# China Pharma Holdings, Inc.: Form 10-Q/A for the period ended Sep 30, 2010

- Company: [China Pharma Holdings, Inc.](/companies/cphi.md) (CIK 1106644)
- Form: 10-Q/A
- Filed: 2011-03-15
- Accepted by EDGAR: Mar 15, 2011, 17:24 ET
- Period: 2010-09-30
- Accession: 0001010549-11-000240
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/1106644/000101054911000240/cphi10qa093010.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1106644/000101054911000240/

## Management's discussion and analysis

As filed, 29,970 characters.

#### Disclosure Regarding Forward-Looking Statements

*The statements contained in this report with respect to our financial condition, results of operations and business that are not historical facts are forward-looking statements. Forward-looking statements can be identified by the use of forward-looking terminology, such as "anticipate", "believe", "expect", "plan", "intend", "seek", "estimate", "project", "could", "may" or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the reader of the forward-looking statements that any such statements that are contained in this report reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors, including, but not limited to, economic, competitive, regulatory, technological, key employee, and general business factors affecting our operations, markets, growth, services, products, licenses and other factors, some of which are described in this report and in “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009 and some of which are discussed in our other filings with the Securities and Exchange Commission. These forward-looking statements are only estimates or predictions. No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of risks facing our company, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events.*

*These risk factors should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. All written and oral forward looking statements made in connection with this report that are attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given these uncertainties, we caution investors not to unduly rely on our forward-looking statements. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as required by applicable law or regulation.*

### Business Overview

We are principally engaged in the development, manufacture, packaging, marketing and distribution of generic and branded pharmaceutical products for a wide range of high incidence and high mortality conditions in The People’s Republic of China (the “PRC”). All of our operations are conducted in the PRC, where our 8,000-square-meter manufacturing facility is located. With eight different production lines, we have the capability to manufacture pharmaceutical products in the form of dry powder injectables, liquid injectables, tablets, capsules, oral solutions and granules. Over 90% of our pharmaceutical products are sold on a prescription basis and have been approved for at least one or more therapeutic indications by the Chinese State Food and Drug Administration (the “SFDA”) based upon demonstrated safety and efficacy.

At September 30, 2010, we manufactured 20 pharmaceutical products for a wide variety of diseases and medical indications, each of which may be classified into one of three general categories: a basic generic drug, which is a common drug in the PRC marketplace for which there is a very large market, a “super” or “first to market” generic drug, which is a generic Western drug that is new to the PRC marketplace, and a modern Traditional Chinese Medicine, which generally is a non-synthetic, plant-based medicinal compound of the type that has been widely used in the PRC for thousands of years, to which we apply modern production techniques to produce a pharmaceutical product in different formulations, such as tablets, capsules or powders. In selecting generic drugs to develop and manufacture, we consider several factors, including the number of other manufacturers currently producing the particular drug, the size of the market, the proposed or required method of distribution, the existing and expected pricing for the particular drug in the marketplace, the costs of manufacturing that drug, and the costs of acquiring or developing the formula for that drug. We believe we have historically selected to manufacture generic drugs that have very large addressable markets and higher profit margins relative to other drugs being manufactured and distributed in the PRC.

In 2002, we built, and we currently own and operate, an approximately 8,000-square-meter manufacturing facility in Haikou, Hainan Province that supports eight modern, scalable production lines. We implement quality control procedures in compliance with standards for Good Manufacturing Practice, or GMP standards, and applicable SFDA regulations to ensure consistent quality in our products.

We market and sell our products through 16 sales offices covering all major cities and provinces in China. To comply with applicable Chinese law relating to sales of prescription drugs to certain hospitals and clinics, we also use a distribution system comprised of approximately 1,250 independent regional distributors. We have grown significantly in recent years, with our net revenues increasing from $8.7 million in 2005 to $61.7 million in 2009, representing a compound annual growth rate, or CAGR, of 63% during this period. Our net revenues increased by $8.3 million, or by 20%, to $50.4 million in the first nine months of 2010 as compared to the comparable period of 2009. Our net income increased from $3.8 million in 2005 to $20.2 million in 2009, representing a CAGR of 52% during this period. Our net income increased by $3.7 million or 28% to $16.9 million in the first nine months of 2010 as compared to the comparable period of 2009, due to a one-time adjustment of our estimate for bad debt allowance in the third quarter of 2009 and gains in derivatives. Without giving effect to this one-time adjustment and the gains in derivatives, our net income for the nine-month period in 2010 would have been approximately 20% higher than the comparable period in 2009. Please see the table entitled “Reconciliation of Non-GAAP Adjusted Net Income and Basic and Diluted EPS” contained in the Net Income section below for a reconciliation of these non-GAAP measures to US GAAP.

We often have a seasonal pattern in our sales revenues throughout the year for a variety of reasons, including 1) the higher rates of occurrence of cerebral/cardio diseases and flu in the winter season and 2) Chinese New Year being in the first quarter. As a result, our fourth quarter revenues tend to be higher and our first quarter revenues tend to be lower.

We have a strong focus on bringing new and first-to-market generic medicines to market through the purchase of medical formulas from research institutions as well as our own in-house research and development activities. As of September 30, 2010, in addition to our portfolio of 20 commercialized products, we had nine drugs at different stages of the registration process, including three which had passed SFDA technical analysis and entered clinical trials (including a new anti-drug-resistance antibiotic product), as follows:

- During the third quarter of 2010, we completed the Phase I clinical trials of our novel cephalosporin-based combination antibiotic. In Phase I, the clinical trials focused on the study of clinical pharmacology as well as the evaluation of safety on the human body, through observing tolerance and pharmacokinetics to provide support for dosage and drug delivery design. Phase II of the trial has commenced.
- We completed the clinical trials earlier this year for Candesartan, a front-line drug therapy we developed for the treatment of hypertension. Since then, we have completed all testing procedures for this new product, and we are currently waiting for the final production approval from the SFDA.
- We continue to receive positive feedback from patients during our clinical trial of Rosuvastatin, a generic form of Crestor we are developing. The majority of the patients in the clinical trial have completed the treatment cycle, and the final phase of the trial is near completion.

In addition to the products mentioned above, we have several other products that focus on our main therapeutic areas pending SFDA technical review and plan to initiate clinical trials in the near future. We are also evaluating additional opportunities on an ongoing basis, directed by the organic growth and market demands of China's pharmaceutical market. We are working closely with several pharmaceutical research institutions and universities and remain focused on creating a steady increase in new products and, in turn, revenue. We remain focused on improving our product portfolio and increasing our internal growth, maintaining and developing new marketing channels, and using our existing retail network in the expanding markets in the PRC to raise our overall market share. The organic growth of the Chinese pharmaceutical market has had a positive affect on, and will continue to direct, our company's development.

The growth of China’s pharmaceutical market is driven by China’s rapid economic growth. Increased healthcare spending by the Chinese government to reform the healthcare system has already greatly improved the accessibility to and desire for medical care. Important additional factors include: the aging of the population and the resulting increase in age-related disorders; the urban migration of the population; and improved awareness of self-health care.

The Healthcare Reform program announced last year by the Chinese government is now in its implementation stage. After the official announcement of the Essential Drugs List (“EDL”) in late 2009, we have seen gradual but meaningful and notable increases in demand for the EDL products. While the Healthcare Reform is unquestionably moving forward, the pace of implementation varies significantly from province to province. As a result, the effect of the pricing regulations also have varied significantly from province to province.

We continue to believe that the regulators in the PRC want to see prices of the essential drugs affordable, on the one hand, but permit drug companies a fair profit on the other hand. We think we are well positioned in the current environment, as our product portfolio is well diversified. Pricing or volume changes of one single product should not have a material impact on our overall profitability. Furthermore, our management team has been in the Chinese pharmaceutical industry for more than 20 years, and it is very experienced at adapting to changes. We will seek to remain flexible with our product mix to achieve our profitability goals.

### Results of Operations

The following table presents our results of operations for the three-month and nine-month periods ended September 30, 2010 and 2009 by using U.S. GAAP measures.

|  | Three Months Ended September 30th 2010 (as restated) | 2009 (as restated) | % Chg | Nine Months Ended September 30th 2010 (as restated) | 2009 (as restated) | % Chg |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Revenue | $18,680,390 | $15,522,953 | 20% | $50,414,254 | $42,116,290 | 20% |
| Cost of Revenue | 11,055,254 | 8,979,083 | 23% | 29,610,973 | 23,724,155 | 25% |
| Gross Profit | 7,625,136 | 6,543,870 | 17% | 20,803,281 | 18,392,135 | 13% |
| Selling Expenses | 449,295 | 807,231 | -44% | 1,653,763 | 2,013,915 | -18% |
| General and Admin Expenses | 873,157 | 521,676 | 67% | 2,420,412 | 1,563,330 | 55% |
| Bad Debt Expense (Benefit) | 107,186 | (2,836,495) |  | 215,707 | (2,101,710) |  |
| Income from Operations | 6,195,498 | 8,051,458 | -23% | 16,979,062 | 16,916,600 | 0% |
| Derivative Gains (Loss) | 429,687 | (1,673,102) |  | 1,795,196 | (1,963,177) |  |
| Income Tax Expense | (674,051) | (867,750) | -22% | (1,796,749) | (1,711,703) | 5% |
| Net Income | $5,914,614 | $5,490,126 | 8% | $16,851,026 | $13,163,842 | 28% |
| Basic Net Income per Share | $0.14 | $0.13 | 5% | $0.39 | $0.31 | 25% |
| Basic Weighted Average Shares Outstanding | 43,393,642 | 42,278,938 |  | 43,306,075 | 42,278,938 |  |
| Diluted Net Income per Share | $0.14 | $0.13 | 8% | $0.39 | $0.31 | 26% |
| Diluted Weighted Average Shares Outstanding | 43,407,175 | 42,278,938 |  | 43,503,330 | 42,278,938 |  |

### Three Months Ended September 30, 2010 and 2009

### Revenue

For the three months ended September 30, 2010, our revenues increased by $3.2 million, or 20%, to $18.7 million from the $15.5 million we generated in the corresponding period of 2009.

Set forth below are our revenues by product category in millions USD for each of the three months ended September 30, 2009 and 2010.

| Product Category | Three Months Ended September 30 2010 | 2009 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 5.9 | $ 5.6 | $ 0.3 | 5% |
| Anti-Viro/ Infection & Respiratory | $ 6.0 | $ 6.1 | -$ 0.1 | -2% |
| Digestive Diseases | $ 2.4 | $ 1.6 | $ 0.8 | 51% |
| Other | $ 4.5 | $ 2.3 | $ 2.2 | 100% |

On a year-over-year basis, we continued to experience healthy revenue growth during the quarter ended September 30, 2010. We continued to achieve strong performance in the “Digestive Diseases” category with continued strong sales of Omeprazole, the generic gastroesophageal reflux disease (GERD）drug we launched in the fourth quarter of 2009. Sales of Omeprazole during the quarter ended September 30, 2010 was approximately $1.04 million. The strong growth in our “Other” category came from higher sales of Granistron and of Vitamin B6, which is one of the two products we produce that is on the National EDL. We continue to see rising demand in EDL-listed products and also limited pressure on pricing. We are optimistic on our ability to capture new markets and continue to carefully manage our product mix. The revenues of our CNS Cerebral and Cardio Vascular category increased by 5% during the quarter ended September 30, 2010 compared to the same quarter last year with strong performances coming from our Ozagrel and Gastrodin Injection products. Revenues derived from our products in our “Anti-Viro/Infection & Respiratory” category decreased by 2%, but still remained at a relatively high level.

### Cost of Revenue

For the three months ended September 30, 2010, our cost of revenue was $11.1 million, or 59% of total revenue, compared to $9.0 million, or 58% of total revenue during the comparable period of 2009. The increase in cost of revenue during the third quarter of 2010 was primarily due to higher volume of products sold for the 2010 period.

### Gross Profit

Gross profit for the three months ended September 30, 2010 was $7.6 million, which was approximately 17% higher compared to $6.5 million for the third quarter of 2009. Our gross profit margin for the third quarter of 2010 was 40.8%, compared to 42.2% in the corresponding quarter of 2009. The lower gross profit margin in the third quarter of 2010 was due to a higher volume of lower-margin products sold compared to the same period a year ago and also overall pricing pressure from the Healthcare Reform.

### Selling Expenses

Our selling expenses for the three months ended September 30, 2010 were $0.45 million, a decrease of approximately $358,000, or 44%, compared to $0.81 million for the three months ended September 30, 2009. Selling expenses were approximately 2.5% of revenue in the third quarter of 2010 compared to 5.2% during the comparable quarter a year ago. Our selling expenses typically vary between 2.5% to 5% of total revenue.

### General Administrative Expenses

Our general and administrative expenses for the three months ended September 30, 2010 was $0.87 million, an increase of $0.35 million, or 68%, compared to $0.52 million for the same period in 2009. The increase in our general and administrative expense was in part due to an increase of share-based compensation expense and the amortization expenses for our drug formulas during the quarter ended September 30, 2010 compared to the same quarter a year ago.

### Bad Debt Expense

Due to the peculiarity of the Chinese pharmaceutical market environment, deferred payments to pharmaceutical companies by state-owned hospitals and local medicine distributors are a normal phenomenon. Over 90% of our drugs are sold to state-owned hospitals and local medicine distributors, which creates slow collections of our trade receivables. Since most hospitals in China are backed by the government, management believes the deferred payments from hospitals are secure and will eventually be collected. Historically, we have not written-off any receivables in our 17-year history of doing business with hospitals.

As of September 30, 2010, our bad debt allowance for accounts receivable was $2.98 million compared to $2.83 million as of June 30, 2010. The increase of $107,186 in our bad debt allowance during the third quarter represented a corresponding increase in our bad debt expense for the quarter.

### Income from Operations

Our operating income for the three months ended September 30, 2010 was approximately $6.2 million, compared to $8.1 million for the same period in 2009, which represented a decrease of $1.9 million, or 23%. The decrease in operating income was primarily due to the effect of a one-time adjustment in our bad debt allowance that created a benefit of $2.8 million in the corresponding quarter one year ago.

### Derivative Gains (Losses)

Changes to the derivative warrant liability are recognized in the results of operations and resulted in a derivative gain of $0.43 million during three months ended September 30, 2010 and a derivative loss of $1.67 million in the corresponding period a year ago. (Please see Note 9 to our consolidated financial statements contained in this report.)

### Income Tax Expense

Income tax expense for the three months ended September 30, 2010 was $0.67 million, compared with $0.87 million in the same quarter a year ago. The corporate tax rate for our operating subsidiary in China was 11%, which will remain the same through the end of this year. In 2011, the corporate tax rate for our operating subsidiary will increase to 24%. We are currently applying for the “National High-tech Enterprise” status. The management is optimistic that we will get this designation in the coming months, and if we do, our corporate tax rate will be at 15% for three years starting from 2011.

### Net Income

Our net income for the three months ended September 30, 2010 increased by $0.42 million, or approximately 8%, to $5.9 million from $5.5 million for the three months ended September 30, 2009. Net income for the three-month period ended September 30, 2009 included the positive effect of a one-time $2.8 million adjustment of our bad debt allowance as discussed above as well as gains and losses in derivatives (for both the 2010 and 2009 periods). Without the effect of this one-time adjustment and change in value of the derivatives, management estimates that the net income for the third quarter of 2010 would have been $5.49 million and third quarter of 2009 would have been $4.26 million. On this more comparable basis, our net income for the third quarter of 2010 would have been 29% higher than the same period a year ago. The non-GAAP measures of the operating results of the comparable periods in 2010 and 2009, excluding the approximate impact of the one-time bad debt estimate change and derivative gains and losses, are described below and are reconciled to the corresponding GAAP measures in the following table.

*(Unaudited, $ in thousand except share and per share data)*

|  | China Pharma Holdings, Inc. Reconciliation of Non-GAAP Adjusted Net Income and Diluted EPS For the Three Months Ended September 30, 2010 Net income | EPS | 2009 Net income | EPS | For the Nine Months Ended September 30, 2010 Net income | EPS | 2009 Net income | EPS |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Adjusted net income, excluding approximate after-tax impact of derivative gain(loss) and one-time bad debt estimate change | $5,485 | $0.13 | $4,263 | $0.10 | $15,056 | $0.35 | $12,569 | $0.30 |
| Add: Derivate Gain (Loss) (a) | 430 | 0.01 | (1,673) | (0.04) | 1,795 | 0.04 | (1,963) | (0.05) |
| Adjusted net income, excluding approximate after-tax impact of derivative gain (loss) (Non-GAAP) | 5,915 | 0.14 | 2,590 | 0.06 | 16,851 | 0.39 | 10,606 | 0.25 |
| Approximate after-tax impact of one-time bad debt estimate change (b) | - | - | 2,900 | 0.07 | - | - | 2,558 | 0.06 |
| Net income as reported (GAAP) | $5,915 | $0.14 | $5,490 | $0.13 | $16,851 | $0.39 | $13,164 | $0.31 |

(a) Represents the approximate amount that net income or EPS of the corresponding periods would have decreased by if derivative reclassification had not been made.

(b) Represents the approximate amount that net income or EPS of the corresponding periods would have decreased by if bad debt estimate had been changed prior to the beginning of 2009.

### Gross Profit

Gross profit for the nine months ended September 30, 2010 was $20.8 million, which was approximately 13% higher compared to the $18.4 million for the first nine months of 2009. Our gross profit margin for the first nine months of 2010 was 41.3%, compared to 43.7% in the first nine months of 2009. The slightly lower gross profit margin in the first nine months of 2010 was mainly due to a higher volume of lower-margin products sold compared to the same period a year ago.

### Selling Expenses

Our selling expenses for the nine months ended September 30, 2010 were approximately $1.65 million, as compared to $2.01 million for the nine months ended September 30, 2009. Selling expenses were approximately 3.3% of revenue in the first nine months of 2010 compared to 4.8% a year ago. Our selling expenses typically vary between 2.5% to 5% of total revenue.

### General Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2010 was $2.42 million, an increase of $0.86 million, or 55%, compared to $1.56 million for the same period in 2009. The increase in our general and administrative expense was in part due to an increase of share-based compensation expense and amortization expenses for our drug formulas during the first nine months of 2010 compared to the same period a year ago.

### Bad Debt Expense

Our bad debt expense for the nine months ended September 30, 2010 was $0.22 million, compared to a bad debt benefit of $2.10 million in the first nine months of 2009.

During 2009, we reviewed and revised our bad debt allowance estimate to align our estimates to be more in line with our experience and also industry collection standards.

### Income from Operations

Our operating income for the nine months ended September 30, 2010 was approximately $17.0 million, which is roughly flat compared to $16.9 million for the same period in 2009 The slight increase in operating income was mainly due to the effect of a one-time adjustment in our bad debt allowance which created a benefit of $2.8 million in the third quarter one year ago.

### Derivative Gains (Losses)

Changes to the derivative warrant liability are recognized in the results of operations and resulted in a derivative gain of $1.80 million during nine months ended September 30, 2010 and a derivative loss of $1.96 million in the corresponding period a year ago. (Please see Note 9 to our consolidated financial statements contained in this report.)

### Income Tax Expense

Income tax expense for the nine months ended September 30, 2010 was $1.8 million, compared to $1.7 million in the same period a year ago.

### Net Income

Our net income for the nine months ended September 30, 2010 was approximately $16.85 million, an increase of approximately $3.69 million, or 28%, from $13.16 million for the nine months ended September 30, 2009. Net income for the nine-month period ended September 30, 2009 included the positive effect of a one-time adjustment of our bad debt allowance. Net income for the nine month periods ended September 30, 2010 and 2009 also included gains and losses of derivatives. Without the effect of this one-time adjustment and the change in value of derivatives, management estimates that the net income for the nine months ended September 30, 2010 and 2009 would have been $15.06 million and $12.57 million, respectively. On this more comparable basis, our net income for the first nine months of 2010 would have been 20% higher than the net income for the corresponding nine months a year ago. Please see the table entitled “Reconciliation of Non-GAAP Adjusted Net Income and Basic and Diluted EPS” contained in the previous Net Income section (for the three-month periods ended September 30, 2010 and 2009) for a reconciliation of these non-GAAP measures.

### Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations and short-term bank loans. As of September 30, 2010, our cash and cash equivalents outstanding was $4.56 million, an increase of $0.93 million from $3.63 million as of December 31, 2009. As of September 30, 2010, we had a principal balance of $2.99 million in short-term bank loans.

During the first nine months of 2010, we continued our vigorous collection efforts from our customers and achieved good results. While we have made progress, improving our accounts receivable collection continues to be a focus of our management team and we expect to make further progress in the quarters to come.

Based on our current operating plan, management believes that our cash provided by operations plus the proceeds from our existing bank loans will be sufficient to meet our working capital needs and our anticipated capital expenditures, including expenditures for new formula acquisitions, for the next 12 months. However, if events or circumstances occur and we do not meet our operating plan as expected, we may be required to seek additional capital and/or to reduce certain discretionary spending, which could have a material adverse effect on our ability to achieve our business objectives. Notwithstanding the foregoing, we may seek additional financing for expansion purposes, which may include debt and/or equity financing. There can be no assurance that any additional financing will be available on acceptable terms, if at all. Any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants.

|  | Nine Months Ended September 30 2010 | 2009 |
| --- | ---: | ---: |
| Net Cash Provided by Operating Activities | $6,060,079 | $6,388,089 |
| Net Cash Used in Investing Activities | (7,147,264) | (10,798,769) |
| Net Cash Provided by Financing Activities | 1,930,673 | 1,315,307 |
| Effect of Exchange Rate change on Cash | 83,191 | 13,001 |
| Cash & Equivalent Beginning Balance | 3,634,753 | 6,927,149 |
| Cash & Equivalent Ending Balance | $4,561,432 | $3,844,777 |

#### Operating Activities:

Net cash provided by operating activities was $6.06 million in the nine-month period ended September 30, 2010 compared to $6.39 million in the same period in 2009. We have improved our receivable collection performance compared to a year ago. Cash used by trade receivables was $4.61 million in the first nine months of 2010 compared to $10.85 million in the corresponding period a year ago, even as sales revenue grew by 20%. Cash usage on inventory increased in the nine months ended September 30, 2010 because of an increase in both raw materials and finished goods inventory.

#### Investing Activities:

Net cash used in investing activities in the nine months ended September 30, 2010 was $7.1 million. The majority of the cash was used for our investments in new drug formulas during the period. This was a decrease of $3.7 million compared to the same period in 2009 of $10.8 million.

#### Financing Activities:

Equity related financing: During the first nine months of 2010, we issued approximately 1.1 million shares of common stock for total proceeds of $2.58 million from the exercise of warrants that were issued in our 2007 offering of equity units. In the corresponding period a year ago, we did not conduct any equity -related financing.

Bank loan related financing: During the first nine months of 2010, the net decrease in our outstanding balance of our short-term bank loan caused a net cash outflow of $0.88 million. During the first nine months of 2009, the net increase in our outstanding balance of our short-term bank loan caused a net inflow of $1.3 million.

Net proceeds from all financing activities for the nine-month period ending September 30, 2010 was $1.93 million, and for the corresponding period of 2009, the net proceeds were $1.32 million.

### Off-Balance Sheet Arrangements

There were no off-balance sheet arrangements during the nine-month periods ended September 30, 2010 or 2009.

### Commitments

At September 30, 2010 and 2009, we had no material commitments except for those expenditures incurred in the ordinary course of business.

### Critical Accounting Policies and Estimates

Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2009, for disclosures regarding our critical accounting policies and estimates. The interim financial statements follow the same accounting policies and methods of computations as those for the year ended December 31, 2009. There were no new accounting policies and estimates during the nine-month period ended September 30, 2010 that affected us in any material respect.

## Market risk

As filed, 139 characters.

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this item.

## Controls and procedures

As filed, 6,041 characters.

### Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act are accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as described above. Based on this evaluation, in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 as originally filed with the SEC on August 9, 2010, our management, including our chief executive officer and chief financial officer, concluded that, as of September 30, 2010, our disclosure controls and procedures were effective at a reasonable assurance level.

However, for the reasons stated in Note 1 to our consolidated financial statements included in this report, we determined that a restatement was required for our financial statements for the year ended December 31, 2009 and our financial statements for the three and nine months ended September 30, 2010 and 2009 contained in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010. As a result of the foregoing, management determined that a material weakness existed with respect to our reporting of complex, non-routine transactions. This weakness was a result of our failure to apply new guidance in ASC Topic 815-40, *Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock* with respect to certain warrants issued in 2008. The proper application of this guidance caused the warrants to be a classified as a derivative liability, which required the restatement of our financial statements as of and for year ended December 31, 2009 and the three and nine months ended September 30, 2010 and 2009.

As result of the material weakness identified with respect to our reporting of complex, non-routine transactions, our chief executive officer and chief financial officer have reevaluated our disclosure controls and procedures and, on March 11, 2011, concluded that our disclosure controls and procedures were not effective as of September 30, 2010. As of the date of this report, we are undertaking steps to augment the technical resources available to us.

A system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the system will meet its objectives. The design of a control system is based, in part, upon the benefits of the control system relative to its costs. Control systems can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. In addition, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. In addition, the design of any control system is based in part upon assumptions about the likelihood of future events.

### Changes in Internal Control Over Financial Reporting

In our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, our chief executive officer and chief financial officer concluded that under the framework set forth in *Internal Control – Integrated Framework* issued by the Committee of Sponsoring Organizations of the Treadway Commission, our internal control over financial reporting was effective. However, due to the restatement of our financial statements for the year ended December 31, 2009 and for three and nine months ended September 30, 2010 and 2009 as described above, our chief executive officer and chief financial officer reassessed that conclusion and determined that there existed a material weakness in our internal controls over financial reporting as of December 31, 2009 and 2010. Management has determined that the design and operation of internal control over financial reporting for complex and non-recurring financing transactions that we had in place during 2009 and 2010 were not effective to allow our management, employees and consultants, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely and reasonable basis. That material weakness was the lack of the needed level of technical resources available to us to evaluate the proper accounting for non-routine complex financial instruments and other highly complex accounting issues.

Because we were not aware of this material weakness during the quarter ended September 30, 2010, there was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. As of the date of this report, we are undertaking steps to augment the technical resources available to us.

Filed Mar 15, 2011.
Source: SEC EDGAR, the filing index for accession 0001010549-11-000240. Last ingested by Listed: Nov 11, 2026, 00:23 ET. No prices; not investment advice.