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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File Number: 000-33167
KIWA BIO-TECH PRODUCTS GROUP CORPORATION
(Name of small business issuer in its charter)
Delaware 84-0448400
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
415 West Foothill Blvd, Suite 206
Claremont, California 91711-2766
(909) 626-2358
(Address and telephone number of principal executive offices)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value OTC Bulletin Board
(Title of Each Class) (Name of each exchange on
which registered)
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 if no disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is contained herein, and no such disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. |X|
Registrant's revenues for its fiscal year ended December 31, 2005 were $631,794.
The aggregate market value of voting and nonvoting common stock held by
non-affiliates of the registrant, based upon the closing bid quotation for the
registrant's common stock, as reported on the OTC Bulletin Board quotation
service, as of March 31, 2006 was approximately $5,035,054.
The number of shares of registrant's common stock outstanding as of March 31,
2006 was 59,235,930.
Transitional Small Business Disclosure Format: YES |_| NO |X|
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TABLE OF CONTENTS
Page
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Part I
ITEM 1. BUSINESS...........................................................................1
The Company......................................................................1
Intellectual Property and Product Lines..........................................2
Strategies.......................................................................3
Market Overview..................................................................4
Construction Plan................................................................4
Competition......................................................................5
Raw Materials and Suppliers......................................................5
Customers........................................................................5
Seasonality......................................................................5
Employees........................................................................5
Regulatory Concerns..............................................................5
Environmental Matters............................................................5
Risk Factors.....................................................................6
ITEM 2. PROPERTY..........................................................................13
ITEM 3. LEGAL PROCEEDINGS.................................................................13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............................13
Part II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS .........................14
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................................14
Overview........................................................................15
Major Customers and Suppliers...................................................15
Going Concern...................................................................15
Trends and Uncertainties in Regulation and Government Policy in China...........16
Critical Accounting Policies and Estimates......................................17
Results of Operations...........................................................18
Liquidity and Capital Resources.................................................20
Inflation and Currency Matters..................................................21
Commitments and Contingencies...................................................22
Off-Balance Sheet Arrangements..................................................22
Recent Accounting Pronouncements................................................22
ITEM 7. FINANCIAL STATEMENTS..............................................................23
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..............................................23
ITEM 8A. CONTROLS AND PROCEDURES...........................................................24
ITEM 8B. OTHER INFORMATION.................................................................24
TABLE OF CONTENTS
Page
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Part III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT........................25
ITEM 10. EXECUTIVE COMPENSATION............................................................26
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS........................................27
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................................28
ITEM 13. EXHIBITS..........................................................................29
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES............................................32
SIGNATURES........................................................................................33
CONSOLIDATED FINANCIAL STATEMENTS................................................................F-1
PART I
ITEM 1. BUSINESS
The Company
References herein to "we", "us", "our" or "the Company" refer to Kiwa Bio-Tech
Products Group Corporation and its wholly-owned subsidiaries unless the context
specifically states or implies otherwise.
Kiwa Bio-Tech Products Group Corporation develops, manufactures, distributes and
markets innovative, cost-effective and environmentally safe bio-technological
products for agriculture, natural resources and environmental conservation. Our
products are designed to enhance the quality of human life by increasing the
value, quality and productivity of crops and decreasing the negative
environmental impact of chemicals and other wastes.
We are the result of a reverse merger between Tintic Gold Mining Company, a
corporation originally incorporated in the state of Utah on June 14, 1933 to
perform mining operations in Utah, and Kiwa Bio-Tech Products Group Ltd., a
company originally organized under the laws of the British Virgin Islands on
June 5, 2002. The merger was accomplished on March 12, 2004, pursuant to an
Agreement and Plan of Merger dated as of March 11, 2004 by and among Tintic Gold
Mining Company, TTGM Acquisition Corporation, a Utah corporation and
wholly-owned subsidiary of Tintic Gold Mining Company, and Kiwa Bio-Tech
Products Group Ltd. Pursuant to the Agreement and Plan of Merger TTGM
Acquisition Corporation merged with and into Kiwa Bio-Tech Products Group Ltd.
Each share of Kiwa Bio-Tech Products Group Ltd. common stock was converted into
1.5445839 shares of Tintic Gold Mining Company Common Stock, with Kiwa Bio-Tech
Products Group Ltd. surviving as Tintic Gold Mining Company's wholly-owned
subsidiary. The wholly-owned subsidiary thereafter merged with the parent. The
merger resulted in a change of control of Tintic Gold Mining Company, with
former Kiwa Bio-Tech Products Group Ltd. stockholders owning approximately 89%
of Tintic Gold Mining Company on a fully diluted basis. Subsequent to the
merger, Tintic Gold Mining Company changed its name to Kiwa Bio-Tech Products
Group Corporation. On July 22, 2004, we completed our reincorporation in the
State of Delaware. On July 22, 2004,we completed the reincorporation in the
state of Delaware.
In 2002, Kiwa Bio-Tech Products Group Ltd. chartered Kiwa Bio-Tech Products
(Shandong) Co. Ltd., a wholly-owned subsidiary organized under the laws of
China, as its offshore manufacturing base to capitalize on low cost, high
quality manufacturing advantages available in China. In October 2003, Kiwa
Bio-Tech Products Group Ltd. completed the first phase of the construction of
its state-of-the-art manufacturing facility in Shandong Province, China. In
November 2003, Kiwa Bio-Tech Products Group Ltd. began shipping its first
commercial product, a bio-fertilizer, to the agricultural market in China. We
have since been working on existing product improvement and new product
development.
Sales in 2005 were disappointingly low largely due to (1) a lack of inventory of
our established product - Photosynthesis Biological Catalyst- caused by a halt
in production at our manufacturing facility in the second half of 2005, and (2)
an inability to produce a new product - bacillus fertilizer, caused largely by
the failure of an expected financing. The halt in manufacturing at our facility
was related to the effort to develop bacillus fertilizer, a solid form product
that decomposes phosphate, potassium and other elements within the soil which
compliments our existing products. The development of bacillus fertilizer was in
furtherance of our plan to develop a full product line of bio-tech products for
agriculture. To produce bacillus fertilizer, it was necessary for us to upgrade
our existing manufacturing facilities and to secure a source of raw materials.
In the third quarter of 2005, we believed we had the financing in place to fund
the facility upgrade. In anticipation of that, we used our working capital to
purchase raw materials for producing bacillus fertilizer. In addition, in the
third quarter of 2005 we closed our existing manufacturing facility for the
upgrade. During the period of closure we were not able to produce inventory for
Photosynthesis Biological Catalyst or any of our other existing products. In the
fourth quarter, the anticipated financing was not realized. As a consequence we
were left with reduced inventory of our existing products and had used up most
of our working capital on raw materials for bacillus fertilizer. This caused us
to largely miss the peak sales season in 2005. In early 2006, we resumed
production at our manufacturing facilities and closed new financing
arrangements. We expect sales in 2006 will significantly improve.
In March 2006 we entered into a purchase agreement with two Chinese investors to
issue 5,000,000 shares of our common stock in a private placement for Renminbi
6,000,0000 (approximately $750,000). As of April 13, 2006, we had received
approximately $350,000 of the amount committed to under the purchase agreement,
which represents 47% of the total commitment. We have agreed with the investors
to defer funding of the remaining commitment to April 30, 2006. A portion of the
proceeds received from the stock sale were used to retire the Company's
financing arrangement with Cornell Capital Partner, LP ("Cornell Capital"). The
balance of the proceeds will be used to settle the outstanding payables to
service providers and for working capital. In April 2006, we are in negotiation
but have not yet closed a convertible note financing with two investors for up
to $4 million. If realized, proceeds from the sale of the convertible notes will
be used to continue our planned development of the bacillus fertilizer and the
existing business, approximately $500,000 of
1
which will be used to upgrade our facility to give it capability to produce
bacillus fertilizer. We also intend to devote approximately $2.5 million to
develop a new product - an anti-viral aerosol agent which was developed by the
Institute of Medicinal Biotechnology, Chinese Academy of Medical Science. The
anti-viral aerosol agent is primarily effective in treating or preventing
diseases for fowls and livestock, such as avian influenza, swine influenza,
Newcastle disease, avian infectious bronchitis, swine infectious
gastroenteritis, swine epidemic diarrhea, hog cholera, foot and mouth disease
and duck viral hepatitis. To commercialize the anti-viral aerosol agent product,
it must pass clinical testing performed by an institution qualified by the China
Agricultural Department. Following favorable testing results, the Company is
required to obtain a certificate for production of animal medicine from the
China Medical Department and the production has to be conducted in a factory
with GMP (good manufacturing practices) qualification for animal drugs by the
China Agriculture Department. The right to exploit the anti-viral aerosol agent
technology is currently held by the Institute of Medicinal Biotechnology. We
have entered into a non-binding memorandum of understanding with the Institute
of Medicinal Biotechnology to commercialize the product.
Intellectual Property and Product Lines
Our goal is to build a platform to commercialize bio-technological research and
development results for applications in agriculture and environmental
protection. In this respect, we are working on developing cooperative research
relationships with several universities in China and the United States. When our
liquidity position improves, we also intend to continue to acquire technologies
to reduce research and development costs and shorten commercialization cycles.
On April 12, 2004, we entered into an agreement with China Agricultural
University to acquire from the university Chinese patent no. ZL 93101635.5
entitled "Highly Effective Composite Bacteria for Enhancing Yield and the
Related Methodology for Manufacturing". The aggregate purchase consideration
under the agreement was $480,411, of which $30,205 was paid in cash at signing
of the agreement and an additional $30,206 was paid in December 2004. For the
balance of the consideration for the purchase, we issued 1,000,000 shares of our
common stock to China Agricultural University in September 2004, valued at $0.42
per share based on its fair market value on July 20, 2004 (aggregate value of
$420,000), the date when the transfer of the patent was approved.
The patent acquired from China Agricultural University covers six different
species of bacillus which have been tested as bio-fertilizers to enhance yield
and plant health. The production methods of the six species are also patented.
The patent will expire on February 9, 2013. In 2006, we plan to utilize the
patent to develop a new series of products that will complement our current
products and create a comprehensive product pipeline. There are no limitations
under this agreement on our exclusive use of the patent. Pursuant to our
agreement with China Agricultural University, the university agreed to provide
research and technology support services at no additional cost to us in the
event we decide to use the patent to produce commercial products. These research
and technology support services include: (1) furnishing faculty or
graduate-level researchers to help bacteria culturing, sampling, testing, trial
production and formula adjustment; (2) providing production technology and
procedures to turn the products into powder form while keeping live required
bacteria in the products; (3) establishing quality standards and quality control
systems; (4) providing testing and research support for us to obtain necessary
sale permits from the Chinese government; and (5) cooperation in developing
derivative products. China Agricultural University has been providing some of
these services since August 2004. If the University fails to provide any of
these support services, our remedy against the university would be to bring a
breach of contract suit for damages.
Pursuant to a non-binding letter of intent with the Institute of Medicinal
Biotechnology, Chinese Academy of Medical Science dated February 26, 2006, we
will acquire the exclusive production right and other related rights of the
anti-viral aerosol agent as animal drug as described above. We are now in the
process of negotiating the documentation described in the letter of intent.
We have obtained four Fertilizers Registration Certificates issued by the
Chinese government, which are: (1) Microorganism Microbial Inoculum Fertilizer
Registration Certificate issued by Ministry of Agriculture; (2) Amino Acid
Foliar Fomular Fertilizer Registration Certificate issued by Ministry of
Agriculture; (3) Organic Fertilizer Registration Certificate issued by
Agriculture Department of Shandong Province, and (4) Water-run Fertilizer
Registration Certificate issued by Agriculture Department of Shandong Province.
Protected by these four Fertilizer Registration Certificates and two trademarks
- "ZHIGUANGYOU" and "PUGUANGFU" - we have developed four series of
bio-fertilizer products with photosynthetic bacteria and/or bacillus as core
ingredients. In 2005, lacking our own bacillus production capability, we
purchased semi-manufactured bacillus goods and reprocessed our products with
other fertilizer components according to our particular fertilizer
prescriptions.
Our plan to develop bacillus fertilizer (including the acquisition of patents
from China Agricultural University), as we continue sales of Photosynthesis
Biological Catalyst, fits in with our overall plan to develop a portfolio of
products to serve the needs of agriculture customers through the various crops
seasons. Management believes that bacillus fertilizer will increase the
company's market share and competitiveness. In addition, we believe greater
product variety will increase sales in the long run and lower average fixed
production costs and marketing costs.
2
The anti-viral aerosol is a broad-spectrum antiviral agent with potent
inhibitory and/or viricidal effects on a variety of RNA viruses found in animals
and fowls, initially discovered and developed by the Institute of Medicinal
Biotechnology, Chinese Academy of Medical Sciences. Pursuant to related
technical appraisal report published by the Ministry of Health of the People's
Republic of China (the "PRC"), no adverse effects have been found of this agent,
and it is not irritant or erosive to the skin, mucous membrane or the eyes of
the recipient animal after swallowing or inhalation. Furthermore, the report
indicates that the anti-viral aerosol is not carcinogenic, teratogenic or
mutagenic. We plan to develop a commercialized product in the form of spray for
applying in hen houses and other animal holding facilities to prevent and cure
virus-caused diseases. When we have acquired from the Institute of Medicinal
Biotechnology all necessary rights and know-how to produce the product, we will
apply for a certificate for production of animal medicine from the Ministry of
Agriculture of the PRC.
Strategies
With the world's largest population to feed, China's demand for agricultural
products is immense. Problems with pollution and soil contamination have
increased pressure on the Chinese government to conserve land and enhance
environmental protection. Serious diseases such as H5N1 avian flu are spreading
around the world and have threatened the development of stockbreeding. More
critically, such diseases have threatened the health and safety of humans
through possible bird to human and human to human transmission. China thus faces
an urgent need to improve unit land yield, prevent and treat such diseases and
reduce pollution. We plan to address this need through the development of our
ag-biotechnology products which may resolve all these problems in
environmentally friendly ways. To exploit this opportunity, our core strategies
are as follows:
o Build a platform for world-class biotechnological research and
development results to be commercialized into products for applications in
agriculture, natural resources conservation, and environmental protection;
o Invest in mature technologies that will not require large amounts of
research expense to develop into commercial products;
o Establish strategic alliances for research and development, sales and
distribution and customer acquisition with complimentary entities in the
biological-agriculture and natural resources conservation industry;
o Complete our manufacturing facility in China;
o Enhance overall management systems, operational structure and
corporate governance; and
o Utilize proprietary technology to supply products at lower cost than
our competitors.
Our sales strategy involves utilizing both a direct sales force and distribution
networks. Our distribution efforts are expected to include the following:
o Leveraging government support and existing rural area distribution
networks to more effectively reach end-users;
o Cooperating with special fertilizer distributors who also help farmers
resell their products;
o Focusing on large-to-medium size wholesalers of agricultural
production materials at provincial and municipal levels;
o Establishing a three-level distribution network consisting of a
company-centralized sales office, prefectural representative office and
direct distributors in villages and towns; and
o Leveraging existing sales channel network of affiliates' products to
save costs of building the network from scratch.
We plan to target major agricultural companies and growers as customers that can
realize significant financial benefits from using our products including:
o High value crop (such as fruits and vegetables) growers and breed
bases in China that supply major cities;
o Agricultural producers in China who export to Japanese, Korean and
other regional markets; and
o "Green" or organic growers of produce throughout the world.
3
Given the global trend of customers favoring environmentally safe organically
grown food, growers' needs for higher crop yields and better quality and
increasing pressure of treating and preventing such diseases as H5N1 avian flu,
we also foresee strong market needs in other international markets including
East Asia and Southeast Asia. We plan to explore these markets when the time is
right.
Market Overview
Modern agricultural practices largely rely on heavy use of chemical fertilizers
and pesticides which cause tremendous harm to the environment and soils. Such
practices have been under increasing public scrutiny across the world, leading
to increased consumer demand for agricultural practices that are more
environmentally friendly. China has only 9.1%(1) of the world's agricultural
land but needs to feed over 1.3(2) billion people, or approximately 22.9%(3) of
the world's population. To increase the overall crop yield, farmers in China use
vast amounts of chemical fertilizers. According to the China Statistics Bureau
and the Food & Agriculture Organization of the United Nations, the use of
chemical fertilizers in China increased 64.2%(4) in the past decade and
accounted for one-third of total world fertilizer consumption.(5) Long-term
excessive use of chemical fertilizers in China has led to severe soil
contamination and pollution. If the situation continues unchanged, the largest
population in the world could potentially face severe food and water shortages
and an increasingly polluted living environment.
One solution to the environmental problem is bio-fertilizer, an environmental
friendly fertilizer. China's current consumption of bio-fertilizer consists of
only 2.3%(6) of the total fertilizer consumption in China. The Chinese
agricultural industry has started to recognize the importance of bio-fertilizers
to sustainable long-term agriculture in China. Our serial commercialized
products, with Photosynthesis Biological Catalyst or/and bacillus as main
ingredients, capitalize on this market trend and we hope to become one of the
leaders in developing green technologies for productive, more sustainable
agriculture in China.
Our main markets have so far been in China, mostly in Shandong Province, Jiangsu
and Zhejiang Provinces. In 2006, with continuous expansion of the current
market, our sales efforts are focused on Jilin Province, Henan Province, and
Guangdong Province, the three largest agricultural provinces in terms of grain
yield or exports of fish and other aquatic products.
Our planned anti-viral aerosol agent product is intended to prevent and treat
various virus infections in fowl and livestock. It is estimated that the Chinese
market volume of one prevention cycle for all fowl and livestock from avian flu
can reach as high as $100 million. If the treatment market and global market are
taken into consideration, the market potential is much greater. We believe that
if we obtain the requisite funding and our able to complete our plans to develop
the anti-viral aerosol agent product, we can expect to obtain a significant
share of the Chinese market upon launching.
Construction Plan
Our initial construction plan for our manufacturing facility in Shandong
Province, China contemplated three Phases. We completed the first phase of
construction in October 2003 and began to produce product thereafter. The
production capacity of the completed facility is 600 tons of bio-organic
products. Completion of the next phase of construction will expand the
manufacturing capacity to 1,000 tons and will enable us to produce the bacillus
fertilizer, a capacity which we currently lack.
In the third quarter of 2005, we halted production and closed the facility for
the planned second phase of construction, as we anticipated a financing
arrangement that would enable us to complete the construction. The anticipated
financing was not consummated and as of April 2006, the second phase of
construction has not yet commenced. We plan to devote $500,000 from newly raised
financing for the completion of the second phase of construction in 2006.
As a pre-requisition for commercializing a new anti-viral aerosol agent product,
its production has to be conducted in a factory with GMP qualification by the
China Agriculture Department. Since our existing manufacturing facility in
Shandong Province does not have GMP qualification, we plan to acquire an
existing GMP factory or construct a new plant with GMP qualification in 2006.
The expected cost is approximately $1 million. We plan to execute the plan when
we have secured a $4 million financing which we hope to complete in 2006.
Construction or acquisition of a new GMP factory will delay the third phase of
construction planned for the existing manufacturing facility in Shandong.
-------------------------------------------
(1) Total area of cultivated land of China is 127,082,000 hectares - as
cited on page 385 in "China Statistical Yearbook" published by National Bureau
of Statistics of China (September 2002). Total area of world cultivated land is
1,401,700,000 hectares - as cited on page 17 in "Summary of Food and
Agricultural Statistics 2003" published by Food and Agricultural Organization of
the United Nations (2003).
(2) Calculated based on data from the website of National Bureau of
Statistics of China: http://www.stats.gov.cn.
(3) Calculated based on data from the website of National Bureau of
Statistics of China : http://www.stats.gov.cn.
(4) Calculated based on data published in the "China Statistical Yearbook"
published by National Bureau of Statistics of China (September 2002), page 389.
(5) Calculated based on data published in "Current Agriculture Situation
and Chemical Fertilizer Demand in China," by Gao Xiangzhao, Ma Shangbao and Du
Sen, published by Science Publication House (July 2004), page 73.
(6) Bio-fertilizer production and consumption of 1,000,000 metric tons, as
cited on page 1 of "Bio-Fertilizer Present and Future," by Linfeng Li, published
by Jiangxi Agricultural University. Aggregate fertilizer consumption of
43,390,000 metric tons, as cited on page 73 of "Current Agriculture Situation
and Chemical Fertilizer Demand in China," by Gao Xiangzhao, Ma Shangbao and Du
Sen, published by Science Publication House (July 2004).
4
Competition
Due to the unique products that we offer and the very early stage of the
bio-fertilizer market in China, we believe there is little direct competition
for our products in the Chinese marketplace. We may experience competition from
existing products that are similar to Photosynthesis Biological Catalyst,
bacillus and other organic fertilizers. Management believes that we have product
differentiation and cost advantages (cost to customer) that will enable us to be
more profitable than our competitors.
In addition, we face competition from large chemical fertilizer manufacturers in
China. These chemical fertilizer manufacturers have provided chemical
fertilizers to farmers in China for several years and customers are more
accustomed to using their established products as compared to our products.
Raw Materials and Suppliers
The major raw materials for our photosynthetic bacteria and bacillus production
are photosynthetic bacteria, bacillus spp. sodium acetate, glucose, diammonium
phosphate, dipotassium hydrogen phosphate, and turf. Other chemicals are also
used in the growth media. These materials are either cultured by our technicians
or purchased from local markets. The key raw materials used in production of our
products are widely available from a wide variety of supply sources.
Historically, we have not experienced any difficulty in procuring adequate
quantities of raw materials.
Three suppliers accounted for 64.0%, 17.2%, 12.5% of our net purchases for the
fiscal year ended December 31, 2005, respectively. Historically these suppliers
have met our needs. In addition, the raw materials used in our products are
available from a variety of alternative sources.
We do not have agreements with our suppliers due to the availability of numerous
suppliers who have the ability to supply our raw materials on fairly short
notice. We place purchase orders when we need supplies.
Customers
Two customers accounted for 51.3% and 45.3% of our net sales for the fiscal year
ended December 31, 2005, respectively. No other single customer accounted for
more than 3% of our revenues.
Seasonality
Our operating results have been and are expected to continue to be subject to
seasonal trends. This trend is dependent on numerous factors, including the
markets in which we operate, growing seasons, climate, economic conditions and
numerous other factors beyond our control. Generally, we expect the second and
third quarters will be stronger than the first and fourth quarters, primarily
because the second and third quarters correspond with the growing seasons in our
primary markets in China. It is during those growing seasons when application of
our products by our customers would be most beneficial and we therefore expect
greater demand for our products during those periods. There can be no assurance
that these operating patterns will occur. But we will seek to develop markets
outside China such as in Southeast Asia to reduce the impact of seasonality.
Employees
We currently employ 20 full-time employees in China, one in the United States
and one in Hong Kong. We also have 15 seasonal employees in China.
Regulatory Concerns
Our production needs to comply with bio-fertilizer standard production and
testing procedures issued by the Chinese Ministry of Agriculture. We have
complied with the applicable government standard production and testing
procedures.
Environmental Matters
5
The bacteria used in our products are naturally occurring in many water bodies
and have been extensively tested for environmental safety. They have been
recognized as group beneficiary bacteria that can digest small inorganic and
organic molecules for water cleaning and other water treatment purposes. They
are environmentally friendly and are not known to cause any environmental
problems.
Risk Factors
We operate in a market environment that is difficult to predict and that
involves significant risks and uncertainties, many of which will be beyond our
control. The following risk factors and other information included in this
Annual Report should be carefully considered. The risks and uncertainties
described below are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations. If any of the following risks occur,
our business, financial condition, operating results, and cash flows could be
materially adversely affected.
(1) RISKS RELATED TO OUR BUSINESS
INVESTORS MAY NOT BE ABLE TO ADEQUATELY EVALUATE OUR BUSINESS DUE TO OUR SHORT
OPERATING HISTORY, LACK OF SIGNIFICANT REVENUE AND LIMITED PRODUCT OFFERINGS.
DUE TO THIS SHORT OPERATING HISTORY, WE HAVE NOT YET GENERATED ANY PROFITS AND
WILL REQUIRE ADDITIONAL FUNDING TO IMPLEMENT OUR BUSINESS PLAN. IN ADDITION, WE
HAVE BEEN THE SUBJECT OF A GOING CONCERN EXPLANATORY PARAGRAPH. FOR THE YEAR
ENDED DECEMBER 31, 2004 and 2005 FROM OUR INDEPENDENT ACCOUNTANTS.
We have only been operating our current business in ag-biotechnology since June
2002, providing a limited period for investors to evaluate our business model.
Because of this limited operating history and the uncertain nature of the
rapidly changing markets that we serve, we believe any prediction of future
results of operations is difficult. We have generated insignificant revenue,
have not been profitable, and incurred a severe decrease of sales in the second
half of 2005 due to insufficiency of working capital resulted from the failure
of an anticipated financing. From the inception of our current business in
ag-biotechnology on June 5, 2002 to December 31, 2005, we had accumulated losses
of $5,482,555. We expect to continue to have operating losses for the
foreseeable future as we are still in the process of exploring market, further
research and product tests. We will require additional capital to implement our
business plan and continue operating. To the extent that we are unable to
successfully raise the capital necessary to fund our future cash requirements on
a timely basis and under acceptable terms and conditions, we will not have
sufficient cash resources to maintain operations, and may have to curtail or
cease operations and consider a formal or informal restructuring or
reorganization.
We have obtained four Fertilizers Registration Certificates under which we can
produce and market microorganism microbial Inoculum fertilizer Registration,
amino acid aoliar aomular fertilizer, organic fertilizer and water-run
fertilizer. There can be no assurances that any of the intellectual property or
products intended to be developed by us will be marketed successfully or that
ultimately we can develop a sufficiently large production capacity and
sufficiently large customer demand to operate on a profitable basis. Until
sufficient cash flow is generated from operations, we will have to utilize our
capital resources or external sources of funding to satisfy our working capital
needs. Furthermore, our prospects must be evaluated in light of risks,
uncertainties, expenses and difficulties frequently encountered by companies in
an early growth stage.
Our independent auditors have added an explanatory paragraph to their audit
opinion issued in connection with our financial statements for the year ended
December 31, 2004 and 2005, which states that the financial statements raise
substantial doubt as to our ability to continue as a going concern. Our ability
to make operations profitable or obtain additional funding will determine our
ability to continue as a going concern.
Notwithstanding this, the Company believes that the following facts mitigate
going-concern doubts:
o We have obtained four prerequisite bio-fertilizer certificates from the
Chinese government to commercialize the technologies related to photosynthetic
bacteria and bacillus. It is very time-consuming, costly and uncertain to
acquire such approvals in China.
o Our products have had a good reception among the final consumers in those
high-additional-value crops markets. It is from such markets that we can obtain
higher margin profit.
o In March we received a commitment to purchase 5,000,000 shares of our common
stock for approximately $750,000, of which we have received approximately
$350,000, of which we have used approximately $110,000 to retire indebtedness
and current obligations and of which we expect to use $240,000 for working
capital.
6
OUR BUSINESS IS SUBJECT TO SEASONAL FLUCTUATIONS.
See "Business-Seasonality" in Item 1.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, WHICH MAY RESULT IN
VOLATILITY OR HAVE AN ADVERSE EFFECT ON THE MARKET PRICE OF OUR COMMON STOCK.
We have experienced, and expect to continue to experience, substantial variation
in our net sales and operating results from quarter to quarter. Our business is
subject to seasonal fluctuations due to growing seasons in different markets. We
believe the factors that influence this variability of quarterly results
include: (1) the timing and size of orders from major customers; (2) budgeting
and purchasing cycles of customers; (3) the timing of enhancements to products
or new products introduced by us or our competitors; (4) changes in pricing
policies made by us, our competitors or suppliers, including possible decreases
in average selling prices of products in response to competitive pressures;
(5)fluctuations in general economic conditions; and (6) the status of operating
cash.
We may also choose to reduce prices or to increase spending in response to
competition or to pursue new market opportunities. Due to fluctuations in our
revenue and operating expenses, we believe that period-to-period comparisons of
our results of operations are not a good indication of our future performance.
It is possible that in some future quarter or quarters our operating results
will be below the expectations of securities analysts or investors. In that
case, our stock price could fluctuate significantly or decline.
From January 1, 2005 to December 31, 2005, the market price for our common stock
as quoted on the OTC Bulletin Board has ranged from $0.059 to $0.007. High
volatility in the market price of our common stock may result in lower prices
for our common stock, making it more difficult for us to obtain equity financing
on terms and conditions which are favorable to us, if at all. We expect to
continue to incur losses in the near future as we develop and market our initial
products. As a result, we will be dependent on additional debt or equity
financing to fund our operations. If such financing is not available on terms
which are acceptable to us, we may have to delay development of new products
and/or reduce sales and marketing efforts for our existing products. Such
actions may have an adverse effect on our results of operations. In addition,
uncertainties with respect to our ability to raise additional capital would make
operational planning more difficult for management.
REVOCATION OF OUR RIGHT TO USE PATENTS OR OTHER INTELLECTUAL PROPERTY RIGHTS
COULD ADVERSELY IMPACT THE GROWTH OF OUR BUSINESS.
We acquired a patent in April 2004 from China Agricultural University, entitled
"Highly Effective Composite Bacteria for Enhancing Yield and the Related
Methodology for Manufacturing," issued by the China Intellectual Property
Bureau. If our rights under this patent are challenged or if we default on our
obligations under applicable Chinese regulatory requirements, our right to use
that patent could be revoked and we would no longer be permitted to use that
patent in our research, development and sales activities. Such a revocation or
default could have an adverse impact on the growth of our business by reducing
the introduction of new products, and consequently, sales.
OUR SUCCESS DEPENDS IN PART ON OUR SUCCESSFUL DEVELOPMENT AND SALE OF PRODUCTS
CURRENTLY IN THE RESEARCH AND DEVELOPMENT STAGE.
Some of our product candidates are still in the research and development stage.
The successful development of new products is uncertain and subject to a number
of significant risks. Potential products that appear to be promising at early
states of development may not reach the market for a number of reasons,
including but not limited to, the cost and time of development. Potential
products may be found to be ineffective or cause harmful side effects, fail to
receive necessary regulatory approvals, be difficult to manufacture on a large
scale or be uneconomical or fail to achieve market acceptance. Our failure to
successfully develop and sell new products may delay or eliminate future
acquisition plans and would most likely slow our development. Our plans to
introduce additional proprietary products may not be realized as expected, if at
all.
There can be no assurance that any of our intended products will be successfully
developed or that we will achieve significant revenues from such products even
if they are successfully developed. Our success is dependent upon our ability to
develop and market our products on a timely basis. There can be no assurance
that we will be successful in developing or marketing such products or taking
advantage of the perceived demand for such products. In addition, there can be
no assurance that products or technologies developed by others will not render
our products or technologies non-competitive or obsolete. The China
bio-fertilizer market is still in a very early stage and is very fragmented with
many potential customers, but with no single producer or small group of
producers dominating the market. To some extent, however, we also face
competition from large chemical fertilizer manufacturers in China. These
chemical fertilizer manufacturers have provided chemical fertilizers to farmers
in China for several years and customers are more accustomed to using their
established products as compared to new products.
7
FAILURE TO ADEQUATELY EXPAND TO ADDRESS EXPANDING MARKET OPPORTUNITIES COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF OPERATIONS.
We anticipate that a significant expansion of operations will be required to
address potential market opportunities. There can be no assurances that we will
expand our operations in a timely or sufficiently large manner to capitalize on
these market opportunities. The anticipated substantial growth is expected to
place a significant strain on our managerial, operational and financial
resources and systems. While management believes it must implement, improve and
effectively use our operational, management, research and development,
marketing, financial and employee training systems to manage anticipated
substantial growth, there can be no assurances that these practices will be
successful.
OUR SUCCESS DEPENDS IN PART UPON OUR ABILITY TO RETAIN AND RECRUIT KEY
PERSONNEL.
Our success is highly dependent upon the continued services of our executive
officers, key product development personnel and key scientific personnel. Given
the intense competition for qualified management and product development
personnel in our industry, the loss of the services of any key management or
product development personnel may significantly and detrimentally affect our
business and prospects. The employment agreements with two of our key personnel
in China, Lianjun Luo and Qu Bin, were expired on October 1, 2005 and March 1,
2006, respectively. We do not have employment agreements with any other members
of management or key personnel. There can be no assurance that we will be able
to retain these personnel, and it may be time-consuming and costly to recruit
qualified replacement personnel.
WE CURRENTLY DO NOT HAVE SUFFICIENT REVENUES TO SUPPORT OUR BUSINESS ACTIVITIES,
EXPECT OPERATING LOSSES CONTINUE, AND WILL REQUIRE ADDITIONAL FINANCING WHICH WE
MAY NOT BE ABLE TO SECURE.
We require substantial working capital to fund our business. In the short term,
we still need to continue building out our manufacturing facility, adjust our
product formula to improve product stability and optimize our product offerings,
expand our sales and marketing efforts in China, expand our distribution base in
China, introduce new products, and acquire a small or medium sized
bio-technology company in the Chinese agricultural and/or environmental markets
or a factory with GMP qualification. In the long term, we plan to become a
commercialization platform for world-class biotechnological research and
development results for applications in agriculture, natural resources
conservation and environmental protection, launch our products in the United
States and other markets, continue our introduction of new products, create
formal strategic alliances with selected United States companies to co-develop
and/or co-market products in the United States and China, and form an
international biotechnology research center in China for the research and
development of agricultural, environmental and medical applications.
We incurred a severe decrease of sales in the second half of 2005 due to the
temporarily closing of our manufacturing facility for the planned upgrade and
the failure of the anticipated financing that would have allowed us to construct
a facility to produce bacillus fertilizer. We currently do not have sufficient
revenues to support our business activities and we expect operating losses to
continue. Especially in the first half of 2006, we will require additional
capital to fund our operations and finance our research and development
activities. Funding, whether from a public or private offering of debt or
equity, a bank loan or a collaborative agreement, may not be available when
needed or on favorable terms. If we are unable to obtain necessary financing in
the amounts and on terms deemed acceptable, we will have to limit, delay, scale
back or eliminate our research and development activities or future operations.
Any of the foregoing may adversely affect our business and cause us to
discontinue as a going concern.
ENTERING INTO EQUITY OR DEBT FINANCINGS COULD RESULT IN DILUTION TO EXISTING
STOCKHOLDERS.
We will be required to raise additional capital to fund our operations and
finance our research and development activities through a public or private
offering of debt or equity. Any equity financing could result in dilution to the
existing stockholders as a direct result of our issuance of additional shares of
our capital stock. Debt financings will result in interest expense and likely
subject us to negative covenants that would limit our operational flexibility,
and if convertible into equity, could also dilute then-existing stockholders.
THE RISKS ASSOCIATED WITH RAISING CAPITAL THROUGH COLLABORATIONS AND LICENSING
AGREEMENTS COULD ADVERSELY AFFECT OUR BUSINESS.
We will be required to raise additional capital to fund our operations and
finance our research and development activities through collaborative and/or
licensing agreements. Under these agreements, we may be subject to various
restrictive covenants which could significantly limit our operating and
financial flexibility and may limit our ability to respond to changes in our
business or competitive environment. If we are unable to obtain necessary
financing in the amounts and on terms deemed acceptable, we may have to limit,
delay, scale back or eliminate our research and development activities or future
operations. Any of the foregoing may adversely affect our business.
8
RESTRICTIONS ON CURRENCY EXCHANGE MAY LIMIT OUR ABILITY TO EFFECTIVELY RECEIVE
AND USE OUR REVENUE.
Because most of our future revenues may be in the form of China Renminbi, any
future restrictions on currency exchanges may limit our ability to use revenue
generated in Renminbi to fund our business activities outside China or to make
dividend or other payments in U.S. Dollars. Although the Chinese government
introduced regulations since 1996 to allow greater convertibility of the
Renminbi, for current account transactions significant restrictions still
remain, including primarily the restriction that foreign invested enterprises
may only buy, sell and/or remit foreign currencies at those banks authorized to
conduct foreign exchange business after providing valid commercial documents. In
addition, conversion of Renminbi for capital account items, including direct
investment and loans, is subject to governmental approval in China, and
companies are required to open and maintain separate foreign exchange accounts
for capital account items. We cannot be certain that the Chinese regulatory
authorities will not impose more stringent restrictions on the convertibility of
the Renminbi, especially with respect to foreign exchange transactions.
We may also be subject to foreign exchange risk and foreign ownership
restrictions. The Chinese government is loosening its control on foreign
exchange transactions. More liberal foreign exchange policies will reduce our
foreign exchange risk by increasing the liquidity of revenues generated in
Renminbi. Fluctuations in the exchange rate of the Renminbi relative to the U.S.
Dollar could adversely affect our results of operations by affecting our
reported earnings for any given period. However since July 2005, RMB has been
appreciating at all times. In addition, foreign ownership restrictions could
also impact our ability to expand our business through investment and
acquisition opportunities. If we are unable to pursue such strategic
opportunities due to foreign ownership regulations, the growth of our business
could be limited.
CHANGES IN CHINA'S POLITICAL, SOCIAL, ECONOMIC OR LEGAL SYSTEMS COULD MATERIALLY
HARM OUR BUSINESS.
All of our manufacturing and production and the majority of our sales occur in
China. Consequently, an investment in our common stock may be adversely affected
by the political, social and economic environment in China. Under its current
leadership, China has been pursuing economic reform policies, including the
encouragement of private economic activity and greater economic
decentralization. There can be no assurance, however, that the Chinese
government will continue to pursue such policies, that such policies will be
successful if pursued, or that such policies will not be significantly altered
from time to time.
Our business and prospects are dependent upon agreements and regulatory approval
with various entities controlled by Chinese governmental instrumentalities.
Historically, our operations in China have received relatively favorable
treatment from these instrumentalities as a result of the Chinese government's
policies of encouraging economic development and innovation, especially in
underdeveloped regions. However, our operations and prospects would be
materially and adversely affected by a change in China's economic policies,
which could make it more difficult for us to obtain necessary approvals from
governmental authorities and to obtain economic incentives from governmental
authorities. In addition, if the Chinese government elects not to honor certain
contracts as a result of political change, it might be difficult to enforce
these contracts against such governmental entities in China. In addition, the
legal system of China relating to foreign investments is both new and
continually evolving, and currently there can be no certainty as to the
application of its laws and regulations in particular instances.
A SLOW-DOWN IN THE CHINESE ECONOMY MAY ADVERSELY EFFECT OUR GROWTH AND
PROFITABILITY.
The growth of the Chinese economy has been uneven across geographic regions and
economic sectors. There can be no assurance that growth of the Chinese economy
will be steady or that any recessionary conditions will not have a negative
effect on our business. Several years ago, the Chinese economy experienced
deflation, which may reoccur in the foreseeable future. The performance of the
Chinese economy overall affects our profitability as expenditures for
agricultural technological products may decrease due to slowing domestic demand.
ANY RECURRENCE OF SARS, AVIAN INFLUENZA OR ANOTHER WIDESPREAD PUBLIC HEALTH
PROBLEM, COULD ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS.
A renewed outbreak of SARS, Avian influenza or another widespread public health
problem in China, where most of our revenue is derived, could have a negative
effect on our operations. Our operations may be impacted by a number of
health-related factors, including the following: (1) quarantines or closures of
some of our offices and factories which would severely disrupt our operations,
(2) the sickness or death of our key officers and employees, and (3)a general
slowdown in the Chinese economy.
9
Any of the foregoing events or other unforeseen consequences of public health
problems could adversely affect our business and results of operations.
OUR ABILITY TO GENERATE REVENUES COULD SUFFER IF THE CHINESE AG-BIOTECHNOLOGY
MARKET DOES NOT DEVELOP AS ANTICIPATED.
The agriculture-biotechnology market in China, the primary market in which we do
business, is in the early stages of development. While we believe the market
opportunity looks promising, we expect that the market will take several years
to develop. While it is difficult to project exactly how long it will take to
develop the ag-biotechnology industry in China, we anticipate that it will take
at least ten years to reach a level of development which is similar to the
current state of the industry in the United States. Successful development of
the ag-biotechnology market in China depends on the following: (1) continuation
of governmental and consumer trends favoring the use of products and
technologies designed to create sustainable agriculture; (2) educating the
Chinese agricultural community and consumers about the uses of ag-biotechnology
products; and (3) certain institutional developments such as governmental
agricultural subsidies designed to promote the use of environmentally friendly
ag-biotechnological products.
There are no assurances that these trends will continue, governmental subsidies
will be offered, or that the Chinese agricultural community and consumers will
be successfully educated about the uses of ag-biotechnology products. The
conduct of business in the ag-biotechnology market involves high risks. There
can be no assurances that the ag-biotechnology market in China will develop
sufficiently to facilitate our profitable operation. While we believe that we
will benefit from our first-mover advantage in a growing market, existing
competitors and new entrants in the ag-biotechnology market are expected to
create fierce competition in the future as the market evolves. Competitors and
new entrants may introduce new products into the market that may detrimentally
affect sales of our existing products, and consequently our revenues. We intend
to fund operations through sales, debt and equity financings until such time as
the ag-biotechnology market in China is sufficiently developed to support our
profitable operation.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, AND
MAY BE EXPOSED TO INFRINGEMENT CLAIMS FROM THIRD PARTIES.
Our success will depend in part on our ability to obtain patent protection for
our technology, to preserve our trade secrets and to operate without infringing
on the proprietary rights of third parties. We have several trademarks
registered in China, which will be protected by the trademark laws in China for
ten years and are renewable at the expiration of the initial ten year term. In
addition, we acquired a China patent in 2004 from the China Agricultural
University entitled "Highly Effective Composite Bacteria for Enhancing Yield and
the Related Methodology for Manufacturing," issued by China Intellectual
Property Bureau, which has a remaining term of seven years.
We may also file patents with the PRC Intellectual Property Bureau and/or the
U.S. Patent and Trademark Office as we deem appropriate, or buy other patents
such as above said anti-viral aerosol agent patents There can be no assurance
that the patents applied for will be reviewed in a timely manner, that any
additional patents will be issued or that any patents issued will afford
meaningful protection against competitors with similar technology or that any
patents issued will not be challenged by third parties. There also can be no
assurance that others will not independently develop similar technologies,
duplicate our technologies or design around our technologies whether or not
patented. There also can be no assurance that we will have sufficient resources
to maintain a patent infringement lawsuit should anyone be found or believed to
be infringing our patents. There also can be no assurance that the technology
ultimately used by us will be covered in any additional patent applications that
we may file. We do not believe that our technology infringes on the patent
rights of third parties. However, there can be no assurance that certain aspects
of our technology will not be challenged by the holders of other patents or that
we will not be required to license or otherwise acquire from third parties the
right to use additional technology. The failure to overcome such challenges or
obtain such licenses or rights on acceptable terms could have a material adverse
affect on us, our business, results of operations and financial condition.
The processes and know-how of importance to our technology are dependent upon
the skills, knowledge and experience of our technical personnel, consultants and
advisors and such skills, knowledge and experience are not patentable. To help
protect our rights, we require employees, significant consultants and advisors
with access to confidential information to enter into confidentiality and
proprietary rights agreements. There can be no assurance, however, that these
agreements will provide adequate protection for our trade secrets, know-how or
proprietary information in the event of any unauthorized use or disclosure.
There can be no assurance that we will be able to obtain a license for any
technology that we may require to conduct our business or that, if obtainable,
such technology can be licensed at a reasonable cost. The cost of obtaining and
enforcing patent protection and of protecting proprietary technology may involve
a substantial commitment of our resources. Any such commitment may divert
resources from other areas of our operations. We may be required to license or
sublicense certain technology or patents in order to commence operations. There
can be no assurance that we will be able to obtain any necessary licenses or to
do so on satisfactory terms. In addition, we could incur substantial costs in
defending ourselves against suits brought by other parties for infringement of
intellectual property rights and there are no assurances that we will have the
resources to do so.
10
WE MAY BECOME INVOLVED IN INTELLECTUAL PROPERTY LITIGATION, THE DEFENSE OF WHICH
COULD ADVERSELY IMPACT OUR BUSINESS OPERATIONS.
Currently we have one patent in China (Patent Number ZL93 101635.5 and
International patent classification Number A01N 63/00), which covers six
different species of bacillus which have been tested as bio-fertilizers to
enhance yield and plant health as well as the production methods of the six
species. The patent will expire on February 19, 2013.
While we have not received any allegations, complaints or threats of litigation
relating to any intellectual property rights, we may, from time to time, become
involved in litigation regarding patent and other intellectual property rights.
From time to time, we may receive notices from third parties of potential
infringement and claims of potential infringement. Defending these claims could
be costly and time consuming and would divert the attention of management and
key personnel from other business issues. The complexity of the technology
involved and the uncertainty of intellectual property litigation increase these
risks. Claims of intellectual property infringement also might require us to
enter into costly royalty or license agreements. However, we may be unable to
obtain royalty or license agreements on terms acceptable to us, or at all. In
addition, third parties may attempt to appropriate the confidential information
and proprietary technologies and processes used in our business, which we may be
unable to prevent and which would harm the businesses and our prospects.
WE FACE TECHNICAL RISKS ASSOCIATED WITH COMMERCIALIZING OUR TECHNOLOGY WHICH
COULD HAVE A MATERIAL ADVERSE IMPACT ON OUR BUSINESS RESULTS AND OPERATIONS.
A key to our future success is the ability to produce our bacillus series of
products at lower costs than our competitors. Although we are currently
utilizing our proprietary technology to produce such products at lower costs,
our method for producing such products on a commercial basis has only recently
begun. Further, although results from recent independent tests and our early
production results have been encouraging, the ability of our technology to
commercially produce such products at consistent levels is still being
evaluated. There can be no assurance that we will continue to be able to produce
such products at lower costs than our competitors, nor that our technology will
be able to commercially produce such products at consistent levels.
WE DEPEND ON A FEW CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR REVENUE.
Two customers together accounted for approximately 96.6% of our net sales for
the fiscal year ended December 31, 2005. The loss of any of our significant
customers would result in a material reduction in our sales and results of
operations. We do not have long-term contracts with any of our customers.
Purchases generally occur on an order-by-order basis, and relationships exist as
long as there is a perceived benefit to both parties. A decision by a major
customer, whether motivated by competitive considerations, financial
difficulties, and economic conditions or otherwise, to decrease its purchases
from us or to change its manner of doing business with us, could adversely
affect our business and financial condition. There can be no assurances that we
will be able to retain these customers or further expand our customer base to
reduce our dependence on a small number of customers. Our inability to generate
new customers could negatively impact our business and our ability to continue
as a going concern.
WE HAVE LIMITED BUSINESS INSURANCE COVERAGE.
The insurance industry in China is still in its early stage of development.
Insurance companies in China offer limited business insurance. As a result, we
do not have any business liability insurance coverage for our operations.
Moreover, while business disruption insurance is available, we have determined
that the risks of disruption and cost of the insurance are such that we do not
require it at this time. Any business disruption, litigation or natural disaster
might result in substantial costs and diversion of resources.
(2) RISK RELATED TO OUR COMMON STOCK
IF AN ACTIVE TRADING MARKET FOR OUR SECURITIES DOES NOT REMAIN IN EXISTENCE, THE
MARKET PRICE OF OUR SECURITIES MAY DECLINE AND STOCKHOLDERS' LIQUIDITY MAY BE
REDUCED.
Our common stock is quoted on the OTC Bulletin Board, however, trading volume is
very limited. We cannot guarantee that trading volumes to sustain a regular
trading market will ever develop. The OTC Bulletin Board is an inter-dealer,
over-the-counter market that provides significantly less liquidity than the
NASD's automated quotation system. Quotes for stocks included on the OTC
Bulletin Board are not listed in the financial sections of newspapers as are
those for the NASDAQ Stock Market. Therefore, prices for securities quoted
solely on the OTC Bulletin Board may be difficult to obtain and holders of
common stock may be unable to resell their securities at or near their original
purchase price or at any price. As of December 31, 2005, we had 373 stockholders
of record. As of December 31, 2005, the closing price per share of common stock
was $0.0095 and the average daily trading volume for the last three months in
2005 was 175,665 shares. Market prices for our common stock will be influenced
by a number of factors, including: (1) the issuance of new equity securities;
(2) changes in interest rates; (3) competitive developments, including
announcements by competitors of new products or services or significant
contracts, acquisitions, strategic partnerships, joint ventures or capital
commitments; (4) variations in quarterly operating results; (5) change in
financial estimates by securities analysts; (6) the depth and liquidity of the
market for our common stock; (7) investor perceptions of our company and the
ag-biotechnology industry generally; and (8) general economic and other
conditions.
11
THE DESIGNATION OF OUR COMMON STOCK AS "PENNY STOCK" COULD IMPACT THE TRADING
MARKET FOR OUR COMMON STOCK DUE TO BROKER-DEALER REQUIREMENTS IMPOSED BY THE
DESIGNATION OF OUR COMMON STOCK AS "PENNY STOCK."
Our common stock is a "penny stock" as defined in Rules 15g-2 through 15g-6
promulgated under Section 15(g) of the Securities Exchange Act of 1934, as
amended, as it meets the following definitions: (i) the stock trades at a price
less than $5.00 per share; (ii) it is not traded on a "recognized" national
exchange; (iii) it is not quoted on the NASDAQ Stock Market, or even if so, has
a price less than $5.00 per share; and (iv) is issued by a company with net
tangible assets less than $2.0 million, if in business more than a continuous
three years, or with average revenues of less than $6.0 million for the past
three years. The principal result or effect of being designated a "penny stock"
is that securities broker-dealers cannot recommend the stock but must trade in
it on an unsolicited basis.
Section 15(g) of the Securities Exchange Act of 1934, as amended, and Rule 15g-2
promulgated thereunder by the Securities and Exchange Commission require
broker-dealers dealing in penny stocks to provide potential investors with a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document before effecting any transaction in a
penny stock for the investor's account.
Potential investors in our common stock are urged to obtain and read such
disclosure carefully before purchasing any shares that are deemed to be "penny
stock." Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve
the account of any investor for transactions in such stocks before selling any
penny stock to that investor. This procedure requires the broker-dealer to (i)
obtain from the investor information concerning his or her financial situation,
investment experience and investment objectives; (ii) reasonably determine,
based on that information, that transactions in penny stocks are suitable for
the investor and that the investor has sufficient knowledge and experience as to
be reasonably capable of evaluating the risks of penny stock transactions; (iii)
provide the investor with a written statement setting forth the basis on which
the broker-dealer made the determination in (ii) above; and (iv) receive a
signed and dated copy of such statement from the investor, confirming that it
accurately reflects the investor's financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult for holders of our common stock to resell their shares to third
parties or to otherwise dispose of them in the market or otherwise.
PROVISIONS IN OUR CHARTER AND THE CORPORATE LAW OF OUR STATE OF INCORPORATION
COULD DETER OR PREVENT AN ACQUISITION OR CHANGE OF CONTROL.
Provisions of our certificate of incorporation may deter or prevent a change in
control of management. Specifically, our certificate of incorporation allows our
Board of Directors to issue 20,000,000 shares of preferred stock, in one or more
series and with such rights and preferences including voting rights, without
further stockholder approval. In the event that the Board of Directors
designates additional series of preferred stock with rights and preferences,
including super-majority voting rights, and issues such preferred stock, the
preferred stock could make our acquisition by means of a tender offer, a proxy
contest or otherwise, more difficult, and could also make the removal of
incumbent officers and directors more difficult. As a result, these provisions
may have an anti-takeover effect. The preferred stock authorized in our
certificate of incorporation may inhibit changes of control.
In addition, we are subject to the provisions of Section 203 of the Delaware
General Corporation Law. That section provides, with some exceptions, that a
Delaware corporation may not engage in any of a broad range of business
combinations with a person or affiliate, or associate of the person, who is an
"interested stockholder" for a period of three years from the date that the
person became an interested stockholder unless: (i) the transaction resulting in
a person becoming an interested stockholder, or the business combination, is
approved by the Board of Directors of the corporation before the person becomes
an interested stockholder; (ii) the interested stockholder acquires 85% or more
of the outstanding voting stock of the corporation in the same transaction that
makes it an interested stockholder, excluding shares owned by persons who are
both officers and directors of the corporation, and shares held by some employee
stock ownership plans; or (iii) on or after the date the person becomes an
interested stockholder, the business combination is approved by the
corporation's Board of Directors and by the holders of at least 66 2/3% of the
corporation's outstanding voting stock at an annual or special meeting,
excluding shares owned by the interested stockholder. An "interested
stockholder" is defined as any person that is (a) the owner of 15% or more of
the outstanding voting stock of the corporation or (b) an affiliate or associate
of the corporation and was the owner of 15% or more of the outstanding voting
stock of the corporation at any time within the three-year period immediately
prior to the date on which it is sought to be determined whether the person is
an interested stockholder.
12
These provisions could also limit the price that future investors might be
willing to pay in the future for our common stock. This could have the effect of
delaying, deferring or preventing a change in control of our Company and/or a
change in the members our Board of Directors. The issuance of preferred stock
could also effectively limit or dilute the voting power of our stockholders.
Accordingly, such provisions of our certificate of incorporation, as amended,
may discourage or prevent an acquisition or disposition of our business that
could otherwise be in the best interest of our shareholders.
INVESTORS SHOULD NOT RELY ON AN INVESTMENT IN OUR COMMON STOCK FOR DIVIDEND
INCOME AS WE DO NOT INTEND TO PAY DIVIDENDS IN THE FORESEEABLE FUTURE.
We do not anticipate paying any cash dividends on our common stock in the
foreseeable future. We intend to retain any earnings to finance the growth of
our business. We cannot assure you that we will ever pay cash dividends.
Therefore, investors should not rely on an investment in our common stock if
they require dividend income. The only income in the foreseeable future such
investors will receive from an investment in our common stock will come from
increases in the market price of our common stock. There can be no assurances
that the market price of our common stock will increase or continue to increase,
and such increases will most likely be uncertain and unpredictable. Whether we
pay any cash dividends in the future will depend on the financial condition,
results of operations and other factors that the Board of Directors will
consider.
IT MAY BE DIFFICULT FOR INVESTORS TO ENFORCE A SERVICE OF PROCESS OR ENFORCE
LIABILITIES AGAINST US.
We are incorporated in the State of Delaware, and our principal executive
offices are located in the State of California. However, substantially all our
fixed assets and operations are located in the PRC. In addition, some of our
directors and officers are Chinese citizens and residents. As a result, it may
be more difficult for investors or other third parties to attach our assets in
enforcement of a judgment against us or to enforce liabilities and obligations
against us in certain circumstances. It may also be difficult to enforce service
of process against directors and officers in China.
ITEM 2. PROPERTY
In June 2002 the Company entered into an agreement with Zoucheng Municipal
Government granting the Company use of at least 15.7 acres in Shandong Province,
China at no cost for 10 years to construct a manufacturing facility. Under the
agreement, the Company has the option to pay a fee of $60,197 per acre for the
land use right at the expiration of the 10-year period. The Company may not
transfer or pledge the temporary land use right. In the same agreement, the
Company has also committed to invest approximately $18 million to $24 million
for developing the manufacturing and research facilities in Zoucheng, Shandong
Province. As of December 31, 2005, the Company had invested approximately $1.4
million for the project. Management believes that neither the Company nor
management will be liable for compensation or penalty if the investment
commitment is not fulfilled. As of December 31, 2004, the first phase of a
three-phase construction plan has been completed and production has begun in the
completed facility. The production capacity of the completed facility is 600
tons of bio-organic product. Completion of the next phase of construction will
expand the manufacturing capcity to 1,000 tons and will enable us to produce the
bacillus fertilizer.
We lease our principal executive offices located at 415 West Foothill Blvd,
Suite 206, Claremont, California 91711-2766. The lease has a term of three years
and expires in March 2008. We currently expect that we will renew this lease
prior to its expiration. During the fiscal year of 2004, we leased our principal
executive offices located at 17700 Castleton Street, Suite 589, City of
Industry, California 91748. Such lease has a term of two years and expired on
June 11, 2005.
We also lease an office in Beijing under an operating lease expiring in June
2008 with an aggregate monthly lease payment of approximately $4,990. We
currently expect that we will renew this lease prior to its expiration. Prior to
relocating our existing Beijing office, we leased another office in Beijing
under an operating lease expiring in April 2005 with an aggregate monthly lease
payment of approximately $2,882.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2005.
13
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
The Company's common stock has been quoted on the OTC Bulletin Board of the NASD
under the symbol "KWBT.OB" since March 30, 2004, and was quoted under the symbol
"TTGM.OB" prior to the merger in March 2004. The merger transaction is described
in "Business-The Company" under Item 1. During 2005, the market price for our
common stock has ranged from $0.059 to $0.007.
The following table sets forth the high and low bid quotations per share of our
common stock as reported on the OTC Bulletin Board for the periods indicated.
The high and low bid quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
-------------------------------------------- -------------------- --------------
Fiscal Year 2004 High Low
-------------------------------------------- -------------------- --------------
First Quarter $0.50 $0.12
Second Quarter $0.75 $0.32
Third Quarter $0.45 $0.09
Fourth Quarter $0.10 $0.06
-------------------------------------------- -------------------- --------------
-------------------------------------------- -------------------- --------------
Fiscal Year 2005 High Low
-------------------------------------------- -------------------- --------------
First Quarter $0.059 $0.0122
Second Quarter $0.023 $0.007
Third Quarter $0.0155 $0.0102
Fourth Quarter $0.014 $0.0091
-------------------------------------------- -------------------- --------------
-------------------------------------------- -------------------- --------------
Fiscal Year 2006 High Low
-------------------------------------------- -------------------- --------------
January 1, 2006 through March 31, 2006 $0.085 $0.0062
-------------------------------------------- -------------------- --------------
The foregoing high and low bid quotations take into account the 1-for-4 stock
split of our shares that occurred during the first quarter of 2004.
Holders
As of December 31, 2005, there were approximately 373 shareholders of record of
our common shares.
Dividends
We have not paid any dividends on our common shares since our inception and do
not anticipate that dividends will be paid at any time in the immediate future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
This Annual Report on Form 10-KSB for the fiscal year ended December 31, 2005
contains "forward-looking" statements within the meaning of Section 21E of the
Securities and Exchange Act of 1934, as amended, including statements that
include the words "believes", "expects", "anticipates", or similar expressions.
These forward-looking statements include, among others, statements concerning
our expectations regarding our working capital requirements, financing
requirements, business, growth prospects, competition and results of operations,
and other statements of expectations, beliefs, future plans and strategies,
anticipated events or trends, and similar expressions concerning matters that
are not historical facts. The forward-looking statements in this Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2005 involve known and
unknown risks, uncertainties and other factors (described in "Business--Risk
Factors" under Item 1) that could cause our actual results, performance or
achievements to differ materially from those expressed in or implied by the
forward-looking statements contained herein.
14
Overview
Our business plan is to develop, manufacture, distribute and market innovative,
cost-effective and environmentally safe bio-technological products for the
agricultural, natural resources and environmental protection markets located
primarily in China. We are also reviewing the feasibility of moving into a
related market to manufacture drugs for avian flu and related applications. We
intend to improve existing products and to develop new products. Our activities
to date have included conducting research and development, acquiring and
developing intellectual property, raising capital, developing a manufacturing
facility, identifying strategic acquisitions and marketing our products. Our
first product, a photosynthesis biological catalyst or "bio-fertilizer", was
introduced in China's agricultural market in November 2003.
The Company took its present corporate form in March 2004 when Tintic Gold
Mining Company, a Utah public corporation, merged with and into Kiwa Bio-Tech
Products Group Ltd., a privately-held British Virgin Islands corporation. See
"Business--The Company" in Item 1. For accounting purposes this transaction was
treated as an acquisition of Tintic Gold Mining Company by Kiwa Bio-Tech
Products Group Ltd. in the form of a reverse triangular merger and a
recapitalization of Kiwa Bio-Tech Products Group Ltd. and its wholly owned
subsidiary, Kiwa Bio-Tech Products (Shandong) Co., Ltd. On July 22, 2004, we
completed our reincorporation in the state of Delaware.
On April 12, 2004, we entered into an agreement with China Agricultural
University to acquire patent Number ZL 93101635.5 entitled "Highly Effective
Composite Bacteria for Enhancing Yield and the Related Methodology for
Manufacturing," which was originally granted by the PRC Intellectual Property
Bureau on July 12, 1996. There are no limitations under this agreement on our
exclusive use of the patent. The patent covers six different species of bacillus
which have been tested as bio-fertilizers to enhance yield and plant health. The
production methods of the six species are also patented. The patent will expire
on February 9, 2013.
By the end of December 31, 2005, we obtained four Fertilizers Registration
Certificates issued by the Chinese government department under which we have
developed nearly 20 series commercialized products, with bacillus and/or
Photosynthesis Biological Catalyst as core ingredients.
We generated approximately $630,000 and $1.3 million in revenue from principal
operations in fiscal years 2005 and 2004, respectively, reflecting a decrease of
51.4%. The marked decrease is due to the temporarily closing of our
manufacturing facility for the planned upgrade to manufacture bacillus
fertilizer and the failure of an anticipated financing in the second half of
2005 to finance the upgrade.
In March 2006, we entered into a purchase agreement with two Chinese investors
to issue 5,000,000 shares of our common stock in a private placement for
Renminbi 6,000,0000 (approximately $750,000). As of April 13, 2006, we had
received approximately $350,000 of the amount committed to under the purchase
agreement, which represents 47% of the total commitment. We have agreed with the
investors to defer funding of the remaining commitment to April 30, 2006. A
portion of the proceeds received from the stock sale were used to retire the
Company's financing arrangement with Cornell Capital. The balance of the
proceeds will be used to settle the outstanding payables to service providers
and for working capital. In April 2006 we are in negotiation but have not yet
concluded convertible note financing for the aggregate amount of up to $4
million. We expect to apply approximately $500,000 of the proceeds from the sale
of the convertible notes to finish the second phase of our construction plan
(including the capability to produce bacillus fertilizer). Approximately $2.5
million will be applied to developing the anti-viral aerosol agent product
mentioned above, approximately $1.0 million of which will be to acquire a
GMP-qualified factory for production and the balance of which will be applied to
development of the product and acquisition of rights and approvals.
Major Customers and Suppliers
We have two significant customers accounting for 51.3% and 45.3%, of our net
sales for the fiscal year ended December 31, 2005, respectively. No other single
customer accounted for more than 3% of our revenues. These two customers are
leading agricultural distributors in the eastern and northern regions of China.
During the fiscal year ended December 31, 2005, the total number of customers
increased although the total sales volume dropped. However, our revenues
generated during the fiscal year ended December 31, 2005 were approximately
$630,000, reflecting a decrease of 51.4% compared to the revenues generated
during the fiscal year ended December 31, 2004. This marked decrease is mainly
due to the temporarily closing of our manufacturing facility for the planned
upgrade and the failure of an anticipated financing in the second half of 2005.
Three suppliers accounted for 64.0%, 17.2% and 12.5% of our net purchases for
the fiscal year ended December 31, 2005, respectively. Our total purchases
increased to $606,965 during the fiscal year 2005 compared with $526,897 during
the fiscal year 2004.
Going Concern
15
Our consolidated financial statements have been prepared assuming that we will
continue as a going concern, which contemplates the realization of assets and
the satisfaction of liabilities in the normal course of business. The carrying
amounts of assets and liabilities presented in the consolidated financial
statements do not purport to represent the realizable or settlement values. We
incurred a net loss of $1,327,759 and $2,728,673 during the fiscal years ended
December 31, 2005 and 2004, respectively, and our current liabilities exceeded
our current assets by $1,006,983 and $55,630 at December 31, 2005 and 2004,
respectively.
Furthermore, we are continuing to develop our manufacturing facility and have
not generated significant revenues from our operations. Until sufficient cash
flow is generated from operations, we will have to utilize our capital resources
or external sources of funding to satisfy our working capital needs. Our
revenues from operations were disappointingly low during 2005 due to the
temporary closing of our manufacturing facility for the planned upgrade to
produce bacillus fertilizer and the failure of an anticipated financing in the
second half of 2005 to fund the upgrade, all of which resulted in a lack of
inventory of both our bacillus fertilizer and our existing products and the
consequent loss of sales. These factors create substantial doubt about our
ability to continue as a going concern.
We generated approximately $630,000 during fiscal year 2005 from sales of our
products. If the Company can achieve the necessary financing to increase its
working capital, we believe the Company will be well-positioned to increase
sales of these products and to generate measurable revenues in 2006.
In March 2006 we entered into a purchase agreement with two Chinese investors to
issue 5,000,000 shares of our common stock in a private placement for RMB
6,000,0000 (approximately $750,000). As of April 13, 2006, we had received
approximately $350,000 of the amount committed to under the purchase agreement,
which represents 47% of the total commitment. We have agreed with the investors
to defer funding of the remaining commitment to April 30, 2006. A portion of the
proceeds received from the stock sale were used to retire the Company's
financing arrangement with Cornell Capital. The balance of the proceeds will be
used to settle the outstanding payables to service providers and for working
capital. In April 2006 we are in negotiation but have not yet concluded
convertible note financing for the aggregate amount of up to $4 million.
Proceeds from the sale of the convertible notes will be used to continue our
planned development of the bacillus fertilizer and the existing business. We
also intend to devote part of the proceeds to develop the anti-viral aerosol
agent product mentioned above and to acquire a GMP-qualified factory for its
production.
In late 2006, we may raise additional capital through the issuance of debt or
equity securities to fund the development of our planned business operations,
although there can be no assurances that we will be successful in obtaining this
financing. To the extent that we are unable to successfully raise the capital
necessary to fund our future cash requirements on a timely basis and under
acceptable terms and conditions, we will not have sufficient cash resources to
maintain operations, and may have to curtail operations and consider a formal or
informal restructuring or reorganization.
Trends and Uncertainties in Regulation and Government Policy in China
AGRICULTURAL POLICY CHANGES IN CHINA
Economic growth in China has averaged 9 1/2 percent over the past two decades
and seems likely to continue at that pace for some time. However China now faces
an imbalance between urban and rural environments as well as the manufacturing
and agricultural industries. Since 2004, the Chinese central government has
adopted a series of effective policies to promote the development of
agriculture. On February 10, 2004, the Chinese central government issued a new
policy to correct the imbalance by offering favorable taxation of agricultural
products. On December 29, 2005, the Standing Committee of the National People's
Congress decided to abolish the agricultural tax starting January 1, 2006. The
abolition of the agricultural tax would increase incomes of farmers and ease
their financial burdens. Each of (1) Decision of the State Council on
Implementing the Interim Regulation on Promoting the Adjustment of Industrial
Structure promulgated by the State Council on December 7, 2005, (2) Guiding
Catalogue for the Adjustment of Industrial Structure issued by the State
Council, the National Development and Reform Commission on December 7, 2005, and
(3) Outline of National Medium and Long-Term Plans for Science & Technology
Development (2006-2020) promulgated by the State Council on February 9, 2006
adopted policies favorable to agriculture. We should benefit from these
favorable policies as farmers will retain more of their income and will most
likely spend some of that income on our products, resulting in greater sales. In
addition, we anticipate receiving additional governmental support in marketing
our products to farmers due to additional procedural changes included with the
new policy.
GENERAL FISCAL AND MONETARY POLICY CHANGES IN CHINA
The volatility in the inflation rate in China in the past decade (almost eight
times that in the United States and four times that in Western Europe) suggests
that China's domestic monetary policy has not always been successful in
maintaining low and stable inflation. In recent years, China has been adopting
restricted or prudent fiscal and monetary policies to fight potential inflation.
However, the agricultural area has been one of a few industries which will
continue to enjoy expansionary policy. We have previously benefited from
16
these policies, as evidenced by our receipt of non-interest bearing loans of
over $1.5 million from the Chinese government so far. As the government further
increases investment in the agricultural area, we believe that similar loans or
other favorable financing programs will be made available to us in the future,
which we anticipate will assist us with managing liquidity and capital resources
during our growth period. However, if these financing programs are not made
available in the future, we may have to borrow on terms which are less favorable
to us, or we may not be able to borrow additional funds at all on terms which
are acceptable.
FOREIGN INVESTMENT POLICY CHANGES
The Chinese government is considering changes to its current policy that provide
favorable tax treatment to foreign invested enterprises as compared to Chinese
domestic business. The new policy under consideration will consolidate
enterprise income tax laws between foreign invested enterprises and Chinese
domestic enterprises. The new policy will also provide transitional arrangements
to facilitate the consolidation. No timetable has been announced yet for the
consolidation. If the new policy is implemented, newly established foreign
invested enterprises will not enjoy favorable tax treatment as in effect under
current tax laws. It is anticipated that the proposed policy will not have an
impact on companies like ours, which have already been granted favorable tax
treatment. We believe this beneficial tax status will make an investment in our
Company more attractive to both foreign and domestic investors in China, which
could improve our liquidity or provide additional capital resources. However, if
we were to be subject to such new policies, our tax rate and tax liability would
increase.
FOREIGN EXCHANGE POLICY CHANGES
China is considering allowing its currency to be freely exchangeable for other
major currencies. This change will result in greater liquidity for revenues
generated in Renminbi ("RMB"). We would benefit by having easier access to and
greater flexibility with capital generated in and held in the form of RMB. The
majority of our assets are located in China and most of our earnings are
currently generated in China, and are therefore denominated in RMB. Changes in
the RMB-U.S. Dollar exchange rate will impact our reported results of operations
and financial condition. In the event that RMB appreciates over the next year as
compared to the U.S. Dollar, our earnings will benefit from the appreciation of
the RMB. However, if we have to use U.S. Dollars to invest in our Chinese
operations, we will suffer from the depreciation of U.S. Dollars against the
RMB. On the other hand, if the value of the RMB were to depreciate compared to
the U.S. Dollar, then our reported earnings and financial condition would be
adversely affected when converted to U.S. Dollars.
On July 21, 2005, the People's Bank of China announced it would appreciate the
RMB, increasing the RMB-U.S. Dollar exchange rate from approximately US$ 1.00 =
RMB 8.28 to approximately US$ 1.00 = RMB 8.11. So far the trend of such
appreciation is still continuous; the exchange rate of U.S. Dollar against RMB
on March 31, 2006 was 1:8.0170.
Critical Accounting Policies and Estimates
We prepared our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires the use of estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period.
Management periodically evaluates the estimates and judgments made. Management
bases its estimates and judgments on historical experience and on various
factors that are believed to be reasonable under the circumstances. Actual
results may differ from these estimates as a result of different assumptions or
conditions.
The following critical accounting policies affect the more significant judgments
and estimates used in the preparation of our consolidated financial statements.
ACCOUNTS RECEIVABLES
We perform ongoing credit evaluations of our customers by analyzing historical
bad debts, customer concentrations, customer credit worthiness, current economic
trends and changes in customer payment patterns, and intend to establish an
allowance for doubtful accounts when amounts are not considered fully
collectible or when they are more than 365 days past due.
Accounts receivables over one year period amounted to $65,772 and $82,942 as of
December 31, 2005 and March 31, 2006, respectively. Though we have no conclusive
indication of insolvency from any of our customers, for the sake of prudence, we
accrued bad debt allowance of $82,942 equal to the account receivables more than
one year old as of March 31, 2006.
17
Terms of our sales vary from cash on delivery to a credit term up to three to
twelve months. Ordinarily, we require our customers to pay between 20% and 60%
of the purchase price of an order placed, depending on the results of our credit
investigations, prior to shipment. The remaining balance is due within twelve
months, unless other terms are approved by management. As stated in the
"Business--Risk Factors" under Item 1, the agriculture-biotechnology market in
China is in the early stages of development and we are still in the process of
exploring the new market. We may also distribute our bio-products to special
wholesalers with favorable payment terms with a focus on the future. We maintain
a policy that all sales are final and we do not allow returns. However, in the
event of defective products, we may allow customers to exchange the defective
products for new products within 90 days of delivery. In the event of any
exchange, the customers pay all transportation expenses.
INVENTORIES
Inventories are stated at the lower of cost or net realizable value. Cost is
determined on the weighted average method. Inventories include raw materials,
work-in-progress, finished goods and low-value consumables. Net realizable value
is the estimated selling price in the ordinary course of business, less
estimated costs to complete and dispose. Management believes that there was no
obsolete inventory as of December 31, 2005.
REVENUE RECOGNITION
We recognize revenue in accordance with Securities and Exchange Commission Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements", as amended by SAB No. 104, "Revenue Recognition". Sales represent
the invoiced value of goods, net of value added tax, supplied to customers, and
are recognized upon delivery of goods and passage of title.
In general we maintain a policy that all sales are final and we do not allow
returns. As discussed below under the heading, "Results of Operations",
management approved an isolated return of an export sale to a Cambodia
distributor because the distributor was experiencing cash flow difficulties.
Management continues to evaluate and estimate expected returns at the time of
sale. If a return is estimated, a reserve account is recorded to offset sales.
As at December 31, 2005 we had determined that there are no significant
estimated returns.
IMPAIRMENT OF ASSETS
Our long-lived assets consist of property and equipment and intangible assets.
As of December 31, 2005, the net value of property and equipment and intangible
assets was $1,436,866 and $410,586, respectively, which represented
approximately 46.0% and 13.2% of our total assets, respectively.
We periodically evaluate our investment in long-lived assets, including property
and equipment, for recoverability whenever events or changes in circumstances
indicate the net carrying amount may not be recoverable. Our judgments regarding
potential impairment are based on legal factors, market conditions and
operational performance indicators, among others. In assessing the impairment of
property and equipment, we make assumptions regarding the estimated future cash
flows and other factors to determine the fair value of the respective assets. If
these estimates or the related assumptions change in the future, we may be
required to record impairment charges for these assets.
As discussed above, our production facilities were temporarily closed in the
second half of 2005, with production resuming in early 2006. Based on our
analysis, we have determined that there was no impairment to our current
production facilities as of December 31, 2005.
INCOME TAXES
We record a valuation allowance to reduce our deferred tax assets arising from
net operating loss carryforwards to the amount that is more likely than not to
be realized. In the event we were to determine that we would be able to realize
our deferred tax assets in the future in excess of our recorded amount, an
adjustment to the deferred tax assets would be credited to operations in the
period such determination was made. Likewise, should we determine that we would
not be able to realize all or part of our deferred tax assets in the future, an
adjustment to the deferred tax assets would be charged to operations in the
period such determination was made.
Results of Operations
TWELVE MONTHS ENDED DECEMBER 31, 2005 AND 2004
Net Sales. Net sales were $631,794 and $1,300,251 for the twelve months ended
December 31, 2005 and 2004, respectively, representing a decrease of 51.4%. The
severe decrease in sales revenue is due to the temporary closing of our
manufacturing facility for the planned upgrade to produce bacillus fertilizer
and the failure of an anticipated financing in the second half of 2005 to fund
the upgrade, all of which resulted in a lack of inventory of both our bacillus
fertilizer and our existing products and the consequent loss of sales. In
addition, the Company entered into a sales agreement to sell fertilizer products
amounted to $385,530 to a Cambodian customer in March 2005. However, the
customer did not settle the payment in according to the agreement. In November
2005, the customer agreed to return the products to the Company and thus the
previously recognized revenue is reversed.
18
Cost of Sales. Cost of sales were $232,692 and $641,236 for the twelve months
ended December 31, 2005 and 2004, respectively. The decrease of $408,544 or
63.7% in cost of sales was primarily due to the severe decrease of sales.
Gross (Loss) Profit. Gross (loss) profit was $399,102 and $659,015,
respectively, representing a profit margin of 63.2% and 50.7% for the twelve
months ended December 31, 2005 and 2004, respectively. This $259,913 (39.4%)
decrease was due to our decreased sales in 2005.
Consulting and Professional Fees. Consulting and professional fees were $614,532
and $448,442 for the twelve months ended December 31, 2005 and 2004,
respectively, representing an increase of $166,090 or 37.0%. Most of these fees
are related to fund-raising, investor relations, public company operations and
marketing. The increase in consulting and professional fees in 2005 is primarily
attributable to consulting and professional fees relating to investor relation
service, market consulting services and financing commissions.
Officers' Compensation. Officers' compensation decreased by $38,671 or 50% to
$38,727 for the twelve months ended December 31, 2005, as compared to $77,398
for the comparable period of 2004. The decrease is mainly due to reduction in
compensation to one of our officers.
General and Administrative. General and administrative expenses were $664,637
for the twelve months ended December 31, 2005, as compared to $598,492 for the
same period of 2004, an increase of $66,145 or 11.1%. The increase is largely
attributable to the accrued bad debt allowance of $82,942 in 2005, and there was
no bad debt allowance for the comparable period in 2004. General and
administrative expenses include salaries, travel and entertainment, rent, office
expense, telephone expense and insurance costs, and other marketing expenses.
Research and Development. Research and development expenses decreased by $38,358
to $11,264, or 77.3%, for the twelve months ended December 31, 2005, as compared
to $49,622 for the twelve months ended December 31, 2004. This decrease is
attributable to the reduced expenses related to field testing of our products
for sales licenses granted in 2005 and insufficiency of working capital in the
second half of 2005.
Depreciation and Amortization. Depreciation and amortization, excluding
depreciation and amortization included in cost of production, increased $53,485
to $106,283, or 101.3%, for the twelve months ended December 31, 2005, as
compared to $52,798 for the same period of 2004. The increase in amount
amortized is due to the fact that patents were amortized for a full year in 2005
but for only four months in 2004.
Reverse Merger Costs. The reverse merger costs are non-recurring and there was
no reverse merge cost in 2005. In 2004, reverse merger costs equaled $1,417,434,
which included non-cash costs relating to the issuance of the warrants and
options of $1,114,380 to consultants.
Net Interest Income (Expense). Net interest expense decreased by $293,834 to
$510,079, a 63.5% reduction, for the twelve months ended December 31, 2005, as
compared to interest expense of $803,913 for the same period of 2004. The
factors associated with this decrease include the following: (1) amortization of
beneficial conversion feature of convertible loan charged as interest expenses
in 2005 was only $106,666, representing a decrease of $593,334, compared to
$700,000 in 2004; (2) amortization of fair value of warrants in 2005 was
$78,446, representing an increase of $33,813, compared to $44,633 in 2004; (3)
net interest on loan principle is $108,722, representing an increase of $49,442,
compared to $59,280 in 2004.
Other Income. We had other income of $2,416 for the period ended December 31,
2005, generated from a grant from the municipal government in Shandong Province
of China during 2005. In 2004, we had other income of $60,411 attributable to
the forgiveness by Zoucheng Science & Technology Bureau (Shandong Province,
China) of money we borrowed in 2003.
Comprehensive Income (Loss). Comprehensive income (loss) decreased by $1,423,272
to $1,305,401 for the twelve months ended December 31, 2005, as compared to
$2,728,673 for the comparable period of 2004. The decrease in comprehensive loss
in the current year as compared to the comparable year period in 2004 is
primarily due to non-recurring costs of the reverse merger equal to $1,417,434
and the decrease of interest expense resulting from the termination of the
conversion feature of a convertible note that was converted to common stock on
June 8, 2004.
19
Liquidity and Capital Resources
Since inception of our ag-biotech business in 2002, we have relied on the
proceeds from the sale of our equity securities and loans from both unrelated
and related parties to provide the resources necessary to fund the development
of our business plan and operations. During the fiscal year ended December 31,
2005, we raised $1,208,501 in debt financing, of which $720,000 was raised in
the form of convertible notes from four unrelated parties and $488,501 from two
related parties.
Our current liabilities exceed our current assets and we continue to suffer
losses. In the second half of 2005, we suffered an insufficiency of working
capital that was resulted by the temporarily closing of the manufacturing
facility for planned upgrade and the failure of an anticipated financing in the
second half of 2005. Our sales volume in the second half of 2005 declined
severely as a result of the temporarily closing of the manufacturing facility
and the delay of the launching of the new bacillus fertilizers as planned.
We will require additional capital to fund our business plan and to develop our
manufacturing facility. We have not generated significant revenues from our
operations for such purposes. In March 2006, we entered into a purchase
agreement with two Chinese investors to issue 5,000,000 shares of our common
stock in a private placement for RMB 6,000,0000 (approximately $750,000). As of
April 13, 2006, we had received approximately $350,000 of the amount committed
to under the purchase agreement, which represents 47% of the total commitment.
We have agreed with the investors to defer funding of the remaining commitment
to April 30, 2006. In April 2006 we are in negotiation but have not yet
concluded convertible note financing for the aggregate amount of up to $4
million. These amounts may not be sufficient to allow us to implement our
business plan. In the remaining period of 2006, we may raise additional capital
through the issuance of debt or equity securities to fund the development of our
planned business operations, although there can be no assurances that we will be
successful in this regard. There can be no assurances that we will be able to
obtain sufficient funds to allow us to continue operations and to develop our
facilities and products as scheduled.
In November 2002 and June 2003, we borrowed money from a local bank in Beijing
to purchase two automobile purchases. The borrowing was in the form of two loans
for $38,663 and $25,498, with interest rates of 5.32% and 5.02%, respectively.
The maturity dates are October 2007 and March 2008, respectively. As of December
31, 2005, the outstanding balances of these loans were $11,768 and $15,772,
respectively.
In 2005, we borrowed $310,464 from China Star Investment Group ("China Star"),
$199,514 of which were pursuant to Advance Agreements entered into with China
Star, and the balance of $110,950 which were Company expenses and other
obligations paid by China Star and booked as accounts payable to China Star. The
Advance Agreements are unsecured and bear interest at 12% per annum, and are due
180 days from the date of draw down. The Company has also granted detachable
warrants to China Star to purchase 997,571 shares of our common stock. In 2005,
we repaid China Star $159,404. As of December 31, 2005, the total outstanding
balance owed to China Star under the loan and for all other obligations was
$263,165, consisting of a $112,105 existing balance owed to China Star as of
December 31, 2004 and a net increase in borrowings from China during 2005 of
$151,060.
On May 23, 2005, we entered into a loan agreement for $156,685 from the
Company's Chairman of the Board and the Chief Executive Officer, Mr. Wei Li
("Mr. Li") and subsequently repaid $4,337 to him. The loans were unsecured and
bore interest at 12% per annum with the period of 180 days since the date of
draw down. This loan has been extended to June 30, 2006. Mr. Li has also paid
certain operating expenses on behalf of the Company during the fiscal year of
2005. As of December 31, 2005, the total outstanding balance owed to Mr. Li
under the loan and for other obligations was $191,861.
As of March 31, 2006, the Company terminated its Standby Equity Distribution
Agreement financing arrangement with Cornell Capital. The associated promissory
note, $400,000 original principal amount (the "Cornell Note"), had a total of
$110,176.10 principal and interest outstanding on March 31, 2006 when it was
fully paid-off with a payment for that amounts from the proceeds of 5,000,000
shares of stock issued in a private placement to Chinese investors and the loan
from a related party, China Star. On March 31, 2006, the Company signed a
Termination Agreement with Cornell Capital, Butler Gonzalez LLP or its successor
and Newbridge Securities Corporation in which Cornell Capital acknowledged full
satisfaction of the Cornell Note and released the Company from all liability
under the Cornell Note and the Standby Equity Distribution Agreement. In
connection with the settlement Cornell Capital returned 5,864,357 collateral
shares of the Company's common stock to the Company.
On May 30, 2005 and June 16, 2005, the Company entered into three convertible
promissory note agreements for the aggregate of $320,000 with interest at 12%
per annum (the "12% Loans"), and issued 1,600,000 detachable warrants. The
lenders are unrelated parties located in the United States. The 12% Loans were
initially due in three months from date of draw down, but the final maturity
dates were extended for another three months. Mr. Li has provided personal
guarantees for the 12% Loans. As part of the loan terms, the lenders have the
right to convert the 12% Loans into shares of the Company's common stock at any
time prior to the maturity. The conversion price is based on 75% of the closing
quote of the Company's common stock on the date of conversion. The Company did
not pay the 12% Loans by the extended maturity date. We have received a notice
from one of the lenders of his intention to convert $150,000 of the 12% Loans to
the Company's common stock in April 2006. We are now in negotiations with the
lenders holding the remaining balance of $170,000 to extend the payment date. We
have not received from the lenders and notice of default or demand for immediate
payment.
20
We qualified for non-interest bearing loans under a government sponsored program
to encourage economic development in certain industries and locations. As of
December 31, 2005, we had obtained non-interest bearing loans from the Chinese
local government of approximately $1,510,264, of which $1,424,996 is currently
outstanding. We are required to begin repayment of the outstanding balance of
the loans in the first year after our Chinese subsidiary reaches an accumulative
profit position. The entire balance is to be fully repaid within three years
thereafter.
At December 31, 2005 and 2004, we had cash of $14,576 and $17,049, respectively.
As of December 31, 2005 and 2004, our net working capital (deficiency) was
($1,006,983) and ($55,630), respectively, reflecting current ratios of 0.56:1
and 0.96:1, respectively, at such dates.
During the fiscal year ended December 31, 2005, our operations utilized cash of
$419,827 as compared to $1,149,909 utilized for the fiscal year ended December
31, 2004.
During the fiscal year ended December 31, 2005, we utilized cash of $229,989 for
investing activities consisting primarily of property and equipment purchases.
This was offset in part by collections due from other receivables. Cash utilized
for investing activities during the fiscal year ended December 31, 2004, was
$219,645, which reflects a 4.7% increase which is primarily resulted from the
purchase of research equipments during the fiscal year of 2005.
During the fiscal year ended December 31, 2005, we generated a net of $632,570
from financing activities, consisting of the proceeds from convertible notes
payable of $720,000 and loans advanced from related parties of $488,501, offset
in part by the repayment of a short-term loan of $50,000, to related parties of
$163,741, convertible notes payable of $350,000 and long-term borrowings of
$12,190. During the fiscal year ended December 31, 2004, we generated $1,337,873
from financing activities through increases in convertible loans and long-term
borrowings.
If we can achieve the necessary financing, our plan is to continue to develop
our manufacturing facility. As of March 31, 2006, we have invested approximately
$1.4 million in the first phase of our manufacturing facility, including $1
million in buildings and $45,000 in equipment. We estimate that the total
investment for the completion of the construction of our manufacturing facility
for bacillus fertilizer and anti-viral aerosol agent products and the respective
marketing and distribution costs will be approximately$4 millions over an
estimated 2 years.
We do not anticipate generating sufficient positive internal operating cash flow
to fund our planned operations for several years. In the next year, we intend to
raise additional capital through the issuance of debt or equity securities to
fund the development of our planned business operations, although there can be
no assurances that we will be successful in obtaining this financing. To the
extent that we are unable to successfully raise the capital necessary to fund
our future cash requirements on a timely basis and under acceptable terms and
conditions, we will not have sufficient cash resources to maintain operations,
and may have to curtail operations and consider a formal or informal
restructuring or reorganization.
Inflation and Currency Matters
In the most recent decade, the Chinese economy has experienced periods of rapid
economic growth as well as relatively high rates of inflation, which in turn has
resulted in the periodic adoption by the Chinese government of various
corrective measures designed to regulate growth and contain inflation. Our
success depends in substantial part on the continued growth and development of
the Chinese economy.
Foreign operations are subject to certain risks inherent in conducting business
abroad, including price and currency exchange controls, and fluctuations in the
relative value of currencies. We conduct virtually all of our business in China
and, accordingly, the sale of our products is settled primarily in RMB. As a
result, devaluation or currency fluctuation of the RMB against the U.S. Dollar
would adversely affect our financial performance when measured in U.S. Dollars.
Although prior to 1994 the RMB experienced significant devaluation against the
U.S. Dollar, the RMB has remained fairly stable since then. In addition, the RMB
is not freely convertible into foreign currencies, and the ability to convert
the RMB is subject to the availability of foreign currencies. Effective December
1, 1998, all foreign exchange transactions involving the RMB must take place
through authorized banks or financial institutions in China at the prevailing
exchange rates quoted by the People's Bank of China. The exchange rate was
approximately $1.00 to RMB 8.28 at December 31, 2004. On July 21, 2005, the
People's Bank of China increased the US$-RMB exchange rate to approximately US$
1.00 = RMB 8.11. So far the trend of such appreciation is still continuous, the
exchange rate on March 31, 2006 of U.S. Dollar against RMB is 1:8.0170. This
change results in greater liquidity for revenues generated in RMB. We benefit by
having easier access to and greater flexibility with capital generated in and
held in the form of RMB.
21
As China has recently been admitted as a member of the World Trade Organization,
the central government of China is expected to adopt a more rigorous approach to
partially deregulate currency conversion restrictions, which may in turn
increase the exchange rate fluctuation of the RMB. Should there be any major
change in the central government's currency policies, we do not believe that
such an action would have a detrimental effect on our operations, since we
conduct virtually all of our business in China, and the sale of our products is
settled in RMB.
Commitments and Contingencies
The Company has the following material contractual obligations:
Operating lease commitments - The Company previously leased an office in Beijing
under an operating lease that expired in April 2005 with an aggregate monthly
lease payment of approximately $2,882. This operating lease was replaced by
another operating lease expiring in March 2008 with an aggregate monthly lease
payment of approximately $4,990. Rent expense under the operating leases for the
fiscal year ended December 31, 2005 was $52,416.
The Company previously leased an office in the United States under a commercial
lease agreement with China Star that expired in June 2005 with an aggregate
monthly lease payment of approximately $2,560. This operating lease was replaced
by another operating lease with a third party expiring in June 2008 with an
aggregate monthly lease payment of approximately $1,000. Pursuant to the lease
agreement, rent expense for the fiscal year ended December 31, 2005 was $20,763.
At December 31, 2005, the remaining minimum lease payments amounted to $29,833.
In December 2004, we entered into an agreement with Mr. Li, pursuant to which
Mr. Li leased the Company a motor vehicle. The monthly rental payment is $1,812
and the Company made no payments of rental expenses for the fiscal year ended
December 31, 2005.
Off-Balance Sheet Arrangements
At December 31, 2005, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have been
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. As such, we are not exposed to
any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
Recent Accounting Pronouncements
In September 2004, Emerging Issues Task Force ("EITF") reached a consensus on
EITF Issue No. 04-08 ("EITF 04-08"), "The Effect of Contingently Convertible
Debt on Diluted Earnings per Share." Under current interpretations of FASB No.
128, "Earnings per Share," issuers of contingently convertible debt instruments
("Co-Cos") generally exclude the potential common stocks underlying the Co-Cos
from the calculation of diluted earnings per share until the underlying common
stock achieves a specified price target, or other contingency is met. EITF 04-08
requires that Co-Cos should be included in diluted earnings per share
computations, if dilutive, regardless of whether the market price trigger has
been met. We do not anticipate that the adoption of EITF 04-08 will have a
significant effect on our earnings or financial position.
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151, Inventory Costs,
which clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material. SFAS No. 151 will be effective for
inventory costs incurred during fiscal years beginning after June 15, 2005. We
do not believe the adoption of SFAS No. 151 will have a material impact on our
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123-R, Share Based Payments, which
requires that the compensation cost relating to share-based payment transactions
(including the cost of all employee stock options) be recognized in the
financial statements. The cost will be measured based on the estimate fair value
of the equity or liability instruments issued. SFAS 123-R covers a wide range of
share-based compensation arrangements including share options, restricted share
plans, performance-based awards, share appreciation rights, and employee share
purchase plans. Management believes the adoption of this pronouncement will not
have a material effect on our consolidated financial statements.
22
Also, in December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions". The amendments made by SFAS No. 153 are based on the principle
that the exchange of nonmonetary assets should be measured using the estimated
fair market value of the assets exchanged. SFAS No. 153 eliminates the narrow
exception for nonmonetary exchanges of similar productive assets, and replaces
it with a broader exception for exchanges of nonmonetary assets do not have
commercial substance. A nonmonetary exchange has "commercial substance" if the
future cash flows of the entity are expected to change significantly as a result
of the transaction. This pronouncement is effective for monetary exchanges in
fiscal periods beginning after June 15, 2005. Management believes the adoption
of this pronouncement will not have a material effect on our consolidated
financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections". This statement requires entities that voluntarily make a change in
accounting principle to apply that change retrospectively to prior periods'
financial statements, unless this would be impracticable. SFAS No. 154
supersedes APB Opinion No. 20, "Accounting Changes", which previously required
that most voluntary changes in accounting principle be recognized by including
in the current period's net income the cumulative effect of changing to the new
accounting principle. SFAS No. 154 also makes a distinction between
"retrospective application" of an accounting principle and the "restatement" of
financial statements to reflect the correction of an error. SFAS No. 154 applies
to accounting changes and error corrections that are made in fiscal years
beginning after December 15, 2005. Management believes the adoption of this
statement will not have an immediate material impact on the consolidated
financial statements of the Company.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"),
"Accounting for Conditional Asset Retirement Obligations". FIN 47 clarifies that
the term "conditional asset retirement obligation", which as used in SFAS No.
143, "Accounting for Asset Retirement Obligations", refers to a legal obligation
to perform an asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the
control of the entity. The entity must record a liability for a "conditional"
asset retirement obligation if the fair value of the obligation can be
reasonably estimated. FIN 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. The adoption of this statement does not have an
immediate material impact on the consolidated financial statements of the
Company.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed
by management to have a material impact on the Company's present or future
consolidated financial statements.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of Kiwa Bio-Tech Products Group
Corporation and its subsidiaries including the notes thereto, together with the
report thereon of Mao & Company, CPAs, Inc. and Grobstein, Horwath & Company,
LLP are presented beginning on page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On March 13, 2006, Grobstein, Horwath & Company LLP informed the Company by
written letter that it was resigning as the certifying accounting firm for the
Company and its subsidiaries effective immediately. Effective March 14, 2006,
our board of directors approved the selection of Mao & Company, CPAs, Inc. as
our certifying accounting firm for the fiscal year ending December 31, 2005.
During March 2004, we completed a stock exchange transaction with the
shareholders of Kiwa Bio-Tech Products Group Ltd. ("Kiwa Bio-Tech") resulting in
Kiwa Bio-Tech becoming a wholly owned subsidiary of the Company. This stock
exchange transaction also resulted in a recapitalization of the Company with
Kiwa Bio-Tech becoming the surviving entity of the transaction for accounting
purposes. Grobstein, Horwath & Company, LLP audited Kiwa Bio-Tech's financial
statements for the period from June 5, 2002 (date of inception) to December 31,
2002 and the fiscal year ended December 31, 2003. Grobstein, Horwath & Company,
LLP's reports for those periods did not contain an adverse opinion or a
disclaimer of opinion, and were not qualified or modified as to uncertainty,
audit scope or accounting principles.
During the Company's fiscal year ended December 31, 2004, for which audit
services were provided by Grobstein, Horwath & Company, LLP, and through March
13, 2006, there were no disagreements with Grobstein, Horwath & Company, LLP on
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope and procedures, which, if not resolved to the
satisfaction of Grobstein, Horwath & Company, LLP, would have caused them to
make reference to the subject matter in their report.
Prior to Mao & Company, CPAs, Inc. becoming our independent registered public
accounting firm, neither we, nor anyone on our behalf, consulted with Mao &
Company, CPAs, Inc. regarding either the application of accounting principles to
a specific or contemplated transaction or the type of audit opinion that might
be rendered on our financial statements.
23
ITEM 8A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including the
Chief Executive Officer and Chief Financial Officer, we have evaluated the
effectiveness of our disclosure controls and procedures pursuant to Rule
13a-15(b) of the Securities and Exchange Act of 1934 as of the end of the period
covered by this Annual Report on Form 10-KSB. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer have concluded that these
disclosure controls and procedures are effective. There were no changes in the
Company's internal control over financial reporting during the quarter ended
December 31, 2005 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
We plan to evaluate the level of our internal controls, identify certain
possible matters involving internal control deficiencies and adopt remedial
measures according to the Committee of Sponsoring Organizations of the Treadway
Commission framework in 2006 with the assistance of a professional internal
control consultant. We believe we can meet the requirements as defined in
Section 404 of Sarbanes-Oxley Act of 2002 by the end of 2006.
ITEM 8B. OTHER INFORMATION
NOT APPLICABLE.
24
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The following table provides information about our executive officers and
directors and their respective age and position as of March 31, 2006. The
directors listed below will serve until the Company's next annual meeting of the
shareholders:
Name Age Position
----------------------- ------- --------------------------------------------
Wei Li 44 Chief Executive Officer and Chairman of the
Board of Directors
Lian jun Luo 36 Chief Financial Officer and Director
Da chang Ju 65 Director
Yun long Zhang 42 Director
Johnson Shun-Pong Lau 32 Chief Operating Officer
Qi Wang 39 Vice President - Technical
Wei Li became our Chief Executive Officer and Chairman of the Board of Directors
on March 12, 2004. From January 1, 2004 to the time of the Tintic/Kiwa merger,
Mr. Li was the acting Chief Executive Officer of Kiwa Bio-Tech Products Group
Ltd. Mr. Li founded Kiwa Bio-Tech Products Group Ltd. to capitalize on the
growth of the ag-biotechnology industry in China. Prior to founding Kiwa
Bio-Tech Products Group Ltd., Mr. Li founded China Star, an entity which
provides integrated financing services and/or venture investments to growth
businesses in China. Mr. Li served as President of China Star from June 1993 to
January 2004. In 1989, Mr. Li founded Xinhua International Market Development
Ltd., a company which engaged in investing in China's high tech, pharmaceutical,
medical device, media, entertainment and real estate industries. Mr. Li holds a
B.S. in finance from Hunan Finance and Economics University.
Lian jun Luo became our Chief Financial Officer on March 12, 2004, and one of
our directors on March 27, 2004. Mr. Luo served as the Chief Executive Officer
of Kiwa Bio-Tech Products Group Ltd. from October 2002 to December 2003. From
January 2002 to October 2002, Mr. Luo served as the Chief Financial Officer of
China Star. From August 2000 to December 2001, Mr. Luo served as manager of
Security Department and Assistant to President at Jilin Hengfa Group Ltd., a
Chinese drug manufacturing company, responsible for the company's preparation
for an aborted IPO and for merger and acquisition activities. From May 1998 to
July 2000, Mr. Luo worked as manager of Investment Department and Associate
General Manager for Hongli Enterprise Ltd, a Chinese investment company on
merger and acquisition transactions. Mr. Luo obtained his law degree from China
University of Political Science and Law in 1993. Mr. Luo is a certified public
accountant and lawyer in China.
Da chang Ju became one of our directors on March 12, 2004. From 1987 to 1999
when he retired, Mr. Ju worked as General Manager of XinShen Company, an
investment firm in China. He was responsible for the company's daily operations
and investment decision making. He served as a board member of Kiwa Bio-Tech
Products Group Ltd. since 2003 and a board member of China Star from 1999 to
2000. Mr. Ju holds a B.S. in mathematics from Capital Normal University in
Beijing, China.
Yun long Zhang became one of our directors on March 27, 2004. From May 2000 to
present, Mr. Zhang has been the General Manager of China Star, responsible for
the group's daily operations. From 1994 to 2000, Mr. Zhang served as the head of
the Investment Department at China National Economic and Systems Reform Research
and Services Center, an economic reform think tank for the central government.
Mr. Zhang holds a degree in statistics.
Johnson Shun-Pong Lau became our Chief Operating Officer on July 19, 2005. Mr.
Lau served as the Vice President - Finance of a company listed on the OTC
Bulletin Board from August 2004 to April 2005. Prior to that, Mr. Lau worked in
the audit department of the Hong Kong and Beijing offices of Deloitte Touche
Tohmatsu for over seven years. Mr. Lau received his bachelor's degree of
commerce from Monash University, Australia in 1996. He is a Certified Public
Accountant in Hong Kong Institute of Certified Public Accountants (HKICPA) and a
Certified Practising Accountant of CPA Australia.
Qi Wang became our Vice President - Technical on July 19, 2005. Mr. Wang served
as a Professor and Advisor for Ph.D students in Department of Plant Pathology,
China Agricultural University ("CAU") since January 2005. Prior to that, he
served as an assistant professor and lecturer of CAU since June 1997. He
obtained his master degree and Ph.D in agricultural science from CAU in July
1994 and July 1997, respectively. Mr. Wang received his bachelor's degree of
science from Inner Mongolia Agricultural University in July 1989. He is a
committee member of various scientific institutes in China, including the
National Research and Application Center for Increasing-Yield Bacteria, Chinese
Society of Plant Pathology, Chinese Association of Animal Science and Veterinary
Medicine.
25
Family Relationships
There are no family relationships among our directors or executive officers.
Section 16(a) Beneficial Ownership Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our officers,
directors and certain persons holding more than 10 percent of a registered class
of our common stock to file with the Securities and Exchange Commission initial
reports of ownership and reports of changes in ownership of our common stock.
Officers, directors and certain other shareholders are required by the
Securities and Exchange Commission to furnish the Company with copies of all
Section 16(a) forms they file. To the best of the Company's knowledge, based
solely upon a review of the copies of such reports, during 2005, all of the
required filings were made on a timely basis.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics (the "Code") that is
applicable to all employees, consultants and members of the Board of Directors,
including the Chief Executive Officer, Chief Financial Officer and Secretary.
This Code embodies our commitment to conduct business in accordance with the
highest ethical standards and applicable laws, rules and regulations. We will
provide any stockholder a copy of the Code, without charge, upon written request
to the Company's Secretary.
Board Composition and Audit Committee
The board of directors is currently composed of four members, including Wei Li,
Lian jun Luo, Da chang Ju and Yun long Zhang. All board actions require the
approval of a majority of the directors in attendance at a meeting at which a
quorum is present.
We currently do not have an audit committee. We intend, however, to establish an
audit committee of the board of directors as soon as practicable. We envision
that the audit committee will be primarily responsible for reviewing the
services performed by our independent auditors, evaluating our accounting
policies and our system of internal controls.
ITEM 10. EXECUTIVE COMPENSATION
Summary Compensation Table
Our chief executive officer does not earn any compensation during 2005 and 2004.
We had no officers or directors in 2004 and 2005 whose total annual salary and
bonus during 2005 and 2004 exceeded $100,000.
Annual Compensation
Name and Principal Position Year Salary ($) Bonus ($) All Other Compensation ($) Securities Underlying Options
-------------------------- ---- ---------- --------- -------------------------- -----------------------------
Wei Li(1) 2005 - - - -
2004 - - - -
-------------------------------------
(1) Appointed Chief Executive Officer and a director of the Company in June
2004.
2004 Stock Incentive Plan
On May 10, 2004, our Board of Directors determined that it was in our best
interest to provide equity incentives to certain of our directors, officers and
employees and/or consultants and adopted, subject to stockholder approval, our
2004 Stock Incentive Plan (the "2004 Stock Plan"). On June 3, 2004, our
stockholders approved the 2004 Stock Plan. Under the 2004 Stock Plan, we may
issue to qualifying participants options and stock purchase rights with respect
to up to 1,047,907 shares of our common stock, of which not more than 350,000
shares may be granted to any participant in any fiscal year. This key aspect of
our compensation program is designed to attract, retain, and motivate the highly
qualified individuals required for our long-term success. As of December 31,
2005, we had not made any grants under our 2004 Stock Plan.
The options of the 2004 Stock Plan will expire ten years from the date of grant.
The options which are not issued to an officer, a director or a consultant, will
become exercisable at least as rapidly as 20% per year over the five-year period
commencing on the date of grant.
Stock Option and stock appreciation rights Granted in 2005
26
We did not grant any stock options or stock appreciation rights ("SARs") to any
officers or directors during 2005.
Aggregate Option and SAR Exercises in 2005 and Fiscal Year-End Values
No stock options or SARs were exercised by any officers or directors. At
December 31, 2005, none of the Named Executive Officers held any stock options
or SARs. The Company did not adjust or amend the exercise price of any stock
options or SARs previously awarded to any named executive officers during 2005.
Compensation of Directors
At this time, we do not have any arrangement or policy for compensation of
directors for their services on our Board of Directors. If any, when we do
compensate directors, we do not anticipate paying employee directors additional
compensation for their service above their compensation as an employee.
In 2005, there were no other arrangements pursuant to which any director was
compensated for services provided as a director.
Employment Contracts and Termination of Employment and Change of Control
Arrangements
We entered into an employment agreement with each of two key employees, Messrs.
Lian jun Luo and Bin Qu, on March 18, 2003.
Mr. Luo's agreement has a three-year term commencing on October 10, 2002, which
is renewable upon written agreement of the parties prior to expiration. Under
the agreement, Mr. Luo is entitled to an annual base salary of RMB 144,000 each
year and shares of common stock of the Company equal to 1% of the total number
of shares outstanding on each of October 1, 2003, 2004 and 2005. Mr. Luo may
also be granted an annual performance bonus of RMB 56,000.
Mr. Qu's agreement has a three-year term commencing on March 1, 2003, which is
renewable upon written agreement of the parties prior to expiration. Mr. Qu had
a three-month probationary period which ended on June 1, 2003. Under the
agreement, Mr. Qu is entitled to an annual base salary of RMB 144,000 each year
and shares of common stock of the Company equal to 1% of the total number of
shares outstanding on each of March 1, 2004, 2005 and 2006. Mr. Qu may also be
granted an annual performance bonus of RMB 56,000.
During the term of their respective agreements Messrs. Luo and Qu may not
compete with the Company or hire or solicit the Company's employees. In
addition, each of Messrs. Luo and Qu agreed, during the term of the respective
agreements and for five years after the termination thereof, not to disclose any
of the Company's confidential information. If the Company terminates either
agreement, Mr. Luo or Mr. Qu, as applicable, will be entitled to three months'
severance. If Mr. Luo or Mr. Qu terminates his employment agreement, he must pay
a default penalty equal to three months of his salary.
Except as set forth above, we do not have employment agreements with any other
members of management or key personnel. In addition, there are no compensatory
plans or arrangements with respect to a named executive officer that would
result in payments or installments in excess of $100,000 upon the resignation,
retirement or other termination of such executive officer's employment with us
or from a change-in-control.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth as of December 31, 2005 certain information with
respect to the beneficial ownership of our common stock by (i) each of our
directors and executive officers, (ii) each person who is known by us to
beneficially own more than 5% of our outstanding common stock, and (iii) all of
our directors and executive officers as a group. The numbers for each
stockholder listed below include shares of our common stock issuable upon the
exercise of options or any other rights beneficially owned by such person or
entity that are exercisable within 60 days of December 31, 2005. Percentage
ownership is calculated based on 59,235,930 shares of our common stock
outstanding as of December 31, 2005. None of the shares listed below are
issuable pursuant to stock options, SARs or warrants.
27
Number of Percent of
Name Shares Class
------------------------------------------------------ ---------- ---------
Wei Li (1)............................................ 12,356,672 20.9%
Da chang Ju (2)....................................... 10,062,088 17.0%
Lian jun Luo.......................................... 308,916 *
James Nian Zhan....................................... 308,916 *
Yun long Zhang........................................ 308,916 *
Johnson Shun-Pong Lau ................................ 196,000 *
All Star Technology Inc. (1).......................... 12,356,672 20.9%
InvestLink (China) Limited (2)........................ 10,062,088 17.0%
De jun Zou............................................ 3,089,168 5.2%
Times Crossword Investment Ltd. (3)................... 3,089,168 5.2%
Yi Mao (3)............................................ 3,089,168 5.2%
All officers and directors as a group (6 persons)..... 23,541,508 39.7%
-------------------
* Less than 1%.
(1) Consists of shares held by All Star Technology Inc., a British Virgin
Islands international business company. Wei Li exercises voting and
investment control over the shares held by All Star Technology Inc. Wei Li
is a principal stockholder of All Star Technology Inc. and may be deemed
to beneficially own such shares, but disclaims beneficial ownership in
such shares held by All Star Technology Inc. except to the extent of his
pecuniary interest therein.
(2) Consists of 7,812088 shares of common stock held directly by InvestLink
(China) Limited ("Investlink") and 2,250,000 shares of common stock held
by InvestLink as custodian for Gui sheng Chen. InvestLink has the sole
power to vote or direct the vote and dispose or direct the disposition of
10,062,088 shares but disclaims beneficial ownership of such shares except
to the extent of its pecuniary interest therein. Da chang Ju exercises
voting and investment control over the shares held by InvestLink. Da chang
Ju is a principal stockholder of InvestLink and may be deemed to
beneficially own such shares, but disclaims beneficial ownership in such
shares held by InvestLink except to the extent of his pecuniary interest
therein.
(3) Mr. Yi Mao exercises voting and investment control over the shares held by
Times Crossword Investment, Ltd.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
China Star Investment Group
Mr. Li, the Company's Chairman of the Board and the Chief Executive Officer,
owns a 28% interest in China Star. Mr. Yun long Zhang, one of our directors, is
also General Manager of China Star, responsible for the group's daily
operations. As of December 31, 2005, the Company had an outstanding balance owed
to China Star of $263,165.
On June 29, September 30, and December 31, 2005, the Company entered into
advance agreements with China Star for advances of $94,845, $91,071 and $13,598,
respectively. The advances are unsecured, bear interest at 12% per annum and
were initially due 180 days from the date of draw down. The advances have been
extended to June, 30, 2006. The Company has also granted to China Star warrants
to purchase 997,571 shares of its common stock.
Additionally, we lease an office in the United States under a commercial lease
agreement with China Star that expired in June 2005 with an aggregate monthly
lease payment of approximately $2,560. Pursuant to the lease agreement dated
April 1, 2004, rent expenses for the fiscal year ended December 31, 2005 were
$15,360. We paid the rental expenses amounted to $15,360 under the lease in
2005. We did not renew the lease when it expired in 2005.
Mr. Wei Li
The balance of $191,861 shown on the balance sheet owed to Mr. Li, primarily
consisted of a loan and the operating expenses that Mr. Li paid on behalf of the
Company.
On May 23, 2005, the Company entered an advance agreement with Mr. Li for
various advances amounting to $156,685. The advances were unsecured and bore
interest at 12% per annum with the period of 180 days since the date of draw
down. The advances have been extended to June 30, 2006. In consideration of the
advances, the Company granted to Mr. Li warrants to purchase 783,423 shares of
our common stock.
Mr. Li also executed a guarantee of repayment of each of the 10% Loan and the
12% Loans (described in Note 9 to the Consolidated Financial Statements and
under "Managementi-s Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources"). As of March 31, 2006, the 10%
Loan was retired and the 12% Loans had an outstanding balance of $320,000.
In December 2004, we entered into an agreement with Mr. Li pursuant to which Mr.
Li leases a company's motor vehicle. The monthly rental payment is $1,812 and
the Company made no payment of rental expenses for the fiscal year ended
December 31, 2005.
28
ITEM 13. EXHIBITS
Description of Exhibits
-----------------------
Exhibit No. Description Incorporated by Exhibit No. in
Reference in Document Incorporated
Document
2.1 Agreement and Plan of Merger, dated March 11, 2004, by Form 8-K filed on March 2.1
and among Tintic Gold Mining Company, TTGM 29, 2004
Acquisition Corporation, and Kiwa
Bio-Tech Products Group Ltd.
2.2 Agreement and Plan of Merger, dated July 22, 2004, between Form 8-K filed on July 2.1
Kiwa Bio-Tech Products Group Corporation, a Utah 23, 2004
corporation, and Kiwa Bio-Tech Products Group Corporation.
3.1 Certificate of Incorporation, effective as of July 21, Form 8-K filed on July 3.1
2004. 23 2004
3.2 Bylaws, effective as of July 22, 2004. Form 8-K filed on July 3.2
23, 2004
10.1 Standby Equity Distribution Agreement, dated July 6, 2004, Form SB-2 filed August 10.1
between Cornell Capital Partners, LP and Kiwa Bio-Tech 2, 2004
Products Group Corporation.
10.2 Placement Agent Agreement, dated July 6, 2004, between Form SB-2 filed August 10.2
Newbridge Securities Corporation and Kiwa Bio-Tech 2, 2004
Products Group Corporation.
10.3 Registration Rights Agreement, dated July 6, 2004, Form SB-2 filed August 10.3
between Cornell Capital Partners, LP and Kiwa Bio-Tech 2, 2004
Products Group Corporation.
10.4 Warrant Purchase Agreement, dated March 12, 2004, issued Form 10-QSB filed May 10.1
to Westpark Capital, Inc. 20, 2004
10.5 Convertible Loan Agreement, dated January 25, 2004 between Form 10-QSB filed May 10.2
Kiwa Bio-tech Products Group Ltd. and Kao Ming Investment 20, 2004
Company
10.6 Convertible Loan Agreement dated March 12, 2004 for Form 10-QSB filed 10.1
$200,000 between Kiwa Bio-Tech Products Group August 20, 2004
Corporation and Jzu Hsiang Trading Co., Ltd.
10.7 Engagement agreement between Kiwa Bio-Tech Products Group Form 10-QSB filed 10.3
Corporation and Cinapsys Inc. dated May 24, 2004 August 20, 2004
10.8 Patent Transfer Agreement dated April 12, 2004, between Form SB-2/A filed 10.5
Kiwa Bio-Tech Products (Shandong) Co., Ltd. and China October 8, 2004
Agricultural University.
10.9 Patent Transfer Contract, dated April 12, 2004, between Form SB-2/A filed 10.5
Kiwa Bio-Tech Products Group Corporation and China November 23, 2004
Agricultural University
10.10 Contract of Project of Venture Capital of Zoucheng Form SB-2/A filed 10.6
Science & Technology Plan (Contract No.: 2004) among KIWA October 8, 2004
Bio-Tech Products (Shandong) Company, Science & Technology
Bureau and Zoucheng Branch of China Commercial Bank of
ICBC dated April 2004.
10.11 Contract of Project of Venture Capital of Zoucheng Form SB-2/A filed 10.7
Science & Technology Plan (Contract No. 2002) among KIWA October 8, 2004
Bio-Tech Products (Shandong) Company, Zoucheng Science &
Technology Bureau and Zoucheng Branch of China Commercial Bank of
ICBC dated November 2002.
10.12 Contract of Project of Venture Capital of Zoucheng Form SB-2/A filed 10.7
Science & Technology Plan (Contract No. 2002) among KIWA November 23, 2004
Bio-Tech Products Group Limited, Zoucheng Municipal
People's Government
Bureau and Zoucheng Branch of China Commercial Bank of
ICBC dated May 26, 2002.
29
Description of Exhibits
-----------------------
Exhibit No. Description Incorporated by Exhibit No. in
Reference in Document Incorporated
Document
10.13 PBC Project Investment Agreement between KIWA Bio-Tech Form 10-KSB filed April 10.13
Products Group Limited and Zoucheng Municipal Government 13, 2005
dated June 25, 2002
10.14 Employment Agreement dated March 18, 2003 between Form SB-2/A filed 10.13
Kiwa Bio-Tech Products Group and Lian jun Luo November 23, 2004
10.15 Employment Agreement dated March 18, 2003 between Form SB-2/A filed 10.14
Kiwa Bio-Tech Products Group and Bin Qu November 23, 2004
Convertible Loan Agreement dated October 20, 2003 between Form SB-2/A filed 10.8
10.16 China Star Investment Group and Kiwa Bio-Tech Products October 8, 2004
Group Ltd., as amended by letter agreement dated August 1,
2004
10.17 Loan Agreement dated July 26, 2004 between China Star Form SB-2/A filed 10.15
Investment Group and Kiwa Bio-Tech Products Group November 23, 2004
Corporation
10.18 Commercial Lease Agreement dated April 1, 2004 between Form SB-2/A filed 10.10
Kiwa Bio-Tech Products Group Corporation and China Star October 8, 2004
Investment Company.
10.19 Convertible Note Agreement dated September 23, 2004 among Form 10-QSB filed 10.4
Kiwa Bio-Tech Products Group Corporation and Young San Kim November 15, 2004
and Song N. Bang
10.20 Amendment, dated April 7, 2005, to Convertible Note Form 10-KSB filed April 10.20
Agreement dated September 23, 2004 among Kiwa Bio-Tech 13, 2005
Products Group Corporation and Young San Kim and Song N.
Bang
10.21 Common Stock Warrant dated September 23, 2004, issued Form 10-QSB filed 10.5
by Kiwa Bio-Tech Products Group Corporation to November 15, 2004
Young San Kim
10.22 Common Stock Warrant dated September 23, 2004, issued by Form 10-QSB filed 10.6
Kiwa Bio-Tech Products Group Corporation to Song N. Bang November 15, 2004
10.23 Promissory Note of Kiwa Bio-Tech Products Group Form 10-KSB filed April 10.23
Corporation, principal amount $400,000, issued to Cornell 13, 2005
Capital Partners, LP on January 4, 2005, as amended by
letter agreements dated March 21, 2005 and April 5, 2005.
10.24 Payment Acknowledgment and Release, dated June 8, 2005, Form 10-QSB filed May 10.1
among Kiwa Bio-Tech Products Group Corporation and Young 20, 2005
San Kim and Song N. Bang
10.25 Advance Agreement, dated May 23, 2005, between Kiwa Form 10-QSB filed 10.2
Bio-Tech Products Group Corporation and Mr. Wei Li. August 15, 2005
10.26 Promissory Note of Kiwa Bio-Tech Products Group Form 8-K filed on 10.1
Corporation, principal amount $150,000, issued to Donald August 12, 2005
Worthly dated May 30, 2005, as amended June 1, 2005.
10.27 Promissory Note of Kiwa Bio-Tech Products Group Form 8-K filed on 10.2
Corporation, principal amount $70,000, issued to Gertrude August 12, 2005
Yip dated May 30, 2005, as amended.
10.28 Promissory Note of Kiwa Bio-Tech Products Group Form 8-K filed on 10.3
Corporation, principal amount $100,000, issued to Hiro August 12, 2005
Sugimura and Elaine Sugimura dated June 16, 2005.
10.29 Advance Agreement, dated June 29, 2005, between Kiwa Form 10-QSB filed 10.7
Bio-Tech Products (Shandong) Co. Ltd. and China Star August 15, 2005
Investment Management Co. Ltd.
30
Description of Exhibits
-----------------------
Exhibit No. Description Incorporated by Exhibit No. in
Reference in Document Incorporated
Document
10.30 Advance Agreement, dated September 30, 2005, between Kiwa Form 10-QSB filed 10.1
Bio-Tech Products (Shandong) Co. Ltd. and China Star November 21, 2005
Investment Management Co. Ltd.
10.31 Advance Agreement, dated December 31, 2005, between Kiwa
Bio-Tech Products (Shandong) Co. Ltd. and China Star
Investment Management Co. Ltd.
10.32 Stock Purchase Agreement dated March 10, 2006 Form 8-K filed on March
15, 2006
10.33 Termination Agreement between Kiwa Bio-Tech Products Group Form 8-K filed on April 10.1
Corporation and Cornell Capital dated on March 31, 2006 4, 2006
10.34 Amendment, dated April 13, 2006 to Stock Purchase
Agreement dated March 10, 2006
21 List of Subsidiaries Form 10-QSB filed May 21
20, 2005
31.1 Certification of Principal Executive Officer pursuant to
Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934
31.2 Certification of Principal Financial Officer pursuant to
Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934
32.1 Certification of Principal Executive Officer, pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer, pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
31
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Fees Paid to Independent Public Accountants for 2005 and 2004
Audit Fees
The aggregate audit fees for 2005 were approximately $69,000. The amounts
include fees of approximately $45,000 for professional services rendered by Mao
& Company, CPAs, Inc. in connection with the audit of our consolidated financial
statements as of and for the 2005 fiscal year and fees of approximately $22,500
for professional services rendered by Grobstein, Horwath & Company, LLP in
connection with reviews of our unaudited consolidated interim financial
statements for the first, second and third quarters of 2005.
The aggregate audit fees for 2004 were approximately $95,500. The amounts
include fees for professional services rendered by Grobstein, Horwath & Company,
LLP in connection with the audit of our consolidated financial statements for
the 2004 fiscal year and reviews of our quarterly reports on the Form 10-QSB for
the first, second and third quarters of 2004 fiscal year.
Audit-Related Fees
There were no audit-related fees billed by Mao & Company, CPAs, Inc. or
Grobstein, Horwath & Company, LLP for other services rendered to the Company for
the 2005 fiscal year.
Audit-related fees for 2004 for assurance and related services by Grobstein,
Horwath & Company, LLP were $63,527. The amount includes fees for auditing the
financial statements in relation to our registration statement on Form SB-2 and
to the reverse merger on March 12, 2004 and not reported under the caption Audit
Fees.
Tax Fees
There were no fees for tax services billed by Mao & Company, CPAs, Inc. or
Grobstein, Horwath & Company, LLP for other services rendered to the Company for
the 2005 fiscal year.
Tax fees for 2004 for professional services rendered by Grobstein, Horwath &
Company, LLP were $5,000. The amount includes fees for tax compliance,
authority, audit support and planning services.
All Other Fees
There were no additional aggregate fees billed by Mao & Company, CPAs, Inc. for
2005 or by Grobstein, Horwath & Company, LLP for 2004 for other services
rendered to the Company. Since we do not have a formal audit committee, our
entire Board of Directors serves as our audit committee. We have not adopted
pre-approval policies and procedures with respect to the Company's accountants,
but our Board of Directors approved the engagement of each of Mao & Company,
CPAs, Inc. and Grobstein, Horwath & Company, LLP before their respective
engagements.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on April 14, 2006.
KIWA BIO-TECH PRODUCTS GROUP CORPORATION
By: /s/ Wei Li
-----------
Wei Li
Chief Executive Officer and Chairman of the Board of Directors
(Principal Executive Officer)
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on April 14, 2006.
/s/ Wei Li April 14, 2006 Chief Executive Officer and Chairman of the Board of
---------- (Principal Executive Officer)
Directors
Wei Li
/s/ Lian jun Luo April 14, 2006 Chief Financial Officer and Director
---------------- (Principal Financial Officer and Principal Accounting
Lian jun Luo Officer)
/s/ Da Chang Ju April 14, 2006 Director
---------------
Da chang Ju
/s/ Yun Long Zhang April 14, 2006 Director
------------------
Yun long Zhang
33
KIWA BIO-TECH PRODUCTS GROUP CORPORATION AND ITS SUBSIDIARIES
Index to Consolidated Financial Statements
Page
----
Report of Mao & Company CPAs, Inc. dated April 14, 2006................................ F-2
Report of Grobstein, Horwath & Company, LLP dated February 25, 2005.................... F-3
Consolidated Balance Sheets as of December 31, 2005 and 2004........................... F-4
Consolidated Statements of Operations and Comprehensive Income for the years
ended December 31, 2005 and 2004....................................................... F-5
Consolidated Statements of Stockholders' Equity (Deficiency) for the period from
January 1, 2004 through December 31, 2005 ............................................. F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2005 and 2004... F-8
Notes to Consolidated Financial Statements............................................. F-9
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Kiwa Bio-Tech Products Group Corporation
We have audited the accompanying consolidated balance sheet of Kiwa Bio-Tech
Products Group Corporation and Subsidiary (the "Company") as of December 31,
2005, and the related consolidated statements of operations, stockholders'
equity (deficiency) and cash flows for the year ended December 31, 2005. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with the auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal controls over financial reporting. Our audit included consideration of
internal controls over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Kiwa Bio-Tech
Products Group Corporation and Subsidiary as of December 31, 2005 and the
consolidated results of their operations and their cash flows for the year ended
December 31, 2005, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a working capital deficit and a net capital deficiency that
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Mao & Company CPAs, Inc.
New York, New York
April 14, 2006
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Kiwa Bio-Tech Products Group Corporation
We have audited the accompanying consolidated balance sheets of Kiwa Bio-Tech
Products Group Corporation and Subsidiary (the "Company") as of December 31,
2004, and the related consolidated statements of operations, stockholders'
equity (deficiency) and cash flows for the year ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards
as established by the Auditing Standards Board (United States) and in accordance
with the auditing standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. The Company is not required to have, nor were
we engaged to perform, an audit of its internal controls over financial
reporting. Our audit included consideration of internal controls over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly we express no such opinion. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our
audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Kiwa Bio-Tech
Products Group Corporation and Subsidiary as of December 31, 2004 and the
consolidated result of their operations and their cash flows for the year ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a working capital deficit and a net capital deficiency that
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Grobstein, Horwath & Company, LLP
Sherman Oaks, California
February 25, 2005
F-3
Consolidated Balance Sheets
Kiwa Bio-Tech Products Group Corporation and Subsidiaries
Consolidated Balance Sheets
Year Ended December 31,
--------------------------
2005 2004
----------- -----------
ASSETS
Current assets
Cash and cash equivalents $ 14,576 $ 17,049
Accounts receivable 701,486 963,403
Other receivable -- 157,495
Inventories 495,597 83,677
Prepaid expenses 1,962 131,600
Other current assets 27,186 26,340
----------- -----------
Total current assets 1,240,807 1,379,564
Property, Plant and Equipment:
Buildings 1,012,219 986,965
Machinery and equipment 447,361 218,250
Automobiles 103,914 101,321
Office equipment 57,423 49,688
Computer software 8,940 8,717
----------- -----------
1,629,857 1,364,941
Less: accumulated depreciation (192,991) (109,847)
----------- -----------
Property plant and equipment - net 1,436,866 1,255,094
Construction in progress 33,429 32,595
Intangible asset-net 410,586 463,730
----------- -----------
Total assets $ 3,121,688 $ 3,130,983
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities
Accounts payable and accrued expenses $ 1,000,477 $ 560,874
Construction costs payable 372,338 370,453
Short-term loans -- 50,000
Due to related parties 454,193 128,884
Convertible notes payable-unrelated party 407,135 312,104
Current portion of bank notes payables 13,647 12,879
----------- -----------
Total current liabilities 2,247,790 1,435,194
Long-term liabilities, less current portion:
Unsecured loans payable 1,424,996 1,389,443
Bank notes payable 13,895 26,853
----------- -----------
Total long-term liabilities 1,438,891 1,416,296
Shareholders' equity (deficiency)
Common stock -$0.001 par value
Authorized 100,000,000 shares and 50,000,000 shares at December 31, 2005
and 2004, respectively Issued and outstanding 59,235,930 shares and
40,873,711 shares at December 31, 2005 and
2004, respectively 59,236 40,874
Preferred stock -$0.001 par value
Authorized 20,000,000 shares and nil shares
at December 31, 2005 and 2004, respectively
Issued and outstanding nil shares at
December 31, 2005 and 2004 -- --
Additional paid-in capital 4,835,968 4,393,415
Deficit Accumulated (5,482,555) (4,154,796)
----------- -----------
Accumulated other comprehensive income 22,358
----------- -----------
Total shareholders' equity (deficiency) (564,993) 279,493
----------- -----------
Total liabilities and stockholders' equity $ 3,121,688 $ 3,130,983
----------- -----------
F-4
Consolidated Statements of Operations and Comprehensive Income
Year Ended December 31,
2005 2004
------------ ------------
Net sales $ 631,794 $ 1,300,251
Cost of sales 232,692 641,236
------------ ------------
Gross profit 399,102 659,015
Operating expenses:
Consulting and professional fees 614,532 448,442
Officers' compensation 38,727 77,398
General and administrative 664,637 598,492
Research and development 11,264 49,622
Depreciation and amortization 106,283 52,798
Reverse merger costs -- 1,417,434
Total costs and expenses 1,435,443 2,644,186
------------ ------------
Operating loss (1,036,341) (1,985,171)
------------ ------------
Interest expense, net (293,834) (803,913)
Other income 2,416 60,411
------------ ------------
Net loss $ (1,327,759) $ (2,728,673)
------------ ------------
Other comprehensive income (loss):
Translation adjustment 22,358 --
------------ ------------
Comprehensive loss $ (1,305,401) $ (2,728,673)
============ ============
Net loss per common share $ (0.026) $ (0.074)
-basic and diluted
Weighted average number of common shares
outstanding
-basic and diluted 50,957,995 36,887,339
F-5
Consolidated Statement of Stockholders' Equity (Deficiency)
Kiwa Bio-Tech Products Group Corporation and Subsidiaries
Consolidated Statement of Stockholders' Equity (Deficiency)
Total
Common Stock Additional Other Stockholders'
-------------------- Paid-in Accumulated Comprehensive Equity
Shares Amount Capital Deficits Income (Deficiency)
-------------------------------------------------------------------------------------------------------------
Balance, January 1, 2004 30,891,676 30,892 1,184,108 (1,426,123) - (211,123)
-------------------------------------------------------------------------------------------------------------
Shares retained by public shareholders
in March 2004 reverse merger
transaction 4,038,572 4,038 (4,038) - - -
-------------------------------------------------------------------------------------------------------------
Issuance of warrants valued at $0.54 per
share on March 30, 2004 in conjunction
with March 2004 reverse
merger transaction - - 943,380 - - 943,380
-------------------------------------------------------------------------------------------------------------
Issuance of stock options valued at
$0.57 per share on March 30, 2004 to
consultant in conjunction with
March 2004 reverse merger transaction - - 171,000 - - 171,000
-------------------------------------------------------------------------------------------------------------
Beneficial conversion feature of
convertible note payable funded on
January 25, 2004 - - 500,000 - - 500,000
-------------------------------------------------------------------------------------------------------------
Beneficial conversion feature of
convertible note payable funded on
April 7, 2004 - - 200,000 - - 200,000
-------------------------------------------------------------------------------------------------------------
Restricted shares issued to a
consultant for services at $0.45 per
share on May 24, 2004. 75,000 75 33,675 - - 33,750
-------------------------------------------------------------------------------------------------------------
Shares issued upon conversion of
convertible notes payable at $0.25 per
share on June 8, 2004 2,800,000 2,800 697,200 - - 700,000
-------------------------------------------------------------------------------------------------------------
Shares issued to China Agricultural
University in conjunction with April
2004 Patent Transfer Agreement at $0.42
per share on July 19, 2004 1,000,000 1,000 419,000 - - 420,000
-------------------------------------------------------------------------------------------------------------
Shares issued to consultant in
conjunction with July 2004 Standby
Equity Distribution transaction at
$0.001 per share on July 29, 2004 26,567 27 (27) - - -
-------------------------------------------------------------------------------------------------------------
Shares issued for commitment fee in
conjunction with July 2004 Standby
Equity Distribution transaction at
$0.001 per share on July 29, 2004 704,039 704 (704) - - -
-------------------------------------------------------------------------------------------------------------
Shares issued to lawyer for legal
services at $0.014 per share on
September 14, 2004 892,857 893 124,107 - - 125,000
-------------------------------------------------------------------------------------------------------------
Issuance of warrants on September 23,
2004 in conjunction with September 2004
convertible notes payable - - 82,559 - - 82,559
-------------------------------------------------------------------------------------------------------------
Shares issued to consultants for
services at $0.10 per share on October
1, 2004 415,000 415 41,085 - - 41,500
-------------------------------------------------------------------------------------------------------------
Issuance of restricted common stock to
a consultant as final compensation at
$0.07 per share on November 19, 2004 30,000 30 2,070 - - 2,100
-------------------------------------------------------------------------------------------------------------
Net loss for the year ended
December 31, 2004 - - - (2,728,673) - (2,728,673)
-------------------------------------------------------------------------------------------------------------
F-6
Total
Common Stock Additional Other Stockholders'
-------------------- Paid-in Accumulated Comprehensive Equity
Shares Amount Capital Deficits Income (Deficiency)
-------------------------------------------------------------------------------------------------------------
Balance, December 31, 2004 40,873,711 40,874 4,393,415 (4,154,796) - 279,493
-------------------------------------------------------------------------------------------------------------
Issuance of common stock to Cornell Capital
Partners, Limited in the first nine
months of 2005, as first to thirty-third
repayments in conjunction with
Promissory Note dated January 4,
2005 18,362,219 18,362 294,503 - - 312,865
-------------------------------------------------------------------------------------------------------------
Issuance of detachable warrants in
conjunction with the issuance of
convertible promissory notes to the
holders in June 2005 - - 21,700 - - 21,700
-------------------------------------------------------------------------------------------------------------
Beneficial conversion feature of the
convertible promissory notes funded in
June 2005 - - 106,666 - - 106,666
-------------------------------------------------------------------------------------------------------------
Issuance of detachable warrants in
conjunction with the advance agreement
with a director dated May 23, 2005 - - 8,633 - - 8,633
-------------------------------------------------------------------------------------------------------------
Issuance of detachable warrants in
conjunction with the advance agreement
with a related party dated June 29, 2005 - - 5,417 - - 5,417
-------------------------------------------------------------------------------------------------------------
Issuance of detachable warrants in
conjunction with the advance agreement
with a director dated September 30, 2005 - - 5,021 - - 5,021
-------------------------------------------------------------------------------------------------------------
Issuance of detachable warrants in
conjunction with the advance agreement
with a director dated December 31, 2005 613 613
-------------------------------------------------------------------------------------------------------------
Net loss for the year ended December
31, 2005 - - - (1,327,759) - (1,327,759)
-------------------------------------------------------------------------------------------------------------
Translation adjustment - - - - 22,358 (22,358)
-------------------------------------------------------------------------------------------------------------
Balance, December 31, 2005 59,235,930 59,2364,835,968 (5,482,555) 22,358 564,993
-------------------------------------------------------------------------------------------------------------
F-7
Consolidated Statements of Cash Flows
Kiwa Bio-Tech Products Group Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31,
--------------------------
2005 2004
----------- -----------
Cash flows from operating activities:
Net loss $(1,327,759) $(2,728,673)
Adjustments to reconcile net loss to net cash used in
operating activities:
Issuance of common stock for services -- 202,350
Issuance of securities for reverse merger costs -- 1,114,380
Depreciation and amortization 146,932 91,061
Amortization of detachable warrants 78,447 44,663
Amortization of beneficial conversion feature
of convertible notes payable 106,666 700,000
(Gain)/Loss on disposal of Property, Plant and Equipment -- 121,268
Changes in operating assets and liabilities:
(Increase)decrease in :
Accounts receivable 261,917 (918,168)
Inventories (411,920) 51,524
Other receivable 157,495 (157,495)
Prepaid expenses 129,638 (131,600)
Other current assets (846) 83,471
Due from related party -- 30,574
Increase(decrease)in:
Accounts payable and accrued expenses 439,603 499,781
Construction cost payable -- (153,045)
----------- -----------
Net cash used in operating activities (419,827) (1,149,909)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (229,989) (159,234)
Acquisition of intangible asset -- (60,411)
----------- -----------
Net cash used in investing activities (229,989) (219,645)
----------- -----------
Cash flows from financing activities:
Decrease (increase) in restricted cash -- 300,000
Proceeds from short-term loans -- 50,000
Repayment of short-term loans (50,000) (283,930)
Proceeds from related parties 488,501 28,884
Repayment to related parties (163,741) --
Proceeds from convertible notes payable 720,000 1,050,000
Repayment of convertible notes payable (350,000) --
Proceeds from long-term borrowings -- 265,806
Repayment of long-term borrowings (12,190) (72,887)
----------- -----------
Net cash provided by financing activities 632,570 1,337,873
----------- -----------
Foreign currency translation 14,773 --
Cash and cash equivalents:
Net decrease (2,473) (31,681)
Balance at beginning of year 17,049 48,730
----------- -----------
Balance at end of year $ 14,756 $ 17,049
----------- -----------
Supplemental Disclosures of Cash flow Information:
Cash paid for interest $ 6,354 $ 57,966
Cash paid for taxes -- --
Non-cash investing and financing activities:
Issuance of common stock for convertible notes payable 312,865 700,000
Beneficial conversion feature of convertible notes payable 106,666 700,000
Transfer from convertible notes due to related party -- 100,000
Issuance of common stock in exchange for patent -- 420,000
Issuance of detachable warrants in conjunction
with issuance of convertible notes payable $ 41,384 $ 82,559
----------- -----------
F-8
Notes to Consolidated Financial Statements
1. Background and Basis of Presentation
Organization - On March 12, 2004, pursuant to an Agreement and Plan of Merger
dated as of March 11, 2004, by and among Tintic Gold Mining Company ("Tintic"),
TTGM Acquisition Corporation, a Utah corporation and wholly-owned subsidiary of
Tintic Gold Mining Company, and Kiwa Bio-Tech Products Group Ltd. ("Kiwa
Bio-Tech"), a British Virgin Islands international business company, TTGM
Acquisition Corporation merged with and into Kiwa Bio-Tech. Each share of Kiwa
Bio-Tech common stock was converted into 1.5445839 shares of Tintic Gold Mining
Company Common Stock, with Kiwa Bio-Tech surviving as Tintic Gold Mining
Company's wholly-owned subsidiary. The merger resulted in a change of control of
Tintic Gold Mining Company, with former Kiwa Bio-Tech stockholders owning
approximately 89% of Tintic Gold Mining Company on a fully diluted basis. The
Company accounted for this transaction as a reverse merger. Subsequent to the
merger, Tintic Gold Mining Company changed its name to Kiwa Bio-Tech Products
Group Corporation (the "Company"). On July 22, 2004, we completed our
reincorporation in the State of Delaware.
Business - The Company's business plan is to develop, manufacture, distribute
and market innovative, cost-effective and environmentally safe bio-technological
products for the agricultural, natural resources and environmental protection
markets, primarily in China. The Company intends to improve existing products
and to develop new products. Activities to date have included conducting
research and development, acquiring and developing intellectual property,
raising capital, development of a manufacturing facility, identification of
strategic acquisitions and marketing our products. The Company's first product,
a photosynthesis biological catalyst, was introduced in the Chinese agricultural
market in November 2003.
In 2002, Kiwa Bio-Tech chartered Kiwa Bio-Tech Products (Shandong) Co. Ltd.
("Kiwa-SD"), a wholly-owned subsidiary organized under the laws of China, as its
offshore manufacturing base to capitalize on low cost, high quality
manufacturing advantages available in China. The Company has completed the
development stage in fourth quarter of 2004 as the Company generated substantial
revenue from planned principal operations.
Basis of Presentation - The consolidated financial statements include the
operations of Kiwa Bio-Tech Products Group Corporation and its wholly-owned
subsidiaries, and are presented in accordance with generally accepted accounting
principles in the United States. All significant intercompany balances and
transactions have been eliminated in consolidation.
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the consolidated financial statements, and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Country Risk - As the Company's principal operations are conducted in China, the
Company is subject to special considerations and significant risks not typically
associated with companies in North America and Western Europe. These risks
include, among others, risks associated with the political, economic and legal
environments and foreign currency exchange limitations encountered in China. The
Company's results of operations may be adversely affected by changes in the
political and social conditions in China, and by changes in governmental
policies with respect to laws and regulations, among other things.
In addition, all of the Company's transactions undertaken in China are
denominated in RMB, which must be converted into other currencies before
remittance out of China may be considered. Both the conversion of RMB into
foreign currencies and the remittance of foreign currencies abroad require the
approval of the Chinese government.
Credit Risk - The Company performs ongoing credit evaluations of its customers
and intends to establish an allowance for doubtful accounts when amounts are not
considered fully collectable. According to the Company's credit policy, the
Company provides 100% bad debt provision for the amounts outstanding over 365
days, which management believes is consistent with industry practice in the
China region.. Though we have no conclusive indication of insolvency from any of
our customers, for the sake of prudence, we accrued bad debt allowance $82,942
for the long outstanding balance. Management of the Company believes that the
accounts receivable balance as of December 31, 2004 will be fully collected.
F-9
Going Concern - The consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business. The carrying amounts of assets and liabilities presented in
the consolidated financial statements do not purport to represent the realizable
or settlement values. We incurred a net loss of $1,327,759 and $2,728,673 during
the fiscal year ended December 31, 2005 and 2004, respectively, and our current
liabilities exceeded our current assets by $1,006,983 and $55,630 at December
31, 2005 and 2004, respectively. These factors create substantial doubt about
our ability to continue as a going concern.
In March 2006 the Company entered into a purchase agreement to issue 5,000,000
shares of common stock for the proceeds of approximately $750,000. As of the
April 13, 2006, the Company had received approximately $350,000, which
represented47% of the total proceeds, committed to. The Company and the
investors have agreed to defer funding of the remaining commitment to April 30,
2006 (See Note 21). In April 2006, we are in negotiation but not yet concluded
the issuance of convertible notes with two investors for the aggregate amount of
up to $4 million. Company management continues to evaluate the Company's cash
needs and the availability of debt and equity financing to fund the Company's
operations.
As a result of the aforementioned conditions, the Company's registered
independent public accountants, in their independent auditors' reports on the
consolidated financial statements as of and for the year ended December 31, 2005
and 2004, have included an explanatory paragraph in their opinion indicating
that there is substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not contain any adjustments that
might result from the outcome of this uncertainty.
Revenue Recognition - The Company recognizes sales in accordance with Securities
and Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 101,
"Revenue Recognition in Financial Statements", as amended by SAB No. 104,
"Revenue Recognition". Sales represent the invoiced value of goods, net of value
added tax ("VAT"), supplied to customers, and is recognized upon delivery of
goods and passage of title.
All of the Company's sales made in China are subject to the Chinese value-added
tax at rates ranging from 13% to 17% ("output VAT"). Such output VAT is payable
after offsetting VAT paid by the Company on purchases ("input VAT").
Net Loss Per Common Share - Basic loss per common share is calculated by
dividing net loss by the weighted average number of shares of common stock
outstanding during the period. Diluted loss per common share reflects the
potential dilution that would occur if dilutive securities (stock options,
warrants and convertible debt) were exercised. These potentially dilutive
securities were not included in the calculation of loss per share for the
periods presented because the Company incurred a loss during such periods and
thus their effect would have been anti-dilutive. Accordingly, basic and diluted
loss per common share is the same for all periods presented. As of December 31,
2005, potentially dilutive securities aggregated 21,669,116 shares of common
stock. The loss per common share calculation for fiscal year ended December 31,
2005 and 2004 reflect the March 2004 recapitalization of Kiwa Bio-Tech.
The Company effected a 4-for-1 split of its outstanding shares of common stock
effective March 29, 2004, in conjunction with the reverse merger transaction
with Kiwa Bio-Tech as described above. Unless otherwise indicated, all share and
per share amounts presented herein have been adjusted to reflect the stock
split.
Advertising - The Company charges all advertising costs to expense as incurred.
Advertising expenses for the years ended December 31, 2005 and 2004 were $30,141
and $17,416, respectively.
Research and development - Research and development costs are charged to expense
as incurred.
Cash and Cash Equivalents - Highly liquid investments with a maturity of three
months or less at the time of acquisition are considered to be cash equivalents.
F-10
Financial Instruments and Fair Value - The Company accounts for financial
instruments under the provisions of Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities", which requires that all derivative financial instruments be
recognized in the consolidated financial statements and maintained at fair value
regardless of the purpose or intent for holding them. Changes in fair value of
derivative financial instruments are either recognized periodically in income or
stockholders' equity (as a component of comprehensive income), depending on
whether the derivative is being used to hedge changes in fair value or cash
flows. The adoption of SFAS No. 133 did not have a material impact on the
Company's consolidated financial position or its results of operations because
the Company does not currently hold any derivative financial instruments and
does not engage in hedging activities. The carrying amounts for cash and cash
equivalents, accounts receivable, other receivables, deposits and prepayments,
short-term borrowings, accounts payable, other payables and accruals approximate
their fair values because of the short maturity of those instruments.
Inventories - Inventories are stated at the lower of cost, determined on a
weighted average basis, and net realizable value. Work in progress and finished
goods are composed of direct material, direct labor and a portion of
manufacturing overhead. Net realizable value is the estimated selling price, in
the ordinary course of business, less estimated costs to complete and dispose.
Management believes that there is no obsolete inventory.
Property, Plant and Equipment - Property, Plant and Equipment are stated at
cost. Major expenditures for betterments and renewals are capitalized while
ordinary repairs and maintenance costs are expensed as incurred. Depreciation
and amortization is provided using the straight-line method over the estimated
useful lives of the assets after taking into account the estimated residual
value. The estimated useful lives are as follows:
Buildings 20-35 years
Machinery and equipments 4-12 years
Automobiles 8 years
Office equipment 5 years
Computer software 3 years
Construction in progress represents factory and office buildings under
construction. The Company capitalizes interest during the construction phase of
qualifying assets in accordance with SFAS No. 34, "Capitalization of Interest
Cost". No interest was capitalized during 2005 and 2004 as the construction in
progress was minimal.
We periodically evaluate our investment in long-lived assets, including property
and equipment, for recoverability whenever events or changes in circumstances
indicate the net carrying amount may not be recoverable. Our judgments regarding
potential impairment are based on legal factors, market conditions and
operational performance indicators, among others. In assessing the impairment of
property and equipment, we make assumptions regarding the estimated future cash
flows and other factors to determine the fair value of the respective assets. If
these estimates or the related assumptions change in the future, we may be
required to record impairment charges for these assets. The Company has
determined that there was no impairment of long-lived assets at December 31,
2005.
Income Taxes - The Company accounts for income taxes under the provisions of
SFAS No. 109, "Accounting for Income Taxes", which requires recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the consolidated financial statements or tax
returns. Deferred tax assets and liabilities are recognized for the future tax
consequence attributable to the difference between the tax bases of assets and
liabilities and their reported amounts in the financial statements. Deferred tax
assets and liabilities are measured using the enacted tax rate expected to apply
to taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the
enactment date. The Company establishes a valuation when it is more likely than
not that that the assets will not be recovered.
Operating Leases - Operating leases represent those leases under which
substantially all the risks and rewards of ownership of the leased assets remain
with the lessors. Rental payments under operating leases are charged to expense
on the straight-line basis over the period of the relevant leases.
Foreign Currency Translation - The functional currency of the Company is China
Renminbi ("RMB"), which is the primary medium of exchange where Kiwa-SD
operates. The Company reports its financial results in United States dollars
("U.S. dollars").
F-11
Translations of amounts from RMB into U.S. dollars were at approximately US$
1.00 = RMB 8.28 for all periods prior to July 21, 2005. Due to the stability of
the RMB during the periods covered by the consolidated financial statements
prior to July 21, 2005, no material exchange differences exist during the
aforesaid period. On July 21, 2005, the People's Bank of China announced it
would appreciate the RMB, increasing the RMB-US$ exchange rate from
approximately US$ 1.00 = RMB 8.28 to approximately US$ 1.00 = RMB 8.11. The
Company translates Kiwa-SD's assets and liabilities into U.S. dollars using the
rate of exchange prevailing at the balance sheet date (at December 31, 2005, the
prevailing exchange rate of the US dollar against the RMB was 8.0702), and the
statement of operations is translated at the average rates over the relevant
reporting period. Equity items are translated at historical rates. Adjustments
resulting from the translation from RMB into US$ are recorded in shareholders'
equity as part of accumulated comprehensive income (loss). Gains or losses
resulting from transactions in currencies other than RMB are reflected in the
statement of operations.
Comprehensive (Loss) Income - The Company has adopted the SFAS No. 130,
"Reporting Comprehensive Income", which establishes standards for reporting and
presentation of comprehensive income (loss) and its components in a full set of
general-purpose financial statements. The Company has chosen to report
comprehensive income (loss) in the statements of operations and comprehensive
income.
Stock Issued for Compensation and Financing - The Company from time to time
issues shares of common stock, options or warrants for services rendered or for
financing costs. Stock issued to non-employees is valued based on the market
price on the transaction date. With respect to stock options and warrants issued
to non-employees, the Company has adopted the SFAS No. 123, "Accounting for
Stock-Based Compensation," which establishes a fair value method of accounting
for stock-based compensation plans. In accordance with SFAS No. 123, the cost of
stock options and warrants issued to non-employees is measured at the grant date
based on the fair value of the award. The fair value of the stock-based award is
determined using the Black-Scholes option-pricing model. The resulting amount is
charged to expense on the straight-line basis over the period in which the
Company expects to receive benefit, which is generally the term of the loan
period.
With respect to stock awards issued to employees, the Company has elected to
continue to account for stock-based employee compensation plans utilizing the
intrinsic value method. The provisions of SFAS No. 123 currently in effect allow
companies to either record an expense in the financial statements to reflect the
estimated fair value of stock options or warrants to employees, or to continue
to follow the intrinsic value method set forth in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), but
to disclose on an annual basis the pro forma effect on net income (loss) and net
income (loss) per common share had the fair value of the stock options and
warrants been recorded in the financial statements. SFAS No. 123 was amended by
SFAS No. 148, which now requires companies to disclose in financial statements
the pro forma effect on net income (loss) and net income (loss) per common share
of the estimated fair market value of stock options or warrants issued to
employees. Under the intrinsic value method, the compensation cost for stock
options and warrants is measured as the excess, if any, of the fair market price
of the Company's common stock at the date of grant above the amount an employee
must pay to acquire the common stock. The Company did not issue any stock
options to its officers or management during the fiscal years ended December 31,
2005 and 2004.
As of December 15, 2005, SFAS No. 123 and APB No. 25 will be superseded by SFAS
No. 123R, which will require all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statements
based on their fair values, beginning with the first interim or annual period
after December 15, 2005. See "Recent Accounting Pronouncements," below.
Reclassification from prior year audited financial statements - Certain prior
year comparative figures have been reclassified to conform with the current year
presentation.
2. Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 151, "Inventory Costs", which clarifies the accounting for abnormal amounts
of idle facility expense, freight, handling costs, and wasted material. SFAS No.
151 will be effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a
material impact on our consolidated financial statements.
F-12
In December 2004, the FASB issued SFAS No. 123-R, "Share Based Payments", which
requires that the compensation cost relating to share-based payment transactions
(including the cost of all employee stock options) be recognized in the
financial statements. The cost will be measured based on the estimate fair value
of the equity or liability instruments issued. SFAS 123-R covers a wide range of
share-based compensation arrangements including share options, restricted share
plans, performance-based awards, share appreciation rights, and employee share
purchase plans. Management believes the adoption of this pronouncement will not
have a material effect on our consolidated financial statements.
Also, in December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions". The amendments made by SFAS No. 153 are based on the principle
that the exchange of nonmonetary assets should be measured using the estimated
fair market value of the assets exchanged. SFAS No. 153 eliminates the narrow
exception for nonmonetary exchanges of similar productive assets, and replaces
it with a broader exception for exchanges of nonmonetary assets do not have
commercial substance. A nonmonetary exchange has "commercial substance" if the
future cash flows of the entity are expected to change significantly as a result
of the transaction. This pronouncement is effective for monetary exchanges in
fiscal periods beginning after June 15, 2005. Management believes the adoption
of this pronouncement will not have a material effect on our consolidated
financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections". This statement requires entities that voluntarily make a change in
accounting principle to apply that change retrospectively to prior periods'
financial statements, unless this would be impracticable. SFAS No. 154
supersedes APB Opinion No. 20, "Accounting Changes", which previously required
that most voluntary changes in accounting principle be recognized by including
in the current period's net income the cumulative effect of changing to the new
accounting principle. SFAS No. 154 also makes a distinction between
"retrospective application" of an accounting principle and the "restatement" of
financial statements to reflect the correction of an error. SFAS No. 154 applies
to accounting changes and error corrections that are made in fiscal years
beginning after December 15, 2005. Management believes the adoption of this
statement will not have an immediate material impact on the consolidated
financial statements of the Company.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"),
"Accounting for Conditional Asset Retirement Obligations". FIN 47 clarifies that
the term "conditional asset retirement obligation," which as used in SFAS No.
143, "Accounting for Asset Retirement Obligations", refers to a legal obligation
to perform an asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the
control of the entity. The entity must record a liability for a "conditional"
asset retirement obligation if the fair value of the obligation can be
reasonably estimated. FIN 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. The adoption of this statement does not have an
immediate material impact on the consolidated financial statements of the
Company.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed
by management to have a material impact on the Company's present or future
consolidated financial statements.
3. Inventories
Inventories consisted of the following at December 31, 2005 and 2004:
----------------------------------------------------------------------------
December 31, 2005 December 31, 2004
----------------------------------------------------------------------------
Raw materials $417,237 $ 36,248
Work in progress - 32,295
Finished goods 78,360 15,134
Total $495,597 $ 83,677
----------------------------------------------------------------------------
F-13
4. Other receivable
The other receivable consists of a right to receive the repayment of an advance
of $157,495 previously made to an unrelated U.S. incorporated entity, Kiwa
Bio-Tech Products, Inc. ("KBPI"), for payment of merger costs in March 2004.
KBPI has fully repaid the amount during 2005.
5. Prepaid expenses
As of December 31, 2004, the prepaid expenses mainly consisted of $63,750
prepaid to KBPI for one-year of marketing service. According to the marketing
service agreement, KBPI would be entitled to receive a royalty of 8% of the
gross profits derived from the products or services sold by the Company which
are referred by KBPI. The Company did not pay any royalty fee to KBPI since it
did not successfully refer any sales to the Company throughout the term of the
agreement.
Other consulting fees included $45,000 prepaid to a consultant for public
relation services and sourcing of equity and debt financing for the Company over
a one-year consulting period. The Company prepaid $6,850 to another consultant
for public relation services over six months. In addition, $16,000 in 2004 was
prepaid to a placement agent of the Company to raise bridge financing. No
consulting fees were paid in 2003.
As of December 31, 2005, the prepaid expenses amounted $1,962, including prepaid
rental, web hosting fee and insurance.
Prepaid expenses consisted of the following at December 31, 2005 and 2004:
-----------------------------------------------------------------------------------------
December 31, 2005 December 31, 2004
Marketing service fee - $ 63,750
Fees for public relations and sourcing of financing - 51,850
Others 1,962 -
Place agent fee - 16,000
-----------------------------------------------------------------------------------------
Total $1,962 $131,600
-----------------------------------------------------------------------------------------
6. Property Plant and Equipment
The total gross amount of property, plant and equipment was $1,629,857 and
$1,364,941 as of December 31, 2005 and 2004, respectively. The increase of
$264,916 is mainly due to research and development equipment purchased during
2005 for $223,067. The research and development equipment has various uses.
Depreciation expense was approximately $83,144 and $74,379 for the fiscal years
ended December 31, 2005 and 2004, respectively.
7. Intangible Assets
The Company's intangible asset as of December 31, 2005 consisted of the
following:
---------- ---------------------- ---------------- --------------- -----------------
Expected Gross Accumulated Intangible
Amortization Period Carrying Value Amortization asset,
Net
---------- ---------------------- ---------------- --------------- -----------------
Patent 8.5 years $480,411 $69,825 $410,586
---------- ---------------------- ---------------- --------------- -----------------
The following table presents future expected amortization expense related to the
patent:
Amount
----------
2006 $ 56,518
2007 56,518
2008 56,518
2009 56,518
2010 56,518
Thereafter 127,996
---------
$ 410,586
---------
F-14
8. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following at December 31,
2005 and 2004:
--------------------------------------------------------------------------
2005 2004
--------------------------------------------------------------------------
Consulting and professional payables $ 411,360 $ 140,566
Payables to material suppliers 211,903 230,618
Interest payable 106,880 23,430
Salary payable 92,557 35,325
Insurance payable 81,553 47,711
Office rent payable 39,007 -
Payables to equipment suppliers 13,761 13,417
Others 43,456 69,807
--------------------------------------------------------------------------
Total $ 1,000,477 $ 560,874
--------------------------------------------------------------------------
9. Construction Costs Payable
Construction costs payable represents remaining amounts to be paid for the first
phase of the construction project.
10. Related Party Transactions
Amounts due to related parties consisted of the following at December 31, 2005
and 2004:
------------------------------------ ------------- ----------------------- ---------------------
Notes December 31, 2005 December 31, 2004
Mr. Wei Li ("Mr. Li") (i) $ 191,861 $ 16,779
China Star ("China Star Investment (ii) 263,165 112,105
Group")
Unamortized fair value of warrants
issued to China Star (833) -
------------------------------------ ------------- ----------------------- ---------------------
Total $ 454,193 $128,884
------------------------------------ ------------- ----------------------- ---------------------
(i) Mr. Li
Mr. Li is the Chairman of the Board and the Chief Executive Officer of the
Company. The balance due to Mr. Li primarily consists of a loan and operating
expenses that Mr. Li paid on behalf of the Company.
On May 23, 2005, the Company entered into a loan agreement with Mr. Li for
various advances amounting to the aggregate of $156,685. The advances were
unsecured and bore interest at 12% per annum with the period of 180 days since
the date of draw down. The due dates of the advances have been extended to June
30, 2006. The Company has also granted 783,423 shares of detachable warrants to
Mr. Li.
F-15
Each warrant attached to the advances entitles Mr. Li to subscribe for one share
of common stock of the Company at an exercise price equal to the closing quote
of the Company's shares on the date of draw down, which ranged from $0.011 to
$0.0481 per share. The warrants expire two years from the date of issue. None of
the detachable warrants were exercised in the fiscal year ended December 31,
2005. The value of the detachable warrants at the time of their issuance was
determined to be $8,633, calculated pursuant to the Black-Scholes option pricing
model in accordance with EITF Issue No 00-27. This value has been recorded as a
reduction to the advance and has been credited to additional paid-in capital,
and is being amortized on the straight-line basis over the term of the loan with
the amounts amortized being recognized as interest expense. Any unamortized
discount remaining at the date of conversion of the advance will be recognized
as interest expense in the period the conversion takes place.
Mr. Li also executed a guarantee of repayment of the 10% Loan and the 12% Loans
(described at Note 12) to the Financial Statements and under "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources"). On December 31, 2005, the 10%
Loan was repaid in full and retired and the 12% Loans had an outstanding balance
of $320,000.
In December 2004 we entered into an agreement with Mr. Li, pursuant to which Mr.
Li leases the Company a motor vehicle. The monthly rental payment is $1,812 and
the Company made no payments of rental expenses for the fiscal year ended
December 31, 2005.
(ii) China Star
China Star is a company which is 28% owned by Mr. Li. Mr. Yun long Zhang, one of
our directors, is also General Manager of China Star, who is responsible for its
daily operations.
On June 29, September 30, and December 31, 2005, the Company entered into
advance agreements with China Star for advances of $94,845, $91,071 and $13,598,
respectively. The advances were drawn down in stages over the second and third
quarters of 2005, respectively. The advances were unsecured, bore interest at
12% per annum and were initially due in 180 days from the date of draw down. The
due dates on all of the advances have been extended to June 2006. The Company
has also granted detachable warrants to China Star to purchase the aggregate of
997,571 shares of common stock. As of December 31, 2005, the Company had an
outstanding balance due to China Star of $263,165.
Each warrant attached to the advance entitles China Star to subscribe for one
share of common stock of the Company at an exercise price equal to the closing
quote of the Company's shares on the date of draw down, which ranged from $0.009
to $0.03 per share. The warrants expire two years from the date of issue. None
of the detachable warrants were exercised in the fiscal year ended December 31,
2005. The fair value of the detachable warrants at the time of their issuance
was determined to be $10,438, calculated pursuant to the Black-Scholes option
pricing model in accordance with EITF Issue No 00-27.
Additionally, we lease an office in the United States under a commercial lease
agreement with China Star that expired in June 2005 with an aggregate monthly
lease payment of approximately $2,560. Pursuant to the lease agreement dated
April 1, 2004, rent expenses for the fiscal year ended December 31, 2005 were
$15,360. We paid the rental expenses amounted to $15,360 under the lease in
2005. We did not renew the lease when it expired in 2005.
11. Short-Term Loans
As of December 31, 2004, short term loans consisted of loans of $50,000 from
Greater China Securities Inc. The loans were unsecured, non-interest bearing and
were repaid in February 2005.
12. Convertible Notes Payable
The balance of convertible notes payable as of December 31, 2005 and 2004 was
$407,135 and $312,104, respectively.
F-16
10% Loan
On September 23, 2004, the Company entered into a convertible loan agreement for
$350,000 with interest at 10% per annum (the "10% Loan"), and issued 1,050,000
detachable warrants. The lender is an unrelated party located in the United
States. The 10% Loan was initially due on March 23, 2005, but the final maturity
date was subsequently extended to April 21, 2005. The Company did not repay the
10% Loan by the extended maturity date. Prior to June 8, 2005, the Company made
payments to the lender in the amount of $359,991, which included a penalty
interest payment. On June 8, 2005, the Company signed a Payment Acknowledgment
and Release with the lender in which the lender acknowledged full satisfaction
of the 10% Loan and released the Company from all liability under the 10% Loan.
Each warrant attached to the 10% Loan entitles the holder to subscribe for one
share of common stock of the Company at an exercise price of $0.20 per share
through September 23, 2007. None of the detachable warrants were exercised in
the fiscal year ended December 31, 2005. The fair value of the detachable
warrants at the time of their issuance was determined to be $82,559, calculated
pursuant to the Black-Scholes option pricing model in accordance with EITF Issue
No 00-27. This fair value has been recorded as a reduction to the convertible
loan and has been credited to additional paid-in capital, and is being amortized
on the straight-line basis over the term of the loan with the amounts amortized
being recognized as interest expense. Any unamortized discount remaining at the
date of conversion of the loan will be recognized as interest expense in the
period the conversion takes place. In addition, the Company's Chief Executive
Officer, Mr. Li, also executed a guarantee of repayment of the loan which is
secured by shares of the Company's common stock that he owns.
In connection with the 10% Loan, the Company recorded deferred debt issuance
costs of $32,000, consisting of the direct costs incurred for the issuance of
the convertible loan. Debt issuance costs were amortized on the straight-line
method over the term of the 10% Loan, with the amounts amortized being
recognized as interest expense.
Promissory Note with Cornell Capital Partners, LP
On January 4, 2005, as amended by letter agreements dated March 21, 2005 and
April 5, 2005, the Company completed a loan transaction pursuant to which the
Company received an advance of $400,000 (before deduction of expenses and fees)
from Cornell Capital Partners, LP ("Cornell Capital") in exchange for the
issuance by the Company of a promissory note in the original principal amount of
$400,000 (the "Cornell Note"). The Cornell Note, bore interest at a rate of 10%
per annum and had a term of 290 days. The Company's obligations under the
Cornell Note could be paid from proceeds the Company received pursuant to the
Standby Equity Distribution Agreement entered into with Cornell Capital on July
6, 2004.. Pursuant to the terms of the Cornell Note, the Company deposited in
escrow 39 requests for advances under the Standby Equity Distribution Agreement
in the amount of $10,000 each and one request in the amount of $29,589, as well
as sufficient shares of the Company's Common Stock registered pursuant to the
Company's Registration Statement No. 333-117868, to cover the advances. An
attorney served as escrow agent in connection with the advance notices and
shares that were deposited in escrow pursuant to the Cornell Note. To the extent
the Cornell Note was not repaid in cash by the Company, the escrow agent
released requests for advances to Cornell Capital and Cornell Capital, at its
discretion, could apply the proceeds from the advances to the outstanding
balance on the Cornell Note. As of December 31, 2005, the escrow agent had
released 32 such advances for an aggregate of 18,362,219 shares of common stock
with repayment of $312,865. The balance of principal due on the Cornell Note as
of December 31, 2005 was $87,135.
As of March 31, 2006 the Company settled the Cornell Note with a payment of
$110,176, constituting all outstanding principal and accrued interest on the
Cornell Note (See Note 21).
12% Loans
On May 30, 2005 and June 16, 2005, the Company entered into three convertible
promissory note agreements for the aggregate of $320,000 with interest at 12%
per annum (the "12% Loans"), and issued 1,600,000 detachable warrants. The
lenders are unrelated parties located in the United States. The 12% Loans are
initially due in 3 months from date of draw down, but the final maturity dates
were extended for another three months. Mr. Li has provided personal guarantees
for the 12% Loans. As part of the loan terms, the lenders have the right to
convert the 12% Loans into shares of the Company's common stock at any time
prior to the maturity. The conversion price is based on 75% of the closing quote
of the Company's common stock on the date of conversion. However, the Company
has the right in its sole discretion to redeem the 12% Loans in whole or in part
for 125% of the face amount plus unpaid accrued interest. The Company did not
pay the 12% Loans by the extended maturity date. In April 2006 the Company
received notice from one of the lenders of its intention to convert $150,000 of
the 12% Loans to the Company's common stock. The Company is now negotiating with
the lenders of the remaining balance of $170,000 to defer the payment date. The
Company has not received from the lenders any notice of default or demand for
immediate payment.
F-17
Each warrant attached to the 12% Loans entitles the holder to subscribe for one
share of common stock of the Company at an exercise price equal to the closing
quote of the Company's shares on the date of draw down, which ranged from $0.018
to $0.023 per share. The warrants expire two years from the date of issue. None
of the detachable warrants were exercised in the fiscal year ended December 31,
2005. The fair value of the detachable warrants at the time of their issuance
was determined to be $21,700, calculated pursuant to the Black-Scholes option
pricing model in accordance with EITF Issue No 00-27.
The fair value of the beneficial conversion feature of the 12% Loans was
determined to be $106,666, based on a formula that takes the lower of
outstanding loan principal and the difference between the conversion price and
the fair market value of the Company's common stock. The fair value of $106,666
was recorded as a reduction to convertible notes payable and will be charged to
operations as interest expense from the date of draw down through the date of
maturity, which resulted in a charge to operations of $106,666 during the fiscal
year ended December 31, 2005.
In connection with the 12% Loans, the Company recorded deferred debt issuance
costs of $16,000, consisting of the direct costs incurred for the issuance of
the convertible loan. Debt issuance costs are being amortized on the
straight-line method over the term of the 12% Loans, with the amounts amortized
being recognized as interest expense. Any unamortized debt issuance costs
remaining at the date of conversion of the 12% Loans will be recognized as
interest expense in the period the conversion takes place.
Other Loans
On January 25, 2004, the Company entered into a convertible loan agreement for
$500,000, with interest at 12%, payable at maturity. The loan was scheduled to
mature on September 25, 2004. As part of the loan terms, the lender has the
right to convert the loan into shares of the Company's common stock at $0.25 per
share at any time prior to the maturity date, subject to the Company completing
a reverse merger transaction in the United States, which was accomplished in
March 2004. On June 8, 2004, the lender converted the $500,000 loan into
2,000,000 shares of the Company's common stock at the agreed upon conversion
price of $0.25 per share. The lender is an unrelated party located outside the
United States.
The fair value of the beneficial conversion feature of this convertible loan was
determined to be $500,000, based on a formula that takes the lower of
outstanding loan principal and the difference between the $0.25 conversion price
and the fair market value of the Company's common stock of $0.60 per share. The
fair value of $500,000 was recorded as a reduction to convertible notes payable
and charged to operations as interest expense from January 25, 2004 through the
conversion date (June 8, 2004), which resulted in a charge to operations of
$281,250 before the conversion date. The unamortized deferred interest expense
of $218,750 as of the conversion date was charged to operations.
On March 12, 2004, the Company entered into a convertible loan agreement for
$200,000, with interest at 12%, payable at maturity. The loan was scheduled to
mature three months after funding. As part of the loan terms, the lender has the
right to convert the loan into shares of the Company's common stock at $0.25 per
share at any time prior to the maturity date, subject to the Company completing
a reverse merger transaction in the United States, which was accomplished in
March 2004. The loan was not funded until April 7, 2004. On June 8, 2004, the
lender converted the $200,000 loan into 800,000 shares of the Company's common
stock at the agreed upon conversion price of $0.25 per share. The lender is an
unrelated party located outside the United States.
The fair value of the beneficial conversion feature of this convertible loan was
determined to be $200,000, based on a formula that takes the lower of
outstanding loan principal and the difference between the $0.25 conversion price
and the fair market value of the Company's common stock of $0.60 per share. The
fair value of $200,000 was recorded as a reduction to convertible notes payable
and charged to operations as interest expense from April 7, 2004 through the
conversion date (June 8, 2004), which resulted in a charge to operations of
$133,333 before the conversion date. The unamortized deferred interest expense
of $66,667 as of the conversion date was charged to operations.
F-18
13. Unsecured loans payable
Unsecured loans payable consisted of the following at December 31, 2005 and
2004:
----------------------------------------------------------------------------------------------------------------------
Notes December 31, 2005 December 31, 2004
----------------------------------------------------------------------------------------------------------------------
Unsecured loan payable to Zoucheng Municipal $1,115,214 $1,087,390
Government, non-interest bearing, becoming due within (i)
three years from Kiwa-SD's first profitable year
on a formula basis, interest has not been imputed due
to the undeterminable repayment date
----------------------------------------------------------------------------------------------------------------------
Unsecured loan payable to Zoucheng Science & Technology 309,782 302,053
Bureau, non-interest bearing, it is due in Kiwa-SD's first (ii)
profitable year, interest has not been imputed due to the
undeterminable repayment date
----------------------------------------------------------------------------------------------------------------------
Total $1,424,996 $1,389,443
----------------------------------------------------------------------------------------------------------------------
Note: (i) The unsecured loan payable consists of amounts borrowed under a
project agreement with Zoucheng Municipal Government, whereby the
Company is allowed to borrow up to $1.2 million. The loan is
non-interest bearing, becoming due within three years from Kiwa-SD's
first profitable year on a formula basis. Interest has not been imputed
due to the undeterminable repayment date.
According to the project agreement, Zoucheng Municipal Government
granted the Company use of at least 15.7 acres in Shandong Province,
China at no cost for 10 years to construct a manufacturing facility.
Under the agreement, the Company has the option to pay a fee of $60,197
per acre for the land use right after the 10-year period. The Company
may not transfer or pledge the temporary land use right. The Company
also committed to invest approximately $18 million to $24 million for
developing the manufacturing and research facilities in Zoucheng,
Shandong Province. As of December 31, 2005, the Company invested
approximately $1.4 million for the project. Management believes that
neither the Company nor management will be liable for compensation or
penalty if such commitment is not fulfilled.
(ii) The amount was borrowed from Zoucheng Science & Technology Bureau
in 2004. It is non-interest bearing, unsecured and due in Kiwa-SD's
first profitable year. Interest has not been imputed due to the
undeterminable repayment date.
The Company qualifies for non-interest bearing loans under a government
sponsored program to encourage economic development in certain industries and
locations. To qualify for the favorable loan terms, a company must meet the
following criteria: (1) be a technology company with innovative technology or
product (as determined by the Science Bureau of the central government); (2)
operate in specific industries, such as agriculture, environmental, education,
and others, which the government has determined are important to encourage
development; and (3) be located in undeveloped areas such as Zoucheng, Shandong
Province where the manufacturing facility of the Company is located.
14. Bank notes payable
Bank notes payable (including current portion) consisted of the following at
December 31 of the years indicated:
----------------------------------------------------------------------- ---------------------------------------------
2005 2004
----------------------------------------------------------------------- ---------------------------------------------
Note payable to a bank, payable in monthly installments of $735 up to October
2007 secured by an automobile, bearing an interest rate of
5.32% per annum. $11,768 $23,159
----------------------------------------------------------------------- ---------------------------------------------
Note payable to a bank, payable in quarterly installments of principle equal to
$1,275 up to March 2008, secured by an automobile,
bearing an interest rate of 5.02% per annum. 15,774 16,573
----------------------------------------------------------------------- ---------------------------------------------
Total $27,542 $39,732
----------------------------------------------------------------------- ---------------------------------------------
F-19
Maturities of notes payable as of December 31, 2005 are as follows:
----------------------------------------------------------------------
Years Ending December 31 Amount
----------------------------------------------------------------------
2006 $13,647
2007 12,590
2008 1,305
----------------------------------------------------------------------
Total $27,542
----------------------------------------------------------------------
15. Equity-Based Transactions
(a) Authorized share capital
On June 3, 2004, a majority of the Company's stockholders approved an amendment
to the Company's Second Restated and Amended Articles of Incorporation to (a)
increase from 50,000,000 to 100,000,000 the authorized number of shares of the
Company's common stock and (b) authorize 20,000,000 shares of preferred stock
(the rights, preferences, privileges and restrictions to be determined by the
Board of Directors). The amendment was effective on July 16, 2004.
(b) Issued and outstanding share capital
From January 1, 2004 to December 31, 2005, the Company has engaged in the
following equity-based transactions:
In conjunction with the March 2004 reverse merger transaction (see under
"Organization" in Note 1), the Company entered into the following equity-based
transactions:
a. In exchange for 100% of the issued and outstanding shares of Kiwa Bio-Tech,
the Kiwa Bio-Tech stockholders were issued 30,891,676 shares of Tintic's common
stock;
b. The stockholders of Tintic retained their 4,038,572 shares of common stock
which were issued and outstanding prior to the consummation of the Merger
Agreement;
c. Tintic assumed 1,852,501 stock options issuable by Kiwa Bio-Tech at March 12,
2004;
d. Effective March 11, 2004, the Company issued a warrant to its financial
advisor to purchase 1,747,000 shares of common stock exercisable at $0.20 per
share for six years. The fair value of this warrant was determined to be
approximately $0.54 per share pursuant to the Black-Scholes option-pricing
model. The aggregate fair value of such warrant of $943,380 was charged to
operations as reverse merger costs during the year ended December 31, 2004; and
e. Effective March 30, 2004, the Company issued a stock option to a consultant
to purchase 300,000 shares of common stock exercisable at $0.20 per share for
ten years. The fair value of this option was determined to be approximately
$0.57 per share pursuant to the Black-Scholes option pricing model. The
aggregate fair value of such option of $171,000 was charged to operations as
reverse merger costs during the year ended December 31, 2004.
On April 12, 2004, the Company entered into an agreement with China Agricultural
University to acquire patent no. ZL 93101635.5 entitled "Highly Effective
Composite Bacteria for Enhancing Yield and the Related Methodology for
Manufacturing," which was originally granted by the PRC Patent Bureau on July
12, 1996. The purchase consideration was $480,411, of which $30,205 was paid at
signing of the agreement and an additional $30,205 was paid in December 2004. In
addition, the Company issued 1,000,000 shares of common stock valued at $0.42
per share based on its fair market value on July 19, 2004 (aggregate value
$420,000), the date when the application for the patent right holder alternation
registration was approved.
F-20
On May 24, 2004, the Company entered into a contract with Cinapsys Inc. to
provide investor relations services. The engagement was for a period of twelve
months and provided for a monthly retainer of $4,000 and the issuance of 75,000
shares of common stock. The Company recorded a prepaid expense of $33,750 based
on the closing price of its common stock on the effective date of the agreement
and is amortizing such amount to operations over the 12 month contract period.
On September 27, 2004, the Company terminated the engagement letter with
Cinapsys Inc. according to the termination clause and the Board of Directors
authorized the issuance of the above 75,000 shares of common stocks to Cinapsys
Inc. Accordingly, the prepaid expense was written off in 2004.
On July 6, 2004, the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital which was terminated on March 31, 2006. Under the
Standby Equity Distribution Agreement, the Company could, at its discretion,
periodically issue and sell to Cornell Capital common stock for a total purchase
price of up to $10,000,000, subject to further limitations noted in the next
paragraph.
Under the Standby Equity Distribution Agreement, the formula for calculating the
purchase price for shares issued is equal to 99% of the market price, which is
defined as the lowest volume weighted average price of the common stock during
the five trading days following the notice date. Cornell Capital received a
one-time commitment fee of 704,039 shares of the Company's common stock
following execution of the Agreement on July 29, 2004, which was treated as a
reduction of the proceeds. Cornell Capital was paid a fee equal to 4% of each
advance, which was retained from each advance. As a result, our proceeds from
the sale of shares under the Standby Equity Distribution Agreement were equal to
95% of the market price, calculated as described above. In connection with the
Standby Equity Distribution Agreement, the Company also entered into a Placement
Agent Agreement with Newbridge Securities Corporation, a registered
broker-dealer. On July 29, 2004, the Company paid Newbridge Securities
Corporation a one-time placement agent fee of 26,567 shares of common stock with
a value of approximately $10,000 based on the volume weighted average price of
the Company's common stock as quoted by Bloomberg, LP on the date of the
Placement Agent Agreement which was treated as a reduction of the proceeds. The
Company registered the shares of common stock issuable under the Standby Equity
Distribution Agreement for resale by Cornell Capital pursuant to a Registration
Statement on Form SB-2 (No. 333-117868), which was declared effective by the SEC
in December 2004.
The amount of stock the Company was permitted to sell under the Standby Equity
Distribution Agreement at one time was subject to a maximum advance amount of
$500,000, with no cash advance occurring within seven trading days of a prior
advance, and the Company could not request cash advances if the shares to be
issued in connection with an advance would result in Cornell Capital owning more
than 9.9% of the Company's outstanding common stock.
In total, before the Standby Equity Distribution Agreement was terminated, the
escrow agent released 32 advances or an aggregate of 18,362,219 shares of common
stock with repayment of $312,865. The balance due on the Cornell Note as of
December 31, 2005 was $87,135. On March 31, 2006, the Company paid of all
outstanding principal and interest on the Cornell Note ($110,176) and terminated
the Standby Equity Distribution Agreement. See Note 12 regarding termination of
the agreement.
On September 14, 2004, the Company issued 892,857 shares of common stock to
Stubbs Alderton and Markiles, LLP, with an aggregate value of $125,000, as
payment for legal fees incurred during 2004.
On October 1, 2004, the Company entered a Consulting Agreement with Amy L. Yi to
provide investor relations services. The engagement was for a period of six
months and provided for the issuance of 200,000 shares of common stock. The
Company recorded a prepaid expense of $20,000 based on the closing price of its
common stock on the effective date of the agreement and amortized such amount to
operations over the six month contract period.
On October 1, 2004, the Company entered a Consulting Agreement with Robert
Sullivan to provide investor relations services. The engagement was for a period
of three months and provided for the issuance of 165,000 shares of common stock.
The Company recorded a prepaid expense of $16,500 based on the closing price of
its common stock on the effective date of the agreement and amortized such
amount to operations over the three month contract period.
On October 1, 2004, the Company entered a Consulting Agreement with Barry R.
Clark to provide investor relations services. The engagement was for a period of
four months and provided for the issuance of 200,000 shares of common stock. The
Company recorded a prepaid expense of $20,000 based on the closing price of its
common stock on the effective date of the agreement and amortized such amount to
operations over the four month contract period. After one month of service, the
Company terminated the engagement with Barry R. Clark according to the
termination clause and the Board of Directors authorized the cancellation of
certificates representing 150,000 shares of stock issued to Barry R. Clark and
the issuance of 30,000 shares of restricted stock to Barry R. Clark as final
compensation, which was recognized as consulting expenses as of December 31,
2004.
F-21
(c) Option
On June 3, 2004, a majority of the Company's stockholders approved the adoption
of the Company's 2004 Stock Incentive Plan (the "Plan"). There are reserved
1,047,907 shares of the Company's common stock for the issuance of stock options
and stock purchase rights under the Plan, of which not more than 350,000 shares
may be granted to any participant in any fiscal year.
The options granted under of the Plan will expire ten years from the date of
grant. The options which are not issued to an officer, a director or a
consultant will become exercisable at least as rapidly as 20% per year over the
five-year period commencing on the date of grant. As of December 31, 2005, no
stock options or stock purchase rights had been granted under the Plan.
16. Major Customers and Suppliers
Two customers accounted for 51.3%, 45.3% of our net sales for the fiscal year
ended December 31, 2005. No other single customer accounted for more than 3% of
our revenues. All of the revenues are generated from Chinese customers in 2005.
Three customers accounted for 46.1%, 26.3% and 18.5% of our net sales for the
fiscal year ended December 31, 2004. The revenue from Chinese and South-East
Asian customers accounted for 53.9% and 46.1% in 2004 respectively.
Three suppliers accounted for 64.0%, 17.2% and 12.5% of our net purchases for
the fiscal year ended December31, 2005. Three suppliers accounted for 49.2%,
27.6%, and 4.1% of our net purchases for the fiscal year ended December 31,
2004. The raw materials used in our products are available from a variety of
alternative sources.
17. Other Income
During the year ended December 31, 2005, the Company received a grant from
municipal government in Shandong Province of China amounted to $2,416, because
the Company is a high-tech enterprise qualified by the local government. The
subsidy is non-recurring.
In 2004, the Company had other income of $60,411 attributable to the forgiveness
by Zoucheng Science & Technology Bureau in Shandong Province, China of a loan
borrowed in 2003.
18. Taxation
As of December 31, 2005 and 2004, the Company has no material deferred tax
assets, since the Company has incurred operating losses and has established a
valuation allowance equal to the total deferred tax asset. In addition, there
was also no material deferred tax liability as of December 31, 2005 and 2004.
In accordance with the relevant tax laws in China, Kiwa-SD would normally be
subject to a corporate income tax rate of 33% on its taxable income. However, in
accordance with the relevant tax laws in China, Kiwa-SD is exempt from corporate
income taxes for its first two profit making years and is entitled to a 50% tax
reduction for the succeeding three years. Kiwa-SD has not provided for any
corporate income taxes since it had no taxable income for the years ended
December 31, 2005 and 2004.
In accordance with the relevant tax laws in the British Virgin Islands, Kiwa
Bio-Tech Products Group Ltd., as an International Business Company, is exempt
from income taxes.
F-22
A reconciliation of the provision for income taxes determined at the statutory
average state and local income taxes to the Company's effective income tax rate
is as follows:
Year ended Year ended
December 31, December 31,
2005 2004
------------------ ------------------
Statutory income tax 33% 33%
Impact of effective tax exemption (33%) (33%)
------------------ ------------------
Effective rate - -
------------------ ------------------
19. Lease Commitments
The Company has the following material contractual obligations:
Operating lease commitments - The Company previously leased an office in Beijing
under an operating lease that expired in April 2005 with an aggregate monthly
lease payment of approximately $2,882. This operating lease was replaced by
another operating lease expiring in March 2008 with an aggregate monthly lease
payment of approximately $4,990. Rent expense under the operating leases for the
fiscal year ended December 31, 2005 and 2004 was $52,416 and $31,703
respectively.
The Company previously leased an office in the United States under a commercial
lease agreement with China Star expired in June 2005 with an aggregate monthly
lease payment of approximately $2,560. This operating lease was replaced by
another operating lease with a third party expiring in June 2008 with an
aggregate monthly lease payment of approximately $1,000. Pursuant to the lease
agreements, rent expense for the fiscal year ended December 31, 2005 and 2004
was $20,763 and $21,904, respectively. At December 31, 2005, the remaining
minimum lease payments amounted to $29,833.
Lease commitments under the foregoing lease agreements are as follows:
-----------------------------------------------------
Fiscal year Amount
-----------------------------------------------------
2006 $72,114
2007 72,114
2008 21,004
-----------------------------------------------------
Total $165,232
-----------------------------------------------------
20. Retirement Plan
As stipulated by the regulations of the Chinese government, Kiwa-SD has defined
contribution retirement plans for their employees. The Chinese government is
responsible for the pension liability to these retired employees. The Company
was required to make specified contributions to the state-sponsored retirement
plan at 20% of the local average salary cost. Each of the employees of the PRC
subsidiaries of the Company is required to contribute 8% of his/her basic
salary. For the fiscal years ended December 31, 2005 and 2004, accrued
contributions made by the Company were $32,210 and $26,146, respectively.
21. Subsequent Events
On March 10, 2006, the Company entered into a Stock Purchase Agreement with two
Chinese citizens, pursuant to which the Company agreed to issue 5,000,000 shares
of our common stock in exchange for RMB 6,000,000 (RMB1.20 per share). The Stock
Purchase Agreement was disclosed on the Company's 8-K filed on March 10, 2006.
(On March 10, 2006 the US$-RMB exchange rate as published by the State
Administration of Foreign Exchange of the PRC was $1.00 US$ per 8.0492RMB.) In
issuing the stock, the Company relied on Section 4(2) of the Securities Act of
1993 and Rule 506 of Regulation D promulgated under the act for its exemption
from the registration requirements of the act. No underwriters or brokers were
used in the transaction and no underwriting or broker fees were paid. The
F-23
purchaser was granted "piggy-back" registration rights in the event that the
Company undertakes to register any of its shares. The registration rights, which
are set forth in Exhibit A to the Stock Purchase Agreement expire four years
from the effective date of the Stock Purchase Agreement. Pursuant to the
agreement, 30% of the total purchase price for the stock is due in 10 days from
the effective date and the balance must be paid in 20 days. As of April 13,
2006, the Company had received proceeds under the agreement of approximately
$350,000. The Company will issue certificates for the 5,000,000 subscribed-for
shares when the balance of the purchase price has been paid, which the parties
have agreed will occur on or before April 30, 2006.
Pursuant to a Termination Agreement dated March 31, 2006, the Company terminated
the following agreements with Cornell Capital: the Standby Equity Distribution
Agreement dated July 6, 2004; the Registration Rights Agreement dated July 6,
2004; the Placement Agent Agreement dated July 6, 2004 and the Promissory Note
in favor of Cornell Capital dated January 4, 2005 (all of the foregoing, the
"Financing Agreements"). Prerequisite to termination of the Financing
Agreements, the Company paid Cornell Capital $110,176, constituting all
outstanding principal and accrued interest on the Cornell Note. In the
conjunction with the termination and settlement, Cornell Capital returned
5,864,357 shares of our common stock that were held as collateral under the
Standby Equity Distribution Agreement. These shares were cancelled and converted
to authorized but unissued shares of the Company.
F-24