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FCPG > SEC Filings for FCPG > Form 10-K/A on 19-Nov-2012All Recent SEC Filings

Show all filings for FIRST CHINA PHARMACEUTICAL GROUP, INC.

Form 10-K/A for FIRST CHINA PHARMACEUTICAL GROUP, INC.


19-Nov-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This discussion summarizes the significant factors affecting the operating results, financial condition, liquidity and cash flows of the Company and its subsidiaries for the fiscal years ended March 31, 2011 and 2010. The discussion and analysis that follows should be read together with our consolidated financial statements and the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Except for historical information, the matters discussed in this section are forward looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond the Company's control. Consequently, and because forward-looking statements are inherently subject to risks and uncertainties, the actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. You are urged to carefully review and consider the various disclosures made by us in this report.

OVERVIEW

As a result of the Exchange Transaction, through our wholly-owned subsidiary, XYT, we are now engaged in drug logistics and distribution in Yunnan Province, China through drug stores, medical clinics and hospitals, as well as the wholesale distribution of medicine products, chemical agents, antibiotics, biochemistry drugs and biological preparations to hospitals and the XYT store located at the Company's distribution facility in Kunming. XYT was founded in November 2002 and is a provincial pharmaceutical distributor that offers approximately 5,000 drugs, of which approximately 1,000 are over-the-counter drugs, approximately 1,000 are prescription drugs, approximately 2,000 are prepared Chinese medicines and approximately 1,000 are supplements. Currently, XYT has approximately 4,700 customers and supplies approximately 10% of such customers' inventories with a sales network that covers the entire Yunnan Province of China. XYT believes it has a strategic advantage over certain of its competitors in Yunnan Province as it has obtained government approval to fill orders over the internet. XYT received the License of Internet Drug Information Service issued by the Yunnan Food and Drug Administration in October 2009. This license enables XYT to bypass municipal and county pharmaceutical distributors, market XYT's product line, provide pricing information and provide products directly to XYT customers. Bypassing these layers of distribution enables XYT to offer products to its customers at a significantly lower price than its major competitors while maintaining its margins.

Our continuing strategy is to build a nationwide pharmaceutical distribution network throughout China. We plan to expand our customer base through the use of the following tactics: broadening of our current product line to attract larger customers that currently do not utilize us and benefit from internet ordering and the lower prices that we offer; providing computers to customers to attract new customers as our management is unaware of any other pharmaceutical distribution company providing this benefit; and increasing our current sales force to directly target hospitals, medical clinics and pharmacies.


Our management's discussion and analysis of our financial condition and results of operations are only based on XYT's current drug logistics and distribution business in China. Key factors affecting our results of operations include revenues, cost of revenues, operating expenses and income and taxation.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP"), and this requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure of contingent assets and liabilities at the dates of the consolidated financial statements as well as the reported amounts of revenues and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ significantly from these estimates under different assumptions or conditions. Significant estimates include:

Valuation of accounts receivable

An allowance for impairment of trade and other receivables is established when there is objective evidence that we will not be able to collect all amounts due according to the original terms of receivables. The amount of the allowance is the difference between the receivables' carrying amount and the present value of estimated future cash flows, discounted at the effective interest rate computed at initial recognition. The amount of the allowance is recognized in the income statement.

Inventories

Net realizable value of inventories is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale. For the years ended March 31, 2011 and 2010, the Company recorded no allowance for slow-moving and obsolete inventories.

Deferred income taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of income and comprehensive income in the periods that includes the enactment date.

Useful lives of plant and machinery

Depreciation of property, plant and equipment is calculated to write off the cost, less their estimated residual value, if any, using the straight-line method over their estimated useful lives. The principal depreciation periods are as follows:

Machinery 5 years Motor Vehicles 4 years Office equipment 3 years


Recently Issued Accounting Pronouncements

In April 2009, the FASB issued FSP 157-4, Determining Fair Value When The Volume And Level Of Activity For The Asset Or Liability Have Significantly Decreased And Identifying Transactions That Are Not Orderly ("FSP 157-4"). FSP 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. FSP 157-4 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, FSP 157-4 requires comparative disclosures only for periods ending after initial adoption. The adoption of the provisions of FSP 157-4 is not anticipated to materially impact on the Company's results of operations or the fair values of its assets and liabilities.

In May 2009, the FASB issued FSP SFAS 165 "Subsequent Events." The objective of this Statement is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 is effective for the interim and annual periods ending after June 15, 2009, which is now codified as FASB ASC 855 "Subsequent Events." The adoption of FASB ASC 855 did not have a material impact on the Company's financial position, results of operations and cash flows. Effective February 24, 2010, the Company adopted Accounting Standards Update ("ASU") No. 2010-09, "Subsequent Events (Topic 855):
Amendments to Certain Recognition and Disclosure Requirements," which removes the requirement to disclose the date through which subsequent events have been evaluated. The adoption of the ASU did not have a material impact on the Company's financial position, results of operations and cash flows.

In June 2009, the FASB issued SFAS No. 166 Accounting For Transfers Of Financial Assets ("SFAS 166"). This statement is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor's continuing involvement in transferred financial assets. This Statement must be applied as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009, and is required to be adopted by the Company in the first quarter of fiscal year 2011. Earlier application is prohibited. This Statement must be applied to transfers occurring on or after the effective date. The Company does not expect the adoption of SFAS 166 to have a material impact on its financial position, results of operations and cash flows.

In June 2009, the FASB issued SFAS No. 167, "Amendments to FASB Interpretation No. 46(R)," which is codified as ASC 810. ASC 810 amends FASB Interpretation No.
46(R), "Variable Interest Entities" for determining whether an entity is a variable interest entity ("VIE") and requires an enterprise to perform an analysis to determine whether the enterprise's variable interest or interests give it a controlling financial interest in a VIE. Under ASC 810, an enterprise has a controlling financial interest when it has a) the power to direct the activities of a VIE that most significantly impact the entity's economic performance and b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. ASC 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity's economic performance.

ASC 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. ASC 810 shall be effective as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. ASC 810 is effective for the Company in the first quarter of fiscal 2011. The Company is currently evaluating the effect of ASC 810 on its financial statements and results of operation and is currently not yet in a position to determine such effects.

In June 2009, the FASB issued SPAS 168, "The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No 162," which supersedes all existing non-SEC accounting and reporting standards. The codification does not change GAAP but rather organizes it into a new hierarchy with two levels; authoritative and non-authoritative. All authoritative GAAP carries equal weight and is organized in a topical structure. The adoption of SPAS 168 did not have a material impact on the Company's financial position, results of operations and cash flows.


In August 2009, the FASB issued Accounting Standards Update ("ASU") No. 2009-05, "Measuring Liabilities at Fair Value," which is codified as ASC 820, "Fair Value Measurements and Disclosures." This Update provides amendments to ASC 820-10, Fair Value Measurements and Disclosures -Overall, for the fair value measurement of liabilities. This Update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or that is consistent with the principles of ASC 820. The amendments in this Update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents transfer of the liability.

The amendments in this Update also clarify that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the assets are required are Level 1 fair value measurements. ASC 820 is effective for the first reporting period (including interim periods) beginning after August 28, 2009. The adoption of this Update did not have a significant impact to the Company's financial statements.

In September 2009, the FASB issued ASU No. 2009-06, "Income Taxes (Topic 740)-Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities," and it provides implementation guidance on accounting for uncertainty in income taxes effective for interim and annual reporting period ending on or after September 15, 2009. The adoption of ASU No. 2009-06 did not have any impact on the Company's financial position, results of operations and cash flows.

In December 2009, the FASB issued ASU No. 2009-17, "Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities ("ASU 2009-17")." ASU 2009-17 amends the variable-interest entity guidance in FASB ASC 810-10-05-8 to clarify the accounting treatment for legal entities in which equity investors do not have sufficient equity at risk for the entity to finance its activities without financial support. ASU 2009-17 shall be effective as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009. ASU 2009-17 is effective for the Company in the first quarter of fiscal 2011. The Company is currently evaluating the effect of ASU 2009-17 on its consolidated financial statements and results of operation and is currently not yet in a position to determine such effects.

In January 2010, the FASB issued ASU No. 2010-06 "Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements." This update provides amendments to Subtopic 820-10 that required new disclosures for 2 situations: (i) a reporting entity should disclose separately the amount of significant transfer in and out of Level 1 and 2 fair value measurements and describe the reasons for the transfers; (ii) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuance, and settlements. None of the new pronouncements has current application to the Company.

In February 2010, the FASB issued ASU No. 2010-09 "Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements." This Update provides amendments to: (i) an entity that either (a) is an SEC filer or
(b) is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets), is required to evaluate subsequent events through the date that the financial statements are issued. If an entity meets neither of those criteria, then it should evaluate subsequent events through the date the financial statements are available to be issued; (ii) the glossary of Topic 855 is amended to include the definition of SEC filer; (iii) an entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated; (iv) the glossary of Topic 855 is amended to remove the definition of public entity; and (v) the scope of the reissuance disclosure requirements is refined to include revised financial statements only.

In May 2010, the FASB issued ASU No. 2010-19 "Foreign Currency (Topic 830):
Foreign Currency Issues: Multiple Foreign Currency Exchange Rates (SEC Update)." The purpose of this Update is to codify the SEC Staff Announcement made at the March 18, 2010 meeting of the FASB Emerging Issues Task Force (EITF) by the SEC Observer to the EITF. The Staff Announcement provides the SEC Staff's view on certain foreign currency issues related to investments in Venezuela. None of the new pronouncements has current application to the Company.


In December 2010, the FASB issued Update No. 2010-28 "Intangibles-Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." The amendments in this Update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For nonpublic entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities may early adopt the amendments using the effective date for public entities.

None of the above new pronouncements has current application to us, but may be applicable to our future financial reporting.

Results of Operations

Comparison of the Years Ended March 31, 2011 and 2010

The following table sets forth certain information regarding our results of
operation.

                                                                         Years Ended March 31
                                                                        2011               2010
Statements of Operations Data
Sales                                                              $   28,999,198     $   25,723,902
Cost of Sales                                                        (23,749,000)       (21,045,598)
Gross Profit                                                            5,250,198          4,678,304
Selling, general and administrative expenses, and other expenses      (1,669,789)          (981,382)
Derivative loss                                                       (1,716,112)                  -
Income tax expense                                                    (1,085,378)          (934,463)
Net Income                                                                778,919          2,762,459
Effects of foreign currency translation conversion                        202,391             21,037
Comprehensive income                                                     981,3100          2,783,496

Sales

Our sales of Chinese patent drugs, antibiotics, bio-chemicals, chemical preparations, and biologicals totaled US$28,999,198 for the year ended March 31, 2011, an increase of 13% from US$25,723,902 for the year ended March 31, 2010. This increase in sales was primarily due to increased selling efforts by XYT and FCPG HK's staff and the addition of several products with high profit margins. In addition, several new hospitals were added as customers which contributed to increased sales volume. Further, we had the ability to market our product line over the internet in 2011 due to our receipt, in November 2010, of Chinese government approval to market our product line in such manner. We began to realize the benefits of internet marketing from November 2010 onward, resulting in increased sales for the year ended March 31, 2011.

Cost of sales

Cost of sales consists primarily of material cost, labor cost, and related expenses which are directly attributable to the selling of pharmaceutical products. Cost of sales for the year ended March 31, 2011 increased by 13% to US$23,749,000 from US$21,045,598 for the year ended March 31, 2010. The largest component of our cost of sales is the purchase price for our goods. This increase in cost of sales percentage from the prior year is relatively consistent with XYT and FCPG HK's percentage increase in sales described above, reflecting its increased selling efforts. Specifically, our increased selling efforts are a result of our ability to market our product line over the internet in 2011 due to our receipt, in November 2010, of Chinese government approval to market our product line in such manner. We were not able to undertake such internet marketing efforts (and incur such related costs) during the year ended March 31, 2010.


Although we anticipate that the cost of sales will increase due to inflationary price increases, we do not believe that such increases will be material for fiscal year 2012. We anticipate that beyond 2011, our price for materials and other production costs will continue to increase due to inflation. If our costs of sales increase, this may have a negative effect on our net income because due to market conditions and competitive conditions, we may not be able to increase the price for our products in proportion to the increase in costs of goods sold.

Gross profit

Gross profit for the year ended March 31, 2011 was US$5,250,198, an increase of 12%, from US$4,678,304 for the year ended March 31, 2010. The increase in gross profit reflects increased overall sales as described above, as well as the sale of certain higher margin products. Specifically, our freeze-dry powder injector and antibiotics products have higher margins than our Chinese medicine products. Our increased costs of sales for the year ended March 31, 2011 was partially offset by the increased sales of our higher margin products (freeze-dry powder injector and antibiotics) for the year ended March 31, 2011.

Selling, general and administrative expenses, and others

Selling, general and administrative expenses increased by 87% to US$1,831,141 for the year ended March 31, 2011 from US$981,382 for the year ended March 31, 2010. The increase is largely due to an increase in legal and accounting expenses and administrative expenses from $162,471 for the year ended March 31, 2010 to $1,356,288 for the year ended March 31, 2011. The increase in administrative expenses was mainly due to the securities issuance cost paid to placement agents.

Derivative loss

Derivative loss was $1,716,112 for the year ended March 31, 2011. This loss is a non cash decrease to the income statement that is a result of the Black-Scholes derivative valuation of the warrants issued by the Company in relation to the financing in March 2011. The valuation of these warrants is required by US GAAP and can produce either a non cash gain or loss; depending upon the fair market value of the common stock. This is a non cash transaction and does not positively affect the Company's working capital.

Income tax expense

Income tax expense for the year ended March 31, 2011 was US$1,085,378 compared to income tax expense of US$934,463 for the year ended March 31, 2010. The 16% increase was due to the increase in profits in FCPG HK of $0 for the year ended March 31, 2010 to $2,883,208 for the year ended March 31, 2011, where we were subject to a 16.5% income tax rate.

Net income

Our net income for the year ended March 31, 2011 was US$778,919, a decrease of 72%, from US$2,762,459 for the year ended March 31, 2010. This decrease was primarily due to the increase in selling, general and administrative expenses related to our private offering. In addition, derivative loss produced a significant non-cash expense.

Effects of foreign currency translation conversion

We recognized a gain of US$202,391 on the effects of foreign currency conversion for the year ended March 31, 2011, as compared to a gain of US$21,037 for the year ended March 31, 2010. This change is due to differences in exchange rates used during the years for converting from XYT's functional currency of Renminbi to U.S. dollars for financial reporting purposes.

Comprehensive income

Our comprehensive income decreased by 9% from US$2,783,496 for the year ended March 31, 2010 to US$2,536,070 for the year ended March 31, 2011. The decrease is attributable to the above-mentioned increases in sales and gross profits, offset in part by selling and administrative expenses and income tax expenses.


Liquidity and Capital Resources

Overview

As of March 31, 2011, we had cash and equivalents on hand of US$740,368, and a working capital deficit of US$5,718,593. We believe that our cash on hand and working capital will be sufficient to meet our operational cash requirements through December 31, 2011. If XYT does not meet its revenue objectives over that period, the Company may need to sell additional equity securities, which could result in dilution to current stockholders, or seek additional loans. The incurrence of indebtedness would result in increased debt service obligations and could require the Company to agree to operating and financial covenants that would restrict its operations. Financing may not be available in amounts or on terms acceptable to the Company, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

Substantially all of our revenues are earned by XYT, our PRC subsidiary. However, PRC regulations restrict the ability of our PRC subsidiary to make dividends and other payments to their offshore parent company. Pursuant to the law of PRC on foreign-capital enterprises, when XYT decides to distribute profits, reserve funds and bonus and welfare funds for workers and staff members shall be withdrawn from the profits after a foreign-capital enterprise has paid income tax in accordance with the provisions of the Chinese tax law. The proportion of reserve funds to be withdrawn shall not be lower than 10% of the total amount of profits after payment of tax; the withdrawal of reserve funds may be stopped when the total cumulative reserve has reached 50% of the registered capital. The proportion of bonus and welfare funds for workers and staff members to be withdrawn shall be determined by the foreign-capital enterprise of its own accord. Companies may be subject to a fine up to 5,000 RMB as a result of non-compliance of such rules. The registered capital of XYT is US$2,295,000. Shareholders of XYT had not determined the proportion of reserve . . .

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