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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
COMMISSION FILE NUMBER: 000-33167
KIWA BIO-TECH PRODUCTS GROUP CORPORATION
(Exact name of small business issuer as specified in its charter)
DELAWARE 84-0448400
(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)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 |_|
o Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). YES |_| NO |X|
As of May 8, 2006, the number of shares registrant's common stock outstanding
was 59,235,930.
Transitional Small Business Disclosure Format: YES |_| NO |X|
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1
TABLE OF CONTENTS
PAGE
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS...........................................................................1
Condensed Consolidated Balance Sheets (unaudited)..............................................1
Condensed Consolidated Statements of Operations and Comprehensive Income (Unaudited)...........2
Condensed Consolidated Statement of Stockholders' Equity (Deficiency) (Unaudited)..............3
Condensed Consolidated Statements of Cash Flows (Unaudited)....................................4
Notes to Condensed Consolidated Financial Statements (Unaudited)...............................5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION..........15
Overview......................................................................................16
Going Concern.................................................................................16
Major Customers and Suppliers:................................................................17
Trends and Uncertainties in Regulation and Government Policy in China.........................17
Critical Accounting Policies and Estimates....................................................18
Results of Operations for Three Months Ended March 31, 2006 and 2005..........................19
Liquidity and Capital Resources...............................................................20
Inflation and Currency Matters................................................................22
Commitments and Contingencies.................................................................23
Off-Balance Sheet Arrangements................................................................23
Recent Accounting Pronouncements..............................................................23
ITEM 3. CONTROLS AND PROCEDURES.......................................................................23
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.............................................................................24
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS...................................24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES...............................................................24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........................................24
ITEM 5. OTHER INFORMATION.............................................................................24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..............................................................24
SIGNATURES 30
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
KIWA BIO-TECH PRODUCTS GROUP CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
March 31, December 31,
2006 2005
----------------------------
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 13,531 $ 14,576
Accounts receivable 705,865 701,486
Inventories 490,561 495,597
Prepaid expenses 1,500 1,962
Other current assets 32,569 27,176
------------ ------------
Total current assets 1,244,026 1,240,807
Property, plant and equipment:
Buildings 1,018,936 1,012,219
Machinery and equipment 450,329 447,361
Automobiles 104,603 103,914
Office equipment 57,804 57,423
Computer software 9,000 8,940
------------ ------------
1,640,672 1,629857
Less: accumulated depreciation (214,995) (192,991)
------------ ------------
Property, plant and equipment - net 1,425,677 1,436,866
Construction in progress 33,650 33,429
Intangible assets-net 398,723 410,586
------------ ------------
Total assets $ 3,102,076$ $ 3,121,688
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIENCY)
Current liabilities
Accounts payable and accrued expenses $1,062,792$ $ 1,000,477
Construction cost payable 374,809 372,338
Due to related party 495,672 454,193
Convertible notes payable-unrelated party 320,000 407,135
Current portion of bank notes payable 13,854 13,647
------------ ------------
Total current liabilities 2,267,127 2,247,790
Long-term liabilities, less current portion:
Unsecured loans payable 1,434,452 1,424,996
Bank notes payable 11,864 13,895
------------ ------------
Total long-term liabilities 1,446,316 1,438,891
Stockholders' equity (deficiency)
Common stock - $0.001 par value
Authorized 100,000,000 shares at March 31, 2006 and
December 31, 2005 Issued and outstanding 59,235,930
shares at March 31, 2006 and December 31, 2005,
respectively 59,236 59,236
Common stock subscribed - $0.001 par value 5000 --
Preferred stock -$0.001 par value
Authorized 20,000,000 shares at March 31, 2006 and
December 31, 2005 Issued and outstanding nil shares
at March 31, 2006 and December 31, 2005 -- --
Additional paid-in capital 5,581,529 4,835,968
Stock subscription receivable (619,132) --
Deficit accumulated (5,666,999) (5,482,555)
Accumulated other comprehensive income 28,999 22,358
------------ ------------
Total stockholders' deficiency (611,367) (564,993)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY 3,102,076$ 3,121,688
============ ============
See accompanying notes to condensed consolidated financial statements.
-1-
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(UNAUDITED)
KIWA BIO-TECH PRODUCTS GROUP CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March. 31,
-----------------------------
2006 2005
------------ ------------
NET SALES $ 11,023 $ 410,692
Cost of sales 7,410 74,973
------------ ------------
GROSS PROFIT 3,613 335,719
OPERATING EXPENSES:
Consulting and professional fees 44,400 136,573
Officers' compensation 5,967 8,350
General and administrative 72,222 247,800
Research and development 7,901 7,280
Depreciation and amortization 33,162 29,495
------------ ------------
TOTAL COSTS AND EXPENSES 163,652 429,498
------------ ------------
OPERATING LOSS: (160,039) (93,779)
INTEREST EXPENSE, NET (24,404) (67,404)
------------ ------------
NET LOSS (184,443) $ (161,183)
------------ ------------
OTHER COMPREHENSIVE INCOME (LOSS)
Translation adjustment 6,641 --
------------ ------------
COMPREHENSIVE LOSS $ (177,802) $ (161,183)
------------ ------------
NET LOSS PER COMMON SHARE $ (0.003) $
- BASIC AND DILUTED (0.004)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 59,235,930 42,778,689
============ ============
See accompanying notes to condensed consolidated financial statements.
-2-
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
(UNAUDITED)
KIWA BIO-TECH PRODUCTS GROUP CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
Common Stock
Common Stock subscribed
------------ ------------ Accumulated
Shares Amount Shares Amount APIC Deficits OCIiu
---------- ---------- ---------- ---------- ---------- ----------- ----------
BALANCE, DECEMBER 31, 2004 40,873,711 40,874 -- -- 4,393,415 (4,154,796) --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of common stock to
Cornell Capital in the first
nine months of 2005, as
repayments in conjunction
with Promissory Note dated
on January 4, 2005 18,362,219 18,362 -- -- 294,503 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of detachable warrants
in conjunction with the
issuance of convertible
promissory notes in June 2005 -- -- -- -- 21,700 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Beneficial conversion feature of
convertible note payable funded
in June, 2005 -- -- -- -- 106,666 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of detachable warrants
in conjunction with the various
advances from a director in
May 2005 -- -- -- -- 8,633 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of detachable warrants
in conjunction with the advances
from a related party dated
June 29, 2005 -- -- -- -- 5,417 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of detachable warrants
in conjunction with the advances
from a related party dated
September 30, 2005 -- -- -- -- 5,021 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of detachable warrants
in conjunction with the advances
from a related party dated
December 31, 2005 -- -- -- -- 613 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Net loss for the year ended
December 31, 2005 -- -- -- -- (1,327,759) -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Other comprehensive
income-Translation adjustment -- -- -- -- -- 22,358 --
---------- ---------- ---------- ---------- ---------- ----------- ----------
BALANCE, DECEMBER 31, 2005 59,235,930 59,236 -- -- 4,835,968 (5,482,556) 22,358
---------- ---------- ---------- ---------- ---------- ----------- ----------
Subscription of 5 million
shares of common stock
pursuant o the Stock Purchase
Agreement dated as of
March 10, 2006, with the
certificate not issued until
full payment -- -- 5,000,000 5,000 740,416 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Issuance of detachable warrants
in conjunction with the
advances from a related party
dated March 31, 2006 -- -- -- -- 5,145 -- --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Net loss for three months ended
March 31, 2006 -- -- -- -- -- (184,443) --
---------- ---------- ---------- ---------- ---------- ----------- ----------
Other comprehensive
income-Translation adjustment -- -- -- -- -- -- 6,641
---------- ---------- ---------- ---------- ---------- ----------- ----------
BALANCE, MARCH. 31, 2006 59,235,930 59,236 5,000,000 5,000 5,581,529 28,999 (619,132)
---------- ---------- ---------- ---------- ---------- ----------- ----------
APIC: Additional Paid-in Capital
OCI: Other Comprehensive Income
SSR: Stock Subscription Receivable
SSRiu Total
---------- ----------
BALANCE, DECEMBER 31, 2004 -- 279,493
---------- ----------
Issuance of common stock to
Cornell Capital in the first
nine months of 2005, as
repayments in conjunction
with Promissory Note dated
on January 4, 2005 -- 312,865
---------- ----------
Issuance of detachable warrants
in conjunction with the
issuance of convertible
promissory notes in June 2005 -- 21,700
---------- ----------
Beneficial conversion feature of
convertible note payable funded
in June, 2005 -- 106,666
---------- ----------
Issuance of detachable warrants
in conjunction with the various
advances from a director in
May 2005 -- 8,633
---------- ----------
Issuance of detachable warrants
in conjunction with the advances
from a related party dated
June 29, 2005 -- 5,417
---------- ----------
---------- ----------
Issuance of detachable warrants
in conjunction with the advances
from a related party dated
September 30, 2005 -- 5,021
---------- ----------
Issuance of detachable warrants
in conjunction with the advances
from a related party dated
December 31, 2005 -- 613
---------- ----------
Net loss for the year ended
December 31, 2005 -- (1,327,759)
---------- ----------
Other comprehensive
income-Translation adjustment -- 22,358
---------- ----------
BALANCE, DECEMBER 31, 2005 -- (564,994)
---------- ----------
Subscription of 5 million
shares of common stock
pursuant o the Stock Purchase
Agreement dated as of
March 10, 2006, with the
certificate not issued until
full payment (619,132) 126,284
---------- ----------
Issuance of detachable warrants
in conjunction with the
advances from a related party
dated March 31, 2006 -- 5,145
---------- ----------
Net loss for three months ended
March 31, 2006 -- (184,443)
---------- ----------
Other comprehensive
income-Translation adjustment -- 6,641
---------- ----------
BALANCE, MARCH. 31, 2006 (611,367)
---------- ----------
See accompanying notes to condensed consolidated financial statements.
-3-
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
KIWA BIO-TECH PRODUCTS GROUP CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months Ended March 31,
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (184,443) $ (161,183)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 33,867 40,381
Amortization of detachable warrants 980 37,896
Changes in operating assets and liabilities:
(Increase)decrease in :
Accounts receivable (4,379) (323,363)
Inventories 5,036 38,827
Other receivable -- 62,410
Prepaid expenses 462 24,709
Other current assets (5,383) (3,607)
Increase(decrease)in:
Accounts payable and accrued expenses 62,314 9,153
Construction cost payable (3,625)
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (91,546) (278,402)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment -- (4,175)
Acquisition of intangible asset -- --
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES -- (4,175)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from subscription of common stock 126,284 --
Repayment of short-term loans -- (50,000)
Proceeds from related parties 44,268 --
Repayment to related parties -- (60,159)
Proceeds from convertible notes payable -- 400,000
Repayment of convertible notes payable (87,135) --
Repayment of long-term borrowings (2,004) (3,181)
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 81,413 286,660
------------ ------------
FOREIGN CURRENCY TRANSLATION 9,088 --
CASH AND CASH EQUIVALENTS:
Net decrease (1,045) (4,083)
Balance at beginning of period 14,576 17,049
BALANCE AT END OF PERIOD $ 13,531 $ 21,132
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 23,306 $ 16,507
Cash paid for taxes -- --
Non-cash investing and financing activities:
Issuance of common stock as partial repayments in
conjunction with Promissory Note dated January 4, 2005 -- $ 100,000
Issuance of detachable warrants in conjunction
with the advance agreement with a related party dated
March 31, 2006 $ 5,145 $ --
------------ ------------
See accompanying notes to condensed consolidated financial statements.
-4-
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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.
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.
BASIS OF PRESENTATION - The consolidated financial statements include the
operations of the Company 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 Renminbi (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 a bad debt allowance of
$86,041, which represents the total outstanding accounts receivables over 365
days old.
-5-
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 $184,443 and $161,183 during the
three months ended March 31, 2006 and 2005, respectively, and our current
liabilities exceeded our current assets by $1,023,101 and $1,006,983 at March
31, 2006 and December 31, 2005, 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 May 12,
2006, the Company had received approximately $400,000, which represented 53% of
the total proceeds. The Company and the investors have agreed to defer funding
of the remaining commitment to May 31, 2006 (See Note 13 to the Condensed
Consolidated Financial Statements). From 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 contained in the Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 2005, 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, convertible debt and stock subscription) 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
March 31, 2006, potentially dilutive securities aggregated 26,930,383 shares of
common stock.
ADVERTISING - The Company charges all advertising costs to expense as incurred.
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.
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.
6
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 three months ended March 31, 2006 and
2005 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 March 31, 2006.
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
Renminbi ("RMB") of China, which is the primary medium of exchange where Kiwa-SD
operates. The Company reports its financial results in United States dollars
("U.S. dollars").
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 (on March 31, 2006, the
prevailing exchange rate of the US dollar against the RMB was 8.0170), 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 and comprehensive income.
7
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 - As of December 15, 2005, SFAS No.
123R, "Share-Based Payment," superseded SFAS No. 123 and APB No. 25, and will
begin with the first interim or annual period after December 15, 2005. Under
SFAS 123R, compensation cost is calculated on the date of grant using the fair
value of the option as determined using the Black Scholes method. The Black
Scholes valuation calculation requires the Company to estimate key assumptions
such as expected term, volatility and forfeiture rates to determine the fair
value of a stock option. The estimate of these key assumptions is based on
historical information and judgment regarding market factors and trends. The
compensation cost is amortized straight-line over the vesting period.
Prior to December 31, 2005, the Company accounted for stock options under the
recognition and measurement provisions of APB Opinion No.25 (APB25), "Accounting
for Stock Issued to Employees," and related Interpretations, as permitted by
FASB Statement No.123 (SFAS123), "Accounting for Stock-Based Compensation."
RECLASSIFICATION FROM PRIOR YEAR 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.
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.
8
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. Management believes the adoption of this statement does
not have an immediate material impact on the consolidated financial statements
of the Company.
The adoption of EITF Issue No. 03-13, "Applying the Conditions in Paragraph 42
of FASB Statement No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, in Determining Whether to Report Discontinued Operations" in
the first quarter of 2005 did not have a material impact on the Company's
results of operations and financial condition.
In October 2005, the FASB issued FSP FAS 123(R)-2, "Practical Accommodation to
the Application of Grant Date as Defined in FASB Statement No. 123(R)", which
provides clarification of the concept of mutual understanding between employer
and employee with respect to the grant date of a share-based payment award. This
FSP provides that a mutual understanding of the key terms and conditions of an
award shall be presumed to exist on the date the award is approved by management
if the recipient does not have the ability to negotiate the key terms and
conditions of the award and those key terms and conditions will be communicated
to the individual recipient within a relatively short time period after the date
of approval. This guidance shall be applied upon initial adoption of SFAS 123R.
The Company does not expect the adoption of the FSP will have a material impact
on its consolidated results of operations and financial condition.
In November 2005, the FASB issued FSP FAS 123(R)-3, "Transition Election Related
to Accounting for the Tax Effects of Share-Based Payment Awards", which provides
a practical transition election related to accounting for the tax effects of
share-based payment awards to employees. An entity must follow either the
transition guidance for the APIC pool in SFAS 123R or the alternative transition
method described in the FSP. The alternative method comprises a computational
component that establishes a beginning balance of the APIC pool and a simplified
method to determine the subsequent impact on the APIC pool of awards that are
fully vested and outstanding upon the adoption of SFAS 123R. The impact on the
APIC pool of awards partially vested upon, or granted after, the adoption of
SFAS 123R should be determined in accordance with the guidance in that
statement. The FSP was effective November 10, 2005. As described in the FSP, an
entity will be permitted to take up to one year to determine its transition
alternatives to make its one-time election. The Company does not expect the
adoption of the FSP will have a material impact on its consolidated results of
operations and financial condition.
In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of
FASB Statements No. 133 and 140." SFAS No. 155 amends SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities", to permit fair value
remeasurement for any hybrid financial instrument with an embedded derivative
that otherwise would require bifurcation, provided that the whole instrument is
accounted for on a fair value basis. SFAS No. 155 amends SFAS No. 140,
"Accounting for the Impairment or Disposal of Long-Lived Assets", to allow a
qualifying special-purpose entity (SPE) to hold a derivative financial
instrument that pertains to a beneficial interest other than another derivative
financial instrument. SFAS No. 155 applies to all financial instruments acquired
or issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006, with earlier application allowed. The Company does not
expect the adoption of SFAS No. 155 to have a material impact on its
consolidated results of operations and financial condition.
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.
-9-
3. INVENTORIES
Inventories consisted of the following as of March 31, 2006 and December 31,
2005:
March 31, 2006 December 31, 2005
(unaudited)
-------------- -----------------
Raw materials $ 420,596 $ 17,237
Work in progress 257 --
Finished goods 69,707 78,360
-------------- -----------------
Total $ 490,561 $ 495,597
============== =================
4. PREPAID EXPENSES
As of March 31, 2006 and December 31, 2005, the prepaid expenses amounted to
$1,500 and $1,962, respectively, including prepaid rental, web hosting fee and
insurance.
5. PROPERTY, PLANT AND EQUIPMENT
The total gross amount of property, plant and equipment was $1,640,672 and
$1,629,857 as of March 31, 2006 and December 31, 2005, respectively. The
increase of $10,815 is due to the continuous appreciation of RMB, and all of our
property, plant and equipment are located in China and recorded in RMB.
Depreciation expense was approximately $22,004 and $19,382 for three months
ended March 31, 2006 and 2005, respectively.
6. INTANGIBLE ASSET
The Company's intangible asset as of March 31, 2006 consisted of the following:
Expected Gross Accumulated Intangible Asset,
Amortization Period Carrying Value Amortization Net
Patent 8.5 years $480,411 $81,688 $398,723
The following table presents future expected amortization expense related to the
patent:
Amount
------------
2006 $ 44,655
2007 56,518
2008 56,518
2009 56,518
2010 56,518
Thereafter 127,996
------------
$ 410,586
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consisted of the following at December 31,
2005 and 2004:
March 31, 2006 December 31,2005
(unaudited)
----------------- -----------------
Consulting and professional payables $ 445,952 $ 411,360
Payables to material suppliers 214,624 211,903
Interest payable 106,038 106,880
Salary payable 96,694 92,557
Insurance payable 84,031 81,553
Office rent payable 54,545 39,007
Payables to equipment suppliers 13,852 13,761
Others 47,056 43,456
----------------- -----------------
Total $ 1,062,792 $ 1,000,477
----------------- -----------------
-10-
8. CONSTRUCTION COSTS PAYABLE
Construction costs payable represents remaining amounts to be paid for the first
phase of the construction project.
9. RELATED PARTY TRANSACTIONS
Amounts due to related parties consisted of the following as of March 31, 2006
and December 31, 2005:
Notes March 31, 2006 December 31, 2005
-------------- -----------------
Mr. Wei Li ("Mr. Li") (i) $ 197,707 $ 191,861
China Star Investment Management Co. Ltd. (ii) 302,963 263,165
("China Star")
Unamortized fair value of warrants issued to
China Star (4,998) (833)
-------------- -----------------
Total $ 495,672 $ 454,193
-------------- -----------------
(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.
Mr. Li also executed a guarantee of repayment of the 10% Loan and the 12% Loans
(described in Note 10 to the Condensed Consolidated Financial Statements and
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources" in Item 1). In 2005, the 10%
Loan was repaid in full and retired and as of March 31, 2005, 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 motor vehicle to the Company. The monthly rental payment is
$1,871 and $1,871 and the Company made no payments of rental expenses for the
three months ended March 31, 2006 and 2005, respectively
(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 and is responsible for its
daily operations.
In 2005, the Company entered into three advance agreements with China Star for
combined advances of $199,514. 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 an aggregate of
997,571 shares of common stock.
On March 31, 2006, the Company entered into an advance agreement with China Star
for advances of $38,655. The advances were drawn down in stages over the first
quarter of 2006. The advances were unsecured, bore interest at 12% per annum and
were initially due 180 days from the date of draw down. The Company has also
granted detachable warrants to China Star to purchase an aggregate of 193,276
shares of common stock. As of March 31, 2006, the Company had an outstanding
balance due to China Star of $302,963. In issuing the warrants, the Company
relied on Section 4(2) of the Securities Act of 1933, as amended (the
"Securities Act") and Rule 506 of Regulation D promulgated under the Securities
Act for its exemption from the registration requirements of the Securities Act.
-11-
Each warrant attached to the advances 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. The warrants expire two
years from the date of issue. None of the detachable warrants were exercised as
of March 31, 2006. The fair value of the detachable warrants at the time of
their issuance was determined pursuant to the Black-Scholes option pricing model
in accordance with EITF Issue No 00-27.
The Company previously leased an office in the United States under a commercial
lease agreement with China Star with an aggregate monthly lease payment of
approximately $2,560. The lease expired in June 2005 and 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 three months ended March 31, 2006 and 2005 was $3,000 and
$7,680, respectively.
10. CONVERTIBLE NOTES PAYABLE
The balance of convertible notes payable as of March 31, 2006 and December 31,
2005 was $320,000 and $407,135 respectively.
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. As of March
31, 2006 and December 31, 2005, the balance of the 12% Loans was $320,000 and
$320,000, respectively.
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.
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 as of March 31, 2006. 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 charged to
operations as interest expense from the date of draw down through the date of
maturity.
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 were amortized on the straight-line
method over the term of the 12% Loans, with the amounts amortized being
recognized as interest expense.
-12-
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 issued a promissory note (the "Cornell Note") in the
original principal amount of $400,000 to Cornell Capital Partners, LP ("Cornell
Capital"), and received an advance of $400,000 (before deduction of expenses and
fees). The Cornell Note bore interest at a rate of 10% per annum and had a term
of 290 days.
In 2005, the Company issued an aggregate of 18,362,219 shares of common stock
with repayment of $312,865 to Cornell Capital, pursuant to the Standby Equity
Distribution Agreement dated as of July 6, 2004. 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 $87,135 and accrued interest on
the Cornell Note, and signed a Termination Agreement with Cornell Capital,
pursuant to which the Company terminated all the agreements with Cornell
Capital, including the Standby Equity Distribution Agreement dated July 6, 2004.
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. Mr. Li Wei, the Company's Chief Executive Officer, also
executed a guarantee of repayment of the loan which is secured by shares of the
Company's common stock that he owns. Prior to June 8, 2005, the Company made
payments to the lender in the amount of $359,991, which included a penalty
interest payment and was released 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 as of
March 31, 2006. The fair value of the detachable warrants at the time of their
issuance was determined to be $82,559, and was fully amortized on the
straight-line basis over the term of the loan with the amounts amortized being
recognized as interest expense.
OTHER LOANS
On January 25, 2004, the Company entered into a convertible loan agreement for
$500,000, with interest at 12% per annum, payable at maturity. The loan was
scheduled to mature on September 25, 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, recorded as a reduction to convertible notes payable
and fully charged to operations as interest expense in 2004.
On March 12, 2004, the Company entered into a convertible loan agreement for
$200,000, with interest at 12% per annum, payable at maturity. The loan was not
funded until April 7, 2004 and was scheduled to mature three months after
funding. 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, recorded as a reduction to convertible notes payable
and fully charged to operations as interest expense in 2004.
11. UNSECURED LOANS PAYABLE
The balance of unsecured loans payable as of March 31, 2006 and December 31,
2006 was $1,434,452 and $1,424,996, respectively. The difference of $9,456 was
caused by the different exchange rates prevailing at the two dates. Unsecured
loans payable consisted of the following at March 31, 2006 and December 31,
2005:
Notes March 31, 2006 December 31, 2005
(Unaudited)
Unsecured loan payable to Zoucheng Municipal $1,122,615 $1,115,214
Government, non-interest bearing, becoming (i)
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
Unsecured loan payable to Zoucheng Science (ii)
& Technology Bureau, non-interest bearing,
it is due in Kiwa-SD's first profitable year,
interest has not been imputed due to the
undeterminable repayment date 311,837 309,782
-------------- -----------------
Total $1,434,452 $1,424,996
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 Chinese government
sponsored program to encourage economic development in certain industries and
locations in China. 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 Chinese
government); (2) operate in specific industries, such as agriculture,
environmental, education, and others, which the Chinese 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.
12. EQUITY-BASED TRANSACTIONS
(A) AUTHORIZED SHARE CAPITAL
The Company's authorized capital consists of 100,000,000 shares of common stock
and 20,000,000 shares of preferred stock.
(B) ISSUED AND OUTSTANDING SHARE CAPITAL
As of March 31, 2006 and December 31, 2005, the Company had 59,235,930 shares of
common stock issued and outstanding. From January 1, 2005 to March 31, 2006, the
Company has engaged in the following equity-based transactions:
On January 4, 2005, the Company issued the Cornell Note in the original
principal amount of $400,000 to Cornell Capital, and received an advance of
$400,000. In the first nine months of 2005, the Company issued an aggregate of
18,362,219 shares of common stock (released from escrow in 32 separate
transactions), with repayment of $312,865 of the Cornell Note. The balance due
on the Cornell Note as of December 31, 2005 was $87,135. On March 31, 2006, the
Company paid all outstanding principal and interest on the Cornell Note
($110,176) and terminated the Standby Equity Distribution Agreement. See Note 10
regarding the Cornell Note and the Termination Agreement.
-13-
(C) OPTION
On June 3, 2004, a majority of the Company's stockholders approved the adoption
of the Company's 2004 Stock Incentive Plan (the "Plan"). 1,047,907 shares of the
Company's common stock were reserved for the issuance of stock options and stock
purchase rights under the Plan, of which not more than 350,000 shares may be
granted to any participant in any fiscal year.
The options granted under of the Plan will expire ten years from the date of
grant. The options which are not issued to an officer, a director or a
consultant will become exercisable at least as rapidly as 20% per year over the
five-year period commencing on the date of grant. As of March 31, 2006, no stock
options or stock purchase rights had been granted under the Plan.
13. COMMON STOCK SUBSCRIPTION
On March 10, 2006, the Company entered into a Stock Purchase Agreement with two
Chinese citizens, pursuant to which the Company agreed to issue 5,000,000 shares
of our common stock in exchange for RMB6,000,000 (RMB1.20 per share). The Stock
Purchase Agreement was disclosed on the Company's 8-K filed on March 15, 2006.
(On March 10, 2006 the US$-RMB exchange rate as published by the State
Administration of Foreign Exchange of the PRC was $1.00 US$ per RMB8.0492). In
issuing the stock, the Company relied on Section 4(2) of the Securities Act of
1993 (the "Securities Act") and Rule 506 of Regulation D promulgated under the
Securities Act for its exemption from the registration requirements of the
Securities Act. No underwriters or brokers were used in the transaction and no
underwriting or broker fees were paid. The 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. The Company will issue certificates for the 5,000,000
subscribed-for shares when the balance of the purchase price has been paid. As
of March 31, 2006, the Company had received proceeds of $126,284 under the
agreement. In addition, the company accounted for the balance $619,132 of this
common stock subscription as stock subscription receivable, shown as a reduction
of stockholders' equity as of March 31, 2006.
As of May 12, 2006, the Company had received approximately $400,000, which
represented 53% of the total proceeds. The Company and the investors have agreed
to defer funding of the remaining commitment to May 31, 2006.
14. MAJOR CUSTOMERS AND SUPPLIERS
Three customers accounted for 53.8% of our net sales for the three months ended
March 31, 2006. One customer accounted for 94% of our net sales for the three
months ended March 31, 2005.
Three suppliers accounted for 45.2%, 20.2%, and 10% of our purchases of raw
materials and 27%, 25% and 10% of our purchases of raw materials for the three
months ended March 31, 2006 and 2005, respectively. The raw materials used in
our products are made available to us from a variety of alternative sources.
15. TAXATION
As of March 31, 2006 and December 31, 2005, 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, the
Company has no material deferred tax liability as of March 31, 2006 and December
31, 2005.
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,
Kiwa-SD is claiming an exemption available under the same relevant tax laws
under which it is exempt from paying 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 made no payments of corporate income taxes since it had no
taxable income for the three months ended March 31, 2006 and 2005.
In accordance with the relevant tax laws in the British Virgin Islands, Kiwa
Bio-Tech Products Group Ltd., as a British Virgin Islands international business
company, is exempt from paying income taxes.
-14-
16. LEASE COMMITMENTS
The Company is subject to 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
three months ended March 31, 2006 and 2005 was $14,970 and $8,646, respectively.
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
agreements, rent expense for the three months ended March 31, 2006 and 2005 was
$3,000 and $7,680, respectively.
Lease commitments under the foregoing lease agreements are as follows:
Fiscal year Amount
2006 $ 54,144
2007 72,114
2008 21,004
Total $ 147,262
17. SUBSEQUENT EVENTS
On May 8, 2006, the Company entered into a Technology Transfer Agreement with
Jinan Kelongboao Bio-Tech Co., Ltd. ("JKB") in connection with the technology
transfer and related technical service for the AF-01 Anti-viral Aerosol.
Pursuant to the Agreement, JKB agrees to transfer its AF-01 Anti-viral Aerosol
technology for veterinary medicines to the Company. The AF-01 technology, which
can be used to deliver animal vaccines by aerosol spray, is recognized by a
technological achievement appraisal certificate issued by the government of
China. JKB agrees to facilitate transfer of the technology by providing
consulting services to the Company and to cooperate in the development of an
animal vaccine product for the market. Pursuant to the agreement, the Company
will pay JKB a transfer fee of RMB 10 million (approximately US$1.247 million),
of which RMB6 million (approximately $749,157) will be paid in cash and RMB4
million (approximately $499,438) will be paid in stock. The cash portion will be
paid in installments, the first RMB 3 million installment due May 23, 2006 and
three other RMB1 million installments due upon the achievement of certain
milestones, the last milestone being the issuance by the PRC Ministry of
Agriculture of a new medicine certificate in respect of the technology. The RMB4
million stock payment will be due 90 days after the AF-01 technology is approved
by the appropriate PRC department for productions and use as a livestock
disinfector for preventing bird flu. The issuance price shall be based on the
average of closing prices within five days before the date of issuance. The
Agreement also stipulates that, in the event that the production approval of the
AF-01 technology for use as a livestock disinfector for preventing bird flu
cannot be acquired due to reasons of the technology, JKB shall refund to the
Company all the transfer fees that have been paid.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
This Quarterly Report on Form 10-QSB for the quarterly period ended March 31,
2006 contains "forward-looking" statements within the meaning of Section 21E of
the Securities and Exchange Act of 1934, as amended (the "Exchange Act"),
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 Quarterly Report on Form 10-QSB for the
quarterly period ended March 31, 2006 involve known and unknown risks,
uncertainties and other factors 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.
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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.
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.
We have obtained the following four Fertilizer Registration Certificates issued
by the Chinese government: (1) Microorganism Microbia Inoculum Fertilizer
Registration Certificate issued by the Ministry of Agriculture; (2) Amino Acid
Foliar Fomular Fertilizer Registration Certificate issued by the Ministry of
Agriculture; (3) Organic Fertilizer Registration Certificate issued by the
Agriculture Department of Shandong Province, and (4) Water-run Fertilizer
Registration Certificate issued by the Agriculture Department of Shandong
Province. In addition to these four Fertilizer Registration Certificates, we
have two trademarks registered in China - "ZHIGUANGYOU" and "PUGUANGFU". Under
the protection of this intellectual property, we have developed four series of
bio-fertilizer products with photosynthetic bacteria and/or bacillus as core
ingredients.
Pursuant to the Technology Transfer Agreement dated May 8, 2006 in connection
with the technology transfer and related technical service for the AF-01
Anti-viral Aerosol (see Note 17 to Condensed Consolidated Financial Statements
in Item 1), we would be able to acquire the exclusive production right and other
related rights to produce an anti-viral aerosol drug for use with animals. 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
such as bird flu. Our hope is to develop a commercialized product in the form of
spray for applying in fowl houses and other animal holding facilities to prevent
and cure virus-caused diseases. On May 10, the Company signed an Acquisition
Framework Agreement with Beijing Huasheng Medicine Co. ("BSM"). The framework
agreement expresses the mutual intent of the parties to enter into an
acquisition transaction in which the Company will acquire 60% of the equity of
BSM. BSM has Good Manufacturing Process (GMP) certification. We are now in the
process of applying for a new animal medicine certification of AF-01 Anti-viral
Aerosol and negotiating the documentation described in the framework agreement.
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 $184,443 and $161,183 during the three months
ended March 31, 2006 and 2005, respectively, and our current liabilities
exceeded our current assets by $1,023,101 and $1,006,983 as of March 31, 2006
and December 31, 2005, 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 May 12,
2006, the Company had received approximately $400,000, which represented 53% of
the total proceeds. The Company and the investors have agreed to defer funding
of the remaining commitment to May 31, 2006 (See Note 13 to Condensed
Consolidated Financial Statements in Item 1). From 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. Management continues to
evaluate the Company's cash needs and the availability of debt and equity
financing to fund the Company's operations.
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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.
MAJOR CUSTOMERS AND SUPPLIERS:
Three customers accounted for 53.8% of our net sales for the three months ended
March 31, 2006. One customer accounted for 94% of our net sales for the three
months ended March 31, 2005.
Three suppliers accounted for 45.2%, 20.2%, and 10% of our purchases of raw
materials and 27%, 25% and 10% of our purchases of raw materials for the three
months ended March 31, 2006 and 2005, respectively. The raw materials used in
our products are made available to us from a variety of alternative sources.
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 tend to increase incomes of farmers and
ease their financial burdens. Three was a series of policies adopted by the
State Council on February 9, 2006 that are favorable to agriculture including
(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). We believe we
will benefit from these favorable policies as farmers can be expected to 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 is
expected to continue to enjoy expansionary policy. We have previously benefited
from 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.
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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 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 bank has continued to
gradually appreciate the RMB - 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 receivable over one year old amounted to $86,041 and $82,942 as of
March 31 and April 30, 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 $86,041 equal to the account receivables more than
one year old as of April 30, 2006.
-18-
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. 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, we will allow customers to exchange 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 March 31, 2006.
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 for Three
Months Ended March 31, 2006 and 2005", 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 as of the time of sale. If a return is estimated, a
reserve account is recorded to offset sales. As at March 31, 2006, we have
determined that there are no significant estimated returns.
IMPAIRMENT OF ASSETS
Our long-lived assets consist of property and equipment assets and intangible
assets. As of March 31, 2006, the net value of property, plant and equipment
assets and intangible assets was $1,425,677 and $398,723, respectively, which
represented approximately 46.0% and 12.9% 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 March 31, 2006.
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 FOR THREE MONTHS ENDED MARCH 31, 2006 AND 2005
NET SALES. Net sales were $11,023 and $410,692 for the three months ended March
31, 2006 and 2005 respectively, representing a 97% decrease. The primary cause
of low sales in the first quarter of 2006 was the halt in operations at our
manufacturing facility in the second half of 2005 to upgrade the facility to
produce bacillus fertilizer. (See related discussion under "Liquidity and
Capital Resources", below. This upgrade was delayed due to the failure to obtain
expected financing for it in second half of 2005. We restarted production the
first quarter of 2006 but volume has been low due to a shortage of working
capital. In addition, sales in the first quarter of 2006 were low because the
first quarter is a low season for products in China. Consequently, net sales for
the three months ended March 31, 2005 were mainly attributable to exports.
-19-
Cost of Sales. Costs of sales were $7,410 and $74,973 for the three months ended
March 31, 2006 and 2005, respectively. The decrease of $67,564, or 90%, in cost
of sales was primarily due to the reduction of sales volume.
Gross Profit. Gross profit was $3,613 for the three months ended March 31, 2006
representing a profit margin of 33%. Gross profit was $335,719 for the three
months ended March 31, 2006, a profit margin of 82%. The higher gross margin for
the three months ended March 31, 2005 was mainly attributable to higher price of
exports then.
Consulting and Professional Fees. Consulting and professional fees were $44,400
and $136,573 for the three months ended March 31, 2006 and 2005 respectively,
representing a decrease of $92,173 or 67%. The higher consulting and
professional fees in 2005 were primarily attributable to consulting and
professional fees paid to Cornell Capital in connection with the financing
completed in January 2005.
Officers' Compensation. Officers' compensation decreased by $2,383, or 29%, to
$5,967 for the three months ended March 31, 2006 as compared to $8,350 for the
three months ended March 31, 2005.
General and Administrative. General and administrative expense was $72,222 for
the three months ended March 31, 2006, as compared to $247,800 for the same
period of 2005, a decrease of $175,578, or 71%, primarily as a result of
decrease of quantity of business and employees of the Company for the three
months ended March 31, 2006 as compared to the same period of 2005. General and
administrative expenses mainly include salaries, travel and entertainment, rent,
office expense, telephone expense and insurance costs.
Research and Development. Research and development expense increased $621, or
9%, to $7,901 for the three months ended March 31, 2006, as compared to $7,280
for the three months ended March 31, 2005. The increase is mainly due to
depreciation of new research equipment purchased in the fourth quarter of 2005.
Depreciation and Amortization. Depreciation and amortization, excluding
depreciation and amortization included in cost of sales, increased $3,208, or
11%, to $33,162 for the three months ended March 31, 2006, as compared to
$29,945 for the three months ended March 31, 2005. This decrease is mainly the
result of an adjustment related to the amortization of the patent for the fiscal
year of 2004, which was adjusted in the first quarter of 2005, and partial
depreciation of our facilities recognized as current-period charges because of
abnormal lower-volume production for three months ended March 31, 2006
Interest Income (Expense). Interest expense decreased $43,000, or 64%, to
$24,404 for the three months ended March 31, 2006, as compared to interest
expense of $67,404 for the three months ended March 31, 2005. This decrease is
due to the amortization of fair value of a convertible loan in the first quarter
of 2005.
Net Loss. Net loss increased $23,260, or 14% to $184,443 for the three months
ended March 31, 2006 as compared to $161,183 for the three months ended March
31, 2005. The increase in net loss in the current period as compared to first
quarter 2005 is primarily due to reduction in revenue and gross margin.
Comprehensive Loss. Comprehensive loss increased by $16,619, or 10%, to $177,802
for the three months ended March 31, 2006, as compared to $161,183 for the
comparable period of 2005. The reasons for the increase in comprehensive loss in
the current period as compared to the comparable period in 2005 primarily
include: (1) gross profit decreased by $340,856; (2) all expenses including
operation expenses and interest only decreased by $317,596; and (3) there was a
currency translation adjustment of $6,641 for the current period, when there was
not any such adjustment for the comparable period of 2005.
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 three months ended March 31,
2006, we raised $44,268 in debt financing from two related parties and $126,284
in a common stock subscription under the Stock Purchase Agreement dated as of
March 10, 2006.
-20-
Our current liabilities exceed our current assets and we continue to suffer
losses. In the second half of 2005 we interrupted production at our
manufacturing facility with the intention of upgrading the facility to produce a
new, potentially lucrative series of bacillus fertilizer. Unfortunately an
anticipated financing in the second half of 2005 did not close, which
contributed to a shortage of working capital and prevented us from upgrading our
facility as planned. 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 fertilizer product as
planned. In the first quarter of 2006, although we have begun to increase our
production levels, but the volume of production and sale remains low.
We qualified for non-interest bearing loans under a Chinese government-sponsored
program to encourage economic development in certain industries and locations in
China. As of March 31, 2006, we had obtained non-interest bearing loans from the
Chinese local government of approximately $1,500,000, of which $1,434,452 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.
In November 2002 and June 2003, we borrowed money from a local bank in Beijing
to finance 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% per annum,
respectively. The maturity dates are October 2007 and March 2008, respectively.
As of March 31, 2006, the combined outstanding balance of these loans was
$25,718.
On September 23, 2004, the Company entered into a convertible loan agreement for
$350,000 with interest at 10% per annum. Prior to June 8, 2005, the Company made
payments to the lender in the amount of $359,991, which included a penalty
interest payment (See Note 10 to the Condensed Consolidated Financial Statements
in Item 1).
On January 4, 2005, the Company issued a promissory note in the original
principal amount of $400,000 to Cornell Capital, and received an advance of
$400,000. The Cornell Note bore interest at a rate of 10% per annum and had a
term of 290 days. In 2005, the Company issued an aggregate of 18,362,219 shares
of common stock with repayment of $312,865. As of March 31, 2006, the Company
settled the Cornell Note with a payment of $110,176, constituting the
outstanding principal amount of $87,135 and accrued interest on the Cornell Note
(See Note 10 to the Condensed Consolidated Financial Statements in Item 1).
On May 30, 2005 and June 16, 2005, the Company entered into three convertible
promissory note agreements in the aggregate amount of $320,000 with interest at
12% per annum, and issued 1,600,000 detachable warrants. 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. 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 any notice of default or demand for immediate payment.
(See Note 10 to the Condensed Consolidated Financial Statements in Item 1)
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
March 31, and May 12, 2006, we had received $126,284 and approximately $400,000
of the amount under the purchase agreement, which represents17% and53% of the
total commitment. We have agreed with the investors to defer funding of the
remaining commitment to May 31, 2006.
In the first quarter of 2006, we borrowed $38,665 from China Star, pursuant to
certain advance agreements we had entered into with China Star dated as of March
31, 2006. The advance agreements are unsecured and bear interest at 12% per
annum, and are due 180 days from the date of draw down. As of March 31, 2005,
the total outstanding balance owed to China Star under the loan and for all
other obligations was $302,963 (See Note 9 to the Condensed Consolidated
Financial Statements in Item 1).
In the first quarter of 2006, the Company owed our CEO,Wei Li, $5,613 for a
motor vehicle lease obligation. As of March 31, 2005, the total outstanding
balance owed to Mr Li for all current and former obligations and loans was
$197,707 (see Note 9 to the Condensed Consolidated Financial Statements in Item
1).
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Since April 2006 we have been in negotiation but have not yet concluded
convertible note financing for the aggregate amount of up to $4 million. Even if
realized, these amounts may not be sufficient to allow us to implement our
business plan. During 2006, we may need 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 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.
At March 31, 2006 and December 31, 2005, we had cash of $13,531 and $14,576,
respectively. At March 31, 2006 and December 31, 2005, our net working capital
deficiency was $1,023,101 and $1,006,983, respectively, reflecting current
ratios of 0.55:1 and 0.55:1, respectively, as of such dates.
During the three months ended March 31, 2006, our operations utilized cash of
$91,546, as compared to $278,402 utilized for the three months ended March 31,
2005, as a result of the decreased business activity.
During the three months ended March 31, 2006, no cash flow occurred from
investing activities, as compared to $4,175 utilized for the purchase of
equipment for the three months ended March 31, 2005.
During the three months ended March 31, 2006, we generated $81,413 from
financing activities, consisting of the proceeds from common stock subscription
of $126,284 and several advances from related parties of $44,268, offset by the
repayments of the Cornell Note of $87,135 and long-term borrowings of $2,004.
During the three months ended March 31, 2005, we generated $286,660 from
financing activities, consisting of the proceeds from the Cornell Note of
$400,000 and offset by the repayments of short-term loan of $50,000, amounts due
to related party of $60,159 and long-term borrowings of $3,181.
If we can achieve the necessary financing, our plan is to continue 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 million over an
estimated two-year period.
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 bank continues to gradually increase the exchange
rate. On March 31, 2006 it was US$ 1.00 = RMB 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.
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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 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
three months ended March 31, 2006 and 2005 was $14,970 and $8,646, respectively.
The Company previously leased an office in the United States under a commercial
lease agreement with China Star with an aggregate monthly lease payment of
approximately $2,560. The lease expired in June 2005 and 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 three months ended March 31, 2006 and 2005 was $3,000 and
$7,680, respectively.
OFF-BALANCE SHEET ARRANGEMENTS
At March 31, 2006 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.
RELATED PARTY TRANSACTIONS
See Note 9 to the Condensed Consolidated Financial Statements in Item 1.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Condensed Consolidated Financial Statements in Item 1.
ITEM 3. 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 Exchange Act as of the end of the period covered by this
Quarterly Report on Form 10-QSB. 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 March 31,
2006 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.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not a party to any legal proceedings and are not aware of any such
proceedings known to be contemplated.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The issuance of detachable warrants to China Star to purchase the aggregate of
193,276 shares of common stock of the Company, in connection with the advance
agreement with China Star dated March 31, 2006 (as more fully described in Note
9 to the Condensed Consolidated Financial Statements in Item 1) was an
unregistered sale of equity securities under the Securities Act. In issuing the
warrants, the Company relied on Section 4(2) of the Securities Act and Rule 506
of Regulation D promulgated under the Securities Act for its exemption from the
registration requirements of the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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 on 10.1
between Cornell Capital Partners, LP and Kiwa Bio-Tech August 2, 2004
Products Group Corporation.
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10.2 Placement Agent Agreement, dated July 6, 2004, between Form SB-2 filed on 10.2
Newbridge Securities Corporation and Kiwa Bio-Tech August 2, 2004
Products Group Corporation.
10.3 Registration Rights Agreement, dated July 6, 2004, Form SB-2 filed on 10.3
between Cornell Capital Partners, LP and Kiwa Bio-Tech August 2, 2004
Products Group Corporation.
10.4 Warrant Purchase Agreement, dated March 12, 2004, issued Form 10-QSB filed on 10.1
to Westpark Capital, Inc. May 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 on 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 on 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 on 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 on 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 on 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 on 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 on 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.
10.13 PBC Project Investment Agreement between KIWA Bio-Tech Form 10-KSB filed on 10.13
Products Group Limited and Zoucheng Municipal Government April 13, 2005
dated June 25, 2002
10.14 Employment Agreement dated March 18, 2003 between Form SB-2/A filed on 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 on 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 on 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 on 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 on 10.10
Kiwa Bio-Tech Products Group Corporation and China Star October 8, 2004
Investment Company.
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10.19 Convertible Note Agreement dated September 23, 2004 among Form 10-QSB filed on 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 on 10.20
Agreement dated September 23, 2004 among Kiwa Bio-Tech April 13, 2005
Products Group Corporation and Young San Kim and Song N.
Bang
10.21 Common Stock Warrant dated September 23, 2004, issued by Form
10-QSB filed on 10.5 Kiwa Bio-Tech Products Group Corporation to
Young San Kim November 15, 2004
10.22 Common Stock Warrant dated September 23, 2004, issued by Form 10-QSB filed on 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 on 10.23
Corporation, principal amount $400,000, issued to Cornell April 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 on 10.1
among Kiwa Bio-Tech Products Group Corporation and Young May 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 on 10.7
Bio-Tech Products (Shandong) Co. Ltd. and China Star August 15, 2005
Investment Management Co. Ltd.
10.30 Advance Agreement, dated September 30, 2005, between Kiwa Form 10-QSB filed on 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 Form 10-KSB filed April 10.31
Bio-Tech Products (Shandong) Co. Ltd. and China Star 17, 2006
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 Supplementary Agreement for Stock Purchase Agreement dated Form 10-KSB filed on 10.34
on April 13, 2006 April 17, 2006
10.35 Supplementary Agreement for Stock Purchase Agreement dated
May 12, 2006
10.36 Advance Agreement, dated March 31, 2006, between Kiwa
Bio-Tech Products (Shandong) Co. Ltd. and China Star
Investment Management Co. Ltd.
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10.37 Technology Transfer Agreement, dated May 8, 2006, between Form 8-K filed on May 10.1
Kiwa Bio-Tech Products Group Corporation and Jinan 15, 2006
Kelongboao Bio-Tech Co., Ltd.
21 List of Subsidiaries Form 10-QSB filed on 21
May 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
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
KIWA BIO-TECH PRODUCTS GROUP CORPORATION
(Registrant)
/s/ Wei Li May 15, 2006 Chief Executive Officer and Chairman
------------------- of the Board of Directors
Wei Li (Principal Executive Officer)
/s/ Lian jun Luo May 15, 2006 Chief Financial Officer and Director
------------------- (Principal Financial Officer and
Lian jun Luo Principal Accounting Officer)
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