U.S. Securities and Exchange
Commission Washington, D.C. 20549
Form 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
For the transition period from _____ to _____
Commission file number 0-27937
DRAGON PHARMACEUTICAL INC.
(Exact name of small business issuer as specified in its charter)
Florida 65-0142474
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1055 West Hastings Street, Suite 1900
Vancouver, British Columbia
Canada V6E 2E9
(Address of principal executive offices)
(604) 669-8817
(Issuer's telephone number)
(Former address if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the 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 [ ]
Number of shares of common stock outstanding as of March 31, 2005: 62,878,004
PART I. FINANCIAL INFORMATION
Item 1. Financial Statement
DRAGON PHARMACEUTICAL INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
CONTENTS
PAGE F-1 CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2005 (UNAUDITED)
AND DECEMBER 31, 2004
PAGE F-2 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(UNAUDITED)
PAGE F-3 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
PERIODS ENDED MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31,
2004
PAGE F-4 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS
ENDED MARCH 31, 2005 AND 2004 (UNAUDITED)
PAGES F-5 TO F-21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
ASSETS
March 31, 2005 December 31,
Note (Unaudited) 2004
---------- ------------------ -----------------
CURRENT ASSETS
Cash and cash equivalents $ 1,785,238 $ 910,425
Accounts receivable, net of allowances 2 8,770,244 6,675,298
Inventories, net 3 16,585,898 16,623,906
Value added tax receivable - 162,443
Prepaid expenses 1,154,013 911,228
------------------ -----------------
Total Current Assets 28,295,393 25,283,300
------------------ -----------------
PROPERTY AND EQUIPMENT, NET 4 63,883,442 63,520,202
OTHER ASSETS
Intangible assets, net 6 2,650,693 432,769
Other receivables 2,428,564 2,213,842
Investments -cost 12,077 12,077
------------------ -----------------
Total Other Assets 5,091,334 2,658,688
------------------ -----------------
TOTAL ASSETS $ 97,270,169 $ 91,462,190
------------ ================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 4,766,797 $ 3,047,485
Accrued retirement benefits 7 114,432 114,432
Other payables and accrued liabilities 8 17,117,072 17,705,163
Notes payable - short-term 9 5,033,816 12,884,057
Due to related companies 11 627,889 4,660,984
------------------- -----------------
Total Current Liabilities 27,660,006 38,412,121
------------------- -----------------
LONG-TERM LIABILITIES
Long term accounts payable 10 21,904,603 21,873,147
Long term retirement benefits 7 841,713 870,321
Notes payable - long-term 9 14,770,532 6,316,426
Due to related companies 11 - 1,328,502
------------------- -----------------
Total Long-Term Liabilities 37,516,848 30,388,396
------------------- -----------------
TOTAL LIABILITIES 65,176,854 68,800,517
------------------- -----------------
COMMITMENTS AND CONTINGENCIES -
STOCKHOLDERS' EQUITY
Authorized: 200,000,000 common shares at
par value of $0.001 each Issued and
outstanding: 62,878,004 (December 31, 2004:
44,502,004) common shares 62,878 44,502
Additional paid-in capital 22,138,830 13,983,002
Retained earnings
Unappropriated 1,235,080 -
Appropriated 8,686,318 8,686,318
Due from stockholder (29,791) (52,149)
------------------- -----------------
Total Stockholders' Equity 32,093,315 22,661,673
------------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 97,270,169 $ 91,462,190
------------------------------------------ =================== =================
The accompanying notes are an integral part of these consolidated
financial statements.
F-1
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004 (UNAUDITED)
Note 2005 (Unaudited) 2004 (Unaudited)
---------- -------------------- --------------------
NET SALES 12 $ 11,828,663 $ 7,155,036
COST OF SALES 8,619,484 3,957,103
-------------------- --------------------
GROSS PROFIT 3,209,179 3,197,933
-------------------- --------------------
OPERATING EXPENSES
Selling expense 1,143,967 808,902
General and administrative expenses 1,004,141 422,030
Depreciation and amortization 249,608 12,458
-------------------- --------------------
Total Operating Expenses 2,397,716 1,243,390
-------------------- --------------------
INCOME FROM OPERATIONS 811,463 1,954,543
OTHER INCOME (EXPENSE)
Interest expense (241,051) (14,615)
Other income 11,084 -
Funds Released by Chinese Government Related to
Asset Acquisition of a State-owned Enterprise
by the Company 13 885,864 -
Other expense (35,534) -
-------------------- --------------------
Total Other Income 620,363 (14,615)
-------------------- --------------------
INCOME FROM OPERATIONS BEFORE TAXES 1,431,826 1,939,928
INCOME TAX EXPENSE 1(M) (196,746) -
-------------------- --------------------
NET INCOME 1,235,080 1,939,928
OTHER COMPREHENSIVE INCOME
Foreign currency translation loss - -
-------------------- --------------------
COMPREHENSIVE INCOME $ 1,235,080 $ 1,939,928
==================== ====================
Net income per share - basic and diluted $ 0.02 $ 0.04
==================== ====================
Weighted average number of shares outstanding
during the period - basic and diluted 60,427,871 44,502,004
==================== ====================
The accompanying notes are an integral part of these
consolidated financial statements.
F - 2
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE PERIODS ENDED MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
Common Stock Additional Unappropriated Appropriated
Paid-In Retained Retained Due From
Shares Amount Capital Earnings Earnings Stockholder Total
---------- ----------- ----------- ------------ ----------- ------------ --------
Balance, December 31, 2003, adjusted 44,502,004 $ 44,502 $ 7,841,363 $ 6,054,864 $1,286,784 $ (228,148) $14,999,365
for the effect of recapitalization
of reverse acquisition (Note 5(B))
Registered capital appropriation - - 6,141,639 (6,141,639) - - -
Notes receivable - stockholders - - - - - 175,999 175,999
Net income for the year ended
December 31, 2004 - - - 7,486,309 - - 7,486,309
Transfer to retained earnings for
appropriated statutory and staff welfare
reserves - - - (7,399,534) 7,399,534 - -
---------- ----------- ---------- -------------- ---------- ---------- ----------
Balance, December 31, 2004 44,502,004 $ 44,502 13,983,002 - 8,686,318 (52,149) 22,661,673
Reverse acquisition (Note 5(B)) 18,376,000 18,376 5,740,370 - - - 5,758,746
Related party debt forgiveness - - 2,415,458 - - - 2,415,458
Notes receivable - stockholders - - - - - 22,358 22,358
Net income for the three months
ended March 31, 2005 - - - 1,235,080 - - 1,235,080
---------- ----------- ----------- ----------- ---------- -------- ----------
Balance, March 31, 2005 (Unaudited) 62,878,004 $ 62,878 $22,138,830 $ 1,235,080 $8,686,318 $(29,791) $32,093,315
========== =========== =========== =========== ========== ======== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F - 3
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004 (UNAUDITED)
2005 2004
------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,235,080 $ 1,939,928
Adjustments to reconcile net income to NET cash
provided by (used in)operating activities:
Depreciation and amortization 1,416,661 377,881
Allowance for doubtful accounts 12,610 182,500
Provision for excess and obsolete inventories 476,583 -
Funds Released by Chinese Government Related to Asset
Acquisition of a State-owned Enterprise by the Company (745,828) -
Changes in operating assets and liabilities, net of effect of reverse
acquisition (Note 5(B)):
(Increase) decrease in:
Accounts receivable (725,437) (1,493,528)
Inventories 146,990 (368,914)
Value added tax receivable 162,443 -
Prepaid expenses (142,364) (16,363)
Other assets (214,722) -
Deposits - 1,166,953
Increase (decrease) in:
Accounts payable 90,780 8,290,203
Other payables and accrued expenses 160,585 (3,942,683)
------------------- -------------------
Net Cash Provided By (Used In) Operating Activities 1,873,381 6,135,977
------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (782,134) (13,148,687)
Cash acquired in connection with reverse acquisition (Note 5(B)) 2,103,481 -
------------------- -------------------
Net Cash Provided By (Used In) Investing Activities 1,321,347 (13,148,687)
------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 603,865 7,246,378
Due to related companies (2,946,138) (289,914)
Due from stockholder 22,358 228,148
------------------- -------------------
Net Cash Provided By (Used In) Financing Activities (2,319,915) 7,184,612
------------------- -------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 874,813 171,902
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 910,425 515,791
------------------- -------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,785,238 $ 687,693
=================== ===================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest expense $ 245,373 $ 14,615
=================== ===================
Cash paid during the period for income taxes $ 166,495 $ -
=================== ===================
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: During
March 2005, $2,415,459 of loans payable to an entity related to a director of
the Company was converted into equity of the Company.
The accompanying notes are an integral part of these consolidated financial statements.
F - 4
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION
(A) Organization and Basis of Presentation
The Company was formed on August 22, 1989 as First Geneva Investments
Inc. under the laws of the State of Florida. The Company changed its
name to Dragon Pharmaceutical Inc. on August 31, 1998. Pursuant to a
share exchange agreement, dated July 29, 1998, the Company acquired
100% of the issued and outstanding shares of Allwin Newtech Ltd.
("Allwin") by issuing 7,000,000 common shares of the Company. This
transaction was accounted for as a reverse acquisition.
Allwin was incorporated under the laws of the British Virgin Islands
on February 10, 1998. Pursuant to a Sino-Foreign Co-operative Company
Contract, dated April 18, 1998, Allwin and a Chinese corporation
formed a limited liability company under the Chinese law, named as
Sanhe Kailong Bio-pharmaceutical Co., Ltd. ("Kailong"), located in
Hebei Province, China. Allwin has a 95% interest in Kailong. Pursuant
to another Sino-foreign Co-operative Company Contract, dated July 27,
1999, Allwin completed the acquisition of a 75% interest in Nanjing
Huaxin Bio-pharmaceutical Co. Ltd. ("Huaxin"). In January 2002, the
Company acquired the balance of Huaxin. Kailong is inactive and Huaxin
is in the business of the production and sales of biopharmaceutical
products in China. Allwin Biotrade Inc. ("Biotrade") was incorporated
in the British Virgin Islands on June 6, 2000 for the purpose of
marketing and distributing biopharmaceutical products outside China.
Dragon Pharmaceuticals (Canada) Inc. ("Dragon Canada") was
incorporated in British Columbia, Canada on September 15, 2000 for the
purpose of researching and developing new biopharmaceutical products.
Pursuant to a share purchase agreement, dated June 11, 2004, the
Company acquired 100% of the issued and outstanding shares of Oriental
Wave Holding Limited ("Oriental Wave") by issuing 44,502,004 common
shares of the Company. This transaction was completed on January 12,
2005 and has been accounted for as a reverse acquisition (See Note
5(B)).
Oriental Wave was incorporated in the British Virgin Islands on
January 7, 2003. Shanxi Weiqida Pharmaceutical Company Limited
("Shanxi Weiqida"), a People's Republic of China limited liability
company was incorporated on January 22, 2002. Shanxi Weiqida is
principally engaged in research and development, manufacturing, and
selling of pharmaceutical products in the People's Republic of China
("PRC").
During 2003, Shanxi Weiqida's shareholders exchanged 100% of their
ownership of Shanxi Weiqida for 50,000 shares of Oriental Wave under a
reorganization plan. The transfer was accounted for as a
reorganization of entities under common control as the companies were
beneficially owned by identical shareholders and share common
management. The financial statements have been prepared as if the
reorganization had occurred retroactively.
F-5
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
The consolidated financial statements include the accounts of the
Company and its 100% owned subsidiaries: Oriental Wave, Shanxi
Weiqida, Allwin, Kailong, Huaxin, Biotrade and Dragon Canada. All
significant intercompany balances and transactions have been
eliminated in consolidation.
(B) Use of Estimates
In preparing financial statements in conformity with generally
accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and
expenses during the reported period. Actual results could differ from
those estimates.
(C) Cash Equivalents
For purposes of the cash flow statements, the Company considers all
highly liquid investments with original maturities of three months or
less at the time of purchase to be cash equivalents.
(D) Accounts Receivable
The Company extends unsecured credit to its customers in the ordinary
course of business but mitigates the associated risks by performing
credit checks and actively pursuing past due accounts. An allowance
for doubtful accounts is established and recorded based on
management's assessment of the credit history with the customer and
current relationships with them.
(E) Investments
During the twelve months ended December 31, 2004, the Company made an
investment in a private company of $12,077. The investment represents
less than 1% of the total equity outstanding of the private company
outstanding as of March 31, 2005. The private company investment is
carried at cost and written down to fair market value when indications
exist that this investment has other than temporarily declined in
value. As of March 31, 2005, no impairment in the value of the
investment has been recorded.
(F) Inventories
Inventories are stated at the lower of cost or market value, cost
being determined on a first-in, first-out method. The Company provides
inventory allowances based on excess and obsolete inventories
determined principally by customer demand and product expiration
dates.
F-6
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
(G) Property and Equipment
Property and equipment are stated at cost, less accumulated
depreciation. Expenditures for additions, major renewals and
betterments are capitalized and expenditures for maintenance and
repairs are charged to expense as incurred.
Depreciation is provided on a straight-line basis, less estimated
residual value over the assets estimated useful lives. The estimated
useful lives are as follows:
Buildings 50 Years
Plant and machinery 10 Years
Motor vehicles 8 Years
Furniture, fixtures and equipment 5 Years
Land use rights are stated at cost, less accumulated amortization. The
land use rights are amortized over the term of the relevant rights of
50 years from the date of acquisition.
Depreciable assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable based on projected undiscounted cash flows associated with
the assets. A loss is recognized for the difference between the fair
value and the carrying amount of the assets. Fair value is determined
based upon market quote, if available, or is based on valuation
techniques.
(H) Fair Value of Financial Instruments
The carrying amount of the Company's cash, receivables and payables
and short-term bank loan approximates their fair value due to the
short maturity of those instruments.
(I) Intangible Assets
Under the Statement of Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets", all goodwill and certain
intangible assets determined to have indefinite lives will not be
amortized but will be tested for impairment at least annually.
Intangible assets other than goodwill will be amortized over their
useful lives of 10 years and reviewed for impairment in accordance
with SFAS No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets".
(J) Revenue Recognition
The Company recognizes revenue from the sale of pharmaceutical
products at the time when title to the products transfers, the amount
is fixed and determinable, evidence of an agreement exists, and the
customer bears the risk of loss, net of estimated provisions for
returns, rebates and sales allowances.
F-7
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
(K) Advertising Costs
Advertising costs are expensed as incurred. Advertising expense
totaled $981 and $1,159 for the three months ended March 31, 2005 and
2004, respectively.
(L) Research and Development
Research and development costs related to both present and future
products are expensed as incurred. Total expenditures on research and
development charged to selling, general and administrative expenses
for the three months ended March 31, 2005 and 2004 were $12,310 and
$52,238, respectively.
(M) Income Taxes
The Company accounts for income taxes under the Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes"
("Statement 109"). Under Statement 109, deferred tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
Under Statement 109, the effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that
includes the enactment date. The Company located its factories in a
special economic region in China. This economic region allows foreign
enterprises a two-year income tax exemption from central government
tax beginning in the first year after they become profitable and a 50%
income tax reduction for the following three years. The Company was
approved as a wholly owned foreign enterprise in October 2002.
(N) Foreign Currency Translation
The functional currency of the Company is the Chinese Renminbi
("RMB"). Transactions denominated in currencies other than RMB are
translated into United States dollars using period end exchange rates
as to assets and liabilities and average exchange rates as to revenues
and expenses. Capital accounts are translated at their historical
exchange rates when the capital transaction occurred. Net gains and
losses resulting from foreign exchange translations are included in
the statements of operations and stockholder's equity as other
comprehensive gain (loss).
(O) Comprehensive Income
The foreign currency translation gain or loss resulting from
translation of the financial statements expressed in RMB to United
States Dollar is reported as other comprehensive income in the
statements of operations and stockholders' equity.
F-8
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
(P) Segments
The Company operates in three reportable segments, Chemical Division,
Pharma Division and Biotech Division.
(Q) Earnings Per Share
Income per share is computed using the weighted average number of
shares outstanding during the period. The Company adopted SFAS No.
128, "Earnings per share". Diluted earnings per share, as determined
using the treasury method, is equal to the basic income per share as
common stock equivalents consisting of options to acquire 3,128,000
common shares that are outstanding at March 31, 2005 are not
significantly dilutive, however, they may be dilutive in future.
(R) Reclassifications
Certain 2004 balances have been reclassified to conform to the 2005
presentation.
(S) Stock Based Compensation
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-based Compensation", as amended by SFAS No. 148 "Accounting for
Stock-based Compensation - Transition and Disclosure - An amendment of
SFAS No. 123". SFAS 123 encourages, but does not require, companies to
adopt a fair value based method for determining expense related to
stock-based compensation. The Company continues to account for
stock-based compensation issued to employees and directors using the
intrinsic value method as prescribed under Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" and
related Interpretations.
(T) Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 151,
"Inventory Costs - an amendment of ARB No. 43, Chapter 4 SFAS No. 152,
"Accounting for Real Estate Time-Sharing Transactions - an amendment
of FASB Statements No. 66 and 67," and SFAS No. 153, "Exchanges of
Non-monetary Assets - an amendment of APB Opinion No. 29" were
recently issued. SFAS No. 151, 152, 153 and 123 (revised 2004) have no
current applicability to the Company and have no effect on the
financial statements.
F-9
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
NOTE 2 ACCOUNTS RECEIVABLE
Accounts receivable at March 31, 2005 (unaudited) and December 31,
2004 consisted of the following:
March 31, 2005
(Unaudited) December 31, 2004
-------------- -----------------
Trade and other receivables $ 9,208,581 $ 6,799,872
Less: allowance for doubtful accounts 438,337 124,574
------------- -----------------
Accounts receivable, net $ 8,770,244 $ 6,675,298
============= =================
For the periods ended March 31, 2005 and 2004, the Company recorded an
allowance for doubtful accounts of $12,610 and $182,500, respectively,
in the Consolidated Statement of Operations.
NOTE 3 INVENTORIES
Inventories at March 31, 2005 (unaudited) and December 31, 2004
consisted of the following:
March 31, 2005 December 31,
(Unaudited) 2004
-------------- -----------------
Raw materials $ 4,064,998 $ 4,287,604
Work-in-progress 10,855,610 10,994,088
Finished goods 2,720,670 2,302,073
--------------- -----------------
17,641,278 17,583,765
Less: provision for obsolescence
and impairment 1,055,380 959,859
--------------- ------------------
$16,585,898 $ 16,623,906
=============== ==================
For the periods ended March 31, 2005 and 2004, the Company recorded a
provision for obsolete inventories of $476,583 and nil, respectively,
in the Consolidated Statement of Operations.
F-10
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
NOTE 4 PROPERTY AND EQUIPMENT
The following is a summary of property and equipment at March 31, 2005
(unaudited) and December 31, 2004:
March 31, 2005 (Unaudited)
---------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
--------------- ----------------- ---------------
Plant and equipment $ 42,770,616 $ 4,384,223 $ 38,386,393
Land and buildings 19,691,310 475,662 19,215,648
Motor vehicles 737,560 164,687 572,873
Furniture and office equipment 2,942,351 819,419 2,122,932
Leasehold improvements 1,083,653 1,028,137 55,516
Idle equipment 555,339 455,339 100,000
Construction in progress 3,430,080 - 3,430,080
--------------- ----------------- ---------------
$ 71,210,909 $ 7,327,467 $ 63,883,442
=============== ================= ===============
December 31, 2004
---------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
--------------- ----------------- ---------------
Plant and equipment $ 41,154,014 $ 2,293,918 $ 38,860,096
Land and buildings 19,687,676 381,521 19,306,155
Motor vehicles 611,261 55,166 556,095
Furniture and office equipment 2,499,188 392,511 2,106,677
Construction in progress 2,691,179 - 2,691,179
--------------- ----------------- ---------------
$ 66,643,318 $ 3,123,116 $ 63,520,202
=============== ================= ===============
Depreciation expense for periods ended the March 31, 2005 and 2004 was
$1,286,636 and $362,785 respectively.
NOTE 5 ACQUISITIONS
(A) Land Use Rights
During July 2003, the Company acquired land use rights and buildings
from a government liquidator in exchange for assuming certain future
employment, healthcare and land acquisition costs of the factory and
its former employees. The agreement requires the Company to pay
certain minimum wages and health care costs until the date of their
employment, retirement or death, whichever occurs first. The total
amount of the liabilities assumed on the closing date was $8,897,685.
The Company has calculated the related asset value by computing the
net present value of the future expected payments to the remaining
employees assuming an interest rate of 3% and has recorded the land at
F-11
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
a net present value of $3,332,907 (See Note 7). As of March 31, 2005,
the Company had employed 651 former employees and 207 former employees
have retired.
(B) Oriental Wave Holding Limited
The Company completed the acquisition of Oriental Wave on January 12,
2005 whereby the Company issued 44,502,004 common shares in exchange
for all of the issued and outstanding shares of Oriental Wave. The
transaction has been approved by the Company's shareholders and the
regulatory authorities, who also approved an increase in the
authorized share capital to 200,000,000 common shares.
This transaction resulted in the former shareholders of Oriental Wave
owning 68.35% of the issued and outstanding shares of the combined
entity at the close of the transaction. Accounting principles
applicable to reverse acquisition has been applied to record the
acquisition. Under this basis of accounting, Oriental Wave is the
acquirer and, accordingly, the consolidated entity is considered to be
a continuation of Oriental Wave with the net assets of the Company
deemed to have been acquired and recorded at its fair market value.
The Statement of operations includes the results of Oriental Wave for
the entire period and those of the Company from January 13, 2005
(unaudited).
The net assets acquired were:
Cash and short term securities $ 2,103,481
Accounts receivable 1,382,119
Inventories 585,565
Prepaid and deposits 100,421
----------------
Total Current Assets 4,171,586
Fixed Assets 867,742
Intangible and other assets, net 2,349,222
----------------
Total Assets 7,388,550
Less accounts payables and accrued liabilities (1,629,804)
----------------
Net assets acquired $ 5,758,746
================
A summarized statement of operations for the Company for the twelve
days ended January 12, 2005 is as follows:
Sales $ 145,435
----------------
Gross Profit 109,059
----------------
Total operating expenses 166,881
----------------
Loss for the period $ (57,822)
================
F-12
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
NOTE 6 INTANGIBLE ASSETS
The Company acquired $603,865 in licenses from a company related to a
director with the balance being recorded pursuant to the reverse
acquisition of Oriental Wave (Note 5(B)).
Intangible assets consist of the following as of March 31, 2005 and
December 31, 2004:
March 31, 2005 December 31,
(Unaudited) 2004
-------------- --------------
Licenses $ 2,951,814 $ 603,865
Less: accumulated amortization 301,121 171,096
--------------- --------------
$ 2,650,693 $ 432,769
=============== ==============
Amortization expense for the periods ended March 31, 2005 and 2004 was
$130,025, and $15,096, respectively.
NOTE 7 ACCRUED RETIREMENT BENEFITS
During July 2003, the Company acquired land use rights and buildings
from a government liquidator. The present value of accrued expected
retirement benefits related to the land costs is recorded at March 31,
2005 and December 31, 2004 as follows:
March 31, 2005 December 31,
(Unaudited) 2004
----------------- -------------------
Total liabilities assumed at closing date $ 8,897,685 $ 8,897,685
Less: net present value of liabilities not
expected to be paid 5,564,778 5,564,778
----------------- -------------------
Present value of expected liabilities 3,332,907 3,332,907
Less: amounts paid and liabilities not
expected to be paid 2,376,762 2,348,154
----------------- -------------------
956,145 984,753
Less: current portion 114,432 114,432
----------------- -------------------
$ 841,713 $ 870,321
================= ===================
Under the terms of the contract with the liquidator, the Company will
remain contingently liable for these liabilities until the date of
retirement or re-employment for each employee (See Note 5(A)).
F-13
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
NOTE 8 OTHER PAYABLES AND ACCRUED LIABILITIES
Other payables and accrued liabilities at March 31, 2005 and December
31, 2004 consist of the following:
March 31, 2005 December 31,
(Unaudited) 2004
---------------- --------------
Machinery and equipment payable $ 6,023,275 $ 7,050,243
Accrued expenses 6,595,401 6,360,198
Value added tax payables 280,805 -
Income taxes payable 196,746 166,495
Other taxes payable 109,994 121,054
Deposits received from customers 3,910,851 4,007,173
---------------- ---------------
$ 17,117,072 $ 17,705,163
================ ===============
NOTE 9 NOTES PAYABLE
Balance at March 31, 2005 and December 31, 2004:
March 31, 2005 December 31,
(Unaudited) 2004
----------------- --------------
Note payable to a bank, interest rate of 6.372% per
annum, guaranteed by a third party, due June 2005 $ 420,290 $ 420,290
Note payable to a bank, interest rate of 6.372% per annum,
guaranteed by a third party, due June 2005 386,473 386,473
Note payable to a bank, interest rate of 8.874% per
annum, guaranteed by a third party, due July 2005 603,865 -
Note payable to a bank, interest rate of 6.1380% per
annum, guaranteed by a third party, due November 2005 3,623,188 3,623,188
Note payable to a bank, interest rate of 6.039% per annum,
secured by leasehold land and fixed assets, due April 2005 - 8,454,106
Note payable to a bank, interest rate of 6.039% per annum,
secured by leasehold land and fixed assets, due April 2006 1,811,594 -
F-14
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
Note payable to a bank, interest rate of 5.76% per annum,
guaranteed by a third party, due November 2006 6,316,426 6,316,426
Note payable to a bank, interest rate of 6.039% per annum,
secured by leasehold land and fixed assets, due April 2007 6,642,512 -
---------------- ---------------
19,804,348 19,200,483
Less current maturities 5,033,816 12,884,057
---------------- --------------
$ 14,770,532 $ 6,316,426
================ ================
Maturities are as follows:
Fiscal year ended December 31,
2005 $ 5,033,816
2006 8,128,020
2007 6,642,512
---------------
$ 19,804,348
===============
NOTE 10 LONG TERM ACCOUNTS PAYABLE
Long term accounts payable balances at March 31, 2005 and December 31,
2004 is the final payment of construction contracts which had been
finished through December 31, 2004. According to the contract terms,
the final payments on the contracts will be settled as follows:
March 31, 2005 December 31,
(Unaudited) 2004
------------------- --------------------
Settlement Arrangement
Accounts payable due 2006 $ 21,904,603 $ 21,873,147
=================== ====================
F-15
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
NOTE 11 DUE TO RELATED PARTIES
The amounts due to related party at March 31, 2005 and December 31,
2004 are unsecured and non-interest bearing:
March 31, 2005 December 31,
(Unaudited) 2004
-------------- ------------
Due to a company owned by a stockholder
and director due March 2006 $ 402,199 $ 1,328,502
Due to a company owned by a stockholder
and director due March 2006 225,690 4,660,984
------------ ------------
627,889 5,989,486
Less: current maturities 627,899 4,660,984
------------ -------------
$ - $ 1,328,502
============ =============
NOTE 12 SEGMENTS
The Company operates in three reportable segments, the Pharma
Division, Chemical Division and Biotech Division. The accounting
policies of the segments are the same as described in the summary of
significant accounting policies. The Company evaluates segment
performance based on income from operations. All intercompany
transactions between segments have been eliminated. As a result, the
components of operating income for one segment may not be comparable
to another segment. The following is a summary of the Company's
segment information for the periods ended March 31, 2005 and 2004 and
as of March 31, 2005 and December 31, 2004.
Chemical Pharma Biotech
Division Division Division Total
--------------- --------------- -------------- ----------------
2005
Three months ended March 31, 2005 (Unaudited)
Sales $ 5,704,033 $ 5,320,771 $ 803,859 $ 11,828,663
Gross profit 34,425 2,508,222 666,532 3,209,179
Depreciation and amortization 1,063,263 153,804 199,594 1,416,661
As of March 31, 2005 (Unaudited)
Total assets 67,221,570 23,962,434 6,086,165 97,270,169
Additions to long-lived assets 757,262 18,452 6,420 782,134
Intangible assets - 417,672 2,233,021 2,650,693
F-16
Chemical Pharma Biotech
Division Division Division Total
--------------- --------------- -------------- --------------
2004
Three months ended March 31, 2004
Sales $ 849,785 $ 6,305,251 $ - $ 7,155,036
Gross profit 328,173 2,869,760 - 3,197,933
Depreciation and amortization 234,781 143,100 - 377,881
As of December 31, 2004
Total assets 67,850,276 23,611,914 - 91,462,190
Additions to long-lived assets 27,295,156 852,773 - 28,147,929
Intangible assets - 432,769 - 432,769
NOTE 13 OTHER INCOME - Funds Released by Chinese Government Related to Asset
Acquisition of a State-owned Enterprise by the Company
In July 2003, the Company, through Shanxi Weiqida, acquired out of
bankruptcy the land use rights of a state-owned enterprise. (please
also refer to Note 5(A)) During 2004, the Company received $1,751,208
from the government liquidator of the state-owned enterprise to assist
the Company in the settlement of human resources related expenses in
connection with the land use rights acquisition. The Company set up an
offsetting obligation of which $818,806 remained outstanding at
December 31, 2004. During the first quarter of 2005, the government
liquidator allowed the Company to retain the remaining cash balance of
$745,828.
During the first quarter of 2005, the Datong Municipal Government
approved the transfer of a fund with a balance of $140,036 originally
reserved for the employee housing welfare as part of the liquidation
process of the state-owned enterprise.
As a result, the Company recorded other income of $885,864 during the
current period to reflect the above transactions.
NOTE 14 COMMITMENTS AND CONTINGENCIES
(A) Employee Benefits
The full time employees of the Company are entitled to employee
benefits including medical care, welfare subsidies, unemployment
insurance and pension benefits through a Chinese government mandated
multi-employer defined contribution plan. The Company is required to
accrue for those benefits based on certain percentages of the
employees' salaries. The total provision for such employee benefits
was $116,217 and $141,730 for the periods ended March 31, 2005 and
2004, respectively. The Company is required to make contributions to
the plans out of the amounts accrued for medical and pension benefits.
The Chinese government is responsible for the medical benefits and the
pension liability to be paid to these employees.
F-17
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
(B) Loan Guarantee
The Company has guaranteed bank loans to two suppliers in the amount
of $181,000 (RMB1.5 million) due on August 11, 2005 and $2,415,000
(RMB20 million) due on July 16, 2005.
The Company has also issued a guarantee to a bank as security for
loans to a third party vendor of $2,415,000 (RMB20 million) due on
September 26, 2007 and $3,623,000 (RMB30 million) due on October 27,
2007. This vendor pledged assets totaling $8,484,000 (RMB70.2 million)
to the Company for this guarantee.
(C) Capital Commitments
According to the Articles of Association of Shanxi Weiqida, the
Company has to fulfill registered capital of $19,205,116 (RMB
159,018,360) within five years from December 16, 2003. As of March 31,
2005, the Company has fulfilled $14,656,174 (RMB 121,353,123) of
registered capital requirement and has registered capital commitments
of $4,548,942 (See Note 14(A)).
(D) Contingent Employment Benefits
During July 2003, the Company acquired land and buildings from a
government liquidator in exchange for assuming certain future
employment, healthcare and land acquisition costs of the factory and
its former employees. Under the terms of the contract with the
liquidator, the Company will remain contingently liable for these
liabilities until the date of retirement, re-employment or death for
each employee. As of March 31, 2005, the Company has rehired 651
former employees, 207 employees have retired and approximately 200
former employees remain unemployed. If the Company is unable to
provide continued employment to these individuals, it will be liable
to pay each former employee approximately $49 per month until his or
her date of retirement or death, whichever comes first (See Notes 5 &
7).
(E) Operating Leases
The Company has entered into operating lease agreements with respect
to Huaxin's production plant in Nanjing, China for an amount of RMB
2,700,000 (US$326,217) per annum until June 11, 2009 (see note 19(b)
also) and the Company's administrative offices in Vancouver for an
amount escalating from CDN$200,000 to CDN$230,000 (US$127,000 to
US$146,000) per annum until March 31, 2007. The Company decided to
close the facility in Nanjing, effective July 31, 2005, and build a
new facility in Datong, China at the site of the manufacturing
facilities of Oriental Wave. The Company has renegotiated the
termination of its lease, without penalty, though the Company may be
required to pay up to approximately RMB 600,000 ($72,500) relating to
F-18
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
severance and benefit costs associated with the closure. Minimum
payments required under the agreements are as follows:
2005 $ 247,989
2006 189,964
2007 47,844
-----------------------------------------------------
Total $485,797
=====================================================
(F) Cell Line Development
The Company has contracted with a European Institute of Biotechnology
to develop a high yield proprietary cell line and production process
technology for the Company. Product from this advanced technology will
be used by the Company to enter the European market, once certain
competitor's patents expire. The total cost of development will be
$648,800 (EUROS 500,000) of which $387,600 (EUROS 300,000) remains
unpaid at March 31, 2005.
NOTE 15 STOCKHOLDERS' EQUITY
(A) Capital Contribution (See note 13(C))
On January 31, 2005 Oriental Wave paid Shanxi Weiqida $479,988 towards
its registered capital requirement under Chinese law.
On February 22, 2005 Oriental Wave paid Shanxi Weiqida $198,682
towards its registered capital requirement under Chinese law
(B) Appropriated Retained Earnings
Shanxi Weiqida is required to make appropriations to reserves funds,
comprising the statutory surplus reserve, statutory public welfare
fund and discretionary surplus reserve, based on after-tax net income
determined in accordance with generally accepted accounting principles
of the People's Republic of China (the "PRC GAAP"). Appropriation to
the statutory surplus reserve should be at least 10% of the after tax
net income determined in accordance with the PRC GAAP until the
reserve is equal to 50% of the entities' registered capital.
Appropriations to the statutory public welfare fund are at 5% to 10%
of the after tax net income determined in accordance with the PRC
GAAP. The statutory public welfare fund is established for the purpose
of providing employee facilities and other collective benefits to the
employees and is non-distributable other than in liquidation.
Appropriations to the discretionary surplus reserve are made at the
discretion of the Board of Directors.
F-19
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
(C) Stock Options
The Company did not grant any options during the year ended December
31, 2004. During the period ended March 31, 2005, the Company granted
options to its directors and employees to purchase 2,260,000 shares at
a price of $1.18 per share (being the market price at the time),
expiring January 12, 2010. Options to purchase 1,460,000 shares were
exercisable immediately with 400,000 options becoming available
January 12, 2006 and the balance of 400,000 options vesting on January
12, 2007.
The following summarizes stock option information for the period ended
March 31, 2005:
----------------------------------------------------------------------
Weighted Average
Shares Exercise Price
----------------------------------------------------------------------
Options outstanding at December 31, 2003 2,599,000 $ 2.04
Forfeited (705,000) $ 1.57
Exercised (145,000) $ 0.50
----------------------------------------------------------------------
Options outstanding at December 31, 2004 1,749,000 $ 2.36
Granted 2,260,000 $ 1.18
Forfeited (881,000) $ 2.93
----------------------------------------------------------------------
Options outstanding at March 31, 2005 3,128,000 $ 1.35
======================================================================
Options Outstanding Options Exercisable
----------------------------------------------------------------- --------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
------------------------------------------------------------------- ------------------------------
$0.01 - $1.00 350,000 3.01 $ 0.68 325,000 $ 0.68
$1.01 - $2.00 2,478,000 4.55 $ 1.23 1,678,000 $ 1.25
$3.01 - $4.00 300,000 0.62 $ 3.13 300,000 $ 3.13
---------- --------- ------- -------- ------
3,128,000 4.00 $ 1.35 2,303,000 $ 1.41
========== ========= ======= ========== ======
The Company accounts for its stock-based compensation plan in
accordance with APB Opinion No. 25, under which no compensation is
recognized in connection with options granted to employees and
directors except if options are granted with a strike price below fair
value of the underlying stock. The Company adopted the disclosure
requirements SFAS No. 123, Accounting for Stock-Based Compensation.
Accordingly, the Company is required to calculate and present the pro
forma effect of all awards granted. For disclosure purposes, the fair
value of each option granted to an employee has been estimated as of
the date of grant using the Black-Scholes option pricing model with
the following assumptions: risk-free interest rate of 5.5%, dividend
yield 0%, volatility of 90%, and expected lives of approximately 0 to
5 years. The weighted average fair value of the options granted during
the period was $0.69. Based on the computed option values and the
F-20
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004
------------------------------------------------------
number of the options issued, had the Company recognized compensation
expense, the following would have been its effect on the Company's net
income:
------------------------------------- ---------------- ---------------
2005 2004
------------------------------------- ---------------- ---------------
Net income for the period:
- as reported $1,235,080 $1,939,928
- pro-forma $157,699 $1,939,928
------------------------------------- ---------------- ---------------
Basic and diluted income per share:
- as reported $0.02 $0.04
- pro-forma $0.00 $0.04
------------------------------------- --------------- ----------------
NOTE 16 RELATED PARTY TRANSACTIONS
See Notes 6 and 11.
NOTE 17 CONCENTRATIONS AND RISKS
During the three months ended March 31, 2005, 85% of the Company's
revenues were derived from customers located in China and 99% of its
assets are located in China. Comparatively, 100% of the Company's
revenues during the three months ended March 31, 2004 were derived
from customers located in China and 100% of its assets were located in
China.
F-21
Item 2. Management's Discussion and Analysis and Plan of Operations
The following discusses the Company's ("Dragon") financial condition and
results of operations for the quarter ended March 31, 2005 based upon the
Company's consolidated financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States of
America (US GAAP). It should be read in conjunction with the Company's financial
statements and the notes thereto and other financial information included in the
Company's Form 10-KSB for the fiscal year ended December 31, 2004.
Due to Dragon's acquisition of Oriental Wave Holding Limited ("Oriental
Wave") on January 12, 2005 being deemed a reverse take-over transaction, the
following discussion reflects the Company's results of operations for the
quarter ended March 31, 2005, including the results of Oriental Wave for the
full quarter and the results of the biotech business of Dragon for the period
from January 13, 2005 to March 31, 2005. Comparatively, the financial statements
for the quarter ended March 31, 2004 only reflect the results of the Pharma and
Chemical businesses of Oriental Wave.
Overview
--------
Incorporated in Florida, USA and headquartered in Vancouver, B.C., Canada,
Dragon, prior to the acquisition of Oriental Wave, was formed to develop,
market, and sell biologics such as Erythropoietin (EPO) in China and
international markets outside of China. Dragon manufactures and sells EPO
through its wholly-owned drug manufacturing company Nanjing Huaxin
Bio-pharmaceutical Co., Ltd. ("Nanjing Huaxin") located in Nanjing City, China,.
Dragon's EPO has been approved and marketed in nine countries including China,
India, Egypt, Brazil, Ecuador, the Dominican Republic, Trinidad-Tobago, Peru,
and Kosovo. In addition, we are preparing to enter the European market upon
obtaining product approval of our newly developed EPO products.
On January 12, 2005, the Company completed the acquisition of Oriental Wave
in a reverse take-over transaction. Oriental Wave, through its wholly owned
subsidiary in China, Shanxi Weiqida Pharmaceutical Ltd. ("Shanxi Weiqida"),
currently has three production facilities in China: two Chinese State Food and
Drug Administration (SFDA) certified GMP (Good Manufacturing Practice)
production facilities consisting of a pharmaceutical facility with a production
capacity of 610 million tablets and capsules, 80 million injectables, 47 million
sachets of granules, 10 million suppositories and 180 tons of sterilized bulk
drugs per year, and a chemical plant producing clavulanic acid with an annual
capacity of 30 tons. In addition, Oriental Wave has a third facility producing
7-ACA, an intermediate for Cephalosporin antibiotics, by a fermentation process.
7-ACA is an intermediate product and does not require GMP certification for the
7-ACA production facility. Oriental Wave has received approval from the SFDA for
306 drugs, of which 66, mainly anti-infectious drugs, were actively exploited in
China in 2004. Dragon acquired all of the outstanding shares of Oriental Wave
from Mr. Yanlin Han, Mr. Zhanguo Weng, and Ms. Xuemei Liu. As a result of the
acquisition, Mr. Han, Mr. Weng, and Ms. Liu collectively owned 68.35% of
Dragon's outstanding shares of common stock at the time of the closing of the
transaction.
As a result of the acquisition of Oriental Wave, Dragon has transformed
into a diversified and growth oriented generic pharmaceutical company with three
key business units. These units consist of a Biotech division for biologics
products, such as EPO a Chemical division for bulk pharmaceutical chemicals and
intermediates, such as Clavulanic Acid and 7-ACA, and a Pharma division for
formulated drugs, including prescription, over-the-counter drugs and sterilized
bulk drugs. The Company, after the acquisition, has significantly increased the
size of operations and now has four manufacturing facilities in China (three in
Datong city and one in Nanjing city), approximately 1,800 employees, an
3
additional 1,200 contract sales representatives in China, and 55 key products in
86 different dosages and presentations currently in the Chinese market. The
Company now operates its three business divisions, a Pharma Division, a Chemical
Division, and a Biotech Division, through two indirect wholly-owned subsidiaries
in China, Shanxi Weiqida and Nanjing Huaxin.
Pharma Division
---------------
The Pharma Division's operations are located in the Datong Economic and
Technology Development Zone, Datong City, Shanxi Province, China. The Pharma
Division produces and markets chemical generic, mainly anti-infectious, drugs.
The Pharma Division currently holds 306 product approvals from the SFDA, of
which only 66 prescription, over-the-counter, and sterilized bulk products are
currently commercialized in China. The Company plans to build a new workshop for
the freeze-drying of temperature sensitive pharmaceutical products. Among these
products is Levofloxacin, a product marketed by the Company whose production is
currently outsourced to a third party contract manufacturer. The business
strategy of the Pharma Division is to focus on the expansion and development of
the Chinese market by managing its product portfolio and selecting promising
products for commercialization.
Chemical Division
-----------------
The Chemical Division's operations are located at Datong Gongnong Road in
Datong City, Shanxi Province, China. The Chemical Division produces
pharmaceutical intermediate and active pharmaceutical ingredients (APIs), to
sell to other pharmaceutical companies for further processing and formulation
into other sterilized bulk drugs, non-sterilized bulk drugs or formulated
products.
The Chemical Division manages the production of Clavulanic Acid, 7-ACA,
and, in the future, Abamectin for both the Chinese and international markets. In
January 2004, the Chemical Division began operating a production facility for
Clavulanic Acid, and in July 2004, the second production facility producing
7-ACA started operating. The third production facility for Abamectin, with a
planned capacity of 120-tons, is currently under construction and is expected to
be completed in the fourth quarter of 2005. 2005 will be the first full year for
the Chemical Division to contribute sales and net income to the Company.
One of the key products in Chemical Division is Clavulanic Acid, a drug
that combines with antibiotics to fight drug resistance. Dragon is currently the
sole producer in China. Two Clavulanic Acid containing products were approved
for export to India and the initial sale of these products to India started in
2004. Another key product in the Chemical Division is 7-ACA, an intermediate for
Cephalosporin antibiotics. The 400-ton annual production capacity of 7-ACA
positions Dragon to become one of the largest producers in the world. The export
of 7-ACA to India commenced in 2004. Dragon's Chemical Division has entered into
a 3-year long term supply agreement with Aurobindo Pharma Limited, Indian's
fifth largest pharmaceutical company, to purchase 50% of the products from the
Chemical Division.
Biotech Division
----------------
The Biotech Division's operations are located in Nanjing City, Jiangsu
Province, China. The sole product currently produced by the Biotech Division is
Erythropoietin or EPO, which stimulates red blood cell development, and is the
best selling drug in the world with a market size of approximately US$10 billion
in 2004. Dragon's EPO is the generic version of the originator's (Amgen)
product. Dragon's Biotech Division develops, manufactures, and markets generic
biotech products within China (72% of the divisional sales for fiscal 2004) and
in developing countries as the current core markets, and has already been
approved and sold in 9 countries: China, India, Egypt, Brazil, Peru, Ecuador,
4
Trinidad-Tobago, the Dominican Republic and Kosovo. Currently, Dragon's EPO only
competes in countries where there is no patent protection. Dragon is, however,
preparing to enter the European market with a new EPO product currently under
development in Austria.
The Company will build a new state-of-the-art EPO production facility in
Datong City, China and relocate the EPO production from its current facility in
Nanjing city. The new EPO production facility is under construction on a site
adjacent to the campus of the Chemical Division, which already includes the
entire basic infrastructure such as power, steam, purified water supply, and
water treatment facilities. The relocation of the EPO production site to Datong
City will allow the Company to capitalize on the existing production
infrastructure and the efficiency of unified operational management. It is
anticipated that the capacity of the new facility will double for bulk EPO
production and triple for the sterile vialing of the product.
Results of Operations
---------------------
Dragon accounted for the acquisition of Oriental Wave as a reverse
take-over transaction, as the former shareholders of Oriental Wave own the
majority of the shares of Dragon, collectively 68.35% of the issued shares of
common stock as of the closing of the transaction. Dragon operates a financial
year from January 1 to December 31 and uses the purchase method of accounting
for financial reporting purposes under US GAAP. Under this basis of accounting,
Oriental Wave has been identified as the acquirer and, accordingly, the combined
company is considered to be a continuation of the operations of Oriental Wave
and includes the accounts of Dragon (before the acquisition) from the
acquisition date. Therefore, Dragon reports results for the first quarter of
2005, which includes the results of Oriental Wave for the full three-month
period ended March 31, 2005 and Dragon (before the acquisition) for the period
from January 13, 2005 to March 31, 2005, whereas the results for the first
quarter of 2004 reflects the operations of Oriental Wave for a three-month
period ended March 31, 2004.
Results of Operations for the Three Months Ended March 31, 2005 and 2004
Sales. Sales for the first quarter ended March 31, 2005 increased 65% to
$11.83 million from $7.16 million for the same period in 2004. $10.11 million,
or 85.5% of the sales for the first quarter in 2005 were generated from the
sales of products in the Chinese market, and the remaining $1.72 million or
14.5% were generated from the sales of products in the international markets.
All sales for the first quarter in 2004 were generated from the sale of products
in the Chinese market. In the first quarter of 2005, $5.32 million, or 45% of
the sales, were from the Pharma Division, $5.70 million, or 48% of sales, were
from the Chemical Division and $0.80 million, or 7% of sales, were from the
Biotech Division. For the same period in 2004, 88% of sales were from the Pharma
Division and 12% of sales were from the Chemical Division which commenced
operation on January 1, 2004. The increase in sales during the three months
ended March 31, 2005 as compared to the same period for the prior year was
primarily due to increases in sales from the Chemical and Biotech Divisions.
Cost of sales for the three months ended March 31, 2005 was $8.62 million
compared to $3.96 million for the three months ended March 31, 2004. The cost of
sales is attributed to the production costs of Dragon's pharmaceutical products
with the increase in the cost of sales related to the growth in products and
sales in the Chemical Division. Gross profit and gross margin for the three
months ended March 31, 2005 were $3.21 million and 27.13% compared to $3.20
million and 44.69% for the same period of 2004. The decrease in gross margin was
mainly due to the increase in sales of the Chemical Division whose facilities
were new in 2004 and is currently at the ramp up stage of production which
incurs higher per unit production and operation cost, especially depreciation
expenses.
5
Divisional Sales and Gross Margin Analysis
The Company's businesses are organized under three business divisions: the
Pharma Division, the Chemical Division and the Biotech Division.
Pharma Division
---------------
The Pharma Division's sales for the first quarter of 2005 were $5.32
million, accounting for 44.9% of the total sales of the Company. Comparatively,
the Pharma division's sales were $6.30 million for the same period in 2004,
contributing 88% of the total sales of the Company. The lower sales were mainly
due to the reduction in the retail price of certain prescription drugs imposed
by the Chinese government. The lower contribution from the Pharma division was
due to the relative growth of the Chemical division achieved during the first
quarter of 2005 compared to 2004. The overall gross margin for the division for
the first quarter increased to 47%, representing a 164 basis point improvement
from the same period of 2004. The increase in the gross profit margin was mainly
due to the increase in production level and the use of certain self-produced
chemicals from the Chemical Division in the Pharma division.
Chemical Division
-----------------
The Chemical Division's sales for the first quarter of 2005 were $5.70
million, representing a 571% increase from the sales of $0.85 million during the
same period in 2004. The increase is due to the introduction of 7-ACA and the
expansion of Clavulanic Acid sales outside China. The Chemical division was new
in 2004 as only the Clavulanic Acid facility had started production and the
sales during the first quarter of 2004 were only made to Chinese customers.
Since then, the Company started the pilot production of the 7-ACA production
facility and the Company has received export permits to sell two Clavulanic Acid
products to the Indian market.
The Chemical Division's gross margin for the first quarter of 2005 was 1%.
The gross margin for the division was low as the Company has increased and
expanded the production infrastructure and the associated fixed manufacturing
costs, but it is still in the process of ramping up production to cost-
efficient levels. Production in the Chemical Division during the first quarter
of 2004 was limited to Clavulanic Acid. Since then, the Company invested $15.78
million in capital expenditure for the 7-ACA facility and other new production
infrastructure (power, steam, purified water supply and water treatment). These
new facilities have greatly increased production capacity and capability for the
Chemical Division and also have increased the fixed costs in the form of
depreciation expense of the new facilities constructed and overhead of the
utilities costs to power the new facilities. For example, depreciation expenses
for the Chemical Division increased to $1.06 million for the first quarter of
2005 from $0.23 million for the same period of 2004. These fixed costs are
expected to fall, or a per unit basis, with the ramp up of the production level.
6
Biotech Division
----------------
The Biotech Division's sales for the period January 13, 2005 to March 31,
2005 were $0.80 million, representing 7% of the Company's sales. The gross
margin for the this period was 82.92%. The acquisition of Oriental Wave by
Dragon was completed on January 12, 2005 and was accounted for as a reverse
take-over transaction. As a result, only sales from the Biotech Division from
January 13, 2005 to March 31, 2005 were included in the Company's sales for the
first quarter of 2005.
On a pro-forma basis (which includes Dragon's biotech sales of $0.15
million from January 1 to 12, 2005) for the full first quarter of 2005, the
Biotech Division's sales were $0.95 million in 2005, representing an 8.1%
increase from Biotech sales of $0.88 million for the same period in 2004. The
increase in total sales mainly came from the increase in international sales
outside of China. The Biotech Division's pro-forma gross margin for the full
first quarter of 2005 was 81.67%, significantly improved from 71.86% for the
same period of 2004. The improvement of the gross margin for the full first
quarter of 2005 was due to a combination of a larger percentage of sales to
overseas customers (at a higher margin than the Chinese sales during the current
quarter) and no provision for inventory obsolescence was recorded in the first
quarter of 2005.
Other Income. During the three months ended March 31, 2005, Dragon
recognized $0.62 million of Other Income. This amount primarily consisted of
$0.89 million from funds released by the Chinese government related to asset
acquisition of a state-owned enterprise by the Company in 2003. No similar gain
occurred during the same period of the prior year.
During 2004, the Company received $1.75 million from the government
liquidator of the state-owned enterprise to assist the Company in the settlement
of human resources related expenses in connection with the land use rights
acquisition. The Company set up an offsetting obligation of which $0.82 million
remained outstanding at December 31, 2004. During the first quarter of 2005, the
government liquidator allowed the Company to retain the remaining cash balance
of $0.75 million.
During the first quarter of 2005, the Datong Municipal Government approved
the transfer of a fund with a balance of $0.14 million originally reserved for
the employee housing welfare as part of the liquidation process of the
state-owned enterprise.
As a result, the Company recorded other income of $0.89 million during the
current period to reflect the above transactions.
Expenses. Total operating expenses were $2.40 million for the three months
ended March 31, 2005 compared to $1.24 million for the same period in 2004. For
the three months ended March 31, 2005, the major category of operating expenses
was General and Administration expenses which included $0.46 million for
salaries, compensation and benefits, $0.192 million for travel and entertainment
expenses, and $0.87 million for rent compared to $0.12 million for salaries,
compensation and benefits and $0.03 million for travel and entertainment
expenses for the three months of 2004. Operating expenses also included selling
expense of $1.14 million and depreciation and amortization of $0.25 million. The
increase in operating expenses of $1.15 million for the three months ended March
31, 2005 as compared to the same period for the prior year reflects the
increased overhead related to the operations of both the Pharma and Chemical
Divisions in 2005 (compared to just the Pharma Division and one of the two
facilities of the Chemical Division in 2004) and the addition of the Biotech
operations and the head office in Vancouver. In addition, depreciation and
amortization expense increased during the three months ended March 31, 2005 due
to the increase in fixed assets of the Chemical Division in 2005.
7
Net Income. Dragon had net income of $1.24 million for the three months
ended March 31, 2005 compared to net income of $1.94 million for the same period
in 2004. In addition, net income reflects other income of $0.89 million from
funds released by the Chinese government related to asset acquisition of a
state-owned enterprise by the Company in 2003 and income tax expense of $0.20
million. Shanxi Weiqida is currently subject to income tax at an incentive tax
rate, at half of the normal tax rate, for a period of three years commencing in
2005.
Basic Net Income Per Share. Dragon's net income per share has been computed
by dividing the net income for the period by the weighted average number of
shares outstanding during the same period. Net income per share for the three
months ended March 31, 2005 was $0.02 per share and for the three months ended
March 31, 2004 was $0.04 per share. The weighted average number of shares
outstanding during the three months ended March 31, 2005 and 2004 were
60,427,871 and 44,502,004 shares, respectively. The outstanding common stock
options have no significant dilutive effect on the weighted average number of
shares outstanding.
Liquidity and Capital Resources
As of March 31, 2005, Dragon had current assets of $28.30 million,
including a cash balance of $1.79 million and accounts receivables of $8.77
million, and current liabilities of $27.66 million.
As of March 31, 2005, Dragon's current liabilities of $27.66 million were
as follows:
Accounts Payable $4,766,797
Accrued Retirement Benefits - current portion $114,432
Other Payables and Accrued Expenses $17,117,072
Due to Related Companies $627,889
-----------
Notes Payable-Short Term:
------------------------
Note payable to a bank, interest rate of
6.372% per annum, due June 2005 $420,290
Note payable to a bank, interest rate of
6.372% per annum, due June 2005 $386,473
Note payable to a bank, interest rate of
4.779% per annum, due November 2005 $3,623,188
Note payable to a bank, interest rate of
8.874% per annum, due July 2005 $603,865
------------ -----------
Notes Payable - Short Term Subtotal $5,033,816
-----------
Total Current Liabilities $27,660,004
The Accounts payable were incurred as part of the normal course of business
of Dragon, while Other Payables and Accrued Expenses were incurred as part of
the investment in establishing the Chemical Division.
8
As of March 31, 2005, Dragon had outstanding short-term notes (less than
one year term) totaling $5.03 million, after $8.45 million, originally due in
April 2005, was renewed and extended: $6.64 million for two years and the
remaining $1.81 million for one year. Dragon believes that it will be successful
in renegotiating other notes due based on the assumption that the Company has
enhanced its ability to generate additional profit and cash flow from its
operation since the notes were originally entered into. Since then, the
Company's Chemical division commenced production and began generating sales and
cash flow. Further, it entered into a three-year long term supply contract with
Aurobindo Biopharma to supply specified amounts of Clavulanic Acid and 7-ACA
produced from its Chemical Division. Assuming that Dragon is successful in
renegotiating its notes as mentioned above, it believes that it will have enough
cash flow for its operations for at least the next twelve months.
Long-term Liabilities:
At March 31, 2005, Dragon had long-term liabilities of $37.52 million as
follows:
Long-term accounts payable $21,904,603
Long-term retirement benefits $841,713
Note Payable - Long Term
------------------------
Note payable to a bank, interest rate of
6.039% per annum, due April 2006 $1,811,594
Note payable to a bank, interest rate of 5.76% $6,316,426
per annum, due November 2006
Note payable to a bank, interest rate of
6.039% per annum, due April 2007 $6,642,512
----------------
Note Payable - Long Term $14,770,532
---------------
Total Long-term Liabilities $37,516,848
---------------
As of March 31, 2005, the Company had long-term retirement benefits of
$0.84 million, which was incurred in July 2003 when Shanxi Weiqida acquired land
and buildings from a government liquidator in exchange for assuming certain
future employment, healthcare and land acquisition costs of the factory and its
former employees during July 2003. The Company is required to pay certain
minimum wages and health care costs until the date of their employment,
retirement, or death, whichever occurs first. The total amount of the
liabilities assumed on the closing date was $8.90 million, which approximated
the appraised value of the land. As of March 31, 2005, Shanxi Weiqida had
employed 651 former employees, and 207 former employees have retired. Shanxi
Weiqida has calculated the related asset value by computing the net present
value of the future expected payments to the remaining approximately 200
employees assuming an interest rate of 3%. As of March 31, 2005, approximately
200 former employees of Datong Pharmaceutical remained as the obligation of
Dragon.
Dragon had long-term notes payables (one to two years) totaling $14.77
million of which $1.81 is due April 2006, $6.32 million which will be due
November 2006, and $6.45 million due April 2007, in addition to long-term
account payables of $21.90 million due in 2006. Assuming Dragon can successfully
renew part of the short-term notes mentioned above, Dragon believes that it will
be able to meet its long-term notes payable and long-term account payables when
they become due with the expected increase in profit and cash flow from the
addition of the Chemical Division in 2005.
9
Further, Dragon has engaged an investment banker in the U.S. to raise
capital through the sale of its equity securities which would enhance Dragon's
financial position. However, no assurance can be given that Dragon will be able
to raise additional capital through the sale of its equity securities.
Item 3. Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined by Exchange Act Rule 13a-15(e))
as of the end of our third fiscal quarter pursuant to Exchange Act Rule
13a-15(b). Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in ensuring that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
There have been no changes in our internal control over financial reporting
identified in connection with our evaluation as of the end of the first fiscal
quarter that occurred during such quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not currently involved in any legal proceedings.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 12, 2005, we completed the acquisition of all the outstanding
shares of Oriental Wave pursuant to the Share Purchase Agreement. In connection
with the acquisition, we issued an aggregate of 44,502,004 shares of common
stock. In addition, pursuant to the Share Purchase Agreement, Mr. Han, Mr. Weng
and Ms. Liu collectively received 4,282,402 Additional Dragon Closing Shares.
The Additional Dragon Closing Shares are being held in escrow and may be
released or cancelled depending on whether or not certain of our options or
warrants outstanding as of the closing date have been subsequently exercised or
expired. Mr. Han, Mr. Weng and Ms. Liu will have no voting rights or dispositive
powers over the Additional Dragon Closing Shares while they are held in escrow,
and they will not be deemed to be outstanding unless they are released from
escrow. The number of common stock and Additional Dragon Closing Shares issued
in connection with the acquisition of Oriental Wave is as follows.
Additional Dragon
Name Common Stock Closing Shares*
---- ------------ -----------------
Yanlin Han 31,151,403 2,997,682
Zhanguao Weng 8,900,401 856,480
Xuemei Liu 4,450,200 428,240
* Subsequent to January 12, 2005, 881,000 options to acquire common
shares have expired, therefore, 1,902,570 Additional Dragon Closing Shares
will be cancelled. As a result, Mr. Yanlin Han's Additional Dragon Closing
Shares will be 1,665,883, Mr. Zhanguo Weng's Additional Dragon Closing
Shares will be 475,966 and Ms. Xuemei Liu's Additional Dragon Closing
Shares will be 237,983.
10
The issuance of the shares of common stock and Additional Dragon Closing
Shares by us to Mr. Han, Mr. Weng and Ms. Liu pursuant to the Share Purchase
Agreement was exempt from registration upon reliance of Regulation S.
Item 3. Defaults Upon Senior Securities.
None
Item 4. Submission of Matters to a Vote of Security Holders.
On January 11, 2005, we held our annual meeting of shareholders. The
following proposals were presented and adopted by our shareholders.
Proposal For Against Abstain
-------- --- -------- -------
1. To approve the issuance of our shares of common stock to complete the 11,907,466 38,850 5,112
acquisition of all outstanding shares of Oriental Wave Holding Ltd.
2. To approve an amendment to our Certificate of Incorporation to 16,812,137 123,147 3,212
increase the number of authorized shares of common stock from
50,000,000 shares to 200,000,000 shares.
3. To elect Dr. Wick and Dr. Sun as directors to serve for one-year terms or
until their successors have been elected and qualified;
Dr. Wick 16,889,246 59,250
Dr. Sun 16,889,246 59,250
4. To ratify the appointment of Moore Stephens Ellis Foster Ltd., 16,936,446 6,400 5,650
Chartered Accountants, to audit our financial statements for the
year ending December 31, 2004.
Item 5. Other Information.
None
Item 6. Exhibits.
(a) Exhibits.
Exhibit No.
31.1 Certification by the Principal Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act.
11
31.2 Certification by the Principal Accounting Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act.
32 Certification by the Principal Executive and Financial
Officers Pursuant to Section 906 of the Sarbanes-Oxley Act.
(b) Reports on Form 8-K:
(1) Form 8-K filed on March 2, 2005 filing certain
agreements previously entered into by either Dragon
Pharmaceutical Inc. or Oriental Wave Holdings Limited
related to their business.
(2) Form 8-K filed January 18, 2005 announcing approval of
the proposal presented at Dragon's annual meeting of
shareholders held on January 11, 2005.
12
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DRAGON PHARMACEUTICAL INC.
(registrant)
Dated: May 16, 2005 /s/ Garry Wong
---------------------------
Garry Wong
Chief Financial Officer
13