The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes appearing elsewhere in this Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, particularly in "Item 1A. Risk Factors." Overview
We are engaged in the research, development, manufacture, and distribution of botanical products, bio-pharmaceutical products, and traditional Chinese medicines, or TCM, inthe People's Republic of China . We have three GMP certified production facilities - Ah City Natural and Biopharmaceutical plant, Dongfanghong pharmaceutical plant and Qingyang natural extraction plant -capable of producing 18 dosage forms and over 200 different products. Our products include but are not limited to (i) botanical anti-depression and nerve-regulation products, (ii) biopharmaceutical products, and (iii) botanical antibiotic and traditional OTC Chinese medicines. Botanical anti-depression and nerve-regulation products account for approximate 70% of our revenues and we continue to strengthen our development in this area. We have entered into sales agency agreements with our sales agents through them our products are sold to over 3,000 distributors and over 70 sales centers across 24 provinces inChina .
Comparison of Years Ended
Total Comprehensive Income Total comprehensive income increased by approximately$10.501 million , or 54.5%, from approximately$19.27 million in 2010 to approximately$29.77 million in 2011. This increase was primarily attributable to an increase of approximately$17.53 million , or 31.8%, in net sales, and an increase of approximately$3.77 million , or 14.6%, in cost of goods sold and an increase of approximately$1.06 million , or 21.3%, in sales and marketing expenses, an increase of approximately$0.43 million , or 11.9%, in general and administration expenses, an increase of approximately$0.55 million , or 18.1%, in research and development expenses, and an increase of$2.45 million in cumulative currency translation adjustments. Our gross profit margin increased from 53.3% in 2010 to 59.4% in 2011. Sales Our sales consist primarily of revenues generated from sales of Botanical anti-depression and nerve regulation products; Biopharmaceutical products and Botanical antibiotics and traditional OTC Chinese medicines. Sales increased by approximately$17.53 million , or 31.8%, from approximately$55.18 million in 2010 to approximately$72.71 million in 2011. This increase in sales was primarily attributable to the launching of our new products and strong market acceptance of our Siberian Ginseng Series products as a result of our marketing efforts, in addition to the price increase of our overall products. 23 We provide incentive sales rebates to our sales agents. The rebate rate, which is based on a product basis, averaged of 8.7% and 12.0% of total sales for the year endedOctober 31, 2011 and 2010, respectively. Sales rebates are netted against total sales. The following table sets forth information regarding the net sales of our principal products before sales rebate during the fiscal years endedOctober 31, 2011 and 2010: 2011 2010 2011 over 2010 Quantity Amount % of Quantity Amount % of Quantity Amount % of Product name (Pack'000) ($'000) Sales (Pack'000) ($'000) Sales (Pack'000) ($'000) Sales Siberian Ginseng (Acanthopanax) Series 356 40,939 51.4 % 388 32,208 51.4 % -32 8,731 0.0 % Tianma Series 50 5,448 6.8 % 59 4,780 7.6 % -9 668 -0.8 % Compound Yangjiao Tablets 68 7,854 9.9 % 77 7,271 11.6 % -9 583 -1.7 % Shark Vital Capsules - - 0.0 % 5 2,345 3.7 % -5 -2,345 -3.7 % Shengmai Granules 52 2,427 3.0 % 79 3,224 5.1 % -27 -797 -2.1 % Banlangen Granules 39 1,587 2.0 % 49 1,374 2.2 % -10 213 -0.2 % Compound Honeysuckle Granules 115 8,046 10.1 % 163 9,723 15.5 % -48 -1,677 -5.4 % QingReJieDu Oral Liquid 36 1,295 1.6 % 16 473 0.8 % 20 822 0.8 % Compound Schizandra Tablets 15 1,548 1.9 % 5 438 0.7 % 10 1,110 1.2 % Ginseng and Venison Extract 66 8,283 10.4 % 10 865 1.4 % 56 7,418 9.0 % Badger Oil 9 2,181 2.9 % - - 0.0 % 9 2,181 2.9 % Total 806 79,608 100.0 % 851 62,701 100.0 % -45 16,907 0.0 % While we had increased sales, we experienced a decrease in the sales of a number of our products mainly from the following few reasons. First, we increased the overall selling prices of our products range from 14.6% to 46.5% onJanuary 1, 2011 . The market normally needs six months or even longer to absorb the impact of price increase. Second, as the PRC government moves forward with the Healthcare Reform, we experienced demanding fluctuation and this situation will continue until the Healthcare Reform fully in place and the national healthcare system mature. Third, we increased the capacity per package for some of our products, such as Siberian Ginseng Tablets, the tablets per bottle increased from 100 to 400 tablets per bottle. Fourth, we focused our effort to our main products, Siberian Ginseng Series, Ginseng and Venison Extract, Badger Oil and Compound Schizandra Tablets which accounted for 66.5% of our total sales and have higher gross margin and we have dominated the market of these four products and will continue to put more effort to strengthen our market share. The PRC government is injecting funds into healthcare insurance system to reimburse full or part of the medical expenses consumed by Chinese citizen. We expect the Healthcare Reform, when fully in place, will greatly improve the affordability of healthcare cost of Chinese people and therefore increase the demand for our products. We have establishedMedical Reform Sales Department as a dedicated resource focused on capturing this tremendous growth opportunity. 24 In the third quarter of our fiscal year 2010, we introduced two new products to the market, Qing Re Jie Du Oral Liquid, which is used to cure seasonal flu, and Compound Schisandra Tablets, also known as magnolia vine, has been clinically proven to have significant benefits to the functioning and regulation of the central nervous system. In the last quarter of our fiscal year 2010, we introduced Ginseng and Venison Extract product to the market which nourishes the blood and kidney, restores the body's energy and increase endurance and has been in great demand since we launched the product. In the first quarter of our fiscal year 2011, we introduced Badger Oil which treats burns and scalds and attracted great attention from many patients.
On
2011 2010
Sales revenues before sales rebate (in thousands)
806 851
Average selling prices/pack (in thousands)
The increase in average sales price per pack, as reflected in the table, is primarily attributable to the increase in the sales price of individual products, namely Siberian Ginseng (Acanthopanax) Series, Tianma Series, Banlangen Granules and Ginseng and Venison Extract as demonstrated in the following table, which reflects the average sales price per pack by product for 2011 and 2010 and the percentage changes in the sales price per pack.
Average Price Per Pack Percentage Product 2011 2010 Change
Siberian Ginseng (Acanthopanax) Series
38.5 % Tianma Series 109 81 34.5 % Compound Yangjiao Tablets 116 94 23.4 % Shark Vital Capsules - 469 -100.0 % Shengmai Granules 47 41 14.6 % Banlangen Granules 41 28 46.4 % Compound Honeysuckle Granules 70 60 16.7 % Compound Schizandra Tablets 103 88 17.0 % Ginseng and Venison Extract 126 86 46.5 % Qing Re Jie Du Oral Liquid 36 30 20.0 % Badger Oil 242 - - Total$ 99 $ 74 33.8 % We expect the demand for our products will increase as we continue to garner greater market acceptance, in particular the benefits of our Siberian Ginseng (Acanthopanax) Series in treating depression and nerve-regulation. Further, we see signs of increased demand from our newly launched product, Ginseng and Venison Extract which accounted for over 10% of our total sales revenue in fiscal year 2011. We believe that we will have a continuous and stable sales increase in these products for fiscal year 2012. In addition, we anticipate that we will be successful in becoming one ofChina's essential medicine suppliers as the PRC government moves forward with its Health Reforms in 2012. 25 Cost of Goods Sold Our costs of goods sold consist primarily of direct and indirect manufacturing costs, including raw material, packaging material, labor cost, utilities and depreciation. Cost of goods sold increased approximately$3.77 million , or 14.6%, from approximately$25.77 million in 2010 to approximately$29.53 million in 2011. This increase was primarily attributable to increase in products sold and increases in certain raw material prices such as sugar and Siberian Ginseng raw material. Although we anticipate that the cost of goods will increase due to inflationary price increases, we do not believe that such increases will be material for fiscal year 2012. We anticipate that beyond 2012, our price for raw materials and other production costs will continue to increase due to inflation. If our costs of goods increase, this may have a negative effect on our net income because due to market conditions and competitive conditions, we may not be able to increase the price for our products in proportion to the increase in costs of goods sold.
Operating and Administrative Expenses
Our total operating expenses consist primarily of sales and marketing expenses, general and administrative expenses and research and development expenses. Our total operating expenses increased by approximately$2.04 million , or 17.5%, from approximately$11.62 million in 2010 to approximately$13.66 million in 2011.
Sales and Marketing. Our sales and marketing expenses consist primarily of advertising and market promotion expenses, and other overhead expenses incurred by the Company's sales and marketing personnel. Sales and marketing expenses increased approximately$1.06 million , or 21.3%, from approximately$4.97 million for 2010 to approximately$6.02 million for 2011. This increase was primarily attributable to an increase of approximately$0.97 million , or 20.2%, in advertising expenses as the Company intensified TV advertisements inHeilongjiang province for our botanic anti-depression series. Sales and marketing expenses are likely to increase as we continue expanding our distribution network throughoutChina and seek to increase our market share
and awareness of our products.
General and Administrative. Our general and administrative expenses consist primarily of salary, travel, entertainment expenses, rental, benefits, share-based compensation, and professional service fees. General and administrative expenses increased by approximately$0.43 million , or 11.9%, from approximately$3.61 million for 2010 to approximately$4.05 million for 2011. This increase was primarily attributable to an increase of approximately$0.29 million in rental expenses, an increase of approximately$0.13 million in amortization expenses and an increase of$0.09 million in salary expenses. General and administrative expenses are likely to increase as we continue to expand our production, sourcing capacity, and distribution capacity throughoutChina . Research and Development. Our research and development expenses consist primarily of salary, equipment rental expenses, and Siberian Ginseng (Acanthopanax) cultivation related expenses. Research and development expenses increased approximately$0.55 million , or 18.1%, from approximately$3.04 million for 2010 to approximately$3.59 million for 2011. This increase was primarily attributable to development of Siberian Ginseng (Acanthopanax) cultivation and extraction of effective components of the Siberian Ginseng (Acanthopanax) plant, and development of other products, and research in cultivation techniques for Siberian Ginseng. Research and development expenses are likely to increase as we continue to devote our resources to development of new products and enhancement of our existing products. 26 Income from Operations
As a result of the foregoing, our income from operations increased by
approximately
Income Tax Expenses We are subject toU.S. federal and state income taxes. Our subsidiary registered in the PRC is subject to enterprise income taxes inChina . For the calendar years of 2011and 2010, our PRC subsidiary was granted a tax reduction of 10% and 25%, respectively, with income tax payable of 15% and 0%, respectively. Our income tax expenses increased from$0 for fiscal year 2010 to approximately$3.73 million for fiscal year 2011.
Cumulative Currency Translation Adjustments
Our principal country of operations is the PRC and our functional currency is the Renminbi, but our reporting currency is theU.S. dollar. All translation adjustments resulting from the translation of our financial statements intoU.S. dollars are reported as cumulative currency translation adjustments. Our cumulative currency translation adjustments increased by approximately$2.45 million , from approximately$1.40 million in 2010 to approximately$3.85 million in 2011.
Liquidity and Capital Resources
We had retained earnings of approximately$53.46 million and$79.38 million as ofOctober 31, 2010 and 2011, respectively. As ofOctober 31, 2011 , we had cash of approximately$15.28 million and total current assets of approximately$51.07 million . As ofOctober 31, 2011 , we had a working capital surplus of approximately$40.84 million . With the anticipated income from 2012, we believe our cash are adequate to satisfy our working capital needs and sustain our ongoing operations for the next twelve months.
Our summary cash flow information is as follows:
Year ended October 31 Net cash provided by (used in): 2011 2010 ($ in thousands) Operating activities 21,140 23,835 Investing activities (34,664 ) (4,699 )
Net Cash Provided by Operating Activities
Net cash provided by operating activities decreased approximately$2.70 million , from net cash provided by operating activities of approximately$23.84 million in 2010 to net cash provided by operating activities of approximately$21.14 million in 2011. This decrease was primarily attributable to an increase in net income of approximately$8.05 million , an increase in the trade receivables of approximately$4.61 million as a result of increased sales, an increase in inventories of approximately$4.97 million , an increase in other receivables of approximately$6.37 million and an increase in tax payable of approximately
$4.90 million . 27
Net cash used in investing activities increased approximately$29.97 million , from approximately$4.70 million in 2010 to approximately$34.66 million in 2011. This increase was primarily attributable to the increase in payments made to purchase land use right, exclusive using right of undergrowth resources, prepayment of five patents and construction in progress.
Net Cash Provided by Financing Activities
We did not have any financing activities during fiscal years ended
Outstanding Long-Term Indebtedness
None
Off-balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Contractual Obligations OnOctober 12, 2009 , we entered into a purchase agreement withHarbin Renhuang Pharmaceutical Stock Co. Ltd ("Renhuang Stock") to acquire the land use right, property and plant located at our Ah City Natural and Biopharmaceutical plant for a total consideration of$25,096,070 . Pursuant to the purchase agreement, a payment of$15,685,044 was made to Renhuang Stock inOctober 2009 and a payment of$7,842,522 was made to Renhuang Stock inJanuary 2011 , with a final payment of$1,568,504 will be paid once we received all the related title transfer document from local government, at which time title for the assets will be transferred. According to the agreement, we were exempted from lease payments for the underlying assets starting fromMay 1, 2010 . OnApril 10, 2010 , CBP China entered into a Purchase Agreement with Hongxiangmingyuan ofHeilongjiang Yongtai Company , to acquire two office floors for a total consideration of$6,017,504 . Pursuant to the Purchase Agreement, a payment of$4,212,253 was made inApril 2010 and recorded as deposits on the consolidated balance sheet. Pursuant to the Purchase Agreement, final payment of$1,805,251 is due byDecember 20, 2012 , at which time title for the assets will be transferred. Accordingly the transaction is considered incomplete as at
October 31, 2011 . 28 Remaining Name of Fixed Asset Purchase Date Prepaid Amount Amount Total Amount US$ US$ US$
Ah City Pharmaceutical Plant October, 2009 23,527,566 1,568,504 25,096,070 Two Office Floor April, 2010 4,212,253 1,805,251 6,017,504 Total 27,739,819 3,373,755 31,113,574 In January, 2011, CBP China started its Ah City Phase Two project for Siberian Ginseng products development and industrialization and entered into a Construction and Engineering Design Contract (the "Contract") withHeilongjiang Medical Architecture Design Institute (the "Institute") for architectural design. A few payments have been made to Institute and relevant local government departments for design and start up fees and we recorded$1,937,103 as Construction in progress for Ah City Phase Two project. The estimated total investment for Ah City Phase Two is$18,822,053 . In anticipation of the project proceeding, we expect to pay approximately$9,356,129 in our fiscal year 2012 and$7,528,821 in our fiscal year 2013. The project is anticipated to be finished in 2013. Projected
Name of Construction in Progress Started Date Paid Amount
Remaining Amount Total Amount
US$ US$ US$ Ah City Phase Two(Siberian Ginseng Product Industrialization) August, 2011 1,937,103
16,884,950 18,822,053 OnJanuary 11, 2011 , CBP China entered into an Exclusive Licensing Agreement forHarbin Renhuang Pharmaceutical Co., Ltd. to Use Forest Resources underYichun Red Star Forestry Bureau (the "Agreement") withYichun Red Star Forestry Bureau of Heilongjiang Province (the "Forestry Bureau ") which provides us with 30 years exclusive license right to use approximately 6,667 hectares of undergrowth resources including approximately 67 hectares of Siberian Ginseng GAP cultivation base inHeilongjiang Province . Pursuant to the Agreement, a payment of$7,842,522 was made toForestry Bureau in January, 2011, second payment of$6,274,018 was made in October, 2011 and with a final payment of$1,568,504 due in 12 months from the date of Agreement approved by local government authorities for a total consideration of$15,685,044 . Siberian Ginseng is a plant with medically-established anti-depressant and mood regulation qualities and is also an active ingredient in our market-leading line of all-natural anti-depressant medications. We will be responsible for continued maintenance and protection of wild resources to make this area a professional Siberian Ginseng base. In the fourth quarter of our fiscal year 2011, we purchased five patents listed as the following table. Remaining Name of Intangible Assets Purchase Date Paid Amount
Amount Total Amount
US$ US$ US$ Patent of Ingredients and preparation for Parkinson Drug August, 2011 1,348,914 1,348,914 2,697,828 Patent of Ingredients and preparation for XiangDousu August, 2011 1,333,229 1,333,229 2,666,458 Patent of Mudouye Extract September, 2011 1,882,205 1,882,205 3,764,410 Patent of Hongdoushan Extract September, 2011 2,368,442 2,368,442 4,736,884 Patent of Ingredients and preparation for Jizhi Pills October, 2011 2,117,481 2,117,481 4,234,962Yichun Red Star Forrest Bureau Undergrowth Resource Exclusive Licensing right January, 2011 14,116,540 1,568,504 15,685,044 Total 23,166,811 10,618,775 33,785,586 29
On
Remaining Advertising Contract Contract Date Paid Amount
Amount Total Amount
US$ US$ US$
1,529,292 6,117,167
As ofOctober 31, 2011 , the Company has capital commitments for purchase of Ah City Nature and Pharmaceutical Plant, two office floors, undergrowth resources right, five patents, advertising contract and Ah City Phase Two construction in progress of approximately$32,406,772 . The amounts to be paid in the future years are as follows: Calendar Year Payment for properties 2012 $ 23,072,700 2013 9,334,072 2014 2015 2016 Thereafter Total $ 32,406,772 Critical Accounting Policies The consolidated financial statements include the financial statements of the Company and our subsidiaries. All transactions and balances among us and our subsidiaries have been eliminated upon consolidation.
Accounting Judgments and Estimates
Certain amounts included in or affecting our consolidated financial statements and related disclosures must be estimated, requiring us to make certain assumptions with respect to values or conditions that cannot be known with certainty at the time the financial statements are prepared. These estimates and assumptions affect the amounts we report for assets and liabilities and our disclosure of contingent assets and liabilities at the date of our financial statements. We routinely evaluate these estimates, utilizing historical experience, consulting with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates. Any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known. 30
We believe that certain accounting policies are of more significance in our consolidated financial statement preparation process than others, which policies are discussed below. See also Note 2 to the consolidated financial statements for a summary of our principal accounting policies.
Estimates of allowances for bad debts - We must periodically review our trade and other receivables to determine if all are collectible or whether an allowance is required for possible uncollectible balances.
Estimate of the useful lives of property and equipment - We must estimate the useful lives and proper salvage values of our property and equipment. We must also review property and equipment for possible impairment.
Estimate of the useful lives of intangible assets - We must estimate the useful lives of our intangible assets. We must also review intangible assets for possible impairment.
Inventory - We must determine whether we have any obsolete or impaired inventory.
Revenue recognition - Revenue from the sale of goods is recognized on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are shipped to customers and the title has passed.
Please refer to the notes to the financial statements included elsewhere in this filing for a more complete listing of all of our critical accounting policies.
New Accounting Pronouncements
InApril 2011 , the FASB issued ASU 2011-02 Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. For public companies, this ASU is effective for interim and annual periods beginning on or afterJune 15, 2011 , and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. Early application is permitted. It is not expected to have a material impact on the Company's consolidated financial statements. InMay 2011 , the FASB issued ASU 2011-04 Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements inU.S. GAAP and IFRSs. This ASU is the result of joint efforts by theFASB andInternational Accounting Standards Board ("IASB") to develop a single, converged fair value framework - that is, converged guidance on how (not when) to measure fair value and on what disclosures to provide about fair value measurements. Thus, there are few differences between this ASU and its international counterpart, IFRS 13. While this ASU is largely consistent with existing fair value measurement principles inU.S. GAAP, it expands Topic 820's existing disclosure requirements for fair value measurements and makes other amendments. Many of these amendments were made to eliminate unnecessary wording differences betweenU.S. GAAP and IFRSs. However, some could change how the fair value measurement guidance in Topic 820 is applied. This ASU is effective for interim and annual periods beginning afterDecember 15, 2011 for public entities. It is not expected to have a material impact on the Company's consolidated financial statements. 31
InJune 2011 , the FASB issued ASU 2011-05 Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. This ASU removes the presentation options in Topic 220 and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. This ASU does not change the items that must be reported in other comprehensive income. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning afterDecember 15, 2011 . Early adoption is permitted. This ASU does not require incremental disclosures in addition to those required by Topic 250 or any transition guidance. Because the Company is currently adopted to present comprehensive income within the consolidated statements of changes of equity and therefore, it is expected this ASU would change the presentation of comprehensive income in the Company's consolidated financial statements upon its adoption. It is not expected to have a material impact on the Company's consolidated financial statements. InDecember 2011 , the FASB issued ASU 2001-11 Balance Sheet (Topic 210)-Disclosures about Offsetting Assets and Liabilities: The amendments in this Update will enhance disclosures required byU.S. GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. This information will enable users of an entity's financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or afterJanuary 1, 2013 , and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. It is not expected to have a material impact on the Company's consolidated financial statements. InDecember 2011 , the FASB issued ASU 2011-12 Comprehensive Income (Topic 220): In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report 2 reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning afterDecember 15, 2011 . Nonpublic entities should begin applying these requirements for fiscal years ending afterDecember 15, 2012 , and interim and annual periods thereafter. It is not expected to have a material impact on the Company's consolidated financial statements.
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