10-K 1 tb9399.txt FORM 10-K ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to___________ Commission File Number: 0-49666 TIENS BIOTECH GROUP (USA), INC. (Exact name of registrant as specified in its charter) Delaware 75-2926439 ---------------------------- ------------------------------ (State or other jurisdiction (I.R.S. Employer incorporation of Identification No.) or organization) No. 6, Yuanquan Rd. Wuqing New Tech Industrial Park Tianjin, China 301700 ------------------------------------------------------------ (Address of principal executive offices, including zip code) Registrant's Telephone Number: 011 86-22-8213-7658 Securities registered under 12(b) of the Exchange Act: Title of Each Class Name of Each Exchange on which Registered ------------------------------ ----------------------------------------- Common Stock, par value $0.001 The American Stock Exchange Securities registered under 12(g) of the Exchange Act: None. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Based upon the closing sale price of $4.28 per share of Common Stock on the American Stock Exchange on June 30, 2006, the aggregate market value of the 3,503,586 voting stock held by non-affiliates of the Registrant was approximately $14,995,348. There were 71,333,586 shares of the Company's common stock outstanding on March 26, 2007. DOCUMENTS INCORPORATED BY REFERENCE - None ================================================================================ FORWARD-LOOKING INFORMATION This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or the Company's future financial performance. The Company has attempted to identify forward-looking statements by terminology including "anticipates", "believes", "expects", "can", "continue", "could", "estimates", "expects", "intends", "may", "plans", "potential", "predict", "should" or "will" or the negative of these terms or other comparable terminology. These statements are only predictions, uncertainties and other factors, including the risks outlined under Risk Factors contained in Item 1A of this Annual Report may cause the Company's actual results, levels of activity, performance or achievements to be materially different from any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. The Company expectations are as of the date this Form 10-K is filed, and the Company does not intend to update any of the forward-looking statements after the date this Annual Report on Form 10-K is filed to confirm these statements to actual results, unless required by law. AVAILABILITY OF SEC FILINGS The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The public may read and copy these materials at the Securities and Exchange Commission's ("SEC") Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Company and other companies that file materials with the SEC electronically. You may also obtain copies of the Company's reports filed with the SEC, free of charge, on our website at http://www.tiens-bio.com. PART I ITEM 1. BUSINESS In this Annual Report on Form 10-K, references to "dollars" and "$" are to United States Dollars and references to "RMB" are to Chinese Renminbi (RMB). References to "we", "us", "our", the "Company" or "Tiens USA" include Tiens Biotech Group (USA), Inc. and its subsidiaries. OVERVIEW Tiens USA researches, develops, manufactures, and markets nutrition supplement products, including wellness products and dietary supplement products, and personal care products. Our operations are conducted from our headquarters in Tianjin, People's Republic of China ("China" or the "PRC") through our 80% owned subsidiary, Tianjin Tianshi Biological Development Co. Ltd. ("Biological"). We sell our products to affiliated companies in China and in 63 countries internationally. CORPORATE HISTORY AND ORGANIZATION Our Company was incorporated on July 13, 1990 as Super Shops, Inc. under the laws of the State of Michigan. In October 2000, Super Shops, Inc. reincorporated in Delaware and changed its name to MIA Acquisition Corp. On February 11, 2002, in connection with a change in control transaction, MIA Acquisition Corp changed its name to Strategika, Inc. From 2000 until the reorganization described below, our Company had only nominal assets and liabilities and was a development stage company attempting to provide network security services to companies. 2 Pursuant to an Agreement and Plan of Reorganization, dated August 22, 2003, among our Company, Tianshi International Holdings Group Ltd., a British Virgin Islands company ("Tianshi International"), and Jinyuan Li, Wenjun Jiao and Yupeng Yan, all Chinese Nationals who were stockholders of Tianshi International, on September 9, 2003, our Company received from the Tianshi International stockholders all of the issued and outstanding common stock of Tianshi International in exchange for the issuance by our Company of 68,495,000 shares of our common stock to the Tianshi International stockholders, representing 95% of the issued and outstanding common stock of our Company at such time, after giving effect to the issuance. We own 100% of Tianshi International. On June 18, 2003, Tianshi International acquired 80% of Biological's outstanding shares from Tianshi Hong Kong International Development Co., Ltd., which is 100% owned by our Chairman, Chief Executive Officer and President, Jinyuan Li. Biological is a Chinese-foreign equity joint venture company established under Chinese laws on March 27, 1998, subject to the Law on Sino Foreign Equity Joint Ventures. Tianjin Tianshi Pharmaceuticals Co., Ltd. ("Tianshi Pharmaceuticals"), a Chinese company, owns the remaining 20% of Biological. Tianjin Pharmaceuticals is 87.66% owned by Tianjin Tianshi Group Co., Ltd. ("Tianshi Group"), a Chinese company, and 7.29% owned by Mr. Li's daughter, Baolan Li. Tianshi Group is 90% owned by Jinyuan Li and 10% owned by Baolan Li. Tianshi Group also owns 51% of Tianjin Tianshi Biological Engineering Co. Ltd. ("Tianshi Engineering"), the entity to which we sell all of our products for consumption in China. Baolan Li owns the remaining 49% of Tianshi Engineering. In April 2004, Tianshi International entered a joint venture contract with Tianshi Pharmaceuticals to establish Tiens Yihai Co. Ltd., a Chinese-Foreign Equity Joint Venture ("Tiens Yihai"). Tiens Yihai is 99.4% owned by Tianshi International and 0.6% owned by Tianshi Pharmaceuticals. Tiens Yihai is located in Shanghai, China, and was established to build a new research and development facility which would also produce our nutrition supplement, home care, and personal care products. PRODUCTS AND MANUFACTURING We have developed and produce 35 nutrition supplement products, which include wellness products and dietary supplements, and 25 personal care products, which include skin care products and personal washing products. Each of our wellness products includes at least one health function and has been issued a Certificate of Domestic Wellness Product by the State Food and Drug Administration (SFDA). This SFDA certificate is required for the production and sale of wellness products in China. Dietary supplements, which do not include any health functions and are considered to be "ordinary food", do not require an SFDA certificate. Each of our products has been issued a Product Standard Code by the Bureau of Technical Supervision, We have put a great emphasis on product quality assurance. In 2002, we were awarded a Quality System Certificate for compliance with the standard "ISO9001: 2000" in the area of Design and Development, Production and Service of Food and Health Care Food in China. In addition, many of our products have received a certificate for Hazard Analysis Critical Control Point ("HACCP"). HACCP identifies and assesses hazards and risk associated with the manufacture, distribution and use of food-handling establishments. Our products are manufactured at our facility in Tianjin, China. The manufacturing processes of our nutrition supplement products are categorized into six types depending on the different forms of the finished products: Powder, Tea, Capsules, Tablets, Granules and Soft Gel Capsules. All of our manufacturing complies with the product standards approved by the Bureau of Technical Supervision in China. 3 The following two tables describe all of our nutrition supplement products, which include wellness products and dietary supplement products. WELLNESS PRODUCTS* -----------------
PRODUCT MAIN INGREDIENTS -------------------------------------------------- -------------------------------------------------- Tianshi Nutrient Super Calcium Powder (a) (b) Zymolytic bone calcium powder, oligosaccharide, de-fatted milk powder, VA, VD, VC, iron Tianshi Super Calcium Powder with Metabolic Zymolytic bone calcium powder,oligosaccharide, Factors (a) (b) pumpkin powder, VA, VD, VB1, VB2 Tianshi Super Calcium Powder for Children (a) (b) Zymolytic bone calcium powder, VA, VD, VC, taurine, zinc, iron Tianshi Super Calcium Capsules with Zymolytic bone calcium powder, lecithin, taurine, Lecithin (a) (b) VB1, VB12, VC, b-cyclodextrin Tianshi ThroatCare Granules (b) Radix ophiopogonis, Fructus canarli, honeysuckle, ebony, haw powder, mint, liquorice Tianshi Grape Extract Capsules (a) (b) Grape seed extract, starch Tianshi Slimming Tea (a) (b) Folium nelumbinis, semen cassiae, oolong tea, rhizoma alismatis, folium llicis latifoliae, radixet rhizoma rhei, pericarpium citri reticulatae Tianshi Spirulina Tablets (b) Dried spirulina powder Tianshi Spirulina Capsules (a) (b) Dried spirulina powder Tianshi Cell Rejuvenation Capsules (a) (b) Carrot powder, heba gynostemma pentapyllum, tea polyphenol, VC Tianshi Zinc Capsules (a) (b) Zinc lactate, glucose, egg protein powder Tianshi Cordyceps Capsules (a) (b) Cordyceps mycelium powder Tianshi Chitosan Capsules (a) (b) Chitosan Tianshi Sweet Dreams Granules (a) (b) Fructus crataegi, fructus lycii, poria, starch, aspartame, melatonin Tianshi Vitality Softgels (a) (b) Wheat plumule oil, lecithin, b-carotene Tianshi Metabolic Balance Capsules (a) (b) Radix salviae miltiorrhizae, radix polygoni multiflori, fructus crataegi Tianshi Lipid Metabolic Management Tea (a) (b) Herba gynostemma pentaphyllum,folium nelumbinis, radix polygoni mutiflori, green tea, semen cassiae
DIETARY SUPPLEMENT PRODUCTS* ---------------------------
PRODUCTS MAIN INGREDIENTS -------------------------------------------------- -------------------------------------------------- Tianshi Super Calcium Milk Powder (a) (b) Whole milk powder, Zymolytic bone calcium powder, non-dairy creamer, aspartame, multi-vitamins Tianshi Double-cellulose Tablets (a) (b) Polydextrose, haw powder, hydroxypropyl cellulose, maize cellulose, gelatin, magnesium stearate aspartame (phenylalanine) Tianshi Lycopene Tablets (a) (b) Natural tomato power, lactose, starch, calcium carbonate, micro-crystal cellulose, malt dextrin, carboxymethyl amylo-sodium, magnesium stearate Tianshi Sea Buckthorn Oil Softgels (a) (b) Sea buckthorn oil Tianshi Pine Pollen Powder Capsules Natural pine pollen powder, povidone Tianshi Protein Powder (b) Soybean separating protein, whey protein, soybean phospholipids Tianshi Eel Oil Capsules (a) Eel oil Tianshi Multi-Vit-Mine Coffee(b) Instant Coffee Powder, Non-dairy Creamer, De-fatted Milk Powder, Cocoa Powder, Milk and Egg Yolk Powder, Vitamins, Minerals and Aspartame Tianshi Gourmet Powder with Super Calcium (b) Monosodium glutamate, 1+G Zymolytic bone calcium powder Tianshi Effervescent Vitamin C Tablets Citric acid, sodium bicarbonate, malt dextrin, orange powder, VC, aspartame Tianshi Garlic Tablets Natural garlic, powder, lactose, starch, calcium carbonate, micro-crystal cellulose, malt dextrin, carboxymethl amylo-sodium, magnesium stearate Tianshi FOS Syrup Fructooligosaccharide syrup Tianshi Tibet-Garlic Capsules Tibet-Garlic, Yellow Mountain chrysanthemum, Yam Tianshi Breast Beauty Capsules Active collagen peptide, Extract of root of kudzu vine, Extract of dandelion Tianshi Hemp Seed Oil Softgels Hemp seeds oil, Gelatin Tianshi Fresh Breath Spray Honeysuckle extract, taraxacum extract, anti-bacteria peptide and menthol Tianshi Sea Cucumber Capsules natural sea cucumber Tianshi Snak-powder Capsules Agkistrodon halys powder, Zaocys dhumnades powder, coix seed extracts, peach kernel extracts
* These products are not intended to diagnose, treat, cure or prevent any disease. (a) This product has received Halal Approval, which certifies that our manufacturing processes comply with the requirements of Islamic dietary law. (b) This product has received HACCP Certificate. 4 We have 25 products in our personal care product series. We group these products into two categories: o Skin Care Products, which includes Moisturizing Cleaning Foam and Moisturizing Softener. o Personal Washing Products, which includes Tianshi Child Care Body Wash and Tianshi Spirulina Body Wash. TRADEMARKS AND PATENTS We consider the "Tiens" logo important to our business and have registered our products under the logo "Tiens" with the State Administration of Industry and Commerce in China. The registration is valid for a period of ten years from May 21, 2002 and can be renewed for further ten-year periods multiple times. We have conducted extensive research and developed Tianshi Super Calcium Powder with Metabolic Factors and Tianshi Super Calcium Powder for Children, which have each been awarded a patent from State Intellectual Properties Office in China with respective patent numbers of ZL97115067.2 and ZL97115068.0. These two patents are effective for 20 years, commencing on January 13, 2001. SUPPLIERS We have established long-term relationships with most of our suppliers. We believe that the raw materials required for manufacturing our products are relatively easy to find and alternative suppliers are convenient to locate. Our current major suppliers, all of whom are based in China, include:
SUPPLIER PRODUCT -------------------------------------------------- ------------------------------- Wuxi Changjiang Capsule Co., Ltd Capsules Hangzhou Xueyu Biological Technology Co., Ltd. Cordyceps Powder Beijing Xinglong Extratio Co., Ltd Seabuckthorn Oil, Wheatgerm Oil Fanya Dairy Product (Shanghai) Co., Ltd. Whole & Skimmed Milk Powder Beijing Yinhelu Co., Ltd. Skimmed Milk Powder Anguo City Jinmu Chinese Herbs Co., Ltd. Chinese Herbs Tianjin Jianfeng Natural Production R&D Co., Ltd. Grape Seeds Extract Suzhou Capsule Co., Ltd. Capsules Zhejiang Wanfeng Group Pharmaceutical Co. Ltd. Cordyceps Powder Shanghai Youpin Biological Chemical Co., Ltd. Cordyceps Powder
RESEARCH AND DEVELOPMENT We incurred research and development expenses of $1.0 million, $0.6 million and $0.2 million in 2006, 2005 and 2004 respectively. As of December 31, 2006, we employed 79 staff members in research and development, and we anticipate hiring an additional 15 research and development employees in 2007. MARKETING AND DISTRIBUTION In China, we sell our products to Tianshi Engineering, an affiliated Chinese company. Tianshi Engineering, in turn, sells the products to end-users through its chain stores and Chinese affiliated companies. Our strategy in China is to expand our market share through opening additional branches, chain stores, and Chinese affiliated companies of Tianshi Engineering. Tianshi Engineering established five new branches in China during 2006, for a total of 111 branches. Prior to 2006, Biological sold all of its products to Tianshi Engineering as finished products at a price equal to 25% of the Chinese market price for the products. This 25% figure was negotiated between the parties in 2003, before we acquired Tianshi International, and we believe that it is a reasonable sales price for us to receive. Tianshi Engineering then sells the products to purchasers through individual distributors in its representative offices or through its affiliates. Through this process, the commission to those individual distributors is 52% of the Chinese market price; while the representative offices or affiliates incur 3-6% of the Chinese market price as their operation expenses and Tianshi Engineering retains 17-20% as expenses and profits. This is summarized as follows: 5 Biological (Costs, expenses and profit) 25% Tianshi Engineering (expenses and profit) 17-20% Tianshi Engineering's Representative Offices or Affiliates 3-6% Individual Distributors' Commission 52% ----------- Chinese Market Price 100% During 2006, we applied the same pricing formula to our finished products which were sold to Tianshi Engineering from our inventory. At the beginning of 2006, we also began selling semi-finished products to Tianshi Engineering. In order to qualify for a direct selling license in China, Tianshi Engineering is required to produce a part of the products that it sells in China. As a result, we began to sell semi-finished products to Tianshi Engineering, which jointly shares with us licenses to produce, manufacture and sell the products. The price of semi-finished goods sold to Tianshi Engineering was originally set at the beginning of 2006 to provide us with a 75% gross profit margin. However, based on fluctuations in the cost of raw materials and quantities produced, this percentage varied during the year. This 75% figure was negotiated between the parties, and we believe that it is reasonable. The goal of this new pricing policy was to try to maintain the Company's gross margins on semi-finished goods at a similar level to historical gross margins for finished goods. Internationally, our strategy is to develop a strong direct sales force through our international affiliated companies. Currently the United States is not a significant part of our business. We sell our products to an extensive direct sales force of overseas affiliates and independent distributors who use the products themselves and/or resell them to other distributors or consumers. We sell to affiliated companies located in 63 countries, including Indonesia, Russia, Ukraine, Nigeria, South Africa, Kazakhstan, Peru, Greece, Kenya and Vietnam. As operation costs vary from country to country, international market prices vary accordingly. We sell our products to overseas affiliates at the FOB (destination port) price, which consists of 25% of the Chinese retail price, including customs duty, value-added tax and other miscellaneous transportation cost. The individual distributors of overseas affiliates sell the products to purchasers for commissions equal to 52.5% of the respective Chinese retail prices. The overseas affiliates mark up the products to cover their expenses and realize profits of approximately 10%. For the year ended December 31, 2006, all of our sales were to related parties. Sales revenue generated from sales in China to Tianshi Engineering contributed approximately 40.5% of our total revenues. COMPETITION Our main competitors are direct sales companies, such as Amway, Avon, Mary Kay, Nu Skin, Herbalife, SunRider, Unicity Network, FLP and Morinda. Some of these competitors have been granted a direct selling business license in China pursuant to China's recent regulations governing direct selling. The direct selling regulations require Tianshi Engineering, our affiliate who sells our products in China, to apply for approval to conduct a direct selling enterprise in China. Tianshi Engineering has made an application for, but has not yet received, a direct selling license in China. TIENS YIHAI In April 2004, Tianshi International entered a joint venture contract with Tianshi Pharmaceuticals to establish Tiens Yihai. Tiens Yihai is 99.4% owned by Tianshi International and 0.6% owned by Tianshi Pharmaceuticals. Tiens Yihai is located in Shanghai, China, and was established to build a new research and development facility, which would also produce our nutrition supplement, home care, and personal care products. In October 2004, the Company paid a deposit of $3.6 million to Zhu Jia Jiao Industrial Park Economic Development Ltd (representative of the local government, "Local Government") for acquiring the land use right of 1,600 mu (263 acres) located in Shanghai. However, in 2005, the Chinese central government issued its "Adjustment of Macro-Economic Policy". This policy implemented a new system of investment and use of state-owned assets, including land. Pursuant to this policy, local government organizations adjusted and re-allotted projects, including investment, construction and reconstruction of state-owned resources. As a result, projects and enterprises that had been affected, including Tiens Yihai, were awaiting further decisions by state and local government. 6 On November 10, 2006, Tiens International and the Local Government entered into a supplemental agreement pursuant to which the parties have agreed to the acquisition by Tiens Yihai of a reduced 486 mu (80 acres) parcel of land. The remaining 1,114 mu (184 acres) may not be available for purchase in the future. Therefore, the Local Government has agreed to refund to us $1.6 million of the original $3.6 million deposit when we receive a construction license for the development. In order to proceed with the purchase of the property by Tiens Yihai, Tianshi International is required to provide a loan of $6.4 million to the Local Government for relocation costs for people living on the property. The $6.4 million loan is to be funded in two installments: o The first installment of $3.2 million was paid on November 27, 2006. o The second installment of $3.2 million is to be paid after Tiens Yihai obtains a construction license to develop the property. The parties have agreed to allow Tianshi International to reduce this second installment by the amount of the $1.6 million refund due to it. In return for the loan, Tiens Yihai will receive a tax credit in the amount of $6.4 million. There is currently no guarantee or written contract requiring the Local Government to transfer the property to Tiens Yihai. If Tiens Yihai is not able to acquire the property, it is not clear whether the initial loan of $3.2 million will be refunded to Tianshi International. Presently, we are unable to forecast the direction, outcome and/or completion date of the Yihai Project. As of December 31, 2006, Tiens Yihai was a developmental stage company and had not yet conducted any operations. REGULATORY FRAMEWORK PRODUCT REGULATION The central governing authority in China for wellness products is the SFDA, which is under the jurisdiction of the State Council. SFDA issues administrative rules. Provincial, city and town authorities implement the rules of the SFDA. Other than the SFDA, other ministries and administrations also have certain responsibility for the management of wellness or nutrition supplement products, such as the State Administration for Industry and Commerce. We develop and manufacture products that are mainly classified as nutrition supplement products, which includes wellness products and dietary supplement products. Wellness products may not be sold in China without a wellness products certificate. The governmental approval process in China for a newly developed wellness product is as follows: 1. An application for a product certificate is filed with SFDA, which directs the applicant requiring the applicant to send the product samples to one of the government appointed research institutes; 2. The appointed research institute conducts clinic trials, stability tests, function tests and toxicity tests on the product, makes a report and sends the report back to SFDA within 6 months; 3. The Expert Committee of SFDA makes a final decision on the application and issues a "wellness products certificate" or a refusal notice to the applicant. This certificate authorizes the sales and marketing of the product in China. The certificate does not expire and does not require renewal. The whole process generally takes 9 to 12 months. Dietary supplement products are not subject to SFDA regulation. SALES AND MARKETING REGULATIONS In most countries, sales of our products are usually considered under the categories of general commodities, which do not require specific permits and are not subject to the strict regulations applied to drugs and medicine. In some countries, direct selling (or multi-level marketing) is highly regulated or prohibited. Since we sell our products to our affiliated companies for sale internationally, the local approval issues with respect to sales and distribution are addressed by our affiliates. 7 In China, we are aiming to expand our market share through the branches, chain stores, and affiliated companies of Tianshi Engineering, our affiliate who sells our products in China. Because direct selling was only recently authorized in China, the regulatory environment with respect to direct selling in this market remains fluid and the process for obtaining the necessary governmental approvals have been interpreted differently by different governmental authorities. The direct selling regulations require Tianshi Engineering to apply for approval to conduct a direct selling enterprise in China. Tianshi Engineering has applied for a direct selling license in a number of provinces and must obtain a series of approvals from the Departments of Commerce in such provinces, as well as the Departments of Commerce in each city and district in which we plan to operate. Tianshi Engineering is also required to obtain the approval of the State Ministry of Commerce, which is the national government authority overseeing direct selling. Tianshi Engineering has found that it is taking more time than anticipated to work through the approval process with the Chinese authorities. These authorities have broad discretion in interpreting the regulations and granting necessary approvals. A delay in obtaining approvals at one level can delay its ability to obtain approvals at the next level. The complexity of the approval process as well as the government's continued cautious approach as direct selling develops in China makes it difficult to predict a timeline for obtaining these approvals. Until the application is approved, Tianshi Engineering will continue to sell our products through its branches and chain stores in China. ENVIRONMENTAL COMPLIANCE We are subject to China's National Environmental Protection Law, as well as a number of other national and local laws and regulations regulating air, water and noise pollution and setting pollutant discharge standards. We believe that all our manufacturing operations are in material compliance with all applicable environmental laws. EMPLOYEES As of December 31, 2006, we had 1,342 employees. We believe that our relations with our employees are satisfactory. ITEM 1A. RISK FACTORS THE FOLLOWING MATTERS, AMONG OTHERS, MAY HAVE A MATERIAL ADVERSE EFFECT ON THE BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR OTHERWISE, OF THE COMPANY. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR STATEMENTS. WE ARE SUBJECT TO, AMONG OTHERS, THE FOLLOWING RISKS: RISKS RELATED TO OUR BUSINESS OUR REPUTATION, REVENUES AND OPERATING INCOME MAY BE ADVERSELY AFFECTED BY PRODUCT LIABILITY CLAIMS. As a manufacturer of products designed for human consumption, claims may be brought against us that a product injured its consumer. Our dietary supplement products consist of vitamins, minerals, herbs and other ingredients that are not subject to pre-market regulatory approval. Our products could contain contaminated substances, and some of our products contain innovative ingredients that do not have long histories of human consumption. Previously unknown adverse reactions resulting from human consumption of these ingredients could occur. A product liability claim against us could result in increased costs and could adversely affect our reputation with our customers, which in turn could adversely affect our revenues and operating income. 8 OUR NEWLY DEVELOPED PRODUCTS MAY NOT BE COMPATIBLE WITH MARKET NEEDS. Our business is particularly subject to changing consumer trends and preferences. Our continued success depends in part on our ability to anticipate and respond to these changes, and we may not respond in a timely or commercially appropriate manner to such changes. Because markets for nutrition supplement products differentiate geographically, we must accurately assess demand in each specific market into which we wish to make sales. If we fail to accurately assess consumer health needs in each market we target, we may face limited market acceptance of our products, which could have a material adverse effect on our sales and revenue. OUR PRODUCTS MUST KEEP PACE WITH ADVANCES IN THE INDUSTRY OR THEY MAY BE DISPLACED BY COMPETITORS' NEWLY DEVELOPED PRODUCTS. The nutrition supplement products industry is characterized by rapid product development, with significant competitive advantages gained by companies that introduce products that are first to market, deliver constant innovation in products and techniques, offer frequent new product introductions and have competitive prices. Our future growth partially depends on our ability to develop products that are more effective in meeting consumer needs. In addition, we must be able to manufacture and effectively market those products. The sales of our existing products may decline if a competing product is introduced by other companies. The success of our new product offerings depends upon a number of factors, including our ability to: o accurately anticipate consumer needs; o innovate and develop new products; o successfully commercialize new products in a timely manner; o price our products competitively; o manufacture and deliver our products in sufficient volumes and in a timely manner; and o differentiate our product offerings from those of our competitors. If we fail to do any of the above or we focus on technologies that do not lead to more effective products, our current and future products could be surpassed by more effective or advanced products of others. OUR PRODUCTS MAY BE COPIED BY OUR COMPETITORS. In general, we rely on trade secrets to protect our intellectual property. We have been issued patents from the State Intellectual Properties Office in China for two of our products: Tianshi Super Calcium Powder with Metabolic Factors and Tianshi Super Calcium Powder for Children. These two patents are effective for 20 years, which commenced on January 13, 2001. If we fail to adequately protect our intellectual property and trade secrets, our competitors may copy our products, which could hurt our business. OUR MANUFACTURING PROCESS IS SUBJECT TO RISKS There are risks associated with ingredients mixing and production processes and techniques. Our manufacturing process requires a significant degree of technical expertise. If we fail to manufacture our products to specifications or inadvertently use defective materials in the manufacturing process, the reliability and performance of our products will be compromised. We rely on our manufacturing operations to produce nearly all of the proprietary products we sell. Our manufacturing operations produce all of the products we sell. Any significant disruption in those operations for any reason, such as regulatory requirements and loss of certifications, power interruptions, fires, hurricanes, war or other force majeure, could adversely affect our sales and customer relationships. 9 WE HAVE LIMITED CONTROL OVER THE ACTIVITIES OF OUR DISTRIBUTORS. We place significant reliance on a network of affiliates to act as our primary sales force. Although a majority of our affiliated companies are controlled in whole or part by Jinyuan Li, our Chairman, Chief Executive Officer and President, such affiliates are not employed or otherwise controlled by us and are generally free to conduct their business at their own discretion. The distributors are dedicated more to establishing their own reputations and business relationships than to promoting our products. The simultaneous loss of a number of these distributors could have a material adverse effect on our business, financial condition, and results of operations. WE HAVE ONLY RECENTLY BECOME PROFITABLE. We began operating in July 1998, and incurred losses until 2002. Although we have been profitable due to increases in sales since 2003, this relatively short history of profitability may not be adequate to fully assess our ability to achieve market acceptance of our products or our ability to respond to competition and continue this level of performances. Therefore, we can give no assurance that we will maintain profitability in the long run. WE CONDUCT OUR BUSINESS WITH RELATED PARTIES, AND YOUR INVESTMENT MAY BE SUBJECT TO CONFLICT OF INTEREST AND SELF-DEALING RISKS. Due to the inter-related ownership and business dealings among us and our affiliates, there are conflict of interest and self-dealing risks and increased potential for manipulation of financial results. We have affiliated companies or business entities that are owned by Jinyuan Li and his immediate family members (mostly his daughter Baolan Li). Although all affiliated companies and business entities were established so that they are legally and financially independent, except for the common ownership, they are centrally administrated by Tianshi Group. The decisions of Tianshi Group could materially affect the operation of our business, which could be adverse to our investors. We sell all of our products for resale in China to Tianshi Engineering. As both we and Tianshi Engineering are majority owned by Jinyuan Li, even given consideration to the internal price transferring policies set among the related parties, these internal policies could be faulty or might not be strictly followed. We are currently establishing a system to try to ensure the independence of our operations and financial controls. However, there can be no assurance that the systems and controls can be effectively designed. WE FACE RISKS DUE TO OUR RELIANCE ON SALES IN INTERNATIONAL MARKETS. Our future success will depend in part on the continued expansion of international sales. Such international operations expose us to certain risks, including but not limited to; a need for export licenses; unexpected regulatory requirements; tariffs and other potential trade barriers and restrictions; political, legal and economic instability in foreign markets; longer account receivable cycles; difficulties in managing operations across disparate geographic areas; foreign currency fluctuations; limited protection of our intellectual property rights in some countries; dependence on local distributors; and potential disruptions in sales due to military or terrorist acts. Any or a combination of these risks could result in a material adverse effect on our business, financial condition or results of operations. OUR PRODUCTS ARE SUBJECT TO REGULATION OVER NUTRITIONAL SUPPLEMENT PRODUCTS IN MARKETS OUTSIDE CHINA. Nutrition supplement products are subject to regulatory requirements that vary by country. Obtaining approval to sell nutrition supplement products internationally involves complexities of dealing with a variety of governmental regulations. We have limited experience in dealing with the specific regulations that may be required to sell our products in certain international markets, which could delay our ability to obtain relevant regulatory approval for our products. In addition, our product sales in other countries are subject to product regulatory regimes of various degrees and direct marketing or distribution regulations. Although currently these aspects are handled by our affiliated distributors in the relevant jurisdictions, there can be no assurance that the current operations of our company and our affiliates and distributors will not be adversely affected by compliance issues and changes in applicable laws and regulations in relevant jurisdictions. 10 THE DISTRIBUTION OF OUR PRODUCTS IS SUBJECT TO REGULATION OUTSIDE CHINA. Products distributed outside China are subject to government regulations of different jurisdictions, which could be stricter than in China. In some developed countries, the government regulations for product approval could be stricter than in China, while in developing countries, government regulation could be uncertain. Our products could take a significantly longer time than we expect to gain regulatory approval or may never gain approval in certain countries, which could limit our ability to promote, sell and distribute products. In addition, in terms of our marketing approach, multi-level marketing may also be prohibited in some countries. As such, our sales may be adversely affected if such approval cannot be obtained in certain jurisdictions. OUR MANAGEMENT LACKS EXPERIENCE OPERATING A U.S. PUBLIC COMPANY. Our management had no experience operating a U.S. public company before our acquisition of Tianshi International. The initial difficulties with public company regulations faced by U.S. managers of a newly public company are aggravated with respect to our management, by our unfamiliarity with Western regulatory regimes and language and time zone differences. In addition, management must integrate new accounting rules and control procedures. Learning compliance is likely to distract management from operations to a greater degree than might be the case of management of a U.S. company, and the period during which our management masters the rules, when errors are more likely to occur, may be longer. Accordingly, the expense and operational risks inherent to a transition from private to public company are greater for Tiens USA than might usually be the case. RISKS RELATED TO DOING BUSINESS IN CHINA WE ARE SUBJECT TO THE RISKS ASSOCIATED WITH DOING BUSINESS IN CHINA. As most of our operations are conducted in China, we are subject to special considerations and significant risks not typically associated with companies operating in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. Our results may be adversely affected by changes in the political and social conditions in China, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. Although the majority of productive assets in China are owned by the Chinese government, in the past several years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent or ineffectual, there are no assurances that: o We will be able to capitalize on economic reforms; o The Chinese government will continue its pursuit of economic reform policies; o The economic policies, even if pursued, will be successful; and o Economic policies will not be significantly altered from time to time. THE RESEARCH, DEVELOPMENT, TESTING, MANUFACTURING AND MARKETING OF OUR PRODUCTS ARE SUBJECT TO VARIOUS GOVERNMENTAL REGULATIONS IN CHINA. Government regulation includes inspection of and controls over testing, manufacturing, safety and environmental controls, efficacy, labeling, advertising, promotion, record keeping and the sale and distribution of wellness products. Tianshi Engineering is also subject to government regulations with respect to the prices it will charge, the rebates it may offer to customers and the methods of its marketing. Government regulation may substantially increase the cost of developing, manufacturing and selling our products. UNCERTAINTY IN THE DEVELOPMENT OF DIRECT SELLING REGULATIONS MAY ADVERSELY AFFECT SALES OF OUR PRODUCTS IN CHINA. Substantially all of our assets are located in China, and approximately 50%, 56% and 40.5% of our revenues in 2004, 2005 and 2006, respectively, derive from our operations in China. Accordingly, our operations are subject, to a significant degree, to Chinese law. In China, we are aiming to expand our market share through the branches, chain stores, and affiliated companies of Tianshi Engineering, our affiliate who sells our products in China. Because direct selling was only recently authorized in China, the regulatory environment with respect to direct selling in this market remains fluid and the process for obtaining the necessary governmental approvals have been interpreted differently by different governmental authorities. The direct selling regulations require Tianshi Engineering to apply for approval to conduct a direct selling enterprise in China. 11 Tianshi Engineering has applied for a direct selling license in a number of provinces and must obtain a series of approvals from the Departments of Commerce in such provinces, as well as the Departments of Commerce in each city and district in which we plan to operate. Tianshi Engineering is also required to obtain the approval of the State Ministry of Commerce, which is the national government authority overseeing direct selling. Tianshi Engineering has found that it is taking more time than anticipated to work through the approval process with the Chinese authorities. These authorities have broad discretion in interpreting the regulations and granting necessary approvals. A delay in obtaining approvals at one level can delay our ability to obtain approvals at the next level. The complexity of the approval process as well as the government's continued cautious approach as direct selling develops in China makes it difficult to predict a timeline for obtaining these approvals. If Tianshi Engineering does not receive a direct selling license in China, then its ability to compete against its competitors who have received such a license may be hurt. As a result, Tianshi Engineering may lose distributors who find a competitor's direct selling business and compensation model more attractive. This could materially decrease the revenues that we receive from sales by Tianshi Engineering in China. DUE TO CHINESE CENTRAL GOVERNMENT POLICIES, WE MAY NOT BE ABLE TO COMPLETE DEVELOPMENT OF OUR TIENS YIHAI RESEARCH AND DEVELOPMENT FACILITY. In 2005, the Chinese central government issued its "Adjustment of Macro-Economic Policy". This policy implemented a new system of investment and use of state-owned assets, including land. Pursuant to this policy, local government organizations adjusted and re-allotted projects, including investment, construction and reconstruction of state-owned resources. As a result, projects and enterprises that had been affected, including Tiens Yihai, were awaiting further decisions by state and local government. On November 10, 2006, Tiens International and the Local Government entered into a supplemental agreement pursuant to which the parties have agreed to the acquisition by Tiens Yihai of a reduced 486 mu (80 acres) parcel of land. In order to proceed with the purchase of the property by Tiens Yihai, Tianshi International is required to provide a loan of $6.4 million to the Local Government for relocation costs for people living on the property. The $6.4 million loan is to be funded in two installments: o The first installment of $3.2 million was paid on November 27, 2006. o The second installment of $3.2 million is to be paid after Tiens Yihai obtains a construction license to develop the property. The parties have agreed to allow Tianshi International to reduce this second installment by the amount of the $1.6 million refund due to it. In return for the loan, Tiens Yihai will receive a tax credit in the amount of $6.4 million. There is currently no guarantee or written contract requiring the Local Government to transfer the property to Tiens Yihai. If Tiens Yihai is not able to acquire the property, it is not clear whether the initial loan of $3.2 million will be refunded to Tianshi International. Presently, we are unable to forecast the direction, outcome and/or completion date of the Yihai Project. As of December 31, 2006, Tiens Yihai was a developmental stage company and had not yet conducted any operations. If we are unable to receive the necessary additional construction approvals from the Local Government for the Tiens Yihai Research and Development Facility, we may be required to seek alternative sites for a new research and development facility. This could delay the development of new products and materially adversely affect our financial condition. 12 THE LEGAL AUTHORITIES IN CHINA ARE IN THE PROCESS OF EVALUATING HERETOFORE TAX AND FEE BENEFITS PROVIDED TO FOREIGN INVESTORS AND COMPANIES TO ENCOURAGE DEVELOPMENT WITHIN THE COUNTRY SUCH THAT THESE BENEFITS MAY BE LESSENED OR REMOVED WITH THE CONSEQUENCE THAT EXPENSES MAY RISE IMPACTING MARGINS AND NET INCOME. In 2003 and 2004, Biological was exempt from paying income taxes in China. From January 1, 2005 through December 31, 2007, Biological is subject to an income tax at a reduced rate of 7.5%. From January 1, 2008 forward, Biological will be subject to a 15% income tax rate. The legal authorities in China are evaluating tax and fee benefits that have been available to foreign investors and companies operating in China and tax holidays for new enterprises. It is anticipated, in the near term, there are going to be changes that may substantially reduce or eliminate many, if not all, the tax and other governmental fee advantages that heretofore have been available to foreign entities and newly created entities whether or not such new entities are foreign. The goal is to institute greater equalization of tax and government fee treatment of all corporate and similar entities in China. China is being encouraged to create this more equal treatment because of its WTO obligations and public opinion within China. There may be phase-ins of various taxes and fees for entities that currently benefit from either no or lower tax rates and fees compared to wholly Chinese companies and entities, but there can be no assurance of this. Even if there are phase-in periods, the length of such periods is not known. Overall, it is expected that the cost of operating in China will increase for those companies and entities that have had various tax and fee advantages in the past. WE ARE SUBJECT TO COMPLEX CHINESE BUSINESS REGULATIONS. As China changes its economy from planned to more market-oriented, uncertainties arise regarding governmental policies and measures. Although, in recent years, the Chinese government has implemented measures emphasizing the use of market forces for economic reform, reduction of state ownership of productive assets, and establishment of sound corporate governance practices, a substantial portion of productive assets in China are still owned by the Chinese government. For example, all lands are state owned and leased to business entities or individuals through governmental grants of state-owned Land Use Rights. The grant process is typically based on government policies at the time of grant, which can be lengthy and complex and may adversely affect our planned manufacturing expansion. The Chinese government also exercises significant control over China's economic growth through allocation of resources, foreign currency control and providing preferential treatment to particular industries or companies. BECAUSE MOST OF OUR DIRECTORS AND OFFICERS RESIDE OUTSIDE OF THE UNITED STATES, AND SUBSTANTIALLY ALL OF OUR ASSETS ARE LOCATED OUTSIDE OF THE UNITED STATES, IT MAY BE DIFFICULT FOR INVESTORS TO ENFORCE THEIR LEGAL RIGHTS AGAINST SUCH INDIVIDUALS OR SUCH ASSETS. Most of our directors and officers reside outside of the United States, and substantially all of our assets are located outside of the United States. As a result, it may not be possible for investors in the United States to enforce their legal rights, to effect service of process upon our directors or officers or to enforce judgments of United States courts predicated upon civil liabilities and criminal penalties of our directors and officers under Federal securities laws. Although China has executed the Agreement on Mutual Judicial Assistance in Criminal Matters with the United States in June 2000, there is no extradition treaty between the United States and China. Therefore, it is unclear whether criminal penalties under United States federal securities laws would be enforced effectively in China, if at all. OUR OPERATING COMPANY IS SUBJECT TO RESTRICTIONS ON DIVIDEND PAYMENTS AND OTHER DISTRIBUTIONS TO US. Current regulations in China would permit our operating company in China to pay dividends to us only out of its accumulated distributable profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, our operating company in China will be required to set aside at least 10% (up to an aggregate amount equal to half of its registered capital) of its accumulated profits each year. Such cash reserve may not be distributed as cash dividends. In addition, if our operating company in China incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. 13 THE CHINESE LEGAL SYSTEM IS NOT FULLY DEVELOPED AND HAS INHERENT UNCERTAINTIES THAT COULD LIMIT THE LEGAL PROTECTIONS AVAILABLE TO INVESTORS. The Chinese legal system is a system based on written statutes and their interpretation by the Supreme People's Court. Prior court decisions may be cited for reference but have limited legal precedents. Since 1979, the PRC government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. Two examples are the promulgation of the Contract Law of the PRC to unify the various economic contract laws into a single code, which went into effect on October 1, 1999, and the Securities Law of the People's Republic of China, which went into effect on July 1, 1999. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and their non-binding nature, interpretation and enforcement of these laws and regulations involve uncertainties. In addition, as the Chinese legal system develops, changes in such laws and regulations, their interpretation or their enforcement may have a material adverse effect on our business operations. ENFORCEMENT OF REGULATIONS IN CHINA MAY BE INCONSISTENT. Although the Chinese government introduced new laws and regulations to modernize its securities and tax systems on January 1, 1994, China does not yet possess an expansive body of business law. As a result, the enforcement, interpretation and implementation of regulations may prove to be inconsistent and it may be difficult to enforce contracts. WE MAY EXPERIENCE LENGTHY DELAYS IN RESOLUTION OF LEGAL DISPUTES. As China has not developed a dispute resolution mechanism similar to the Western court system, dispute resolution over Chinese projects and joint ventures can be difficult and there is no assurance that any dispute involving our business in China can be resolved expeditiously and satisfactorily. CHINESE ECONOMIC, POLITICAL AND SOCIAL CONDITIONS AS WELL AS GOVERNMENT POLICIES COULD ADVERSELY AFFECT OUR BUSINESS. All of our business, assets and operations are located in China. The economy of China differs from the economies of most developed countries in many respects, including government involvement, level of development, growth rate, control of foreign exchange, and allocation of resources. The economy of China has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry by imposing industrial policies. It also exercises significant control over China's economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. The economy of China has experienced significant growth in the past 20 years, but growth has been uneven both geographically and among various sectors of the economy. The Chinese government has implemented various measures from time to time to control the rate of economic growth. Some of these measures benefit the overall economy of China, but may have a negative effect on us. For example, our operating results and financial condition may be adversely affected by: o changes in the rate or method of taxation; o imposition of additional restrictions on currency conversion and remittances abroad; o reduction in tariff or quota protection and other import restrictions; and o changes in the usage and costs of state-controlled transportation services. 14 FLUCTUATIONS IN THE VALUE OF THE CHINESE RENMINBI RELATIVE TO FOREIGN CURRENCIES COULD AFFECT OUR OPERATING RESULTS. Substantially all our revenues and expenses are denominated in the Chinese Renminbi. However, we use the United States dollar for financial reporting purposes. The value of Chinese Renminbi against the United States dollar and other currencies may fluctuate and is affected by, among other things, changes in China's political and economic conditions. The Chinese government values the exchange rate of the Chinese Renminbi against a number of currencies, rather than just exclusively the United States dollar. Although the Chinese government has stated its intention to support the value of the Chinese Renminbi, we cannot assure you that the government will not revalue it. As our operations are primarily in China, any significant revaluation of the Chinese Renminbi may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert United States dollars into Chinese Renminbi for our operations, appreciation of this currency against the United States dollar could have a material adverse effect on our business, financial condition and results of operation. Conversely, if we decide to convert our Chinese Renminbi into United States dollars for other business purposes and the United States dollar appreciates against this currency, the United States dollar equivalent of the Chinese Renminbi would be reduced. To date, we have not engaged in any hedging transactions in connection with our operations. RISKS RELATED TO OUR COMMON STOCK THE LIQUIDITY OF OUR COMMON STOCK IS AFFECTED BY ITS LIMITED TRADING MARKET. Shares of our common stock are traded on the American Stock Exchange under the symbol "TBV". There is currently no broadly followed established trading market for our common stock. An established trading market may never develop or be maintained. Active trading markets generally result in lower price volatility and more efficient execution of buy and sell orders. The absence of an active trading market reduces the liquidity of shares. The trading volume of our common stock historically has been limited and sporadic. As a result of this trading activity, the quoted price for our common stock is not necessarily a reliable indicator of its fair market value. Further, if we cease to be quoted, holders would find it more difficult to dispose of, or to obtain accurate quotations as to the market value of our common stock and the market value of our common stock likely would decline. OUR COMMON STOCK MAY BE SUBJECT TO REGULATIONS PRESCRIBED BY THE SECURITIES AND EXCHANGE COMMISSION RELATING TO "PENNY STOCK". The Securities and Exchange Commission has adopted regulations that generally define a penny stock to be any equity security that has a market price (as defined in such regulations) of less than $5.00 per share, subject to certain exceptions. If our common stock meets the definition of a penny stock, it will be subjected to these regulations, which impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors. WE ARE MAJORITY OWNED BY ONE STOCKHOLDER. Our president and chief executive officer, Jinyuan Li, controls a majority of our common stock. Mr. Li beneficially owns approximately 92% of our outstanding common stock. As a result, Mr. Li has the ability to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control, including a merger, consolidation or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control, even if such change of control would benefit our other shareholders. OUR COMMON STOCK WILL LIKELY BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS. The stock market has experienced extreme price and volume fluctuations in recent years that have significantly affected the quoted prices of securities of many companies, including companies in our industry. The changes often appear to occur without regard to specific operating performance. In addition, there has been a limited public market for our common stock. We cannot predict the extent to which investor interest in us will be maintained. Such interest is necessary for an active, liquid trading market for our common stock. Active trading markets generally result in lower price volatility and more efficient execution of buy and sell orders for investors. The price and trading volumes of our common stock may fluctuate widely due to the limited public market for our stock. 15 SHARES AVAILABLE FOR FUTURE SALE MAY DILUTE AND DEPRESS THE PRICE OF OUR COMMON STOCK. A significant number of our shares are eligible for sale pursuant to Rule 144, and their sale could depress the market price of our stock. Some or all of the shares of common stock may be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect on the market for the shares of common stock. In general, a person who has held restricted shares for a period of one year may, upon filing with the SEC a notification on Form 144, sell into the market common stock in an amount equal to the greater of 1% of the outstanding shares or the average weekly number of shares sold in the last four weeks prior to such sale. Such sales may be repeated once each three months, and any of the restricted shares may be sold by a non-affiliate after they have been held two years. WE DO NOT ANTICIPATE PAYING DIVIDENDS IN THE FORESEEABLE FUTURE, AND THE LACK OF DIVIDENDS MAY HAVE A NEGATIVE EFFECT ON THE STOCK PRICE. We have never declared or paid any cash dividends or distributions on our common stock. We currently intend to retain our future earnings to support operations and to finance expansion and, therefore, do not anticipate paying any cash dividends on our common stock in the foreseeable future. ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ITEM 2. PROPERTIES We conduct our main business activities in Tianjin, China. Our primary facilities are located at No. 6. Yuanquan Road, Wuqing New-tech Industrial Park, Tianjin, PRC, and include: o three management buildings with a total area of 8,246 square meters, which are leased from Tianshi Group; o one research building with an area of 2,400 square meters, which are leased from Tianshi Group; o seven production plants with a total area is 19,425 square meters, which are leased from Tianshi Group; and o six warehouses with a total area of 18,250 square meters, three of which we own and three of which we lease. We lease our office building and manufacturing facilities in Tianjin, China from Tianshi Group, a related party through common ownership. Since 2003, Biological has leased office space and manufacturing facilities from Tianshi Group. The lease expires at the end of 2007 and requires annual rent at 1% of our total gross revenues. The rent was negotiated by the parties prior to entering into the agreement, before we acquired Tianshi International, and we believe that it is a reasonable rent for the facilities. In addition, we are obligated to pay insurance, maintenance and other expenses related to the premises. ITEM 3. LEGAL PROCEEDINGS We are not a party to any material pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On November 21, 2006, the annual meeting of stockholders of the Company (the "Annual Meeting") was held at the Company's Tianjin offices for the following purposes: 1. Elect the following persons to the Board of Directors: Jinyuan Li, Wenjun Jiao, Yupeng Yan, Ping Bai, Gilbert Raker, Howard Balloch, and Socorro Quintero. 2. Ratify the Board of Directors' appointment of Moore Stephens Wurth Frazer and Torbet, LLP, the independent public accountants as the auditor of the Company for the fiscal year 2006. 16 In this Annual Meeting, there were accordingly present, in person or by proxy, an aggregate of 68,161,839 shares of Common Stock, such shares being a majority of the 71,333,586 shares of Common Stock entitled to notice of and to vote at the meeting. The result of the vote taken for the election of directors at the meeting was as follows: No. of Shares No. of Shares Withheld Directors For Against Authority --------------------------- -------------- -------------- -------------- Jinyuan Li 68,104,224 22,615 35,000 Wenjun Jiao 68,096,890 29,949 35,000 Yupeng Yan 68,098,577 28,262 35,000 Ping Bai 68,097,977 28,862 35,000 Socorro Quintero 68,125,488 1,351 35,000 Howard Balloch 68,030,352 96,487 35,000 Gilbert Raker 68,125,793 1,046 35,000 The result of the vote taken for the ratification of the appointment of Moore Stephens Wurth Frazer and Torbet, LLP was as follows: o 68,152,5794 shares voted in favor of the proposal, o 4,133 shares voted against the proposal, and o 3,820 shares abstained. 17 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASERS OF EQUITY SECURITIES STOCK PERFORMANCE PRESENTATION The following chart compares the cumulative stockholder return on the Company's common stock with the cumulative total stockholder return of (i) the AMEX Composite Index and (ii) the Nasdaq Biotechnology Index. CUMULATIVE TOTAL RETURN AMONG TIENS BIOTECH GROUP (USA), INC., AMEX COMPOSITE MARKET INDEX AND NASDAQ BIOTECH INDEX (1) (2) [CHART APPEARS HERE]
OCTOBER 7, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2003 2003 2004 2005 2006 ------------ ------------ ------------ ------------ ------------ Tiens Biotech Group (USA), Inc. $ 100.00 $ 301.25 $ 175.00 $ 90.50 $ 98.25 AMEX Composite Index $ 100.00 $ 115.51 $ 141.18 $ 173.14 $ 202.41 Nasdaq Biotechnology Index $ 100.00 $ 95.59 $ 101.44 $ 104.32 $ 105.42
(1) Assumes $100 invested on October 7, 2003 and assumes dividends reinvested. The Company has not paid any dividends on its common stock, and no dividends are included in the report of the Company's performance. Measurement points are at the last trading day of the fiscal years ended December 31, 2003, 2004, 2005 and 2006. The material in this chart is not soliciting material, is not deemed filed with the SEC and is not incorporated by reference in any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date of this proxy statement and irrespective of any general incorporation language in such filing. (2) The Company was listed on the American Stock Exchange as of April 25, 2005. The Company's common stock began quotation on the Over the Counter Bulletin Board on October 7, 2003. Prior to October 7, 2003, the Company's common stock was eligible for quotation on the Over the Counter Bulletin Board, but there was no trading activity. MARKET PRICES OF COMMON STOCK Our common stock was listed on the Over the Counter Bulletin Board under the symbol "TBGU" from January 1, 2004 to April 24, 2005. The following table sets forth the range of high and low bid prices reported by the OTCBB in each fiscal quarter from January 1, 2005 to April 24, 2005. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. On April 25, 2005, our common stock was listed on the American Stock Exchange under the symbol "TBV". The table also sets forth the range of high and low bid prices for our common stock reported by the American Stock Exchange in each fiscal quarter from April 25, 2005 to December 31, 2006. High Low ---------- ---------- Fiscal 2005 ----------- Quarter Ended March 31, 2005 $ 7.00 $ 4.88 April 1, 2005 to April 24, 2005 $ 7.50 $ 4.15 April 25, 2005 to June 30, 2005 $ 6.95 $ 4.93 Quarter ended September 30, 2005 $ 6.41 $ 3.68 Quarter ended December 31, 3005 $ 5.40 $ 2.82 Fiscal 2006 ----------- Quarter Ended March 31, 2006 $ 5.02 $ 3.62 Quarter Ended June 30, 2006 $ 7.47 $ 4.01 Quarter ended September 30, 2006 $ 4.40 $ 2.61 Quarter ended December 31, 3006 $ 4.02 $ 2.80 SHAREHOLDERS As of March 26, 2007, there were a total of 71,333,586 shares of our common stock outstanding, held by approximately 946 stockholders of record. This number of holders of record does not represent the actual number of beneficial owners of shares of our common stock because shares are frequently held in "street name" by securities dealers and others for the benefit of individual owners who have the right to vote their shares. 18 DIVIDEND POLICY We have not declared any dividends on our common stock since inception and do not intend to pay dividends on our common stock in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES None. AUTHORIZATION OF SECURITIES FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS None. ISSUER PURCHASES OF EQUITY SECURITIES None. 19 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth certain of our historical financial data. The selected consolidated historical financial data set forth below are not necessarily indicative of the results of future operations and should be read in conjunction with the discussion under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the historical consolidated financial statements and accompanying notes included elsewhere in this document. The following selected financial data as of and for the years ended December 31, 2002, 2003, 2004, 2005 and 2006 have been derived from our audited consolidated financial statements. The consolidated financial statements for the year ended December 31, 2002 are those of Tianshi International and its 80% owned subsidiary Biological and have been presented for comparison purposes only.
YEAR ENDED DECEMBER 31 ------------------------------------------------------------------------------ 2002 2003 2004 2005 2006 -------------- -------------- -------------- -------------- -------------- INCOME STATEMENT DATA: Revenue - related parties .................... $ 14,096,726 $ 38,392,208 $ 58,910,532 $ 68,688,669 $ 66,790,466 Cost of sales ................................ 8,297,845 12,725,161 17,483,739 17,451,605 18,082,441 -------------- -------------- -------------- -------------- -------------- Gross profit ................................. 5,798,881 25,667,047 41,426,793 51,237,064 48,708,025 Selling, general and administrative expenses . 3,193,190 3,171,338 7,363,248 13,413,875 12,789,810 -------------- -------------- -------------- -------------- -------------- Income from operations ....................... 2,605,691 22,495,709 34,063,545 37,823,189 35,918,215 Other income (expense), net .................. (110,860) (1,178,389) 388,266 (639,137) 161,091 -------------- -------------- -------------- -------------- -------------- Income before provision for income taxes and minority interest ...................... 2,494,831 21,317,320 34,451,811 37,184,052 36,079,306 Provision for income taxes ................... 0 0 0 2,984,302 2,823,899 -------------- -------------- -------------- -------------- -------------- Income before minority interest .............. 2,494,831 21,317,320 34,451,811 34,199,750 33,255,407 Minority interest ............................ 498,966 4,263,498 7,013,515 7,321,630 6,963,330 -------------- -------------- -------------- -------------- -------------- Net income ................................... 1,995,865 17,053,822 27,438,296 26,878,120 26,292,077 Other comprehensive income Foreign currency translation adjustment ... 0 0 (8,239) 2,246,380 3,480,775 -------------- -------------- -------------- -------------- -------------- Comprehensive income ......................... $ 1,995,865 $ 17,053,822 $ 27,430,057 $ 29,124,500 $ 29,772,852 ============== ============== ============== ============== ============== Weighted average number of shares outstanding ......................... 29,137,549 44,730,609 71,801,819 71,333,586 71,333,586 Earnings per share, basic and diluted ...... $ 0.07 $ 0.38 $ 0.38 $ 0.38 $ 0.37 BALANCE SHEET DATA (at end of period): Cash and cash equivalents and current investments ................................ $ 302,974 $ 12,725,043 $ 39,243,872 $ 77,545,991 $ 54,270,065 Working capital .............................. 4,830,368 28,121,818 53,716,852 81,067,056 74,008,466 Total assets ................................. 33,797,956 57,101,642 83,518,933 121,624,154 148,746,998 Current potion of long-term debt ............. 263,677 259,364 155,442 2,130,000 2,130,000 Long-term debt ............................... 446,029 155,591 10,657,742 8,527,742 6,397,742 Stockholders' equity ......................... 16,032,170 33,086,192 60,522,899 89,647,399 119,420,251
20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS: The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The words or phrases "would be," "will allow," "expect to", "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements". Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under "Liquidity and Capital Resources"; (e) whether Tianshi Engineering, our affiliate who sells our products in China, obtains a direct selling license in China; and (f) whether the Chinese government grants Tiens Yihai the right to acquire the property in Shanghai, China for a research and development facility. Statements made herein are as of the date of the filing of this Form 10-K with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement. The following discussion and analysis should be read in conjunction with "Item 6. Selected Financial Data" and our consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-K. OVERVIEW Tiens USA researches, develops, manufactures, and markets nutrition supplement products, including wellness products and dietary supplement products, and personal care products. Our operations are conducted from our headquarters in Tianjin, China through our 80% owned subsidiary, Biological. We sell our products to affiliated companies in China and internationally. We develop our products at our product research and development center, which employs highly qualified professionals in the fields of pharmacology, biology, chemistry and fine chemistry. We have developed and produce 35 nutrition supplement products, which include wellness products and dietary nutrition supplements, and 25 personal care products, which include skin care products and personal washing products. In China, we sell our products to Tianshi Engineering, an affiliated company. Tianshi Engineering, in turn, sells the products to end-users through its chain stores and Chinese affiliated companies. Internationally, we sell our products to an extensive direct sales force of overseas affiliates and independent distributors who use the products themselves and/or resell them to other distributors or consumers. In April 2004, Tianshi International entered a joint venture contract with Tianshi Pharmaceuticals to establish Tiens Yihai. Tiens Yihai is 99.4% owned by Tianshi International and 0.6% owned by Tianshi Pharmaceuticals. Tiens Yihai is located in Shanghai, China, and was established to build a new research and development facility which would also produce our nutrition supplement, home care, and personal care products. 21 RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005 REVENUE. In 2006 revenue was $66.8 million compared to $68.7 million in 2005, a decrease of 2.8%. The breakdown of revenue between Chinese and international sales is as follows. CHINESE AND INTERNATIONAL REVENUE Revenue Year 2005 Year 2006 % Change -------------------------- -------------- -------------- ------------ China $ 38,181,090 $ 27,074,979 -29.1% International $ 30,507,579 $ 39,715,487 30.2% In 2006 revenue from China decreased to $27.1 million, or 29.1% compared to $38.2 million in 2005. At the beginning of 2006, we began selling semi-finished products to Tianshi Engineering. In order to qualify for a direct selling license in China, Tianshi Engineering, our related party customer in China, is required to produce a part of the products that it sells in China. As a result, in 2006, we began to sell semi-finished products to Tianshi Engineering, which jointly shares with us licenses to produce, manufacture and sell the products. These semi-finished products have a lower sales price than the finished products we had previously sold to Tianshi Engineering. In addition, we believe that sales to China in 2006 were negatively impacted by other factors, including: o continued consumer uncertainty in China regarding the impact of recently enacted direct selling regulations and uncertainty regarding the timing of the direct selling license application process and approval; and o increased government and media scrutiny on the direct selling industry, particularly following publication of new direct selling regulations at the end of 2005. The application of Tianshi Engineering for a direct selling license in China is still pending. Until the application is approved, Tianshi Engineering will continue to sell our products through its branches and chain stores in China. In 2006, international sales increased to $39.7 million, or 30.2% compared to $30.5 million in 2005. The strong growth reflects a significant increase in demand for our products in Indonesia, as well as strong revenue growth in Kazakhstan, South Africa, Thailand, Ukraine, Congo and Ghana. COST OF SALES. Cost of sales increased by $0.6 million in 2006, a 3.6% increase compared with 2005. Cost of sales as a percentage of revenue increased to 27.1% for the twelve months ended December 31, 2006 compared to 25.4% for 2005. In order to improve the quality of our products, during 2006 we introduced some new manufacturing procedures and stricter quality control testing than previously, which added to our manufacturing costs. However, we believe that once our production team becomes more familiar with the new production procedures, the manufacturing costs of our products will decrease. In addition, due to the uncertainty of the Chinese market, we did not achieve domestic sales growth and the average fixed cost per unit was higher than in 2005. GROSS PROFIT. Gross profit decreased by 4.9% to $48.7 million in 2006, compared to $51.2 million in 2005. The gross profit margin for 2006 was 72.9% compared to 74.6% in 2005 as a result of the reasons discussed under cost of sales. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses decreased to $12.8 million in 2006, or 4.7% compared to $13.4 million in 2005. This decrease primarily reflects a decrease in transportation expenses, as well as a decrease in low cost supplies expenses and expenses relating to the startup costs of Tiens Yihai. In 2006 we began to sell semi-finished goods to Tianshi Engineering and the transportation costs that were previously incurred by us are now incurred by Tianshi Engineering. The selling and administrative expenses as a percentage of sales decreased to 19.1% in 2006 from 19.5% in 2005. OTHER INCOME (EXPENSE), NET. Other income (expense), net was $0.2 million of income in 2006, compared to expense of $0.6 million in 2005. 22 The increase is a result of improved cash management, including the purchase of an investment product and deposits in higher interest-bearing accounts. NET INCOME. For the above stated reasons, net income in 2006 was $26.3 million compared to $26.9 million in 2005, a decrease of 2.2%. YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004 REVENUE. In 2005, revenue was $68.7 million compared to $58.9 million in 2004, an increase of 16.6%. The breakdown of revenue between Chinese and international sales is as follows. CHINESE AND INTERNATIONAL REVENUE Revenue Year 2004 Year 2005 % Change -------------------------- -------------- -------------- ------------ China $ 29,210,167 $ 38,181,090 30.7% International $ 29,700,365 $ 30,507,579 2.7% In 2005 revenue from China increased to $38.2 million, or 30.7% compared to $29.2 million in 2004. The increase reflects a significant increase in the demand for our products in China during 2005, resulting from the increase in our networking sales forces in China and the establishment of 40 new branches in China by Tianshi Engineering. In 2005 international sales increased to $30.5 million, or 2.7% compared to $29.7 million in 2004. The slight increase reflects an increase in demand from two newly established affiliate companies located in Rwanda and Venezuela, and relatively flat revenue in other international markets for 2005. COST OF SALES. Although revenue increased by nearly $10 million in 2005, cost of sales remained constant at $17.5 million, compared with 2004. Cost of sales as a percentage of revenue decreased to 25.4% in 2005 compared to 29.7% in 2004. This reflects improved economies of scale relating to the expansion of our production, as well as a decrease in raw material costs per unit based on larger raw material purchase orders. GROSS PROFIT. Gross profit increased to $51.2 million in 2005, or 23.7%, from $41.4 million in 2004. The gross profit margin in 2005 was 74.6% compared to 70.3% in 2004 as a result of the reasons discussed under cost of sales. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased to $13.4 million in 2005, or 82.2%, over $7.4 million in 2004. This increase reflects the steps we have taken to support future sales increases, and was primarily attributable to an increase in head count, resulting in an increase in related salary, welfare and insurance costs. There was also an increase in low cost supplies expense, such as stationery and furniture, relating to additional office space required by the additional employees. The selling and administrative expenses as a percentage of sales increased to 19.5% in 2005 from 12.5% in 2004. OTHER INCOME (EXPENSE), NET. Other income (expense), net was $0.6 million of expense in 2005, compared to income of $0.4 million in 2004. In 2005, we incurred $532,887 of interest relating to the terms of our long-term loan agreement with Tianyuan Capital Development Corp. Ltd., as more fully described under the caption "Certain Relationships and Related Transactions--Loans." We also incurred expense of $339,299 for additional taxes and penalties paid by us to the Chinese government during the first quarter in 2005 as the result of a VAT examination by the local government. PROVISION FOR INCOME TAXES. Provision for income taxes increased to $3.0 million in 2005, compared to none in 2004. This was due to our operating subsidiary in China, Biological, becoming subject to an annual income tax rate of 7.5% in 2005. In 2003 and 2004, Biological was exempt from paying income taxes in China. From January 1, 2005 through December 31, 2007, Biological is subject to an income tax at a reduced rate of 7.5%. From January 1, 2008 forward, Biological will be subject to a 15% income tax rate. NET INCOME. Net income in 2005 was $26.9 million compared to $27.4 million in 2004. The increase in selling general and administrative expenses almost entirely offset our improvements in revenue and gross profit margin. 23 QUARTERLY RESULTS OF OPERATIONS The following table sets forth selected unaudited quarterly data for the periods shown.
Quarter Ended -------------------------------------------------------------------------------------------------------------- March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31, 2005 2005 2005 2005 2006 2006 2006 2006 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Revenue-related parties $ 14,295,999 $ 17,307,659 $ 19,126,809 $ 17,958,202 $ 16,722,560 $ 14,292,998 $ 19,187,748 $ 16,587,160 Cost of sales 3,457,418 4,197,812 4,954,198 4,842,177 4,806,296 3,842,392 5,066,051 4,367,702 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Gross profit 10,838,581 13,109,847 14,172,611 13,116,025 11,916,264 10,450,606 14,121,697 12,219,458 Selling, general and administrative expenses 2,633,875 2,465,676 2,795,414 5,518,910 2,566,422 3,271,232 2,803,859 4,148,297 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Income from operations 8,204,706 10,644,171 11,377,197 7,597,115 9,349,842 7,179,374 11,317,838 8,071,161 Other (expense) income, net (463,061) (224,103) (126,969) 174,996 (37,721) 1,075 164,104 33,633 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Income before provision for income taxes and minority interest 7,741,645 10,420,068 11,250,228 7,772,111 9,312,121 7,180,449 11,481,942 8,104,794 Provision for income taxes 616,259 829,185 869,769 669,089 733,531 576,029 878,931 635,408 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Income before minority interest 7,125,386 9,590,883 10,380,459 7,103,022 8,578,590 6,604,420 10,603,011 7,469,386 Minority interest 1,520,106 1,995,963 2,175,715 1,629,846 1,808,881 1,419,943 2,167,747 1,566,759 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Net income $ 5,605,280 $ 7,594,920 $ 8,204,744 $ 5,473,176 $ 6,769,709 $ 5,184,477 $ 8,435,264 $ 5,902,627 Other comprehensive income foreign currency translation adjustment 999 999 2,047,847 196,535 717,827 267,960 1,411,012 1,083,976 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive income $ 5,606,279 $ 7,595,919 $ 10,252,591 $ 5,669,711 $ 7,487,536 $ 5,452,437 $ 9,846,276 $ 6,986,603 ============ ============ ============ ============ ============ ============ ============ ============ Weighted average number of shares outstanding 71,333,586 71,333,586 71,333,586 71,333,586 71,333,586 71,333,586 71,333,586 71,333,586 Earnings per share, basic and diluted $ 0.08 $ 0.11 $ 0.12 $ 0.08 $ 0.09 $ 0.07 $ 0.12 $ 0.08
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following table sets forth payments due by period for fixed contractual obligations as of December 31, 2006.
Payments due by period (1) --------------------------------------------------------- Less than More than 1 year 1-3 years 3-5 years 5 years ------------ ------------ ------------ ------------ Long-term Debt Obligations $ 2,130,000 $ 4,260,000 $ 2,137,742 $ 0 Operating Lease Obligations 265,844 0 0 0 ------------ ------------ ------------ ------------ Total $ 2,395,844 $ 4,260,000 $ 2,137,742 $ 0 ============ ============ ============ ============
(1) We lease our office building and manufacturing facilities in Tianjin, China from Tianshi Group, a related party through common ownership. On June 30, 2002, we entered into a written lease agreement with Tianshi Group to pay annual rent at 1% of our total gross revenues. The term of this agreement is for five years commencing on January 1, 2003. Because the rent is based upon a percentage of our gross total revenues, we are not able to include a fixed figure in the table relating to this obligation. The total amount paid on this was $662,082 for the 12 months ended December 31, 2006. 24 FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES The account receivable-related parties increased by $10.8 million, from $2.2 million in 2005 to $12.9 million in 2006. The increase is due primarily to payment extensions given to Tianshi Engineering to allow it to fund its marketing efforts in China in anticipation of receiving a direct selling license in China. Inventories at December 31, 2006 decreased to $6.8 million compared to $7.5 million at December 31, 2005. At the beginning of 2006 we started selling semi-finished goods to Tianshi Engineering to enable it to qualify for a direct selling license in China. Therefore, there were less finished products in inventory. Accounts payable increased to $4.1 million as of December 31, 2006 compared to $2.7 million, as of December 31, 2005. The increase was mainly due to longer credit terms given by our suppliers. Property, plant and equipment increased to $30.5 million as of December 31, 2006 compared to $24.9 million as of December 31, 2005. The increase was primarily due to costs related to the construction of a new conference center at our headquarters in Tianjin. We typically generate positive cash flow from operations due to favorable gross margins. Net cash provided by operating activities decreased to $12.9 million for the twelve months ended December 31, 2006, compared to $43.3 million for the same period in 2005. The decrease primarily reflects an increase in accounts receivable-related parties of $16.5 million and an increase in other receivable-related parties of $5.7 million. Net cash used in investing activities for 2006 increased by $29.7 million to $35.9 million. This increase was mainly due to the short-term loan of $25.0 million made by Biological to Tianshi Engineering and a loan of $3.2 million relating to the Yihai project made to the Local Government. Net cash used in financing activities was $2.1 million for 2006, compared to $0.2 million for 2005. In 2006 we paid two installment payments totaling $2.1 million relating to the $10.7 million loan for the Yihai project. As of December 31, 2006 and December 31, 2005, we had cash of $54.3 million and $77.5 million, respectively. The decrease was primarily due to the short-term loan to Tianshi Engineering and the loan to the Local Government relating to the Yihai project. Approximately 64% of the cash was held in the bank account of Biological and 27% in the bank account of Tiens Yihai. Going forward, our primary requirements for cash consist of: o the continued production of existing products and general overhead and personnel related expenses to support these activities; o continued promotion of networking sales activities; o the development costs of new products; and o expansion of production scale to meet the demands of our markets. We anticipate that our current operating activities will enable us to meet our anticipated cash requirements for 2007. We estimate that the construction of our Tiens Yihai research, development and manufacturing facility will require approximately $200 million. If we receive approval to proceed with the development of the Tiens Yihai project, we may require additional financing to fund the project. MANAGEMENT ASSUMPTIONS Management anticipates, based on internal forecasts and assumptions relating to our current operations that existing cash and funds generated from operations will be sufficient to meet working capital for at least the next 12 months. In the event that our business plans change, our assumptions change or prove inaccurate or if other capital resources and projected cash flow otherwise prove to be insufficient to fund operations (due to unanticipated expense, technical difficulties, or otherwise), we could be required to seek additional financing. There can be no assurance that we will be able to obtain additional financing on terms acceptable to us, or at all. 25 OFF-BALANCE SHEET ARRANGEMENTS We have no off-balance sheet arrangements. CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See note 2 to our consolidated financial statements, "Summary of Significant Accounting Policies." Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations. REVENUE RECOGNITION We recognize revenue from domestic sales by distributors in China, net of sales commissions and taxes only when the related Chinese distributor recognizes sales of the Company's products to unaffiliated third parties. We recognize revenue from international sales (non-Chinese) to both affiliated and unaffiliated third parties, net of commissions and taxes as goods are shipped and clear review by the international customs department. We generally are not contractually obligated to accept returns. However, on a case by case negotiated basis, we permit customers to return their products. In accordance with SFAS No. 48, "Revenue Recognition when the Right of Return Exists", revenue is recorded net of an allowance for estimated returns. Such reserves are based upon management's evaluation of historical experience and estimated costs. The amount of the reserves ultimately required could differ materially in the near term from amounts included in the accompanying consolidated financial statements. As of December 31, 2006, Tianshi Engineering, an affiliated company, owned all of the related party distributors which sell our products in China. ALLOWANCE FOR DOUBTFUL ACCOUNTS Our trade accounts receivables are mainly due from related companies. Management reviews its accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each year-end, paying particular attention to the age of receivable outstanding. INVENTORIES Inventories are stated at the lower of cost or market using the first-in, first-out basis. Management reviews inventory annually for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence. RECENT ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments", which amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 155 provides guidance to simplify the accounting for certain hybrid instruments by permitting fair value re-measurement for any hybrid financial instrument that contains an embedded derivative, as well as, clarifies that beneficial interests in securitized financial assets are subject to SFAS No. 133. In addition, SFAS No. 155 eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold under SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a new basis occurring after the beginning of an entity's first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS to have a material impact on our consolidated financial statements. 26 In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets", which amends SFAS No. 140. SFAS No. 156 specifically provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities, and provides an approach to simplify efforts to obtain hedge accounting treatment. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after September 15, 2006, with early adoption being permitted. We do not expect the adoption of SFAS 156 to have a material impact on our consolidated results of operations and financial condition. In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes". FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The requirements of FIN 48 are effective for our fiscal year beginning January 1, 2007. We do not expect the adoption of FIN 48 to have a material impact on our consolidated results of operations and financial condition. In September 2006, the SEC issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of each on a company's balance sheet and statement of operations and the related financial statement disclosures. Early application of the guidance in SAB 108 is encouraged in any report for an interim period of the first fiscal year ending after November 15, 2006. We do not expect the adoption of SAB 108 to have a material impact on our consolidated results of operations and financial condition. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS 157"), which provides enhanced guidance for using fair value to measure assets and liabilities. This standard also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 12, 2007, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating whether the adoption of SFAS157 will have a material effect on our consolidated results of operations and financial condition. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, "Employer's Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("SFAS 158"). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. The standard also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. An employer without publicly traded equity securities is required to recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after June 15, 2007. We do not expect the adoption of SFAS 158 to have a material impact on our consolidated results of operations and financial condition. 27 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK EFFECTS OF INFLATION We are subject to commodity price risks arising from price fluctuations in the market prices of the various raw materials that comprise our products. Price risks are managed by each business unit through productivity improvements and cost-containment measures. For the time being, the management does not believe that inflation risk is material to our business or our consolidated financial position, results of operations or cash flows. EFFECT OF FLUCTUATIONS IN FOREIGN EXCHANGE RATES Our operating subsidiary, Biological, is located in China, buys all of its raw materials in China, and sells 40.5% of our products in China, using the Chinese Renminbi ("RMB") as the functional currency. Based on Chinese government regulations, all foreign currencies under the category of current accounts are allowed to be freely exchanged with hard currencies. On July 21, 2005, the Chinese government approved the increase in the valuation of RMB against the US dollar by 2%. Because we report our revenues in US dollars, changes in the valuation of RMB may impact our net income. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on its future business, product pricing, results of operations or financial condition. Currently we have not entered agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statement required by this item may be found following the signature page of this annual report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of management, including our chief executive officer and the chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report (the "Evaluation Date"). Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the material information required to be included in our SEC reports is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms relating to our company, including our consolidating subsidiaries, and was made known to them by others within those entities, particularly during the period when this report was being prepared. Additionally, there were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date. We have not identified any significant deficiencies or material weaknesses in our internal controls, and therefore there were no corrective actions taken. 28 PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Set forth below are the names of the directors, executive officers and key employees of the Company as of March 29, 2007. With the exception of Jinyuan Li, who served on the Board since the reorganization in September 2003, all other directors served on the Board since January 2004. NAME AGE POSITION ------------------------- --------- ----------------------------------------- Jinyuan Li 49 Chairman, Chief Executive Officer, President and Director Wenjun Jiao 43 Chief Financial Officer and Director Yupeng Yan 44 Executive Vice President and Director Socorro Quintero 55 Director Howard Balloch 56 Director Gilbert Raker 63 Director None of our directors and officers was selected pursuant to any agreement or understanding with any other person. There is no family relationship between any director or executive officer and any other director or executive officer. JINYUAN LI Mr. Li has served as the Chairman of the Board and a Director since September 2003. Mr. Li is also the President and founder of the Company. He also serves as President of Tianshi Group and has held that position since 1995. Mr. Li has 14 years of experience in the petroleum and plastics industries. He holds a number of leadership positions in government and social associations, including as commissioner of the Tianjin Political Consultative Conference; Standing Director of China Entrepreneur's National Council; Executive Commissioner of All-China Federation of Industry and Commerce; Vice President of Chinese Bioengineering Association; and Vice president of Chinese Healthcare Association. Mr. Li was elected as one of the Top Ten Most Outstanding Talents in the Greater China Area; one of the Ten Most Popular Personages Among the High-Ranking, by China Economic Forum; Excellent Entrepreneur, by the Organization Committee of the Second Chinese Entrepreneur Forum in 2003, and as the Most Creative Chinese Businessman of Asia in 2004. Mr. Li holds a MBA degree from Nankai University. WENJUN JIAO Mr. Jiao has served as the Chief Financial Officer of the Company since September 2003. Prior to that, Mr. Jiao served as the Chief Financial Officer of Tianjin Tianshi Biological Development Co. Ltd from May 2001 through 2003. Mr. Jiao holds a Doctorate Degree in Accounting form Tianjin University of Finance and Economics and a MBA Degree from Oklahoma City University. Mr. Jiao is a Certified Public Accountant in China. Before he joined Tianjin Tianshi Biological Development Co. Ltd, Mr. Jiao served as CFO of various large companies and as chairman of a consulting company in China. Mr. Jiao has 19 years of sound financial management experience in the manufacturing, trade, construction and consulting industries and received the "2005 Top Ten CFO of China Award" in 2005. YUPENG YAN Mr. Yan has served as Executive Vice-President of the Company since September 2003. Prior to that, Mr. Yan served as Vice-President of Tianshi Group from March 1997 to May 2004. Since June 2004, Mr. Yan has also served as head of Tianshi Marketing Group. Mr. Yan currently holds a number of leadership positions including Vice-Dean of Tianshi Occupational Technique Institute, and Vice-Chairman of Tianshi Science and Technique Association. Mr. Yan was elected as one of the Chinese Ten Outstanding Professional Managers in 2004. Mr. Yan received an Executive Masters of Business Administration Degree from Nankai University in July 2004. 29 SOCORRO QUINTERO Dr. Quintero serves as a director of the Company. Dr. Quintero is an Associate Professor of Finance at Oklahoma City University's Meinders School of Business ("OCU"). Prior to joining OCU in 1993, she served as Assistant Professor of Finance at the University of South Florida. Dr. Quintero has extensive work experience in various industrial engineering capacities and management levels while working for Atlantic Steel Company, Abbott Laboratories and Levi Strauss & Co. She received a Bachelor of Science in Physics from the University of the Philippines, a Master of Science in Industrial Engineering from the Georgia Institute of Technology, and a Doctorate degree in Finance from the University of Texas at Austin. GILBERT RAKER Mr. Raker serves as a director of the Company, and has served as the President, Chief Executive Officer and Chairman of the Board of SEMX Corporation (Pink Sheets: SEMX) since 1988. SEMX Corporation manufactures materials and components used in microelectronic circuitry, primarily for the automotive, consumer electronics, defense, medical and aerospace industries. Prior to 1988, Mr. Raker worked at two private equity investment firms and was employed as Chief Financial Officer by two New York Stock Exchange listed companies and several private companies. Mr. Raker received his Bachelor of Science degree in Chemistry from Eastern University and his Master of Business Administration in Production Management from Syracuse University. HOWARD BALLOCH Mr. Balloch serves as a director of the Company, and has been the President and Chief Executive Officer of the Canada China Business Council since 2001. In addition, Mr. Balloch served as the Canadian ambassador to the People's Republic of China from February of 1996 until July of 2001. Mr. Balloch currently serves on the board of directors of the following companies: Magic Lantern Group, Inc. (AMEX: GML), Zi Corporation (TSX: ZIC, NASDAQ: ZICA), Oztime Media, a wholly-owned subsidiary of Zi Corporation, Ivanhoe Energy, Inc. (TSX: IE, NASDAQ: IVAN), Ivanhoe Mines Ltd. (TSX, NYSE, NASDAQ: IVN), East Energy Corp (TSX: EEC), Methanex Corporation (TSX: MX, NASDAQ: MEOH), Maple Leaf Education Holding and Capital Club, Beijing. Mr. Balloch is the founder and President of The Balloch Group, an investment advisory and merchant banking firm located in Beijing, China. He currently serves as an Adjunct Professor of International Business at the University of British Columbia. Mr. Balloch received his Bachelor of Arts and Master of Arts degrees from McGill University. AUDIT COMMITTEE The Board of Directors has established an audit committee in accordance with Rule 10A-3 of the Exchange Act. The members of the Audit Committee are Socorro Quintero (Chairman), Howard Balloch and Gilbert Raker, each of whom are independent as defined under Section 121(A) of the American Stock Exchange listing standards currently in effect. None of the Audit Committee members is a current officer or employee of the Company or any of its affiliates. The Board of Directors has determined that Socorro Quintero and Gilbert Raker each qualify as an "audit committee financial expert" under Item 401(b) of Regulation S-K of the Exchange Act. 30 CODE OF BUSINESS CONDUCT AND ETHICS The Board has adopted a Code of Business Conduct and Ethics to promote its commitment to the legal and ethical conduct of the Company's business. The Chief Executive Officer, Chief Financial Officer, and other senior officers are required to abide by the Code of Business Conduct and Ethics, which provides the foundation for compliance with all corporate policies and procedures, and best business practices. The Code of Business Conduct and Ethics was filed as an exhibit to the Company's annual report on Form 10-KSB for the year ended December 31, 2004. A written copy of the Code of Business Conduct and Ethics will be provided upon request at no charge by writing to the Company's corporate secretary, Alexander Jiao, at Tiens Biotech Group (USA), Inc., No. 6, Yuanquan Road, Wuqing New-Tech Industrial Park, Tianjin, China 301700. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Based solely upon a review of Forms 3 and 4 and amendments to these forms furnished to the Company, all parties subject to the reporting requirements of Section 16(a) of the Exchange Act filed all such required reports during and with respect to 2006. ITEM 11. EXECUTIVE COMPENSATION. COMPENSATION DISCUSSION AND ANALYSIS All compensation decisions for our executive officers, including the salary of our CEO and President, Jinyuan Li, are made by Jinyuan Li. Because Mr. Li owns more than 50% of our voting stock, we are a "controlled company" pursuant to Rule 801(a) of the American Stock Exchange Rules ("Amex Rules"). Therefore, we are exempt from Amex Rule 805(a), which requires that the compensation of a CEO and all other executive officers be determined, or recommended to the Board for determination, by a compensation committee composed of independent directors, or the majority of independent directors on the Board. The objectives of our compensation programs. We seek to attract and retain executive officers of the highest caliber and motivate them to maximize the success of our business. What our compensation program is designed to reward. Our CEO believes that he is incentivized by his large equity ownership in the Company. Therefore, he believes that a long-term employment contract providing a base salary is appropriate compensation for him. With respect to the other executive officers' base salaries, our CEO bases his recommendations on past salary levels with the Company and his perception of the quality of their respective performances and attempts to match their salaries with his perception of compensation levels at a small number of companies he considers comparable. Our CEO also takes in to consideration the relatively low salary provided to executive officers by companies in China compared to public companies in the United States. Our CEO assesses the normal responsibilities of each position, as well as the extra responsibilities and additional work related to special projects which such executive officers may be expected to perform. No relative weight was assigned to any of the foregoing factors. Elements of compensation. Each executive officer receives cash compensation as a base salary. Base salary for our executive officers is fixed by their respective employment agreements, as described under "Employment Agreements." Jinyuan Li and Wenjun Jiao's salaries for 2006 were fixed pursuant to employment agreements with Biological entered into in 2005. Their base salaries were based on our CEO's subjective perceptions of salaries paid by comparable companies for comparable positions. Executive officers also will receive payments upon termination of their employment agreements for specified reasons. 31 Jinyuan Li holds 92.3% of our shares of common stock. Our other executive officers have also been shareholders of our common stock as disclosed under "Security Ownership Table" since the reorganization of our Company in September 2003. Each of our executive officers received shares in the Company as a result of their share ownership of our business before the reorganization. Our CEO believes that the executive officers' equity interest in our Company motivates them to maximize the success of our business and therefore did not consider bonuses for 2006. We do not currently have a stock option plan, but may consider adopting one in the future to further incentivize its employees. Why we chose to pay each element. We have entered into long-term employment agreements with Messrs. Li and Jiao which provides for a base salary. Our employment agreements with Messrs. Li and Jiao provide for payments upon termination for specified reasons. These payments are required by local Chinese employment regulations. Additional information regarding applicable payments under such agreements is provided under the heading "Potential Payments Upon Termination or Change of Control." How we determine the amount for each element to pay. With respect to the executive officers' base salaries, our CEO bases his recommendations on past salary levels and his perception of the quality of their respective performances and attempts to match their salaries with his perception of compensation levels at a small number of companies he considers comparable, although not necessarily included in the AMEX Composite Index or Nasdaq Biotechnology Index. Our CEO assesses the normal responsibilities of each position, as well as the extra responsibilities and additional work related to special projects which such executive officers may be expected to perform. Our CEO also takes in to consideration the relatively low salary provided to executive officers by companies in China compared to public companies in the United States. The amount of the payments required to be paid upon termination of employment agreements for specified reasons are determined according to local Chinese employment regulations. COMPENSATION COMMITTEE REPORT The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K of the Exchange Act with management and the full Board. Based on that review and discussion, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in the Company's Annual Report on Form 10-K for 2006. The Compensation Committee Gilbert Raker, Chairman Wenjun Jiao Yupeng Yan COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During 2006, the members of the Compensation Committee were Gilbert Raker, Wenjun Jiao, Yupeng Yan, and Ping Bai (who resigned as a director as of February 25, 2007). The Compensation Committee did not deliberate on executive compensation for fiscal 2006. Wenjun Jiao, Yupeng Yan and Ping Bai were each an employee and officer of the Company during 2006. No member of the Compensation Committee has a relationship that would constitute an interlocking relationship with Executive Officers or Directors of the Company or another entity. 32 SUMMARY COMPENSATION TABLE The table below summarizes the total compensation paid or earned by each of the named executive officers for the fiscal year ended December 31, 2006.
CHANGE IN PENSION VALUE AND NON-EQUITY NONQUALIFIED INCENTIVE DEFERRED STOCK OPTION PLAN COMPENSATION ALL OTHER NAME AND SALARY BONUS AWARDS AWARDS COMPENSATION EARNINGS COMPENSATION TOTAL PRINCIPAL POSITION (1) YEAR ($) ($) ($) ($) ($) ($) ($) ($) ------------------------ ---- ---------- -------- ------ ------ ------------ ------------ ------------ ---------- Jinyuan Li 2006 $ 166,660 $ 0 $ - $ - $ - $ - $ - $ 166,660 Chairman, 2005 $ 145,455 $ 0 $ - $ - $ - $ - $ - $ 145,455 Chief Executive Officer 2004 $ 145,455 $ 0 $ - $ - $ - $ - $ - $ 145,455 and President Wenjun Jiao 2006 $ 77,000 $ 0 $ - $ - $ - $ - $ - $ 77,000 Chief Financial Officer 2005 $ 48,000 $ 0 $ - $ - $ - $ - $ - $ 48,000 2004 $ 35,670 $ 0 $ - $ - $ - $ - $ - $ 35,670
(1) Ping Bai and Yupeng Yan were employee Directors of the Company during 2006 but did not qualify as a "named executive officer" because their respective total compensation was less than $100,000. GRANTS OF PLAN BASED AWARDS; OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END; OPTION EXERCISES AND STOCK VESTED The Company does not have any stock option plans. PENSION BENEFITS None. NONQUALIFIED DEFERRED COMPENSATION The Company does not provide any nonqualified deferred compensation to any of its employees. EMPLOYMENT AGREEMENTS The Company's subsidiary, Biological, has entered into an employment agreement with each of its named executive officers and employee directors of the Company. Jinyuan Li's contract is dated June 1, 2005 and has an indefinite period. Wenjun Jiao's contract is dated June 1, 2005 and terminates on June 30, 2010. The employment contracts for Ping Bai and Yupeng Yan are dated April 1, 2004 and expire on March 31, 2009. Under each of these employment contracts, the employee may rescind the contract with 30 days written notice. For 2006, the Companied paid a salary of $166,660 to Jinyuan Li and $77,000 to each of Ping Bai, Wenjun Jiao and Yupeng Yan. POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE OF CONTROL The employment contracts of Messrs. Li and Jiao each provide for a one-time lump sum payment equal to six months of the employee's then current salary if we terminate their employment contract for one of the following reasons: o The employee has a non-work-related injury and is unable to perform his responsibilities; or o The employee is unable to perform his responsibilities for other reasons; or 33 o The circumstances based on which the employment contract was entered into have materially changed and the performance of the contract becomes impractical; or o We are contemplating bankruptcy and determine to reduce staff. Assuming that Messrs. Li and Jiao were terminated for one of the above-stated reason, Mr. Li would receive $83,330 and Mr. Jiao would receive $38,500. There are no other circumstances, including a change of control of our Company, where we are required to make any additional payment to Messrs. Li and Jiao. DIRECTOR COMPENSATION For the fiscal year ended December 31, 2006, members of the Board who are not employees of the Company are entitled to receive an annual cash retainer of $30,000. DIRECTOR SUMMARY COMPENSATION TABLE The table below summarizes the compensation paid by the Company to non-employee Directors for the fiscal year ended December 31, 2006.
CHANGE IN PENSION VALUE FEES AND DEFERRED EARNED OR STOCK OPTION COMPENSATION ALL OTHER PAID IN CASH AWARDS AWARDS EARNINGS COMPENSATION TOTAL NAME (1) ($) ($) ($) ($) ($) ($) ---------------- ------------ -------- -------- ------------ ------------ -------- Howard Balloch $ 30,000 $ 0 $ 0 $ 0 $ 0 $ 30,000 Ping Bai (2) $ 0 $ 0 0 0 $ 0 $ 0 $ 0 Gilbert Raker $ 30,000 $ 0 $ 0 $ 0 $ 0 $ 30,000 Socorro Quintero $ 30,000 $ 0 $ 0 $ 0 $ 0 $ 30,000 Yupeng Yan (2) 0 $ 0 0 0 $ 0 $ 0 $ 0
(1) Jinyuan Li and Wenjun Jiao are not included in this table as they are employees of the Company and thus receive no compensation for their services as Directors. Their compensation is disclosed in the table in the "Summary Compensation Table". (2) Yupeng Yan and Ping Bai were employee Directors of the Company during 2006 and received no additional compensation for their services as Directors. They are not named executive officers and are excluded from the "Summary Compensation Table". 34 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth information with respect to the beneficial ownership of shares of common stock as of March 28, 2007 by each person or entity who is known by the Company to beneficially own five percent or more of the common stock; each director and executive officer of the Company; and all directors and executive officers of the Company as a group. NAME OF BENEFICIAL OWNER (1) NUMBER OF SHARES PERCENT OF CLASS ------------------------------------ ---------------- ---------------- Jinyuan Li 65,835,000 92.3% Wenjun Jiao 665,000 * Yupeng Yan 665,000 * Socorro Maria Quintero -- -- Howard R. Balloch -- -- Gilbert D. Raker -- -- All Directors and Executive Officers as a Group (6 persons) 67,165,000 94.2% ---------- * Less than one percent. (1) Unless otherwise indicated, the address for each named individual or group is c/o Tiens Biotech Group (USA), Inc., No. 6, Yuanquan Road, Wuqing New-Tech Industrial Park, Tianjin, China 301700. Unless otherwise indicated, the Company believes that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days upon the exercise of options, warrants or convertible securities (in any case, the "Currently Exercisable Options"). Each beneficial owner's percentage ownership is determined by assuming that the Currently Exercisable Options that are held by such person (but not those held by any other person) have been exercised and converted. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE. We market all of our products through various domestic and international business entities that are related to our company through common ownership. Related party sales amounted to 100% of our total consolidated sales. We have a sales contract with Tianshi Engineering which requires Tianshi Engineering to purchase all of our products to be sold in China. We sell our finished products to Tianshi Engineering at a price equal to 25% of the Chinese market price for the products. This 25% figure was negotiated between the parties in 2003, before we acquired Tianshi International, and we believe that it is a reasonable sales price for us to receive. The price of semi-finished goods sold to Tianshi Engineering was originally set at the beginning of 2006 to provide us with a 75% gross profit margin. However, based on fluctuations in the cost of raw materials and quantities produced, this percentage varied during the year. This 75% figure was negotiated between the parties, and we believe that it is reasonable. The goal of this new pricing policy was to try to maintain the Company's gross margins on semi-finished goods at a similar level to historical gross margins for finished goods. All of Tianshi Engineering's Chinese affiliated companies are owned in whole or in part by Jinyuan Li's immediate family members. Internationally, we sell our products directly to our overseas affiliates. Due to the common ownership, there are no formal sales or administrative agreements among Biological and those overseas related parties. The business operations among these related entities are regulated through internal ordinances. Our related party transactions are required to be reviewed and approved or ratified by a majority of our non-interested Board of Directors. The following table is provided to facilitate your understanding of the relationships between related parties and us and their transactions with us during 2006 and 2005. 35
DECEMBER 31, DECEMBER 31, 2006 2005 ------------- ------------- Revenue-related party $ 66,790,466 $ 68,688,669 Accounts receivable, trade - related parties, net of $ 12,926,670 $ 2,165,958 allowance for doubtful accounts of $86,776 and $206,916 as of December 31, 2006 and 2005, respectively Other receivables - related parties $ 8,397,227 $ 3,281,081 Loans receivable - related parties $ 25,640,000 $ 0 Advances from customers - related parties $ 1,570,120 $ 2,077,130 Other payables - related parties $ 522,105 $ 1,816,534 Current portion of long-term debt - related party $ 2,130,000 $ 2,130,000 Notes payable - related party $ 6,397,742 $ 8,527,742
REVENUE Related party sales amounted to $66.8 million and $68.7 million for 2006 and 2005, respectively, which represent 100% of our sales for those periods. ACCOUNTS RECEIVABLE Related party accounts receivable amounted to $12.9 million and $2.2 million as of December 31, 2006 and 2005, respectively, net of an allowance for doubtful accounts of $86,776 and $206,916, respectively. Historically, Tianshi Engineering remitted payment to us upon sales to third party customers. However, in order to support Tianshi Engineering's marketing efforts in anticipation of receiving a direct selling license in China, we have agreed to allow Tianshi Engineering to retain those collections. Balances not remitted to us within 90 days are converted to other receivables - related parties. Beginning on January 1, 2007, the other receivables - related parties became interest bearing. The stated interest rate is the interest rate for the same level of loan stipulated by the People's Bank of China. The credit terms provide an interest-free credit term of three months. Any amounts exceeding this term are transferred from accounts receivable - related parties to other receivable - related parties. Beginning January 1, 2007, the other receivables - related parties will then become interest bearing once a loan contract is adopted. The interest rate is the interest rate, on the date the loan commences, that is stipulated by the People's Bank of China for a loan of the same level. OTHER RECEIVABLES We are owed $8.4 million and $3.3 million as of December 31, 2006 and 2005, respectively, classified as other receivables from related parties. In addition to other receivables which arise from accounts receivable older than three months, other receivables are also generated from our various cash advances and short-term loans and the allocation of administrative and operating costs and various non-operational transactions incurred with related parties. On October 15, 2005 the Company made a loan of $2.4 million with no interest to Tianjin Juchao Commercial and Trading Co., Ltd ("Juchao"), a Chinese company owned 40% by Jinyuan Li and 60% by Baolan Li, his daughter. Subsequently, during the second quarter of 2006, the owners began dissolving Juchao and the related $2.4 million other receivable obligation was transferred to and assumed by Tianshi Group. LOANS RECEIVABLE Related party loans receivable were $25.6 million in 2006 and $0 in 2005. On October 1, 2005, Biological loaned Tianshi Engineering $25.6 million. The loan was non-interest bearing, matured on December 31, 2005 and was repaid upon maturity. The purpose of the loans was to enable Tianshi Engineering to strengthen its sales network in China. On January 1, 2006, this amount was loaned to Tianshi Engineering again, with a maturity date of December 31, 2006. On December 22, 2006, the loan was extended to June 30, 2007 and was converted to an interest-bearing loan. The interest rate for the loan is the current interest rate for the same level of loan stipulated by the People's Bank of China. 36 NOTES PAYABLE In 2004, Tianshi International entered a term loan agreement with Tianyuan Capital Development Corp. Ltd. ("Tianyuan Capital"), pursuant to which Tianyuan Capital agreed to lend $10.65 million in the aggregate to Tianshi International, at an interest rate of 5% per year, with interest payable on June 30 and December 31, commencing December 31, 2004. Tianshi International must repay the loan in ten consecutive semi-annual installments of $1,065,000 commencing June 30, 2006 and ending June 30, 2011. Tianshi International used the loan proceeds in Tiens Yihai. Mr. Jinyuan Li owns 100% of Tianyuan Capital. Interest of $532,887 and two installment payments totaling $2,130,000 were made in 2006. ADVANCES FROM CUSTOMERS Advances from related party customers were $1.6 million and $2.1 million as of December 31, 2006 and 2005, respectively. These advances represent prepayments made to us to insure that overseas customers could obtain enough of our products to meet their market demands. OTHER PAYABLES Other payables due to related parties were $0.5 million and $1.8 million as of December 31, 2006 and 2005, respectively. These amounts arose from cash advances from related parties such as management fees due to related parties and various non-operational transactions. TRANSACTIONS WITH TIANSHI GROUP Since 2003, Biological has leased office space and manufacturing facilities from Tianshi Group. The lease expires at the end of 2007 and requires annual rent at 1% of our total gross revenues. The rent was negotiated by the parties prior to entering into the agreement, before we acquired Tianshi International, and we believe that it is a reasonable rent for the facilities. The term of this agreement is for five years commencing on January 1, 2003. In addition, we are obligated to pay insurance, maintenance and other expenses related to the premises. The total amount paid on this lease amounted to $662,082 for the 12 months ended December 31, 2006. On November 10, 2006, Tiens International signed a supplemental agreement with the Local Government in Shanghai relating to the Tiens Yihai project. Pursuant to that agreement, Tiens International has agreed to loan the Local Government $6.4 million. In addition, Tianshi Group has agreed to provide a guarantee on behalf of the Local Government for an additional loan from Commercial Bank of $6.4 million. In February 2006, we transferred an amount of $440,366 from construction in progress to other receivables-related parties. This pertained to the transfer of certain assets to Tianshi Group that were no longer necessary for our operations. On November 10, 2006, Tiens International and the Local Government entered into a supplemental agreement relating to the Tiens Yihai research and development project. Pursuant to that agreement, the parties have agreed to the acquisition by Tiens Yihai of a reduced 486 mu (80 acres) parcel of land. The remaining 1,114 mu (184 acres) may not be available for purchase in the future. Therefore, the Local Government has agreed to refund to us $1.6 million of the original $3.6 million deposit when we receive a construction license for the development. In order to proceed with the purchase of the property by Tiens Yihai, Tianshi International is required to provide a loan of $6.4 million to the Local Government for relocation costs for people living on the property. The $6.4 million loan is to be funded in two installments: o The first installment of $3.2 million was paid on November 27, 2006. o The second installment of $3.2 million is to be paid after Tiens Yihai obtains a construction license to develop the property. The parties have agreed to allow Tianshi International to reduce this second installment by the amount of the $1.6 million refund due to it. 37 In return for the loan, Tiens Yihai will receive a tax credit in the amount of $6.4 million and accrue interest on the loan at a rate equal to the rate stipulated by the People's Bank of China for loans of the same size. In addition, Tianshi Group has agreed to provide a guarantee on behalf of the Local Government for an additional loan from a commercial bank for $6.4 million. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The Board has reappointed Moore Stephens Wurth Frazer and Torbet, LLP as independent auditors to audit our financial statements for the fiscal year ended December 31, 2006. Moore Stephens Wurth Frazer and Torbet, LLP has served as our independent auditor since 2002. PUBLIC ACCOUNTING FEES 2006 2005 ---------- ---------- Audit Fees $ 240,000 $ 220,000 Audit Related Fees $ 0 $ 0 Tax Fees $ 10,000 $ 10,000 All Other Fees $ 11,000 $ 35,000 Audit fees were for professional services rendered by Moore Stephens Wurth Frazer and Torbet, LLP during the 2005 and 2006 fiscal years for the audit of our annual financial statements and the review of the financial statements included in our quarterly reports on Forms 10-Q and 10-QSB, and services that are normally provided by Moore Stephens Wurth Frazer and Torbet, LLP in connection with statutory and regulatory filings or engagements for those fiscal years. Moore Stephens Wurth Frazer and Torbet, LLP did not bill any other fees for services rendered to us during the fiscal years ended December 31, 2005 and 2006 for assurance and related services in connection with the audit or review of our financial statements. Tax fees involved preparation of the consolidated tax returns. All other fees consisted of professional advice on the Company's compliance with Section 404 of the Sarbanes-Oxley Act of 2002. PRE-APPROVAL OF SERVICES The Audit Committee has adopted pre-approval policies for all services, including both audit and non-audit services, provided by the Company's independent auditors. For audit services, each year the independent auditor provides the Audit Committee with an engagement letter outlining the scope of the audit services proposed to be performed during the year, which must be formally accepted by the Audit Committee before the audit commences. The independent auditor also submits an audit services fee proposal, which also must be approved by the Committee before the audit commences. The audit, tax, and all other fees and services described above were pre-approved for 2005 and 2006. 38 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES EXHIBITS EXHIBIT NO. DESCRIPTION ----------- ------------------------------------------------------------------ 2.1 Agreement and Plan of Reorganization, as amended, dated as of August 22, 2003, by and among Strategika, Tianshi International and the Stockholders of Tianshi International. (1) 3.1 Certificate of Incorporation of MIA Acquisition Corp. (2) 3.2 By-laws of MIA Acquisition Corp. (2) 3.3 Certificate of Amendment to Certificate of Incorporation of MIA Acquisition Corp. changing the company's name to Strategika, Inc. (2) 4.1 Specimen Stock Certificate. (2) 10.1 Stock Purchase Agreement, dated February 11, 2002, by and between Rene Larrave and MIA Acquisition Corp. (2) 10.3 Product Purchase and Sales Agreement, dated June 25, 2003, by and between Tianjin Tianshi Biological Development Co., Ltd. And Tianjin Tianshi Biological Engineering Co. Ltd. (3) 10.4 Lease Agreement, dated June 30, 2002, by and between Tianshi Group Co. Ltd. and Tianjin Tianshi Biological Development Co., Ltd. (3) 10.5 Supplemental Lease Agreement, dated June 30, 2005 by and between Tianshi Group Co. Ltd. and Tianjin Tianshi Biological Development Co., Ltd. (3) 10.6* Term Loan Agreement, dated January 1, 2006 by and between Tianjin Tianshi Biological Development Co., Ltd. and Tianjin Tianshi Biological Engineering Co., Ltd. 10.7* Term Loan Agreement, dated December 22, 2006 by and between Tianjin Tianshi Biological Development Co., Ltd. and Tianjin Tianshi Biological Engineering Co., Ltd. 10.8* Supplemental Agreement for the Construction and Development of Tiens Yihai Industrial Park Project, dated November 10, 2006 by and between Shanghai Zhu Jia Jiao Industrial Park Economic Development Ltd. Company, Tianshi International Holdings Group Ltd. Company and Zhu Jia Jiao Townhouse, Qing Pu District, Shanghai. 21.1* Subsidiaries. 23.1* Consent of Independent Accountants, Moore Stephens Wurth Frazer and Torbet, LLP. 31.1* Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2* Certification of the Chief Financial Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1* Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Filed herewith (1) Filed as an exhibit to the Registrant's Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 31, 2005. (2) Filed as an exhibit to the Registrant's Form 10-KSB filed with the Securities and Exchange Commission on March 7, 2002. (3) Filed as an exhibit to the Registrant's Form 10-K filed with the Securities and Exchange Commission on March 31, 2006. 39 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. TIENS BIOTECH GROUP (USA), INC. Date: March 29, 2007 /s/ Jinyuan Li ------------------------------------- Jinyuan Li Chief Executive Officer and President (Principal Executive Officer) Date: March 29, 2007 /s/ Wenjun Jiao ------------------------------------- Wenjun Jiao Chief Financial Officer (Principal Accounting Officer) 40 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE ------------------------- ----------------------------------- -------------- /s/ Jinyuan Li Chairman of the Board, March 29, 2007 ------------------------- Chief President Jinyuan Li (Principal Executive Officer) /s/ Wenjun Jiao Chief Financial Officer March 29, 2007 ------------------------- (Principal Accounting Officer) Wenjun Jiao and Director /s/ Yupeng Yan Executive Vice President March 29, 2007 ------------------------- And Director Yupeng Yan /s/ Gilbert Raker Director March 29 2007 ------------------------- Gilbert Raker /s/ Howard Balloch Director March 29, 2007 ------------------------- Howard Balloch /s/ Socorro Quintero Director March 29, 2007 ------------------------- Socorro Quintero 41 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Tiens Biotech Group (USA), Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of Tiens Biotech Group (USA), Inc. and Subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income and other comprehensive income, and equity, and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tiens Biotech Group (USA), Inc. and Subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. /S/ Moore Stephens Wurth Frazer and Torbet, LLP Walnut, California March 19, 2007 F-1 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2006 AND 2005
2006 2005 ------------- ------------- ASSETS ------ CURRENT ASSETS: Cash $ 54,270,065 $ 77,545,991 Accounts receivable, trade - related parties, net of allowance for doubtful accounts of $86,776 and $206,916 as of December 31, 2006 and 2005, respectively 12,926,670 2,165,958 Accounts receivable, trade - third parties 18,135 - Inventories 6,845,108 7,516,352 Other receivables 349,905 234,486 Other receivables - related parties 8,397,227 3,281,081 Employee advances 111,121 145,071 Prepaid expense 2,135,917 1,698,090 ------------- ------------- Total current assets 85,054,148 92,587,029 ------------- ------------- PLANT AND EQUIPMENT, net 30,511,319 24,877,688 ------------- ------------- OTHER ASSETS: Intangible assets, net 510,183 476,637 Long-term prepaid expenses 7,031,348 3,682,800 Loans receivable - related party 25,640,000 - ------------- ------------- Total other assets 33,181,531 4,159,437 ------------- ------------- Total assets $ 148,746,998 $ 121,624,154 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable $ 4,123,105 $ 2,698,813 Advances from customers - related parties 1,570,120 2,077,130 Wages and benefits payable 992,068 1,045,052 Other taxes payable 969,760 1,413,054 Other payables 500,213 339,390 Other payables - related parties 522,105 1,816,534 Dividend payable to minority interest 238,311 - Current portion of long term debt 2,130,000 2,130,000 ------------- ------------- Total current liabilities 11,045,682 11,519,973 LONG TERM DEBT, net of current portion 6,397,742 8,527,742 ------------- ------------- Total liabilities 17,443,424 20,047,715 ------------- ------------- MINORITY INTEREST 11,883,323 11,929,040 ------------- ------------- SHAREHOLDERS' EQUITY: Common stock, $0.001 par value, 260,000,000 shares authorized, 71,333,586 issued and outstanding, respectively 71,334 71,334 Paid-in-capital 8,842,009 8,842,009 Statutory reserves 9,420,783 9,420,783 Retained earnings 95,371,137 69,079,060 Accumulated other comprehensive income 5,714,988 2,234,213 ------------- ------------- Total shareholders' equity 119,420,251 89,647,399 ------------- ------------- Total liabilities and shareholders' equity $ 148,746,998 $ 121,624,154 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-2 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
2006 2005 2004 ------------- ------------- ------------- REVENUE $ 66,790,466 $ 68,688,669 $ 58,910,532 COST OF SALES 18,082,441 17,451,605 17,483,739 ------------- ------------- ------------- GROSS PROFIT 48,708,025 51,237,064 41,426,793 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 12,789,810 13,413,875 7,363,248 ------------- ------------- ------------- INCOME FROM OPERATIONS 35,918,215 37,823,189 34,063,545 OTHER (EXPENSE) INCOME, net 161,091 (639,137) 388,266 ------------- ------------- ------------- INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY INTEREST 36,079,306 37,184,052 34,451,811 PROVISION FOR INCOME TAXES 2,823,899 2,984,302 - ------------- ------------- ------------- INCOME BEFORE MINORITY INTEREST 33,255,407 34,199,750 34,451,811 MINORITY INTEREST 6,963,330 7,321,630 7,013,515 ------------- ------------- ------------- NET INCOME 26,292,077 26,878,120 27,438,296 OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation adjustment 3,480,775 2,246,380 (8,239) ------------- ------------- ------------- COMPREHENSIVE INCOME $ 29,772,852 $ 29,124,500 $ 27,430,057 ============= ============= ============= EARNINGS PER SHARE, BASIC AND DILUTED $ 0.37 $ 0.38 $ 0.38 ============= ============= ============= WEIGHTED AVERAGE NUMBER OF SHARES 71,333,586 71,333,586 71,801,819 ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-3 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EQUITY FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Number Common Paid-in Statutory Retained of shares stock capital reserves earnings ------------ -------- ------------ ----------- ------------ BALANCE, January 1, 2004 71,998,586 $ 71,999 $ 8,841,344 $ 3,730,137 $ 20,453,290 Cancellation of common stock (665,000) (665) 665 Receipt of stock receivable Foreign currency translation loss Net income 27,438,296 Adjustment to statutory reserve 5,690,646 (5,690,646) ------------ -------- ------------ ----------- ------------ BALANCE, December 31, 2004 71,333,586 71,334 8,842,009 9,420,783 42,200,940 Net Income 26,878,120 Foreign currency translation gain ------------ -------- ------------ ----------- ------------ BALANCE, December 31, 2005 71,333,586 71,334 8,842,009 9,420,783 69,079,060 Net Income 26,292,077 Foreign currency translation gain ------------ -------- ------------ ----------- ------------ BALANCE, December 31, 2006 71,333,586 $ 71,334 $ 8,842,009 $ 9,420,783 $ 95,371,137 ============ ======== ============ =========== ============ Accumulated other Stock comprehensive receivable income (loss) Totals ---------- ------------- ------------- BALANCE, January 1, 2004 $ (6,650) $ (3,928) $ 33,086,192 Cancellation of common stock Receipt of stock receivable 6,650 6,650 Foreign currency translation loss (8,239) (8,239) Net income 27,438,296 Adjustment to statutory reserve ---------- ------------- ------------- BALANCE, December 31, 2004 - (12,167) 60,522,899 Net Income 26,878,120 Foreign currency translation gain 2,246,380 2,246,380 ---------- ------------- ------------- BALANCE, December 31, 2005 - 2,234,213 89,647,399 Net Income 26,292,077 Foreign currency translation gain 3,480,775 3,480,775 ---------- ------------- ------------- BALANCE, December 31, 2006 $ - $ 5,714,988 $ 119,420,251 ========== ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-4 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 26,292,077 $ 26,878,120 $ 27,438,296 Adjustments to reconcile net income to cash provided by operating activities: Minority interest 6,963,330 7,321,630 7,013,515 Depreciation 2,509,261 1,701,415 1,303,433 Amortization 103,694 134,070 51,718 Loss on sale of assets 2,550 289,632 124,536 Bad debts (123,302) 173,169 30,442 Inventory write off 59,832 154,525 - (Increase) decrease in assets: Accounts receivable, trade - related parties (16,542,297) 3,810,415 (6,079,930) Accounts receivable, trade - third parties (17,763) - - Other receivables (125,232) 303,201 (389,216) Other receivables - related parties (5,667,880) 2,096,269 11,773,082 Inventories 847,005 (2,949,054) (563,202) Employee advances 38,067 (67,007) 746,324 Prepaid expense (394,419) (1,081,102) 415,194 Increase (decrease) in liabilities: Accounts payable 1,305,537 850,852 (740,810) Accounts payable - related parties (211,274) (549,371) Advances from customers - related parties (565,520) 1,366,951 (4,468,312) Wages and benefits payable (93,942) 862,872 139,923 Other taxes payable (481,080) 763,249 416,390 Other payables 153,890 70,110 236,218 Other payables - related parties (1,324,779) 837,554 (367,014) ------------- ------------- ------------- Net cash provided by operating activities 12,939,029 43,305,597 36,531,216 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Loans to related party (24,992,000) - - Loan to Chinese Government (3,178,500) - - Acquisition of intangibles (42,273) (113,133) (158,153) Purchase of land use right - - (3,593,700) Proceeds from sales of equipment and automobiles 76,596 28,581 713,036 Purchase of equipment and automobiles (7,769,394) (6,100,936) (4,268,097) ------------- ------------- ------------- Net cash used in investing activities (35,905,571) (6,185,488) (7,306,914) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments, net of borrowings on short term notes payable - - (5,324,000) Payments on long term debt (2,130,000) (156,984) (259,513) Payments to minority interest shareholder - (58,136) (7,778,113) Proceeds from long term debt - - 10,657,742 Proceeds of stock receivable - - 6,650 ------------- ------------- ------------- Net cash used in financing activities (2,130,000) (215,120) (2,697,234) ------------- ------------- ------------- EFFECT OF EXCHANGE RATE CHANGES ON CASH 1,820,616 1,397,130 (8,239) ------------- ------------- ------------- (DECREASE) INCREASE IN CASH (23,275,926) 38,302,119 26,518,829 CASH, beginning of year 77,545,991 39,243,872 12,725,043 ------------- ------------- ------------- CASH, end of year $ 54,270,065 $ 77,545,991 $ 39,243,872 ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-5 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 NOTE 1 - BACKGROUND Tiens Biotech Group (USA), Inc. (the "Company" or "Tiens") was incorporated on July 13, 1990 as Super Shops, Inc. in the State of Michigan. In October 2000, Super Shops, Inc. reincorporated in Delaware and changed its name to MIA Acquisition Corp., and subsequently to Strategika, Inc. in February 2002. Pursuant to an Agreement and Plan of Reorganization, dated August 22, 2003 (the "Agreement"), the Company, Tianshi International Group Limited ("Tianshi International"), and Jinyuan Li, Wenjun Jiao and Yupeng Yan, all Chinese Nationals who were stockholders of Tianshi International (the "Tianshi Stockholders"), on September 9, 2003, the Company received from the Tianshi Stockholders all of the issued and outstanding common stock of Tianshi International in exchange for the issuance by the Company of 68,495,000 shares of its common stock to the Tianshi Stockholders, representing 95% of the issued and outstanding common stock of the Company at such time, after giving effect to the issuance. The purchase of Tianshi International and the issuance of the Company's common stock in connection with the purchase have been accounted for as a reverse acquisition presented as a recapitalization, except no goodwill or other intangible assets have been recorded. For accounting purposes, the original Tianshi International is considered the acquirer in the reverse acquisition. The historical financial statements are those of the original Tianshi International. Tianshi International was incorporated March 24, 2003, in the territory of the British Virgin Islands. On June 18, 2003, Tianshi International acquired 80% of Tianjin Tianshi Biological Development Co., Ltd ("Biological") from Tianshi Hong Kong International Development Co., Ltd. ("Tianshi Hong Kong"), which is 100% owned by the Company's Chairman, Chief Executive Officer and President, Jinyuan Li. Biological is a Chinese-foreign equity joint venture company established under the laws of the People's Republic of China (the "PRC" or "China") on March 27, 1998. Biological is subject to the Law on Sino Foreign Equity Joint Ventures, its implementation regulations and other related rules and regulations. Biological is an independent legal entity having the legal structure of a limited liability company, similar to a regular corporation with limited liability organized under state laws in the United States of America. The Articles of Association of Biological provides for a 50-year term with registered capital of $10,000,000. As an approved Chinese-foreign equity joint venture, Biological receives special income tax incentive treatment from both the local (Wuqing County) and central governments in China. The original partners in this joint venture were Tianshi Hong Kong, incorporated in Hong Kong which owned 80% of the joint venture, and Tianjin Tianshi Biological Engineering Co., Ltd ("Tianshi Engineering"), which owned the remaining 20% of Biological. Tianshi Hong Kong is owned 100% by Jinyuan Li. Tianshi Engineering is 49% owned by Ms. Baolan Li and 51% by Tianjin Tianshi Group Co., Ltd. ("Tianshi Group"). In June 2003, Tianshi Engineering transferred its 20% interest in Biological for no consideration to Tianjin Tianshi Pharmaceuticals Co., Ltd ("Tianshi Pharmaceuticals") and Tianshi International acquired 80% of Biological from Tianshi Hong Kong for no consideration. This transfer was made for no consideration, since Jinyuan Li is president and sole shareholder of both companies. F-6 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 As result of the above transactions, Tianshi International is now a wholly owned subsidiary of the Company and Biological remains an 80% owned subsidiary of Tianshi International. The summary of Tiens' organization is described as follows: As of December 31, 2006, Tiens is owned 4.91% by public stockholders, 2.8% by officers and 92.29% by Mr. Jinyuan Li. Tiens owns 100% of Tianshi International. Tianshi International owns 80% of Biological. Tianshi Group is owned 90% by Mr. Jinyuan Li and 10% by his daughter, Ms. Baolan Li. Tianshi Group owns 87.66% of Tianshi Pharmaceuticals and 51% of Tianshi Engineering. Tianshi Pharmaceuticals owns 20% of Biological. Ms. Baolan Li owns 49% of Tianshi Engineering and 7.29% of Tianshi Pharmaceuticals. Tianjin Feishi Transportation Co., Ltd. owns 5.05% of Tianshi Pharmaceuticals. On April 20, 2004, Tianshi International entered a joint venture contract (the "Joint Venture Project") with Tianshi Pharmaceuticals to establish Tiens Yihai Co. Ltd. ("Tiens Yihai"). Tiens Yihai is located in Shanghai, PRC, and is in the business of research and development, production and marketing of healthcare, home care and personal care products. Tiens Yihai is a foreign investment joint venture which is incorporated under the laws of PRC. Tiens Yihai is classified as a Foreign Investment Enterprise ("FIE") in the PRC and is subject to the FIE laws of the PRC. Tiens Yihai is a Chinese registered limited liability company with a legal structure similar to a regular corporation and a limited liability company organized under state laws in the United States of America. The Articles of Association provide for a 50-year term beginning on May 27, 2004 with registered capital of $200,000,000. Tianshi International contributes 99.4% of the registered capital and Tianshi Pharmaceuticals contributes the remained 0.6%. The Company through its subsidiaries is primarily engaged in the manufacturing of nutritional supplement products, including wellness products and dietary supplement products, and personal care products. In the PRC, the Company sells its products to Tianshi Engineering. Tianshi Engineering, in turn, sells the products to end-users through its chain stores and Chinese affiliated companies. Outside the PRC, the Company sells its products to an extensive direct sales force of overseas affiliates and independent distributors who use the products themselves and/or resell them to other distributors or consumers. The Company sells to affiliated companies located in 63 countries. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION --------------------- The financial statements of the Company and its subsidiaries are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). F-7 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 THE REPORTING ENTITY -------------------- The Company's consolidated financial statements reflect the activities of the Company and the following Company subsidiaries:
Subsidiary % Ownership -------------------------------------------------- ------------------------- ------------ Tianshi International Holdings Group, Ltd British Virgin Islands 100.0% Tianjin Tianshi Biological Development Co., Ltd P.R.C. 80.0% Tiens Yihai Co., Ltd. P.R.C. 99.4%
PRINCIPLES OF CONSOLIDATION --------------------------- The consolidated financial statements include the financial statements of the Company and its subsidiaries. All significant inter-company transactions and balances are eliminated in consolidation. USE OF ESTIMATES ---------------- The preparation of financial statements in conformity with U.S.GAAP requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates. FOREIGN CURRENCY TRANSLATION ---------------------------- The reporting currency of the Company is the US dollar. Biological's and Tiens Yihai's financial records are maintained and the statutory financial statements are stated in its local currency, Renminbi (RMB), as their functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People's Bank of China at the end of each reporting period. This quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People's Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People's Bank of China. The rate of exchange quoted by the People's Bank of China on December 31, 2006 was US$1.00 = RMB7.8003. The weighted average translation rate of US$1.00 = RMB7.9637 was applied to income statement accounts. Approval of foreign currency payments by the Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents and signed contracts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. These amounts are not material to the consolidated financial statements. F-8 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 FAIR VALUE OF FINANCIAL INSTRUMENTS ----------------------------------- The Company's financial instruments consist primarily of cash, trade receivable, trade payables, advances, other receivables, and debt instruments. The management believes that the carrying values of these financial instruments approximate their fair values because of their short-term nature. Long term debt is priced at current interest rates, and thus approximates fair values. CASH AND CASH EQUIVALENTS ------------------------- Cash includes cash on hand and demand deposits in accounts maintained with banks of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts. ALLOWANCES FOR DOUBTFUL ACCOUNTS -------------------------------- The Company's trade accounts receivables are mainly due from related companies. Management reviews its accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each year-end paying particular attention to the age of receivable outstanding. At December 31, 2006 and 2005, receivables outstanding more than 180 days totaled $31,586 and $4,694,584, respectively. The Company did not incur any losses on receivables for the periods reported. The following table represents the changes of allowance for doubtful accounts:
Balance at Charged to Balance at Beginning Costs and End of of Period Expences Recovery Period ------------ ------------ ------------ ------------ Year ended December 31, 2006 Reserves and allowances deducted from asset accounts: Allowance for doubtful accounts $ 206,916 $ 86,776 $ 206,916 $ 86,776 Year ended December 31, 2005 Reserves and allowances deducted from asset accounts: Allowance for doubtful accounts $ 30,442 $ 176,474 $ - $ 206,916 Year ended December 31, 2004 Reserves and allowances deducted from asset accounts: Allowance for doubtful accounts $ - $ 30,442 $ - $ 30,442
INVENTORIES ----------- Inventories are stated at the lower of cost or market using the first-in, first-out basis. The Company reviews its inventory annually for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence. PREPAID EXPENSE --------------- Prepaid expense consists of advances to suppliers and short-term prepaid expenses. The Company reviews its advances to suppliers annually for determining whether provisions should be accounted. The amount included in Prepaid Expense is the net amount of any provisions. LOANS RECEIVABLE - RELATED PARTY -------------------------------- The loans receivable - related party represents a loan of $25,640,000 that has been made to Tianshi Engineering (see Note 4). PLANT AND EQUIPMENT, NET ------------------------ Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives of the assets are as follows: F-9 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 Estimated Useful Life ------------------------- Buildings 20 years Machinery and equipment 10 years Computer, office equipment and furniture 5 years Automobiles 5 years Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company's plant facilities. No depreciation is provided for construction in progress until such time as the relevant assets are completed and are ready for their intended use. The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the consolidated statements of income. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Major additions and betterment to buildings and equipment are capitalized. Long-term assets of the Company are reviewed annually as to whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of depreciation to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2006, the Company expects these assets to be fully recoverable. OTHER ASSETS ------------ All the land located in the PRC is owned by the government and cannot be sold to any individual or company. However, the government grants the user a "land use right" to use the land. The Company acquired two land use rights for fifty years from the PRC on December 1, 1999 and October 4, 2004 for $635,795 in total. The costs of the rights are being amortized over ten years, using the straight-line method. Other intangible assets include patents and trademarks and are amortized over the estimated useful life ranging from five to ten years. A portion of long-term prepaid expense represents a deposit made in October 2004 with a local government agency in the amount of $3.59 million to acquire the land use right for land located in Shanghai, China. The land use right deposit is in connection with Tiens Yihai Industrial Park Project ("Tiens Yihai Project") described in Note 10. The land use right is for a term of 50 years and as of December 31, 2006, the Company has not legally acquired the right from the government, but the Company is actively pursuing and working with the government to complete the necessary procedures to obtain final approval on the land use right. On November 10, 2006, the Company signed a Supplemental Agreement for the Construction and Development of "Tiens Yihai Industrial Park Project" (the "Supplemental Agreement") with the same local government agency, agreeing to provide a loan of $6,357,000 to the local government agency for Tiens Yihai Project (see Note 10). Half of the loan, $3,178,500 was funded on November 27, 2006. Since this loan was related to the acquisition of land use right, it was also included in Long-term prepaid expense. F-10 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 MINORITY INTEREST ----------------- Minority interest represents the outside shareholder's 20% ownership of Biological and 0.6% ownership of Tiens Yihai. The net income is net of minority interest. REVENUE RECOGNITION ------------------- The Company recognizes revenue from domestic sales by distributors in China, net of sales commissions and taxes only when the related Chinese distributor recognizes sales of the Company's products to unaffiliated third parties. The Company recognizes revenue from international sales (non-Chinese) to both affiliated and unaffiliated third parties, net of commissions and taxes as goods are shipped and clear review by the international customs department. The Company is generally not contractually obligated to accept returns. However, on a case by case negotiated basis, the Company permits customers to return their products. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 48, "Revenue Recognition when the Right of Return Exists", revenue is recorded net of an allowance for estimated returns. Such reserves are based upon management's evaluation of historical experience and estimated costs. The amount of the reserves ultimately required could differ materially in the near term from amounts included in the accompanying consolidated financial statements. RESEARCH AND DEVELOPMENT ------------------------ Research and development expenses include salaries, supplies, and overhead such as depreciation, utilities and other costs. These costs are expensed as incurred in accordance with SFAS No. 2, "Accounting for Research and Development Costs." The Company expensed research and development cost of $1 million, $0.6 million and $0.2 million in 2006, 2005 and 2004, respectively. These costs are included in selling, general and administrative expenses in the accompanying statements. INCOME TAXES ------------ The Company has adopted SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consists of taxes currently due plus deferred taxes. There are no deferred tax amounts at December 31, 2006 and 2005. The charge for taxation is based on the results for the year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. F-11 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which deductible temporary differences can be utilized. Deferred tax is calculated at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when related items are credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis. EARNINGS PER SHARE ------------------ The Company has adopted SFAS No. 128, "Earnings per Share". SFAS No. 128 requires the presentation of earnings per share ( "EPS" ) as Basic EPS and Diluted EPS. Basic EPS excludes dilution and is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period. There are no differences between Basic and Diluted EPS for the periods ended December 31, 2006, 2005 and 2004. OTHER COMPREHENSIVE INCOME (LOSS) --------------------------------- Other comprehensive income (loss) represents foreign currency translation adjustment for the year. The amounts shown in the Consolidated Statements of Income and Other Comprehensive Income and Consolidated Statements of Equity do not include other comprehensive income attributed to minority interest. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS ----------------------------------------- In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments", which amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 155 provides guidance to simplify the accounting for certain hybrid instruments by permitting fair value remeasurement for any hybrid financial instrument that contains an embedded derivative, as well as clarifies that beneficial interests in securitized financial assets are subject to SFAS No. 133. In addition, SFAS No. 155 eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold under SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a new basis occurring after the beginning of an entity's first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS 155 to have a material impact on the consolidated financial statements. F-12 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets", which amends SFAS No. 140. SFAS No. 156 specifically provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities, and provides an approach to simplify efforts to obtain hedge accounting treatment. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after September 15, 2006, with early adoption being permitted. We do not expect the adoption of SFAS 156 to have a material impact on our consolidated results of operations and financial condition. In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes". FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The requirements of FIN 48 are effective for our fiscal year beginning January 1, 2007. We do not expect the adoption of fin 48 to have a material impact on our consolidated results of operations and financial condition. In September 2006, the SEC issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of each on a company's balance sheet and statement of operations and the related financial statement disclosures. Early application of the guidance in SAB 108 is encouraged in any report for an interim period of the first fiscal year ending after November 15, 2006. We do not expect the adoption of SAB 108 to have a material impact on our consolidated results of operations and financial condition. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS 157"), which provides enhanced guidance for using fair value to measure assets and liabilities. This standard also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 12, 2007, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating whether the adoption of SFAS157 will have a material effect on our consolidated results of operations and financial condition. F-13 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, "Employer's Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("SFAS 158"). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. The standard also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. An employer without publicly traded equity securities is required to recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after June 15, 2007. We do not expect the adoption of SFAS 158 to have a material impact on our consolidated results of operations and financial condition. RECLASSIFICATION ---------------- Certain prior year amounts have been reclassified to conform to the current presentation. NOTE 3 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Income taxes paid for the year ended December 31, 2006 and 2005 amounted to $2,731,755 and $2,302,275. No income taxes were paid for the year ended December 31, 2004 as the Company was not taxed during that year. Interest paid amounted to $532,887, $515,692 and $173,078 for the years ended December 31, 2006, 2005 and 2004, respectively. In February 2006, the Company transferred construction in progress no longer useful to the Company totaling $440,366 to Tianshi Group. This amount was outstanding on December 31, 2006 and was included in Other Receivables - related party of the Consolidated Balance Sheets as of December 31, 2006. In April 2006, the board of Biological declared a dividend in the amount of $7,546,745 to its minority shareholder (Tianshi Pharmaceuticals). The Company used the dividend to offset the receivables from Tianshi Engineering in the amount of $7,308,434 on June 22, 2006. The right of offset existed because: 1. Tianshi Engineering had determinable outstanding payables to the Company; 2. Tianshi Pharmaceuticals had determinable outstanding payables to Tianshi Engineering, its affiliate; 3. The Company had a determinable obligation to pay a dividend to Tianshi Pharmaceuticals; 4. The Company had the right to setoff the amount owed by Tianshi Engineering and the amount owed by the Company to Tianshi Pharmaceuticals; 5. Each of the Company, Tianshi Pharmaceuticals and Tianshi Engineering agreed to the offset; and 6. The agreement to offset is enforceable pursuant to Chinese contract law. F-14 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 The remaining balance of $238,311 is disclosed under dividend payable to minority interest in the accompanying consolidated balance sheets. NOTE 4 - LOAN RECEIVABLE - RELATED PARTIES During the last quarter of 2005, Tianshi Engineering borrowed RMB 200,000,000 ($25,640,000) from Biological. This amount was repaid to Biological by December 31, 2005. Then this amount was loaned to Tianshi Engineering again on January 1, 2006 with a due date of December 31, 2006. The loan was originally interest free. The purpose of the loan is to help Tianshi Engineering to strengthen its sales network in China. On December 22, 2006, the loan was extended to June 30, 2007 and was converted to an interest-bearing loan. The stated interest rate is the current interest rate for the same level of loan stipulated by the People's Bank of China. As of December 31, 2006, the interest rate was 6.30% NOTE 5 - EMPLOYEE ADVANCES Employee advances represents cash advances to various employees of the Company. In the PRC, a majority of business transactions are completed in cash. These cash advances represent monies advanced to certain employees to pay for various expenses and purchases related to the Company's daily operations. Employee advances amounted to $111,121 and $145,071 at December 31, 2006 and December 31, 2005, respectively. NOTE 6 - INVENTORIES Inventories consist of the following at December 31, 2006 and 2005, respectively: 2006 2005 ------------ ------------ Raw materials $ 2,106,929 $ 2,538,980 Packing materials 1,113,360 999,392 Miscellaneous supplies 377,819 302,510 Work in process 688,007 129,144 Processing materials 369,618 813,713 Finished goods 2,189,375 2,732,613 ------------ ------------ Total $ 6,845,108 $ 7,516,352 ============ ============ The Company has written off obsolete goods that amounted to $59,832, $154,525 and $0 for the years ended December 31, 2006, 2005 and 2004, respectively. NOTE 7 - PROPERTY, PLANT AND EQUIPMENT, NET Plant and equipment consists of the following at December 31, 2006 and 2005: F-15 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 2006 2005 ------------ ------------ Buildings and improvements $ 14,829,748 $ 13,907,626 Office facilities 323,753 283,503 Computer equipment and software 1,622,731 1,441,159 Equipment 9,329,628 7,352,056 Vehicles 5,187,572 3,619,837 Construction in progress 7,629,623 3,991,285 ------------ ------------ Total 38,923,055 30,595,466 Less: accumulated depreciation (8,411,736) (5,717,778) ------------ ------------ Plant and equipment, net $ 30,511,319 $ 24,877,688 ============ ============ Depreciation expense for the years ended December 31, 2006, 2005 and 2004 amounted to $2,509,261, $1,701,415 and $1,303,433, respectively. NOTE 8 - OTHER RECEIVABLE - RELATED PARTIES Other receivable - related parties are generated by the Company making various cash advances and short term loans, the allocation of various expenses to related parties, and amounts transferred from accounts receivable. The following table summarizes the other receivables balance from related parties as of December 31: December 31, December 31, 2006 2005 ------------ ------------ Tianjin Juchao Commercial and Trading Co., Ltd $ - $ 2,411,657 Tianjin Tianshi Biological Engineering Co., Ltd 5,592,772 - Xiong Real Estate Development 1,039 620,000 Tianjin Tianshi Technical School 46,589 - JinMao (Group) Holding 104,466 101,044 Shanghai Tianshi Jinquan Investment Co. 2,129 - Tianjin Tianshi Group Co., Ltd 2,650,232 148,380 ------------ ------------ Total $ 8,397,227 $ 3,281,081 ============ ============ NOTE 9 - INTANGIBLE ASSETS Amortization expense for the years ended December 31, 2006, 2005 and 2004 amounted to $103,694, $134,070 and $51,718, respectively, and intangible assets consists of the following at December 31: F-16 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 2006 2005 ------------ ------------ Land use rights $ 673,627 $ 635,795 Other intangible assets 267,815 150,965 Less accumulated amortization (431,259) (310,123) ------------ ------------ Intangible assets, net $ 510,183 $ 476,637 ============ ============ NOTE 10 - INVESTMENT IN TIENS YIHAI CO. LTD. -------------------------------------------- On April 20, 2004, Tianshi International entered a Joint Venture Project with Tianshi Pharmaceuticals to establish Tiens Yihai. On September 15, 2004, the board of directors of Tianshi International ratified the Joint Venture Project. The total amount to be invested in Tiens Yihai will amount to $400 million, of which $200 million will be registered capital. Tianshi International will contribute $198.8 million, representing approximately 99.4% of the registered capital of Tiens Yihai, and Tianshi Pharmaceuticals will contribute $1.2 million representing 0.6% of the registered capital of Tiens Yihai. Tianshi International will secure additional financing for the remaining $200 million. A total of 15%, or approximately $30,000,000, of the registered capital is required to be contributed by the joint venture partners, within three months after the business license has been issued. The remaining registered capital amounts are required to be contributed by each joint venture partner by May 27, 2007. Tianshi International has made its required capital contribution in the amount of $29,861,853. In October 2004, the Company paid a 10% deposit totaling of $3.59 million to Zhu Jia Jiao Industrial Park Economic Development Ltd (representative of the local government, "Local Government") for acquiring the land use right of 1,600 mu (263 acres) located in Shanghai. However, in 2005, the Chinese central government issued its "Adjustment of Macro-Economic Policy". This policy implemented a new system of investment and use of state-owned assets, including land. Pursuant to this policy, local government organizations have been adjusting and re-allotting projects, including investment, construction and reconstruction of state-owned resources. As a result, projects and enterprises that had been affected, including Tiens Yihai, which project is proposed to be constructed on state-owned property, were awaiting further decisions by state and local government. On November 10, 2006, Tiens International and the Local Government entered into the Supplemental Agreement. In order to proceed with the purchase of the property by Tiens Yihai, Tianshi International is required to provide a loan of RMB50,000,000 ($6,357,000) to the Local Government for relocation costs for people living on the property. The RMB50,000,000 ($6,357,000) loan is to be funded in two installments: o The first installment of RMB25,000,000 ($3,178,500) was paid on November 27, 2006. o The second installment of RMB25,000,000 ($3,178,500) is to be paid after Tiens Yihai obtains a construction engineering license to develop the property. F-17 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 There is currently no guarantee or written contract requiring the government to transfer the property to Tiens Yihai. If Tiens Yihai is not able to acquire the property, it is not clear whether the initial loan of RMB25,000,000 ($3,178,500) will be refunded to Tianshi International. In return for the loan of RMB50,000,000 ($6,357,000), Tiens Yihai will receive a tax credit in the amount of RMB50,000,000 ($6,357,000) and accrue interest at a rate equal to the interest rate stipulated by the People's Bank of China for a loan of the same level. In addition, Tianshi Group, a related party, has agreed to provide a guarantee on behalf of the Local Government for an additional loan from a commercial bank of RMB50,000,000 ($6,357,000). Presently, we are unable to forecast the direction, outcome and/or completion date of the Yihai Project. As of December 31, 2006, Tiens Yihai was a developmental stage company and had not yet conducted any operations. Long-term prepaid expenses consists of: December 31, December 31, 2006 2005 ------------ ------------ Prepaid land use right $ 3,807,540 $ 3,682,800 Loan to Chinese government 3,223,808 - ------------ ------------ Total long term prepayment $ 7,031,348 $ 3,682,800 ============ ============ NOTE 11 - LONG TERM DEBT ------------------------ Note payable - related party ---------------------------- On September 10, 2004, Tianshi International signed a loan agreement with Tianyuan Capital Development Corp. Ltd. ("Tianyuan Capital") to borrow $10.65 million to fund Tianshi International's contribution due to Tiens Yihai. Mr. Jinyuan Li, the president and major shareholder of the Company, is a director of Tiens Yihai and a director of Tianyuan Capital. Mr. Jinyuan Li owns 100% of Tianyuan Capital. The principal of the loan will be paid in ten consecutive semi-annual installments of $1,065,000 on the last day of June and December, commencing June, 2006 and ending June 31, 2011. The first interest payment was to be paid on December 31, 2004 at an annual interest rate of 5%. Interest of $532,887 was paid for the year ended December 31, 2006, and two installment payments had been made by the end of December, 2006. Total principal payments for the next five years on all long-term debt are as follows: December 31, December 31, 2006 2005 ------------ ------------ Note payable to Tianyuan Capital Development Corp. Ltd., related party $ 8,527,742 $ 10,657,742 Less current portion of long term debt (2,130,000) (2,130,000) ------------ ------------ Total $ 6,397,742 $ 8,527,742 ============ ============ F-18 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 Year Ending December 31, Amount ------------------------------ ------------- 2007 $ 2,130,000 2008 2,130,000 2009 2,130,000 2010 2,130,000 2011 7,742 NOTE 12 - MINORITY INTEREST AND DISTRIBUTION -------------------------------------------- The roll forward of Minority Interest in the Balance Sheet is shown below:
Biological Yihai Minority Minority Biological Owners Owners Total Minority (USD) (20%) Yihai (USD) (0.60%) Interest --------------- --------------- --------------- --------------- --------------- December 31, 2003 $ 41,363,630 $ 8,272,726 $ - $ - $ 8,272,726 Paid-in-capital - - 30,033,868 180,203 180,203 Comprehensive income 35,067,574 7,013,515 - - 7,013,515 Dividend distribution (24,646,935) (4,929,387) - - (4,929,387) Dividend distribution (15,125,000) (3,025,000) - - (3,025,000) --------------- --------------- --------------- --------------- --------------- December 31, 2004 36,659,269 7,331,854 30,033,868 180,203 7,512,057 Comprehensive income 36,633,220 7,326,644 (835,705) (5,014) 7,321,630 Dividend distribution (14,523,235) (2,904,647) - - (2,904,647) --------------- --------------- --------------- --------------- --------------- December 31, 2005 58,769,254 11,753,851 29,198,163 175,189 11,929,040 Comprehensive income 37,464,431 7,492,886 1,356,883 8,142 7,501,028 Dividend distribution (37,733,723) (7,546,745) - - (7,546,745) --------------- --------------- --------------- --------------- --------------- December 31, 2006 $ 58,499,962 $ 11,699,992 $ 30,555,046 $ 183,331 $ 11,883,323 =============== =============== =============== =============== ===============
Dividends declared are split pro rata between the shareholders according to their ownership interest. The payment of the dividends may occur at different times to the shareholders resulting in distributions which do not appear to be reflective of the minority ownership percentages. In 2006 and 2005, minority shareholders owned approximately 20% of the Company's subsidiaries. The table below shows the allocation of dividends between Tianshi International and the minority shareholder and dividends outstanding. F-19 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006
TIANSHI MINORITY Date INTERNATIONAL SHAREHOLDER Totals --------------------------------- ------------------ ------------------ ------------------ Dividends outstanding, December 31, 2004 Balance US$ 9,743,635 US$ - US$ 9,743,635 Dividends declared 11,618,588 2,904,647 14,523,235 Dividends paid (6,204,800) (2,904,647) (9,109,447) Accumulated Other Comprehensive Income (loss) 728,420 - 728,420 ------------------ ------------------ ------------------ Dividends outstanding, December 31, 2005 Balance US$ 15,885,843 - 15,885,843 Dividends declared 30,186,978 7,546,745 37,733,723 Dividends paid (1,557,742) (7,308,434) (8,866,176) Accumulated Other Comprehensive Income (loss) 1,463,775 - 1,463,775 ------------------ ------------------ ------------------ Dividends outstanding, December 31, 2006 Balance US$ 45,978,854 238,311 46,217,165 ================== ================== ==================
NOTE 13 - INCOME TAXES ---------------------- The Company is subject to income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which each entity is domiciled. The Company's subsidiary, Tianshi International, was incorporated in the British Virgin Islands and is not liable for income taxes. The Company's subsidiaries, Biological and Tiens Yihai, are Sino-Foreign Joint Ventures incorporated in the PRC. Pursuant to the income tax laws of the PRC concerning Foreign Investment Enterprises and foreign Enterprises and various local income tax laws (the "Income Tax Law"), Sino-foreign joint venture enterprises generally are subject to income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income as reported in their statutory financial statements unless the enterprise is located in specially-designated regions or cities for which more favorable effective rates apply. Biological is located in a Special Economic Zone and is subject to the special reduced income tax rate of 15%. Pursuant to the approval of the relevant PRC tax authorities, Biological is fully exempt from PRC income taxes for two years starting from the year profits are first made, followed by a 7.5% reduced tax rate for the next three years. Prior to the year ended December 31, 2002, Biological suffered operating losses. Biological started generating taxable profits in the year ended December 31, 2003. Effective January 1, 2005, the two-year 100% exemption for income taxes expired for Biological and it became subject to income tax at a reduced rate of 7.5%. Tiens Yihai is located in a Special Industry Zone and is subject to the special reduced income tax rate of 15%. Pursuant to the approval of the relevant local Chinese tax authorities, Tiens Yihai is fully exempt from PRC income taxes for two years starting from the first year profits are made, followed by a 7.5% reduced tax rate for the next three years. In addition, in order to encourage Tiens Yihai doing business in the Special Industry Zone, the local Chinese tax authorities agreed to refund 50% of the total income tax after the five-year tax break. As of December 31, 2006, Tiens Yihai is in the developmental stage of its organization and did not have any operating income. F-20 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 Provision for income taxes for the years ending December, 2006, 2005 and 2004 were $2,823,899, $2,984,302 and $0, respectively. The following table reconciles the U.S. statutory rates to the Company's effective tax rate: 2006 2005 --------------- --------------- U.S. Statutory rate 34.0% 34.0% Foreign income not recognized in USA (34.0) (34.0) China income taxes 33.0 33.0 China income taxes savings (25.5) (25.5) --------------- --------------- Total provision for income taxes 7.5% 7.5% =============== =============== The estimated tax savings due to the reduced tax rate for the years ending December 31, 2006, 2005 and 2004 amounted to $9,601,257, $10,146,627 and $11,369,098, respectively. The net effect on earnings per share if the income tax had been applied would decrease earnings per share for the years ended December 31, 2006, 2005 and 2004 by $0.11, $0.11 and $0.13, respectively NOTE 14 - ACCUMULATED OTHER COMPREHENSIVE INCOME ------------------------------------------------
Tianshi Biological Yihai International Total --------------- --------------- --------------- --------------- Balance as of December 31, 2005 $ 1,088,433 $ 732,331 $ 413,449 $ 2,234,213 Increase during the year 1,020,641 995,361 1,464,773 3,480,775 --------------- --------------- --------------- --------------- Balance as of December 31, 2006 $ 2,109,074 $ 1,727,692 $ 1,878,222 $ 5,714,988 =============== =============== =============== ===============
Accumulated Other Comprehensive Income incurred in Biological and Tiens Yihai due to the balance sheets translation. Accumulated Other Comprehensive Income incurred in Tianshi International due to the effect of foreign exchange rate on dividend receivable from Biological. Since this income is not realized, it was included in Accumulated other comprehensive income. NOTE 15 - RETIREMENT PLAN ------------------------- Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all employees. All Biological employees are entitled to a retirement pension amount calculated based upon their salary at their date of retirement and their length of service in accordance with a government managed pension plan. The PRC government is responsible for the pension liability to the retired staff. F-21 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 Biological is required to make contributions to the state retirement plan at 20% of the employees' monthly salary. Employees are required to contribute 8% of their salary to the plan. Total pension expense incurred by the Company amounted to $475,331, $434,363 and $89,593 for the years ended December 31, 2006, 2005 and 2004, respectively. The Company also has an unemployment insurance plan for its employees. The plan requires each employee to contribute 1% of salary to the plan. The Company matches the contributions in an amount equal to two times the contribution of each participant. The Company made contributions to the unemployment insurance plan of $45,871, $41,860 and $9,677 for the years ended December 31, 2006, 2005 and 2004, respectively. All contributions are paid to a PRC insurance company, which in turn, is responsible for the liability. On January 1, 2002, the Company introduced a basic medical insurance plan for its employees. Pursuant to the new medical insurance plan, the Company is required to pay an amount equal to 10% of its employees' salary to a PRC insurance company, which amounted to $259,315, $181,597 and $42,849 for the years ended December 31, 2006, 2005 and 2004, respectively. NOTE 16 - STATUTORY RESERVES ---------------------------- The laws and regulations of the People's Republic of China require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations, in proportions determined at the discretion of the board of directors, after the statutory reserve. The statutory reserves represent restricted retained earnings and include the surplus reserve fund, the common welfare fund, and the enterprise fund. Statutory reserve fund ---------------------- The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company's registered capital. As of December 31, 2005, the Company's statutory reserve fund had reached 50% of the Company's registered capital, therefore, no statutory reserve is required thereafter. The transfer to this reserve must be made before distribution of any dividend to shareholders. For the years ended December 31, 2006, 2005 and 2004, the Company transferred $0, $0 and $2,845,324, respectively. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years' losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholdings, or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital. F-22 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 Common welfare fund ------------------- The Company is required to transfer 5% to 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to the statutory common welfare fund. This fund can only be utilized on capital items for the collective benefit of the Company's employees, such as construction of dormitories, cafeteria facilities, and other staff welfare facilities. This fund is non-distributable other than upon liquidation. The transfer to this fund must be made before distribution of any dividend to shareholders. For the years ended December 31, 2006, 2005 and 2004, the directors authorized, subject to shareholders' approval, the transfer of $0, $0 and $1,422,661, respectively. Enterprise fund --------------- The enterprise fund may be used to acquire fixed assets or to increase the working capital to expend on production and operation of the business. No minimum contribution is required. For the years ended December 31, 2006, 2005 and 2004, the board of directors authorized, subject to shareholders' approval, the transfer of $0, $0 and $1,422,661, respectively. The Chinese government restricts distributions of registered capital and the additional investment amounts required by the Chinese joint ventures. Approval by the Chinese government must be obtained before distributions of these amounts can be returned to the shareholders. NOTE 17 - RELATED PARTY TRANSACTIONS Transactions with Tianshi Engineering ------------------------------------- The Company sells products to Tianshi Engineering, a related party through common ownership. The related party distributors in turn market and sell the Company's products to independent distributors or end users of the products. The related party distributors are solely responsible for all marketing and payments of sales commissions to independent distributors. Total sales to the related party amounted to $27,074,979, $38,181,090 and $29,210,167 for the years ended December 31, 2006, 2005 and 2004. This represents 100% of total sales in China for the years then ended. Historically, Tianshi Engineering remitted payment to the Company upon sales to third party customers. However, in order to support Tianshi Engineering's marketing efforts in anticipation of receiving a direct selling license in China, the Company has agreed to allow Tianshi Engineering to retain those collections. Balances not remitted to the Company within 90 days are converted to other receivables - related parties. Beginning on January 1, 2007, the other receivables - related parties become interest bearing. The stated interest rate is the interest rate for the same level of loan stipulated by the People's Bank of China. As of December 31, 2006, the interest rate was 6.30%. On October 1, 2005, Biological loaned Tianshi Engineering RMB 200,000,000 ($25,640,000). The loan was non-interest bearing, matured on December 31, 2005 and was repaid upon maturity. The purpose of the loans was to enable Tianshi Engineering to strengthen its sales network in China. On January 1, 2006, this amount was loaned to Tianshi Engineering again, with a maturity date of December 31, 2006. In order to continue support of Tianshi Engineering's efforts in China, on December 22, 2006, the loan was extended to June 30, 2007 and was converted to an interest-bearing loan. The interest rate for the loan is the current interest rate stipulated by the People's Bank of China for a loan of the same amount. All receivables from Tianshi Engineering will be settled by cash payment. F-23 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 As of December 31, 2006 and 2005, amounts due from Tianshi Engineering were as follows:
2006 2005 --------------- --------------- Accounts receivable - related parties $ 7,827,372 $ 204,275 Other receivable - related parties 5,592,772 - Loan receivable - related parties 25,640,000 - --------------- --------------- Total receivables from Tianshi Engineering $ 39,060,144 $ 204,275 =============== ===============
Transactions with Tianshi Group ------------------------------- On June 30, 2003, the Company entered into an office and facilities lease agreement with Tianshi Group, a company owned 90% by Jinyuan Li and 10% by Baolan Li. Under the terms of the 5 year agreement, the Company's annual rent is equal to 1% of gross revenues. In addition, the Company is obligated to pay insurance, maintenance and other expenses related to the premises. Rent expense totaled $662,082, $667,990 and $595,494 for the years ended December 31, 2006, 2005 and 2004, respectively. F-24 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 On October 15, 2005 the Company made a loan of $2.4 million to Tianjin Juchao Commercial and Trading Co., Ltd ("Juchao"), a Chinese company owned 40% by Jinyuan Li and 60% by Baolan Li, his daughter, with no interest. Subsequently, during the second quarter of 2006, the owners began dissolving Juchao and the related $2.4 million other receivable obligation was transferred to and assumed by Tianshi Group. On November 10, 2006, Tiens International signed an agreement with Shanghai Zhu Jia Jiao Industrial Park Economic Development Ltd (see note 10). Tianshi Group has also agreed to provide a guarantee on behalf of the local government for a loan from a commercial bank of RMB50,000,000. In February 2006, the Company transferred an amount of $440,366 from construction in progress to other receivables-related parties. This pertained to the transfer of certain assets to Tianshi Group that were no longer necessary for the Company's operations. As of December 31, 2006 and 2005, amounts due from Tianshi Group were $2,650,232 and $148,380, respectively and were included in Other receivable - related parties. Transaction with international related party distributors --------------------------------------------------------- The Company sells products to international distributors. The Company's CEO Jinyuan Li, is one of the owners of these distributors. The distributors market and sell the Company's products to independent distributors or end users of the products. Total sales to these related parties international distributors were $39,715,487, $30,507,579 and $29,700,365 for the years ended December 31, 2006, 2005 and 2004. Total accounts receivable as of December 31, 2006 and 2005 were $5,099,298 and $1,961,683, respectively. F-25 TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2006 NOTE 18 - ADDITIONAL PRODUCT SALES INFORMATION The Company has a single operating segment. 99.9% of the Company's revenues were generated from related parties. Summarized enterprise-wide financial information concerning the Company's revenues based on geographic area and product groups is shown in the following tables: Revenue by Geographic Area: Revenue 2006 2005 2004 -------------------- --------------- --------------- --------------- China $ 27,074,979 $ 38,181,090 $ 29,210,167 International 39,715,487 30,507,579 29,700,365 --------------- --------------- --------------- Total $ 66,790,466 $ 68,688,669 $ 58,910,532 =============== =============== =============== Revenue by Product Group:
Revenue 2006 2005 2004 ---------------------------------------- --------------- --------------- --------------- Wellness products $ 58,845,597 $ 58,884,556 $ 53,103,810 Dietary supplement products 5,255,277 4,360,795 2,543,765 Personal care products 2,689,592 5,443,318 3,262,957 --------------- --------------- --------------- Total $ 66,790,466 $ 68,688,669 $ 58,910,532 =============== =============== ===============
F-26