UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

xQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2012

 

or

 

oTransition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from ______ to ______.

 

Commission File Number 001-34394

 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY

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

 

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

 

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

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

(Address of principal executive offices and zip code)

 

(8629) 8819-3188

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x    No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

  Large Accelerated Filer  ¨ Accelerated Filer  ¨
  Non-accelerated filer  ¨ Smaller Reporting Company  x

 

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

  

As of August 10, 2012, the Company had 7,604,800 shares of common stock outstanding.

 

 
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY

 

FORM 10-Q

 

INDEX

 

  Page No.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS  
   
PART I.  FINANCIAL INFORMATION 4
     
Item 1. Condensed Consolidated Financial Statements 4
     
  Condensed Consolidated Balance Sheets as of June 30, 2012 (unaudited) and December 31, 2011 4
     
  Condensed Consolidated Statements of Income and Comprehensive Income for the Three Months and Six Months Ended June 30, 2012 and 2011 (unaudited) 5
     
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (unaudited) 6
     
  Condensed Consolidated Statement of Shareholders’ Equity as of June 30, 2012 (unaudited) 7
     
  Notes to the Condensed Consolidated Financial Statements (unaudited) 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
     
Item 4. Controls and Procedures 34
     
PART II.  OTHER INFORMATION 35
     
Item 6. Exhibits 36
     
SIGNATURES 37

 

2
 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

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

 

Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the heading “Risks Relating to Our Business” contained in Form 10-K for the year ended December 31, 2011, as well as those discussed elsewhere in this Quarterly Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We file reports with the SEC. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.

 

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

 

3
 

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   June 30,   December 31, 
    2012    2011 
   (Unaudited)    
ASSETS        
CURRENT ASSETS:          
Cash  $2,341,981   $7,048,968 
Accounts receivable, net of allowance for doubtful accounts of $542,888 and $438,678 as of June 30, 2012 and December 31, 2011, respectively   10,687,845    3,391,493 
Inventories   13,277,963    14,851,159 
Deposits, prepaid expenses and other receivables   2,772,002    3,421,487 
Prepayments for raw materials purchasing   36,688,923    29,226,961 
Loans receivable   2,911,829    964,088 
Total current assets   68,680,543    58,904,156 
           
PROPERTY, PLANT AND EQUIPMENT, NET   28,070,683    28,376,559 
           
CONSTRUCTION-IN-PROGRESS   9,553,513    8,839,055 
           
OTHER ASSETS:          
Long-term prepayments   1,207,154    1,512,817 
Long-term prepayments for acquisitions   177,520    569,788 
Intangible assets, net   5,513,494    5,674,206 
Total other assets   6,898,168    7,756,811 
Total assets  $113,202,907   $103,876,581 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
CURRENT LIABILITIES:          
Accounts payable  $2,626,855   $1,047,067 
Other payables and accrued expenses   5,039,774    5,274,598 
Short-term loans   6,815,500    7,366,320 
Deposits from customers   1,404,409    1,432,529 
Taxes payable   2,936,992    160,081 
Due to related parties   336,072    56,273 
Total current liabilities   19,159,602    15,336,868 
           
OTHER LIABILITIES:          
Deferred government grant   396,250    393,500 
Warrant/purchase option liability   21,000    43,400 
Total other liabilities   417,250    436,900 
Total liabilities   19,576,852    15,773,768 
           
COMMITMENTS AND CONTINGENCIES          
           
SHAREHOLDERS’ EQUITY          
Preferred stock, $0.001 par value, 50,000,000 shares authorized. No Series “A” shares authorized. 48,000,000 Series “B” shares authorized. No Series “B” shares issued and outstanding   -    - 
Common stock, $0.001 par value, 40,000,000 shares authorized, 7,604,800 and 7,161,919 shares issued and outstanding as of June 30, 2012 (Unaudited) and December 31, 2011   7,605    7,162 
Paid-in capital   37,021,085    35,784,378 
Statutory reserves   5,708,135    5,708,135 
Retained earnings   42,095,651    38,492,031 
Accumulated other comprehensive income   8,793,579    8,111,107 
Total shareholders’ equity   93,626,055    88,102,813 
Total liabilities and shareholders’ equity  $113,202,907   $103,876,581 

 

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

 

4
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

(Unaudited)

 

   For Three Months Ended June30,   For Six Months Ended June30, 
   2012   2011   2012   2011 
                     
REVENUE, NET  $8,870,848   $9,096,141   $16,797,185   $16,183,095 
                     
COST OF REVENUE   3,746,938    4,637,007    7,390,596    8,128,353 
                     
GROSS PROFIT   5,123,910    4,459,134    9,406,589    8,054,742 
                     
OPERATING EXPENSES:                    
Research and development   330,532    1,801,551    334,186    2,089,023 
Selling expenses   670,567    609,826    1,376,183    979,230 
General and administrative   1,834,280    515,293    2,939,715    1,810,091 
Total operating expenses   2,835,379    2,926,670    4,650,084    4,878,344 
                     
INCOME FROM OPERATIONS   2,288,531    1,532,464    4,756,505    3,176,398 
                     
OTHER INCOME (EXPENSE):                    
Other income (expense), net   2,238    (4,549)   55,998    (4,367)
Interest income (expense), net   (25,929)   (98,973)   (179,541)   (69,301)
Change in fair value of warrant/purchase option liability   16,800    360,153    22,400    1,095,647 
Total other income (expense), net   (6,891)   256,631    (101,143)   1,021,979 
                     
INCOME BEFORE PROVISION FOR INCOME TAXES   2,281,640    1,789,095    4,655,362    4,198,377 
                     
PROVISION FOR INCOME TAXES   582,774    281,705    1,051,742    759,155 
                     
NET INCOME   1,698,866    1,507,390    3,603,620    3,439,222 
                     
OTHER COMPREHENSIVE INCOME                    
Foreign currency translation adjustment   123,715    1,130,579    682,472    1,596,172 
                     
COMPREHENSIVE INCOME  $1,822,581   $2,637,969   $4,286,092   $5,035,394 
                     
EARNINGS PER SHARE:                    
Basic  $0.23   $0.21   $0.48   $0.48 
Diluted  $0.23   $0.21   $0.48   $0.48 
                     
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:                    
Basic   7,461,227    7,169,419    7,454,837    7,168,176 
Diluted   7,461,227    7,169,419    7,454,837    7,174,888 

 

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

 

5
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND 2011
(Unaudited)

 

   Six months ended
 June 30,
 
   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $3,603,620   $3,439,222 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Depreciation   635,856    498,760 
Amortization   200,570    385,722 
Provision for doubtful accounts   101,246    - 
Change in fair value of warrant/purchase option liability   (22,400)   (1,095,647)
Common stock to be issued to related parties for compensation   -    26,525 
Common stock issued under 2010 stock incentive plan   1,037,911    - 
Change in operating assets and liabilities          
Accounts receivable   (7,381,238)   1,085,951 
Inventories   1,678,678    (8,711,510)
Deposits, prepaid expenses and other receivables   649,485    (919,717)
Prepayments for raw materials purchasing   (7,121,001)   1,654,995 
Accounts payable   1,614,377    577,915 
Other payables and accrued expenses   99,033    (449,155)
Deposits from customers   (38,170)   286,977 
Taxes payable   2,778,594    (702,883)
Net cash used in operating activities   (2,163,439)   (3,922,845)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Payments of long-term prepayments   (349,464)   (307,642)
Refund of long-term prepayments   475,980    - 
Loan to third parties   (1,942,963)   (2,847,846)
Collection of loan to third parties   -    8,871,193 
Purchases of property, plant and equipment   (127,531)   (46,186)
Purchases of intangible assets   -    (51,222)
Payments on construction-in-progress   (79,806)   (4,013,980)
Net cash (used in) provided by investing activities   (2,023,784)   1,604,317 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Proceeds from short-term loans   63,464    1,724,019 
Repayment of short-term loans   (666,372)   (612,440)
Repayment of government grants   (317,320)   - 
Due to related parties   280,901    190,630 
Net cash (used in) provided by financing activities   (639,327)   1,302,209 
           
EFFECT OF EXCHANGE RATE CHANGES ON CASH   119,563    174,990 
           
DECREASE IN CASH   (4,706,987)   (841,329)
           
CASH, beginning of period   7,048,968    5,887,831 
           
CASH, end of period  $2,341,981   $5,046,502 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid for interest  $309,010   $119,128 
Cash paid for income taxes  $88,054   $1,262,699 
Non-cash investing and financing activities          
Long-term prepayment transferred to construction-in-progress  $666,372   $571,692 
Construction-in-progress transferred to property, plant and equipment  $3,630   $- 
Share issued to settle payables to related parties  $199,239   $- 

 

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

 

6
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

 

                       Accumulated     
               Retained earnings   other     
   Common stock   Paid-in   Statutory       comprehensive     
   Shares   Amount   capital   reserves   Unrestricted   income   Total 
BALANCE, December 31, 2011   7,161,919   $7,162   $35,784,378   $5,708,135   $38,492,031   $8,111,107   $88,102,813 
                                    
Share issued under 2010 stock incentive plan   442,881    443    1,236,707    -    -    -    1,237,150 
Foreign currency translation   -    -    -    -    -    682,472    682,472 
Net income   -    -    -    -    3,603,620    -    3,603,620 
                                    
BALANCE, June 30, 2012   7,604,800   $7,605   $37,021,085   $5,708,135   $42,095,651   $8,793,579   $93,626,055 

 

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

 

7
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Note 1 - ORGANIZATION

 

Organization and description of business

 

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

 

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

 

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

 

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

 

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

 

On August 11, 2010, Sida became the parent company of Skystar Biotechnology (Jingzhou) Co., Limited (“Skystar Jingzhou”), a company established in Jingzhou, Hubei province, China on February 5, 2010, with registered capital of approximately $4.1 million (RMB 26,000,000), of which approximately $3.7 million (RMB 23,480,000) has been paid. On July 5, 2012, Skystar Jingzhou fulfilled the requirement of remaining capital of $399,420 (RMB 2,520,000) and received the government's approval.

 

On March 15, 2011, Xi’an Tianxing formed Xi’an Sikaida Bio-products Co., Ltd. (“Xi’an Sikaida”) with registered capital of approximately $1,585,000 (RMB 10,000,000) paid by Xi’an Tianxing.

 

On January 7, 2012, the current GMP certification of Huxian veterinary medication facility expired and its production was temporarily suspended. Management expects to receive the renewed GMP certification and resume the production in third quarter.

 

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

 

8
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

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

 

Principles of consolidation

 

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

 

The Company has evaluated the relationship with Xi’an Tianxing and Xi’an Tianxing’s wholly owned subsidiaries, Xi’an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi’an Tianxing. Xi’an Sikaida and Shanghai Siqiang.

 

Use of estimates

 

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

 

Foreign currency translation

 

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

 

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

 

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

 

9
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

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

 

Fair values of financial instruments

 

ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy, which requires classification based on observable and unobservable inputs when measuring fair value. Certain current assets and current liabilities are financial instruments.  Management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, their current interest rates are equivalent to interest rates currently available.  The three levels of valuation hierarchy are defined as follows:

  

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
   
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
   
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

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

 

   Warrants – (1)   Purchase Options – (2) 
   June 30,
2012
   December 31,
2011
   June 30,
2012
   December 31,
2011
 
Stock price  $-   $2.74   $2.20   $2.74 
Exercise price  $-   $5.00   $8.11   $8.11 
Annual dividend yield   -    -    -    - 
Expected term (years)   -    0.16    2.00    2.50 
Risk-free interest rate   -    0.01%   0.33%   0.25%
Expected volatility   -    68%   68%   64%

 

(1) As of December 31, 2011, 34,230 warrants with an exercise price of $5.00 were outstanding. All of these warrants expired on February 28, 2012. As of June 30, 2012, none of these warrants was outstanding.

 

(2) As of December 31, 2011 and June 30, 2012, 140,000 purchase options with an exercise price of $8.11 were outstanding.

 

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

 

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

 

The fair value of the 140,000 purchase options outstanding as of June 30, 2012 was determined using the Black-Scholes Model, utilizing level 2 inputs, and recorded the change in earnings. As a result, the warrant/purchase option liability is carried on the consolidated balance sheets at fair value. The Company recognized gains of $16,800 and $360,153 from the change in fair value of derivative liability for the three months ended June 30, 2012 and 2011, respectively, and gains of $22,400 and $1,095,647 for the six months ended June 30, 2012 and 2011, respectively.

 

10
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2012:

 

   Carrying
Value at
June 30,
   Fair Value Measurement at
June 30, 2012
 
   2012   Level 1   Level 2   Level 3 
Purchase option liability  $21,000   $   $21,000   $ 

 

Below is the reconciliation for the warrant/purchase option liability changes from December 31, 2011 to June 30, 2012.

 

Balance, December 31, 2011   43,400 
Change in fair value   (22,400)
Balance, June 30, 2012  $21,000 

  

Revenue recognition

 

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

 

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

 

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

 

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

 

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

 

   Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
                 
Revenue                    
Micro-organism  $4,002,206   $1,981,128   $7,137,246   $3,577,222 
Veterinary Medications   2,458,714    6,341,859    5,467,301    11,206,906 
Feed Additives   1,267,061    390,872    2,301,833    717,279 
Vaccines   1,142,867    382,282    1,890,805    681,688 
Total Revenue   8,870,848    9,096,141    16,797,185    16,183,095 
                     
Cost of Revenue                    
Micro-organism   1,169,412    580,806    2,076,252    1,074,988 
Veterinary Medications   1,399,006    3,842,551    3,191,654    6,664,457 
Feed Additives   1,032,139    164,382    1,882,023    305,248 
Vaccines   146,381    49,268    240,667    83,660 
Total Cost of Revenue   3,746,938    4,637,007    7,390,596    8,128,353 
Gross Profit  $5,123,910   $4,459,134   $9,406,589   $8,054,742 

 

11
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Cash

 

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

 

Accounts receivable and other receivables

 

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

 

Inventories

 

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

 

Property, plant and equipment

 

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

 

  Estimated Useful Life
Buildings and improvements 10-40 years
Machinery and equipment 5-10 years
Office equipment and furniture 5-10 years
Vehicles 5-10 years

 

Management assesses the carrying value of property, plant and equipment annually or more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management believes that, as of June 30, 2012 and December 31, 2011, there was no impairment for its property, plant and equipment.

 

Construction-in-progress

 

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

 

Intangible assets

 

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

 

12
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

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

 

Impairment of Intangible assets — the Company evaluates the carrying value of intangible assets at least annually when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of June 30, 2012 and December 31, 2011, there was no impairment of its intangible assets.

 

Comprehensive income

 

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

 

Shipping and handling costs

 

Shipping and handling costs related to costs of goods sold are included in selling expenses, which totaled $463,630 and $350,054 for the three months ended June 30, 2012 and 2011, respectively, and $847,333 and $544,270 for the six months ended June 30, 2012 and 2011, respectively.

 

Advertising costs

 

Advertising costs are charged to selling expenses as incurred, Advertising costs were insignificant for the three months and six months ended June 30, 2012 and 2011.

 

Research and development costs

 

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

 

Income taxes

 

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

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. As of June 30, 2012, there are no unrecognized tax benefits, and the Company does not expect a significant change in tax benefits in the next 12 months.  Penalties and interest levied by taxing authorities, if any, are classified as income tax expense in the year incurred.  No significant penalties or interest relating to income taxes have been incurred during the three months and six months ended June 30, 2012 and 2011. 

 

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

 

13
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Stock-based compensation

 

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

 

Earnings per share

 

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

 

Related parties

 

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

 

Operating segments

 

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

 

Recently issued accounting pronouncements

 

In July 2012, the FASB issued 2012-02 Intangibles — Goodwill and Other (Topic 350): The amendments in this update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. Under these amendments, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on qualitative assessment, that it is not more likely than not, the indefinite-lived intangible asset is impaired. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued. It is not expected to have a material impact on the Company’s consolidated financial statements.

 

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

 

Note 3 - CONCENTRATIONS AND CREDIT RISK

 

The Company’s operations are all carried out in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic, and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

 

14
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

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

 

For the three months and six months ended June 30, 2012 and 2011, all of the Company’s sales occurred in the PRC. No major customers accounted for more than 10% of the Company’s total revenues. All accounts receivable at June 30, 2012 and December 31, 2011 are from customers located in the PRC.

 

The Company’s six largest vendors accounted for approximately 87% and 86% of the Company’s total purchases for the three months and six months ended June 30, 2012, respectively, while the Company’s six largest vendors accounted for approximately 59% and 66% of the Company’s total purchases for the three months and six months ended June 30, 2011, respectively.

 

The Company had one product that accounted for 13% and 17% of the Company’s total revenues for the three months and six months ended June 30, 2012, respectively, while the Company had one product that accounted for 22% and 19% of the Company’s total revenues for the three months and six months ended June 30, 2011, respectively.

 

Note 4 - ACCOUNTS RECEIVABLE, NET

 

Accounts receivable consisted of the following:

 

   June 30,
2012
   December 31,
2011
 
Account receivable  $11,230,733   $3,830,171 
Allowance for doubtful accounts   (542,888)   (438,678)
Account receivable, net  $10,687,845   $3,391,493 

 

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

 

Allowance for doubtful accounts, January 1, 2012  $438,678 
Addition   101,246 
Translation adjustment   2,964 
Allowance for doubtful accounts, June 30, 2012  $542,888 

 

Note 5 – INVENTORIES

 

Inventories consist of the following:

 

   June 30,
2012
   December 31,
2011
 
Raw materials  $12,411,795    12,646,663 
Packaging materials   239,948    181,304 
Work-in-process   6,844    22,559 
Finished goods   778,752    2,171,238 
Other   63,863    51,085 
    13,501,202    15,072,849 
Less: Allowance for obsolete inventories   (223,239)   (221,690)
Total  $13,277,963    14,851,159 

 

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

 

15
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Note 6 - DEPOSITS, PREPAID EXPENSES AND OTHER RECEIVABLES

 

Deposits, prepaid expenses and other receivables are comprised of the following:

 

   June 30,
2012
   December 31,
 2011
 
Prepayment for enterprise income taxes  $1,171,101   $2,162,070 
Value added taxes receivable   117,058    - 
Other prepayments   926,030    751,025 
Other receivables   557,813    508,392 
Total  $2,772,002   $3,421,487 

 

Note 7 – PREPAYMENTS FOR RAW MATERIALS PURCHASING

 

Prepayments for raw materials purchasing are comprised of the following:

 

   June 30,
2012
   December 31,
 2011
 
Prepayments for raw materials purchasing  $36,227,978   $28,824,123 
Prepayments for packaging materials purchasing   460,945    402,838 
Total  $36,688,923   $29,226,961 

 

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

 

Note 8 – LOANS RECEIVABLE

 

In November 2010, the Company provided an unsecured non-interest bearing loan to Xi’an Tiantai Investment, Ltd., the Company’s acquisition advisor, in the amount of $190,200 (RMB 1,200,000) for two years from November 26, 2010 through November 25, 2012.

 

On April 1, 2012, the Company provided an unsecured interest bearing loan to Shaanxi Jiali Pharmaceutical Co., Ltd., in the amount of $792,500 (RMB 5,000,000) at an annual interest rate of 12.0% for eight months from April 1, 2012 through November 30, 2012.

 

On April 6, 2012, the Company provided an unsecured interest bearing loan to an unrelated third party, in the amount of $871,750 (RMB 5,500,000) at an annual interest rate of 12.0% for six months from April 6, 2012 through October 5, 2012.

 

As of June 30, 2012 and December 31, 2011, the Company had other unsecured non-interest bearing short-term loans in the amount of $1,057,379 (RMB 6,671,159) and $775,208 (RMB 4,925,082), respectively, due from the Company’s employees and unrelated third parties. Up to August 7, 2012, loans receivable of $802,169 have been repaid.

 

Note 9 – PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, plant and equipment consist of the following:

 

   June 30,
2012
   December 31,
2011
 
Buildings and improvements  $26,047,197   $25,866,428 
Machinery and equipment   5,838,494    5,675,995 
Office equipment and furniture   330,934    320,498 
Vehicles   592,548    588,436 
Total   32,809,173    32,451,357 
Less: accumulated depreciation   (4,738,490)   (4,074,798)
Plant and equipment, net  $28,070,683   $28,376,559 

 

16
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Depreciation expense was $292,727 and $166,332 for the three months ended June 30, 2012 and 2011, respectively. For the six months ended June 30, 2012 and 2011, depreciation expense was $635,856 and $498,760, respectively.

 

Note 10 - CONSTRUCTION-IN-PROGRESS

 

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

 

Xi’an facility

 

Xi’an Tianxing has a vaccine facility and a veterinary medicine facility located in Huxian, Xi’an.

 

In 2011, the Company started two projects at the vaccine facility to modify air filtration, water treatment, and other facility changes based on recommendations by outside experts hired by the Company to advise on the GMP qualification process for the vaccine facility. As of June 30, 2012, this vaccine facility had a total construction-in-progress of $2,142,056 (RMB 13,514,552). The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification process to be completed by the second half of 2012.

 

In 2011, the Company started a facility improvement project in the amount of approximately $317,000 (RMB 2,000,000) for the Huxian Animal Laboratory. The facility is a supporting project to the Huxian vaccine facility and is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification process to be completed by the second half of 2012.

 

In 2011, the Company started a facility improvement project in the amount of $1,128,520 (RMB 7,120,000) at the Huxian veterinary medicine facility to prepare its GMP re-examination. The project includes a renovation project to clean 3,160 square feet in area and to replace or implement an exhaust ventilation system, color steel enclosure, process water piping, purification equipment, fire alarm, and combined air supply unit. This facility is currently awaiting the final approval of GMP re-examination from Ministry of Agriculture. The Company expects that the GMP re-examination will be completed during the third quarter of 2012.

 

Jingzhou facility

 

In 2011, the Company started a facility improvement project to expand veterinary medicine production capacity at the Jingzhou facility. The project includes plant construction and water supply and drainage and has an estimated total cost of $1,664,251 (RMB 10,500,000). The Company expects the project will be completed by the second half of 2012.

 

Kunshan facility

 

In 2011, the Company started a supporting project at the Kunshan micro-organism facility that includes the construction and installation of plumbing, sewer, electrical, HVAC, fire protection and alarm system, drainage, office, lab, road construction, parking, and landscaping. As of June 30, 2012, the facility had a total in construction-in-progress of $4,957,401 (RMB 31,276,982). The construction and installation were completed and the project will be inspected and accepted. The Company expects the project will be completed during the third quarter of 2012. The management anticipates that Kunshan plant will start small-scale production in the second half of 2012. However, the management does not expect that this facility will have significant impact to the Company’s revenue in 2012 as a whole.

 

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

 

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

 

   Total in CIP
as of
   Estimate cost to   Estimated   Estimated
Project  6/30/2012   Complete   Total Cost   Completion Date
Xi'an vaccine facility  $2,142,056   $-   $2,142,056   Second half of 2012
Xi'an animal laboratory   317,000    -    317,000   Second half of 2012
Xi'an veterinary medication facility   1,128,520    -    1,128,520   Third Quarter of 2012
Jingzhou veterinary medication facility   1,008,536    655,715    1,664,251   Second half of 2012
Kunshan micro-organism facility   4,957,401    -    4,957,401   Third Quarter of 2012
TOTAL CIP Balance  $9,553,513   $655,715   $10,209,228    

 

As of June 30, 2012 and December 31, 2011, the Company had construction in progress amounting to $9,553,513 and $8,839,055, respectively. No interest expense had been capitalized for construction in progress for the three months and six months ended June 30, 2012 and 2011 as management determined the amount of capitalized interest would be insignificant. 

 

17
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Note 11 - LONG-TERM PREPAYMENTS

 

Long-term prepayments consist of the following:

 

   June 30,
2012
   December 31,
2011
 
R&D project  $317,000   $314,800 
Construction deposits   417,095    920,790 
Deposits for equipment purchase and land use rights   473,059    277,227 
Deposits for potential acquisitions   177,520    569,788 
Total  $1,384,674   $2,082,605 

 

As of June 30, 2012 and December 31, 2011, deposits for potential acquisitions totaled $177,520 and $569,788, respectively, all of which was held by an unrelated third party engaged to facilitate potential acquisition projects. 

 

Note 12 – INTANGIBLE ASSETS

 

Intangible assets consist of the following:

 

   June 30,
2012
   December 31,
2011
 
Land use rights  $4,794,627   $4,761,352 
Technological know-how   2,219,000    2,203,600 
Patents   317,000    314,800 
Total   7,330,627    7,279,752 
Less: accumulated amortization   (1,817,133)   (1,605,546)
Intangible assets, net  $5,513,494   $5,674,206 

 

For the three months ended June 30, 2012 and 2011, the amortization expense for intangibles assets amounted to $100,197 and $154,800, respectively. For the six months ended June 30, 2012 and 2011, the amortization expense for intangibles assets amounted to $200,570 and $385,722, respectively.

 

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

 

Years ending December 31,  Amount 
Remainder of 2012  $200,368 
2013   242,235 
2014   242,235 
2015   242,235 
2016   242,235 
Thereafter   4,344,186 
Total  $5,513,494 

 

18
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Note 13 – SHORT-TERM LOANS

 

On May 5, 2011, the Company obtained a one year loan with Industrial and Commercial Bank of China Songzi Branch for $475,500 (RMB 3,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate. This loan was secured by the Company’s land use rights in Jingzhou, Hubei Province and guaranteed by the legal representative of Skystar Jingzhou. This loan was fully repaid on May 2, 2012.

 

On July 8, 2011, the Company obtained a one year loan with Chang’an Bank for $792,500 (RMB 5,000,000) at an annual interest rate of 8.203%. This loan was secured by the Company’s office buildings and its Chairman and CEO’s personal property located in Xi’an City, which includes an office building contributed by a shareholder in 2005 as additional capital of Xi’an Tianxing. As of June 30, 2012, the title to this property has not been passed to the Company. This loan is also personally guaranteed by the Company’s Chairman and CEO and his wife. This loan was fully repaid on July 11, 2012.

 

On August 25, 2011, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $792,500 (RMB 5,000,000) at an annual interest rate of 9.411%. This loan is secured by the Company’s office buildings located in Xi’an City. This loan is also personally guaranteed by the Company’s Chairman and CEO.

 

On December 22, 2011, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $475,500 (RMB 3,000,000) at an annual interest rate of 9.411%. This loan is secured by the Company’s office buildings located in Xi’an City. This loan is also personally guaranteed by the Company’s Chairman and CEO and his wife.

 

On December 1, 2011, the Company obtained a one year loan with Bank of Chengdu for $4,755,000 (RMB 30,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate, which was 8.528% at June 30, 2012. This loan is secured by the Company’s land use right and manufacturing plant located in Huxian County.

 

In 2011, the Company obtained two three-month loans with a third-party individual for a total amount of $126,800 (RMB 800,000). During the first quarter of 2012, the Company borrowed another two short-term loans for a total amount of $63,400 (RMB 400,000) with this third-party individual. These four loans are non-interest bearing and are unsecured. On April 6, 2012, the Company repaid one loan of $47,550 (RMB 300,000). On April 9, 2012, the Company repaid the other three remaining loans totaling $142,650 (RMB 900,000). As of June 30, 2011, no loans from the third party individual remained outstanding.

 

Interest expense incurred and associated with the short-term loans amounted to $156,427 and $309,010 for the three months and six months ended June 30, 2012, respectively, none of which has been capitalized as part of construction-in-progress in 2012. Interest expense incurred and associated with the short-term loans amounted to $95,341 and $149,750 for the three months and six months ended June 30, 2011, respectively, none of which has been capitalized as part of construction-in-progress in 2011.

 

Outstanding short-term loans consisted of the following:

 

   June 30, 2012   December 31, 2011       Interest
Bank  Amt RMB   Amt USD   Amt RMB   Amt USD   Due Date   Rate
                        
Chang’an Bank   5,000,000   $792,500    5,000,000   $787,000   07/07/12    8.203%
Shaanxi Agricultural Yanta Credit Union   5,000,000    792,500    5,000,000    787,000   08/24/12    9.411%
Shaanxi Agricultural Yanta Credit Union   3,000,000    475,500    3,000,000    472,200   12/21/12    9.411%
Commercial Bank of China Songzi Branch   -    -    3,000,000    472,200   05/04/12     (1) 
Bank of Chengdu   30,000,000    4,755,000    30,000,000    4,722,000   11/30/12     (1) 
Third-party Individual   -    -    800,000    125,920   Various    0%
Total   43,000,000   $6,815,500    46,800,000   $7,366,320          

 

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

 

19
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

Note 14 - DEFERRED GOVERNMENT GRANT

 

Deferred government grant represents subsidies for Good Manufacturing Practice projects granted by various levels of the PRC government which may be required by the PRC government for repayment. As of June 30, 2012 and December 31, 2011, deferred government grant (after various repayments) were RMB 2,500,000, equivalent to $396,250 and $393,500, respectively. 

 

Note 15 - CAPITAL TRANSACTIONS

 

Stock-based compensation

 

On March 30, 2010, the Company agreed to issue 2,500 shares of common stock to a non-executive director in exchange for services unrelated to his services as a director at the fair market value of $11.74 per share based on the closing price on March 30, 2010. On April 16, 2010, the Company entered into another agreement to grant 10,000 shares of common stock to that director for his one year service from April 1, 2010. The closing price per share on the grant date was $10.61. The common stock compensation vests in four equal quarterly installments of 2,500 shares. Shares owed were accrued at the end of each quarter at the fair market value on the grant date of $10.61 per share. On August 31, 2011, the Company entered into another agreement to grant 36,000 shares of common stock to that director for his one year service from April 1, 2011. The closing price per share on the grant date was $2.58. The common stock compensation vests in four equal quarterly installments of 9,000 shares. Shares owed were accrued at the end of each quarter at the fair market value on the grant date of $2.58 per share. Currently, the Company is working on completing the contract with this director for his service beginning April 1, 2012. As of June 30, 2012 and December 31, 2011, Nil and 34,500 shares to be issued to this non-executive director included in the accrued expenses amounted to $Nil and $149,235, respectively.

 

On May 26, 2009, the Company agreed to issue 5,556 shares of common stock to a director at the beginning of each term of his directorship. The trading value of the common stock on May 26, 2009 was $4.50 per share. The Company issued 5,556 shares on February 26, 2010. In accordance with the agreement between the Company and this director, this director must continue to serve as a member of the Board until his successor is duly elected and qualified in order to receive the shares. This director has continued in his position, and the Company is working on the agreement with this director. As of June 30, 2012 and December 31, 2011, Nil and 11,112 share to be issued to this non-executive director included in the accrued expenses amounted to Nil and $50,004, respectively.

 

 On July 29, 2011, the Company entered into a one-year employment agreement with its CFO. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, 4,000 shares of which shall be issuable on the 6 month anniversary and the remainder 4,000 shares of which shall be issuable on the 12 month anniversary. The closing price per share on the grant date was $4.20. On July 29, 2012, the Company entered into another one-year employment agreement with the CFO. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, vested in four equal quarterly installments of 2,000 shares. The closing price per share of the stock on the next business day of the grant date was $2.17.

 

Equity Compensation Plan

 

On December 8, 2009, the Company’s board of directors approved a stock incentive plan for officers, directors, employees and consultants entitled the “Skystar Bio-Pharmaceutical Company 2010 Stock Incentive Plan” (the “2010 Plan”). The maximum number of shares that may be issued under the 2010 Plan is 700,000 shares of common stock. The 2010 Plan was approved by the Company’s stockholders on December 31, 2009, and awards may be granted thereunder until December 7, 2019. On May 4, 2012, the Board approved common stock grants in the total amount of 442,881 shares to the Company’s employees and members of the Board of Directors, all of which grants were made pursuant to the terms and provisions of the Plan. As of June 30, 2012, there are 247,119 shares of the Company’s common stock remaining available for future issuance under the Plan. Of the 442,881 shares issued in May 2012, 62,612 shares were issued to settle payables to directors and CFO of $256,056, and the remaining 380,269 shares, valued at $981,094 based on the grant date fair value of the common stock of $2.58 per share. A total of $992,107 and $1,037,911 were charged to general and administrative expenses for the three months and six months ended June 30, 2012, respectively.

 

Warrants and Purchase Options

 

On February 28, 2007, in connection with a financing the Company issued 195,000 warrants to four investors with an exercise price of $6.00 per share for a term of three years (number of warrants and exercise price adjusted for 1-for-10 reverse stock split on May 12, 2009 and 2-for-1 forward stock split on November 16, 2009).  On the same date, the Company also issued warrants to the placement agent, exercisable for 114,100 shares of the Company’s common stock at a price of $5.00 per share for a five-year term (number of warrants and exercise price adjusted for 1-for-10 reverse stock split on May 12, 2009 and 2-for-1 forward stock split on November 16, 2009).  Up to December 31, 2011, 274,870 warrants were exercised. As of June 30, 2012, the remaining 34,230 warrants expired.

 

20
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

  

In connection with the 2009 equity offering discussed below, the Company granted 140,000 common stock purchase options to five designees of the Underwriters with a vesting date of June 30, 2010. The options are exercisable from June 30, 2010 to June 30, 2014, and each option is exercisable for one share of the Company’s common stock at an exercise price at $8.11 per share. All options were provided for services performed. On June 30, 2010, the purchase options were reclassified from equity to warrant/purchase option liabilities, and the Company reclassified $779,674 from additional paid in capital to warrant/purchase option liability. As of December 30, 2011 and June 30, 2012, 140,000 common stock purchase options were outstanding.

 

The fair value of each warrant and purchase option is estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions noted in the table stated in Note 2.

 

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

 

   Number of
warrants/purchase
options
   Weighted –
average
exercise price
   Weighted-
average
remaining
contractual term
(Year)
 
Outstanding at January 1, 2011   174,230   $7.50    2.04 
Granted   -           
Forfeited   -           
Exercised   -           
Outstanding at December 31, 2011   174,230   $7.50    2.04 
Granted   -    -      
Forfeited   (34,230)   5    Nil  
Exercised   -           
Outstanding at June 30, 2012   140,000   $8.11    2.00 
Exercisable at June 30, 2012   140,000   $8.11    2.00 

 

Note 16 - STATUTORY RESERVES

 

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

 

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

  

21
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

  

Note 17 – TAXES

 

Skystar is subject to United States federal income tax. Skystar Cayman is a tax-exempt company incorporated in the Cayman Islands. Fortune Time did not have any assessable profits arising in or derived from Hong Kong for 2012 and 2011, and accordingly no provision for Hong Kong profits tax was made in these periods.

 

The Company’s subsidiaries and VIEs are subject to the PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25%. Xi’an Tianxing has been approved as a new technology enterprise, and under PRC Income Tax Laws is entitled to a preferential tax rate of 15%.

 

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months and six months ended June 30, 2012 and 2011:

 

   For the three months ended
June 30,
   For the six months ended
June 30,
 
   2012   2011   2012   2011 
U.S. Statutory rate   34.0%   34.0%   34.0%   34.0%
Foreign income not recognized in the U.S.   (34.0)   (34.0)   (34.0)   (34.0)
China income tax rate   25.0    25.0    25.0    25.0 
China income tax exemption   (10.0)   (10.0)   (10.0)   (10.0)
Stock-based compensation   7.7    -    4.1    - 
Other item (1)   2.8    0.7    3.5    3.1 
Total provision for income taxes   25.5%   15.7%   22.6%   18.1%

 

(1) Other item is for operating expenses incurred by Skystar that are not deductible in the PRC and expenses incurred by other subsidiaries that are not deductible on the consolidated level, which resulted in an increase in the effective tax rate of 2.8% and 0.7% for the three months ended June 30, 2012 and 2011, respectively, and an increase of 3.5% and 3.1% for the six months ended June 30, 2012 and 2011, respectively.

 

Taxes payable consisted of the following:

 

   June 30,
2012
   December 31,
2011
 
Value added tax  $2,604,934   $110,880 
Other taxes   332,058    49,201 
Total  $2,936,992   $160,081 

 

As of June 30, 2012, the estimated net operating loss carry forwards of Skystar for U.S. income tax purposes amounted to $6,418,183, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, beginning in 2026 and through 2030. Management believes that the realization of the benefits arising from this loss appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at June 30, 2012 and December 31, 2011. The valuation allowance at June 30, 2012 and December 31, 2011 was $2,182,182 and $1,799,945, respectively. The Company’s management reviews this valuation allowance periodically and makes adjustments as necessary. As of June 30, 2012, the Company has no other deferred tax amounts.

 

The Company did not provide for deferred income taxes and foreign withholding taxes on the cumulative undistributed earnings of foreign subsidiaries as of June 30, 2012 of $26,500,000 (RMB 167,191,000). The cumulative undistributed earnings of foreign subsidiaries were included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations.  Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.

 

22
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

 

Note 18 - EARNINGS PER SHARE

 

The following is the calculation of earnings per share:

 

   For the three months ended
June 30,
   For the six months ended
June 30,
 
   2012   2011   2012   2011 
Net income  $1,698,866   $1,507,390   $3,603,620   $3,439,222 
                     
Weighted average shares used in basic computation   7,461,227    7,169,419    7,454,837    7,168,176 
Diluted effect of stock warrants   -    -    -    6,712 
Weighted average shares used in diluted computation   7,461,227    7,169,419    7,454,837    7,174,888 
                     
Earnings per share:                    
                     
Basic  $0.23   $0.21   $0.48   $0.48 
Diluted  $0.23   $0.21   $0.48   $0.48 

 

For the three months and six months ended June 30, 2012 and 2011, the outstanding 140,000 options were excluded from the diluted earnings per share calculation as they are anti-dilutive.

 

For the three months ended June 30, 2011, a total of 34,230 warrants were excluded from the diluted earnings per share calculation as they were anti-dilutive.

 

Note 19 - RELATED PARTY TRANSACTIONS AND ARRANGEMENTS

 

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

 

   June 30, 2012   December 31, 2011 
         
Shares to be issued to related parties (Note 15)          
Scott Cramer – non-executive director  $-   $149,235 
Mark D. Chen – non-executive director   -    50,004 
Total  $-   $199,239 
           
Amounts due to (from) related parties          
Scott Cramer – non-executive director and shareholder (1)  $99,469   $147,877 
Officers, shareholders and other related parties (2)   236,603    (91,604)
Total  $336,072   $56,273 

 

  (1) As of June 30, 2012 and December 31, 2011, the Company had unpaid reimbursement and compensation due to Scott Cramer valued at $99,469 and $147,877, respectively. 

 

  (2) The amounts due to (from) officers, shareholders and other related parties at June 30, 2012 and December 31, 2011 include unpaid reimbursement and compensation and, advances to Mr. Weibing Lu and other related parties for business expenses.

  

Also refer to Notes 13, 15 and 20 for other related party transactions and arrangements.

 

23
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

  

 Note 20 - COMMITMENTS AND CONTINGENCIES

 

(a)  Lease commitments

 

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

 

The Company entered into a tenancy agreement for the lease of factory premises of Xi’an Tianxing in Sanqiao for a period of ten years from October 1, 2004 to December 31, 2014. The annual rent for the factory premises is subject to a 10% increase every two years starting October 1, 2009. As of June 30, 2012, the annual rent for the factory premises was adjusted to approximately $20,225 (RMB 127,600).

 

The Company leases office space in Xi’an from Mr. Weibing Lu, the Company’s Chairman and CEO, for a period of five years from January 1, 2007 to December 31, 2011, with annual rent of approximately $26,248 (RMB 165,600). In January 2012, the Company renewed the lease with Mr. Lu for another 5 years from January 1, 2012 to December 31, 2016 at rent of approximately $28,530 (RMB 180,000) per year.

 

The Company also entered into a tenancy agreement with Mr. Weibing Lu for the lease of Shanghai Siqiang’s office in Shanghai for a period of ten years from August 1, 2007 to August 1, 2017 with annual rent of approximately $22,824 (RMB 144,000).

 

The Company entered into a one year tenancy agreement for an office lease in Kunshan, Jiangsu province from April 15, 2011 to April 14, 2012 with annual rent of approximately $3,043 (RMB 19,200). On April 15, 2012, the Company entered into a new six-month tenancy agreement for this office from April 15, 2012 to October 14, 2012 with six-month rent of approximately $1,602 (RMB 10,105).

 

The Company entered into a tenancy agreement for the lease of warehouse premises in Xi’an for a period of three years from July 20, 2011 to July 19, 2014 with annual rent of approximately $37,248 (RMB 235,000) subject to a 10% increase every two years starting July 20, 2013.

 

On February 21, 2012, the Company entered into a six-month tenancy agreement for an office lease in Jingzhou, Hubei province from February 21, 2012 to August 20, 2012 with six-month rent of approximately $285 (RMB 1,800).

 

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

 

Period  Unrelated third parties   Related parties   Total 
Six months ending December 31, 2012  $29,741   $25,677   $55,418 
Year ending December 31, 2013   59,755    51,354    111,109 
Year ending December 31, 2014   16,547    51,354    67,901 
Year ending December 31, 2015   -    51,354    51,354 
Year ending December 31, 2016 and thereafter   -    64,668    64,668 
 Total  $106,043   $244,407   $350,450 

    

Rental expense to unrelated third parties for the three months ended June 30, 2012 and 2011 amounted to $15,007 and $9,285, respectively. Rental expense to unrelated third parties for the six months ended June 30, 2012 and 2011 amounted to $30,542 and $14,331, respectively.

 

Rental expense to related parties for the three months ended June 30, 2012 and 2011 amounted to $13,218 and $11,779, respectively. Rental expense to related parties for the six months ended June 30, 2012 and 2011 amounted to $25,703 and $21,129, respectively.

 

(b)  Legal proceedings

 

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Except as set forth below, our management is not aware of any legal matters or pending litigation that would have a significant effect on the Company’s consolidated financial statements as of June 30, 2012.

 

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

 

24
 

  

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

 

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

 

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

 

Although the Second Circuit declined to issue sanctions against Chien, it expressly warned Chien “that the continued filing of duplicative, vexatious, or frivolous appeals regarding issues already resolved by this Court may result in the imposition of sanctions, including a leave-to-file sanction requiring Chien to obtain permission from this Court prior to filing further submissions in this Court.” Mr. Chien has filed a petition for writs of certiorari with the Supreme Court of the United States. The Supreme Court has not yet acted on Chien’s petitions.

 

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

 

(c)  Ownership of leasehold property

 

In 2005, a shareholder contributed a leasehold office building as additional capital of Xi’an Tianxing. However, as of June 30, 2012, title to this leasehold property has not passed to the Company. The Company does not believe there are any legal barriers for the shareholder to transfer the ownership to the Company. However, in the event that the Company fails to obtain the ownership certificate for the leasehold property, there is a risk that we may be required to vacate the building. Management believes that this possibility is remote, and, as such, no provision has been made in the consolidated financial statements for this potential occurrence.

 

(d) R&D project

 

In 2008, Xi’an Tianxing contracted with Northwestern Agricultural Technology University to work jointly on an R&D project concerning the application of nano-technology in the prevention of major milk cow disease. The total projected budget for this project is approximately $634,000 (RMB 4,000,000), which is to be paid according to completed stages of the project. The project reached trial stage in September 2009. As of June 30, 2012, the Company incurred approximately $475,980 (RMB 3,000,000) of cumulative expenses relating to this project.

 

In 2009, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project on fish diseases linked immunosorbent detection kit and fish diseases multi-linked monoclonal antibody therapeutic agents. The contracted amount for this project is approximated $951,000 (RMB 6,000,000). As of June 30, 2012, the Company has incurred approximately $539,444 (RMB 3,400,000) of cumulative expenses relating to this project.

 

During the first quarter of 2011, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project to develop new treatment and diagnosis method for Mycoplasmal pneumonia of swine. The project term is from January 2011 through September 2013. The cost to the Company for the initial phase is approximately $317,000 (RMB 2,000,000). As of June 30, 2012, the Company has incurred approximately $79,330 (RMB 500,000).

 

25
 

 

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(Unaudited)

 

 

During the second quarter of 2011, Xi’an Tianxing launched four new R&D projects to develop ceftiofur sodium for injection (powder for injection), a sulfuric acid injection neostigmine, dexamethasone sodium phosphate injection, and houttuynia preparation of compound application in weaning piglets. The projected budget for the R&D project of ceftiofur sodium for injection (powder for injection) is approximately $554,750 (RMB 3,500,000). As of June 30, 2012, the Company has incurred approximately $555,310 (RMB RMB 3,500,000). The projected budget for the R&D project of a sulfuric acid injection neostigmine is approximately $475,500 (RMB 3,000,000). As of June 30, 2012, the Company has incurred approximately $389,010 (RMB 2,451,849). The projected budget for the R&D project of dexamethasone sodium phosphate injection is approximately $555,944 (RMB 3,507,531). As of June 30, 2012, the Company has incurred approximately $556,505 (RMB 3,507,531). The projected budget for the R&D project of houttuynia preparation of compound application in weaning piglets is approximately $713,250 (RMB 4,500,000). As of June 30, 2012, the Company has incurred approximately $681,227 (RMB 4,293,630).

 

During the second quarter of 2012, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project of ring disease and pseudo-rabies specific transfer factor and blue-ear disease and Mycoplasma pneumoniae disease specific transfer factor to enhance the livestock and poultry's own immuneforce and prevent the onset of conventional disease. The project term is from April 2012 through March 2013. The cost to the Company for the initial phase is approximately $47,550 (RMB 300,000). As of June 30, 2012, the project was in clinical research stage and the Company has incurred approximately $1,587 (RMB 10,000).

 

In addition, the Company also launched various R&D projects in 2011 on veterinary products formula adjustment, pet drug development and fermentation engineering design and development and lab tests. As of June 30, 2012, approximately $857,547 (RMB 5,404,937) has been incurred related to these projects and lab tests.

 

R&D projects are summarized as follows:

 

Project  Amount
incurred as
of 6/30/2012
   Amount
expected to be
incurred
   Total amount
of
project
 
Project with the Fourth Military Medical University (1)  $539,444   $412,100   $951,000 
Project with Northwestern Agricultural Technology University (2)   475,980    158,500    634,000 
Project with the Fourth Military Medical University (3)   79,330    237,750    317,000 
In-house R&D project (4)   555,310    0    554,750 
In-house R&D project (5)   389,010    86,882    475,500 
In-house R&D project (6)   556,505    0    555,944 
In-house R&D project (7)   681,227    32,710    713,250 
Project with the Fourth Military Medical University (8)   1,587    45,966    47,550 
Other in-house R&D projects (9)   857,547    15,850    872,532 
TOTAL  $4,135,940   $989,758   $5,121,526 

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

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

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

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

(5) Project for sulfuric acid injection neostigmine

(6) Project for dexamethasone sodium phosphate injection

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

(8) Project for transfer factor test

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

 

All payments made for R&D projects have been expensed as incurred.

 

(e) Registered capital commitment

 

Skystar Kunshan’s remaining registered capital of $12,750,000 was originally required to be invested by May 7, 2012. In 2011, the asset acquisition of Kunshan facility was completed. The Company is in the process of getting the government’s approval to transfer the asset purchased to satisfy some of our registered capital commitment. As of the date of this report, the Company has not received the approval nor a new due date for the payment of the remaining registered capital.

 

As of June 30, 2012, Skystar Jingzhou has remaining registered capital of $399,420 (RMB 2,520,000) required to be invested. On July 5, 2012, the Company paid up the remaining capital of $399,420 (RMB 2,520,000) of Skystar Jingzhou.

 

26
 

 

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

 

This Quarterly Report on Form 10-Q contains forward-looking statements regarding Skystar Bio-Pharmaceutical Company and our business, financial condition, results of operations and prospects within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements. Although forward-looking statements in this Quarterly Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. When used in this document and other documents, releases and reports released by us, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “the facts suggest” and words of similar import, are intended to identify any forward-looking statements. You should not place undue reliance on these forward-looking statements. These statements reflect our current view of future events and are subject to certain risks and uncertainties as noted below. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. Actual events, transactions and results may materially differ from the anticipated events, transactions or results described in such statements. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize. Many factors could cause actual results to differ materially from our forward looking statements. Other unknown, unidentified or unpredictable factors could materially and adversely impact our future results. You should read the following discussion and analysis in conjunction with our unaudited financial statements contained in this report, as well as the audited financial statements, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Risk Factors” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. The Company undertakes no obligation to update the forward-looking statements contained in this report to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except as may occur as part of its ongoing periodic reports filed with the SEC. Given these uncertainties, the reader is cautioned not to place undue reliance on such statements.

 

Overview

 

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

 

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

 

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

 

On August 21, 2007, Xi’an Tianxing invested $79,250 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Company Limited (‘Shanghai Siqiang’). Xi’an Tianxing is the 100% shareholder. Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipment.

 

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

 

Nasdaq Listing Compliance Matters

 

On January 12, 2012, we received staff determination from the Nasdaq Stock Market (“Exchange”) indicating that since we did not hold our 2010 annual shareholder meeting by December 31, 2011, we were not in compliance with Nasdaq Listing Rule 5620(a) and (b) relating to the time frame of and proxy solicitation in connection with annual shareholder meetings and, therefore, the Exchange staff determined to initiate proceedings to delist our securities from Nasdaq at the open of business on January 23, 2012. On March 26, 2012, following our presentation at an oral hearing before the Nasdaq Listing Qualifications Panel, we received a letter informing the Company that the Panel had granted our request to remain listed on the Exchange, subject to the condition that by April 28, 2012, we provided evidence that we held our 2011Annual Meeting of Shareholders. On April 27, 2012, we held our 2011 Annual Meeting of Shareholders, at which our shareholders elected all members of our Board and ratified the engagement of Crowe Horwath LLP as our independent registered public accounting firm. On May 1, 2012, the Exchange confirmed that we had met the requirements of the Panel’s decision dated March 26, 2012, and was in compliance with all other applicable requirements for continued listing on Nasdaq. The matter is now closed. 

 

27
 

 

Critical Accounting Policies and Estimates

 

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

 

Principles of consolidation

 

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

 

We have evaluated the relationship with Xi’an Tianxing and Xi’an Tianxing’s wholly owned subsidiaries, Xi’an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi’an Tianxing. Xi’an Sikaida and Shanghai Siqiang.

 

Revenue recognition

 

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

 

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

 

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

 

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

 

Accounts receivable

 

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

 

Stock based compensation

 

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

 

Recently Issued Accounting Pronouncements

 

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

  

28
 

 

Results of Operations – Three Months ended June 30, 2012 and 2011

 

The following table summarizes our results of operations for the three months ended June 30, 2012 and 2011.

 

    Three Months Ended June 30,  
    2012     2011  
    Amount     % of
total revenue
    Amount     % of
total revenue
 
Revenue   $ 8,870,848       100.0 %   $ 9,096,141       100.0 %
Gross Profit   $ 5,123,910       57.8 %   $ 4,459,134       49.0 %
Operating Expenses   $ 2,835,379       32.0 %   $ 2,926,670       32.2 %
Income from Operations   $ 2,288,531       25.8 %   $ 1,532,464       16.8 %
Other Income (Expenses)   $ (6,891     (0.1 % $ 256,631       2.8 %
Income Tax Expenses   $ 582,774       6.6 %   $ 281,705       3.1 %
Net Income   $ 1,698,866       19.1 %   $ 1,507,390       16.5 %

 

Revenues.   All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC.  For the three months ended June 30, 2012, we had revenues of $8,870,848 as compared to revenues of $9,096,141 for the three months ended June 30, 2011, a decrease of $225,293 or 2.5% as expected due to there being no production at the Huxian veterinary medication plant during the quarter for GMP re-examination.  We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  The selling prices of our products increased more than 1.5% on average in the three months ended June 30, 2012 compared to the same period of 2011. The decrease in revenue was primarily due to the decrease of sales volume.

 

Revenue — Veterinary Medications. Revenue from sales of our veterinary medications decreased by $3,883,145 or 61.2% from $6,341,859 for the three months ended June 30, 2011 to $2,458,714 for the three months ended June 30, 2012. The decrease of revenue was primarily due to no production at Huxian plant for the second quarter of 2012. On January 7, 2012, the current GMP certification of Huxian veterinary medications facility expired and its production was temporarily suspended. In June 2012, China's Ministry of Agriculture (MOA) inspected Huxian veterinary medications facility and published its recommendation to renew its GMP certificate which is valid for another five years on the China Institute of Veterinary Drug Control's website. Following post-inspection protocol, we expect to receive our renewed GMP certificate in the third quarter of 2012 and to resume the production thereafter. We currently have two veterinary medications plants located in Huxian and Jingzhou with Huxian being our main facility. The Jingzhou plant completed its GMP re-examination in 2011 and resumed its normal production in 2012. We plan to increase the production and sales of veterinary medications in the Jingzhou plant to offset the negative impact during the period the Huxian plant is closed due to GMP re-examination. Of the total revenues from veterinary medications during three months ended June 30, 2012, approximately 46% of total revenue resulted from the sale of Praziquantel tablets, which treats schistosomiasis. The selling prices of our veterinary medication products for the three months ended June 30, 2012 increased approximately 5.4% on average from the same period of last year. The decrease in revenue was primarily due to the decrease of sales volume.

 

Revenue — Micro-Organism. Revenue from sales of our micro-organism products increased by $2,021,078 or 102.0% from $1,981,128 for the three months ended June 30, 2011 to $4,002,206 for the three months ended June 30, 2012. The increase was primarily due to growing market demand for organic and environmental-friendly food products in China resulting in increasing the utilization of non-drug feed additives in animal husbandry industry and our increased sales efforts to respond to this market trend. Due to the temporary reduction of veterinary medication production, we were able to shift some of our veterinary medication production and sales forces to focus on the manufacturing and selling of micro-organism products and penetrate the market. The revenue from sales of our micro-organism products was the largest revenue contributor for the entire company and contributed 45.1% of total revenue during the three months ended June 30, 2012. The increase in micro-organism sales also contributed the majority of revenue growth for the entire company during the three months ended June 30, 2012. The selling prices of our micro-organism products for the three months ended June 30, 2012 have not changed meaningfully on average from last year. The increase in revenue was mainly due to the increase of sales volume.

 

Revenue — Feed Additives. Revenue from sales of our feed additives product line increased by $876,189 or 224.2% from $390,872 for the three months ended June 30, 2011 to $1,267,061 for the three months ended June 30, 2012. The increase was primarily the result of increased production and added sales forces temporarily shifted from veterinary medication product line to this product line. The selling prices of our feed additives products for the three months ended June 30, 2012 have not changed meaningfully on average from last year. The increase in revenue was primarily due to the increase of sales volume.

 

Revenue — Vaccines. Revenue from sales of our vaccines increased by $760,585 or 199.0% from $382,282 for the three months ended June 30, 2011 to $1,142,867 for the three months ended June 30, 2012. The increase was primarily the result of increased sales efforts. We completed the construction of a new vaccine facility at our Huxian plant in 2010. The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification will be completed by the second half of 2012, and we expect to commence production shortly thereafter for large-scale production. The selling prices of our vaccine products increased approximately 0.2% on average for the three months ended June 30, 2012 compared to those in the same period of 2011. The increase in revenue was primarily due to the increase of sales volume.

 

29
 

 

Cost of Sales.   Cost of sales, which consists of raw materials, direct labor, and manufacturing overhead for our four product lines, was $3,746,938 for the three months ended June 30, 2012, as compared to $4,637,007 for the three months ended June 30, 2011, a decrease of $890,069 or 19.2%, as a result of decreased sales of our veterinary medications product line. For the three months ended June 30, 2012, raw material costs comprised the majority or approximately 75.1% of total cost of sales, packing material costs comprised approximately 15.2% of total cost of sales, and labor costs and manufacturing overhead comprised approximately 9.7% of total cost of sales. The increased gross margins in the second quarter of 2012 was mainly because the majority of our revenue growth during the quarter came from highly profitable micro-organism and vaccine product lines, while the relatively less profitable veterinary medications product line reduced its production, and therefore sales, during the quarter, as described above.

 

Cost of Sales — Veterinary Medications.   Cost of sales of our veterinary medications product line decreased from $3,842,551 for the three months ended June 30, 2011 to $1,399,006 for the three months ended June 30, 2012, a decrease of $2,443,545 or 63.6%.  This decrease was mainly due to no production at the Huxian veterinary medication plant during the quarter for GMP re-examination. Cost of sales of veterinary medications product line comprised 37.3% of total cost of sales for the three months ended June 30, 2012.

 

Cost of Sales — Micro-Organism.   Cost of sales of our micro-organism product line increased from $580,806 for the three months ended June 30, 2011 to $1,169,412 for the three months ended June 30, 2012, an increase of $588,606 or 101.3%.  This increase was mainly due to the corresponding increased sales.

 

Cost of Sales — Feed Additives.   Cost of sales of our feed additives product line increased from $164,382 for the three months ended June 30, 2011 to $1,032,139 for the three months ended June 30, 2012, an increase of $867,757 or 527.9%.  This increase in cost of sales was mainly due to the corresponding increase in feed additive sales and significantly increased raw material costs of yeast extract, the main raw material used in the manufacturing of feed additives products. We are searching for alternative raw materials as potential substitutes for certain main raw materials to manufacture our feed additives products and control rising costs.

 

Cost of Sales — Vaccines.   Cost of sales of our vaccines product line increased from $49,268 for the three months ended June 30, 2011 to $146,381 for the three months ended June 30, 2012, an increase of $97,113 or 197.1%.  This increase was the result of the corresponding increase of vaccine product sales.

 

The following table summarizes our operating expenses for the three months ended June 30, 2012 and 2011.

 

    Three Months Ended June 30,  
    2012     2011  
    Amount     % of total
revenue
    Amount     % of total
revenue
 
Operating Expenses                                
Research and Development Costs   $ 330,532       3.7 %   $ 1,801,551       19.8 %
Selling Expenses   $ 670,567       7.6 %   $ 609,826       6.7 %
General and Administrative Expenses   $ 1,834,280       20.7 %   $ 515,293       5.7 %
Total Operating Expenses   $ 2,835,379       32.0 %   $ 2,926,670       32.2 %

 

Research and Development Costs.  Research and development costs totaled $330,532 for the three months ended June 30, 2012 as compared to $1,801,551 for the three months ended June 30, 2011, a decrease of $1,471,019 or 81.7%. The decrease was primarily due to less R&D efforts undertaken during the second quarter of 2012 as compared to the same period of 2011.

 

Selling Expenses.  Selling expenses totaled $670,567 for the three months ended June 30, 2012 as compared to $609,826 for the three months ended June 30, 2011, an increase of $60,741 or 10.0%.  This increase is primarily a result of increased shipping and handling costs related to delivering our products to customers as we continued to expand our market to remote areas, and to the increased number of units to be shipped. Shipping and handling costs totaled $463,630 and $350,054 for the three months ended June 30, 2012 and 2011, respectively, an increase of $113,576 or 32.4%.

 

General and Administrative Expenses.  General and administrative expenses totaled $1,834,280 for the three months ended June 30, 2012 as compared to $515,293 for the three months ended June 30, 2011, an increase of $1,318,987 or 256.0%. The increase was mainly due to the stock based compensation expense of $992,107 for the stock grants on May 4, 2012 to the Company’s employees and members of the Board of Directors, all of which grants were made pursuant to the terms and provisions of the 2010 Stock Incentive Plan.

 

30
 

 

Results of Operations – Six Months ended June 30, 2012 and 2011

 

The following table summarizes our results of operations for the six months ended June 30, 2012 and 2011.

 

    Six Months Ended June 30,  
    2012     2011  
    Amount    

% of

total revenue

    Amount    

% of

total revenue

 
Revenue   $ 16,797,185       100.0 %   $ 16,183,095       100.0 %
Gross Profit   $ 9,406,589       56.0 %   $ 8,054,742       49.8 %
Operating Expenses   $ 4,650,084       27.7 %   $ 4,878,344       30.1 %
Income from Operations   $ 4,756,505       28.3 %   $ 3,176,398       19.7 %
Other Income (Expenses)   $ (101,143     (0.6 % $ 1,021,979       6.3 %
Income Tax Expenses   $ 1,051,742       6.3 %   $ 759,155       4.7 %
Net Income   $ 3,603,620       21.4 %   $ 3,439,222       21.3 %

 

Revenues.   All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC.  For the six months ended June 30, 2012, we had revenues of $16,797,185 as compared to revenues of $16,183,095 for the six months ended June 30, 2011, an increase of $614,090 or 3.8%.  We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  The selling prices of our products increased 0.4% on average in the six months ended June 30, 2012 compared to the same period of 2011. The increase in revenue was primarily due to the increase of sales volume.

 

Revenue — Veterinary Medications. Revenue from sales of our veterinary medications decreased by $5,739,605 or 51.2% from $11,206,906 for the six months ended June 30, 2011 to $5,467,301 for the six months ended June 30, 2012. The decrease of revenue was primarily due to no production at the Huxian plant for most of the first half of 2012 for GMP re-certification. Of the total revenues from veterinary medications during six months ended June 30, 2012, approximately 54% of total revenue resulted from the sale of Praziquantel tablets, which treats schistosomiasis. The selling prices of our veterinary medication products for the six months ended June 30, 2012 increased approximately 1.2% on average from the same period of last year. The decrease in revenue was primarily due to the decrease of sales volume.

 

Revenue — Micro-Organism. Revenue from sales of our micro-organism products increased by $3,560,024 or 99.5% from $3,577,222 for the six months ended June 30, 2011 to $7,137,246 for the six months ended June 30, 2012. The increase was primarily due to growing market demand for micro-organism products and our increased production and sales efforts during the first half year of 2012. Due to the temporary reduction of veterinary medication production, we were able to shift some of our veterinary medication production and sales forces to focus on the manufacturing and selling of micro-organism products and penetrate the market. The revenue from sales of our micro-organism products was the largest revenue contributor for the entire company and contributed 42.5% of total revenue during the six months ended June 30, 2012. The increase in micro-organism sales also contributed the majority of revenue growth for the entire company during the six months ended June 30, 2012. The selling prices of our micro-organism products for the six months ended June 30, 2012 have not changed meaningfully on average from last year. The increase in revenue was mainly due to the increase of sales volume.

 

Revenue — Feed Additives. Revenue from sales of our feed additives product line increased by $1,584,554 or 220.9% from $717,279 for the six months ended June 30, 2011 to $2,301,833 for the six months ended June 30, 2012. The increase was primarily the result of our increased production and extra sales forces temporarily shifted from the Huxian veterinary medication facility. The selling prices of our feed additives products for the six months ended June 30, 2012 have not changed meaningfully on average from last year. The increase in revenue was primarily due to the increase of sales volume.

 

Revenue — Vaccines. Revenue from sales of our vaccines increased by $1,209,117 or 177.4% from $681,688 for the six months ended June 30, 2011 to $1,890,805 for the six months ended June 30, 2012. The increase was primarily the result of our increased sales efforts. The selling prices of our vaccine products increased approximately 0.2% on average for the six months ended June 30, 2012 compared to those in the same period of 2011. The increase in revenue was primarily due to the increase of sales volume.

 

Cost of Sales.   Cost of sales was $7,390,596 for the six months ended June 30, 2012, as compared to $8,128,353 for the six months ended June 30, 2011, a decrease of $737,757 or 9.1%, as a result of decreased sales of our veterinary medications product line. For the six months ended June 30, 2012, raw material costs comprised the majority or approximately 74.0% of total cost of sales, packing material costs comprised approximately 16.2% of total cost of sales, and labor costs and manufacturing overhead comprised approximately 9.8% of total cost of sales. The increased gross margins in the first half of 2012 was mainly because the majority of our revenue growth during the first two quarters came from highly profitable micro-organism and vaccine product lines, while the relatively less profitable veterinary medications product line reduced its production, and therefore sales, during the period, as described above.

 

31
 

 

Cost of Sales — Veterinary Medications.   Cost of sales of our veterinary medications product line decreased from $6,664,457 for the six months ended June 30, 2011 to $3,191,654 for the six months ended June 30, 2012, a decrease of $3,472,803 or 52.1%.  This decrease was mainly due to the decrease in corresponding sales as a result of no production at the Huxian facility for the most of the first quarter and entire second quarter of 2012. Cost of sales of veterinary medications product line comprised 43.2% of total cost of sales for the six months ended June 30, 2012.

 

Cost of Sales — Micro-Organism.   Cost of sales of our micro-organism product line increased from $1,074,988 for the six months ended June 30, 2011 to $2,076,252 for the six months ended June 30, 2012, an increase of $1,001,264 or 93.1%.  This increase was mainly due to the corresponding increased sales.

 

Cost of Sales — Feed Additives.   Cost of sales of our feed additives product line increased from $305,248 for the six months ended June 30, 2011 to $1,882,023 for the six months ended June 30, 2012, an increase of $1,576,775 or 516.6%.  This increase in cost of sales was mainly due to the corresponding increase in feed additive sales and significantly increased raw material costs of yeast extract, the main raw material used in the manufacture of feed additives products.

 

Cost of Sales — Vaccines.   Cost of sales of our vaccines product line increased from $83,660 for the six months ended June 30, 2011 to $240,667 for the six months ended June 30, 2012, an increase of $157,007 or 187.7%.  This increase was the result of the corresponding increase of vaccine product sales.

 

The following table summarizes our operating expense for the six months ended June 30, 2012 and 2011.

 

   Six Months Ended June 30, 
   2012   2011 
   Amount   % of total
revenue
   Amount   % of total
revenue
 
Operating Expenses                    
Research and Development Costs  $334,186    2.0%  $2,089,023    12.9%
Selling Expenses  $1,376,183    8.2%  $979,230    6.0%
General and Administrative Expenses  $2,939,715    17.5%  $1,810,091    11.2%
Total Operating Expenses  $4,650,084    27.7%  $4,878,344    30.1%

 

Research and Development Costs.  Research and development costs totaled $334,186 for the six months ended June 30, 2012 as compared to $2,089,023 for the six months ended June 30, 2011, a decrease of $1,754,837 or 84.0%. The decrease was primarily due to less R&D efforts undertaken during the first half of 2012.

 

Selling Expenses.  Selling expenses totaled $1,376,183 for the six months ended June 30, 2012 as compared to $979,230 for the six months ended June 30, 2011, an increase of $396,953 or 40.5%.  This increase is primarily a result of increased shipping and handling costs related to delivering our products to customers as we continued to expand our market to remote areas, and to rising unit costs for transportation and delivery services and the increased number of units to be shipped. Shipping and handling costs totaled $847,333 and $544,270 for the six months ended June 30, 2012 and 2011, respectively, an increase of $303,063 or 55.7%. In addition, the increases in the selling commission due to new sales incentive programs initiated later last year also contributed to the increase in selling costs. Selling commission totaled $298,809 and $182,087 for the six months ended June 30, 2012 and 2011, respectively, an increase of $116,722 or 64.1%.

 

General and Administrative Expenses.  General and administrative expenses totaled $2,939,715 for the six months ended June 30, 2012 as compared to $1,810,091 for the six months ended June 30, 2011, an increase of $1,129,624 or 62.4%. The increase was mainly due to the stock based compensation expense of $1,037,911 for the stock grants on May 4, 2012 pursuant to the 2010 Stock Incentive Plan. The decreased amortization expenses of $185,152 in the first half of 2012 partially offset the impact of the increase in stock based compensation expense. The decrease in amortization expense was because patent acquired through the acquisition of Jingzhou plant was fully amortized in 2011.

 

Liquidity

 

For the six months ended June 30, 2012, cash used in operating activities was $2,163,439 compared to cash used in operating activities of $3,922,845 for the six months ended June 30, 2011. The major operating activities that provided cash for the six months ended June 30, 2012 were net income of $3,603,620 and an increase in tax payable of $2,778,594. The major operating activities that used cash for the six months ended June 30, 2012 were an increase in accounts receivable of $7,381,238 and an increase in prepayments for raw materials purchasing of $7,121,001. The inflation rate in China eased to 2.2% in June 2012 from 2011 peak. According to our observation of raw material marketplace, the raw material prices in our sector became more stable in recent months as compared to last year. We will monitor the market situation closely and continue the strategy to prepay our suppliers accordingly to ensure the supply of raw materials at relatively lower cost levels. As of June 30, 2012, we had approximately 63 suppliers that we made advances to in order to secure our raw material needs and to obtain favorable pricing. We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.

 

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Cash used in investing activities for the six months ended June 30, 2012 was $2,023,784, as compared to cash provided by investing activities of $1,604,317 for the six months ended June 30, 2011. Cash used in investing activities for the six months ended June 30, 2012 was primarily the result of loans to third parties of $1,942,963.

 

Cash used in financing activities for the six months ended June 30, 2012 was $639,327, as compared to cash provided by financing activities of $1,302,209 for the six months ended June 30, 2011. Cash used in financing activities for the six months ended June 30, 2012 was primarily the result of repayment of short-term loans of $666,372.

 

As of June 30, 2012, we had cash of $2,341,981. Our total current assets were $68,680,543, and our total current liabilities were $19,159,602, which resulted in a net working capital of $49,520,941.

 

Capital Resources

 

We finance our ongoing operating activities by using funds from our operations and external credit or financing arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources. We secured $63,464 in short-term loans and repaid $666,372 during the six months ended June 30, 2012. Considering our existing working capital position and our ability to access debt funding sources, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements to support our ongoing operations for at least next twelve months.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations  

 

   Payments Due by Period 
Contractual Obligations  Total   Less than
1 year
   1 – 3 years   3 – 5 years   More than
5 years
 
R&D Project Obligation  $989,758   $989,758   $-   $-   $- 
Operating Lease Obligations   350,450    55,418    179,010    116,022    - 
Government Grant Obligation   317,000    317,000    -    -    - 
Total  $1,657,208   $1,362,176   $179,010   $116,022   $- 

 

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

 

Skystar Kunshan is located in Kunshan, Jiangsu province, China. Skystar Kunshan has a registered capital of $15,000,000, of which we invested $2,250,000 in cash. The remaining $12,750,000 of capital was originally required to be invested prior to May 7, 2012. In 2011, the asset acquisition of Kunshan facility was completed. The Company is in the process of getting the government’s approval to transfer the asset purchased to satisfy some of our registered capital commitment. As of the date of this report, the Company has not received the approval nor a new due date for the payment of the remaining registered capital.

 

Skystar Jingzhou is located in Jingzhou, Hubei province, China. Skystar Jingzhou has a registered capital of approximately $4.1 million (RMB 26,000,000), of which approximately $3.7 million (RMB 23,480,000) has been paid. As of June 30, 2012, Skystar Jingzhou has remaining registered capital of $399,420 (RMB 2,520,000) required to be invested. On July 5, 2012,we paid up the remaining capital of $399,420 (RMB 2,520,000) of Skystar Jingzhou.

 

Off-Balance Sheet Arrangements

 

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

 

Exchange Rate

 

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

 

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

 

    June 30, 2012   December 31, 2011  
Assets and liabilities   1 RMB = 0.1585 USD   1 RMB = 0.1574 USD  
           
     For Three Months Ended June 30,  
    2012   2011  
Statements of operations and cash flows   1 RMB = 0.1585 USD   1 RMB = 0.1538 USD  
           
    For Six Months Ended June 30,  
    2012   2011  
Statements of operations and cash flows   1 RMB = 0.1586 USD   1 RMB = 0.1531 USD  

 

Inflation

 

China's annual consumer inflation cooled to 2.2 percent in June from 3.8 percent in March, which suggested that inflation is no longer an imminent threat to China. "China's current economic situation is generally stable, but it still faces relatively huge downward pressure,” Premier Wen Jiabao said. He also was quoted by the official Xinhua news agency as saying more aggressive efforts were needed to support growth. For the six months ended June 30, 2012, we were able to secure favorable pricing by prepaying certain suppliers to lock in prices ahead of time. As a result, we did not experience as much cost pressure as evidenced in the spot market prices of raw materials. To take precautions to minimize the negative impact of cost increases that erode our profit margin, we will continue the practice of prepayments to suppliers through the rest of the year.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

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

 

Based on the evaluation, the Certifying Officers concluded that, as of June 30, 2012, our disclosure controls and procedures were ineffective due to an ongoing material weakness related to the lack of accounting personnel with an appropriate level of knowledge, experience, and training in the application of U.S. GAAP. We have initiated a plan and are taking steps to implement the following measures to remediate this material weakness:

 

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

 

For the six months ended June 30, 2012, we hired additional accounting staff, realigned the responsibilities of key personnel involved in financial reporting, and continued the efforts that we initiated last year to streamline and standardize accounting processes. We intend to continue to implement and optimize these steps during the second half of 2012 and will conduct quarterly measurements and assessments of the Company’s financial reporting systems, as a whole.

 

Changes in Internal Control over Financial Reporting

 

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

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation that would have a significant effect on the Company’s consolidated financial statements as of June 30, 2012.

 

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

 

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

 

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

 

Although the Second Circuit declined to issue sanctions against Chien, it expressly warned Chien “that the continued filing of duplicative, vexatious, or frivolous appeals regarding issues already resolved by this Court may result in the imposition of sanctions, including a leave-to-file sanction requiring Chien to obtain permission from this Court prior to filing further submissions in this Court.” Mr. Chien has filed a petition for writs of certiorari with the Supreme Court of the United States. The Supreme Court has not yet acted on Chien’s petitions.

 

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

 

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ITEM 6. EXHIBITS

 

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

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

 

101.LAB**

 

 

XBRL Taxonomy Extension Label Linkbase

     
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase

  

 

 

Filed herewith.

 

** To be filed by amendment to this Quarterly Report pursuant to Regulation S-T.

 

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

 

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

 

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SIGNATURES

 

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

 

  SKYSTAR BIO-PHARMACEUTICAL COMPANY  
       
August 14, 2012 By:   /s/ Weibing Lu  
    Weibing Lu  
    Chief Executive Officer  
    (Principal Executive Officer)  

 

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

 

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