10-Q 1 hbmk_10q.htm FORM 10-Q hbmk_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014

or

o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission File Number: 000-53231

HUBEI MINKANG PHARMACEUTICAL LTD.
(Exact name of registrant as specified in its charter)

Nevada
 
26-24106855
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
55 Ubi Ave. 3, #03-01, Mintwell Building Singapore
 
408864
(Address of principal executive offices)
 
(Zip Code)
 
+65-6747-7883
Registrant’s telephone number, including area code
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes  x   No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x   No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o Accelerated filer o
Non-accelerated filer o Smaller reporting company x
(Do not check if a smaller reporting company)    
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  x
 
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 52,189,045 shares of common stock of the issuer was outstanding as of May 15, 2014.
 


 
 

 
TABLE OF CONTENTS
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS     3  
         
PART I – FINANCIAL INFORMATION     4  
           
Item 1.
Financial Statements (Unaudited)
    4  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations     5  
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
    11  
Item 4.
Controls and Procedures.
    11  
           
PART II – OTHER INFORMATION     12  
           
Item 1.
Legal Proceedings
    12  
Item 1A.
Risk Factors
    12  
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
    12  
Item 3.
Defaults upon Senior Securities
    12  
Item 4.
MINE SAFETY DISCLOSURES
    12  
Item 5.
Other Information
    12  
Item 6.
Exhibits
    12  

 
2

 
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements made in this Quarterly Report on Form 10-Q constitute “forward-looking statements” as that term is defined in applicable securities laws. Forward-looking statements are projections in respect of future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, which may cause our or our industry’s actual results, levels of activity or performance to be materially different from any future results, levels of activity or performance expressed or implied by these forward-looking statements. These risks and uncertainties include: (1) a continued downturn in international economic conditions; (2) any adverse occurrence with respect to our patented technology; (3) our ability to bring new products to market; (4) market demand for our products; (5) shifts in industry capacity; (6) product development or other initiatives by our competitors; (7) fluctuations in the availability and cost of materials required to produce our products; (8) potential negative financial impact from claims, lawsuits and other legal proceedings or challenges; and (9) other factors beyond our control.  Important factors that you should also consider, include, but are not limited to, the factors discussed under “Risk Factors” in our annual report on Form 10-K for the fiscal year ended December 31, 2013 filed with the Securities and Exchange Commission on April 15, 2014.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity or performance. These forward-looking statements speak only as of the date on which they are made, and except to the extent required by applicable law, including the securities laws of the United States, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements contained in this quarterly report.

REFERENCES
 
As used in this Quarterly Report: (i) the terms “we,” “us,” “our,” “Hubei Minkang” and the “Company” mean Hubei Minkang Pharmaceutical Ltd. and its wholly-owned subsidiaries, HBMK Pharmaceutical Limited and Hubei Minkang Pharmaceutical Co., Ltd.; (ii) “SEC” refers to the Securities and Exchange Commission; (iii) “Securities Act” refers to the United States Securities Act of 1933, as amended; (iv) “Exchange Act” refers to the United States Securities Exchange Act of 1934, as amended; and (v) all dollar amounts refer to United States dollars unless otherwise indicated.
 
 
3

 
 
PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Our unaudited consolidated interim financial statements included in this Form 10-Q are as follows:
 
Consolidated Balance Sheets as of March 31, 2014 (unaudited) and December 31, 2013;
    F-2  
Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2014 and 2013 (unaudited);
    F-3  
Consolidated Statement of Stockholders’ Equity for the interim period ended March 31, 2014 (unaudited);
    F-4  
Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013 (unaudited); and
    F-5  
Notes to the Consolidated Financial Statements (unaudited).
    F-6  
 
It is the opinion of management that the unaudited interim consolidated financial statements for the three months ended March 31, 2014 and 2013 include all adjustments necessary in order to ensure that the unaudited interim consolidated financial statements are not misleading. These unaudited interim financial statements reflect all adjustments which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented in accordance with accounting principles generally accepted in the United States of America. Except where noted, these unaudited interim consolidated financial statements follow the same accounting policies and methods of their application as our Company’s audited annual financial statements for the year ended December 31, 2013. All adjustments are of a normal recurring nature. These unaudited interim consolidated financial statements should be read in conjunction with our Company’s audited annual financial statements as of and for the year ended December 31, 2013, which were attached to the Company’s Annual Report on Form 10-K filed with the SEC on April 15, 2014.
 
 
4

 
 
Hubei Minkang Pharmaceutical Ltd.

March 31, 2014 and 2013

Index to the Consolidated Financial Statements
 
Contents   Page(s)  
       
Consolidated Balance Sheets as of March 31, 2014 (Unaudited) and  December 31, 2013
    F-2  
         
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three Months Ended March 31, 2014 and 2013 (Unaudited)     F-3  
         
Consolidated Statement of Stockholders’ Equity for the Interim Period  Ended March 31, 2014 (Unaudited)     F-4  
         
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013 (Unaudited)     F-5  
         
Notes to the Consolidated Financial Statements (Unaudited)     F-6  
 
 
F-1

 
 
Hubei Minkang Pharmaceutical Ltd.
 
Consolidated Balance Sheets
 
   
March 31,
2014
   
December 31,
2013
 
   
(Unaudited)
       
             
ASSETS
           
CURRENT ASSETS
           
Cash
  $ 5,307,900     $ 6,234,193  
Restricted cash, unearned government grant
    375,777       392,663  
Banker's acceptance notes receivable
    1,513,140       1,574,887  
Accounts receivable, net
    1,142,057       955,807  
Advance on purchases
    581,412       575,701  
Inventories
    3,738,057       3,984,602  
Prepayments and other current assets
    461,326       292,362  
Deposit for formation of majority-owned subsidiary
    584,112       588,986  
                 
Total Current Assets
    13,703,781       14,599,201  
                 
PROPERTY, PLANT AND EQUIPMENT
               
Property, plant and equipment
    6,466,914       6,520,874  
Accumulated depreciation
    (1,864,100 )     (1,780,791 )
                 
Property, plant and equipment, net
    4,602,814       4,740,083  
                 
LAND USE RIGHTS
               
Land use rights
    2,514,230       2,535,208  
Accumulated amortization
    (465,133 )     (456,338 )
                 
Land use rights, net
    2,049,097       2,078,870  
                 
PURCHASED FORMULAE
               
Purchased formulae
    1,953,368       1,969,667  
Accumulated amortization
    (1,806,866 )     (1,772,701 )
                 
Purchased formulae, net
    146,502       196,966  
                 
Total Assets
  $ 20,502,194     $ 21,615,120  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
CURRENT LIABILITIES
               
Loans payable
  $ 3,245,067     $ 3,272,144  
Accounts payable
    1,976,819       2,277,513  
Customer deposits
    2,116,278       2,585,067  
Advances from stockholders
    10,668       17,060  
Unearned government grant
    375,777       392,663  
Accrued expenses and other current liabilities
    1,528,075       1,643,338  
                 
Total Current Liabilities
    9,252,684       10,187,785  
                 
Total Liabilities
    9,252,684       10,187,785  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
STOCKHOLDERS' EQUITY
               
Proferred stock par value $0.001: 10,000,000 shares authorized; none issued or outstanding
    -       -  
Common stock par value $0.001: 168,750,000 shares authorized; 52,189,045 shares issued and outstanding
    52,189       52,189  
Additional paid-in capital
    5,823,848       5,823,848  
Retained earnings
    3,750,704       3,832,988  
Acumulated other comprehensive income:
               
Foreign currency translation gain
    1,622,769       1,718,310  
                 
Total Stockholders' Equity
    11,249,510       11,427,335  
                 
Total Liabilities and Stockholders' Equity
  $ 20,502,194     $ 21,615,120  
 
See accompanying notes to the consolidated financial statements.
 
 
F-2

 
 
Hubei Minkang Pharmaceutical Ltd.
 
Consolidated Statements of Operations and Comprehensive Income
 
   
For the Three Months
   
For the Three Months
 
   
Ended
   
Ended
 
   
March 31,
2014
   
March 31,
2013
 
   
(Unaudited)
   
(Unaudited)
 
             
Net Revenues
  $ 2,885,436     $ 2,731,552  
                 
Cost of Goods Sold
    1,676,138       1,617,846  
                 
Gross Margin
    1,209,298       1,113,706  
                 
Operating Expenses
               
Selling expenses
    547,277       563,526  
Professional fees
    50,000       44,209  
Research and development
    9,211       11,313  
General and administrative expenses
    699,555       744,744  
                 
Total operating expenses
    1,306,043       1,363,792  
                 
Income (Loss) from Operations
    (96,745 )     (250,086 )
                 
Other (Income) Expense:
               
Government grants - energy conservation
    (13,738 )     (13,343 )
Interest income
    (7,922 )     (7,047 )
Interest expense
    54,615       56,613  
Other (income) expense
    (51,635 )     (70 )
                 
Other (income) expense, net
    (18,680 )     36,153  
                 
Income (Loss) before Income Tax Provision
    (78,065 )     (286,239 )
                 
Income Tax Provison
    4,219       -  
                 
Net Income (Loss)
    (82,284 )     (286,239 )
                 
Other Comprehensive Income (Loss)
               
Foreign currency translation gain (loss)
    (95,541 )     55,007  
                 
Total other comprehensive income (loss)
    (95,541 )     55,007  
                 
Comprehensive Income (Loss)
  $ (177,825 )   $ (231,232 )
                 
Net Income (Loss) Per Common Share - Basic and Diluted
  $ (0.00 )   $ (0.01 )
                 
Weighted average common shares outstanding:
               
- basic and diluted
    52,189,045       52,189,045  
 
See accompanying notes to the consolidated financial statements.
 
 
F-3

 
 
Hubei Minkang Pharmaceutical Ltd.
 
Consolidated Statement of Stockholders' Equity
For the Interim Period Ended March 31, 2014
(Unaudited)
 
   
Common Stock Par Value $0.001
   
Additional
         
Accumulated Other
Comprehensive Income
Foreign Currency
   
Total
 
   
Number of
         
Paid-in
   
Retained
   
Translation
   
Stockholders'
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Gain
   
Equity
 
                                     
Balance, December 31, 2012
    52,189,045     $ 52,189     $ 5,823,848     $ 3,705,720     $ 1,371,260     $ 10,953,017  
                                                 
Comprehensive income
                                               
Net Income
                            127,268               127,268  
Other comprehensive income
                                               
Foreign currency translation gain
                                    347,050       347,050  
                                                 
Total comprehensive income
                                            474,318  
                                                 
Balance, December 31, 2013
    52,189,045       52,189       5,823,848       3,832,988       1,718,310       11,427,335  
                                                 
Comprehensive income
                                               
Net Loss
                            (82,284 )             (82,284 )
Other comprehensive income
                                               
Foreign currency translation loss
                                    (95,541 )     (95,541 )
                                                 
Total comprehensive income (loss)
                                            (177,825 )
                                                 
Balance, March 31, 2014
    52,189,045     $ 52,189     $ 5,823,848     $ 3,750,704     $ 1,622,769     $ 11,249,510  
 
See accompanying notes to the consolidated financial statements.
 
 
F-4

 
 
Hubei Minkang Pharmaceutical Ltd.
 
Consolidated Statements of Cash Flows
 
   
For the Three Months
   
For the Three Months
 
   
Ended
   
Ended
 
   
March 31,
2014
   
March 31,
2013
 
   
(Unaudited)
   
(Unaudited)
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income (loss)
  $ (82,284 )   $ (286,239 )
                 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
         
Depreciation expense
    98,045       89,535  
Amortization expense - land use rights
    12,571       12,349  
Amortization expense - purchased formulae
    48,834       47,971  
Changes in operating assets and liabilities:
               
Banker's acceptance notes receivable
    48,715       7,948  
Accounts receivable
    (194,158 )     250,228  
Advance on purchases
    (10,475 )     (114,723 )
Inventories
    213,573       (956,252 )
Prepayments and other current assets
    4,996       (5,050 )
Accounts payable
    (282,747 )     (272,605 )
Customer deposits
    (447,397 )     965,413  
Taxes payable
    (176,378 )     (548,687 )
Deferred revenue from government grant
    (13,637 )     (13,359 )
Accrued expenses and other current liabilities
    (108,236 )     (230,999 )
                 
Net cash provided by (used in) operating activities
    (888,578 )     (1,054,470 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Release of restricted cash
    13,637       13,359  
Purchases of property, plant and equipment
    -       (40,619 )
                 
Net cash provided by (used in) investing activities
    13,637       (27,260 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from loans payable
    811,267       796,927  
Repayment of loans payable
    (811,267 )     (796,927 )
Advances from (repayments to) stockholders
    (6,294 )     (91,895 )
                 
Net cash provided by (used in) financing activities
    (6,294 )     (91,895 )
                 
Effect of foreign exchange rate change on cash
    (45,058 )     27,509  
                 
Net change in cash
    (926,293 )     (1,146,116 )
                 
Cash at beginning of the reporting period
    6,234,193       6,073,324  
                 
Cash at end of the reporting period
  $ 5,307,900     $ 4,927,208  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
               
Interest paid
  $ 54,615     $ 56,613  
                 
Income tax paid
  $ -     $ -  
 
See accompanying notes to the consolidated financial statements.
 
 
F-5

 
 
Hubei Minkang Pharmaceutical Ltd.
March 31, 2014 and 2013
Notes to the Consolidated Financial Statements
(Unaudited)
 
Note 1 – Organization and Operations

Hubei Minkang Pharmaceutical Ltd. (formerly Nexgen Petroleum Corp., Blackrock Petroleum Corp. or DGT Corp.)

Hubei Minkang Pharmaceutical Ltd. (formerly Nexgen Petroleum Corp., Blackrock Petroleum Corp. or DGT Corp.) ("Hubei" or the “Company”) was incorporated on April 17, 2006 under the laws of the State of Nevada. Through various acquisitions and name changes, the Company engaged in the business of acquiring, exploring and developing oil and gas properties.

On October 20, 2010, the Company changed to its current name, Hubei Minkang Pharmaceutical Ltd. to reflect its intended acquisition of HBMK Pharmaceutical Limited (“HBMK”), a BVI corporation.

The Company discontinued its oil and gas exploration business upon consummation of the share exchange agreement (“Share Exchange Agreement”) with HBMK and all of the shareholders of HBMK on September 21, 2011.

HBMK Pharmaceutical Limited and Subsidiary

HBMK Pharmaceutical Limited

HBMK Pharmaceutical Limited was incorporated on June 29, 2010 under the laws of the Territory of the British Virgin Islands (“BVI”). HBMK was formed by the stockholders of Sensori Holdings (S) Pte Ltd., the sole stockholder of Hubei Minkang Pharmaceutical Co., Ltd. for the sole purpose of acquiring all of the registered and contributed capital of Hubei Minkang Pharmaceutical Co., Ltd.

Prior to October 12, 2010, the date of recapitalization, HBMK was inactive and had no assets or liabilities.

Hubei Minkang Pharmaceutical Co., Ltd.

Hubei Minkang Pharmaceutical Co., Ltd. (“Minkang”) was incorporated on December 18, 2003 under the laws of the People’s Republic of China (“PRC”). Minkang engages in the research, development, manufacturing and distribution of traditional Chinese medicine.

Merger of Minkang

On October 12, 2010, HBMK acquired all of the registered and contributed capital of Minkang from Sensori Holdings (S) Pte Ltd., Minkang’s then sole stockholder in exchange for 3,620,000 shares of the HBMK’s common stock. The number of shares issued represented 100% of the issued and outstanding common stock immediately after the consummation of the Minkang acquisition.

As a result of the ownership interests of the former stockholder of Minkang, for financial statement reporting purposes, the merger between HBMK and Minkang has been treated as a reverse acquisition with Minkang deemed the accounting acquirer and HBMK deemed the accounting acquiree under the acquisition method of accounting in accordance with section 805-10-55 of the FASB Accounting Standards Codification. The reverse merger is deemed a capital transaction and the net assets of Minkang (the accounting acquirer) are carried forward to HBMK (the legal acquirer and the reporting entity) at their carrying value before the acquisition. The acquisition process utilizes the capital structure of HBMK and the assets and liabilities of Minkang which are recorded at historical cost. The equity of the combined entity is the historical equity of Minkang retroactively restated to reflect the number of shares issued by HBMK in the transaction.

Acquisition of HBMK Pharmaceutical Limited and Subsidiary Recognized as a Reverse Acquisition

On July 8, 2011, Hubei entered into a share exchange agreement (the “Share Exchange Agreement”) with HBMK and all of the shareholders of HBMK and consummated the Share Exchange Agreement on September 21, 2011, with the HBMK stockholders representing 100% of the then issued and outstanding capital stock of HBMK. Pursuant to the terms of the Share Exchange Agreement, Hubei acquired all of the issued and outstanding shares of capital stock of HBMK from HBMK’s then stockholders in exchange for 33,500,000 shares of the Hubei’s common stock. The number of shares issued represented approximately 77.8% of the issued and outstanding common stock immediately after the consummation of the Share Exchange Agreement.
 
 
F-6

 

As a result of the controlling financial interest of the former stockholders of HBMK, for financial statement reporting purposes, the merger between Hubei and HBMK has been treated as a reverse acquisition with HBMK deemed the accounting acquirer and Hubei deemed the accounting acquiree under the acquisition method of accounting in accordance with section 805-10-55 of the FASB Accounting Standards Codification. The reverse acquisition is deemed a capital transaction and the net assets of HBMK (the accounting acquirer) are carried forward to Hubei (the legal acquirer and the reporting entity) at their carrying value before the acquisition. The acquisition process utilizes the capital structure of Hubei and the assets and liabilities of HBMK which are recorded at historical cost. The equity of the combined entity is the historical equity of HBMK retroactively restated to reflect the number of shares issued by Hubei in the transaction.

Note 2 – Significant and Critical Accounting Policies and Practices

The Management of the Company is responsible for the selection and use of appropriate accounting policies and the appropriateness of accounting policies and their application. Critical accounting policies and practices are those that are both most important to the portrayal of the Company’s financial condition and results and require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain. The Company’s significant and critical accounting policies and practices are disclosed below as required by generally accepted accounting principles.

Basis of Presentation - Unaudited Interim Financial Information

The accompanying unaudited interim consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, and with the rules and regulations of the United States Securities and Exchange Commission (“SEC”) to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited interim financial statements furnished reflect all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of the results for the full year. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended December 31, 2013 and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on April 15, 2014.

Use of Estimates and Assumptions and Critical Accounting Estimates and Assumptions

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date(s) of the financial statements and the reported amounts of revenues and expenses during the reporting period(s).

Critical accounting estimates are estimates for which (a) the nature of the estimate is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change and (b) the impact of the estimate on financial condition or operating performance is material. The Company’s critical accounting estimates and assumptions affecting the financial statements were:
 
 
(i)
Allowance for doubtful accounts: Management’s estimate of the allowance for doubtful accounts is based on historical sales, historical loss levels, and an analysis of the collectability of individual accounts; and general economic conditions that may affect a client’s ability to pay. The Company evaluated the key factors and assumptions used to develop the allowance in determining that it is reasonable in relation to the financial statements taken as a whole.
 
 
(ii)
Inventory Obsolescence and Markdowns: The Company’s estimate of potentially excess and slow-moving inventories is based on evaluation of inventory levels and aging, review of inventory turns and historical sales experiences. The Company’s estimate of reserve for inventory shrinkage is based on the historical results of physical inventory cycle counts.
 
 
(iii)
Fair value of long-lived assets: Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated over the newly determined remaining estimated useful lives. The Company considers the following to be some examples of important indicators that may trigger an impairment review: (i) significant under-performance or losses of assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of assets or in the Company’s overall strategy with respect to the manner or use of the acquired assets or changes in the Company’s overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in the Company’s stock price for a sustained period of time; and (vi) regulatory changes. The Company evaluates acquired assets for potential impairment indicators at least annually and more frequently upon the occurrence of such events.
 
 
F-7

 
 
These significant accounting estimates or assumptions bear the risk of change due to the fact that there are uncertainties attached to these estimates or assumptions, and certain estimates or assumptions are difficult to measure or value.

Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable in relation to the financial statements taken as a whole under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Management regularly evaluates the key factors and assumptions used to develop the estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such evaluations, if deemed appropriate, those estimates are adjusted accordingly.

Actual results could differ from those estimates.

Principles of Consolidation

The Company applies the guidance of Topic 810 “Consolidation” of the FASB Accounting Standards Codification to determine whether and how to consolidate another entity. Pursuant to ASC Paragraph 810-10-15-10 all majority-owned subsidiaries—all entities in which a parent has a controlling financial interest—shall be consolidated except (1) when control does not rest with the parent, the majority owner; (2) if the parent is a broker-dealer within the scope of Topic 940 and control is likely to be temporary; (3) consolidation by an investment company within the scope of Topic 946 of a non-investment-company investee. Pursuant to ASC Paragraph 810-10-15-8 the usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree. The Company consolidates all less-than-majority-owned subsidiaries, if any, in which the parent’s power to control exists.
 
The Company's consolidated subsidiaries and/or entities are as follows:

Name of consolidated
subsidiary or entity
 
State or other jurisdiction of
incorporation or organization
 
Date of incorporation or formation
(date of acquisition, if applicable)
 
Attributable interest
 
               
HBMK Pharmaceutical Limited
 
The Territory of the British Virgin Islands
 
June 29, 2010
    100 %
                 
Hubei Minkang Pharmaceutical Co., Ltd.
 
PRC
 
December 18, 2003
    100 %

The consolidated financial statements include all accounts of the Company and its consolidated subsidiaries and/or entities as of the reporting period ending date(s) and for the reporting period(s).

All inter-company balances and transactions have been eliminated.

Fair Value of Financial Instruments

The Company follows paragraph 820-10-35-37 of the FASB Accounting Standards Codification (“Paragraph 820-10-35-37”) to measure the fair value of its financial instruments and paragraph 825-10-50-10 of the FASB Accounting Standards Codification for disclosures about fair value of its financial instruments. Paragraph 820-10-35-37 establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (U.S. GAAP), and expands disclosures about fair value measurements. To increase consistency and comparability in fair value measurements and related disclosures, Paragraph 820-10-35-37 establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three (3) broad levels. The three (3) levels of fair value hierarchy defined by Paragraph 820-10-35-37 are described below:

Level 1
 
Quoted market prices available in active markets for identical assets or liabilities as of the reporting date.
     
Level 2
 
Pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date.
     
Level 3
 
Pricing inputs that are generally observable inputs and not corroborated by market data.

 
F-8

 
 
Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable.

The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

The carrying amounts of the Company’s financial assets and liabilities, such as cash, restricted cash – unearned government grants, banker’s acceptance notes receivable, accounts receivable, advance on purchases, prepayments and other current assets, accounts payable, customer deposits, taxes payable, deferred revenue from government grants, accrued expenses and other current liabilities approximate their fair values because of the short maturity of these instruments.

The Company’s loans payable approximate the fair value of such instruments based upon management’s best estimate of interest rates that would be available to the Company for similar financial arrangements at March 31, 2014 and December 31, 2013.
 
Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.

Fair Value of Non-Financial Assets or Liabilities Measured on a Recurring Basis

The Company identifies potentially excess and slow-moving inventories by evaluating turn rates, inventory levels and other factors. Excess quantities are identified through evaluation of inventory aging, review of inventory turns and historical sales experiences. The Company provides lower of cost or market reserves for such identified excess and slow-moving inventories. The Company establishes a reserve for inventory shrinkage, if any, based on the historical results of physical inventory cycle counts.

Carrying Value, Recoverability and Impairment of Long-Lived Assets

The Company has adopted paragraph 360-10-35-17 of the FASB Accounting Standards Codification for its long-lived assets. The Company’s long-lived assets, which include property, plant and equipment, land use rights, and purchased formulae are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

The Company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated with the related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated over the newly determined remaining estimated useful lives.

The Company considers the following to be some examples of important indicators that may trigger an impairment review: (i) significant under-performance or losses of assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of assets or in the Company’s overall strategy with respect to the manner or use of the acquired assets or changes in the Company’s overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in the Company’s stock price for a sustained period of time; and (vi) regulatory changes. The Company evaluates acquired assets for potential impairment indicators at least annually and more frequently upon the occurrence of such events.

The key assumptions used in management’s estimates of projected cash flow deal largely with forecasts of sales levels, gross margins, and operating costs of the manufacturing facilities. These forecasts are typically based on historical trends and take into account recent developments as well as management’s plans and intentions. Any difficulty in manufacturing or sourcing raw materials on a cost effective basis would significantly impact the projected future cash flows of the Company’s manufacturing facilities and potentially lead to an impairment charge for long-lived assets. Other factors, such as increased competition or a decrease in the desirability of the Company’s products, could lead to lower projected sales levels, which would adversely impact cash flows. A significant change in cash flows in the future could result in an impairment of long lived assets.
 
 
F-9

 

The impairment charges, if any, is included in operating expenses in the accompanying consolidated statements of income and comprehensive income (loss).

Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.

Restricted Cash, Unearned Government Grants

The Company follows paragraph 210-10-45-4 of the FASB Accounting Standards Codification for restricted cash, unearned government grants. Restricted cash, unearned government grants represents grants received from the City of Yichang government to be used in the Company’s environmental protection and improvement projects.

Banker’s Acceptance Notes Receivable

The Company accepts bankers’ acceptance notes in payment of accounts receivable with certain customers. These notes are usually of a short term nature, approximately three to nine months in length. They are non-interest bearing, are due on the date of maturity; are paid by the customers’ bank or credit worthy issuer upon presentation.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are recorded at the invoiced amount, net of an allowance for doubtful accounts. The Company follows paragraph 310-10-50-9 of the FASB Accounting Standards Codification to estimate the allowance for doubtful accounts. The Company performs on-going credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by the review of their current credit information; and determines the allowance for doubtful accounts based on historical write-off experience, customer specific facts and general economic conditions that may affect a client’s ability to pay.

Pursuant to paragraph 310-10-50-2 of the FASB Accounting Standards Codification account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company has adopted paragraph 310-10-50-6 of the FASB Accounting Standards Codification and determine when receivables are past due or delinquent based on how recently payments have been received.

Outstanding account balances are reviewed individually for collectability. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. Bad debt expense is included in general and administrative expenses, if any.

There was no allowance for doubtful accounts at March 31, 2014 or December 31, 2013.

The Company does not have any off-balance-sheet credit exposure to its customers at March 31, 2014 or December 31, 2013.

Advance on Purchases

Advance on purchases primarily represents amounts paid to vendors for future delivery of products ranging from three (3) months to nine (9) months, all of which are fully or partially refundable depending upon the terms and conditions of the purchase agreements.
 
 
F-10

 

Inventories

Inventory Valuation

The Company values inventories, consisting of raw materials, packaging material and finished goods, at the lower of cost or market. Cost is determined on the first-in and first-out (“FIFO”) method for raw materials and packaging materials and the weighted average cost method for finished goods. Cost of finished goods comprises direct labor, direct materials, direct production cost and an allocated portion of production overhead. The Company reduces inventories for the diminution of value, resulting from product obsolescence, damage or other issues affecting marketability, equal to the difference between the cost of the inventory and its estimated market value. Factors utilized in the determination of estimated market value include (i) current sales data and historical return rates, (ii) estimates of future demand, (iii) competitive pricing pressures, (iv) new product introductions, (v) product expiration dates, and (vi) component and packaging obsolescence.

Normal Capacity and Period Costs of Underutilized or Idle Capacity of the Production Facilities

The Company follows paragraph 330-10-30-3 of the FASB Accounting Standards Codification for the allocation of production costs and charges to inventories. The Company allocates fixed production overhead to inventories based on the normal capacity of the production facilities expected to be achieved over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. Judgment is required to determine when a production level is abnormally low (that is, outside the range of expected variation in production). Factors that might be anticipated to cause an abnormally low production level include significantly reduced demand, labor and materials shortages, and unplanned facility or equipment down time. The actual level of production may be used if it approximates normal capacity. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of abnormally low production or idle plant and unallocated overheads of underutilized or idle capacity of the production facilities are recognized as period costs in the period in which they are incurred rather than as a portion of the inventory cost.

Inventory Obsolescence and Markdowns

The Company evaluates its current level of inventories considering historical sales and other factors and, based on this evaluation, classify inventory markdowns in the income statement as a component of cost of goods sold pursuant to Paragraph 420-10-S99 of the FASB Accounting Standards Codification to adjust inventories to net realizable value. These markdowns are estimates, which could vary significantly from actual requirements if future economic conditions, customer demand or competition differ from expectations. Other significant estimates include the allocation of variable and fixed production overheads. While variable production overheads are allocated to each unit of production on the basis of actual use of production facilities, the allocation of fixed production overhead to the costs of conversion is based on the normal capacity of the Company’s production facilities, and recognizes abnormal idle facility expenses as current period charges. Certain costs, including categories of indirect materials, indirect labor and other indirect manufacturing costs which are included in the overhead pools are estimated. The management of the Company determines its normal capacity based upon the amount of operating hours of the manufacturing machinery and equipment in a reporting period.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Expenditures for major additions and betterments are capitalized. Maintenance and repairs are charged to operations as incurred. Depreciation of property, plant and equipment is computed by the straight-line method (after taking into account their respective estimated residual values) over the estimated useful lives of the respective assets as follows:

   
Estimated Useful Life (Years)
 
       
Buildings and leasehold improvements (i)
    20  
         
Construction in progress (ii)
 
-
 
         
Machinery and equipment
    7  
         
Vehicles
    5  
         
Medical and office equipment
    5  
         
Office equipment
    5-8  
 
(i) Amortized on a straight-line basis over the term of the lease or the estimated useful lives, whichever is shorter.
 
(ii) Construction in progress represents direct costs of construction or the acquisition cost of long-lived assets. Under U.S. GAAP, all costs associated with construction of long-lived assets should be reflected as long-term as part of construction-in-progress. Capitalization of these costs ceases and the construction in progress is transferred to property, plant and equipment when substantially all of the activities necessary to prepare the long-lived assets for their intended use are completed. No depreciation is provided until the construction of the long-lived assets is complete and ready for their intended use.
 
Upon sale or retirement of property, plant and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in the statements of income and comprehensive income (loss).
 
 
F-11

 
 
Planned Major Maintenance Activities

The Company follows the guidance of paragraph 360-10-25-5 of the FASB Accounting Standards Codification (“Paragraph 360-10-25-5”), which prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities. Paragraph 360-10-25-5 also requires disclosures regarding the method of accounting for planned major maintenance activities and the effects of implementing the Paragraph 360-10-25-5. The guidance in Paragraph 360-10-25-5 affects the Company with regard to its manufacturing facility requiring periodic major maintenance to meet the Certification of Good Manufacturing Practices (“GMP”) requirement every five (5) years in connection with its pharmaceutical products manufacturing license as mandated by China State Food and Drug Administration (“CFDA”). As a result, the Company has retroactively applied the required change in accounting, electing the deferral method of accounting for planned major maintenance activities. The deferral method requires the capitalization of planned major maintenance costs at the point they occur and the depreciation and amortization of these costs over their estimated useful lives or the period until future maintenance activities of five (5) years are repeated, whichever is shorter.

Land Use Rights

Land use rights represent the cost to obtain the rights to use certain parcels of land in China. Land use rights are carried at cost and amortized on a straight-line basis over the lives of the rights of fifty (50) years. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts.

Purchased Formulae

The Company has adopted paragraph 350-30-25-3 of the FASB Accounting Standards Codification for purchased formulae. Under the requirements, the Company amortizes the costs of purchased formulae over their estimated useful lives of ten (10) years. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts.

Customer Deposits

Customer deposits primarily represent amounts received from customers for future delivery of products, all of which were fully or partially refundable depending upon the terms and conditions of the sales agreements.

Related Parties

The Company follows subtopic 850-10 of the FASB Accounting Standards Codification for the identification of related parties and disclosure of related party transactions.

Pursuant to Section 850-10-20 the related parties include a. affiliates of the Company; b. entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825–10–15, to be accounted for by the equity method by the investing entity; c. trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management; d. principal owners of the Company; e. management of the Company; f. other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests; and g. other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

The financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include: a. the nature of the relationship(s) involved; b. a description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements; c. the dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period; and d. amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement.
 
 
F-12

 

Commitment and Contingencies

The Company follows subtopic 450-20 of the FASB Accounting Standards Codification to report accounting for contingencies. Certain conditions may exist as of the date the consolidated financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or un-asserted claims that may result in such proceedings, the Company evaluates the perceived merits of any legal proceedings or un-asserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, and an estimate of the range of possible losses, if determinable and material, would be disclosed.

Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the guarantees would be disclosed. Management does not believe, based upon information available at this time, that these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. However, there is no assurance that such matters will not materially and adversely affect the Company’s business, financial position, and results of operations or cash flows.

Revenue Recognition

The Company follows paragraph 605-10-S99-1 of the FASB Accounting Standards Codification for revenue recognition. The Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the product has been shipped or the services have been rendered to the customer, (iii) the sales price is fixed or determinable, and (iv) collectability is reasonably assured.

The Company derives the majority of its revenue from sales contracts with customers with revenues being generated upon the shipment of goods. Persuasive evidence of an arrangement is demonstrated via invoice, product delivery is evidenced by warehouse shipping log as well as a signed bill of lading from trucking or rail company and title transfers upon shipment from the Company’s warehouse based on free on board (“FOB”) shipping point or when the goods arrive at their destination based on free on board (“FOB”) destination; the sales price to the customer is fixed upon acceptance of the purchase order and there is no separate sales rebate, discount, or volume incentive. When the Company recognizes revenue, no provisions are made for returns because, historically, there have been very few sales returns and adjustments that have impacted the ultimate collection of revenues.

Net sales of products represent the invoiced value of goods, net of value added taxes (“VAT”). The Company is subject to VAT which is levied on all of the Company’s products at the rate of 17% on the invoiced value of sales. Sales or Output VAT is borne by customers in addition to the invoiced value of sales and Purchase or Input VAT is borne by the Company in addition to the invoiced value of purchases to the extent not refunded for export sales, if any.

Shipping and Handling Costs

The Company accounts for shipping and handling fees in accordance with paragraphs 605-45-45-19 through 605-45-45-23 of the FASB Accounting Standards Codification. While amounts charged to customers for shipping products are included in revenues, the related costs are classified in cost of goods sold as incurred.

Research and Development

The Company follows paragraph 730-10-25-1 of the FASB Accounting Standards Codification (formerly Statement of Financial Accounting Standards No. 2 “Accounting for Research and Development Costs”) and paragraph 730-20-25-11 of the FASB Accounting Standards Codification (formerly Statement of Financial Accounting Standards No. 68 “Research and Development Arrangements”) for research and development costs. Research and development costs are charged to expense as incurred. Research and development costs consist primarily of remuneration for research and development staff, depreciation and maintenance expenses of research and development equipment, material and testing costs for research and development as well as research and development arrangements with unrelated third party research and development institutions.
 
 
F-13

 
 
Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities

The research and development arrangements usually involve specific research and development projects. Often times, the Company makes non-refundable advances upon signing of these research and development arrangements. The Company adopted paragraph 730-20-25-13 and 730-20-35-1 of the FASB Accounting Standards Codification (formerly Emerging Issues Task Force Issue No. 07-3 “Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities”) for those non-refundable advances. Non-refundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts are recognized as an expense as the related goods are delivered or the related services are performed. The management continues to evaluate whether the Company expect the goods to be delivered or services to be rendered. If the management does not expect the goods to be delivered or services to be rendered, the capitalized advance payment are charged to expense.

Government Grants

Receipts of government grants (i) to construct environmental protection and improvement projects and (ii) to encourage research and development and (iii) to subsidize energy conservation activities which are non-refundable are credited to unearned government grants upon receipt. The grants are used for purchases of assets, to subsidize the research and development and energy conservation expenses incurred, for compensation expenses already incurred or for good performance of the Company.

Grants applicable to the construction of the environmental protection and improvement projects are recorded as a credit to the total cost of pollution prevention projects upon completion of the pollution prevention projects. For research and development expenses, the Company matches and offsets the government grants with the expenses of the research and development activities as specified in the grant approval document in the corresponding period when such expenses are incurred and records related government grants as credit to research and development and pollution prevention project cost accordingly. For government grants received as compensation for expenses already incurred are recognized as income in the period they become recognizable.

Foreign Currency Transactions

The Company applies the guidelines as set out in Section 830-20-35 of the FASB Accounting Standards Codification (“Section 830-20-35”) for foreign currency transactions. Pursuant to Section 830-20-35 of the FASB Accounting Standards Codification, foreign currency transactions are transactions denominated in currencies other than U.S. Dollar, the Company’s reporting currency or Chinese Yuan or Renminbi, the Company’s functional currency. Foreign currency transactions may produce receivables or payables that are fixed in terms of the amount of foreign currency that will be received or paid. A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally shall be included in determining net income for the period in which the exchange rate changes. Likewise, a transaction gain or loss (measured from the transaction date or the most recent intervening balance sheet date, whichever is later) realized upon settlement of a foreign currency transaction generally shall be included in determining net income for the period in which the transaction is settled. The exceptions to this requirement for inclusion in net income of transaction gains and losses pertain to certain intercompany transactions and to transactions that are designated as, and effective as, economic hedges of net investments and foreign currency commitments. Pursuant to Section 830-20-25 of the FASB Accounting Standards Codification, the following shall apply to all foreign currency transactions of an enterprise and its investees: (a) at the date the transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be measured and recorded in the functional currency of the recording entity by use of the exchange rate in effect at that date as defined in section 830-10-20 of the FASB Accounting Standards Codification; and (b) at each balance sheet date, recorded balances that are denominated in currencies other than the functional currency or reporting currency of the recording entity shall be adjusted to reflect the current exchange rate.

Net gains and losses resulting from foreign exchange transactions, if any, are included in the Company’s statements of income and comprehensive income (loss).

Income Tax Provision

The Company accounts for income taxes under Section 740-10-30 of the FASB Accounting Standards Codification, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of income and comprehensive income (loss) in the period that includes the enactment date.
 
 
F-14

 

The Company adopted section 740-10-25 of the FASB Accounting Standards Codification (“Section 740-10-25”). Section 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under Section 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty (50) percent likelihood of being realized upon ultimate settlement. Section 740-10-25 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.

The estimated future tax effects of temporary differences between the tax basis of assets and liabilities are reported in the accompanying consolidated balance sheets, as well as tax credit carry-backs and carry-forwards. The Company periodically reviews the recoverability of deferred tax assets recorded on its consolidated balance sheets and provides valuation allowances as management deems necessary.

Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability. In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions. In management’s opinion, adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
 
Uncertain Tax Positions

The Company did not take any uncertain tax positions and had no adjustments to the unrecognized tax liabilities or benefits pursuant to the provisions of Section 740-10-25 for the reporting period ended March 31, 2014 or 2013.

Foreign Currency Translation

The Company follows Section 830-10-45 of the FASB Accounting Standards Codification (“Section 830-10-45”) for foreign currency translation to translate the financial statements of the foreign subsidiary from the functional currency, generally the local currency, into U.S. Dollars. Section 830-10-45 sets out the guidance relating to how a reporting entity determines the functional currency of a foreign entity (including of a foreign entity in a highly inflationary economy), re-measures the books of record (if necessary), and characterizes transaction gains and losses. Pursuant to Section 830-10-45, the assets, liabilities, and operations of a foreign entity shall be measured using the functional currency of that entity. An entity’s functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment, or local currency, in which an entity primarily generates and expends cash.

The functional currency of each foreign subsidiary is determined based on management’s judgment and involves consideration of all relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures, would be considered the functional currency, but any dependency upon the parent and the nature of the subsidiary’s operations must also be considered. If a subsidiary’s functional currency is deemed to be the local currency, then any gain or loss associated with the translation of that subsidiary’s financial statements is included in accumulated other comprehensive income. However, if the functional currency is deemed to be the U.S. Dollar, then any gain or loss associated with the re-measurement of these financial statements from the local currency to the functional currency would be included in the consolidated statements of income and comprehensive income (loss). If the Company disposes of foreign subsidiaries, then any cumulative translation gains or losses would be recorded into the consolidated statements of income and comprehensive income (loss). If the Company determines that there has been a change in the functional currency of a subsidiary to the U.S. Dollar, any translation gains or losses arising after the date of change would be included within the statement of income and comprehensive income (loss).

Based on an assessment of the factors discussed above, the management of the Company determined the relevant subsidiary’s local currency to be the functional currency for its foreign subsidiary.

The financial records of the Company are maintained in their local currency, the Renminbi (“RMB”), which is the functional currency. Assets and liabilities are translated from the local currency into the reporting currency, U.S. dollars, at the exchange rate prevailing at the balance sheet date. Revenues and expenses are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the financial statements. Foreign currency translation gain (loss) resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining accumulated other comprehensive income in the statement of stockholders’ equity.
 
 
F-15

 

RMB is not a fully convertible currency. All foreign exchange transactions involving RMB must take place either through the People’s Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange. The exchange rate adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC. Commencing July 21, 2005, China adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies. The exchange rate of the US dollar against the RMB was adjusted from approximately RMB 8.28 per U.S. dollar to approximately RMB 8.11 per U.S. dollar on July 21, 2005. Since then, the PBOC administers and regulates the exchange rate of the U.S. dollar against the RMB taking into account demand and supply of RMB, as well as domestic and foreign economic and financial conditions.

Unless otherwise noted, the rate presented below per U.S. $1.00 was the midpoint of the interbank rate as quoted by OANDA Corporation (www.oanda.com) contained in its financial statements. Management believes that the difference between RMB vs. U.S. dollar exchange rate quoted by the PBOC and RMB vs. U.S. dollar exchange rate reported by OANDA Corporation were immaterial. Translations do not imply that the RMB amounts actually represent, or have been or could be converted into, equivalent amounts in U.S. dollars. Translation of amounts from RMB into U.S. dollars has been made at the following exchange rates for the respective periods:
 
   
March 31,
2014
   
December 31,
2013
   
March 31,
2013
   
December 31,
2012
 
Balance sheets
    6.1632       6.1122       6.2741       6.3086  
                                 
Statements of operations and comprehensive income (loss)
    6.1178       6.1943       6.2814          
 
Comprehensive Income (Loss)

The Company has applied section 220-10-45 of the FASB Accounting Standards Codification (“Section 220-10-45”) to present comprehensive income (loss). Section 220-10-45 establishes rules for the reporting of comprehensive income (loss) and its components. Comprehensive income (loss), for the Company, consists of net income and foreign currency translation adjustments and is presented in the Company’s consolidated statements of income and comprehensive income (loss) and stockholders’ equity.

Net Income (Loss) per Common Share

Net income (loss) per common share is computed pursuant to section 260-10-45 of the FASB Accounting Standards Codification. Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock and potentially outstanding shares of common stock during the period to reflect the potential dilution that could occur from common shares issuable through contingent share arrangements, stock options and warrants.

There were no potentially dilutive common shares outstanding for the reporting period ended March 31, 2014 or 2013.

Cash Flows Reporting

The Company adopted paragraph 230-10-45-24 of the FASB Accounting Standards Codification for cash flows reporting, classifies cash receipts and payments according to whether they stem from operating, investing, or financing activities and provides definitions of each category, and uses the indirect or reconciliation method (“Indirect method”) as defined by paragraph 230-10-45-25 of the FASB Accounting Standards Codification to report net cash flow from operating activities by adjusting net income to reconcile it to net cash flow from operating activities by removing the effects of (a) all deferrals of past operating cash receipts and payments and all accruals of expected future operating cash receipts and payments and (b) all items that are included in net income that do not affect operating cash receipts and payments. The Company reports the reporting currency equivalent of foreign currency cash flows, using the current exchange rate at the time of the cash flows and the effect of exchange rate changes on cash held in foreign currencies is reported as a separate item in the reconciliation of beginning and ending balances of cash and cash equivalents and separately provides information about investing and financing activities not resulting in cash receipts or payments in the period pursuant to paragraph 830-230-45-1 of the FASB Accounting Standards Codification.
 
 
F-16

 

Subsequent Events

The Company follows the guidance in Section 855-10-50 of the FASB Accounting Standards Codification for the disclosure of subsequent events. The Company will evaluate subsequent events through the date when the financial statements are issued. Pursuant to ASU 2010-09 of the FASB Accounting Standards Codification, the Company as an SEC filer considers its financial statements issued when they are widely distributed to users, such as through filing them on EDGAR.

Recently Issued Accounting Pronouncements

In July 2013, the FASB issued ASU No. 2013-11, Income Tax (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.

In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this Update change the requirements for reporting discontinued operations in Subtopic 205-20.

Under the new guidance, a discontinued operation is defined as a disposal of a component or group of components that is disposed of or is classified as held for sale and “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The ASU states that a strategic shift could include a disposal of (i) a major geographical area of operations, (ii) a major line of business, (iii) a major equity method investment, or (iv) other major parts of an entity. Although “major” is not defined, the standard provides examples of when a disposal qualifies as a discontinued operation.

The ASU also requires additional disclosures about discontinued operations that will provide more information about the assets, liabilities, income and expenses of discontinued operations. In addition, the ASU requires disclosure of the pre-tax profit or loss attributable to a disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements.

The ASU is effective for public business entities for annual periods beginning on or after December 15, 2014, and interim periods within those years.

Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.
 
Note 3 – Inventories

Inventories consisted of the following:

   
March 31,
2014
   
December 31,
2013
 
                 
Raw materials
 
$
613,568
   
$
611,583
 
                 
Packaging materials
   
154,873
     
127,489
 
                 
Work-in-process
   
558,603
     
963,090
 
                 
Finished goods (*)
   
2,411,013
     
2,282,440
 
                 
Inventories, net
 
$
3,738,057
   
$
3,984,602
 

(*) In accordance with the National Medicine Administration Law of the People's Republic of China, all manufacturers of pharmaceutical products are required to comply with applicable Good Manufacturing Practices (“GMP”) certifications and obtain GMP Certificates every five years. The Company’s GMP certification for one of its products expired on December 31, 2013. The Company made certain additional production runs prior to December 31, 2013 to produce sufficient amounts of finished goods to meet the market demands while it is in the process of obtaining the renewal of the GMP certificate for the Product.
 
 
F-17

 
 
Slow-moving or Obsolescence Markdowns

There were no slow-moving or inventory obsolescence adjustments for the reporting period ended March 31, 2014 and 2013, respectively.

Note 4 – Deposit for Establishment of a Majority-Owned Subsidiary

On September 29, 2013, Minkang formed a majority-owned subsidiary, Hubei Minkang Kunyan Pharmaceutical Co., Ltd. (“Minkang Kunyan”) with Hubei Kunyan Medicine Industry Co., Ltd. (“Kuanyan”), a PRC corporation located in Yichang City, Hubei Province. The registered capital of Minkang Kunyan is RMB30 million (approximately $4,882,892) whereby Minkang and Kunyan will contribute RMB18 million (approximately $2,929,735) and RMB12 million (approximately $1,953,157), representing 60 percent and 40 percent equity interest in Minkang Kunyan, respectively. The Chinese government issued a provisional business license to Minkang Kunyan contingent upon Minkang Kunyan passing the Good Manufacturing Process (“GMP”) inspection, obtaining the GMP certificate and a medicine production license from China State Food and Drug Administration (“CFDA”) within a year from the date of issuance.

As of March 31, 2014, Minkang and Kunyan contributed RMB3.6 million (approximately $584,112) and RMB2.4 million (approximately $389,408) of the registered capital, respectively. For financial reporting purposes, Minkang recorded its capital contribution as a deposit for the establishment of a majority-owned subsidiary.

Note 5 – Property, Plant and Equipment
 
(i) Construction-in-progress

Minkang is in the process of constructing a pollution prevention station, which is recorded as construction in progress.

(ii) Capitalized Interest

For the reporting period ended March 31, 2014 and 2013, Minkang did not capitalize any interest to fixed assets.

(iii) Depreciation and Amortization Expense

Depreciation and amortization expense was $98,045 and $89,535 for the reporting period ended March 31, 2014 and 2013, respectively.

(iv) Collateralization of Buildings

Certain of Minkang’s buildings are collateralized for loans from the Bank of Communications Limited, Yichang City Branch and Hubei Bank Corporation Limited.

(v) Impairment
 
The Company completed the annual impairment test of property, plant and equipment and determined that there was no impairment as the fair value of property, plant and equipment, exceeded their carrying values at December 31, 2013.
 
 
F-18

 

Note 6 – Land Use Rights

Minkang
 
In 2004 and 2008, Minkang entered into a series of agreements with the Chinese government, whereby the Company paid RMB 15,495,700 to acquire the rights to use 37,919.86 square meters of land in the aggregate for approximately 50 years and obtained land use right certificates expiring from February 23, 2054 through November 5, 2058. The related acquisition costs are being amortized over the term of the rights.
 
(i) Amortization Expense
 
Amortization expense was $12,571 and $12,349 for the reporting period ended March 31, 2014 and 2013, respectively.
 
(ii) Collateralization of Land Use Rights
 
Certain of Minkang’s land use rights are collateralized for loans from the Bank of Communications Limited, Yichang City Branch and Hubei Bank Corporation Limited.
 
(iii) Impairment
 
The Company completed the annual impairment test of land use rights and determined that there was no impairment as the fair value of land use rights, exceeded their carrying values at December 31, 2013.

Note 7 – Acquired Formulae

Minkang

In 2004, Minkang entered into a series of agreements with the Chinese government, whereby the Company paid RMB 12,039,000 to acquire certain formulae. The acquisition costs are being amortized over the estimated useful lives of the acquired formulae of approximately twenty (20) years.
 
(i) Amortization Expense

Amortization expense was $48,834 and $47,971for the reporting period ended March 31, 2014 and 2013, respectively.

(ii) Impairment
 
The Company completed the annual impairment test of purchased formulae and determined that there was no impairment as the fair value of acquired formulae, exceeded their carrying values at December 31, 2013.
 
 
F-19

 
 
Note 8 – Loans Payable

Loans payable consisted of the following:

   
March 31,
2014
   
December 31,
2013
 
                 
Loan payable of RMB10,000,000 from Bank of Communications Limited, Yichang City Branch, collateralized by certain of Minkang’s buildings and land use rights, with interest at 110% of the bank’s benchmark rate, payable monthly, with principal due on May 17, 2014.
   
1,622,533
     
1,636,072
 
                 
Loan payable of RMB5,000,000 to Hubei Bank Corporation Limited, collateralized by certain of the Company’s buildings and land use rights, with interest at 110% of the bank’s benchmark payable monthly, with principal due and repaid on January 29, 2014.
   
-
     
818,036
 
                 
Loan payable of RMB5,000,000 to Hubei Bank Corporation Limited, collateralized by certain of the Company’s buildings and land use rights, with interest at 110% of the bank’s benchmark payable monthly, with principal due and repaid on April 7, 2014 (*).
   
811,267
     
818,036
 
                 
Loan payable of RMB5,000,000 to Hubei Bank Corporation Limited, collateralized by certain of the Company’s buildings and land use rights, with interest at 6.765% per annum and payable monthly, with principal due on January 20, 2015.
   
811,267
     
-
 
                 
   
$
3,245,067
   
$
3,272,144
 
 
* On April 10, 2014, Minkang obtained a loan of RMB5,000,000 (approximately $811,627) from Hubei Bank Corporation Limited, collateralized by certain of the Company’s buildings and land use rights, with interest at 6.765% per annum payable monthly, with principal due April 10, 2015.

Note 9 – Related Party Transactions

Related parties

Related parties with whom the Company had transactions are:

Related Parties
 
 
Relationship
       
Koh, Sock Hua
   
Stockholder of the Company
       
Lee, Tong Tai
   
Chief Executive Officer and stockholder of the Company
       
Koh, Cheoh Nguan
   
Stockholder of the Company
       
Ang, Siew Khim
   
Treasurer, secretary, director and stockholder of the Company
       
Sensori Holdings (S) Pte Ltd.
   
An entity owned and controlled by significant stockholders of the Company
 
 
F-20

 
 
Advances from Stockholders

From time to time, stockholders of the Company advance funds to the Company for working capital purposes. These advances are unsecured, non-interest bearing and due on demand.

Note 10 – Earned Government Grants and Unearned Government Grants/Restricted Cash

Unearned government grants and earned government grants were as follows:

 
Earned Government Grants
for reporting period ended
 
Unearned Government
Grants/Restricted Cash at
 
 
March 31,
2014
 
March 31,
2013
 
March 31,
2014
 
December 31,
 2013
 
                         
Pollution prevention projects
  $ 13,738     $ 13,343     $ 375,777     $ 392,663  
 
Note 11 – Stockholders’ Equity

Shares Authorized

Upon formation the aggregate number of shares which the Corporation shall have authority to issue is one hundred million (100,000,000) shares, consisting of two classes to be designated, respectively, “Common Stock” and “Preferred Stock,” with all of such shares having a par value of $0.001 per share. The total number of shares of Common Stock that the Corporation shall have authority to issue is ninety million (90,000,000) shares. The total number of shares of Preferred Stock that the Corporation shall have authority to issue is ten million (10,000,000) shares.

On September 7, 2007, the Company filed a Certificate of Change to the Certificate of Incorporation pursuant to NRS 78.209 with the Secretary of State of Nevada, effective September 20, 2007, and changed its authorized capital from 90,000,000 shares of common stock with a par value of $0.001 and 10,000,000 shares of preferred stock with a par value of $0.001 to 1,350,000,000 shares of common stock with a par value of $0.001 and 10,000,000 shares of preferred stock with a par value of $0.001.

On September 29, 2010, the Company filed a Certificate of Change to the Certificate of Incorporation pursuant to NRS 78.209 with the Secretary of State of Nevada, effective October 20, 2010, and changed its authorized capital from 1,350,000,000 shares of common stock with a par value of $0.001 and 10,000,000 shares of preferred stock with a par value of $0.001 to 168,750,000 shares of common stock with a par value of $0.001 and 10,000,000 shares of preferred stock with a par value of $0.001.
 
 
F-21

 

Note 12 – Concentrations and Credit Risk

Customer and Credit Concentrations

Customer concentrations and credit concentrations are as follows:

   
Net Sales for Reporting
Period Ended
   
Accounts
Receivable at
 
   
March 31,
2014
   
March 31,
2013
   
March 31,
2014
   
December 31,
 2013
 
                         
Customer #0999
    49.9 %     51.6 %    - %     - %
                               
Customer #0579
    6.5 %     13.7 %     18.0 %     15.0 %
                                 
Customer #1212
    15.9 %     11.0 %     67.0 %     27.0 %
                                 
      72.3 %     76.3 %     85.0 %     42.0 %
 
A reduction in sales from or loss of such customers would have a material adverse effect on the Company’s results of operations and financial condition.

Product Concentration

Product concentrations are as follows:

   
For the Reporting Period Ended
March 31,
2014
   
For the Reporting Period Ended
March 31,
2013
 
                 
Product A (*)
   
50.0
%
   
50.1
%
                 
Product B
   
25.0
%
   
18.0
%
                 
Effective income tax rate
   
75.0
%
   
68.1
%

(*) In accordance with the National Medicine Administration Law of the People's Republic of China, all manufacturers of pharmaceutical products are required to comply with applicable Good Manufacturing Practices (“GMP”) certifications and obtain GMP Certificates every five years. The Company’s GMP certification for product A expired on December 31, 2013 and the Company is in the process of obtaining the renewal of the GMP certificate for Product A.
 
 
F-22

 

Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents.

Substantially all of the Company’s cash was held by major financial institutions located in the PRC, none of which are insured. However, the Company has not experienced any losses on these accounts and management believes that the Company is not exposed to significant risks on such accounts.

Note 13 – Foreign Operations

Operations

Substantially all of the Company’s operations are carried out and all of its assets are located in the PRC, which may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies since 1980, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions; nor that the PRC government’s pursuit of economic reforms will be consistent or effective.

Interest Rate

The tight monetary policy currently instituted by the PRC government and increases in the interest rate would have a material adverse effect on the Company’s results of operations and financial condition. In particular, the Company is exposed to fluctuations in interest rates due to the fact that interest rates on all of Minkang’s borrowings are based on 110% of the banks’ benchmark rate, a 1% increase in average interest rates on the Company’s borrowings would increase future interest expense by approximately RMB200,000 (approximately $33,000) per year based on the outstanding balances of RMB20 million (approximately $3.3 million) of loans payable at reporting period end date.

The Company did not use any interest rate collars or hedges to manage or reduce interest rate risk. As a result, any increase in interest rates on the variable rate borrowings would increase interest expense and reduce net income.
 
 
F-23

 

Currency Convertibility Risk

Substantially all of the Company’s businesses are transacted in RMB, which is not freely convertible into foreign currencies. Under China’s Foreign Exchange Currency Regulation and Administration, the Company is permitted to exchange RMB for foreign currencies through banks authorized to conduct foreign exchange business. 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 rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with invoices and signed contracts.

Foreign Currency Exchange Rate Risk

On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to U.S. Dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant volatility of the RMB against the U.S. Dollar.

Any significant revaluation of RMB may materially and adversely affect the cash flows, revenues, earnings and financial position reported in U.S. Dollar.

The Company had no foreign currency hedges in place to reduce such exposure.

Note 14 – Subsequent Events

The Company has evaluated all events that occurred after the balance sheet date through the date when the financial statements were issued. The Management of the Company determined that there were no reportable subsequent events to be disclosed.
 
 
F-24

 
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The following discussion and analysis should be read in conjunction with: (i) the accompanying unaudited condensed consolidated financial statements and notes thereto for the three months ended March 31, 2014, (ii) the consolidated financial statements and notes thereto for the year ended December 31, 2013 included in our Annual Report on Form 10-K (“Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on April 15, 2014 and (iii) the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K.  Aside from certain information as of December 31, 2013, all amounts herein are unaudited. The results of operations for the periods ended March 31, 2014 and the same periods last year are not necessarily indicative of the operating results for the full years.

Overview

We were incorporated in the State of Nevada on April 17, 2006, under the name DGT Corp. and commenced operations shortly thereafter.  We intended to provide digital photo editing services for photo studios in North America, with plans to expand globally.

In late 2007, we determined to cease our digital photo editing services business and to focus our efforts on the oil and gas industry as an exploration and development company. However, we were not as successful as expected in exploring our oil and gas interests in Morgan County, Tennessee, we decided to seek out a new business opportunity.

We entered into our current line of business on September 21, 20111 by acquiring HBMK Pharmaceutical Limited (“HBMK”) and HBMK’s wholly-owned subsidiary Hubei Minkang Pharmaceutical Co., Ltd. (“Hubei Minkang PRC”).

We now conduct our business through Hubei Minkang PRC, a large-scale pharmaceutical company that mainly produces and markets Traditional Chinese Medicines (“TCM”) and certain chemical pharmaceuticals. Most of our products are available for purchase Over-the-Counter and some by prescription only.  Hubei Minkang PRC has three Good Manufacturing Practice (“GMP”) certifications and seven production lines capable of producing 10 different product types including pills, tablets, capsules, granules, oral liquids, syrups, mixtures and injections, in more than 400 formulations and dosages.

On September 29, 2013, Hubei Minkang PRC formed a subsidiary, Hubei Minkang Kunyan Phramaceutical Co., Ltd. (“Minkang Kunyan”) with Kunyan Pharmaceutical Co., Ltd. (“Kunyan”) in order to build a state of the art pharmaceutical processing facility to support production demands and new GMP standards for all production lines.  Hubei Minkang PRC and Minkang Kunyan each own 60% and 40% equity interest in Minkang Kunyan. The Chinese government issued a provisional business license for Minkang Kunyan contingent upon Minkang Kunyan’s passage of the GMP inspection, obtaining the GMP certificate and a medicine production license from the China Food and Drug Administration within a year from the date of issuance.  The registered capital of Minkang Kunyan is RMB 30 million (approximately $4,882,892 whereby Hubei Minkang PRC and Kunyan shall each contribute RMB 18 million (approximately $2,929,735) and RMB 12 million (approximately $1,953,157), respectively.  As of March 31, 2014, Hubei Minkang PRC and Kunyan contributed RMB 3.6 million (approximately $584,112) and RMB 2.4 million (approximately $389,408) of the registered capital, respectively.

Our registered agent’s office is located at Nevada Agency & Transfer Company, 50 West Liberty Street, Suite 880, Reno, Nevada, 89501 and our principal business office is located at 55 Ubi Ave. 3, #03-01, Mintwell Building, Singapore 408864.

 
5

 
 
Plan of Operations
 
During the next 12 months, management plans to raise fund to make the remaining registered capital contribution to Minkang Kunyan. If, however, we cannot raise the fund then we may have to delay some or all of our plans with respect to building the pharmaceutical processing facility.
 
Our vision is to produce high quality TCM products in an environmentally friendly manner using advanced technology and techniques, and distributing the products throughout China, through the following strategies:

 
· 
focusing on production of highest margin products;

 
· 
continuous improvement of production facilities and process;

 
· 
lowering production costs while maintaining product quality;

 
· 
increasing direct sales to reduce distribution costs;

 
· 
acquiring control of raw material supply;

 
· 
developing and acquire new products; and

 
· 
expanding distribution throughout China and overseas.
 
Results of Operations

The following table sets forth our results of operations for the three month periods ended March 31, 2014 and 2013.
 
 
6

 
 
   
For the Three Months
   
For the Three Months
 
   
Ended
   
Ended
 
   
March 31, 2014
   
March 31, 2013
 
   
(Unaudited)
   
(Unaudited)
 
             
 Net Revenues
  $ 2,885,436     $ 2,731,552  
                 
 Cost of Goods Sold
    1,676,138       1,617,846  
                 
 Gross Margin
    1,209,298       1,113,706  
                 
 Operating Expenses
               
 Selling expenses
    547,277       563,526  
 Professional fees
    50,000       44,209  
 Research and development
    9,211       11,313  
 General and administrative expenses
    699,555       744,744  
                 
 Total operating expenses
    1,306,043       1,363,792  
                 
 Income (Loss) from Operations
    (96,745 )     (250,086 )
                 
 OTHER (INCOME) EXPENSE:
               
 Government grants - energy conservation
    (13,738 )     (13,343 )
 Interest income
    (7,922 )     (7,047 )
 Interest expense
    54,615       56,613  
 Other (income) expense
    (51,635 )     (70 )
                 
 Other (income) expense, net
    (18,680 )     36,153  
                 
 Income (Loss) before Income Tax Provision
    (78,065 )     (286,239 )
                 
 Income Tax Provison
    4,219       -  
                 
 Net Income (Loss)
    (82,284 )     (286,239 )
                 
 Other Comprehensive Income
               
 Foreign currency translation gain (loss)
    (95,541 )     55,007  
                 
 Total other comprehensive income
    (95,541 )     55,007  
                 
 Comprehensive Income (Loss)
  $ (177,825 )   $ (231,232 )
                 
 Net Income (Loss) Per Common Share - Basic and Diluted
  $ (0.00 )   $ (0.01 )
                 
 Weighted average common shares outstanding:
               
 - basic and diluted
    52,189,045       52,189,045  
 
 
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Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

Revenues

We had sales of $2,885,436 for the three month period ended March 31, 2014 as compared to sales of $2,731,552 for the three month period ended March 31, 2013.  The increase in sales was mainly attributable to increased sales of the product An Ka Huangmin Jiaonang.  The product Yinxing Damo Zhusheye accounted for $1,442,718 of sales revenue for the three month period ended March 31, 2014 and $1,515,936 of sales revenue for the three month period ended March 31, 2013.  An Ka Huangmin Jiaonang accounted for $721,359 of sales revenue for the three month period ended March 31, 2014 and $ $543,831 of sales revenue for the three month period ended March 31, 2013.

We had total cost of goods sold of $1,676,138 for the three months ended March 31, 2014 as compared to $1,617,846 for the three month ended March 31, 2013. The increase of cost of goods sold was mainly due to the increase in the cost of raw material of our major product An Ka Huangmin.

We had gross profit of $1,209,298 for the three months ended March 31, 2014 as compared to gross profit of $1,113,706 for the three months ended March 31, 2013. Our gross profit increased principally as a result of the increase in sales of An Ka Huangmin for the three months ended March 31, 2014.

Expenses
 
Selling Expenses:  Our selling expenses were $547,277 and $563,526 for the three months ended March 31, 2014 and 2013, respectively.  The decrease was due to the decrease in sales commission fee in connection with the product Yinxing Damo.

Professional Fees:  Our professional fees were $50,000 and $44,209 for the three months ended March 31, 2014 and 2013, respectively.  This increase was led by increase in auditing fees for financial reporting.
 
Research and Development:  Our research and development expenses were $9,211 and $11,313 for the three months ended March 31, 2014 and 2013, respectively.  The Company had less fund available to expend on research and development activities for the three months ended March 31, 2014. The Company expects to receive a government grant to support its research and development activities in the near future.
 
General and Administrative Expenses:  Our general and administrative expenses were $699,555 and $744,744 for the three months ended March 31, 2014 and 2013, respectively.  The decrease was a primary result of decrease in employee benefit, repairing fee and management fee in year 2014.

Interest Expenses:  Our interest expenses were $54,615 and $56,613 for the three months ended March 31, 2014 and 2013, respectively.

Net Income (Loss)

Our net income (loss) was ($82,284) and ($286,239) for three months ended March 31, 2014 and 2013, respectively.  The increase in net income of $203,955 resulted primarily from an increase in sales of An Ka Huangmin Jiaonang. The sales of An Ka Huangmin Jiaonang increased by $177,528 for the three months ended March 31, 2014, compared to the three months ended March 31, 2013.

Liquidity and Capital Resources

We had cash of $5,307,900 as of March 31, 2014.

During the year ended December 31, 2014, we had a loan payable of $811,267 due to Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest of 6.675% per year, calculated and payable monthly. Such loan was due and repaid on January 20, 2014. January 10, 2014, we borrowed a new loan of $811,267 due to Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest at 6.765% per year, calculated and payable monthly and the principal due and payable on January 20, 2015.

 
8

 
 
During the period ended March 31, 2014, we had another loan payable of $811,267 due to Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest of 6.675% per year, calculated and payable monthly. Such loan was due and repaid on April 7, 2014. On April 10, 2014, we borrowed a second new loan from Hubei Bank (Yichang Branch), with interest of 6.765% per year, principal due and payable on April 10, 2015.

Furthermore, during the period ended March 31, 2014, we had a loan payable of $1,622,533 due to Bank of Communications (Yichang Branch), collateralized and secured by certain of Hubei Minkang PRC’s buildings and land use rights, with interest of 110% of the bank’s benchmark rate, calculated and paid monthly and the principal due and payable on May 17, 2014.

On January 29, 2013, we sold in a private placement 8,011,606 restricted shares of our common stock to fourteen individuals and one entity at a subscription price of $0.20 per Share for gross proceeds of $1,602,321.
 
Our primary source of funds for the interim period ended March 31, 2014, was cash flow from operations, loans from the Bank of Communications (Yichang Branch) and Hubei Bank (Yichang Branch), and proceeds from the private placement completed in on January 29, 2013. During the next 12 months, management plans to raise fund to make the remaining registered capital contribution to Minkang Kunyan. There can be no assurance that further sources of debt or equity financing will be available or on acceptable terms. If, however, we cannot raise the fund then we may have to delay some or all of our plans with respect to building the pharmaceutical processing facility.
 
Foreign Currency Translation

The financial records of our subsidiary Hubei Minkang PRC are maintained in its local currency, the Renminbi (“RMB”), which is the functional currency.  Assets and liabilities are translated from the local currency into the reporting currency, U.S. dollars, at the exchange rate prevailing at the balance sheet date.  Revenues and expenses are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the financial statements.  Foreign currency translation gain (loss) resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining accumulated other comprehensive income in the statement of stockholders’ equity.

RMB is not a fully convertible currency.  All foreign exchange transactions involving RMB must take place either through the People’s Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange.  The exchange rate adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC.  Commencing July 21, 2005, China adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies.  The exchange rate of the US dollar against the RMB was adjusted from approximately RMB 8.28 per U.S. dollar to approximately RMB 8.11 per U.S. dollar on July 21, 2005.  Since then, the PBOC administers and regulates the exchange rate of the U.S. dollar against the RMB taking into account demand and supply of RMB, as well as domestic and foreign economic and financial conditions.

Unless otherwise noted, the rate presented below per U.S. $1.00 was the midpoint of the interbank rate as quoted by OANDA Corporation (www.oanda.com) contained in its financial statements.  Management believes that the difference between RMB vs. U.S. dollar exchange rate quoted by the PBOC and RMB vs. U.S. dollar exchange rate reported by OANDA Corporation were immaterial.  Translations do not imply that the RMB amounts actually represent, or have been or could be converted into, equivalent amounts in U.S. dollars.  Translation of amounts from RMB into U.S. dollars has been made at the following exchange rates for the respective periods:

   
March 31, 2014
   
December 31, 2013
   
March 31, 2013
   
December 31, 2012
 
                         
Balance sheets
    6.1632       6.1122       6.2741       6.3086  
                                 
Statements of operations and comprehensive income (loss)
    6.1178       6.1943       6.2814       6.3116  
 
 
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Statement of Cash Flows

During the three months ended March 31, 2014, our net cash decreased by $926,293 which included net cash provided by operating activities of $888,578, net cash used in investing activities of $13,637 and net cash used in financing activities of $6,294 and effect of exchange rate changes on cash of $45,058.

Cash Flow used in Operating Activities

Net cash used in operating activities of $888,578 was mainly comprised of (i) net income of ($82,284); (ii) non-cash depreciation expense and amortization expense adjustment of $159,450; and (iii) an increase of accounts receivable of $194,158, a decrease in banker’s acceptance notes receivable of $48,715, an increase in advance on purchases of $10,475, a decrease in inventories of $213,573 and a decrease in prepayments and other current assets of $4,996 from operating assets, a decrease in customer deposits of $447,397, a decrease in taxes payable of $176,378, a decrease in accounts payable of $282,747, a decrease in deferred revenue from government grant of $13,637 and a decrease of accrued expenses and other current liabilities of $108,236 from operating liabilities.

Cash Flow used in Investing Activities

During the three months ended March 31, 2014, cash used in investing activities of $13,637 consisted of release of restricted cash of $13,637.

Cash Flow used in Financing Activities

During the three months ended March 31, 2014, cash used in financing activities of ($6,294) consisted of (i) proceeds from loans payable of $811,267 (ii) repayment of loans payable of $811,267, and (iii) repayments of our stockholders’ advances of $6,294.

Loan Obligations

During the year ended December 31, 2014, we had a loan payable of $811,267 due to Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest of 6.675% per year, calculated and payable monthly. Such loan was due and repaid on January 20, 2014. January 10, 2014, we borrowed a new loan of $811,267 due to Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest at 6.765% per year, calculated and payable monthly and the principal due and payable on January 20, 2015.

During the period ended March 31, 2014, we had another loan payable of $811,267 due to Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest of 6.675% per year, calculated and payable monthly. Such loan was due and repaid on April 7, 2014. On April 10, 2014, we borrowed a second new loan from Hubei Bank (Yichang Branch), collateralized by certain of Hubei Minkang PRC’s buildings and land use rights, with interest of 6.765% per year, principal due and payable on April 10, 2015.

Furthermore, as of March 31, 2014, we had a loan payable of $1,622,533 due to Bank of Communications (Yichang Branch), collateralized and secured by certain of Hubei Minkang PRC’s building and land use rights, with interest at 6.6% per year calculated and paid monthly and the principal due and payable on May 17, 2015.

Off-Balance Sheet Arrangements

There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 
10

 
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

ITEM 4. CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, 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, Lee Tong Tai (being our principal executive officer, principal financial officer and principal accounting officer), to allow for timely decisions regarding required disclosure.  Our Chief Executive Officer and Chief Financial Officer is responsible for establishing and maintaining disclosure controls and procedures for our Company.

Our management has evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2014 (under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer), pursuant to Rule 13a-15(b) promulgated under the Securities Exchange Act of 1934, as amended.  Based on this evaluation, our Company’s Chief Executive Officer and Chief Financial Officer has concluded that our Company’s disclosure controls and procedures were not effective as of March 31, 2014, due to the material weaknesses as discussed below.

The term “internal control over financial reporting” is defined as a process designed by, or under the supervision of, the registrant’s principal executive and principal financial officers, or persons performing similar functions, and effected by the registrant’s board of directors, management and other personnel, 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 and includes those policies and procedures that:

 
· 
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant;

 
· 
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant; and

 
· 
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant’s assets that could have a material effect on the financial statements.

A material weakness is defined in Public Company Accounting Oversight Board Auditing Standard No. 5 as a significant deficiency, or a combination of significant deficiencies, in internal control over financial reporting that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

The matters involving internal controls and procedures that our management considered to be material weaknesses under the standards of the Public Company Accounting Oversight Board were: (1) lack of a functioning audit committee due to a lack of a majority of independent members and a lack of a majority of outside directors on our Board of Directors, resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures; (2) inadequate segregation of duties consistent with control objectives; and (3) ineffective controls over period end financial disclosure and reporting processes. The aforementioned material weaknesses were identified by our Chief Executive Officer and Chief Financial Officer in connection with the review of our financial statements as of March 31, 2014.
 
Management believes that the material weaknesses set forth in items (2) and (3) above did not have an effect on our financial results. However, management believes that the lack of a functioning audit committee and the lack of a majority of outside directors on our Board of Directors results in ineffective oversight in the establishment and monitoring of required internal controls and procedures, which could result in a material misstatement in our financial statements in future periods.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting that occurred during our fiscal quarter ended March 31, 2014 that have materially affected, or are likely to materially affect, our internal control over financial reporting.
 
 
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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not a party to any pending legal proceeding. We are not aware of any pending legal proceeding to which any of our officers, directors, affiliates or any beneficial holders of 5% or more of our voting securities are adverse to us or have a material interest adverse to us.

ITEM 1A. RISK FACTORS

There were no material changes to the Risk Factors disclosed in “Item 1A.  Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2013.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS
 
Exhibit Number
 
Description of Exhibit
     
10.1
 
Loan Contract, dated January 20, 2014, by and between Hubei Minkang Pharmaceutical Co., Ltd. and Hubei Bank Co., Ltd. for RMB 5,000,000, incorporated by referenced to Exhibit 10.19 to the Company’s Annual Report on Form 10-K filed with the SEC on April 15, 2014.
31.1
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act.
32.1+
 
Certification of Chief Executive Officer and Chief Financial officer Under Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act.
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase
_____________
+ In accordance with the SEC Release 33-8238, deemed being furnished and not filed.
 
 
12

 
 
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.
 
 
  HUBEI MINKANG PHARMACEUTICAL LTD.  
       
Date: May 20, 2014
By:
/s/ Lee Tong Tai  
    Lee Tong Tai  
    President, Chief Executive Officer and Chief Financial Officer  
    (Principal Executive Officer, Principal Financial Officer and Principal Accounting Officer)  
 
 
 
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