As a result of these factors, we reported net income of $1,773,771 for the three months ended June 30, 2011 as compared to net income of $6,322,262 for the three months ended June 30, 2010. This translated to earnings per common share of $0.06 and $0.24 (basic and diluted) for the three months ended June 30, 2011 and 2010, respectively.
The functional currency of our operating subsidiaries and affiliates is the Chinese Renminbi (“RMB”). The financial statements of our operating subsidiaries and affiliates are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations. As a result of these translations, which are a non-cash adjustment, we reported a foreign currency translation gain of $1,546,706 for the three months ended June 30, 2011 as compared to $323,270 for the three months ended June 30, 2010. This non-cash gain had the effect of increasing our reported comprehensive income.
As a result of our foreign currency translation gains, we had comprehensive income for the three months ended June 30, 2011 of $3,320,477, compared with $6,645,532 for the three months ended June 30, 2010.
Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis.
At June 30, 2011 and December 31, 2010, we had a cash balance of $886,445 and $1,339,972, respectively. These funds are distributed in financial institutions located in China.
Our working capital decreased $160,033 to working capital deficit of $3,669,247 at June 30, 2011 from working capital deficit of $3,509,214 at December 31, 2010. This decrease in working capital is primarily attributed to:
The changes in asset and liabilities discussed above is based on a comparison of amounts on our balance sheets as of June 30, 2011 and December 31, 2010 and does not necessarily reflect changes in assets and liabilities reflected on our cash flow statement, for which we use the average foreign exchange rate during the period to calculate these changes.
Our balance sheet as of June 30, 2011 also reflects notes payable to related parties of $5,361,684 due on December 30, 2015 which was a series of working capital loans made to us since December 31, 2005 by the Company’s Chief Executive Officer, his wife, Chief Executive Officer’s father-in-law and two employees of the Company. These loans bear interest based on a floating annual interest rate, which is 80% of China bank interest rate and are unsecured. During the six months ended June 30, 2011, we did not repay any portion of the principal of these loan balances.
Net cash provided by operating activities for the six months ended June 30, 2011 was $6,654,189 as compared to net cash provided by operating activities of $8,908,338 for the six months ended June 30, 2010. For the six months ended June 30, 2011, net cash provided by operating activities was primarily attributable to net income of approximately $4,009,000 and the add back of non-cash charges such as: depreciation of approximately $211,000, amortization of intangible assets of approximately $607,000, common shares issued for service of approximately $708,000 and common shares issued for compensation of $1,388,000. In addition, the receipt of cash from changes in operating assets and liabilities, such as: a decrease in prepaid expenses and other current assets of approximately $67,000, an increase in taxes payable of approximately $5,183,000 which was mainly attributable to the increase in value-added taxes payable, an increase in unearned revenue of approximately $18,000 and an increase in due to related parties of approximately $225,000, offset by the use of cash from changes in operating assets and liabilities, such as: an increase in accounts receivable of approximately $2,823,000 due to the credit provided to more customers in order to encourage customers to purchase our product, an increase in inventories of approximately $243,000, a decrease in accounts payable of approximately $18,000 and a decrease in other payables and accrued liabilities of approximately $2,679,000 mainly due to the payments made in fiscal 2011 for fiscal 2010 accrued sales commission, employees bonus and accrued expenses for service and accrued payables for construction.
For the six months ended June 30, 2010, net cash provided by operating activities was primarily attributable to net income of approximately $11,251,000 and the add back of non-cash charges, such as: depreciation of approximately $13,000, amortization of intangible assets of approximately $877,000, amortization of deferred debt issuance costs of approximately $52,000, amortization of discount on convertible redeemable preferred stock of approximately $152,000, interest expense attributable to beneficial conversion feature of preferred shares of approximately $185,000, common shares issued for service of approximately $120,000 and common shares issued for compensation of approximately $110,000. In addition, the receipt of cash from changes in operating assets and liabilities, such as: a decrease in prepaid expenses and other current assets of approximately $354,000, an increase in accounts payable of approximately $65,000, an increase in taxes payable of approximately $592,000 and an increase in due to related parties of approximately $166,000, offset by the use of cash from changes in operating assets and liabilities, such as: an increase in accounts receivable of approximately $3,240,000, an increase in inventories of approximately $638,000, a decrease in other payables and accrued liabilities of approximately $631,000 and a decrease in unearned revenue of approximately $520,000.
Net cash used in investing activities for the purchase of property and equipment for the six months ended June 30, 2011 and 2010 amounted to approximately $7,132,000 and $11,781,000, respectively.
Net cash provided by financing activities for the six months ended June 30, 2011 and 2010 was $0.
We reported a net decrease in cash for the six months ended June 30, 2011 of $453,527 as compared to a net decrease in cash of $2,867,016 for the six months ended June 30, 2010.
We estimate that our working capital is sufficient to fund our current operations for the next 12 months. Lotus East has historically funded its capital expenditures from its working capital. As of June 30, 2011, Lotus East has contractual commitments of approximately $52 million related to a Technology Transfer Agreement and the construction of the new facility in Inner Mongolia and a New Drug Patent Transfer Agreement and a research and development agreement. While it intends to fund the costs with its existing working capital associated with the Technology Transfer Agreement and the New Drug Patent Transfer Agreement and the research and development agreement and a portion of the construction of the new facility in Inner Mongolia, it is dependent upon the continued growth of its operations and prompt payment of outstanding accounts receivables by its customers to ensure that it has sufficient cash for these commitments. Our ability to fully fund the costs associated with the new facility in Inner Mongolia is materially dependent upon our ability to obtain secured bank financing and/or government grants and/or other third party financing.
41
There is no guarantee that Lotus East can obtain these financings on favorable terms at the right time. Although the Chinese government has announced an economic stimulation plan, there is no guarantee that we will be awarded the government grants successfully. While Lotus East’s management believes the Company will be successful in securing the necessary funding through its increasing revenue, faster collections on receivables, and continuing discussions with various commercial banks, there are no assurances that the funding will be available in the amounts or at the time required to meet Lotus East’s commitments. In the event that Lotus East is not successful in obtaining the funds it needs for the Technology Transfer Agreement and the New Drug Patent Transfer Agreement, it is possible that it could default under the terms of the two agreements and forfeit any funds paid to date. If Lotus East fails to obtain all of the funding necessary to complete the construction of the new facility in Inner Mongolia, which is estimated to be approximately $49.5 million in the next few years, it could get back approximately $34.6 million for the payments on the land use right, which is refundable if the Chinese local government does not grant it land use right certificate.
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual Obligations
We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows. The total of contractual obligations and commitments does not include any payments made by us.
The following table summarizes our contractual obligations as of June 30, 2011, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by period
|
|
|
|
Total
|
|
Less than
1 year
|
|
1-3
Years
|
|
3-5
Years
|
|
5+
Years
|
|
Related parties indebtedness
|
|
$
|
7,216,861
|
|
$
|
1,855,177
|
|
$
|
—
|
|
$
|
5,361,684
|
|
$
|
—
|
|
Interest payment on notes payable – related parties
|
|
$
|
1,014,586
|
|
$
|
—
|
|
$
|
—
|
|
$
|
1,014,586
|
|
$
|
—
|
|
Technology purchase obligations
|
|
$
|
1,701,732
|
|
$
|
850,866
|
|
$
|
850,866
|
|
$
|
—
|
|
$
|
—
|
|
New drug patent purchase obligations
|
|
$
|
464,109
|
|
$
|
464,109
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
Construction obligations in Inner Mongolia
|
|
$
|
49,504,950
|
|
$
|
—
|
|
$
|
18,564,356
|
|
$
|
30,940,594
|
|
$
|
—
|
|
Obligations from research and development agreement
|
|
$
|
61,881
|
|
$
|
61,881
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
Total contractual obligations
|
|
$
|
59,964,119
|
|
$
|
3,232,033
|
|
$
|
19,415,222
|
|
$
|
37,316,864
|
|
$
|
—
|
Off-balance Sheet Arrangements
We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable for a smaller reporting company.
42
Item 4T. Controls and Procedures.
Our internal control over financial reporting is a process designed by or under the supervision of our principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on our consolidated financial statements.
Our management does not expect that our disclosure controls or our internal controls over financial reporting will prevent all errors and frauds. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Such limitations include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures, such as simple errors or mistakes or intentional circumvention of the established process.
Disclosure Controls and Procedures
Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.
As required by Rule 13a-15 under the Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2011. As discussed in more detail below, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of June 30, 2011, due to the material weaknesses that we identified in internal control over financial reporting in our annual report on Form 10-K for the fiscal year ended December 31, 2010 (the “Form 10-K”).
Remediation Measures of Material Weakness
We have implemented, or plan to implement, the measures described below under the supervision and guidance of our management to remediate the material weaknesses identified in the Form 10-K and to strengthen our internal controls over financial reporting. Key elements of the remediation effort include, but are not limited to, the following initiatives, which have been implemented, or are in the process of implementation, as of the date of filing of this interim report:
|
|
|
|
|
·
|
We plan to engage a consultant or consulting firm in fiscal 2011, to review, evaluate and identify inadequacies of our existing internal control procedures, and to make recommendation and implement changes as necessary for the improvement of our internal controls.
|
|
|
|
|
|
|
·
|
We will continue to bring in additional qualified financial personnel for the accounting department to further strengthen our financial reporting function. We have started training our internal accounting staff in US GAAP and financial reporting requirements.
|
|
|
|
|
|
|
·
|
Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, we will implement procedures to assure that the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.
|
We believe that the foregoing steps will remediate the material weakness identified in the Form 10-K, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.
43
A material weakness (within the meaning of PCAOB Auditing Standard No. 5) 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 our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting.
Changes in Internal Control over Financial Reporting
Except as described above, there have been no changes in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 1A. Risk Factors.
There are no material changes from the risk factors previously disclosed in the Annual Report on Form 10-K
for the year ended December 31, 2010, filed with the SEC on March 28, 2011.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. (Removed and Reserved)
Item 5. Other Information.
None.
Item 6. Exhibits.
|
|
|
|
No.
|
|
Description
|
|
31.1
|
|
Rule 13a-14(a)/ 15d-14(a) Certification of Chief Executive Officer
|
|
|
|
|
|
31.2
|
|
Rule 13a-14(a)/ 15d-14(a) Certification of Chief Financial Officer
|
|
|
|
|
|
32.1
|
|
Section 1350 Certification of Chief Executive Officer
|
|
|
|
|
|
32.2
|
|
Section 1350 Certification of Chief Financial Officer
|
|
|
|
|
|
101*
|
|
XBRL data files of Financial Statements and Notes contained in this Quarterly Report on Form 10-Q.
|
* In accordance with Regulation S-T, the Interactive Data Files in Exhibit 101 to the Quarterly Report on Form 10-Q shall be deemed “furnished” and not “filed.”
44
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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|
|
Lotus Pharmaceuticals, Inc.
|
|
|
|
|
|
|
|
|
|
Date: August 12, 2011
|
By:
|
/s/ Zhongyi Liu
|
|
|
Zhongyi Liu
|
|
|
Chief Executive Officer and President, principal executive officer
|
|
|
|
|
|
Date: August 12, 2011
|
By:
|
/s/ Yan Zeng
|
|
|
Yan Zeng
|
|
|
Chief Financial Officer, principal financial officer
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45
