UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
o
o
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2011
For the transition period from _____ to __________
Commission file number 001-34711
CHINA JO-JO DRUGSTORES, INC.
(Exact name of registrant as specified in its charter)
Nevada
(State or other jurisdiction of incorporation or organization)
98-0557582
(IRS Employer Identification No.)
Room 507-513, 5th Floor A Building, Meidu Plaza
Gongshu District
Hangzhou, Zhejiang Province
People’s Republic of China
(Address of Principal Executive Offices)
+86 (571) 88077078
(Issuer Telephone Number)
N/A
(Former name or former address, if changed since last report)
Title of Each Class
Common Stock $0.001 Par Value
Name of Each Exchange on Which Registered
NASDAQ Capital Market
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
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 o No þ
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and
will not be contained herein, to the best of 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Non-accelerated filer o
Accelerated filer o
Smaller reporting company þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
As of June 24, 2011, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $12,407,387 based on a
closing price of $1.74 per share of common stock as reported on the NASDAQ Stock Market on such date.
The registrant had a total of 13,531,579 shares of common stock outstanding as of June 24, 2011.
1
TABLE OF CONTENTS
TO ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED MARCH 31, 2011
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Reserved
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Conditions and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions
Principal Accounting Fees and Services
Exhibits, and Financial Statement Schedules
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
Exhibit Index
Signatures
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Page
4
16
31
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37
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CAUTION REGARDING FORWARD-LOOKING INFORMATION
This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and
assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-
looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words “estimate,”
“anticipate,” “believe,” “expect,” or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such
statements, prospective investors should carefully review various risks and uncertainties identified in this Report, including the matters set forth under
the captions “Risk Factors” and in the Company’s other SEC filings. These risks and uncertainties could cause the Company’s actual results to differ
materially from those indicated in the forward-looking statements. The Company undertakes no obligation to update or publicly announce revisions to
any forward-looking statements to reflect future events or developments.
Although forward-looking statements in this annual report on Form 10-K reflect the good faith judgment of our management, such statements can only
be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and
actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors
that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the heading
“Risks Relating to Our Business” below, as well as those discussed elsewhere in this annual report on Form 10-K. Readers are urged not to place
undue reliance on these forward-looking statements, which speak only as of the date of this annual report on Form 10-K. We file reports with the
Securities and Exchange Commission (“SEC”). You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100
F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that
contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise
after the date of this annual report on Form 10-K. Readers are urged to carefully review and consider the various disclosures made
throughout the entirety of this annual report, which attempt to advise interested parties of the risks and factors that may affect our business,
financial condition, results of operations and prospects.
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ITEM 1. BUSINESS
General
PART I
China Jo-Jo Drugstores, Inc. (the “Company”) is primarily an operator of retail pharmacies in the People’s Republic of China (“PRC” or
“China”). We currently have 55 locations under three brands: 53 “Jiuzhou Grand Pharmacy” stores and one “Quannuo Grand Pharmacy” store in
Hangzhou, the capital of Zhejiang Province, and one “Lydia Grand Pharmacy” store in Shanghai. Our stores provide customers with a wide variety of
medicinal products, including prescription and over-the-counter (“OTC”) drugs, nutritional supplements, traditional Chinese medicine (“TCM”) products,
personal care products, family care products, medical devices, as well as convenience products including consumable, seasonal and promotional items.
We briefly offered baijiu, or Chinese white liquor, at some of our pharmacies, from December 2010 to February 2011. Each store typically carries
approximately 2,500 to 7,000 different products. In addition to these products, we have licensed doctors of both western medicine and TCM onsite for
consultation, examination and treatment of common ailments at scheduled hours. Two of our stores have adjacent medical clinics offering urgent care
(to provide treatment for minor ailments such as sprains, minor lacerations and dizziness which can be treated on an outpatient basis), TCM (including
acupuncture, therapeutic massage and cupping) and minor outpatient surgical treatments (such as suturing). Our store locations vary in size; however,
our 55 stores presently average approximately 250 square meters. We attempt to tailor our product offerings, physician access and operating hours
based on the community where each individual store is located.
All of our ongoing business operations are carried out by companies in China that either we control through contractual arrangement or are our
wholly-owned subsidiaries:
● Hangzhou Jiuzhou Grand Pharmacy Chain Co., Ltd. (“Jiuzhou Pharmacy”), which we control contractually, operates our “Jiuzhou Grand
Pharmacy” stores;
● Shanghai Lydia Grand Pharmacy Co., Ltd. (“Shanghai Lydia”), which is wholly-owned by Jiuzhou Pharmacy, operates our “Lydia Grand
Pharmacy” store and will operate such additional “Lydia Grand Pharmacy” locations that we may open in Shanghai;
● Hangzhou Quannuo Grand Pharmacy Co., Ltd. (“Hangzhou Quannuo”), which operates the “Quannuo Grand Pharmacy” store, is a wholly-
owned subsidiary;
● Hangzhou Jiuzhou Clinic of Integrated Traditional and Western Medicine (General Partnership) (“Jiuzhou Clinic”), which we control
contractually, operates one of our two medical clinics; and
● Hangzhou Jiuzhou Medical & Public Health Service Co., Ltd. (“Jiuzhou Service”), which we also control contractually, operates our other
medical clinic.
In February 2010, we entered into a 30-year lease for the land use rights to approximately 53 acres of land in Lin’an, in northwestern Zhejiang
Province approximately 30 miles from Hangzhou. Currently, more than ten plant varieties, including fructus rubi (used in TCM to promote blood
circulation), white atractylodes rhizome (used in TCM to treat physical and mental fatigue) and atractylodes macrocephala (used in TCM to control
sweating), have been planted on approximately 48 acres, which we are expecting to harvest near the end of 2011 through early 2012, and ultimately sell
as packaged herbs through our store locations and in bulk to third parties. In August 2010, we established Hangzhou Jiuxin Qianhong Agriculture
Development Co., Ltd. (“Jiuxin Qianhong”) as a wholly-owned subsidiary to operate this project.
Since May 2010, we have also been operating an online drugstore (www.dada360.com) that currently sells OTC drugs and nutritional
supplements. In April 2010, we were granted an Internet Pharmaceutical Transaction Service Qualification Certificate by the State Food and Drug
Administration of Zhejiang Province, which allows us to engage in online retail pharmaceutical sales throughout China. In July 2010, we established
Zhejiang Shouantang Pharmaceutical Technology Co., Ltd. (“Shouantang Technology”) as a wholly-owned subsidiary to carry out such business, and
acquired Zhejiang Quannuo Internet Technology Co., Ltd. (“Quannuo Technology”) in November 2010 to operate the website and provide software
and technical support. As a part of our acquisition of Quannuo Technology, we also acquired its wholly-owned subsidiary, Hangzhou Quannuo, and the
“Quannuo Grand Pharmacy” store. We are currently working to establish multiple payment methods with banks and online payment intermediaries.
On April 15, 2011, Jiuzhou Pharmacy entered into an equity ownership transfer agreement with the owners of Zhejiang Jiuxin Medicine Co., Ltd.
(“Jiuxin Medicine”) to acquire their equity interests in Jiuxin Medicine. Jiuxin Medicine is licensed to transport and store pharmaceutical products, and
we sought to acquire this company in order to carry out such functions internally. In April 2011, the business license of Jiuxin Medicine was transferred
to Jiuzhou Pharmacy, although no consideration was paid. As of the date of this Form 10-K, we are still negotiating the payment terms with the sellers.
Throughout this Form 10-K, we will sometimes refer to Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, as well as the subsidiaries of
Jiuzhou Pharmacy, collectively as “HJ Group.”
Our Corporate History and Structure
We were incorporated in Nevada on December 19, 2006, under the name “Kerrisdale Mining Corporation”, with a principal business objective to
acquire and develop mineral properties. Although we had acquired certain mining claims, we were not operational.
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On July 14, 2008, we amended our Articles of Incorporation to change our authorized capital stock from 75,000,000 shares of common stock, par
value $0.001 per share, to 500,000,000 shares of common stock, par value $0.001 per share, and 10,000,000 shares of preferred stock, par value
$0.001. The preferred stock is “blank check,” with the right to set its designations, preferences, limitations, privileges, qualifications, dividend,
conversion, voting, and other special or relative rights, conferred on our board of directors.
On September 17, 2009, we acquired control of Renovation Investment (Hong Kong) Co., Ltd. (“Renovation”) pursuant to a share exchange
agreement. We control Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service through contractual arrangements between each of these companies and
Renovation’s wholly-owned subsidiary, Zhejiang Jiuxin Investment Management Co., Ltd. (“Jiuxin Management”).
On September 24, 2009, we amended our Articles of Incorporation to change our name from “Kerrisdale Mining Corporation” to “China Jo-Jo
Drugstores, Inc.”
On April 9, 2010, we effected a 1-for-2 reverse stock split of our issued and outstanding shares of common stock and a proportional reduction of
our authorized shares of common stock, by filing a Certificate of Change Pursuant to Nevada Revised Statutes 78.209 with the Nevada Secretary of
State on April 6, 2010. All share information in this Form 10-K takes into account this reverse stock split.
On April 28, 2010, we completed a registered public offering of 3.5 million shares of common stock at a price of $5.00 per share, resulting in
gross proceeds to us, prior to deducting underwriting discounts, commissions and offering expenses, of approximately $17.5 million.
Renovation
Renovation is a limited liability company incorporated in Hong Kong on September 2, 2008. Renovation was formed by the owners of HJ Group
as a special purpose vehicle for purposes of raising capital, in accordance with requirements of the PRC State Administration of Foreign Exchange
(“SAFE”). Specifically, SAFE issued the Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage
in Financing and Inbound Investment via Overseas Special Purpose Vehicles (“Circular No. 75,”) on October 21, 2005. To further clarify the
implementation of Circular 75, on May 31, 2007, SAFE issued an official notice known as Hi Zhong Fa [2007] No. 106 (“Circular 106”). The Circular
75 and the supplementing Circular 106 require the owners of any Chinese company to obtain SAFE’s approval before establishing any offshore holding
company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, the owners of HJ Group who are our three
founders, namely Lei Liu, Li Qi and Chong’an Jin, submitted their applications to SAFE on July 25, 2008. On August 16, 2008, SAFE approved the
application, permitting these Chinese nationals to establish Renovation as an offshore, special purpose vehicle which may have foreign ownership and
participate in foreign capital raising activities. After SAFE’s approval, Mr. Liu, Ms. Qi and Dr. Jin became holders of 100% of Renovation’s issued
and outstanding capital stock on September 2, 2008.
On June 9, 2009, Circular 106 was superseded by the Notice on Foreign Exchange Implementing Guidelines regarding Capital Account
Management (“Circular 77”) which allows offshore holding company to be formed before SAFE registration is complete. See “Relevant PRC
Regulations – SAFE Registration” below.
Jiuxin Management
Jiuxin Management was organized in the PRC on October 14, 2008. Because all of its issued and outstanding capital stock is held by
Renovation, a Hong Kong company, Jiuxin Management is deemed a “wholly foreign owned enterprise” (“WFOE”) under PRC laws. The principal
purpose of Jiuxin Management is to manage, hold and own rights in and to the businesses and profits of HJ Group through a series of contractual
arrangements as described further below. Other than activities relating to such contractual arrangements, Jiuxin Management has no other separate
operations of its own.
HJ Group
Jiuzhou Pharmacy is a PRC limited liability company established on September 9, 2003 by our three founders: Lei Liu (55%), Chong’an Jin
(23%) and Li Qi (22%). Jiuzhou Pharmacy operates a chain of pharmacies in Hangzhou that is presently comprised of 53 stores.
The current subsidiaries of Jiuzhou Pharmacy are:
● Shanghai Lydia, which was established on January 17, 2011 in order to operate drugstores in Shanghai; and
● Jiuxin Medicine, which was established on December 31, 2003, and which business license was transferred to Jiuzhou Pharmacy in April
2011 although no consideration has been paid as of the date of this Form 10-K in connection with such transfer.
Jiuzhou Pharmacy had another subsidiary, namely Hangzhou Kuaileren Grand Pharmacy Co., Ltd. (“Kuaileren”), which was formally dissolved
on April 9, 2011. Kuaileren was established on May 9, 2006, with registered capital of RMB 100,000. Kuaileren’s then sole owner transferred all of
his ownership interest to our three founders for no consideration on June 30, 2009, who in turn transferred the ownership interest to Jiuzhou Pharmacy
for no consideration on August 28, 2009. Prior to its dissolution, Kuaileren operated a “Kuaileren Grand Pharmacy” store, which now operates as a
“Jiuzhou Grand Pharmacy” store.
Jiuzhou Clinic is a PRC general partnership established on October 10, 2003 by our three founders: Lei Liu (39%), Li Qi (30%) and Chong’an
Jin (31%). Jiuzhou Clinic is a medical practice currently operating adjacent to Jiuzhou Pharmacy’s Daguan branch, providing primary, urgent, minor
surgical and traditional medical care services. Additionally, Jiuzhou Clinic’s physicians consult with, and examine, patients at other Jiuzhou Pharmacy
stores.
5
Jiuzhou Service is a PRC limited liability company established on November 2, 2005 by our three founders: Lei Liu (39%), Li Qi (30%) and
Chong’an Jin (31%). Jiuzhou Service is licensed as a healthcare management company and currently manages the medical clinic operating adjacent to
Jiuzhou Pharmacy’s Wenhua branch that provides services similar to those provided by Jiuzhou Clinic.
Shouantang Technology
Shouantang Technology is a PRC limited liability company established on July 16, 2010. Shouantang Technology, like Jiuxin Management, is
wholly owned by Renovation, and as such, it is deemed a WFOE under PRC laws. Shouantang Technology is an investment company that finances its
operating subsidiary Quannuo Technology. Other than activities relating to investing and financing the working capital of Quannuo Technology,
Shouantang has no separate operations of its own.
In November 2010, Shouantang Technology acquired 100% of Quannuo Technology and its wholly-owned subsidiary, Hangzhou Quannuo,
pursuant to an equity ownership transfer agreement. Quannuo Technology is a PRC limited liability company established on July 7, 2009. Quannuo
Technology operates and maintains the website for our online drugstore and provides software and technical support. Hangzhou Quannuo is a PRC
limited liability company established on July 8, 2010. Hangzhou Quannuo operates our “Quannuo Grand Pharmacy” store.
Jiuxin Qianhong
Jiuxin Qianhong is a PRC limited liability company established on August 10, 2010. Qianhong operates our herbal plants cultivation project.
Contractual Arrangements with HJ Group and our Three Founders
Our relationships with HJ Group and our three founders are governed by a series of contractual arrangements that they have entered into with
Jiuxin Management.
PRC regulations on foreign investment currently permit foreign companies to establish or invest in WFOEs or joint ventures that engage in
wholesale or retail sales of pharmaceuticals in China. For retail sales, however, these regulations restrict the number and size of retail pharmacy stores
that a foreign investor may establish. If a foreign investor owns more than 30 stores that sell a variety of branded pharmaceutical products sourced
from different suppliers, such foreign investor’s ownership interests in the stores are limited to 49.0%. The contractual arrangements with Jiuzhou
Pharmacy enable us to bypass such restrictions, since neither we nor our subsidiaries own equity interests in Jiuzhou Pharmacy, while at the same time,
we retain control of the drugstore chain by virtue of the contractual arrangements.
Similarly, PRC regulations place certain restrictions on foreign ownership of medical practice. Foreign investors can acquire ownership interests
through a Sino-foreign joint venture only and cannot do so through a WFOE. Since we do not have actual equity interest in Jiuzhou Clinic or Jiuzhou
Service, but control these entities through contractual arrangements, the PRC regulations restricting foreign ownership of medical practice are not
applicable to us or our structure.
Under PRC laws, Jiuxin Management, Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic are each an independent business entity not
exposed to the liabilities incurred by any of the other three entities. The contractual arrangements constitute valid and binding obligations of the parties
of such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance
with the laws of the PRC. These contractual arrangements, as amended and in effect, include the following:
Consulting Services Agreement. Pursuant to the exclusive consulting services agreement, Jiuxin Management has the exclusive right to provide
to Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic with general business operation services, including advice and strategic planning, as well as
consulting services related to their current and future operations (the “Services”). Additionally, Jiuxin Management owns the intellectual property rights
developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services.
Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic each pays a quarterly consulting service fees in RMB to Jiuxin Management that is equal to its
profits for such quarter. This agreement is in effect unless and until terminated by written notice of a party to the agreement in the event that: (a) a
party becomes bankrupt, insolvent, is the subject of proceedings or arrangements for liquidation or dissolution, ceases to carry on business, or becomes
unable to pay its debts as they become due; (b) Jiuxin Management terminates its operations; or (c) circumstances arise which would materially and
adversely affect the performance or the objectives of the agreement. Jiuxin Management may also terminate the agreement with Jiuzhou Pharmacy,
Jiuzhou Medical or Jiuzhou Clinic if one of them breaches the terms of the agreement, or without cause.
Operating Agreement. Pursuant to the operating agreement, Jiuxin Management agrees to guarantee the contractual performance by Jiuzhou
Pharmacy, Jiuzhou Medical and Jiuzhou Clinic of their agreements with any third party. In return, our three founders (the “Owners”) must appoint
designees of Jiuxin Management to the boards of directors and senior management of Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic. In
addition, Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic each agrees to pledge its accounts receivable and all of its assets to Jiuxin
Management. Moreover, Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic agree that without the prior consent of Jiuxin Management, they will
not engage in any transactions that could materially affect their respective assets, liabilities, rights or operations, including, without limitation, incurrence
or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual
property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. Jiuzhou Pharmacy, Jiuzhou
Medical and Jiuzhou Clinic further agree to abide by corporate policies set by Jiuxin Management with respect to their daily operations, financial
management and employment issues. The term of this agreement is from August 1, 2009 until the maximum period of time permitted by law. On the
other hand, Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic cannot terminate this agreement.
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Equity Pledge Agreement. Pursuant to the equity pledge agreement, the Owners have pledged all of their equity interests in Jiuzhou Pharmacy,
Jiuzhou Medical and Jiuzhou Clinic to Jiuxin Management in order to guarantee the performance by Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou
Clinic of their respective obligations under the consulting services agreement. If Jiuzhou Pharmacy, Jiuzhou Medical, Jiuzhou Clinic or the Owners
breaches their respective contractual obligations, Jiuxin Management, as pledgee, will be entitled to certain rights, including the right to sell the pledged
equity interests. The Owners have also agreed that upon occurrence of any event of default, Jiuxin Management shall be granted an exclusive,
irrevocable power of attorney to take actions in the place and stead of the Owners to carry out the security provisions of this agreement and take any
action and execute any instrument that Jiuxin Management may deem necessary or advisable to accomplish the purposes of this agreement. The
Owners agree not to dispose of the pledged equity interests or take any actions that would prejudice Jiuxin Management’s interests. This agreement
will expire two (2) years after the obligations of Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic under the consulting services agreements have
been fulfilled.
Option Agreement. Pursuant to the option agreement, the Owners irrevocably grant Jiuxin Management or its designee an exclusive option to
purchase, to the extent permitted under PRC law, all or part of their equity interests in Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic for the
cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Jiuxin Management
or its designee has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement is from August 1, 2009
until the maximum period of time permitted by law.
Proxy Agreement. Pursuant to the proxy agreement, the Owners irrevocably grant a Jiuxin Management designee with the right to exercise
their voting and other ownership rights in Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic, including the rights to attend any meeting of the
Owners (or participate by written consent in lieu of such meeting) in accordance with applicable laws and each company’s incorporating documents, as
well as the rights to sell or transfer all or any of the Owners’ equity interests in Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic, and to appoint
and vote for their directors. The proxy agreement may be terminated by mutual consent of the parties or upon 30-day written notice from Jiuxin
Management.
Other than pursuant to the forgoing contractual arrangements, Jiuzhou Pharmacy, Jiuzhou Medical and Jiuzhou Clinic cannot transfer any funds
generated from their respective operations. The contractual arrangements were originally entered into on August 1, 2009, and amended on October 27,
2009.
Our Corporate Structure
The following diagram illustrates our corporate structure as of the date of this Form 10-K:
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The table below summarizes the status of the registered capital of our PRC subsidiaries and controlled companies as of the date of this Form 10-
K:
Entity Name
Jiuxin Management
Jiuzhou Pharmacy
Shanghai Lydia
Jiuzhou Clinic
Jiuzhou Service
Jiuxin Medicine
Jiuxin Qianhong
Shouantang Technology
Quannuo Technology
Hangzhou Quannuo
Our Products
Entity Type
Subsidiary
VIE
VIE
VIE
VIE
VIE
Subsidiary
Subsidiary
Subsidiary
Subsidiary
Registered Capital
USD 4.5 million
RMB 5 million
RMB 1 million
N/A
RMB 500,000
RMB 10 million
RMB 10 million
USD $20 million
RMB 10 million
RMB 800,000
Registered Capital Paid
USD 4.5 million
RMB 5 million
RMB 1 million
N/A
RMB 500,000
RMB 10 million
RMB 10 million
USD $11 million
RMB 2 million
RMB 800,000
Due Date for Unpaid
Registered Capital
N/A
N/A
N/A
N/A
N/A
N/A
N/A
July 16, 2012
July 7, 2011
N/A
The products available at our drugstores can be broadly classified into the following categories:
Prescription Drugs. We offer approximately 1,954 prescription drugs, of which 353 require a physician’s prescription. Of these 353 drugs, 90%
of the prescriptions are issued by physicians in our employ. We accept prescriptions only from licensed health care providers. Our in-store pharmacists
verify the validity, accuracy and completeness of all prescription drug orders. We ask all prescription drug customers to provide us with information
regarding drug allergies, current medical conditions and current medications. All pharmaceutical products in the PRC (both prescription and OTC) are
subject to price controls, with a recommended price and a price ceiling for each drug that are periodically adjusted by the relevant government
authorities in an effort to make healthcare more widely available. The latest such adjustment occurred in March 2011 and affected 852 different
prescription pharmaceutical products. However, this adjustment only required us to adjust 166 of our prescription and OTC drug prices for the fiscal
year ended March 31, 2011. Because we have always priced our drugs substantially below price ceilings, price controls have not affected our revenue
historically, and we do not expect them to do so in the future. Sales of prescription drugs accounted for approximately 38.8% of our drugstore revenue
for the fiscal year ended March 31, 2011.
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OTC Drugs. We offer approximately 1,349 OTC drugs, including western medicines and TCM, for the treatment of common diseases. Sales of
OTC drugs accounted for approximately 33.9% of our drugstore revenue for the fiscal year ended March 31, 2011.
Nutritional Supplements. We offer approximately 1,036 nutritional supplements, including a variety of healthcare supplements, vitamin, mineral
and dietary products. Sales of nutritional supplements accounted for approximately 8.4% of our drugstore revenue for the fiscal year ended March 31,
2011.
TCM Products. Each of our stores maintains a TCM counter, staffed by licensed herbalists who put together packages of herbs in a process
similar to how our in-store pharmacists fill out prescriptions. Additionally, we offer various types of drinkable herbal remedies and pre-packaged herbal
mixtures for making soup, which are used by consumers as health supplements. TCM products typically have higher margins than prescription and
OTC drugs. Sales of TCM products accounted for approximately 10.5% of our drugstore revenue for the fiscal year ended March 31, 2011.
Sundry Products. Our sundry products include personal care products such as skin care, hair care and beauty products, convenience products
such as soft drinks, packaged snacks, and other consumable, cleaning agents, stationeries, and seasonal and promotional items tailored to local
consumer demand for convenience and quality. We believe offering these products increases customer visits by increasing the shopping convenience
for our customers. Sales of sundry products accounted for approximately 2.1% of our revenue for the fiscal year ended March 31, 2011.
Medical Devices. Our medical device offerings include family planning and birth control products, early pregnancy test products, portable
electronic diagnostic apparatus, rehabilitation equipment, and surgical tools such as hemostats, needle forceps and surgical scissors. Sales of medical
devices accounted for approximately 1.3% of our drugstore revenue for the fiscal year ended March 31, 2011.
Liquor. We obtained retail licenses to sell alcohol for 40 of our retail pharmacies, and briefly sold Wu Liang Ye and Maotai, both well-known
brands of baijiu, or Chinese white liquor, from December 2010 to February 2011. Sales of liquor accounted for approximately 5.0% of our drugstore
revenue for the fiscal year ended March 31, 2011. Substantially all liquor sales were made to a single customer.
Customers
For the fiscal year ended March 31, 2011, our stores collectively served an average of approximately 11,000 customers per day. We periodically
conduct qualitative customer surveys, helping us to build a stronger understanding of our market position and our customers’ purchasing habits.
Our customers pay by cash, debit or credit cards, or medical insurance cards under municipal and provincial medical insurance programs. During
our fiscal year ended March 31, 2011, approximately 81.6% of our revenue came from cash sales, 12.8% from Hangzhou’s medical insurance cards
and 5.5% come from debit, credit, provincial medical insurance and other charge card sources. We obtain payments from the relevant government
social security bureaus, for sales made to eligible participants in the national medical insurance program on a monthly basis. See “Relevant PRC
Regulations — Reimbursement under the National Medical Insurance Program.” According to relevant regulations, a drugstore must operate for at
least one year before becoming eligible to apply to be licensed to accept Hangzhou’s medical insurance cards. As of the date of this Form 10-K, 26 of
our stores in Hangzhou are licensed to accept medical insurance cards while 4 are awaiting approval. We plan to apply for such license for our
remaining stores in Hangzhou when they become eligible. Our stores accepting medical insurance cards are designated as such on their outer signage.
Our Stores
Prior to opening a store, we carefully evaluate sites to maximize consumer traffic, store visibility and convenience for our customers. All of our
stores are located in well-established residential communities and prime retail locations where consumer purchasing power is relatively concentrated.
Depending on its size, each drugstore has between two to twelve pharmacists on staff, all of whom are properly licensed. As of the date of this Form
10-K, we operate a chain of 55 drugstores under three brands: Jiuzhou Grand Pharmacy (53 stores in Hangzhou), Quannuo Grand Pharmacy (1 store
in Hangzhou) and Lydia Grand Pharmacy (1 store in Shanghai). While we aim to brand our drugstore as consistently as possible, the “Jiuzhou Grand
Pharmacy” name may not be available to us in new markets that we enter (such as Shanghai).
After opening, a location may take up to 120 days to achieve our projected revenue goals for that particular location. Various factors influence
individual store revenue including, but not limited to: location, nearby competition, local population demographics, and square footage. To date, we have
not closed or targeted for closure any store due to underperformance.
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Employees
We had 546 employees as of March 31, 2011, including 533 fulltime and 13 part-time employees. The following table sets forth the number of
our employees for each area of operations and as a percentage of our total workforce as of March 31, 2011:
Non-pharmacist store staff
Pharmacists
Management- non-pharmacists
Physicians
Non-physician clinic staff
Total
As of March 31, 2011
Employees
Percentage
288
138
74
33
13
546
52.7%
25.3 %
13.6%
6.0%
2.4%
100%
We place strong emphasis on the quality of our employees at all levels, including in-store pharmacists and store staff who directly interact with
our customers. We provide extensive training for newly recruited employees in the first three months of their employment. The training is designed to
encompass a number of areas, such as knowledge about our products and how best to interact with our customers. In addition, we regularly carry out
training programs on medicine information, nutritional information, selling skills for our store staff and in-store pharmacists. We believe these programs
have played an important role in strengthening the capabilities of our employees.
In addition to our employees, there are 25 sales personnel provided to our drugstores by various manufacturers, which pay us a fee for their
presence in our stores. These manufacturers also compensate us to train these salespersons in our stores’ policies and procedures.
Marketing and Promotion
Our marketing and promotion strategy is to build brand recognition, increase customer traffic to our stores, attract new customers, build strong
customer loyalty, maximize repeat customer visits and develop incremental revenue opportunities.
Our marketing department designs our chain-wide marketing efforts while each store designs local promotions based on local demographics and
market conditions. We also launch single store promotional campaigns and community activities in connection with the openings of new stores. Our
store managers and staff are also encouraged to propose their own advertising and promotion plans, including holiday promotions, posters and
billboards. In addition, we offer special discounts and gift promotions for selected merchandise periodically in conjunction with our suppliers’ marketing
programs. We also provide ancillary services such as providing free blood pressure measurements in our stores.
Many of our promotion programs are designed to encourage manufacturers to invest resources to market their brands within our stores. We
charge manufacturers promotional fees in exchange for granting them the right to promote and display their products in our stores during promotional
periods. We also allow manufacturers and distributors to station salespeople at our drugstore locations to promote their products, for which we receive
a fee. We believe that manufacturer promotions improve our customers’ shopping experience because manufacturers provide purchasing incentives
and information to help customers to make informed purchase decisions. We work to maintain strong inventory positions for merchandise featured in
our promotions, as we believe this increases the effectiveness of our spending on promotion activities.
As part of our marketing campaign, we offer rewards card to customers at our Jiuzhou Grand Pharmacy and Lydia Grand Pharmacy locations.
Certain discount pricing is only available to our customers with the rewards card. After a customer signs up for the rewards card, we communicate via
the customer’s preferred method: e-mail, traditional mail or text messages. Approximately 50% of our customers use the rewards card when making
purchases. We intend to further extend this program to enhance customer experience and for customer retention.
We run advertisements periodically in selected newspapers to promote our brands and the products carried in our stores. Under our agreements
with certain newspapers, we run one-page weekly or monthly advertisements in these newspapers, and the newspapers publish healthcare-related
feature articles relating to the products we advertise near the dates of our advertisements. We also promote our brands and products using billboards
and radio and television commercials. Advertising expenses are borne either by the manufacturers of the products being advertised or us, or are shared,
depending on our agreement with the particular manufacturer. Our advertisements are designed to promote our brands, our corporate image and the
prices of products available for sale in our stores.
Distribution Methods of Our Products or Services
Through March 2011, we outsourced all operations of a distribution center, including inventory, delivery and distribution, to Zhejiang Yingte
Logistics Co., Ltd. (“Yingte Logistics”), one of the largest logistics companies in Zhejiang Province. Yingte Logistics is certified by Zhejiang Province
to distribute prescription medicines and other products.
Pursuant to our annual contract with Yingte Logistics, which was most recently renewed on January 1, 2011, in addition to providing delivery and
distribution services, Yingte Logistics would provide us with a 5,000 square meter capacity warehouse for our exclusive use. Inventory and inventory
management would be controlled through our centralized management system that tracks inventory status retrieval, and is linked to all of our drugstores
to track sales volume by product. Based on such information, we would instruct Yingte Logistics to make deliveries to each drugstore as necessary.
We terminated our agreement with Yingte Logistics in April 2011 in connection with the transaction with Jiuxin Medicine described below.
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On April 15, 2011, Jiuzhou Pharmacy entered into an equity ownership transfer agreement with the owners of Jiuxin Medicine to acquire 100%
of their equity interests in Jiuxin Medicine. We sought to acquire Jiuxin Medicine to carry out the services provided by Yingte Logistics internally. The
business license of Jiuxin Medicine was transferred to Jiuzhou Pharmacy on April 15, 2011, although no consideration was paid in connection with such
transfer. As of the date of this Form 10-K, we are still negotiating the payment terms with the sellers.
Jiuxin Medicine is located in Hangzhou approximately 7 miles from our headquarters. Its 8,000 square meters facility includes a climate-control
storage area suitable to store goods at various temperatures, and we have been using this facility as our distribution center since May 2011. Currently,
Jiuxin Medicine outsources distribution to Yingte Logistics under a one-year Logistics Service Agreement that expires March 31, 2012. We expect to
take over the management of Jiuxin Medicine once the purchase consideration is finalized and paid. We plan for Jiuxin Medicine to eventually carry out
distribution for us and for third parties including hospitals and other drugstores.
Suppliers
We currently purchase the products sold at our pharmacies from approximately 366 suppliers, including 236 wholesalers and 130 direct
manufacturers. For the year ended March 31, 2011, two vendors, namely Yiyang Pharmaceutical Co., Ltd. and Yingte Logistics, accounted for 27% of
our total purchases and 11% of total purchase deposits as of March 31, 2011. Neither of these companies is related to or affiliated with us. We believe
that competitive sources are readily available for substantially all of the merchandise we carry in our stores. We believe that as we grow in size, our
greater sourcing capability will make us a more attractive distribution channel for many drug manufacturers who can reduce their marketing expense
while increasing their sales volume by selling directly to us, thereby reducing our cost of purchase.
Cash Control
For the fiscal year ended March 31, 2011, approximately 81.6% of our sales were made in cash. Therefore, we have adopted strict cash control
procedures in all of our stores. Specifically, the details of each sales event are recorded in our integrated information management system, and the cash
generated at our stores is collected and deposited frequently in designated bank accounts, which are controlled by our headquarters. Depending on
store’s activity, cash will be either deposited daily or several times per week.
Quality Control
We place strong emphasis on quality control for both merchandise sourcing and in-store services. Our quality control starts with procurement.
We select products based on the manufacturers and wholesalers’ GMP and GSP compliance status and their product quality, manufacturing facilities
and technology, packaging, transportation and storage capabilities as well as market acceptance and cost competitiveness of the products. Additionally,
we conduct random quality inspections of each batch of products we procure. We replace our suppliers if they fail to pass our quality inspections. Since
there is a significant manufacturing capability surplus within the Chinese pharmaceutical industry, it is possible for us to change suppliers without a
material interruption to our business.
All of our employees participate in a mandatory 36-hour training program regarding quality control annually, and we regularly dispatch quality
inspectors to our stores to monitor the service quality of our staff.
Competition
The drugstore industry in China is intensely competitive, rapidly evolving and highly fragmented. We primarily compete with other retail
drugstore chains or drugstores, but also increasingly face competition from discount stores, convenience stores and supermarkets as we increase our
offering of non-drug convenience products and services. We compete for customers primarily on the basis of store location, merchandise selection,
prices, the unique combination of pharmacy and medical care services that we offer and brand name recognition. We believe that continued
consolidation of the drugstore industry and new store openings by chain store operators will further increase competitive pressures.
We believe the primary competitive factors include: (i) the ability to negotiate favorable discounts from drug manufacturers; (ii) responsiveness
to customers’ needs; (iii) the ability to identify and apply effective cost management programs utilizing clinical strategies; (iv) the commitment to
provide flexible, clinically-oriented services to customers; and (v) the quality, scope and costs of products and services offered to our customers. We
compete with a number of large, national drugstore chains that may have more financial resources and stronger brand strength and management
expertise than us, including China Nepstar Chain Drugstore Ltd. (“Nepstar”), LBX Pharmacy (“LBX”) and Tian Tian Hao Grand Pharmacy (“Tian
Tian”). In Hangzhou, as of March 31, 2011, Nepstar operated approximately 180 stores, Tian Tian operated approximately 90 stores and LBX
Pharmacy operated approximately 20 stores. We additionally compete with local and independent drugstores and government-operated pharmacies. On
average, the square footage of Tian Tian and Nepstar stores are significantly smaller than our average store size and do not have the breadth of
product offerings or categories. Moreover, none of our competitors provide the medical consultations that we offer at our drugstores.
Intellectual Property
We have one Class 5 trademark (for pharmaceuticals), “Jiuzhou Tongxin,” that was issued on February 14, 2011 and registered under Jiuzhou
Pharmacy. We plan to use it to brand certain products that we may sell in our stores. We have also applied to register twelve trademarks, four under
Shouantang Technology and eight under Shanghai Lydia, and expect them to be registered sometime in 2013. We own and operate the following
websites: www.dada360.com
in China), and
www.chinajojodrugstores.com (our English-language corporate website). We also own 25 inactive domain names. We do not own any patents, nor do
we have any pending patent applications, and we are not a beneficiary of any licenses, franchises, concessions or royalty agreements.
(our online drugstore), www.jiuzhou-drugstore.com
(our corporate website used
All our employees are required to enter into written employment agreements with us, pursuant to which they are subject to confidentiality
obligations.
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Relevant PRC Regulations
SAFE Registration
In October 2005, China’s State Administration of Foreign Exchange (“SAFE”) issued the Notice on Relevant Issues Concerning Foreign
Exchange Administration for PRC Residents Engaging in Financing and Roundtrip Investments via Overseas Special Purpose Vehicles
(“Circular 75”). Circular 75 regulates foreign exchange matters in relation to the use of a “special purpose vehicle” (“SPV”) by PRC residents to seek
offshore equity financing and conduct “round trip investment” in China. Under Circular 75, a SPV is an offshore entity established or controlled,
directly or indirectly, by PRC residents or PRC entities for the purpose of seeking offshore equity financing using assets or interests owned by such
PRC residents or PRC entities in onshore companies, while round trip investment refers to direct investment in China by the PRC residents through the
SPV, including without limitation establishing foreign invested enterprises and using such foreign invested enterprises to purchase or control (by way of
contractual arrangements) onshore assets. Circular 75 requires PRC residents and PRC entities to complete foreign exchange registration with the
local offices of SAFE for their overseas investments. In addition, any PRC resident that is the shareholder of SPV is required to amend his or her
SAFE registration with the SAFE or its competent local branch, with respect to that SPV in connection with any of its increase or decrease of capital,
transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China.
To further clarify the implementation of Circular 75, on May 31, 2007, SAFE issued an official notice known as Hi Zhong Fa [2007] No.
106 (“Circular 106”) which requires PRC subsidiaries of an offshore company governed by Circular 75 to coordinate and supervise the filing of SAFE
registrations in a timely manner by such company’s shareholders who are PRC residents. If these shareholders fail to comply, the PRC subsidiaries are
required to report to the local SAFE authorities. On June 9, 2009, Circular 106 was superseded by the Notice on Foreign Exchange Implementing
Guidelines regarding Capital Account Management (“Circular 77”) which allows establishing or controlling a SPV before the SAFE registration is
complete. Recently, a SAFE Notice on Issuance of the Operating Procedures for PRC Residents Engaging in Financing and Roundtrip
Investments via Overseas Special Purpose Vehicles (“Circular 19”) has been promulgated to simplify the SAFE registration process and will further
supersede Circular 77 and come into force on July 1, 2011. Our three founders, who are PRC residents, are in compliance with the Circular 75 and its
implementing circulars.
Dividend Distribution
The principal laws, rules and regulations governing dividends paid by our PRC affiliated entities include the Company Law of the PRC (1993),
as amended in 2005 and effective in 2006, Wholly Foreign Owned Enterprise Law (1986), as amended in 2000, and Wholly Foreign Owned
Enterprise Law Implementation Rules (1990), as amended in 2001. Under these laws and regulations, each of our consolidated PRC entities,
including wholly foreign owned enterprises, or WFOEs, and domestic companies in China may pay dividends only out of their accumulated profits, if
any, determined in accordance with PRC accounting standards and regulations. In addition, each of our consolidated PRC entities, including WFOEs
and domestic companies, is required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its statutory
surplus reserve fund until the accumulative amount of such reserve reaches 50% of its respective registered capital. These reserves are not
distributable as cash dividends. As of March 31, 2011, the accumulated balance of our statutory reserve funds reserves amounted to RMB 9.5 million
($1.3 million) and the accumulated profits of our consolidated PRC entities that were available for dividend distribution amounted to RMB 160.5 million
($23.3 million).
Taxation
Under the EIT Law, enterprises are classified as resident enterprises and non-resident enterprises. An enterprise established outside of China
with its “de facto management bodies” located within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to
a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define “de facto management bodies” as a managing
body that in practice exercises “substantial and overall management and control over the production and operations, personnel, accounting, and
properties” of the enterprise; however, it remains unclear whether the PRC tax authorities would deem our managing body as being located within
China. Due to the short history of the EIT Law and lack of applicable legal precedents, the PRC tax authorities determine the PRC tax resident
treatment of entities organized under the laws of foreign jurisdictions on a case-by-case basis.
If the PRC tax authorities determine that we and/or Renovation and/or us is a “resident enterprise” for PRC enterprise income tax purposes, a
number of PRC tax consequences could follow. First, Renovation and/or us may be subject to enterprise income tax at a rate of 25% on our respective
worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Second, although the EIT Law provides that “dividends, bonuses
and other equity investment proceeds between qualified resident enterprises” is exempted income, and the implementing rules of the EIT Law refers
“dividends, bonuses and other equity investment proceeds between qualified resident enterprises” as the investment proceeds obtained by a resident
enterprise from its direct investment in another resident enterprise, it is still unclear whether the dividends we receives indirectly from Jiuxin
Management constitute “dividend between qualified resident enterprises” and consequently be qualified for tax exemption.
If Renovation is treated as a PRC “non-resident enterprise” under the EIT Law, then dividends that Renovation receives from Jiuxin
Management (assuming such dividends were considered sourced within the PRC) (i) may be subject to a 5% PRC withholding tax, provided that
Renovation owns more than 25% of the registered capital of Jiuxin Management incessantly within 12 months immediately prior to obtaining dividend
from Jiuxin Management, and if the Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the
Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income is applicable, or (ii) if such treaty does not
apply (i.e., because the PRC tax authorities may deem Renovation to be a conduit not entitled to treaty benefits), may be subject to a 10% PRC
withholding tax. Similarly, if we are treated as a PRC “non-resident enterprise” under the EIT Law, and Renovation were treated as a PRC “resident
enterprise” under the EIT Law, then dividends that we receives from Renovation (assuming such dividends were considered sourced within the PRC)
may be subject to a 10% PRC withholding tax. Any such taxes on dividends could materially reduce the amount of dividends, if any, that we could pay
to our shareholders.
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Finally, the new “resident enterprise” classification could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our
investors that are non-resident enterprises so long as such non-resident enterprise investors do not have an establishment or place of business in China
or, despite the existence of such establishment of place of business in China, the relevant income is not effectively connected with such establishment
or place of business in China, to the extent that such dividends have their sources within the PRC. Similarly, any gain realized on the transfer of our
shares by such investors is also subject to a 10% PRC income tax if such gain is regarded as income derived from sources within China. In such event,
we may be required to withhold a 10% PRC tax on any dividends paid to its investors that are non-resident enterprises. Our investors that are non-
resident enterprises also may be responsible for paying PRC tax at a rate of 10% on any gain realized from the sale or transfer of its ordinary shares in
certain circumstances. We would not, however, has an obligation to withhold PRC tax with respect to such gain.
Moreover, the State Administration of Taxation issued “Circular 698” on December 10, 2009, that reinforces taxation on transfer of non-listed
shares by non-resident enterprises through overseas holding vehicles. Circular 698 applies retroactively and was deemed to be effective as of January
2008. Pursuant to Circular 698, where (i) a foreign investor who indirectly holds equity interest in a PRC resident enterprise through an offshore
holding company indirectly transfers equity interests in a PRC resident enterprise by selling the shares of the offshore holding company, and (ii) the
offshore holding company is located in a jurisdiction where the effective tax rate is lower than 12.5% or where the offshore income of its residents is
not taxable, the foreign investor is required to provide the tax authority in charge of that PRC resident enterprise with certain relevant information
within 30 days of the transfer. The tax authorities in charge will evaluate the offshore transaction for tax purposes. In the event that the tax authorities
determine that such transfer is abusing forms of business organization and there is no reasonable commercial purpose other than avoidance of PRC
enterprise income tax, the tax authorities will have the power to conduct a substance-over-form re-assessment of the nature of the equity transfer. A
reasonable commercial purpose may be established when the overall offshore structure is set up to comply with the requirements of supervising
authorities of international capital markets. If the State Administration of Taxation’s challenge of a transfer is successful, they will deny the existence
of the offshore holding company that is used for tax planning purposes. Since Circular 698 has a short history, there is uncertainty as to its application.
General PRC Government Approval
As a distributor and retailer of pharmaceutical products, we are subject to regulation and oversight by different levels of the food and drug
administration in China, in particular, the SFDA. The Law of the PRC on the Administration of Pharmaceutical Products, as amended, provides the
basic legal framework for the administration of the production and sale of pharmaceutical products in China and governs the manufacturing, distributing,
packaging, pricing and advertising of pharmaceutical products in China. The corresponding implementation regulations set out detailed rules with
respect to the administration of pharmaceuticals in China. We are also subject to other PRC laws and regulations that are applicable to business
operators, retailers and foreign-invested companies.
Distribution of Pharmaceutical Products
A distributor of pharmaceutical products must obtain a distribution permit from the relevant provincial- or designated municipal- or county-level
food and drug administration. The grant of such permit is subject to an inspection of the distributor’s facilities, warehouses, hygienic environment,
quality control systems, personnel and equipment. The distribution permit is valid for five years, and the holder must apply for renewal of the permit
within six months prior to its expiration. In addition, a pharmaceutical product distributor needs to obtain a business license from the relevant
administration for industry and commerce prior to commencing its business. All of our consolidated entities that engage in retail pharmaceutical
business have obtained necessary pharmaceutical distribution permits, and we do not expect any difficulties for us to renew these permits and/or
certifications.
In addition, under the Supervision and Administration Rules on Pharmaceutical Product Distribution promulgated by the SFDA on
January 31, 2007, and effective May 1, 2007, a pharmaceutical product distributor is responsible for its procurement and sales activities and is liable for
the actions of its employees or agents in connection with their conduct of distribution on behalf of the distributor. A retail distributor of pharmaceutical
products is not allowed to sell prescription pharmaceutical products, or Tier A OTC pharmaceutical products, listed in the national or provincial medical
insurance catalogs without the presence of a certified in-store pharmacist. See “Reimbursement under the National Medical Insurance Program.”
Restrictions on Foreign Ownership of Wholesale or Retail Pharmaceutical Business in China
PRC regulations on foreign investment currently permit foreign companies to establish or invest in wholly foreign-owned enterprises or joint
ventures that engage in wholesale or retail sales of pharmaceuticals in China. For retail sales, these regulations restrict the number and size of retail
pharmacy stores that a foreign investor may establish. If a foreign investor owns more than 30 stores that sell a variety of branded pharmaceutical
products sourced from different suppliers, the foreign investor’s ownership interests in the stores are limited to 49.0%.
Our WFOE, Jiuxin Management, has entered into contractual arrangements with Jiuzhou Pharmacy and our three founders.
13
Good Supply Practice Standards
GSP standards regulate wholesale and retail pharmaceutical product distributors to ensure the quality of distribution of pharmaceutical products
in China. All wholesale and retail pharmaceutical product distributors are required to apply for GSP certification within 30 days after obtaining the drug
distribution permit. The current applicable GSP standards require pharmaceutical product distributors to implement strict controls on the distribution of
medicine products, including standards regarding staff qualifications, distribution premises, warehouses, inspection equipment and facilities, management
and quality control. Specifically, the warehouse must be able to store the pharmaceutical products at various required temperatures and humidity,
handle transport, warehouse entries, delivery and billing by computerized logistics management systems. The GSP certificate is usually valid for five
years. Currently, Jiuzhou Pharmacy and Jiuxin Medicine are GSP certified. Hangzhou Quannuo and Shanghai Lydia have applied for GSP certification
and expect to be certified by December 2011. Our Quannuo Grand Pharmacy and Lydia Grand Pharmacy stores are permitted to operate without GSP
certificates while the GSP applications are being processed.
Prescription Administration
Under the Rules on Administration of Prescriptions promulgated by the SFDA, effective May 1, 2007, doctors are required to include the
chemical ingredients of the medicine they prescribe in their prescription and are not allowed to include brand names in their prescription. This regulation
is designed to provide consumers with choices among different pharmaceutical products that contain the same chemical ingredients.
Advertisement of Pharmaceutical Products
In order to prevent misleading advertising of pharmaceutical products, the State Administration for Industry and Commerce (“SAIC”) and the
SFDA jointly promulgated the Standards for Examination and Publication of Advertisements of Pharmaceutical Products and Rules for
Examination of Advertisement of Pharmaceutical Products in March 2007. Under these regulations, there are prohibitions on the advertising of
certain pharmaceutical products, and advertisement of prescription pharmaceutical products may only be made in authorized medical magazines. In
addition, an approval must be obtained from the provincial level of food and drug administration before a pharmaceutical product may be advertised.
Such approval, once obtained, is valid for one year.
Product Liability and Consumers Protection
Product liability claims may arise if the products sold have any harmful effect on the consumers. The injured party may make a claim for
damages or compensation. The General Principles of the Civil Law of the PRC, which became effective in January 1987, state that manufacturers
and sellers of defective products causing property damage or injury shall incur civil liabilities for such damage or injuries.
The Product Quality Law of the PRC was enacted in 1993 and amended in 2000 to strengthen the quality control of products and protect
consumers’ rights and interests. Under this law, manufacturers and distributors who produce or sell defective products may be subject to confiscation
of earnings from such sales, revocation of business licenses and imposition of fines, and in severe circumstances, may be subject to criminal liability.
The Law of the PRC on the Protection of the Rights and Interests of Consumers was promulgated on October 31, 1993 and became
effective on January 1, 1994 to protect consumers’ rights when they purchase or use goods or services. All business operators must comply with this
law when they manufacture or sell goods and/or provide services to customers. In extreme situations, pharmaceutical product manufacturers and
distributors may be subject to criminal liability if their goods or services lead to the death or injuries of customers or other third parties.
The Tort Law of the PRC was promulgated on December 26, 2009 and came into force on July 1, 2010. The Tort Law provides that
manufacturers and distributors who produce or sell defective products shall be responsible for the damage caused by the defective products.
Price Controls
The retail prices of some pharmaceutical products sold in China, primarily those included in the national and provincial medical insurance
catalogs and those pharmaceutical products whose production or distribution are deemed to constitute monopolies, are subject to price controls in the
form of fixed prices (for non-profit medical institutions) or price ceilings. Manufacturers or distributors cannot freely set or change the retail price for
any price-controlled product above the applicable price ceiling or deviate from the applicable fixed price imposed by the PRC government. The prices
of medicines that are not subject to price controls are determined freely at the discretion of the respective pharmaceutical companies, subject to
notification to the provincial pricing authorities.
The retail prices of medicines that are subject to price controls are administered by the Price Control Office of the National Development and
Reform Commission (“NDRC”), and implemented by provincial and regional price control authorities. The retail price, once set, also effectively
determines the wholesale price of that medicine. From time to time, the NDRC publishes and updates a list of medicines that are subject to price
control. Fixed prices and price ceilings on medicine are determined based on profit margins that the relevant government authorities deem reasonable,
the type and quality of the medicine, its production costs, the prices of substitute medicine and the extent of the manufacturer’s compliance with the
applicable Good Manufacturing Practice (“GMP”) standards. The NDRC directly regulates the pricing of a portion of the medicine on the list, and
delegates to provincial and regional price control authorities the authority to regulate the pricing of the rest of the medicine on the list. Provincial and
regional price control authorities have discretion to authorize price adjustments based on the local conditions and the level of local economic
development. There are approximately 14,784 OTC and prescription drug products that are subject to price controls. The price controls of all of those
pharmaceutical products are administered by the NDRC.
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Only the manufacturer of a medicine may apply for an increase in the retail price of the medicine, and it must either apply to the provincial price
control authorities in the province where it is incorporated, if the medicine is provincially regulated, or to the NDRC, if the medicine is NDRC regulated.
For a provincially regulated medicine, in cases where provincial price control authorities approve an application, manufacturers must file the newly
approved price with the NDRC for record and thereafter the newly approved price will become binding and enforceable across China.
Since May 1998, the PRC government has been ordering reductions in the retail prices of various pharmaceutical products. The latest price
reduction occurred in March 2011 and affected 852 different pharmaceutical products, which required us to make minimal price adjustments to 166
prescription drugs. Currently, of the total number of pharmaceutical products and OTC drugs we offered, 1,092 are subject to price controls. Price
controls, however, have had no significant impact on our operations as our price points have historically been substantially below such government-
imposed ceilings.
The NDRC may grant premium pricing status to certain pharmaceutical products that are under price control. The NDRC may set the retail
prices of pharmaceutical products that have obtained premium pricing status at a level that is significantly higher than comparable products.
Reimbursement under the National Medical Insurance Program
Eligible participants in the national medical insurance program, mainly consisting of urban residents, are entitled to purchase medicine when
presenting their medical insurance cards in an authorized pharmacy, provided that the medicine they purchase have been included in the national or
provincial medical insurance catalogs. Depending on relevant local regulations, authorized pharmacies either sell medicine on credit and obtain
reimbursement from relevant government social security bureaus on a monthly basis, or receive payments from the participants at the time of their
purchases, and the participants in turn obtain reimbursement from relevant government social security bureaus.
Medicine included in the national and provincial medical insurance catalogs is divided into two tiers. Purchases of Tier A pharmaceutical
products are generally fully reimbursable, except that certain Tier A pharmaceutical products are only reimbursable to the extent the medicine are used
for specifically stated purposes in the medical insurance catalogs. Purchasers of Tier B pharmaceutical products, which are generally more expensive
than Tier A pharmaceutical products, are required to make a certain percentage of co-payments, with the remaining amount being reimbursable. The
percentage of reimbursement for Tier B OTC pharmaceutical products varies in different regions in the PRC. Factors that affect the inclusion of
medicine in the medical insurance catalogs include whether the medicine is consumed in large volumes and commonly prescribed for clinical use in
China and whether it is considered to be important in meeting the basic healthcare needs of the general public.
The PRC Ministry of Labor and Social Security, together with other government authorities, has the power to determine every two years which
medicine are included in the national medical insurance catalog, under which of the two tiers the included medicine falls, and whether an included
medicine should be removed from the catalog. Provincial governments are required to include all Tier A medicines listed on the national Medical
Insurance Catalog in their provincial medical insurance catalogs. For Tier B medicines listed in the national medical insurance catalog, provincial
governments have the discretion to adjust upwards or downwards by no more than 15% from the number of Tier B medicine listed in the national
medical insurance catalog that is to be included in the provincial medical insurance catalogs. The amount in a participant’s individual account under the
program varies, depending on the amount of contributions from the participant and his or her employer. Generally, participants under the national
medical insurance program who are from relatively wealthier parts of China and metropolitan centers have greater amounts in their individual accounts
than those from other parts of the country. Different regions in China have different requirements regarding the caps of reimbursements in excess of
the amounts in the individual accounts.
Sales of Nutritional Supplements and other Food Products
According to the PRC Food Safety Law, which superseded the Food Hygiene Law on June 1, 2009, and the Measures for the
Administration of Food Circulation Permits and the Administrative Measures for the Licensing of Catering Services, which superseded the
Rules on Food Hygiene Certification on May 1, 2010, a distributor of nutritional supplements and other food products must obtain a food circulation
permit from local Administration of Industry and Commerce. The grant of such permit is subject to an inspection of the distributor’s facilities,
warehouses, hygienic environment, quality control systems, personnel and equipment. The food circulation permit is valid for three years, and the holder
must apply for renewal of the certificate within 30 days prior to its expiration. Currently, Jiuzhou Pharmacy, Shanghai Lydia, Hangzhou Quannuo and
each of our drugstore locations all hold a valid Food Circulation Permit. The permits of seven stores are expiring in 2011; the permits of Jiuxin
Medicine, Jiuzhou Pharmacy and twelve stores will expire in 2012. Other permits will expire in 2013 or after. We have started the renewal process for
the permits that are expiring in 2011, which we expect to complete in one to two months for each such permit. We believe that there is no difficulty in
renewing such permits.
Medical Practice
Healthcare providers in China are required to comply with many laws and regulations at the national and local government levels. The laws and
regulations applicable to our medical practice include the following:
● We must register with and maintain an operating license from the local public health authority for each clinic that we operate, and is subject
to annual review by the public health authority;
● The Licensed Physician Act requires that we only hire PRC licensed physicians;
● All waste material from our clinics must be properly collected, sterilized, deposited, transported and disposed of, and we are required to keep
records of the origin, type and amount of all waste materials that we generate for at least three years;
● We must have at least 3 physicians, 5 nurses and 1 technician on staff at each clinic; and
● We must establish and follow protocols to prevent medical malpractice, which require us to: (i) insure that patients are adequately informed
before they consent to medical operations or procedures; (ii) maintain complete medical records which are available for review by the
patient, physicians and the courts; (iii) voluntarily report any event of malpractice to a local government agency; and (iv) support and justify
the medical services we provide in any administrative investigation or litigation. If we fail to comply with applicable laws and regulations,
we could suffer penalties, including the loss of our license to operate.
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Interim Regulations on Administration of Sino-Foreign Joint Venture and Cooperative Medical Institutions
As per China’s WTO commitments, “foreign service suppliers are permitted to establish joint venture hospitals or clinics with local Chinese
partners with quantitative limitations in line with China’s needs. Foreign majority ownership is permitted.” In accordance with the Interim Regulations
on Administration of Sino-Foreign Joint Venture and Cooperative Medical Institutions jointly issued by the Ministry of Health (“MOH”) and
MOFCOM in 2000, the Chinese party of Sino-foreign joint ventures and cooperative medical institutions shall hold no less than 30% of shares and legal
rights or interest, which also mean foreign investors are allowed to hold a maximum stake of 70%. Such regulations also specify that the establishment
of Sino-foreign joint venture and cooperative medical institutions should be approved respectively by MOH and MOFCOM. In other words, foreigners
are allowed to run hospitals or clinics in the form of equity or co-operative joint ventures with an equity interest of up to 70% and a duration for co-
operation of up to 20 years.
Liquor Sale
According to the Regulations on Retail Sale of Alcohol and the Regulations on Alcohol Distribution, alcohol retailers are required to
register with the local Administration of Industry and Commerce within 60 days upon receipt of business license and to obtain a liquor license and a
food hygiene certificate to operate their facilities. Stores that sell alcoholic beverages must comply with food safety and fire safety requirements and
must not sell to minors (under age of 18). Alcohol retailers must keep records of all suppliers and such records must be maintained for at least three
years. Distributors who violate relevant regulations are subject to fines or suspension of license.
Internet Pharmacy Sale
The PRC government regulates Internet access, the distribution of online information and the conduct of online commerce through strict business
licensing requirements and other government regulations. Companies which sell pharmaceutical products to consumers through internet are required to
obtain: (1) a drug distribution permit; (2) an internet pharmaceutical information provider qualification certificate (renewable every five years); (3) an
internet pharmaceutical transaction service qualification certificate (renewable every five years); (4) a value-added telecommunication operation
permit; and (5) registration with the Administration of Information Industry. Internet pharmacies are not allowed to distribute prescription drugs. The
websites that sell pharmaceutical products must ensure transaction security and enable the consumers to consult with licensed pharmacists. Also,
internet-based business in China is required to obtain and maintain certain assets relevant to its business, such as delivery and storage facilities. Jiuzhou
Pharmacy obtained all above-mentioned certificates and registration and launched our online drugstore in May 2010. Since November 2010, Quannuo
Technology has been operating the website and providing software and technical support.
TCM Manufacturing
The SFDA has adopted a non-mandatory licensing process for manufacturers of TCM according to the Good Agricultural Practice for Chinese
Crude Drugs (“GAP”). Manufacturers who meet the government-set requirements will be granted a GAP certificate. Such requirements include size
and environment of plantation, variety of plants, source of seeds, insect control measures, etc. Manufacturers may apply for GAP certificate by
submitting required materials to the provincial office of the SFDA, which will review and forward the materials with comments to the SFDA. The
SFDA will review and submit qualified candidates to its licensing center, which will then arrange and conduct on-site examinations. Candidates who
pass the examinations will be granted a GAP certificate. The GAP certificate is renewable every five years. Since the GAP certification is not
mandatory, we have not applied for such certification in connection with our herbal plants cultivation project, and currently have no plan to do so.
Environmental Matters
Our drugstore operations do not involve any activities subject to specific PRC environmental regulations. Our medical clinics are in compliance
with applicable regulations regarding the administration of medical wastes, including collections, temperate storage, and packaging and labeling of
medical wastes. Pursuant to such regulations, we contract with Dadi Weikang Medical Wastes Disposal Center to dispose of all medical wastes
generated by our clinics.
ITEM 1A. RISK FACTORS
RISK FACTORS
You should carefully consider the risks described below together with all of the other information included in this report before making an
investment decision with regard to our securities. The statements contained in or incorporated into this report that are not historic facts are
forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth
in or implied by forward-looking statements. If any of the following risks actually occurs, our business, financial condition or results of
operations could be harmed. In that case, the trading price of our common stock could decline, and you may lose all or part of your
investment.
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Risks Relating to Our Business in General
Our relatively limited operating history makes it difficult to evaluate our future prospects and results of operations.
We have a limited operating history. Jiuzhou Pharmacy opened its first drugstore in March 2004, Jiuzhou Clinic began its first clinic in October
2003, and Jiuzhou Service commenced operation in November 2005. Accordingly, you should consider our future prospects in light of the risks and
uncertainties experienced by early stage companies in evolving industries such as the pharmaceutical industry in China. Some of these risks and
uncertainties relate to our ability to:
● maintain our market position;
● attract additional customers and increase spending per customer;
● respond to competitive market conditions;
● increase awareness of our brand and continue to develop customer loyalty;
● respond to changes in our regulatory environment;
● maintain effective control of our costs and expenses;
● raise sufficient capital to sustain and expand our business;
● attract, retain and motivate qualified personnel; and
● ability to find and open new locations.
If we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected.
We depend substantially on the continuing efforts of our executive officers, and our business and prospects may be severely disrupted if we
lose their services.
Our future success is dependent on the continued services of the key members of our management team. In particular, we depend on the
services of the three co-founders of HJ Group, Mr. Lei Lu, who is also our chief executive officer and the chairman of our board of directors, and Ms.
Li Qi and Mr. Chong’an Jin, who are also members of our board of directors. The implementation of our business strategy and our future success
depend in large part on our continued ability to attract and retain highly qualified management personnel. We face competition for personnel from other
drugstore chains, retail chains, supermarkets, convenience stores, pharmaceutical companies and other organizations. Competition for these individuals
could cause us to offer higher compensation and other benefits in order to attract and retain them, which could materially and adversely affect our
financial condition and results of operations. We may be unable to attract or retain the personnel required to achieve our business objectives and failure
to do so could severely disrupt our business and prospects. The process of hiring suitably qualified personnel is also often lengthy. In the past, we have
had two major challenges to our recruiting efforts: (1) unqualified candidates who represent themselves as being qualified, and (2) talented and
competent candidates who do not match our job requirements. If our recruitment and retention efforts are unsuccessful in the future, it may be more
difficult for us to execute our business strategy.
We do not maintain key-man insurance for members of our management team. If we lose the services of any senior management, we may not
be able to locate suitable or qualified replacements, and may incur additional expenses to recruit and train new personnel, which could severely disrupt
our business and prospects. Furthermore, as we expect to continue to expand our operations, we will need to continue attracting and retaining
experienced management. Each of our three founders has entered into a confidentiality and non-competition agreement with us regarding these
agreements. However, if any disputes arise between our founders and us, we cannot assure you, in light of uncertainties associated with the PRC legal
system, that any of these agreements could be enforced in China, where the three founders reside and hold some of their assets. See “Risks Related to
Doing Business in China — Uncertainties with respect to the PRC legal system could limit the protections available to you and us.”
We may need additional capital, and the sale of additional shares or other equity securities could result in dilution to our stockholders.
We believe that our current cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash
needs for the near future. We may, however, require additional cash resources due to changed business conditions or other future developments,
including any investments or acquisitions we may decide to pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to
sell additional equity or debt securities or obtain credit facility. The sale of additional equity securities could result in dilution to our stockholders. The
incurrence of additional indebtedness would result in increased debt service obligations and could result in further operating and financing covenants
that would further restrict our freedom to operate our business, such as conditions that:
● limit our ability to pay dividends or require us to seek consent for the payment of dividends;
● increase our vulnerability to general adverse economic and industry conditions;
● require us to dedicate a portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow
to fund capital expenditures, working capital and other general corporate purposes; and
● limit our flexibility in planning for, or reacting to, changes in our business and our industry.
We cannot guarantee that we will be able to obtain any additional financing on terms that are acceptable to us, or at all.
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We have significant cash deposits with our suppliers and landlords in order to obtain and maintain our inventory and maintain and establish
store locations, which we may not be able to recover in the event of bankruptcy by our suppliers or landlords or other events beyond our
control.
Our ability to obtain products and maintain inventory at our existing and new locations, and to maintain and establish leases for our existing and
new locations, is dependent upon our ability to post and maintain significant cash deposits with our suppliers and landlords. In China many vendors are
unwilling to extend credit terms for product sales which require cash deposits to be made, and landlords may require 12 months or longer of cash
deposit as security from tenants. At March 31, 2011, we had approximately $16,5 million on deposit with suppliers, $4.6 million as a deposit on an
inventory purchase and approximately $4.4 million as deposits with landlords for our retail locations. Were we unable or unwilling to establish such
advances and deposits our ability to generate sales and expand our business would be adversely affected. In general, we expect the amounts required
for advances and deposits to increase as we undertake our expansion plans, complete store openings and expand our business through acquisitions or
otherwise. We do not generally receive interest on any of our supplier or landlord deposits and such deposits are subject to loss as a result of the
creditworthiness or bankruptcy of the party who holds our funds, as well as the risk from illegal acts such as conversion, fraud, theft or dishonesty
associated with the third party. If these circumstances were to arise, we would find it difficult or impossible, due to the unpredictability of legal
proceedings in China, to recover all or a portion of the amount on deposit with our vendors or landlords.
Risks Relating to Our Pharmacy Operations
Our operating results are difficult to predict, and we may experience significant fluctuations in our operating results.
Our operating results may fluctuate significantly. As a result, you may not be able to rely on period to period comparisons of our operating results
as an indication of our future performance. Factors causing these fluctuations include, among others:
● our ability to maintain and increase sales to existing customers, attract new customers and satisfy our customers’ demands;
● the frequency of customer visits to our drugstores and the quantity and mix of products our customers purchase;
● the price we charge for our products or changes in our pricing strategies or the pricing strategies of our competitors;
● timing and costs of marketing and promotional programs organized by us and/or our suppliers, including the extent to which we or our
suppliers offer promotional discounts to our customers;
● our ability to acquire merchandise, manage inventory and fulfill orders;
● technical difficulties, system downtime or interruptions that may affect our product selection, procurement, pricing, distribution and retail
management processes;
● the introduction by our competitors of new products or services;
● the effects of strategic alliances, potential acquisitions and other business combinations, and our ability to successfully and timely integrate
them into our business;
● changes in government regulations with respect to pharmaceutical and retail industries; and
● current economic and geopolitical conditions in China and elsewhere.
In addition, a significant percentage of our operating expenses are fixed in the short term. As a result, a delay in generating revenue for any reason
could result in substantial operating losses.
Moreover, our business is subject to seasonal variations in demand. In particular, traditional retail seasonality affects the sales of certain
pharmaceuticals and other non-pharmaceutical products. Sales of our pharmaceutical products benefit in our fiscal third quarter (October 1st through
December 31st) from the winter cold and flu season, and are lower in our fiscal fourth quarter (January 1st through March 31st ) because Chinese
New Year falls into that quarter each year and our customers generally pay fewer visits to drugstores during this period. In addition, sales of some
health and beauty products are driven, to some extent, by seasonal purchasing patterns and seasonal product changes. Failure to manage the increased
sales effectively in the high sale season, and increases in inventory in anticipation of sales increase could have a material adverse effect on our
financial condition, results of operations and cash flow.
Many of the factors discussed above are beyond our control, making our quarterly results difficult to predict, which could cause the trading price
of our securities to decline below investor expectations. You should not rely on our operating results for prior periods as an indication of our future
results.
We may not be able to timely identify or otherwise effectively respond to changing customer preferences, and we may fail to optimize our
product offering and inventory position.
The drugstore industry in China is rapidly evolving and is subject to rapidly changing customer preferences that are difficult to predict. Our
success depends on our ability to anticipate and identify customer preferences and adapt our product selection to these preferences. In particular, we
must optimize our product selection and inventory positions based on sales trends. We cannot assure you that our product selection, especially our
selections of nutritional supplements and food products, will accurately reflect customer preferences at any given time. If we fail to anticipate
accurately either the market for our products or customers’ purchasing habits or fail to respond to customers’ changing preferences promptly and
effectively, we may not be able to adapt our product selection to customer preferences or make appropriate adjustments to our inventory positions,
which could significantly reduce our revenue and have a material adverse effect on our business, financial condition and results of operations.
Our success depends on our ability to establish effective advertising, marketing and promotional programs.
Our success depends on our ability to establish effective advertising, marketing and promotional programs, including pricing strategies
implemented in response to competitive pressures and/or to drive demand for our products. Our advertisements are designed to promote our brand, our
corporate image and the prices of products available for sale in our stores. Our pricing strategies and value proposition must be appropriate for our
target customers. If we are not able to maintain and increase the awareness of our pharmacy brand, products and services, we may not be able to
attract and retain customers and our reputation may also suffer. We expect to incur substantial expenses in our marketing and promotional efforts to
both attract and retain customers. However, our marketing and promotional activities may be less successful than we anticipate, and may not be
effective at building our brand awareness and customer base. We also cannot assure you that our current and planned spending on marketing activities
will be adequate to support our future growth. Failure to successfully execute our advertising, marketing and promotional programs may result in
material decreases in our revenue and profitability.
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If we are unable to optimize management of our distribution activities, we may be unable to meet customer demand.
Since May 2011, we have been using Jiuxin Medicine’s facility for inventory, although we continue to outsource our distribution functions to
Yingte Logistics. Our ability to meet customer demand may be significantly limited if we do not successfully and efficiently conduct our distribution
activities, or if Jiuxin Medicine’s facility is destroyed or shut down for any reason, including as the result of a natural disaster. Any disruption in the
operation of our distribution could result in higher costs or longer lead times associated with distributing our products. In addition, as it is difficult to
predict accurate sales volume in our industry, we may be unable to optimize our distribution activities, which may result in excess or insufficient
inventory, warehousing, fulfillment or distribution capacity. Furthermore, failure to effectively control product damage during distribution process could
decrease our operating margins and reduce our profitability.
Failure to maintain optimal inventory levels could increase our inventory holding costs or cause us to lose sales, either of which could have a
material adverse effect on our business, financial condition and results of operations.
We need to maintain sufficient inventory levels to operate our business successfully as well as meet our customers’ expectations. However, we
must also guard against the risk of accumulating excess inventory. We are exposed to inventory risks as a result of our increased offering of private
label products, rapid changes in product life cycles, changing consumer preferences, uncertainty of success of product launches, seasonality, and
manufacturer backorders and other vendor-related problems. We cannot assure you that we can accurately predict these trends and events and avoid
over-stocking or under-stocking products. In addition, demand for products could change significantly between the time product inventory is ordered
and the time it is available for sale.
When we begin selling a new product, it is particularly difficult to forecast product demand accurately. The purchase of certain types of
inventory may require significant lead-time. As we carry a broad selection of products and maintain significant inventory levels for a substantial portion
of our merchandise, we may be unable to sell such inventory in sufficient quantities or during the relevant selling seasons. Carrying too much inventory
would increase our inventory holding costs, and failure to have inventory in stock when a customer orders or purchases it could cause us to lose that
order or lose that customer, either of which could have a material adverse effect on our business, financial condition and results of operations.
The centralization of procurement may not help us achieve anticipated savings and may place additional burdens on the management of our
supply chain.
All of the product procurement for our drugstore chain is handled through our corporate headquarters. Such centralization of merchandise
procurement and replenishment operations is intended to reduce cost of goods sold as a result of volume purchase benefits. However, we may be less
successful than anticipated in achieving these volume purchase benefits. In addition, the centralization of merchandise procurement is expected to
increase the complexity of tracking inventory, create additional inventory handling and transportation costs and place additional burdens on the
management of our supply chain. Furthermore, we may not be successful in achieving the cost savings expected from the renegotiation of certain
supplier contracts due to the nature of the products covered by those contracts and the market position of the related suppliers. If we cannot
successfully reduce our costs through centralizing procurement, our profitability and prospects would be materially and adversely affected.
Our brand names, trade secrets and other intellectual property are valuable assets. If we are unable to protect them from infringement, our
business and prospects may be harmed.
We consider two of our pharmacy brand names, namely “Jiuzhou Grand Pharmacy” and “Lydia Grand Pharmacy”, to be valuable assets. We
may be unable to prevent third parties from using such brand names without authorization, which may adversely affect our business and reputation,
including the perceived quality and reliability of our products and services. We own one trademark and have twelve trademark applications pending.
We also own 28 websites, three of which are currently operating.
We also rely on trade secrets to protect our know-how and other proprietary information, including pricing, purchasing, promotional strategies,
customer lists and/or suppliers lists. However, trade secrets are difficult to protect. While we use reasonable efforts to protect our trade secrets, our
employees, consultants, contractors or advisors may unintentionally or willfully disclose our information to competitors. In addition, confidentiality
agreements, if any, executed by the foregoing persons may not be enforceable or provide meaningful protection for our trade secrets or other
proprietary information in the event of unauthorized use or disclosure. Our employees are required to sign an employment agreement as a condition of
employment, which contains a confidentiality provision.
If we were to enforce a claim that a third party had illegally obtained and was using our trade secrets, our enforcement efforts could be
expensive and time-consuming, and the outcome is unpredictable. In addition, if our competitors independently develop information that is equivalent to
our trade secrets or other proprietary information, it will be even more difficult for us to enforce our rights and our business and prospects could be
harmed.
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Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the intellectual
property rights of others. However, because the validity, enforceability and scope of protection of intellectual property rights in the PRC are uncertain
and still evolving, we may not be successful in prosecuting these cases. In addition, any litigation or proceeding or other efforts to protect our
intellectual property rights could result in substantial costs and diversion of our resources and could seriously harm our business and operating results.
Furthermore, the degree of future protection of our proprietary rights is uncertain and may not adequately protect our rights or permit us to gain or keep
our competitive advantage. If we are unable to protect our trade names, trade secrets and other propriety information from infringement, our business,
financial condition and results of operations may be materially and adversely affected.
We may be exposed to intellectual property infringement and other claims by third parties which, if successful, could disrupt our business
and have a material adverse effect on our financial condition and results of operations.
Our success depends, in large part, on our ability to use our proprietary information and know-how without infringing third party intellectual
property rights. As litigation becomes more common in China, we face a higher risk of being the subject of claims for intellectual property infringement,
invalidity or indemnification relating to other parties’ proprietary rights. Our current or potential competitors, many of which have substantial resources,
may have or may obtain intellectual property protection that will prevent, limit or interfere with our ability to conduct our business in China. Moreover,
the defense of intellectual property suits, including trademark infringement suits, and related legal and administrative proceedings can be both costly and
time consuming and may significantly divert the efforts and resources of our management personnel. Furthermore, an adverse determination in any
such litigation or proceedings to which we may become a party could cause us to:
● pay damage awards;
● seek licenses from third parties;
● pay ongoing royalties;
● redesign our product offerings; or
● be restricted by injunctions,
each of which could effectively prevent us from pursuing some or all of our business and result in our customers or potential customers deferring or
limiting their purchase from our stores, which could have a material adverse effect on our financial condition and results of operations.
We rely on computer software and hardware systems in managing our operations, the capacity of which may restrict our growth and the
failure of which could adversely affect our business, financial condition and results of operations.
We are dependent upon our integrated information management system to monitor daily operations of our drugstores and to maintain accurate
and up-to-date operating and financial data for compilation of management information. In addition, we rely on our computer hardware and network for
the storage, delivery and transmission of the data of our retail system. Any system failure which causes interruptions to the input, retrieval and
transmission of data or increase in the service time could disrupt our normal operation. Although we believe that our disaster recovery plan is adequate
in handling the failure of our computer software and hardware systems, we cannot assure you that we can effectively carry out this disaster recovery
plan and that we will be able to restore our operation within a sufficiently short time frame to avoid our business being disrupted. Any failure in our
computer software and/or hardware systems could have a material adverse effect on our business, financial condition and results of operations. In
addition, if the capacity of our computer software and hardware systems fails to meet the increasing needs of our expanding operations, our ability to
grow may be constrained.
As a retailer of pharmaceutical and other healthcare products, we are exposed to inherent risks relating to product liability and personal
injury claims.
Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceutical and other healthcare products, such as with respect
to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings, unintentional distribution of counterfeit drugs. Furthermore, the
applicable laws, rules and regulations require our in-store pharmacists to offer counseling, without additional charge, to our customers about medication,
dosage, delivery systems, common side effects and other information the in-store pharmacists deem significant. Our in-store pharmacists may also
have a duty to warn customers regarding any potential negative effects of a prescription drug if the warning could reduce or negate these effects and
we may be liable for claims arising from advices given by our in-store pharmacists. In addition, product liability claims may be asserted against us with
respect to any of the products we sell and as a retailer, we are required to pay for damages for any successful product liability claim against us,
although we may have the right under applicable PRC laws, rules and regulations to recover from the relevant manufacturer for compensation we paid
to our customers in connection with a product liability claim. We may also be obligated to recall affected products. If we are found liable for product
liability claims, we could be required to pay substantial monetary damages. Furthermore, even if we successfully defend ourselves against this type of
claim, we could be required to spend significant management, financial and other resources, which could disrupt our business, and our reputation as well
as our brand name may also suffer. We, like many other similar companies in China, do not carry product liability insurance. As a result, any imposition
of product liability could materially harm our business, financial condition and results of operations. In addition, we do not have any business interruption
insurance due to the limited coverage of any business interruption insurance in China, and as a result, any business disruption or natural disaster could
severely disrupt our business and operations and significantly decrease our revenue and profitability.
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Future acquisitions are expected to be a part of our growth strategy, and could expose us to significant business risks.
One of our strategies is to grow our business through acquisition. However, we cannot assure you that we will be able to identify and secure
suitable acquisition opportunities. Our ability to consummate and integrate effectively any future acquisitions on terms that are favorable to us may be
limited by the number of attractive acquisition targets, internal demands on our resources and, to the extent necessary, our ability to obtain financing on
satisfactory terms for larger acquisitions, if at all. Moreover, if an acquisition target is identified, the third parties with whom we seek to cooperate may
not select us as a potential partner or we may not be able to enter into arrangements on commercially reasonable terms or at all. The negotiation and
completion of potential acquisitions, whether or not ultimately consummated, could also require significant diversion of management’s time and
resources and potential disruption of our existing business. Furthermore, we cannot assure you that the expected synergies from future acquisitions will
actually materialize. In addition, future acquisitions could result in the incurrence of additional indebtedness, costs, and contingent liabilities. Future
acquisitions may also expose us to potential risks, including risks associated with:
● the integration of new operations, services and personnel;
● unforeseen or hidden liabilities;
● the diversion of financial or other resources from our existing businesses;
● our inability to generate sufficient revenue to recover costs and expenses of the acquisitions; and
● potential loss of, or harm to, relationships with employees or customers.
Any of the above could significantly disrupt our ability to manage our business and materially and adversely affect our business, financial condition and
results of operations.
We may not be able to manage our expansion of operations effectively and failure to do so could strain our management, operational and
other resources, which could materially and adversely affect our business and growth potential.
We anticipate continued expansion of our business to address growth in demand for our products and services, as well as to capture new market
opportunities. The continued growth of our business has resulted in, and will continue to result in, substantial demands on our management, operational
and other resources. In particular, the management of our growth will require, among other things:
● our ability to continue to identify and lease new store locations at acceptable prices;
● our ability to optimize product offerings and increase sales of private label products;
● our ability to control procurement cost and optimize product pricing;
● our ability to control operating expenses and achieve a high level of efficiency, including, in particular, our ability to manage the amount of
time required to open new stores and for stores to become profitable, to maintain sufficient inventory levels and to manage warehousing,
buying and distribution costs;
● information technology system enhancement;
● strengthening of financial and management controls;
● increased marketing, sales and sales support activities; and
● hiring and training of new personnel.
If we are not able to manage our growth successfully, our business and prospects would be materially and adversely affected.
We depend on the continued service of, and on the ability to attract, motivate and retain a sufficient number of qualified and skilled staff,
especially in-store pharmacists, for our stores.
Our ability to continue expanding our retail drugstore chain and deliver high quality products and customer service depends on our ability to
attract and retain qualified and skilled staff, especially in-store pharmacists. In particular, the applicable PRC regulations require at least one qualified
pharmacist to be stationed in every drugstore to instruct or advise customers on prescription drugs. Over the years, a significant shortage of
pharmacists has developed due to increasing demand within the drugstore industry as well as demand from other businesses in the healthcare industry.
We cannot assure you that we will be able to attract, hire and retain sufficient numbers of skilled personnel and in-store pharmacists necessary to
continue to develop and grow our business. In the past, our major recruiting challenges included unqualified candidates who represent themselves as
being qualified, and talented and competent candidates who do not match our job requirements. The inability to attract and retain a sufficient number of
skilled personnel and in-store pharmacists could limit our ability to open additional stores, increase revenue or deliver high quality customer service. In
addition, competition for these individuals could cause us to offer higher compensation and other benefits in order to attract and retain them, which
could materially and adversely affect our financial condition and results of operations.
We face significant competition, and if we do not compete successfully against existing and new competitors, our revenue and profitability
would be materially and adversely affected.
The drugstore industry in China is highly competitive, and we expect competition to intensify in the future. Our primary competitors include other
drugstore chains and independent drugstores. We also increasingly face competition from discount stores, convenience stores and supermarkets as we
increase our offering of non-drug convenience products and services. We compete for customers and revenue primarily on the basis of store location,
merchandise selection, price, services that we offer and our brand name. We believe that the continued consolidation of the drugstore industry and
continued new store openings by chain store operators will further increase competitive pressures in the industry. In addition, we may be subject to
additional competition from new entrants to the drugstore industry in China. If the PRC government removes the barriers for the foreign companies to
operate majority-owned retail drugstore business in China, we could face increased competition from foreign companies. Some of our larger
competitors may enjoy competitive advantages, such as:
● greater financial and other resources;
● larger variety of products;
● more extensive and advanced supply chain management systems;
● greater pricing flexibility;
● larger economies of scale and purchasing power;
● more extensive advertising and marketing efforts;
● greater knowledge of local market conditions;
● stronger brand recognition; and
● larger sales and distribution networks.
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As a result, we may be unable to offer products similar to, or more desirable than, those offered by our competitors, market our products as effectively
as our competitors or otherwise respond successfully to competitive pressures. In addition, our competitors may be able to offer larger discounts on
competing products, and we may not be able to profitably match those discounts. Furthermore, our competitors may offer products that are more
attractive to our customers or that render our products uncompetitive. In addition, the timing of the introduction of competing products into the market
could affect the market acceptance and market share of our products. Our failure to compete successfully could materially and adversely affect our
business, financial condition, results of operation and prospects.
Changes in economic conditions and consumer confidence in China may influence the retail industry, consumer preferences and spending
patterns.
Our business and revenue growth primarily depend on the size of the retail market of pharmaceutical products in China. As a result, our revenue
and profitability may be negatively affected by changes in national, regional or local economic conditions and consumer confidence in China. In
particular, as we focus our expansion of retail stores in metropolitan markets, where living standards and consumer purchasing power are relatively
high, we are especially susceptible to changes in economic conditions, consumer confidence and customer preferences of the urban Chinese population.
External factors beyond our control that affect consumer confidence include unemployment rates, levels of personal disposable income, national,
regional or local economic conditions and acts of war or terrorism. Changes in economic conditions and consumer confidence could adversely affect
consumer preferences, purchasing power and spending patterns. In addition, acts of war or terrorism may cause damage to our facilities, disrupt the
supply of the products and services we offer in our stores or adversely impact consumer demand. Any of these factors could have a material adverse
effect on our business, financial condition and results of operations.
The retail prices of some of our products are subject to control, including periodic downward adjustment, by PRC governmental authorities.
An increasing percentage of our pharmaceutical products, primarily those included in the national and provincial medical insurance catalogs, are
subject to price controls in the form of fixed retail prices or retail price ceilings. See “Relevant PRC Regulations — Price Controls” below. In addition,
the retail prices of these products are also subject to periodic downward adjustments as the PRC governmental authorities seek to make
pharmaceutical products more affordable to the general public. Since May 1998, the relevant PRC governmental authorities have ordered price
reductions of thousands of pharmaceutical products. The latest price reduction occurred in March 2011 and affected 852 different prescription
pharmaceutical products. Currently, 1,092 of the prescription and OTC drugs that we offer are subject to price controls. As we generally price our
product substantially below the price ceilings, only 166 of our prescription drug prices required adjustment, the impact of which was negligible. Any
future price controls or government mandated price reductions, however, may have a material adverse affect on our financial condition and results of
operations, including significantly reducing our revenue and profitability.
Our retail operations require a number of permits and licenses in order to carry on their business.
Drugstores in China are required to obtain certain permits and licenses from various PRC governmental authorities, including Drug Distribution
Permit and GSP certification. We are also required to obtain food hygiene certificates for the distribution of nutritional supplements and food products.
We cannot assure you that we can maintain all required licenses, permits and certifications to carry on our business at all times, and from time to time
we may have not been in compliance with all such required licenses, permits and certifications. Moreover, these licenses, permits and certifications are
subject to periodic renewal and/or reassessment by the relevant PRC governmental authorities and the standards of such renewal or reassessment may
change from time to time. We intend to apply for the renewal of these licenses, permits and certifications when required by applicable laws and
regulations. Any failure by us to obtain and maintain all licenses, permits and certifications necessary to carry on our business at any time could have a
material adverse effect on our business, financial condition and results of operations. In addition, any inability to renew these licenses, permits and
certifications could severely disrupt our business, and prevent us from continuing to carry on our business. Any changes in the standards used by
governmental authorities in considering whether to renew or reassess our business licenses, permits and certifications, as well as any enactment of new
regulations that may restrict the conduct of our business, may also decrease our revenue and/or increase our costs and materially reduce our
profitability and prospects. Furthermore, if the interpretation or implementation of existing laws and regulations changes or if new regulations come into
effect requiring us to obtain any additional licenses, permits or certifications that were previously not required to operate our existing businesses, we
cannot assure you that we may successfully obtain such licenses, permits or certifications.
The continued penetration of counterfeit products into the retail market in China may damage our brand and reputation and have a material
adverse effect on our business, financial condition, results of operations and prospects.
There has been continued penetration of counterfeit products into the pharmaceutical retail market in China. Counterfeit products are generally
sold at lower prices than the authentic products due to their low production costs, and in some cases are very similar in appearance to the authentic
products. Counterfeit pharmaceuticals may or may not have the same chemical content as their authentic counterparts, and are typically manufactured
without proper licenses or approvals as well as fraudulently mislabeled with respect to their content and/or manufacturer. Although the PRC
government has been increasingly active in combating counterfeit pharmaceutical and other products, there is not yet an effective counterfeit
pharmaceutical product regulation control and enforcement system in China. Although we have implemented a series of quality control procedures in
our procurement process, we cannot assure you that we would not be selling counterfeit pharmaceutical products inadvertently. Any unintentional sale
of counterfeit products may subject us to negative publicity, fines and other administrative penalties or even result in litigation against us. Moreover, the
continued proliferation of counterfeit products and other products in recent years may reinforce the negative image of retailers among consumers in
China. The continued proliferation of counterfeit products in China could have a material adverse effect on our business, financial condition, and results
of operation.
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We may be subject to fines and penalties if we fail to comply with the applicable PRC laws and regulations governing sales of medicines
under the PRC National Medical Insurance Program.
Eligible participants in the PRC national medical insurance program, mainly consisting of urban residents in China, are entitled to buy medicines
using their medical insurance cards in an authorized pharmacy, provided that the medicines they purchase have been included in the national or
provincial medical insurance catalogs. The pharmacy, in turn, obtains reimbursement from the relevant government social security bureaus. Moreover,
the applicable PRC laws, rules and regulations prohibit pharmacies from selling goods other than pre-approved medicines when purchases are made
with medical insurance cards. We have established procedures to prohibit our drugstores from selling unauthorized goods to customers who make
purchases with medical insurance cards. However, we cannot assure you that those procedures will be strictly followed by all of our employees in all
of our stores.
The alcohol distribution industry is highly competitive.
The alcoholic distribution industry in our region is intensely competitive. The principal competitive factors in the industry include product range,
pricing, distribution capabilities and responsiveness to consumer preferences, with varying emphasis on these factors depending on the market and the
product. We face significant competition from various regional distributors and wholesalers, who compete principally on price.
Our alcohol sales are linked to economic conditions and shifts in consumer preferences, including a reduction in the consumption of alcohol.
Our alcohol sales are affected by the overall economic trends in the PRC, the level of consumer spending, the rate of taxes levied on alcohol and
consumer confidence in future economic conditions. During a period of economic slowdown, reduced consumer confidence and spending may result in
reduced demand for our alcohol and limitations on our ability to increase prices and finance marketing and promotional activities.
Our sales of alcohol are subject to extensive government regulation.
Distribution of alcohol in the PRC is subject to regulation by national and local governmental agencies. These regulations and laws address such
matters as licensing and permit requirements, competition, trade and pricing practices, taxes, distribution methods and relationships, required labeling
and packaging, advertising, sales promotion and relations with wholesalers and retailers.
Risks Relating to Our Medical Services
If we do not attract and retain qualified physicians and other medical personnel, our ability to provide medical services would be adversely
affected.
The success of our medical services will be, in part, dependent upon the number and quality of doctors, nurses and other medical support
personnel that we employ and our ability to maintain good relations with them. Our medical staff may terminate their employment with us at any time.
If we are unable to successfully maintain good relationships with them, our ability to provide medical services may be adversely affected.
The provision of medical services is heavily regulated in the PRC and failure to comply with those regulations could result in penalties, loss of
licensure, additional compliance costs or other adverse consequences.
Healthcare providers in China, as in most other populous countries, are required to comply with many laws and regulations at the national and
local government levels. These laws and regulations relate to: licensing; the conduct of operations; the ownership of facilities; the addition of facilities
and services; advertising; confidentiality, maintenance and security issues associated with medical records; billing for services; and prices for services.
If we fail to comply with applicable laws and regulations, we could suffer penalties, including the loss of our licenses to operate. In addition, further
healthcare legislative reform is likely, and could materially adversely affect our business and results of operations in the event we do not comply or if
the cost of compliance is expensive. The above list of certain regulated areas is not exhaustive and it is not possible to anticipate the exact nature of
future healthcare legislative reform in China. Depending on the priorities determined by the Chinese Ministry of Health, the political climate at any
given time, the continued development of the Chinese healthcare system and many other factors, future legislative reforms may be highly diverse,
including stringent infection control policies, improved rural healthcare facilities, increased regulation of the distribution of pharmaceuticals and
numerous other policy matters. Consequently, the implications of these future reforms could result in penalties, loss of licensure, additional compliance
costs or other adverse consequences.
As a provider of medical services, we are exposed to inherent risks relating to malpractice claims.
As a provider of medical services, any misdiagnosis or improper treatment may result in adverse publicity regarding us, which would harm our
reputation. If we are found liable for malpractice claims, we could be required to pay substantial monetary damages. Furthermore, even if we
successfully defend ourselves against this type of claim, we could be required to spend significant management, financial and other resources, which
could disrupt our business, and our reputation as well as our brand name may also suffer. Because malpractice claims are not common in China, we do
not carry malpractice insurance. As a result, any imposition of malpractice liability could materially harm our business, financial condition and results of
operations.
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We face competition that could adversely affect our results of operations.
Our clinics compete with a large number and variety of healthcare facilities in their respective markets. There are numerous government-run
and private hospitals and clinics available to the general populace. There can be no assurance that these or other clinics, hospitals or other facilities will
not commence or expand such operations, which would increase their competitive position. Further, there can be no assurance that a healthcare
organization, having greater resources in the provision or management of healthcare services, will not decide to engage in operations similar to those
being conducted by us in Hangzhou.
Risks Related to the Cultivation of Herbal Plants Used for TCM
We intend to distribute herbal plants being cultivated on our leased land, from which we may not be able to generate significant revenue, if
any.
At the present, more than ten herbal plants are being cultivated on land that we are leasing in Lin’an, Zhejiang Province, including fructus rubi
(used in TCM to promote blood circulation), white atractylodes rhizome (used in TCM to treat physical and mental fatigue) and atractylodes
macrocephala (used in TCM to control sweating), which we intend to sell as packaged herbs at our pharmacies and in bulk to third parties after they
are harvested and processed. While we have already devoted considerable resources, there is no assurance that we will ultimately be able to generate
significant revenue, it at all, from such endeavor.
Any revenue that we may derive from our cultivation project, if any, is affected by the volatility of prices for TCM raw herbs.
The herbal plants that are being cultivated and that we are planning to distribute are priced based on market prices primarily determined by TCM
manufacturers and TCM trading companies in local markets. Such market prices have increased significantly in recent years in response to changes in
the supply of and demand for raw herbs for TCM, market uncertainty and a variety of additional factors that are beyond our control, including inflation,
changes of weather, outbreak of disease, domestic government regulation, market speculation and overall economic conditions. We do not and will not
have control over the factors affecting prices for the plants that we are planning to distribute in the areas in which we intend to distribute them. There
can be no assurance that market prices, which historically have fluctuated widely, will continue to increase or remain stable and any future declines in
prices will reduce any revenue, if any, that we may derive from our cultivation project.
Unforeseen and severe weather can reduce cultivation activity and lead to a decrease in anticipated harvest of the plants that are being
cultivated on our leased land.
The climatic and seasonal factors such as weather conditions, level of rainfall and temperature may, among other things, affect the quality,
overall supply and availability of raw herbs for TCM, including the plants that are being cultivated on our leased land. Sustained adverse weather
conditions in Zhejiang Province in general and in Lin’an in particular where our cultivation site is located, such as rain, extreme cold or snow could
disrupt or curtail cultivation and harvesting activities which in turn could reduce our anticipated harvest yields, delay the timing of our anticipated
harvest and distribution, and negatively affect the quality of our harvest. In addition, natural disasters such as fires, earthquakes, snowstorms, extreme
climatic or weather conditions such as floods or droughts, or natural conditions such as crop disease, pests or soil erosion, may negatively impact the
cultivation and harvest of the plants that are being cultivated on our leased land. The occurrence of any of these may reduce the amount of revenue, if
any, that we may derive from our cultivation project.
In addition, the actual climatic conditions in Zhejiang Province and in Lin’an may not conform to historical patterns and may be affected by
variations in weather patterns, including any potential impact of climate change. The effects of climate change may produce more variable or severe
weather events that can adversely affect our ability to cultivate and harvest successfully. Each of these events could increase the cost of our
cultivation project beyond our anticipation, which in turn could affect our overall profitability.
Should the plants that are being cultivated on our leased land become contaminated or deteriorate once we commence distribution, and we
may be exposed to negative publicity about product safety which could have a negative impact on our financial condition.
The contamination or deterioration of the plants that are being cultivated on our leased land and that we are planning to distribute could harm our
reputation and business. Once we are able to commence distribution, any such contamination or deterioration could result in their recall and criminal or
civil liability, and restrict our ability for further distribution, thereby reducing the potential returns, if any, on the resources and efforts that we have
invested into our cultivation project. Any resulting negative publicity could also drive consumers away from our pharmacies, which would have a
material and adverse effect on our business, financial condition and results of operations.
We may also be affected by factors such as negative publicity resulting from the publication of industry findings, research reports or health
concerns concerning the safety of TCM products produced in China or the plants that are being cultivated on our leased land in particular. Such
complaints and negative publicity may lead to a loss of consumer confidence and a reduction in the demand for TCM or the plants that we plan to
distribute.
We have limited control over the availability and the quality of the local farmers with whom we intend cooperate because we do not anticipate
employing them directly.
We plan to hire local farmers to harvest the plants currently being cultivated on our leased land. We do not anticipate employing these farmers
directly. Instead, the farmers will be recruited and employed by the local villagers’ committees that we will enter into agreements with. We have
limited control over the availability and the quality of this labor. A shortage of suitable laborers may adversely affect our harvest yields.
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Risks Related to Our Online Drugstore Business
We rely on computer software and hardware systems in managing our online drugstore, the capacity of which may restrict our growth and
the failure of which could adversely affect our business, financial condition and results of operations.
We are dependent upon our electronic commerce system to carry out our online pharmaceutical sales. Any system failure which causes
interruptions to the input, retrieval and transmission of data or increases in service time could disrupt our normal operation. Although we believe we
have a disaster recovery plan, which can handle the failure of our computer software and hardware systems, we cannot assure you that we can
effectively carry out this disaster recovery plan and that we will be able to restore our operation within a sufficiently short time frame to avoid
disruption to our business. Any failure in our computer software and/or hardware systems could have a material adverse effect on our business,
financial condition and results of operations. In addition, if the capacity of our computer software and hardware systems fails to meet the increasing
needs of our operations, our ability to grow may be constrained.
We only recently introduced our online drugstore business and, as a result, it may be difficult to evaluate its performance and prospects.
In April 2010, we were granted an Internet Pharmaceutical Transaction Service Qualification Certificate by the State Food and Drug
Administration of Zhejiang Province, which allows us to engage in online retail pharmaceutical sales throughout China. In May 2010, we launched
www.dada360.com to sell OTC drugs and nutritional supplements online. In July 2010, we established Shouantang Technology as a wholly-owned
subsidiary to carry out the internet pharmacy business, and acquired Quannuo Technology in November 2010 to operate the website and provide
software and technical support. Our ability to generate a profit from online sales remains unproven. Our online business strategy has not been tested
over time and we cannot be certain that we will be able to successfully manage or grow our online business. We may incur significant costs as we
continue to implement and improve our website. Given the limited operating history of our online business, it may be difficult for you to evaluate its
performance and prospects.
Uncertainties regarding the growth and sustained profitability of e-commerce in China could adversely affect our online business prospects.
While e-commerce has existed in China since the 1990s, only recently have certain e-commerce companies in China become profitable. Thus,
the long-term viability and prospects of various e-commerce business models, and e-commerce generally, in China remain relatively untested. Our
future operating results from our online drugstore business will depend on numerous factors affecting the development of e-commerce in China, which
may be beyond our control. These factors include:
● the growth of personal computer, Internet and broadband usage and penetration in China, and the rate of any such growth;
● the trust and confidence level of consumers in online shopping in China, as well as changes in customer demographics and consumers’
tastes and preferences;
● the selection, price and popularity of products that we and our competitors offer on websites;
● whether alternative retail channels or business models that better address the needs of consumers emerge in China;
● the development of fulfillment, payment and other ancillary services associated with online purchases; and
● general economic conditions, particularly economic conditions affecting discretionary consumer spending.
A decline in the popularity of shopping on the Internet in general, or failure by us to adapt our website and improve the online shopping experience of
our customers in response to trends and consumer needs, may adversely affect our online business prospects.
If our online drugstore business fails to obtain and maintain the requisite assets, licenses, qualified personnel and approvals required under
the complex regulatory environment for internet-based businesses in China, the business prospects for such business may be materially and
adversely affected.
Internet-based businesses in China are highly regulated by the PRC government and numerous PRC regulatory authorities are empowered to
issue and implement regulations governing various aspects of these businesses. Our online drugstore business is operated by our PRC subsidiary,
Quannuo Technology, which is required to obtain and maintain certain assets relevant to its business, such as computers and other electrical equipment,
as well as applicable licenses or approvals from different regulatory authorities. These assets and licenses are essential to the operation of an e-
commerce business and are generally subject to annual review by the relevant governmental authorities. Furthermore, we may be required to obtain
additional licenses. If we fail to obtain or maintain any of the required assets, licenses or approvals, our internet business may be deemed illegal and it
may be subject to various penalties, such as confiscation of illegal income, fines and the discontinuation or restriction of its operations. Any such
disruption may materially and adversely affect our online business prospects.
Risks Related to Our Corporate Structure
Chinese regulations limit foreign ownership of Chinese pharmacy chain operating 30 or more stores and limit foreign ownership of Chinese
medical clinics to Sino-foreign joint venture. Our “Jiuzhou Grand Pharmacy” and “Lydia Grand Pharmacy” stores are operated by Jiuzhou
Pharmacy and its subsidiary Shanghai Lydia, and our clinics are operated by Jiuzhou Clinic and Jiuzhou Service, all of which we control by
means of contractual arrangements. The validity of such contractual arrangements is uncertain. If the Chinese government determines that
these contractual arrangements do not comply with applicable regulations, our business could be adversely affected. If the PRC regulatory
bodies determine that such contractual arrangements do not comply with PRC regulatory restrictions on foreign investment in drugstore and
medical practice or in our business generally, we could be subject to severe penalties. In addition, changes in such Chinese laws and
regulations may materially and adversely affect our business.
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Current PRC regulations limit any foreign investor’s ownership in a drugstore operator to 49.0% if such operator owns interests in more than 30
drugstores in China that sell a variety of branded pharmaceutical products sourced from different suppliers. Since we do not own any equity interests in
Jiuzhou Pharmacy (or its subsidiary Shanghai Lydia), but controls it through contractual arrangements with our wholly foreign owned enterprise
(“WFOE”), Jiuxin Management, we have been advised by our PRC counsel, Allbright Law Offices (“Allbright”), that the regulations on foreign
ownership of drugstores do not apply to us even if Jiuzhou Pharmacy or Shanghai Lydia expands beyond 30 stores. Similarly, foreign ownership of
medical practice in China is limited to means of Sino-foreign joint venture. Since we do not have actual equity interest in Jiuzhou Clinic or Jiuzhou
Service, but control these entities through contractual arrangements, Allbright has advised us that the PRC regulations restricting foreign ownership of
medical practice are not applicable to us or our structure.
There are, however, uncertainties regarding the interpretation and application of PRC laws, rules and regulations, including but not limited to the
laws, rules and regulations governing the validity and enforcement of our contractual arrangements. Although we have been advised by Allbright, that
based on their understanding of the current PRC laws, rules and regulations, the structure for operating our business in China (including our corporate
structure and contractual arrangements with Jiuzhou Pharmacy, Jiuzhou Clinic, Jiuzhou Service and our three founders) comply with all applicable PRC
laws, rules and regulations, and do not violate, breach, contravene or otherwise conflict with any applicable PRC laws, rules or regulations, we cannot
assure you that the PRC regulatory authorities will not determine that our corporate structure and contractual arrangements violate PRC laws, rules or
regulations. If the PRC regulatory authorities determine that our contractual arrangements are in violation of applicable PRC laws, rules or regulations,
our contractual arrangements will become invalid or unenforceable, and we may not be able to consolidate the operations of HJ Group with our results
of operations. In addition, new PRC laws, rules and regulations may be introduced from time to time to impose additional requirements that may be
applicable to our contractual arrangements. For example, pursuant to the PRC Property Rights Law that became effective on October 1, 2007, the
pledge of any equity interests of a PRC private entity shall become effective once it is duly registered with the local branches of the State
Administration for Industry and Commerce (“SAIC”). Following the promulgation of the Property Law, SAIC further issued the Administrative
Measures for Registrations of Share Pledge on September 1, 2008, which provided detailed procedural guidance for the local SAIC offices to handle
the registrations of share pledge. The Equity Pledge Agreements entered by Jiuxin Management with Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou
Service as part of the contractual arrangements have created a legally binding obligation on the parties upon the execution date; however, the pledge
established under these agreements does not become effective until due registration with local SAIC office. On May 18, 2010, registration of the
pledged equity interests in Jiuzhou Pharmacy was completed.
The Chinese government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and
other licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental
bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new Chinese laws or
regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found in violation of any current
or future Chinese laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations
or cease to provide certain services. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a
substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations.
If we are determined to be in violation of any existing or future PRC laws, rules or regulations or fail to obtain or maintain any of the required
governmental permits or approvals, the relevant PRC regulatory authorities would have broad discretion in dealing with such violations, including:
● revoking the business and operating licenses of our PRC consolidated entities;
● discontinuing or restricting the operations of our PRC consolidated entities;
● imposing conditions or requirements with which we or our PRC consolidated entities may not be able to comply;
● requiring us or our PRC consolidated entities to restructure the relevant ownership structure or operations;
● restricting or prohibiting our use of the proceeds from our initial public offering to finance our business and operations in China; or
● imposing fines.
The imposition of any of these penalties would severely disrupt our ability to conduct business and have a material adverse effect on our financial
condition, results of operations and prospects.
We may be adversely affected by complexity, uncertainties and changes in Chinese regulation of drugstores and the practice of medicine.
The Chinese government regulates drugstores and the practice of medicine including foreign ownership, and the licensing and permit
requirements. These laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. As a
result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be a violation of applicable laws and
regulations. Issues, risks and uncertainties relating to Chinese government regulation of the industry include the following:
● we only have contractual control over HJ Group. We do not own them due to the restriction of foreign investment in pharmacy chains with
30 or more drugstores and foreign ownership of medical practice; and
● uncertainties relating to the regulation of drugstores and medical practice in China, including evolving licensing practices, means that permits,
licenses or operations at our company may be subject to challenge. This may disrupt our business, or subject us to sanctions, requirements to
increase capital or other conditions or enforcement, or compromise enforceability of related contractual arrangements, or have other
harmful effects on us.
The interpretation and application of existing Chinese laws, regulations and policies and possible new laws, regulations or policies have created
substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, pharmaceutical
businesses in China, including our business.
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Our contractual arrangements with Jiuzhou Pharmacy, Jiuzhou Clinic, Jiuzhou Service and their respective owners may not be as effective
in providing control over these entities as direct ownership.
We have no equity ownership interest in HJ Group, and rely on contractual arrangements to control and operate the HJ Group companies and
their businesses. These contractual arrangements may not be as effective in providing control over these companies as direct ownership. For example,
Jiuzhou Pharmacy, Jiuzhou Clinic or Jiuzhou Service could fail to take actions required for our business despite its contractual obligation to do so. If
Jiuzhou Pharmacy, Jiuzhou Clinic or Jiuzhou Service fails to perform under its agreements with us, we may have to rely on legal remedies under
Chinese law, which may not be effective. In addition, we cannot assure you that our three founders will act in our best interests.
Because we rely on contractual arrangements to control HJ Group and for our revenue, the termination of such agreements will severely and
detrimentally affect our continuing business viability under our current corporate structure.
We are a holding company and do not have any assets or conduct any business operations other than the contractual arrangements between
Jiuxin Management, our WFOE, and each of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service. All of our business operations are conducted by,
and we derive all of our revenues from, HJ Group. Because neither we nor Jiuxin Management own equity interests of HJ Group, the termination of
the contractual arrangements would sever our ability to continue receiving payments from Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service under
our current holding company structure.
As we do not have any equity interests in any of the HJ Group companies, in the event the contractual arrangements terminate, we will lose our
control over them and their business operations, as well as our sole source of revenues. Should this occur, we may seek to acquire control of HJ Group
through other means, although we cannot guarantee that we will do so, nor can we guarantee that we will be successful if we do.
We cannot assure you that there will not be any event or reason that may cause the contractual arrangements to terminate. In the event that the
contractual arrangements are terminated for any reason, this may have a severe and detrimental effect on our continuing business viability under our
current corporate structure, which in turn may affect the value of your investment.
We rely principally on dividends paid by our consolidated operating entities to fund any cash and financing requirements we may have, and
any limitation on the ability of our consolidated PRC entities to pay dividends to us could have a material adverse effect on our ability to
conduct our business.
We are a holding company, and rely principally on dividends paid by our consolidated PRC operating entities for cash requirements, including the
funds necessary to service any debt we may incur, which are passed on to us through Jiuxin Management. If any of the consolidated operating entities
incurs debt in its own name in the future, the instruments governing the debt may restrict dividends or other distributions on its equity interest to us. In
addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements in a manner that would materially and
adversely affect our ability to pay dividends and other distributions on our equity interest.
Furthermore, applicable PRC laws, rules and regulations permit payment of dividends by our consolidated PRC entities only out of their retained
earnings, if any, determined in accordance with PRC accounting standards. Under PRC laws, rules and regulations, our consolidated PRC entities are
required to set aside at least 10.0% of their after-tax profit based on PRC accounting standards each year to their statutory surplus reserve fund until
the accumulative amount of such reserves reach 50.0% of their respective registered capital. As a result, our consolidated PRC entities are restricted
in their ability to transfer a portion of their net income to us whether in the form of dividends, loans or advances. As of March 31, 2011, our restricted
reserves totaled RMB 9,460,695 ($1,309,109) and we had unrestricted retained earnings of RMB 160,505,337 ($23,287,474). Our restricted reserves
are not distributable as cash dividends. Any limitation on the ability of our consolidated operating entities to pay dividends to us could materially and
adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and
conduct our business.
Management members of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service have potential conflicts of interest with us, which may
adversely affect our business and your ability for recourse.
Mr. Lei Liu, our chairman and chief executive officer, is also the executive director of Jiuzhou Pharmacy, a general partner of Jiuzhou Clinic,
and the supervising director of Jiuzhou Service. Mr. Chong’an Jin, one of our directors, is the supervising director of Jiuzhou Pharmacy, the managing
general partner of Jiuzhou Clinic, and the executive director of Jiuzhou Service. Ms. Li Qi, our corporate secretary and also a member of the board of
directors, is the general manager of each of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service and a general partner of Jiuzhou Clinic. Conflicts of
interests between their respective duties to our company and HJ Group may arise. As our directors and executive officer (in the case of Mr. Liu), they
have a duty of loyalty and care to us under U.S. and Hong Kong law when there are any potential conflicts of interests between our company and HJ
Group. We cannot assure you, however, that when conflicts of interest arise, every one of them will act completely in our interests or that conflicts of
interests will be resolved in our favor. For example, they may determine that it is in HJ Group’s interests to sever the contractual arrangements with
Jiuxin Management, irrespective of the effect such action may have on us. In addition, any one of them could violate his or her legal duties by diverting
business opportunities from us to others, thereby affecting the amount of payment that Jiuzhou Pharmacy, Jiuzhou Clinic or Jiuzhou Service is obligated
to remit to us under the consulting services agreement.
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In the event that you believe that your rights have been infringed under the securities laws or otherwise as a result of any one of the
circumstances described above, it may be difficult or impossible for you to bring an action against HJ Group or our officers or directors who are
members of HJ Group’s management, all of whom reside within China. Even if you are successful in bringing an action, the laws of China may render
you unable to enforce a judgment against the assets of the HJ Group companies and their respective management, all of which are located in China.
Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service are subject to restrictions on making payments to us.
Risks Related to Doing Business in China
As a result of our holding company structure, we rely primarily on payments from Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service under
their contractual arrangements with our WFOE, Jiuxin Management, as well as dividends from our PRC subsidiaries, for our revenue. The Chinese
government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China. We may
experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency. See “Government control of
currency conversion may affect the value of your investment.” Furthermore, if our affiliated entity in China incurs debt on their own in the future, the
instruments governing the debt may restrict their ability to make payments. If we are unable to receive all of the revenues from our operations through
these contractual arrangements, we may be unable to pay dividends on our ordinary shares.
Uncertainties with respect to the Chinese legal system could adversely affect us.
We conduct our business through our subsidiaries and controlled companies in the PRC. Our operations in China are governed by Chinese laws
and regulations. We are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly
foreign-owned enterprises. The Chinese legal system is based on written statutes. Prior court decisions may be cited for reference but have limited
precedential value.
Since 1979, Chinese legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in
China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all
aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of
published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the
Chinese legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may
have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition,
any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based
on United States or other foreign laws against us or our management.
We are a holding company and conduct our business through our subsidiaries and controlled companies in the PRC.. In addition, all of our
operating assets are located in, and all of our other senior executive officers (excepting our chief financial officer) reside within, China. As a result, it
may not be possible to effect service of process within the United States or elsewhere outside China upon our senior executive officers and directors
not residing in the United States, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws.
Moreover, our Chinese counsel has advised us that China does not have treaties with the United States or many other countries providing for the
reciprocal recognition and enforcement of judgment of courts. As a result, our public shareholders may have substantial difficulty in protecting their
interests through actions against our management or directors than would shareholders of a corporation with assets and management members located
in the United States.
We may need to obtain additional governmental approvals to open new drugstores. Our inability to obtain such approvals will have a material
adverse effect on our business and growth.
According to the Measures on the Administration of Foreign Investment in the Commercial Sector promulgated by the PRC Ministry of
Commerce (the “Measures”), which became effective on June 1, 2004, a company that is directly owned by a foreign invested enterprise needs to
obtain relevant governmental approvals before it opens new retail stores. However, there are no specific laws, rules or regulations with respect to
whether it is necessary for a company contractually controlled by a foreign invested enterprise to obtain approvals to open new retail stores. In addition,
the Measures state that PRC Ministry of Commerce will promulgate a detailed implementation regulation to govern foreign invested enterprises
engaging in drug sale. However, such implementation regulation has not yet been promulgated. Therefore we cannot assure you that the PRC Ministry
of Commerce will not require that such approvals to be obtained. If additional governmental approval is deemed to be necessary and we are not able to
obtain such approvals on a timely basis or at all, our business, financial condition, results of operations and prospects, as well as the trading price of our
common stock, will be materially and adversely affected.
28
The advent of recent healthcare reform directives from the PRC government may increase both competition and our cost of doing business.
Under the auspices of the Healthy China 2020 program (the “Program”), published by China’s National Development and Reform Commission
in October 2008, the PRC government has set in motion a series of policies in fairly rapid successions aimed to improve China’s healthcare system.
Such policies include (1) discouraging hospitals from both prescribing and dispensing medication, (2) the unveiling of formal healthcare reform
guidelines in April 2009, aimed to improve the availability of and subsidies for “essential” drugs, and (3) a series of price adjustments, the latest of
which is in March 2011, and affected listing approximately 852 medicines. While an underlying goal of these policies is to make drugs more accessible
to China’s poorer populations, such policy as discouraging hospitals from both prescribing and dispensing medication also serve to create opportunities
that in turn will intensify business competition in the Chinese retail drugstore industry, as well as competition for skilled labor and retail spaces.
Additionally, we expect the NEDL to lead to a rise in the number of government-subsidized community healthcare service centers, which will erode the
convenience and price advantage that our drugstores traditionally enjoy against hospitals.
Governmental control of currency conversion may affect the value of your investment.
The Chinese government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency
out of China. We receive substantially all of our revenues in RMB. Under our current structure, our income is primarily derived from payments from
the three HJ Group companies. Shortages in the availability of foreign currency may restrict the ability of our subsidiaries and our PRC affiliated
entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated
obligations. Under existing Chinese foreign exchange regulations, payments of current account items, including profit distributions, interest payments
and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from China State Administration of Foreign
Exchange by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB is
to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign
currencies. The Chinese government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the
foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay
dividends in foreign currencies to our stockholders.
Fluctuation in the value of RMB may have a material adverse effect on your investment.
The value of RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and
economic conditions. Our revenues, costs, and financial assets are mostly denominated in RMB while our reporting currency is the U.S. dollar.
Accordingly, this may result in gains or losses from currency translation on our financial statements. We rely entirely on fees paid to us by our
affiliated entities in China. Therefore, any significant fluctuation in the value of RMB may materially and adversely affect our cash flows, revenues,
earnings and financial position, and the value of, and any dividends payable on, our stock in U.S. dollars. For example, an appreciation of RMB against
the U.S. dollar would make any new RMB denominated investments or expenditures more costly to us, to the extent that we need to convert U.S.
dollars into RMB for such purposes. An appreciation of RMB against the U.S. dollar would also result in foreign currency translation losses for
financial reporting purposes when we translate our U.S. dollar denominated financial assets into RMB, as RMB is our reporting currency.
Dividends we receive from our subsidiary located in the PRC may be subject to PRC withholding tax.
The current PRC Enterprise Income Tax Law, or the EIT Law, and the implementation regulations for the EIT Law issued by the PRC State
Council, became effective as of January 1, 2008. The EIT Law provides that a maximum income tax rate of 20% is applicable to dividends payable to
non-PRC investors that are “non-resident enterprises,” to the extent such dividends are derived from sources within the PRC, and the State Council
has reduced such rate to 10% through the implementation regulations. We are a Nevada holding company and substantially all of our income is derived
from our subsidiaries and controlled companies located in the PRC. Therefore, dividends paid to us by our subsidiaries in China may be subject to the
10% income tax if we are considered as a “non-resident enterprise” under the EIT Law. If we are required under the EIT Law and its implementation
regulations to pay income tax for any dividends we receive from our PRC subsidiaries, it may have a material and adverse effect on our net income
and materially reduce the amount of dividends, if any, we may pay to our shareholders.
We face risks related to health epidemics and other outbreaks.
Our business could be adversely affected by the effects of an epidemic outbreak, such as the SARS epidemic in April 2004. Any prolonged
recurrence of such adverse public health developments in China may have a material adverse effect on our business operations. For instance, health or
other government regulations adopted in response may require temporary closure of our stores or offices. Such closures would severely disrupt our
business operations and adversely affect our results of operations. We have not adopted any written preventive measures or contingency plans to
combat any future outbreak of SARS or any other epidemic.
If relations between the United States and China worsen, investors may be unwilling to hold or buy our stock and our stock price may
decrease.
At various times during recent years, the United States and China have had significant disagreements over political and economic issues.
Controversies may arise in the future between these two countries. Any political or trade controversies between the United States and China, whether
or not directly related to our business, could reduce the price of our common stock.
To date, we have not paid any cash dividends and no cash dividends will be paid in the foreseeable future.
Risks Related to an Investment in Our Securities
We do not anticipate paying cash dividends on our common stock in the foreseeable future and we may not have sufficient funds legally
available to pay dividends. Even if the funds are legally available for distribution, we may nevertheless decide not to pay any dividends. We intend to
retain all earnings for our operations.
29
The NASDAQ Capital Market may delist our common stock from trading on its exchange, which could limit investors’ ability to effect
transactions in our common stock and subject us to additional trading restrictions.
Our common stock is listed on the NASDAQ Capital Market. We cannot assure you that our common stock will continue to be listed on the
NASDAQ Capital Market in the future. If the NASDAQ Capital Market delists our common stock from trading on its exchange, we could face
significant material adverse consequences including:
● a limited availability of market quotations for our common stock;
● a limited amount of news and analyst coverage for our company; and
● a decreased ability to issue additional securities or obtain additional financing in the future.
Although publicly traded, the trading market in our common stock may be substantially less liquid than the average stock quoted on the
NASDAQ Capital Market, and such low trading volume may adversely affect the price of our common stock.
Although our common stock has been listed on the NASDAQ Capital Market since April 22, 2010, the historical trading volume of our common
stock has generally been very low. Reported average daily trading volume in our common stock from May 1, 2010 through June 24, 2011 was
approximately 39,121 shares. Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for
you to sell your shares of common stock at a price that is attractive to you.
The market price for our stock may be volatile.
The market price for our stock may be volatile and subject to wide fluctuations in response to factors including the following:
● actual or anticipated fluctuations in our quarterly operating results;
● changes in financial estimates by securities research analysts;
● conditions in the retail pharmacy markets;
● changes in the economic performance or market valuations of other retail pharmacy operators;
● announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;
● addition or departure of key personnel;
● fluctuations of exchange rates between RMB and the U.S. dollar;
● intellectual property litigation; and
● general economic or political conditions in China.
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating
performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our stock.
Volatility in our common share price may subject us to securities litigation
The market for our common stock is characterized by significant price volatility when compared to seasoned issuers, and we expect that our
share price will continue to be more volatile than a seasoned issuer for the indefinite future. As an illustration of such volatility, the closing price of our
common stock during the 52 weeks preceding the date of this Form 10-K ranged from a low of $1.65 to a high of $6.16. In the past, plaintiffs have
often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may, in the
future, be the target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management's attention and
resources.
Our officers and directors own a substantial portion of our outstanding common stock, which will enable them to influence many significant
corporate actions and in certain circumstances may prevent a change in control that would otherwise be beneficial to our shareholders.
Our directors and executive officers collectively control approximately 47.3% of our outstanding shares of stock that are entitled to vote on all
corporate actions. These stockholders, acting together, could have a substantial impact on matters requiring the vote of the shareholders, including the
election of our directors and most of our corporate actions. This control could delay, defer or prevent others from initiating a potential merger, takeover
or other change in our control, even if these actions would benefit our shareholders and us. This control could adversely affect the voting and other
rights of our other shareholders and could depress the market price of our common stock.
The elimination of monetary liability against our directors, officers and employees under Nevada law and the existence of indemnification
rights to our directors, officers and employees may result in substantial expenditures by us and may discourage lawsuits against our
directors, officers and employees.
Our bylaws contain specific provisions that eliminate the liability of our directors for monetary damages to our company and shareholders, and
we are prepared to give such indemnification to our directors and officers to the extent provided by Nevada law. We may also have contractual
indemnification obligations under our employment agreements with our officers. The foregoing indemnification obligations could result in our company
incurring substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup.
These provisions and resultant costs may also discourage our company from bringing a lawsuit against directors and officers for breaches of their
fiduciary duties, and may similarly discourage the filing of derivative litigation by our shareholders against our directors and officers even though such
actions, if successful, might otherwise benefit our company and shareholders.
30
Legislative actions, higher insurance costs and potential new accounting pronouncements may impact our future financial position and
results of operations.
There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and there may potentially be new accounting pronouncements
or additional regulatory rulings that will have an impact on our future financial position and results of operations. The Sarbanes-Oxley Act of 2002 and
other rule changes as well as proposed legislative initiatives following the Enron bankruptcy are likely to increase general and administrative costs and
expenses. In addition, insurers are likely to increase premiums as a result of high claims rates over the past several years, which we expect will
increase our premiums for insurance policies. Further, there could be changes in certain accounting rules. These and other potential changes could
materially increase the expenses we report under generally accepted accounting principles, and adversely affect our operating results
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.
We are subject to reporting obligations under the U.S. securities laws. The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002,
as amended, adopted rules requiring every public company to include a management report on such company's internal controls over financial reporting
in its annual report, which contains management's assessment of the effectiveness of our internal controls over financial reporting. We reported certain
material weaknesses involving control activities, specifically:
Accounting and Finance Personnel Weaknesses - The current accounting staff is relatively inexperienced, and requires substantial training so as
to meet with the higher demands necessary to fulfill the requirements of U.S. GAAP-based reporting and SEC rules and regulations.
Management’s assessment of the control deficiency over accounting and finance personnel as of March 31, 2011 considered the following
factors including: the number of adjustments proposed by our independent auditors during our quarterly review and annual audit processes; the
significance of the audit adjustments impact on the overall financial statements; how appropriately we complied with U.S. GAAP on transactions; and
how accurately we prepared supporting information to provide to our independent auditors on a quarterly and annual basis. Based on the above factors,
management concluded that the control deficiency over accounting and finance personnel should be a material weakness as of March 31, 2011 and
2010, respectively, because the situation regarding the insufficient number of qualified resources in our U.S. reporting team remained the same in these
two years.
We did not maintain effective controls over internal audit function due to the lack of qualified internal auditors who are familiar with internal audit
and U.S. GAAP, and we did not implement adequate and proper supervisory review to ensure that significant internal control deficiencies can be
detected or prevented.
Our management has undertaken steps to address these issues, subsequent to year end, including hiring a third party to assist us with identifying
the steps necessary to improve our internal controls and the implementation of such steps. However, there is no assurance that additional remedial
measures will not be necessary, or that after the remediation our management will be able to conclude that our internal controls over our financial
reporting are effective.
Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems
for the foreseeable future. Effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial
reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could
result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the
trading price of our common stock. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other
resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.
Shares eligible for future sale may adversely affect the market.
From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary
brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act, subject to certain limitations. In general,
pursuant to amended Rule 144, non-affiliate stockholders may sell freely after six months subject only to the current public information requirement
(which disappears after one year). Affiliates may sell after six months subject to the Rule 144 volume, manner of sale (for equity securities), current
public information and notice requirements. Of the 13,531,579 shares of our common stock outstanding as of June 24, 2011, approximately 7,376,002
million shares are, or will be, freely tradable without restriction, unless held by our "affiliates", as of such date. Any substantial sale of our common
stock pursuant to Rule 144 or pursuant to any resale prospectus may have a material adverse effect on the market price of our common stock. If our
founders and service consultants were to sell their shares, they would be subject to volume and/or other restrictions imposed by Rule 144.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Our corporate headquarters and 54 of our 55 stores, as well as the offices of Shouantang Technology and Quannuo Technology, are located in
Hangzhou. The land on which herbal plants for TCM are being cultivated is located in Lin’an approximately 30 miles from Hangzhou. We also have
one store location in Shanghai.
31
As of the date of this Form 10-K, we have entered into 61 operating leases for our headquarters, offices for Quannuo Technology
and Shouantang Technology, and retail spaces with various terms, periods and other rental provisions. All such leases are with third parties with the
exception of our headquarters and a retail space, which we are leasing from our Chairman Mr. Lei Liu. We believe that our leased properties are well
maintained and in good operating condition, and are sufficient for our current business operations. The leases do not contain any material escalating
lease payments or contingent rental payment terms. See Note 6, "Long Term Deposits," and Note 16, “Commitments and Contingencies,” of the
footnotes to our audited financial statements for the years ended March 31, 2011 and 2010, included elsewhere in this Form 10-K.
We must negotiate with the landlords for an extension of the old leases or enter into new leases upon their termination, and our landlords may
request a rent increase. Under applicable PRC law, we have priority over other potential lessees with respect to the leased store space on the same
terms. We also do not expect any significant difficulties in renewal of existing leases upon their expiration, where desired. Our community stores are
normally relatively small in size and the facilities inside the store are easily movable. As a result, we do not expect our drugstore operations to be
materially and adversely affected by any failure to renew or enter into new leases.
We are also leasing two pieces of land in Lin’an from The People's Government of Qianhong Village, and have entered into 30-year lease in
connection therewith in February 2010. One piece of land is approximately 4.6 acres and is zoned for industrial use, and the other is approximately 48.6
acres of forestry land. More than ten herb plants are currently being cultivated on both pieces of land. The lease amount for the land was prepaid in full
in March 2010. See Note 7, "Prepaid Non Current," and Note 17, "Commitments and Contingencies," of the footnotes to our audited financial
statements for the years ended March 31, 2011 and 2010, included elsewhere in this Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
Except as described below, we know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any
material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial
stockholder, is an adverse party or has a material interest adverse to our company.
On December 8, 2009, Jiuzhou Pharmacy filed suit against The Ventana Group, LLC and Michael Hom in the California Superior Court for the
County of San Mateo (Case Number CV490272), alleging breach of contract of an agreement entered into with the defendants in 2008 and seeking
damages of $25,000. The suit was subsequently amended to remove Mr. Hom as a defendant. In May 2010, Jiuzhou Pharmacy sought for default
judgment against the remaining defendant. On July 14, 2010, a default judgment was entered in favor of Jiuzhou Pharmacy.
ITEM 4. RESERVED
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASE OF EQUITY SECURITIES
Market Information
Our common stock has been trading on the NASDAQ Capital Market under the symbol “CJJD” since April 22, 2010. Our common stock was
previously quoted on the Over-The-Counter Bulletin Board, or OTCBB, under the trading symbol “CJJD.OB” until April 21, 2010.
The following table sets forth the high and low bid information for our common stock on the OTCBB through April 21, 2010 and on the
NASDAQ Capital Market since April 22, 2010 for the periods indicated. The bid prices reflect inter-dealer quotations, do not include retail markups,
markdowns, or commissions, and do not necessarily reflect actual transactions.
The OTCBB
Bid
Price per Share (1)
The Nasdaq
Capital Market
Price per Share (2)
High
Low
High
Low
$
$
$
$
$
$
$
$
N/A
N/A
N/A
N/A
9.50 $
10.00 $
5.30 $
0.00 $
N/A $
N/A $
N/A $
N/A $
3.48 $
3.60 $
0.10 $
$
0.00
1.65 $
5.60 $
2.76
2.50
6.10 $
6.94 $
5.49 $
N/A $
4.15
3.92
3.80
N/A
N/A $
$
N/A
N/A
N/A
Quarter ended
June 30, 2011 (3)
March 31, 2011
December 31, 2010
September 30, 2010
June 30, 2010
March 31, 2010
December 31, 2009
September 30, 2009
(1)
Through April 21, 2010.
(2)
From April 22, 2010 forward.
(3)
Through June 27, 2011.
Based on the records of our transfer agent, we had approximately 13,531,579 shares of common stock issued and outstanding as of June 24,
2011.
32
Holders
Based on the records of our transfer agent, there were 10 stockholders of record of our common stock as of June 24, 2011 (not including
beneficial owners who hold shares at broker/dealers in “street name”).
Dividends
While there are no restrictions that limit our ability to pay dividends, we have not paid, and do not currently intend to pay cash dividends on our
common stock in the foreseeable future. Our policy is to retain all earnings, if any, to provide funds for operation and expansion of our business. The
declaration of dividends, if any, will be subject to the discretion of our board of directors, which may consider such factors as our results of operations,
financial condition, capital needs and acquisition strategy, among others.
Securities Authorized for Issuance under Equity Compensation Plans
Please see the discussion in Item 12 titled “Equity Compensation Plan Information” below.
Recent Sales of Unregistered Securities
None during the three months ended March 31, 2011.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our results of operations and financial condition for fiscal years ended March 31, 2011 and 2010
should be read in conjunction with our financial statements and the notes to those financial statements that are included elsewhere in this
Form 10-K. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such
as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in
these forward-looking statements as a result of a number of factors, including those set forth under the “Risk Factors”, “Cautionary Notice
Regarding Forward-Looking Statements” and “Description of Business” sections and elsewhere in this Form 10-K. We use words such as
“anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,”
“predict,” and similar expressions to identify forward-looking statements. Although we believe the expectations expressed in these forward-
looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ
materially from those discussed in these statements. Factors that could contribute to such differences include, but are not limited to, those
discussed in the “Risk Factors” section of this Form 10-K. We undertake no obligation to update publicly any forward-looking statements
for any reason even if new information becomes available or other events occur in the future.
Our financial statements are prepared in US$ and in accordance with accounting principles generally accepted in the United States. See “Exchange
Rates” below for information concerning the exchanges rates at which Renminbi (“RMB”) were translated into US$ at various pertinent dates and for
pertinent periods.
Overview
We are primarily an operator of retail pharmacies based in Zhejiang Province, China. Our drugstores provide customers with a wide variety of
medicinal products, including prescription and OTC drugs, nutritional supplements, TCM products, personal care products, family care products, medical
devices, as well as convenience products including consumable, seasonal and promotional items. We briefly offered baijiu, or Chinese white liquor, at
some of our pharmacies from December 2010 to February 2011. Each store typically carries approximately 2,500 to 7,000 different products. In
addition to these products, we have licensed doctors of both western medicine and TCM onsite for consultation, examination and treatment of common
ailments at scheduled hours. Our stores presently average approximately 250 square feet.
In addition to pharmacies and medical clinics, we plan to distribute herbal plants being cultivated on our leased land at our pharmacies and to
third parties. In August 2010, we established Jiuxin Qianhong as a wholly-owned subsidiary to operate this cultivation project. Currently, more than ten
herbal plants, including fructus rubi, white atractylodes rhizome and atractylodes macrocephala, are being cultivated on approximately 48 acres, which
we expect to harvest in the latter half of 2011 through early 2012.
33
We have also been operating an online drugstore (www.dada360.com) that sells non-prescription drugs (including over-the-counter drugs and
nutritional supplements), since May 2010. In July 2010, we established Shouantang Technology as a wholly-owned subsidiary and acquired Quannuo
Technology in November 2010 to operate the website and provide software and technical support. As a part of our acquisition of Quannuo Technology,
we also acquired its wholly-owned subsidiary, Hangzhou Quannuo, and the “Quannuo Grand Pharmacy” store. Other than activities relating to
investing and financing the working capital of Quannuo Technology, Shouantang has had no separate operations of its own as of March 31, 2011.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements in accordance with accounting principles generally accepted in the United States, we are
required to make judgments, estimates and assumptions that affect: (i) the reported amounts of our assets and liabilities; (ii) the disclosure of our
contingent assets and liabilities at the end of each reporting period; and (iii) the reported amounts of revenue and expenses during each reporting period.
We continually evaluate these estimates based on our own historical experience, knowledge and assessment of current business and other conditions,
our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments
about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process,
our actual results could differ from those estimates.
We believe that any reasonable deviation from those judgments and estimates would not have a material impact on our financial condition or
results of operations. To the extent that the estimates used differ from actual results, however, adjustments to the statement of operations and
corresponding balance sheet accounts would be necessary. These adjustments would be made in future financial statements.
When reading our financial statements, you should consider: (i) our critical accounting policies; (ii) the judgment and other uncertainties affecting
the application of such policies; and (iii) the sensitivity of reported results to changes in conditions and assumptions. We believe the following
accounting policies involve the most significant judgment and estimates used in the preparation of our financial statements. We have not made any
material changes in the methodology used in these accounting policies during the past eighteen months.
Revenue recognition
Revenue from sales of prescription medicine at the drugstores is recognized when the prescription is filled and the customer picks up and pays
for the prescription.
Revenue from sales of other merchandise at the drugstores is recognized at the point of sale, which is when the customer pays for and receives
the merchandise.
Revenue from medical services (which is nominal) is recognized after the service has been rendered to the customer.
Revenue from sales of merchandise to non-retail customers is recognized when the following conditions are met: 1) persuasive evidence of an
arrangement exists (sales agreements and customer purchase orders are used to determine the existence of an arrangement); 2) delivery of goods has
occurred and risks and benefits of ownership have been transferred, which is when the goods are received by the customer at its designated location in
accordance with the sales terms; 3) the sales price is fixed or determinable; and 4) collectability is probable. Historically, sales returns have been
immaterial.
Our revenue is net of value added tax (“VAT”) collected on behalf of tax authorities in respect of the sale of merchandise. VAT collected from
customers, net of VAT paid for purchases, is recorded as a liability in the balance sheet until it is paid to the tax authorities.
Vendor allowances
We account for vendor allowances according to the accounting standard, Accounting by a Customer (Including a Reseller) for Certain
Consideration Received from a Vendor, and by Reseller to Sales Incentives Offered to Consumers by Manufacturers. Vendor allowances
reduce the carrying value of inventories and subsequently transferred to cost of goods sold when the inventories are sold, unless those allowances are
specifically identified as reimbursements for advertising, promotion and other services, in which case they are recognized as a reduction of the related
advertising and promotion costs.
Slotting allowances are a major portion of total allowances. With slotting allowances, vendors reimburse us for the cost of placing new products
on our shelves. We have no obligation or commitment to keep any such products on our shelves for a minimum period.
A small portion of vendor allowance also includes advertising and promotion allowances for the promotion of vendors' products in our stores.
The promotion may be any combination of a temporary price reduction or a feature in print ads.
Depreciation and Amortization
Our non-current assets include property and equipment, including leasehold improvements, long term deposits and long term advances to
suppliers. We depreciate our equipment assets using the straight-line method over the estimated useful lives of the assets. We make estimates of the
useful lives of the equipment (including the salvage values), in order to determine the amount of depreciation expense to be recorded during any
reporting period. We amortize leasehold improvements of our retail drugstores and other business premises over the shorter of five years or lease term.
A majority of our leases have a five-year term. We estimate the useful lives of our other property and equipment at the time we acquire the assets
based on our historical experience with similar assets as well as anticipated technological and other changes. If technological changes were to occur
more rapidly than anticipated or in a different form than anticipated, we may shorten the useful lives assigned to these assets as appropriate, which will
result in the recognition of increased depreciation and amortization expense in future periods. There was no change to the estimated useful lives and
salvage values during the years ended March 31, 2011 and 2010.
34
Impairment of Long-Lived Assets
We evaluate our long lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying
value may not be recoverable from its estimated future cash flows. Recoverability is measured by comparing the asset’s net book value to the related
projected undiscounted cash flows from these assets, considering a number of factors including past operating results, budgets, economic projections,
market trends and product development cycles. If the net book value of the asset exceeds the related undiscounted cash flows, the asset is considered
impaired, and a second test is performed to measure the amount of impairment loss. No significant indication of impairment noted as of March 31,
2011.
Inventories
We state our inventory at the lower of cost or market. Cost is determined using the first in first out method. Market is the lower of replacement
cost or net realizable value. We carry out physical inventory counts on a monthly basis at each store and distribution location to ensure that the amounts
reflected in the consolidated financial statements at each reporting period are properly stated and valued. We record write-downs to inventory for
shrinkage losses and damaged merchandise that are identified during the inventory counts. The inventory write downs for the years ended March 31,
2011 and 2010 have been immaterial.
Results of Operations
The following table summarizes our results of operations for the years ended March 31, 2011 and 2010.
Revenue
Gross Profit
Selling Expenses
General and Administrative Expenses
Income from Operations
Other Income (Expense)
Income Tax Expenses
Net Income
Years Ended March 31,
2010
Amount
Percentage of
total revenue
$
$
$
$
$
$
$
$
55,174,929
16,898,040
2,630,332
1,510,154
12,757,554
(55,520)
2,880,293
9,821,741
100.0 % $
30.6 % $
4.8 % $
2.7 % $
23.1 % $
(0.1) % $
5.2 % $
17.8 % $
2011
Amount
69,969,479
21,142,094
4,838,745
4,723,943
11,579,406
376,397
3,523,345
8,432,458
Percentage of
total revenue
100.0 %
30.2 %
6.9 %
6.8 %
16.5 %
0.5 %
5.0 %
12.1 %
Revenue. Our revenue increased by $14,794,550 or 26.8% to $69,969,479 for the year ended March 31, 2011 from $55,174,929 for the year
ended March 31, 2010 due to new store openings and maturing stores. Of this increase, $6,023,144 or 40.7% was attributable to new stores, with the
remainder primarily attributable to our maturing stores that we opened prior to March 31, 2010. We operated 51 stores as of March 31, 2011, as
compared to 25 stores as of March 31, 2010. We anticipate that our overall revenue will continue to increase as we open additional stores.
Gross Profit. Our gross margin increased by $4,244,054 or 25.1% to $21,142,094 for the year ended March 31, 2011 from $16,898,040 for the
year ended March 31, 2010. Our gross margin slightly decreased from 30.6% for the year ended March 31, 2010 to 30.2% for the year ended March
31, 2011. We anticipate that our overall gross profit will continue to increase as our sales increase. Additionally, we anticipate that our gross margin will
increase as we will be able to obtain better pricing terms from our suppliers and achieve further economies of scale as a result of purchasing larger
quantities of products.
Selling Expenses. Our selling expenses increased by $2,208,413 or 84.0% to $4,838,745 for the year ended March 31, 2011 from $2,630,332 for
the year ended March 31, 2010. The increase in selling expenses was increased rent expense and salaries as a result of opening new store locations.
Selling expenses as a percentage of our revenue increased to 6.9% for the year ended March 31, 2011 from 4.8% for the year ended March 31, 2010.
We expect that our selling expenses will increase as we continue to expand our store network within Zhejiang Province as well as Shanghai.
General and Administrative Expenses. Our general and administrative expenses increased by $3,213,789 or 212.0% to $4,723,943 for the
year ended March 31, 2011 from $1,510,154 for the year ended March 31, 2010. General and administrative expenses as a percentage of our revenue
increased to 6.8% from 2.7% for the year ended March 31, 2011. The increases in absolute dollars as well as a percentage of revenue related to
professional fees incurred as a U.S. publicly traded company, increased salaries, and warehousing costs. As we continue to open drugstores, further
develop our infrastructure, and incur expenses related to being a U.S. public company, we anticipate that our general and administrative expenses will
increase in absolute dollars as well as a percentage of total revenue.
35
Income from Operations. As a result of higher selling and general and administrative expenses, our income from operations decreased by
$1,178,148 or 9.0% to $11,579,406 for the year ended March 31, 2011 from $12,757,554 for the year ended March 31, 2010. Our operating margin for
the years ended March 31, 2011 and 2010 was 16.5% and 23.1%, respectively.
Income Taxes. Our income tax expense increased to $3,523,345 for the year ended March 31, 2011 from $2,880,293 for the year ended March
31, 2010 as a result of certain expenses incurred in the United States not being deductible for PRC income tax purposes.
Net Income. As a result of the foregoing, our net income decreased to $8,432,458 for the year ended March 31, 2011 from $9,821,741 for the
year ended March 31, 2010.
Liquidity
In summary, our cash flows for the periods indicated are as follows:
Net cash (used in) provided by operating activities
Net cash (used in) provided by investing activities
Net cash (used in) provided by financing activities
Year Ended March 31, 2011
March 31,
2011
March 31,
2010
(5,183,748)
(5,250,092)
15,770,507
807,309
(602,225)
(400,503)
For the year ended March 31, 2011, we used $5,183,748 in operating activities, as opposed to $807,309 provided by operating activities for the
year ended March 31, 2010. The change is primarily attributable to increases in advances to suppliers of $9,177,936 and in other current assets of
$6,927,371, offset by a $1,075,811 increase in trade accounts payable and an increase in other payables and accrued liabilities of $2,370,213.
We used $5,250,092 in investing activities during the year ended March 31, 2011, primarily for purchasing a store location and making related
leasehold improvements as well as leasehold improvements at other store locations as compared to $602,225 spent during the year ended March 31,
2010.
Cash provided by financing activities was $15,770,507 for the year ended March 31, 2011 as compared to of $400,503 used in financing activities
for the year ended March 31, 2010. The increase was a result of the $15.7 million in net proceeds that we raised in a public offering of our common
stock in April 2010.
As of June 27, 2011, we had cash of $ 6,190,312. Our total current assets as of March 31, 2011 were $39,456,654 and our total current liabilities
were $11,717,481 which resulted in a net working capital of $27,739,173 as of March 31, 2011.
Capital Resources
In April 2010, we completed a public offering of 3.5 million shares of our common stock at a price of $5.00 per share resulting in gross proceeds
of $17.5 million and net proceeds of $15.7 million after deducting commissions and all other expenses. During the next 90 days, we may complete our
acquisition of Jiuxin Medicine that may require an all cash payment and have an obligation to contribute RMB 8,000,000 to complete the registered
capital requirement for Quannuo Technology. We believe that with our current working capital, we will be able to meet these obligations. However, if
we are to acquire additional businesses or further expand our operations, we may need additional capital.
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual Obligations
When we open store locations, we typically enter into lease agreements that are generally between four to five years. Our commitments for
minimum rental payments under our leases for the next five years and thereafter are as follows:
Years ending March 31,
2012
2013
2014
2015
2016
Thereafter
$
2,832,615
2,480,687
2,025,371
1,613,378
680,293
489,517
Logistics Services Commitments
As of March 31, 2011, we used a third party service provider, Yingte Logistics, to accept goods from our suppliers and to deliver the goods to
our store locations. Pursuant to our one-year agreement with Yingte Logistics entered into on January 1, 2011, we are obligated to pay 1% of the
purchase price of the goods received from our suppliers by Yingte Logistics during the term of the agreement, from January 1, 2011 to December 31,
2011, with a contractual minimum of 3.9 million RMB.
36
We terminated our agreement with Yingte Logistics in April 2011, and now use Jiuxin Medicine’s facility as our distribution center. We are,
however, still using Yingte Logistics for delivery of goods to our stores.
Off-balance Sheet Arrangements
We do not have any outstanding financial guarantees or commitments to guarantee the payment obligations of any third parties. We have not
entered into any derivative contracts that are indexed to our shares and classified as stockholder’s equity or that are not reflected in our consolidated
financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as
credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity,
market risk or credit support to us or engages in leasing, hedging or research and development services with us.
Exchange Rates
Our PRC subsidiaries and VIEs maintain their books and records RMB, the lawful currency of the PRC. In general, for consolidation purposes,
we translate their assets and liabilities into U.S. Dollars using the applicable exchange rates prevailing at the balance sheet date, and the statement of
income is translated at average exchange rates during the reporting period. Adjustments resulting from the translation of their financial statements are
recorded as accumulated other comprehensive income.
Until July 21, 2005, RMB had been pegged to USD at the rate of RMB8.30: USD$1.00. On July 21, 2005, the PRC government reformed the
exchange rate system into a managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. In
addition, the exchange rate of RMB to USD was adjusted to RMB8.11: USD$1.00 as of July 21, 2005. The People’s Bank of China announces the
closing price of a foreign currency such as USD$ traded against RMB in the inter-bank foreign exchange market after the closing of the market on
each working day, which will become the unified exchange rate for the trading against RMB on the following working day. The daily trading price of
USD against RMB in the inter-bank foreign exchange market is allowed to float within a band of ±0.3% around the unified exchange rate published by
the People’s Bank of China. This quotation of exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign
exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the
exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the Bank of China or other institutions required
submitting a payment application form together with invoices, shipping documents and signed contracts.
The exchange rates used to translate amounts in RMB into US Dollars for the purposes of preparing the consolidated financial statements or
otherwise stated in this report were as follows:
Balance sheet items, except for the registered and paid-up capital, as of end of period/year
Amounts included in the statement of operations, statement of changes in stockholders'
equity and statement of cash flows for the period/ year ended
March 31,
2010
USD1:RMB
0.1467
USD1:RMB
0.14664
March 31,
2011
USD1:RMB
0.1527
USD1:RMB
0.14909
No representation is made that RMB amounts have been, or would be, converted into US$ at the above rates.
Inflation
We believe that inflation has not had a material effect on our operations to date.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS
The consolidated financial statements and financial statement schedule are included in Part III, Item 15 (a) (1) and (2) of this Annual report on
Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
37
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act
reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is
accumulated and communicated to our management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and
management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of March 31, 2011, the end of the fiscal year covered by this report, our management, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, has performed an evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934).
Based on the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this
report, our disclosure controls and procedures were ineffective at the reasonable assurance level.
Management’s Report on Internal Control over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)). Under the supervision and with the participation of our management, including our principal executive officer and principal
financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal
Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our
evaluation, management concluded that our internal control over financial reporting was not effective as of March 31, 2011 due to the following
material weaknesses:
Accounting and Finance Personnel Weaknesses - The current accounting staff is relatively inexperienced, and requires substantial
training so as to meet with the higher demands necessary to fulfill the requirements of U.S. GAAP-based reporting and SEC rules and
regulations. Therefore, we did not maintain effective controls and did not implement adequate and proper supervisory review to ensure that
significant internal control deficiencies can be detected or prevented.
Management’s assessment of the control deficiency over accounting and finance personnel as of March 31, 2011 considered the following
factors including:
a. the number of adjustments proposed by our independent auditors during our quarterly review and annual audit processes;
b. the significance of the audit adjustments impact on the overall financial statements;
c. how appropriately we complied with U.S. GAAP on transactions; and
d. how accurately we prepared supporting information to provide to our independent auditors on a quarterly and annual basis.
Based on the above factors, management concluded that the control deficiency over accounting and finance personnel should be a material
weakness as of March 31, 2011 and 2010, respectively, because the situation regarding the insufficient number of qualified resources in our
U.S. reporting team remained the same in these two years.
Subsequent to the fiscal year ended March 31, 2011, our management has identified the steps it believes are necessary to address the
weaknesses described above, and expect that we will satisfactorily address the control deficiencies and weaknesses relating to these matters by the
end of our fiscal year ending March 31, 2012, although there can be no assurance that compliance will be achieved in this time frame.
This annual report does not include an attestation report of our independent registered accounting firm regarding internal control over financial
reporting. The management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that
permit the Company to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph
(d) of Exchange Act Rule 13a-15 or Rule 15d-15 that occurred during the fourth quarter ended March 31, 2011 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Controls
Management does not expect that the Company’s disclosure controls and procedures or internal control over financial reporting will prevent or
detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only
reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements
due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.
ITEM 9B. OTHER INFORMATION
None.
38
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
PART III
The following table identifies our current executive officers and directors as of the date of this Form 10-K, their respective offices and positions,
and their respective dates of election or appointment:
Name
Lei Liu
Bennet P. Tchaikovsky
Li Qi
Chong’an Jin
Shike Zhu
Marc Thomas Serrio
Bowen Zhao
Yuehai Ke
Shuizhen Wu
Xiaomeng Yu
Biographies
Age
46
42
38
47
48
52
75
39
61
32
Position
Chief Executive Officer and Chairman of the Board of Directors
Chief Financial Officer
Secretary and Director
Director
Director
Director
Director
Director
Director
Director
Date of Appointment
September 17, 2009
September 17, 2009
October 23, 2009
October 23, 2009
October 23, 2009
March 15, 2010
March 15, 2010
March 15, 2010
March 15, 2010
March 15, 2010
Lei Liu, Chief Executive Officer and Chairman of the Board of Directors
Mr. Liu is one of our three founders, and has been the executive director of Jiuzhou Pharmacy since September 2003 and the supervising director of
Jiuzhou Service since November 2005. From December 1997 to August 2003, Mr. Liu worked as a general manager of Tai He Drugstore, which is not
related to or affiliated with us. From September 1992 to November 1997, Mr. Liu was an administration official of Hangzhou Medical Junior College,
his alma mater, where he was also a researcher and an anatomy instructor from September 1983 to July 1992. Mr. Liu has been a licensed researcher
in the PRC since September 1988. As the founder responsible for our vision and direction, Mr. Liu is invaluable to us and our board of directors.
Bennet P. Tchaikovsky, Chief Financial Officer
Mr. Tchaikovsky is presently the chief financial officer of VLOV, Inc., which he performs on a part-time basis. From May 2008 through April 2010,
Mr. Tchaikovsky served as the Chief Financial Officer of Skystar Bio-Pharmaceutical Company which he served on a part time basis. From March
2008 through November 2009, Mr. Tchaikovsky served as a director of Ever-Glory International Group. From December 2008 through November
2009, Mr. Tchaikovsky served as a director of Sino Clean Energy, Inc. From July 2004 through October 2007, Mr. Tchaikovsky served as the chief
financial officer of Innovative Card Technologies, Inc. Mr. Tchaikovsky acted as a consultant to Innovative Card Technologies from November 2007
until July 2008. None of these companies is related to or affiliated with the Company. Mr. Tchaikovsky is a licensed Certified Public Accountant and
an inactive member of the California State Bar. He received a B.A. in Business Economics from the University of California at Santa Barbara, and a
J.D. from Southwestern University School of Law.
Li Qi, Secretary and Director
Ms. Qi is one of our three founders and is currently the general manager of both Jiuzhou Pharmacy and Jiuzhou Service. From January 2000 to June
2003, Ms. Qi worked as a general manager of Zhejiang Yikang Drugstore, which is not related or affiliated to us. From October 1991 to January 2000,
Ms. Qi worked in the Branch Hospital of Hangzhou No. 1 People’s Hospital as a nurse. Ms. Qi is a licensed TCM pharmacist in the PRC and is a
1991 graduate of Hangzhou Nurse School. As the founder overseeing our day-to-day corporate operations, Ms. Qi is invaluable to us and our board of
directors.
Chong’an Jin, Director
Mr. Jin is one of our three founders and is presently the executive director of Jiuzhou Service and the managinggeneral partner of Jiuzhou Clinic. From
June 1996 to September 2003, Mr. Jin worked as a general manager for Hangzhou Qiantang Medical Outpatient Clinic, which is not related or affiliated
to us. From December 1991 to October 1994, he worked in Hangzhou Hospital of Traditional Chinese Medicine as a physician of western medicine.
From September 1988 to December 1991, Mr. Jin worked in Zhejiang Tumor Hospital as a physician of western medicine. In July 1988, Mr. Jin
received a B.S. in Medicine from Sun Yat-sen Medical University, and is a licensed pharmacist in the PRC. As the founder overseeing our
pharmacists and medical clinic personnel, Mr. Jin is invaluable to us and our board of directors.
Shike Zhu, Director
Mr. Zhu is the chairman of Huai Nan Tian Rui Goods & Materials Co., Ltd., a post he has held since 2003. He is also the director of Tianri Rubber
Products Co., Ltd. since 1994, where he was also the deputy general manager from 1994 to 1998. Since May 2008, Mr. Zhu has served as advisor to
the chairman of China Wind Systems, Inc. (NASDAQ: CWS). None of these companies is related to or affiliated with us. From October 1988 to May
1994, Mr. Zhu was an official of Tiantai municipal government in Zhejiang Province, serving as vice director of the Overseas Chinese Affairs Office
and vice director of the Overseas Chinese Federation. Mr. Zhu is a graduate of Zhejiang TV University Engineering Management College.. Mr. Zhu’s
management experience with and working knowledge of both private and public companies assist our board of directors in better carrying out its
supervision of our Company and management personnel.
39
Marc Thomas Serrio, Director
Mr. Serrio is chief financial officer of Ready Pac Foods, Inc., a position he has held since January 2011. He is also founder and president of MTS
Advisory since January 1996 which specializes in providing financial executive services to early stage and middle market companies in various
industries. Mr. Serrio was interim chief financial officer and interim chief operating officer of Kate Somerville LLC from July 2008 to March 2009,
chief financial officer of Detection Logic, Inc. from November 2005 to March 2008, and chief financial officer of TriTech Software Systems from
March 1999 to November 2005. None of these companies is related to or affiliated with the Company. Mr. Serrio is a graduate of the Marshall School
of Business at the University of Southern California, with a B.S. in business administration in 1981 and a M.B.A. with emphasis on investment finance
and business economics in 1985. The Company’s Board of Directors has determined that Mr. Serrio should serve as a director given his senior level
management experience in finance and accounting areas.
Bowen Zhao, Director
Mr. Zhao is a senior economist who has dedicated the past 54 years toward the development of the pharmaceutical industry in Zhejiang Province. Mr.
Zhao is currently the deputy president of Zhejiang Province Industry and Economic Association, Zhejiang Province Entrepreneur Association and
China Commercial Pharmacy Association, positions he has held since December 1994. In September 1996, Mr. Zhao was instrumental in organizing
Zhejiang Province Commercial Pharmacy Association (which became Zhejiang Province Pharmaceutical Industry Association in September 2002), and
has served as its president since its founding. Mr. Zhao has been with Zhejiang Pharmaceutical Co., Ltd., which is not related to or affiliated with us,
since September 1983 and is currently its deputy manager. Mr. Zhao has been with Zhejiang Province Pharmaceutical Administration since May 1995,
and is currently its deputy director. Mr. Zhao’s active involvements with regional trade groups and organizations provide us with valuable insights on
issues and trends that are relevant to us and our business.
Yuehai Ke, Director
Dr. Ke is a professor of molecular genetics and cell signal transduction at the Department of Basic Medicine at Zhejiang University’s School of
Medicine since September 2007, where he also advices doctorate candidates. Dr. Ke graduated from Zhejiang University in 1995, where he majored in
biochemistry. After graduation, Dr. Ke joined the Chinese Center for Disease Control and Prevention from September 1995 to July 1998. Dr. Ke
obtained his master degree in medicine in 1998 from Fudan University, where he studied genetic disease of human multiple genes, and his doctorate
degree in 2001 also from Fudan University. In 2000, Dr. Ke was an exchange student at the School of Public Health at the University of Texas in
Houston. From February 2002 to September 2007, Dr. Ke studied cell signal transduction at the Cancer and Stem Cell Research Center of the
Burnham Medical Research Institute in California. From September 2005 to September 2007, Dr. Ke was an associate professor at the Chinese
Academy of Medical Sciences & Peking Union Medical College, focusing his research and studies on the application development of cell kinetics
models and genetic analysis. Given Dr. Ke’s academic stature and accomplishments, his presence on our board of directors enhances our Company
reputation and image in the markets where we operate.
Shuizhen Wu, Director
Dr. Wu has been with Zhejiang No. 1 Hospital, which is affiliated with Zhejiang University’s School of Medicine, since July 2005, where she is
currently a researcher and senior management personnel. From July 1978 to May 1994, Dr. Wu served as deputy director of the medical faculty at
Zhejiang Medical University. Dr. Wu is a 1978 graduate of Zhejiang Medical University. Through Dr. Wu’s association with the top regional medical
facilities, we have access to, and the ability to recruit from, the top graduates for our pharmacies and medical clinics.
Xiaomeng Yu, Director
Mr. Yu is president of China Mingsheng Bank’s Xiasha branch in Hangzhou, where he was previously its senior client manager from October 2005 to
July 2008. From August, 2003 to September 2005, Mr. Yu was translator and site manager for Hangzhou Road Engineering Equipment Co., Ltd. None
of these companies is related to or affiliated with the Company. Mr. Yu graduated from Japan’s Daito Bunka University in September 2003 with a
degree in business management. Mr. Yu’s standing in and knowledge of the Hangzhou business community serves as an important bridge between us
and the financial institutions with whom we may desire to do business with.
Family Relationships
There are no family relationships between or among any of the current directors, executive officers or persons nominated or charged to become
directors or executive officers. There are no family relationships among our officers and directors and those of our subsidiaries and affiliated
companies.
Involvement in Certain Legal Proceedings
There are no orders, judgments, or decrees of any governmental agency or administrator, or of any court of competent jurisdiction, revoking or
suspending for cause any license, permit or other authority to engage in the securities business or in the sale of a particular security or temporarily or
permanently restraining any of our officers or directors from engaging in or continuing any conduct, practice or employment in connection with the
purchase or sale of securities, or convicting such person of any felony or misdemeanor involving a security, or any aspect of the securities business or
of theft or of any felony. Nor are any of the officers or directors of any corporation or entity affiliated with us so enjoined.
Compliance with Section 16(a) of the Exchange Act
Based solely on review of the copies of such forms furnished to the Company, or written representations that no reports were required, the
Company believes that for the fiscal year ended March 31, 2011, our directors, executive officers and holders of 10% or more of our common stock
complied with Section 16(a) filing requirements applicable to them, except for Mr. Shike Zhu.
40
The Board of Directors and Committees
We seek directors with established strong professional reputations and experience in areas relevant to the strategy and operations of our
businesses. We also seek directors who possess the qualities of integrity and candor, who have strong analytical skills and who are willing to engage
management and each other in a constructive and collaborative fashion. We also seek directors who have the ability and commitment to devote
significant time and energy to service on the board and its committees. We believe that all of our directors meet the foregoing qualifications.
Based on the information submitted by Marc Thomas Serrio, Bowen Zhao, Yuehai Ke, Shuizhen Wu and Xiaomeng Yu, our board of directors
has determined that each of them is independent under Rule 5605(a)(2) of The NASDAQ Listing Rules.
During the fiscal year ended March 31, 2011, our board of directors and its committees held the following number of meetings and took the
following number of actions by unanimous written consent:
Board of directors
Audit committee
Compensation committee
Nominating committee
Meetings
0
4
0
0
Unanimous written
consents
3
1
1
1
Audit Committee
Our audit committee operates under a written charter, and is made up of three independent directors: Marc Thomas Serrio, Yuehai Ke and
Shuizhen Wu, who were appointed to the committee on March 15, 2010. Our board of directors has determined, based on information furnished by Mr.
Serrio and other available information, that Mr. Serrio meets the requirements of an “audit committee financial expert” as such term is defined in the
rules promulgated under the Securities Act and the Exchange Act, and has accordingly designated him as such as well as chairman of the committee.
The responsibilities of our audit committee include:
● meeting with our management periodically to consider the adequacy of our internal control over financial reporting and the objectivity of our
financial reporting;
● appointing the independent registered public accounting firm, determining the compensation of the independent registered public accounting
firm and pre-approving the engagement of the independent registered public accounting firm for audit and non-audit services;
● overseeing the independent registered public accounting firm, including reviewing independence and quality control procedures and
experience and qualifications of audit personnel that are providing us audit services;
● meeting with the independent registered public accounting firm and reviewing the scope and significant findings of the audits performed by
them, and meeting with management and internal financial personnel regarding these matters; and
● reviewing our financing plans, the adequacy and sufficiency of our financial and accounting controls, practices and procedures, the activities
and recommendations of the auditors and our reporting policies and practices, and reporting recommendations to our full board of directors
for approval.
Compensation Committee
Our compensation committee operates under a written charter, and is made up of three independent directors: Yuehai Ke, Bowen Zhao and
Xiaomeng Yu, who were appointed to the committee on March 15, 2010. Dr. Ke is chairman of the committee. Our compensation committee will
oversee and, as appropriate, making recommendations to the board of directors regarding the annual salaries and other compensation of our executive
officers and our employees, and other policies, and provide assistance and recommendations with respect to our compensation policies and practices.
Nominating Committee
Our nominating committee operates under a written charter, and is made up of three independent directors: Shuizhen Wu, Bowen Zhao and
Xiaomeng Yu, who were appointed to the committee on March 15, 2010. Dr. Wu is chairwoman of the committee. Our compensation committee will
assist in the selection of director nominees, approve director nominations to be presented for stockholder approval at our annual general meeting and fill
any vacancies on our board of directors, consider any nominations of director candidates validly made by stockholders, and review and consider
developments in corporate governance practices.
Code of Ethics
We have adopted a code of ethics that applies to our officers, directors and employees, including our chief executive officer, senior executive
officers, principal accounting officer, and other senior financial officers. A copy of our code of ethics will also be provided to any person without
charge, upon written request sent to us at our offices located at Room 507-513, 5th Floor, A Building, Meidu Plaza, Gongshu District, Hangzhou,
Zhejiang Province, China.
41
ITEM 11. EXECUTIVE COMPENSATION
Summary of Compensation
The following summary compensation table indicates the cash and non-cash compensation earned during the fiscal years ended March 31, 2011
and 2010 by (i) our CEO (principal executive officer), (ii) our CFO (principal financial officer), (iii) the three most highly compensated executive
officers other than our CEO and CFO who were serving as executive officers at the end of our last completed fiscal year, whose total compensation
exceeded $100,000 during such fiscal year ends, and (iv) up to two additional individuals for whom disclosure would have been provided but for the fact
that the individual was not serving as an executive officer at the end of our last completed fiscal year, whose total compensation exceeded $100,000
during such fiscal year ends.
SUMMARY COMPENSATION TABLE
Bonus
($)
Stock
Awards
( $)
Option
Awards
($)
Non-Equity
Incentive
Plan
Compensation
($)
Nonqualified
Deferred
Compensation
Earnings
($)
All Other
Compensation
( $)
Name and
Principal
Position
Fiscal Year
ended
March 31,
2010
2011
2010
2011
2010
2011
Salary
($)
21,942
22,000
-0-
100,000
19,894
20,000
Lei Liu,
CEO (1)
Bennet P. Tchaikovsky,
CFO (2)
Li Qi,
Secretary (1)
______________________
(1) Compensation as reported is based on interbank exchange rate of RMB 0.15220 to $1.00 on March 31, 2011.
-0-
-0-
-0-
61,796
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
Total
($)
21,942
22,000
-0-
161,796
19,894
20,000
(2) Mr. Tchaikovsky’s compensation under “Stock Awards” represents 13,261 shares of common stock in connection with the Loanout agreement
for his services dated May 14, 2010, including 9,261 shares vested as of March 31, 2011 pursuant to a vesting schedule and 4,000 shares issued
as a bonus.
Outstanding Equity Awards at Fiscal Year Ended March 31, 2011
As of March 31, 2011, we had an obligation to issue 13,261 shares to Mr. Tchaikovsky. Such shares were issued to Mr. Tchaikovsky in May
2011 under the China Jo-Jo Drugstores, Inc. 2010 Equity Incentive Plan.
Employment Agreements, Termination of Employment and Change-in-Control Arrangements
Except as described below, we currently have no employment agreements with any of our executive officers, nor any compensatory plans or
arrangements resulting from the resignation, retirement or any other termination of any of our executive officers, from a change-in-control, or from a
change in any executive officer’s responsibilities following a change-in-control.
Agreements for the Services of Bennet P. Tchaikovsky
On July 30, 2009, Jiuzhou Pharmacy entered into a CFO Services Agreement (the “CFO Agreement”) with Worldwide Officers, Inc., a
California corporation (“WOI”), to retain the services of Bennet P. Tchaikovsky as its chief financial officer until the completion of a financing. Under
the terms of the CFO Agreement, Mr. Tchaikovsky performs his duties from the United States for compensation of $30,000 through the close of a
financing. The CFO Agreement terminates at the closing of a financing, provided that Jiuzhou Pharmacy shall enter into a new agreement at that time
with WOI to continue Mr. Tchaikovsky’s engagement as chief financial officer. Jiuzhou Pharmacy may also terminate the CFO Agreement upon a 30-
day written notice to Mr. Tchaikovsky. On the other hand, Mr. Tchaikovsky may terminate the CFO Agreement upon a 90-day written notice to
Jiuzhou Pharmacy.
On May 14, 2010, we entered into a Loanout Agreement with Worldwide Officers, Inc. (“WOI”) pursuant to which we engaged the services of
Mr. Tchaikovsky as our Chief Financial Officer for a period of one year beginning May 14, 2010. Mr. Tchaikovsky has been serving as our Chief
Financial Officer since May 15, 2011 without a written agreement with us.
Under the Loanout Agreement, we will pay cash compensation of $100,000 to WOI in 4 installments of $25,000 upon the signing of the Loanout
Agreement and on July 28, 2010, October 28, 2010 and January 28, 2011. We will also issue 10,000 restricted shares of our common stock to WOI as
further compensation for Mr. Tchaikovsky’s services which will be held in escrow and vest in five installments and distributed to WOI or its designee
at the end of the one year term. In addition, we will issue to WOI 4,000 shares of our common stock as bonus. The shares issuable to WOI are to be
issued under a stock plan to be adopted by us, which we agree to use best efforts to adopt by August 31, 2010. In addition to the foregoing, WOI is also
entitled to reimbursement of reasonable expenses incurred in connection with Mr. Tchaikovsky’s services, and Mr. Tchaikovsky is entitled to be
included as an insured under a directors and officers’ insurance policy to be obtained by us.
Concurrently with the entry of the Loanout Agreement, we entered into an Indemnification Agreement with Mr. Tchaikovsky, pursuant to which
we agree to hold Mr. Tchaikovsky harmless and indemnify him for and against any expense, liability or loss paid or incurred in connection with any
action, suit or proceeding arising from or related to the fact that he is or was an officer of the Company, or serving in other capacities at the request of
the Company, or anything done by him in such capacity.
42
Director Compensation
The following table provides compensation information for our directors during the fiscal year ended March 31, 2011:
Name
Lei Liu (2)
Li Qi (2)
Chong’an Jin
Shike Zhu
Marc Thomas Serrio (3)
Bowen Zhao
Yuehai Ke
Shuizhen Wu
Xiaomeng Yu
Fiscal Year
ended
March 31,
2011
2011
2011
2011
2011
2011
2011
2011
2011
DIRECTOR COMPENSATION TABLE
Fees
Earned
or
Paid in
Cash
($)
Stock
Awards
($)(1)
Option
Awards
($)(1)
Non-Equity
Incentive
Plan
Compensation
($)
Nonqualified
Deferred
Compensation
Earnings
($)
All Other
Compensation
($)
Total
($)
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
40,000
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
40,000
-0-
-0-
-0-
-0-
(1) Reflects dollar amount expensed by the Company during the applicable fiscal year for financial statement reporting purposes.
(2)
This individual's compensation is reflected in the Summary Compensation Table on page 42 above.
(3) Mr. Serrio’s compensation under “Stock Awards” represents 6,897 shares of common stock in connection with his director offer letter dated
March 14, 2010, which shares were issued to him in May 2011 under the China Jo-Jo Drugstores, Inc. 2010 Equity Incentive Plan.
We do not currently have an established policy to provide compensation to members of our board of directors for their services in that capacity,
although we have entered into certain agreements with a director as described below. We intend to develop such a policy in the near future.
Agreements with Directors
On March 15, 2010, we entered into an agreement with Mr. Serrio in the form of a director offer letter, pursuant to which we have agreed to
compensate him $40,000 annually for his services as a director and audit committee financial expert and chairman, in the form of 6,897 restricted
shares of our common stock payable in four quarterly installments beginning with the quarter ending March 31, 2010. Additionally, we are obligated to
obtain and maintain a directors and officers’ insurance policy, and to include Mr. Serrio as an insured under such policy.
Concurrently with the director offer letter, we also entered into an indemnification agreement with Mr. Serrio, pursuant to which we agree to
hold Mr. Serrio harmless and indemnify him from and against any expense, liability or loss paid or incurred in connection with any action, suit or
proceeding arising from or related to the fact that Mr. Serrio is or was a director of the Company or anything done by him in such capacity.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
Equity Compensation Plan Information
Plan Category
Equity compensation plans approved by
security holders
Equity compensation plans not approved by
security holders
TOTAL
Number of securities to be
issued
upon exercise of
outstanding
options, warrants and rights
Weighted-average exercise
price of outstanding options,
warrants and rights
Number of securities
remaining
available for future issuance
under equity compensation
plans
26,897
—
26,897
4.98
—
4.98
1,998,103
—
1,998,103
On September 21, 2010, our board of directors approved a stock incentive plan for officers, directors, employees, and consultants entitled
“China Jo-Jo Drugstores, Inc. 2010 Equity Incentive Plan” (the “Plan”). The maximum number of shares that may be issued under the Plan is
2,025,000 shares of our common stock. The Plan was approved by our shareholders at our annual meeting held on November 2, 2010. Under the Plan,
the Company may issue common stock and/or options to purchase common stock to our officers, directors, employees and consultants. The Plan is
administered either by our board of directors or a committee that it designates comprising of at least two “non-employee” directors. The board (or the
committee if one is designated) has full and complete authority, in its discretion, but subject to the express provisions of the Plan, to grant awards, to
determine the number of awards to be granted and the time or times at which awards shall be granted; to establish the terms and conditions upon which
awards may be exercised; to remove or adjust any restrictions and conditions upon awards; to specify, at the time of grant, provisions relating to
exercisability of awards and to accelerate or otherwise modify the exercisability of any awards; and to adopt such rules and regulations and to make all
other determinations deemed necessary or desirable for the administration of the Plan. As of March 31, 2011, there are 1,998,103 shares of our
common stock remaining available for future issuance under the Plan.
43
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding our common stock beneficially owned on June 24, 2011 for (i) each stockholder
known to be the beneficial owner of 5% or more of our outstanding common stock, (ii) each executive officer and director, and (iii) all executive
officers and directors as a group. To the best of our knowledge, subject to community and marital property laws, all persons named have sole voting
and investment power with respect to such shares, except as otherwise noted.
Common Stock Beneficially Owned
Executive officers and directors: (1)
Lei Liu, chief executive officer and chairman of the board of directors (4)
Bennet P. Tchaikovsky, chief financial officer (5)
Li Qi, Secretary and Director (4)
Chong’an Jin, Director (4)
Shike Zhu, Director (6)
Marc Thomas Serrio (7)
Bowen Zhao (8)
Yuehai Ke (9)
Shuizhen Wu (10)
Xiaomeng Yu (11)
All directors and executive officers as a group (5 persons)
5% Shareholders: (1)
Super Marvel Limited (4)
Number of
Shares
beneficially
owned (2)
Percentage of
class beneficially
owned (3)
6,030,000
114,000
6,030,000
6,030,000
250,000
10,231
0
0
0
0
6,404,231
44.6 %
* %
44.6 %
44.6 %
1.8 %
*
0 %
0 %
0 %
0 %
47.3 %
6,030,000
44.6 %
Less than 1%.
*
(1) Unless otherwise noted, the address for each of the named beneficial owners is: Room 507-513, 5th Floor, A Building, Meidu Plaza,
Gongshu District, Hangzhou, Zhejiang Province, China.
(2) Under Rule 13d-3, a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement,
understanding, relationship, or otherwise has or shares: (i) voting power, which includes the power to vote, or to direct the voting of shares;
and (ii) investment power, which includes the power to dispose or direct the disposition of shares. Certain shares may be deemed to be
beneficially owned by more than one person (if, for example, persons share the power to vote or the power to dispose of the shares). In
addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire the shares (for example, upon
exercise of an option) within 60 days of the date as of which the information is provided. In computing the percentage ownership of any
person, the amount of shares outstanding is deemed to include the amount of shares beneficially owned by such person (and only such
person) by reason of these acquisition rights. As a result, the percentage of outstanding shares of any person as shown in this table does
not necessarily reflect the person's actual ownership or voting power with respect to the number of shares of common stock actually
outstanding.
(3) Unless otherwise noted, the number and percentage of outstanding shares of common stock is based upon 13,531,579 shares outstanding as
of June 24, 2011.
(4) The address of Super Marvel Limited (“Super Marvel”) is P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British
Virgin Islands. The owners of Super Marvel are Lei Liu (39%), who is also its executive director, and Li Qi (30%) and Chong’an Jin
(31%), who are also its directors. As such, they are deemed to have or share investment control over Super Marvel’s portfolio. The
numbers of shares of common stock reported herein as beneficially owned by Mr. Liu, Ms. Qi and Mr. Jin are held by Super Marvel,
which they in turn own indirectly through their respective ownership of Super Marvel.
(5) Bennet P. Tchaikovsky’s address is: 6571 Morningside Drive, Huntington Beach, CA 92648.
(6)
(7) Marc Thomas Serrio’s address is: P.O. Box 91836, Pasadena, California 91109. Includes 3,334 shares to which Mr. Serrio has the right to
Shike Zhu’s address is: Citigroup Tower, 24/F, 33 Hua Yuan Shi Qiao Road, Pudong New Area, Shanghai, China 200120.
acquire within 60 days of June 11 2011.
(8) Bowen Zhao’s address is: Room 1315, Hualong Business Building, No. 110 N. Ganshan Road, Hangzhou, China 310000.
(9) Yuehai Ke’s address is: 388 Yuhangtang Road, Hangzhou, China 310058.
(10) Shuizhen Wu’s address is: Room 2302, #20 Building, Hanlinguan Daxue Road, Hangzhou, China 310000.
(11) Xiaomeng Yu’s address is: Wen Hui Guan Quen Fang 7-2, No. 3 Street, Baiyang Street, Economic Commercial and Technological
Development Area, Hangzhou, China 310018.
44
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Share Exchange Agreement
On September 17, 2009, in connection with the share exchange agreement that we executed with Renovation and its stockholders, we issued
7,900,000 shares of our common stock to the stockholders of Renovation in exchange for 100% of the issued and outstanding common stock of
Renovation. As a result, the stockholders of Renovation became our controlling shareholders and Renovation became our wholly-owned subsidiary.
Other Related Party Transactions
Set forth below are the related party transactions us and our officers and/or directors as of the dates set forth on the table:
Amount due to director (1):
March 31,
2011
March 31,
2010
$
800,058
$
935,000
(1) As of March 31, 2011, the amount due to directors represents contribution from directors, Li Qi, Chong 'an Jin, and Lei Liu to Jiuxin Management
to enable Jiuxin Management to meet its approved PRC registered capital requirements. Such contributions are to be returned to the directors
upon demand.
We also lease a retail space and our corporate office from Mr. Liu under long-term operating lease agreements from August 2010 to August
2012 and from January 2011 to December 2012, respectively. The rents are $178,912 and $175,968 for years ended March 31, 2011 and 2010,
respectively. The rent paid to Mr. Liu amounted to $178,912 and $175,968 for the years ended March 31, 2011 and 2010, respectively.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Frazer Frost, LLP (“Frazer Frost”) served as our independent registered public accounting firm for fiscal year ended March 31, 2010. On April
19, 2011, we dismissed Frazer Frost and appointed Friedman, LLP (“Friedman”) as our new independent registered public accounting firm for fiscal
year ended March 31, 2011. The following table shows the fees that were billed for audit and other services provided by these firms during the 2010
and 2011 fiscal years:
2010
Frazer Frost
Fiscal year ended March 31,
2011
Frazer Frost
Friedman
Audit fees (1)
Audit-related fees (2)
Tax fees (3)
All other fees (4)
Total
$
$
$
235,000
0
0
0
235,000
$
$
0
75,000
0
3,500
$
78,500
160,000
15,000
0
0
175,000
(1) Audit Fees – This category includes the audit of our annual financial statements, review of financial statements included in our Quarterly Reports
on Form 10-Q, and services that are normally provided by independent auditors in connection with statutory and regulatory filings or the
engagement for fiscal years. This category also includes advice on audit and accounting matters that arose during, or as a result of, the audit or
the review of interim financial statements.
(2) Audit-Related Fees – This category consists of assurance and related services by our independent auditors that are reasonably related to the
performance of the audit or review of our financial statements and are not reported above under "Audit Fees." The services for the fees disclosed
under this category include consultation regarding our correspondence with the SEC.
(3) Tax Fees – This category consists of professional services rendered by our independent auditors for tax compliance and tax advice. The services
for the fees disclosed under this category include tax return preparation and technical tax advice.
(4) All Other Fees – This category consists of fees for other miscellaneous items.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1) Financial Statements
The following consolidated financial statements of China Jo-Jo are included in Part II, Item 8 of this Report:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at March 31, 2011 and 2010
Consolidated Statements of Operations and Comprehensive Income for the Years Ended March 31, 2011 and 2010
Consolidated Statements of Shareholders’ Equity for the Years Ended March 31, 2011 and 2010
Consolidated Statements of Cash Flows for the Years Ended March 31, 2011 and 2010
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules
Schedules are omitted because the required information is not present or is not present in amounts sufficient to require submission of the schedule or
because the information required is given in the consolidated financial statements or the notes thereto.
(3) Exhibits
45
Exhibit
Number
2
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
10.27
10.28
10.29
10.30
10.31
14
16.1
16.2
21
23.1
23.2
31.1
31.2
32.1
32.2
99.1
99.2
99.3
99.4
EXHIBIT INDEX
Description
Share Exchange Agreement among Kerrisdale Mining Corporation (“Kerrisdale”), certain of its stockholders, Renovation Investment
(Hong Kong) Co., Ltd. (“Renovation”) and its shareholders dated September 17, 2009 (3)
Articles of Incorporation of Kerrisdale (1)
Certificate of Amendment to Articles of Incorporation of Kerrisdale filed with the Nevada Secretary of State on July 14, 2008 (2)
Articles of Merger between Kerrisdale Mining and China Jo-Jo Drugstores, Inc. filed with the Nevada Secretary of State on September
22, 2009 (3)
Bylaws (1)
Text of Amendments to the Bylaws (2)
Certificate of Change Pursuant to NRS 78.209 with an effective date of April 9, 2010 (7)
Specimen of Common Stock Certificate (1)
2010 Equity Incentive Plan (10)
Consulting Services Agreement between Zhejiang Jiuxin Investment Management Co., Ltd. (“Jiuxin Management”) and Hangzhou
Jiuzhou Grand Pharmacy Chain Co., Ltd. (“Jiuzhou Pharmacy”) dated August 1, 2009 (3)
Operating Agreement among Jiuxin Management, Jiuzhou Pharmacy and its owners dated August 1, 2009 (3)
Equity Pledge Agreement among Jiuxin Management, Jiuzhou Pharmacy and its owners dated August 1, 2009 (3)
Option Agreement among Jiuxin Management, Jiuzhou Pharmacy and its owners dated August 1, 2009 (3)
Voting Rights Proxy Agreement among Jiuxin Management, Jiuzhou Pharmacy and its owners dated August 1, 2009 (3)
Consulting Services Agreement between Jiuxin Management and Hangzhou Jiuzhou Clinic of Integrated Traditional and Western
Medicine (General Partnership) (“Jiuzhou Clinic”) dated August 1, 2009 (3)
Operating Agreement among Jiuxin Management, Jiuzhou Clinic and its owners dated August 1, 2009 (3)
Equity Pledge Agreement among Jiuxin Management, Jiuzhou Clinic and its owners dated August 1, 2009 (3)
Option Agreement among Jiuxin Management, Jiuzhou Clinic and its owners dated August 1, 2009 (3)
Voting Rights Proxy Agreement among Jiuxin Management, Jiuzhou Clinic and its owners dated August 1, 2009 (3)
Consulting Services Agreement between Jiuxin Management and Hangzhou Jiuzhou Medical & Public Health Service Co., Ltd.
(“Jiuzhou Service”) dated August 1, 2009 (3)
Operating Agreement among Jiuxin Management, Jiuzhou Service and its owners dated August 1, 2009 (3)
Equity Pledge Agreement among Jiuxin Management, Jiuzhou Service and its owners dated August 1, 2009 (3)
Option Agreement among Jiuxin Management, Jiuzhou Service and its owners dated August 1, 2009 (3)
Voting Rights Proxy Agreement among Jiuxin Management, Jiuzhou Service and its owners dated August 1, 2009 (3)
Amendment to Consulting Services Agreement between Jiuxin Management and Jiuzhou Pharmacy dated October 27, 2009 (4)
Amendment to Operating Agreement between Jiuxin Management and Jiuzhou Pharmacy dated October 27, 2009 (4)
Amendment to Option Agreement between Jiuxin Management and Jiuzhou Pharmacy dated October 27, 2009 (4)
Amendment to Voting Rights Proxy Agreement between Jiuxin Management and Jiuzhou Pharmacy dated October 27, 2009 (4)
Amendment to Consulting Services Agreement between Jiuxin Management and Jiuzhou Clinic dated October 27, 2009 (4)
Amendment to Operating Agreement between Jiuxin Management and Jiuzhou Clinic dated October 27, 2009 (4)
Amendment to Option Agreement between Jiuxin Management and Jiuzhou Clinic dated October 27, 2009 (4)
Amendment to Voting Rights Proxy Agreement between Jiuxin Management and Jiuzhou Clinic dated October 27, 2009 (4)
Amendment to Consulting Services Agreement between Jiuxin Management and Jiuzhou Service dated October 27, 2009 (4)
Amendment to Operating Agreement between Jiuxin Management and Jiuzhou Service dated October 27, 2009 (4)
Amendment to Option Agreement between Jiuxin Management and Jiuzhou Service dated October 27, 2009 (4)
Amendment to Voting Rights Proxy Agreement between Jiuxin Management and Jiuzhou Service dated October 27, 2009 (4)
Director Offer Letter with Marc Thomas Serrio dated March 15, 2010 (6)
Indemnification Agreement with Marc Thomas Serrio dated March 15, 2010 (6)
Loanout Agreement with Worldwide Officers, Inc. dated May 14, 2010 (8)
Indemnification Agreement with Mr. Bennet Tchaikovsky dated May 14, 2010 (8)
Code of Business Conduct and Ethics (6)
Letter from Frazer Frost, LLP dated April 25, 2011 (12)
Letter from Frazer Frost, LLP dated May 19, 2011 (13)
List of subsidiaries *
Consent of Independent Publicly Registered Accounting Firm, Friedman, LLP *
Consent of Independent Publicly Registered Accounting Firm, Frazer Frost, LLP *
Section 302 Certification by the Corporation’s Chief Executive Officer *
Section 302 Certification by the Corporation’s Chief Financial Officer *
Section 906 Certification by the Corporation’s Chief Executive Officer *
Section 906 Certification by the Corporation’s Chief Financial Officer *
Agreement for Logistics Services entered into between Jiuzhou Pharmacy and Zhejiang Yingte Logistics Co., Ltd. (“Yingte Logistics”)
dated January 1, 2011 (11)
Form of CFO Services Agreement entered into between Jiuzhou Pharmacy and Worldwide Officers, Inc. on July 30, 2009 (5)
Project Agreement between The People’s Government of Qianhong Village, Lin’an, Zhejiang Province (the “Qianhong Local
Government”) and Jiuzhou Pharmacy dated February 27, 2010 (9)
Security Deposit Agreement between the Qianhong Local Government and Jiuzhou Pharmacy dated February 27, 2010 (9)
46
*
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
Filed herewith
Incorporated by reference from the Registrant’s Registration Statement on Form SB-2 filed on November 28, 2007
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 15, 2008
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on September 24, 2009
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on October 30, 2009
Incorporated by reference from the Registrant’s Registration Statement on Form S-1/A filed on January 27, 2010
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on March 16, 2010
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on April 14, 2010
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on May 14, 2010
Incorporated by reference from the Registrant’s Annual Report on Form 10-K filed on June 29, 2010
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on November 3, 2010
Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed on February 14, 2011
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on April 25, 2011
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on May 19, 2011
47
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.
SIGNATURES
Date: June 29, 2011
Date: June 29, 2011
CHINA JO-JO DRUGSTORES, INC.
(Registrant)
By: /s/ Lei Liu
Lei Liu
Chief Executive Officer
By: /s/ Bennet P. Tchaikovsky
Bennet P. Tchaikovsky
Chief Financial Officer
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Name
Title
/s/ Lei Liu
Lei Liu
Chief Executive Officer / Director
/s/ Bennet P. Tchaikovsky
Bennet P. Tchaikovsky
Chief Financial Officer
/s/ Li Qi
Li Qi
/s/ Chong’an Jin
Chong’an Jin
/s/ Shike Zhu
Shike Zhu
/s/ Yuehai Ke
Yuehai Ke
/s/ Marc Thomas Serrio
Marc Thomas Serrio
/s/ Shuizhen Wu
Shuizhen Wu
/s/ Xiaomeng Yu
Xiaomeng Yu
/s/ Bowen Zhao
Bowen Zhao
Secretary / Director
Director
Director
Director
Director
Director
Director
Director
48
Date
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
June 29, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
China Jo-Jo Drugstore, Inc. and subsidiaries
We have audited the accompanying consolidated balance sheets of China Jo-Jo Drugstore, Inc. and subsidiaries (the “Company”) as of March 31,
2011 and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity, and cash flows for the year ended
March 31, 2011. 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 audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides 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 the Company as of
March 31, 2011, and the consolidated results of its operations and its cash flows for year then ended in conformity with accounting principles generally
accepted in the United States of America.
/s/ Friedman LLP
Marlton, New Jersey
June 29, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
China Jo-Jo Drugstores, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of China Jo-Jo Drugstores, Inc. and subsidiaries as of March 31, 2010 and 2009, and
the related consolidated statements of income and other comprehensive income, shareholders’ equity and cash flows for each of the years in the two-
year period ended March 31, 2010. China Jo-Jo Drugstores, Inc. and subsidiaries’ management is responsible for these financial statements. Our
responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 China Jo-Jo
Drugstores, Inc. and subsidiaries as of March 31, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the two-
year period ended March 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
/s/ Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth Frazer and Torbet, LLP, see Form 8-K filed on January 7, 2010)
Brea, California
June 29, 2010
CHINA JO-JO DRUGSTORES, INC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2011 AND MARCH 31, 2010
ASSETS
CURRENT ASSETS
Cash
Restricted cash
Trade accounts receivable, net
Inventories
Other receivables
Advances to suppliers
Other current assets
Total current assets
PROPERTY AND EQUIPMENT, net
OTHER ASSETS:
Long term deposit
Prepaid noncurrent
Intangible assets
Total other assets
Total assets
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable, trade
Notes payable
Other payables
Other payables - related parties
Customer deposits
Taxes payable
Short-term loans
Accrued liabilities
Total current liabilities
Purchase option derivative liability
Total liabilities
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock; $0.001 par value; 10,000,000 shares authorized;
nil issued and outstanding as of March 31, 2011 and 2010
Common stock; $0.001 par value; 250,000,000 shares authorized;
13,519,434 and 10,000,000 shares issued and outstanding
as of March 31, 2011 and March 31, 2010, respectively
Paid-in capital
Statutory reserves
Retained earnings
Accumulated other comprehensive loss
Total shareholders' equity
$
2011
2010
6,489,905 $
921,876
1,484,850
4,617,420
1,049,564
16,528,772
8,364,267
39,456,654
801,593
746,703
1,228,294
3,770,411
282,073
6,850,240
1,331,167
15,010,481
5,471,432
1,186,292
2,540,758
6,075,478
390,302
9,006,538
2,311,661
5,508,963
-
7,820,624
$
53,934,624 $
24,017,397
$
3,530,204 $
2,704,680
627,734
880,058
2,038,608
1,624,558
-
311,639
11,717,481
153,226
11,870,707
2,330,317
1,464,241
225,716
935,000
-
1,235,083
880,200
257,091
7,327,648
-
7,327,648
13,530
16,333,956
1,309,109
23,287,474
1,119,848
42,063,917
10,000
877,884
1,309,109
14,855,016
(362,260)
16,689,749
Total liabilities and shareholders' equity
$
53,934,624 $
24,017,397
See reports of independent registered public accounting firms. The accompanying notes are an integral part of these consolidated financial statements.
F-1
CHINA JO-JO DRUGSTORES, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR YEARS ENDED MARCH 31, 2011 AND 2010
REVENUES
COST OF GOODS SOLD
GROSS PROFIT
SELLING EXPENSES
GENERAL & ADMINISTRATIVE EXPENSES
OPERATING EXPENSES
INCOME FROM OPERATIONS
OTHER INCOME (EXPENSE), NET
CHANGE IN FAIR VALUE OF PURCHASE OPTION DERIVATIVE LIABILITY
INCOME BEFORE INCOME TAXES
PROVISION FOR INCOME TAXES
NET INCOME
OTHER COMPREHENSIVE INCOME
Foreign currency translation adjustments
COMPREHENSIVE INCOME
2011
69,969,479 $
2010
55,174,929
$
48,827,385
38,276,889
21,142,094
16,898,040
4,838,745
4,723,943
9,562,688
2,630,332
1,510,154
4,140,486
11,579,406
12,757,554
127,172
249,225
(55,520)
-
11,955,803
12,702,034
3,523,345
2,880,293
8,432,458
9,821,741
1,482,108
177
$
9,914,566 $
9,821,918
BASIC AND DILUTED WEIGHTED AVERAGE NUMBER OF SHARES
13,254,792
9,025,000
BASIC AND DILUTED EARNING PER SHARE
$
0.64 $
1.09
See reports of independent registered public accounting firms. The accompanying notes are an integral part of these consolidated financial statements.
F-2
CHINA JO-JO DRUGSTORES, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR YEARS ENDED MARCH 31, 2011 AND 2010
Common Stock
Number of
shares
Amount
Paid-in
capital
Retained Earnings
Statutory
reserves Unrestricted
Totals
Accumulated
other
comprehensive
income/(loss)
BALANCE, March 31, 2009
7,900,000 $
7,900 $
669,700 $ 1,309,109 $ 5,033,275 $
(362,437) $ 6,657,547
Shares issued for reorganization on
September 17, 2009
Stock-based compensation
Net income
Shareholder contribution
Foreign currency translation adjustments
2,100,000
2,100
(2,100)
202,120
8,164
9,821,741
-
202,120
9,821,741
8,164
177
177
BALANCE, March 31, 2010
10,000,000 $
10,000 $
877,884 $ 1,309,109 $ 14,855,016 $
(362,260) $16,689,749
Issuance of common stock
Fractional shares due to the one-for-two
reverse split
Classification of purchase option as a
derivative liability
Stock based compensation
Net Income
Foreign currency translation adjustments
3,500,000
3,500 15,705,108
15,708,608
2
-
30,475
30
(402,451)
153,415
8,432,458
(402,451)
153,445
8,432,458
1,482,108 1,482,108
BALANCE, March 31, 2011
13,530,477 $
13,530 $16,333,956 $ 1,309,109 $ 23,287,474 $
1,119,848 $42,063,917
See reports of independent registered public accounting firms. The accompanying notes are an integral part of these consolidated financial statements.
F-3
CHINA JO-JO DRUGSTORES, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 2011 AND 2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization
Stock compensation
Change in fair value of purchase option derivative liability
Change in operating assets
Accounts receivable, trade
Inventories
Other receivables
Advances to suppliers
Other current assets
Long term deposit
Prepaid rent - noncurrent
Change in operating liabilities
Accounts payable, trade
Other payables and accrued liabilities
Taxes payable
Net cash provided by (used in) operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment
Additions to leasehold improvements
Payments on construction-in-progress
Cash paid for business acquisition
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in restricted cash
Proceeds from notes payable
Proceeds from equity financing
Proceeds from short-term loans
Payments on short-term loans
Payments on other payables- related parties
Net cash provided by (used in) financing activities
EFFECT OF EXCHANGE RATE ON CASH
INCREASE (DECREASE) IN CASH
CASH, beginning of year
CASH, end of year
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest
Cash paid for income taxes
2011
2010
$
8,432,458 $
9,821,741
810,374
153,445
(249,225)
(201,405)
(648,785)
(686,305)
(9,177,936)
(6,927,371)
(131.302)
(332,971)
1,075,811
2,370,213
329,251
(5,183,748)
(443,112)
(768,583)
(3,431,597)
(606,800)
(5,250,092)
(141,192)
1,152,597
15,708,608
-
(894,564)
(54,942)
15,770,507
396,574
126,325
-
38,527
(973,099)
(212,380)
441,738
(765,493)
(293,640)
(5,507,130)
(2,151,905)
(536,436)
422,487
807,309
(74,516)
-
-
(527,709)
(602,225)
(746,703)
-
-
2,343,600
(2,932,400)
935,000
(400,503)
351,645
710
5,688,312
(194,709)
801,593
996,302
$
6,489,905 $
801,593
$
$
23,872
2,235,386
$
$
65,011
2,606,347
See reports of independent registered public accounting firms. The accompanying notes are an integral part of these consolidated financial statements.
F-4
CHINA JO-JO DRUGSTORES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2011
Note 1 – DESCRIPTION OF BUSINESS AND ORGANIZATION
China Jo-Jo Drugstores, Inc. (“Jo-Jo Drugstores” or the “Company”), was incorporated in Nevada on December 19, 2006, originally under the name
“Kerrisdale Mining Corporation.” On September 24, 2009, the Company changed its name to “China Jo-Jo Drugstores, Inc.” in connection with a share
exchange transaction as described below.
On September 17, 2009, the Company completed a share exchange transaction with Renovation Investment (Hong Kong) Co., Ltd. (“Renovation”),
where by 7,900,000 shares of common stock were issued to the stockholders of Renovation in exchange for 100% of the capital stock of Renovation.
The completion of the share exchange transaction resulted in a change of control. The share exchange transaction was accounted for as a reverse
acquisition and recapitalization and, as a result, the consolidated financial statements of the Company (the legal acquirer) is, in substance, those of
Renovation (the accounting acquirer), with the assets and liabilities, and revenues and expenses, of the Company being included effective from the date
of the share exchange transaction. Renovation has no substantive operations of its own except for its holdings of Zhejiang Jiuxin Investment
Management Co., Ltd. (“Jiuxin Management”) and Zhejiang Shouantang Medical Technology Co., Ltd. (“Shouantang Technology”), its wholly-owned
subsidiaries.
The Company is primarily in the retail drugstore business in the People’s Republic of China (“China” or the “PRC”). As of March 31, 2011, all of the
Company’s pharmacies except one were operated by Hangzhou Jiuzhou Grand Pharmacy Chain Co., Ltd. (“Jiuzhou Pharmacy”), a company which
the Company controls through contractual arrangements, and the two wholly-owned subsidiaries of Jiuzhou Pharmacy, Hangzhou Kuaileren Grand
Pharmacy Co. Ltd. (“Kuaileren”) and Shanghai Lydia Grand Pharmacy Co., Ltd. (“Shanghai Lydia”) (See Note 17 – Subsequent Events). One
drugstore is operated by Hangzhou Quannuo Grand Pharmacy Co., Ltd. (“Hangzhou Quannuo”), a wholly-owned subsidiary of Zhejiang Quannuo
Internet Technology Co., Ltd. (“Quannuo Technology”), which is wholly-owned by Shouantang Technology.
The Company also operates two medical clinics through Hangzhou Jiuzhou Clinic of Integrated Traditional and Western Medicine (“Jiuzhou Clinic”)
and Hangzhou Jiuzhou Medical and Public Health Service Co., Ltd. (“Jiuzhou Service”), both of which are also controlled by the Company through
contractual arrangements. In addition, Hangzhou Jiuxin Qianhong Agriculture Development Co., Ltd. (“Jiuxin Qianhong”), which is wholly-owned by
Jiuxin Management, is operating a cultivation project of herbal plants used for traditional Chinese medicine (“TCM”).
Thus, the accompanying consolidated financial statements reflect the activities of the Company and each of the following entities:
Subsidiaries
Renovation HK
Jiuxin Management
Shouantang Technology
Background
● Incorporated in Hong Kong SAR on September 2, 2008
● Established in the PRC on October 14, 2008
● Deemed a wholly foreign owned enterprise (“WFOE”) under PRC law
● Registered capital of $4,500,000 fully paid
● Established in the PRC on July 16, 2010 by Renovation with registered capital of $20
Ownership
100%
100%
100%
million
● Deemed a WFOE under PRC law
● $11 million of registered capital paid as of March 31, 2011, the balance of $9 million due
by July 16, 2012
● To carry out internet pharmacy business, is cooperating with several major online stores
in China to develop its business
Jiuxin Qianhong
Quannuo Technology
● Established in the PRC on August 10, 2010 by Jiuxin Management
● Registered capital of RMB 10,000,000 Renminbi (“RMB”) fully paid
● To carry out cultivation of TCM herbal plants
● Established in the PRC on July 7, 2009
● Registered capital of RMB 10,000,000. RMB 2,000,000 was paid and the balance of
100%
100%
Hangzhou Quannuo
Jiuzhou Pharmacy (1)
Jiuzhou Clinic (1)
Jiuzhou Service (1)
Kuaileren
8,000,000 is due by July 7, 2011
● Acquired by Shouantang Technology in November 2010
● To develop software for internet pharmacy business, which is cooperating with several
major online stores in China to develop its business
● Established in the PRC on July 8, 2010 by Quannuo Technology
● Registered capital of RMB 800,000 fully paid
● Operates one “Quannuo Grand Pharmacy” as a Jiuzhou Pharmacy franchise store in
100%
Hangzhou
● Established in the PRC on September 9, 2003
● Registered capital of RMB 5 million fully paid
● Operates the “Hangzhou Jiuzhou Grand Pharmacy” stores in and around Hangzhou
● Established in the PRC as a general partnership on October 10, 2003
● Operates a medical clinic adjacent to one of Jiuzhou Pharmacy’s stores
● Established in the PRC on November 2, 2005
● Registered capital of RMB 500,000 fully paid
● Operates a medical clinic adjacent to one of Jiuzhou Pharmacy’s stores
● Established in the PRC on May 9, 2006
● Registered capital of RMB 100,000 fully paid
● Acquired by the owners of Jiuzhou Pharmacy in June 2009, and transferred to Jiuzhou
Pharmacy for no consideration in August 2009
● Operated the “Kuaileren Grand Pharmacy” store in Hangzhou
VIE by contractual
arrangements (2)
VIE by contractual
arrangements (2)
VIE by contractual
arrangements (2)
VIE by contractual
arrangements as a
wholly-owned subsidiary
of Jiuzhou Pharmacy
Shanghai Lydia
● Established in the PRC on January 31, 2011 by Jiuzhou Pharmacy
● Registered capital of RMB 1,000,000 fully paid
● Operates the “Lydia Grand Pharmacy” store in Shanghai
VIE by contractual
arrangements as a
wholly-owned subsidiary
of Jiuzhou Pharmacy
F-5
(1)
Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service have been under the common control of the same three owners (the “Owners”) since
their respective establishment dates, pursuant to agreements amongst the Owners to vote their interests in concert as memorialized in a voting
agreement. Based on such voting agreement, the Company has determined that common control exists among these three companies in
accordance with generally accepted accounting standards. Operationally, the Owners have operated these three companies in conjunction
with one another since each company’s respective establishment date. Kuaileren and Shanghai Lydia are also deemed under the common
control of the Owners as they are each wholly-owned by Jiuzhou Pharmacy.
(2) To comply with certain foreign ownership restrictions of pharmacy and medical clinic operators, Jiuxin Management entered into a series of
contractual arrangements with Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service on August 1, 2009. These contractual arrangements are
comprised of five agreements: consulting services agreement, operating agreement, equity pledge agreement, voting rights agreement and
option agreement. As a result of these agreements, which obligate Jiuxin Management to absorb all of the risks of loss from the activities of
Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, and enable the Company (through Jiuxin Management) to receive all of their expected
residual returns, the Company accounts for all three companies (as well as the two subsidiaries of Jiuzhou Pharmacy) as a variable interest
entity (“VIE”) under the accounting standards of the Financial Accounting Standards Board (“FASB”). Accordingly, the financial statements
of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, as well as those of Kuaileren and Shanghai Lydia, are consolidated into the financial
statements of the Company.
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and consolidation
The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of
America. The consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiaries and VIEs. All
significant inter-company transactions and balances between the Company, its subsidiaries and VIEs are eliminated upon consolidation.
Consolidation of variable interest entities
In accordance with accounting standards regarding consolidation of variable interest entities, VIEs are generally entities that lack sufficient equity to
finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs
with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary
beneficiary is required to consolidate the VIE for financial reporting purposes.
The Company has concluded, based on the contractual arrangements, that Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service are each a VIE and
that the Company’s wholly-owned subsidiary, Jiuxin Management, absorbs a majority of the risk of loss from the activities of these companies, and
enable the Company, through Jiuxin Management, to receive a majority of their respective expected residual returns. The Company has also concluded
that Kuaileren and Shanghai Lydia are VIEs by virtue of being wholly-owned subsidiaries of Jiuzhou Pharmacy.
Additionally, as Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service are under common control, the consolidated financial statements have been
prepared as if the transactions had occurred retroactively as to the beginning of the reporting period of these consolidated financial statements.
Control and common control is defined under the accounting standards as “an individual, enterprise, or immediate family members who hold more than
50 percent of the voting ownership interest of each entity.” Because the Owners collectively own 100% of Jiuzhou Pharmacy, Jiuzhou Clinic and
Jiuzhou Service, and have agreed to vote their interests in concert since the establishment of each of these three companies as memorialized the Voting
Rights Proxy Agreement, the Company believes that the Owners collectively have control and common control of the three companies. Accordingly,
the Company believes that Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service were constructively held under common control by Jiuxin
Management as of the time the Contractual Agreements were entered into, establishing Jiuxin Management as their primary beneficiary. Jiuxin
Management, in turn, is owned by Renovation, which is owned by the Company.
Although the Company has determined that the accounting standards regarding consolidation of VIEs do not provide for retroactive accounting
treatment, Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service in substance were controlled by the Owners on September 9, 2003, October 10, 2003,
and November 2, 2005, the establishment dates of Jiuzhou Pharmacy, Jiuzhou Clinic and Jiuzhou Service, respectively. Such common control conditions
resulted in the share exchange transaction to be a capital transaction in substance, reflected as a recapitalization, and the Company has accordingly
recorded the consolidation of Renovation at its historical cost.
F-6
Risks and Uncertainties
The operations of the Company are located in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be
influenced by the political, economic, and legal environments in the PRC, as well as by the general state of the PRC economy. The Company’s
operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western
Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The
Company’s results may be adversely affected by changes in the political, regulatory and social conditions in the PRC, and by changes in governmental
policies or interpretations with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and
methods of taxation, among other things. Although the Company has not experienced losses from these situations and believes that they are in
compliance with existing laws and regulations including the organization and structure disclosed in Note 1, this may not be indicative of future results.
The Company has significant cash deposits with suppliers in order to obtain and maintain inventory. Our ability to obtain products and maintain
inventory at our existing and new locations is dependent upon our ability to post and maintain significant cash deposits with our suppliers. In the PRC,
many vendors are unwilling to extend credit terms for product sales which require cash deposits to be made. We do not generally receive interest on
any of our supplier deposits and such deposits are subject to loss as a result of the creditworthiness or bankruptcy of the party who holds our funds, as
well as the risk from illegal acts such as conversion, fraud, theft or dishonesty associated with the third party. If these circumstances were to arise, we
would find it difficult or impossible, due to the unpredictability of legal proceedings in China, to recover all or a portion of the amount on deposit with our
vendors or landlords.
The current management team own controlling interests in the Company and are also the majority owners of the controlled variable interest entities in
the PRC. The Company only controls the variable interest entities through certain agreements which obligate them to absorb the risk of loss and to
receive the residual expected returns. As such, the controlling shareholders of the Company and the variable interest entities could cancel these
agreements or permit them to expire at the end of the agreement terms, and therefore the Company would not retain control of the operating
subsidiaries.
Use of estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The significant
estimates made in the preparation of the accompanying consolidated financial statements relate to the assessment of the carrying values of accounts
receivable and related allowance for doubtful accounts, useful lives of property and equipment, and fair value of purchase option derivative liability.
Because of the use of estimates inherent in the financial reporting process, actual results could materially differ from those estimates.
Fair values of financial instruments
The accounting standards regarding fair value of financial instruments and related fair value measurements define fair value, establish a three-level
valuation hierarchy for disclosures of fair value measurement and enhance disclosure requirements for fair value measures. The carrying amounts
reported in the accompanying consolidated balance sheets for receivables, payables, notes payable and short-term loans qualify as financial instruments
and are a reasonable estimate of fair values because of the short period of time between the origination of such instruments and their expected
realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:
●
●
●
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are
observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.
In connection with the public offering of the Company’s common stock that closed on April 28, 2010, the Company issued to its underwriters, Madison
Williams and Company and Rodman & Renshaw, LLC, an option for $100 to purchase up to a total of 105,000 shares of common stock (3% of the
shares sold in the public offering) at $6.25 per share (125% of the price of the shares sold in the public offering). The option is exercisable commencing
on October 23, 2010 and expires on April 22, 2015.
The Company is treating the common shares underlying the option as a derivative liability as the strike price of the option is denominated in U.S. dollars,
a currency other than the Company’s functional currency, the Chinese RMB. As a result, the option is not considered indexed to the Company’s own
stock, and as such, all future changes in the fair value of the option are recognized currently in earnings until such time as the option is exercised or
expired.
On April 22, 2010, the issue date of the option, the Company classified the fair value of this option as a liability resulting in a decrease of additional paid-
in capital of $402,451 and the establishment of a $402,451 in liability to recognize the option’s fair value. The Company recognized a gain of $249,225
from the change in fair value of the option liability for the year ended March 31, 2011, respectively. There was no option outstanding as of March 31,
2010.
F-7
This option does not trade in an active securities market, and as such, the Company estimates its fair value using the Black-Scholes Option Pricing
Model (the “Black-Scholes Model”) on the date that the option was originally issued and as of March 31, 2011 using the following assumptions:
Stock price
Exercise price
Annual dividend yield
Expected term (years)
Risk-free interest rate
Expected volatility
Underwriter Purchase Option
April 22,
2010
March 31,
2011 (1)
$
$
4.78 $
6.25 $
0%
5.00
2.57%
120%
2.61
6.25
0%
4.06
1.29%
102%
(1) As of March 31, 2011, the option to purchase 105,000 shares of common stock had not been exercised.
Expected volatility is based on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond
to the term of the option. The Company believes this method produces an estimate that is representative of future volatility over the expected term of
this option. The expected life is based on the remaining term of the option. The risk-free interest rate is based on U.S. Treasury securities according to
the remaining term of the option.
As required by the FASB’s accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is
significant to the fair value measurement. Depending on the product and the terms of the transaction, the fair values of option liability are modeled using
a series of techniques, including closed-form analytic formula, such as the Black-Scholes Model, which does not entail material subjectivity because the
methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.
The fair value of the 105,000 shares underlying the option outstanding as of March 31, 2011 was determined using the Black-Scholes Model, with
certain inputs significant to the valuation methodology as level 2 inputs, and the Company recorded the change in fair value in earnings. As a result, the
option liability is carried on the consolidated balance sheets at fair value.
The following table sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair
value as of March 31, 2011:
Carrying Value at
March 31,
2011
Purchase option derivative liability
$
153,226 $
Revenue recognition
Fair Value Measurement at
March 31,
2011
Level 2
— $
153,226 $
Level 1
Level 3
—
Revenue from sales of prescription medicine at the drugstores is recognized when the prescription is filled and the customer picks up and pays for the
prescription.
Revenue from sales of other merchandise at the drugstores is recognized at the point of sale, which is when the customer pays for and receives the
merchandise.
Revenue from medical services is recognized after the service has been rendered to the customer.
Revenue from sales of merchandise to non-retail customers is recognized when the following conditions are met: (1) persuasive evidence of an
arrangement exists (sales agreements and customer purchase orders are used to determine the existence of an arrangement); (2) delivery of goods has
occurred and risks and benefits of ownership have been transferred, which is when the goods are received by the customer at its designated location in
accordance with the sales terms; (3) the sales price is fixed or determinable; and (4) collectability is probable. Historically, sales returns have been de
minimis.
The Company’s revenue is net of value added tax (“VAT”) collected on behalf of PRC tax authorities in respect of the sale of merchandise. VAT
collected from customers, net of VAT paid for purchases, is recorded as a liability in the accompanying consolidated balance sheets until it is paid to
the relevant PRC tax authorities.
F-8
Cash and cash equivalents
Cash and cash equivalents include cash on hand, cash on deposit with banks and credit and debit card sales transactions which settle within seven days
of the fiscal year-end. The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash
equivalents.
Restricted cash
The Company’s restricted cash consists of cash in a bank as security for its notes payable. The Company has notes payable outstanding with the bank
and is required to keep certain amounts on deposit that are subject to withdrawal restrictions. The notes payable are generally short term in nature due
to their short maturity period of six to nine months; thus, restricted cash is classified as a current asset.
Accounts receivable
Accounts receivable represent amounts due from banks relating to retail sales that are paid or settled by the customers’ debit or credit cards, amounts
due from government social security bureaus relating to retail sales of drugs, prescription medicine, and medical services that are paid or settled by the
customers’ medical insurance cards, and amounts due from non-retail customers for sales of merchandise.
Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The
Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, bad debt
percentages determined by management, based on historical experience and current economic climate, are applied to customers’ balances categorized
by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the
amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an
adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts
receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable,
and known bad debts are written-off against allowance for doubtful accounts when identified. For the year ended March 31, 2011 and 2010, $393,987
and $0 accounts receivable were written off.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the first in first out method (“FIFO”). Market is the lower of
replacement cost or net realizable value. The Company carries out physical inventory counts on a monthly basis at each store and warehouse location
to ensure that the amounts reflected in the consolidated financial statements at each reporting period are properly stated and valued. The Company
records write-downs to inventories for shrinkage losses and damaged merchandise that are identified during the inventory counts. Historically, these
amounts have not been material to the consolidated financial statements.
Property and equipment
Property and equipment are stated at cost, net of accumulated depreciation or amortization. Depreciation is calculated on the straight-line method over
the following estimated useful lives of the assets, taking into consideration the assets’ estimated residual value. Leasehold improvements are amortized
over the shorter of lease term or remaining lease period of the underlying assets. Following are the estimated useful lives of the Company’s property
and equipment:
Leasehold improvements
Motor vehicles
Office equipment & furniture
Estimated Useful Life
3-5 years
5 years
3-5 years
Maintenance, repairs and minor renewals are charged to expense as incurred. Major additions and betterment to property and equipment are
capitalized.
Impairment of long lived assets
The Company evaluates long lived tangible and intangible assets for impairment, whenever events or changes in circumstances indicate that the
carrying value may not be recoverable from its estimated future cash flows. Recoverability is measured by comparing the asset’s net book value to the
related projected undiscounted cash flows from these assets, considering a number of factors including past operating results, budgets, economic
projections, market trends and product development cycles. If the net book value of the asset exceeds the related undiscounted cash flows, the asset is
considered impaired, and a second test is performed to measure the amount of impairment loss. No significant indication of impairment noted as of
March 31, 2011
Notes payable
During the normal course of business, the Company constantly issues Bank Acceptance Bills as a payment method to settle down outstanding accounts
payables to various material suppliers. The Company recorded such Bank Acceptance Bills as Notes payables. The notes payable are generally short
term in nature due to their short maturity period of six to nine months.
F-9
Income taxes
The Company records income taxes pursuant to the accounting standards for income taxes. These standards require 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 and the net change in deferred taxes. A valuation allowance is
recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized. As of March 31, 2011 and 2010, the
Company did not have any net deferred tax assets or liabilities.
The FASB’s accounting standards clarify the accounting and disclosure for uncertain tax positions and prescribe a recognition threshold and
measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. The accounting standards also
provide guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. Under these
standards, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a
tax examination being presumed to occur. Penalties or interest incurred relating to underpayment of income taxes are classified as income tax expense
in the period incurred. No significant penalties or interest relating to income taxes have been incurred during the years ended March 31, 2011 and
2010.
All of the tax returns of the Company, since inception, are subject to examination by the tax authorities.
Value added tax
Sales revenue represents the invoiced value of goods, net of Value Added Tax (“VAT”). All of the Company’s products are sold in the PRC and are
subject to a VAT on the gross sales price. The VAT rates range up to 17%, depending on the type of products sold. The VAT may be offset by VAT
paid by the Company on raw materials and other materials included in the cost of producing or acquiring its finished products. The Company recorded a
VAT payable and VAT receivable net of payments in the accompanying financial statements. The VAT tax return is filed offsetting the payables
against the receivables.
Stock based compensation
The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with
the FASB’s accounting standards regarding accounting for stock-based compensation and accounting for equity instruments that are issued to other
than employees for acquiring or in conjunction with selling goods or services. Costs are measured at the estimated fair market value of the
consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably determinable. The value of equity
instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of
performance by the provider of goods or services as defined by these accounting standards. In the case of equity instruments issued to consultants, the
fair value of the equity instrument is recognized over the term of the consulting agreement.
Advertising and promotion costs
Advertising and promotion costs are expensed as incurred. Advertising and promotion costs amounted to $458,979 and $455,543 for years ended
March 31, 2011 and 2010, respectively. Advertising and promotion costs consist primarily of print and television advertisements.
Pre-opening costs
Expenditures related to the opening of new drugstores, other than expenditures for property and equipment, are expensed as incurred.
Vendor allowances
The Company accounts for vendor allowances by reducing the carrying value of inventories which are subsequently transferred to cost of goods sold
when the inventories are sold, unless those allowances are specifically identified as reimbursements for advertising, promotion and other services, in
which case they are recognized as a reduction of the related advertising and promotion or other service costs.
The Company recognized vendor allowances of $414,365 and $236,084 in cost of goods sold for the years ended March 31, 2011 and 2010,
respectively.
Distribution costs
Distribution costs represent the costs of transporting merchandise from warehouse to stores. These costs are expensed as incurred and are included in
sales and marketing costs.
Operating leases
The Company leases premises for retail drugstores and offices under non-cancelable operating leases. Operating lease payments are expensed over
the term of lease. A majority of the Company’s retail drugstore leases have a 3 to 10-year term with a renewal option upon the expiration of the lease.
The Company has historically been able to renew a majority of its drugstores leases. Under the terms of the lease agreements, the Company has no
legal or contractual asset retirement obligations at the end of the lease. Land leased from government is amortized on a straight-line basis over a 30-
year term.
F-10
Commitments and contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and other sources are recorded when it is probable that a liability has
been incurred and the amount of the assessment can be reasonably estimated. Historically, the Company has experienced no product liability or
malpractice claims.
Foreign currency translation
The Company uses the United States dollar (“U.S. dollars” or “USD”) for financial reporting purposes. The Company’s subsidiaries and VIEs maintain
their books and records in their functional currency the Renminbi (“RMB”), being the currency of the People’s Republic of China .
In general, for consolidation purposes, the Company translates the assets and liabilities of its subsidiaries and VIEs into U.S. dollars using the applicable
exchange rates prevailing at the balance sheet date, and the statements of income and cash flows are translated at average exchange rates during the
reporting period. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in
the corresponding balances on the balance sheet. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the
financial statements of the subsidiaries and VIEs are recorded as accumulated other comprehensive income.
The balance sheet amounts with the exception of equity at March 31, 2011 and 2010 were translated at 1 RMB to $0.1527 USD and at 1 RMB to
$0.1467 USD, respectively. The average translation rates applied to income and cash flow statement amounts for the years ended March 31, 2011 and
2010 were at 1 RMB to $0.14909 USD and at 1 RMB to $0.14664 USD, respectively.
Concentrations and credit risk
The Company’s operations are all carried out in the PRC, with over 95% of the sales coming from Hangzhou. Accordingly, the Company’s business,
financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of
the PRC’s economy. The Company’s operations are also subject to specific considerations and significant risks not typically associated with companies
in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign
currency exchange. The Company’s results may be adversely affected by changes in 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.
Certain financial instruments, which subject the Company to concentration of credit risk, consist of cash and restricted cash. The Company has cash
balances at financial institutions located in Hong Kong and PRC. Balances at financial institutions in Hong Kong may, from time to time, exceed Hong
Kong Deposit Protection Board’s insured limits. Balances at financial institutions and state-owned banks within the PRC are not covered by insurance.
As of March 31, 2011 and 2010, the Company had deposits totaling $7,068,093 and $1,533,175 that were not covered by insurance, respectively. To
date, the Company has not experienced any losses in such accounts.
For the fiscal year ended March 31, 2011 and 2010, all of the Company’s sales and purchases arose in the PRC.
For the fiscal year ended March 31, 2011, two vendors collectively accounted for 27% of the Company’s total purchases and 11% of total purchase
deposits as of March 31, 2011. For the fiscal year ended March 31, 2010, two vendors collectively accounted for 23% of the Company’s total
purchases and 10% of advances to suppliers.
Recently issued accounting pronouncements
In May 2011, the FASB and International Accounting Standards Board (“IASB”) (collectively the “Boards”) issued Accounting Standard Update
(“ASU”) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and IFRSs. ASU 2011-04 created a uniform framework for applying fair value measurement principles for companies
around the world and clarified existing guidance in US GAAP. ASU 2011-04 is effective for the first reporting annual period beginning after December
15, 2011 and shall be applied prospectively. The Company does not expect the adoption of this ASU to have any material effect on its consolidated
financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future
date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
Reclassification
Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no effect on net income
or cash flows as previously reported.
F-11
Note 3 – OTHER CURRENT ASSETS
Other current assets consist of the following:
Prepaid rental expenses
Lease rights transfer fees (1)
Security deposit with vendor
Prepaids and other current assets
Advance to contractor
Total
March 31,
2011
March 31,
2010
1,316,626
380,981
4,581,132
166,148
1,919,380
8,364,267
$
$
1,205,881
92,021
-
33,265
-
1,331,167
$
$
(1)
Lease rights transfer fees are paid by the Company to secure store rentals in coveted areas. These additional costs of acquiring the right to lease
new store locations are capitalized and amortized over the period of the initial lease term.
Note 4 – PROPERTY AND EQUIPMENT
Property and equipment as of March 31, 2011 and 2010 consisted of the following:
Leasehold improvements
Office equipment and furniture
Motor vehicles
Total
Less: Accumulated depreciation
Construction-in-progress
Property and equipment, net
March 31,
2011
March 31,
2010
3,481,773 $
867,304
269,275
4,618,352
(2,661,615)
3,514,695
5,471,432 $
2,588,627
379,668
162,665
3,130,960
(1,944,668)
-
1,186,292
$
$
Construction-in-progress includes leasehold improvements in progress at one store location that the Company purchased and nine store locations that
the Company leased as of March 31, 2011. The stores are currently under remodeling and are not in operation. No depreciation is provided for
construction-in-progress until such time as the assets are completed and placed into service.
Total depreciation expense for property and equipment was $622,001 and $396,574 for the years ended March 31, 2011 and 2010, respectively.
Note 5 – ADVANCES TO SUPPLIERS
Advances to suppliers consist of deposits with or advances to outside vendors for future inventory purchases. Most of the Company’s vendors require
a certain amount of money to be deposited with them as a guarantee that the Company will receive its purchase on a timely basis. This amount is
refundable and bears no interest. As of March 31, 2011 and 2010, advances to suppliers amounted to $16,528,772 and $6,850,240, respectively.
Historically, the company has not experienced any losses as a result of these advances.
Note 6 – LONG TERM DEPOSITS, LANDLORDS
Long term deposits are money deposited with or advanced to landlords for securing retail store leases for which the Company does not anticipate
applying or being returned within the next twelve months. Most of the Company’s landlords require a minimum of nine months’ rent being paid upfront
plus additional deposits.
Note 7 – PREPAID - NONCURRENTS
Prepaid – noncurrent consist of the following:
Prepayment for lease of land use right – noncurrent (1)
Lease rights transfer fees-noncurrent (2)
Total
March 31,
2011
March 31,
2010
$
$
5,497,358 $
578,120
6,075,478 $
5,281,200
227,763
5,508,963
(1)
(2)
This is a payment made to a local government in connection with entering into a 30-year operating land lease agreement.
Lease rights transfer fees are paid by the Company to secure store rentals in coveted areas. These additional costs of acquiring the right to lease
new store locations are capitalized and amortized over the period of the initial lease term.
F-12
Note 8 – TAXES
Income tax
Entity
Jo-Jo Drugstores
Renovation
Jiuxin Management
Shouantang Technology
Qianhong
Quannuo Technology
Hangzhou Quannuo
Jiuzhou Pharmacy
Jiuzhou Clinic
Jiuzhou Service
Kuaileren
Shanghai Lydia
Income Tax Jurisdiction
United States
Hong Kong
PRC
PRC
PRC
PRC
PRC
PRC
PRC
PRC
PRC
PRC
The following table reconciles the U.S. statutory tax rates to the Company's effective tax rate for the years ended March 31, 2011 and 2010:
U.S. Statutory rates
Foreign income not recognized in the
U.S.
China income taxes
Other (a)
Effective tax rate
2011
2010
34%
(34)
25
4
29%
34%
(34)
25
(2 )
23%
(a) The 4% for the year ended March 31, 2011 represents expenses incurred by the Company that were not deductible for PRC income tax.
Jo-Jo Drugstores is incorporated in the U.S. and has incurred a net operating loss for income tax purposes for 2010. As of March 31, 2011, the
estimated net operating loss carryforwards for U.S. income tax purposes amounted to $813,000 which may be available to reduce future years’ taxable
income. These carryforwards will expire, if not utilized by 2031. Management believes that the realization of the benefits arising from this loss appears
to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has
provided a 100% valuation allowance at March 31, 2011. The valuation allowance at March 31, 2011 was $277,000. The Company’s management
reviews this valuation allowance periodically and makes adjustments as necessary. The Company did not have operating loss as of March 31, 2010.
The Company had cumulative undistributed earnings of foreign subsidiaries of approximately $24.3 million as of March 31, 2011, which are included in
consolidated retained earnings and will continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings.
Value added tax
VAT on sales and on purchases amounted to $11,451,967 and $8,230,455 for the year ended March 31, 2011, and $8,985,061 and $6,245,139 for the
year ended March 31, 2010, respectively.
Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government. VAT taxes are not impacted
by the income tax holiday.
Taxes payable at March 31, 2011 and 2010 consisted of the following:
VAT
Income tax
Others
Total taxes payable
March 31,
2011
March 31,
2010
$
$
421,562 $
1,146,453
56,543
1,624,558 $
341,989
875,868
17,226
1,235,083
F-13
Note 9 – SHORT-TERM LOANS
Short-term loans represent amounts due to various banks and are normally due on demand or within one year. These loans generally can be renewed
with the banks. Short-term bank loans at March 31, 2011 and 2010 consisted of the following:
Two loans with Hangzhou Bank, due September 2010 with annual interest at 4.86%, secured by
the personal properties of certain of the Company’s shareholders
Hangzhou Bank, due July 2010 with annual interest at 4.86%, secured by the personal properties
of certain of the Company’s shareholders
Total
March 31,
2011
March 31,
2010
$
$
-
$
586,800
-
- $
293,400
880,200
Interest expense amounted to $23,871 and $65,011 for the years ended March 31, 2011 and 2010, respectively.
Note 10 – POSTRETIREMENT BENEFITS
Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all permanent employees. The contribution for
each employee is based on a percentage of the employee’s current compensation as required by the local government. The Company contributed
$255,610 and $155,543 in employment benefits and pension for the years ended March 31, 2011 and 2010, respectively.
Note 11 – RELATED PARTY TRANSACTIONS AND ARRANGEMENTS
Amounts receivable from and payable to related parties are summarized as follows:
Amount due to directors (1):
March 31,
2011
March 31,
2010
$
800,058 $
935,000
(1) As of March 31, 2011 and 2010, amount due to directors represents contributions from the Owners to Jiuxin Management to enable Jiuxin
Management to meet its approved PRC registered capital requirements.
As of March 31, 2011, notes payable amounted $1,609,336 were secured by the personal properties of certain of the Company’s shareholders
respectively.
One of the Company’s retail spaces and its corporate office are leased from Lei Liu, a director of the Company, under long-term operating lease
agreements from August 2010 to August 2012 and from January 2011 to December 2012, respectively. The rent expense amounted to $178,912 and
$175,968 for the years ended March 31, 2011 and 2010, respectively. Rent paid to Mr. Liu amounted to $178,912 and $175,968 as of March 31, 2011
and 2010, respectively.
Note 12 – STOCKHOLDER’S EQUITY
Common stock
On April 9, 2010, the Company effected a 1-for-2 reverse split of its issued and outstanding shares of common stock and a proportional reduction of its
authorized shares of common stock. All share and per share amounts used in the Company’s consolidated financial statements and accompanying
notes have been retroactively restated to reflect the 1-for-2 reverse stock split.
On April 28, 2010, the Company closed a public offering of 3.5 million shares of common stock at $5.00 per share with gross proceeds of
approximately $17.5 million.
Stock-based compensation
On September 1, 2009, pursuant to agreements entered on July 30, 2009, the shareholders of Renovation sold 250,000 shares of Renovation to service
providers including the Company’s chief financial officer and legal counsel. Using the fair value of services provided as of March 31, 2010, the
Company estimated that the total stock compensation expense to be recognized from these transactions was $202,120. The Company recognized
$126,325 as stock compensation expense for the year ended March 31, 2010. The remaining $75,795 was applied to accrued legal fees, which were
expensed during the year ended March 31, 2009.
On March 15, 2010, the Company entered into a service agreement with a non-executive director and agreed to issue 6,897 shares of restricted
common stock for his annual service. The shares vested as follows: 321 shares on March 31, 2010, 1,720 shares on June 30, 2010, 1,739 shares on
September 30, 2010, 1,738 shares on December 31, 2010 and 1,379 shares on March 13, 2011. On March 15, 2011, the service agreement was
renewed and 11,268 shares of restricted common stock will be issued. The trading value of the Company’s common stock on March 15, 2011 and 2010
was $3.55 and $5.80, respectively. $40,000 and $1,863 were charged to general and administrative expense for the years ended March 31, 2011 and
2010, respectively.
On May 1, 2010, the Company agreed to issue 2,340 shares of common stock to its legal counsel as partial payment for six months of legal services.
The trading value of the Company’s common stock on May 1, 2010 was $4.80. $11,232 was charged to general and administrative expense for the
year ended March 31, 2011.
On May 1, 2010, the Company agreed to issue 6,000 shares of common stock to an employee as partial payment for compensation. 5,500 shares were
vested as for the year ended March 31, 2011. The trading value of the Company’s common stock on May 1, 2010 was $4.80. $26,400 was charged to
general and administrative expense for the year ended March 31, 2011.
F-14
On May 14, 2010, the Company entered into an agreement pursuant to which the Company agreed to issue 10,000 shares of restricted common stock
to its chief financial officer upon the adoption of a stock incentive plan (the “Plan”) as part of his annual compensation. The shares vested as follows:
1,753 shares on June 30, 2010, 2,521 shares on September 30, 2010, 2,521 shares on December 31, 2010, 2,466 shares on March 31, 2011 and 739
shares on April 27, 2011. The trading value of the Company’s common stock on May 14, 2010 was $4.66. $43,156 was charged to general and
administrative expense for the year ended March 31, 2011.
The Company also agreed under the agreement with the chief financial officer to issue 4,000 shares of restricted common stock from the Plan as a
bonus. The trading value of the Company’s common stock on May 14, 2010 was $4.66. $18,640 was charged to general and administrative expense for
the year ended March 31, 2011.
On November 1, 2010, the Company agreed to issue 2,340 shares of common stock to its legal counsel as partial payment for six months of legal
services. The trading value of the Company’s common stock on November 1, 2010 was $5.00. $9,761 was recorded as service compensation expense
for the year ended March 31, 2011.
Statutory reserve
Statutory reserves represent restricted retained earnings. Based on their legal formation, the Company is required to set aside 10% of its net income as
reported in their statutory accounts on an annual basis to the Statutory Surplus Reserve Fund (the “Reserve Fund”). Once the total amount set aside in
the Reserve Fund reaches 50% of the entity’s registered capital, further appropriations become discretionary. The Reserve Fund can be used to
increase the entity’s registered capital upon approval by relevant government authorities or eliminate its future losses under PRC GAAP upon a
resolution by its board of directors. The Reserve Fund is not distributable to shareholders, as cash dividend or otherwise, except in the event of
liquidation.
Appropriations to the Reserve Fund are accounted for as a transfer from unrestricted earnings to statutory reserves. During the years ended March 31,
2011 and 2010, the Company did not made appropriations to the statutory reserves. The other subsidiaries were still in the development stage and had
not allocated any contribution to the statutory surplus reserve fund.
There are no legal requirements in the PRC to fund the Reserve Fund by transfer of cash to any restricted accounts, and the Company does not do so.
Shareholders contribution
On June 8, 2009, the owners of Jiuzhou Pharmacy acquired 100% equity interest of Kuaileren from its owner for stock consideration, and contributed
same to Jiuzhou Pharmacy on August 21, 2009. The registered capital of Kuaileren is $15,000 (RMB 100,000). The transfer of the equity interest has
been treated as a contribution to owner’s equity and has been valued at $8,164, the estimated fair value of the equity interest transferred.
Note 13 – EARNINGS PER SHARE
The Company reports earnings per share in accordance with the provisions of the FASB’s related accounting standard. This standard requires
presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share.
Basic earnings per share excludes dilution, but includes vested restricted stocks and is computed by dividing income available to common stockholders
by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could
occur if securities or other contracts to issue common stock were exercised and converted into common stock.
The following is a reconciliation of the basic and diluted earnings per share computation:
Net income for earnings per share
Weighted average shares used in basic computation
Diluted effect of purchase options
Weighted average shares used in diluted computation
Earnings per share – Basic and diluted:
Years Ended
March 31,
2011
2010
$
$
8,432,458 $
13,254,792
-
13,254,792
0.64 $
9,821,741
9,025,000
-
9,025,000
1.09
For the year ended March 31, 2011, 105,000 shares underlying outstanding purchase options were excluded from the diluted earnings per share
calculation as they are anti-dilutive.
Note 14 – SEGMENTS
The Company sells prescription and over-the-counter medicines, TCM, dietary supplement, medical devices, Chinese white liquor and sundry items.
The class of customers, selling practice and distribution process are the same for all products. Based on qualitative and quantitative criteria established
by the FASB’s accounting standard, “Disclosures about Segments of an Enterprise and Related Information,” the Company considers itself to be
operating within one reportable segment.
F-15
The Company does not have long-lived assets located outside the PRC. In accordance with the enterprise-wide disclosure requirements of FASB’s
accounting standard, the Company's net revenue from external customers by main products is as follows:
Prescription Drugs
Over-The-Counter (OTC) Drugs
Nutritional Supplements
TCM
Chinese White Liquor
Sundry Products
Medical Devices
Total
Note 15 – BUSINESS COMBINATION
Years Ended
March 31,
2011
27,118,482
23,715,596
5,894,410
7,364,943
3,491,743
1,465,722
918,583
69,969,479
$
$
2010
21,210,967
19,042,200
5,137,890
6,407,200
-
2,260,710
1,115,962
55,174,929
$
$
On November 19, 2010, Shouantang entered into Equity Ownership Transfer Agreements with the owners of Quannuo Technology to acquire 100% of
equity interests of Quannuo Technology and its subsidiary, Hangzhou Quannuo. Quannuo Technology develops software for online drugstores.
Shouantang acquired all assets and assumed all liabilities of Quannuo Technology. The consideration of the transaction included a cash payment of
$606,800 (RMB 4,000,000) to pay off outstanding loans with the former owners, with the excess capitalized by the Company as intangible assets of
approximately $443,125. Amortization expense of the intangible assets was $54,439 for the year ended March 31, 2011.
Note 16 – COMMITMENTS AND CONTINGENCIES
Operating lease commitments
The Company recognizes lease expense on a straight line basis over the term of its leases in accordance with the relevant accounting standards. The
Company has entered into various tenancy agreements for its store premises and for the land that it has leased from a local government to be used
potentially for the cultivation of Chinese medicinal herbs.
The Company’s commitments for minimum rental payments under its leases for the next five years and thereafter are as follows:
Years ending March 31,
2012
2013
2014
2015
2016
Thereafter
$
Amount
2,832,615
2,480,687
2,025,371
1,613,378
680,293
489,517
Total rent expense amounted to $2,807,170 and $1,301,497 for the years ended March 31, 2011 and 2010, respectively.
As of March 31, 2011 and 2010, prepayment on retail and office leases amounted to $1,316,626 and $1,205,881, respectively.
Note 17 – SUBSEQUENT EVENTS
On April 9, 2011, Kuaileren was dissolved and its assets transferred to Jiuzhou Pharmacy. The store that previously operated as “Kuaileren Grand
Pharmacy” was rebranded and now operates as a “Jiuzhou Grand Pharmacy” store.
On April 15, 2011, Jiuzhou Pharmacy entered into an equity ownership transfer agreement with the owners of Zhejiang Jiuxin Medicine Co., Ltd.
(“Jiuxin Medicine”) to acquire their equity interests in Jiuxin Medicine. Jiuxin Medicine is licensed to transport and store pharmaceutical products, and
the Company sought to acquire Jiuxin Medicine in order to carry out such functions internally. In April 2011, the business license of Jiuxin Medicine
was transferred to Jiuzhou Pharmacy, although no consideration was paid. As of the date of this Form 10-K, the Company is still negotiating the
payment terms with the sellers.
EX-21.1 2 a6777431ex21_1.htm EXHIBIT 21.1
F-16
List of Subsidiaries
Exhibit 21.1
1.
2.
3.
4.
Renovation Investment (Hong Kong) Co., Ltd. (“Renovation”) is a Hong Kong company and is wholly-owned by the Company.
Zhejiang Jiuxin Investment Management Co., Ltd. (“Jiuxin Management”) is a Chinese company and is wholly-owned by Renovation.
Hangzhou Jiuxin Qianhong Agriculture Development Co., Ltd. is a Chinese company and is wholly-owned by Jiuxin Management.
Zhejiang Shouantang Pharmaceutical Technology Co., Ltd. (“Shouantang Technology”) is a Chinese company and is wholly-owned by
Renovation.
5.
Zhejiang Quannuo Technology Co., Ltd. (“Quannuo Technology”) is a Chinese company and is wholly-owned by Shouantang Technology.
Hangzhou Quannuo Grand Pharmacy Co., Ltd. is a Chinese company and is wholly-owned by Quannuo Technology.
6.
EX-23.1 3 a6777431ex23_1.htm EXHIBIT 23.1
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File No. 333-171849) of China Jo-Jo Drugstores,
Inc. and subsidiaries of our report dated June 29, 2011 relating to the consolidated financial statements, which appear in this Form 10-K.
/s/ Friedman LLP
Marlton, New Jersey
June 29, 2011
EX-23.2 4 a6777431ex23_2.htm EXHIBIT 23.2
Exhibit 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File No. 333-171849) of China Jo-Jo Drugstores,
Inc. and subsidiaries of our report dated June 29, 2010 relating to the consolidated financial statements, which appear in this Form 10-K.
/s/ Frazer Frost LLP
Brea, California
June 29, 2011
EX-31.1 5 a6777431ex31_1.htm EXHIBIT 31.1
Exhibit 31.1
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Lei Liu, certify that:
1. I have reviewed this annual report on Form 10-K of China Jo-Jo Drugstores, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and we have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to
the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):
a) All significant deficiencies and material weakness in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal
control over financial reporting.
Date: June 29, 2011
/s/ Lei Liu
Lei Liu
Chief Executive Officer
EX-31.2 6 a6777431ex31_2.htm EXHIBIT 31.2
Exhibit 31.2
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Bennet P. Tchaikovsky, certify that:
1. I have reviewed this annual report on Form 10-K of China Jo-Jo Drugstores, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and we have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to
the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):
a) All significant deficiencies and material weakness in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal
control over financial reporting.
Date: June 29, 2011
/s/ Bennet P. Tchaikovsky
Bennet P. Tchaikovsky
Chief Financial Officer
EX-32.1 7 a6777431ex32_1.htm EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
In connection with the annual report of China Jo-Jo Drugstores, Inc. (the “Company”) on Form 10-K for the year ending March 31, 2011 as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, Lei Liu, Chief Executive Officer of the Company, hereby certify as of
the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as
amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the
Company at the dates and for the periods indicated.
/s/ Lei Liu
Lei Liu
Chief Executive Officer
June 29, 2011
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and
furnished to the Securities and Exchange Commission or its staff upon request.
EX-32.2 8 a6777431ex32_2.htm EXHIBIT 32.2
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the annual report of China Jo-Jo Drugstores, Inc. (the “Company”) on Form 10-K for the year ending March 31, 2011 as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, Bennet P. Tchaikovsky, Chief Financial Officer of the Company, hereby
certify as of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at
the dates and for the periods indicated.
/s/ Bennet P. Tchaikovsky
Bennet P. Tchaikovsky
Chief Financial Officer
June 29, 2011
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and
furnished to the Securities and Exchange Commission or its staff upon request.