U.S.
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE
ACT OF 1934
For
the fiscal year ended December 31, 2007
or
o
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: 001-32477
TIENS
BIOTECH GROUP (USA), INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
|
75-2926439
|
|
(State
or other jurisdiction of incorporation or organization )
|
(I.R.S.
Employer Identification No.)
|
No.
6,
Yuanquan Rd.
Wuqing
New Tech Industrial Park
Tianjin,
China 301700
----------------------------------------
(Address
of principal executive offices) (Zip Code)
Registrant’s
Telephone Number, including area code: 011 86-22-8213-7626
Securities
registered under 12(b) of the Exchange Act:
|
Title
of Each Class
|
Name
of Each Exchange on which Registered
|
|
Common
Stock, par value $0.001
|
The
American Stock Exchange
|
Securities
registered under 12(g) of the Exchange Act: None.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes
o
No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes
o
No
x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes
x
No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of the registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
x
Indicate
by check mark if the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes
o
No
x
Based
upon the closing sale price of $3.83 per share of Common Stock on the American
Stock Exchange on June 30, 2007, the aggregate market value of the 3,503,586
shares of voting stock held by non-affiliates of the Registrant was
approximately $13,418,734.
There
were 71,333,586 shares of the Company’s common stock outstanding on March 28,
2008.
FORWARD-LOOKING
INFORMATION
This
Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, and Section 21E of the
Securities Exchange Act of 1934. These statements relate to future events or
the
Company’s future financial performance. The Company has attempted to identify
forward-looking statements by terminology including “anticipates”, “believes”,
“expects”, “can”, “continue”, “could”, “estimates”, “expects”, “intends”, “may”,
“plans”, “potential”, “predict”, “should” or “will” or the negative of these
terms or other comparable terminology. These statements are only predictions,
uncertainties and other factors, including the risks outlined under Risk Factors
contained in Item 1A of this Annual Report may cause the Company’s actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels or activity, performance or
achievements expressed or implied by these forward-looking statements. Although
the Company believes that the expectations reflected in the forward-looking
statements are reasonable, the Company cannot guarantee future results, levels
of activity, performance or achievements. The Company expectations are as of
the
date this Form 10-K is filed, and the Company does not intend to update any
of
the forward-looking statements after the date this Annual Report on Form 10-K
is
filed to confirm these statements to actual results, unless required by law.
AVAILABILITY
OF SEC FILINGS
The
Company files annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and proxy and information statements and amendments
to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). The public may
read and copy these materials at the Securities and Exchange Commission’s
(“SEC”) Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549.
The public may obtain information on the operation of the public reference
room
by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website
(http://www.sec.gov) that contains reports, proxy and information statements
and
other information regarding the Company and other companies that file materials
with the SEC electronically. You may also obtain copies of the Company’s reports
filed with the SEC, free of charge, on our website at
http://www.tiens-bio.com.
PART
I
ITEM
1. BUSINESS.
In
this Annual Report on Form 10-K, references to “dollars” and “$” are to United
States Dollars and references to “RMB” are to Chinese Renminbi (RMB). References
to “we”, “us”, “our”, the “Company” or “Tiens USA” include Tiens Biotech Group
(USA), Inc. and its subsidiaries.
Overview
Tiens
USA
researches, develops, manufactures, and markets nutrition supplement products,
including wellness products and dietary supplement products. Our operations
are
conducted from our headquarters in Tianjin, People’s Republic of China (“China”
or the “PRC”) through our 80% owned subsidiary, Tianjin Tianshi Biological
Development Co., Ltd. (“Biological”). We sell our products for distribution in
China to an affiliated company that in turn sells the products to consumers
through its chain store and its Chinese affiliated companies. Outside of China,
we sell our products to overseas affiliated companies located in 52 countries
that in turn sell them to independent direct sales distributors.
Corporate
History and Organization
Our
Company was incorporated on July 13, 1990 as Super Shops, Inc. under the laws
of
the State of Michigan. In October 2000, Super Shops, Inc. reincorporated in
Delaware and changed its name to MIA Acquisition Corp. On February 11, 2002,
in
connection with a change in control transaction, MIA Acquisition Corp changed
its name to Strategika, Inc. From 2000 until the reorganization described below,
our Company had only nominal assets and liabilities and was a development stage
company attempting to provide network security services to companies.
On
September 9, 2003, pursuant to an Agreement and Plan of Reorganization, dated
August 22, 2003, among the Company, Tianshi International Holdings Group Ltd.,
a
British Virgin Islands company (“Tianshi Holdings”), and Jinyuan Li, Wenjun Jiao
and Yupeng Yan, all Chinese Nationals who were stockholders of Tianshi Holdings,
the Company received from the Tianshi Holdings stockholders all of the issued
and outstanding common stock of Tianshi Holdings in exchange for the issuance
by
the Company of 68,495,000 shares of our common stock to the Tianshi Holdings
stockholders, representing 95% of the issued and outstanding common stock of
the
Company at such time, after giving effect to the issuance.
On
June
18, 2003, Tianshi Holdings acquired 80% of Biological’s outstanding shares from
Tianshi Hong Kong International Development Co., Ltd., which is 100% owned
by
our Chairman, Chief Executive Officer and President, Jinyuan Li. Biological
is a
Chinese-foreign equity joint venture company established under Chinese laws
on
March 27, 1998, subject to the Law on Sino Foreign Equity Joint Ventures. On
December 31, 2003 the Company changed its name from Strategika, Inc. to Tiens
Biotech Group (USA), Inc.
Tianjin
Tianshi Pharmaceuticals Co., Ltd. (“Tianshi Pharmaceuticals”), a Chinese
company, owns the remaining 20% of Biological. Tianjin Pharmaceuticals is 87.66%
owned by Tianjin Tianshi Group Co., Ltd. (“Tianshi Group”), a Chinese company,
and 7.29% owned by Mr. Li’s daughter, Baolan Li. Tianshi Group is 90% owned by
Jinyuan Li and 10% owned by Baolan Li. Tianshi Group also owns 51% of Tianjin
Tianshi Biological Engineering Co., Ltd. (“Tianshi Engineering”), the entity to
which we sell all of our products for consumption in China. Baolan Li owns
the
remaining 49% of Tianshi Engineering.
In
April
2004, Tianshi Holdings entered a joint venture contract with Tianshi
Pharmaceuticals to establish Tiens Yihai Co. Ltd., a Chinese-Foreign Equity
Joint Venture (“Tiens Yihai”). Tiens Yihai is 99.4% owned by Tianshi Holdings
and 0.6% owned by Tianshi Pharmaceuticals. Tiens Yihai is located in Shanghai,
China, and was established to build a new research and development facility
in
Shanghai, China. In March 2007, the Company decided to suspend the proposed
development by Tiens Yihai.
On
December 20, 2007, Tianshi Holdings entered into a Sale and Purchase Agreement
with Tianshi International Investment Group Co., Ltd., a British Virgin Islands
Company (“Tianshi Investment”). Jinyuan Li owns 100% of Tianshi Investment.
Pursuant to the Sale and Purchase Agreement, Tianshi Holdings agreed to buy
all
of the registered share capital of Tianjin Tiens Life Resources Co., Ltd.,
a
Chinese Foreign Investment Enterprise (“Life Resources”) for $64.2 million. Life
Resources was incorporated on April 29, 2005 as a Foreign Investment Enterprise
(“FIE”) in Wuqing, Tianjin, PRC, with a registered share capital of $30,000,000.
On March 13, 2008 the Chinese government approved an increase in the registered
capital of Life Resources from $30,000,000 to $50,000,000. The closing of the
transaction was subject to government approval of transfer of the share capital
of Life Resources to Tianshi Holdings. On March 13, 2008, the Chinese government
approved the transfer of the shares of Life Resources. Life Resources is
currently constructing research and development, manufacturing and logistic
facilities, as well as administrative offices in Tianjin, China.
The
following chart shows the ownership interests in our subsidiaries.
Products
and Manufacturing
We
have
developed and produce 33 nutrition supplement products, which include wellness
products and dietary supplements.
Each
of
our wellness products includes at least one health function and has been issued
a Certificate of Domestic Wellness Product by the State Food and Drug
Administration (SFDA). This SFDA certificate is required for the production
and
sale of wellness products in China. Dietary supplements, which do not include
any health functions, are considered to be “ordinary food,” and do not require a
SFDA certificate. Each of our products has been issued a Product Standard Code
by the Bureau of Technical Supervision.
We
have
put great emphasis on product quality assurance. In 2002, we were awarded a
Quality System Certificate for compliance with the standard “ISO9001: 2000” in
the area of Design and Development, Production and Service of Food and Health
Care Food in China. In addition, many of our products have received a
certificate for Hazard Analysis Critical Control Point (“HACCP”). HACCP
identifies and assesses hazards and risk associated with the manufacture,
distribution and use of food-handling establishments. In 2007, four of our
products received a kosher certificate from the Kosher Supervision of America
(“KSA”), which is recognized by rabbinical societies throughout the world. These
products bear the KSA symbol, which tells consumers that they are in compliance
with kosher standards.
Our
products are manufactured at our facility in Tianjin, China. The manufacturing
processes of our nutrition supplement products are categorized into six types
depending on the different forms of the finished products: Powder, Tea,
Capsules, Tablets, Granules and Soft Gel Capsules. All of our manufacturing
complies with the product standards approved by the Bureau of Technical
Supervision in China.
The
following table lists our products.
|
*
|
These
products are not intended to diagnose, treat, cure or prevent any
disease.
|
|
(a)
|
This
product has received Halal Approval, which certifies that our
manufacturing processes comply with the requirements of Islamic dietary
law.
|
| (b) |
This
product has received an HACCP
Certificate.
|
| (c) |
This
product has received KSA Kosher
Certificate.
|
During
2007, we phased out production of our personal care line of products, which
had
not been a material part of our business, to focus on our wellness products
and
dietary supplements. For the years ended December 31, 2007, 2006 and 2005,
all
of our revenue was generated from related party customers. See note 16 to our
consolidated financial statements for a breakdown of domestic and international
revenue, and revenue by product group for the last three fiscal years. In 2007,
2006 and 2005 our
Tianshi
Cordyceps Capsules accounted for 18.1%, 16.5% and 14.1% of our revenue,
respectively, and
our
Tianshi
Nutrient Super Calcium Powder
accounted for 15.8%, 14.1% and 17.3% of our revenue, respectively.
Trademarks
and Patents
We
consider the “Tiens” logo important to our business and have registered our
products under the logo “Tiens” with the State Administration of Industry and
Commerce in China. The registration is valid for a period of ten years from
May
21, 2002 and can be renewed for further ten-year periods multiple times. We
have
conducted extensive research and developed Tianshi Super Calcium Powder with
Metabolic Factors and Tianshi Super Calcium Powder for Children, which have
each
been awarded a patent from State Intellectual Properties Office in China with
respective patent numbers of ZL97115067.2 and ZL97115068.0. These two patents
are effective for 20 years, commencing on January 13, 2001.
Suppliers
We
have
established long-term relationships with most of our suppliers. We believe
that
the raw materials required for manufacturing our products are relatively easy
to
find and alternative suppliers are convenient to locate.
Research
and Development
We
incurred research and development expenses of $0.7 million, $1.0 million and
$0.6 million in 2007, 2006 and 2005 respectively. As of December 31, 2007,
we
employed 69 staff members in research and development, and we anticipate hiring
an additional 19 research and development employees in 2008.
Marketing
and Distribution
In
China,
we sell our products to Tianshi Engineering, an affiliated Chinese company.
Tianshi Engineering, in turn, sells the products to customers through its
branches and affiliated companies and at chain stores which are owned by
individual distributors. During 2007 Tianshi Engineering closed eleven of its
less profitable branches in China. As of December 31, 2007, Tianshi Engineering
had 100 branches in China. Prior to 2006, Biological sold all of its products
to
Tianshi Engineering as finished products at a price equal to 25% of the Chinese
market price for the products. This 25% figure was negotiated between the
parties in 2003, before we acquired Tianshi Holdings, and we believe that it
is
a reasonable sales price for us to receive.
At
the
beginning of 2006, we also began selling semi-finished products to Tianshi
Engineering. To qualify for a direct selling license in China, Tianshi
Engineering is required to produce a part of the products that it sells in
China. As a result, we began to sell semi-finished products to Tianshi
Engineering, which jointly shares with us licenses to produce, manufacture
and
sell the products. The price of semi-finished goods sold to Tianshi Engineering
was originally set at the beginning of 2006 to provide us with a 75% gross
profit margin. However, based on fluctuations in the cost of raw materials
and
quantities produced, this percentage varied during the year. This 75% figure
was
negotiated between the parties, and we believe that it is reasonable. The goal
of this new pricing policy was to try to maintain the Company’s gross margins on
semi-finished goods at a similar level to historical gross margins for finished
goods.
Internationally,
our strategy is to develop a strong direct sales force through our international
affiliated companies. Currently the United States is not a significant part
of
our business. We sell our products to overseas affiliated companies located
in
52 countries who in turn sell them to independent direct sales distributors.
During 2007, in order to consolidate our international distribution, we reduced
the number of countries where we sell directly to overseas affiliates from
63 to
52. Therefore, some of our overseas affiliate customers also now sell our
products on to other overseas affiliates which are no longer our direct
customers. In 2007 our highest sales outside of China were to the following
ten
countries, in descending order: Indonesia, Russia, Ukraine, Kazakhstan, Congo,
Hungary, South Africa, Peru, India and Columbia.
As
operation costs vary from country to country, international market prices vary
accordingly. We sell our products to overseas affiliates at the FOB (destination
port) price, which consists of 25% of the Chinese retail price, including
customs duty, value-added tax and other miscellaneous transportation cost.
The
overseas affiliates mark up the products to cover their expenses and realize
profits of approximately 10%.
Backlog
was $12.2 million as of December 31, 2007, compared to $15.4 million as of
December 31, 2006. We expect all of the backlog at the end of 2007 to be filled
within the 2008 fiscal year.
Competition
We
compete with other direct selling organizations, some of which have a longer
operating history and higher visibility, name recognition and financial
resources than we do. The leading direct selling companies in our existing
markets are Avon and Alticor (Amway). Some of our competitors, including Avon
and Alticor (Amway), have been granted a direct selling business license in
China pursuant to China’s recent regulations governing direct selling. In some
instances, these licenses can be limited to certain cities and/or provinces.
The
direct selling regulations require Tianshi Engineering, our affiliate who sells
our products in China, to apply for approval to conduct a direct selling
enterprise in China. Tianshi Engineering has made an application for, but has
not yet received, a direct selling license in China.
Regulatory
Framework
Product
Regulation
The
central governing authority in China for wellness products is the SFDA, which
is
under the jurisdiction of the State Council. SFDA issues administrative rules.
Provincial, city and town authorities implement the rules of the SFDA. Other
than the SFDA, other ministries and administrations also have certain
responsibility for the management of wellness or nutrition supplement products,
such as the State Administration for Industry and Commerce.
We
develop and manufacture products that are mainly classified as nutrition
supplement products, which includes wellness products and dietary supplement
products. Wellness products may not be sold in China without a wellness products
certificate. The governmental approval process in China for a newly developed
wellness product is as follows:
| 1. |
An
application for a product certificate is filed with SFDA, which directs
the applicant to send the product samples to one of the government
appointed research institutes;
|
| 2. |
The
appointed research institute conducts clinic trials, stability tests,
function tests and toxicity tests on the product, makes a report
and sends
the report back to SFDA within 6 months;
and
|
| 3. |
The
Expert Committee of SFDA makes a final decision on the application
and
issues a “wellness products certificate” or a refusal notice to the
applicant.
|
This
certificate authorizes the sales and marketing of the product in China. The
certificate does not expire and does not require renewal. The whole process
generally takes 9 to 12 months. Dietary supplement products are not subject
to
SFDA regulation.
Sales
and Marketing Regulations
In
most
countries, sales of our products are usually considered under the categories
of
general commodities, which do not require specific permits and are not subject
to the strict regulations applied to drugs and medicine. In some countries,
direct selling (or multi-level marketing) is highly regulated or prohibited.
Since we sell our products to our affiliated companies for sale internationally,
the local approval issues with respect to sales and distribution are addressed
by our affiliates.
In
China,
we are aiming to expand our market share through the branches, chain stores,
and
affiliated companies of Tianshi Engineering, our affiliate who sells our
products in China. Because direct selling was only recently authorized in China,
the regulatory environment with respect to direct selling in this market remains
fluid and the process for obtaining the necessary governmental approvals have
been interpreted differently by different governmental authorities. The direct
selling regulations require Tianshi Engineering to apply for approval to conduct
a direct selling enterprise in China.
Tianshi
Engineering has applied for a direct selling license in a number of provinces
and must obtain a series of approvals from the Departments of Commerce in such
provinces, as well as the Departments of Commerce in each city and district
in
which we plan to operate. Tianshi Engineering is also required to obtain the
approval of the State Ministry of Commerce, which is the national government
authority overseeing direct selling.
Tianshi
Engineering has found that it is taking more time than anticipated to work
through the approval process with the Chinese authorities. These authorities
have broad discretion in interpreting the regulations and granting necessary
approvals. A delay in obtaining approvals at one level can delay its ability
to
obtain approvals at the next level. The complexity of the approval process
as
well as the government’s continued cautious approach as direct selling develops
in China makes it difficult to predict a timeline for obtaining these approvals.
Until the application is approved, Tianshi Engineering will continue to sell
our
products through its branches, chain stores, and affiliated companies in
China.
Environmental
Compliance
We
are
subject to China’s National Environmental Protection Law, as well as a number of
other national and local laws and regulations regulating air, water and noise
pollution and setting pollutant discharge standards. We believe that all our
manufacturing operations are in material compliance with all applicable
environmental laws.
Employees
As
of
December 31, 2007, we had 1,405 employees. We believe that our relations with
our employees are satisfactory.
ITEM
1A. RISK FACTORS.
THE
FOLLOWING MATTERS, AMONG OTHERS, MAY HAVE A MATERIAL ADVERSE EFFECT ON THE
BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS,
FINANCIAL OR OTHERWISE, OF THE COMPANY. REFERENCE TO THIS CAUTIONARY STATEMENT
IN THE CONTEXT OF A FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED
TO
BE A STATEMENT THAT ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR
STATEMENTS. WE ARE SUBJECT TO, AMONG OTHERS, THE FOLLOWING RISKS:
RISKS
RELATED TO OUR BUSINESS
WE
MAY NOT BE ABLE TO RAISE ADEQUATE FUNDS TO COMPLETE THE CONSTRUCTION OF OUR
NEW
HEADQUARTERS, RESEARCH AND DEVELOPMENT AND MANUFACTURING FACITILITIES BEING
BUILT BY LIFE RESOURCES.
In
December 2007, we entered into an agreement to acquire Life Resources, a company
which is currently constructing research and development, manufacturing and
logistic facilities, as well as administrative offices totaling approximately
420,000 square meters in Tianjin, China.
We
currently estimate that the budget for completion of the Life Resources project
will be approximately $220 million, including the $64 million already spent
to
acquire all of the registered share capital of Life Resources. We intend to
construct the facilities in phases over several years, based on available cash
and capacity needs. Depending on the rate of construction and our cash flow,
we
may require additional financing to complete the funding of that project. If
we
are not able to fund the completion of the new facilities, our future growth
opportunities may be limited.
OUR
REPUTATION, REVENUES AND OPERATING INCOME MAY BE ADVERSELY AFFECTED BY PRODUCT
LIABILITY CLAIMS.
As
a
manufacturer of products designed for human consumption, claims may be brought
against us that a product injured its consumer. Our dietary supplement products
consist of vitamins, minerals, herbs and other ingredients that are not subject
to pre-market regulatory approval. Our products could contain contaminated
substances, and some of our products contain innovative ingredients that do
not
have long histories of human consumption. Previously unknown adverse reactions
resulting from human consumption of these ingredients could occur. A product
liability claim against us could result in increased costs and could adversely
affect our reputation with our customers, which in turn could adversely affect
our revenues and operating income.
OUR
NEWLY DEVELOPED PRODUCTS MAY NOT BE COMPATIBLE WITH MARKET
NEEDS.
Our
business is particularly subject to changing consumer trends and preferences.
Our continued success depends in part on our ability to anticipate and respond
to these changes, and we may not respond in a timely or commercially appropriate
manner to such changes. Because markets for nutrition supplement products
differentiate geographically, we must accurately assess demand in each specific
market into which we wish to make sales. If we fail to accurately assess
consumer health needs in each market we target, we may face limited market
acceptance of our products, which could have a material adverse effect on our
sales and revenue.
OUR
PRODUCTS MUST KEEP PACE WITH ADVANCES IN THE INDUSTRY OR THEY MAY BE DISPLACED
BY COMPETITORS’ NEWLY DEVELOPED PRODUCTS.
The
nutrition supplement products industry is characterized by rapid product
development, with significant competitive advantages gained by companies that
introduce products that are first to market, deliver constant innovation in
products and techniques, offer frequent new product introductions and have
competitive prices. Our future growth partially depends on our ability to
develop products that are more effective in meeting consumer needs. In addition,
we must be able to manufacture and effectively market those products. The sales
of our existing products may decline if a competing product is introduced by
other companies.
The
success of our new product offerings depends upon a number of factors, including
our ability to:
|
·
|
accurately
anticipate consumer needs;
|
|
·
|
innovate
and develop new products;
|
|
·
|
successfully
commercialize new products in a timely manner;
|
|
·
|
price
our products competitively;
|
|
·
|
manufacture
and deliver our products in sufficient volumes and in a timely manner;
and
|
|
·
|
differentiate
our product offerings from those of our competitors.
|
If
we
fail to do any of the above or we focus on technologies that do not lead to
more
effective products, our current and future products could be surpassed by more
effective or advanced products of others.
OUR
PRODUCTS MAY BE COPIED BY OUR COMPETITORS.
In
general, we rely on trade secrets to protect our intellectual property.
We have
been issued patents from the State Intellectual Properties Office in China
for
two of our products: Tianshi Super Calcium Powder with Metabolic Factors
and
Tianshi Super Calcium Powder for Children. These two patents are effective
for
20 years, which commenced on January 13, 2001. If we fail to adequately
protect
our intellectual property and trade secrets, our competitors may copy our
products, which could hurt our business.
OUR
MANUFACTURING PROCESS IS SUBJECT TO RISKS.
There
are
risks associated with ingredients mixing and production processes and
techniques. Our manufacturing process requires a significant degree of technical
expertise. If we fail to manufacture our products to specifications or
inadvertently use defective materials in the manufacturing process, the
reliability and performance of our products will be compromised.
We
rely
on our manufacturing operations to produce nearly all of the proprietary
products we sell. Any significant disruption in those operations for any reason,
such as regulatory requirements and loss of certifications, power interruptions,
fires, hurricanes, war or other force majeure, could adversely affect our sales
and customer relationships.
WE
HAVE LIMITED CONTROL OVER THE ACTIVITIES OF OUR
DISTRIBUTORS.
We
place
significant reliance on a network of affiliates to act as our primary sales
force. Although a majority of our affiliated companies are controlled in whole
or part by Jinyuan Li, our Chairman, Chief Executive Officer and President,
such
affiliates are not employed or otherwise controlled by us and are generally
free
to conduct their business at their own discretion. The distributors are
dedicated more to establishing their own reputations and business relationships
than to promoting our products. The simultaneous loss of a number of these
distributors could have a material adverse effect on our business, financial
condition, and results of operations.
WE
CONDUCT OUR BUSINESS WITH RELATED PARTIES, AND YOUR INVESTMENT MAY BE SUBJECT
TO
CONFLICT OF INTEREST AND SELF-DEALING RISKS.
Due
to
the inter-related ownership and business dealings among us and our affiliates,
there are conflict of interest and self-dealing risks and increased potential
for manipulation of financial results. We have affiliated companies or business
entities that are owned by Jinyuan Li and his immediate family members (mostly
his daughter Baolan Li). Although all affiliated companies and business entities
were established so that they are legally and financially independent, except
for the common ownership, they are centrally administrated by Tianshi Group.
The
decisions of Tianshi Group could materially affect the operation of our
business, which could be adverse to our investors.
We
sell
all of our products for resale in China to Tianshi Engineering. As both we
and
Tianshi Engineering are majority owned by Jinyuan Li, even given consideration
to the internal price transferring policies set among the related parties,
these
internal policies could be faulty or might not be strictly followed.
WE
FACE RISKS DUE TO OUR RELIANCE ON SALES IN INTERNATIONAL
MARKETS.
Our
future success will depend in part on the continued expansion of international
sales. Such international operations expose us to certain risks, including
but
not limited to; a need for export licenses; unexpected regulatory requirements;
tariffs and other potential trade barriers and restrictions; political, legal
and economic instability in foreign markets; longer account receivable cycles;
difficulties in managing operations across disparate geographic areas; foreign
currency fluctuations; limited protection of our intellectual property rights
in
some countries; dependence on local distributors; and potential disruptions
in
sales due to military or terrorist acts. Any or a combination of these risks
could result in a material adverse effect on our business, financial condition
or results of operations.
OUR
PRODUCTS ARE SUBJECT TO REGULATION OVER NUTRITIONAL SUPPLEMENT PRODUCTS IN
MARKETS OUTSIDE CHINA.
Nutrition
supplement products are subject to regulatory requirements that vary by country.
Obtaining approval to sell nutrition supplement products internationally
involves complexities of dealing with a variety of governmental regulations.
We
have limited experience in dealing with the specific regulations that may be
required to sell our products in certain international markets, which could
delay our ability to obtain relevant regulatory approval for our products.
In
addition, our product sales in other countries are subject to product regulatory
regimes of various degrees and direct marketing or distribution regulations.
Although currently these aspects are handled by our affiliated distributors
in
the relevant jurisdictions, there can be no assurance that the current
operations of our company and our affiliates and distributors will not be
adversely affected by compliance issues and changes in applicable laws and
regulations in relevant jurisdictions.
THE
DISTRIBUTION OF OUR PRODUCTS IS SUBJECT TO REGULATION OUTSIDE
CHINA.
Products
distributed outside China are subject to government regulations of different
jurisdictions, which could be stricter than in China. In some developed
countries, the government regulations for product approval could be stricter
than in China, while in developing countries, government regulation could be
uncertain. Our products could take a significantly longer time than we expect
to
gain regulatory approval or may never gain approval in certain countries, which
could limit our ability to promote, sell and distribute products. In addition,
in terms of our marketing approach, multi-level marketing may also be prohibited
in some countries. As such, our sales may be adversely affected if such approval
cannot be obtained in certain jurisdictions.
OUR
MANAGEMENT LACKS EXPERIENCE OPERATING A U.S. PUBLIC
COMPANY.
Our
management had no experience operating a U.S. public company before our
acquisition of Tianshi Holdings. The initial difficulties with public company
regulations faced by U.S. managers of a newly public company are aggravated
with
respect to our management, by our unfamiliarity with Western regulatory regimes
and language and time zone differences. In addition, management must integrate
new accounting rules and control procedures. Learning compliance is likely
to
distract management from operations to a greater degree than might be the case
of management of a U.S. company, and the period during which our management
masters the rules, when errors are more likely to occur, may be longer.
Accordingly, the expense and operational risks inherent to a transition from
private to public company are greater for Tiens USA than might usually be the
case.
RISKS
RELATED TO DOING BUSINESS IN CHINA
WE
ARE SUBJECT TO THE RISKS ASSOCIATED WITH DOING BUSINESS IN
CHINA.
As
most
of our operations are conducted in China, we are subject to special
considerations and significant risks not typically associated with companies
operating in North America and Western Europe. These include risks associated
with, among others, the political, economic and legal environments and foreign
currency exchange. Our results 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, anti-inflationary measures,
currency conversion and remittance abroad, and rates and methods of taxation,
among other things.
Although
the majority of productive assets in China are owned by the Chinese government,
in the past several years the government has implemented economic reform
measures that emphasize decentralization and encourage private economic
activity. Because these economic reform measures may be inconsistent or
ineffectual, there are no assurances that:
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·
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We
will be able to capitalize on economic
reforms;
|
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·
|
The
Chinese government will continue its pursuit of economic reform policies;
|
|
·
|
The
economic policies, even if pursued, will be successful;
and
|
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·
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Economic
policies will not be significantly altered from time to
time.
|
A
RECENT CAMPAIGN IMPOSED BY THE CHINESE GOVERNMENT AGAINST THE EXPORT OF UNSAFE
FOOD AND SUBSTANDARD PRODUCTS, IN HINDERING OUR ABILITY TO EXPORT OUR PRODUCTS
INTERNATIONALLY.
In
August
2007, China’s Administration of Quality Supervision, Inspection and Quarantine
(“AQSIQ”) announced an ongoing national campaign in China against unsafe food
and substandard products. The special campaign against poor product quality
was
launched in response to a series safety scares involving Chinese products
worldwide. The campaign set 20 detailed goals, including twelve "100 percents".
For example, 100 percent of food producers should be licensed; 100 percent
of
agricultural wholesale markets in cities must be monitored; 100 percent of
suppliers of raw materials for exported products should be inspected; and 100
percent of agricultural products must be free of five types of strong
pesticides. The campaign, which was originally scheduled to finish at the end
of
2007, is currently scheduled to continue throughout 2008.
As
a
result of this campaign by the AQSIQ, there has been a general slow-down and
backlog of export clearances for Chinese food products, and we have experienced
significant delays in obtaining export clearance for all of the products which
we sell to our international affiliates. We believe that these delays have
resulted in some of our international affiliates not being able to purchase
sufficient quantities of our products to meet their demand, resulting in a
loss
of sales. Continued delays in the export clearance for our products may continue
to result in us not being able to meet the demand for our products from our
international affiliates and future loss of sales. Currently we are not able
to
provide an estimate as to the timing for the clearance of our products for
export.
THE
RESEARCH, DEVELOPMENT, TESTING, MANUFACTURING AND MARKETING OF OUR PRODUCTS
ARE
SUBJECT TO VARIOUS GOVERNMENTAL REGULATIONS IN CHINA.
Government
regulation includes inspection of and controls over testing, manufacturing,
safety and environmental controls, efficacy, labeling, advertising, promotion,
record keeping and the sale and distribution of wellness products. Tianshi
Engineering is also subject to government regulations with respect to the prices
it will charge, the rebates it may offer to customers and the methods of its
marketing. Government regulation may substantially increase the cost of
developing, manufacturing and selling our products.
UNCERTAINTY
IN THE DEVELOPMENT OF DIRECT SELLING REGULATIONS MAY ADVERSELY AFFECT SALES
OF
OUR PRODUCTS IN CHINA.
Substantially
all of our assets are located in China, and approximately 56.0%, 40.5% and
40.9%
of our revenues in 2005, 2006 and 2007, respectively, were derived from our
operations in China. Accordingly, our operations are subject, to a significant
degree, to Chinese law. In China, we are aiming to expand our market share
through the branches, chain stores, and affiliated companies of Tianshi
Engineering, our affiliate who sells our products in China. Because direct
selling was only recently authorized in China, the regulatory environment with
respect to direct selling in this market remains fluid and the process for
obtaining the necessary governmental approvals have been interpreted differently
by different governmental authorities. The direct selling regulations require
Tianshi Engineering to apply for approval to conduct a direct selling enterprise
in China.
Tianshi
Engineering has applied for a direct selling license in a number of provinces
and must obtain a series of approvals from the Departments of Commerce in such
provinces, as well as the Departments of Commerce in each city and district
in
which we plan to operate. Tianshi Engineering is also required to obtain the
approval of the State Ministry of Commerce, which is the national government
authority overseeing direct selling.
Tianshi
Engineering has found that it is taking more time than anticipated to work
through the approval process with the Chinese authorities. These authorities
have broad discretion in interpreting the regulations and granting necessary
approvals. A delay in obtaining approvals at one level can delay our ability
to
obtain approvals at the next level. The complexity of the approval process
as
well as the government’s continued cautious approach as direct selling develops
in China makes it difficult to predict a timeline for obtaining these approvals.
If Tianshi Engineering does not receive a direct selling license in China,
then
its ability to compete against its competitors who have received such a license
may be hurt. As a result, Tianshi Engineering may lose distributors who find
a
competitor’s direct selling business and compensation model more attractive.
This could materially decrease the revenues that we receive from sales by
Tianshi Engineering in China.
WE
MAY NOT BE REFUNDED
MONIES WE HAVE PAID FOR THE TIENS YIHAI PROPERTY.
In
2005,
the Chinese central government issued its “Adjustment of Macro-Economic Policy”.
This policy implemented a new system of investment and use of state-owned
assets, including land. Pursuant to this policy, local government organizations
adjusted and re-allotted projects, including investment, construction and
reconstruction of state-owned resources. As a result, projects and enterprises
that had been affected, including Tiens Yihai, were awaiting further decisions
by state and local government.
On
November 10, 2006, Tiens International and the Local Government entered into
a
supplemental agreement pursuant to which the parties have agreed to the
acquisition of land use rights by Tiens Yihai of a reduced 486 mu (80 acres)
parcel of land. In order to proceed with the purchase of land use rights of
the
property by Tiens Yihai, Tianshi Holdings is required to provide a loan of
$6.4
million to the Local Government for relocation costs for people living on the
property. The $6.4 million loan is to be funded in two
installments:
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·
|
The
first installment of $3.2 million was paid on November 27,
2006.
|
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·
|
The
second installment of $3.2 million is to be paid after Tiens Yihai
obtains
a construction license to develop the property. The parties have
agreed to
allow Tianshi Holdings to reduce this second installment by the amount
of
the $1.6 million refund due to it.
|
In
return
for the loan, Tiens Yihai will receive a tax credit in the amount of the loan.
In March 2007, we received notice that the Local Government had approved the
land use rights for 50 acres of the Tiens Yihai property. As a result of the
reduction in the number of acres for which we have received land use rights
and
continued uncertainty relating to the Tiens Yihai project, management made
a
decision to suspend the development of the project. We are currently reviewing
alternative commercial uses for the Tiens Yihai site, as well as the possibility
of selling the land use rights to a third party. If Tiens Yihai does not proceed
with construction on the Tiens Yihai site or is not able to sell the land use
rights to a third party, it is not clear whether the Local Government will
return the $1.6 million it previously agreed to refund or repay the initial
loan
of $3.2 million made in November 2006.
THE
LEGAL AUTHORITIES IN CHINA ARE IN THE PROCESS OF EVALUATING HERETOFORE TAX
AND
FEE BENEFITS PROVIDED TO FOREIGN INVESTORS AND COMPANIES TO ENCOURAGE
DEVELOPMENT WITHIN THE COUNTRY SUCH THAT THESE BENEFITS MAY BE LESSENED OR
REMOVED WITH THE CONSEQUENCE THAT EXPENSES MAY RISE IMPACTING MARGINS AND NET
INCOME.
Biological
is located in Tianjin Wuqing Development Area, a national new technology
development zone, and is subject to the special reduced income tax rate of
15%.
Pursuant to the approval of the relevant PRC tax authorities, Biological is
fully exempt from PRC income taxes for two years starting from the year profits
are first made, followed by a 7.5% reduced tax rate for the next three years.
Prior
to
the year ended December 31, 2002, Biological suffered operating losses.
Biological started generating taxable profits in the year ended December 31,
2003. Effective January 1, 2005, the two-year
full
exemption for income taxes expired for Biological and it became subject to
income tax at a reduced rate of 7.5%.
Beginning
January 1, 2008, the new Enterprise Income Tax (“EIT”) law will replace the
existing laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises
(“FIEs”). The new standard EIT rate of 25% will replace the 33% rate currently
applicable to both DES and FIEs. The two years tax exemption, three years 50%
tax reduction tax holiday for production-oriented FIEs will be eliminated.
According to the new EIT, high-tech companies could be subject to a special
reduced tax rate of 15%. The qualification of a high-tech company is to be
reviewed annually. Biological currently qualifies as a high-tech company.
However, there are no detailed regulations regarding the implementation of
new
EIT. In the first quarter of 2008, we were required by local tax authority
to
prepay income tax at a tax rate of 25%. We are
currently evaluating the effect of the new EIT law will have on our financial
position.
WE
ARE SUBJECT TO COMPLEX CHINESE BUSINESS REGULATIONS.
As
China
changes its economy from planned to more market-oriented, uncertainties arise
regarding governmental policies and measures. Although, in recent years, the
Chinese government has implemented measures emphasizing the use of market forces
for economic reform, reduction of state ownership of productive assets, and
establishment of sound corporate governance practices, a substantial portion
of
productive assets in China are still owned by the Chinese government. For
example, all lands are state owned and leased to business entities or
individuals through governmental grants of state-owned land use rights. The
grant process is typically based on government policies at the time of grant,
which can be lengthy and complex and may adversely affect our planned
manufacturing expansion. The Chinese government also exercises significant
control over China’s economic growth through allocation of resources, foreign
currency control and providing preferential treatment to particular industries
or companies.
BECAUSE
MOST OF OUR DIRECTORS AND OFFICERS RESIDE OUTSIDE OF THE UNITED STATES, AND
SUBSTANTIALLY ALL OF OUR ASSETS ARE LOCATED OUTSIDE OF THE UNITED STATES, IT
MAY
BE DIFFICULT FOR INVESTORS TO ENFORCE THEIR LEGAL RIGHTS AGAINST SUCH
INDIVIDUALS OR SUCH ASSETS.
Most
of
our directors and officers reside outside of the United States, and
substantially all of our assets are located outside of the United States. As
a
result, it may not be possible for investors in the United States to enforce
their legal rights, to effect service of process upon our directors or officers
or to enforce judgments of United States courts predicated upon civil
liabilities and criminal penalties of our directors and officers under Federal
securities laws. Although China has executed the Agreement on Mutual Judicial
Assistance in Criminal Matters with the United States in June 2000, there is
no
extradition treaty between the United States and China. Therefore, it is unclear
whether criminal penalties under United States federal securities laws would
be
enforced effectively in China, if at all.
OUR
OPERATING COMPANY IS SUBJECT TO RESTRICTIONS ON DIVIDEND PAYMENTS AND OTHER
DISTRIBUTIONS TO US.
Current
regulations in China would permit our operating company in China to pay
dividends to us only out of its accumulated distributable profits, if any,
determined in accordance with Chinese accounting standards and regulations.
In
addition, our operating company in China will be required to set aside at least
10% (up to an aggregate amount equal to half of its registered capital) of
its
accumulated profits each year. Such cash reserve may not be distributed as
cash
dividends. In addition, if our operating company in China incurs debt on its
own
behalf in the future, the instruments governing the debt may restrict its
ability to pay dividends or make other payments to us.
THE
CHINESE LEGAL SYSTEM IS NOT FULLY DEVELOPED AND HAS INHERENT UNCERTAINTIES
THAT
COULD LIMIT THE LEGAL PROTECTIONS AVAILABLE TO INVESTORS.
The
Chinese legal system is a system based on written statutes and their
interpretation by the Supreme People’s Court. Prior court decisions may be cited
for reference but have limited legal precedents. Since 1979, the PRC government
has been developing a comprehensive system of commercial laws, and considerable
progress has been made in introducing laws and regulations dealing with economic
matters such as foreign investment, corporate organization and governance,
commerce, taxation and trade. Two examples are the promulgation of the Contract
Law of the PRC to unify the various economic contract laws into a single code,
which went into effect on October 1, 1999, and the Securities Law of the
People’s Republic of China, which went into effect on July 1, 1999. However,
because these laws and regulations are relatively new, and because of the
limited volume of published cases and their non-binding nature, interpretation
and enforcement of these laws and regulations involve uncertainties. In
addition, as the Chinese legal system develops, changes in such laws and
regulations, their interpretation or their enforcement may have a material
adverse effect on our business operations.
ENFORCEMENT
OF REGULATIONS IN CHINA MAY BE INCONSISTENT.
Although
the Chinese government introduced new laws and regulations to modernize its
securities and tax systems on January 1, 1994, China does not yet possess an
expansive body of business law. As a result, the enforcement, interpretation
and
implementation of regulations may prove to be inconsistent and it may be
difficult to enforce contracts.
WE
MAY EXPERIENCE LENGTHY DELAYS IN RESOLUTION OF LEGAL
DISPUTES.
As
China
has not developed a dispute resolution mechanism similar to the Western court
system, dispute resolution over Chinese projects and joint ventures can be
difficult and there is no assurance that any dispute involving our business
in
China can be resolved expeditiously and satisfactorily.
CHINESE
ECONOMIC, POLITICAL AND SOCIAL CONDITIONS AS WELL AS GOVERNMENT POLICIES COULD
ADVERSELY AFFECT OUR BUSINESS.
All
of
our assets and operations are located in China. The economy of China differs
from the economies of most developed countries in many respects, including
government involvement, level of development, growth rate, control of foreign
exchange, and allocation of resources. The economy of China has been
transitioning from a planned economy to a more market-oriented economy. Although
in recent years the Chinese government has implemented measures emphasizing
the
utilization of market forces for economic reform, the reduction of state
ownership of productive assets and the establishment of sound corporate
governance in business enterprises, a substantial portion of productive assets
in China is still owned by the Chinese government. In addition, the Chinese
government continues to play a significant role in regulating industry by
imposing industrial policies. It also exercises significant control over China’s
economic growth through the allocation of resources, controlling payment of
foreign currency-denominated obligations, setting monetary policy and providing
preferential treatment to particular industries or companies.
The
economy of China has experienced significant growth in the past 20 years, but
growth has been uneven both geographically and among various sectors of the
economy. The Chinese government has implemented various measures from time
to
time to control the rate of economic growth. Some of these measures benefit
the
overall economy of China, but may have a negative effect on us. For example,
our
operating results and financial condition may be adversely affected by:
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changes
in the rate or method of taxation;
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|
imposition
of additional restrictions on currency conversion and remittances
abroad;
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reduction
in tariff or quota protection and other import restrictions;
and
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changes
in the usage and costs of state-controlled transportation
services.
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FLUCTUATIONS
IN THE VALUE OF THE CHINESE RENMINBI RELATIVE TO FOREIGN CURRENCIES COULD AFFECT
OUR OPERATING RESULTS.
Substantially
all our revenues and expenses are denominated in the Chinese Renminbi. However,
we use the United States dollar for financial reporting purposes. The value
of
Chinese Renminbi against the United States dollar and other currencies may
fluctuate and is affected by, among other things, changes in China’s political
and economic conditions. The Chinese government values the exchange rate of
the
Chinese Renminbi against a number of currencies, rather than just exclusively
the United States dollar. Although the Chinese government has stated its
intention to support the value of the Chinese Renminbi, we cannot assure you
that the government will not revalue it. As our operations are primarily in
China, any significant revaluation of the Chinese Renminbi may materially and
adversely affect our cash flows, revenues and financial condition. For example,
to the extent that we need to convert United States dollars into Chinese
Renminbi for our operations, appreciation of this currency against the United
States dollar could have a material adverse effect on our business, financial
condition and results of operation. Conversely, if we decide to convert our
Chinese Renminbi into United States dollars for other business purposes and
the
United States dollar appreciates against this currency, the United States dollar
equivalent of the Chinese Renminbi would be reduced. To date, we have not
engaged in any hedging transactions in connection with our
operations.
RISKS
RELATED TO OUR COMMON STOCK
THE
LIQUIDITY OF OUR COMMON STOCK IS AFFECTED BY ITS LIMITED TRADING
MARKET.
Shares
of
our common stock are traded on the American Stock Exchange under the symbol
“TBV”. There is currently no broadly followed established trading market for our
common stock. An established trading market may never develop or be maintained.
Active trading markets generally result in lower price volatility and more
efficient execution of buy and sell orders. The absence of an active trading
market reduces the liquidity of shares. The trading volume of our common stock
historically has been limited and sporadic. As a result of this trading
activity, the quoted price for our common stock is not necessarily a reliable
indicator of its fair market value. Further, if we cease to be quoted, holders
would find it more difficult to dispose of, or to obtain accurate quotations
as
to the market value of our common stock and the market value of our common
stock
likely would decline.
OUR
COMMON STOCK MAY BE SUBJECT TO REGULATIONS PRESCRIBED BY THE SECURITIES AND
EXCHANGE COMMISSION RELATING TO “PENNY STOCK”.
The
Securities and Exchange Commission has adopted regulations that generally define
a penny stock to be any equity security that has a market price (as defined
in
such regulations) of less than $5.00 per share, subject to certain exceptions.
If our common stock meets the definition of a penny stock, it will be subjected
to these regulations, which impose additional sales practice requirements on
broker-dealers who sell such securities to persons other than established
customers and accredited investors.
WE
ARE MAJORITY OWNED BY ONE STOCKHOLDER.
Our
president and chief executive officer, Jinyuan Li, controls a majority of our
common stock. Mr. Li beneficially owns approximately 92% of our outstanding
common stock. As a result, Mr. Li has the ability to exert significant control
over our management and affairs requiring stockholder approval, including
approval of significant corporate transactions. This concentration of ownership
may have the effect of delaying or preventing a change in control, including
a
merger, consolidation or other business combination involving us, or
discouraging a potential acquirer from making a tender offer or otherwise
attempting to obtain control, even if such change of control would benefit
our
other shareholders.
OUR
COMMON STOCK WILL LIKELY BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME
FLUCTUATIONS.
The
stock
market has experienced extreme price and volume fluctuations in recent years
that have significantly affected the quoted prices of securities of many
companies, including companies in our industry. The changes often appear to
occur without regard to specific operating performance. In addition, there
has
been a limited public market for our common stock. We cannot predict the extent
to which investor interest in us will be maintained. Such interest is necessary
for an active, liquid trading market for our common stock. Active trading
markets generally result in lower price volatility and more efficient execution
of buy and sell orders for investors. The price and trading volumes of our
common stock may fluctuate widely due to the limited public market for our
stock.
SHARES
AVAILABLE FOR FUTURE SALE MAY DILUTE AND DEPRESS THE PRICE OF OUR COMMON
STOCK.
A
significant number of our shares are eligible for sale pursuant to Rule 144,
and
their sale could depress the market price of our stock. Some or all of the
shares of common stock may be offered from time to time in the open market
pursuant to Rule 144, and these sales may have a depressive effect on the market
for the shares of common stock. In general, a person who has held restricted
shares for a period of one year may, upon filing with the SEC a notification
on
Form 144, sell into the market common stock in an amount equal to the greater
of
1% of the outstanding shares or the average weekly number of shares sold in
the
last four weeks prior to such sale. Such sales may be repeated once each three
months, and any of the restricted shares may be sold by a non-affiliate after
they have been held two years.
WE
DO NOT ANTICIPATE PAYING DIVIDENDS IN THE FORESEEABLE FUTURE, AND THE LACK
OF
DIVIDENDS MAY HAVE A NEGATIVE EFFECT ON THE STOCK PRICE.
We
have
never declared or paid any cash dividends or distributions on our common stock.
We currently intend to retain our future earnings to support operations and
to
finance expansion and, therefore, do not anticipate paying any cash dividends
on
our common stock in the foreseeable future.
ITEM
1B. UNRESOLVED STAFF COMMENTS.
Not
applicable.
ITEM
2. PROPERTIES.
We
conduct our main business activities in Tianjin, China. Our primary facilities
are located at No. 6. Yuanquan Road, Wuqing New-tech Industrial Park, Tianjin,
PRC.
Since
2003, Biological has leased office space and manufacturing facilities from
Tianshi Group. The lease expired at the end of 2007 and required annual rent
at
1% of our total gross revenues. The rent was negotiated by the parties before
we
acquired Tianshi Holdings, and we believe that it is a reasonable rent for
the
facilities. In 2007 we paid $522,318 to Tianshi Group under the lease. In
addition, we are obligated to pay insurance, maintenance and other expenses
related to the premises. Effective January 1, 2008, we entered into a new lease
with Tianshi Group regarding the following properties on the same terms as
the
lease which expired at the end of 2007:
| • |
three
office buildings with a total area of 8,265 square
meters;
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one
research building with an area of 2,400 square meters;
and
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one
dormitory with an area of 2,365 square
meters.
|
On
December 14, 2007, Biological entered into a Real Property Transfer Agreement
(the “Transfer Agreement”) with Tianshi Group. Under the Transfer Agreement,
Biological transferred to Tianshi Group title to buildings consisting of
approximately 34,000 square meters of office, workshop, conference and
exhibition space located at the Company’s headquarters in Tianjin China for
$15,316,496. Biological also transferred land use rights on the underlying
land,
which is owned by the government of China, continuing through December 30,
2054
with respect to the conference center property and May 31, 2043 with respect
the
other properties. On December 14, 2007, Biological and Tianshi Group also
entered a Lease Agreement pursuant to which Biological has the right to use
and
occupy the office and workshop spaces being transferred under the Transfer
Agreement. The lease is rent-free, but Biological is required to pay Tianshi
Group for utility charges and maintenance costs on the buildings. The lease
continues until the earlier of the date that we move to the new administrative
offices being constructed by Life Resources, or the land use rights on the
underlying property expire.
The
following properties are covered by the December 14, 2007 lease:
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two
workshops with an area of 8,600 square
meters;
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two
warehouses with an area of 9,447 square meters;
and
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one
power station with an area of 615 square
meters
|
Tiens
Yihai Property
In
April
2004, Tianshi Holdings entered a joint venture contract with Tianshi
Pharmaceuticals to establish Tiens Yihai. Tiens Yihai is 99.4% owned by Tianshi
Holdings and 0.6% owned by Tianshi Pharmaceuticals. Tiens Yihai is located
in
Shanghai, China, and was established to build a new research and development
facility, which would also produce certain of our products. In October 2004,
the
Company paid a deposit of $3.6 million to Zhu Jia Jiao Industrial Park
Economic
Development
Ltd (representative of the local government, “Local Government”) for acquiring
the land use right of 1,600 mu (263 acres) located in Shanghai. However, in
2005, the Chinese central government issued its “Adjustment of Macro-Economic
Policy”. This policy implemented a new system of investment and use of
state-owned assets, including land. Pursuant to this policy, local government
organizations adjusted and re-allotted projects, including investment,
construction and reconstruction of state-owned resources. As a result, projects
and enterprises that had been affected, including Tiens Yihai, were awaiting
further decisions by state and local government.
On
November 10, 2006, Tiens International and the Local Government entered into
a
supplemental agreement pursuant to which the parties have agreed to the
acquisition of land use rights by Tiens Yihai of a reduced 486 mu (80 acres)
parcel of land. The remaining 1,114 mu (184 acres) may not be available for
purchase in the future. Therefore, the Local Government has agreed to refund
to
us $1.6 million of the original $3.6 million deposit when we receive a
construction license for the development.
In
order
to proceed with the purchase of the property by Tiens Yihai, Tianshi Holdings
is
required to provide a loan of $6.4 million to the Local Government for
relocation costs for people living on the property. The $6.4 million loan is
to
be funded in two installments:
|
·
|
The
first installment of $3.2 million was paid on November 27,
2006.
|
|
·
|
The
second installment of $3.2 million is to be paid after Tiens Yihai
obtains
a construction license to develop the property. The parties have
agreed to
allow Tianshi Holdings to reduce this second installment by the amount
of
the $1.6 million refund due to it.
|
In
return
for the loan, Tiens Yihai will receive a tax credit in the amount of the loan.
In March 2007, we received notice that the Local Government had approved the
land use rights for 50 acres of the Tiens Yihai property. As a result of the
reduction in the number of acres for which we have received land use rights
and
continued uncertainty relating to the Tiens Yihai project, management made
a
decision to suspend the development of the project. We are currently reviewing
alternative commercial uses for the Tiens Yihai site, as well as the possibility
of selling the land use rights to a third party.
Life
Resources Property
On
December 20, 2007, Tianshi Holdings entered into a Sale and Purchase Agreement
with Tianshi Investment to buy all of the registered share capital of Life
Resources for $64.2 million. The closing of the transaction was subject to
government approval of transfer of the share capital of Life Resources to
Tianshi Holdings. On March 13, 2008, the Chinese government approved the
transfer. Pursuant to the Sale and Purchase Agreement, the Tianshi Holdings
advanced a deposit of $64,247,182 to Tianshi Investment on December 20, 2007.
This acquisition deposit was settled as follows:
|
·
|
$28,592,743
was paid by canceling a loan in the principal amount of RMB200,000,000
to
Tianshi Engineering owned by Biological together with interest accrued;
|
|
·
|
$16,557,914
was paid by canceling of other receivable owned by Tianshi Engineering
to
Biological; and
|
|
·
|
$19,096,525
was paid in cash.
|
Life
Resources is currently constructing research and development, manufacturing
and
logistic facilities, as well as administrative offices totaling approximately
420,000 square meters. Construction began in July 2006. The facilities are
located 7 kilometers from our current headquarters in Tianjin, China. We
currently estimate that the budget for completion of the Life Resources project
will be approximately $220 million, including the $64 million already spent
to
acquire all of the registered share capital of Life Resources. We intend to
move
our headquarters to these new facilities upon its completion.
ITEM
3. LEGAL PROCEEDINGS.
We
are
not a party to any material pending legal proceedings.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On
December 4, 2007, the annual meeting of stockholders of the Company (the “Annual
Meeting”) was held at the Company’s Tianjin offices for the following purposes:
|
1.
|
Elect
the following persons to the Board of Directors: Jinyuan Li, Wenjun
Jiao,
Yupeng Yan, Gilbert Raker, Howard Balloch, and Socorro Quintero.
|
|
2.
|
Ratify
the Board of Directors’ appointment of Grobstein, Horwath & Company
LLP, the independent public accountants as the auditor of the Company
for
the fiscal year 2007.
|
In
this
Annual Meeting, there were accordingly present, in person or by proxy, an
aggregate of 67,970,169 shares of Common Stock, such shares being a majority
of
the 71,333,586 shares of Common Stock entitled to notice of and to vote at
the
meeting.
The
result of the vote taken for the election of directors at the meeting was as
follows:
|
Directors
|
No.
of Shares For
|
No.
of Shares Against
|
Withheld
Authority
|
|||
|
Jinyuan
Li
|
67,959,959
|
10,210
|
0
|
|||
|
Wenjun
Jiao
|
67,959,959
|
10,210
|
0
|
|||
|
Yupeng
Yan
|
67,959,959
|
10,210
|
0
|
|||
|
Socorro
Quintero
|
67,959,959
|
10,210
|
0
|
|||
|
Howard
Balloch
|
67,959,359
|
10,810
|
0
|
|||
|
Gilbert
Raker
|
67,959,959
|
10,210
|
0
|
The
result of the vote taken for the ratification of the appointment of Grobstein,
Horwath & Company LLP was as follows:
|
·
|
67,959,924
shares voted in favor of the proposal,
|
|
·
|
7,208
shares voted against the proposal, and
|
|
·
|
3,037
shares abstained.
|
PART
II
ITEM
5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASERS OF EQUITY SECURITIES.
Stock
Performance Presentation
The
following chart compares the cumulative stockholder return on the Company’s
common stock with the cumulative total stockholder return of (i) the AMEX
Composite Index and (ii) the Nasdaq Biotechnology Index.
Cumulative
Total Return
Among
Tiens Biotech Group (USA), Inc.,
AMEX
Composite Market Index and NASDAQ Biotech Index (1) (2)
|
October
7,
2003
|
December
31,
2003
|
December
31,
2004
|
December
31,
2005
|
December
31,
2006
|
December
31,
2007
|
||||||||||||||
|
Tiens
Biotech Group (USA), Inc.
|
$
|
100.00
|
$
|
301.25
|
$
|
175.00
|
$
|
90.50
|
$
|
98.25
|
$
|
58.50
|
|||||||
|
Amex
Composite Index
|
$
|
100.00
|
$
|
115.51
|
$
|
141.18
|
$
|
173.14
|
$
|
202.41
|
$
|
237.17
|
|||||||
|
Nasdaq
Biotechnology Index
|
$
|
100.00
|
$
|
95.61
|
$
|
101.47
|
$
|
104.35
|
$
|
105.42
|
$
|
110.25
|
|||||||
(1)
Assumes $100 invested on October 7, 2003 and assumes dividends reinvested.
The
Company has not paid any dividends on its common stock, and no dividends are
included in the report of the Company’s performance. Measurement points are at
the last trading day of the fiscal years ended December 31, 2003, 2004, 2005,
2006 and 2007. The material in this chart is not soliciting material, is not
deemed filed with the SEC and is not incorporated by reference in any filing
of
the Company under the Securities Act of 1933, as amended, or the Exchange Act,
whether made before or after the date of this proxy statement and irrespective
of any general incorporation language in such filing.
(2)
The
Company was listed on the American Stock Exchange as of April 25, 2005. The
Company’s common stock began quotation on the OTC Bulletin Board on October 7,
2003. Prior to October 7, 2003, the Company’s common stock was eligible for
quotation on the OTC Bulletin Board, but there was no trading
activity.
Market
Prices of Common Stock
Our
common stock was listed on the OTC Bulletin Board under the symbol “TBGU” from
January 1, 2004 to April 24, 2005. On April 25, 2005, our common stock was
listed on the American Stock Exchange under the symbol “TBV”. The following
table sets forth the range of high and low bid prices for our common stock
reported by the American Stock Exchange in each fiscal quarter from January
1,
2006 to December 31, 2007.
|
High
|
Low
|
||||||
|
Fiscal
2006
|
|||||||
|
Quarter
Ended March 31, 2006
|
$
|
5.02
|
$
|
3.62
|
|||
|
Quarter
Ended June 30, 2006
|
$
|
7.47
|
$
|
4.01
|
|||
|
Quarter
ended September 30, 2006
|
$
|
4.40
|
$
|
2.61
|
|||
|
Quarter
ended December 31, 2006
|
$
|
4.02
|
$
|
2.80
|
|||
|
Fiscal
2007
|
|||||||
|
Quarter
Ended March 31, 2007
|
$
|
6.99
|
$
|
3.75
|
|||
|
Quarter
Ended June 30, 2007
|
$
|
4.55
|
$
|
3.55
|
|||
|
Quarter
ended September 30, 2007
|
$
|
4.55
|
$
|
2.65
|
|||
|
Quarter
ended December 31, 2007
|
$
|
6.85
|
$
|
2.25
|
|||
Shareholders
As
of
March 25, 2008, there were a total of 71,333,586 shares of our common stock
outstanding, held by approximately 941 stockholders of record. This number
of
holders of record does not represent the actual number of beneficial owners
of
shares of our common stock because shares are frequently held in “street name”
by securities dealers and others for the benefit of individual owners who have
the right to vote their shares.
Dividend
Policy
We
have
not declared any dividends on our common stock since inception and do not intend
to pay dividends on our common stock in the foreseeable future.
Recent
Sales of Unregistered Securities
None.
Authorization
of Securities for Issuance Under Equity Compensation Plans
None.
Issuer
Purchases of Equity Securities
None.
ITEM
6. SELECTED FINANCIAL DATA.
The
following table sets forth certain of our historical financial data. The
selected consolidated historical financial data set forth below are not
necessarily indicative of the results of future operations and should be read
in
conjunction with the discussion under the heading “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” and the historical
consolidated financial statements and accompanying notes included elsewhere
in
this document. The following selected financial data as of and each of the
five
years ended December 31, 2003 through 2007 have been derived from our audited
consolidated financial statements.
|
Year
Ended December 31
|
||||||||||||||||
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||
|
Income
Statement Data:
|
||||||||||||||||
|
Revenue
- related parties
|
$
|
54,900,060
|
$
|
66,790,466
|
$
|
68,688,669
|
$
|
58,910,532
|
$
|
38,392,208
|
||||||
|
Cost
of sales
|
16,526,695
|
18,082,441
|
17,451,605
|
17,483,739
|
12,725,161
|
|||||||||||
|
Gross
profit
|
38,373,365
|
48,708,025
|
51,237,064
|
41,426,793
|
25,667,047
|
|||||||||||
|
Selling,
general and administrative expenses
|
14,306,660
|
12,789,810
|
13,413,875
|
7,363,248
|
3,171,338
|
|||||||||||
|
Income
from operations
|
24,066,705
|
35,918,215
|
37,823,189
|
34,063,545
|
22,495,709
|
|||||||||||
|
Other
income (expense), net
|
1,520,208
|
161,091
|
(639,137
|
)
|
388,266
|
(1,178,389
|
)
|
|||||||||
|
Income
before provision for income taxes
|
||||||||||||||||
|
and
minority interest
|
25,586,913
|
36,079,306
|
37,184,052
|
34,451,811
|
21,317,320
|
|||||||||||
|
Provision
for income taxes
|
2,026,875
|
2,823,899
|
2,984,302
|
0
|
0
|
|||||||||||
|
Income
before minority interest
|
23,560,038
|
33,255,407
|
34,199,750
|
34,451,811
|
21,317,320
|
|||||||||||
|
Minority
interest
|
4,966,397
|
6,963,330
|
7,321,630
|
7,013,515
|
4,263,498
|
|||||||||||
|
Net
income
|
18,593,641
|
26,292,077
|
26,878,120
|
27,438,296
|
17,053,822
|
|||||||||||
|
Other
comprehensive income
|
||||||||||||||||
|
Foreign
currency translation adjustment
|
8,265,358
|
3,480,775
|
2,246,380
|
(8,239
|
)
|
0
|
||||||||||
|
Comprehensive
income
|
$
|
26,858,999
|
$
|
29,772,852
|
$
|
29,124,500
|
$
|
27,430,057
|
$
|
17,053,822
|
||||||
|
Weighted
average number of shares outstanding
|
71,333,586
|
71,333,586
|
71,333,586
|
71,801,819
|
44,730,609
|
|||||||||||
|
Earnings
per share, basic and diluted
|
$
|
0.26
|
$
|
0.37
|
$
|
0.38
|
$
|
0.38
|
$
|
0.38
|
||||||
|
Balance
Sheet Data
(at
end of period)
:
|
||||||||||||||||
|
Cash
and cash equivalents and current investments
|
$
|
48,678,945
|
$
|
54,270,065
|
$
|
77,545,991
|
$
|
39,243,872
|
$
|
12,725,043
|
||||||
|
Working
capital
|
59,323,558
|
74,008,466
|
81,067,056
|
53,716,852
|
28,121,818
|
|||||||||||
|
Total
assets
|
181,627,637
|
148,746,998
|
121,624,154
|
83,518,933
|
57,101,642
|
|||||||||||
|
Current
potion of long-term debt
|
2,130,000
|
2,130,000
|
2,130,000
|
155,442
|
259,364
|
|||||||||||
|
Long-term
debt
|
4,267,742
|
6,397,742
|
8,527,742
|
10,657,742
|
155,591
|
|||||||||||
|
Stockholders’
equity
|
$
|
146,348,355
|
$
|
119,420,251
|
$
|
89,647,399
|
$
|
60,522,899
|
$
|
33,086,192
|
||||||
ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS.
FORWARD-LOOKING
STATEMENTS:
The
following discussion of the financial condition and results of operations should
be read in conjunction with the consolidated financial statements and related
notes thereto. The words or phrases “would be,” “will allow,” “expect to”,
“intends to,” “will likely result,” “are expected to,” “will continue,” “is
anticipated,” “estimate,” “project,” or similar expressions are intended to
identify “forward-looking statements”. Such statements include those concerning
our expected financial performance, our corporate strategy and operational
plans. Actual results could differ materially from those projected in the
forward-looking statements as a result of a number of risks and uncertainties,
including: (a) those risks and uncertainties related to general economic
conditions in China, including regulatory factors that may affect such economic
conditions; (b) whether we are able to manage our planned growth efficiently
and
operate profitable operations, including whether our management will be able
to
identify, hire, train, retain, motivate and manage required personnel or that
management will be able to successfully manage and exploit existing and
potential market opportunities; (c) whether we are able to generate sufficient
revenues or obtain financing to sustain and grow our operations; (d) whether
we
are able to successfully fulfill our primary requirements for cash which are
explained below under “Liquidity and Capital Resources”; and (e) whether Tianshi
Engineering, our affiliate who sells our products in China, obtains a direct
selling license in China. Statements made herein are as of the date of the
filing of this Form 10-K with the Securities and Exchange Commission and should
not be relied upon as of any subsequent date.
Unless
otherwise required by applicable law, we do not undertake, and we specifically
disclaim any obligation, to update any forward-looking statements to reflect
occurrences, developments, unanticipated events or circumstances after the
date
of such statement.
The
following discussion and analysis should be read in conjunction with “Item 6.
Selected Financial Data” and our consolidated financial statements and the
related notes thereto and other financial information contained elsewhere in
this Form 10-K.
Overview
Tiens
USA
researches, develops, manufactures, and markets nutrition supplement products,
including wellness products and dietary supplement products. Our operations
are
conducted from our headquarters in Tianjin, China through our 80% owned
subsidiary, Biological. We sell our products to affiliated companies in China
and internationally.
We
develop our products at our product research and development center, which
employs highly qualified professionals in the fields of pharmacology, biology,
chemistry and fine chemistry. We have developed and produce 33 nutrition
supplement products, which include wellness products and dietary nutrition
supplements. During 2007, we phased out production of our personal care line
of
products, which had not been a material part of our business, to focus on our
wellness products and dietary supplements.
In
China,
we sell our products to Tianshi Engineering, an affiliated company. Tianshi
Engineering, in turn, sells the products to customers through its branches
and
affiliated companies and at chain stores which are owned by individual
distributors. Internationally, we sell our products to overseas affiliates
who
in turn sell to independent distributors who use the products themselves and/or
resell them to other distributors or consumers.
Results
of Operations
Year
Ended December 31, 2007 Compared to Year Ended December 31,
2006
Revenue.
In
2007
revenue was $54.9 million compared to $66.8 million in 2006, a decrease of
17.8%. The breakdown of revenue between Chinese and international sales is
as
follows.
Chinese
and International Revenue
|
Revenue
|
Year
2007
|
Year
2006
|
%
Change
|
||||||
|
China
|
$
|
22,476,135
|
$
|
27,074,979
|
-17.0%
|
||||
|
International
|
$
|
32,423,925
|
$
|
39,715,487
|
-18.4%
|
||||
In
2007
revenue from China decreased to $22.5 million, or 17.0% compared to $27.1
million in 2006, primarily due to a decrease in sales. In order to qualify
for a
direct selling license in China, Tianshi Engineering, our related party customer
in China, is required to produce a part of the products that it sells in China.
Therefore, at the beginning of 2006, we began selling semi-finished products
to
Tianshi Engineering, which jointly shares with us licenses to produce,
manufacture and sell the products. These semi-finished products have a lower
sales price than the finished products we had previously sold to Tianshi
Engineering. During 2006 we still had a considerable inventory of finished
products that we continued to sell to Tianshi Engineering. As a result, during
2006 we were still selling some of the higher-priced finished products. In
2007,
substantially all of the products we sold to Tianshi Engineering were
semi-finished products.
In
addition, in the third quarter of 2006, Tianshi Engineering conducted a special
promotion to stimulate sales in China. No similar promotion was held in 2007.
The application of Tianshi Engineering for a direct selling license in China
is
still pending. Until the application is approved, Tianshi Engineering will
continue to sell our products through its branches, affiliated companies and
chain stores in China.
In
2007,
international sales decreased by 18.4% to $32.4 million, compared to $39.7
million in 2006. This mainly reflects a sharp decrease in sales to countries
in
Africa during the second quarter of 2007 and a decrease in sales generally
in
other countries. In addition, in August of 2007, AQSIQ announced an ongoing
national campaign in China against unsafe food and substandard products. The
special campaign against poor product quality was launched in response to a
series safety scares involving Chinese products worldwide. The campaign set
20
detailed goals, including twelve "100 percents". For example, 100 percent of
food producers should be licensed; 100 percent of agricultural wholesale markets
in cities must be monitored; 100 percent of suppliers of raw materials for
exported products should be inspected; and 100 percent of agricultural products
must be free of five types of strong pesticides. The campaign, which was
originally scheduled to finish at the end of 2007, is currently scheduled to
continue throughout 2008.
As
a
result of this campaign by the AQSIQ, there has been a general slow-down and
backlog of export clearances for Chinese food products, and we have experienced
significant delays in obtaining export clearance for all of the products which
we sell to our international affiliates. However, to date, there have not been
any specific problems identified with our products. We believe that these delays
have resulted in some of our international affiliates not being able to purchase
sufficient quantities of our products to meet their demand and a corresponding
decrease in our international revenues. Continued delays in the export clearance
for our products may continue to result in us not being able to meet the demand
for our products from our international affiliates.
Cost
of sales.
Cost of
sales were $16.5 million in 2007 compared to $18.1 million in 2006, a decrease
of 8.6%. This decrease was primarily due to the corresponding decrease in sales
revenue. Cost of sales decreased at a lesser rate than revenue because the
cost
of raw materials increased during 2007 while our product prices remained
unchanged.
Gross
profit.
Gross
profit decreased by 21.2% to $38.4 million in 2007, compared to $48.7 million
in
2006. The gross profit margin for 2007 was 69.9% compared to 72.9% in 2006.
The
semi-finished products which we were selling in China during 2007 had a lower
profit margin than the finished products which we were selling
in
2006.
Selling,
general and administrative expenses.
Selling,
general and administrative expenses increased by 11.9% to $14.3 million in
2007,
compared to $12.8 million in 2006. The increase was primarily due to increases
in salaries and benefits ($629,769), consulting expenses ($392,751), insurance
costs ($340,571) and depreciation expenses ($247,071). The selling and
administrative expenses as a percentage of sales increased to 26.1%
in 2007
from 19.1% in 2006.
Other
income, net.
Other
income, net was $1.5 million of income in 2007, compared to income of $0.2
million in 2006. Other income mainly includes interest income. On January 1,
2007, the $25.6 million loan to Tianshi Engineering became interest bearing.
In
addition beginning in January 2007, accounts receivable relating to Tianshi
Engineering and which are older than 90 days are transferred to other
receivables-related parties and become interest bearing.
Net
income.
For the
above stated reasons, net income in 2007 was $18.6 million compared to $26.3
million in 2006, a decrease of 29%.
Year
Ended December 31, 2006 Compared to Year Ended December 31,
2005
Revenue.
In 2006
revenue was $66.8 million compared to $68.7 million in 2005, a decrease of
2.8%.
The breakdown of revenue between Chinese and international sales is as
follows.
Chinese
and International Revenue
|
Revenue
|
Year
2006
|
Year
2005
|
%
Change
|
||||||
|
China
|
$
|
27,074,979
|
$
|
38,181,090
|
-29.1%
|
||||
|
International
|
$
|
39,715,487
|
$
|
30,507,579
|
30.2%
|
||||
In
2006
revenue from China decreased to $27.1 million, or 29.1% compared to $38.2
million in 2005. At the beginning of 2006, we began selling semi-finished
products to Tianshi Engineering. In order to qualify for a direct selling
license in China, Tianshi Engineering, our related party customer in China,
is
required to produce a part of the products that it sells in China. As a result,
in 2006, we began to sell semi-finished products to Tianshi Engineering, which
jointly shares with us licenses to produce, manufacture and sell the products.
These semi-finished products have a lower sales price than the finished products
we had previously sold to Tianshi Engineering.
In
addition, we believe that sales to China in 2006 were negatively impacted by
other factors, including:
|
·
|
continued
consumer uncertainty in China regarding the impact of direct selling
regulations and uncertainty regarding the timing of the direct selling
license application process and approval;
and
|
|
·
|
increased
government and media scrutiny on the direct selling industry, particularly
following publication of new direct selling regulations at the end
of
2005.
|
In
2006,
international sales increased to $39.7 million, or 30.2% compared to $30.5
million in 2005. The strong growth reflected a significant increase in demand
for our products in Indonesia, as well as strong revenue growth in Kazakhstan,
South Africa, Thailand, Ukraine, Congo and Ghana.
Cost
of sales.
Cost of
sales increased by $0.6 million in 2006, a 3.6% increase compared with 2005.
Cost of sales as a percentage of revenue increased to 27.1% for the twelve
months ended December 31, 2006 compared to 25.4% for 2005. In order to improve
the quality of our products, during 2006 we introduced some new manufacturing
procedures and stricter quality control testing than previously, which added
to
our manufacturing costs. In addition, due to the uncertainty of the Chinese
market, we did not achieve domestic sales growth and the average fixed cost
per
unit was higher than in 2005
.
Gross
profit.
Gross
profit decreased by 4.9% to $48.7 million in 2006, compared to $51.2 million
in
2005. The gross profit margin for 2006 was 72.9% compared to 74.6% in 2005
as a
result of the reasons discussed under cost of sales.
Selling,
general and administrative expenses.
Selling,
general and administrative expenses decreased to $12.8 million in 2006, or
4.7%
compared to $13.4 million in 2005. This decrease primarily reflects a decrease
in transportation expenses, as well as a decrease in low cost supplies expenses
and expenses relating to the startup costs of Tiens Yihai. In 2006 we began
to
sell semi-finished goods to Tianshi Engineering and the transportation costs
that were previously incurred by us are now incurred by Tianshi Engineering.
The
selling and administrative expenses as a percentage of sales decreased to 19.1%
in 2006 from 19.5% in 2005.
Other
income (expense), net.
Other
income (expense), net was $0.2 million of income in 2006, compared to expense
of
$0.6 million in 2005.
The
increase was a result of improved cash management, including the purchase of
an
investment product and deposits in higher interest-bearing
accounts.
Net
income.
For the
above stated reasons, net income in 2006 was $26.3 million compared to $26.9
million in 2005, a decrease of 2.2%.
Quarterly
Results of Operations
The
following table sets forth selected unaudited quarterly data for the periods
shown.
|
Quarter
Ended
|
|||||||||||||||||||||||||
|
Dec.
31,
2007
|
Sept.
30,
2007
|
June
30,
2007
|
March
31,
2007
|
Dec.
31,
2006
|
Sept.
30,
2006
|
June
30,
2006
|
March
31, 2006
|
||||||||||||||||||
|
Revenue-related
parties
|
$
|
13,315,311
|
$
|
11,027,478
|
$
|
14,320,482
|
$
|
16,236,789
|
$
|
16,587,160
|
$
|
19,187,748
|
$
|
14,292,998
|
$
|
16,722,560
|
|||||||||
|
Cost
of sales
|
4,546,711
|
3,089,791
|
4,454,594
|
4,435,599
|
4,367,702
|
5,066,051
|
3,842,392
|
4,806,296
|
|||||||||||||||||
|
Gross
profit
|
8,768,600
|
7,937,687
|
9,865,888
|
11,801,190
|
12,219,458
|
14,121,697
|
10,450,606
|
11,916,264
|
|||||||||||||||||
|
Selling,
general and administrative expenses
|
3,953,263
|
3,801,914
|
3,328,727
|
3,222,756
|
4,148,297
|
2,803,859
|
3,271,232
|
2,566,422
|
|||||||||||||||||
|
Income
from operations
|
4,815,337
|
4,135,773
|
6,537,161
|
8,578,434
|
8,071,161
|
11,317,838
|
7,179,374
|
9,349,842
|
|||||||||||||||||
|
Other
(expense) income, net
|
475,918
|
149,683
|
446,994
|
447,613
|
33,633
|
164,104
|
1,075
|
(37,721
|
)
|
||||||||||||||||
|
Income
before provision for income taxes and minority interest
|
5,291,255
|
4,285,456
|
6,984,155
|
9,026,047
|
8,104,794
|
11,481,942
|
7,180,449
|
9,312,121
|
|||||||||||||||||
|
Provision
for income taxes
|
416,222
|
344,248
|
555,395
|
711,010
|
635,408
|
878,931
|
576,029
|
733,531
|
|||||||||||||||||
|
Income
before minority interest
|
4,875,033
|
3,941,208
|
6,428,760
|
8,315,037
|
7,469,386
|
10,603,011
|
6,604,420
|
8,578,590
|
|||||||||||||||||
|
Minority
interest
|
995,606
|
848,212
|
1,369,361
|
1,753,218
|
1,566,759
|
2,167,747
|
1,419,943
|
1,808,881
|
|||||||||||||||||
|
Net
income
|
3,879,427
|
3,092,996
|
5,059,399
|
6,561,819
|
5,902,627
|
8,435,264
|
5,184,477
|
6,769,709
|
|||||||||||||||||
|
Other
comprehensive income foreign currency translation
adjustment
|
3,334,871
|
1,593,144
|
2,062,282
|
1,275,061
|
1,083,976
|
1,411,012
|
267,960
|
717,827
|
|||||||||||||||||
|
Comprehensive
income
|
$
|
7,214,298
|
$
|
4,686,140
|
$
|
7,121,681
|
$
|
7,836,880
|
$
|
6,986,603
|
$
|
9,846,276
|
$
|
5,452,437
|
$
|
7,487,536
|
|||||||||
|
Weighted
average number of shares outstanding
|
71,333,586
|
71,333,586
|
71,333,586
|
71,333,586
|
71,333,586
|
71,333,586
|
71,333,586
|
71,333,586
|
|||||||||||||||||
|
Earnings
per share, basic and diluted
|
$
|
0.05
|
$
|
0.04
|
$
|
0.07
|
$
|
0.09
|
$
|
0.08
|
$
|
0.12
|
$
|
0.07
|
$
|
0.09
|
|||||||||
Contractual
Obligations and Commercial Commitments
The
following table sets forth payments due by period for fixed contractual
obligations as of December 31, 2007.
|
Payments
due by period (1)
|
||||||||||||||||
|
Total
|
Less
than
1
year
|
1-3
years
|
3-5
years
|
More
than
5
years
|
||||||||||||
|
Long-term
Debt Obligations
|
$
|
6,397,742
|
$
|
2,130,000
|
$
|
4,260,000
|
$
|
7,742
|
$
|
0
|
||||||
|
Operating
Lease Obligations
|
574,550
|
574,550
|
0
|
0
|
0
|
|||||||||||
|
Total
fixed contractual obligations
|
$
|
6,972,292
|
$
|
2,704,550
|
$
|
4,260,000
|
$
|
7,742
|
$
|
0
|
||||||
(1)
We
lease our office building and manufacturing facilities in Tianjin, China from
Tianshi Group, a related party, through common ownership. On June 30, 2002,
we
entered into a written lease agreement with Tianshi Group to pay annual rent
at
1% of our total gross revenues. This agreement expired on December 31, 2007.
We
have entered into a new on-year lease agreement with Tianshi Group, effective
January 1, 2008, with the same terms. Because the rent is based upon a
percentage of our gross total revenues, we are not able to include a fixed
figure in the table relating to this obligation. The total amount paid in 2007
under this lease was $522,318.
Financial
Condition, Liquidity and Capital Resources
We
have
historically met our working capital and capital expenditure requirements,
including funding for expansion of operations, through net cash flow provided
by
operating activities. Our principal source of liquidity is our operating cash
flow.
Net
cash
provided by operating activities was $5.5 million in 2007, compared to $12.9
million in 2006. The decrease primarily reflects the decrease in net income
and
the fact that, during 2007, Tianshi Engineering did not pay us cash for products
it purchased from us, but offset such amounts from other liabilities we owed
Tianshi Engineering and other affiliates.
As
of
December 31, 2007, we had positive working capital of $59.3 million. Cash was
$48.7 million as of December 31, 2007, compared to $54.3 as of December 31,
2006.
Net
cash
used in investing activities was $8.3 million in 2007 compared to $35.9 million
in 2006. In 2006 we made a $25.6 million loan to Tianshi Engineering. That
loan
was paid off on December 20, 2007 by canceling an equal amount of the
consideration due to Tianshi Investment for the acquisition of Life Resources.
Net
cash
used in financing activities was $6.2 million for 2007, compared to $2.1 million
for 2006. In 2007 Biological paid a $6.7 million dividend to its minority
shareholder.
Accounts
receivable-related parties increased slightly to $14.3 million as of December
31, 2007 from $12.9 million as of December 31, 2006. Other receivable-related
parties increased to $13.1 million as of December 31, 2007 from $8.4 million
as
of December 31, 2006. Historically, Tianshi Engineering remitted payment to
us
upon sales to third-party customers. However, to support Tianshi Engineering’s
marketing efforts in anticipation of receiving a direct selling license in
China, we agreed to allow Tianshi Engineering to defer payment to us. Beginning
in January 2007, accounts receivable relating to Tianshi Engineering older
than
90 days are transferred to other receivables-related parties and become interest
bearing.
Going
forward, our primary requirements for cash consist of:
|
·
|
construction
by Life Resources of new research and development, manufacturing
and
logistic facilities, and administrative
offices;
|
|
·
|
the
continued production of existing products and general overhead and
personnel related expenses to support these
activities;
|
|
·
|
the
development costs of new products;
and
|
|
·
|
expansion
of production scale to meet the demands of our markets.
|
We
estimate that the completion of the Life Resources project will require
approximately $220 million, including the $64 million already spent to acquire
all of the registered share capital of Life Resources. We intend to construct
the facilities in phases over several years, based on available cash and
capacity needs. Depending on the rate of construction and our cash flow, we
may
require additional financing to complete the funding of that project. We
anticipate that our current operating activities will enable us to meet our
anticipated cash requirements for 2008.
Management
Assumptions
Management
anticipates, based on internal forecasts and assumptions relating to our current
operations that existing cash and funds generated from operations will be
sufficient to meet working capital for at least the next 12 months. In the
event
that our business plans change, our assumptions change or prove inaccurate
or if
other capital resources and projected cash flow otherwise prove to be
insufficient to fund operations (due to unanticipated expense, technical
difficulties, or otherwise), we could be required to seek additional financing.
There can be no assurance that we will be able to obtain additional financing
on
terms acceptable to us, or at all.
Off-Balance
Sheet Arrangements
We
have
no off-balance sheet arrangements.
Critical
Accounting Policies
Management’s
discussion and analysis of its financial condition and results of operations
are
based upon our consolidated financial statements, which have been prepared
in
accordance with accounting principles generally accepted in the United States.
Our financial statements reflect the selection and application of accounting
policies which require management to make significant estimates and judgments.
See note 2 to our consolidated financial statements, “Summary of Significant
Accounting Policies.” Management bases its estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates under different
assumptions or conditions. We believe that the following reflect the more
critical accounting policies that currently affect our financial condition
and
results of operations.
Revenue
Recognition
During
2007, the Company sold both semi-finished products and finished products to
Tianshi Engineering domestically. Revenue from semi-finished products was
recognized at FOB
Tianjin
shipping point. Revenue from finished products was recognized only when the
related party Chinese distributors recognized sales of the Company's products
to
unaffiliated third parties. Revenues in both cases are net of
taxes.
For
overseas sales, the Company only sells finished products. The Company recognizes
revenue from international sales (non-Chinese) to both affiliated and
unaffiliated third parties, net of taxes as goods are shipped and clear review
by the customs department of the Chinese government.
The
Company is generally not contractually obligated to accept returns. However,
on
a case by case negotiated basis, the Company permits customers to return their
products. In accordance with SFAS No. 48, "Revenue Recognition when the Right
of
Return Exists", revenue is recorded net of an allowance for estimated returns.
Such reserves are based upon management's evaluation of historical experience
and estimated costs. The amount of the reserves ultimately required could differ
materially in the near term from amounts included in the accompanying
consolidated financial statements. As of December 31, 2007, Tianshi Engineering,
an affiliated company, owned all of the related party distributors which sell
our products in China.
Allowance
for Doubtful Accounts
Our
trade
accounts receivables are mainly due from related companies. We have a general
allowance for doubtful debts of 0.5% of the year-end balance of accounts
receivable-related parties. Management reviews its accounts receivable on a
regular basis to determine if the bad debt allowance is adequate at each
year-end, paying particular attention to the age of receivable outstanding.
Inventories
Inventories
are stated at the lower of cost or market using the moving average basis.
Management reviews inventory annually for possible obsolete goods or to
determine if any reserves are necessary for potential obsolescence.
Recent
Accounting Pronouncements
On
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 157, "Fair Value Measurement"
("SFAS 157"), which provides enhanced guidance for using fair value to measure
assets and liabilities. This standard also responds to investors' requests
for
expanded information about the extent to which companies measure assets and
liabilities at fair value, the information used to measure fair value, and
the
effect of fair value measurements on earnings. The standard applies whenever
other standards require (or permit) assets or liabilities to be measured at
fair
value.
The
standard does not expand the use of fair value in any new circumstances. SFAS
157 is effective for financial statements issued for fiscal years beginning
after November 12, 2007, and interim periods within those fiscal years. Early
adoption is permitted. The Company is currently evaluating whether the adoption
of SFAS 157 will have a material effect on its consolidated results of
operations and financial condition.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115" (“SFAS 159”). SFAS 159 permits companies to choose to measure
many financial instruments and certain other items at fair value
that
are
not
currently required to be measured at fair value. The objective of SFAS 15