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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10 -K
For the fiscal year ended June 30, 2012
ACT OF 1934
For the transition period from ______________ to __________________
Commission file number: 000 - 51312
SHENGTAI PHARMACEUTICAL, INC.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including; area code 011 - 86 - 536 – 2188831
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to section 12(g) of the Act:
Common Stock par value $0.001
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
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. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). xYes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ Yes x No
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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting companies” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
Note.—If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
The aggregate market value of the voting and non-voting common equity held by non-affiliates* computed by reference to the price of $1.04 per share of common stock at which the common equity was last sold on December 30, 2011, the last day of our most recently completed second fiscal quarter, as reported on www.yahoo.com was: $4,753,734.96.
* Excludes 5,014,013 shares of common stock held by executive officers, directors and stockholders whose individual ownership exceeds 10% of common stock outstanding on December 30, 2011.
Note. — If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. ¨ Yes ¨ No
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
There were 9,584,912 shares of Common Stock, par value $0.001, issued and outstanding as of September 27, 2012.
DOCUMENTS INCORPORATED BY REFERENCE
Item 1. Business.
This Annual Report on Form 10-K (including the section regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this Annual Report on Form 10-K. Additionally, statements concerning future matters are forward-looking statements.
Although forward-looking statements in this Annual Report on Form 10-K reflect our good faith judgment, 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 in Item 1A—“Risks Factors” below, as well as those discussed elsewhere in this Annual Report on Form 10-K. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We file reports with the SEC. We make available on our web site under “Investor Relations/SEC Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such materials with or furnish them to the SEC. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. 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 us.
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 Annual Report on Form 10-K. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.
All references to “us,” “we,” the “Company” and “Shengtai” refer to Shengtai Pharmaceutical, Inc., and its subsidiaries, Weifang Shengtai Pharmaceutical Co., Ltd., a wholly foreign-owned entity in the PRC (“Weifang Shengtai”), and Shengtai Holding Inc., a New Jersey corporation (“SHI”). All references to “China” or the “PRC” refer to the People’s Republic of China.
Shengtai Pharmaceutical, Inc. was incorporated in 2004 in the State of Delaware. The Company, through its direct and indirect subsidiaries in China, manufactures and distributes glucose and starch as pharmaceutical raw materials, other starch products and other glucose products such as corn meals, food and beverage glucose and dextrin. Most of the Company’s sales are made in the People’s Republic of China, the “PRC.”
Dextrose, a form of glucose, is one of the most important carbohydrates and the chief source of energy in the human body. As such, dextrose monohydrate is used in a wide array of pharmaceutical products such as transfusions and intravenous drips for restorative and nutritional purposes.
Approximately 43.06% of our revenues for the fiscal year ended June 30, 2012 were attributable to sales of glucose products.
Approximately 29.19% of our sales revenues for the fiscal year ended June 30, 2012 were attributable to sales of starch products.
Approximately 27.75% of our sales revenue for the fiscal year ended June 30, 2012 were attributable to sales of other products which are mainly by products of our cornstarch products. Other products include corn embryo, fibers, and other products.
On November 9, 2010, the Company effected a 1-for-2 reverse stock split of its issued and outstanding shares of common stock, and reduced the number of its authorized shares of common stock and preferred stock by the same reverse stock split ratio. The authorized number of shares of common stock is reduced from 100,000,000 to 50,000,000, and the authorized number of shares of preferred stock is reduced from 5,000,000 to 2,500,000. The number of common stock and relevant items affected by common stock referred to throughout this Annual Report reflects the post reverse split information.
We manufacture products in three categories: (i) raw materials for pharmaceutical and medicinal companies or purposes, (ii) raw materials for the food and beverage industries and (iii) other products.
Raw materials for pharmaceutical and medicinal companies or purposes:
These products accounted for 23.74% of our sales for the fiscal year ended June 30, 2012. Set forth below is a list of our major pharmaceutical and medical grade products:
Raw Materials for the Food and Beverage and Processing Industries:
These products accounted for 48.42% of our sales for the fiscal year ended June 30, 2012. Set forth below is a list of our major raw materials for the food and beverage and processing industries:
These products accounted for 27.84% of our sales for the fiscal year ended June 30, 2012. Set forth below is a list of our other products:
Sales of Products by Types and Geographic Locations
Approximately 80.94% of our revenues for the fiscal year ended June 30, 2012 were attributable to domestic sales made in the PRC.
Set forth below is a breakdown of the principal products we sold over the previous two fiscal years and the revenues from such sales.
Sales and Marketing
Sales are carried out directly by our sales department at our headquarters in Weifang and we are not dependent on distributors or middlemen. As of June 30, 2012, all the provinces in the mainland PRC (except Tibet) have been covered by our domestic sales network. Historically, we have exported our products to customers in over seventy countries. We plan to increase our global sales. Our products currently are mainly exported to Asia and Southeast Asia, but we intend to apply for security certifications to certify that we are in compliance with international production standards which will help us to expand our sales into the United States and Europe.
Our products are delivered by ground transportation, including by rail. Products sold internationally are shipped by sea. We generally bear the costs of transportation. We absorb the shipping and handling cost into our pricing.
The Glucose Production Process
Our glucose is made from enzyme-converted cornstarch. The glucose that we produce is of low heat, endotoxin lower than 0.125Eu/ml, high purity, and meets the production standard lower than 0.06Eu/ml.
Glucose is produced from cornstarch in the following steps:
Under normal circumstances, the conversion ratio from cornstarch to glucose is close to 100%, with no waste products. In case of a power outage or equipment malfunction, sub-standard output, when it is detected by our quality control procedures, is re-processed.
The three principal ingredients for glucose production are cornstarch, enzyme preparations, and active carbon. The major suppliers for these raw materials are as follows:
Cornstarch Manufacturing Facility
The Company’s cornstarch production facility has a maximum capacity of 400,000 tons per year and for the past year, has produced more than the corn starch it requires. During the fiscal year ended June 30, 2012, the Company used internally 154,017 metric tons of corn starch, and sold 123,781 metric tons of corn starch.
Our corn starch production complex consists of the following areas:
We purchased a total of 85.12 tons and 79.35 tons of enzyme preparations during the years ended June 30, 2012 and 2011, respectively.
Fujian Sha County Qingshan Chemical Carbon Corporation is one of the major active carbon producers in the PRC. We purchased a total of 1,219.3 tons and 1,186.56 tons of active carbon from it during the years ended June 30, 2012 and 2011, respectively. There are a number of other suppliers of active carbon from whom we can make purchases, if necessary.
We are not dependent on any single supplier for raw materials and machinery, nor have we ever experienced a shortage in the supply of raw materials or machinery.
Glucose Manufacturing Facility
Our glucose production capacity is 215,000 tons per year as of June 30, 2012, an increase of 5,000 tons compared with 210,000 tons as of June 30, 2011. During the fiscal year ended June 30, 2012, the Company has sold 136,270 metric tons of glucose products.
Our PRC production facilities are fully certified by applicable PRC regulations for GMP, ISO9001, ISO22000 and HACCP international quality standards.
We have implemented a three-tier quality control system: production team level, workshop level, and management accountability for quality. We combine this with strict quality-oriented procedures to ensure that all products are produced in a pollution-free, contamination-free and efficient production environment. A team of workers on-duty is responsible for the smooth operation of the production process by adhering to proper procedures. The intermediate output from each production step is sampled and checked to ensure that the final output meets specified quality standards. Equipment is regularly checked and maintained to ensure proper operation. The quality of the water used in the production process and the level of airborne particles and microbes in the production sites are also regularly checked to eliminate contamination. The quality of all output is reviewed by the General Manager of the Quality Control Department, and ultimately approved by the CEO. A full set of written quality control records is maintained.
The quality indices of our manufactured glucose are as follows:
The quality indices of our Dextrose Monohydrate Transfusion (liquid glucose) are as follows:
Physical and chemical index
Industry Overview and Trends
The process of pharmaceutical transfusion was first put to use in 1832. Since then clinical transfusion has grown from its rather limited choice of original physiological brine to more than 200 different kinds of transfusion media.
The diverse range of transfusion media can be grouped into five categories:
Dextrose Monohydrate is widely used medically and clinically for restorative and nutritional purposes. For example, a solution of pure glucose, Dextrose or D-glucose, has been recommended for use by subcutaneous injection as a restorative measure after major operations or as a nutritive measure in debilitating diseases.
Dextrose Monohydrate is widely used in hospitals and clinical institutions in the PRC and is covered by the PRC Government-subsidized Medical Insurance Scheme.
Glucose exists in many forms in nature, including in plants, fruits, honey and animal products. In human bodies, every 100 ml of blood typically contains 80-120 mg glucose. Glucose is the ingredient for many saccharide compounds such as saccharose, maltose, starch, glycogen and vitamins. The properties of glucose are summarized as: white crystal with sweet taste, easily soluble in water, difficult to dissolve in alcohol, insoluble in organic solvents such as ether, chloroform and neutral reaction to litmus.
Liquid glucose is a transparent and viscous liquid, and is produced by the action of enzymes on refined cornstarch. Glucose is formed by the hydrolysis of many carbohydrates, including sucrose, maltose, cellulose, starch and glycogen. Fermentation of glucose by yeast produces ethyl alcohol and carbon dioxide. Glucose is made industrially by the hydrolysis of starch under the influence of diluted aid, or more commonly, under that of enzymes.
Glucose is used for many different purposes, as a raw material for many food and beverage products and as a substitute for sucrose. With the technological advances in food and beverage production, and also in response to the demand from consumers for healthier food and drinks, producers are using more and more glucose as a raw material. Glucose is also used in veterinary medicine as a carrier of animal medicines.
Glucose is used by the pharmaceutical and chemical industries in a variety of ways. By different reaction mechanisms, different types of chemical compounds are produced, by the self-oxidation and combination mechanism to produce calcium gluconate, zinc gluconate, and glucorone; by the hydro-reduction mechanism to produce sorbic alcohol and manno-alcohol, or to produce Vitamin B2, glutamine, ribose, and other vitamins.
Our principal customers are:
We market our products within the PRC and plan to expand our export business as we increase our production capabilities.
Our competitiveness is reflected in the following:
Domestic and International Market
We mainly exported glucose and cornstarch products overseas and we plan to continue to export more products to overseas markets. Our export revenues from major export markets are summarized as follows for the years ended June 30, 2012 and 2011:
Some of our competitors and their main products are listed below.
(trans – competitor in Dextrose Monohydrate transfusion solution)
(oral – competitor in oral Dextrose Monohydrate)
(andh – competitor in Dextrose Anhydrous)
In the domestic market, we are the largest manufacturer of pharmaceutical grade glucose. Internationally, we have the following significant advantages.
With the PRC being a major corn-producing region of Asia, and Shandong being the major corn-producing province of the PRC, our operating subsidiary Weifang Shengtai, located in Shandong, has the advantage of receiving a steady supply of raw materials nearby with low transportation costs.
In Changle County where we are located, there is plenty of land for us to expand.
We export to markets such as South Korea, Russia, Australia and Singapore and fifty other countries. Taking into consideration the geographical proximity and cross-cultural similarities with the Northern and South-Eastern Asian markets, we can be competitive in terms of product price, delivery lead-time and customer service responsiveness. The management believes that the Company has lower cost advantage over its international competitors because it has access to lower corn prices and lower labor cost.
We are one of the leading producers of pharmaceutical Dextrose Monohydrate products in the PRC, with an estimated greater than 30% of the overall PRC market. We have production lines for a full set of Dextrose Monohydrate products. Other suppliers of pharmaceutical Dextrose Monohydrate products do not have production lines for a full set of Dextrose Monohydrate products.
Our orders are processed on a made to order basis.
We plan to:
We (i) optimized our web site to describe and promote our business, (ii) reorganized sales department, (iii) bought advertisements for various search words and phrases (e.g., the word, "glucose,” on Alibaba.com search engines, (iv) conducted seminars at various trade show events to promote our products, and (v) optimized our web site so that people doing ‘natural’ searches will see the web site link on the first page of the search by refining the Search Engine Optimization.
We expanded our warehouse capacity to enable us to store more raw materials and thus lock in lower raw material cost while the corn prices increase continuously. We had 50,000 tons and 36,000 tons of raw material capacity as of June 30, 2012 and 2011, respectively.
Our customers are principally located in the PRC. Our principal customers are hospitals and pharmaceutical companies. Below is a list of our largest PRC customers:
There was no customer that individually accounted for more than 10% of our sales for fiscal years ended June 30, 2012 and 2011.
Ownership of the trademark, "Heng De Bao," was transferred to us at no charge from Changle Medical Starch Factory (our State-owned predecessor company) on or about July 28, 2000. The trademark was assigned by the Chinese Trademark Bureau and registered under classes 31 (for our pharmaceutical starch and white dextrin products) and 5 (for our pharmaceutical glucose products). The class 31 registration is valid through June 9, 2019. The class 5 registration is valid through May 9, 2021. International Class Code 5 covers pharmaceuticals, veterinary and sanitary preparations; dietetic substances adapted for medical use; food for babies; plasters, materials for dressings; material for stopping teeth, dental wax; disinfectants; preparations for destroying vermin; fungicides, herbicides. International Class Code 31 covers agricultural, horticultural, and forestry products and grains not included in other classes; live animals, fresh fruits and vegetables; seeds, natural plants, and flowers; and malt which is animal food.
We purchased automobile insurance with third party liability coverage for our vehicles and liabilities insurance for our key personnel and Company. We do not have other insurance such as property insurance, business liability or disruption insurance coverage for our operations in the PRC. While a lawsuit against a company such as Weifang Shengtai in the PRC would be rare, we cannot make any assurance that we will not have exposure for liability in the event of a lawsuit.
Because we manufacture pharmaceutical products, we are subject to the laws governing the Good Practice in the Manufacturing and Quality Control of Drugs (as amended in 1998) as promulgated by the PRC State Food and Drug Administration on March 18, 1999.
We are also subject to business license and approval regulations that are required for all corporations in the PRC.
We have obtained Certificates of Good Manufacturing Practices for Pharmaceutical Products, "GMP Certificates,” issued by the PRC State Food and Drug Administration. The GMP Certificates certify that we have complied with the requirements of Chinese Current Good Manufacturing Practices for Pharmaceutical Products in the manufacture of Dextrose Monohydrate oral glucose, Dextrose Monohydrate glucose, and Anhydrous glucose and the GMP Certificate is valid through November 10, 2013. Additionally, we have obtained Drug Registration Certificates for glucose and glucose pro oral from the State Food and Drug Administration in accordance with the PRC Medical Products Governance Law and its implementing regulations.
We are subject to PRC environmental laws, rules and regulations that are standard to manufacturing facilities.
All of our production lines including the new glucose production lines have passed inspection by the Environmental Protection Bureau of the PRC and were issued Certificates of Qualification.
As of June 30, 2012, we employed approximately 733 full-time employees, excluding 7 directors of Weifang Shengtai and Shengtai. Of these employees, approximately 30 are sales personnel, approximately 166 perform operating and administrative functions and approximately 537 are in production, storage and distribution.
Item 1A. Risk Factors.
Investment in our common stock involves risks. You should carefully consider the risks we describe below before deciding to invest. The market price of our common stock could decline due to any of these risks, in which case you could lose all or part of your investment. In assessing these risks, you should also refer to the other information included in this Annual Report, including our consolidated financial statements and the accompanying notes. You should pay particular attention to the fact that we are a holding company with substantial operations in China and are subject to legal and regulatory environments that in many respects differ from that of the United States. Our business, financial condition or results of operations could be affected materially and adversely by any of the risks discussed below and any others not foreseen. This discussion contains forward-looking statements.
Risks related to doing business in the People’s Republic of China
Our business operations are conducted primarily in the PRC. Because PRC laws, regulations and policies are continually changing, our PRC operations will face several risks summarized below.
Our ability to operate in the PRC may be harmed by changes in its laws and regulations
Our offices and manufacturing plants are located in the PRC and the production, sale and distribution of our products are subject to PRC rules and regulations. In particular, the manufacture and supply of pharmaceutical grade and medicinal products are subject to the PRC rules and regulations, such as the Good Practice in the Manufacturing and Quality Control of Drugs (as amended in 1998) as promulgated by the PRC State Food and Drug Administration on March 18, 1999 and the PRC Medical Products Governance Law. In addition, because we operate a cornstarch production facility which produces waste water, we are subject to the environmental rules and regulations such as the Integrated Wastewater Discharge Standard (GB8978-1996).
The PRC only recently has afforded provincial and local economic autonomy and permitted private economic activities. The PRC government has exercised and continues to exercise substantial control over virtually every sector of the PRC economy through regulation and state ownership.
Our ability to operate in the PRC may be harmed by changes in its laws and regulations, including those relating to manufacturing, taxation, import and export tariffs, environmental regulations, land use rights, property and other matters.
Our production and manufacturing facility is subject to PRC regulation and environmental laws. The PRC government has been active in regulating the pharmaceutical and medicinal goods industry. Our business and products are subject to government regulations mandating the use of good manufacturing practices. Changes in these laws or regulations in the PRC, or other countries we sell into, that govern or apply to our operations could have a materially adverse effect on our business. For example, the law could change so as to prohibit the use of certain chemical agents in our products. If such chemical agents are found in our products, then such a change would reduce our productivity of that product.
We are a state-licensed corporation. If we were to lose our state-licensed status, we would no longer be able to manufacture our products in the PRC.
There is no assurance that PRC economic reforms will not adversely affect our operations in the future
As a developing nation, the PRC's economy is more volatile than that of developed Western industrial economies. It differs significantly from that of the U.S. or a Western European country in such respects as structure, level of development, capital reinvestment, resource allocation and self-sufficiency. Only in recent years has the PRC economy moved from what had been a command economy through the 1970s to one that during the 1990s encouraged substantial private economic activity. Although the PRC government still owns the majority of productive assets in the PRC, in the past several years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activity.
In 1993, the Constitution of the PRC was amended to reinforce such economic reforms. The trends of the 1990s indicate that future policies of the Chinese government will emphasize greater utilization of market forces. The PRC government has confirmed that economic development will follow the model of a market economy. For example, in 1999 the Government announced plans to amend the Chinese Constitution to recognize private property, although private business will officially remain subordinated to the state-owned companies, which are the mainstay of the Chinese economy. However, there can be no assurance that, under some circumstances, the government's pursuit of economic reforms will not be restrained or curtailed. Actions by the central government of the PRC could have a significant adverse effect on economic conditions in the country as a whole and on the economic prospects for our Chinese operations. Economic reforms could either benefit or damage our operations and profitability. Some of the things that could have this effect are: (i) level of government involvement in the economy; (ii) control of foreign exchange; (iii) methods of allocating resources; (iv) international trade restrictions; and (v) international conflict.
Under the present direction, we believe that the PRC will continue to strengthen its economic and trading relationships with foreign countries and business development in the PRC will follow market forces. While we believe that this trend will continue, there can be no assurance that this will be the case. A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises and could require us to divest ourselves of any interest we then hold in Chinese properties or businesses. Although the PRC government has been pursuing economic reform policies for more than three decades, there is no assurance that the government will continue to pursue these policies or that these policies may not be significantly changed, especially in the event of a change in leadership, social or political disruption, or other circumstances affecting the PRC's political, economic and social life.
Because these economic reform measures may be inconsistent, ineffectual or temporary, there are no assurances that:
Anti-inflation measures may be ineffective or harm our ability to do business in the PRC
Since 1979, the PRC government has continued to reform its economic system. Because many reforms are unprecedented or experimental, they are expected to be refined and improved. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or in the disparities in per capita wealth between regions within the PRC, could lead to further readjustment of the reform measures. This refining and readjustment process may instead negatively affect our operations and there is no guarantee that it will be effective.
Over the last few years, the PRC's economy has registered a high growth rate. During the past ten years, the rate of inflation in the PRC has been as high as 5.9% and as low as -0.7%. (Statistics Bulletin, National Bureau of Statistics, the People’s Republic of China, http://www.stats.gov.cn/tjgb/index.htm). Recently, there have been indications that rates of inflation have increased. In response, the PRC government recently has taken measures to curb this excessively expansive economy. These corrective measures were designed to restrict the availability of credit or regulate growth and contain inflation. These measures have included devaluations of the PRC currency, the Renminbi (RMB), restrictions on the availability of domestic credit, reducing the purchasing capability of certain customers, and limited re-centralization of the approval process for purchases of some foreign products. These austere measures alone may not succeed in slowing down the economy's excessive expansion or control inflation, and may result in severe dislocations in the PRC economy. The PRC government may adopt additional measures to further combat inflation, including the establishment of freezes or restraints on certain projects or markets. Such measures could harm the market for our products and inhibit our ability to conduct business in the PRC.
The PRC’s legal and judicial system may not adequately protect our business and operations and the rights of foreign investors
The PRC legal and judicial system may negatively impact foreign investors. In 1982, the National People's Congress amended the Constitution of China to authorize foreign investment and guarantee the "lawful rights and interests" of foreign investors in the PRC. However, the PRC's system of laws is not yet comprehensive. The legal and judicial systems in the PRC are still rudimentary, and enforcement of existing laws is inconsistent. Many judges in the PRC lack the depth of legal training and experience that would be expected of a judge in a more developed country. Because the PRC judiciary is relatively inexperienced in enforcing the laws that do exist, anticipation of judicial decision-making is more uncertain than would be expected in a more developed country. It may be impossible to obtain swift and equitable enforcement of laws that do exist, or to obtain enforcement of the judgment of one court by a court of another jurisdiction. The PRC's legal system is based on the civil law regime, that is, it is based on written statutes; a decision by one judge does not set a legal precedent that is required to be followed by judges in other cases. In addition, the interpretation of Chinese laws may be varied to reflect domestic political changes.
The promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors. However, the trend of legislation over the last 20 years has significantly enhanced the protection of foreign investment and allowed for more control by foreign parties of their investments in PRC enterprises. There can be no assurance that a change in leadership, social or political disruption, or unforeseen circumstances affecting the PRC's political, economic or social life, will not affect the PRC government's ability to continue to support and pursue these reforms. Such a shift could have a material adverse effect on our business and our prospects.
The practical effect of the PRC legal system on our business operations in the PRC can be viewed from two separate but intertwined considerations. First, as a matter of substantive law, the Foreign Invested Enterprise laws provide significant protection from government interference. In addition, these laws guarantee the full enjoyment of the benefits of corporate articles and contracts to Foreign Invested Enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are qualitatively different from the general corporation laws of the United States. Similarly, the PRC accounting rules mandate accounting practices, which are not consistent with U.S. generally accepted accounting principles. PRC’s accounting rules require that an annual "statutory audit" be performed in accordance with PRC accounting standards and that the books of accounts of Foreign Invested Enterprises are maintained in accordance with Chinese accounting rules. Article 14 of the People's Republic of China Wholly Foreign-Owned Enterprise Law requires a wholly foreign-owned enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities, at the risk of business license revocation. Weifang Shengtai is a wholly foreign-owned enterprise. Second, while the enforcement of substantive rights may appear less clear than United States procedures, the Foreign Invested Enterprises and Wholly Foreign-Owned Enterprises are Chinese registered companies, which enjoy the same status as other Chinese registered companies in business-to-business dispute resolution.
Since the Articles of Association of Weifang Shengtai do not provide for the resolution of disputes the parties are free to proceed to either the Chinese courts, or if they are in agreement, to arbitration.
Any award rendered by an arbitration tribunal is enforceable in accordance with the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958). Therefore, as a practical matter, although no assurances can be given, the Chinese legal infrastructure, while different in operation from its United States counterpart, should not present any significant impediment to the operation of Foreign Invested Enterprises.
In addition, some of our present and future executive officers and our directors, most notably, Mr. Qingtai Liu, Mr. Yongqiang Wang, and Mr. Yaojun Liu, may be residents of the PRC and not of the United States, and substantially all the assets of these persons are located outside the U.S. As a result, it could be difficult for investors to effect service of process in the United States, or to enforce a judgment obtained in the United States against us or any of these persons.
The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. We and any future subsidiaries are considered foreign persons or foreign funded enterprises under PRC laws, and as a result, we are required to comply with PRC laws and regulations. These laws and regulations are sometimes vague and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our business.
Governmental control of currency conversion may affect the value of your investment.
The majority of our revenues will be settled in Renminbi and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenues generated in Renminbi to fund any future business activities outside the PRC or to make dividend or other payments in U.S. dollars. Although the PRC government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises like us may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in the PRC authorized to conduct foreign exchange business.
In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in the PRC, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the PRC regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi.
The value of our securities and your ability to receive dividends may be affected by the foreign exchange rates between U.S. dollars and Renminbi and the PRC government’s control over the Renminbi.
The value of our common stock will be affected by the foreign exchange rates between U.S. dollars and Renminbi, and between those currencies and other currencies in which our sales may be denominated. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position, our business, and the price of our common stock may be harmed. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiary in the PRC would be reduced.
The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. We receive substantially all of our revenues in Renminbi which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi is to be converted into foreign currency and remitted out of the PRC to pay capital expenses, such as the repayment of bank loans denominated in foreign currencies.
The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain expenses as they come due.
The fluctuation of the Renminbi may materially and adversely affect your investment.
The value of the Renminbi against the U.S. Dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC's political and economic conditions. As we rely almost entirely on revenues earned in the PRC—most of our sales occur in the PRC—any significant revaluation of the Renminbi may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert U.S. Dollars we receive from an offering of our securities into Renminbi for our operations, appreciation of the Renminbi against the U.S. Dollar could have a material adverse effect on our business, financial condition and results of operations. Conversely, if we decide to convert our Renminbi into U.S. Dollars for the purpose of making payments for dividends on our common shares or for other business purposes and the U.S. Dollar appreciates against the Renminbi, the U.S. Dollar equivalent of the Renminbi we convert would be reduced. In addition, the depreciation of significant U.S. Dollar denominated assets could result in a charge to our income statement and a reduction in the value of these assets. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. Dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in appreciation of the Renminbi against the U.S. Dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. Dollar.
Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC domestic residents and registration requirements for employee stock ownership plans or share option plans may subject our PRC resident beneficial owners or the plan participants to personal liability, limit our ability to inject capital into our PRC subsidiaries, limit our subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.
The China State Administration of Foreign Exchange ("SAFE") issued a public notice in October 2005 requiring PRC domestic residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies, referred to in the notice as an "offshore special purpose company." PRC domestic residents who are shareholders of offshore special purpose companies and have completed round trip investments but did not make foreign exchange registrations for overseas investments before November 1, 2005 were retroactively required to register with the local SAFE branch before March 31, 2006. PRC resident shareholders are also required to amend their registrations with the local SAFE in certain circumstances. After consultation with China counsel, we do not believe that any of our PRC domestic resident shareholders are subject to the SAFE registration requirement, however, we cannot provide any assurances that all of our shareholders who are PRC residents will not be required to make or obtain any applicable registrations or approvals required by these SAFE regulations in the future. The failure or inability of our PRC resident shareholders to comply with the registration procedures set forth therein may subject us to fines and legal sanctions, restrict our cross-border investment activities, or limit our PRC subsidiaries’ ability to distribute dividends or obtain foreign-exchange-dominated loans to our Company.
As it is uncertain how the SAFE regulations will be interpreted or implemented, we cannot predict how these regulations will affect our business operations or future strategy. For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may adversely affect our results of operations and financial condition. In addition, if we decide to acquire a PRC domestic company, we cannot assure you that we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrations required by the SAFE regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.
In December 2006, the People’s Bank of China promulgated the Implementation Rules of the Administrative Measures for Individual Foreign Exchange, or the Individual Foreign Exchange Rules, setting forth the respective requirements for foreign exchange transactions by PRC individuals under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Individual Foreign Exchange Rules, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. On March 28, 2007, SAFE promulgated the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, PRC citizens who are granted stock options by an overseas publicly-listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures. We and our PRC employees who may be granted stock options are subject to the Stock Option Rule. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions.
Risks related to our business
We cannot give any assurance that any plans for future expansion will be implemented or that they will be successful.
While we have expansion plans, which include making full use of the newly built cornstarch manufacturing plant, partially completed and operational since January 2007, upgrading our existing glucose manufacturing facility, building a new glucose manufacturing facility and expanding our sales overseas, there is no guarantee that such plans will be implemented or that they will be successful. These plans are subject to, among other things, their feasibility to meet the challenges we face, our ability to arrange for sufficient funding and the ability to hire qualified and capable employees to carry out these expansion plans.
We have a limited operating history and limited historical financial information upon which you may evaluate our performance.
Our operating subsidiary, Weifang Shengtai, was incorporated in 1999 and our operations have been largely confined to the PRC. In addition, while we have had some experience in managing a cornstarch manufacturing facility, we may not be adequately prepared to manage and operate a larger, more modern facility.
We are in our early stages of development and face risks associated with a new company in a growth industry. We may not successfully address these risks and uncertainties or successfully implement our operating strategies. If we fail to do so, it could materially harm our business to the point of having to cease operations and could impair the value of our common stock to the point investors may lose their entire investment. Even if we accomplish these objectives, we may not generate positive cash flows or the profits we anticipate in the future.
Although our revenues have grown rapidly since our inception from the growing demand for our glucose products, we cannot assure you that we will maintain our profitability or that we will not incur net losses in the future. We expect that our operating expenses will increase as we expand. Any significant failure to realize anticipated revenue growth could result in significant operating losses. We will continue to encounter risks and difficulties frequently experienced by companies at a similar stage of development, including our potential failure to:
There are limitations to the effectiveness of our internal controls over financial reporting and only reasonable assurance can be placed on them. Stockholder confidence in our financial reporting and disclosures made in our public filings could be affected, which would harm our business and the trading price of our stock.
The PRC historically has not adopted a western style of management and financial reporting concepts and practices, or a modern western style of banking, computer and other control systems. We have had difficulty in hiring and retaining a qualified Chief Financial Officer. Our Chief Financial Officer’s resignations during the last two years has led us to conclude that there was a material weakness in our disclosure controls and procedures in that they were not effective and was not adequately designed to ensure that the information required to be disclosed by the Company in the reports the Company submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and that such information was accumulated and communicated to the Company’s Chief Executive Officer and Chief Financial Officer in a manner that allowed for timely decisions regarding required disclosure.
Although we have concluded that our internal control over financial reporting and disclosure controls and procedures are not effective, we believe that the financial statements included in our past filings correctly present our financial condition, results of operations and cash flows for the fiscal years covered thereby in all material respects.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
As a result of these material weaknesses and deficiencies in our disclosure controls and procedures, current and potential stockholders could lose confidence in our financial reporting and disclosures made in our public filings, which would harm our business and the trading price of our stock.
We face stiff competition, some of which may be from companies which may be better capitalized and more experienced than us.
We face competition from other domestic and global manufacturers and suppliers of pharmaceutical grade glucose. Although we view ourselves in a favorable position vis-à-vis our competition, some of the other companies that sell into our markets may be more successful than us and/or have more experience and financial resources than we do. This additional experience and financial backing may enable our competitors to produce more cost-effective products and market their products with more success than we are able to, which would decrease our sales. We expect that we will be required to continue to invest in product development and productivity improvements to compete effectively in our markets. However, we cannot assure you that we can successfully remain competitive. If our competitors develop a more efficient product or undertake more aggressive and costly marketing campaigns than us, this could have a material adverse effect on our business, results of operations or financial condition.
A slowdown in the PRC economy may adversely affect our operations.
As all of our operations are conducted in the PRC and most of our revenues are generated from sales in the PRC, a slowdown or other adverse developments in the PRC economy could materially and adversely affect our customers, demand for our products, and our business. Recent economic slowdown since 2008 had affected our business, especially our cornstarch related business. While we believe that the economy is recovering, and although we believe that the demand for our products is not totally dependent on the health of the economy, we do not know how sensitive we are to a slowdown in economic growth or other adverse changes in the PRC economy. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for our products and materially and adversely affect our business.
Our major competitors may be better able than us to successfully endure downturns in our sector. In periods of reduced demand for our products, we can either choose to maintain market share by reducing our selling prices to meet competition or maintain selling prices, which would likely sacrifice market share. Sales and overall profitability would be reduced under either scenario. In addition, we cannot assure you that additional competitors will not enter our existing markets, or that we will be able to compete successfully against existing or new competition.
Inflation in the PRC could negatively affect our profitability and growth.
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may have an adverse effect on profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. Such an austere policy can lead to a slowing of economic growth. In October 2004, the People's Bank of China, the PRC's central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the PRC economy. Repeated rises in interest rates by the central bank would likely slow economic activity in the PRC which could, in turn, materially increase our costs and also reduce demand for our products.
A widespread health problem in the PRC could negatively affect our operations
A potential outbreak of widespread public health problem in the PRC, such as H1N1 flu, could force us temporarily to stop our operations, and thus have an adverse effect on our operations. Our operations may be impacted by a number of health-related factors, including quarantines or closures of some offices that would adversely disrupt our operations. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.
Enforcement against us or our directors and officers may be difficult
Because our principal assets are located outside of the U.S., and all of our five directors and all of our officers reside outside of the U.S., it may be difficult for you to enforce your rights based on U.S. Federal securities laws against us and our officers and some directors or to enforce a U.S. court judgment against us or them in the PRC.
In addition, our operating subsidiary is located in the PRC and substantially all of its assets are located outside of the U.S. It may, therefore, be difficult for investors in the U.S. to enforce their legal rights based on the civil liability provisions of the U.S. Federal securities laws against us in the courts of either the U.S. or the PRC, even if civil judgments are obtained in U.S. courts to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the U.S. and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties under the U.S. Federal securities laws or otherwise.
We have identified significant deficiencies in our internal controls.
As set forth in Item 9A, below, we have identified significant deficiencies in our internal controls. While we are taking steps to address these significant deficiencies, there can be no assurance that such steps will be adequate to entirely cure the deficiencies.
Inadequate funding for our capital expenditures may affect our growth and profitability
Our sales revenues have increased from $19,999,826 for the year ended June 30, 2004, to $ 179,029,127 for the year ended June 30, 2012. Our continued growth is dependent upon our ability to raise capital from outside sources and improvement of profitability. Our ability to obtain financing will depend upon a number of factors, including:
If we are unable to obtain financing, as needed, on a timely basis and on acceptable terms to our investors or lenders, our financial position, competitive position, growth and profitability may be adversely affected.
We may not be able to effectively control and manage our growth.
With our business and markets grow and develop, it will be necessary for us to finance and manage expansion in an orderly fashion. We may not have the requisite experience to manage and operate a larger, more modern cornstarch manufacturing plant and a bigger glucose production line. In addition, we may face challenges in managing expanding product offerings and in integrating acquired businesses with our own. These events would increase demands on our existing management, workforce and facilities. Failure to satisfy these increased demands could interrupt or adversely affect our operations and cause production backlogs, longer product development time frames and administrative inefficiencies.
Significant fluctuations in raw material prices may have a material adverse effect on us.
We do not have any long-term supply contracts with our raw materials suppliers. Any significant fluctuation in price of our raw materials could have a material adverse effect on the manufacturing cost of our products. We are subject to market conditions and although raw materials are generally available and we have not experienced any raw materials shortage in the past, we cannot assure you that the necessary materials will continue to be available to us at prices currently in effect or acceptable to us.
We may have limited options in the short-term for alternative supplies if our suppliers fail for any reason, including their business failure or financial difficulties, to continue the supply of raw materials. Moreover, identifying and accessing alternative sources may increase our costs.
Although we are in the corn-producing region in the Shandong province, there is no guarantee that we will not face a shortage of corn because of some natural calamity or other reasons beyond our control.
We had also mitigated the risks of a shortage in cornstarch by implementing a vertical integration manufacturing program, which includes building our own cornstarch processing plant, in which the plant is now operational. This will not only lower production costs and improve profit margins, but it will also allow Weifang Shengtai to produce higher quality, lower-cost cornstarch. We cannot guarantee these measures will be effective in eliminating all risks attendant to the supply of raw materials. In the event that our cost of materials increase, we may have to raise prices of our products, making us less competitive in price.
We may not be able to adjust our product prices, especially in the short-term, to recover the costs of any increases in raw materials. Our future profitability may be adversely affected to the extent we are unable to pass on higher raw materials costs to our customers.
Potential environmental liability could have a material adverse effect on our operations and financial condition.
To the knowledge of management, neither the production nor the sale of our products constitute activities, or generate materials in a material manner, that requires our operation to comply with the PRC environmental laws. Although it has not been alleged by PRC government officials that we have violated any current environmental regulations, we cannot assure you that the PRC government will not amend the current PRC environmental protection laws and regulations. Our business and operating results may be materially and adversely affected if we were to be held liable for violating existing environmental regulations or if we were to increase expenditures to comply with environmental regulations affecting our operations.
We rely on Mr. Qingtai Liu, our Chief Executive Officer and President, for the management of our business, and the loss of his services may significantly harm our business and prospects.
We depend, to a large extent, on the abilities and participation of our current management team, but have a particular reliance upon Mr. Qingtai Liu, our Chief Executive Officer and President, for the direction of our business. The loss of the services of Mr. Liu, for any reason, may have a material adverse effect on our business and prospects. We cannot assure you that the services of Mr. Liu will continue to be available to us, or that we will be able to find a suitable replacement for Mr. Liu. We have not entered into an employment contract with Mr. Liu. We do not have key man insurance policy on Mr. Qingtai Liu. If Mr. Liu dies and we are unable to replace Mr. Liu for a prolonged period of time, we may be unable to carry out our long term business plan and our future prospect for growth, and our business may be harmed.
We may not be able to hire and retain qualified personnel to support our growth and if we are unable to retain or hire such personnel in the future, our ability to improve our products and implement our business objectives could be adversely affected.
Our future success depends heavily upon the continuing services of the members of our senior management team, in particular our Chief Executive Officer and President, Mr. Qingtai Liu. If one or more of our senior executives or other key personnel is/are unable or unwilling to continue in his/her/their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Competition for senior management and personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or senior personnel, or attract and retain high-quality senior executives or senior personnel in the future. This failure could materially and adversely affect our future growth and financial condition.
We have inadequate insurance coverage
We do not presently maintain product liability insurance, and our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties or claims filed against us.
We currently do not carry any product liability or other similar insurance. We cannot assure you that we would not face liability in the event of the failure of any of our products. This is particularly true given our plan to significantly expand our sales into international markets, such as the United States, where product liability claims are more prevalent.
Except for automobile insurance, and Directors & Officers Liability and Company Reimbursement Insurance, we do not have other insurance such as business liability or disruption insurance coverage for our operations in the PRC.
We do not maintain a reserve fund for warranty or defective products claims. Our costs could substantially increase if we experience a significant number of warranty claims. We have not established any reserve funds for potential warranty claims since historically we have experienced few warranty claims for our products so that the costs associated with our warranty claims have been low. If we experience an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, it would have a material adverse effect on our financial condition and results of operations.
Risks related to an investment in our common stock
Our Chief Executive Officer and President controls us through his position and stock ownership and his interests may differ from other stockholders
Our Chief Executive Officer and President, Mr. Qingtai Liu, beneficially owns approximately 39.12% of our common stock. As a result, although Mr. Liu is not the holder of a majority of the outstanding shares, Mr. Liu may be able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions, including business combinations. Mr. Liu's interests may differ from other stockholders.
We do not intend to pay cash dividends in the foreseeable future
We currently intend to retain all future earnings for use in the operation and expansion of our business. We do not intend to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate. Should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiary based in the PRC, Weifang Shengtai. Our operating subsidiary, from time to time, may be subject to restrictions on its ability to make distributions to us, including as a result of restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions. See "Risks related to doing business in the People’s Republic of China."
There is currently a limited trading market for our common stock
Our common stock has been quoted on the over-the-counter Bulletin Board since January 2007. Because we were formerly a shell company, our bid and ask quotations have not regularly appeared on the OTC Bulletin Board for any consistent period of time. There is a limited trading market for our common stock and our common stock may never be included for trading on any stock exchange or through any other quotation system, including, without limitation, the NYSE Alternext. You may not be able to sell your shares due to the absence of an established trading market.
Our common stock is subject to the Penny Stock Regulations
Our common stock is, and will continue to be, subject to the SEC's "penny stock" rules to the extent that the price remains less than $5.00. Those rules, which require delivery of a schedule explaining the penny stock market and the associated risks before any sale, may further limit your ability to sell your shares.
The SEC has adopted regulations which generally define "penny stock" to be an equity security that has a market price of less than $5.00 per share. Our common stock, when and if a trading market develops, may fall within the definition of penny stock and subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors, generally those with assets in excess of $1,000,000, or annual incomes exceeding $200,000 or $300,000, together with their spouse.
For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser's prior written consent to the transaction. Additionally, for any transaction, other than exempt transactions, involving a penny stock, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the "penny stock" rules may restrict the ability of broker-dealers to sell our common stock and may affect the ability of investors to sell their common stock in the secondary market.
Our common stock is illiquid and subject to price volatility unrelated to our operations
The market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.
Sales of substantial amounts of common stock, or the perception that such sales could occur, and the existence of warrants to purchase shares of common stock at prices that may be below the then current market price of the common stock, could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of our equity securities.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
Our facility in the PRC is located at Changda Road East,Development District, Changle County, Shandong Province, PRC 262400.
All land in the PRC is state-owned and cannot be sold to any individual or entity. Instead, the government grants or allocates landholders a "land use right." Weifang Shengtai has the right to use various parcels of land that range from 20 to 50 years in term, all of which are currently being used by Weifang Shengtai for its business.
Weifang Shengtai occupies an area of approximately 252,275 square meters (62.34 acres) in Changle Economic and Technology Development Zone. Set forth below is the detailed information regarding the land:
Item 3. Legal Proceedings.
In April 2012, several law firms announced investigation of the Company in connection with the receipt of a going private proposal from Chairman and Chief Executive Officer Mr. Liu to acquire common stock at $1.65 per share in cash. To the best of our knowledge, no actions have been filed against the Company or its current officers and directors as of the date of this annual report.
Item 4. Mine Safety Disclosures.
Item 5. Market for Registrant’s Common Equity, Related Stock holder Matters and Issuer Purchases of Equity Securities.
We began trading on the OTC Bulletin Board on January 12, 2007under the symbol "SGTI.OB." The following table sets forth for the period indicated the prices of the common stock (adjusted for the 1-for-2 reverse stock split which occurred on November 12, 2010) in the over-the-counter market, as reported and summarized by the OTC Bulletin Board. Such prices are based on inter-dealer bid and asked prices, without markup, markdown, commissions, or adjustments and may not represent actual transactions. As of September 27, 2012, the last reported closing price of our common stock was $1.59 per share.
As of September 27, 2012, there were 9,584,912 shares of our common stock issued and outstanding and there were 21 holders of record of our common stock.
Since our incorporation, no dividends have been paid on our common stock. We intend to retain any earnings for use in our business activities, so it is not expected that any dividends on our common stock will be declared and paid in the foreseeable future.
As a holding company, our ability to pay dividends is dependent on the receipt of dividends from SHI and our PRC-based operating company Weifang Shengtai. The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. We receive substantially all of our revenues in Renminbi which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency dominated obligations.
Equity Compensation Plan Information and Warrants and Options
As of September 27, 2012, we had no outstanding warrants to purchase shares of common stock.
On January 4, 2008, the Company adopted the Shengtai Pharmaceutical, Inc. 2007 Stock Incentive Plan (“2007 Plan”).
On January 14, 2008, the Company granted stock options to purchase 250,000 shares of the Company’s common stock and non-qualified stock options to purchase 80,000 shares of the Company’s common stock under the Stock Incentive Plan. All options have an exercise price of $6.68 which is the closing price on the date of grant, and expire five years after the date of grant. All options vest over a period of three years from the date of grant.
Pursuant to the employment agreement entered into on March 1, 2010 between the Company and Mr. Hu Ye, the Company’s former Chief Financial Officer (“Ye Employment Agreement”), the Company granted Mr. Hu Ye an option to purchase 150,000 shares of common stock of the Company (“Ye Options”). The shares were to vest over 3 years starting March 1, 2010 and terminate on the third anniversary of the date of issuance of the option. However, the Ye Employment Agreement was terminated in December 2010, and as a result, the Ye Options were forfeited.
The following table gives information about the Company’s common stock that may be issued upon the exercise of options and warrants as of June 30, 2012.
Recent Sales of Unregistered Securities
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Item 6. Selected Financial Data.
The following selected financial data for the fiscal years ended 2012, 2011, 2010, 2009 and 2008 are derived from our audited consolidated financial statements. The data should be read in conjunction with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Factors that may cause our results to differ include, but are not limited to: changes in the scope or timing of our projects; slowdown in the demand for pharmaceutical grade glucose and glucose and starch products generally, which could reduce revenues and profit margins.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we, nor any other person, assume responsibility for the accuracy and completeness of the forward-looking statements. We are under no obligation to update any of the forward-looking statements after the filing of this Annual Report on Form 10-K to conform such statements to actual results or to changes in our expectations.
The following discussion should be read in conjunction with our audited consolidated financial statements and the related notes and other financial information appearing elsewhere in this Form 10-K and other reports and filings made with the Securities and Exchange Commission. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 1A—Risk Factors.
The Company was incorporated in 2004 in the State of Delaware. The Company, through its direct and indirect subsidiaries in China, manufactures and distributes glucose and starch as pharmaceutical raw materials, other starch products and other glucose products such a corn meals, food and beverage glucose and dextrin. Most of the Company’s sales are made in the People’s Republic of China, the “PRC.”
During the reporting period, our production and sales of glucose products remained relatively stable.
The Company’s cornstarch production facility has a maximum capacity of 400,000 tons per year. The facility allows us to use self-produced cornstarch to produce glucose and to be able to ensure the adequacy and quality of the cornstarch we use. Since cornstarch is produced on our premises, we are able to eliminate costs to ship the cornstarch to our glucose production facility, thus resulting in lower manufacturing costs. The cornstarch sales quantity decreased about 17.87%, or 26,924 tons, during the twelve months ended June 30, 2012 compared to the same period in 2011.
In addition to our pharmaceutical glucose series of products, we also produce other glucose and starch products such as industrial glucose, cornstarch, dextrin, and other products used for food, beverage and industrial production.
Management has been placing emphasis on (i) product quality control (ii) enhancement of operating efficiency (iii) expansion of geographical coverage and diversification of customer base, and (iv) new product development. We believe that these points of emphasis are essential for maintaining our competitiveness.
The Company’s glucose production facility passed GMP inspection, the Company’s facilities and many of its products are fully certified for GMP, IS09001, ISO22000 and HACCP international quality standards. We also possess an Export Health Registration Certificate. The rate of quality output, output conforming to pharmaceutical-grade glucose product specifications, is maintained in accordance with government standards and the standards of our customers.
The Company has a three-tier quality control system and a well-equipped quality inspection center to ensure timely detection and reprocessing of non-conforming products.
Our production lines are vertically integrated. Our production facilities are all inter-connected by an enclosed pipeline system to enhance overall production efficiency, minimize wastage of water and raw materials, and to avoid production contamination.
We have developed new production technology to recycle our waste water and byproducts. We are continually improving overall production efficiency by analyzing and ameliorating inefficient production processes. Environmental protection and production efficiency are also important in our growth.
In the last few years, we have managed to successfully expand our domestic sales network. As of June 30, 2012, the Company’s sales network covered all of the provinces of mainland China with the exception of the Tibet Autonomous Region. Historically, we have exported our products to customers in over fifty countries, and we plan to increase our global sales in the coming years.
We constantly strive to broaden and diversify our customer base in order to mitigate our reliance on certain big customers and expand our sales. We believe a broad market for our products can increase demand for our products, reduce our vulnerability to market changes, and provide additional areas of growth in the future. Our top ten customers accounted for only 34.47% for our total sales for the fiscal year ended June 30, 2012.
We will continue to identify and pursue product quality and innovative technology to increase our market share and optimize our cost structure. Barring unforeseen circumstances, we anticipate continued growth in sales during the next few years. Our ability to meet increased customer demand and stay profitable will however continue to depend on factors such as the global and Chinese economy, market demand, production capacity, and working capital.
Result of Operations
Year Ended June 30, 2012 Compared with Year Ended June 30, 2011
The following table shows our operating results for the fiscal years ended June 30, 2012 and 2011.
Sales revenue for the fiscal year ended June 30, 2012 was $179,029,127, an increase of $7,311,260, or 4.26% compared with $171,717,866 in the corresponding period in 2011. The increase in sales revenue resulted from an increase in the average selling prices, offset by decreased sales quantity of corn starch products. The Company’s average selling prices increased 3.87% for glucose products, 5.42% for cornstarch products, and 2.52% for other products, in the year ended June 30, 2012 compared to the year ended June 30, 2011. The Company’s sales quantity increased by 1.48% for glucose products, decreased by 17.87% for cornstarch products, and increased by 6.29% for other products, for the year ended June 30, 2012 compared to the year ended June 30, 2011. Net sales quantities from exports for the year ended June 30, 2012 decreased approximately 1.69 %, or 1,395 tons compared to the year ended June 30, 2011. The decrease is mainly attributable to decreased sales of glucose products and cornstarch products, offset by increased exporting sales quantities of other products. The decrease in export sales quantity of glucose products is due to a decrease in demand resulting from a price decrease in sugar substitute products in the global market. The decreased export sales quantity of corn starch products is due to increased competition in the global cornstarch market. The increase in export sales of other products is due to increased orders from our regular customers and increased sales from our other newly developed products, including corn germ meal, which can be used as animal food. Domestic sales quantity for the year ended June 30, 2012 decreased by approximately 4.83% compared to the year ended June 30, 2011. The decrease was mainly attributable to increased domestic sales quantity of our glucose products, offset by decreased domestic sales quantity of cornstarch products and other products. The increase in domestic sales quantity of our glucose products is due to increased sales from new customers. The decrease in sales quantity of our cornstarch products and other products is due to increased competition.
Costs of sales for the year ended June 30, 2012 was $161,705,181, an increase of $13,111,135, or 8.82% as compared to $148,594,046 in the corresponding period in 2011. The increase of cost of sales is mainly due to an increase in corn prices. Gross profit for the year ended June 30, 2012 was $17,323,946, a decrease of $5,799,874, or 25.08%, as compared to $23,123,820 for the year ended June 30, 2011. Gross profit margin for the year ended June 30, 2012 was 9.68%, a decrease from 13.47% for the year ended June 30, 2011. The decrease in gross profit margin is because the percentage increase in the cost of sales is greater than the percentage increase in net sales.
Selling, general and administrative expenses were $11,825,104 for the year ended June 30, 2012, an increase of $2,020,060 or 20.6%, as compared to $9,805,044 for the year ended June 30, 2011. The increase of selling, general, and administrative expenses is caused by increased selling, general and administrative expenses in PRC, offset by decreased selling, general and administrative expenses in the United States. The Company’s selling, general and administrative expenses in the United States in the year ended June 30, 2012 decreased by $389,447 compared to the year ended June 30, 2011. The decrease is mainly due to decreased salary expenses of $364,000 and decreased option expenses of $211,082 offset by increased taxation expense expenses of $46,088. The salary expenses from the US entity decreased because during the year ended June 30, 2012 the Company's CEO agreed to give up his accrued salaries of $210,000 since April 2010 and the Company's CFO agreed to give up his accrued salaries of $154,000 since March 2010. The total accrued salary expense of $364,000 was reversed by increasing additional paid in capital in the year ended June 30, 2012. The Company incurred non-cash stock option expenses of $27,602 and $238,684 for the year ended June 30, 2012 and 2011, respectively. The selling, general and administrative expenses from our PRC operating entities increased by $2,020,060 for the year ended June 30, 2012 compared to the year ended June 30, 2011. The selling expenses from our PRC operating entities increased by $1,451,470 in the year ended June 30, 2012 compared to the same period in 2011. The increase in selling expenses is mainly attributable to the increase in shipping and handling expenses of $1,455,994 as a result of increased gas cost. The general and administrative expenses incurred in PRC increased $568,590 in the year ended June 30, 2012 compared to the year ended June 30, 2011. The increase is mainly attributable to the increase in depreciation expenses of $183,051 and workers' insurance expenses of $108,654.
Net income for the year ended June 30, 2012 was $1,072,594, a decrease of $6,578,457 or 85.98%, as compared to net income of $7,651,051 for the same period in 2011. The decrease in net income was primarily due to the decrease in gross profit, increase in selling and general and administrative expenses, and increase in interest expenses.
Liquidity and Capital Resources
Net cash used in operating activities for the fiscal year ended June 30, 2012 was $23,737,700, a decrease of $28,807,300 or 568.24%, compared to $5,069,599 net cash provided by operating activities for the fiscal year ended June 30, 2011. The decrease is due to decreased net income, increased accounts receivables, increased payments to acquire inventories, increased payments to pay back accounts payables, and decreased customer deposit, offset by decreased other receivable, decreased prepayments and other assets, and increased deprecation during the year ended June 30, 2012 as compared to the year ended June 30, 2011.
Net cash used in investing activities for fiscal year ended June 30, 2012 was $1,655,433, a decrease of $6,442,584 or 79.56%, compared to $8,098,017 used in investing activities for the year ended June 30, 2011. The decrease is due to reduced investment in construction in progress during the year ended June 30, 2012 compared to the year ended June 30, 2011.
Net cash provided by financing activities for the fiscal year ended June 30, 2012 was $26,099,389, a decrease of $26,283,774 or 14,254.82%, as compared to $184,385 used in financing activities for the same period in2011. The decrease is mainly due to increased short term bank loans, increased notes payables, less payments of notes payable, offset by increased restricted cash, more payments of short term bank loans, and less payment of capital lease during the year ended June 30, 2012 compared to the year ended June 30, 2011.
Other than the equity financing in 2008, our PRC operating subsidiary, Weifang Shengtai financed its operations and capital expenditure requirements primarily through bank loans and operating income. Weifang Shengtai had a total of $73,483,997 and $48,094,740 short term bank loans outstanding as of June 30, 2012, and 2011, respectively. The loans were secured by Weifang Shengtai’s properties ,non-related party and order ,etc.The terms of all these short term loans were for one year. Weifang Shengtai has never defaulted on any loans. In addition, Weifang Shengtai had $17,835,706 and $11,447,800 in short-term notes due to banks as of June 30, 2012 and 2011, respectively. These notes were due within one year and secured by 50% to 100% of the loan amount in restricted cash. Some were guaranteed by unrelated third parties.
Weifang Shengtai does not have any long term loans from local banks.
We have guaranteed certain borrowings of other unrelated third parties including short term bank loans, lines of credit and bank notes. The total guaranteed amounts were $7,918,534, and $7,735,000 as of June 30, 2012, and 2011. Some unrelated third parties have guaranteed approximately $11,402,689 and $11,138,400 of our debt, as of June 30, 2012 and 2011, respectively.
Future cash commitments
The Company estimates the need for capital to run new production facilities. The exact amount will be determined based on both the market demand for the Company’s products and the time needed for these facilities to run at full capacity. The Company will carefully review its financial condition and consider financing with internally generated cash, bank loans or additional equity. The Company expects that its proceeds from operating cash flows and its cash balances, together with amounts available under its loans, will be sufficient to meet its anticipated liquidity needs for the next twelve months.
Critical Accounting Policies and Estimates
We have disclosed in the notes to our financial statements those accounting policies that we consider to be significant in determining our results of operations and our financial position which are incorporated by reference herein. The following reflects the more critical accounting policies that currently affect our financial condition and results of operations.
The Company recognizes revenue when the goods are delivered, title has passed, pricing is fixed, and collection is reasonably assured. Sales revenue represents the invoiced value of goods, net of value-added tax (“VAT”), and estimated returns of product from customers. Most of the Company’s products sold in the PRC are subject to a VAT rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished products and certain freight expenses. We allow our customers to return products only if our product is later determined by us to be ineffective. Based on our historical experience over the past three years, product returns have been insignificant throughout all of our product lines. Therefore, we do not estimate deductions or allowance for sales returns. Sales returns are taken against revenue when products are returned from customers. Sales are presented net of any discounts given to customers.
Use of estimates
In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include the recoverability of long-lived assets and the valuation of inventories. Actual results could differ from those estimates.
In the normal course of business, the Company extends credit to its customers without requiring collateral or other security interests. Management reviews its accounts receivables at each reporting period to provide for an allowance against accounts receivable for an amount that could become uncollectible. This review process may involve the identification of payment problems with specific customers. The Company estimates this allowance based on the aging of the accounts receivable, historical collection experience, and other relevant factors, such as changes in the economy and the imposition of regulatory requirements that can have an impact on the industry. These factors continuously change, and can have an impact on collections and the Company’s estimation process. These impacts may be material.
Certain accounts receivable amounts are charged off against allowances after designated periods of collection. Subsequent cash recoveries are recognized as income in the period when they occur.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method, with a 3% residual value, over the estimated useful lives of the assets.
Foreign currency translation
Our functional currency is Renminbi, “RMB.” Foreign currency transactions are translated at the applicable rates of exchange in effect at the transaction dates. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. Revenues and expenses are translated at the average exchange rates in effect during the reporting period.
Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated Other Comprehensive Income.” Gains and losses resulting from foreign currency translations are included in Accumulated Other Comprehensive Income.
Item7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to credit risk from our cash at bank, fixed deposits and contract receivables. The credit risk on cash at bank and fixed deposits is limited because the counterparts are recognized financial institutions. Contract receivables are subject to credit evaluations. We periodically record a provision for doubtful collections based on an evaluation of the collectability of contract receivables by assessing, among other factors, the customer’s willingness or ability to pay, repayment history, general economic conditions and our ongoing relationship with the customers.
Substantial portion of our business, assets and operations are located and conducted in the PRC. While the PRC’s economy has experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. The economic crisis since 2008 has certain effect on the growth of the China economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. In February 2009, the National Development and Reform Commission (NDRC) stated that it will allocate RMB 10 billion (US$1.46 billion) from the central budget to build 2,000 township hospitals and 29,000 urban community health service centers. The funds are part of the central government's RMB 850-billion commitment to financing the country's health care reform plan. The plan will be implemented over the course of next three years. With that as a backdrop, we believe the long-term prospect for pharmaceutical grade glucose is very good despite the near-term challenges. Some of these measures benefit the overall economy of the PRC, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in regulations applicable to us. If there are any changes in any policies by the PRC government and our business is negatively affected as a result, then our financial results, including our ability to generate revenues and profits, will also be negatively affected.
Foreign Currency Risk
Substantially all of our operations are conducted in the PRC. Our sales and purchases are conducted within the PRC in Renminbi. Conversion of the Renminbi into foreign currencies is regulated by the People’s Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the Renminbi, there can be no assurance that such exchange rate will not again become volatile or that the Renminbi will not devalue significantly against the U.S. dollar. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from our operations in the PRC. In addition, the Renminbi is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.
Item 8. Financial Statements and Supplementary Data
The information required by this Item 8 is included in Item 15 of this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
During the fiscal year ended June 30, 2012, there were no changes in or disagreements with accountants on accounting and financial disclosure.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, the Chairman, Chief Financial Officer and Chief Executive Officer concluded that our disclosure controls and procedures were not effective.
Management’s Report on Internal Control over Financial Reporting
Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted accounting principles (GAAP).
Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 30, 2012. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the results of our assessment, the Company has determined that as of June 30, 2012, there was a material weakness in the Company’s internal control over financial reporting. In particular, identified personnel turnover in the areas concerned, mainly referring to our Chief Financial Officer’s resignations during the last two years, has led us to conclude that our disclosure controls and procedures were not effective and were not adequately designed to ensure that the information required to be disclosed by the Company in the reports the Company submits under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and that such information was accumulated and communicated to the Company’s Chief Executive Officer and Chief Financial Officer in a manner that allowed for timely decisions regarding required disclosure.
Based on this evaluation, management concluded that our internal control over financial reporting was not effective as of June 30, 2012. Notwithstanding the existence of such material weakness in our internal controls over financial reporting, our management, including our Chief Executive Officer, believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.
Management is committed to remediating the material weakness as quickly as possible. Additionally, and in recognition of immediate financial reporting needs, the Company intends to implement additional controls and procedures during the current fiscal year to continue to ensure timely and accurate financial reporting objectives. Such additional controls and procedures may include: The retention of a U.S. based CPA as Chief Financial Officer with U.S. GAAP experience and appropriate knowledge of internal controls over financial reporting, for purposes of appropriate oversight of the financial reporting process and continued training of the accounting staff; recruitment of additional personnel with relevant U.S. GAAP experience to enhance our financial reporting and internal control function; and retention of the services of a consultant for advisory services with respect to SOX 404 compliance.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal controls over financial reporting during the fiscal year ended June 30, 2012, that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)).
Item 9B. Other Information.
Item 10. Directors, Executive Officers and Corporate Governance
Below are our executive officers and directors. All of our executive officers and directors are residents of the PRC. As a result, it may be difficult for investors to effectuate service of process within the United States upon them or to enforce court judgments obtained against them in the United States courts.
(1) Mr. Yongqiang Wang was appointed as Chief Financial Officer on December 1, 2010 .
(2) Mr. Yaojun Liu and Mr. Fei He were elected as directors on June 1, 2010. And Mr. He resigned as a director of the Company on August 20, 2011.
(3) Mr. Tao Jin and Mr. Lawrence Lee were appointed as directors on November 1, 2011 and February 13, 2012, respectively.
(4) Winfred Lee was not elected as a director on the annual shareholder meeting held on February 13, 2012.
The following is a summary of the biographical information of our directors and officers:
Qingtai Liu, 55, graduated from the Electrical Engineering Faculty of the Shandong Technical University with a Bachelor of Science degree in February 1982. He became the workshop director and head of the production department of Changle Wireless Device Factory until 1988, whereupon he assumed the position of Head of Science and Technology at the Changle Power Factory. In 1990, Mr. Liu became the Director of Weifang Fifth Pharmaceutical Plant. From January 1999 to present day, he is the Chairman and Chief Executive Officer of Weifang Shengtai Pharmaceutical Co., Ltd. Under his leadership, the Company successfully developed unique production techniques for the production of glucose and medicinal coating products, and has won Technology Innovation awards issued by the Chang Le County, Weifang City and the Shandong provincial government offices. The medicinal coating material technology that Mr. Liu jointly developed with the Shandong University has been certified by the Technology Development Bureau of the Shandong Province to be of international standard. Over the years, Mr. Liu has been endorsed by the Weifang City Government office as a Leading Technology Innovator and a Distinguished Pharmaceutical Production Director. He also is the deputy to the People’s Conference of both Weifang City and Changle County.
Yongqiang Wang, 43, became Chief Financial Officer of the Company on December 31, 2010. Mr. Wang graduated with an Associate’s degree from the Shandong Economic and Management Institute. Mr. Wang joined Weifang Shengtai in April 2006 as Assistant to the Chief Executive Office with major responsibilities in supervising the Finance Department. He assumed the position of Manager of the Finance Department of Weifang Shengtai in February 2007. Before he joined Weifang Shengtai, Mr. Wang was Finance Manager at Shandong Lehua Group Co., Ltd from January 1996 to April 2006, and Finance Manager at Shandong Hongxiang Food General Factory from January 1994 to December 1995.
Yaojun Liu, 36, is currently a partner at Global Law Office, a law firm based in Beijing, the PRC since 2006. Prior to that, between 2003 and 2006, Mr. Liu served as an attorney at Jingtian & Gongcheng Law Firm, a law firm based in Beijing, the PRC. Before practicing law, Mr. Liu was a senior project manager at the Investment Banking Headquarter of Haitong Securities Co., Ltd. Mr. Liu graduated with a Master of Economic Law from Renmin University, Beijing, China in 2001. He then graduated with a LL.M. of Commercial Law from University of Sheffield, UK in 2003. Mr. Liu is a Qualified Practice Lawyer and also a Certified Public Accountant in China. Since June 2008, Mr. Liu has been the Board member of Yuhe International, Inc.
Tao Jin, 45, is a Senior Partner with the Chinese law firm of Jincheng Tongda & Neal, based in Beijing, where he specializes in M&A, foreign investments in China and capital market transactions.Mr. Jin started his legal practice in 1996 at the New York office of Cleary, Gottlieb, Steen & Hamilton where he represented numerous investment banks and corporations in a variety of M&A and capital markets transactions. Mr. Jin joined Sullivan & Cromwell’s Hong Kong office in 1999 where he continued to focus on M&A transactions. His clients included major multinational corporations, investment banks, PRC corporations and private equity funds. Mr.Jin joined JP Morgan’s legal department in 2002 as head legal counsel for M&A and capital market transactions in China. Immediately prior to joining Jincheng Tongda, Mr. Jin was a partner with Jun He Law Offices from 2005 through 2010. Mr. Jin received his B.S from Beijing University and his J.D. from Columbia University, and is fluent in English and Mandarin. Mr. Jin is admitted to the New York bar.
Lawrence Lee, 48, is currently the managing director of the Boardroom Advisors Company Limited, a financial advisory firm. Mr. Lee served as chief financial officer of Synutra International, Inc. a NASDAQ-listed company, from October 1, 2007 to November 15, 2009. From August 1, 2004 to September 30, 2007, Mr. Lee was vice president and chief financial officer of Kasen International Holdings Limited, a public company listed on the Hong Kong Stock Exchange. Prior to that, Mr. Lee served as chief financial officer at Eagle Brand Holdings Limited, a company listed on the Singapore Stock Exchange. Mr. Lee’s experience also includes serving as a financial controller at the Korean division of Exel Plc, and serving as a senior auditor at Waste Management Inc.’s international department in London. Mr. Lee is a fellow member of the Association of Chartered Certified Accountants (ACCA). Mr. Lee received a bachelor’s degree in management and engineering from Beijing Institute of Technology, a master’s degree in economics from Renmin University of China, and a master’s degree in accounting and finance from the London School of Economics.
Fei He, 44, is a Strategy and M&A director of DSM (China) Limited responsible for strategy and mergers and acquisitions since 2007. Mr. He worked for A.T. Kearney in China and led the strategic consultation for several merger and acquisition projects in the hi-tech industries in China. Before going back to China, Mr. He was a director of the WOLVERINE Venture Capital Fund in the United States between 2002 and 2005. Prior to that, Mr. He worked for Pfizer in the United States since 1998 in several positions as post-doctoral researcher, senior scientist and business development manager. Mr. He graduated with a Bachelor of Science from Beijing University, Beijing, China in 1990. He then graduated with a Ph. D. of Chemistry from University of California, Davis in 1998. Mr. He also obtained a Master of Business Administration from University of Michigan Ross School of Business in 2004.
Winfred Lee, 51, has been a Contract Administrator with Tenet Healthsystems for South Bay Medical Center, North Hollywood Medical Center, Midway Hospital, Century City Hospital, and Brotman Medical Center from 1997. Mr. Lee graduated with a Bachelor of Science in Business Management from Brigham Young University, Provo, Utah in 1984. He then graduated with a Doctor of Medicine from the Medical College of Wisconsin, Milwaukee, Wisconsin, in 1988 and a Doctor of Jurisprudence from the J. Reuben Clark Law School at Brigham Young University, Provo, Utah, in 1992. Mr. Lee is a member of the California Bar and the Phi Delta Phi Legal Society.
All of our directors hold offices until the next annual meeting of the shareholders of the Company, and until their successors have been qualified after being elected or appointed. Officers serve at the discretion of the board of directors.
There are no family relationships among our directors or executive officers. There is no arrangement or understanding between or among our officers and directors pursuant to which any director or officer was or is to be selected as a director or officer, and there is no arrangement, plan or understanding as to whether non-management shareholders will exercise their voting rights to continue to elect the current Board of Directors.
Directors are responsible for overseeing the Company’s business consistent with their fiduciary duty to stockholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The board believes that there are general requirements for service on the Company’s board of directors that are applicable to all directors and that there are other skills and experience that should be represented on the board as a whole but not necessarily by each director. The board and the Nominating Committee consider the qualifications of director and director candidates individually and in the broader context of the board’s overall composition and the Company’s current and future needs.
Qualifications for All Directors
In its assessment of each potential candidate, including those recommended by stockholders, the Nominating Committee considers the nominee’s judgment, integrity, experience, independence, understanding of the Company’s business or other related industries and such other factors the Nominating Committee determines are pertinent in light of the current needs of the board. The Nominating Committee also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.
The board and the Nominating Committee require that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board conducts interviews of potential director candidates to assess intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially. The board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole
The board has identified particular qualifications, attributes, skills and experience that are important to be represented on the board as a whole, in light of the Company’s current needs and its business priorities. The board believes that it should include some directors with a high level of financial literacy and some directors who possess relevant business experience as a Chief Executive Officer or a President or like position. Marketing is the core focus of our business and the Company seeks to develop and deploy the world’s most innovative and effective marketing and technology. Therefore, the board believes that marketing and technology experience should be represented on the board.
Set forth below are a chart and a narrative disclosure that summarize the specific qualifications, attributes, skills and experiences described above. An “X” in the chart below indicates that the item is a specific reason that the director has been nominated to serve on the Company’s Board. The lack of an “X” for a particular qualification does not mean that the director does not possess that qualification or skill. Rather, an “X” indicates a specific area of focus or expertise of a director on which the board currently relies.
Our directors and executive officers have not, during the past ten years:
The audit committee is responsible for (i) recommending independent accountants to the Board, (ii) reviewing our financial statements with management and the independent accountants, (iii) making an appraisal of our audit effort and the effectiveness of our financial policies and practices and (iv) consulting with management and our independent accountants with regard to the adequacy of internal accounting controls. Our audit committee Chairman is Mr. Lawrence Lee. The directors who serve on the audit committee are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers. Our Board of Directors has adopted a written charter for the Audit Committee.
The compensation committee of the board of directors is responsible for (i) determining the general compensation policies, (ii) establishing compensation plans, (iii) determining senior management compensation and (iv) administering our stock option plans. Our compensation committee Chairman is Mr. Yaojun Liu. The directors who serve on the compensation committee are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers. Our board of directors has adopted a written compensation committee charter.
The purpose of the nominating committee of the board of directors is to assist the board of directors in identifying and recruiting qualified individuals to become board members and select director nominees to be presented for board and/or stockholder approval. The nominating committee will be involved evaluating the desirability of and recommending to the board any changes in the size and composition of the board, evaluation of and successor planning for the chief executive officer and other executive officers. The qualifications of any candidate for director will be subject to the same extensive general and specific criteria applicable to director candidates generally. Our Nominating Committee Chairman is Tao Jin. The directors who serve on the nominating committee are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers. The nominating committee has a written charter.
Audit Committee Financial Experts
The Board has determined that Mr. Lawrence Lee of the Audit Committee qualifies as an “audit committee financial expert” as defined by the SEC and also meets the additional criteria for independence of audit committee members set forth in Rule 10A-3(b)(l) under the Exchange Act.
Code of Ethics
We have adopted a code of ethics to apply to our principal executive officer, principal financial officer, principal accounting officer and controller, or persons performing similar functions. The Code of Ethics is currently available on our website at http://www.shengtaipharmaceutical.com.
Board Leadership Structure and Role in Risk Oversight
The Board of director consists of five members: two executive directors and three independent directors. The board’s role in the risk oversight of the Company includes, among other things:
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors and persons who own more than 10% of a registered class of our equity securities to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission (the "SEC”). Such persons are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file.
Based solely on review of the copies of such forms received by us with respect to the fiscal year ended June 30, 2012, or written representations from certain reporting persons, we believe that our directors, officers and persons who own more than ten percent of a registered class of our equity securities have complied with all applicable Section 16(a) filing requirements.
Item 11. Executive Compensation
Compensation Discussion and Analysis
We endeavor to provide our “named executive officers,” as defined in Item 402 of Regulation S-K, with a competitive base salary that is in- line with their roles and responsibilities when compared to peer companies of comparable size in the same or similar locality.
It is not uncommon for PRC private corporations in that locality to have base salaries as the sole and only form of compensation. The base salary level is established and reviewed based on the level of responsibilities, the experience and tenure of the individual and the current and potential contributions of the individual. The base salary is compared to the list of similar positions within comparable peer companies and with consideration of the executive’s relative experience in his or her position. Base salaries are reviewed periodically and at the time of promotion or other changes in responsibilities.
We plan to implement a more comprehensive compensation program, which takes into account other elements of compensation, including without limitation, short and long term compensation, cash and non-cash, and other equity-based compensation such as stock options. This compensation program shall be comparative to our peers in the industry and aimed to retain and attract talented individuals.
We have formed a Compensation Committee of the Board of Directors comprised solely of independent directors to oversee the compensation of our named executive officers. The members of our Compensation Committee are Yaojun Liu (Chairman), Tao Jin and Lawrence Lee. The Board has determined that all members of the compensation committee are independent directors under the rules of the Nasdaq Stock Market or NYSE Amex, as applicable. The compensation committee administers the Company’s benefit plans, reviews and administers all compensation arrangements for executive officers, and establishes and reviews general policies relating to the compensation and benefits of our officers and employees. The compensation committee operates under a written charter that is made available on the website mentioned above.
Summary Compensation Table
The following table sets forth information with respect to the compensation of each of the named executive officers for services provided in all capacities to the Company in the fiscal years ended June 30, 2012 and 2011 in their capacity as such officers. No other executive officer or former executive officer received more than $100,000 in compensation in the fiscal years reported below.
We have entered into employment agreements with Qingtai, Liu, our chief executive officer, and with Yongqiang Wang , our Chief Financial Officer.
In the fiscal year ended June 30, 2011, the base salaries of Messrs. Liu and Wang were decreased to provide additional cash flow for the Company so that it could lock in lower prices of raw materials due to inflation in China. Messrs. Liu and Wang agreed to reduce their salaries to $18,564 and $13,923, respectively, for the fiscal year ended June 30, 2011 and executed addendums to their Employment Agreements to this effect (“2011 Addendums”).
In the fiscal year ended June 30, 2012, the base salaries of Messrs. Liu and Wang were decreased to provide additional cash flow for the Company so that it could lock in lower prices of raw materials due to inflation in China. Messrs. Liu and Wang agreed to reduce their salaries to $19,004 and $14,253, respectively, for the fiscal year ended June 30, 2012 and executed addendums to their Employment Agreements to this effect (“2012 Addendums”).
In the Ye Employment Agreement between the Company and Mr. Hu Ye, the Company’s former Chief Financial Officer, the Company granted Mr. Hu Ye an option to purchase 150,000 shares of common stock of the Company. The shares vest over 3 years starting March 1, 2010 and terminate on the third anniversary of the date of issuance of this option. The Company valued the shares at $5.20 per share, which represents 130 % of the fair market value being calculated in the private placement price on May 15, 2007. However, the Ye Employment Agreement was terminated in December 2010, and as a result, the Ye Options were forfeited. The fair values of Ye Options were estimated at the date of grant with the following assumptions:
Outstanding Equity Awards at 2012 Fiscal Year End
The following table provides information on the holdings of stock options of the named executive officers as of June 30, 2012. This table includes unexercised and unvested options awards. Each outstanding award is shown separately for each named officer.
2007 Stock Incentive Plan
On January 4, 2008, our board of directors adopted the 2007 Plan, pursuant to which 1,000,000 shares of our common stock are reserved for issuance as awards to employees, consultants and nonemployee directors. The purposes of the 2007 Plan is to attract, retain and reward such individuals and strengthen the mutuality of interests between such individuals and the Company’s stockholders. Under the 2007 Plan, we are authorized to issue options, stock appreciation rights, restricted stock and other stock-based awards. The 2007 Plan will be administrated by our compensation committee.
Compensation of Directors.
Our current non-executive directors are compensated for all services they perform as directors, including attendance at Board of Directors meetings and service as members of committees of the Board of Directors to which they are appointed. Executive officers are not compensated for services they perform as directors of the Company.
The details of such compensation are:
The non-executive directors are also reimbursed for all of their out-of-pocket expenses in traveling to and attending meetings of the Board of Directors and committees on which they would serve.
The following table sets forth a summary of compensation paid to our directors who are not listed in the Summary Compensation Table during the fiscal year ended June 30, 2012 and 2011.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth certain information with respect to the beneficial ownership of our voting securities by (i) any person or group owning more than 5% of any class of voting securities, (ii) each director, (iii) our chief executive officer and the Company’s top three most highly compensated officers and (iv) all executive officers and directors as a group as of September 27, 2012. Except as indicated in the footnotes to this table, each beneficial owner named in the table below has sole voting and sole investment power with respect to all shares beneficially owned and each person’s address is c/o Shengtai Pharmaceutical, Inc., Hi-Tech Industrial Park of Changle County, Shandong Province, PRC 262400.
(1) Includes (i) 3,494,863 shares of our common stock directly owned by Mr. Liu, (ii) 194,150 shares of our common stock owned by Mr. Liu’s spouse, which are deemed to be beneficially owned by Mr. Liu, and (iii) options to 100,000 shares of our common stock with an exercise price of $6.60 per share, which are exercisable within 60 days.
(2) Includes options to purchase10,000 shares of our common stock with an exercise price of $6.60 per share, which are exercisable within 60 days.
(3) Includes options to purchase 26,667 shares of our common stock with an exercise price of $6.60 per share, which are exercisable within 60 days.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Weifang Shengtai entered into a joint venture partnership with Weifang City Investment Company and Changle Century Sun Paper Industry Co., Ltd on September 16, 2003 and formed Changle Shengshi Redian Co., Ltd, “Changle Shengshi.” Changle Shengshi was incorporated at Weifang City, Shandong Province, People’s Republic of China. Changle Shengshi’s principal activity is to produce and sell electricity and heat.
Weifang Shengtai owned a 30% interest in Changle Shengshi as of June 30, 2004. On April 12, 2005, its percentage ownership in Changle Shengshi was diluted from 30% to 20% due to an additional investment into Changle Shengshi from another party. In order to meet increasing demands for electricity and steam by Weifang Shengtai and Changle Paper, Weifang Shengtai invested $1,467,000 in Changle Shengshi in March 2010 and Changle Paper invested a corresponding amount such that Weifang Shengtai and Changle Sunshine Paper Ltd. continue to be 20% and 80% owners, respectively, of Changle Shengshi. In 2012, the Company increased its investment of approximately $1,268,000 to Changle Shengshi. Changle Paper increased investment proportionately. After the investment, the Company still owns 20% of Changle Shengshi. As of June 30, 2012, Weifang Shengtai invested approximately $5,567,861 towards its registered capital, which accounts for a 20% share of Changle Shengshi’s paid-in capital.
As an investor and shareholder of Changle Shengshi, Weifang Shengtai enjoys a preferential discount of 70% off the market price of electricity supplied by the plant to Weifang Shengtai. The intercompany profits were eliminated on our financial statements.
Weifang Shengtai had a total of $405,926, and $943,779 of accounts payable and accrued liabilities to Changle Shengshi at June 30, 2012, and 2011, respectively. The utilities expenses amounted to $15,918,448, and $15,573,614, for the years ending June 30, 2012, and 2011, respectively.
From time to time, the Company borrows monies from Qingtai Liu, the Company’s CEO and President, for cash flow purposes of the Company. The loans do not require collateral and the principal is due upon demand. Before January 1, 2009, the interest rate was at 7.2% for the first six months, and then 10.8% thereafter until the full principal amounts are paid by the Company. After January 1, 2009, the interest rate was changed to 9.6% for the loan period. Employee loan from officer amounted to $37,027 and $36,285 as of June 30, 2012 and 2011, respectively. Interest expense related to this loan was $3,056 and $2,934 for the years ended June 30, 2012 and 2011, respectively.
As of June 30, 2012, the Company advanced $8,029,394 to its purchasing department employees as purchase advances for corn purchases. This amount is guaranteed by the Company's CEO and president by his personal properties.
Item 14. Principal Accounting Fees and Services
Aggregate fees billed by our current principal accountants, Kabani & Company, Inc. and Chan & Zhang LLP for audit services related to the most recent fiscal years, and for other professional services were as follows:
Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our independent accountants must now be approved in advance by our Audit Committee to assure that such services do not impair our accountants' independence. Our Audit Committee’s Chairman is Mr. Lawrence Lee and the other members are Mr. Yaojun Liu and Mr. Tao Jin as of June 30, 2012. Our Audit Committee reviews and recommends to our Board of Directors for approval audit and permissible non-audit services performed by Kabani & Company as well as fees charged by them for such services.
Item 15. Exhibits, Financial Statement Schedules
Reference is made to the Index to Financial Statements on Page F-1.
See Exhibit Index
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the date indicated.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SHENGTAI PHARMACEUTICAL, INC. AND SUBSIDIARIES
All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable and therefore have been omitted.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Shengtai Pharmaceutical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Shengtai Pharmaceutical, Inc. and Subsidiaries (the “Company”) as of June 30, 2012 and 2011, and the related statements of income, stockholders' equity, and cash flows for each of the years in the two-year period ended June 30, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We have conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Shengtai Pharmaceutical, Inc. and Subsidiaries as of June 30, 2012, and the consolidated results of its operations and cash flows for each of the years in the two-year period ended June 30, 2012 in conformity with accounting principles generally accepted in the United States of America.
/s/ Kabani & Company, Inc.
Kabani & Company, Inc.
Certified Public Accountants
Los Angeles, California
September 28, 2012
SHENGTAI PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
SHENGTAI PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
SHENGTAI PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
SHENGTAI PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2012 AND 2011
The accompanying notes are an integral part of these consolidated financial statements.
SHENGTAI PHARMACEUTICAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization background and principal activities
Shengtai Pharmaceutical, Inc, the "Company,” was incorporated in March 2004 in the State of Delaware. The Company, through its subsidiaries, manufactures and distributes glucose and starch as pharmaceutical raw materials, other starch products and other glucose products such as corn meals, food and beverage glucose and dextrin. The Company's business operations are conducted in the People's Republic of China, the "PRC.”
Note 2 - Summary of significant accounting policies
Principles of consolidation
The consolidated financial statements of Shengtai Pharmaceutical, Inc. and its subsidiaries reflect the activities of the parent and its wholly-owned subsidiaries Shengtai Holding, Inc., “SHI,” and Weifang Shengtai Pharmaceutical Co., Ltd., “Weifang Shengtai.” All material inter-company transactions and balances have been eliminated in consolidation.
Use of estimates
The preparation of 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 and 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.
Foreign currency translation
The reporting currency of the Company is the US dollar. The Company uses Renminbi, "RMB,” as its functional currency. The results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rates at the balance sheet dates, and equity is translated at the historical exchange rates. As a result, amounts related to assets and liabilities reported on the statements of cash flows will not necessarily agree with changes in the corresponding accounts on the balance sheets. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statements of shareholders' equity. 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.
Assets and liabilities were translated at 6.314 RMB and 6.464 RMB to $1.00 at June 30, 2012 and 2011, respectively. The equity accounts were stated at their historical rate. The average translation rates applied to income statement for amounts for the years ended June 30, 2012 and 2011 were approximately 6.352 RMB and 6.617 RMB to $1.00, respectively. The statement of cash flows are also translated at average translation rates for the period; therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
The Company recognizes revenue when the goods are shipped, title has passed, pricing is fixed, and collection is reasonably assured. Sales revenue represents the invoiced value of goods, net of value-added tax, "VAT,” and estimated returns of product from customers. Most of the Company's products sold in the PRC are subject to a VAT rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished products and certain freight expenses. The Company allows its customers to return products only if they are later determined by the Company to be ineffective. Based on the Company’s historical experience, product returns have been insignificant throughout all of its product lines. Therefore, the Company does not estimate deductions or allowance for sales returns. Sales returns are taken against revenue when products are returned from customers. Sales are presented net of any discounts given to customers.
Shipping and handling
Shipping and handling costs related to costs of goods sold are included in selling, general and administrative expenses. For the years ended June 30, 2012 and 2011, shipping and handling costs amounted to $7,173,847 and $5,718,145, respectively.
The carrying amounts reported in the balance sheets for current receivables and payables, including short term loans, qualify as financial instruments and 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, the stated rate of interest is equivalent to rates currently available. The three levels are defined as follows:
The Company did not identify any assets or liabilities that are required to be presented on the balance sheet at fair value in accordance with US GAAP.
The Company measures stock-based compensation cost at the grant date based on the fair value of the award and recognize it as expense over the applicable vesting period of the stock award (generally three to five years) using the straight-line method.
Earnings per share
The Company presents 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 exclude dilution and are computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
The following is a reconciliation of the basic and diluted earnings per share computation for the years ended June 30, 2012 and 2011:
At June 30, 2012 and 2011, no warrants or stock options were included in the calculation of diluted earnings per share due to out-of-money status of the warrants and stock options.
Cash and cash equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.
The Company through its bank agreements is required to keep certain amounts on deposit that is subject to withdrawal restrictions. These amounts were $13,084,586 and $8,972,600 as of June 30, 2012 and 2011, respectively.
In the normal course of business, the Company extends credit to its customers without requiring collateral or other security interests. Management reviews its accounts receivable at each reporting period to provide for an allowance against accounts receivable for an amount that could become uncollectible. This review process may involve the identification of payment problems with specific customers. The Company estimates this allowance based on the aging of the accounts receivable, historical collection experience, and other relevant factors, such as changes in the economy and the imposition of regulatory requirements that can have an impact on the industry. These factors continuously change, and can have an impact on collections and the Company's estimation process. These impacts may be material. Certain accounts receivable amounts are charged against allowances after designated period of collection efforts. Subsequent cash recoveries are recognized as income in the period when they occur.
The activities in the allowance for doubtful accounts for trade accounts receivable is as follows for the years ended June 30, 2012 and 2011:
Concentrations of risk
The Company's operations are 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 Chinese 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 others.
Management believes the credit risk on bank deposits is limited because the counterparties are banks with high credit-ratings assigned by international credit-rating agencies, or state-owned banks in China. Cash includes cash on hand and demand deposits in accounts maintained with state-owned banks within the PRC and the United States of America. The cash deposits in U.S. financial institutions exceed the amounts insured by the U.S. government. Balances at financial institutions or state owned banks within the PRC are not covered by insurance. Non-performance by these institutions could expose the Company to losses for amounts in excess of insured balances. At June 30, 2012 and 2011, the Company’s bank balances with the Banks in PRC amounted $17,987,762 and $13,017,076, respectively, which are uninsured and subject to credit risk. The Company has not experienced nonperformance by these institutions.
The Company’s concentrations of credit risk also relate to trade accounts receivable and accounts payable. There was no customers that individually comprised 10% or more of our sales for fiscal year ended June 30, 2012 and 2011. There was one vendor, Changle Shengshi Redian Co., Ltd, that individually comprised 10.07% or $19,316,616 of the Company’s total purchase for the year ended June 30, 2012. The Company has accounts payable of $405,945 due to Changle Shengshi Redian Co., Ltd. as of June 30, 2012. There was one vendor, Dezhou No.5 Grain and Cooking Oil Warehouse that individually comprised 11.08% or $15,253,993 of the Company’s total purchase for the year ended June 30, 2011. The Company did not have any accounts payable to Dezhou No.5 Grain and Cooking Oil Warehouse as on June 30, 2011.
For export sales, the Company frequently requires significant down payments or letter of credit by its customers prior to shipment. During the year, the Company maintains export credit insurance to protect the Company against the risk that the overseas customers may default on settlement.
The following table summarizes financial information for the years ended June 30, 2012 and 2011, concerning the Company’s revenues based on geographic area:
Geographical distribution of sales to foreign countries which is based on physical shipments to such countries is as follows:
Inventories are stated at the lower of cost (weighted average basis) or market and consist of the following as of June 30, 2012 and 2011:
The Company reviews its inventory periodically for possible obsolescence or determination if any reserves are necessary. As of June 30, 2012 and 2011, the Company determined that no reserves were necessary.
Prepayments and other assets
Prepayments represent partial payments or deposits for inventory purchases. These advances amounting to $1,023,154 and $2,296,982 as of June 30, 2012 and 2011, respectively, and are interest free and unsecured.
Advances for construction
As of June 30, 2012 and 2011, advances for construction amounted to $2,188,892 and $2,039,929, respectively. Advances for construction are paid to unrelated parties, interest free, and with no collateral and no guarantee.
Plant and equipment
Plant and equipment are stated at cost less accumulated depreciation. Additions and improvements to property and equipment accounts are recorded at cost. Maintenance, repairs, and minor renewals are charged directly to expense as incurred. Major additions and betterments to property and equipment accounts are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives less residual value.
Estimated useful lives of the assets are as follows:
Long-lived assets of the Company are reviewed at least annually or more often if circumstances dictate, to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of depreciation to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of June 30, 2012 and 2011, the Company expects these assets to be fully recoverable.
Investment in unconsolidated affiliate
Equity method investments are recorded at original cost and adjusted to recognize the Company's proportionate share of the investee's net income or losses and additional contributions made and distributions received. The Company recognizes a loss if it is determined that other than temporary decline in the value of the investment exists. (Note 5)
Intangible assets consist of the following:
Intangible assets are primarily comprised of land use rights, which are pledged as collateral for bank loans as of June 30, 2012 and 2011. The Chinese government owns all land in the PRC. However, the government grants "land use rights" for terms ranging from 20 to 50 years. The Company amortizes the cost of land use rights over the usage terms using the straight-line method.
The Company increased $2,511 for software upgrade during the year ended June 30, 2012.
Intangible assets are reviewed at least annually and more often if circumstances dictate, to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of June 30, 2012 and 2011, the Company determined that there had been no impairment. For the years ended June 30, 2012 and 2011, amortization expense relating to these intangible assets amounted to $59,368 and $56,632, respectively.
The following table consists of the expected amortization expenses for the next five years and thereafter:
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, and as a result the ultimate amount of tax liability may be uncertain. However, the Company does not anticipate any events that would lead to changes to these uncertainties.
The Company accounts for income taxes in accordance with ASC 740 (formerly SFAS 109, "Accounting for Income Taxes"). Under the asset and liability method as required by ASC 740, 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. Under ASC 740, 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. As of June 30, 2012 and 2011, the Company does not have material deferred taxes for its China operation. The Company and its subsidiaries are subject to income taxes on an entity basis on income arising in, or derived from, the tax jurisdiction in which they operate. As the Group has only net loss generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2012 and 2011. The Group believes that the realization of the benefits arising from this loss appears to be uncertain due to its limited operating history and continuing losses for United States income tax purses. Accordingly, the company has provided 100% valuation allowance at the year end for its United States operation.
The Company evaluates uncertain tax position utilizing a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeal or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.
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, and as a result the ultimate amount of tax liability may be uncertain. However, the Company does not anticipate any events that would lead to changes to these uncertainties.
Value Added Tax
Enterprises or individuals who sell products, engage in repair and maintenance or import and export goods in the PRC are subject to a value added tax in accordance with Chinese laws. The standard value added tax rate is 17% of the gross sales price; however, for the Company’s corn, the VAT rate is 13%. A credit is available whereby VAT paid on the purchases of semi-finished products, raw materials used in the production of the Company's finished products, and payment of freight expenses can be used to offset the VAT due on sales of the finished products.
VAT on sales and VAT on purchases amounted to $23,215,964 and $25,124,814, respectively, for the year ended June 30, 2012. VAT on sales and VAT on purchases amounted to $21,725,658 and $21,718,996, respectively, for the year ended June 30, 2011. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the Chinese government. VAT taxes are not impacted by the income tax holiday in the PRC.
From time to time, the Company guarantees the debt of others unrelated to the Company. The Company records guarantees at the fair value of the expected future payments. However, as of June 30, 2012, the Company estimates that it will not be required to make any payments under these guarantees based on the past experience and the financial condition of the companies to which the guarantees were made.
Recent accounting pronouncements
In December 2011, the FASB issued guidance on offsetting (netting) assets and liabilities. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The new guidance is effective for annual periods beginning after January 1, 2013.
In September 2011, the Financial Accounting Standards Board (“FASB”) issued new guidance related to evaluating goodwill for impairment. The new guidance provides entities with the option to perform a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before applying the quantitative two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the quantitative two-step goodwill impairment test. Entities also have the option to bypass the assessment of qualitative factors for any reporting unit in any period and proceed directly to performing the first step of the quantitative two-step goodwill impairment test, as was required prior to the issuance of this new guidance. An entity may begin or resume performing the qualitative assessment in any subsequent period. The new guidance became effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The adoption of this new guidance in 2012 did not impact the Company’s financial position, results of operations or cash flows.
In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). In accordance with ASU 2011-05, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. ASU 2011-05 does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 is effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2011. We are currently evaluating the impact of this standard on our consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” (“ASU 2011-04”). The amendments in ASU 2011-04 result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, ASU 2011-04 changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments in ASU 2011-04 to result in a change in the application of the requirements in Topic 820. ASU 2011-04 is effective prospectively for interim and annual reporting periods beginning after December 15, 2011. This ASU will become effective for the company beginning in the quarter ended January 31, 2012 and we do not expect an impact on our consolidated financial statements.
Note 3 - Other receivables
Other receivables amounted to $8,862,789 and $8,359,103 as of June 30, 2012 and 2011, respectively. Other receivables include receivables from unrelated parties and they are receivables not related for sales.
As of June 30, 2012 and 2011, the other receivables include Company's advances of $8,029,394 and $6,961,500 from its purchasing department employees as purchase advances for corn purchases. This amount is guaranteed by the Company's CEO and president by his personal properties.
Note 4 - Plant and equipment and Construction-in-progress
Plant and equipment and construction-in-progress consist of the following as of June 30, 2012 and 2011:
Construction-in-progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities. No depreciation is provided for construction-in-progress until such time as the assets are completed and placed into service. Depreciation expense for the years ended June 30, 2012 and 2011 amounted to $8,001,930 and $7,153,155, respectively. Interest costs totaling $275,699 and $872,756 were capitalized into construction-in-progress for the years ended June 30, 2012 and 2011, respectively.
Note 5 - Investment in unconsolidated affiliate
On September 16, 2003, Weifang Shengtai entered into a joint venture partnership with Weifang City Investment Company and Changle Century Sun Paper Industry Co., Ltd, “Changle Paper,” and formed Changle Shengshi Redian Co., Ltd, "Changle Shengshi.” Changle Shengshi was incorporated in Weifang City, Shandong Province, the PRC. Changle Shengshi's principal activity is to produce and sell electricity and steam to Weifang Shengtai and Changle for the use of their own production. Weifang Shengtai owns 20% of Changle Shengtai and the Company accounts for this 20% investment under the equity method of accounting.
Summarized financial information of Changle Shengshi is as follows as of June 30, 2012 and 2011:
Equity Investment Reconciliation is as follows as of June 30, 2012 and 2011:
Summarized financial information of Changle Shengshi is as follows for the years ended June 30, 2012 and 2011:
In order to meet increasing demands for electricity and steam by Weifang Shengtai and Changle Paper, during the year ended June 30, 2012, the Company increased investment in Changle Shengshi by 8,000,000 RMB (approximately $1.42 million) and Changle Paper invested a corresponding amount such that Weifang Shengtai and Changle Sunshine Paper Ltd. continue to be 20% and 80% owners, respectively, of Changle Shengshi. After the investment, the Company still owns 20% of Changle Shengshi.
Note 6 - Related party transactions
Accounts payable and accrued liabilities - related party
The Company’s utilities (electricity and steam) are mostly provided by Changle Shengshi (See Note 5). As of June 30, 2012 and 2011, the Company’s accounts payable and accrued liabilities due to Changle Shengshi was $405,945 and $943,779, respectively, which related to a portion of the Company’s utilities being provided by Changle Shengshi. The Company’s utilities expense amounted to approximately $15,918,448 and $15,573,614 for the years ended June 30, 2012 and 2011, respectively.
Other Payable- Officer
From time to time, the Company borrows money from Qingtai Liu, the Company’s CEO and President, for cash flow purposes of the Company. The loans do not require collateral and the principal is due upon demand. Before January 1, 2009, the interest rate was at 7.2% for the first six months, and then 10.8% thereafter until the full principal amounts are paid by the Company. After January 1, 2009, the interest rate was changed to 9.6% for the loan period. Employee loan from officer amounted to $37,027 and $36,285 as of June 30, 2012 and 2011, respectively. Interest expense related to this loan was $3,056 and $2,934 for the years ended June 30, 2012 and 2011, respectively.
As of June 30, 2012, the Company advanced $8,029,394 to its purchasing department employees as purchase advances for corn purchases. This amount is guaranteed by the Company's CEO and president by his personal properties.
Note 7 - Debt
Short term loans
Short term loans represent amounts due to various banks that are normally due within one year, and these loans can be renewed with the banks. As of June 30, 2012 and 2011, the Company’s short term bank loans consisted of the following:
Notes payable - banks
Notes payable represent amounts due to various banks which are normally due within one year, and these notes can be renewed with the banks. As of June 30, 2012 and 2011, the Company’s notes payables consisted of the following:
From time to time, the Company borrows money from certain employees for cash flow purposes of the Company. These loans do not require collateral, and the principal is due upon demand. Before January 1, 2009, the interest rate was at 7.2% for the first six months, and then 10.8% thereafter until the full principal amounts are paid by the Company. After January 1, 2009, the interest rate was changed to 7.2% for the loan period. In January 2010, the interest rate was changed to 9.6%. Employee loans amounted to $295,076 and $261,938 as of June 30, 2012 and 2011, respectively. Interest expense related to these loans was $ 27,379 for the year ended June 30, 2012 and $ 32, 645 for the year 2011, respectively.
Total interest expense and financial charges, net of capitalized interest, on all debt for the years ended June 30, 2012 and 2011, amounted to $6,079,464 and $3,578,615, respectively. Interest capitalized into construction-in-progress totaled $275,699 and $872,756 for the years ended June 30, 2012 and 2011, respectively.
Note 8 - Income taxes
Starting on September 1, 2009, the Company is subject to a 25% income tax rate pursuant to the Income Tax Laws of PRC.
Income tax provision-current for the years ended June 30, 2012 and 2011 amounted to $393,010 and $2,846,741, respectively, as follows:
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the years ended June 30:
For the year ended June 30, 2012 and 2011, the Company’s effective tax rate were 25% and 27.0%, respectively. Income before income taxes includes losses from non-Chinese entities, which are not deductible. After adjusting the non-Chinese entities losses, the Company’s effective rate was equivalent to the effective rate in China.
Substantially all of the Company’s income before income taxes and related tax expense are from PRC sources. Actual income tax benefit reported in the consolidated statements of income and comprehensive income differ from the amounts computed by applying the US statutory income tax rate of 34% to income before income taxes for the years ended June 30, 2012 and 2011 for the following reasons:
During the year ended June 30, 2012, the Company received income tax refund of $393,998.
Shengtai Pharmaceutical, Inc. and Shengtai Holding, Inc. were incorporated in the United States and for the United States income tax purposes, have accumulated net operating loss carry forwards $620,332 and $275,508 for the years ended June 30, 2012 and 2012, respectively. Deferred tax assets are amounting to $210,913 and $93,673 for the years then ended June 30, 2012 and 2011, respectively. For the United States income tax purposes, the tax benefits from the net operating loss carry forwards, which may be available to reduce future years’ taxable income, amounting $847,610 and $636,697 as of June 30, 2012 and 2011, respectively. The Company’s management believes that the utilization of the tax benefits from the net operating loss carry forwards appears uncertain due to the Company’s limited operating history and continuing losses expected at Shengtai Pharmaceutical, Inc. and Shengtai Holding, Inc., therefore, the Company has applied 100% valuation allowance to the deferred tax benefits to reduce the deferred asset to zero.
As of June 30, 2012, the Company’s foreign subsidiary has cumulative undistributed earnings of $37,374,321 that is included in consolidated retained earnings and will continue to be indefinitely reinvested in foreign operations. No provision has been made for the United States deferred taxes related to future repatriation of these cumulative undistributed earnings, nor is it practicable to estimate the amount of income taxes that would incur if the Company concluded that such earnings will be remitted in the future.
Taxes payable consisted of the following as of June 30, 2012 and 2011:
Note 9 - Commitments and Contingencies
As of June 30, 2012, the Company had guaranteed loans on behalf of three unrelated parties. The Company is obligated to perform under the guarantee if those guarantee companies fail to pay principal and interest payments when due. The maximum potential amount of future undiscounted payments under the guarantee is $8.34 million for those guarantee companies, including accrued interest. However, the guarantees given by the Company have been fully secured by the Company’s CEO’s personal assets. The Company has not recorded a liability for the guarantee because management estimates that those companies are current in their payment obligations, and the likelihood of the Company having to make payments under the guarantee is remote.
Details of guarantee amounts to unrelated parties for their short term bank loans as of June 30, 2012 and 2011 are as follows:
As of June 30, 2012, Weifang Century-Light Industry Co., Ltd and Yuanli Chemical Engineering Inc. guaranteed $6,651,569 and $4,751,120 for the Company, respectively.
As of June 30, 2011, Weifang Century-Light Industry Co., Ltd and Yuanli Chemical Engineering Inc. guaranteed $6,497,400 and $4,641,000 for the Company, respectively.
In April 2012, several law firms announced investigation of the Company in connection with the receipt of a going private proposal from Chairman and Chief Executive Officer Mr. Liu to acquire common stock at $1.65 per share in cash. To the best of our knowledge, no actions have been filed against the Company or its current officers and directors as of the date of this annual report.
Note 10 - Stockholders’ equity
On November 9, 2010, the Company effected a 1-for-2 reverse stock split of its issued and outstanding shares of Common Stock; reducing the number of its authorized shares of Common Stock and Preferred Stock by the same reverse stock split ratio. The reverse stock split and the reduction of the number of authorized shares of Common Stock and Preferred Stock were authorized by the stockholders of the Company at its annual general meeting of stockholders held on October 26, 2010. As of November 12, 2010, the outstanding and issued shares were approximately 9,584,912 shares (prior to the reverse stock split the number outstanding was 19,169,805), before rounding up fractional shares. The authorized number of shares of Common Stock was reduced from 100,000,000 to 50,000,000, and the authorized number of shares of Preferred Stock was reduced from 5,000,000 to 2,500,000. These financial statements have been adjusted retroactively to reflect the reverse stock split.
In connection with the 1-for-2 reverse stock split, all outstanding warrants and options will have 1-for-2 reverse split with the exercise price doubled.
On May 15, 2007, in connection with the Share Purchase Agreement, the Company issued 2,187,500 warrants, "Investor Warrants,” which carry an exercise price of $5.20 and a 5-year term. The Investor Warrants are callable if the Company's shares trade at or above $16.00 per share for 20 consecutive trading days and underlying shares are registered for resale. The Investor Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction. During the year ended June 30, 2008, a total of 97,403 warrants were exercised by three shareholders.
Also in connection with the Share Purchase Agreement, the Company issued 109,375 warrants, "Placement Agent Warrants,” to Brill Securities, the Placement Agent. These Placement Agent Warrants have the same terms as the Investor Warrants. These warrants were issued on August 8, 2007.
Concurrent with the offering related to the Share Purchase Agreement, the Company issued 37,500 warrants to Chinamerica Fund, LLP and 12,500 warrants to Jeff Jenson, collectively, the "Lead Investor Warrants,” to compensate Chinamerica Fund LLP as the lead investor and Jeff Jenson in assisting in providing the shell company, West Coast Car Company. These Lead Investor Warrants have the same terms as the Investor Warrants except that they have an exercise price of $0.02 per share. In June 2008, Jeff Jenson exercised the 12,500 warrants issued to him. In November 2008, Chinamerica Fund, LLP exercised the 37,500 warrants issued to the fund.
All Investor Warrants, Placement Agent Warrants and Lead Investor Warrants meet the conditions for equity classification pursuant to ASC 815 (formerly SFAS 133, "Accounting for Derivatives") and ASC 815 (formerly EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock"). Therefore, these warrants were classified as equity and accounted for as common stock issuance cost.
All warrants were expired as of June 30, 2012.
On January 4, 2008, the Company adopted the "Shengtai Pharmaceutical, Inc. 2007 Stock Incentive Plan,” the "Stock Incentive Plan.” The Company believes that awards under the Stock Incentive Plan better align the interests of its employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the fair value of the Company's stock at the date of grant.
On May 14, 2008, the Company granted 250,000 stock options and 80,000 non-qualified stock options pursuant to the Stock Incentive Plan. All options have an exercise price of $6.68, which was the closing price on the date of grant, and expire five years after the date of grant. All options vest over a period of three years on a quarterly basis from the date of grant.
The Company uses the Black-Scholes option pricing model which was developed for use in estimating the fair value of options. Option pricing models require the input of highly complex and subjective variables, including the expected life of options granted and the Company's expected stock price volatility over a period equal to or greater than the expected life of the options. Because changes in the subjective assumptions can materially affect the estimated value of the Company's employee stock options, it is management's opinion that the Black-Scholes option valuation model may not provide an accurate measure of the fair value of the Company's employee stock options and that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
The assumptions used in calculating the fair value of options granted in 2008 using the Black-Scholes option pricing model are as follows:
The volatility of the Company's common stock was estimated by management based on the historical volatility; the risk free interest rate was based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the estimated life of the options; and the expected dividend yield was based on the current and expected dividend policy. The fair value of the options was based on the Company's common stock price on the date the options were granted. Because the Company does not have sufficient applicable history of employee stock options activity, the Company uses the simplified method to estimate the life of the options by taking the sum of the vesting period and the contractual life and then calculating the midpoint, which is the estimated term of the options.
In the Chief Financial Officer Employment Agreement, the “Employment Agreement,” entered into on March 1, 2010 between the Company and Mr. Hu Ye, the former Chief Financial Officer, the Company granted Mr. Hu Ye an option to purchase 150,000 shares of common stock of the Company. The shares vest over 3 years starting March 1, 2010 and terminate on the third anniversary of the date of issuance of this option. The Company valued the shares at $5.20 per share, which represents 130 % of the fair market value being calculated in the private placement price on May 15, 2007. The fair values of stock options granted to the CFO were estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:
The Chief Financial Officer Employment Agreement between the Company and Mr. Hu Ye was terminated in December 2010, and the 150,000 options granted were forfeited.
On June 1, 2010, the Company hired two directors, Mr. Yaojun Liu and Mr. Fei He. In the Employment Agreements entered into on June 1, 2010 between the Company and each director, the Company granted each director an option to purchase 40,000 shares of common stock of the Company. The shares vest over 3 years starting June 1, 2010 and terminate on the third anniversary of the date of issuance of this option. The Company valued the shares at $5.20 per share. The fair values of stock options granted to the two directors were estimated at the date of grant amounting $165,611 using the Black-Scholes option-pricing model with the following assumptions:
The stock option activity was as follows for the year ended June 30, 2012:
The Employment Agreement between the Company and Mr. Fei He was terminated in August 2011.
The Company’s forfeiture rate for the year ended June 30, 2012 is 25.5%.
Following is a summary of the status of options outstanding at June 30, 2012:
Compensation expense from stock options recognized for the years ended June 30, 2012 and 2011 were $27,602 and $238,684, respectively. As of June 30, 2012, there is $27,602 estimated expense with respect to unvested stock-based awards yet to be recognized as an expense over the employee's remaining weighted average service period.
Note 11 - Statutory reserves
The laws and regulations of the PRC require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations in proportions determined at the discretion of the board of directors, after the statutory reserves. The statutory reserves include the surplus reserve fund, and the enterprise fund. These statutory reserves represent restricted retained earnings.
Surplus reserve fund
The Company is required to transfer 10% of its net income, as determined in accordance with the PRC’s accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital. The transfer to this reserve must be made before distribution of any dividends to shareholders. For the years ended June 30, 2012 and 2011, the Company transferred $157,303 and $854,022, to this reserve. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
Pursuant to the Company’s articles of incorporation, the Company is to appropriate 10% of its net profits as statutory surplus reserve up to $7,500,000. As of June 30, 2012 the Company had appropriated to the statutory reserve approximately $4,200,000. The Company plans to contribute $3,300,000 in the future.
The enterprise fund may be used to acquire fixed assets or to increase the working capital to expand production and operations of the Company. No minimum contribution is required and the Company has not made any contribution to this fund as of June 30, 2012.
Note 12 – Sale Leaseback
On December 10, 2008, the Company entered into a sale leaseback arrangement and sold part of its equipment to an unrelated third party for approximately $5,134,500. The leaseback has been accounted for as a capital lease with the same third party to lease the same equipment for 4 years, with total payments of approximately $8,119,845. The title of the equipment will be transferred back to the Company upon the last payment and after the third party receives a one time payment of $44,010 from the Company. The lease matured in July 2010, and the total payments of principal and interest are $8,285,895.
Note 13 - Retirement benefit plans
Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for the benefit of all permanent employees. The Company is required to make contributions to the state retirement plan at 15% to 20% of the monthly base salaries of all current permanent employees. The PRC government is responsible for the administration and benefit liability to retired employees. For the years ended June 30, 2012 and 2011, the Company made contributions in the amounts of $577,322 and $449,874, respectively, to the Company’s retirement plan.
Note 14 - Subsequent events
In July 2012, the Company obtained a short term bank loan of $2,375,560 from Qingdao Bank, due January 2013; monthly interest only payments; interest rates of 6.0% per annum, guaranteed by certain collateral, unsecured.
In August 2012, the Company obtained a short term bank loan of $4,751,120 from China Construction Bank, due July 2013; monthly interest only payments; interest rates of 6.0% per annum, guaranteed by certain collateral, unsecured.
In August 2012, the Company obtained a short term bank loan of $3,167,414 from China Construction Bank, due July 2013; monthly interest only payments; interest rates of 6.0% per annum, guaranteed by certain collateral, unsecured.
In August 2012, the Company obtained a short term loan of $4,751,120 form Bank of Communication, due August 2013;monthly interest only payments; interest rate of 6.60% per annum, guaranteed by certain collateral, unsecured.
In September 2012, the Company obtained a short term loan of $3,167,414 form Agriculture Bank of China, due September 2013; monthly interest only payments; interest rate of 7.20% per annum, guaranteed by certain collateral, unsecured.
In September 2012, the Company obtained a short term loan of $1,583,707 form Industrial and Commercial Bank of China, due July 2013; monthly interest only payments; interest rate of 6.60% per annum, guaranteed by certain collateral, unsecured.
* filed herewith