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, 2006
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 [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the (Exchange Act). Yes [ ] No [X]
Number of shares of common stock outstanding as of March 31, 2006: 62,878,004
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS AT MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
(Basis of Presentation - Note 1)
CONTENTS
PAGE 3 CONSOLIDATED BALANCE SHEETS AS AT MARCH 31, 2006 AND
DECEMBER 31, 2005
PAGE 4 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
PAGE 5 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
YEARS ENDED MARCH 31, 2006 AND DECEMBER 31, 2005
PAGE 6 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
MARCH 31, 2006 AND 2005
PAGES 7 - 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS AT MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
(Basis of Presentation - Note 1)
ASSETS
------
December 31,
Notes March 31, 2006 2005
---------- ------------------- --------------
CURRENT ASSETS
Cash and cash equivalents 18 $ 1,530,159 $ 1,311,378
Restricted cash 11,18 1,853,955 3,327,829
Accounts receivable, net of allowances 2 9,986,162 7,906,720
Inventories, net 3 14,108,221 14,131,735
Prepaid expenses 1,261,108 1,316,688
------------------- --------------
Total Current Assets 28,739,605 27,994,350
------------------- --------------
PROPERTY AND EQUIPMENT, NET 4,9 69,964,853 69,227,688
OTHER ASSETS
Intangible assets, net 6 3,234,007 3,367,066
Investments -cost 12,446 12,392
Goodwill 965,000 965,000
------------------- --------------
Total Other Assets 4,211,453 4,344,458
------------------- --------------
TOTAL ASSETS $ 102,915,911 $ 101,566496
------------ =================== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 7,130,543 $ 6,476,539
Accrued retirement benefits 7 84,470 90,714
Other payables and accrued liabilities 8 20,157,901 17,866,466
Loans payable - short-term 9 16,027,380 13,479,554
Notes payable 10 1,853,955 3,327,829
Due to related companies 11 62,553 61,993
------------------- -------=------
Total Current Liabilities 45,316,802 41,303,095
------------------- --------------
LONG-TERM LIABILITIES
Long term accounts payable 12 10,045,185 12,216,832
Long term retirement benefits 7 562,860 620,396
Loans payable - long-term 9 12,842,133 14,596,396
------------------- --------------
Total Long-Term Liabilities 23,450,178 27,433,624
------------------- --------------
TOTAL LIABILITIES 68,766,980 68,736,719
------------------- --------------
COMMITMENTS AND CONTINGENCIES (Note 15)
STOCKHOLDERS' EQUITY
Authorized: 200,000,000 common shares at par value of $0.001 each
Issued and outstanding: 62,878,004 common shares 62,878 62,878
Additional paid-in capital 24,408,348 24,317,830
Retained earnings 6,193,404 5,099,891
Reserves 2,628,008 2,628,008
Accumulated other comprehensive income 880,222 750,102
Due from stockholders (23,929) (28,932)
------------------- --------------
Total Stockholders' Equity 34,148,931 32,829,777
------------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 102,915,911 $ 101,566,496
------------------------------------------ =================== ==============
The accompanying notes are an integral part of these consolidated financial statements.
3
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED) Expressed in US Dollars
Note 2006 2005
------- --------------- ----------------
NET SALES 13 $ 16,637,377 $ 11,828,663
COST OF SALES 12,407,835 8,619,484
--------------- ----------------
GROSS PROFIT 4,229,542 3,209,179
--------------- ----------------
OPERATING EXPENSES
Selling expense 1,593,756 1,143,967
General and administrative expenses 1,681,840 1,004,141
Depreciation and amortization 289,737 243,932
--------------- ----------------
Total Operating Expenses 3,565,333 2,392,040
--------------- ----------------
INCOME FROM OPERATIONS 664,209 817,139
OTHER INCOME (EXPENSE)
Interest expense 12 (896,580) (241,051)
Other income 14(A) 1,477,180 11,084
Funds Released by Chinese Government Liquidator 14(B) - 885,864
Other expense (7,260) (35,534)
--------------- ----------------
Total other income 573,340 620,363
--------------- ----------------
INCOME BEFORE TAXES 1,237,549 1,437,502
INCOME TAX EXPENSE (144,036) (196,746)
--------------- ----------------
NET INCOME 1,093,513 1,240,756
OTHER COMPREHENSIVE INCOME
Foreign currency translation 130,120 -
--------------- ----------------
COMPREHENSIVE INCOME $ 1,223,633 $ 1,240,756
=============== ================
Earnings per share - basic and diluted $ 0.02 $ 0.02
=============== ================
Weighted average number of shares outstanding during the
year - basic and diluted 62,878,004 60,427,871
=============== ================
The accompanying notes are an integral part of these consolidated financial statements.
4
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND THE YEAR ENDED DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
Accumulated
Common Stock Additional other
--------------------- Paid-In Retained compre- Due from
Shares Amount Capital Earnings Reserves hensive loss Stockholder Total
---------- --------- ----------- ----------- ---------- ------------ ---------- ----------
Balance, December 31, 2004, 44,502,004 $44,502 $13,983,002 $ - $7,562,432 $ - $(52,149) $21,537,787
adjusted for the effect of
recapitalization of reverse
acquisition (Note 5)
Reverse acquisition (Note 5) 18,376,000 18,376 7,919,370 - - - - 7,937,746
Related party debt settled for
equity (Note 17) - - 2,415,458 - - - - 2,415,458
Notes receivable - stockholders - - - - - - 23,217 23,217
Comprehensive income (loss)
- foreign currency translation - - - - - 750,102 - 750,102
Transfer from appropriated
earnings - to retained earnings 5,204,022 (5,204,022) - - -
- to liabilities - - - - (17,103) - - (17,103)
Transfer from retained earnings for
reserves (Note 16(B)) - - - (286,701) 286,701 - - -
Net income for the year ended
December 31, 2005 - - - 182,570 - - - 182,570
---------- --------- ----------- ----------- ---------- ---------- ---------- ----------
Balance, December 31, 2005 62,878,004 $ 62,878 24,317,830 5,099,891 2,628,008 750,102 (28,932) 32,829,777
Notes receivable - stockholders - - - - - - 5,003 5,003
Comprehensive income (loss)
- foreign currency translation - - - - - 130,120 - 130,120
Stock compensation expense - - 90,518 - - - - 90,518
Net income for the period - - - 1,093,513 - - - 1,093,514
---------- --------- ----------- ----------- ---------- ---------- ---------- ----------
Balance, March 31, 2006 62,878,004 $ 62,878 $24,408,348 $ 6,193,404 $2,628,008 $ 880,222 $(23,929) $34,148,931
========== ========= =========== =========== ========== ========== ========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
5
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED) Expressed in US Dollars
2006 2005
-------------- ---------------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income $ 1,093,513 $ 1,240,756
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization 1,509,512 1,410,985
Provision for doubtful accounts 160,823 12,610
Stock compensation expense 90,518 -
Provision for obsolete inventories - 476,583
Gain on disposal of cell line (Note 14(A)) (1,000,000) -
Proceed on disposition of assets 27,658 -
Funds Released by Chinese Government Liquidator (Note 14) - (745,828)
Changes in operating assets and liabilities, net of effect of reverse acquisition (Note 5)
Accounts receivable (2,200,960) (725,437)
Inventories 84,850 146,990
Value added tax receivable - 162,443
Prepaid expenses 60,960 (142,364)
Other receivables - (214,722)
Accounts payable (43,682) 90,780
Other payables and accrued expenses 637,531 160,585
-------------- ---------------
Net Cash Provided By (Used In) Operating Activities 893,065 1,873,381
-------------- ---------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Purchase of property and equipment (1,876,998) (782,134)
Proceeds on disposition of assets 527,658 -
Cash and cash equivalents acquired in connection with reverse acquisition (Note 5 - 2,103,481
-------------- ---------------
Net Cash Provided By (Used In) Investing Activities (1,349,340) 1,321,347
-------------- ---------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Proceeds from loans payable 669,516 603,865
Due to related companies (3,605) (2,946,138)
Due from stockholder 5,009 175,999
-------------- ---------------
Net Cash Provided By (Used In) Financing Activities 670,920 (2,319,915)
-------------- ---------------
LOSS ON TRANSLATION OF FOREIGN CURRENCY 4,136 -
-------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 218,781 874,813
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,311,378 910,425
-------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,530,159 $ 1,785,238
============== ================
Cash paid during the period for interest expense $ 416,429 $ 245,373
============== ================
Cash paid during the period for income taxes $ 98,877 $ 166,495
============== ================
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
During March 2005, $2,415,458 of loans payable to an entity related to a
director of the Company was converted into equity of the Company (Note 17).
The Company capitalized interest of $39,163 and $79,012 during the three months
ended March 31, 2006 and 2005, respectively.
The Company recognized non-cash imputed interest of $508,292 and $nil the three
months ended March 31, 2006 and 2005, respectively.
The accompanying notes are an integral part of these consolidated financial
statements.
6
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 1 BASIS OF PRESENTATION
(A) The accompanying unaudited interim consolidated balance sheets,
statements of operations, stockholders' equity and cash flows
reflected all adjustments, consisting of normal recurring adjustments
and other adjustments, that are, in the opinion of management,
necessary for a fair presentation of the financial position of the
Company, at March 31, 2006, and the results of operations and cash
flows for the interim periods ended March 31, 2006 and 2005.
The accompanying unaudited interim consolidated financial statements
have been prepared in conformity with U.S. generally accepted
accounting principles, which contemplate continuation of the Company
as a going concern. The Company has a current liabilities in excess of
current assets, however, the Company has developed and is implementing
a plan to decrease its debt and increase its working capital which
will allow the Company to continue operations.
To meet these objectives, the Company plans to seek additional equity
through the conversion of some of its liabilities and expects to raise
funds through a private investment in order to support existing
operations and expand the range and scope of its business. The Company
has also significantly increased production levels to generate
additional cash flow under contracted supply agreements. In addition,
the Company intends to continue to renegotiate and extend loans, as
required, when they become due, as has been done in the past. There is
no assurance that such additional funds will be available for the
Company on acceptable terms, if at all. If adequate funds are not
available or not available on acceptable terms, the Company may be
required to scale back or abandon some activities. Management believes
that actions presently taken provide the opportunity for the Company
to continue as a going concern. The Company's ability to achieve these
objectives cannot be determined at this time. These conditions raise
substantial doubt about the Company's ability to continue as a going
concern. These financial statements do not include any adjustments
that might result from this uncertainty.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instruction for Form 10-QSB pursuant
to the rules and regulations of Securities and Exchange Commission
and, therefore, do not include all information and notes normally
provided in audited financial statements and should be read in
conjunction with the Company's consolidated financial statements for
the year ended December 31, 2005 included in the annual report
previously filed on Form 10-KSB.
The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for the full
year.
7
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
(B) In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation". SFAS 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity
instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee
services in share-based payment transactions. SFAS 123(R) requires
that the fair value of such equity instruments be recognized as
expense in the historical financial statements as services are
performed. Prior to SFAS 123(R), only certain pro-forma disclosures of
fair value were required.
SFAS 123(R) was adopted by the Company using the modified prospective
transition method beginning January 1 2006. Accordingly during the
three months ended March 31, 2006 the Company recorded a non-cash
stock based compensation expense for awards granted prior to, but not
yet vested, as of January 1, 2006, as if the fair value method
required for pro forma disclosure under FAS 123 were in effect for
expense recognition purposes. This resulted in $90,518 being charged
to income during the current period, whereas $1,077,381 was charged on
a pro forma basis in the prior period (Note 16(C)). The effect of the
adoption of SFAS 123(R) on the Company's consolidated financial
statements of the current period is a reduction in the income from
continuing operations, income before income taxes and net income of
$90,518. The adoption of SFAS123(R) had no effect on the cash flow
from operations, cash flow from financing activities and basic and
diluted earnings per share.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs--an
amendment of ARB No. 43, Chapter 4", which is the result of the FASB's
project to reduce differences between U.S. and international
accounting standards. SFAS No. 151 requires idle facility costs,
abnormal freight, handling costs, and amounts of wasted materials
(spoilage) be treated as current-period costs. Under this concept, if
the costs associated with the actual level of spoilage or production
defects are greater than the costs associated with the range of normal
spoilage or defects, the difference would be charged to current-period
expense, not included in inventory costs.
SFAS No. 151 was adopted by the Company beginning January 1 2006. The
adoption of SFAS No. 151 did not have an impact on the Company's
consolidated financial statements during the current period and is not
expected to have an effect in the future.
NOTE 2 ACCOUNTS RECEIVABLE
Accounts receivable at March 31, 2006 and December 31, 2005 consisted
of the following:
March 31, 2006 December 31, 2005
-------------------- -------------------
Trade and other receivables $ 10,651,810 $ 8,409,047
Less: allowance for doubtful accounts 665,648 502,327
-------------------- -------------------
Accounts receivable, net $ 9,986,162 $ 7,906,720
==================== ===================
For the period ended March 31, 2006, the Company recorded a provision
for doubtful accounts of $160,823 in the Consolidated Statements of
Operations compared to $112,610 for the period ended March 31, 2005.
8
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 3 INVENTORIES
Inventories at March 31, 2006 and December 31, 2005 consisted of the
following:
March 31, 2006 December 31, 2005
-------------------- -------------------
Raw materials $ 3,132,224 $ 4,144,900
Work-in-progress 6,432,757 6,280,283
Finished goods 4,792,534 4,523,663
-------------------- -------------------
14,357,515 14,948,846
Less: provision for obsolescence 249,294 817,111
-------------------- -------------------
$ 14,108,221 $ 14,131,735
==================== ===================
For the period ended March 31, 2006, the Company disposed of obsolete
inventories resulting in a recovery of $507,820 in the Consolidated
Statements of Operations compared to a provision for obsolete
inventories of $476,583 for the period ended March 31, 2005.
NOTE 4 PROPERTY AND EQUIPMENT
The following is a summary of property and equipment at March 31, 2006
and December 31, 2005:
March 31, 2006
-----------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
---------------- ------------------ ---------------
Plant and equipment $ 46,869,453 $ 8,489,255 $ 38,380,198
Land use rights and buildings 21,363,673 848,691 20,514,982
Motor vehicles 969,210 150,299 818,911
Furniture and office equipment 3,076,960 1,324,011 1,752,949
Leasehold improvements 8,487 2,342 6,145
Construction in progress 8,491,668 - 8,491,668
---------------- ------------------ ---------------
$ 80,779,451 $ 10,814,598 $ 69,964,853
================ ================== ===============
9
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
December 31, 2005
---------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
--------------- ----------------- ---------------
Plant and equipment $ 46,673,710 $ 7,350,550 $ 39,323,160
Land use rights and buildings 21,312,872 743,593 20,569,279
Motor vehicles 752,919 218,136 534,783
Furniture and office equipment 3,066,099 1,252,221 1,813,878
Leasehold improvements 1,020,949 1,018,504 2,445
Construction in progress 6,984,143 - 6,984,143
--------------- ----------------- ---------------
$ 79,810,692 $ 10,583,004 $ 69,227,688
=============== ================= ===============
Depreciation expense for periods ended the March 31, 2006 and 2005 was
$1,370,948 and $1,280,960, respectively. Land use rights and equipment
with a net book value of $33.1 million are pledged as collateral for
$22.3 million in loans payable (Note 9)
NOTE 5 ACQUISITION OF ORIENTAL WAVE HOLDINGS 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
acquisition represented an important strategic step in strengthening
the competitive position of the Company. 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 as of January 12, 2005. 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 of
approximately $7.9 million. The Statement of operations includes the
results of Oriental Wave for the year ended December 31, 2005 and
those of the Company from January 13 to December 31, 2005.
The allocation of the net assets acquired is as follows:
Cash and cash equivalents $ 2,103,481
Accounts receivable 1,527,554
Inventories 549,189
Prepaid and deposits 100,421
----------------
Total Current Assets 4,280,645
Property and equipment 785,742
10
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
Intangible assets 3,380,222
In-process research and development 265,000
Goodwill 965,000
----------------
Total Assets 9,676,609
Less accounts payables and accrued liabilities (1,738,863)
----------------
Net assets acquired $ 7,937,746
================
The intangible assets consist of the production technology and license
and customer base acquired and are being amortized over a period of
seven years. The in-process research and development costs of $265,000
were written-off to other expense during the year ended December 31,
2005, subsequent to the acquisition.
11
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 6 INTANGIBLE ASSETS
The Company acquired $603,865 in licenses from a company related to a
director in 2002 with the balance being recorded pursuant to the
reverse acquisition of Oriental Wave (Note 5).
Intangible assets consist of the following as of March 31, 2006 and
December 31, 2005:
March 31, 2006 December 31, 2005
------------------ -------------------
Production technology $ 1,670,223 $ 1,670,223
Product licenses 1,220,815 1,217,905
Customer base 1,160,000 1,160,000
------------------ -------------------
4,051,038 4,048,128
Less: accumulated amortization 817,031 681,062
------------------ -------------------
$ 3,234,007 $ 3,367,066
================== ===================
Amortization expense for periods ended March 31, 2006 and 2005 was
$138,564 and $130,025, respectively.
12
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 7 ACCRUED RETIREMENT BENEFITS
During July 2003, the Company acquired Land Use Rights and buildings
from a government liquidator. The present value of the accrued
retirement benefits assumed is recorded at March 31, 2006 and December
31, 2005 as follows:
March 31, 2006 December 31, 2005
------------------- -------------------
Total liabilities assumed at closing date $ 8,897,685 $ 8,897,685
Less: reduction of liability due to re-employment (4 ,949,474) (4 ,949,474)
Less: net present value of liabilities initially not
expected to be paid (615,304) (615,304)
------------------- -------------------
Present value of expected liabilities at closing date 3,332,907 3,332,907
Less: amounts paid and adjustment for liabilities not
expected to be paid 2,685,577 2,621,797
------------------- -------------------
647,330 711,110
Less: current portion 84,470 90,714
------------------- -------------------
$ 562,860 $ 620,396
=================== ===================
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 Notes 15(D)
NOTE 8 OTHER PAYABLES AND ACCRUED LIABILITIES
Other payables and accrued liabilities at March 31, 2006 and December
31, 2005 consist of the following:
March 31, 2006 December 31, 2005
------------------ -------------------
Machinery and equipment payable $ 5,212,137 $ 4,253,448
Non-interest bearing demand loans 1,968,151 1,416,357
Current portion of long term payables 6,577,159 7,157,013
Accrued expenses 1,021,296 1,147,101
Value added tax payables 62,020 277,052
Income taxes payable 190,406 144,499
Other taxes payable 206,317 159,809
Deposits received from customers 4,920,415 3,311,187
------------------ -------------------
$ 20,157,901 $ 17,866,466
================== ===================
13
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 9 LOANS PAYABLE
The Loans payable, denominated in Renminbi Yuan, at March 31, 2006 and
December 31, 2005are as follows:
March 31, 2006 December 31, 2005
------------------ --------------------
RMB 4.8 million Loan payable to a bank, interest rate of 8.874% per
annum, guaranteed by an unrelated third
party, due April 2006 $ 597,386 $ 594,796
RMB 15,000,000 Loan payable to a bank, interest rate of 6.138% per annum,
secured by property and equipment of
$2.950.480, due April 2006 1,866,833 1,858,736
RMB 30 million Loan payable to a bank, interest rate of 6.138% per annum,
secured by property and equipment of
$5,123,703, due May 2006 3,733,665 3,717,472
RMB 5 million Loan payable to a bank, interest rate of 7.254% per annum,
secured by property and equipment of
$1,236,067, due September 2006 622,278 619,579
RMB 1.6 million Loan payable to a bank, interest rate of 7.254% per
annum, secured by property and equipment of
$661,798, due September 2006 209,085 208,178
RMB 52.3 million Loan payable to a bank, interest rate of 6.92% per
annum, secured by property and equipment of
$9,281,312, due November 2006 6,509,023 6,480,793
RMB 20 million Loan payable to a bank, interest rate of 6.138% per annum,
secured by property and equipment of
$10,232,169, due January 2007 2,489,110 -
RMB 55 million Loan payable to a bank, interest rate of 6.336% per annum,
secured by property and equipment of
$3,582,780, due April 2007 6,845,053 6,815,366
14
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
RMB 38 million Loan payable to a company, non-interest
bearing and unsecured, due June 30, 2007 4,730,158 4,709,643
RMB 10.18 million Loan payable to a company, non-interest bearing and
unsecured, due December 31, 2007
1,266,922 3,071,387
------------------ --------------------
28,869,513 28,075,950
Less current maturities 16,027,380 13,479,554
----------------- --------------------
$ 12,842,133 $ 14,596,396
================= ====================
Maturities are as follows:
Fiscal year ended December 31,
2006 $ 13,538,270
2007 15,331,243
--------------------
$ 28,869,513
====================
15
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
N0TE 10 NOTES PAYABLE
Shanxi Weiqida has in place a banking facility where its bank has
issued a number of bon- interest bearing notes payable to vendors of
Shanxi Weiqida totaling $1,853,955, due between May and July 2006.
These notes, are secured by $1,853,955 in bank deposits of Shanxi
Weiqida and the bank deposits may be used only for the purpose of
repaying the notes.
NOTE 11 DUE TO RELATED PARTIES
The amounts due to related parties at March 31, 2006 and December 31,
2005 are due to the spouse of a shareholder and director and are
unsecured and non-interest bearing.
NOTE 12 LONG TERM ACCOUNTS PAYABLE
March 31, December 31,
2006 2005
-------------- ---------------
Non interest bearing amounts payable to
contractors related to the acquisition of plant
and equipment. The amounts have been discounted
using a rate of 6.5% as a result of term
modifications made in 2005. The discount has been
applied against the cost of the plant and
equipment acquired. Due dates range from April 30, 2007
through December 31, 2008. $ 10,045,185 $ 12,216,832
============== ==============
During the period the Company accreted interest of $508,292 (2005 $Nil).
Future annual payments are as follows:
2007 $ 1,604,515
2008 9,969,227
---------------
$ 11,573,742
===============
16
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 13 SEGMENTS
The Company operates in three reportable segments, the Pharma
Division, Chemical Division and Biotech Division. The Pharma Division
produces chemical generic, mainly anti-infectious, drugs. The Chemical
Division produces the bulk intermediate or ingredient to sell to other
pharmaceutical companies for further processing and formulation into
finished products. The Biotech Division produces Erythropoietin or
EPO, an injection that stimulates red blood cell. 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 gross profit. All sales by division were to
external customers (see Note 18 also). As a result, the components of
gross profit for one segment may not be comparable to another segment.
The following is a summary of the Company's segment information for
the three months ended March 31, 2006 and 2005 and as of March 31,
2006 and December 31, 2005.
Chemical Pharma Biotech
Division Division Division Total
--------------- --------------- -------------- ----------------
2006
Sales $ 11,475,377 $ 4,564,245 $ 597,755 $ 16,637,377
Gross profit 2,218,876 1,578,208 432,458 4,229,542
Depreciation and amortization 1,167,706 173,390 168,416 1,509,512
As at March 31, 2006
Total assets 77,567,977 17,895,309 7,452,625 102,915,911
Additions to long-lived assets 1,813,213 10,267 53,518 1,876,998
Intangible assets 46,329 368,179 2,819,499 3,234,007
2005
Three months ended March 31, 2005
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 1,057,587 153,804 199,594 1,410,985
As at December 31, 2005
Total assets 75, 831,748 17,601,551 8,133,197 101,566,496
Additions to long-lived assets 10,238,939 116,961 1,800,151 12,156,051
Intangible assets 47,336 382,072 2,937,658 3,367,066
17
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 14 OTHER INCOME
(A) 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 contracted cost to develop the
cell line was $592,000 (EUROS 500,000) of which $355,000 (EUROS
300,000) was unpaid.
In, January 2006, the Company disposed of the cell line, and all
applicable obligations relating, thereto, being developed for the
Company to enter the European market. The cell line was sold to a
Company controlled by a Director of the Company who was also the
President of the Company prior to the transaction. The cell line had a
carrying value of $0 and was sold for $1 million, resulting in a gain
of $1 million.
Government grants
-----------------
During the three months ended March 31, 2006, the Shanxi Weiqida
applied for, and received, grants of $465,864 from the government for
bringing in investment and new technology to Datong city, Shanxi
Province.
(B) Funds Released by Chinese Government Liquidator
--------------------------------------------------
In July 2003, the Company, through Shanxi Weiqida, acquired out of
bankruptcy the Land Use Rights of a state-owned enterprise. After
entering into this transaction, the Company was approached by an
unrelated state agency to administer certain benefits payable to
former employees of the agency (the government liquidator) as the
Company had already established an infrastructure to make payments to
these employees for settlement of liabilities related to the
transaction. As a result, during 2004, the Company received $1,751,208
from the government liquidator, for the settlement of human resources
related expenses of the bankrupt enterprise. As well, during the first
quarter of 2005, a separate municipal agency, 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. The two agencies,
unrelated to the acquisition, allowed the Company to retain the cash
balance of $745,828 as well as the reserve of $140,036 as payment for
services provided by the Company. As a result, the Company recorded
other income of $885,864 during the three months ended March 31, 2005
year to reflect the above transactions.
NOTE 15 COMMITMENTS AND CONTINGENCIES
(A) Employee Benefits
---------------------
The full time employees of Shanxi Weiqida are entitled to employee
benefits including medical care, worker compensation, 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
18
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
was $130,927 and $116,217 for the three months ended March 31, 2006
and 2005, 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.
(B) Loan Guarantee
------------------
The Company has guaranteed a bank loan to a supplier in the amount of
$2,489,000 (RMB20 million) due on July 16, 2006. Interest on the loan
is charged at 7.905% and the bank has the right to seek settlement
from the Company for payment should the supplier fail to repay the
loan. There is no recourse or possible recovery for the Company should
the suppliers default on their bank loans. The maximum potential
amount of future payments (undiscounted) that the Company could be
required to make is $2,547,000 (RMB20.55 million). The Company
provided the guarantees to these suppliers to maintain a good business
relationship.
The Company has also issued a guarantee to a bank as security for
loans to a third party vendor of $2,489,000 (RMB20 million) due on
September 26, 2007 and $3,734,000 (RMB30 million) due on October 27,
2007. Interest is charged at the bank's base rate plus 5.9475 %. The
bank has the right to seek settlement from the Company for payment
should the third party vendor fail to repay the loan. The maximum
potential amount of future payments (undiscounted) that the Company
could be required to make is $ 6,793,000 (RMB54.82 million). This
vendor has pledged assets totaling $8,743,000 (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 fulfil registered capital of $19,704,877 (RMB
159,018,360) within five years from December 16, 2003. As of March 31,
2006, the Company has fulfilled $15,037,562 (RMB 121,353,123) of
registered capital requirement and has registered capital commitments
of $4,667,316 (See Note 16(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 earliest of date of retirement, re-employment or
death for each employee. As of March 31, 2006, the Company has rehired
679 former employees, 246 employees have retired and 129 former
employees remain unemployed. If the Company is unable to provide
continued employment to these remaining unemployed individuals, it
will be liable to pay them each approximately $55 per month until his
or her date of retirement, at age 60 or 50, respectively, or death,
whichever comes first (See Note 7).
19
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
(E) Operating Leases
--------------------
(a) The Company has entered into an operating lease agreement for
their administrative offices in Vancouver for an amount
escalating from CDN$73,000 to CDN$78,000 (US$62,600 to US$66,500)
per annum until March 31, 2011. The Company has subleased its
previous office space which is leased until March 31, 2007. The
total minimum payments required under both leases are as follows:
2006, balance of year $ 195,115
2007 $ 111,996
2008 $ 64,038
2009 $ 65,941
2010 $ 66,416
Thereafter $ 16,604
---------------------------------------------------------------
$ 520,110
===============================================================
The Company anticipates recovering $123,300 and $41,100 during fiscal
2006 and 2007, respectively, under its sublease agreement.
20
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
NOTE 16 STOCKHOLDERS' EQUITY
(A) Capital Contribution (See note 15(C))
----------------------------------------
On January 31, 2005 and on February 22, 2005 Oriental Wave paid Shanxi
Weiqida $479,988 and $198,682, respectively, towards its registered
capital requirement under Chinese law.
(B) Reserves
------------
Pursuant to PRC regulations, Shanxi Weiqida is required to make
appropriations to reserves funds, comprising the reserve fund, staff
welfare fund and enterprise expansion fund, 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 reserve fund 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 Shanxi Weiqida's registered capital. The
reserve fund is established for covering the potential loss.
Appropriations to the staff welfare fund are at a percentage, as
determined by the Board of Directors, of the after tax net income
determined in accordance with the PRC GAAP. The staff welfare fund is
established for the purpose of providing employee facilities and other
collective benefits to the employees. Appropriations to the enterprise
expansion fund are made at the discretion of the Board of Directors.
The enterprise expansion fund is established for expanding business
operation. The reserve fund and enterprise expansion fund are recorded
as part of shareholders' equity but are not available for distribution
to shareholders other than in liquidation; while the staff welfare
fund is recorded as a liability and is not for distribution to
shareholders. The appropriations for reserves are made by the Board of
Directors on an annual basis.
(C) Stock Options
------------------
The Company has adopted the 2005 Stock Option Plan, effective August
13, 2005, which allows for the granting of options to Directors and
Employees for a period of up to ten years. The Company did not grant
any options during the three months ended March 31, 2006. During the
year ended December 31, 2005, the Company granted options to its
directors and employees to purchase 5,920,000 shares at a weighted
average price of $0.91 per share, with 2,260,000 shares at exercise
price of $1.18 (being the market price at the time) expiring on
January 12, 2010 and 3,660,000 shares at exercise price of $0.74
(being the market price at the time) expiring on September 30, 2010.
Options to purchase 4,320,000 shares were exercisable immediately with
400,000 options becoming available on January 12, 2006, 400,000
options becoming available on September 30, 2006, 400,000 options
becoming available on January 12, 2007 and the balance of 400,000
options vesting on September 30, 2007.
21
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
The following summarizes stock option information for the year ended
March 31, 2006:
--------------------------------------------------------------------------------------------------------------
Weighted
Shares Average
Exercise Price
--------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 2004 1,749,000 $ 2.36
Granted 5,920,000 $ 0.91
Forfeited/cancelled (1,231,500) $ 2.93
--------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 2005 6,437,500 $ 0.92
Cancelled (675,000) $ 0.80
--------------------------------------------------------------------------------------------------------------
Options outstanding at March 31, 2006 5,762,500 $ 0.93
==============================================================================================================
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 3,435,000 4.30 $0.74 3,035,000 $0.73
$1.01 - $2.00 2,327,500 3.59 $1.22 1,927,500 $1.23
--------- ---- ----- --------- -----
5,762,500 4.02 $0.93 4,962,500 $0.93
========= ==== ===== ========= =====
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation". SFAS 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity
instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee
services in share-based payment transactions. SFAS 123(R) requires
that the fair value of such equity instruments be recognized as
expense in the historical financial statements as services are
performed. Prior to SFAS 123(R), only certain pro-forma disclosures of
fair value were required. SFAS 123(R) was adopted by the Company
effective as of the beginning of fiscal 2006, on a modified
prospective basis, whereby the Company records a non-cash stock based
compensation based upon the fair value of the options at the time they
are granted. This resulted in $90,518 being charged to income during
there current period.
The Company previously accounted 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
22
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
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 for the options granted in January 2005 and $0.43
for the options granted in September 2005. Based on the computed
option values and the number of the options issued, had the Company
recognized compensation expense in the prior period the following
would have been its effect on the Company's net income and earnings
per share:
--------------------------------------------------- ------------------- ----------------
For the three months ended March 31, 2006 2005
--------------------------------------------------- ------------------- ----------------
Net income for the period:
- as reported $1,093,513 $1,240,756
- pro-forma $1,093,513 $163,375
------------------------------------------------ ------------------- ----------------
Basic and diluted income per share:
- as reported $0.02 $0.02
- pro-forma $0.02 $0.00
------------------------------------------------ ------------------- ----------------
NOTE 17 RELATED PARTY TRANSACTIONS
During March 2005, $2,415,458 of loans payable to an entity related to
a director of the Company was converted into equity of the Company.
See Notes 6, 11 and 14(A) also.
NOTE 18 CONCENTRATIONS AND RISKS
64% and 85% of the Company's revenues for the three months ended March
31, 20065 and 2005, respectively, were derived from customers located
in China. The Company had sales of $4,784,861 in the Chemical Biotech
Divisions to a customer in India, representing 29% of the Company's
revenues for the three months ended March 31, 2006. 99% of the
Company's assets at March 31, 2006 and December 31, 2005 were located
in China.
Sales to the Company's five largest customers accounted for
approximately 54% and 33% of the Company's sales for the three months
ended March 31, 2006 and 2005, respectively; while sales to the
Company's largest customer accounted for approximately 29% and 8%,
respectively. Amounts owing from one customer represented 9% of the
Company's trade and other receivables at March 31, 2006 and 12 % of
the Company's trade and other receivables at December 31, 2005.
The Company is exposed to the risk arising from changing interest
rates. A detailed analysis of the Company's Loans Payable, together
with their respective interest rates and maturity dates, are included
in Note 9.
23
DRAGON PHARMACEUTICAL INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND DECEMBER 31, 2005
(UNAUDITED) Expressed in US Dollars
The majority of the Company's assets, liabilities, revenues and
expenses are denominated in Renminbi, which was tied to the US Dollar
and is now tied to a basket of currencies of China's largest trading
partners, is not a freely convertible currency. The appreciation of
the Renminbi against the US Dollar would result in an increase in the
assets, liabilities, revenues and expenses of the Company and a
foreign currency gain included in comprehensive income. Conversely,
the devaluation of the Renminbi against the US Dollar would result in
a decrease in the assets, liabilities, revenues and expenses of the
Company and a foreign currency loss included in comprehensive income.
At March 31, 2006, approximately US$1,393,327 of the cash and cash
equivalents (December 31, 2005: US$774,369) and all of the restricted
cash are held in Renminbi.
24
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The following discusses the Company's financial condition and results of
operations for the three months ended March 31, 2006 based upon the Company's
interim unaudited consolidated financial statements which have been prepared in
accordance with the United States generally accepted accounting principles. It
should be read in conjunction with the Company's audited 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, 2005.
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 manufactured and sold EPO through
its wholly-owned drug manufacturing company Nanjing Huaxin Bio-pharmaceutical
Co., Ltd. ("Nanjing Huaxin") located in Nanjing City, China,. Nanjing Huaxin's
EPO has been approved and marketed in nine countries including China, India,
Egypt, Brazil, Ecuador, the Dominican Republic, Trinidad-Tobago, Peru, and
Kosovo. Since August 2005, the Nanjing Huaxin facility was closed and the EPO
production facility was relocated to Datong, China. The new EPO production
facility is currently located next to the Chemical division facility of Shanxi
Weiqida.
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 five production facilities in China: four 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, 10 million suppositories and 180 tons of sterilized bulk drugs per
year, a chemical plant producing clavulanic acid with an annual capacity of 50
tons, a biotech facility producing EPO and a pharmaceutical facility producing
freeze-dry injectables. In addition, Oriental Wave has a fifth 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 86, mainly anti-infectious drugs,
are actively exploited in China. 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 divisions. These divisions 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 through two indirect wholly-owned subsidiaries in
China, Shanxi Weiqida and Nanjing Huaxin.
The Company, after the acquisition, has significantly increased the size of
operations and now has five manufacturing facilities in Datong city, China,
approximately 1,800 employees, an additional 1,200 contract sales
representatives in China, and 63 key products in 101 different dosages and
presentations currently in the Chinese market.
25
Pharma Division
The Pharma Division's operations are located in the Datong Economic and
Technology Development Zone, Datong City, Shanxi Province, China. Pharma
Division produces chemical generic, mainly anti-infectious, drugs. The Pharma
Division currently holds approximately 319 product approvals from SFDA, of which
only 85 prescription, over-the-counter and sterilized bulk products in different
dosages and presentations are currently commercialized in China. At the end of
December, 2005, the Company completed 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 was outsourced
to a third party contract manufacturer. The Pharma Division operates its
business strategies to focus on the expansion and development of the Chinese
market by managing its product portfolio and selecting potential products for
commercialization.
Chemical Division
The Chemical Division's facilities are located on Datong Gongnong Road,
Datong City, Shanxi Province, China. The Chemical Division produces the bulk
pharmaceutical intermediates and API to sell to other pharmaceutical companies
for further processing and formulation into finished products. The Chemical
Division manages the production of Clavulanic acid and 7-ACA for both Chinese
and international markets. The designed production capacity for Clavulanic
Potassium and 7-ACA were 30 tons and 400 tons respectively. After the Company's
investment in the process optimization and technology improvement, the current
production capacity reaches 50 tons and 600 tons for Clavulanic Potassium and
7-ACA respectively. The production for Clavulanic Acid was started in January
2004 and the production of 7-ACA was started in July 2004. One of the key
products in Chemical Division is Clavulanic acid, a drug that combines with
antibiotics increase the effectiveness of the antibiotics. Dragon is currently
the only producer of Clavulanic acid in China. Another key product in the
Chemical Division is 7-ACA, an intermediate for Cephalosporin antibiotics. The
600-ton production capacity of 7-ACA positions Dragon among the main producers
in the world. The export of 7-ACA to India commenced in 2004. In 2004, Dragon's
Chemical Division entered into a 3-year long term supply agreement with a large
Indian pharmaceutical company and the Company currently set a target to sell 50%
of production to the Indian market. The Chemical Division operates its business
strategies to upgrade its technology in order to improve yields and lower
production cost, to develop 7-ACA and Clavulanic acid downstream bulk products,
and to apply for approvals in the US and EU to enter into European and North
American markets.
Biotech Division
The Biotech Division's facility was relocated to Datong, China from its
original production site in Nanjing City, China at the end of December, 2005.
The new EPO production site is 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 will allow the Company to capitalize on the existing
production infrastructure and the efficiency of unified operational management.
In the new facility, it is anticipated that the capacity for bulk EPO will be
doubled to 120 grams and the capacity for sterile vialing will be tripled to 5
million vials. The sole product of the Biotech Division is Erythropoietin or
EPO, an injectable that stimulates red blood cell development. Dragon's Biotech
Division develops, manufactures and markets generic EPO with China and
developing countries as the current core markets, and has already been approved
and sold in 9 countries: China, India, Egypt, Brazil, Peru, Ecuador,
Trinidad-Tobago, Dominican Republic and Kosovo. Currently, Dragon's EPO is sold
only in countries where there is no patent protection. In the past, Dragon was
preparing to enter the European market with a new EPO product under development
in Austria. However, in January 2006, the Company sold the development contract
with the Austrian partner to a related party for $1 million cash and assumption
of all obligations under the contract.
26
Critical Accounting Policies and Estimates and Recent Accounting Pronouncements
The accompanying management's discussion and analysis of results of
operations and financial condition are based upon the Dragon's consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The
preparation of these financial statements requires management to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues,
and expenses and related disclosure of contingent assets and liabilities.
Management evaluates estimates on an ongoing basis. Management bases its
estimates on historical experiences and various other factors and assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ materially from these estimates under different assumptions or
conditions.
A summary of significant accounting policies and a description of
accounting policies that are considered critical are described in Note 1 to the
Consolidated Financial Statements contained in this report and in Note 1 to the
Dragon's Annual Report on Form 10-KSB for the year ended December 31, 2005. In
addition, a description of Recent Accounting Pronouncements is contained in Note
1(B) to the Consolidated Financial Statements contained in this report and in
Note 1(U) to the Consolidated Financial Statements to the Corporation's Annual
Report on Form 10-KSB for the year ended December 31, 2005.
Results of Operations
Results of Operations for the Three Months Ended March 31, 2006 and 2005
Sales. Sales for the first quarter ended March 31, 2006 increased 41% to
$16.64 million from $11.83 million for the same period in 2005. $10.66 million,
or 64% of the sales for the first quarter in 2006 were generated from the sales
of products in the Chinese market, and the remaining 5.98 million or 36% were
generated from the sales of products in the international markets. $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 international markets. In the
first quarter of 2006, $4.56 million, or 27% of the sales, were from the Pharma
Division, $11.48 million, or 69% of sales were from the Chemical Division and
$0.60 million, or 4% of sales, were from the Biotech Division. For the same
period in 2005, 45% of sales were from the Pharma Division, 48% of sales were
from the Chemical Division and 7% of sales were from the Biotech Division. The
increase in sales during the three months ended March 31, 2006 as compared to
the same period for the prior year was primarily due to increases in sales from
the Chemical Division.
Cost of sales for the three months ended March 31, 2006 was $12.41 million
compared to $8.62 million for the three months ended March 31, 2005. 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, 2006 were $4.23 million and 25% compared to $3.21 million
and 27% for the same period of 2005. The slight decrease in gross margin was
mainly due to the increase in sales of the Chemical Division which carried a
slightly lower gross margin than products from the other two divisions.
27
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 2006 were $4.56
million, accounting for 27% of the total sales of the Company. Comparatively,
the Pharma division's sales were $5.32 million for the same period in 2005,
contributing 45% 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
also due to the tremendous growth of the Chemical division achieved during the
first quarter of 2006 compared to 2005. The overall gross margin for the
division for the first quarter decreased to 35%, representing a 12 basis point
decline from the same period of 2005. The reduction in the retail price resulted
in the decrease in profit margin.
Chemical Division
The Chemical Division's sales for the first quarter of 2006 were $11.48
million, representing a 101% increase from the sales of $5.70 million during the
same period in 2005. The increase is due to the continued increase in export of
7-ACA outside China.
The Chemical Division's gross margin for the first quarter of 2006 was 19%.
The gross margin for the division increased from 1% in the comparative period
due to the significant increase in production level especially for 7-ACA during
the first quarter of 2006 as compared to the same period of 2005.
Biotech Division
The Biotech Division's sales for the three months ended March 31, 2006 were
$0.06 million or 4% of sales compared to $0.80 million, or 7% of sales, for the
comparative period. The decrease was due to the Company not having any
international sales during the period as the new production facilities in Datong
have not yet received international orders outside China.
Other Income. During the three months ended March 31, 2006, Dragon
recognized $0.57 million of Other Income. This amount primarily consisted of a
$1 million gain on the sale of the European EPO cell line development. During
the quarter, Dragon disposed of the European EPO cell line, and all applicable
obligations relating, thereto, being developed for Dragon to enter the European
market. The European EPO cell line was sold to AS Biotech AG, a Swiss company
controlled by Dr. Alexander Wick, a Director of Dragon who was also Dragon's
President prior to the transaction. The European EPO cell line had a carrying
value of $0 and was sold for $1 million and the assumption of all obligations
under the agreement. In addition, during the quarter, the Company received $0.47
in Government grants in China. This other income was offset in part by $0.90 in
interest expense.
Expenses. Total operating expenses were $3.57 million for the three months
ended March 31, 2006 compared to $2.40 million for the same period in 2005. For
the three months ended March 31, 2006, the major category of operating expenses
was General and Administration expenses which included $0.62 million for
salaries, compensation and benefits (of which $0.09 was non-cash stock
compensation as a result of stock options granted in the prior year), $0.17
28
million for travel expenses, bad debts expense of $0.16and $0.07 million for
rent compared to $0.46 million for salaries, compensation and benefits and $0.13
million for travel expenses for the three months of 2005. Operating expenses
also included selling expense of $1.50 million and depreciation and amortization
of $0.29 million. The increase in operating expenses of $1.17 million for the
three months ended March 31, 2006 as compared to the same period for the prior
year reflects the additional overhead costs associated with the increase in
production and sales in the Chemical Division.
Net Income. Dragon had net income of $1.09 million for the three months
ended March 31, 2006 compared to net income of $1.24 million for the same period
in 2005. In addition, net income reflects other income of $1.47 million from the
gain on the sale of the European EPO cell line development and the receipt of
Government grants in China. 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 both the
three months ended March 31, 2006 and 2005 was $0.02 per share. The weighted
average number of shares outstanding during the three months ended March 31,
2006 and 2005 were 62,878,004 and 60,427,871 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, 2006, Dragon had current liabilities of $45.32 million and
current assets of $28.74 million, including cash balance of $3.38 million and
accounts receivables of $9.99 million. The excess of current liabilities over
current assets is mainly due to the Company financiang operations through bank
loans and payables and investment in the new EPO and Freeze-dry Injectable
workshops.
The Company has developed and is implementing a plan to decrease its debt
and increase its working capital which will allow the Company to continue
operations.
To meet these objectives, the Company plans to seek additional equity
through the conversion of some of its liabilities and expects to raise funds
through a private investment in order to support existing operations and expand
the range and scope of its business. The Company has also significantly
increased production levels to generate additional cash flow under contracted
supply agreements. In addition, the Company intends to continue to renegotiate
and extend loans, as required, when they become due, as has been done in the
past. There is no assurance that such additional funds will be available for the
Company on acceptable terms, if at all. If adequate funds are not available or
not available on acceptable terms, the Company may be required to scale back or
abandon some activities. Management believes that actions presently taken
provide the opportunity for the Company to continue as a going concern. The
Company's ability to achieve these objectives cannot be determined at this time.
As of March 31, 2006, Dragon had current liabilities of $45,316,802 as
follows:
------------------------------------------------------------- ----------------------- ---------------------------
Accounts Payable $7,130,543
------------------------------------------------------------- ----------------------- ---------------------------
Accrued Retirement Benefits - current portion $84,470
------------------------------------------------------------- ----------------------- ---------------------------
Other Payables and Accrued Expenses $20,157,901
------------------------------------------------------------- ----------------------- ---------------------------
Due to Related Companies $62,553
------------------------------------------------------------- ----------------------- ---------------------------
Notes payable $ 1,853,955
------------------------------------------------------------- ----------------------- ---------------------------
Loans Payable-Short Term:
Loan payable to a bank, interest rate of 8.874% per annum,
guaranteed by a third party, due April 2006 $597,386
------------------------------------------------------------- ----------------------- ---------------------------
Loan payable to a bank, interest rate of 6.138% per annum,
secured by property and equipment of $2,950,480, due April
2006 $1,866,833
------------------------------------------------------------- ----------------------- ---------------------------
29
------------------------------------------------------------- ----------------------- ---------------------------
Loan payable to a bank, interest rate of 6.138% per annum,
secured property and equipment of $5,123,703, due April 2006 $3,733,665
------------------------------------------------------------- ----------------------- ---------------------------
Loan payable to a bank, interest rate of 7.254% per annum,
secured by property and equipment of $1,236,067, due
September 2006 $622,278
------------------------------------------------------------- ----------------------- ---------------------------
Loan payable to a bank, interest rate of 7.254% per annum,
secured by property and equipment of $661,798 due September 2006 $209,085
------------------------------------------------------------- ----------------------- ---------------------------
Loan payable to a bank, interest rate of 6.92% per annum,
secured by property and equipment of $9,281,312, due
November 2006 6,509,023
------------------------------------------------------------- ----------------------- ---------------------------
Loan payable to a bank, interest rate of 6.138% per annum,
secured by property and equipment of $10,232,169, due
January 2007 2,489,110
------------------------------------------------------------- ----------------------- ---------------------------
Loans Payable - Short Term Subtotal $16,027,380
------------------------------------------------------------- ----------------------- ---------------------------
Total Current Liabilities $45,316,802
------------------------------------------------------------- ----------------------- ---------------------------
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.
As of March 31, 2006, Dragon had outstanding short-term loans (less than
one year term) totaling $16.03 million. Dragon believes that it will be
successful in the renegotiating loans due based on the assumption that the
Company has enhanced its ability to generate additional cash flow from its
operation since the loans were originally entered into, even though there is no
assurance of renewing the loan. Since then, the Company's Chemical Division
commenced production and began generating revenues 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.
Long-term Liabilities:
At March 31, 2006, Dragon had long-term liabilities of $23,450,178 as
follows:
---------------------------------------------------------------- ---------------- -----------------
Long-term accounts payable $10,045,185
---------------------------------------------------------------- ---------------- -----------------
Long-term retirement benefits $562,860
---------------------------------------------------------------- ---------------- -----------------
Loan Payable - Long Term
---------------------------------------------------------------- ---------------- -----------------
Loan payable to a bank, interest rate of 6.336% per annum,
secured by property and equipment of $3,582,780, due April 2007 6,845,053
---------------------------------------------------------------- ---------------- -----------------
Loan payable to a company, non-interest bearing and unsecured,
due June 2007 4,730,158
---------------------------------------------------------------- ---------------- -----------------
Loan payable to a company, non-interest bearing and unsecured,
due December 2007 1,266,922
---------------------------------------------------------------- ---------------- -----------------
Loan Payable - Long Term $12,842,133
---------------------------------------------------------------- ---------------- -----------------
Total Long-term Liabilities $23,450,178
---------------------------------------------------------------- ---------------- -----------------
As of March 31, 2006, the Company had long-term retirement benefits of
$0.56 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, 2006, Shanxi Weiqida had employed 679 former
employees, and 246 former employees have retired. Shanxi Weiqida has calculated
the related asset value by computing the net present value of the future
30
expected payments to the remaining 129 employees assuming an interest rate of
3%. As of March 31, 2006, 129 former employees of Datong Pharmaceutical remained
as the obligation of Dragon.
Dragon has long-term loans payables (one to two years) totaling
approximately $12.84 million of which $6.85 million will be due April 2007,
$4.73 million will be due June 2007and $1.27 million due April 2007, in addition
to long-term account payables of $11.57 million which are due to be paid April
2007 through December 2008.
During the three months ended March 31, 2006, Dragon financed its
operations, development of its new EPO and freeze-dry injectable facilities, and
increased production level at its Chemical Division through operating revenues,
accounts payables and short-term loans. The Company had anticipated that it
would increase its production level through an equity financing, however, the
anticipated financing has taken longer than expected
Item 3. Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief 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 the quarter pursuant to Exchange Act Rule 13a-15(b)), and
concluded that Dragon's disclosure controls and procedures are effective to
ensure that information required to be disclosed in Dragon's reports filed with
the Securities and Exchange Commission pursuant to the Exchange Act is
accumulated and communicated to management, including Dragon's Chief Executive
Officer and Chief Financial Officer. Based upon that evaluation, as of the end
of the period covered by this report, the Chief Executive Officer and Chief
Financial Officer concluded that Dragon's disclosure controls and procedures
were effective in recording, processing, summarizing and reporting information
required to be disclosed by Dragon 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
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.
None
Item 3. Defaults Upon Senior Securities.
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
31
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
Exhibits.
Exhibit No.
31.1 Certification by the Principal Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act.
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.
32
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)
Date: May 15, 2006 /s/ Yanlin Han
---------------------------
Yanlin Han
Chief Executive Officer
Dated: May 15, 2006 /s/ Garry Wong
---------------------------
Garry Wong
Chief Financial Officer
33