the development of pharmaceutical products. We do not have product liability insurance. If we choose to obtain product liability insurance but cannot obtain sufficient insurance coverage at an acceptable cost or otherwise protect against potential product liability claims, the commercialization of products that we develop may be prevented or inhibited. If we are sued for any injury caused by its products, our liability could exceed our total assets.
We have limited business insurance coverage.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products. We do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption, litigation or natural disaster may result in our incurring substantial costs and the diversion of our resources.
Both our company and Shandong YCT may be adversely affected by complexity, uncertainties and changes in PRC regulation of pharmaceutical business and companies, including limitations on our abilities to own key assets.
The PRC government regulates the pharmaceutical industry including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the pharmaceutical industry. These laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be a violation of applicable laws and regulations.
The interpretation and application of existing PRC laws, regulations and policies and possible new laws, regulations or policies have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, pharmaceutical businesses in China, including our business.
Any deterioration of political relations between the United States and the PRC could impair our financing activities and your investment in us.
The relationship between the United States and the PRC is subject to fluctuation and periodic tension. Changes in political conditions in the PRC and changes in the state of Sino-U.S. relations are difficult to predict and could adversely affect our financing activities. Such a change could lead to a decline in our profitability. Any weakening of relations between the United States and the PRC could have an adverse effect on our efforts to raise capital to expand our present business activities and your investment in us.
Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.
All of Shandong Spring Pharmaceutical’s business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to:
While the PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. Since early 2004, the PRC government has implemented certain measures to control the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition.
Price control may affect both our revenues and net income.
The laws of the PRC provide for the government to fix and adjust prices. To the extent that we are subject to price control, our revenue, gross profit, gross margin and net income will be affected since the revenue we derive from our sales will be limited and, unless there is also price control on the products that we purchase from our suppliers, we may face no limitation on our costs. Further, if price controls affect both our revenue and our costs, our ability to be profitable and the extent of our profitability will be effectively subject to determination by the applicable regulatory authorities in the PRC.
Our operations may not develop in the same way or at the same rate as might be expected if the PRC economy were similar to the totally market-oriented economies of member countries of the Organization for Economic Cooperation and Development (“OECD”).
The economy of the PRC has historically been a nationalistic, “planned economy,” meaning it functions and produces according to governmental plans and pre-set targets or quotas. In certain aspects, the PRC’s economy has been making a transition to a more market-oriented economy, although the government imposes price controls on certain products and in certain industries. However, we cannot predict the future direction of these economic reforms or the effects these measures may have. The economy of the PRC also differs from the economies of most countries belonging to the OECD, an international group of member countries sharing a commitment to democratic government and market economy. For instance:
As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the economy of the PRC were similar to those of the OECD member countries.
We may have limited legal recourse under Chinese law if disputes arise under contracts with third parties.
Almost all of our agreements with our employees and third parties, including our supplier and customers, are governed by the laws of the PRC. The legal system in the PRC is a civil law system based on written statutes. Unlike common law systems, such as we have in the United States, it is a system in which decided legal cases have little precedential value. The government of the PRC has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the PRC, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance or seek an injunction under Chinese law are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.
Uncertainties with respect to the PRC legal system could adversely affect us.
Our operations in China are governed by PRC laws and regulations. We are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value.
Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management.
All of our assets are located outside the United States and all of our current operations are conducted in China. Moreover, the majority of our directors and officers are nationals or residents of China. All or a substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for our stockholders to effect service of process within the United States upon these persons. In addition, there is uncertainty as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities law of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof.
Fluctuation in the value of RMB may have a material adverse effect our financial results as reported in US dollars.
The value of RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. All of China YCT International Group’s financial assets and its revenues and costs are denominated in RMB. We rely entirely on fees paid to us by our clients. Any significant fluctuation in value of RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of the consulting fees payable to us by clients. For example, an appreciation of RMB against the U.S. dollar would make any new RMB denominated investments or expenditures more costly, to the extent that it might need to convert U.S. dollars into RMB for such purposes. An appreciation of RMB against the U.S. dollar would also result in foreign currency translation losses for financial reporting purposes when we translate our RMB denominated financial assets into USD, as USD is our reporting currency.
We do not anticipate paying any cash dividends in the near future.
We presently do not anticipate that we will pay any dividends on any of our capital stock in the foreseeable future. The payment of dividends, if any, would be contingent upon our revenues and earnings, if any, capital requirements, and general financial condition. The payment of any dividends is within the discretion of our Board of Directors. We presently intend to retain all earnings, if any, to implement our business plan; accordingly, we do not anticipate the declaration of any dividends in the foreseeable future.
Certain of our officer and directors own a substantial portion of our outstanding common stock, which enables them to influence many significant corporate actions and in certain circumstances may prevent a change in control that would otherwise be beneficial to our shareholders.
As of the report date, our directors and executive officers control approximately 15.09% of our outstanding shares of common stock. These shareholders, acting together, could have a substantial impact on matters requiring the vote of the shareholders, including the election of our directors and most of our corporate actions. This control could delay, defer or prevent others from initiating a potential merger, takeover or other change in our control, even if these actions would benefit our shareholders and us and this control could adversely affect the voting and other rights of our other shareholders.
Legislative actions and potential new accounting pronouncements may impact our future financial and results of operations.
There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and there may potentially be new accounting pronouncements or additional regulatory rulings that will have an impact on our future financial position and results of operations. The Sarbanes-Oxley Act of 2002 and other rule changes are likely to increase general and administrative costs and expenses. In addition, there could be changes in certain accounting rules. These and other potential changes could materially increase the expenses we report under generally accepted accounting principles, and adversely affect our operating results.
The market price for our stock may be volatile and the volatility in our common share price may subject us to securities litigation.
The market price for our stock may be volatile and subject to wide fluctuations in response to factors including the following:
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our stock.
The market for our common stock is characterized by significant price volatility when compared to seasoned issuers, and we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may, in the future, be the target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management’s attention and resources.
Capital outflow policies in China may hamper our ability to pay dividends to shareholders in the United States.
The PRC has adopted currency and capital transfer regulations. These regulations require that we comply with complex regulations for the movement of capital. Although Chinese governmental policies were introduced in 1996 to allow the convertibility of RMB into foreign currency for current account items, conversion of RMB into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of the State Administration of Foreign Exchange. We may be unable to obtain all of the required conversion approvals for our operations, and Chinese regulatory authorities may impose greater restrictions on the convertibility of the RMB in the future. Because most of our future revenues will be in RMB, any inability to obtain the requisite approvals or any future restrictions on currency exchanges will limit our ability to pay dividends to our shareholders.
Under current PRC law, land is owned by the state, and parcels of land in rural areas, known as collective land, are owned by the rural collective economic organization.
Shandong Spring Pharmaceutical operates on a property of approximately 1,700 acres that is owned by the rural collective economic organization in Sishui, Shandong, pursuant to a cooperative agreement, that expires in December 2016. Besides housing our executive offices, the property includes a manufacturing facility measuring 17,200 square meters and a research facility measuring 3,000 square meters.
By written consent on December 19, 2011, our Board of Directors and shareholders holding a majority of our outstanding voting common stock have authorized to increase the number of the our authorized shares of common stock to 500,000,000 shares of common stock, par value $0.0001 per share, in accordance with Section 141 and Section 228 of the Delaware General Corporation Law. Our directors and majority of shareholders owning 84% of our outstanding Common Stock, as the record date of December 19, 2011, have approved this action. However, at the time the shareholders executed the written consent and the Company filed preliminary proxy materials with the Securities and Exchange Commission , the Company anticipated increasing the number of authorized shares of Common Stock to 500,000,000 as the Company was preparing for a proposed financing of a minimum of $20,000,0000. The Company did not circulate definitive proxy materials or amend its articles of incorporation to increase the number of authorized shares when the financing became unlikely to be completed .
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
(a) Market Information .
Our common stock was listed for quotation on the OTC Bulletin Board until March 26, 2010. It is currently listed under the trading symbol “CYIG” on the OTCQB marketplace. Set forth below are the high and low bid prices for each of the fiscal quarters since April 1, 2010. The reported bid quotations reflect inter-dealer prices without retail markup, markdown or commissions, and may not necessarily represent actual transactions.
(b) Holders . We have 770 registered stockholders of record of our Common Stock, as of July 9, 2012.
(c) Dividend Policy . We have not declared or paid cash dividends or made distributions in the past, and we do not anticipate that we will pay cash dividends or make distributions in the foreseeable future. We currently intend to retain and reinvest future earnings, if any, to finance our operations.
(d) Equity Compensation Plan Information
The information set forth in the table below regarding equity compensation plans (which include individual compensation arrangements) was determined as of March 31, 2012.
(e) Recent Sales of Unregistered Securities .
(f) Repurchase of Equity Securities .
The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Act during the year ended March 31, 2012.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS.
Results of Operations
The following is the sales breakdown by products during the years ended March 31, 2012 and 2011:
During the year ended March 31, 2012, we realized $37,588,937 in revenue, representing an increase of 12% or $4,123,603 as compared to $33,465,334 for the same period in 2011. During the year ended March 31, 2012, a total of 11 products, including health care supplements and medicine, contributed to the increase in revenue, which remained the same as the year ended March 31, 2011.
Part of our revenues were generated by us as the distributor for the products manufactured by Shandong YCT. We entered into a Purchase & Sale Contract with Shandong YCT on December 26, 2006, which sets forth the wholesale price that we pay to Shandong YCT for each of the products it produces. On February 9, 2010, we renewed the Purchase and Sale Contract with Shandong YCT for a term of five years ending on February 28, 2015. Pursuant to the renewed contract, we can purchase 10 products from Shandong YCT on a fixed price, which were selected according to their sales volume and profit. During the year ended March 31, 2012, we generated 39% of our total revenue as the distributor of Shandong YCT, as compared to 58% during the year ended March 31, 2011.
The Huoliyuan Capsule product accounted for 56% of our revenue during the year ended March 31, 2012, compared to 41% during the year ended March 31, 2011. Since July 2010, the Company changed from being a distributor of Shandong Yong Chun Tang to both a manufacturer and distributor of our own products, Huoliyuan Capsule. Since late in the fiscal year ended March 31, 2011, we have made great effort on marketing and developing new customers for our self-produced drug – Huoliyuan Capsule. As a result, we obtained new customers and expanded our sales of Huoliyuann Capsules.
Cost of Goods Sold
Our costs of revenue comprised primarily of the cost of finished goods we purchased from Shandong YCT, the raw materials we purchased from third party vendors, and the manufacturing cost of our own patented drug, Huoliyuan Capsule. The cost of manufacturing Huoliyuan Capsule was approximately 58% of the total cost of goods sold during the year ended March 31, 2012.
During the year ended March 31, 2012, our cost of goods sold totaled $17,410,659, representing an increase of $1,229,476 or 8% as compared to $16,181,183 during the year ended March 31, 2011, reflecting an increase in net sales. The cost ratio for our operation remained steady with the percentages of the costs of goods sold to total revenues decreased slightly from 48% for fiscal year 2011 to 46% for fiscal year 2012. This is primarily due to our steady relationship with our major supplier, Shandong YCT, which enable us to obtain a more favorable sales contract.
Gross profit for the year ended March 31, 2012 was $20,178,278, an increase of 17% or $2,894,127 as compared to the same period for the prior year. The increase was mainly attributed to the larger sales volume and the cost reduction from production cost of our self-produced drug, Huoliyuan capsules. The percentage of our cost of sales over the sales of the Huoliyuan Capsules was down to 42% for the year ended March 31, 2012, from 59% for the same period in 2011 because our production process is more mature and more optimized. In addition, beginning in the fiscal year 2011, we obtained new contracts from external customers to process and package their semi-finished products. Although sales from these products are not a major component of the total sales, the gross margin from these sales was rather high. Overall, gross profit as a percentage of net revenues was approximately 54% for the year ended March 31, 2012, increased from 52% for same period of 2011.
The comparison of the profit margins for the years ended March 31, 2012 and 2011 as follows:
Research and Development Expenses.
Our R&D expenses for the year ended March 31, 2012 were $848,753 or approximate 2% of total corresponding revenue, an increase of $568,368 or 203%, as compared to $280,385 or approximately 1% of total corresponding revenue for the year ended March 31, 2011. This reflected the increased expenses related to making investments in research and development of new technologies and products that can be utilized to refine and extract the beneficial components from plants, primarily gingko.
Our long-term goal is to utilize advanced biological technology to refine and extract the beneficial compounds in plants that have traditionally been known to have medicinal benefits, primarily gingko. As of March 31, 2012, we have 25 employees working on R&D. Our R&D staff is currently engaged in research and development of new technologies and resulting products.
Selling, General and Administrative Expenses.
Our selling expenses consist primarily of sales commissions, advertising and promotion expenses, freight charges and related compensation. Our selling expenses for year ended March 31, 2012 were $3,517,514 or 9% of our total revenue for the period, representing an increase of 1% as compared with the selling expenses ratio for the year ended March 31, 2011. The increase of selling expenses was primarily due to an increase in advertising and promotion expenses related to marketing and promotional activities in Huoliyuan Capsule market.
Our G&A expenses for the year ended March 31, 2012 increased by 665% or $5,001,479 as compared to the prior year. The increase in G&A expenses was principally due to the amortization expense recorded for the acquired US Patent (U.S. No. 6,475,531 B1). During the year ended March 31, 2012, the amortization expense of this patent was $3,558,970.
During the year ended March 31, 2012, the Company recognized an expense in the amount of $5,531,892 for a derivative liability per the ASC 480-10-25-8. This expense was booked to other liability and disclosed in the note 10 – Other liability to the financial statements. The Company also recognized impairment of the US patent in the amount of $31,680,488 as other expenses.
During the year ended March 31, 2012, we realized a net loss of $29,804,368, representing a 389% or $39,785,246 decrease as compared to a net profit of $10,214,768 during the year ended March 31, 2011. The decrease was mainly due to the amortization expenses recorded for the acquired US Patent, as well as the recognized expenses associated with the potential obligation of repurchasing the issued shares and the recognized impairment.
Our business operates entirely in Chinese RMB, but we report our results in our SEC filings in U.S. Dollars. The conversion of our accounts from RMB to Dollars results in translation adjustments, which are reported as a middle step between net income and comprehensive income. The net income is added to the retained earnings on our balance sheet while the translation adjustment is added to a line item on our balance sheet labeled “other comprehensive income,” since it is more reflective of changes in the relative values of U.S. and Chinese currencies than of the success of our business. During the year ended March 31, 2012, the effect of converting our financial results to Dollars was to add $1,299,863 to our other comprehensive income, as compared to $1,329,603 during the year ended March 31, 2011.
Liquidity and Capital Resources
Our principal sources of liquidity were funds generated from our operations. As of March 31, 2012, cash and cash equivalents were $22,146,240, an increase of $16,099,436 or 266% from $6,046,804 as of March 31, 2011. The prepaid account was decreased by $15,581,371, mainly as a result of the refund from Jining Tianruitong Technology Development Limited Company related to the purchase of three patents. The tax payable was decreased by $899,291. Other payable increased by $4,537,391, mainly due to the additional consideration payable for acquisition of the US patent. As a result, Shandong Spring Pharmaceutical had $18,709,948 in working capital, a decrease of $1,084,792 or 5% as compared to the working capital as of March 31, 2011.
Based on our current operating plan, we believe that existing cash and cash equivalents balances, as well as cash forecast by management to be generated by operations, will be sufficient to meet our working capital and capital requirements for our current operations. Our operations have produced positive cash flow, with $14,281,881 provided by operating activities for the year ended March 31, 2012. The outstanding accounts receivable was $115,938 as of March 31, 2012. We expect our marketing activities to continue to operate cash-positively. The operations of our own manufacturing since last year has put some pressure on our cash flow. We may be required to seek additional capital and reduce certain spending as needed on an on-going basis. There can be no assurance that any additional financing will be available on acceptable terms.
In order to fully implement our business plan, however, we will require capital contributions far in excess of our current asset value. Our budget for bringing our manufacturing facility to an operating level that assures profitability is $10 million. To fully implement our business plan, including development of a facility to utilize our proprietary method of extracting flavones from ginkgo by using enzyme technology, we will need $40 million. Our expectation, therefore, is that we will seek to access the capital markets in both the U.S. and China to obtain the funds we require. At present we have no commitment from any source for additional funds and there can be no assurance that the funds will be available on terms acceptable to us.
On October 26, 2010, we signed an agreement to purchase three patents relating to Chinese herbal formulas from Jining Tianruitong Technology Development Limited Company for $15.6 million. Pursuant to this agreement, we made an advance payment of $15,600,000 in October 2010, and the agreement’s effectiveness was conditioned on the patents’ registration for transfer of title with the Chinese Patent Office. Subsequently, this purchase agreement was amended and restated on March 14, 2011. According to the amended agreement, $10,100,000 of the total purchase price would be returned to us from Jining Tianruitong Technology Development Limited Company because certain governmental approvals were not completed for the transfer of patents, which should be purchased as a group. In October 2011, two of the patents were transferred to the Company The two patents are “Treatment to ischemic encephalopathy and its preparation method” (ZL200510045001.9) and “Chinese herbal medicine compound to treat renal insufficiency and its preparation” (ZL200710013301.8), with remaining legal lives of 13.75 years and 14.95 years, respectively. Approval from the State Intellectual Property Office of the PRC is required for the transfer of the patent and has not yet been received. As of March 31, 2012, all of the prepayment related to acquisition of the patents has been returned to the Company
The following table sets forth a summary of our cash flows for the periods indicated:
Net cash provided by operating activities was $14,281,881 for the year ended March 31, 2012, which was an increase of 50% or $4,790,852 from the $9,491,029 net cash provided by operating activities for the same period one year earlier.
The increase was mainly attributable to the increase of accrued expenses and other payable. The increase in accounts payable and accrued expenses and other payable increased cash for the Company’s business operation. The increase in cash provided by operating activities was reduced by the increase in inventory.
During the year ended March 31, 2012, our net cash provided by investing activities was $1,332,153, as compared to $16,395,398 of net cash used in investing activities for the year ended March 31, 2011. This change was primarily due to the refund from Jining Tianruitong Technology Development Limited Company for the year ended March 31, 2012.
The Company's property and equipment assets increased by 5% or $514,254 from $10,298,303 to $10,812,557 as of March 31, 2012 compared to March 31, 2011.. During 2012, the construction in progress increased to $219,983 from $211,189. The Company's intangible assets increased by $1,409,327 in the year ended March 31, 2012, reflecting the two patents transferred from Jining Tianruitong Technology Development Limited Company. In addition, the Company wrote off the net carrying value of the US patent in the amount of $31,680,488 due to impairment.
No net cash was generated or used by financing activities over the year ended March 31, 2012.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.
Critical Accounting Policies and Estimates
We have made no material changes to our critical accounting policies in connection with the preparation of financial statements for fiscal year 2012.
New Accounting Pronouncements
In June 2011, FASB issued an amendment to the FASB Codification Topic 220 – Presentation of Comprehensive Income. The objective of this Update is to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.
In May 2011, FASB issued an amendment to FASB Codification Topic 820 - Fair Value Measurement. The amendments in this Update apply to all reporting entities that are required or permitted to measure or disclose the fair value of an asset, a liability, or an instrument classified in a reporting entity's shareholders' equity in the financial statements. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.
In April 2011, FASB issued an amendment to FASB Codification Topic 310 – Receivables: A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendment requires that, in evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both exist: (1) the restructuring constitutes a concession. (2) The debtor is experiencing financial difficulties. The amendments to Topic 310 clarify the guidance on a creditor's evaluation of whether it has granted a concession as well as on a creditor's evaluation of whether a debtor is experiencing financial difficulties. In addition, the amendments to Topic 310 clarify that a creditor is precluded from using the effective interest rate test in the debtor's guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Risk
While our reporting currency is the US dollar, almost all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. All of our assets are denominated in RMB except for some cash and cash equivalents and accounts receivables. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between US dollar and RMB. If the RMB depreciates against the US dollar, the value of our RMB revenues, earnings and assets as expressed in our US dollar financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.
Inflationary factors such as increases in the costs of our products and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin, selling and distribution, and general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase to cope with these increased costs.
ITEM 8 FINANCIAL STATEMENTS
The full text of our audited consolidated financial statements as of March 31, 2012 and 2011 begins on page F-1 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
On September 6, 2010, the Registrant retained the firm of GZTY CPA Group, LLC to audit the Company’s financial statements for the fiscal year ended March 31, 2010. At no time during the past two fiscal years or any subsequent period did the Company consult with GZTY CPA Group, LLC regarding the application of accounting principles to a specified transaction, either completed or proposed, any issue relating to the financial statements of the Company, or the type of audit opinion that might be rendered for the Company.
On September 10, 2010, Friedman LLP resigned from its position as the independent registered public accounting firm for China YCT International Group, Inc. (the “Company”). Friedman LLP was engaged as the Company’s independent registered public accounting firm on January 12, 2010. Friedman LLP did not issue a report on any of the Company’s financial statements.
During the period from January 12, 2010, to the date of this Current Report, there were no (i) disagreements between the Company and Friedman LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to its satisfaction, would have caused Friedman LLP to make reference to the subject matter of such disagreements in connection with its report, or (ii) “reportable events,” as described in Item 304(a)(1)(v) of Regulation S-K.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures.
The term “disclosure controls and procedures” (defined in SEC Rule 13a-15(e)) refers to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within required time periods. The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this annual report (the “Evaluation Date”). Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, such controls and procedures were effective.
Changes in internal controls.
The term “internal control over financial reporting” (defined in SEC Rule 13a-15(f)) refers to the process of a company that is 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. The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated any changes in the Company’s internal control over financial reporting that occurred during the fourth quarter of the year covered by this annual report, and they have concluded that there was no change to the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. We have assessed the effectiveness of those internal controls as of March 31, 2012, using the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) Internal Control – Integrated Framework as a basis for our assessment.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 and procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
A material weakness in internal controls is a deficiency in internal control, or combination of control deficiencies, that adversely affects the Company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with accounting principles generally accepted in the United States of America such that there is more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected. In the course of making our assessment of the effectiveness of internal controls over financial reporting, we identified one material weakness in our internal control over financial reporting.
As disclosed in our annual report on Form 10-K for the year ended March 31, 2011, we had identified the following material weakness in internal control over financial reporting:
Lack of expertise in U.S accounting principles among the personnel in our Chinese headquarters.
Our books are maintained and our financial statements are prepared by the personnel employed at our executive offices in Shandong Province in the PRC. Few of our employees have experience or familiarity with U.S accounting principles. The lack of personnel in our Shandong office who are trained in U.S. accounting principles is a weakness because it could have led to improper classification of items and other failures to make the entries and adjustments necessary to comply with U.S. GAAP.
As an interim solution, the Company engaged two part time consultants who are qualified financial professionals. In addition, we require all of the accounting personnel in the accounting department take a minimum of 24 CPE credits annually with a focus on US GAAP and internal financial reporting standards. Therefore, management believes that we have remediated the weakness and can remove the assessment going forward. Our Chief Executive Officer and Chief Financial Officer concluded that we have remediated the weakness and China YCT International Group’s system of disclosure controls and procedures was effective as of March 31, 2012 for the purposes described in this paragraph.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
ITEM 9B OTHER INFORMATION
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following individuals are the members of our Board of Directors and executive officers as of June , 2012
All directors hold office until the next annual meeting of our shareholders and until their successors have been elected and qualify. Officers serve at the pleasure of the Board of Directors.
Yan Tinghe. Mr. Yan has served as our Chairman and Chief Executive Officer since 2007. Mr. Yan has over twenty years of experience in corporate management within the food and food supplements industries. Mr. Yan founded Shandong Spring Pharmaceuticals, and he has served as its Chairman since January 2006. During the eight years prior to founding Shandong Spring Pharmaceutical, Mr. Yan was employed as Chairman and General Manager of Shandong YCT Bioengineering Co., Ltd., which manufactures a wide variety of food supplements and is currently the exclusive supplier for Shandong Spring Pharmaceutical. During the period from 1988 to 1997 Mr. Yan served as Executive Vice President of Shishui Sanyin Company, and from 1985 to 1987 as Factory Director of Beijing Shishui Lianhe Preserved Fruits, both of which were multi-facility enterprises in the food industry.
Li Chuanmin. Mr. Li has been our Chief Financial Officer since 2005 and has been involved with corporate financial management and accounting for over 28 years. Since 2005, he has been employed as Chief Financial Officer of the Company’s subsidiary, Shandong Spring Pharmaceutical Co., Ltd. From 2000 to 2005 Mr. Li was employed as Chief Financial Officer of Shandong Yongchuntang Biotechnology Co., Ltd. From 1998 to 2000, Mr. Li was a teacher at the Shandong Finance Institute . From 1990 to 1998, he was employed by an accounting firm in Jining City. Previously Mr. Li was employed in the accounting department of Shandong Sishui Materials Corporation. In 1986, Mr. Li received a diploma from the Shandong Finance Institute.
Zhang Jirui. Mr. Zhang brings over twenty years of technical training to Shandong Spring Pharmaceutical, where he has been employed as Director since January 2006. During 2005, Mr. Zhang was the Manager of the International Market Department for Shandong YCT Bioengineering Co., Ltd., which manufactures a wide variety of food supplements and is currently the exclusive supplier for Shandong Spring Pharmaceutical. During the 22 years prior to joining Shandong YCT, Mr. Zhang was employed as an Instructor in the Shandong Chemical Engineering Vocational School.
Robert J. Fanella. Mr. Fanella, CPA, was appointed as an independent director, effective April 6, 2009. During Mr. Fanella’s more than 36 years career specializing in corporate finance and accounting, he was responsible for audit and financial service oversight for both private and publicly traded companies. Since 2006, Mr. Fanella has been an independent financial consultant, working on various financial and operational projects for companies in industries such as electronic manufacturing, industrial plating, chemical, and health products. From April 2011 to March 2012, Mr. Fanella has served as CFO for ARCIS Resources Corporation (OTCBB: ARCS). From 2002 to 2006, Mr. Fanella was employed as CFO/Owner of Tru-Way, Inc., a metal fabrication business mainly serving the electronics manufacturing industry. The business was sold in 2006. From 1984 to 2002, Mr. Fanella was employed as CFO by MicroEnergy, Inc , a public company of which he was co-founder. MicroEnergy, Inc was a manufacturing firm designing and selling custom switch-mode power supplies to major companies in the OEM electronics market. During the 12 year period prior to founding MicroEnergy, Inc., Mr. Fanella was the CFO/Controller for two smaller businesses in the electronics manufacturing business and welding supplies distribution business, and he spent seven years at Motorola, Inc., in various capacities from Financial Analyst to Business Controller. Mr. Fanella currently serves on the Board of Directors and also is Audit Committee Chairman for American Nano Silicon Technologies, Inc. (OTCBB: ANNO). Mr. Fanella was awarded a Bachelor of Science Degree in Finance by Northern Illinois University in 1972. He was awarded a Masters of Business Administration Degree in Finance with a Marketing concentration from the University of Chicago in 1979. In 1975, Mr. Fanella was registered as a certified public accountant in Illinois.
Bai Junying . Dr. Bai was appointed as an independent director of China YCT International Group on April 6, 2009. Over the last twenty years, Dr. Bai has held senior management roles in several companies, including as CEO of Shandong Dong-e E-jiao Group, CEO of Shandong Xinhua Pharmaceutical Co., Ltd., and head of the research and development department and subsequently vice executive manager of Lukang Pharmaceutical Group Co., Ltd. Dr. Bai is currently the CEO of Shandong Dong E-jiao Group, a national well-know pharmaceutical and health care group. From 2000 to 2005, while Dr. Bai served at Shandong Xinhua Pharmaceutical Group Co., Ltd, where he was responsible for the daily operation of the company. Dr. Bai successfully brought the company public and helped develop the company into one of the leading pharmaceutical companies in China. As Head of the R&D Department at Lukang Pharmaceutical Group from 1987 to 2000, Dr. Bai played a central role in the integration and development of an antibiotic injection agent, which made Lukang Pharmaceutical Group a national research center for antibiotics. In 1990, Dr. Bai obtained his Ph.D. in Pharmacy from Beijing University Health Science Center.
Zhang Wengao. Mr. Zhang was appointed as an independent director of China YCT International Group on April 6, 2009. Mr. Zhang has over 30 years of experience in pharmaceutical, Chinese traditional medicine and diagnostic industries. Mr. Zhang is a full time professor of Shandong University of Traditional Chinese Medicine, specializing in clinical treatment via both Chinese and western methods. From 1985 to 1998, Professor Zhang was a dean of the research and development department of Shandong University of Traditional Chinese Medicine. Professor Zhang has received various awards within the clinical medicine field, including awards for combining western clinical treatment with traditional Chinese medicine methods, and the 20th Geneva Invention Silver Award. Professor Zhang has published more than 200 papers concerning the advantages of Chinese traditional medicine in clinical treatment. Among his other engagements, Mr. Zhang is an associate commissioner of the International Chinese Medicine Association and director of the International Chinese Medicine Association Cardiovascular Committee. In 1968, Mr. Zhang received his bachelor degree majoring in Pharmacy from Shandong University of Traditional Chinese Medicine.
Zhou Hanwei . Mr. Zhou has been employed by Shandong Spring Pharmaceutical Co., Ltd., our wholly owned subsidiary, as its General Manager since 2008. He is a Licensed Pharmacist in the PRC and has over 25 years of experience in the pharmaceutical industry. Prior to joining us, Mr. Zhang was employed by Shandong Guanglin Pharmaceutical as General Manger from 2006 to 2008. He graduated from Shenyang Pharmaceutical University in 1994 and majored in Pharmacy.
Zhang Qiang. Mr., Zhang has served for Shandong Spring Pharmaceutical Co., Ltd., our wholly owned subsidiary, as its Chief Administrative Officer and Head of Human Resource since 2009. He has been involved with Human Resource management for over 10 years. From October 2003 to December 2008, he was employed by Shandong Huajin Group, Inc. as the Head of Administration. Mr. Zhang graduated from Shandong Economies College and is pursuing his Senior HR Manager Certificate.
Ding Xuzhong. Mr. Ding has been served for Shandong Spring Pharmaceutical Co., Ltd., our wholly owned subsidiary, as its Chief Marketing Officer since 2008. He joined us in 2003, and was involved in our marketing development since then. Mr. Ding has over 20 years of experience on marketing, since he graduated from Shandong University in 1991, majoring in marketing.
Shao Zecheng . Mr. Shao has been involved with capital business for over 10 years. Since 2007 he has been employed as vice president of the Company’s subsidiary, Shandong Spring Pharmaceutical Co., Ltd. From 1997 to 2007 Mr. Shao was employed as Minister of Korean Daewoo Group. During the period, he successfully managed, designed and programmed 2 ERP projects and cooperated with the other departments of the company in the past years. All the projects were released on schedule, with high quality that helped the company's business grow. From 1994 to 1997, Mr. Shao was a computer engineer at the Shandong Huajin Group. In 1994 Mr. Shao received a diploma from the Shandong Teachers’ University; In 1996 PLC Engineering OF AB company US. Xiamen City Fujian P.R China; In 2000, received the Super Development Engineer Certificate for PoweBuilder in Sybase Center.
Involvement in Certain Legal Proceedings
None of our directors, executive officers, or control persons has been involved in any of the following events during the past ten years:
Nominating, Compensation and Audit Committees
We have certain standing committees of the Board, each of which is described below.
The Audit Committee consists of Robert J. Fanella, Zhang Wengao and Bai Junying. Mr. Fanella serves as the chairman of the Audit Committee. The Board has determined that each of the members of the Audit Committee satisfies the independence requirements of the NASDAQ Stock Market. The Audit Committee oversees our accounting and financial reporting processes and procedures, reviews the scope and procedures of the internal audit function, appoints our independent registered public accounting firm and is responsible for the oversight of its work and the review of the results of its independent audits.
The Board of Directors has determined that Robert J. Fanella, who serves as Chairman of the Audit Committee, is an audit committee financial expert by reason of his experience in corporate finance. Mr. Fanella is an independent director, within the definition of that term applicable to issuers listed on the NASDAQ Stock Market.
The Compensation Committee consists of Robert J. Fanella, Zhang Wengao and Bai Junying. Mr. Zhang serves as chairman of the Compensation Committee. The Board has determined that each of the members of the Compensation Committee satisfies the independence requirements of the NASDAQ Stock Market. The Compensation Committee oversees the Company’s policies regarding compensation and benefits, evaluates the performance of the Company’s executive officers, reviews and approves the compensation of the Company’s executive officers, and sets the compensation for members of the Board of Directors.
The Nominating and Corporate Governance Committee consists of Robert J. Fanella, Zhang Wengao and Bai Junying. Mr. Bai serves as chairman of the Nominating and Corporate Governance Committee. The Board has determined that each of the members of the Nominating and Corporate Governance Committee satisfies the independence requirements of the NASDAQ Stock Market. The Nominating and Corporate Governance Committee makes recommendations to the Board regarding nominees to be submitted to our shareholders for election at each annual meeting of shareholders, selects candidates for consideration by the full Board to fill any vacancies on the Board, and oversees all of our corporate governance matters.
Code of Ethics
The Board of Directors adopted a code of ethics applicable to the Company’s executive officers in 2009.
Section 16(a) Beneficial Ownership Reporting Compliance
None of the officers, directors or beneficial owners of more than 10% of the Company’s common stock failed to file on a timely basis the reports required by Section 16(a) of the Exchange Act during the year ended March 31, 2012.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
Background and Compensation Philosophy
Our Compensation Committee consists of Robert J. Fanella, Zhang Wengao and Bai Junying all, independent directors. The Compensation Committee and, prior to its establishment in 2009, our Board of Directors determined the compensation to be paid to our executive officers based on our financial and operating performance and prospects, the level of compensation paid to similarly situated executives in comparably sized companies, and contributions made by the officers’ to our success. Each of the named officers will be measured by a series of performance criteria by the Board of Directors, or the compensation committee, on a yearly basis. Such criteria will be set forth based on certain objective parameters such as job characteristics, required professionalism, management skills, interpersonal skills, related experience, personal performance and overall corporate performance.
Our Board of Directors and Compensation Committee have not adopted or established a formal policy or procedure for determining the amount of compensation paid to our executive officers. The Compensation Committee makes an independent evaluation of appropriate compensation to key employees, with input from management. The Compensation Committee has oversight of executive compensation plans, policies and programs.
Our compensation program for our executive officers and all other employees is designed such that it will not incentivize unnecessary risk-taking. The base salary component of our compensation program is a fixed amount and does not depend on performance. Our cash incentive program takes into account multiple metrics, thus diversifying the risk associated with any single performance metric, and we believe it does not incentivize our executive officers to focus exclusively on short-term outcomes. Our equity awards are subject to vesting to align the long-term interests of our executive officers with those of our stockholders.
Elements of Compensation
We provide our executive officers with a base salary and certain bonuses to compensate them for services rendered during the year. Our policy of compensating our executives with a cash salary has served us well. Because of our history of attracting and retaining executive talent, we do not believe it is necessary at this time to provide our executives equity incentives, or other benefits in order for us to continue to be successful, apart from the common stock award granted to our directors as described below.
The annual compensation for Yan Tinghe and Li Chuanming for the year ended March 31, 2012 was $46,924 and $31,283 respectively. All such amounts were paid in cash. The base salary reflects each executive’s skill set and the market value of that skill set as determined by our Board of Directors and/or our executive officers. No compensation was paid to the independent directors during the fiscal year ended March 31, 2012.
There were no stock options acquired by the executive officers during the year ended March 31, 2012.
SUMMARY COMPENSATION TABLE
The following table sets forth all compensation awarded to, earned by, or paid by the Company and its subsidiaries to our Chief Executive Officer and Chief Financial Officer, during the past three fiscal years. There were no executive officers whose total salary and bonus for the fiscal year ended March 31, 2012 exceeded $100,000.
Remuneration of Directors
There were 22,222 shares of common stock compensation to the independent directors for the year ended March 31, 2012. The total amount of the compensation in the form of issuing shares of common stock to the independent directors was $11,111 for the year ended March 31, 2012.
The Board of Directors agreed to issue to Dr. Bai Junying and Zhang Wengao, upon commencement of their service in 2009 and on each anniversary of his commencement date, common shares with a market value equal to $10,000 cash plus $25,000 in the form of restricted shares of common stock.
The Board of Directors agreed to issue to Mr. Robert J. Fanella, upon commencement of his service in 2009 and on each anniversary of his commencement date, common shares with a market value equal to $15,000 cash plus $40,000 in the form of restricted shares of common stock.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth information known to us with respect to the beneficial ownership of our 73,868,110 outstanding shares of common stock as of June 29, 2012 regarding the following:
Except as otherwise indicated, we believe that the beneficial owners of the common stock listed below have sole voting power and investment power with respect to their shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission.
* Indicate less than 0.01%
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Our Chairman and Chief Executive Officer, Yan Tinghe, was the principal owner of Shandong Yong Chun Tang (“Shandong YCT”). Since January 2007, the exclusive business activity of Shandong Spring Pharmaceutical has been the distribution of products manufactured by Shandong YCT. In addition, Shandong YCT contributed the initial funds for the development of our manufacturing facility. During the year ended March 31, 2010, Shandong Spring Pharmaceutical collected loans receivable of $2,075,549 from Shandong YCT and Changqing Paper Co., Ltd., a company owned by Mr. Yan Tinghe. Following of such payments, there was no outstanding loans receivable from Shandong YCT and Changqing Paper Co., Ltd..) Mr. Yan does not own any Shandong YCT‘s shares after transferring all of his shares on December 16, 2009.
Other than the aforesaid relationship, neither Yan Tinghe nor Zhang Jirui has engaged in any transaction with China YCT International Group or Shandong Spring Pharmaceutical during the past two fiscal years that had a transaction value in excess of $60,000.
The following members of our Board of Directors are independent, as “independent” is defined in the rules of the NASDAQ Stock Market: Robert J. Fanella, Dr. Bai Junying and Zhang Wengao.
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES
GZTY CPA GROUP, LLC billed $88,000 to the Company for professional services rendered for the audit of fiscal year ending on March 31, 2012 financial statements .
GZTY CPA GROUP, LLC billed $0 to the Company during fiscal year ending March 31, 2012 for assurance and related services that are reasonably related to the performance of the fiscal 2012 and fiscal 2012 audits.
GZTY CPA GROUP, LLC billed $0 to the Company during fiscal 2011 for professional services rendered for tax compliance, tax advice and tax planning.
Friedman LLP billed $0 to the Company during fiscal 2010 for professional services rendered for tax compliance, tax advice and tax planning.
All Other Fees
GZTY CPA GROUP, LLC billed $0 to the Company in fiscal 2011 for services not described above.
Friedman LLP billed $0 to the Company during fiscal 2010 for services not described above.
It is the policy of the Company that all services other than audit, review or attest services must be pre-approved by the Board of Directors. No such services have been performed by GZTY CPA GROUP, LLC or Friedman LLP during the years of ending on March 31, 2011 and 2010.
ITEM 15. EXHIBITS
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this Report has been signed below by the following persons, on behalf of the Registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of:
China YCT International Group Inc.
We have audited the consolidated balance sheet of China YCT International Group Inc. (the “Company”) as of March 31, 2012 and 2011, and the related statements of operations, stockholders’ equity and cash flows for the periods then ended. The management of China YCT International Group Inc. is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China YCT International Group Inc. as of March 31, 2012 and 2011, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
CHINA YCT INTERNATIONAL GROUP, INC.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDEDMARCH 31, 2012 AND 2011
Table of Contents
CHINA YCT INTERNATIONAL GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
See Notes to Consolidated Financial Statements
CHINA YCT INTERNATIONAL GROUP, INC.
See Notes to Consolidated Financial Statements
CHINA YCT INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
See Notes to Consolidated Financial Statements
CHINA YCT INTERNATIONAL GROUP, INC.
See Notes to Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND PRINCIPAL ACTIVITIES
China YCT International Group, Inc. (“China YCT”) was incorporated in the State of Florida, in the United States (the “US”) in January 1989. China YCT principally operates through the following directly owned subsidiaries: Landway Nano Bio-Tech, Inc. (100% owned), incorporated in Delaware, in the United States, and Shandong Spring Pharmaceutical Co., Ltd. (“Shandong Spring”) (100% owned), incorporated in the People’s Republic of China (“PRC”). China YCT International Group, Inc. and its subsidiaries are collectively referred to as the “Company.”
China YCT, through its wholly owned subsidiary, Shandong Spring, is engaged in the business of developing, manufacturing and marketing its own medicine from gingko extract, and other dietary supplement products in the PRC.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).
Principles of consolidation
The consolidated financial statements include the financial statements of China YCT, Landway Nano and its wholly owned subsidiary, Shandong Spring. All inter-company transactions and balances are eliminated in consolidation.
Use of estimates
The preparation of financial statements in conformity with US GAAP requires management 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, as well as the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Significant accounting estimates reflected in the Company’s consolidated financial statements include: the valuation of inventory, the estimated useful lives and impairment of property, equipment, and intangible assets.
Cash and cash equivalents
For the purposes of the statement of cash flow, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
The Company recognizes as accounts receivable any products shipped where payments have not been rendered. As of March 31, 2011, the Company considers all its accounts receivable to be collectable and no provision for doubtful accounts has been made in the consolidated financial statements.
Inventory is primarily composed of raw materials and packing materials for manufacturing, work in process, and finished goods. Inventories are valued at the lower of cost or market with cost determined on a weighted average basis. Management compares the cost of inventory with the market value and an allowance is made for writing down the inventory to its market value, if lower than cost.
Property and equipment
Property and equipment are stated at cost. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and locations for its intended use. Depreciation is calculated using the straight-line method over the following useful lives:
Expenditures for maintenance and repairs are charged to expense as incurred. Additions, renewals and betterments are capitalized.
All land in the PRC is owned by the government and cannot be sold to any individual or company. However, the government may grant a “land use right” for occupying, developing and using land. The Company records land use rights obtained as intangible assets at cost, which is amortized evenly over the grant period of 50 years.
In March 2010, the Company purchased one patent from Shandong YCT Corp. The patent is the Company’s exclusive right to use an aglycone type and purification method of biotransformation in the gingko product manufacturing process for a period of 20 years from the patent application date. The patent was recorded at cost when purchased, and is being amortized over the shorter of its remaining legal life, 16.5 years, or its useful life, on a straight-line basis.
On February 28, 2011, the Company acquired U.S. patent No. 6,475,531 B1 titled “Safe Botanical Drug for Treatment and Prevention of Influenza and Increasing Immune Function” through a purchase agreement with L.Y. Research Corp., a New Jersey Corporation.
According to the purchase agreement between the Company and L.Y. Research Corp., the Company acquired the patent from L.Y. Hong Kong Biotech Limited (LYHK), L.Y. Research Corp’s wholly owned subsidiary incorporated in Hong Kong, China, in exchange for 44,254,952 shares of common stock at the acquisition date. In addition, 11,063,968 shares of common stock became issuable to the seller upon the occurrence of the quotation of the Company’s common stock on the OTCBB on September 9, 2011. The consideration of $32,748,665 at inception was calculated by multiplying 44,254,952 common stock shares by the Company’s quoted stock price of $0.74 per share on February 28, 2011. It is being amortized over the shorter of its remaining legal life, 9.9 years, or its useful life, on a straight-line basis. An additional consideration of $2,765,992 was calculated by multiplying 11,063,968 common stock shares by the Company’s quoted price of $0.25 per share on September 9, 2011 when the Company’s stock was successfully listed on the OTCQB and the L.Y. Research Corp was entitled to the 11,063,968 shares of the common stock.
At the year ended on March 31, 2012, the Company reassessed the value of this patent for an impairment analysis. Per the note indicated below, the Company determined that the patent’s value was impaired, therefore, wrote off the net carrying value of the patent as of March 31, 2012.
In October 2011, two patents were transferred to the Company based on a purchase agreement signed with Jining Tianruitong Technology development Company, Limited on October 26, 2010; which are “Treatment to ischemic encephalopathy and its preparation method” (ZL200510045001.9) and “Chinese herbal medicine compound to treat renal insufficiency and its preparation” (ZL200710013301.8). The patents were recorded at cost when purchased, and are being amortized over the shorter of the remaining legal lives, 13.75 years and 14.95 years, respectively; or their useful lives, on a straight-line basis.
The Company’s revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) 104, included in the Codification as ASC 605, Revenue Recognition. Sales revenue is recognized on the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist, and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits.
Revenue from the sale of goods or services is recognized at the time that goods are delivered or services are rendered. Receipts in advance for goods to be delivered or services to be rendered in a subsequent period are carried forward as unearned revenue.
Impairment of long-lived assets
The Company reviews and evaluates the net carrying value of its long-lived assets at least annually, or upon the occurrence of other events or changes in circumstances that indicate that the related carrying amounts may not be recoverable. Per ASC 360-10-35-21, a long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Per ASC 360-10-35-17, an impairment loss shall be recognized only if the carrying amount of the long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group).
The Company reviewed the U.S. patent for impairment due to the indication that the chance of the contingent financing target not being met at October 21, 2012 was changed to high and thereby, the patent would be subject to return with the Company obligated to repurchase the shares issued. The Company determined that the undiscounted cash flow expected to result from the use and eventual disposition of the U.S. Patent was zero as of March 31, 2012. Therefore, the fair value of the U.S. Patent was zero as of March 31, 2012 as calculated per the net present value of the cash flow. The carrying value of the patent should be written off as impairment. Total impairment recognized as included in other expenses in the year ended March 31, 2012 amounted to $31,680,488.
The Company accounts for income tax under the asset and liability method as stipulated by ASC 740 formerly Statement of Financial Accounting Standards (”SFAS”) No. 109, “ Accounting for Income Taxes ”, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of the events that have been included in the financial statements or tax returns. Deferred Income taxes are recognized for all significant temporary differences between tax and financial statements bases of assets and liabilities. Valuation allowances are established against net deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized. The Company didn’t recognize any deferred tax amount at December 31, 2011 as well as March 31, 2011.
China YCT International, Inc. is a holding company of Shandong Spring Pharmaceutical Co., Ltd and does not have any operating activities. Although the contract of the acquisition of the US patent was executed by the holding company, in substance, the patent was acquired and is used by the Company’s operating entity in China. For the same reason, the amortization of the patent was a deduction to the Chinese operating entity’s tax liability. Therefore, the Company does not incur any US income tax liabilities.
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 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.
The Company recorded net VAT payable in the amount of $225,223 and $489,962 as of March 31, 2012 and 2011.
Research and development
Research and development costs are related primarily to the Company’s development of its intellectual property. 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 are classified as plant and equipment and depreciated over their estimated useful lives.
The research and development expense for the years ended March 31, 2012 and 2011 was $848,753 and $280,385, respectively.
Advertising costs for newspaper and television are expensed as incurred. The Company incurred advertising costs of $548,995 and $170 for the years ended March 31, 2012 and 2011, respectively.
Mailing and handling costs
The Company accounts for mailing and handling fees in accordance with the FASB Accounting Standards Codification (“ASC”) 605-45 (Emerging Issues Task Force (EITF) Issue No. 00-10, Accounting for Shipping and Handling Fees and Costs). The Company includes shipping and handling fees billed to customers in net revenues. Amounts incurred by the Company for freight are included in cost of goods sold. For the years ended March 31, 2012 and 2011, the Company incurred $664,706 and $1,342,183 mailing and handling costs, respectively.
Stock Based Compensation
The Company measures compensation expense for its non-employee stock-based compensation under FASB ASC 718. The fair value of the stock issued is used to measure the transaction, as this is more reliable than the fair value of the services received. Fair value is measured as the value of the Company’s common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty’s performance is complete. The fair value of the equity instrument is charged directly to compensation expense.
Net income (loss) per share (“EPS”)
Basic EPS excludes dilution and is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (convertible preferred stock, forward contracts, warrants to purchase common stock, contingently issuable shares, common stock options and warrants and their equivalents using the treasury stock method) were exercised or converted into common stock. There were 31,610,679 shares common stock equivalents available for dilution purposes as of March 31, 2012 and 2011, respectively.
Risks and uncertainties
The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Fair Value of Financial Instruments
For certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued liabilities and short-term debt, the carrying amounts approximate their fair values due to their short maturities.
As of March 31, 2012, the Company did not identify any financial instruments that are required to be presented on the balance sheet at fair value other than those whose carrying amounts approximate fair value due to their short maturities.
Foreign currency translation
The accounts of the Company’s Chinese subsidiary are maintained in RMB and the accounts of the U.S. parent company are maintained in USD. The accounts of the Chinese subsidiary were translated into USD in accordance with Accounting Standards Codification (“ASC”) Topic 830 “Foreign Currency Matters,” with the RMB as the functional currency for the Chinese subsidiary. According to Topic 830, all assets and liabilities were translated at the exchange rate on the balance sheet date; stockholders’ equity is translated at historical rates and statement of income items are translated at the weighted average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with ASC Topic 220, “Comprehensive Income.” Gains and losses resulting from the translations of foreign currency transactions and balances are reflected in the statements of income.
Translation adjustments resulting from this process amounted to $3,341,156 and $2,041,293 and as of March 31, 2012 and 2011, respectively.
The following exchange rates were adopted to translate the amounts from RMB into United States dollars (“USD$”) for the respective periods:
Recent accounting pronouncements
In June 2011, FASB issued an amendment to the FASB Codification Topic 220 – Presentation of Comprehensive Income. The objective of this Update is to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. Early adoption is permitted, and the amendments do not require any transition disclosures. The Company decided to adopt the amendment for the year starting with June 1, 2012. The Company does not expect the adoption of this pronouncement to have a significant impact on tis financial condition or results of operations.
In May 2011, FASB issued an amendment to FASB Codification Topic 820 - Fair Value Measurement. The amendments in this Update apply to all reporting entities that are required or permitted to measure or disclose the fair value of an asset, a liability, or an instrument classified in a reporting entity's shareholders' equity in the financial statements. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820. Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Nonpublic entities may apply the amendments in this Update early, but no earlier than for interim periods beginning after December 15, 2011. The Company does not expect any significant impact in tis financial statements when it is adopted for the year starting from June 1, 2012. The Company does not expect the adoption of this pronouncement to have a significant impact on tis financial condition or results of operations.
In April 2011, FASB issued an amendment to FASB Codification Topic 310 – Receivables: A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendment requires that, in evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both exist: (1) the restructuring constitutes a concession. (2) The debtor is experiencing financial difficulties. The amendments to Topic 310 clarify the guidance on a creditor's evaluation of whether it has granted a concession as well as on a creditor's evaluation of whether a debtor is experiencing financial difficulties. In addition, the amendments to Topic 310 clarify that a creditor is precluded from using the effective interest rate test in the debtor's guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring. The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. As entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies-Loss Contingencies. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of disclosures about Troubled Debt Restructurings in Update No. 2010-20, for interim and annual periods beginning on or after June 15, 2011. For nonpublic entities, the amendments in this Update are effective for annual periods ending on or after December 15, 2012, including interim periods within those annual periods. Early adoption is permitted for public and nonpublic entities. A nonpublic entity may early adopt the amendments for any interim period of the fiscal year of adoption. A nonpublic entity that elects early adoption should apply the provisions of this Update retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The Company decides to adopt the amendment for the year starting from June 1, 2012, and the Company does not expect the adoption of this pronouncement to have a significant impact on its financial condition or results of operations.
NOTE 3 – PREPAID ACCOUNTS
The prepaid account in the amount of $20,887 is a prepayment to Shandong YCT for purchase of its health products.
NOTE 4 - INVENTORY
Inventory consists of finished goods, work-in-process, and raw materials. No allowance for inventory was made for the years ended March 31, 2012 and 2011.
The components of inventories as of March 31, 2012 and 2011 were as follows:
NOTE 5 – PLANT, PROPERTY AND EQUIPMENT, NET
The components of property and equipment as of March 31, 2012 and 2011 were as follows:
The depreciation expense for the years ended March 31, 2012 and 2011 was $480,474 and $236,040, respectively.
NOTE 6 – CONSTRUCTION IN PROGRESS
Construction in progress represents direct costs of construction or acquisition and design fees incurred for the Company’s new plant and equipment. Capitalization of these costs ceases and the construction in progress is transferred to plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. No depreciation is made until construction is completed and put into use.
NOTE 7 - MAJOR CUSTOMER AND VENDOR
In the year ended March 31, 2012, the Company mainly sells products to individual retail customers through eight major distributors.
The Company purchases its products from Shandong Yong Chun Tang (“Shandong YCT”) according to the contract signed on December 26, 2006 between the Company and Shandong Yuan Chun Tang. For the year ended March 31, 2012, the purchase from the three major vendors, including Shandong YCT, was $17,315,268, representing 99.5% of the Company’s annual total purchase.
NOTE 8 - INTANGIBLE ASSETS, NET
The intangible assets of the Company consist of land use right and purchased patents.
Net land use right and purchased patents were as follows:
The amortization expense of land use right for the years ended March 31, 2012 and 2011 was $38,231 and $35,764, respectively.
The amortization expense of patent for the years ended March 31, 2012 and 2011 was $4,539,304 and $584,596, respectively.
The U.S. Patent was written off in the year ended March 31, 2012 due to impairment. The total impairment recognized was $31,680,487. Refer to Note 1 above.
NOTE 9 - TAX PAYABLE
Tax payable at March 31, 2012 and 2011 were as follows:
NOTE 10 - INCOME TAXES
Shandong Spring Pharmaceutical Co., Ltd is subject to the Enterprise income tax (“EIT”) at a statutory rate of 25%.
The expense associated with the recognition of a contingent obligation under ASC 480-10-25-8, is not tax deductible in China. Per ASC 740-10-25-3A, “An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture that is essentially permanent in duration. ” Therefore, the tax difference in the amount of $1,382,973 ($5,531,892 x 25% tax rate) caused by expense recognized at our book but not in the Chinese tax return at March 31, 2012 will be a permanent difference. In addition, the loss from impairment of the US patent is not tax deductible in China. Therefore, the tax difference in the amount of $7,920,122 ($31,680,487 x 25%) caused by loss recognized at our book but not in the Chinese tax return at March 31, 2012 will be a permanent difference as well.
For the years ended March 31, 2012 and 2011, Shandong Spring Pharmaceutical Co., Ltd. recorded income tax provisions of $2,955,424 and $3,410,265, respectively.
NOTE 11 – OTHER LIABILITY:
On February 28, 2011, the Company entered into a purchase agreement with L.Y. Research Corp., a New Jersey corporation (“LY Research”), which purchase agreement was amended and restated on August 15, 2011 and amended on October 21, 2011 (the “Purchase Agreement). Pursuant to the terms of the Purchase Agreement, the Company acquired a patent (the “LY Patent”) from L.Y. (HK) Biotech Limited, a wholly owned company by L.Y. Research Corp., in exchange for 44,254,952 shares of the Company’s common stock at inception date. In addition, there will be two contingent considerations of total 31,610,544 shares to be issued upon the occurrences of some pre-determined events. The first contingent consideration of 11,063,968 shares should be issued upon the Company’s stock being listed on OTCBB or OTCQB.
Because the obligation to issue additional shares to LY Research Cop is upon the occurrence of certain predetermined events, the liability is recognized when the contingencies are resolved. On September 9, 2011, LY Research Corp became entitled to the issuance of 11,063,968 shares of common stock upon the occurrence of the quotation of the Company’s common stock on the OTCQB. Therefore, the liability to issue 11,063,968 shares of common stocks should be recorded for the quarter ended September 30, 2011 and forward.
The amount of the liability is calculated by multiplying the 11,063,968 shares of stocks by the quoted average stock price on September 9, 2011. The stock price per share on September 9, 2011 was $0.25. The calculation of the liability to issue 11,063,968 shares of the common stocks is as followed:
Other Liability $2,765,992 = 11,063,968 shares x $0.25
We recognized $2,765,992 as an “Other Liability” with an offsetting debit to record addition in the US patent, for the quarter ended September 30, 2011 and forward.
NOTE 12 – DERIVATIVE LIABILITY
On February 28, 2011, the Company entered into a purchase agreement with L.Y. Research Corp., a New Jersey corporation (“LY Research”); and the purchase agreement was amended and restated on August 15, 2011 (the “Purchase Agreement”). Pursuant to the terms of the Purchase Agreement, the Company acquired a patent (the “LY Patent”) from L.Y. (HK) Biotech Limited, a wholly owned company by L.Y. Research corp., in exchange for 44,254,952 shares of common stock at the acquisition date. In addition, 11,063,968 shares of common stock will be issued to the seller upon the occurrence of the quotation of the Company’s common stock on the OTCQB or OTCBB; and 20,546,711 shares will be issued to the seller upon the receipt by the Company of a minimum of $20,000,000 in gross proceeds from a debt or equity financing, or a series of debt and/or equity financings (the “Financing”); or upon the quotation of its common stock on NASDAQ or a major stock exchange located outside of the United States (collectively, “Events”). On September 9, 2011, the Company’s stock became quoted at OTCQB; therefore, 11,063,968 shares of common stock became issuable on September 9, 2011.
On October 21, 2011, the Purchase Agreement was further amended to state that if either of the Events should not occur within one year from October 21, 2011; the shares issued pursuant to the Purchase Agreement shall be returned to the Company and the LY Patent shall be returned to LY Research and the Purchase Agreement, as amended, shall be cancelled and of no further force or effect. Because the Company is required to acquire the issued shares by returning the US patent if the predetermined financing event is not met, the term meets the definition under the ASC 480-10-25-8, “Obligations to Repurchase Issuer’s Equity Shares by Transferring Assets”. Per ASC 480-10-25-8, the obligation to repurchase an issuer’s own shares by transferring asset should be recognized as a liability at inception.
In addition, because the acquisition is not a certain future event as of October 21, 2011 and March 31, 2012, the Company considers the contingent obligation to repurchase its own shares as a written put option. Per ASC 480-10-30-7, all financial instruments, recognized under the guidance in Section 480-10-25, other than certain physically settled forward purchase contracts, shall be measured initially at fair value.
The fair value of the obligation on October 21, 2011 should be the market price of the shares that the company is obligated to repurchase if the financing is failing and weighted by the probability of the Company failing to meet the financing target of $20,000,000 or achieving the listing on NASDAQ or a major foreign stock exchange. On October 21, 2011, the company had issued and was obligated to issue 55,318,920 common shares to Dr. Liu. Therefore, the number of potential shares needed to repurchase was 55,318,920 on October 21, 2011 and March 31, 2012.
Determination of the market price of the shares:
Per ASC 820-10-20 “Readily Determinable Fair Value”, “ The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by Pink Sheets LLC. Restricted stock meets that definition if the restriction terminates within one year. ” Because the sales price of the company’s common stock shares was currently available in the over-the-counter market, the fair value of the company’s stock is readily determinable and is the sales price of the stock on October 21, 2011. Because the company’s common stock was not traded on October 21, 2011, the closest quotations were the prices on October 23, 2011, which was $0.40/share; therefore, the fair values per share for were $0.40 for October 21, 2011. As of March 31, 2012, the most recent quoted CYIG stock price was $0.10 (at February 21, 2012).
Determination of the probability of the Company failing to meet the predetermined event:
The Company determined that on October 21, 2011, the chance that the final contingency would not be met, thereby triggering our obligation to repurchase those shares, was around 15% based on the reasons described in its amended 10Q for the quarter ended December 31, 2011. Therefore, the Company recognized $3,319,135 as a derivative liability as of December 31, 2011.
However, during the month of March 2012, the Company was informed by its placement agent that it was highly unlikely that they could achieve the $20M financing by October 21, 2012. Therefore, the Company reassessed the probability of failing to achieve the financing target by October 21, 2012 to be 100% as of March 31, 2012.
The fair value of the derivative obligation at March 31, 2012 was calculated as follows:
$5,531,892 = 55,318,920 x $0.10/share x 100%
The fair value of the derivative obligation was increased by $2,212,757 for the period from October 21, 2011 to March 31, 2012 as a result of the CYIG stock price change and the increased probability of failing to achieve the financing target by October 21, 2012.
NOTE 13 - STOCKHOLDERS’ EQUITY
Stock Issued to Independent Directors
The total amount of the compensation in the form of issuing shares of common stocks to the independent directors was $22,222 and $25,706 for the years ended March 31, 2012 and 2011, respectively.
Stock Issued for Acquisition of Patent
On February 28, 2011, the Company issued 44,254,952 shares of common stocks, as a partial of total considerations to acquire a U.S. patent No. 6,475,531 B1 titled “Safe Botanical Drug for Treatment and Prevention of Influenza and Increasing Immune Function”) from L.Y. Research Corp., a New Jersey Corporation. The shares of the common stocks were valued at the average closing market price on February 28, 2011 in the amount of $32,748,665.
Subsidiaries incorporated in China are required to make appropriations to reserve funds, based on after-tax net income determined in accordance with generally accepted accounting principles of the People’s Republic of China (“PRC GAAP”). Effective January 1, 2006, the Company is only required to contribute to one statutory reserve fund at 10% of net income after tax per annum, and any contributions are not to exceed 50% of the respective companies’ registered capital.
As of March 31, 2012, the Company appropriated $956,633 to the statutory reserve.