10-Q 1 tiens10q093005.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q |X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2005. or Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to . Commission File Number 0-49666 TIENS BIOTECH GROUP (USA), INC. (Exact name of registrant as specified in its charter) Delaware 75-2926439 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) No. 6, Yuanquan Road Wuqing New Tech Industrial Park Tianjin, China 301700 (Address of Principal Executive Offices including zip code) 011-86-22-8213-7658 (Registrant's Telephone Number, Including Area Code) 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 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 |_| There were 71,333,586 shares of the Registrant's Common Stock issued and outstanding on November 11, 2005. Indicate by check mark whether the registrant is an accelerated filer (as defined on Rule 12b-2 of the Exchange Act). Yes |_| No |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes |_| No |X| TIENS BIOTECH GROUP (USA), INC. Index to Form 10-Q Part I. Financial Information Item 1. Condensed Financial Statements (unaudited) Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 Consolidated Statements of Income and Other Comprehensive Income for the three months and the nine months ended September 30, 2005 and 2004 Consolidated Statements of Shareholders' Equity for the nine months ended September 30, 2005 and 2004 Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004 Condensed Notes to Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures Part II. Other Information Item 1. Legal Proceedings Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Item 3. Defaults Upon Senior Securities Item 4, Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits 2
PART I - FINANCIAL INFORMATION Item 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004 ASSETS ------ September 30 December 31 2005 2004 ------------ ------------ (Unaudited) (Audited) ------------ ------------ CURRENT ASSETS: Cash $ 52,006,277 $ 39,243,872 Accounts receivable - related parties, net of allowance for doubtful accounts of $31,145 at September 30, 2005 and $30,442 at December 31, 2004, respectively 5,313,533 6,058,021 Other receivables 32,108 529,036 Other receivables and note receivable - related parties 15,128,016 8,144,740 Inventories 9,059,319 4,567,418 ------------ ------------ Total current assets 81,539,253 58,543,087 ------------ ------------ BUILDINGS, EQUIPMENT AND AUTOMOBILES, net 24,387,551 20,200,806 ------------ ------------ OTHER ASSETS: Intangible assets, net 499,805 469,765 Employee advances 498,293 75,212 Deposits 5,760,974 4,230,063 ------------ ------------ Total other assets 6,759,072 4,775,040 ------------ ------------ Total assets $112,685,876 $ 83,518,933 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable $ 3,279,324 $ 1,791,019 Accounts payable - related parties 247,244 209,199 Advances from customers - related parties 742,956 673,349 Other taxes payable 1,357,539 623,113 Accrued liabilities 715,464 428,839 Other payable - related parties 1,349,833 945,274 Distribution payable to minority interest shareholder 3,084,796 -- Current portion of long term debt -- 155,442 ------------ ------------ Total current liabilities 10,777,156 4,826,235 NON-CURRENT LIABILITIES: Note payable - related party 10,657,742 10,657,742 ------------ ------------ Total liabilities 21,434,898 15,483,977 ------------ ------------ MINORITY INTEREST 7,274,290 7,512,057 ------------ ------------ SHAREHOLDERS' EQUITY: Common stock, $0.001 par value, 260,000,000 shares authorized, 71,333,586 issued and outstanding 71,334 71,334 Paid-in-capital 8,842,009 8,842,009 Statutory reserves 9,420,783 9,420,783 Retained earnings 63,605,883 42,200,940 Accumulated other comprehensive gain (loss) 2,036,679 (12,167) ------------ ------------ Total shareholders' equity 83,976,688 60,522,899 ------------ ------------ Total liabilities and shareholders' equity $112,685,876 $ 83,518,933 ============ ============
The accompanying notes are an integral part of this statement. -2-
TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 3 months ended September 30 9 months ended September 30 ---------------------------- ---------------------------- 2005 2004 2005 2004 (Unaudited) (Unaudited) (Unaudited) (Unaudited) ------------ ------------ ------------ ------------ REVENUE - RELATED PARTIES $ 19,126,809 $ 18,058,888 $ 50,730,467 $ 46,074,775 COST OF SALES 4,954,198 4,304,640 12,609,428 10,922,106 ------------ ------------ ------------ ------------ GROSS PROFIT 14,172,611 13,754,248 38,121,039 35,152,669 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,795,414 2,437,047 7,894,965 5,055,967 ------------ ------------ ------------ ------------ INCOME FROM OPERATIONS 11,377,197 11,317,201 30,226,074 30,096,702 OTHER (EXPENSE) INCOME, NET (126,969) 205,357 (814,133) 523,063 ------------ ------------ ------------ ------------ INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY INTEREST 11,250,228 11,522,558 29,411,941 30,619,765 PROVISION FOR INCOME TAXES 869,769 -- 2,315,214 -- ------------ ------------ ------------ ------------ INCOME BEFORE MINORITY INTEREST 10,380,459 11,522,558 27,096,727 30,619,765 MINORITY INTEREST 2,175,715 2,327,913 5,691,784 6,183,873 ------------ ------------ ------------ ------------ NET INCOME 8,204,744 9,194,645 21,404,943 24,435,892 OTHER COMPREHENSIVE INCOME Foreign currency translation adjustment 2,047,847 -- 2,048,846 -- ------------ ------------ ------------ ------------ COMPREHENSIVE INCOME $ 10,252,591 $ 9,194,645 $ 23,453,789 $ 24,435,892 ============ ============ ============ ============ Weighted average number of shares outstanding 71,333,586 71,872,975 71,333,586 71,957,327 ============ ============ ============ ============ Earnings per share, basic and diluted $ 0.14 $ 0.13 $ 0.33 $ 0.34 ============ ============ ============ ============
The accompanying notes are an integral part of this statement. -3-
TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 Number Common Paid-in Statutory of shares stock capital Reserve ------------- ------------- ------------- ------------- (Unaudited) (Unaudited) (Unaudited) (Unaudited) ------------- ------------- ------------- ------------- BALANCE December 31, 2003, audited 71,998,586 $ 71,334 $ 8,842,009 $ 3,730,137 Cancellation of shares (665,000) -- -- -- Net income -- -- -- -- Receipt of stock receivable -- -- -- -- ------------- ------------- ------------- ------------- BALANCE, September 30, 2004, unaudited 71,333,586 71,334 8,842,009 3,730,137 Net income -- -- -- -- Adjustment to statutory reserve -- -- -- 5,690,646 Foreign currency translation loss -- -- -- -- ------------- ------------- ------------- ------------- BALANCE, December 31, 2004, audited 71,333,586 71,334 8,842,009 9,420,783 Net income -- -- -- -- Foreign currency translation gain -- -- -- -- ------------- ------------- ------------- ------------- BALANCE, September 30, 2005, unaudited 71,333,586 $ 71,334 $ 8,842,009 $ 9,420,783 ============= ============= ============= ============= Accumulated other Retained Stock comprehensive earnings receivable income (loss) Totals ------------- ------------- ------------- ------------- (Unaudited) (Unaudited) (Unaudited) (Unaudited) ------------- ------------- ------------- ------------- BALANCE December 31, 2003, audited $ 20,453,290 $ (6,650) $ (3,928) $ 33,086,192 Cancellation of shares -- -- -- -- Net income 24,435,892 -- -- 24,435,892 Receipt of stock receivable -- 6,650 -- 6,650 ------------- ------------- ------------- ------------- BALANCE, September 30, 2004, unaudited 44,889,182 -- (3,928) 57,528,734 Net income 3,002,404 -- -- 3,002,404 Adjustment to statutory reserve (5,690,646) -- -- -- Foreign currency translation loss -- -- (8,239) (8,239) ------------- ------------- ------------- ------------- BALANCE, December 31, 2004, audited 42,200,940 -- (12,167) 60,522,899 Net income 21,404,943 -- -- 21,404,943 Foreign currency translation gain -- -- 2,048,846 2,048,846 ------------- ------------- ------------- ------------- BALANCE, September 30, 2005, unaudited $ 63,605,883 $ -- $ 2,036,679 $ 83,976,688 ============= ============= ============= =============
The accompanying notes are an integral part of this statement. -4-
TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 2005 2004 ------------ ------------ Unaudited Unaudited ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 21,404,943 $ 24,435,892 Adjustments to reconcile net income to cash provided by operating activities: Minority interest income 5,691,784 6,183,873 Depreciation 1,231,056 1,021,882 Amortization 66,493 35,823 (Gain) loss on sale of equipment (81,997) 61,009 (Increase) decrease in assets: Accounts receivable - related parties 598,697 (9,535,479) Other receivables 496,928 (243,888) Other receivables and note receivable - related parties (9,828,031) 6,756,857 Inventories (4,491,901) (993,589) Intangible assets (87,056) -- Employee advances (423,081) 749,199 Deposits (1,530,911) (170,308) Increase (decrease) in liabilities: Accounts payable 1,488,305 (577,187) Accounts payable - related parties 38,045 (758,570) Advances from customers - related parties 69,607 (5,141,661) Other taxes payable 734,426 117,755 Accrued liabilities 286,625 (21,721) Other payables - related parties 404,559 (309,566) ------------ ------------ Net cash provided by operating activities 16,068,491 21,610,321 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of equipment 25,380 65,129 Purchase of equipment (5,224,870) (1,508,242) ------------ ------------ Net cash used in investing activities (5,199,490) (1,443,113) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Decrease in stock receivable -- 6,650 Payments, net of borrowings on short term notes payable (155,442) (5,324,000) Borrowings on long term debt -- 10,477,942 ------------ ------------ Net cash (used in) provided by financing activities (155,442) 5,160,592 ------------ ------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH 2,048,846 -- ------------ ------------ INCREASE IN CASH 12,762,405 25,327,800 CASH, beginning of period 39,243,872 12,725,043 ------------ ------------ CASH, end of period $ 52,006,277 $ 38,052,843 ============ ============
The accompanying notes are an integral part of this statement. -5- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Background Tiens Biotech Group (USA), Inc. (the "Company" or "Tiens"), formerly known as Strategika, Inc. ("Strategika"), was incorporated on July 13, 1990 as Super Shops, Inc. in the State of Michigan. In October 2000, Super Shops, Inc. reincorporated in Delaware and changed its name to MIA Acquisition Corp., and subsequently to Strategika in February 2002. In August 2003, Strategika and Tianshi International, LI Jinyuan, JIAO Wenjun and YAN Yupeng, all Chinese Nationals who were stockholders of Tianshi International (the "Tianshi Stockholders") entered an Agreement and Plan of Reorganization (the "Agreement"), which was effective September 9, 2003 (the "Effective Date"). Pursuant to the Agreement, Strategika received from the Tianshi Stockholders all of the issued and outstanding common stock of Tianshi International, in exchange for the issuance by Strategika of 68,495,000 shares of its common stock to the Tianshi Stockholders, representing 95% of the issued and outstanding common stock of Strategika, giving effect to the issuance. As additional consideration, Rene Larrave, the sole officer and director of Strategika prior to the reorganization, contributed all of his Strategika common stock to Strategika without additional consideration. The purchase of Tianshi International and the issuance of Strategika common stock has been accounted for as a reverse acquisition presented as a recapitalization, except no goodwill or other intangible assets have been recorded. For accounting purposes, the original Tianshi International is considered the acquirer in the reverse acquisition. The historical financial statements are those of the original Tianshi International. Tianshi International was incorporated March 24, 2003, in the territory of the British Virgin Islands. On June 18, 2003, Tianshi International acquired 80% of Tianjin Tianshi Biological Development Co., Ltd ("Biological"). Biological is a Chinese-foreign equity joint venture company established under the laws of the PRC on March 27, 1997. Biological is subject to the Law on Sino Foreign Equity Joint Ventures ("Joint Venture Law"), its implementation regulations and other related rules and regulations ("Joint Venture Regulations"). Biological is an independent legal entity having the legal structure of a limited liability company, similar to a regular corporation with limited liability organized under state laws in the United States of America. The Articles of Association of Biological provides for a 50 year term with registered capital of $10,000,000. As an approved Chinese-foreign equity joint venture, Biological receives special income tax incentive treatment from both the local (Wuqing County) and central governments in China. The original partners in this joint venture were Tianshi Hong Kong International Development Co., Ltd. ("Tianshi Hong Kong") incorporated in Hong Kong which owned 80% of the joint venture, and Tianshi Engineering, which owned the remaining 20% of Biological. Tianshi Hong Kong is owned 100% by LI Jinyuan. Tianshi Engineering is 49% owned by Ms. Li Baolan and 51% by Tianshi Group. In June 2003, Tianshi Engineering transferred its 20% interest in Biological for no consideration to Tianshi Pharmaceuticals and Tianshi International acquired 80% of Biological from Tianshi Hong Kong for no consideration. This transfer was made for no consideration, since LI Jinyuan is president and sole shareholder of both companies. -6-
TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Background, (continued) As result of the above transactions, Tianshi International is now a wholly owned subsidiary of the Company and Biological remained as a 80% owned subsidiary of Tianshi International. The summary of Tiens' organization is described as follows: Tiens is owned 4.91% by public stockholders, 2.8% by officers and 92.29% by Mr. Li Jinyuan. Tiens owns 100% of Tianshi International. Tianshi International owns 80% of Biological and 99.4% of Tiens Yihai. Tianshi Group is owned 90% by Mr. Li Jinyuan and 10% by his daughter, Ms. Li Baolan. Tianshi Group owns 87.66% of Tianshi Pharmaceuticals and 51% of Tianshi Engineering. Tianshi Pharmaceuticals owns 20% of Biological and 0.6% of Co., Ltd. ("Tiens Yihai"). Ms. Li Baolan owns 49% of Tianshi Engineering and 7.29% of Tianshi Pharmaceuticals. Tianjin Feishi Transportation Co., Ltd. owns 5.05% of Tianshi Pharmaceuticals. Note 2 - Summary of significant accounting policies The reporting entity -------------------- The financial statements in the Strategika filings became those of Tiens. The consolidated financial statements of Tiens reflect the activities of the following Company subsidiaries: Percent Subsidiary Of Ownership ------------------------------------------------------------------------ ------------ Tianshi International Holdings Group, Ltd British Virgin Islands 100.0% Tianjin Tianshi Biological Development Co., Ltd P.R.C. 80.0% Tiens Yihai Co. Ltd. P.R.C. 99.4%
Tianshi International is a corporation organized under the laws of the British Virgin Islands. Tianshi International is a holding company for Tiens 80% investment in Biological and its 99.4% investment in Tiens Yihai. Biological is a foreign investment joint venture which is incorporated under the laws of PRC. Biological is classified as a Foreign Investment Enterprise (FIE) in the PRC and is subject to the FIE laws of the PRC. Biological is a Chinese registered limited liability company with a legal structure similar to a regular corporation and a limited liability company organized under state laws in the United States of America. The Articles of Association provides for a 50 year term beginning on March 27, 1998 with registered capital of $10,000,000. -7- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 - Summary of significant accounting policies, (continued) The reporting entity, (continued) --------------------------------- Tiens Yihai Co. Ltd. (Tiens Yihai) is a foreign investment joint venture which is incorporated under the laws of PRC. Tiens Yihai is classified as a Foreign Investment Enterprise (FIE) in the PRC and is subject to the FIE laws of the PRC. Tiens Yihai is a Chinese registered limited liability company with a legal structure similar to a regular corporation and a limited liability company organized under state laws in the United States of America. The Articles of Association provides for a 50 year term beginning on May 27, 2004 with registered capital of $200,000,000. Tianshi International owns 80% of its subsidiary Biological and 99.4% of its subsidiary Tiens Yihai. The remaining 20% and 0.6% respectively are owned by Tianshi Pharmaceuticals whose majority shareholder is Tianshi Group. Nature of operations -------------------- The Company through its subsidiaries is primarily engaged in the manufacturing and marketing of wellness products, nutrition supplement products and personal care products. The Company sells its products to a sales force of related distributors who in turn sell to independent distributors and managers who resell them to other distributors or public consumers. The Company markets its products in China, South Korea, Japan, India, Thailand, Malaysia, Indonesia, Canada, Peru, Brazil, Russia, Kazakhstan, Belarus, Mongolia, Finland, Lithuania, Britain, Germany, France, Romania, Ukraine, Portugal, Turkey, Italy, Nigeria, Ghana, South Africa and Australia. Revenue recognition ------------------- The Company recognizes revenue from domestic sales by distributors in China, net of sales commissions and taxes only when the related Chinese distributor recognizes sales of the Company's products to unaffiliated third parties. The Company recognizes revenue from international sales (non-Chinese) to both affiliated and unaffiliated third parties, net of commissions and taxes as goods are shipped and clear review by the international customs department. The Company is generally not contractually obligated to accept returns. However, on a case by case negotiated basis, the Company permits customers to return their products. In accordance with SFAS No. 48, "Revenue Recognition when the Right of Return Exists", revenue is recorded net of an allowance for estimated returns. Such reserves are based upon management's evaluation of historical experience and estimated costs. The amount of the reserves ultimately required could differ materially in the near term from amounts included in the accompanying consolidated financial statements. In 2005 and 2004, Tianshi Engineering, a related company, owned all of the related party distributors which sell the Company's products domestically in China. -8- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 - Summary of significant accounting policies, (continued) Foreign currency translation ---------------------------- The reporting currency of the Company is the US dollar. Biological's and Tiens Yihai's financial records are maintained and the statutory financial statements are stated in its local currency, Renminbi (RMB), as their functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People's Bank of China at the end of each reporting period. This 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 People's Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate 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. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to $2,036,679 and $(12,167) as of September 30, 2005 and December 31, 2004, respectively. The balance sheet amounts with the exception of equity at September 30, 2005 were translated at 8.07 RMB to $1.00 USD as compared to 8.26 RMB at December 31, 2004. The equity accounts were stated at their historical rate. The average translation rate of 8.22 RMB for the nine months ended September 30, 2005 was applied to income statement accounts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. These amounts are not material to the consolidated financial statements. Income taxes ------------ The Company has adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consist of taxes currently due plus deferred taxes. There are no deferred tax amounts at September 30, 2005 and 2004. The charge for taxation is based on the results for the year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. -9- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 - Summary of significant accounting policies, (continued) Income taxes, (continued) ------------------------- In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized. Deferred tax is calculated at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis. The Company is subject to income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which each entity is domiciled. The Company's subsidiary, Tianshi International, was incorporated in the British Virgin Islands and is not liable for income taxes. The Company's subsidiaries, Biological and Tiens Yihai, are Sino-Foreign Joint Ventures incorporated in the People's Republic of China. Pursuant to the income tax laws of the PRC concerning Foreign Investment Enterprises and foreign Enterprises and various local income tax laws (the "Income Tax Law"), Sino-foreign joint venture enterprises generally are subject to income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income as reported in their statutory financial statements unless the enterprise is located in specially-designated regions or cities for which more favorable effective rates apply. Biological is located in Special Economic Zone and is subject to the special reduced income tax rate of 15%. Pursuant to the approval of the relevant PRC tax authorities, Biological is fully exempt from PRC income taxes for two years starting from the year profits are first made, followed by a 7.5% reduced tax rate for the next three years. Prior to the year ended December 31, 2002, Biological suffered operating losses. Biological started generating taxable profits in the year ended December 31, 2003. Effective January 1, 2005, the two-year 100% exemption for income taxes expired for Biological and it became subject to income tax at a reduced rate of 7.5%. Tiens Yihai is located in a Special Industry Zone and is subject to the special reduced income tax rate of 15%. Pursuant to the approval of the relevant local Chinese tax authorities, Tiens Yihai is fully exempt from PRC income taxes for two years starting from the year profits are first made, followed by a 15% reduced tax rate for the next three years. In addition, in order to encourage Tiens Yihai doing business in the special industry zone, the local Chinese tax authorities agreed to refund 50% of the total income tax after the five-year tax break. Tiens Yihai was established for the purposes of being in the business of research and development, production and marketing of healthcare, home care and personal care products. As of September 30, 2005, Tiens Yihai is in the developmental stage of its organization and did not have any operating income. -10- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 - Summary of significant accounting policies, (continued) Income taxes, (continued) ------------------------- The provision for income taxes for the nine months ending September 30 consisted of the following: 2005 2004 ------------ ------------ Provision for China Income Tax $ 2,315,214 $ -- ------------ ------------ Total provision for income taxes $ 2,315,214 $ -- ============ ============ The following table reconciles the U.S. statutory rates to the Company's effective tax rate: 2005 2004 ---------- ---------- U.S. Statutory rates 34.0% 34.0% Foreign income not recoginized in USA (34.0) (34.0) China income taxes 7.5 -- ---------- ---------- Total provision for income taxes 7.5% -% ========== ========== Plant and equipment, net ------------------------ Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Depreciation expense for the nine months ended September 30, 2005 and 2004 amounted to $1,231,056 and $1,021,882, respectively. Estimated useful lives of the assets are as follows: Estimated Useful Life --------------------- Buildings 20 years Machinery and equipment 10 years Computer, office equipment and furniture 5 years Automobiles 5 years Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company's plant facilities. No depreciation is provided for construction in progress until such time as the relevant assets are completed and are ready for their intended use. The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the consolidated statements of operations. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Major additions and betterment to buildings and equipment are capitalized. -11- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 - Summary of significant accounting policies, (continued) Plant and equipment, net, (continued) ------------------------------------- Long-term assets of the Company are reviewed annually as to whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of September 30, 2005, the Company expects these assets to be fully recoverable. Plant and equipment consist of the following at: September 30, 2005 December 31, 2004 ------------------ ------------------ Buildings and improvements $ 11,575,659 $ 7,962,799 Office facilities 296,550 162,522 Computer equipment and software 1,265,036 782,846 Equipment 6,831,171 6,514,151 Vehicles 3,653,518 2,771,364 Construction in progress 6,009,748 6,023,223 ------------------ ------------------ Total 29,631,682 24,216,905 Less accumulated depreciation 5,244,131 4,016,099 ------------------ ------------------ Total $ 24,387,551 $ 20,200,806 ================== ================== Cash and concentration of risk ------------------------------ Cash includes cash on hand and demand deposits in accounts maintained with state-owned banks within the People's Republic of China. Total cash in state-owned banks at September 30, 2005 and December 31, 2004 amounted to $52,006,277 and $39,243,872, respectively of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts. Accounts receivable - related parties ------------------------------------- The Company's trade accounts receivables are 100% due from related companies. Management believes that the accounts are fully collectible as these amounts are being collected throughout the year. However, the Company records a provision for accounts receivable trade which ranges from 0.3% to 0.5% of the outstanding accounts receivable balance in accordance with generally accepted accounting principles in the PRC. -12- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2 - Summary of significant accounting policies, (continued) Use of estimates ---------------- The preparation of financial statements in conformity with generally accepted accounting principles of the United States of America requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates. Reclassification ---------------- Certain prior year amounts have been reclassified to conform to the current presentation. Note 3 - Consolidated financial statements and condensed footnotes The interim condensed 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 consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and the instructions to Form 10-QSB and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. Management of 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 Tiens' audited financial statements for the years ended December 31, 2004 and 2003 and notes thereto included in Tiens' Form 10-KSB, dated March 31, 2005. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position of the Company as of September 30, 2005 and the results of operations for the nine months ended September 30, 2005 and 2004, respectively. Interim results are not necessarily indicative of full year performance because of the impact of seasonal and short-term variations. -13- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 - Inventories Inventories are stated at the lower of cost or market using the first-in, first-out basis and consist of the following: September 30, December 31, 2005 2004 ------------- ------------- (Unaudited) (Audited) ------------- ------------- Raw materials $ 4,730,219 $ 2,246,493 Work-in-progress 66,328 284,458 Finished goods 4,262,772 2,036,467 ------------- ------------- $ 9,059,319 $ 4,567,418 ============= ============= Note 5 - Deposits-non current The Company as of September 30, 2005 and December 31, 2004 had outstanding deposits of $5,760,974 and $4,230,063, respectively. The Company has deposited $3.59 million with a local government agency to acquire the land use right for land in Shanghai in connection with its joint venture project described in note 10. The land use right is for a term of 50 years and as of September 30, 2005, the Company has not legally acquired the right from the government. The deposit is non refundable. The balance represents deposits with vendors for purchases of equipment and construction in progress. Note 6 - Supplemental disclosure of cash flow information Income taxes paid for the nine months ended September, 2005 amounted to $1,445,440. No income taxes were paid for the nine months ended September, 2004. Interest paid amounted to $433,353 and $256,622 for the nine months ended September 30, 2005 and 2004, respectively. The Company offset $2,913,525 of its dividend payable due to its minority shareholder against other receivables due from related parties. Note 7 - Earnings per share The Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). SFAS 128 requires the presentation of earnings per share (EPS) as Basic EPS and Diluted EPS. There are no differences between Basic and Diluted EPS for the periods ended September 30, 2005 and 2004. The weighted average number of shares used to calculate EPS for the period ended September 30, 2005 (71,333,586) and 2004 (71,957,327) reflect only the shares outstanding for those periods. On July 31, 2004, the board of directors of the Company accepted the resignation of one of the members of the Board. The resigning director's 665,000 shares of common stock of the Company were returned to the Company and cancelled on September 14, 2004. -14- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8 - Minority interest Minority interest represents the outside shareholders' 20% ownership of Biological and 0.6% ownership of Tiens Yihai. Note 9 - Related party transactions The following is a description of the various individuals and companies discussed in the footnotes and their relationship to the Company. Tianshi International Holdings Group Limited - British Virgin Island Company owned 100% by Tiens Biotech Group (USA), Inc. Li Jinyuan - individual - President and majority shareholder Li Baolan - individual - daughter of Li Jinyuan Tianjin Tianshi Biological Development Co., LTD - Chinese joint venture which Tianshi International Holdings Group Limited owns 80% Tianshi Hong Kong International Development Co., Limited - Hong Kong Company owned 100% by Li Jinyuan Tianjin Tianshi Biological Engineering Co., LTD - Chinese company owned 49% by Li Baolan and 51% by Tianjing Tianshi Group Co., Ltd. Tianjin Tianshi Pharmaceuticals Co., LTD - a Chinese company and the majority shareholder is Tianjin Tianshi Group Co., Ltd. Tianjin Tianshi Group Co., Ltd. - owned 90% by Li Jinyuan and 10% by Li Baolan Sales ----- The Company sells products to distributors that are related to the Company through common ownership. The related party distributors in turn market and sell the Company's products to independent distributors or end users of the products. The related party distributors are solely responsible for all marketing and payments of sales commissions to independent distributors. Related party sales amounted to $50,730,467 and $46,074,775 for the periods ended September 30, 2005 and 2004 which represent 100% of total sales for the periods then ended. Related party accounts receivable related to these sales amounted to $5,313,533 and $6,058,021 as at September 30, 2005 and December 31, 2004, respectively, net of an allowance for doubtful accounts of $31,145 and $30,442, respectively. -15- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 - Related party transactions, (continued) Other receivables and note receivable ------------------------------------- The Company through its Chinese joint venture, Tianjin Tianshi Biological Development Co., Ltd., is owed additional amounts classified as other receivables and notes receivables from various related parties totaling $15,128,016 and $8,144,740 as of September 30, 2005 and December 31, 2004, respectively and consisted of the following: September 30, December 31, 2005 2004 ------------- ------------- Tianjin Juchao Commercial and Trading Co., Ltd $ 318,360 $ 311,160 Tianjin Tianshi Biological Engineering Co., LTD 10,960,504 1,710,446 Tianjin Tianshi Pharmaceuticals Co., LTD -- 2,590,630 Tianjin Tianshi Group Co., Ltd 3,849,152 3,532,504 ------------- ------------- Total $ 15,128,016 $ 8,144,740 ============= ============= On September 1, 2005, the Company issued a short-term note to Tianshi Engineering in the amount of RMB 15, 000,000, translated to $1,857,000. The note is interest free and will be due on December 31, 2005. On September 1, 2005, the Company issued a short-term note to Tianshi Group in the amount of RMB 8,000,000, translated to $990,400. The note bears an annual interest rate of 5.22% and will be due on December 31, 2005. Other receivables are generated by the Company making various cash advances and short term loans and the allocation of various expenses to related parties. These are recurring transactions. The Company does not charge interest on these receivables. Accounts payable ---------------- Accounts payable due to related parties amounted to $247,244 and $209,199 at September 30, 2005 and December 31, 2004, respectively. These amounts were generated from the purchases of raw materials, rent expense and the Company's transportation costs. Other payables -------------- The Company has amounts classified as other payables due to related parties which amounted to $1,349,833 and $945,274 as of September 30, 2005 and December 31, 2004, respectively. These amounts arose from cash advances from related parties such as management fees due to related parties and various non-operational transactions incurred with related parties. The Company borrowed $300,000 from a related company during the second quarter. The amount borrowed is non-interest bearing and was due on June 25, 2005. The loan was paid off in September 2005. -16- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 - Related party transactions, (continued) Note payable ------------ On September 10, 2004, Tianshi International entered into a loan agreement with Tianyuan Capital Development Corp. Ltd. ("Tianyuan Capital") to borrow $10.65 million in order to fund their capital contribution due to Tiens Yihai. Mr. Li Jin Yuan, the president and major shareholder of the Company, is a director of Tiens Yihai and a director of Tianyuan Capital. The principal of the loan will be paid in ten consecutive semiannual installments of $1,065,742 on the last day of each June and December commencing December 31, 2006, and ending December 31, 2011. The first interest payment was to be paid on December 31, 2004 at an annual interest rate of 5%. Accrued interest of $429,293 at June 30, 2005 was paid during the quarter ending September 30, 2005. Accrued interest expense for the three months ended September 30, 2005 amounted to $135,777 and will be paid by the end of December 2005. The principal payment requirements for the next five years are as follows: Ending September 30, Amount ------------- ----------- 2006 $ -- 2007 1,065,000 2008 2,130,000 2009 2,130,000 2010 2,130,000 Thereafter 3,202,742 Rent expense ------------ On June 30, 2003, the Company entered into a written lease agreement with Tianshi Group to pay annual rent on these facilities at 1% of total gross revenues. The term of this agreement is for five years commencing on January 1, 2003. In addition, the Company is obligated to pay insurance, maintenance and other expenses related to the premises. The total amount paid on this lease amounted to $504,470 and $460,748 for the nine months ended September 30, 2005 and 2004, respectively. -17- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10 - Investment in Tiens Yihai Co. Ltd. On April 20, 2004, Tianshi International entered a joint venture contract (the "Joint Venture Project") with Tianshi Pharmaceuticals to establish Tiens Yihai. On September 15, 2004, the board of directors of Tianshi International ratified the Joint Venture Project. Tiens Yihai is located in Shanghai, P.R.C., and is in the business of research and development, production and marketing of healthcare, home care and personal care products. In the footnotes of the Company's financial statements for the quarter ended June 30, 2004, we described this investment as Tiens Ocean Going Co., Ltd. Due to the translation from Chinese to English, the Company has officially confirmed that the English name is Tiens Yihai Co., Ltd. The total amount to be invested in Tiens Yihai will amount to $400 million, of which $200 million will be registered capital. Tianshi International will contribute $198.8 million, representing approximately 99.4% of the registered capital of Tiens Yihai, and Tianshi Pharmaceuticals will contribute $1.2 million representing 0.6% of the registered capital of Tiens Yihai. Tianshi International will secure additional financing for the remaining $200 million. A total of 15% or approximately $30,000,000, of the registered capital is required to be contributed by the joint venture partners, within three months after the business license has been issued. The remaining registered capital amounts are required to be contributed by each joint venture partner within three years of the issuance of the business license or May 27, 2004. Tianshi International has made its required capital contribution in the amount of $29,861,853. -18- TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11 - Minority interest distributions Minority interest represents the outside shareholders' 20% ownership of Biological and 0.6% ownership of Tiens Yihai. The board of directors of Biological has authorized the following distributions to their shareholders in direct proportion to their ownership percentages. TIANSHI MINORITY Date INTERNATIONAL SHAREHOLDER Totals ------------------- ------------- ------------- ------------- March 22, 2004 RMB 82,430,670 RMB 20,607,668 RMB 103,038,338 June 30, 2004 80,525,905 20,131,476 100,657,381 December 31, 2004 100,000,000 25,000,000 125,000,000 Amount paid (182,430,670) (65,739,144) (248,169,814) ------------- ------------- ------------- Outstanding at December 31, 2004 80,525,905 -- 80,525,905 June 30, 2005 195,985,153 48,996,288 244,981,441 Amount paid (49,105,499) (24,078,713) (73,184,212) ------------- ------------- ------------- Outstanding at September 30, 2005 RMB 227,405,559 RMB 24,917,575 RMB 252,323,134 ============= ============= ============= USD 28,152,808 USD 3,084,796 USD 31,237,604 ============= ============= ============= Prior to June 30, 2005, the amounts paid to Tianshi International had been used to invest in its investment Tiens Yihai Co., Ltd described in note 10. Dividends were declared during June 2005 and $6,000,000 was paid to Tianshi International during the quarter ending September 30, 2005. At September 30, 2005, this amount remains in the cash accounts of Tianshi International. The remaining amount of the dividend payable was eliminated in the consolidation. -19- Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS: The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The following discussion contains forward-looking statements. The words or phrases "would be," "will allow," "expect to", "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements". Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether the Company is able to manage its planned growth efficiently and operate profitable operations, including whether its management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether the Company is able to generate sufficient revenues or obtain financing to sustain and grow its operations; and (d) whether it is able to successfully fulfill its requirements for cash which are explained below under "Liquidity and Capital Resources". Statements made herein are as of the date of the filing of this Form 10-Q with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. Unless otherwise required by applicable law, the Company does not undertake, and the Company specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement. OVERVIEW Tiens Biotech Group (USA), Inc. ("Tiens USA") conducts its main business operations through its 80%-owned subsidiary Tianjin Tianshi Biological Development Co., Ltd. ("Biological"), which is based in Tianjin, People's Republic of China (PRC). Tiens USA and its subsidiaries are referred to collectively herein as the "Company." The Company researches, develops, manufactures, and markets nutrition supplement products, including wellness products and dietary supplement products, and personal care products. The Company derives its revenues principally from product sales to affiliated companies around the world. The Company has developed and produced seven major product series, six of which are nutrition supplement products. The seventh series is personal care products. The Company develops its products at its product research and development center, which employs highly qualified professionals in the fields of pharmacology, biology, chemistry and fine chemistry. The Company has obtained all required certificates and approvals from government regulatory agencies to manufacture its products in China, including a Certificate of Good Manufacturing Practices (GMP) issued by the State Drug Administration and a Sanitary Certificate for food manufacturers in China ("Jin (Wuqing) Wei Shi Zheng Zi" 2004, No. 0049) and a Sanitary Certification for wellness products manufacturers ("Jin Wei Jian Zheng Zi" 2004, No. 0006) issued by the PRC Ministry of Health. In addition, all of the Company's products have been certified by appropriate government regulatory agencies, including the State Food and Drug Administration (SFDA) and the Bureau of Technical Supervision, for manufacture and sale in China. In China, the Company conducts the marketing and sales of its products through its affiliated company, Tianjin Tianshi Biological Engineering Co., Ltd. ("Tianshi Engineering"), a company incorporated in China. Tianshi Engineering markets and sells the Company's products in China through its sixty-seven branches, representative offices and chain stores, and nine domestic affiliated companies. Six of the nine domestic affiliated companies are 51% owned by Tianshi Engineering and 49% by Ms. Baolan Li, the daughter of Mr. Jinyuan Li, -20- the Company's Chairman and Chief Executive Officer. The other three domestic affiliated companies are owned by Ms. Baolan Li and Mr. Li's other immediate family members. Outside of China, the Company sells its products through an extensive direct sales force, or multi-level marketing sales force, of overseas affiliates and independent distributors who use the products themselves and/or resell them to other distributors or consumers. These affiliates are located in approximately 90 countries, including the United States, India, Malaysia, Indonesia, Canada, Peru, Brazil, Russia, Kazakhstan, Mongolia, Finland, Lithuania, Britain, Germany, France, Romania, Ukraine, Portugal, Turkey, Italy, Nigeria, Ghana, South Africa and Australia. The Company's direct sales marketing scheme is subject to governmental regulation in each of these countries. In April 2004, the Company's wholly-owned subsidiary, Tianshi International Holdings Group Ltd., a corporation organized under the laws of the British Virgin Islands ("Tianshi International"), entered a joint venture contract with Tianjin Tianshi Pharmaceuticals Co., Ltd. ("Tianshi Pharmaceuticals"), a Chinese company in which the majority shareholder is Tianjin Tianshi Group Co., Ltd. ("Tianshi Group"), a company organized under the PRC laws, to establish Tiens Yihai Co. Ltd., a Chinese-Foreign Equity Joint Venture ("Tiens Yihai"). Tianshi Group is 90% owned by Mr. Jinyan Li and 10% owned by Mr. Li's daughter, Ms. Baolan Li. On September 15, 2004, the Board of Directors of Tianshi International ratified and approved the Tiens Yihai Joint Venture Project. Tiens Yihai is 99.4% owned by Tianshi International and 0.6% owned by Tianshi Pharmaceuticals. Tiens Yihai, located in Shanghai, PRC, was established to conduct research and development, produce and market nutrition supplement products, home care and personal care products. As of September 30, 2005, Tiens Yihai was a developmental stage company and had not yet conducted any operations. The Company receives administrative support from Tianshi Group in the form of administrative services and use of office space. The Company pays Tianshi Group 1% of its annual sales income (excluding value added taxes, or "VAT") for administrative services (except for services provided by the officers of Tianshi Group). A summary of the Company's organization is described as follows: Tiens USA is owned 4.91% by public stockholders, 2.8% by officers and 92.29% by Mr. Jinyuan Li. Tiens USA owns 100% of Tianshi International. Tianshi International owns 80% of Biological and 99.4% of Tiens Yihai. Tianshi Group is owned 90% by Mr. Jinyuan Li and 10% by his daughter, Ms. Baolan Li. Tianshi Group owns 87.66% of Tianshi Pharmaceuticals and 51% of Tianshi Engineering. Tianshi Pharmaceuticals owns 20% of Biological and 0.6% of Tiens Yihai. Ms. Baolan Li owns 49% of Tianshi Engineering and 7.29% of Tianshi Pharmaceuticals. CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The Company's financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See note 2 to the Company's consolidated financial statements, "Summary of Significant Accounting Policies." Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The Company believes that the following reflect the more critical accounting policies that currently affect the Company's financial condition and results of operations. -21-
Revenue recognition ------------------- The Company recognizes revenue from domestic sales by distributors in China, net of sales commissions and taxes, when the related Chinese distributor recognizes sales of the Company's products to unaffiliated third parties. The Company recognizes revenue from international (non-Chinese) sales to both affiliated and unaffiliated third parties, net of commissions and taxes, when goods are shipped and cleared by the international customs department. The Company is generally not contractually obligated to accept returns. However, on a case by case negotiated basis, the Company permits customers to return product. In accordance with SFAS No. 48, "Revenue Recognition when the Right of Return Exists", revenue is recorded net of an allowance for estimated returns. Such reserves are based upon management's evaluation of historical experience and estimated costs. The amount of the reserves ultimately required could differ materially in the near term from amounts included in the accompanying consolidated financial statements. As of September 30, 2005, Tianshi Engineering, an affiliated company, owned all of the related party distributors which sell the Company's products domestically in China. Bad debts --------- The Company's business operations are conducted primarily in China. During the normal course of business, the Company extends unsecured credit to its customers. Management reviews its accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each fiscal year end. The Company records a provision for accounts receivable trade which ranges from 0.3% to 0.5% of the outstanding accounts receivable balance in accordance with generally accepted accounting principles in China. Inventories ----------- The Company records reserves against its inventory to provide for estimated obsolete or unsalable inventory based on assumptions about future demand for its products and market conditions. If future demand and market conditions are less favorable than management's assumptions, additional reserves could be required. Likewise, favorable future demand and market conditions could positively impact future operating results if previously reserved for inventory is sold. RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 Three Months Ended Nine Months Ended September 30, September 30, 2004 2005 Change 2004 2005 Change ------------ ------------ -------- ------------ ------------ -------- Revenue $ 19,126,809 $ 18,058,888 5.9% $ 50,730,467 $ 46,074,775 10.1% Cost of Sales $ 4,954,198 $ 4,304,640 15.1% $ 12,609,428 $ 10,922,106 15.5% Gross Profit $ 14,172,611 $ 13,754,248 3.0% $ 38,121,039 $ 35,152,669 8.4% Gross Profit Margin 74.1% 76.2% 75.1% 76.3% Selling, General and Administrative $ 2,795,414 $ 2,437,047 14.7% $ 7,894,965 $ 5,055,967 56.2% Expenses Selling, General and Administrative 14.6% 13.5% 1.1% 15.6% 11.0% 4.6% Expenses as a Percentage of Sales Other Income (Expense), Net ($ 126,969) $ 205,357 (161.8%) $ (814,133) $ 523,063 (255.7%) Provision for Income Taxes $ 869,769 -- N/A $ 2,315,214 -- N/A Net Income $ 8,204,744 $ 9,194,645 (10.8%) $ 21,404,943 $ 24,435,892 (12.4%) Net Profit Margin 42.9% 50.9% (8.0%) 42.3% 53.0% (10.7%)
REVENUE. For the three months ended September 30, 2005, revenue was $19.1 million compared to $18.1 million for the same period in 2004, an increase of 5.9%. For the nine months ended September 30, 2005, revenue was $50.7 million compared to $46.1 million for the same period in 2004, an increase of 10.1%. The breakdown of revenue between domestic and international sales is as follows. -22-
Domestic and International Revenue ---------------------------------- Three Months Ended Nine Months Ended September 30, September 30, Revenue 2004 2005 Change 2004 2005 Change ------------- ----------- ----------- -------- ----------- ----------- -------- Domestic $ 9,181,333 $ 6,183,549 48.5% $27,494,733 $23,421,659 17.4% International $ 9,945,476 $11,875,339 (16.3)% $23,235,734 $22,653,116 2.6%
For the three months ended September 30, 2005, domestic revenue increased to $9.2 million, or 48.5% compared to $6.2 million for the same period in 2004. Domestic sales for the nine months ended September 30, 2005 increased to $27.5 million from $23.4 million, or 17% compared to the same period in 2004. The increase reflects a significant increase in the demand for the Company's products in China, resulting from the increase in the Company's networking sales forces in China and the establishment of 44 new branches in China. For the three months ended September 30, 2005, international sales decreased to $9.9 million, or (16.3%) compared to $11.9 million for the same period in 2004. The sharp increase in sales in China during the third quarter in 2005 resulted in the overall market demand for the Company's products exceeding its production capability. In order to maintain a stable market share in the competitive Chinese market, the Company decided to meet the domestic market demand first. Therefore, the overseas market demand could not be fully satisfied. The Company's international sales during the nine months ended September 30, 2005 was $23.2 million compared to $22.7 million for the same period in 2004, an increase of 3%. This reflects a slight increase in sales in Africa and Russia during that period. COST OF SALES. Cost of sales for the three months ended September 30, 2005 increased to $5.0 million, or 15.1% compared to $4.3 million for the same period in 2004. For the nine months ended September 30, 2005 cost of sales was $12.6 million compared to $10.9 million for the same period in 2004, an increase of 15.5%. The increase was primarily due to the increased overhead for expanding the Company's production space and hiring more production workers. GROSS PROFIT. Gross profit increased to $14.2 million for the three months ended September 30, 2005, or 3.0%, compared to $13.8 million for the same period in 2004. For the nine months ended September 30, 2004, gross profit increased by 8.4% to $38.1 million, compared to $35.2 million for the same period in 2004. The gross profit margins for the three months and nine months ended September 30, 2005 were 74.1% and 75.1%, respectively, compared to 76.2% and 76.3% for the same periods in 2004, respectively. This 1 to 2% decrease was primarily due to normal fluctuations in costs for materials. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased to $2.8 million for the three months ended September 30, 2005, or 14.7%, compared to $2.4 million for the same period in 2004. For the nine months ended September 30, 2005, selling, general and administrative expenses increased to $7.9 million, or 56.2% compared to $5.1 million for the same period in 2004. This sharp increase for the third quarter reflects the steps the Company has taken to support an increase in future sales, and was mainly attributable to: o an increase in head count, resulting in an increase in related salary, welfare and insurance costs. In addition, the Company increased salaries of existing employees to meet market salary rates; and o an increase in low cost supplies expense relating to additional office space required by the additional employees. -23- The selling and administrative expenses as a percentage of sales increased to 14.6% and 15.6% for the three and nine months ended September 30, 2005, respectively, from 13.5% and 11.0% for the same periods in 2004, respectively. OTHER INCOME (EXPENSE), NET Other income (expense), net was $0.1 million and $0.8 million of expense for the three and nine months ended September 30, 2005, respectively, compared to income of $0.2 and $0.5 million for the same periods in 2004, respectively. For the three months ended September 30, 2005, the Company incurred $135,777 of interest relating to the terms of its long-term loan agreement with Tianyuan Capital Development Corp. Ltd., as more fully described under the caption "Certain Relationships and Related Transactions--Notes Payable." For the same loan, the interest incurred to the Company was $401,554 for the nine months ended September 30, 2005. Another significant item included in other expense was $328,441 of additional taxes and penalties paid by the Company to the PRC government during the first quarter in 2005 as the result of a VAT examination by the local government. This was a one-time charge. PROVISION FOR INCOME TAXES Provision for income taxes increased to $0.9 million and $2.3 million for the three and nine months ended September 30, 2005, respectively, compared to none for the same periods in 2004. This was due to the Company's operating subsidiary in China, Biological, becoming subject to an annual income tax rate of 7.5% in 2005. In 2003 and 2004, Biological was exempt from paying income taxes in China. From January 1, 2005 through December 31, 2007, Biological is subject to an income tax at a reduced rate of 7.5%. From January 1, 2008 forward, Biological will be subject to a 15% income tax rate. NET INCOME As a result of the foregoing factors, net income for the three months ended September 30, 2005 was $8.2 million, a decrease of 10.8% compared to $9.2 million for the same period in 2004. For the nine months ended September 30, 2005, net income was $21.4 million, a decrease of 12.4% compared to the same period in 2004. The decrease was primarily the result of increases in other expense and provision for income taxes. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company markets most of its products through various domestic and international affiliated companies that are related to the Company through common ownership by Mr. Jinyuan Li and his immediate family members. Related party sales amounted to 100% of total sales. Internationally, the Company sells its products directly to its overseas affiliates. Due to the common ownership, there are no formal sales or administrative agreements among Biological and those overseas related parties. The business operations among these related entities are regulated through internal ordinances. For the domestic market, the Company sells its products to Tianshi Engineering, which in turn sells them on through its 67 representative offices, and 9 other affiliated companies in China. The Company has a sales contract with Tianshi Engineering which requires Tianshi Engineering to purchase all of the Company's products to be sold in China. Other receivables and note receivable ------------------------------------- Through Biological, the Company's 80% owned subsidiary, the Company is owed $15,128,016 and $8,144,740 as of September 30, 2005 and December 31, 2004, respectively, classified as other receivables from related parties. These receivables have been generated by the Company making various cash advances, short-term loans and the allocation of various expenses to related parties. These are recurring transactions. On September 1, 2005, the Company entered a loan agreement with Tianshi Engineering, to which the Company lent $1,857,000. The loan is non-interest bearing and shall be paid by December 31, 2005. The purpose of the loan was for the market expansion: the initial stage investment for the 44 new branches in China. -24- On September 7, 2005, the Company entered a loan agreement with Tianshi Group, to which the Company lent $990,400. Tianshi Group shall pay interest to the Company at an annual rate of 5.22%. Both the principal and the interest of the loan shall be paid by December 31, 2005, and $242,000 of the principal of the loan was already paid at the end of September 2005. The purpose of the loan was for the adoption of an Enterprise Resource Planning system and an electronic human resources system. For the nine months ended September 30, 2005, dividends payable to Tianshi Pharmaceuticals in the amount of $2,913,525 were used to offset other receivables from Tianshi Pharmaceuticals. Accounts payable ---------------- Accounts payable as of September 30, 2005 and December 31, 2004, due to related parties were $247,244 and $209,199 as of September 30, 2005 and December 31, 2004, respectively. These amounts were generated from the purchases of raw materials, rent expense and transportation costs. Other payables -------------- Other payables as of September 30, 2005 and December 31, 2004, include $1,349,833 and $945,274, respectively, classified as other payables due to related parties. These amounts arose from cash advances from related parties for payment of management fees due to related parties and various non-operational transactions incurred with related parties. On March 25, 2005 the Company entered a loan agreement with Tian Yuan Investment Ltd, a company owned by Mr. Jinyuan Li, pursuant to which Tianshi International borrowed $300,000. The loan was non-interest bearing and was paid in September 2005. Note payable ------------ On September 10, 2004, in order to fund the capital contribution due to Tiens Yihai Co., Ltd. ("Tiens Yihai"), Tianshi International entered a loan agreement with Tianyuan Capital Development Corp. Ltd. ("Tianyuan Capital") to borrow $10.65 million. Mr. Jinyuan Li is a director of Tiens Yihai and a director of Tianyuan Capital. The principal of the loan is required to be paid in ten consecutive semiannual installments of each $1,065,774 on June 30 and December 31st of each year, commencing on December 31, 2006 and ending June 30, 2011. Interest is required to be paid on the outstanding and principal amount of the loan at an annual interest rate of 5% on June 30 and December 31, commencing on December 31, 2004. As of September 30, 2005, the $429,293 of interest payment for the period ended June 30, 2005 has been made, and the $135,777 of interest expense for the three months ended September 30, 2005 has been accrued. Rent expense ------------ On June 30, 2003, the Company entered a written lease agreement with Tianshi Group to pay annual rent on office facilities occupied by the Company at a rate of 1% of total gross revenues. The term of this agreement is for five years commencing on January 1, 2003. In addition, the Company is obligated to pay insurance, maintenance and other expenses related to the premises. The total amount paid on this lease amounted to $504,470 for the nine months ended September 30, 2005. -25- LIQUIDITY AND CAPITAL RESOURCES The Company typically generates positive cash flow from operations due to favorable gross margins. Net cash provided by operating activities decreased to $16.1 million for the nine months ended September 30, 2005, a decrease of approximately 26%, compared to $21.6 million for the same period in 2004. The decrease primarily reflects an increase in inventories and the increase in other receivables and note receivable-related parties, offset by an increase in advance from customers - related parties, and the decrease in accounts receivable from related parties. Compared to the decrease in advances from customers-related parties for the nine months ended September 30, 2004, $5.1 million, the advances from customers-related parties for the nine months ended September 30, 2005 increased by $69,607, since more customers made prepayments to the Company to insure that they could get enough products to meet the increasing market demands. The account receivable - related parties decreased by $598,697 for the nine months ended September 30, 2005; while it increased by $9,535,479 for the nine months ended September 30, 2004. The approximately $10 million difference was mainly the result of the Company's strengthened internal control procedures and shortened payoff periods, resulting in Biological collecting more money from customers. Compared to the nine months ended September 30, 2004, the net cash used in investing activities as of September 30, 2005 increased by $3.8 million, which was mainly due to the purchase of fixed assets and construction in progress by Biological and Tiens Yihai. About 70% of the increase occurred in Biological, which was primarily for the construction of new production facilities, renewal of production equipment and the purchase of IT equipment. Net cash used in financing activities was $155,442 for the nine months ended September 30, 2005, compared to net cash provided by financing activities of $5.2 million in the same period for 2004. For the nine months ended September 30, 2005, the Company did not have any new long-term borrowings, and there was no much payment on short term notes payable to make during this period. For the same period in 2004, the Company borrowed $10.5 million in long-term debt, and made a $5 million of payment on short-term notes payable. As of September 30, 2005 and December 31, 2004, the Company had cash of $52 million and $39 million, respectively, an increase of $12.8 million. Approximately 50% of the cash was held in the bank account of Biological and 39% in the bank account of Tiens Yihai. The balance of the cash, which is accumulated retained earnings, is held by Biological. In the third quarter, 2005, $6 million of dividend was paid by Biologicl to Tianshi International. For the nine months ended September 30, 2005, $5,870,986 was paid by Biological to its minority shareholder, Tianshi Pharmaceuticals, by offsetting account payable due, and $57,565 was paid in cash. The inventories at September 30, 2005 increased sharply to $9.1 million compared to $4.6 million at December 31, 2004. The increased amount of inventories was mainly due to the increased orders from customers, and the increased number of domestic branches. Tianshi Engineering established 44 new branches for the nine months ended September 30, 2005, which new branches required inventories to be reserved. Therefore, more inventories, including finished goods, raw materials, packaging materials, work-in-process, and low cost supplies, were built up at the end of the third quarter in 2005. As of September 30, 2005 and December 31, 2004, the Company had accounts payable of $3,279,324 and $1,791,019, respectively. The $1.5 million of increase was mainly due to an increase in purchases of materials due to the increase in sales. Going forward, the Company's primary requirements for cash consist of: o the continued production of existing products and general overhead and personnel related expenses to support these activities; o continued promotion of networking sales activities; o the development costs of new products; o construction and development of the business plan for Tiens Yihai, and o expansion of production scale to meet the demands of the Company's fast growing markets. -26- The Company anticipates that its current operating activities will enable it to meet the anticipated cash requirements for the 2005 fiscal year. MANAGEMENT ASSUMPTIONS Management anticipates, based on internal forecasts and assumptions relating to our current operations that existing cash and funds generated from operations will be sufficient to meet working capital for at least the next 12 months. In the event that plans change, our assumptions change or prove inaccurate or if other capital resources and projected cash flow otherwise prove to be insufficient to fund operations (due to unanticipated expense, technical difficulties, or otherwise), we could be required to seek additional financing. There can be no assurance that we will be able to obtain additional financing on terms acceptable to it, or at all. OFF-BALANCE SHEET ARRANGEMENTS We have no off-balance sheet arrangements. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK EFFECTS OF INFLATION We are subject to commodity price risks arising from price fluctuations in the market prices of the various raw materials that comprise our products. Price risks are managed by each business unit through productivity improvements and cost-containment measures. For the time being, the management does not believe that inflation risk is material to our business or our consolidated financial position, results of operations or cash flows. EFFECT OF FLUCTUATION IN FOREIGN EXCHANGE RATES The Company's operating subsidiary, Biological, is located in China, and buys all of its raw materials in China and sells 50% of the Company's products in China using the Chinese Renminbi ("RMB") as the functional currency. Based on Chinese government regulations, all foreign currencies under the category of current accounts are allowed to be freely exchanged with hard currencies. On July 21, 2005, the Chinese government approved the increase in the valuation of RMB against the US dollar by 2%. Because the Company reports its revenues in US dollars, changes in the valuation of RMB may impact the Company's net income. Given the uncertainty of exchange rate fluctuations, the Company cannot estimate the effect of these fluctuations on its future business, product pricing, results of operations or financial condition. Currently the Company has not entered agreements or purchased instruments to hedge its exchange rate risks, although it may do so in the future. Item 4. CONTROLS AND PROCEDURES Our management has evaluated, with the participation of our principal executive and financial officers, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) as of the end of the period covered by this report. Based on this evaluation, our principal executive and financial officers have concluded, subject to the following paragraph, that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by our company in reports that it files or submits under the Exchange Act as accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. During the quarterly period covered by this report, we did not disclose in a timely manner on a current report on Form 8-K two material definitive agreements made outside the ordinary course of business. Our principal executive and financial officers continue to assess whether our disclosure controls and procedures require correction, in light of these circumstances. -27- PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS We are not presently involved in litigation that we expect individually or in the aggregate to have a material adverse effect on our financial condition, results of operation or liquidity. 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. -28- Item 5. OTHER INFORMATION The Company's 80% owned subsidiary, Tianjin Tianshi Biological Development Co., Ltd. ("Biological"), entered a Term Loan Agreement, dated September 7, 2005 (the "Tianshi Group Term Loan Agreement"), with Tianjin Tianshi Group Co. Ltd. ("Tianshi Group"), a company incorporated in China and an affiliate of Biological through common ownership. Under the Tianshi Group Term Loan Agreement, Biological agreed to lend RMB 8.0 million, or approximately US$988,000, to Tianshi Group. The loan is payable on December 31, 2005. Tianshi Group will pay interest on the loan at the rate of 5.22% per annum. Tianshi Group may repay the loan before December 31, 2005, with approval from Biological. Biological entered a Term Loan Agreement, dated September 1, 2005 (the "Engineering Term Loan Agreement"), with Tianjin Tianshi Biological Engineering Co., Ltd. ("Engineering"), a company incorporated in China and an affiliate of Biological through common ownership. Under the Engineering Term Loan Agreement, Biological agreed to lend RMB 15.0 million, or approximately US$1,852,500, to Engineering. The loan is payable on December 31, 2005. The loan does not bear any interest. Engineering may repay the loan prior to December 31, 2005, with approval from Biological. Jinyuan Li, the Chief Executive Officer, President and Chairman of the Company is a majority shareholder of the Company, Tianshi Group and Engineering. Tianshi Group is the majority shareholder of Tianjin Tianshi Pharmaceuticals Co., Ltd., which owns 20% of Biological. The loan to Engineering will be used by Engineering for preliminary stage investment in 44 new branches in China. Biological conducts the marketing and sales of its products in China through Engineering. The loan to Tianshi Group will be used by Tianshi Group to implement ERP and human resource systems. The loans were ratified by the audit committee of the Board of Directors of the Company on November 7, 2005. Item 6. EXHIBITS (b) Exhibits 10.1 Certificates Change and Technology Transfer Agreement of the Six Wellness Products, dated as of October 26, 2005, by and between Tianjin Tianshi biological Development Co., Ltd. and Tianjin Tianshi Biological Engineering Ltd. 10.2 Technology Sharing Agreement of Dietary Supplement Products, dated as of October 26, 2005, by and between Tianjin Tianshi biological Development Co., Ltd. and Tianjin Tianshi Biological Engineering Ltd. 10.3 Certificates Change and Technology Transfer Agreement of Eighteen Wellness Products, dated as of October 26, 2005, by and between Tianjin Tianshi biological Development Co., Ltd. and Tianjin Tianshi Biological Engineering Ltd. 10.4 Term Loan Agreement, dated September 7, 2005, by and between Tianjin Tianshi Biological Development Co., Ltd. and Tianjin Tianshi Group Co. Ltd. 10.5 Term Loan Agreement, dated September 1, 2005, by and between Tianjin Tianshi Biological Development Co., Ltd. and Tianjin Tianshi Biological Engineering Co., Ltd. 31.1 Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -29- Signatures Pursuant to 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. Dated: November 14, 2005 TIENS BIOTECH GROUP (USA), INC. By: /s/ Jinyuan Li ------------------------------------- Jinyuan Li Chief Executive Officer and President (Principal Executive Officer) Dated: November 14, 2005 By: /s/ Wenjun Jiao ------------------------------------- Wenjun Jiao Chief Financial Officer (Principal Financial Officer) -30-