Lotus Pharmaceuticals (LTUS) good Q3 results

Total net revenues for the three months ended September 30, 2010 were $18,504,934 as compared to total net revenues of $14,512,704 for the three months ended September 30, 2009, an increase of $3,992,230 or 27.5%.

For the three months ended September 30, 2010, wholesale revenues increased by $1,659,142 or 14.3%. The increase was mainly attributable to the increased revenues from our newly added five new drugs of approximately $2,164,000 offset by the decreased revenues from other drugs of approximately $505,000. The decrease of wholesale revenue from other drugs was mainly attributable to being out of stock of Levofloxacin Lactate for injection (brand name “Jun Xin”) and Nicergoline for injection (brand name “Ni Mai Jiao Lin”) as discussed above. 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 September 30, 2010, retail revenues increased by $2,333,088 or 80.3%. 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.

Overall, cost of revenues for the three months ended September 30, 2010 increased $1,932,555 or 32.2% as compared to the total cost of revenues for the three months ended September 30, 2009. Our total cost of revenues as a percentage of total net revenues for the three months ended September 30, 2010 increased to 42.8% from 41.3% for the three months ended September 30, 2009. Cost of revenues as a percentage of net revenues from our wholesale operations decreased from 34.9% for the three months ended September 30, 2009 to 32.2% for the three months ended September 30, 2010. In the three months ended September 30, 2010, 13.1% of cost of revenues attributable to our wholesale operations was attributable to the newly added five new drugs and 86.9% of cost of revenues attributable to our wholesale operations was attributable to our other drugs. In the three months ended September 30, 2009, 100% of cost of revenues attributable to our wholesale operations was attributable to our other drugs. The different revenue mix in the three months ended September 30, 2010 had an effect of lowering cost of revenues as a percentage of revenues as compared to the three months ended September 30, 2009. Cost of revenues as a percentage of net revenues from our retail operations for the three months ended September 30, 2010 increased to 69.6% from 66.8% for the three months ended September 30, 2009. During the summer of 2010, it was humid in Beijing. In addition, one of our warehouses was removed from service in order to construct the new building in Beijing. Therefore, our remaining warehouse space could not meet our demand in summer. We addressed this issue by shortening the storage period for our inventory and by reducing our unit sales price. As a result, the cost of revenues as a percentage of net revenues from our retail operations was increased. We expect our total cost of revenues as a percentage of total net revenues will remain in its current level in the rest of 2010.

Gross profit for the three months ended September 30, 2010 was $10,579,203 or 57.2% of total net revenues, as compared to $8,519,528 or 58.7% of total net revenues for the three months ended September 30, 2009. 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 September 30, 2010 were $3,619,558, as compared to the total operating expenses of $2,506,420 for the three months ended September 30, 2009, an increase of $1,113,138 or 44.4%. This increase included the following:

For the three months ended September 30, 2010, selling expenses amounted to $2,452,629 as compared to $1,895,901 for the three months ended September 30, 2009, an increase of $556,728 or 29.4%. For the three months ended September 30, 2010, our selling expenses as a percentage of total net revenues was 13.3% while for the three months ended September 30, 2009, our selling expenses as a percentage of total net revenues was 13.1%. This increase of our selling expenses 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 September 30, 2010, research and development expenses amounted to $21,517 as compared to $0 for the three months ended September 30, 2009, as a result of our research and development agreement with a third party for the clinical trial of the Laevo-Bambuterol drug noted above.

For the three months ended September 30, 2010, general and administrative expenses were $1,145,412, as compared to the general and administrative expenses of $610,519 for the three months ended September 30, 2009, an increase of $534,893 or 87.6%. These changes were summarized below:

The changes in these expenses from the three months ended September 30, 2010 as compared to the three months ended September 30, 2009 included the following:

Salaries and related benefits increased by $33,363 or 23.8%. We anticipate that our salaries and related benefits will remain in its current level with minimal increase in the rest of 2010.

Amortization of our intangible assets and depreciation on our fixed assets increased by $211,110 or 89.2%, which was primarily attributable to the increase in amortization from Inner Mongolia land use right. For the three months ended September 30, 2009, we did not record any amortization for Inner Mongolia land use right for which we recorded twelve-month period amortization in the last quarter of 2009 while for the three months ended September 30, 2010, we recorded three-month period amortization for Inner Mongolia land use right.

Rent increased by $5,338 or 7.1%.

Travel and entertainment expenses decreased by $10,902 or 67.0% which is mainly attributable to decreased travel and entertainment activities.

Professional fees increased by $337,115 or 647.8%, which was primarily attributable to the increase in fees related to our consultants’ service for corporate affairs and development for which we did not have corresponding expenditure in the comparable period of 2009.

Other general and administrative expenses, which included office supplies, general management fees, car insurance, meeting expenses and other office expenses, decreased by $41,131 or 45.8% reflecting efforts at reducing non-sales related corporate activities as well as stricter controls on corporate spending.

As a result of forgoing, we reported income from operations of $6,959,645 for the three months ended September 30, 2010 as compared to income from operations of $6,013,108 for the three months ended September 30, 2009, an increase of $946,537 or 15.7%.

For the three months ended September 30, 2010, total other expenses amounted to $59,371 as compared to other expense of $547,541 for the three months ended September 30, 2009, a decrease of $488,170 or 89.2%. This change was primarily attributable to:

For the three months ended September 30, 2010, our debt issuance costs amounted to $0 as compared to $112,355 for the three months ended September 30, 2009, a decrease of $112,355 or 100.0%. The decrease was attributable to the decrease in amortization amount on debt issuance costs associated with the issuance of Convertible Preferred Stock Series A in February 2008 which we amortized on a 24-month period and began our amortization in March 2008. Debt issuance costs were fully amortized in February 2010. The amortization amount for the three months ended September 30, 2010 was 0 as compared to the three months of amortization expenses in the comparable prior period.

For the three months ended September 30, 2010, interest expense was $59,896 as compared to $436,481 for the three months ended September 30, 2009, a decrease of $376,585 or 86.3%. The decrease in interest expense was primarily attributable to the decrease in interest expenses associated with the Convertible Preferred Stock Series A.

For the three months ended September 30, 2010, our income tax expense was $200,348, as compared to $74,770 for the three months ended September 30, 2009, an increase of $125,578 or 168.0%. The increase in income tax expense was mainly attributable to the increase in taxable income generated by our operating entities.

NET INCOME
As a result of these factors, we reported a net income of $6,699,926 for the three months ended September 30, 2010 as compared to net income of $5,390,797 for the three months ended September 30, 2009. This translated to basic earnings per common share of $0.13 and $0.12, and diluted earnings per common share of $0.12 and $0.11, for the three months ended September 30, 2010 and 2009, respectively.


The functional currency of our operating subsidiaries and affiliates is the Chinese Renminbi (“RMB”). The financial statements of our operating subsidiaries and affiliates are translated to U.S. dollars using period 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. As a result of these translations, which are a non-cash adjustment, we reported a foreign currency translation gain of $1,426,434 for the three months ended September 30, 2010, as compared to $65,626 for the three months ended September 30, 2009. This non-cash gain had the effect of increasing our reported comprehensive income.

As a result of our foreign currency translation gains, we had comprehensive income for the three months ended September 30, 2010 of $8,126,360, compared with $5,456,423 for the three months ended September 30, 2009.

At September 30, 2010 and December 31, 2009, we had a cash balance of $897,650 and $3,945,740, respectively. These funds are distributed in financial institutions located in China.

Our working capital increased $3,123,659 to working capital deficit of $(1,829,075) at September 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 $0.15 million, an increase in inventories of approximately $0.16 million, an increase in prepaid expenses and other assets (current portion) of approximately $0.17 million, a decrease in accounts payable and accrued expenses of approximately $0.27 million, a decrease in other payables of approximately $0.70 million, a decrease in taxes payable of approximately $1.25, a decrease in Series A convertible redeemable preferred stock of approximately $4.17 million offset by a decrease in cash of approximately $3.05 million, a decrease in deferred debt costs of approximately $0.05 million, an increase in unearned revenue of approximately $0.18 million and an increase in due to related parties (current portion) of approximately $0.47 million.

The changes in asset and liabilities discussed above is based on a comparison of amounts on our balance sheets as of September 30, 2010 and December 31, 2009 and does not necessarily reflect changes in assets and liabilities reflected on our cash flow statement, for which we use the average foreign exchange rate during the period to calculate these changes.

Our balance sheet as of September 30, 2010 also reflects notes payable to related parties of $5,174,292 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 nine months ended September 30, 2010, we did not repay any portion of the principal of these loan balances.

Net cash provided by operating activities for the nine months ended September 30, 2010 was $18,978,615 as compared to net cash provided by operating activities of $25,252,740 for the nine months ended September 30, 2009. For the nine months ended September 30, 2010, net cash provided by operating activities was primarily attributable to net income of $17,951,106 and the add back depreciation and amortization of $1,337,324, amortization of deferred debt issuance costs of $52,226, amortization of discount on convertible redeemable preferred stock of $151,553, interest expense attributable to beneficial conversion feature of preferred shares of $184,660 and stock-based compensation of $353,775 and the changes in operating assets and liabilities, such as: a decrease in prepaid expenses and other current assets of $553,428, an increase in accounts payable and accrued expenses of $190,113, an increase in unearned revenue of $153,160 and an increase in due to related parties of $323,264, offset by an increase in accounts receivable of $110,085, an increase in inventories of $133,004, a decrease in other current payables of $738,398 and a decrease in taxes payable of $1,290,507.

For the nine months ended September 30, 2009, net cash provided by operating activities was primarily attributed to net income of $13,744,432, and the add back of depreciation and amortization of $1,081,953, amortization of deferred debt issuance costs of $311,388, amortization of discount on convertible redeemable preferred stock of $880,788, amortization of prepaid expense attributable to warrants of $14,849 and stock-based compensation of $113,834 and the changes in assets and liabilities, such as: a decrease in accounts receivable of $4,379,267, a decrease in inventories of $801,428, a decrease in prepaid expenses and other current assets of $2,018,565, an increase in accounts payable and accrued expense of $230,951, an increase in taxes payable of $1,721,716, an increase in unearned revenue of $658,165 and an increase in due to related parties of $178,047 offset by recognition of unearned revenue of $594,738 and a decrease in other current payables of $287,905.

Net cash used in investing activities for the nine months ended September 30, 2010 amounted to $22,054,326 which was attributable to the purchase of property and equipment. For the nine months ended September 30, 2009, net cash used in investing activities was attributed to the payment for installments on intangible assets of $8,622,567 and the purchase of property and equipment of $15,352,107.

Net cash provided by financing activities for the nine months ended September 30, 2010 and 2009 was $0.

We reported a net decrease in cash for the nine months ended September 30, 2010 of $3,048,090 as compared to a net increase in cash of $1,282,681 for the nine months ended September 30, 2009.

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. As of September 30, 2010, Lotus East has contractual commitments of approximately $55.0 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 in Inner Mongolia, 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 in Inner Mongolia 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 continuing 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 Lotus East’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 $52.9 million in the next five years, it could get back approximately $40.6 million spent to date, including the approximately $33.4 million for the payments on the land use rights, which is refundable if the Chinese local government would not grant it land use rights certificate.

EPS first nine months $0.33, EPS Q3 $0.12. We believe our target for 2010 of $0.45 will be exceeded, but we stick with our EPS target for this year. Book value increased to $1.68.

POSITION: LONG