10QSB 1 fm10qsb_63006.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2006 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from__________to__________. Commission File No. 0-27929 ETERNAL TECHNOLOGIES GROUP, INC. ----------------------------------------- (Exact name of registrant as specified in its charter) Nevada 62-1655508 ------------------------- --------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) Sect. D, 5/F, Block A. Innotech Tower, 235 Nanjing Rd. Heping District, Tianjin 300052 ---------------------------------------- (Address of principal executive offices) 011-86-22-2721-7020 ------------------ (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO _ As of August 20 2006, 40,567,300 shares of Common Stock of the issuer were outstanding. TABLE OF CONTENTS ETERNAL TECHNOLOGIES GROUP, INC. Part I. Financial Information Item 1. Financial Statements Unaudited Consolidated Condensed Balance Sheets at June 30, 2006 and 3 December 31, 2005 Unaudited Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2006 and 2005 4 Unaudited Consolidated Condensed Statements of Cash Flows for the six months ended June 30, 2006 and 2005 5 Notes to the Unaudited Consolidated Condensed Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Controls and Procedures 12 Part II. Other Information Item 1. Legal Proceedings 14 Item 2. Changes in Securities and Small Business Issuer Purchases of Equity Securities 14 Item 3. Defaults Upon Senior Securities 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 5. Other Information 14 Item 6. Exhibits 14 Signatures 15
Part I. Financial Information Item 1. Financial Statements ETERNAL TECHNOLOGIES GROUP, INC. UNAUDITED CONSOLIDATED CONDENSED BALANCE SHEETS June 30, 2006 and December 31, 2005 (Amounts in United States Dollars) ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- June 30, December 31, 2006 2005 ------------------ ------------------ ------------------ ------------------ ASSETS Current assets: Cash and Cash equivalents $ 27,186,142 $ 18,224,488 Short-term investments 9,991,882 9,909,084 Accounts receivable 974,208 7,137,018 Inventories 116,153 135,341 Prepayments and deposits 635,097 257,624 ------------------ ------------------ ------------------ ------------------ Total current assets 38,903,482 35,663,555 Advances to distributors 774,371 520,227 Property and equipment, net of accumulated depreciation 7,049,181 7,317,502 Land use rights, net of accumulated amortization 4,739,640 4,828,051 Intangible assets 1,199,026 1,263,409 ------------------ ------------------ ------------------ ------------------ Total assets $ 52,665,700 $ 49,592,744 ================== ================== ================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes Payable and convertible debt $ 443,366 $ 443,366 Accounts payable and accrued liabilities 822,441 706,717 Amounts due to related parties 101,174 240,368 Income taxes payable 115,318 - Derivative financial instrument liability 273,783 562,830 ------------------ ------------------ ------------------ ------------------ Total current liabilities 1,756,082 1,953,281 ------------------ ------------------ Commitments and contingencies: Stockholders' equity: Preferred shares - $0.001 par value, 5,000,000 authorized, none issued or outstanding - - Common shares - $0.001 par value; 95,000,000 authorized; 40,567,300 and 39,854,026 shares issued and outstanding at June 30, 3006 and December 31, 2005, respectively 40,567 39,854 Additional paid - in capital 13,636,496 13,217,874 Subscription receivable (10,176) (10,176) Retained earnings 35,415,240 33,215,741 Accumulated other comprehensive income 1,827,491 1,176,170 ------------------ ------------------ ------------------ ------------------ Total stockholders' equity 50,909,618 47,639,463 ------------------ ------------------ Total liabilities and stockholders' equity $ 52,665,700 $ 49,592,744 ================== ================== ================== ==================
The accompanying notes are an integral part of these unaudited consolidated condensed financial statements ETERNAL TECHNOLOGIES GROUP, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS For the Three Months and Six Months Ended June 30, 2006 and 2005 (Amounts in United States Dollars) --------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------- Three Months Ended June 30, Six Months Ended June 30, -------------------------------- -------------------------- -------------------------------- 2006 2005 2006 2005 -------------- -------------- ------------ ------------ -------------- -------------- ------------ (Restated) (Restated) Sales $ 10,370,137 $ 10,123,668 $ 14,586,496 $ 12,232,415 Cost of sales 7,594,579 7,471,350 10,384,268 9,037,784 -------------- -------------- -------------- ------------- Gross profit 2,775,558 2,652,318 4,202,228 3,194,631 Depreciation and amortization 266,040 190,168 530,986 380,335 Selling, general and administrative expenses 913,881 475,655 1,314,530 908,887 -------------- -------------- -------------- ------------- -------------- -------------- -------------- ------------- Income from operations 1,595,637 1,986,495 2,356,712 1,905,409 -------------- -------------- -------------- ------------- Other income (expense) Interest income 48,109 47,853 88,837 96,695 Interest expense - (54,761) - (54,761) Change in value of derivative financial instruments 117,435 (104,012) (104,214) (117,483) -------------- -------------- -------------- ------------- -------------- -------------- -------------- ------------- Other income (expense), net 165,544 (110,920) (15,377) (75,549) -------------- -------------- -------------- ------------- Income before provision for income taxes 1,761,181 1,875,575 2,341,335 1,829,860 Provision for income taxes 102,481 - 141,836 - -------------- -------------- -------------- ------------- Net income $ 1,658,700 $ 1,875,575 $ 2,199,499 $ 1,829,860 ============== ============== ============== ============= Net income per common share basic and diluted $ 0.04 $ 0.06 $ 0.05 $ 0.06 ============== ============== ============== ============= ============== ============== ============== ============= Weighted average number of common shares outstanding, basic and diluted 40,567,300 30,679,630 40,321,041 30,679,630 ============== ============== ============== ============ ============== ============== ============== ============
The accompanying notes are an integral part of these unaudited consolidated condensed financial statements. ETERNAL TECHNOLOGIES GROUP, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 2006 and 2005 (Amounts in United States Dollars) ---------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------- 2006 2005 ---------------- ---------------- ---------------- (Restated) Cash flows from operating activities Net income $ 2,199,499 $ 1,829,860 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 530,986 380,335 Common stock issued for service - 134,261 Change in value of derivative financial instruments 104,214 172,244 Changes in operating assets and liabilities: Inventories 20,553 (571,734) Accounts receivable 6,234,810 (9,023,668) Prepayments and deposits (374,874) - Accounts payable and accrued expenses 69,152 597,497 Account payable to related parties (141,619) 104,879 -------------- ---------------- -------------- ---------------- Net cash provided by operating activities 8,642,721 (6,376,326) -------------- ---------------- -------------- ---------------- Cash flows from investing activities: Advances to distributors (249,796) - -------------- ---------------- -------------- ---------------- Net cash provided by investing activities (249,796) - -------------- ---------------- -------------- ---------------- Cash flows from financing activities: Capital contributed - 232,812 -------------- ---------------- -------------- ---------------- Net cash provided by financing activities - 232,812 -------------- ---------------- -------------- ---------------- Effect of exchange rate changes on cash 568,729 - -------------- ---------------- Net increase (decrease) in cash and cash equivalents 8,961,654 (6,143,514) Cash and cash equivalents, beginning of period 18,224,488 27,473,354 -------------- ---------------- Cash and cash equivalents, end of period $ 27,186,142 $ 21.329.840 ============== ================ Supplemental disclosure of cash flow information: Interest Paid $ - $ - ================ ================ ================ ================ Tax paid $ 26,518 $ - ================ ================ ================ ================
The accompanying notes are an integral part of these unaudited consolidated condensed financial statements ETERNAL TECHNOLOGIES GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Amounts in United States Dollars) -------------------------------------------------------------------------------- 1. Background and Critical Accounting Policies Pursuant to an exchange agreement, Eternal Technologies Group, Inc., ("Company") formerly known as Waterford Sterling Corporation, completed its acquisition of 100% interest of Eternal Group Limited and Subsidiaries on December 12, 2002. The Company has treated the transaction as a reverse merger for accounting purposes. Following the acquisition, the former shareholders of Eternal Technology Group Limited, a British Virgin Islands limited liability company, now owns approximately 85% of the issued and outstanding common shares of Eternal Technologies Group Inc. Eternal Phoenix Company Limited was incorporated in the British Virgin Islands with limited liability on March 3, 2000. Pursuant to a resolution passed on June 17, 2000 Eternal Phoenix Company Limited changed its name to ETERNAL TECHNOLOGY GROUP LTD., ("Eternal"). Eternal is a holding company for investments in operating companies. Eternal acquired 100% of Willsley Company Limited ("Willsley"), a company incorporated in the British Virgin Island with limited liability on May 16, 2000. Willsley's principal activity is investments and owns 100% interest in Inner Mongolia Aershan Agriculture & Husbandry Technology Co., Ltd ("Aershan"). Aershan was incorporated in the People's Republic of China ("the PRC") with limited liability on July 11, 2000 and its principal activities are to run a breeding center, transplant embryos, and to propagate quality meat sheep and other livestock breeds in Inner Mongolia. E-Sea Biomedical Engineering Co. International Ltd. was incorporated on October 20, 2004 under the laws of the British Virgin Islands. (E-Sea) E-Sea owns all of the issued and outstanding stock of E-Sea Shenzhen which owns a Chinese patent for dialysis technology and produces and markets a series of instruments for detecting breast disease specifically breast cancer by applying its image processing technology. E-Sea was acquired as of the close of business on September 30, 2005. Inventory Livestock inventories that are purchased for embryo transplanting, resale, or meat processing are recorded at historical cost. Estimated costs of raised livestock prior to use for embryo transplanting, sale, or meat processing are accumulated and capitalized as inventory at the balance sheet date. Embryo inventories are recorded at historical cost. Inventories are measured at lower of cost and net realizable value using the first-in first-out ("FIFO") or weighted average cost formulas. The Company performs a quarterly review of its inventory to identify slow moving, obsolete or otherwise impaired inventory. The identification process includes historical performance of the inventory, current operational plans for the inventory, as well as industry and customer specific trends. If actual results differ from management expectations with respect to the selling of inventories at amounts equal to or greater than their carrying amounts, an adjustment to inventories would be made. Land Lease Rights and Amortization Land lease rights in Mainland China were stated at the amount of the prepayment less accumulated amortization. Amortization of land lease rights was calculated on the straight-line basis over the term of the lease of approximately 25 years. The land lease rights with respect to the Company's farm were originally purchased from the Chinese government for $6,000,000 and such rights extend through 2025. The farm is located in Wulagai Development Area in Inner Mongolia. Foreign Currency Translation The Company's reporting currency is the US$. The Company maintains no material accounts in currency of the United States of America. All of the subsidiaries maintain their books and accounts in the People's Republic of China currency, which is called Renminbi ("RMB"). Translation of the balance sheet amounts from RMB into US$ has been made at the single rate of exchange on June 30, 2006 and December 31, 2005, of 8.01 and 8.07 RMB/US$, respectively. The income statement has been translated at the average rate of exchange in effect during the period of 8.04 RMB/US$ and 8.3 RMB/US$ for the six months ended June 30, 2006 and 2005, respectively. No representation is made as to whether the RMB amounts could have been, or could be, converted into US$ at that rate on June 30, 2006 or 2005 or at any other date. The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People's Bank of China. Approval of foreign currency payments by the Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents and signed contracts. On July 21, 2005, China effectively revalued its currency by removing its "peg" against the U.S. dollar at 8.3:1 and measuring it against a basket of currencies of which the U.S. dollar is only one. ETERNAL TECHNOLOGIES GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Amounts in United States Dollars) -------------------------------------------------------------------------------- 1. Background and Critical Accounting Policies, continued Revenue Recognition In accordance with Staff Accounting Bulletin No. 104 (SAB 104), revenue from the sale of livestock, embryos, and raw materials is recognized when persuasive evidence of an arrangement exists; the price to the buyer is fixed or determinable; the merchandise is delivered to the customer and title passes; and collectibility is reasonably assured. Stock-Based Compensation Stock compensation expense for stock granted to non-employees has been determined in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and the Emerging Task Force consensus in Issue No. 96-18, "Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in conjunction with Selling Goods or Services ("EITF 96-18"), as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. Effective January 1, 2006 the Company adopted the revision to SFAS 123 ("SFAS 123R"), "Share-Based Payment", that focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions utilizing the modified prospective method. This statement replaces SFAS 123, "Accounting for Stock-Based Compensation", and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". SFAS 123R requires companies to expense the fair value of employee stock options and similar awards. Use of Estimates The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Recent Accounting Pronouncements In November 2004, FASB issued SFAS No. 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4" (SFAS No. 151). SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal" as stated in ARB No. 43. The adoption of SFAS No. 151 during the first quarter of 2006 had no material impact on the Company's consolidated financial position, results of operations. 2. Condensed Financial Statements and Footnotes The interim consolidated financial statements presented herein have been prepared by the Company and include the unaudited accounts of the Company and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in the consolidation. These condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-QSB and Item 310 (b) Regulation S-B. Certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes the disclosures made are adequate to make the information presented not misleading. The condensed consolidated financial statements should be read in conjunction with the Company's consolidated financial statements for the year ended December 31, 2005 and notes thereto included in the Company's Form 10-KSB. In the opinion of management, the unaudited consolidated condensed financial statements reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position of the Company as of June 30, 2006, the results of operations for the three and six months ended June 30, 2006 and 2005, respectively. Interim results are not necessarily indicative of full year performance because of the impact of seasonal and short-term variations. 3. Cash and Cash Equivalents At June 30, 2006, the Company maintains bank accounts in the PRC of approximately $27,186,142. 4. Notes Payable The Company's promissory notes payable are in default at June 30, 2006 and 2005 and the holder of the notes has filed suit for payment of the notes. The Company believes it has meritorious defenses to the lawsuit related to the notes. ETERNAL TECHNOLOGIES GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Amounts in United States Dollars) -------------------------------------------------------------------------------- 5. Income Taxes The companies operate in several jurisdictions and may be subject to taxation in those jurisdictions. It is management's intention to reinvest all the income attributable to the Company earned by its operations outside of the United States of America. Accordingly, no United States corporate taxes have been provided in these consolidated financial statements. The Company has a U.S. net operating loss carry forward of approximately $2,300,000 expire in years between 2022 and 2025. However a valuation allowance has been provided as management does not expect the tax benefits to be realized. No other significant deferred assets or liabilities existed at December 31, 2005. The Company's net operating loss carry forwards may be subject to annual limitations, which could reduce or defer the utilization of the losses as a result of an ownership change as defined in section 382 of the Internal Revenue Code. Under current law of the British Virgin Islands (BVI), any dividends and capital gains arising from the Company's investments are not subject to income tax in the British Virgin Islands. Companies with operations in the Peoples Republic of China may be subject to taxes for income therein. The Income Tax Law of the Peoples Republic of China for Enterprises with Foreign Investment and Foreign Enterprises provide certain exemptions from taxation. Under current PRC law, Aershan is exempt from taxation as Aershan's operations currently benefit from a tax holiday. The tax holiday, granted by Xilingol League, which is the local government, and the central PRC government, commenced on the incorporation of Inner Mongolia Aershan Agriculture and Husbandry Technology Co., Ltd., in July 2000. The Company has benefited from this holiday since inception and anticipates that the holiday will extend through July 2008. The tax holiday resulted in tax savings that account for substantially the entire difference between the income tax provision that would be expected using United States federal statutory tax rates and the tax provision of zero for the three and six months ended June 30, 2005. The tax provision for the corresponding period of the current year were $102,481and $ 141,836 respectively, all from the business activities of E-Sea. 6. Contingencies In conjunction with certain subscription agreements entered into during 2003, the Company has agreed to register the shares issued under a Form SB-2 registration statement. There were penalties for not timely meeting filing and effectiveness deadlines, and the Company received claims related to these penalties. On May 24, 2005 the Company issued convertible notes, allowing for conversion of the penalty to the Company's common stock, to the holders of the subscription agreements who accepted settlement. One subscription agreement holder elected to not accept a convertible note and is pursuing legal action as discussed in Part II, Item 1. The Company's operations are conducted in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC economy. The Company's operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. 7. Related Party Transactions During the three and six months ended the Company engaged in various transactions with related parties as follows: -------------------------------------------------------------------------------- Three Months Ended June 30, Six Months Ended June 30, ------------------------------ --------------------------------- ------------------------------ 2006 2005 2006 2005 -------------- -------------- -------------- ---------------- Common stock sold by officer/director with proceeds contributed to the Company for payment of operating expenses $ - $ 50,435 $ - $ 232,812
ETERNAL TECHNOLOGIES GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Amounts in United States Dollars) -------------------------------------------------------------------------------- 8. Segment Reporting The operating segments presented are the segments for which separate financial information is available and for which operating performance is evaluated regularly by management to decide how to allocate resources and in to assess performance. The Company evaluates the performance of the operating segments based on income from operations that is defined as total revenues less operating expenses. The Company has identified two reportable segments: agricultural genetics and medical devices. The agricultural genetics segment activities include a breeding center, embryo-transplantation, and propagating quality sheep meat and other livestock breeds in Inner Mongolia, PRC. Medical devices' operations include the manufacture, development, sales, marketing and delivery of medical devices in the PRC. Included in "Other" are corporate-related items, insignificant operations and costs that are not allocated to the reportable segments. Information regarding our reportable segments for the six months ended June 30, 2006 and 2005, is as follows: Agricultural Medical Genetics Devices Corporate Total ---------------- ---------------- ---------------- ---------------- 2006 ------------------------------------- ------------------------------------- Revenues $ 12,522,328 $ 2,064,168 $ - $ 14,586,496 Income from operations 2,022,248 944,726 (610,262) 2,356,712 Depreciation and amortization 394,855 136,131 - 530,986 Total assets 46,668,036 5,985,406 12,258 52,665,700 2005 ------------------------------------- ------------------------------------- Revenues $ 12,232,415 $ - $ - $ 12,232,415 Income (loss) from operations 2,285,875 - (380,466) 1,905,409 Depreciation and amortization 380,335 - - 380,335 Total assets 43,553,836 - - 43,553,836 Information regarding our reportable segments for the three months ended June 30, 2006 and 2005, is as follows: Agricultural Medical Genetics Devices Corporate Total ---------------- ---------------- ---------------- ---------------- 2006 ------------------------------------- ------------------------------------- Revenues $ 8,913,757 $ 1,456,381 $ - $ 10,370,137 Income from operations 1,423,849 685,213 (513,425) 1,595,637 Depreciation and amortization 197,834 68,206 - 266,040 Total assets 46,668,036 5,985,406 12.258 52,665,700 2005 ------------------------------------- ------------------------------------- Revenues $ 10,370,137 $ - $ - $ 10,123,668 Income (loss) from operations 2,137,165 - (150,670) 1,986,495 Depreciation and amortization 190,168 - - 190,168 Total assets 43,553,836 - - 43,553,836
ETERNAL TECHNOLOGIES GROUP, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Amounts in United States Dollars) -------------------------------------------------------------------------------- 9. Non-Cash Investing and Financing During the three and six months ended the Company engaged in various transactions with related parties as follows: -------------------------------------------------------------------------------- Three Months Ended June 30, Six Months Ended June 30, ------------------------------ ----------------------------- ------------------------------ 2006 2005 2006 2005 -------------- -------------- ------------- ------------- Common stock issued to convert debt $ 52,262 - $ 419,335 -
10. Restatement The accompanying June 30, 2005 financial statements have been restated to properly account for derivative financial instruments associated with convertible debt. Following is the impact of the restatement: As Originally Filed 2005 ------------------------------------ ------------------------------------ Current assets $ 33,085,482 Total assets 43,553,836 Current liabilities 2,999,563 Common stock subject to registration right penalties - Stockholders' equity 40,554,255 Revenues 10,123,668 Gross profit 2,652,318 Income from operations 1,986,495 Other income and expenses (6,908) Net income 1,979,587 Basic and diluted earnings per share 0.06 As Restated 2005 ------------------------------------ ------------------------------------ Current assets $ 33,085,482 Total assets 43,553,836 Current liabilities 3,434,704 Common stock subject to registration right Penalties 91,675 Stockholders' equity 40,138,225 Revenues 10,123,668 Gross profit 2,652,318 Income (loss) from operations 1,986,495 Other income and expenses (110,920) Net income 1,875,575 Basic and diluted earnings per share 0.06 Item 2. Management's Discussion and Analysis or Plan of Operation The Company's business is seasonal. Accordingly, the results of operations for the three and six month periods ended June 30, 2006 are not indicative of the results for any other quarter, period or for the fiscal year. The following is derived from, and should be read in conjunction with, our unaudited consolidated condensed financial statements, and related notes, as of and for the three and six months ended June 30, 2006 and 2005. Three Months Ended June 30, 2006 Compared to Three months Ended June 30, 2005 Revenues Revenues for the three months ended June 30, 2006 increased by $246,469 or 2.4% to $10,370,137 from $10,123,668 for the corresponding period of the prior year. This increase resulted from an increase in sheep embryo transfer revenue of $1,346,155, and the inclusion of E-Sea's sales of $1,458,099. These amounts were offset by decrease in cattle embryo transfers of $656,104, a decrease in the sale of sheep of $231,437 and a decrease in the sales of roll mutton of $1,645,320. Cost of Sales Cost of sales for the three months ended June 30, 2006 increased by $123,229 or 1.6% to $7,594,579 from $7,471,350 for the corresponding period of the prior year. This increase resulted from a 2.4% increase in sales. The gross profit margin from cattle embryo transfers was 27%, gross profit margin from sheep embryo transfers was 8.3%, the gross profit margin from the sale of roll mutton was 19.7% and on the gross margin on the sale of E-Sea products was 55.5%. Depreciation and Amortization Depreciation and amortization expenses increased by $75,872 or 39.9% to $266,049 from $190,168 for the corresponding period of the prior year. This increase is attributable to the acquisition of E-Sea. Selling and Administrative Expenses Selling and administrative expenses increased by $438,226 or 82.6% to 913,881 from $530,416 for the corresponding period of the prior year. This increase resulted primarily from an increase in professional fees, but also included an increase in salaries of $85,893 related to board approved changes in employees salaries and an increase in public relation fees of $72,917. Other Income (Expense) For the three months ended June 30, 2006 the company experienced a small increase of $256 in other income (interest) to $48,109 from $47,853 for the corresponding period of the prior year. The increase is attributable to an increase in balances on deposit. For the three months ended June 30, 2006 the company had a positive change in the value of derivative instruments of $117,435. For the three months ended June 30, 2005 the company had a negative change in the value of derivative instruments of $104,012. For the three months ended June 30, 2006, the Company provided taxes on its income from its E-Sea operations. The remained of the Company's income is from agricultural activities and benefits from a tax holiday. Since E-Sea was not part of the affiliated group as of June 30, 2005, there was no provision for income taxes for the corresponding period of the prior year. As a result of the foregoing, the company had net income of $1,658,700 or $.05 per share for the three months ended June 30, 2006 compared to net income of $1,875,575 or $.06 per share for the corresponding period of the prior year. Six Months Ended June 30, 2006 As Compared to Six Months Ended June 30, 2005 Revenues Revenues for the six months ended June 30, 2006 increased by $2,354,081 or 19.2% to $14,586,496 from $12,232,415 for the corresponding period of the prior year. This increase is primarily attributable to the addition of E-Sea, which generated revenues of $2,064,168. Cost of Sales Cost of sales for the six months ended June 30, 2006 increased by $1,346,484 or 14.9% to $10,384,268 from $8,037,784 for the corresponding period of the prior year. This increase resulted from the addition of E-Sea, which had cost of sales of $787,612, and from changes in the sales mix of cattle embryo transfers, sheep embryo transfers and sales of roll mutton. Depreciation and Amortization Depreciation and amortization expenses increased by $150,651 or 39.6% to $530,986 from $380,335 for the corresponding period of the prior year. This increase is attributable to the acquisition of E-Sea. Selling and Administrative Expenses Selling and administrative expenses increased by $405,643 or 44% to $1,314,530 from $963,648 for the corresponding period of the prior year. This increase resulted primarily from an increase in professional fees, but also included an increase in salaries related to board approved changes in employees salaries and an increase in public relation fees. Other Income (Expense) For the six months ended June 30, 2005 the company experienced a decrease in other income of $60,172. This resulted from a decrease in interest expense of $54,761 the six-month period ended June 30, 2006 due to debt conversions. The Company provided taxes on its income from the E-Sea operations of $142,126 for the six-month ended June 30, 2006. E-Sea was not part of the affiliated group during the corresponding period of the prior year. As a result of the foregoing, the Company had net income of $2,199,499 or $.06 per share for the six months ended June 30, 2006 compared to net income of $1,829,860 or $.06 per share for the corresponding period of the prior year. Liquidity and Capital Resources As of June 30, 2006, the Company had cash and cash equivalents of $27,186,142 and working capital of $37,147,400. This compares with cash and cash equivalents of $18,224,488 and working capital of $33,710,274 as of December 31, 2005. Cash provided by operating activities totaled $8,642,721 for the six months ended June 30, 2006. This compares with cash used in operating activities of $6,376,326 for the corresponding period of the prior year. This $15,199,881 positive increase was almost entirely attributable to changes in trade receivables and the timing of collections. Cash used in investing activities was $249,796 for the six months ended June 30, 2006; however the Company used no cash in investing activities during the period ended June 30, 2005. All of the cash used in investing activities during the six months ended June 30, 2006 was for advances to product distributors. There was no cash provided from financing activities for the six months ended June 30, 2006. This compares with cash provided from financing activities of $232,812 for the six months ended June 30, 2005. The 2005 amount consists entirely of contributed capital. At June 30, 2006, the Company lists notes payable of $443,366. These notes are currently the subject of litigation where the Company is challenging their validity. The Company has cash and bank balances of $27,186,142 at June 30, 2006 and these balances are more than sufficient to cover its PRC operations. However, if the Company is to expand outside the PRC, as it anticipates doing, or pay its non-PRC obligation, it will have to sell additional shares of its stock or borrow funds from third parties. Unless the Company is able to either borrow funds or sell additional shares, it will have insufficient resources to carry out its business objectives outside the PRC for the next twelve (12) months. Item 3. Controls and Procedures We strive to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designated and operated, can provide only reasonable assurance of achieving the desired control objectives and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls. Our former independent accountants, Thomas Leger & Co. LLP conducted audits of our financial statements for 2002, 2003 and 2004. In connection with the issuance of its report of the independent registered public accounting firm, Thomas Leger & Co. LLP reported to our Board of Directors two material weaknesses under standards established by the Public Company Accounting Oversight Board regarding some elements of our system of internal controls. They noted the following material deficiencies: (i) The Company's reported financial statements relating to the acquisition of E-Sea Biomedical Engineering Co. International, Ltd. were indicative of a material weakness in controls over closing procedures and the accounting for non-routine transactions. We determined the Company lacked certain procedures and required expertise needed to properly account for non-routine transactions (such as acquisitions of other businesses) and preparation of its required financial statement disclosure in accordance with U.S. G.A.A.P. and SEC rules and regulations. (ii)The Company has restated its consolidated financial statements for the year-ended December 31, 2002 to reflect merger costs of $867,411 as post acquisition activity. The restatement is considered a material weakness over financial reporting as defined by the PCAOB. We have conducted a review of the errors requiring restatement, including a separate review by our board of directors to determine what remedial measures were necessary. We believe our management has taken or is in the process of taking the steps necessary to correct the errors and avoid similar errors in the future. One important measure is to have our President also become involved in the review of our internal controls and procedures. As required by SEC rule 13a-15(b) we conducted an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, President and Vice President of Finance, the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer, President and Vice President of Finance concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us (including our subsidiaries) required to be included in our periodic SEC filings. Our new independent accountants, Ham Langston & Brezina LLP conducted an audit of our financial statements for 2005. In connection with the issuance of its report to the Board of Directors, Ham, Langston & Brezina LLP reported two material weaknesses under standards established by the Public Company Accounting Oversight Board regarding some elements of our system of internal controls. They noted the following specific material deficiencies. (i) The Company lacked the required expertise needed to properly account for non-routine transactions (such as the acquisition of other businesses and preparation of its required financial statement disclosure in accordance with U.S.G.A.A.P. and SEC rules and regulations. (ii) The Company has restated its consolidated financial statements for the year-ended December 31, 2004 to reflect the accounting for derivatives. The restatement is considered a material weakness over financial reporting as defined by the PCAOB. Other than the foregoing initiatives, there were no significant changes in our internal controls or to our knowledge, in other factors that could significantly affect such internal controls subsequent to the date of their evaluation. While we have taken or are in the process of taking the foregoing steps in order to address the adequacy of our disclosure controls and procedures, and, in addition, to develop and implement a formal set of internal controls and procedures for financial reporting in accordance with SEC's proposed rules to adopt the internal control report requirements included in Section 404 of the Sarbanes-Oxley Act of 2002, the efficiency of the steps we have taken to date and the steps we are still in the process of completing is subject to continued management review supported by confirmation and testing by our internal and external auditors. As a result, it is likely that additional changes will be made to our internal controls. PART II. OTHER INFORMATION Item 1. Legal Proceedings. As of May 16, 2006, we were a party to one legal proceeding. The proceeding involves a lawsuit brought by Western Securities Corporation seeking payment of $500,942 on two outstanding promissory notes, one to Market Management, Inc. and one to Thomas L. Tedrow plus accrued interest since July 11, 2004, attorney's fees, cost of collection and other court costs. This cause of action was initially filed in Federal District Court in the Eastern District of Louisiana. The Company filed a Motion to Dismiss for lack of personal jurisdiction or alternatively a Motion to Dismiss for lack of venue. In October 2005, the Court granted the Company's motion for a change of venue and the case was moved to the Southern District Court of Texas in Houston, Texas. The Company believes that the case is without merit and the basis of the promissory note involves expenditures not made on the company's behalf. Furthermore, the Company has significant counterclaims that it plans to assert against Mr. Tedrow and Market Management, Inc.. The Company believes that this matter will be resolved during 2006 and that the Company will prevail on all counts. The State Court in New York dismissed a cause of action, filed by Bristol Investments Limited against the Company, on February 14, 2006. On March 30, 2006 without stating a new cause of action, Bristol Investments Limited re-filed the cause of action against the Company. As of August 20, 2006, there are no other causes of action pending against the Company. Item 2. Changes in Securities During the three month period ended June 30, 2005 there were no changes in securities. Item. 3. Defaults Upon Senior Securities None Item 4. Submissions of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits EXHIBIT NO. IDENTIFICATION OF EXHIBIT 31.1 Certification Pursuant to 18 U.S.C Section 1350, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification Pursuant to 18 U.S.C Section 1350, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification Pursuant to 18 U.S.C Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification Pursuant to 18 U.S.C Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Signatures Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto authorized. ETERNAL TECHNOLOGIES GROUP, INC. /s/ JIANSHENG WEI ------------------------------------- August 21, 2006 Jiansheng Wei, Chief Executive Officer /s/ ZHENG SHEN August 21, 2006 ------------------------------------- Zheng Shen, Chief Financial Officer CERTIFICATIONS EXHIBIT 31.1 Certification by Jiansheng Wei Pursuant to Securities Exchange Act Rule 13a-14(a) I, Jiansheng Wei, certify that: 1. I have reviewed this quarterlyl report on Form 10-QSB of Eternal Technologies Group, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 21, 2006 /s/ JIANSHENG WEI Jiansheng Wei Chief Executive Officer EXHIBIT 31.2 Certification by Zheng ShenPursuant to Securities Exchange Act Rule 13a-14(a) I, Zheng Shen, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of Eternal Technologies Group, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15-15(f) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 21, 2006 /s/ ZHENG SHEN Zheng Shen Chief Financial Officer EXHIBIT 32.1 Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350 For purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Jiansheng Wei, the Chief Executive Officer of Eternal Technologies Group, Inc. (the "Company"), hereby certifies that, to his knowledge: (i) the Quarterly Report on Form 10-QSB of the Company for the six months ended June 30, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report") fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (ii)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: August 21, 2006 /s/ JIANSHENG WEI Jiansheng Wei Chief Executive Officer EXHIBIT 32.2 Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350 For purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Zheng Shen, the chief financial officer of Eternal Technologies Group, Inc. (the "Company"), hereby certifies that, to his knowledge: (i) the Quarterly Report on Form 10-QSB of the Company for the six months ended June 30, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report") fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (ii)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: August 21, 2006 /s/ ZHENG SHEN Zheng Shen Chief Financial Officer