XNAS:SKBI Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
   
  For the quarterly period ended March 31, 2012

 

  or
   
  o 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 001-34394

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY

(Exact name of small business issuer as specified in its charter)

 

Nevada 33-0901534
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)

 

4/F Building B, Chuangye Square, No. 48 Keji Road,

Gaoxin District, Xi’an Province, P.R. China

(Address of principal executive offices and zip code)

 

(8629) 8819-3188

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x       No  o

 

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  x    No  o

 

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  o Accelerated Filer  o
  Non-accelerated filer  o Smaller Reporting Company  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).      Yes  o     No  x

  

As of May 10, 2012, the Registrant had 7,604,800 shares of common stock outstanding.

 

 
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY

 

FORM 10-Q

 

INDEX

 

     Page No.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS   3
     
PART I.  FINANCIAL INFORMATION    
       
Item 1. Condensed Consolidated Financial Statements   4
       
  Condensed Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011   4
       
  Condensed Consolidated Statements of Income and Comprehensive Income for the Three Months Ended March 31, 2012 and 2011 (unaudited)   5
       
  Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (unaudited)   6
       
  Condensed Consolidated Statements of Shareholders’ Equity as of March 31, 2012 (unaudited) and December 31, 2011   7
       
  Notes to the Condensed Consolidated Financial Statements (unaudited)   8
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   24
       
Item 4. Controls and Procedures   30
       
PART II.  OTHER INFORMATION    
       
Item 6. Exhibits   31
       
SIGNATURES   33

 

2
 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words “estimate,” “anticipate,” “believe,” “expect,” or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this Report, including the matters set forth under the captions “Risk Factors” and in our other SEC filings. These risks and uncertainties could cause our actual results to differ materially from those indicated in the forward-looking statements. We undertake no obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments.

 

Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the heading “Risks Relating to Our Business” below, as well as those discussed elsewhere in this Quarterly Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We file reports with the SEC. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.

 

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

 

3
 

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 

   March 31,   December 31, 
   2012
(Unaudited)
   2011 
ASSETS          
CURRENT ASSETS:          
Cash  $9,386,584   $7,048,968 
Accounts receivable, net of allowance for doubtful accounts of $480,237 (Unaudited) and $438,678 as of March 31, 2012 and December 31, 2011, respectively   5,783,831    3,391,493 
Inventories   13,962,087    14,851,159 
Deposits, prepaid expenses and other receivables   34,914,476    32,648,448 
Loans receivable   981,699    964,088 
Total current assets   65,028,677    58,904,156 
           
PLANT AND EQUIPMENT, NET   28,273,028    28,376,559 
           
CONSTRUCTION-IN-PROGRESS   9,434,227    8,839,055 
           
OTHER ASSETS:          
Long-term prepayments   1,189,788    1,512,817 
Long-term prepayments for acquisitions   652,609    569,788 
Intangible assets, net   5,610,135    5,674,206 
Total other assets   7,452,532    7,756,811 
Total assets  $110,188,464   $103,876,581 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
CURRENT LIABILITIES:          
Accounts payable  $2,046,341   $1,047,067 
Other payable and accrued expenses   6,059,237    5,274,598 
Short-term loans   7,476,480    7,366,320 
Deposits from customers   1,640,457    1,432,529 
Taxes payable   1,585,156    160,081 
Due to related parties   380,669    56,273 
Total current liabilities   19,188,340    15,336,868 
           
OTHER LIABILITIES:          
Deferred government grant   396,000    393,500 
Warrant/purchase option liability   37,800    43,400 
Total other liabilities   433,800    436,900 
Total liabilities   19,622,140    15,773,768 
           
COMMITMENTS AND CONTINGENCIES          
           
SHAREHOLDERS’ EQUITY          
Preferred stock, $0.001 par value, 50,000,000 shares authorized, No Series “A” shares authorized. 48,000,000 Series “B” shares authorized. No Series “B” shares issued and outstanding          
Common stock, $0.001 par value, 40,000,000 shares authorized, 7,161,919 shares issued and outstanding as of March 31, 2012 (Unaudited) and December 31, 2011   7,162    7,162 
Paid-in capital   35,784,378    35,784,378 
Statutory reserves   5,708,135    5,708,135 
Retained earnings   40,396,785    38,492,031 
Accumulated other comprehensive income   8,669,864    8,111,107 
Total shareholders’ equity   90,566,324    88,102,813 
Total liabilities and shareholders’ equity  $110,188,464   $103,876,581 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

4
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011

(Unaudited)

 

   Three Months Ended
 March 31,
 
   2012   2011 
         
REVENUE, net  $7,926,337   $7,086,954 
           
COST OF REVENUE   3,643,658    3,491,346 
           
GROSS PROFIT   4,282,679    3,595,608 
           
OPERATING EXPENSES:          
Research and development costs   3,654    287,472 
Selling expenses   705,616    369,404 
General and administrative expenses   1,105,435    1,294,798 
Total operating expenses   1,814,705    1,951,674 
           
INCOME FROM OPERATIONS   2,467,974    1,643,934 
           
OTHER INCOME (EXPENSE):          
Other income, net   53,760    182 
Interest income (expense), net   (153,612)   29,672 
Change in fair value of warrant/purchase option liability   5,600    735,494 
Total other income (expense), net   (94,252)   765,348 
           
INCOME BEFORE PROVISION FOR INCOME TAXES   2,373,722    2,409,282 
           
PROVISION FOR INCOME TAXES   468,968    477,450 
           
NET INCOME   1,904,754    1,931,832 
           
OTHER COMPREHENSIVE INCOME:          
Foreign currency translation adjustment   558,757    465,593 
           
COMPREHENSIVE INCOME  $2,463,511   $2,397,425 
           
EARNINGS PER SHARE:          
Basic  $0.26   $0.27 
Diluted  $0.26   $0.27 
           
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:          
Basic   7,210,256    7,166,919 
Diluted   7,210,256    7,179,309 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011
(Unaudited)

 

   Three months ended
 March 31,
 
   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $1,904,754   $1,931,832 
          
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Depreciation   343,129    332,428 
Amortization   100,373    230,922 
Provision for doubtful accounts   38,869    - 
Change in fair value of warrant/purchase option liability   (5,600)   (735,494)
Change in operating assets and liabilities          
Accounts receivable   (2,415,647)   (757,356)
Inventories   985,908    (6,826,437)
Deposits, prepaid expenses and other receivables   (2,144,356)   (2,603,343)
Accounts payable   980,926    197,277 
Other payable and accrued expenses   606,331    360,449 
Deposits from customers   199,329    14,989 
Taxes payable   1,427,655    1,566,418 
           
Net cash provided by (used in) operating activities   2,021,671    (6,288,315)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
           
Payments of long-term prepayments   -    (451,722)
Loans receivables   (11,515)   - 
Collection of loans receivables   -    7,609,000 
Purchases of plant and equipment   (54,965)   (22,275)
Purchases of intangible assets   -    (38,045)
Payments on construction-in-progress   (44,940)   (634,222)
           
Net cash (used in) provided by investing activities   (111,420)   6,462,736 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Proceeds from short-term loans   63,520    1,257,007 
Due to related parties   326,061    62,834 
Net cash provided by financing activities   389,581    1,319,841 
           
EFFECT OF EXCHANGE RATE CHANGES ON CASH   37,784    21,296 
           
INCREASE IN CASH   2,337,616    1,515,558 
           
CASH, beginning of period   7,048,968    5,887,831 
           
CASH, end of period  $9,386,584   $7,403,389 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid for interest  $152,583   $54,409 
Non-cash investing and financing activities          
Long-term prepayment transferred to construction-in-progress  $333,480   $421,843 
Construction-in-progress transferred to property, plant and equipment  $3,633   $- 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

 

                       Accumulated     
               Retained earnings   other     
   Common stock   Paid-in   Statutory       comprehensive     
   Shares   Amount   capital   reserves   Unrestricted   income   Total 
BALANCE, December 31, 2011   7,161,919   $7,162   $35,784,378   $5,708,135   $38,492,031   $8,111,107   $88,102,813 
                                    
Foreign currency translation   -    -    -    -    -    558,757    558,757 
Net income   -    -    -    -    1,904,754    -    1,904,754 
                                    
BALANCE, March 31, 2012   7,161,919   $7,162   $35,784,378   $5,708,135   $40,396,785   $8,669,864   $90,566,324 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

7
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(Unaudited)

 

Note 1 - ORGANIZATION

 

Organization and description of business

 

Skystar Bio-Pharmaceutical Company (“Skystar” or the “Company”) was incorporated in Nevada on September 24, 1998. Since its acquisition on November 7, 2005 of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), a Cayman Islands company, the Company has been engaged in the research, development, production, marketing, and sales of veterinary healthcare and medical care products. All current operations of the Company are in the People’s Republic of China (“China” or the “PRC”).

 

All of the Company’s operations are carried out by Xi’an Tianxing Bio-Pharmaceutical Co., Limited (“Xi’an Tianxing”), a PRC joint stock company that the Company controls through contractual arrangements originally between Skystar Cayman and Xi’an Tianxing. On March 10, 2008, the Company entered into a series of agreements transferring all of the rights and obligations of Skystar Cayman under the contractual arrangements to Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), a PRC company. Sida is the wholly owned subsidiary of Fortunate Time International Limited (“Fortunate Time”), a Hong Kong company and wholly owned subsidiary of Skystar Cayman. Xi’an Tianxing also has a wholly owned subsidiary, Shanghai Siqiang Biotechnological Co., Ltd. (“Shanghai Siqiang”), a PRC company.

 

As a result of these contractual arrangements, which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi’an Tianxing as a variable interest entity (“VIE”) under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates Xi’an Tianxing’s results, assets, and liabilities.

 

On September 18, 2009, Skystar Bio-Pharmaceutical Inc. (“Skystar California”) was incorporated in California and became a wholly owned subsidiary of Skystar. On December 20, 2010, we dissolved Skystar California.

 

On April 21, 2010, Kunshan Sikeda Biotechnology Co., Ltd. (“Kunshan Sikeda”) was incorporated in Kunshan, Jiangsu province, China with registered capital of RMB 500,000, of which Xi’an Tianxing and Sida each contributed RMB 250,000. Kunshan Sikeda is jointly owned by Xi’an Tianxing and Sida.

 

On May 7, 2010, Fortunate Time formed Skystar Biotechnology (Kunshan) Co., Limited (“Skystar Kunshan”) in Kunshan, Jiangsu province, China with registered capital of $15,000,000, of which $2,250,000 was paid by Fortunate Time in cash, and of which the remaining $12,750,000 is required to be invested in the future. Kunshan was formed in connection with an acquisition of assets to meet part of the registered capital requirements, and was intended to be a micro-organism manufacturing facility for the Company once the acquisition was complete. The asset acquisition was completed in September 2011, and the Company is in the process of transferring the assets acquired to meet part of the registered capital requirements.

 

On August 11, 2010, Sida became the parent company of Skystar Biotechnology (Jingzhou) Co., Limited (“Skystar Jingzhou”), a company established in Jingzhou, Hubei Province, China on February 5, 2010, with registered capital of approximately $4.1 million (RMB 26,000,000), of which approximately $3.7 million (RMB 23,480,000) has been paid. The remaining approximately $399,168 (RMB 2,520,000) is required to be invested by April 6, 2012. As of the date of this report, the Company has not made this investment.  Skystar Jingzhou is currently in the process of getting the government's approval and will fulfill the requirement of remaining capital of $399,168 (RMB 2,520,000) thereafter. The company expects the process will be completed by the end of the 2nd quarter of 2012.

 

On March 15, 2011, Xi’an Tianxing formed Xi’an Sikaida Bio-products Co., Ltd. (“Xi’an Sikaida”) with registered capital of approximately $1,584,000 (RMB 10,000,000) paid by Xi’an Tianxing.

 

Hereinafter, Skystar, Skystar Cayman, Fortunate Time, Sida, Xi’an Tianxing, Skystar Kunshan, Kunshan Sikeda, Skystar Jingzhou, Shanghai Siqiang, and Xi’an Sikaida are sometimes collectively referred to as the “Company.”

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles (“U.S. GAAP”) applicable to interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (which include all significant normal and recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. The accompanying results of operations are not necessarily indicative of the operating results that may be expected for the entire year ending December 31, 2012. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes thereto of the Company, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the Securities and Exchange Commission (“SEC”).

 

8
 

 

Principles of consolidation

 

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiaries, and its VIEs.  All significant inter-company transactions and balances between the Company, its subsidiaries, and its VIEs have been eliminated in consolidation.

 

Use of estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The level of uncertainty in estimates and assumptions increases with the length of time until the underlying transactions are completed. Actual results may differ from these estimates in amounts that may be material to the consolidated financial statements and accompanying notes. Significant estimates and assumptions made by the Company are used for, but not limited to the allowance for uncollectible receivables, obsolescence reserve against the inventory, tax provision and the fair value for derivatives instruments.

 

Foreign currency translation

 

The Company uses the United States dollar (“U.S. dollar”) for financial reporting purposes and the Chinese Renminbi (“RMB”) as its functional currency. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency, being the primary currency of the economic environment in which their operations are conducted.

 

The Company translates the subsidiaries’ and VIEs’ assets and liabilities into U.S. dollars using the applicable exchange rates prevailing at the balance sheet dates, and the statements of income and comprehensive income and cash flows are translated at average exchange rates during the reporting period. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the subsidiaries’ and VIEs’ financial statements are recorded as accumulated other comprehensive income.

 

The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China.

 

Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents, and signed contracts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

 

Fair values of financial instruments

 

The accounting standards regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires fair value disclosures of those financial instruments.  This accounting standard defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosures requirements for fair value measures.  Certain current assets and current liabilities are financial instruments.  Management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, their current interest rates are equivalent to interest rates currently available.  The three levels of valuation hierarchy are defined as follows:

  

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

 

Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

  

Outstanding warrants and purchase options do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants and purchase options using the Black-Scholes Option Pricing Model (“Black-Scholes Model”) using the following assumptions:

 

9
 

 

   Warrants – (1)   Purchase Options – (2) 
   March 31,
(2012
   December 31,
2011
   March 31,
2012
   December 31,
2011
 
Stock price  $-   $2.74   $2.69   $2.74 
Exercise price  $-   $5.00   $8.11   $8.11 
Annual dividend yield   -    -    -    - 
Expected term (years)   -    0.16    2.25    2.50 
Risk-free interest rate   -    0.01%   0.33%   0.25%
Expected volatility   -    68%   65%   64%

 

(1)  As of December 31, 2011, 34,230 warrants with an exercise price of $5.00 were outstanding. All of these warrants expired on February 28, 2012. As of March 31, 2012, none of these warrants was outstanding.

 

(2) As of December 31, 2011, 140,000 purchase options with an exercise price of $8.11 were outstanding. As of March 31, 2012, 140,000 of these options were outstanding.

 

Expected volatility is based on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the term of the warrants. The Company believes this method produces an estimate that is representative of future volatility over the expected term of these warrants and purchase options. The Company has no reason to believe future volatility over the expected remaining life of these warrants and purchase options is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants and purchase options. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the warrants and purchase options.

 

As required by the FASB’s accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Depending on the product and the terms of the transaction, the fair values warrant/purchase option liability were modeled using a series of techniques, including closed-form analytic formula, such as the Black-Scholes Model, which does not entail material subjectivity because the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.

 

The fair value of the 140,000 purchase options outstanding as of March 31, 2012 was determined using the Black-Scholes Model, utilizing level 2 inputs, and recorded the change in earnings. As a result, the warrant/purchase option liability is carried on the consolidated balance sheets at fair value. The Company recognized gains of $5,600 and $735,494 for the three months ended March 31, 2012 and 2011, respectively.

 

The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2012:

 

   Carrying
Value at
March 31,
   Fair Value Measurement at
March 31, 2012
 
   2012   Level 1   Level 2   Level 3 
Purchase option liability (unaudited)  $37,800   $   $37,800   $ 
                     

 

Below is the reconciliation for the warrant/purchase option liability changes from December 31, 2011 to March 31, 2012.

 

Balance, December 31, 2011   43,400 
Change in fair value   (5,600)
Balance, March 31, 2012  $37,800 

 

The net carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximate their fair value due to the short-term nature of these instruments as well as the variable interest rate for short-term debt.

 

In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company is required to record assets and liabilities at fair value on a non-recurring basis.  Generally, assets are recorded at fair value on a non-recurring basis as a result of impairment charges.  For the three months ended March 31, 2012, there were no impairment charges.     

 

Revenue recognition

 

Revenue of the Company is primarily derived from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected on these consolidated financial statements as sales returns historically have been insignificant.

 

There are two types of sales upon which revenue is recognized:

 

a. Credit sales: revenue is recognized when the products have been delivered to the customers.

 

b. Full payment before delivering: Cash received is recorded as “deposits from customers” and revenue is recognized when the products have been delivered to the customers.

 

10
 

 

Shipping and handling costs related to costs of goods sold are included in selling expenses, which totaled $383,703 and $194,216 for the three months ended March 31, 2012 and 2011, respectively.

 

The Company’s revenues and cost of revenues by product line were as follows: 

 

   Three Months Ended
March 31,
 
   2012   2011 
Revenues          
Micro-organism  $3,135,040   $1,596,094 
Veterinary Medications   3,008,587    4,865,047 
Feed Additives   1,034,772    326,407 
Vaccines   747,938    299,406 
Total Revenues  $7,926,337   $7,086,954 
           
Cost of Revenues          
Micro-organism  $906,841   $494,182 
Veterinary Medications   1,792,647    2,821,906 
Feed Additives   849,884    140,866 
Vaccines   94,286    34,392 
Total Cost of Revenues   3,643,658    3,491,346 
Gross Profit  $4,282,679   $3,595,608 

 

Cash

 

Cash includes currency on hand, demand deposits with banks, and liquid investments with an original maturity of three months or less.

 

Accounts receivable and other receivables

 

Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, a bad debt percentage is estimated by management based on historical experience and current economic climate.  The resulting percentage is applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against allowance for doubtful accounts when identified.

 

Inventories

 

Inventories are stated at the lower of cost or market, as determined on a moving weighted-average basis using the first-in, first-out (FIFO) cost method. Inventories include purchases and related costs incurred in bringing the inventories to their present location and condition. Management reviews inventories for obsolescence and cost in excess of net realizable value at least annually and records a reserve against the inventory and additional cost of goods sold when the carrying value exceeds net realizable value.

 

Plant and equipment

 

Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance and repairs that do not improve or extend the useful lives of the assets are charged to operations as incurred, while renewals and betterments are capitalized. Gains and losses on disposals are included in the results of operations. Estimated useful lives of the assets are as follows:

 

  Estimated Useful Life
Buildings   10-40 years
Machinery and equipment   10 years
Computer, office equipment and furniture   5 years
Vehicles   5-10 years

 

Management assesses the carrying value of plant and equipment annually or more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management believes that, as of March 31, 2012 and December 31, 2011, there was no impairment for its plant and equipment.

 

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Construction-in-progress

 

Construction-in-progress includes direct costs of construction of a factory building. Interest incurred during the period of construction, if significant, is capitalized. All other interest is expensed as incurred. Construction-in-progress is not depreciated until such time as the asset is completed and put into service.

 

Intangible assets

 

Land use rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on the straight-line method over the contractual lease terms.  The land use right granted to the Company’s Huxian facility was for 50 years.  The land use right granted to the Company’s Jingzhou facility was 30 years. The land use right granted to the Company’s Kunshan facility was for 41 years.  

  

Technological know-how — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over estimated useful life between five to ten years that reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.  Drug approval licenses are typically granted in five year terms by the Ministry of Agriculture.

 

Impairment of Intangible assets — the Company evaluates the carrying value of intangible assets annually or more often when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of March 31, 2012 and December 31, 2011, there was no impairment of its intangible assets.

 

Comprehensive income

 

Comprehensive income and loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income is comprised of the changes in foreign currency exchange rates.

 

Research and development costs

 

Research and development costs are charged to operations as incurred and include salaries, professional fees, and technical support fees related to such efforts.

 

Income taxes

 

The Company accounts for income taxes using an asset and liability method.  Under this method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion or all of a deferred tax asset will not be realized.

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. As of March 31, 2012, there are no unrecognized tax benefits, and the Company does not expect a significant change in tax benefits in the next 12 months.  Penalties and interest levied by taxing authorities, if any, are classified as income tax expense in the year incurred.  No significant penalties or interest relating to income taxes have been incurred during the three months ended March 31, 2012 and 2011. 

 

The Company’s operations are subject to income and transaction taxes in the United States and in the PRC jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.

 

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent.  The statute of limitations extends to five years under special circumstances. In the case of transfer pricing issues, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. Accordingly, the income tax returns of the Company’s PRC operating subsidiaries for the years ended December 31, 2006 through 2011 are open to examination by the PRC state and local tax authorities.

 

12
 

 

The Company does not anticipate any events that could cause a change to these uncertainties.

 

Stock-based compensation

 

The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

 

Earnings per share

 

Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including convertible preferred shares, warrants and stock options were converted or exercised. Further, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period or after the end of the period but before the release of the financial statements, by considering it outstanding for the entirety of each period presented. Diluted earnings per share is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 

 

Related parties

 

Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of such principal owners and management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.

 

Operating Segments

 

While the chief decision-makers monitor the revenue streams of the various products lines, operations are managed and financial performance is evaluated on a Company-wide basis.  Product lines are aggregated into one as operating results for all product lines are similar.  Accordingly, all of the major product lines (micro organism, veterinary medicine, feed additives and vaccines) are considered by management to be aggregated in one reportable operating segment.

 

Recently issued accounting pronouncements

 

In May 2011, the FASB issued ASU No. 2011-04 – Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S.GAAP and IFRSs. The amendments in this update intend to converge requirements for how to measure fair value and for disclosing information about fair value measurements in US GAAP with International Financial Reporting Standards. For public entities, this ASU is effective for interim and annual periods beginning after December 15, 2011. The adoption of the provisions in this update did not have a significant impact on the Company’s consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05 – Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this update require (i) 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 (the current option to present components of other comprehensive income (“OCI”) as part of the statement of changes in stockholders’ equity is eliminated) and (ii) presentation of reclassification adjustments from OCI to net income on the face of the financial statements. For public entities, the amendments in this ASU are effective for years, and interim periods within those years, beginning after December 15, 2011. The amendments in this update should be applied retrospectively. Early adoption is permitted. The adoption of the provisions in this update did not have a significant impact on the Company’s consolidated financial statements.

 

In December 2011, the FASB issued ASU No. 2011-11 —Balance Sheet (Topic 210). The objective of this update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not expect the adoption of the provisions in this update will have a significant impact on its consolidated financial statements.

 

13
 

 

In December 2011, the FASB issued ASU No. 2011-12 —Comprehensive Income (Topic 220). The amendments in this update supersede certain pending paragraphs in ASU No. 2011-05, to effectively defer only those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments in this update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of the provisions in this update did not have a significant impact on the Company’s consolidated financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.

 

Note 3 - CONCENTRATIONS AND CREDIT RISK

 

The Company’s operations are all 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 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.

 

Financial instruments which subject the Company to concentration of credit risk consist of cash and accounts receivable. Balances at financial institutions or state-owned banks within the PRC are not covered by insurance. The Company has not experienced any losses in such accounts. The Company provides unsecured credit terms for sales to certain customers.  As a result, there are credit risks with the accounts receivable balances.  The Company constantly re-evaluates the credit worthiness of customers buying on credit and maintains an allowance for doubtful accounts.

 

For the three months ended March 31, 2012 and 2011, all of the Company’s sales occurred in the PRC. No major customers accounted for more than 10% of the Company’s total revenues. All accounts receivable at March 31, 2012 and December 31, 2011 are from customers located in the PRC.

 

The Company’s six largest vendors accounted for approximately 85% and 73% of the Company’s total purchases, respectively, for the three months ended March 31, 2012 and 2011.

 

The Company had one product that accounted for 23% and 15% of the Company’s total revenues for the three months ended March 31, 2012 and 2011, respectively.

 

Note 4 - ACCOUNTS RECEIVABLE, NET

 

Accounts receivable consisted of the following:

 

   March 31,
2012
   December 31,
2011
 
Account receivable  $6,264,068   $3,830,171 
Allowance for doubtful accounts   (480,237)   (438,678)
Account receivable, net  $5,783,831   $3,391,493 

 

The following table presents the movement of allowance for doubtful accounts:

 

Allowance for doubtful accounts, January 1, 2012   438,678 
Addition   38,869 
Recovery    
Translation adjustment   2,690 
Allowance for doubtful accounts, March 31, 2012  $480,237 

 

 Note 5 – INVENTORIES

 

Inventories consist of the following:

 

   March 31,
2012
   December 31,
2011
 
Raw materials  $12,341,645    12,646,663 
Packing materials   231,596    181,304 
Work-in-process   5,218    22,559 
Finished goods   1,554,507    2,171,238 
Other   52,219    51,085 
Total   14,185,185    15,072,849 
Less: Allowance for obsolete inventories   (223,098)   (221,690)
Total  $13,962,087    14,851,159 

 

The Company periodically reviews its reserves for slow-moving and obsolete inventories. 

 

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Note 6 - DEPOSITS, PREPAID EXPENSES AND OTHER RECEIVABLES

 

Deposits and prepaid expenses are comprised of the following:

 

   March 31,
2012
   December 31,
 2011
 
Prepayment for raw materials purchasing  $31,521,801   $28,824,123 
Prepayment for packaging materials purchasing   366,792    402,838 
Prepayment for enterprise income taxes   1,708,019    2,162,070 
Other receivables   655,918    508,392 
Other   661,946    751,025 
Total  $34,914,476   $32,648,448 

 

As part of the Company’s strategy to reduce inventory costs, the Company maintains a balance for prepayment to suppliers in order to secure favorable pricing for raw materials.  As inventory is received throughout the year, this balance will fluctuate with the business operations.

 

Note 7 - PLANT AND EQUIPMENT, NET

 

Plant and equipment consist of the following:

 

   March 31,
2012
   December 31,
2011
 
Building and improvements  $26,030,763   $25,866,428 
Machinery and equipment   5,764,470    5,675,995 
Office equipment and furniture   328,571    320,498 
Vehicles   592,175    588,436 
Total   32,715,979    32,451,357 
Less: accumulated depreciation   (4,442,951)   (4,074,798)
Plant and equipment, net  $28,273,028   $28,376,559 

 

Depreciation expense was $343,129 and $332,428 for the three months ended March 31, 2012 and 2011, respectively.

 

Note 8 - CONSTRUCTION-IN-PROGRESS

 

Construction-in-progress (“CIP”) relates to a plant being built in accordance with the PRC’s Good Manufacturing Practices (“GMP”) Standard.

 

Xi’an facility

 

We started constructing our Huxian vaccine facility in 2005, and it was completed in 2010 and resulted in a transfer to plant and equipment of $9,448,505. In 2011, the Company started two projects at the vaccine facility to modify air filtration, water treatment, and other facility changes based on recommendations by outside experts hired by the Company to advise on the GMP qualification process for the vaccine facility. The Company has finished installing, tooling, and testing of equipment on this facility and resulted in a transfer to plant and equipment of approximately $589,270 (RMB 3,720,142) in 2011. As of March 31, 2012, the facility had a total in construction-in-progress of $2,360,086 (RMB 14,899,533). The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification process to be complete by the second half of 2012.

 

In 2011, the Company started a facility improvement project in the amount of approximately $316,800 (RMB 2,000,000) for the Huxian Animal Laboratory, and it was completed in 2011. The facility is a supporting project to the Huxian vaccine facility and is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification process to be complete by the second half of 2012.

 

15
 

 

In 2011, the Company started a facility improvement project in the amount of $1,127,808 (RMB 7,120,000) at the Huxian veterinary medicine facility to prepare its GMP re-examination, which is expected to take place in the first half of 2012. The project includes a renovation project to clean 3,160 square feet in area and to replace or implement an exhaust ventilation system, color steel enclosure, process water piping, purification equipment, fire alarm, and combined air supply unit. This facility improvement was completed in 2011 and is awaiting the GMP re-examination from Ministry of Agriculture. The Company expects that the GMP re-examination will be completed during the 3rd quarter of 2012.

 

Jingzhou facility

 

In 2011, the Company started a facility improvement project to expand production capacity at the Jingzhou facility. The project includes plant construction and water supply and drainage and has an estimated total cost of $2,005,819 (RMB 12,663,000). As of March 31, 2012, the project was still under construction. The Company expects the project will be completed by the second half of 2012.

 

Kunshan facility

 

In 2010, the Kunshan micro-organism facility and some general facility improvements were completed and placed in service, which resulted in a transfer from Construction-in-Progress to plant and equipment of $1,389,602. In 2011, the Company started a supporting project at the Kunshan facility that includes the construction and installation of plumbing, sewer, electrical, HVAC, fire protection and alarm system, drainage, office, lab, road construction, parking, and landscaping. As of March 31, 2012, the facility had a total in construction-in-progress of $4,954,274 (RMB 31,276,982). The construction and installation were completed and the project will be inspected and accepted shortly. The Company expects the project will be completed by June 2012. We anticipate that Kunshan plant will start small-scale production in the second half of 2012. However, we don’t expect that will bring significant impact to our revenue in 2012 as a whole.

 

No depreciation is provided for construction-in-progress until such time as the assets are completed and placed into service.

 

The construction projects the Company was in the progress of completing are as follows:

 

    Total in CIP
as of
    Estimate cost to     Estimated     Estimated  
Project   3/31/2012     Complete     Total Cost     Completion Date  
Xi'an vaccine facility   $ 2,360,086     $ -     $ 2,360,086     Second half of 2012  
Xi'an animal laboratory     316,800       -       316,800     Second half of 2012  
Xi'an veterinary medication facility     1,127,808       -       1,127,808     The 3rd Quarter of 2012  
Jingzhou facility     675,259       1,330,560       2,005,819     Second half of 2012  
Kunshan facility     4,954,274       -       4,954,274     June 2012  
TOTAL CIP Balance   $ 9,434,227     $ 1,330,560     $ 10,764,787        

 

As of March 31, 2012 and December 31, 2011, the Company had construction in progress amounting to $9,434,227 and $8,839,055, respectively. No interest expense had been capitalized for construction in progress for the three months ended March 31, 2012 and 2011 as management determined the amount of capitalized interest would be insignificant. 

 

Note 9 - LONG-TERM PREPAYMENTS

 

Long-term prepayments consist of the following:

 

   March 31,
2012
   December 31,
2011
 
R&D project  $316,800   $314,800 
Construction deposit   594,000    960,140 
Deposit for equipment purchase   278,988    237,877 
Deposit for potential asset acquisitions   652,609    569,788 
Total  $1,842,397   $2,082,605 

 

As of March 31, 2012 and December 31, 2011, deposits for potential acquisitions totaled $652,609 and $569,788, respectively, all of which was held by an unrelated third party engaged to facilitate potential acquisition projects. 

 

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Note 10 – INTANGIBLE ASSETS

 

Intangible assets consist of the following:

 

   March 31,
2012
   December 31,
2011
 
Land use rights  $4,791,602   $4,761,352 
Technological know-how   2,217,600    2,203,600 
Patents   316,800    314,800 
Total   7,326,002    7,279,752 
Less: accumulated amortization   (1,715,867)   (1,605,546)
Intangible assets, net  $5,610,135   $5,674,206 

 

The Company’s one year loan with Industrial and Commercial Bank of China Songzi Branch (see Note 12) is secured by the Company’s land use rights in Jingzhou, Hubei Province.

 

For the three months ended March 31, 2012 and 2011, the amortization expense for intangibles amounted to $100,373 and $230,922, respectively.

 

Amortization expense expected for the next five years and thereafter is as follows:

 

Years ending December 31,  Amount 
2012  $300,362 
2013   242,082 
2014   242,082 
2015   242,082 
2016   242,082 
Thereafter   4,341,445 
Total  $5,610,135 

 

Note 11 – LOANS RECEIVABLE

 

In November 2010, the Company provided an unsecured non-interest bearing loan to Xi’an Tiantai Investment, Ltd., the Company’s acquisition advisor, in the amount of $190,080 (RMB 1,200,000) for two years from November 26, 2010 through November 25, 2012. As of March 31, 2012, this loan has not been repaid.

 

As of March 31, 2012, the Company had unsecured non-interest bearing short-term loans in the amount of $791,619 (RMB 4,997,592) due from unrelated third parties.

 

Note 12 – SHORT-TERM LOANS

 

On May 5, 2011, the Company obtained a one year loan with Industrial and Commercial Bank of China Songzi Branch for $475,200 (RMB 3,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate, which was 8.528% at March 31, 2012. In 2011, the Company repaid $158,400 (RMB 1,000,000) and subsequently borrowed back $158,400 (RMB 1,000,000). This loan is secured by the Company’s land use rights in Jingzhou, Hubei Province and guaranteed by the legal representative of Skystar Jingzhou. On May 2, 2012, the Company repaid this loan of $475,200 (RMB 3,000,000).

 

On July 8, 2011, the Company obtained a one year loan with Chang’an Bank for $792,000 (RMB 5,000,000) at an annual interest rate of 8.203%. This loan is secured by the Company’s office buildings and its Chairman and CEO’s personal property located in Xi’an City, which includes an office building contributed by a shareholder in 2005 as additional capital of Xi’an Tianxing. As of March 31, 2012, the title to this property has not been passed to the Company. This loan is also personally guaranteed by the Company’s Chairman and CEO and his wife.

 

On August 25, 2011, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $792,000 (RMB 5,000,000) at an annual interest rate of 9.411%. This loan is secured by the Company’s office buildings located in Xi’an City. This loan is also personally guaranteed by the Company’s Chairman and CEO.

 

On December 22, 2011, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $475,200 (RMB 3,000,000) at an annual interest rate of 9.411%. This loan is secured by the Company’s office buildings located in Xi’an City. This loan is also personally guaranteed by the Company’s Chairman and CEO and his wife.

 

On December 1, 2011, the Company obtained a one year loan with Bank of Chengdu for $4,752,000 (RMB 30,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate, which was 8.528% at March 31, 2012. This loan is secured by the Company’s land use right and manufacturing plant located in Huxian County.

 

In 2011, the Company obtained two three-month loans with a third-party individual for a total amount of $125,920 (RMB 800,000). For the three months ended March 31, 2012, the Company borrowed another two short-term loans for a total amount of $63,360 (RMB 400,000) with this third-party individual. These four loans are non-interest bearing and are unsecured. On April 6, 2012, the Company repaid one loan of $47,520 (RMB 300,000). On April 9, 2012, the Company repaid the other three remaining loans totaling $142,560 (RMB 900,000).

 

17
 

 

Interest expense incurred and associated with the short-term loans amounted to $152,583 and $54,409 for the three months ended March 31, 2012 and 2011, respectively, none of which has been capitalized as part of construction-in-progress for the three months ended 2012 and 2011, respectively.

 

Outstanding short-term loans consisted of the following:

 

   March 31, 2012   December 31, 2011       Interest 
Bank  Amt RMB   Amt USD   Amt RMB   Amt USD   Due Date   Rate 
                         
Chang’an Bank   5,000,000    792,000    5,000,000    787,000    07/07/12    8.203%
Shaanxi Agricultural Yanta Credit Union   5,000,000    792,000    5,000,000    787,000    08/24/12    9.411%
Shaanxi Agricultural Yanta Credit Union   3,000,000    475,200    3,000,000    472,200    12/21/12    9.411%
Commercial Bank of China Songzi Branch   3,000,000    475,200    3,000,000    472,200    05/04/12     (1)
Bank of Chengdu   30,000,000    4,752,000    30,000,000    4,722,000    11/30/12     (1)
Third-party Individual   1,200,000    190,080    800,000    125,920    Various    0%
Total   47,200,000   $7,476,480    46,800,000   $7,366,320           

 

  (1) People's Bank of China floating benchmark lending rate over the same period plus 30%, which was 8.528% at March 31, 2012.

 

Note 13 - DEFERRED GOVERNMENT GRANT

 

Deferred government grant represents subsidies for Good Manufacturing Practice projects granted by various levels of the PRC government. To date, the Company received government subsidies totaling $1,188,000 (RMB 7,500,000), of which $792,000 (RMB 5,000,000) was granted by the PRC government, and $158,400 (RMB 1,000,000) was re-paid on December 7, 2010, with the remaining amount to be repaid in 2012. The current portion of deferred government grant of $633,600 (RMB 4,000,000) is included in other payable in the current liabilities. $316,800 (RMB 2,000,000) was granted by Shaanxi provincial government, and $79,200 (RMB 500,000) was granted by Xi’an municipal government. The Shaanxi provincial government grant and Xi’an municipal government grant are not required to be repaid.

 

Note 14 - CAPITAL TRANSACTIONS

 

Stock-based compensation

 

On March 30, 2010, the Company agreed to issue 2,500 shares of common stock to a non-executive director in exchange for services unrelated to his services as a director at the fair market value of $11.74 per share based on the closing price on March 30, 2010. On April 16, 2010, the Company entered into another agreement to grant 10,000 shares of common stock to that director for his one year service from April 1, 2010. The closing price per share on the grant date was $10.61. The common stock compensation vests in four equal quarterly installments of 2,500 shares. Shares owed were accrued at the end of each quarter at the fair market value on the grant date of $10.61 per share. On August 31, 2011, the Company entered into another agreement to grant 36,000 shares of common stock to that director for his one year service from April 1, 2011. The closing price per share on the grant date was $2.58. The common stock compensation vests in four equal quarterly installments of 9,000 shares. Shares owed were accrued at the end of each quarter at the fair market value of the grant date at $2.58 per share. A total of $23,220 and $26,525 was charged to general and administrative expense for the three months ended on March 31, 2012 and 2011, respectively. On October 25, 2010, 5,000 shares were issued to the director for the shares vested in the first two quarters of 2010. As of March 31, 2012, 43,500 shares were accrued for the shares vested and pending to be issued.

 

On May 26, 2009, the Company agreed to issue 5,556 shares of common stock to a director at the beginning of each term of his directorship. The trading value of the common stock on May 26, 2009 was $4.50 per share. The Company issued 5,556 shares on February 26, 2010. As of March 31, 2012, 11,112 shares were accrued for the shares vested and pending to be issued. In accordance with the agreement between the Company and this director, this director must continue to serve as a member of the Board until his successor is duly elected and qualified in order to receive the shares. This director has continued in his position, and the Company is in the process of finalizing its agreement with this director and expects to complete this process shortly.

 

On July 29, 2011, the Company entered into a one-year employment agreement with its CFO. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, 4,000 shares of which shall be issuable on the 6 month anniversary and the remainder 4,000 shares of which shall be issuable on the 12 month anniversary. The closing price per share on the grant date was $4.20. A total of $22,584 was charged to general and administrative expense for the three months ended on March 31, 2012. As of March 31, 2012, 4,000 shares were accrued for the shares vested and pending to be issued.

 

18
 

 

Warrants and Purchase Options

 

On February 28, 2007, in connection with a financing the Company issued 195,000 warrants to four investors with an exercise price of $6.00 per share for a term of three years (number of warrants and exercise price adjusted for 1-for-10 reverse stock split on May 12, 2009 and 2-for-1 forward stock split on November 16, 2009).  On the same date, the Company also issued warrants to the placement agent, exercisable for 114,100 shares of the Company’s common stock at a price of $5.00 per share for a five-year term (number of warrants and exercise price adjusted for 1-for-10 reverse stock split on May 12, 2009 and 2-for-1 forward stock split on November 16, 2009).  For the year ended December 31, 2009, 56,846 warrants were exercised.  For the year ended December 31, 2010, there was a cashless exercise of 218,024 warrants. For the year ended December 31, 2011, no warrants were exercised. As of March 31, 2012, the remaining 34,230 warrants expired.

 

In connection with the 2009 equity offering discussed below, the Company granted 140,000 common stock purchase options to five designees of the Underwriters with a vesting date of June 30, 2010. The options are exercisable from June 30, 2010 to June 30, 2014, and each option is exercisable for one share of the Company’s common stock at an exercise price at $8.11 per share. All options were provided for services performed. On June 30, 2010, the purchase options were reclassified from equity to warrant/purchase option liabilities, and the Company reclassified $779,674 from additional paid in capital to warrant/purchase option liability. As of March 31, 2012, 140,000 common stock purchase options were outstanding.

 

The fair value of each warrant and purchase option is estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Company’s stock, and reflect the assumption that the historical volatilities are indicative of future trends, which may not necessarily be the actual outcome. Expected term of each warrant and purchase option award represents the period of time that options granted are expected to be outstanding and is estimated based on the historical exercise behavior of separate groups of employees or officers. The risk-free rate reflects the interest rate for United States Treasury Notes with similar time-to-maturity to that of the options.

 

    March 31,
2012
    March 31,
2011
 
Expected term (year)     2.25       0.92 – 3.25  
Expected volatility     65 %     53% - 147 %
Expected dividend yield     0 %     0 %
Risk-free rate     0.33 %     0.3% - 1.30 %

 

Following is an activity summary of the Company’s outstanding warrants and purchase options:

 

    Number of
warrants/purchase
options
   

Weighted –

average

exercise price

   

Weighted-

average

remaining

contractual term

(Year)

 
Outstanding at January 1, 2011     174,230     $ 7.50        
Granted     -                
Forfeited     -                
Exercised     -                
Outstanding at December 31, 2011     174,230     $ 7.50        
Granted     -       -        
Forfeited     (34,230     -        
Exercised     -                
Outstanding at March 31, 2012     140,000     $ 8.11       2.25  
Vested and expected to vest at March 31, 2012     140,000     $ 8.11       2.25  
Exercisable at March 31, 2012     140,000     $ 8.11       2.25  

 

Equity Compensation Plan

 

On December 8, 2009, the Company’s board of directors approved a stock incentive plan for officers, directors, employees and consultants entitled the “Skystar Bio-Pharmaceutical Company 2010 Stock Incentive Plan” (the “2010 Plan”). The maximum number of shares that may be issued under the 2010 Plan is 700,000 shares of common stock. The 2010 Plan was approved by the Company’s stockholders on December 31, 2009, and awards may be granted thereunder until December 7, 2019. As of March 31, 2012, there are 690,000 shares of the Company’s common stock remaining available for future issuance under the Plan. On May 4, 2012, the Board approved common stock grants in the total amount of 442,881 shares to the Company’s employees and members of the Board of Directors, all of which grants were made pursuant to the terms and provisions of the Plan.

 

19
 

 

Note 15 - STATUTORY RESERVES

 

Statutory reserves represent restricted retained earnings. Based on the legal formation of the entities, all PRC entities are required to set aside 10% of net income as reported in their statutory accounts on an annual basis to the statutory surplus reserve fund. Once the total statutory surplus reserve reaches 50% of the entity’s registered capital, further appropriations are discretionary. The statutory surplus reserve can be used to increase the entity’s registered capital (upon approval by relevant government authorities) and eliminate its future losses under PRC regulatory requirements (upon a resolution by the board of directors). The statutory surplus reserve is not distributable to shareholders except in the event of liquidation. As of March 31, 2012, Xi’an Tianxing has met the statutory surplus reserve requirement, and $11,192,619 still needs to be transferred to the statutory surplus reserve from other Chinese subsidiaries.

 

Appropriations to the above statutory reserves are accounted for as a transfer from unrestricted earnings to statutory reserves. There are no legal requirements in the PRC to fund these statutory reserves by the transfer of cash to any restricted accounts, and as such, the Company has not transferred any cash to these accounts. These reserves are not distributable as cash dividends.

  

Note 16 – TAXES

 

Skystar is subject to United States federal income tax provisions. Skystar Cayman is a tax-exempt company incorporated in the Cayman Islands and conducts all of its business through its subsidiaries, Fortune Time, Sida, Fortune Time’s subsidiary Skystar Kunshan, Sida’s subsidiary Skystar Jingzhou, Sida’s PRC VIEs, Xi’an Tianxing, Xi’an Tianxing’s subsidiary Shanghai Siqiang, Sida and Xi’an Tianxing’s joint venture Kunshan Sikeda, and Xi’an Tianxing’s subsidiary Xi’an Sikaida.

 

Sida, Skystar Jingzhou, Skystar Kunshan, Xi’an Tianxing, Shanghai Siqiang, Kunshan Sikeda and Xi’an Sikaida are subject to the PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25%. Xi’an Tianxing has been approved as a new technology enterprise, and under PRC Income Tax Laws is entitled to a preferential tax rate of 15%.

 

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months ended March 31, 2012 and 2011:

 

   For the three months ended 
   March 31,
2012
   March 31,
2011
 
U.S. Statutory rate   34.0%   34.0%
Foreign income not recognized in the U.S.   (34.0)   (34.0)
China income tax rate   25.0    25.0 
China income tax exemption   (10.0)   (10.0)
Other item (1)   4.8    4.8 
Total provision for income taxes   19.8%   19.8%

 

(1) Other item is for operating expenses incurred by Skystar that are not deductible in the PRC and expenses incurred by other subsidiaries that are not deductible on the consolidated level, which resulted in an increase in effective tax rate 4.8% and 4.8% for the three months ended March 31, 2012 and 2011, respectively.

 

Taxes payable consisted of the following:

 

   March 31,
2012
   December 31,
2011
 
Value added tax  $1,402,428   $110,880 
Other taxes   182,728    49,201 
Total  $1,585,156   $160,081 

 

Skystar was incorporated in the United States. As of March 31, 2012, the estimated net operating loss carry forwards for U.S. income tax purposes amounted to $6,228,689, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, beginning in 2026 and through 2030. Management believes that the realization of the benefits arising from this loss appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at March 31, 2012 and December 31, 2011. The valuation allowance at March 31, 2012 and December 31, 2011 was $2,117,754 and $2,071,840, respectively. The Company’s management reviews this valuation allowance periodically and makes adjustments as necessary. As of March 31, 2012, the Company has no other deferred tax amounts.

 

The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $57 million as of March 31, 2012, which were included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations.  Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.

 

20
 

 

Note 17 - EARNINGS PER SHARE

 

The following is the calculation of earnings per share:

 

   For the three months ended
March 31,
 
   2012   2011 
Net income  $1,904,754   $1,931,832 
           
Weighted average shares used in basic computation   7,210,256    7,166,919 
Diluted effect of stock warrants and purchase options   -    12,390 
Weighted average shares used in diluted computation   7,210,256    7,179,309 
           
Earnings per share:          
           
Basic  $0.26   $0.27 
Diluted  $0.26   $0.27 

 

For the three months ended March 31, 2011, the average stock price was greater than the exercise prices of warrants which resulted in additional weighted-average common stock equivalents of 12,390.

 

For the three months ended March 31, 2012 and 2011, the outstanding 140,000 options were excluded from the diluted earnings per share calculation as they are anti-dilutive as the average stock price was less than the exercise prices of the options.

 

Note 17 - RELATED PARTY TRANSACTIONS AND ARRANGEMENTS

 

Amounts receivable from and payable to related parties are summarized as follows:

 

   March 31, 2012   December 31, 2011 
         
Shares to be issued to related party (1)          
Scott Cramer – non-executive director (2)  $172,455   $149,235 
Mark D. Chen – non-executive director (3)   50,004    50,004 
Bing Mei – CFO (4)   16,800    - 
Total  $239,259   $199,239 
           
Amounts due to (from) related parties          
           
Scott Cramer – non-executive director and shareholder (5)  $132,561   $147,877 
Officer, shareholder and other related party (6)   248,108    (91,604)
Total  $380,669   $56,273 

 

  (1) The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. As of March 31, 2012 and December 31, 2011, the shares to be issued to related parties included in the accrued expenses were $239,259 and $199,239, respectively.
  (2) As of March 31, 2012 and December 31, 2011, the Company had the obligation under an agreement to issue 43,500 and 34,500 shares of common stock, respectively, to Scott Cramer as compensation valued at $172,455 and $149,235 for being a representative of the Company in the United States for the period April 1, 2010 to March 31, 2012.
  (3) As of March 31, 2012 and December 31, 2011, the Company had the obligation under an agreement to issue 11,112 shares of common stock to Mark D. Chen as compensation valued at $50,004 for being a director for his 2011 and 2010 terms of directorship.
  (4) As of March 31, 2012, the Company had the obligation under an agreement to issue 4,000 shares of common stock to Bing Mei as compensation valued at $16,800 for being CFO for the period July 29, 2011 to July 28, 2012.
  (5) As of March 31, 2012 and December 31, 2011, the Company had unpaid reimbursement and compensation due to Scott Cramer valued at $132,561 and $147,877, respectively. 

  (6) The amount due to (from) officer, shareholders and other related party at March 31, 2012 and December 31, 2011 includes unpaid reimbursement and compensation and, advances to Mr. Weibing Lu and other related parties for business expenses.

  

21
 

 

Note 18 - COMMITMENTS AND CONTINGENCIES

 

(a)  Lease commitments

 

The Company recognizes lease expense on the straight-line basis over the term of the lease.

 

The Company entered into a tenancy agreement for the lease of factory premises in Sanqiao for a period of ten years from October 1, 2004 to December 31, 2014. The annual rent for the factory premises is subject to a 10% increase every two years starting October 1, 2009. As of March 31, 2012, the annual rent for the factory premises was adjusted to approximately $20,212 (RMB 127,600).

 

The Company leases office space in Xi’an from Mr. Weibing Lu, the Company’s Chairman and CEO, for a period of five years from January 1, 2007 to December 31, 2011, with annual rent of approximately $26,231 (RMB 165,600). In January 2012, the Company renewed the lease with Mr. Lu for another 5 years from January 1, 2012 to December 31, 2016 at rent of approximately $28,512 (RMB 180,000) per year.

 

The Company also entered into a tenancy agreement with Mr. Weibing Lu for the lease of Shanghai Siqiang’s office in Shanghai for a period of ten years from August 1, 2007 to August 1, 2017 with annual rent of approximately $22,810 (RMB 144,000).

 

The Company entered into a one year tenancy agreement for an office lease in Kunshan, Jiangsu Province from April 15, 2011 to April 14, 2012 with annual rent of approximately $3,041 (RMB 19,200). On April 15, 2012, the Company entered into a new one year tenancy agreement for this office from April 15, 2012 to April 14, 2013 with annual rent of approximately $3,199 (RMB 20,196).

 

The Company entered into a tenancy agreement for the lease of warehouse premises in Xi’an for a period of three years from July 20, 2011 to July 19, 2014 with annual rent of approximately $37,224 (RMB 235,000) subject to a 10% increase every two years starting July 20, 2013.

 

The minimum future lease payments for the next five years and thereafter are as follows:

 

Period  Amount 
Nine months ending December 31, 2012  $81,568 
Year ending December 31, 2013   111,038 
Year ending December 31, 2014   67,859 
Year ending December 31, 2015   51,322 
Year ending December 31, 2016 and thereafter   64,628 
 Total  $376,415 

 

Rental expense for the three months ended March 31, 2012 and 2011 amounted to $28,020 and $14,396, respectively. 

 

(b)  Legal proceedings

 

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation which would have a significant effect on the Company’s consolidated financial statements as of March 31, 2012.

 

In May 2007, Andrew Chien filed suit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in United States District Court for the District of Connecticut, alleging causes of action for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. On July 17, 2008, in a decision that is now published, the court granted defendants’ motion to dismiss and subsequently dismissed the lawsuit, entering judgment on behalf of the defendants. Chien appealed the dismissal. Defendants filed a postjudgment motion for sanctions against Chien. On February 5, 2009, the court found the action filed by Chien to have been frivolous, and to have constituted a “substantial” violation of Rule 11, and imposed monetary sanctions on both Chien and his former attorney. Chien appealed the award of sanctions. All appeals, including the one referenced below concerning Chien’s second lawsuit, were subsequently consolidated. The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing sanctions against Chien in light of the circumstances and facts on record. This Mandate was entered on or about November 8, 2010.

 

Andrew Chien, proceeding pro se (i.e., he represented himself without an attorney), filed his second lawsuit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court (which was removed to U.S. District Court) alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action. The court held that all claims asserted against the defendants were barred and failed to state a claim on a multiplicity of grounds, including on the basis of res judicata . Defendants filed a second Motion for Sanctions under Rule 11 and the PSLRA, which was granted. Chien appealed the dismissal. The Court of Appeals for the Second Circuit consolidated all of Chien’s appeals from both of his lawsuits. On November 8, 2010, the Court of Appeals affirmed the dismissals and the awards of sanctions. On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. The Supreme Court denied review of the petition.

 

22
 

 

Andrew Chien, again proceeding pro se, commenced his third lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung, Weibing Lu (and also Weinberg & Company, P.A., Moore Stephens Wirth Frazer & Torbet, LLP, Frazer Frost, LLP, Crowe Horwath LLP, Richardson & Patel LLP, Kevin K. Leung, Harvey Kesner, and Jody M. Borrelli) alleging the same facts and circumstances as set forth in the above two matters, although adding the aforementioned accountants and lawyers as defendants to the claims. The matter commenced on August 8, 2011, and shortly thereafter was removed to U.S. District Court. On October 5, 2011, the court dismissed the entire action as to all defendants.  As in the two previous lawsuits, sanctions were issued against Chien.  Moreover, the District Court issued an order prohibiting Chien from filing any more lawsuits against the defendants without prior approval from the court.  Chien has appealed the court’s rulings to the United States Court of Appeals for the second circuit, where all defendants have filed motions to dismiss. The United States Court of Appeals for the Second Circuit recently affirmed the judgments and orders of the United States District Court and dismissed all of Mr. Chien’s pending appeals.

 

Other than the above described legal proceedings, the Company is not aware of any legal matters in which any director, officer, or any owner of record or beneficial owner of more than five percent of any class of voting securities of the Company, or any affiliate of purchaser, or of any such director, officer, affiliate of the Company, or security holder, is a party adverse to the Company or has a material adverse interest to the Company. No provision has been made in the consolidated financial statements for the aforementioned matter.

 

(c)  Ownership of leasehold property

 

In 2005, a shareholder contributed a leasehold office building as additional capital of Xi’an Tianxing. However, as of March 31, 2012, title to this leasehold property has not passed to the Company. The Company does not believe there are any legal barriers for the shareholder to transfer the ownership to the Company. However, in the event that the Company fails to obtain the ownership certificate for the leasehold property, there is a risk that we may be required to vacate the building. Management believes that this possibility is remote, and, as such, no provision has been made in the consolidated financial statements for this potential occurrence.

 

(d) R&D project

 

In 2008, Xi’an Tianxing contracted with Northwestern Agricultural Technology University to work jointly on an R&D project concerning the application of nano-technology in the prevention of major milk cow disease. The total projected budget for this project is approximately $633,600 (RMB 4,000,000), which is to be paid according to completed stages of the project. The project reached trial stage in September 2009. As of March 31, 2012, the Company incurred approximately $476,400 (RMB 3,000,000) of cumulative expenses relating to this project.

 

In 2009, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project on fish diseases linked immunosorbent detection kit and fish diseases multi-linked monoclonal antibody therapeutic agents. The contracted amount for this project is approximated $950,400 (RMB 6,000,000). As of March 31, 2012, the Company has incurred approximately $539,920 (RMB 3,400,000) of cumulative expenses relating to this project.

 

During the first quarter of 2011, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project to develop new treatment and diagnosis method for Mycoplasmal pneumonia of swine. The project term is from January 2011 through September 2013. The cost to the Company for the initial phase is approximately $316,800 (RMB 2,000,000). As of March 31, 2012, the Company has incurred approximately $79,400 (RMB 500,000).

 

During the second quarter of 2011, Xi’an Tianxing launched four new R&D projects to develop ceftiofur sodium for injection (powder for injection), a sulfuric acid injection neostigmine, dexamethasone sodium phosphate injection, and houttuynia preparation of compound application in weaning piglets. The projected budget for the R&D project of ceftiofur sodium for injection (powder for injection) is approximately $554,400 (RMB 3,500,000). As of March 31, 2012, the Company has incurred approximately $438,288 (RMB 2,760,000). The projected budget for the R&D project of a sulfuric acid injection neostigmine is approximately $475,200 (RMB 3,000,000). As of March 31, 2012, the Company has incurred approximately $269,971 (RMB 1,700,071). The projected budget for the R&D project of dexamethasone sodium phosphate injection is approximately $554,400 (RMB 3,500,000). As of March 31, 2012, the Company has incurred approximately $464,683 (RMB 2,926,215). The projected budget for the R&D project of houttuynia preparation of compound application in weaning piglets is approximately $712,800 (RMB 4,500,000). As of March 31, 2012, the Company has incurred approximately $681,828 (RMB 4,293,630).

 

In addition, the Company also launched various R&D projects in 2011 on veterinary products formula adjustment, pet drug development and fermentation engineering design and development and lab tests. As of March 31, 2012, approximately $858,272 (RMB 5,404,737) has been incurred related to these projects and lab tests.

 

R&D projects are summarized as follows:

 

Project  Amount
incurred as
of 3/31/2012
   Amount
expected to
be
incurred
   Total amount
of
project
 
Project with the Fourth Military Medical University (1)  $539,920   $411,840   $950,400 
Project with Northwestern Agricultural Technology University  (2)   476,400    158,400    633,600 
Project with the Fourth Military Medical University (3)   79,400    237,600    316,800 
In-house R&D project (4)   438,288    117,216    554,400 
In-house R&D project (5)   269,971    205,909    475,200 
In-house R&D project (6)   464,683    90,888    554,400 
In-house R&D project (7)   681,828    32,689    712,800 
Other in-house R&D projects (8)   858,273    15,840    871,950 
TOTAL  $3,808,763   $1,270,382   $5,069,550 

 

23
 

 

(1) Project for fish diseases linked immunosorbent detection kit and fish diseases multi-linked monoclonal antibody therapeutic agents

(2) Project for application of nano-technology in the prevention of major milk cow disease

(3) Project for new treatment and diagnosis method for Mycoplasmal pneumonia of swine

(4) Project for ceftiofur sodium for injection (powder for injection)

(5) Project for sulfuric acid injection neostigmine

(6) Project for dexamethasone sodium phosphate injection

(7) Project for houttuynia preparation of compound application in weaning piglets

(8) Other projects for veterinary products formula adjustment, pet drug development and fermentation engineering design and development and lab tests

 

(e) Registered capital commitment

 

Skystar Kunshan’s remaining registered capital of $12,750,000 is originally required to be invested by May 7, 2012. With the government’s approval, this deadline to invest was extended and we are not required to make the capital investment immediately. As of the date of this report, we have not received the notice from the Government for a new due date. In 2011, the asset acquisition of Kunshan facility was completed. We are in the process of getting the government’s approval to transfer the asset purchased to satisfy some of our registered capital commitment. As of the date of this report, we have not received the approval.

 

As of March 31, 2012, Skystar Jingzhou has remaining registered capital of $399,168 (RMB 2,520,000) required to be invested. As of the date of this report, the Company has not made this investment.  Skystar Jingzhou is currently in the process of getting the government's approval and will fulfill the requirement of remaining capital of $399,168 (RMB 2,520,000) thereafter. The company expects the process will be completed by the end of the 2nd quarter of 2012.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Overview

 

We were incorporated in Nevada on September 24, 1998.  We are a holding company that, through our wholly owned subsidiaries in China, including Skystar Bio Technology (Jingzhou) Co. (“Skystar Jingzhou”), and a variable interest entity (“VIE”), Xi’an Tianxing Bio-Pharmaceutical Co., Ltd. (“Xi’an Tianxing”), researches, develops, manufactures, and distributes veterinary health care and medical care products in the People’s Republic of China (“PRC”).

 

All of our operations are carried out by our subsidiaries in China and Xi’an Tianxing, which the Company controls through contractual arrangements between Xi’an Tianxing and Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), the wholly owned subsidiary of Fortunate Time International Limited, the wholly owned subsidiary of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), which became our wholly owned subsidiary in 2005. Such contractual arrangements are necessary to comply with PRC laws limiting foreign ownership of certain companies. Through these contractual arrangements, we have the ability to substantially influence Xi’an Tianxing’s daily operations and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control Xi’an Tianxing, we are considered the primary beneficiary of Xi’an Tianxing.

 

In addition to Xi’an Tianxing, Skystar Jingzhou also manufactures and distributes veterinary medicines, including aquaculture medicines in China. Skystar Jingzhou is a wholly owned subsidiary of the Company’s Sida entity. It was formed with the August 2010 acquisition of a veterinary medicine manufacturing facility in Hubei Province, China.

 

On August 21, 2007, Xi’an Tianxing invested $79,200 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Company Limited (‘Shanghai Siqiang’). Xi’an Tianxing is the 100% shareholder. Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipments.

 

Our financial statements are prepared in U.S. dollars and in accordance with accounting principles generally accepted in the United States of America. See “Exchange Rates” below for information concerning the exchanges rates at which Renminbi were translated into U.S. dollars at various pertinent dates and for pertinent periods.

 

Nasdaq Listing Compliance Matters

 

On January 12, 2012, the Company received staff determination from the Nasdaq Stock Market (“Exchange”) indicating that since the Company did not hold its 2010 annual shareholder meeting by December 31, 2011, the Company was not in compliance with Nasdaq Listing Rule 5620(a) and (b) relating to the time frame of and proxy solicitation in connection with annual shareholder meetings and, therefore, the Exchange staff determined to initiate proceedings to delist the Company’s securities from Nasdaq at the open of business on January 23, 2012. On March 26, 2012, following its presentation at an oral hearing before the Nasdaq Listing Qualifications Panel, the Company received a letter informing the Company that the Panel had granted the Company’s request to remain listed on the Exchange, subject to the condition that by April 28, 2012, Skystar provided evidence that it held its 2011Annual Meeting of Shareholders. On April 27, 2012, the Company held its 2011 Annual Meeting of Shareholders, at which the shareholders of the Company elected all members of the Company’s Board and ratified the engagement of Crowe Horwath LLP as the Company’s independent registered public accounting firm. The Company continues to be in compliance with all other continued listing requirements.

 

On May 1, 2012, the Exchange confirmed that the Company had met the requirements of the Panel’s decision dated March 26, 2012, and was in compliance with all other applicable requirements for continued listing on Nasdaq. The matter is now closed. 

 

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Critical Accounting Policies and Estimates

 

 In preparing the consolidated financial statements in accordance with U.S. GAAP, we make estimates and assumptions about the effect of matters that are inherently uncertain and may change in subsequent periods.  The resulting accounting estimates will, by definition, vary from the related actual results.  We consider the following to be the most critical accounting policies:

 

Principles of consolidation

 

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiaries, and its VIEs.  All significant inter-company transactions and balances between the Company, its subsidiaries, and its VIEs have been eliminated in consolidation.

 

Revenue recognition

 

Revenue of the Company is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected on these consolidated financial statements as sales returns are de minimal based on historical experience.

 

There are two types of sales upon which revenue is recognized:

 

a. Credit sales: revenue is recognized when the products have been delivered to the customers.

 

b. Full payment before delivering: revenue is recognized when the products have been delivered to the customers.

 

Accounts receivable and other receivables

 

Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, bad debt percentages determined by management, based on historical experience and current economic climate, are applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against allowance for doubtful accounts when identified.

 

Intangible assets

 

Land use rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on the straight-line basis over the term granted by the government.

 

Technological know-how — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over the weighted average useful life of nine years, which reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.

 

Impairment of Intangible assets The Company evaluates the carrying value of intangible assets annually or more often when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of March 31, 2012, there was no impairment of its intangible assets.

 

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Earnings per share

 

The Company reports earnings per share and present both basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including convertible preferred shares, warrants and stock options were converted or exercised. Further, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period, or retroactively if the stock dividends or stock splits occur after the end of the period but before the release of the financial statements, by considering it outstanding of the entirety of each period presented. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 

 

Recently Issued Accounting Pronouncements

 

See Item 1 of Part I, “Notes to the Condensed Consolidated Financial Statements — Note 2 – Summary of Significant Accounting Policies — Recently Issued Accounting Pronouncements.”

 

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Results of Operations – Three Months ended March 31, 2012 and 2011

 

The following table summarizes our results of operations for the three months ended March 31, 2012 and 2011.

 

   Three Months Ended March 31, 
   2012   2011 
   Amount   % of
total revenue
   Amount   % of
total revenue
 
Revenue  $7,926,337    100.0%  $7,086,954    100.0%
Gross Profit  $4,282,679    54.0%  $3,595,608    50.7%
Operating Expenses  $1,814,705    22.9%  $1,951,674    27.5%
Income from Operations  $2,467,974    31.1%  $1,643,934    23.2%
Other Income (Expense)  $(94,252)   (1.2)%  $765,348    10.8%
Income Tax Expenses  $468,968    5.9%  $477,450    6.7%
Net Income  $1,904,754    24.0%  $1,931,832    27.3%

 

Revenues.   All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC.  For the three months ended March 31, 2012, we had revenues of $7,926,337 as compared to revenues of $7,086,954 for the three months ended March 31, 2011, an increase of 11.8%.  We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  The selling prices of our products increased less than 0.5% on average in the three months ended March 31, 2012 compared to the same period of 2011. The increase in revenue was primarily due to the increase of sales volume.

 

Revenue — Veterinary Medications. Revenue from sales of our veterinary medications decreased by $1,856,460 or 38.2% from $4,865,047 for the three months ended March 31, 2011 to $ 3,008,587 for the three months ended March 31, 2012. The decrease of revenue was primarily due to there being no production at Huxian plant for the most of the first quarter of 2012. On January 7, 2012, the current GMP certification of Huxian facility expired after five years and we are currently waiting for the Ministry of Agriculture to set a date to conduct its GMP re-examination. The Company has submitted all application materials necessary for a successful GMP re-examination and expects the re-examination will be initiated during the 2nd quarter of 2012 and completed during the 3rd quarter of 2012 according to current MOA’s GMP re-examination rules and our communication with the government. We currently have two veterinary medications plants located in Huxian and Jingzhou with Huxian being our main facility. The Jingzhou plant completed its GMP re-examination in 2011 and resumed its partial production in the first quarter of 2012 and is now under way to resume its normal production. We plan to increase the production and sales of veterinary medications in the Jingzhou plant to offset the negative impact during the period the Huxian plant is closed and waiting for GMP re-examination. In the unlikely event we are unable to pass the GMP re-examination at Huxian plant or the GMP re-examination at Huxian plant is significantly delayed by the Government, we will have less revenue than expected. Of the total revenues from veterinary medications during three months ended March 31, 2012, approximately 60% of total revenue resulted from the sale of Praziquantel tablets, which treats schistosomiasis. The selling prices of our veterinary medication products for the three months ended March 31, 2012 increased approximately 1.1% on average from the same period of last year. The decrease in revenue was primarily due to the decrease of sales volume.

 

Revenue — Micro-Organism. Revenue from sales of our micro-organism products increased by $1,538,946 or 96.4% from $1,596,094 for the three months ended March 31, 2011 to $3,135,040 for the three months ended March 31, 2012. The increase was primarily due to growing market demand for organic and environmental-friendly food products in China resulting in increasing utilizing non-drug feed additives in animal husbandry industry and our increased sales efforts to respond to this market trend. Due to the temporary reduction of veterinary medication production, we were able to shift some of our veterinary medication sales forces to focus on the selling of micro-organism products and penetrate the market. The revenue from sales of our micro-organism products was the largest revenue contributor for the entire company and contributed 39.6% of total revenue during the three months ended March 31, 2012. The increase in micro-organism sales also contributed the majority of revenue growth for the entire company during the three months ended March 31, 2012. The selling prices of our micro-organism products for the three months ended March 31, 2012 have not changed meaningfully on average from last year. The increase in revenue was mainly due to the increase of sales volume.

 

Revenue — Feed Additives. Revenue from sales of our feed additives product line increased by $708,365 or 217.0% from $326,407 for the for the three months ended March 31, 2011 to $1,034,772 for the three months ended March 31, 2012. The increase was primarily the result of increased market demand of our feed additive products and strong sales of our multi-enzyme feed additive products. Plus, added sales forces temporarily shifted from veterinary medication product line helped to increase the sales. The selling prices of our feed additives products for the three months ended March 31, 2012 have not changed meaningfully on average from last year. The increase in revenue was primarily due to the increase of sales volume.

 

Revenue — Vaccines. Revenue from sales of our vaccines increased by $448,532 or 149.8% from $299,406 for the three months ended March 31, 2011 to $747,938 for the three months ended March 31, 2012. We completed the construction of a new vaccine facility at our Huxian plant in 2010. The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification will be completed by the second half of 2012, and we expect to commence production shortly thereafter for large-scale production. The selling prices of our vaccine products have not increased approximately 0.2% on average for the three months ended March 31, 2012 compared to those in the same period of 2011. The increase in revenue was primarily due to the increase of sales volume.

 

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Cost of Sales.   Cost of sales, which consists of raw materials, direct labor, and manufacturing overhead for our four product lines, was $3,643,658 for the three months ended March 31, 2012, as compared to $3,491,346 for the three months ended March 31, 2011, an increase of $152,312 or 4.4%, as a result of increased sales. For the three months ended March 31, 2012, raw material costs comprised the majority or approximately 72.9% of total cost of sales, packing material costs comprised approximately 17.2% of total cost of sales, and labor costs comprised approximately 9.9% of total cost of sales. The increased gross margins in the first quarter of 2012 was mainly because the majority of our revenue growth during the quarter came from highly profitable micro-organism and vaccine product lines, while relatively less profitable veterinary medications product line reduced its production, and therefore sales, during the quarter, as described above.

 

Cost of Sales — Veterinary Medications.   Cost of sales of our veterinary medications product line decreased from $2,821,906 for the three months ended March 31, 2011 to $1,792,647 for the three months ended March 31, 2012, a decrease of $1,029,259 or 36.5%.  This decrease was mainly due to the decrease in corresponding sales. Cost of sales of veterinary medications product line comprised 49.2% of total cost of sales for the three months ended March 31, 2012.

 

Cost of Sales — Micro-Organism.   Cost of sales of our micro-organism product line increased from $494,182 for the three months ended March 31, 2011 to $906,841 for the three months ended March 31, 2012, an increase of $412,659 or 83.5%.  This increase was mainly due to the corresponding increased sales.

 

Cost of Sales — Feed Additives.   Cost of sales of our feed additives product line increased from $140,866 for the three months ended March 31, 2011 to $849,884 for the three months ended March 31, 2012, an increase of $709,018 or 503.3%.  This increase in cost of sales was mainly due to the corresponding increase in feed additive sales and significantly increased raw material costs of yeast extract, the main raw material used in the manufacture of feed additives products.

 

Cost of Sales — Vaccines.   Cost of sales of our vaccines product line increased from $34,392 for the three months ended March 31, 2011 to $94,286 for the three months ended March 31, 2012, an increase of $59,894 or 174.2%.  This increase was the result of the corresponding increase of vaccine product sales.

 

Operating Expenses

 

   Three Months Ended March 31, 
   2012   2011 
   Amount   % of total
revenue
   Amount   % of total
revenue
 
Operating Expenses                    
Research and Development Costs  $3,654    0.1%  $287,472    4.1%
Selling Expenses  $705,616    8.9%  $369,404    5.2%
General and Administrative Expenses  $1,105,435    13.9%  $1,294,798    18.2%
Total Operating Expenses  $1,814,705    22.9%  $1,951,674    27.5%

 

Research and Development Costs.  Research and development costs totaled $3,654 for the three months ended March 31, 2012 as compared to $287,472 for the three months ended March 31, 2011, a decrease of $283,818 or 98.7%. The decrease was primarily due to no significant new R&D efforts undertaken during the first quarter of 2012.

 

Selling Expenses.  Selling expenses totaled $705,616 for the three months ended March 31, 2012 as compared to $369,404 for the three months ended March 31, 2011, an increase of $336,212 or 91.0%.  This increase is primarily a result of significantly increased shipping and handling costs related to delivering our products to customers as we continued to expand our market to remote areas, and to rising oil price and continuing inflation pressure in China, which resulted in higher unit costs for transportation and delivery services. Shipping and handling costs totaled $383,703 and $194,216 for the three months ended March 31, 2012 and 2011, respectively, an increase of $189,487 or 97.6%. In addition, the increases in the sales forces and selling commission due to new sales incentive programs initiated later last year also contributed to the increase in selling costs. Selling salaries totaled $105,810 and $34,811 for the three months ended March 31, 2012 and 2011, respectively, an increase of $70,999 or 204.0%. Selling commission totaled $135,617 and $79,818 for the three months ended March 31, 2012 and 2011, respectively, an increase of $55,799 or 69.9%.

 

General and Administrative Expenses.  General and administrative expenses totaled $1,105,435 for the three months ended March 31, 2012 as compared to $1,294,798 for the three months ended March 31, 2011, a decrease of $189,363 or 14.6%. The decrease was mainly due to decreased amortization expenses, G&A travel and office expenses during the first quarter of 2012. The decrease in amortization expense was because patent acquired through the acquisition of Jingzhou plant was fully amortized in 2011. Amortization expenses totaled $100,373 and $230,922 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $130,549 or 56.5%. In addition, the decreases in the G&A travel and office expenses due to the Company’s continued efforts to optimize cost control also contributed to the decrease in G&A costs in the first quarter. G&A travel costs totaled $16,215 and $120,372 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $104,157 or 86.5%. G&A office expenses totaled $31,042 and $142,140 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $111,098 or 78.2%. The increase in the audit costs of $99,480 in the first quarter of 2012 partially offset the impact of the cost reduction in other G&A items.

 

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Liquidity

 

For the three months ended March 31, 2012, cash provided by operating activities was $2,021,671 compared to cash used in operating activities of $6,288,315 for the three months ended March 31, 2011. The major operating activities that provided cash for the three months ended March 31, 2012 were net income of $1,904,754 and an increase in tax payable of $1,427,655. The major operating activities that used cash for the three months ended March 31, 2012 were an increase in accounts receivable of $2,415,647 and an increase in deposits, prepaid expenses and other receivables of $2,144,356. Although the inflation rate in China eased to 3.6% in March 2012 from 2011 peak, according to our observation on raw material marketplace we believe the rising oil price and inflationary impact will still exist for the rest of 2012, and cost of raw materials will likely continue to rise. We will continue the strategy to prepay our suppliers to ensure the supply of raw materials at relatively lower cost levels and to protect our profit margins from being eroded by inflation and rising oil prices which caused an increase in our transportation costs. As of March 31, 2012, we had approximately 60 suppliers that we made advances to in order to secure our raw material needs and to obtain favorable pricing. We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.

 

Cash used in investing activities for the three months ended March 31, 2012 was $111,420, as compared to cash provided by investing activities of $6,462,736 for the three months ended March 31, 2011. Cash used in investing activities for the three months ended March 31, 2012 was primarily the result of purchase of plant and equipment of $54,965 and payment on construction-in-process of $44,940.

 

Cash provided by financing activities for the three months ended March 31, 2012 was $389,581, as compared to $1,319,841 for the three months ended March 31, 2011. Cash provided by financing activities for the three months ended March 31, 2012 was primarily the result of increase in due to related parties of $326,061.

 

As of March 31, 2012, we had cash of $9,386,584. Our total current assets were $65,028,677, and our total current liabilities were $19,188,340, which resulted in a net working capital of $45,840,337.

 

Capital Resources

 

We finance our ongoing operating activities by using funds from our operations and external credit or financing arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources. We secured $63,520 in short-term loans from a third-party individual during the three months ended March 31, 2012. Considering our existing working capital position and our ability to access debt funding sources, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements to support our ongoing operations for at least next twelve months.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations  

 

     Payments Due by Period  
Contractual Obligations   Total     Less than
1 year
    1 – 3 years     3 – 5 years     More than
5 years
 
R&D Project Obligation   $ 1,270,382     $ 1,270,382     $ -     $ -     $ -  
Operating Lease Obligations     376,415       81,568       178,897       115,950       -  
Government Grant Obligation     633,600       633,600       -       -       -  
Total   $ 2,280,397     $ 1,985,550     $ 178,897     $ 115,950     $ -  

 

In addition to the contractual obligations listed above, we have a future registered capital commitment related to our subsidiaries Skystar Kunshan and Skystar Jingzhou.

 

Skystar Kunshan is located in Kunshan, Jiangsu province, China. Skystar Kunshan has a registered capital of $15,000,000, of which we invested $2,250,000 in cash. The remaining $12,750,000 of capital was originally required to be invested prior to May 7, 2012. With the government’s approval, this deadline to invest was extended and we are not required to make this capital investment immediately. As of the date of this report, we have not received the notice from the government for a new due date. In 2011, the asset acquisition of Kunshan facility was completed. We are in the process of getting the government’s approval to transfer the assets purchased to satisfy some of our registered capital commitment. As of the date of this report, we have not received the approval.

 

Skystar Jingzhou is located in Jingzhou, Hubei Province, China. Skystar Jingzhou has a registered capital of approximately $4.1 million (RMB 26,000,000), of which approximately $3.7 million (RMB 23,480,000) has been paid. As of March 31, 2012, Skystar Jingzhou has remaining registered capital of $399,168 (RMB 2,520,000) required to be invested. As of the date of this report, the Company has not made this investment.  Skystar Jingzhou is currently in the process of getting the government's approval and will fulfill the requirement of remaining capital of $399,168 (RMB 2,520,000) thereafter. The company expects the process will be completed by the end of the 2nd quarter of 2012.

 

Off-Balance Sheet Arrangements

 

We do not have any outstanding financial guarantees or commitments to guarantee the payment obligations of any third parties.  We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity or that are not reflected in our consolidated financial statements.  Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity, or market risk support to such entity.  We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.

 

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Exchange Rate

 

The Company’s operating subsidiaries in China maintain their books and records in Renminbi (“RMB”), the currency of China. In general, for consolidation purposes, we translate the subsidiaries’ assets and liabilities into US Dollars using the applicable exchange rates prevailing at the balance sheet date, and the statement of income is translated at average exchange rates during the reporting period. Adjustments resulting from the translation of the financial statements of the Company’s Chinese subsidiaries are recorded as accumulated other comprehensive income.

 

The exchange rates used to translate amounts in RMB into US Dollar for the purposes of preparing the consolidated financial statements or otherwise stated in this MD&A were as follows: 

 

    March 31, 2011   December 31, 2011   March 31, 2012
Assets and liabilities   1 RMB = 0.15270 USD   1 RMB = 0.15740 USD   1 RMB = 0.15840 USD
Statements of operations and cash flows for the period/year ended   1 RMB = 0.15218 USD   1 RMB = 0.15496 USD   1 RMB = 0.15880 USD

 

Inflation

 

China's inflation averaged 3.8 percent in the first quarter as food prices remained volatile, which suggested that inflation would not cool sharply in coming months. However, inflation now is well below the levels of last year and remains below the government’s official target of 4 percent. Growth, rather than inflation, is the main economic concern for Chinese government. Growth in China has softened markedly in the past few months as the tightening measures taken by the government last year have dampened domestic activity. For the three months ended March 31, 2012, we were able to secure favorable pricing by prepaying for major components to certain suppliers to lock in prices ahead of time. As a result, we did not experience as much cost pressure as evidenced in the spot market prices of raw materials. To take precautions to minimize the negative impact of cost increases that erode our profit margin, we will continue the practice of prepayments to suppliers through the rest of the year.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”), performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), which are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, to allow timely decisions regarding required disclosure.

 

Based on the evaluation, the Certifying Officers concluded that, as of March 31, 2012, our disclosure controls and procedures were ineffective due to an ongoing material weakness related to the lack of accounting personnel with an appropriate level of knowledge, experience, and training in the application of U.S. GAAP. We have initiated a plan and are taking steps to implement the following measures to remediate this material weakness:

 

1. Continue to recruit qualified accounting and finance personnel who have adequate U.S. GAAP experience and knowledge and finish the reorganization of accounting and finance department and the realignment of responsibilities among accounting and finance staff.
2. Continue to standardize accounting processes in each subsidiary, provide accounting and finance staff with adequate training on accounting principles and internal control procedures and increase supervision and review over daily accounting operation and period-end closing.

 

We intend to implement these steps during the first half of 2012 and will conduct quarterly measurements and assessments of the Company’s financial reporting systems, as a whole.

 

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation that would have a significant effect on the Company’s consolidated financial statements as of March 31, 2012.

 

In May 2007, Andrew Chien filed suit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in United States District Court for the District of Connecticut, alleging causes of action for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. On July 17, 2008, in a decision that is now published, the court granted defendants’ motion to dismiss and subsequently dismissed the lawsuit, entering judgment on behalf of the defendants. Chien appealed the dismissal. Defendants filed a postjudgment motion for sanctions against Chien. On February 5, 2009, the court found the action filed by Chien to have been frivolous, and to have constituted a “substantial” violation of Rule 11, and imposed monetary sanctions on both Chien and his former attorney. Chien appealed the award of sanctions. All appeals, including the one referenced below concerning Chien’s second lawsuit, were subsequently consolidated. The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing sanctions against Chien in light of the circumstances and facts on record. This Mandate was entered on or about November 8, 2010.

  

Andrew Chien, proceeding pro se (i.e., he represented himself without an attorney), filed his second lawsuit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court (which was removed to U.S. District Court) alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action. The court held that all claims asserted against the defendants were barred and failed to state a claim on a multiplicity of grounds, including on the basis of res judicata . Defendants filed a second Motion for Sanctions under Rule 11 and the PSLRA, which was granted. Chien appealed the dismissal. The Court of Appeals for the Second Circuit consolidated all of Chien’s appeals from both of his lawsuits. On November 8, 2010, the Court of Appeals affirmed the dismissals and the awards of sanctions. On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. The Supreme Court denied review of the petition.

 

Andrew Chien, again proceeding pro se, commenced his third lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung, Weibing Lu (and also Weinberg & Company, P.A., Moore Stephens Wirth Frazer & Torbet, LLP, Frazer Frost, LLP, Crowe Horwath LLP, Richardson & Patel LLP, Kevin K. Leung, Harvey Kesner, and Jody M. Borrelli) alleging the same facts and circumstances as set forth in the above two matters, although adding the aforementioned accountants and lawyers as defendants to the claims. The matter commenced on August 8, 2011, and shortly thereafter was removed to U.S. District Court. On October 5, 2011, the court dismissed the entire action as to all defendants.  As in the two previous lawsuits, sanctions were issued against Chien.  Moreover, the District Court issued an order prohibiting Chien from filing any more lawsuits against the defendants without prior approval from the court.  Chien has appealed the court’s rulings to the United States Court of Appeals for the second circuit, where all defendants have filed motions to dismiss. The United States Court of Appeals for the Second Circuit recently affirmed the judgments and orders of the United States District Court and dismissed all of Mr. Chien’s pending appeals.

 

Other than the above described legal proceedings, the Company is not aware of any other legal matters in which any director, officer, or any owner of record or beneficial owner of more than five percent of any class of voting securities of the Company, or any affiliate of any such director, officer, affiliate of the Company, or security holder, is a party adverse to the Company or has a material adverse interest to the Company. No provision has been made in the consolidated financial statements for the above contingencies.

 

ITEM 6. EXHIBITS

 

Exh. No.   Description
3.1   Articles of Incorporation, as amended  (2)
     
3.2   Bylaws, as amended (1)
     
31.1   Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
     
31.2   Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
     
32.1   Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
     
32.2   Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
         

101.INS**   XBRL Instance Document
     
101.SCH**   XBRL Taxonomy Extension Schema
     
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase
     
101.DEF**   XBRL Taxonomy Extension Definition Linkbase

 

31
 

 

101.LAB**   XBRL Taxonomy Extension Label Linkbase
     
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase

 

 

 

Filed herewith.

 

** In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed “furnished” and not “filed.”

 

(1)  Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 15, 2008.

 

(2) Incorporated by reference from Registrant’s Quarter Report on Form 10-Q filed on November 15, 2010.

 

32
 

 

SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  SKYSTAR BIO-PHARMACEUTICAL COMPANY  
       
May 15, 2012 By:   /s/ Weibing Lu  
    Weibing Lu  
    Chief Executive Officer  
    (Principal Executive Officer)  

 

       
  By:   /s/ Bing Mei  
    Bing Mei  
    Chief Financial Officer  
    (Principal Financial and Accounting Officer)  

 

33

XNAS:SKBI Skystar Bio-Pharmaceutical Co Quarterly Report 10-Q Filling

Skystar Bio-Pharmaceutical Co XNAS:SKBI Stock - Get Quarterly Report SEC Filing of Skystar Bio-Pharmaceutical Co XNAS:SKBI stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNAS:SKBI Skystar Bio-Pharmaceutical Co Quarterly Report 10-Q Filing - 3/31/2012
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