Item 1. Financial Statements
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
Outline of Our Business
China SXAN Biotech, Inc. is a holding company. Until July 2007 it was engaged exclusively in the business of developing infrared vision systems for commercial applications. In July 2007 the Company acquired the capital stock of Tieli XiaoXingAnling Forest Frog Breeding
Co., Ltd. (“Tieli XiaoXingAnling”), a corporation organized under the laws of The People’s Republic of China. In connection with that acquisition, the Company transferred all of the assets relating to the infrared vision systems business to a subsidiary named Infrared Systems International. Infrared Systems International has filed a registration statement that, when declared effective by the Securities and Exchange Commission, will permit the Company to distribute the capital
stock of Infrared Systems International to its shareholders. Thereafter the Company will be exclusively engaged in the business carried on by Tieli XiaoXingAnling.
Tieli XiaoXingAnling was organized in 2003 in the City of Tieli, which is in the Heilongjiang Province in northeast China. Tieli XiaoXingAnling is engaged in the business of breeding forest frogs, which are also known as snow frogs or winter frogs, since they are traditionally harvested
just prior to their winter hibernation in order to maximize the frog’s fat content. Tieli XiaoXingAnling has obtained patents from the government of China to produce therapeutic wines and tonics from its forest frogs. Tieli XiaoXingAnling has been marketing its forest frog products since 2004 under the brand “Xiao Xing’an Mountain.”
The desirable portion of the Chinese forest frog, known as “hasma,” is a combination of the frog’s ovaries and surrounding fatty tissues. Throughout Chinese history, hasma has been used to treat respiratory problems such as coughing, hemoptysis (expectoration of
blood), and night sweats attributable to tuberculosis. Many Chinese residents also believe that forest frog hasma improves immune function, aids in the treatment of neurasthenia, and slows aging.
Today, however, the forest frog is classified as an endangered species in China. Commercial harvesting of forest frogs in the wild is prohibited by national regulations. To meet the continuing demand for hasma, therefore, a domestic forest frog breeding industry has developed. The mission of Tieli XiaoXingAnling
is to become the leader in this industry.
Results of Operations
Our level of operations increased dramatically during our 2007 fiscal year, which ended on June 30, 2007. Through the first nine months of fiscal 2008, we have continuing that growth, albeit at a slower pace. In the nine month period ended March 31, 2008 our revenue reached $6,026,038, a 52% increase from the $3,972,621
in revenue recorded during the nine months ended March 31, 2007. Similarly, during the three months ended March 31, 2008 our revenue increased by 52%, from $667,447 to $1,015,156, although revenue in the three months ended March 31, 2008 represented only 17% of revenue for the full nine month period ended March 31, 2008. The primary reason that our revenue in the first quarter of fiscal 2008 exceeded our revenue in the second and third quarters was the maturity schedule of our inventory. We
commenced forest frog production in 2004. Forest frogs reach maturity after two years, after which they can be harvested. So the initial inventory of forest frogs that we accumulated in 2004 and 2005 became available for harvesting in the fall of 2006 and spring of 2007. We processed that inventory and took it to market, achieving initial revenues in the second quarter of fiscal 2007, but with sales peaking in the summer of 2007. As we have liquidated our inventory,
sales have waned. Because we continued to hold an inventory of $5,685,278 at March 31, 2008, we expect our near term operations to approximate the levels achieved in recent quarters, until we obtain the funds needed to substantially expand our marketing and production.
We realized a gross margin of 50% on our sales in the first nine months of fiscal year 2008 and 41% on our sales in the quarter ended March 31, 2008. This margin ratio fell below the 60% margin that we achieved in the nine months ended March 31, 2007. The primary causes for the reduction were:
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increased prices for grain in China, which have increased our expense for feedstock; and |
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the increasing proportion of our sales attributable to manufactured products, which require more processing than sales of raw hasma. |
Our gross margin will continue to dwindle in the next two years as we introduce even more manufactured products into our product offerings.
Our selling, general and administrative expenses increased from $95,608 in the three months ended March 31, 2007 to $221,189 in the three months ended March 31, 2008, and from $414,766 in the nine months ended March, 31, 2007 to $1,039,681 in the nine months ended March 31, 2008. The primary reasons for the increase were
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increased administrative salaries, as we have developed a staff capable of managing our growing company; |
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increased selling expenses, related to the increase in our sales volume; and |
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expenses incurred as a result of the merger of Tieli XiaoXingAnling into a U.S. public company. |
We expect that in the next two years our selling, general and administrative expense will remain at its current level or higher, as we will incur the expenses attributable to being a U.S. public company and as we continue to expand the focus of our business operations, necessitating a staff of skilled administrators.
Because we are involved in husbandry, the government of China has allowed us to defer payment of our income taxes until the end of this year. Therefore we have accrued the income tax expense on our Statement of Operations - $29,060 for the three months ended March 31, 2008 and $301,102 for the nine months ended March 31, 2008 –
but recorded the tax as payable on our balance sheet. We expect to satisfy that payable during the winter. During the next five years, we will be entitled to a tax abatement by reason of becoming a foreign-owned entity during the current fiscal year. As a foreign owned entity, Tieli XiaoXingAnling will be entitled to a two year income tax holiday, followed by a 50% income tax reduction for the next three years.
Our operations during the quarter ended March 31, 2008 produced net after tax income of $164,687, and net after tax income of $1,706,242 for the nine months ended March 31, 2008. While the nine month net income represented a modest (3%) increase over the first nine months of fiscal 2007, our
net income for the third quarter of fiscal 2008 was 31% lower than our net income for the third quarter of fiscal 2007. The primary reasons for the reduction in our earnings ratio were the reduction in gross margin and increase in selling, general and administrative expenses discussed earlier. We expect that our earnings-to-revenue ratio in the future will be closer to that realized in recent periods that that realized in fiscal 2007.
Our business operates entirely in Chinese Renminbi, but we will report our results in our SEC filings in U.S. Dollars. The conversion of our accounts from RMB to Dollars results in translation adjustments, which are reported as a middle step between net income and comprehensive income. The net income is added to the
retained earnings on our balance sheet; while the translation adjustment is added to a line item on our balance sheet labeled “accumulated other comprehensive income,” since it is more reflective of changes in the relative values of U.S. and Chinese currencies than of the success of our business. During the three months ended March 31, 2008 the unrealized gain on foreign currency translations added $434,226 to our accumulated other comprehensive income. $853,649 was added to
our equity by unrealized gains on foreign currency translations during the first nine months of fiscal 2008.
Liquidity and Capital Resources
Since Tieli XiaoXingAnling was organized at the end of 2003, its operations have been funded primarily by capital contributions from its shareholders (who became, in July 2007, the controlling shareholders of China SXAN Biotech). In addition, the shareholders have made short-term,
non-interest bearing loans to Tieli XiaoXingAnling when it needed working capital. The result is that at March 31, 2008 the Company had $6,054,662 in working capital, with only $298,495 in debt.
During the nine months ended March 31, 2008, the operations of Tieli XiaoXingAnling generated $250,603 in cash, despite reporting $1,706,242 in net income. This disparity, which was caused by a large increase in inventory during the period, is characteristic of the Company’s
operations. Its balance sheet at March 31, 2008 shows that the company is oriented towards near-term growth, as it includes only $265,414 in cash among its $8,156,774 in current assets. The principal current assets on that date were:
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$1,672,616 in advances to suppliers – payments made to insure that the feedstocks and other raw materials necessary for production during the 2008 growing season are available; |
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$5,685,278 in inventory – primarily forest frog hasma; and |
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$527,981 in other receivables – representing loans made to unrelated third parties to secure favourable business relationships. |
Tieli XiaoXingAnling has adequate resources to fund its operations for the foreseeable future. However, its management has budgeted a capital expenditure over the next twelve months of 85 million RMB (approx. $11 million). Management’s plans include:
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Development of the Company’s forest property in Heli to house an additional five million forest frogs, thus doubling the company’s production; |
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Acquisition of a liquor factory or medical wine factory with the necessary Good Manufacturing Practices (“GMP”) certification from the government, to enable Tieli XiaoXingAnling to rapidly expand its production of medicinal tonic; and |
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Acquisition of a pharmaceutical factory or healthcare products factory with a GMP certification, to enable Tieli XiaoXingAnling to rapidly initiate production of forest frog derivative products. |
Management intends to pursue a variety of sources for the funds required for those capital investments, offering both debt and equity. At the present time, however, no commitment for funds has been received from any source.
Off-Balance Sheet Arrangements
Neither China SXAN Biotech nor Tieli XiaoXingAnling has any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on their financial condition or results of operations.
Risk Factors That May Affect Future Results
You should carefully consider the risks described below before buying our common stock. If any of the risks described below actually occurs, that event could cause the trading price of our common stock to decline, and you could lose all or part of your investment.
Because we are expanding the scope of our operations, unexpected factors may hamper our efforts to implement our business plan.
Until recently, all of our business consisted of the sale of hasma – raw forest frog fatty tissues. We are currently expanding our business operations to include products enriched with hasma, as well as tonics and wines made from hasma. This expansion will involve
us in much broader marketing operations. It will also entail much more complex production operations. Because these are areas in which we have limited experience, problems may occur with production or marketing that we have not anticipated, which would interfere with our business, and prevent us from achieving profitability.
The capital investments that we plan for the next two years may result in dilution of the equity of our present shareholders.
Our business plan contemplates that we will invest approximately 85 million RMB in our business during the next two years. We will raise the funds for that investment primarily by selling equity in our company. At present we have no commitment from any source for those
funds. We cannot determine, therefore, the terms on which we will be able to raise the necessary funds. It is possible that we will be required to dilute the value of our current shareholders’ equity in order to obtain the funds. If, however, we are unable to raise the necessary funds, our growth will be limited, as will our ability to compete effectively.
Competition could prevent us from achieving a significant market position.
There are currently over 5,000 brands of medicinal tonics being sold in China. The struggle to gain brand recognition is complicated by the lack of government regulation of health claims. In order to achieve substantial market presence, we will have to distinguish our brand
from all of the others. In addition, if we are successful in establishing a strong market for our products, other large, well-capitalized nutraceutical companies could be attracted by our success we achieve, and develop similar products. If a well-capitalized company directed its financial strength toward competition with us, it could achieve economies of scale that might permit it to market its products at lower prices than ours. If this occurred before we had established a significant
market awareness of our brand, we might be unable to compete effectively, and would be unable to achieve profitability.
A recession in China could significantly hinder our growth.
The growing demand for our products has been swelled, in large part, by the recent dramatic improvement in the standard of living in China. The continued growth of our market will depend on continuation of recent improvements in the Chinese economy and the amount of disposable income
available to the Chinese population. If the Chinese economy were to contract and money became tight, individuals will be less able to pay premium prices for the benefits of forest frog hasma. Many financial commentators expect a recession to occur in China in the near future. The occurrence of a recession could significantly hinder our efforts to implement our business plan.
We are subject to the risk of disease and natural disasters.
Our business involves the production of livestock. We have not developed alternative sources for raw materials. If our forest frogs or, to a lesser extent, our pigs, become diseased, we could suffer a significant loss of value. In addition, if our farms are damaged
by drought, flood, storm, or the other woes of farming, we will not be able to meet the demand for our products, and are likely to suffer operating losses. Such events could have both an immediate negative effect on our financial results, as well as a long-term negative effect on our ability to grow our business.
Our business and growth will suffer if we are unable to hire and retain key personnel that are in high demand.
Our future success depends on our ability to attract and retain highly skilled scientists, geneticists, agricultural manufacturing specialists, and marketing personnel. In general, qualified individuals are in high demand in China, and there are insufficient experienced personnel
to fill the demand. In a specialized scientific field, such as ours, the demand for qualified individuals is even greater. If we are unable to successfully attract or retain the personnel we need to succeed, we will be unable to implement our business plan.
We may have difficulty establishing adequate management and financial controls in China.
The People’s Republic of China has only recently begun to adopt the management and financial reporting concepts and practices that investors in the United States are familiar with. We may have difficulty in hiring and retaining employees in China who have the experience necessary
to implement the kind of management and financial controls that are expected of a United States public company. If we cannot establish such controls, we may experience difficulty in collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet U.S. standards.
Government regulation may hinder our ability to function efficiently.
The national, provincial and local governments in the People’s Republic of China are highly bureaucratized. The day-to-day operations of our business require frequent interaction with representatives of the Chinese government institutions. The effort to obtain the
registrations, licenses and permits necessary to carry out our business activities can be daunting. Significant delays can result from the need to obtain governmental approval of our activities. These delays can have an adverse effect on the profitability of our operations. In addition, compliance with regulatory requirements applicable to livestock farming and production may increase the cost of our operations, which would adversely affect our profitability.
Capital outflow policies in China may hamper our ability to pay dividends to shareholders in the United States.
The People’s Republic of China has adopted currency and capital transfer regulations. These regulations require that we comply with complex regulations for the movement of capital. Although Chinese governmental policies were introduced in 1996 to allow the convertibility of RMB into foreign
currency for current account items, conversion of RMB into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of the State Administration of Foreign Exchange. We may be unable to obtain all of the required conversion approvals for our operations, and Chinese regulatory authorities may impose greater restrictions on the convertibility of the RMB in the future. Because most of our future revenues will be in RMB, any inability to obtain the requisite
approvals or any future restrictions on currency exchanges will limit our ability to pay dividends to our shareholders.
Currency fluctuations may adversely affect our operating results.
Tieli XiaoXingAnling generates revenues and incurs expenses and liabilities in Renminbi, the currency of the People’s Republic of China. However, as a subsidiary of China SXAN Biotech, it will report its financial results in the United States in U.S. Dollars. As a
result, our financial results will be subject to the effects of exchange rate fluctuations between these currencies. From time to time, the government of China may take action to stimulate the Chinese economy that will have the effect of reducing the value of Renminbi. In addition, international currency markets may cause significant adjustments to occur in the value of the Renminbi. Any such events that result in a devaluation of the Renminbi versus the U.S. Dollar will have
an adverse effect on our reported results. We have not entered into agreements or purchased instruments to hedge our exchange rate risks.
We have limited business insurance coverage.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products, and do not, to our knowledge, offer business liability insurance. As a result, we do not have any business liability insurance coverage for our operations.
Moreover, while business disruption insurance is available, we have determined that the risks of disruption and cost of the insurance are such that we do not require it at this time. Any business disruption, litigation or natural disaster might result in substantial costs and diversion of resources.
China SXAN Biotech is not likely to hold annual shareholder meetings in the next few years.
Management does not expect to hold annual meetings of shareholders in the next few years, due to the expense involved. The current members of the Board of Directors were appointed to that position by the previous directors. If other directors are added to the Board in the
future, it is likely that the current directors will appoint them. As a result, the shareholders of China SXAN Biotech will have no effective means of exercising control over the operations of China SXAN Biotech.
ITEM 3. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as of March 31, 2008. Pursuant to Rule13a-15(e) promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, “disclosure controls and procedures”
means controls and other procedures that are designed to insure that information required to be disclosed by China SXAN Biotech in the reports that it files with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time limits specified in the Commission’s rules. “Disclosure controls and procedures” include, without limitation, controls and procedures designed to insure that information China SXAN Biotech is required to disclose in the
reports it files with the Commission is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure. Based on his evaluation, our Chief Executive Officer and Chief Financial Officer concluded that China SXAN Biotech’s system of disclosure controls and procedures was effective as of March 31, 2008 for the purposes described in this paragraph.
Changes in Internal Controls.
There was no change in internal controls over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act or 1934) identified in connection with the evaluation described in the preceding paragraph that occurred during China SXAN Biotech’s third fiscal quarter that has materially affected or is reasonably
likely to materially affect China SXAN Biotech’s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(c) Unregistered sales of equity securities
None.
(e) Purchases of equity securities
The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the 3rd quarter of fiscal 2008.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits