-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TYG1dr5yp3VX1+MnjYfvn/8Mbsbarmm/hN+6h7PYJ7vRFsnkuH+EADltYZWzjMm7 MQHElvmoWYcVQEf5d4Cf4Q== 0001282826-06-000156.txt : 20061107 0001282826-06-000156.hdr.sgml : 20061107 20061107163937 ACCESSION NUMBER: 0001282826-06-000156 CONFORMED SUBMISSION TYPE: 10QSB/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20061107 DATE AS OF CHANGE: 20061107 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Linkwell CORP CENTRAL INDEX KEY: 0001042463 STANDARD INDUSTRIAL CLASSIFICATION: SPECIALTY CLEANING, POLISHING AND SANITATION PREPARATIONS [2842] IRS NUMBER: 651053546 STATE OF INCORPORATION: FL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-24977 FILM NUMBER: 061194373 BUSINESS ADDRESS: STREET 1: NO. 476 HUTAI BRANCH ROAD STREET 2: BAOSHAN DISTRICT CITY: SHANGHAI STATE: F4 ZIP: 200436 BUSINESS PHONE: (86) 21-56689332 MAIL ADDRESS: STREET 1: NO. 476 HUTAI BRANCH ROAD STREET 2: BAOSHAN DISTRICT CITY: SHANGHAI STATE: F4 ZIP: 200436 FORMER COMPANY: FORMER CONFORMED NAME: KIRSHNER ENTERTAINMENT & TECHNOLOGIES INC DATE OF NAME CHANGE: 20030818 FORMER COMPANY: FORMER CONFORMED NAME: HBOA HOLDINGS INC DATE OF NAME CHANGE: 20001116 FORMER COMPANY: FORMER CONFORMED NAME: MIZAR ENERGY CO DATE OF NAME CHANGE: 19980923 10QSB/A 1 lnk10qa033106.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-QSB/A (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2006 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT For the transition period from ____ to _______ Commission File Number: 000-24977 LINKWELL CORPORATION (Exact name of small business issuer as specified in charter) FLORIDA 65-1053546 ------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) No. 476 Hutai Branch Road, Baoshan District Shanghai, China 200436 (Address of principal executive offices) (86) 21-56689332 (Issuer's telephone number, including area code) N/A (Former name or former address, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes[x] No [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x] State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 45,304,139 shares at May 10, 2006 Transitional Small Business Disclosure Format (Check one): Yes [ ] No [x] LINKWELL CORPORATION AND SUBSIDIARIES FORM 10-QSB/A-1 QUARTERLY PERIOD ENDED MARCH 31, 2006 EXPLANATORY PARAGRAPH: We are amending our Form 10-QSB for the period ended March 31, 2006 as filed with the SEC on May 16, 2006 to restate our Consolidated Balance Sheet at March 30, 2006 and our Consolidated Statement of Operations for the period ended March 31, 2006. These restatements include the following: o We have restated our Consolidated Balance Sheet at March 31, 2006 and our Consolidated Statement of Operations for the period ended March 31, 2006 to properly accrue undeclared and unpaid cumulative dividends on our Series A Convertible Preferred Stock and our Series B 6% Cumulative Preferred Stock and to include those dividends in our calculation of loss or income available to our common stockholders. We have also revised Note 9 of our Notes to Consolidated Financial Statements to disclose the per share an aggregate amount of these dividends, o We have restated our Consolidated Statement of Operations for the period ended March 31, 2006 to reclassify the $9,375 annual fixed return we may Shanghai Shanhai Group, the minority shareholder of Likang, from rent expense to interest expense, and o We have revised Note 1 - Registration rights agreements of the Notes to Consolidated Financial Statements to clarify the basis for the registration rights penalty we have recorded. Please see Note 1 Restatement contained in the Notes to Consolidated Financial Statements appearing later in this Form 10-QSBA which further describes the effect of these restatements. Finally, we are updating disclosure under Part I, Item 3 Controls and Procedures regarding the effectiveness of our internal controls. The Items of this Form 10-QSB/A for the period ended March 31, 2006 which are amended are as follows: o Part I. Financial Information o Item 1 - Financial Statements - o Consolidated Balance Sheet at March 31, 2006, o Consolidated Statement of Operations for the period ended March 31, 2006, and o Notes 1 and 7 of the Notes to Consolidated Financial Statements (unaudited). o Item 2 - Management's Discussion and Analysis or Plan of Operation, and o Item 3. Controls and Procedures. In addition, Part II, Item 6. Exhibits of this Form 10-QSB/A includes currently dated certificates from our Chief Executive Officer and Principal Accounting and Financial Officer in Exhibits 31.1, 31.2 and 32.1. The remaining Items contained in this Form 10-QSB/A consist of all other Items originally contained in our Form 10-QSB for the period ended March 31, 2006 as filed on May 16, 2006. This Form 10-QSB/A does not reflect events occurring after the filing of the original Form 10-QSB except as specifically set forth herein, and supersedes in its entirety the previously filed Form 10-QSB for the period ended March 31, 2006. INDEX Page PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheet (Unaudited) As of March 31, 2006......3 Consolidated Statements of Operations (Unaudited) For the Three Months Ended March 31, 2006 and 2005 ..........4 Consolidated Statements of Cash Flows (Unaudited) For the Three Months Ended March 31, 2006 and 2005...........5 Notes to Unaudited Consolidated Financial Statements.............6 Item 2. Management's Discussion and Analysis or Plan of Operations......20 Item 3. Controls and Procedures.........................................31 PART II - OTHER INFORMATION Item 1. Legal Proceedings...............................................32 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.....32 Item 3. Default Upon Senior Securities..................................32 Item 4. Submission of Matters to a Vote of Security Holders.............32 Item 5. Other Information...............................................32 Item 6. Exhibits.........................................................32 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION Certain statements in this annual report contain or may contain forward-looking statements that are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause our actual results to differ materially from those in the forward-looking statements. These factors include, but are not limited to, our ability to increase our revenues, develop our brands, implement our strategic initiatives, economic, political and market conditions and fluctuations, government and industry regulation, U.S. and global competition, and other factors. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made in this annual. Readers are cautioned not to place undue reliance on these forward-looking statements and readers should carefully review this annual report in its entirety, including the risks described in Item 1. Description of Business - Risk Factors. Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. These forward-looking statements speak only as of the date of this annual report, and you should not rely on these statements without also considering the risks and uncertainties associated with these statements and our business. When used in this quarterly report, the terms the "Company," "Linkwell" "we", and "us" refers to Linkwell Corporation, a Florida corporation, our wholly-owned subsidiary Linkwell Tech Group, Inc., a Florida corporation ("Linkwell Tech") and Linkwell Tech's 90% owned subsidiary Shanghai Likang Disinfectant High-Tech Company, Limited ("Likang"). The information which appears on our web site at www.linkwell.us is not part of this quarterly report. All per share information contained in this quarterly report gives effect to a one for 10 (1:10) reverse stock split effective March 24, 2005. -2- LINKWELL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET March 31, 2006 (As Restated - See Note 1) (Unaudited) ASSETS CURRENT ASSETS: Cash $ 879,920 Accounts receivable, net of allowance for doubtful accounts of $32,919 1,201,964 Accounts receivable - related parties 1,952,525 Inventories 479,295 Prepaid expenses and other 92,536 Loan receivable - related party 100,000 ---------------------- Total Current Assets 4,706,240 PROPERTY AND EQUIPMENT - Net 737,691 ---------------------- Total Assets $ 5,443,931 ====================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Loans payable $ 535,145 Loan payable - related party 163,033 Accounts payable and accrued expenses 923,571 Accrued preferred stock dividends payable 37,874 Income tax payable 47,244 Advances from customers 355,563 ---------------------- Total Current Liabilities 2,062,430 ---------------------- MINORITY INTEREST 274,818 ---------------------- STOCKHOLDERS' EQUITY: Preferred stock (No Par Value; 10,000,000 Shares Authorized; No shares issued and outstanding) - Series A convertible preferred stock (No Par Value; 500,000 Shares Authorized; 375,345 shares issued and outstanding) 277,276 Series B convertible preferred stock (No Par Value; 1,500,000 Shares Authorized; 1,500,000 shares issued and outstanding) 1,395,000 Common Stock ($0.0005 Par Value; 150,000,000 Shares Authorized; 45,304,139 shares issued and outstanding) 22,652 Additional paid-in capital 2,912,442 Accumulated deficit (1,167,630) Deferred compensation (367,223) Other comprehensive gain - foreign currency 34,166 ---------------------- Total Stockholders' Equity 3,106,683 ---------------------- Total Liabilities and Stockholders' Equity $ 5,443,931 ======================
See notes to unaudited consolidated financial statements -3- LINKWELL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (As Restated - See Note 1)
For the Three Months Ended March 31, ----------------------------------- 2006 2005 ---------------- ---------------- (Unaudited) (Unaudited) NET REVENUES: Non-affiliated companies $ 608,271 $ 589,938 Affiliated companies 1,260,255 357,987 ---------------- ---------------- Total Net Revenues 1,868,526 947,925 COST OF SALES 1,227,448 754,637 ---------------- ---------------- GROSS PROFIT 641,078 193,288 ---------------- ---------------- OPERATING EXPENSES: Selling expenses 105,559 44,734 General and administrative 262,616 132,457 ---------------- ---------------- Total Operating Expenses 368,175 177,191 ---------------- ---------------- INCOME FROM OPERATIONS 272,903 16,097 ---------------- ---------------- OTHER INCOME (EXPENSE): Interest income 1,557 182 Interest expense - related party (4,145) - Interest expense (10,770) (11,299) ---------------- ---------------- Total Other Expense (13,358) (11,117) ---------------- ---------------- INCOME BEFORE DISCONTINUED OPERATIONS, INCOME TAXES AND MINORITY INTEREST 259,545 4,980 DISCONTINUED OPERATIONS: Gain from disposal of discontinued operations 12,794 - ---------------- ---------------- INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 272,339 4,980 INCOME TAXES (47,124) (1,401) ---------------- ---------------- INCOME BEFORE MINORITY INTEREST 225,215 3,579 MINORITY INTEREST (23,275) (358) ---------------- ---------------- NET INCOME 201,940 3,221 CUMULATIVE PREFERRED STOCK DIVIDENDS (26,634) - ---------------- ---------------- NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS $ 175,306 $ 3,221 ================ ================ BASIC INCOME PER COMMON SHARE: Income from continuing operations $ 0.00 $ 0.00 Income from discontinued operations 0.00 - ---------------- ---------------- Net income per common share available to common shareholders $ 0.00 $ 0.00 ================ ================ DILUTED INCOME PER COMMON SHARE: Income from continuing operations $ 0.00 $ 0.00 Income from discontinued operations 0.00 - ---------------- ---------------- Net income per common share available to common shareholders $ 0.00 $ 0.00 ================ ================ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic 64,995,951 36,273,470 ================ ================ Diluted 66,824,555 36,273,470 ================ ================
See notes to unaudited consolidated financial statements -4- LINKWELL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (As Restated - See Note 1) For the Three Months Ended March 31, -------------------------------- 2006 2005 --------------- --------------- (Unaudited) (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 201,940 $ 3,221 Gain from discontinued operations 12,794 - --------------- --------------- Income from continuing operations 189,146 3,221 Adjustments to reconcile net income from continuing operations to net cash used in operating activities: Depreciation and amortization 21,872 8,599 Minority interest 23,275 358 Allowance for doubtful accounts 19,402 - Loss on disposal of property and equipment - 124 Stock-based compensation 67,324 - Changes in assets and liabilities: Accounts receivable 137,900 (57,752) Accounts receivable - related party (1,070,531) (128,986) Inventories 496,644 (89,438) Prepaid and other current assets (10,086) 48,892 Other assets 739 - Accounts payable and accrued expenses (485,651) 88,308 Accounts payable - related party - (36,583) Tax payable (28,872) - Advances from customers 227,608 - --------------- --------------- Net Cash Used in Continuing Operating Activities (411,230) (163,257) Net Cash Used in Discontinued Operations - - --------------- --------------- NET CASH USED IN OPERATING ACTIVITIES (411,230) (163,257) --------------- --------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (66,842) - --------------- --------------- NET CASH USED IN INVESTING ACTIVITIES (66,842) - --------------- --------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of loans payable (99,307) - --------------- --------------- NET CASH USED IN FINANCING ACTIVITIES (99,307) - --------------- --------------- EFFECT OF EXCHANGE RATE ON CASH (2,779) - --------------- --------------- NET DECREASE IN CASH (580,158) (163,257) CASH - beginning of year 1,460,078 467,859 --------------- --------------- CASH - end of period $ 879,920 $ 304,602 =============== =============== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest $ - $ 11,299 =============== =============== Income taxes $ - $ 15,484 =============== ===============
See notes to unaudited consolidated financial statements. -5- LINKWELL CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006 NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization Linkwell Corporation (formerly Kirshner Entertainment & Technologies, Inc.) was incorporated in the state of Colorado on December 11, 1996. On May 31, 2000, the Company acquired 100% of HBOA.Com, Inc. The Company focused on development of an Internet portal through which home based business owners, as well as commercial private label businesses, obtain the products, services, and information necessary to start, expand and profitably run their businesses. On December 28, 2000, the Company formed a new subsidiary, Aerisys Incorporated ("Aerisys"), a Florida corporation, to handle commercial private business. In June 2003, the Company formed its entertainment division and changed its name to reflect this new division. On May 2, 2005, the Company entered into and consummated a share exchange with all of the shareholders of Linkwell Tech Group, Inc. ("Linkwell Tech"). Pursuant to the share exchange, the Company acquired 100% of the issued and outstanding shares of Linkwell Tech's common stock, in exchange for 36,273,470 shares of our common stock, which at closing represented approximately 87.5% of the issued and outstanding shares of our common stock. As a result of the transaction, Linkwell became our wholly owned subsidiary. For financial accounting purposes, the exchange of stock was treated as a recapitalization of Kirshner with the former shareholders of the Company retaining 7,030,669 or approximately 12.5% of the outstanding stock. The consolidated financials statements reflect the change in the capital structure of the Company due to the recapitalization and the consolidated financial statements reflect the operations of the Company and its subsidiaries for the periods presented. Linkwell Tech was founded on June 22, 2004, as a Florida corporation. On June 30, 2004, Linkwell Tech acquired 90% of Shanghai Likang Disinfectant High-Tech Company, Ltd. ("Likang") through a stock exchange. The transaction on which Linkwell acquired its 90% interest in Likang resulted in the formation of a U.S. holding company by the shareholders of Likang as it did not result in a change in the underlying ownership interest of Likang. Likang is a science and technology enterprise founded in 1988. Likang is involved in the development, production, marketing and sale, and distribution of disinfectant health care products. Likang's products are utilized by the hospital and medical industry in China. Likang has developed a line of disinfectant product offerings. Likang regards the hospital disinfecting products as the primary segment of its business. Likang has developed and manufactured several series products in the field of skin mucous disinfection, hand disinfection, surrounding articles disinfection, medical instruments disinfection and air disinfection. On June 30, 2005, the Company's Board of Directors approved an amendment of its Articles of Incorporation to change the name of the Company to Linkwell Corporation. The effective date of the name change was after close of business on August 16, 2005. -6- NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Basis of presentation The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The accompanying financial statements for the interim periods are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the periods presented. These consolidated financial statements should be read in conjunction with the financial statements for the year ended December 31, 2005 and notes thereto contained on Form 10-KSB/A of the Company as filed with the Securities and Exchange Commission. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results for the full fiscal year ending December 31, 2006. The consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP"). The consolidated financials statements of the Company include the accounts of its wholly-owned subsidiary, Linkwell Tech, and its 90%-owned subsidiary, Likang. All significant inter-company balances and transactions have been eliminated. Use of estimates The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Significant estimates in 2006 and 2005 include the allowance for doubtful accounts, stock-based compensation, and the useful life of property and equipment and intangible assets. Fair value of financial instruments The carrying amounts reported in the balance sheet for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, customer advances, loans and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments. Cash and cash equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less and money market accounts to be cash equivalents. Accounts receivable The Company has a policy of reserving for uncollectible accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. The Company periodically reviews its accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. At March 31, 2006, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amount of $32,919. Inventories Inventories, consisting of raw materials and finished goods related to the Company's products are stated at the lower of cost or market utilizing the first-in, first-out method. -7- NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Property and equipment Property and equipment are carried at cost. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. Advances from customers Advances from customers at March 31, 2006 of $355,563 consist of prepayments from third party customers to the Company for merchandise that had not yet shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods, in compliance with its revenue recognition policy. Impairment of long-lived assets In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," The Company periodically reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset's estimated fair value and its book value. The Company did not consider it necessary to record any impairment charges during the year ended March 31, 2006. Income taxes The Company files federal and state income tax returns in the United States for its domestic operations, and files separate foreign tax returns for the Company's Chinese subsidiaries. Income taxes are accounted for under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Income (loss) per common share In accordance with SFAS No. 128 "Earnings Per Share," Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Diluted loss per common share is not presented because it is anti-dilutive. The Company's common stock equivalents at March 31, 2006 include the following: Convertible preferred stock 18,753,450 Warrants and options 37,134,865 ------------------ 55,888,315 ================== NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Revenue recognition The Company follows the guidance of the Securities and Exchange Commission's Staff Accounting Bulletin 104 for revenue recognition. In general, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectibility is reasonably assured. The following policies reflect specific criteria for the various revenues streams of the Company: The Company's revenues from the sale of products are recorded when the goods are shipped, title passes, and collectibility is reasonably assured. The Company's revenues from the sale of products to related parties are recorded when the goods are shipped which correlates with the shipment by the related parties to its customers, at which time title passes, and collectibility is reasonably assured. The Company receives sales order on a just-in-time basis from the related party. Generally, the related party does not hold the Company's inventory. If the related party has inventory on hand at the end of a reporting period, the sale is reversed and the inventory is included on the Company's balance sheet. Concentrations of credit risk Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The Company places its cash with high credit quality financial institutions in the U.S. and in China. Almost all of the Company's sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms. The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk. For the three months ended March 31, 2006 and 2005, sales to related parties accounted for 67% and 38% of net revenues, respectively. Comprehensive income The Company uses Statement of Financial Accounting Standards No. 130 (SFAS 130) "Reporting Comprehensive Income". Comprehensive income is comprised of net income and all changes to the statements of stockholders' equity, except those due to investments by stockholders', changes in paid-in capital and distributions to stockholders. Shipping costs Shipping costs are included in selling and marketing expenses and totaled $28,918 and $10,602 for the three months ended March 31, 2006 and 2005, respectively. Advertising Advertising is expensed as incurred. Advertising expenses for the three months ended March 31, 2006 and 2005 was not material. -8- NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Stock-based compensation Effective October 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share Based Payment ("SFAS No. 123R"). SFAS No. 123R establishes the financial accounting and reporting standards for stock-based compensation plans. As required by SFAS No. 123R, the Company recognized the cost resulting from all stock-based payment transactions including shares issued under its stock option plans in the financial statements. Prior to October 1, 2005, the Company accounted for stock-based employee compensation plans (including shares issued under its stock option plans) in accordance with APB Opinion No. 25 and followed the pro forma net income, pro forma income per share, and stock-based compensation plan disclosure requirements set forth in the Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). Non-employee stock based compensation The cost of stock based compensation awards issued to non-employees for services are recorded at either the fair value of the services rendered or the instruments issued in exchange for such services, whichever is more readily determinable, using the measurement date guidelines enumerated in Emerging Issues Task Force Issue ("EITF") 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF 96-18"). Registration rights agreements The Company has adopted View C of EITF 05-4 "Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF 00-19" ("EITF 05-4"). Accordingly, the Company classifies as liability instruments, the fair value of registration rights agreements when such agreements (i) require it to file, and cause to be declared effective under the Securities Act, a registration statement with the SEC within contractually fixed time periods, and (ii) provide for the payment of liquidating damages in the event of its failure to comply with such agreements. Under View C of EITF 05-4, (i) registration rights with these characteristics are accounted for as derivative financial instruments at fair value and (ii) contracts that are (a) indexed to and potentially settled in an issuer's own stock and (b) permit gross physical or net share settlement with no net cash settlement alternative are classified as equity instruments. At March 31, 2006, the Company recorded a registration rights penalty expense of $44,000, which has been included on the accompanying consolidated balance sheet in accounts payable and accrued expenses. The Company has recorded a registration rights penalty which is reflected in its financial statements. This penalty is a reflection of the liquidating damages penalty provisions solely and does not reflect the increase in the dividend rate from 6% to 20%. Foreign currency translation Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transactions and balances in other currencies are converted into U.S. dollars in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, "Foreign Currency Translation," and are included in determining net income or loss. The functional and reporting currency is the U.S. dollar. The functional currency of the Company's Chinese subsidiary is the local currency. The financial statements of the subsidiary are translated into United States dollars using year-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and were not material during the periods presented because the Chinese dollar (RMB) fluctuates with the United States dollar. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. The cumulative translation adjustment and effect of exchange rate changes on cash at March 31, 2006 was $2,779. -9- NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Research and development Research and development costs are expensed as incurred. These costs primarily consist of cost of material used and salaries paid for the development of the Company's products. In certain cases, the Company may employ the resources of third parties for research and development. Accordingly, the Company may incur research and development fees payable to third parties. To date, these fees have been minimal. Research and development costs for the three months ended March 31, 2006 and 2005 was not material and are included in cost of sales. Recent accounting pronouncements In September 2005, the FASB ratified the Emerging Issues Task Force's ("EITF") Issue No. 05-7, "Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues," which addresses whether a modification to a conversion option that changes its fair value affects the recognition of interest expense for the associated debt instrument after the modification and whether a borrower should recognize a beneficial conversion feature, not a debt extinguishment if a debt modification increases the intrinsic value of the debt (for example, the modification reduces the conversion price of the debt). This issue is effective for future modifications of debt instruments beginning in the first interim or annual reporting period beginning after December 15, 2005. The adoption of this pronouncement did not have any effect on the Company's financial position or results of operations. In September 2005, the FASB also ratified the EITF's Issue No. 05-8, "Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature," which discusses whether the issuance of convertible debt with a beneficial conversion feature results in a basis difference arising from the intrinsic value of the beneficial conversion feature on the commitment date (which is recorded in the shareholder's equity for book purposes, but as a liability for income tax purposes), and, if so, whether that basis difference is a temporary difference under FASB Statement No. 109, "Accounting for Income Taxes." This Issue should be applied by retrospective application pursuant to Statement 154 to all instruments with a beneficial conversion feature accounted for under Issue 00-27 included in financial statements for reporting periods beginning after December 15, 2005. The adoption of this pronouncement did not have any effect on the Company's financial position or results of operations. 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 consolidated financial statements upon adoption. Restatement The Company revised its financial statements and notes thereto for the three months ended March 31, 2006 to accrue undeclared and unpaid cumulative preferred stock dividends related to its Series A and Series B preferred stock and to disclose the per share and aggregate amount of these cumulative preferred dividends in its footnotes. The effect of this restatement is to increase current liabilities and decrease stockholders' equity by $37,874, respectively. This change includes an accrual of $11,240 for period ended December 31, 2005 and an accrual of $26,634 for the period ended March 31, 2006. -10- NOTE 2 INVENTORIES At March 31, 2006, inventories consisted of the following: Raw materials $ 261,239 Work in process 26,689 Finished goods 315,082 -------------- 603,010 Less: reserve for obsolescence (123,715) -------------- $ 479,295 ============== NOTE 3 PROPERTY AND EQUIPMENT At March 31, 2006, property and equipment consist of the following: Useful Life ------------------------- Office equipment and furniture 5-7 Years $ 96,885 Autos and trucks 10 Years 123,111 Manufacturing equipment 7 Years 186,323 Building and land 20 Years 489,152 Leasehold improvements 5 Years 3,380 ------------------------- --------------------------- 898,851 Less accumulated depreciation (161,160) --------------------------- $ 737,691 ===========================
For the three months ended March 31, 2006 and 2005, depreciation expense amounted to $21,872 and $8,599, respectively. NOTE 4 LOANS PAYABLE Loans payable consisted of the following at March 31, 2006: Note to De Chang Credit Union due on May 18, 2006 with interest at 6.70% per $ 224,014 annum. Secured by equipment Note to De Chang Credit Union due on September 30, 2006 with interest 6.70% per annum. Secured by equipment 62,226 Note to Agriculture Bank of China due on December 7, 2006 with interest at 6.70% per annum. Secured by equipment 248,905 ---------------- Total 535,145 Less: current portion of loans payable (535,145) ---------------- Loans payable, long-term $ - ================
-11- NOTE 5 DISCONTINUED OPERATIONS In January 2006, the Company sold 100% of the stock of its subsidiary, Aerisys Incorporated to Mr. Gary Verdier, the Company's former CEO, in exchange for assumption of all liabilities and obligation of Aerisys Incorporated. Accordingly, Aerisys is reported as a discontinued operation, and prior periods have been restated in the Company's financial statements and related footnotes to conform to this presentation. Since, the Company did not acquire Aerisys until May 3, 2005, the Company did not present pro forma information. NOTE 6 RELATED PARTY TRANSACTIONS The Company's 90% owned subsidiary, Likang, is engaged in business activities with two affiliated entities. Shanghai Likang Meirui Pharmaceuticals High-Tech Company, Ltd. ("Meirui"), a company of which Shanghai Shanhai Group, Likang's minority shareholder, owns 68%, provides certain contract manufacturing of two products for Likang. Specifically, Meirui provides Likang with Ozone producing device equipment and Ultraviolet radiation lamp lights. In addition, under the terms of a two year agreement entered into in January 2005, Meirui produces the Lvshaxing Air Disinfectant Machine and Likang Surgery hand-washing table for Likang. In January 2005, Likang signed a two year agreement with Meirui to market its products to the retail/consumer market using Meirui's proprietary sales network which caters to the retail/consumer market in China. For the three months ended March 31, 2006 and 2005, the Company recorded net revenues of $4,044 and $8,013 to Meirui, respectively. Additionally, for the three months ended March 31, 2006 and 2005, the Company purchased product from Meirui amounting to $0 and $0, respectively. At March 31, 2006, Meirui owed Likang $3,433. In general, accounts receivable due from Meirui are payable in cash and are due within 4 to 6 months, which approximate normal business terms with unrelated parties. Shanghai Shanhai Group, who is the minority shareholder of Likang, is owned by Group Employee Share-holding Commission (16.25%) and Baoshan District Dachang Town South Village Economic Cooperation Club (83.75%). The Company leases its principal executive offices and warehouse space from Shanghai Shanhai Group for approximately $36,000 per year. Shanghai Shanhai Group also holds the land use permit for the principal executive office building. For the three months ended March 31, 2006 and 2005, rent expense paid to this related party amounted to approximately $9,000 and $5,880, respectively. Additionally, in January 2005, the Company borrowed $163,033 from Shanghai Shanhai Group for working capital purposes. The loan bears interest at 10% per annum and is payable on demand. For the three months ended March 31, 2006, interest expense related to this note amounted to $4,145. Shanghai Likang Pharmaceuticals Technology Company, Limited, which is owned by Messrs. Xuelian Bian (90%) and Wei Guan (10%), the Company's officers and directors, sells the Company's products to third parties. For the three months ended March 31, 2006 and 2005, the Company recorded net revenues of $1,256,211 and $349,974 to Shanghai Likang Pharmaceuticals Technology Company, Limited, respectively. At March 31, 2006, accounts receivable from sales due from Shanghai Likang Pharmaceuticals Technology Company, Limited was $1,949,092. In general, accounts receivable due from Likang are payable in cash and are due within 4 to 6 months, which approximate normal business terms with unrelated parties. On December 28, 2005, the Company loaned $100,000 to Shanghai Likang Pharmaceuticals Technology Company, Limited for working capital purposes. The balance bears interest at 3% and was repaid in April 2006. -12- NOTE 7 - SHAREHOLDERS' EQUITY Preferred Stock (a) Series A Convertible Preferred Stock On May 11, 2005, the Company's Board of Directors approved the creation of 500,000 shares of Series A Convertible Preferred Stock having the following rights, preferences and limitations: (a) each share has a stated value of $.80 per share and no par value; (b) each share ranks equally with any other series of preferred stock designated by the Company and not designated as senior securities or subordinate to the Series A Convertible Preferred Stock; (c) each share entitles the holder to receive a six percent (6%) per annum cumulative dividend when, as and if, declared by the Board of Directors of the Company; (d) these shares are convertible into shares of the Company's Common Stock at a per share value of $.08 per share; (e) the shares have no voting rights, and (f) the shares are not subject to redemption. On June 30, 2005, the Company completed an approximate $277,276 (net of fees of $23,000) financing consisting of 375,345 shares of its 6% Series A Preferred Stock, and common stock purchase warrants to purchase an additional 3,753,450 shares. Each warrant entitles the holder to purchase one share of common stock for a period of five years, at an exercise price of $.10 per share, subject to adjustment. The net proceeds from the transaction will be used for general working capital purposes. To the extent that the investors continue to own the 6% Series A Preferred Stock or warrants, the Company originally agreed to issue the investors additional shares and/or warrants to protect against the Company's future issuance of common stock or securities convertible into common stock at less than the $.08 per share conversion price of the preferred stock and/or $.10 per share exercise price of the warrants, respectively. Prior to December 31, 2005, this provision was waived by the investors. In addition, the Company also granted the holders piggy-back registration rights covering the shares of its common stock underlying the preferred stock and warrants. On the date of issuance of the Series A Preferred Stock, the effective conversion price was at a discount to the price of the common stock into which it was convertible. In accordance with Emerging Issues Task Force ("EITF") 98-5 and EITF 00-27, the Series A Preferred Stock was considered to have an embedded beneficial conversion feature because the conversion price was less than the fair value of the Company's common stock. This beneficial conversion feature is calculated after the warrants have been valued with proceeds allocated on a relative value basis. This series A convertible Preferred was fully convertible at the issuance date, therefore the full amount of proceeds allocated to the Series A Preferred was determined to be the value of the beneficial conversion feature and was recorded as a deemed dividend with a corresponding credit to additional paid-in capital in the amount of $300,276 in fiscal 2005. As of March 31, 2006, accrued cumulative but undeclared dividends in arrears related to the Company's Series A Preferred Stock amounted to approximately $.04 per share aggregating approximately $14,942 and is included on the accompanying balance sheet. -13- NOTE 7 - SHAREHOLDERS' EQUITY (continued) Preferred Stock (continued) (b) Series B 6% Cumulative Preferred Stock On December 28, 2005, the Company closed on a private placement with a group of accredited investors, for the sale of 1,500,000 shares of the Company's Series B 6% Cumulative Preferred Stock (the "Series B Preferred Stock") along with warrants to purchase additional shares of the Company's common stock exempt from registration under the Securities Act in reliance on exemptions provided by Section 4(2) of that act and Regulation D. The 6% Convertible Preferred Stock was priced at $1.00 per share, and the Company received gross proceeds of $1,500,000. Each share of Series B Preferred Stock, as well as the value of all accrued by unpaid dividends, is convertible at the option of the holder into shares of the Company's common stock at a conversion price of $0.10 per share, provided that no holder has the right to convert his shares of Series B Preferred Stock if by virtue of such conversion the holder would become the beneficial owner of than 4.99% of the Company's common stock. This ownership limitation can be waived by the holder upon 61 days notice to the Company. The conversion price is subject to adjustment in the event of stock splits, reclassifications or stock dividends. Thus, if all of the shares of the Series B Preferred Stock were converted to common stock, an additional 15,000,000 shares of common stock would be issued. The shares of Series B Preferred Stock do not have any voting rights except as may be provided under Florida law. In connection with the sale of 1,500,000 shares of the Company's Series B Preferred Stock, the Company issued Class A Common Stock Purchase Warrants to purchase 15,000,000 shares of the Company's common stock at an exercise price of $0.20 per share and Class B Common Stock Purchase Warrants to purchase 15,866,665 (including 866,665 granted to placement agent) shares of its common stock at an exercise price of $0.30 per share. The Class A and Class B warrant exercise prices are subject to adjustment pursuant to anti-dilution provisions on either a cash or cashless exercise basis. The warrants expire five years from the date of issuance. The Series B Preferred Stock ranks ahead of the common stock of the Company upon liquidation of the Company. The Series B Preferred Stock also ranks ahead of the common stock with respect to the payment of dividends. The shares pay cumulative dividends of 6% per annum beginning on October 31, 2006, which increases to 20% per annum if an "event of default", as defined in the agreement, has occurred. The dividends are payable in cash or at the Company's option shares of registered common stock. If the Company elects to pay dividends in the form of shares of its common stock, for purposes of the calculation the shares are valued at the average closing price of our common stock for the 10 trading days preceding the date of the dividend. In connection with the transaction, the Company filed a certificate of designation for the Series B Preferred Stock with the Florida Department of Corporations on December 8, 2005. This filing constituted an amendment to the Company's certificate of incorporation, designating the terms, rights and preferences of a new series of preferred stock of the Company. As of March 31, 2006, accrued cumulative but undeclared dividends in arrears related to the Company's Series B Preferred Stock amounted to approximately $.015 per share aggregating approximately $22,192 and is included on the accompanying balance sheet. -14- NOTE 7 - SHAREHOLDERS' EQUITY (continued) Preferred Stock (continued) The Company paid a due diligence fee of $65,000 in cash and Class B Warrants to purchase 866,665 shares of its common stock to certain of the investors who purchased securities in this offering. The net proceeds from the transaction will be used for working capital purposes. The Company agreed to file a registration statement covering the shares of common stock underlying the securities issued. In the event the registration statement is not filed by February 13, 2006 or does not become effective by June 28, 2006, the Company is required to pay liquidated damages in the amount of $30,000 per month until the deficiency is cured. The transaction documents also provide for the payment of liquidated damages to the investors in certain events, including the Company's failure to maintain an effective registration statement covering the resale of the common shares issuable upon conversion or exercise of the securities. In accordance with Emerging Issues Task Force ("EITF") 98-5 and EITF 00-27, the Series B Preferred was considered to have an embedded beneficial conversion feature because the conversion price was less than the fair value of the Company's common stock. This beneficial conversion feature is calculated after the warrants have been valued with proceeds allocated on a relative value basis. This Series B Convertible Preferred was fully convertible at the issuance date, therefore the full amount of proceeds allocated to the Series B Preferred was determined to be the value of the beneficial conversion feature and was recorded as a deemed dividend with a corresponding credit to additional paid-in capital in the amount of $1,500,000 in fiscal 2005. In 2005, the Company computes the fair value of the warrants using the Black-Scholes valuation model. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. The assumptions used in this model to estimate fair value of the warrants granted are as follows: Warrants Exercise/Conversion Price $0.20 to $0.30 Fair Value of the Company's Common Stock $ 0.153 Expected life in years 5.0 Expected volatility 330% Expected dividend yield 0.0% Risk free rate 3.93% Calculated fair value per share $ 0.153 Common Stock For the three months ended March 31, 2006 and 2005, amortization of stock based compensation amounted to $67,324 and $0, respectively. Stock Options Year 2000 Equity Compensation Plan On October 10, 2000, the Company's Board of Directors adopted its Year 2000 Equity Compensation Plan under which a total of 540,000 shares of common stock are made available for the granting of awards, a portion or all of which may qualify as incentive stock options, non-incentive stock options and restricted stock grants. The purpose of the plan, which was approved by the Company's shareholders on November 10, 2000, is to encourage stock ownership by its officers, directors, key employees and consultants, and to give such persons a greater personal interest in the success of its business and an added incentive to continue to advance and contribute to us. If any option or restricted stock grant expires or terminates before it has been exercised in full, the shares of common stock allocable to the unexercised portion of such option or restricted stock grant may again be subject to an option or restricted stock grant under the 2000 Equity Compensation Plan. The number of shares available and subject to options, option prices and, to the extent applicable, the number of shares -15- NOTE 8 - STOCKHOLDERS' EQUITY (continued) Stock options (continued) subject to any restricted stock grant will be adjusted upward or downward, as the case may be, in the event of any subdivision or consolidation of shares or other capital readjustment, stock dividend, merger, consolidation or similar transaction affecting the shares. At June 30, 2006, the Company did not have any options to purchase shares of its common stock outstanding under the plan. The 2000 Equity Compensation Plan is administered by the Company's Board of Directors who have the sole authority to determine which eligible employees of the company receive options and restricted stock grants under the plan, the times when options and restricted stock grants are granted, the number of shares covered by the option and restricted stock grant, the provisions of any agreement and when options may be exercised or when restricted stock grants become vested. In addition, the Board has the power and authority to construe and interpret the Plan. Stock options may be granted by the Board at prices determined in the discretion of the Board, provided that the option price must be at least equal to the fair market value of the common stock on the date of the grant. The option price is payable in cash, common stock or such other form of payment as may be determined by the Board. The exercise price of an incentive stock option must be at least equal to the fair market value of the Company's common stock on the date of grant or 110% of such value in the case of options granted to an individual who is a 10% or greater shareholder of the company. An optionee generally may exercise an option only while an employee of the Company. If an optionee becomes disabled or dies while in the employ of our company, the option may be exercised within one year of the optionee's death or termination due to disability. The expiration date of an option will be determined by the Board at the time of the grant, but in no event will an incentive stock option be exercisable after the expiration of 10 years from the date of grant or five years in the case of incentive options granted to a 10% or greater shareholder. The Board may grant to an eligible individual shares of the Company's common stock subject to specified restrictions on transferability and vesting as provided in a written grant agreement or resolutions in which the restricted stock grant is adopted and approved by the Board. Restricted stock grants may be made in lieu or cash compensation or as additional compensation. The Board may also make restricted stock grants contingent on pre-established performance goals determined by the Board. Except for certain transfers that may be permitted by the Board, no option or restricted stock grant may be transferred by an eligible individual other than by will or the laws of descent or distribution. The 2000 Equity Compensation Plan terminates on October 10, 2010. The Board of Directors may at any time amend, suspend or discontinue the plan, except that no amendment may be made without the approval of the shareholders which would increase the number of shares subject to the plan, materially change the designation of the class of employees eligible to receive options, remove the administration of the plan from the Board or a committee of the Board or materially increase the benefits accruing to participants under the plan. Non-Qualified Stock Option Plan On December 21, 2000 the Company's Board of Directors adopted our Non-Qualified Stock Option Plan under which a total of 200,000 shares of common stock are made available for granting of non-qualified stock options to officers, directors, employees and key advisors or consultants. The purpose of the plan is to encourage the participants to contribute materially to its growth. If any option expires or terminates before it has been exercised in full, the shares of common stock allocable to the unexercised portion of such option may again be subject to an option under the Non Qualified Stock Option Plan. The number of shares available and subject to options and option prices will be adjusted upward or downward, as the case may be, in the event of any subdivision or consolidation of shares or other capital readjustment, stock dividend, merger, consolidation or similar transaction affecting the shares. At June 30, 2006, the Company did not had any options to purchase shares of our common stock outstanding under the plan. -16- NOTE 8 - STOCKHOLDERS' EQUITY (continued) Stock options (continued) The Non-Qualified Stock Option Plan is administered by our Board of Directors who have the sole authority to determine which who is eligible to receive grants of non-qualified options under the plan, the times when options are granted, the number of shares covered by the option, the provisions of any agreement and when options may be exercised. In addition, the Board has the power and authority to construe and interpret the Plan. Stock options may be granted by the Board at prices determined in the discretion of the Board and the exercise price of the option may be greater than, or less than, the fair market value of our common stock. The option price is payable in cash, common stock or such other form of payment as may be determined by the Board. An optionee generally may exercise an option only while the grantee is employed by us or otherwise providing our company services. If an optionee becomes disabled or dies while in the employ of our company or while otherwise providing services to us, the option may be exercised within 90 days after optionee's death or termination due to disability. The expiration date of an option will be determined by the Board at the time of the grant, but in no event will a stock option be exercisable after the expiration of 10 years from the date of grant. Except for certain transfers that may be permitted by the Board, no option may be transferred by an eligible individual other than by will or the laws of descent or distribution. The 2000 Equity Compensation Plan terminates on December 21, 2010. The Board of Directors may at any time amend, suspend or discontinue the plan, except that no amendment may be made without the approval of the shareholders which would increase the number of shares subject to the plan, materially change the designation of the class of employees eligible to receive options, remove the administration of the plan from the Board or a committee of the Board or materially increase the benefits accruing to participants under the plan. 2005 Equity Compensation Plan Effective June 28, 2005, the Company's Board of Directors authorized, approved and adopted its 2005 Equity Compensation Plan. The purpose of the plan is to encourage stock ownership by our officers, directors, key employees and consultants, and to give these persons a greater personal interest in the success of our business and an added incentive to continue to advance and contribute to us. The Company has currently reserved 5,000,000 of its authorized but unissued shares of common stock for issuance under the plan, and a maximum of 5,000,000 shares may be issued, unless the plan is subsequently amended (subject to adjustment in the event of certain changes in our capitalization), without further action by its Board of Directors and stockholders, as required. Subject to the limitation on the aggregate number of shares issuable under the plan, there is no maximum or minimum number of shares as to which a stock grant or plan option may be granted to any person. Shares used for stock grants and plan options may be authorized and unissued shares or shares reacquired by the Company, including shares purchased in the open market. Shares covered by plan options which terminate unexercised will again become available for grant as additional options, without decreasing the maximum number of shares issuable under the plan, although such shares may also be used by the Company for other purposes. The plan is administered by the Company's Board of Directors or an underlying committee. The Board of Directors or the committee determines from time to time those officers, directors, key employees and consultants to whom stock grants or plan options are to be granted, the terms and provisions of the respective option agreements, the time or times at which such options shall be granted, the type of options to be granted, the dates such plan options become exercisable, the number of shares subject to each option, the purchase price of such shares and the form of payment of such purchase price. All other questions relating to the administration of the plan, and the interpretation of the provisions thereof and of the related option agreements are resolved by the Board or committee. -17- NOTE 7 - SHAREHOLDERS' EQUITY (continued) Stock Options (continued) Plan options may either be options qualifying as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended, or non-qualified options. The Company's officers, directors, key employees and consultants are eligible to receive stock grants and non-qualified options under the plan; only the Company's employees are eligible to receive incentive options. In addition, the plan allows for the inclusion of a reload option provision which permits an eligible person to pay the exercise price of the option with shares of common stock owned by the eligible person and receive a new option to purchase shares of common stock equal in number to the tendered shares. Furthermore, compensatory stock grants may also be issued. Any incentive option granted under the plan must provide for an exercise price of not less than 100% of the fair market value of the underlying shares on the date of grant, but the exercise price of any incentive option granted to an eligible employee owning more than 10% of our outstanding common stock must not be less than 110% of fair market value on the date of the grant. The term of each plan option and the manner in which it may be exercised is determined by the Board of Directors or the committee, provided that no option may be exercisable more than ten years after the date of its grant and, in the case of an incentive option granted to an eligible employee owning more than 10% of the common stock, no more than five years after the date of the grant. The exercise price of non-qualified options shall be determined by the Board of Directors or the Committee, but shall not be less than the par value on the date the option is granted. The per share purchase price of shares issuable upon exercise of a Plan option may be adjusted in the event of certain changes in our capitalization, but no such adjustment shall change the total purchase price payable upon the exercise in full of options granted under the Plan. Unless the plan has been previously suspended or terminated by the Board of Directors, the plan, as it relates to grants of incentive stock options, terminates on June 28, 2015. During the three months ended March 31, 2006, the Company did not grant any stock options. Common Stock Warrants In January 2006, the Company issued China Direct Investments, Inc. three-year common stock purchase warrants to purchase 2,125,000 shares of our common stock at an exercise price of $0.20 per share for business development and management services rendered and to rendered in the future. The fair market value of these warrants of $327,880 will be amortized over the service period and was estimated on the date of grant using the Black-Scholes option-pricing model, in accordance with SFAS No. 123 using the following weighted-average assumptions: expected dividend yield 0%, risk-free interest rate of 4.35%, volatility of 330% and expected term of 3 years. Stock warrant activity for the year ended March 31, 2006 is summarized as follows: Number of Weighted average shares exercise price Outstanding at December 31, 2005 35,009,865 $0.25 Granted 2,125,000 0.20 Exercised - - -------------- ------ Outstanding at March 31, 2006 37,134,865 $0.25 ============== ====== -18- NOTE 7 - SHAREHOLDERS' EQUITY (continued) Common Stock Warrants (continued) The following table summarizes the Company's stock warrants outstanding at March 31, 2006: Warrants outstanding and exercisable ------------------------------------ Weighted Weighted average average Range of remaining exercise exercise price Number life price - -------------------------------------------------- ----------------------- $0.75-2.50 359,750 1.45 $2.02 $0.10 3,753,450 4.25 $0.10 $0.20 17,155,000 4.50 $0.20 $0.30 15,866,665 4.75 0$.30 NOTE 8 OPERATING RISK (a) Country risk Currently, the Company's revenues are primarily derived from the sale of line of disinfectant product offerings to customers in the Peoples Republic of China (PRC). The Company hopes to expand its operations to countries outside the PRC, however, such expansion has not been commenced and there are no assurances that the Company will be able to achieve such an expansion successfully. Therefore, a downturn or stagnation in the economic environment of the PRC could have a material adverse effect on the Company's financial condition. (b) Products risk In addition to competing with other manufacturers of disinfectant product offerings, the Company competes with larger U.S. companies who have greater funds available for expansion, marketing, research and development and the ability to attract more qualified personnel. These U.S. companies may be able to offer products at a lower price. There can be no assurance that the Company will remain competitive should this occur. (c) Exchange risk The Company can not guarantee that the current exchange rate will remain steady, therefore there is a possibility that the Company could post the same amount of profit for two comparable periods and because of a fluctuating exchange rate actually post higher or lower profit depending on exchange rate of Renminbi converted to US dollars on that date. The exchange rate could fluctuate depending on changes in the political and economic environments without notice. (d) Political risk Currently, PRC is in a period of growth and is openly promoting business development in order to bring more business into PRC. Additionally PRC allows a Chinese corporation to be owned by a United States corporation. If the laws or regulations are changed by the PRC government, the Company's ability to operate the PRC subsidiaries could be affected. NOTE 11 FOREIGN OPERATIONS For the three months ended March 31, 2006 and 2005, the Company derived all of its revenue from its subsidiaries located in the People's Republic of China. Identifiable assets by geographic areas as of March 31, 2006 are as follows: Identifiable Assets at March 31, 2006 ------------------------- United States $ 135,871 China 5,308,060 ------------------------- Total $ 5,443,931 ========================= -19- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Overview In May 2005, we closed a share exchange agreement with all of the shareholders of Linkwell Tech under which we acquired 100% of the issued and outstanding shares of Linkwell Tech's common stock in exchange for 36,273,470 shares of our common stock, which at closing represented approximately 87.5% of the issued and outstanding shares of our common stock. As a result of the transaction, Linkwell Tech became our wholly owned subsidiary. In June, 2004, prior to our share exchange with Linkwell Tech, Linkwell Tech acquired 90% of Likang through a stock exchange with Shanghai Likang Pharmaceuticals Technology Company, Limited, the then 90% shareholder of Likang. Shanghai Likang Pharmaceuticals Technology Company, Limited is owned by Messrs. Xuelian Bian and Wei Guan, our officer, directors and principal shareholders. Shanghai Shanhai Group, an unaffiliated third party, owns the remaining 10% of Likang. The transaction in which Linkwell Tech acquired the 90% interest in Likang resulted in the formation of a U.S. holding company by Messrs. Bian and Guan as it did not result in a change in the underlying ownership interests of Likang. For financial accounting purposes, the reverse merger transaction in which we acquired Linkwell Tech was treated as a recapitalization of our company with the former shareholders of the company retaining approximately 12.5% of the outstanding stock. We regard Likang's business of disinfectant products for the commercial medical industry as the primary segment of our business. Our consolidated financials statements included elsewhere in this prospectus for the periods after the date of the stock exchange between our company and Linkwell Tech reflect the change in the capital structure of our company due to the recapitalization. The consolidated financial statements for the three months ended March 31, 2006 and the fiscal year ended December 30, 2005 reflect the operations of our company including Linkwell Tech and Likang for the periods presented while the results of operations for the fiscal year ended December 31, 2004 are those of Likang. Since 1988 we have developed, manufactured and distributed disinfectant health care products primarily to the medical industry in China. In the last few years China has witnessed a variety of public health crises, such as the outbreak of SARS, which demonstrated the need for increased health standards in China. In response, beginning in 2002 the Chinese government has undertaken various initiatives to improve public health and living standards, including continuing efforts to educate the public about the need for proper sanitation procedures and the establishment of production standards for the disinfectant industry in China. As a result of this heightened license and permit system, all disinfectant manufacturers must comply with "qualified disinfection product manufacturing enterprise requirements" established by the Ministry of Public Health. The requirements include standards for both hardware; including facilities and machinery, and software; including the technology to monitor the facilities, as well as the knowledge and capability of both the production staff and quality control procedures. Following the adoption of the industry standards in 2002, we have been granted 26 hygiene licenses by the Ministry of Public Health. We believe that the government standards adopted in July 2002 have increased the barriers to entry for competitors in the disinfectant industry in China. The implementation of these improved production standards and license requirements has effectively decreased the competitiveness of small to mid size manufacturers since the new standards are especially difficult for companies with limited product offerings and inferior technical content. In addition, prior to the adoption of industry standards, disinfectant products were generally marketed and sold based on price as opposed to quality. We believe that as a result of the adoption of industry standards, the marketplace is evolving to a more stringent focus on product quality which we believe will enable us to increase our base of commercial customers thereby increasing our revenues. -20- Historically our focus has been on the commercial distribution of our products. Our customers include hospitals, medical suppliers and distribution companies throughout China. Recently we have made efforts to expand our distribution reach to the retail market. We have repackaged certain of our commercial disinfectant products for sale to the consumer market and have begun to expand our customer base to include hotels, schools, supermarkets, and drugstores. By virtue of the Chinese government's continuing focus on educating the Chinese population about the benefits of proper sanitation procedures, we believe that another key to increasing our revenues is the continued expansion of the retail distribution of our products. The disinfectant industry in China is an emerging industry and the industry is populated with small, regional companies. We estimate that there are in excess of 1,000 manufacturers and distributors of disinfectant products in China; however, most domestic competitors offer a limited line of products and there are few domestic companies with a nationwide presence. We believe that our national marketing and sales presence throughout all 22 provinces, as well as four autonomous regions, and four municipalities of China gives us a competitive advantage over many other disinfectant companies in China and will enable us to leverage the brand awareness for products with commercial customers to the retail marketplace. Our present manufacturing facilities and production capacities are sufficient for the foreseeable future, and we believe that we otherwise have the assets and capital available to us necessary to enable us to increase our revenues in future periods as the overall market for disinfectant products in China continues to increase. During the balance of fiscal 2006 we will continue to focus our efforts on developing a retail market for our products, as well as expanding our traditional base of commercial customers. In this regard, we have allocated approximately $300,000 from our recent private offering to be used towards expanded marketing of our products in the PRC and approximately $400,000 for costs associated with investigating the feasibility of expanding our sales outside the PRC to the U.S. In addition, we may also consider the possible acquisition of independent sales networks which could be used to increase our product distribution as well as smaller, regional companies in our industry. While we have allocated approximately $400,000 of proceeds from our recent private offering, we have not identified any potential acquisition targets. Sale of Aerisys Incorporated Prior to the transaction with Linkwell, our wholly-owned subsidiary, Aerisys Incorporated, had represented our sole operations. Aerisys marketed and sold the Aerisys Intelligent Community (TM), a web-based software program and private, browser-based intranet product that allows schools to collaborate with parents and faculty each day on classroom homework, assignments, critical dates, team priorities and school news in a private forum, primarily to K through 12 private schools. Revenues from Aerisys Incorporated represented slightly less than 1% of our total net revenues for the year ended December 31, 2005, and we were not able to improve sales or business opportunities for Aerisys since May 2005. In February 2006 we sold 100% of the stock of Aerisys Incorporated to Mr. Gary Verdier, our former CEO, in exchange for assumption of all liabilities and obligation of Aerisys Incorporated. -21- Results of Operations Three months ended March 31, 2006 as compared to the three months ended March 31, 2005 Results of Operations
Three Months Ended March 31, $ % ---------------------- --------------------- 2006 2005 Change Change (unaudited) (unaudited) (restated) ---------------------- --------------------- -------------- ------------- Net revenues $ 1,868,526 $ 947,925 $920,601 97.1% Cost of sales 1,227,448 754,637 472,811 62.7% Selling expenses 105,559 44,734 60,825 136.0% GAexpenses 262,616 132,457 130,159 98.3% Total operating expenses 368,175 177,191 190,984 107.8% Operating income 272,903 16,097 256,806 1,595.4% Total other (expense) (13,358) (11,117) (2,241) 20.2% Gain from discontinued operations 12,794 - 12,794 100.0% Income taxes (47,124) (1,401) (45,723) 3,263.6% Minority interest (23,275) (358) (22,917) 6,401.4% Net income $ 201,940 $ 3,221 $198,719 6,169.5% ====================== ===================== ============== ============= Net income attributable to common shareholders $ 175,306 $ 3,221 $172,085 NM ====================== ===================== ============== =============
NM = not material Other key indicators:
Three Months Ended March 31, --------------------------- 2006 2005 % of change (unaudited) (unaudited) Cost of sales as a percentage of revenues 65.7% 79.6% -13.9% Gross profit margin 34.3% 20.4% +13.9% Selling expenses as a percentage of revenues 5.6% 4.7% + 0.9% GAexpenses as a percentage of revenues 14.1% 14.0% + 0.1% Total operating expenses as a percentage of revenues 19.7% 18.7% + 1.0%
Net revenues Net revenues for the three months ended March 31, 2006 were $1,868,526 as compared to net revenues of $947,925 for the three months ended March 31, 2005, an increase of $920,601 or approximately 97.1%. We believe our increase in our net revenues in the three months ended March 31, 2006 was attributable to a recent surge in demand for disinfectant products stemming from health scares such as SARS and the avian flu which have increased the public awareness of health standards in China. As a result, public demand for disinfectant products has increased. While we reported a increase in sales for fiscal 2005 from fiscal 2004 which as continued into the first quarter of fiscal 2006 when compared to the first quarter of fiscal 2005, we cannot be assured that demand will continue to increase or that the initial demand for new products which introduced in fiscal 2005, including Jifro 4% Chlorhexidine Gluconate, Dianerkang, 2% glutaraldehyde disinfectant, and the revised 84' disinfectant, will continue. -22- Of our total net revenues for the three months ended March 31, 2006, approximately 67% were attributable to sales to related parties and approximately 33% were attributable to sales to third parties, as compared to approximately 38% and approximately 62%, respectively, for the three months ended March 31, 2005. Included in our net revenues for the three months ended March 31, 2006 were revenues of $1,260,211 from sales of our products to Shanghai Likang Pharmaceuticals Technology Company, Limited, an affiliated entity, an increase of $906,237, or approximately 259%, from the three months ended March 31, 2005. Also included in our net revenues for the three months ended March 31, 2006 were revenues of $4,044 from sales of our products to Shanghai Likang Meirui Pharmaceuticals High-Tech Co., Ltd., an affiliate, a decrease of $3,969 or approximately 49.5%, from the three months ended March 31, 2005. While we increased sales to non-related parties approximately 3% for the three months ended March 31, 2006 from the comparable period in fiscal 2005, sales to related parties increased $902,269, or approximately 252%, which accounts for our significant increase in revenues in the first quarter of fiscal 2006 from the first quarter of fiscal 2005. Shanghai Likang Pharmaceuticals Technology Company, Limited, sells our products using 72 independent sales representatives in other provinces of China. We primarily attribute this increase in related party sales to the effects of the overall demand for disinfectant products which has increased orders from Shanghai Likang Pharmaceuticals Technology Company, Limited's customers for our products. Cost of sales Cost of sales includes raw materials and manufacturing costs, which includes labor, rent and an allocated portion of overhead expenses such as utilities directly related to product production. For the three months ended March 31, 2006, cost of sales amounted to $1,227,448 or approximately 65.7% of net revenues as compared to cost of sales of $754,637 or approximately 79.6% of net revenues for the three months ended March 31, 2005. Historically, our costs of sales is attributable approximately 65% to raw material costs and approximately 35% to manufacturing costs. We purchase raw materials from six primary suppliers and we have signed purchase contracts with these suppliers in an effort to ensure a steady supply of raw materials. We also purchase raw materials and finished product from Shanghai Likang Meirui Pharmaceutical High-Tech Co. Ltd., an affiliate. These purchases totaled $0 and $0 for the three months ended March 31, 2006 and the three months ended March 31, 2005, respectively. We have not historically experienced a fluctuation in raw material prices and do not anticipate that the prices will vary much during fiscal 2006. The decrease in cost of sales as a percentage of net revenues for the three months ended March 31, 2006 as compared to the three months ended March 31, 2005 is attributable to the effect of price increases during the later part of fiscal 2005. Included in our overhead costs are rent on our manufacturing facilities which included a building we leased from Shanghai Likang Pharmaceuticals Technology Company, Limited, an affiliate, for approximately $11,500 annually, which we purchased during the later part of fiscal 2005 which served to reduce certain of our overhead expenses through the elimination of this rent expense; however, during the later part of fiscal 2005 we leased additional warehouse facilities under agreements which provide for annual rental of approximately $37,000 which are reflected in our overhead expenses for the first quarter of fiscal 2006. We experienced an increase in overhead costs such as utilities and rent during the three months ended March 31, 2006 as compared to the three months ended March 31, 2005. -23- Gross profit Gross profit for the three months ended March 31, 2006 was $641,078 or approximately 34.3% of net revenues, as compared to $193,288 or approximately 20.4% of revenues for the three months ended March 31, 2005. The gross profit reflects an overall increase in our sales prices as we expand into new markets. For example, our Ai'ershi disinfectant tablets are sold in Shanghai for approximately $.83 per bottle. However in newer markets such as DongBei Province, Ai'ershi disinfectant tablets are sold at approximately $1.64 per bottle. An'erdian skin disinfectant sold for approximately $.36 per bottle in BeiJing and Shanghai. We currently sell this product in western cities such as ChongQing and XiAn at approximately $.49 per bottle, an increase of 36%. The trend of increase in our gross profit margins reported in fiscal 2005 has continued into the first quarter of fiscal 2006. While we believe that we will continue to report increased gross profit margins during the balance of fiscal 2006 from the comparable periods in fiscal 2005, if sales of our products do not continue to increase or if we report a drop in sales of products such as our An'erdian Skin Disinfectant line, it is likely that our gross profit margins would decline in future periods. Operating expenses Total operating expenses for the three months ended March 31, 2006 were $368,175, an increase of $190,984, or approximately 107.8%, from total operating expenses in the three months ended March 31, 2005 of $177,191. This increase included the following: * For the three months ended March 31, 2006, selling expenses amounted to $105,559 as compared to $44,734 for the three months ended March 31, 2005, an increase of $60,825 or approximately 136%. This increase is attributable to increased local sales tax costs and commissions associated with our increased revenues of approximately $20,000. We pay local sales tax to local authorities upon sale of product to customers. Similar to the U.S., each Chinese province has its own tax authorities. As we expand our sales into new territories, we will be subject to various taxes. Additionally, during the three months ended March 31, 2006, we incurred additional costs of approximately $18,000 in connection with increased shipping costs to customers, increased advertising costs of approximately $12,000, and increased sales-related consulting expenses of approximately $21,000 related to business development into new territories. We expect our selling expenses to increase as our revenues increase and expect to spend increased funds on adverting and promotion of our products as well as sales training. During fiscal 2006 we intend to expand our marketing efforts and have set aside approximately $300,000 of the proceeds from our recent private placement for increased marketing of our products in the PRC during fiscal 2006. * For the three months ended March 31, 2006, general and administrative expenses were $262,616 as compared to $132,457 for the three months ended March 31, 2005, an increase of $130,159, or approximately 98.3% and included the following: * We incurred consulting fees during the three months ended March 31, 2006 of $67,323 substantially related to the issuance of common stock for business development and management services related to our administrative operations in the United States. We did not incur such costs during the three months ended March 31, 2005. We expect these costs to increase in 2006 due to our business development efforts in the United States. * For the three months ended March 31, 2006, salaries and wages and related benefits increased by approximately $36,000 to $74,519 for the three months ended March 31, 2006 from $38,275 in the 2005 period due to the hiring of additional employees. * We incurred additional operating expenses associated with overall price increases, increased telephone and communications usage, and increase travel and entertainment. Included in our general and administrative expenses is rent expense that we pay on our principal executive offices and warehouse space which we lease from Shanghai Shanhai Group, an affiliate, for approximately $36,000 a year. We anticipate that general and administrative expenses will continue to increase during fiscal 2006 as a result of increased professional fees related to audit costs and our registration statement. In addition, we have allocated $400,000 from the proceeds of our recent private placement for costs, including market research, related to the possible expansion of the market for our products into the U.S. Income from operations We reported income from operations of $272,903 for the three months ended March 31, 2006 as compared to income from operations of $16,097 for the three months ended March 31, 2005, an increase of $256,806 or approximately 1,595%. -24- Other income (expense) For the three months ended March 31, 2006 total other expenses amounted to $13,358 as compared to $11,117 for the three months ended March 31, 2005, an increase of $2,241. This change is primarily attributable to: * Interest expense - related party of $4,145 represents interest due Shanghai Shanhai Company, Likang's minority shareholder, on a demand loan in the principal amount of $161,533 made to Likang for working capital, and * Interest expense was $10,770 as compared to $11,299 for the three months ended March 31, 2005, a decrease of $529 due to decreased borrowings during the three months ended March 31, 2006. Income before discontinued operations, income taxes and minority interest Our income before discontinued operations, income taxes and minority interest increased by $254,565 for the three months ended March 31, 2006 as compared to the comparable 2005 primarily as a result of increased net revenues. Discontinued operations In January 2006, we sold 100% of the capital stock of our Aerisys subsidiary to its former CEO in exchange for an assumption of all liabilities related to it. The gain from discontinued operations in the three months ended March 31, 2006 represents the gain on disposal of this subsidiary. Minority interest For the three months ended March 31, 2006, we reported a minority interest in income of $23,275 as compared to $358 for the three months ended March 31, 2005. The minority interest is attributable to Likang's minority shareholder, and had the effect of reducing our net income. Net income As a result of these factors, we reported net income of $201,940 for the three months ended March 31, 2006 as compared to net income of $3,221 for the three months ended March 31, 2005. Cumulative Preferred Stock Dividends and Net Income Attributable to Common Shareholders For the three months ended March 31, 2006 we accrued dividends in the amount of $26,634 which relates to undeclared and unpaid dividends related to our Series A Convertible Preferred Stock and our Series B 6% Cumulative Preferred Stock. We did not have comparable expenses in fiscal 2005. We reported net income attributable to our common shareholders of $175,305 for the first quarter of fiscal 2006, an increase of $172,085 from the comparable period in fiscal 2005. This translates to an overall per-share income available to shareholders of $.00 for the three months ended March 31, 2006 compared to per-share income of $.00 for the three months ended March 31, 2005. -25- Liquidity and Capital Resources Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. The following table provides certain selected balance sheet comparisons between March 12, 2006 (unaudited) and December 31, 2005:
March 31 December 31, $ of % of 2006 2005 Change Change ----------- ---------------------------------------------- (unaudited) (restated) (restated) Working capital $ 2,643,810 $2,412,757 $ 231,053 + 9.6% Cash $ 879,920 $1,460,078 $( 580,158) - 39.7% Accounts receivable, net $ 1,201,964 $1,347,163 $( 145,199) - 10.8% Accounts receivable related $1,952,525 $ 872,370 $1,080,155 + 124% Inventories $ 479,295 $ 968,224 $( 488,929) - 50.5% Prepaid expenses $ 92,536 $ 81,750 $ 10,786 + 13.2% Loan receivable related $ 100,000 $ 100,000 $ - none Total current assets $ 4,706,240 $4,839,541 $( 133,301) - 2.8% Property and equipment, net $ 737,691 $ 686,234 $ 51,457 + 7.5% Loans payable $ 535,145 $ 628,869 $( 93,724) - 14.9% Loans payable - related $ 163,033 $ 161,533 $ 1,500 + 0.01% Accounts payable and accrued expenses $ 923,571 $1,400,704 $(477,133) - 34.1% Advances from customers $ 355,563 $ 126,199 $ 229,364 + 182% Total liabilities $ 2,062,430 $2,426,784 $(364,354) - 15.0%
At March 31, 2006, we had a cash balance of $879,920. As of March 31, 2006, our cash position by geographic area is as follows: United States $ 2,335 China 877,585 -------------- $ 879,920 Our working capital position increased $231,053 to $2,643,810 at March 31, 2006 from $2,412,757 at December 31, 2005. This increase in working capital is primarily attributable to an increase of approximately $1.1 million in accounts receivable due us from related parties as discussed below, which was offset by decreases in cash (approximately $580,000), accounts receivable due from third parties (approximately $146,000) and inventories (approximately $489,000). The increase in accounts receivable - related parties and corresponding decreases in cash and inventories reflects the effects of increased sales during the first quarter of fiscal 2006 and the corresponding receivables generated by those sales. The decrease in our current assets of $133,301 at March 31, 2006 as compared to December 31, 2005 was offset by an decrease in our current liabilities of $364,354 at March 31, 2006 as compared to December 31, 2005. The decrease in our current liabilities is primarily attributable to decreased borrowings and lower payable and accrued expenses which were offset by an increase in advances from customers. At March 31, 2006, our inventories of raw materials, work in process and finished goods, before a reserve for obsolete inventory totaled $479,295, a decrease of $489,000, or approximately 51%, from December 31, 2005. At March 31, 2006 we have reserved $123,715 for possible obsolescence of inventories which represents a minimal increase from inventory reserves at December 31, 2005. Our management determined the reserve was appropriate based upon its internal analysis of our sales and anticipated customer demand. During fiscal 2005 we introduced several new products which had been in development for a period of time and reformulated several existing products; these new and reformulated products were partially attributable for our increased sales in fiscal 2005. Our management considered the initial market impact from the introduction of the new and reformulated products when it calculated the reserve for possible obsolete inventory for both fiscal 2005 and the first quarter of fiscal 2006. We expect to maintain higher inventory levels to accommodate for anticipated future sales -26- growth as well as a wider variety of products. As of March 31, 2006, our inventory levels decreased due to a surge in revenues. Subsequent to the period, our inventory quantities returned to normal levels as due to increased production. At March 31, 2006 our accounts receivable, allowance for doubtful accounts from third parties was $32,929 as compared to $13,343 at December 31, 2005 and reflects our best estimate of probable losses. In determining the allowance for doubtful accounts, our management reviews our accounts receivable aging as well as the facts and circumstances of specific customers which may indicate the collection of specific amounts are at risk. As is customary in the PRC, we extend relatively long payment terms to our customers. Our terms of sale generally require payment within four to six months, which is considerably longer than customary terms offered in the United States, however, we believe that our terms of sale are customary amongst our competitors for our a company our size within our industry. For fiscal 2005, the average turn on accounts receivable from non-related third parties was 127 days and the average turn on accounts receivable from related parties as 106 days. For the first quarter of fiscal 2006, the average turn on accounts receivable from non-related third parties was 189 day and the average turn on accounts receivable from related parties as 101 days. We also occasionally offer established customers, including related parties, longer payment terms of 240 days on new products as an incentive to purchase these products, which has served to further increase the average days outstanding for accounts receivable. As the market for these new products is established, we will discontinue offering this sales incentive. Generally, a customer will prepay for an order prior to shipment. At March 31, 2006 our balance sheet reflected advances from customers of $355,563, an increase of $229,364, or approximately 182%, from December 31, 2005. At March 31, 2006 related parties owed us $2,052,525 which included: * $1,949,092 in accounts receivable due from to Shanghai Likang Pharmaceuticals Technology Company, Limited for the purchase of products from us, * $3,433 accounts receivable due from Shanghai Likang Meirui Pharmaceutical High-Tech Co. Ltd. for the purchase of products from us, and * $100,000 due from Shanghai Likang Pharmaceuticals Technology Company, Limited which represents a working capital loan to that entity. This loan was repaid in April 2006. As described elsewhere in this prospectus, we sell products to these two affiliated entities. Our terms of sale and settlement on sales to Shanghai Likang Meirui Pharmaceutical High-Tech Co. Ltd. are the same as we offer our third party customers. Shanghai Likang Pharmaceuticals Technology Company, Limited purchase products from us on an as needed basis in order to fill customer orders they have received and do not maintain an inventory of our products. They tender payment to us upon receipt of payment from their customer. The accounts receivable from Shanghai Likang Pharmaceuticals Technology Company, Limited are historically paid in less time than the accounts receivable of our third party customers. Our balance sheet at March 31, 2006 also reflects a loan payable to a related party of $163,033 which is a working capital loan made to us by Shanghai Shanhai Group in January 2005. This loan bears interest at 10% per annum and is due on demand. Net cash used in continuing operating activities for the three months ended March 31, 2006 was $411,230 as compared to $163,257 for the three months ended March 31, 2005. For the three months ended March 31, 2006, we used cash in operations to fund a net increase in accounts receivable of $932,631, including an increase of $1,070,531 in accounts receivables from related parties, and a decrease in accounts payable and accrued expenses of $485,651. These increases were offset by our net income, a decrease in inventory and an increase in advances from customers, together with an add back of non-cash items of $131,783 For the three months ended March 31, 2005, we used cash to fund a net increase in accounts receivable of $186,738, including an increase in accounts receivable - - related parties of $128,986, an increase in inventory of $89,438 and a reduction in accounts payable - related parties of $36,583 which were offset by our net income, increases in prepaid and other current assets and accounts payable and accrued expenses together with an add back of non-cash items of $9,082. -27- Net cash used in investing activities for the three months ended March 31, 2006 was $66,842 as compared to $0 for the three months ended March 31, 2005, which reflected the purchase of additional manufacturing equipment in the first quarter of fiscal 2006. Net cash used by financing activities was $99,307 for the three months ended March 31, 2006 as compared to $0 for the three months ended March 31, 2005 and reflects the repayment of a loan from a financial institution which became due in March 2006. We reported a net decrease in cash for the three months ended March 31, 2006 of $580,158 as compared to a net decrease in cash of $163,257 for the three months ended March 31, 2005. We currently have no material commitments for capital expenditures. As of March 31, 2006, we had approximately $535,000 in short term loans maturing during fiscal 2006. We plan on renewing these loans when they become due at term comparable to current terms. Other than working capital and loans, we presently have no other alternative source of working capital. We want to build an additional manufacturing line and upgrade our manufacturing facilities and technologies, in order to expand our disinfection products. Based upon our preliminary estimates this will require capital and other expenditures of approximately $1 million. We do not have sufficient working capital to fund the additional line and upgrade our manufacturing facilities and technologies as well as providing working capital necessary for our ongoing operations and obligations. We will need to raise additional working capital to complete this project. We may seek to raise additional capital through the sale of equity securities. No assurances can be given that we will be successful in obtaining additional capital, or that such capital will be available in terms acceptable to our company. At this time, we have no commitments or plans to obtain additional capital. Critical Accounting Policies Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by management's applications of accounting policies. Critical accounting policies for our company include revenue recognition and the useful lives of property, plant and equipment. Revenue Recognition - We follow the guidance of the Securities and Exchange Commission's Staff Accounting Bulletin 104 for revenue recognition. In general, we record revenue when persuasive evidence of an arrangement exists, product delivery has occurred, the sales price to the customer is fixed or determinable, and collectibility is reasonably assured. We assess whether the fee associated with our revenue transactions is fixed or determinable based on the payment terms associated with the transaction. If a significant portion of the fee is due after our normal payment terms, we access if the fee is not fixed or determinable. In these cases, we may recognize revenue as the fees become due. We assess collectibility based on the credit worthiness of the customer and past transaction history. We perform initial credit evaluations of our customers and do not require collateral from our customers. If we determine that collection of a fee is not reasonably assured, we defers the fee and recognize the revenue at the time that collection becomes reasonably assured. The following policies reflect specific criteria for our various revenues streams: * Revenues of Aerisys are recognized at the time the services are rendered to customers. Services are rendered when our company's representatives receive the customers' requests and complete the customers' orders. For contacts over a period of time, Aerisys recognizes the revenue on a straight-line basis over the period that the services are provided. * Our revenues from the sale of products are recorded when the goods are shipped, title passes, and collectibility is reasonably assured. -28- * Revenues from the sale of products to related parties are recorded when the goods are shipped which correlates with the shipment by the related parties to its customers, at which time title passes and collectibility is reasonably assured. We receive sales orders on a just-in-time basis from related parties. Generally, the related party does not hold our inventory. If the related party has inventory on hand at the end of a financial reporting period, the sale is reversed and the inventory is included on our balance sheet. We record property and equipment at cost. Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. We review these long-lived assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recoverable. If the undiscounted future cash flows of the long-lived assets are less than the carrying amount, their carrying amount is reduced to fair value and an impairment loss is recognized. To date, we have not recognized any impairment losses. Accounting for Stock Based Compensation - We account for stock based compensation utilizing Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. We have chosen to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the estimated fair market value of our stock at the date of the grant over the amount an employee must pay to acquire the stock. We have adopted the "disclosure only" alternative described in SFAS 123 and SFAS 148 (See Recent Accounting Pronouncements), which require pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied. Because of this election, we continue to account for our employee stock-based compensation plans under Accounting Principles Board (APB) Opinion No. 25 and the related interpretations. We are required to comply with SFAS No. 123 (revised 2004) starting on the first day of our fiscal year 2006. We are currently evaluating the effect that the adoption of SFAS No. 123 (revised 2004) will have on our consolidated operating results and financial condition. No stock-based compensation cost is currently reflected in net income for employee and director option grants as all options granted under the 2005 Incentive Stock Plan and the Non-Employee Directors Stock Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. -29- Recent Accounting Pronouncements In September 2005, the FASB ratified EITF Issue No. 05-7, "Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues," which addresses whether a modification to a conversion option that changes its fair value affects the recognition of interest expense for the associated debt instrument after the modification and whether a borrower should recognize a beneficial conversion feature, not a debt extinguishment if a debt modification increases the intrinsic value of the debt (for example, the modification reduces the conversion price of the debt). This issue is effective for future modifications of debt instruments beginning in the first interim or annual reporting period beginning after December 15, 2005. The adoption of this pronouncement did not have any effect on our financial position or results of operations. In September 2005, the FASB also ratified the EITF's Issue No. 05-8, "Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature," which discusses whether the issuance of convertible debt with a beneficial conversion feature results in a basis difference arising from the intrinsic value of the beneficial conversion feature on the commitment date (which is recorded in the shareholder's equity for book purposes, but as a liability for income tax purposes), and, if so, whether that basis difference is a temporary difference under FASB Statement No. 109, "Accounting for Income Taxes." This Issue should be applied by retrospective application pursuant to Statement 154 to all instruments with a beneficial conversion feature accounted for under Issue 00-27 included in financial statements for reporting periods beginning after December 15, 2005. The adoption of this pronouncement did not have any effect on our financial position or results of operations. 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 consolidated financial statements upon adoption. -30- ITEM 3. CONTROLS AND PROCEDURES As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of March 31, 2006, the end of the period covered by this quarterly report, our management concluded its evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this report, is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and to reasonably assure that such information is accumulated and communicated to our management, including our President, to allow timely decisions regarding required disclosure. Our management, including our President, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. During May 2006 we were required to restate our financial statements for the fiscal year ended December 31, 2005 to correct an accounting error. In November 2006 we restated our financial statements as December 31, 2005 and for the year then ended to correct additional accounting errors primarily related to the treatment of dividends on our various series of preferred stock. This Form 10-QSB/A contains the effect of those restatements. Based upon these accounting errors, our management has determined that there is a deficiency in our internal controls over financial reporting and that our disclosure controls and procedures were ineffective at March 31, 2006. All of our employees and accounting staff are located in the PRC and we do not presently have a chief financial officer, comptroller or similarly titled senior financial officer who is bilingual and experienced in the application of U.S. GAAP. During fiscal 2006 we began a search for an appropriate candidate who can fill such a position; however, we are unable to predict when such a person will be hired. During fiscal 2006 we also intend to provide additional training to our accounting staff in the application of U.S. GAAP. As a result of these matters, our management believes that a deficiency in our internal controls continues to exist. Until we expand our staff to include a bilingual senior financial officer who has the requisite experience necessary, as well as supplement the accounting knowledge of our staff, it is likely that we will continue to have material weaknesses in our disclosure controls. Other than the changes discussed above there have been no changes in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. -31- PART II - OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Submissions of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits. 31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -32- SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Linkwell Corporation Date: November 07, 2006 By: /s/ Xuelian Bian ------------------- Xuelian Bian Chief Executive Officer and principal financial accounting officer -33- EX-31 2 ex311.txt EXHIBIT 31.1 RULE 13a-14(a)/15d-14(a) CERTIFICATION I, Xue Lian Bian, certify that: 1. I have reviewed this annual report on Form 10-QSB/A-1 for the period ended March 31, 2006 of Linkwell Corporation; 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 made, not misleading with respect to the period covered by this annual 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 small business issuer as of, and for, the periods presented in this report; 4. The small business issuer's other certifying officer(s) and I are responsible for establishing for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and 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 small business issuer, 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. Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions after the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting. 5. The small business issuers other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer'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 small business issuer's internal control over financial reporting. November 7, 2006 By: /s/ Xue Lian Bian ---------------------------------------------- Xue Lian Bian, CEO, President and principal executive officer EX-31 3 ex312.txt EXHIBIT 31.2 RULE 13a-14(a)/15d-14(a) CERTIFICATION I, Xue Lian Bian, certify that: 1. I have reviewed this annual report on Form 10-QSB/A-1 for the period ended March 31, 2006 of Linkwell Corporation; 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 made, not misleading with respect to the period covered by this annual 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 small business issuer as of, and for, the periods presented in this report; 4. The small business issuer's other certifying officer(s) and I are responsible for establishing for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and 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 small business issuer, 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. Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions after the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting. 5. The small business issuers other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer'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 small business issuer's internal control over financial reporting. November 7, 2006 By: /s/ Xue Lian Bian -------------------------------------- Xue Lian Bian, CEO, President and principal financial and accounting officer EX-31 4 ex321.txt 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 In connection with the Quarterly Report of Linkwell Corporation (the "Company") on Form 10-QSB/A-1 for the period ended March 31, 2006 as filed with the Securities and Exchange Commission (the "Report"), I, Xue Lian Bian, CEO of the Company, certify, pursuant to 18 U.S.C. SS. 1350, as adopted pursuant to SS. 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. By: /s/ Xue Lian Bian -------------------------------------- Xue Lian Bian, CEO, President and principal financial and accounting officer November 7, 2006 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement 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. -----END PRIVACY-ENHANCED MESSAGE-----