Lotus Pharmaceuticals (LTUS) on track, highlights Q2

Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009


Total net revenues for the three months ended June 30, 2010 were $19,105,001 as compared to total net revenues of $13,631,729 for the three months ended June 30, 2009, an increase of $5,473,272 or 40.2%.
For the three months ended June 30, 2010, wholesale revenues increased by $2,072,414 or 19.4%. The increase was mainly attributable to the increase in our products delivered through our national wholesale channels. We anticipate that our wholesale revenues will continue to increase in the rest of 2010 since the newly added five prescription drugs are expected to increase our market share.

For the three months ended June 30, 2010, retail revenues increased by $3,400,942 or 123.2%. The significant increase was primarily attributable to the growth and success of our OTC Drug Division’s sales force. We expect our retail revenue from our own ten drug stores will remain in its current level with small growth and our retail revenue from our direct sales to other drug stores in Beijing will continue to increase in the rest of 2010.

Cost of sales for our wholesale and other revenues includes direct materials, direct labor fees, manufacturing overhead such as indirect materials, indirect labor fees, utilities and depreciation indirectly related to production, related taxes and purchase third-party manufactured finished goods. For the three months ended June 30, 2010, our total cost of sales amounted to $9,105,751 or 47.7% of total net revenues as compared to cost of sales of $5,743,166 or 42.1% of total net revenues for the three months ended June 30, 2009. During the three months ended June 30, 2010, it was humid in Beijing. In addition, a portion of our prior warehouse was removed in order to construct the new building in Beijing. Therefore, our warehouse capacity reached 100% and could not satisfy our demand in the three months ended June 30, 2010. We addressed this issued by reducing our sales price and shortening the storage period for our inventory. As a result, the cost of sales as a percentage of total net revenue was increased. We expect our cost of sales as a percentage of total net revenue will remain in its current level in the rest of 2010.

Gross profit for the three months ended June 30, 2010 was $9,999,250 or 52.3% of total net revenues, as compared to $7,888,563 or 57.9% of total net revenues for the three months ended June 30, 2009. The decrease in gross profit margin was attributable to the increase in cost of sales as a percentage of total net revenue. We expect that our gross profit margin will remain in its current level with minimal growth in the rest of 2010.

Total operating expenses for the three months ended June 30, 2010 were $3,450,507, as compared to the total operating expenses of $2,570,338 for the three months ended June 30, 2009, an increase of $880,169 or 34.2%. This increase included the following:
For the three months ended June 30, 2010, selling expenses amounted to $2,375,159 as compared to $1,801,235 for the three months ended June 30, 2009, an increase of $573,924 or 31.9%. This increase is primarily attributable to the increase of our sales revenues. We expect our selling expenses will increase in the near future since we anticipate that our revenues will increase in the rest of 2010.

For the three months ended June 30, 2010, general and administrative expenses were $1,075,348, as compared to the general and administrative expenses of $769,103 for the three months ended June 30, 2009, an increase of $306,245 or 39.8%. Mainly to consulting expenses.

As a result of forgoing, we reported income from operations of $6,548,743 for the three months ended June 30, 2010 as compared to income from operations of $5,318,225 for the three months ended June 30, 2009, an increase of $1,230,518 or 23.1%.

As a result of these factors, we reported a net income of $6,322,262 for the three months ended June 30, 2010 as compared to net income of $4,785,533 for the three months ended June 30, 2009. This translated to basic earnings per common share of $0.12 and $0.11, and diluted earnings per common share of $0.12 and $0.10, for the three months ended June 30, 2010 and 2009, respectively.

At June 30, 2010 and December 31, 2009, we had a cash balance of $1,078,724 and $3,945,740, respectively. These funds are in various financial institutions located in China.
Our working capital increased $6,092,933 to $1,140,199 at June 30, 2010 from working capital deficit of $(4,952,734) at December 31, 2009. This increase in working capital is primarily attributed to an increase in accounts receivable of approximately $3.26 million, an increase in inventories of approximately $0.64 million, an increase in prepaid expenses and other assets (current portion) of approximately $0.29 million, a decrease in accounts payable and accrued expenses of approximately $0.29 million, a decrease in other payables of approximately $0.73 million, a decrease in unearned revenue of approximately $0.52 million, a decrease in Series A convertible redeemable preferred stock of approximately $4.17 million offset by a decrease in cash of approximately $2.87 million, an increase in taxes payable of approximately $0.61 million and an increase in due to related parties (current portion) of approximately $0.29 million.

As of June 30, 2010, our accounts receivable was $5,044,427 as compared to $1,784,194 as of December 31, 2009, an increase of $3,260,233. The increase was primarily due to the increase in our sales revenue.

As of June 30, 2010, we had a property and equipment, net of accumulated depreciation, of $28,105,096 as compared to $16,223,775 as of December 31, 2009, an increase of $11,881,321. The increase was primarily attributable to the increased purchases of approximately $11,826,000 for our construction-in-progress of Beijing office building (See note 3) and the favorable RMB currency appreciation which converted our property and equipment, net of accumulated depreciation, in RMB into higher US dollar amounts offset by the depreciation on our fixed assets of approximately $13,000 for the first half of fiscal 2010.

At June 30, 2010, we had Series A Convertible Redeemable Preferred Stock of $0 as compared to $4,170,572 at December 31, 2009, a decrease of $4,170,572. The decrease was attributable to the conversion of the Series A Convertible Redeemable Preferred Stock of $4,048,200 and the reclassification of $595,233 into permanent equity since the mandatory redeemable feature lapsed, offset by the amortization of discount on convertible redeemable preferred stock of $151,553 and the issued additional convertible redeemable preferred stock of $321,308 as dividends in the first quarter of fiscal 2010.

Our balance sheet as of June 30, 2010 also reflects notes payable to related parties of $5,090,316 due on December 30, 2015 which was a series of working capital loans made to us since December 31, 2005 by the Company’s Chief Executive Officer, his wife, two employees of the Company and a Board member. These loans bear interest based on a floating annual interest rate, which is 80% of China bank interest rate and are unsecured. During the six months ended June 30, 2010, we did not repay any portion of the principal of these loan balances.
We believe that our working capital is sufficient to fund our current operations for the next 12 months. Lotus East has historically funded its capital expenditures from its working capital. Lotus East has contractual commitments for approximately $54.1 million related to a Technology Transfer Agreement and the construction of the new manufacturing facility in Inner Mongolia and a New Drug Patent Transfer Agreement. While it intends to fund the costs with its existing working capital associated with the Technology Transfer Agreement and the New Drug Patent Transfer Agreement and a portion of the construction of the new manufacturing facility, it is dependent upon the continued growth of its operations and prompt payment of outstanding accounts receivables by its customers to ensure that it has sufficient cash for these commitments. Our ability to fully fund the costs associated with the new manufacturing facility is materially dependent upon our ability to obtain secured bank financing and/or government grants and/or other third party finance.

There is no guarantee that Lotus East can obtain these financings on favorable terms at the right time. Although the Chinese government has announced an economic stimulation plan, there is no guarantee that we will be awarded the government grants successfully. While Lotus East’s management believes the Company will be successful in securing the necessary funding through its increasing revenue, faster collections on receivables, and continuance discussions with various commercial banks, there are no assurances that the funding will be available in the amounts or at the time required to meet Liang Fang’s commitments. In the event that Lotus East is not successful in obtaining the funds it needs for the Technology Transfer Agreement and the New Drug Patent Transfer Agreement, it is possible that it could default under the terms of the two agreements and forfeit any funds paid to date. If Lotus East fails to obtain all of the funding necessary to complete the construction of the new facility in Inner Mongolia, which is estimated to be approximately $52.0 million in the next five years, it could get back approximately $39.9 million spent to date, including the approximately $32.8 million for the installments on the land use rights, which is refundable if the Chinese local government would not grant it land use rights certificate.

A lot of reading but we are on track to see EPS of around $ 0.45 ($ 0.21 H1) this year. Cash on the balance sheet is low, but working capital is sufficient for the coming 12 months. With a trailing P/E ratio lower than 3, the company is deeply undervalued, also if you look to the book value of $ 1.55.

POSITION: LONG