- Quarterly Report (10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

  

FORM 10-Q

  

¨ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

  

For the quarterly period ended March 31, 2011.

  

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

For the transition period from _____ to_____.

  

Commission File Number: 001-32477

  

TIENS BIOTECH GROUP (USA), INC.

(Exact name of registrant as specified in its charter)

   

Delaware	75-2926439
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)

No. 17, Xinyuan Rd.

Wuqing New Tech Industrial Park

Tianjin, China 301700

(Address of principal executive offices)  (Zip Code)

[phone]

(Registrant’s telephone number, including area code)

 

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(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No ¨

  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer   ¨	Accelerated Filer   ¨
Non-Accelerated Filer   ¨   (Do not check if a smaller reporting company)	Smaller Reporting Company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨    No x

 

There were 71,333,586 shares of the registrant’s common stock outstanding on May 13, 2011.

 

 

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TIENS BIOTECH GROUP (USA), INC.

INDEX TO FORM 10-Q

	PAGE
PART I - FINANCIAL INFORMATION	3
ITEM 1. FINANCIAL STATEMENTS	3
Consolidated Balance Sheets as of March 31, 2011 (Unaudited) and December 31, 2010 (Audited)	3
Consolidated Statements of Income and Other Comprehensive Income for the Three Months Ended March 31, 2011 and 2010 (Unaudited)	4
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (Unaudited)	5
Notes to Consolidated Financial Statements (Unaudited)	6
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27
ITEM 4. CONTROLS AND PROCEDURES	27
PART II - OTHER INFORMATION	27
ITEM 6. EXHIBITS	27

 

 

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PART I - FINANCIAL INFORMATION

  

ITEM 1. FINANCIAL STATEMENTS

 

TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2011 (UNAUDITED) AND DECEMBER 31, 2010 (AUDITED)

		March 31,				December 31,
		2011				2010
		(Unaudited)				(Audited)
ASSETS
CURRENT ASSETS:
Cash		$	9,691,411			$	10,155,522
Accounts receivable, trade-related parties, net of allowance for doubtful accounts of $4,152,284 and $3,869,617 as of March 31, 2011 and December 31, 2010, respectively			11,279,779				10,012,861
Inventories			6,801,856				5,703,349
Other receivables			942,959				1,045,952
Other receivables-related parties			17,327,387				17,376,522
Employee advances			127,314				170,842
Prepaid expenses, net			356,817				415,208
Prepaid taxes			3,689,268				3,646,140
Total current assets			50,216,791				48,526,396
PROPERTY, PLANT AND EQUIPMENT, net			72,098,917				72,037,542
OTHER ASSETS:
Construction in progress			130,736,007				128,715,283
Construction deposits			20,177,749				12,490,855
Intangible assets, net			12,991,801				12,987,000
Other assets			10,302,761				10,721,040
Total other assets			174,208,318				164,914,178
Total assets		$	296,524,026			$	285,478,116
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable		$	14,719,467			$	14,120,791
Advances from customers-related parties			7,546,016				8,688,877
Wages and benefits payable			1,584,986				1,613,782
Short-term debt			7,610,000				3,024,800
Income taxes payable			717,129				490,782
Contractor deposits			195,485				209,376
Contractor payables			26,888,982				28,134,711
Other payables			1,109,025				1,113,416
Other payables-related parties			5,337,033				1,417,516
Total current liabilities			65,708,123				58,814,051
NON-CURRENT LIABILITIES
Long term debt			18,568,400				18,451,280
Deferred income			11,400,523				11,473,853
Total non current liabilities			29,968,923				29,925,133
Total liabilities			95,677,046				88,739,184
EQUITY:
Shareholders' equity of the Company:
Common stock, $0.001 par value, 250,000,000 shares authorized, 71,333,586 issued and outstanding, respectively			71,334				71,334
Paid-in-capital			18,428,796				18,349,908
Statutory reserves			16,465,144				16,465,144
Retained earnings			130,711,559				127,957,951
Accumulated other comprehensive income			24,405,648				23,393,626
Total shareholders' equity of the Company			190,082,481				186,237,963
Noncontrolling interest			10,764,499				10,500,969
Total equity			200,846,980				196,738,932
Total liabilities and equity		$	296,524,026			$	285,478,116

The accompanying notes are an integral part of this statement.

 

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TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (UNAUDITED)

		Three months ended March 31,
		2011				2010
REVENUE-RELATED PARTIES		$	13,050,225			$	11,403,363
COST OF SALES-RELATED PARTIES			4,136,399				3,440,881
GROSS PROFIT			8,913,826				7,962,482
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES			4,870,886				3,497,547
INCOME FROM OPERATIONS			4,042,940				4,464,935
Interest expense			(131,636	)			-
Interest income			7,992				1,872
Other expense			(529,185	)			(253,710	)
OTHER EXPENSE, NET			(652,829	)			(251,838	)
INCOME BEFORE PROVISION FOR INCOME TAXES			3,390,111				4,213,097
PROVISION FOR INCOME TAXES			446,299				609,502
NET INCOME			2,943,812				3,603,595
LESS: Net income attributable to the noncontrolling interest			(190,204	)			(342,057	)
NET INCOME ATTRIBUTABLE TO THE COMPANY			2,753,608				3,261,538
OTHER COMPREHENSIVE INCOME:
Foreign currency translation adjustment			1,012,022				14,970
COMPREHENSIVE INCOME ATTRIBUTABLE TO THE COMPANY			3,765,630				3,276,508
COMPREHENSIVE INCOME ATTRIBUTABLE TO THE NONCONTROLLING INTEREST			257,361				343,398
COMPREHENSIVE INCOME		$	4,022,991			$	3,619,906
EARNINGS PER SHARE, BASIC AND DILUTED		$	0.04			$	0.05
WEIGHTED AVERAGE NUMBER OF SHARES, BASIC AND DILUTED			71,333,586				71,333,586

The accompanying notes are an integral part of this statement.

 

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TIENS BIOTECH GROUP (USA), INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (UNAUDITED)

		Three months ended March 31,
		2011				2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	2,943,812			$	3,603,595
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Deferred income			(145,776	)			-
Provision for doubtful accounts			257,427				202,247
Depreciation			1,117,611				417,469
Amortization			85,020				83,557
loss on assets written off			655,611				-
Gain on sale of assets			-				(15,082	)
Rental expense borne by a related party			84,834				81,749
(Increase) decrease in assets:
Accounts receivable, trade-related parties			(1,457,625	)			4,933,543
Other receivables			109,344				93,577
Other receivables-related parties			141,586				(1,200,159	)
Inventories			(1,050,293	)			304,560
Employee advances			44,495				13,935
Prepaid expense			60,774				64,017
Increase (decrease) in liabilities:
Accounts payable			500,706				(819,926	)
Advances from customers-related parties			(1,194,866	)			4,034,448
Wages and benefits payable			(38,897	)			(416,798	)
Other taxes payable			202,713				550,140
Other payables			(11,159	)			19,487
Other payables-related parties			3,900,777				1,079,414
Net cash provided by operating activities			6,206,094				13,029,773
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in Life Resources			-				3,000,000
Proceeds from disposal of a subsidiary			-				700,000
Construction deposits			(7,783,013	)			(562,642	)
Contractor deposits			(15,180	)			-
Addition to construction in progress			(2,729,380	)			(9,112,590	)
Equipment deposits			(427,179	)			(1,558,192	)
Proceeds from sales of properties			-				2,621,021
Purchase of equipment and automobiles			(163,060	)			(88,505	)
Net cash used in investing activities			(11,117,812	)			(5,000,908	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceed from short term debt			4,554,000				-
Net cash provided by financing activities			4,554,000				-
EFFECT OF EXCHANGE RATE CHANGES ON CASH			(106,393	)			(3,895	)
NET INCREASE (DECREASE) IN CASH			(464,111	)			8,024,970
CASH, beginning of period			10,155,522				1,848,328
CASH, end of period		$	9,691,411			$	9,873,298
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest		$	342,018			$	-
Income taxes		$	223,653			$	213,625

The accompanying notes are an integral part of this statement.

 

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Note 1 - Background

Tiens Biotech Group (USA), Inc. (the "Company" or "Tiens") was incorporated on July 13, 1990 as Super Shops, Inc. in the State of Michigan. In October 2000, Super Shops, Inc. reincorporated in Delaware and changed its name to MIA Acquisition Corp., and subsequently to Strategika, Inc. in February 2002. On December 31, 2003, the Company changed its name from Strategika, Inc. to Tiens Biotech Group (USA), Inc.

The Company is currently owned 4.91% by public stockholders and 95.09% by Jinyuan Li, the Company’s current Chairman, CEO, Acting CFO and President. The Company owns 100% of Tianshi International Holdings Group Limited ("Tianshi Holdings"). Tianshi Holdings owns 80% of Tianjin Tianshi Biological Development Co., Ltd. ("Biological") and 100% of Tianjin Tiens Life Resources Co., Ltd. (“Life Resources”).

Nature of operations

The Company through its subsidiaries is primarily engaged in the manufacturing of nutritional supplement products, including wellness products and dietary supplement products. In the People’s Republic of China (“PRC”), the Company sells its products to Tianjin Tianshi Biological Engineering Co. Ltd. (“Tianshi Engineering”), a Chinese company. Tianshi Engineering, in turn, sells the products to customers through its branches and affiliated companies and at chain stores which are owned by individual distributors. Tianshi Engineering is 100% owned by Tianjin Tianshi Group Co., Ltd. (“Tianshi Group”).  Tianshi Group is 90% owned by Jinyuan Li, the Company’s Chairman, President , Acting CFO   and CEO, and 10% owned by Baolan Li, Jinyuan Li’s daughter, a director of the Company. Outside the PRC, the Company sells its products to overseas affiliated companies located in 45 countries who in turn re-package them and sell to independent direct sales distributors.

Note 2 – Summary of significant accounting policies

Basis of presentation

The financial statements of the Company and its subsidiaries are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These Consolidated Financial Statements for interim periods are unaudited. In the opinion of management, the consolidated financial statements include all adjustments, consisting only of normal, recurring adjustments, necessary for their fair presentation . The results reported in these Consolidated Financial Statements are not necessarily indicative of the results that may be reported for the entire year. The accompanying consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and do not include all information and footnotes necessary for a complete presentation of financial statements in conformity with U.S. GAAP. These Consolidated Financial Statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission on March 31, 2011.

The reporting entity

The Company’s consolidated financial statements reflect the activities of the following Company subsidiaries:

 

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Subsidiary		Jurisdiction of Formation		% Ownership
Tianshi Holdings		British Virgin Islands			100.0	%
Biological		P.R.C.			80.0	%
Life Resources		P.R.C.			100.0	%

Principles of consolidation

The consolidated financial statements include the financial statements of the Company and its subsidiaries. All significant inter-company transactions and balances are eliminated in consolidation.

Use of estimates

In preparing financial statements in conformity with U.S. GAAP, the Company makes estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and sales and expenses during the reported periods. Significant estimates include useful life of long lived asset, provision for bad debt and allowance for sales return.  Management bases its estimates on historical experience and on various other assumptions that they believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results could differ from those estimates.

Foreign currency translation

The reporting currency of the Company is the US dollar. Biological and Life Resources’ financial records are maintained and the statutory financial statements are stated in its local currency, Renminbi (RMB), as their functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by OANDA.com at the end of each reporting period. Translation adjustments resulting from this process are included in other comprehensive income in the statement of income and other comprehensive income.

Translation adjustments amounted to $1,012,022 and $14,970 for the three months ended March 31, 2011 and 2010, respectively. Asset and liability accounts at March 31, 2011 were translated at RMB6.57 to US$1.00 compared to RMB6.84 at March 31, 2010. Equity accounts are stated at their historical rates. The average translation rates applied to income statement accounts for the three months ended March 31, 2011 and 2010 were 6.59 RMB and 6.84 RMB, respectively. Cash flows are also translated at average translation rates for the period. Therefore, amounts reported on the statements of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheets.

Fair value of financial instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value hierarchy prioritizes the inputs used in measuring fair value into three broad levels as follows:

• Level one — Quoted market prices in active markets for identical  assets or liabilities;

•Level two — Inputs other than level one inputs that are either directly or indirectly observable; and

• Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

 

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Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company's financial instruments consist primarily of cash, trade accounts receivable, trade payables, advances, other receivables and debt instruments. The carrying amounts of the Company's financial instruments generally approximate their fair values at March 31, 2011 and December 31, 2010.

Cash

Cash includes cash on hand and demand deposits in accounts maintained with banks of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.

Accounts receivable

The Company's trade accounts receivable are mainly due from related companies. The Company has made full provision for accounts receivable-related parties aged over one year based upon the related parties’ ability to collect their receivables and a general allowance for doubtful debt of 0.5% of the remaining accounts receivable-related parties. Management reviews its accounts receivable on a regular basis to determine if the provision for doubtful debts is adequate, paying particular attention to the ages of receivables outstanding. At March 31, 2011 and December 31, 2010, there were no receivables due from Tianshi Engineering outstanding more than 90 days. At March 31, 2011 and December 31, 2010, receivables due from overseas related companies outstanding more than 180 days totaled $7,547,494 and $6,985,556, respectively. The Company did not charge-off any receivables for the periods reported. The following table represents the changes in the allowance for doubtful accounts:

		Balance at				Increase of provision				Balance at
		Beginning of Period				for Doubtful Accounts				End of Period
Three month period ended March 31, 2011
Reserves and allowances deducted from assets accounts:
Allowance for doubtful accounts:		$	3,869,617			$	282,667			$	4,152,284
Three month period ended March 31, 2010
Reserves and allowances deducted from assets accounts:
Allowance for doubtful accounts:		$	1,419,178			$	202,441			$	1,621,619

Inventories

Inventories are stated at the lower of cost or market using the moving average basis. The Company reviews its inventory annually for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence.

Employee advances

Employee advances represent cash advances to various employees of the Company. In the PRC, a majority of business transactions are completed in cash. These cash advances represent monies advanced to certain employees to pay for various expenses and purchases related to the Company's daily operations.

 

 

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Prepaid expenses

Prepaid expenses consist of advances to suppliers and short-term prepaid expenses. The Company reviews its advances to suppliers annually to determine whether provisions should be made. The amount included in prepaid expenses is net of any provisions. Provisions for prepaid expenses are as follows:

		Balance at
		Beginning of				Increase of provision				Balance at End
		Period				for Doubtful Accounts				of Period
Three month period ended March 31, 2011
Reserves and provisions deducted from assets accounts:
Provision for prepaid expenses:		$	1,056,551			$	6,706			$	1,063,257
Three month period ended March 31, 2010
Reserves and provisions deducted from assets accounts:
Provision for prepaid expenses:		$	1,018,474			$	139			$	1,018,613

Property, plant and equipment, net

Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives of the assets are as follows:

		Estimated Useful Life
Buildings and improvements		20 years
Machinery and equipment		10 years
Computer, office equipment and furniture		5 years
Automobiles		5 years

The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts, and any gain or loss is included in the consolidated statements of income and other comprehensive income. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Major additions and betterments to buildings and equipment are capitalized.

Construction in progress

Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company's plant facilities. No depreciation is provided for construction in progress until such time as the relevant assets are completed and are ready for their intended use.

Construction deposits

Construction deposits represent advances paid by the Company to contractors for construction in progress.

Intangible assets

Intangible assets mainly consist of land use rights. All land located in the PRC is owned by the government and cannot be sold to any individual or company. However, the government grants "land use rights" for a specified period of time. The Company amortizes its land use rights according to the actual useful life of 50 years. Other intangible assets include patents and trademarks and are amortized over their estimated useful lives ranging from five to ten years.

 

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Other assets

Other assets consist of deposits made to purchase equipment and a long-term prepaid expense. The Company will transfer the deposits made to purchase equipment from other assets to property, plant and equipment upon taking ownership. The Company amortizes its long-term prepaid expense according to the service period.

Impairment of long-lived assets

Long-lived assets, including intangible assets, of the Company are reviewed annually as to whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of depreciation and amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives.

Deferred income

Deferred income consists of government grants. On August 2, 2005 and November 20, 2006, the Company received two government grants related to the purchase of land use rights in the amount of RMB35,803,461 (or US$5,449,287). On August 28, 2008, Life Resources paid RMB41,022,061 (or US$6,243,558) for the zoning changes to one parcel of land on which the land use rights were changed from “industrial” to “educational”. On September 12, 2008, the Company received RMB41,022,061 (or US$6,243,558) from a government grant. The grants are treated as deferred income and amortized over the life of the buildings on the land from October 2010.

Noncontrolling interest

Noncontrolling interest represents the outside shareholder’s 20% ownership of Biological and is presented as a reduction of net income to arrive at net income attributable to the Company and as a component of equity.

Revenue recognition

The Company sells both semi-finished products and finished products to Tianshi Engineering domestically. Revenue from semi-finished products is recognized at delivery point. Revenue from finished products is recognized only when the related party Chinese distributors recognized sales of the Company's products to unaffiliated third parties. Revenues in both cases are net of value added taxes.

For overseas sales, the Company sells mostly finished products. The Company recognizes revenue from international sales (non-Chinese) to affiliated parties, net of taxes, as goods are shipped and clear review by the customs department of the Chinese government.

The Company is generally not contractually obligated to accept returns. However, on a case by case negotiated basis, the Company permits customers to return their products. Revenue is recorded net of an allowance for estimated returns. Such reserves are based upon management's evaluation of historical experience and estimated costs. The amount of the reserves ultimately required could differ materially in the near term from amounts included in the accompanying consolidated financial statements. As the Company did not receive any returns of products during the past three years, and management does not anticipate allowing any returns in 2011 related to previous revenues, no allowance for estimated returns has been recorded as of March 31, 2011 and December 31, 2010.

 

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Advertising costs

The Company sells its products to related parties, and these related parties are primarily responsible for marketing. The Company did not incur any advertising costs for the three months ended March 31, 2011 and 2010.

Shipping and handling

Shipping and handling costs totaled $224,653 and $209,005 for the three months ended March 31, 2011 and 2010, respectively. The Company sells products on FOB condition, however, it usually prepays shipping and handling expenses to transportation companies on behalf of customers and collects these shipping and handling expenses when it receives payments from customers. The payments received from customers are included in revenue and the related shipping and handling costs are included in selling, general and administrative expenses.

Research and development

Research and development expenses include salaries, supplies, and overhead such as depreciation, utilities and other costs. These costs are expensed as incurred. The Company expensed research and development costs of $259,147 and $298,133 for the three months ended March 31, 2011 and 2010, respectively. These costs are included in selling, general and administrative expenses in the accompanying statements.

Income taxes

The Company accounts for income taxes under the liability method. Deferred income taxes are recognized for the estimated tax consequences in future years, as differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on enacted tax laws and statutory rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established to reduce deferred tax assets to the amount expected to be realized when, in management’s opinion, it is more likely than not that some portion of the deferred tax assets will not be realized. The provision for income taxes represents current taxes payable net of the change during the period in deferred tax assets and liabilities.

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent. The statute of limitations extends to five years under special circumstances. In the case of transfer pricing issues, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. Accordingly, the income tax returns of the Company’s PRC operating subsidiaries for the years ended December 31, 2008 through 2010 are open to examination by the PRC state and local tax authorities.  The Company records interest and penalties as other expense on the consolidated income and other comprehensive income statements.  During the three months ended March 31, 2011 and 2010, the Company did not recognize any amount in interest and penalties.

Earnings per share

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period. There are no differences between Basic and Diluted EPS for the three months ended March 31, 2011 and 2010.

 

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Note 3 – Inventories

Inventories consisted of the following at March 31, 2011 and December 31, 2010:

		March 31,				December 31,
		2011				2010
Raw materials		$	1,812,201			$	1,392,141
Packaging material			613,024				479,651
Miscellaneous supplies			1,702,383				1,860,462
Work in process			632,593				640,664
Finished goods			2,041,655				1,330,431
Total		$	6,801,856			$	5,703,349

The Company has not written off any obsolete goods for the three months ended March 31, 2011 and 2010.

Note 4 – Prepaid expenses

Prepaid expenses consist of advances to suppliers and short-term prepaid expenses. The details of prepaid expenses, net of the allowance as disclosed in Note 2, at March 31, 2011 and December 31, 2010 are as follows:

		March 31,				December 31,
		2011				2010
Advance to suppliers		$	354,817			$	412,458
Short-term prepaid expenses			2,000				2,750
Total		$	356,817			$	415,208

Note 5 – Prepaid taxes

Prepaid taxes primarily represents prepaid value added tax, which will be deducted from the value added tax payables in future. The detail of prepaid taxes is as follows:

		March 31,				December 31,
		2011				2010
Prepaid value added taxes		$	3,876,716			$	3,822,250
Taxes payable (except income taxes payable)			(187,448	)			(176,110	)
Total		$	3,689,268			$	3,646,140

Note 6 – Property, plant and equipment, net

Property, plant and equipment consist of the following at March 31, 2011 and December 31, 2010:

 

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		March 31,				December 31,
		2011				2010
Buildings and improvements		$	64,310,041			$	63,687,629
Office equipment			599,314				487,179
Computer equipment and software			3,196,567				2,855,978
Machinery and equipment			15,497,881				15,325,589
Automobiles			5,029,852				4,998,126
Total			88,633,655				87,354,501
Less: accumulated depreciation			(16,534,738	)			(15,316,959	)
Property, plant and equipment, net		$	72,098,917			$	72,037,542

Depreciation expense for the three months ended March 31, 2011 and 2010 amounted to $ 1,117,611 and $417,469, respectively. Interest expense related to the construction of buildings or new additions to the Company's plant facilities of $210,382 and $0 for the three months ended March 31, 2011 and 2010 has been capitalized.

Note 7 - Intangible assets

Intangible assets consist of the following at March 31, 2011 and December 31, 2010:

		March 31,				December 31,
		2011				2010
Land use rights		$	14,081,002			$	13,992,186
Other intangible assets			358,255				355,996
Less accumulated amortization			(1,447,456	)			(1,361,182	)
Intangible assets, net		$	12,991,801			$	12,987,000

Amortization expense for the three months ended March 31, 2011 and 2010 amounted to $85,020 and $83,557, respectively.

The estimated amortization expense for the next five years is as follows:

Estimated amortization expense for
the year ending December 31,		Amount
2011		$	308,577
2012		$	308,577
2013		$	297,105
2014		$	296,450
2015		$	294,747
2016 and thereafter		$	11,481,544

Note 8 -Short-term debt

On October 20, 2010, Life Resources entered into an agreement with Construction Bank of China to obtain the loan of RMB20,000,000 (US$3,024,800) for purchasing raw materials and other auxiliary materials at the term of one year. The weighted-average interest rate of the short-term debt is the one-year benchmark lending rate (The interest rate is 5.56% from October 20, 2010 to December 25, 2010, 5.81% from December 26, 2010 to February 9, 2011, and 6.06% from February 9, 2011 to March 31, 2011). Under the agreement, Life Resources is required to take the following obligations:

 

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1. Submit quarterly financial statement within fifteen days after each quarter;

2. Submit any information that significantly affect the repayment ability of the Company;

3. The condition of using the fund should be fulfilled the environmental law;

4. No utilization of bank loans in other than prescribed;and

5. To inform the bank for any related party transaction with an amount over 10% of net asset.

On February 14, 2011, under the following loan agreement (see note 9) Life Resources obtained RMB30,000,000 (US$4,554,000) from Agricultural Bank of China (Agricultural Bank), which is recorded as short-term debt, to fund Life Resources’ construction in progress and is due by October 8, 2011. The interest rate is 6.06% from February 14, 2011 to March 31, 2011.

Note 9 -Long-term debt

On October 9, 2010, Life Resources entered into a loan agreement with Agricultural Bank, pursuant to which Agricultural Bank loaned RMB200,000,000 (or US$30,248,000) with the benchmark lending interest rate of The People’s Bank of China to fund Life Resources’ construction in progress under the guarantee of Tiens Group. Life Resources is permitted the full amount before October 8, 2011, and repay it before October 8, 2013. Under the agreement, Life Resources is required to take the following obligations:

1. The usage of the loan is in accordance with the laws and regulations or contracts;

2. Agree and actively cooperate with the lender and their agents on monitoring, inspecting of the construction of the project, financial activities, usage of loan and other related matters;

3. Submit information timely to the lender as the lender requested regarding the projects, usage of the loan, finance and other; and

4. Submit any information that significantly affect the repayment ability of the Company.

As of March 31, 2011, Life Resources has drawn RMB122,000,000 (or US$18,451,280) of the loan, which was recorded as long-term debt, and RMB30,000,000 which is recorded as short-term debt (see note 8). The interest rate of the long-term loan was equal to the three-year benchmark lending interest rate of The People’s Bank of China which was adjusted twice, from 5.85% to 6.10% since January 1, 2011. The detail information of the obtained amount is as follows:

Obtained date		October 11, 2010				November 12, 2010				December 10, 2010
Amount		$	9,893,000			$	6,088,000			$	2,587,400

The amounts to be paid are as follows:

Date		October 8, 2011				October 8, 2012				October 8, 2013
Amount		$	4,566,000			$	9,132,000			$	16,742,000

Note 10 – Related party transactions and balances

The Company mainly conducts related party transactions with Tianshi Group, Tianshi Engineering, Tianshi Investment, Fuhong Development, Tianjin Tianshi Pharmaceuticals Co., Ltd. (“Tianshi Pharmaceuticals”) and overseas related companies of Tianshi Group. Tianshi Group is owned 90% by Jinyuan Li and 10% by his daughter, Baolan Li. Tianshi Engineering is owned 51% by Tianshi Group and 49% by Baolan Li. Tianshi Pharmaceuticals is wholly owned by Tianshi Group. Tianshi Investment and Fuhong Development are each 100% owned by Jinyuan Li. Jinyuan Li owns or controls the overseas related companies of Tianshi Group.

 

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The Company’s related party transactions are required to be reviewed and approved or ratified by the majority of our non-interested Board of Directors. No director that is a related person in a related party transaction may participate in any discussion, approval or ratification of the related party transaction except to provide information concerning it. The following tables are provided to facilitate an understanding of the transactions and outstanding balances between those related parties.

 

		Three months ended March 31,
		2011				2010
Revenue-related parties		$	13,050,225			$	11,403,363

 

		March 31, 2011				December 31, 2010
Accounts receivable, trade–related parties, net of allowance for doubtful accounts of $4,152,284 and $3,869,617 as of March 31, 2011 and December 31, 2010, respectively		$	11,279,779			$	10,012,861
Other receivables–related parties		$	17,327,387			$	17,376,522
Advances from customers–related parties		$	7,546,016			$	8,688,877
Other payables–related parties		$	5,337,033			$	1,417,516

 

Revenue-related parties

 

The details of revenue-related parties are as follows:

   

		Three months ended March 31,
		2011				2010
Tianshi Engineering		$	8,218,691			$	6,783,273
Overseas Related Companies			4,831,534				4,620,090
Total		$	13,050,225			$	11,403,363

 

The Company markets its products through various domestic and international business entities that are related to the Company through common ownership.

 

In China, the Company sells products to Tianshi Engineering, a related party through common ownership. Tianshi Engineering, in turn, markets and sells the products to customers through its branches and affiliated companies and at chain stores owned by individual distributors. Tianshi Engineering is solely responsible for all marketing and payments of sales commissions to independent distributors.

 

Internationally, the Company sells its products directly to overseas affiliates. These overseas related companies re-package   the Company’s products and then sell to overseas independent distributors or end users of the products. Due to the common ownership, there are no formal sales or administrative agreements among Biological and those overseas related companies. The business operations among these related entities are regulated through internal ordinances.

 

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Accounts receivable, trade-related parties

 

The details of accounts receivable, trade-related parties are as follows:

   

		March 31, 2011				December 31, 2010
Tianshi Engineering		$	984,290			$	1,803,688
Overseas Related Companies			14,447,773				12,078,790
Allowance for Doubtful Accounts			(4,152,284	)			(3,869,617	)
Total		$	11,279,779			$	10,012,861

 

Other receivables-related parties

Other receivables-related parties are generated by the Company making various cash advances and short term loans, the allocation of various expenses to related parties, and amounts transferred from accounts receivable. The following table summarizes the other receivables-related parties balances:

		March 31,				December 31,
		2011				2010
Tiens Life Science Co., Ltd.		$	11,598,376			$	11,525,219
Tianshi Group			3,002,895				-
Tianshi Engineering			2,470,399				5,603,197
All-Legend Property Service (Tianjin) Co., Ltd.			161,461				155,798
All-Legend Hotel Co., Ltd.			38,627				37,856
Tianshi Yinshi Hotel			38,050				37,810
Tianshi Indonesia Logistic & Trade Co., Ltd.			9,865				9,902
Tianshi Taijisheng Health Management Co., Ltd.			5,735				5,459
Shengshi Real Estate Development			1,201				1,072
Others			778				209
Total		$	17,327,387			$	17,376,522

 

Historically, Tianshi Engineering remitted payment to the Company upon sales to third party customers. However, to support Tianshi Engineering’s marketing efforts in anticipation of receiving a direct selling license in China, the Company agreed to allow Tianshi Engineering to defer payment. Balances not remitted to the Company within 90 days are converted to other receivables-related parties. Other receivables-related parties become interest bearing at the interest rate for the same level of loan stipulated by the People’s Bank of China. During the first quarter of 2011, the Company did not convert any accounts receivables-related parties to other receivables-related parties.

The Company and Tianshi Group use common meters at the Company’s headquarters for electricity and water, and also use the same employee insurance account. When making payments to these outside parties, the Company usually pays the fees first and then is reimbursed by Tianshi Group. These pro-rated amounts relating to Tianshi Group are categorized as other receivables-related parties.

 

 

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A portion of the construction in progress at an amount of RMB83,263,708 (US$12,672,736), which is recorded and paid for by Life Resources is built on the land controlled by Tianshi Life Science. In addition, a portion of the construction in progress at an amount of RMB5,245,839 (US$798,417), which is recorded and paid for by Tianshi Life Science  is built on the land controlled by Life Resources. Tianshi Life Science and Life Resources intend to reimburse each other for the cost of the above construction in progress. The agreement is currently being drafted. The balance of RMB78,017,869 (US$11,874,320) has been reclassified as other receivable-related party as of March 31, 2011 and December 31, 2010, accordingly.

During the first quarter of 2011, the Company provided Tianshi Group with $3,500,600 to fund its operating activities. As of March 31, 2011, the amounts had been reclassified as other receivable-related party, accordingly.

 

Advances from customers-related parties

 

These advances represent prepayments made to the Company to insure that related companies could obtain enough of the Company’s products to meet their market demands. As of March 31, 2011 and December 31, 2010, advances from related party customers amounted to $7,546,016 and $8,688,877, respectively.

 

Other payables-related parties

 

The details of other payable-related parties are as follows:

 

		March 31, 2011				December 31, 2010
Tiens Group		$	3,535,048			$	639,529
Tianshi Engineering			1,448,472				431,400
Tianshi Germany Co., Ltd.			105,654				99,759
Tianjin Tianshi Global International Trade Co., Ltd.			97,408				96,794
Tianyuan Capital Development Co., Ltd.			84,359				84,359
Beijing All-Legend Travel Co., Ltd.			66,077				65,660
Tianshi Administrative Committee of Industrial Park			15				15
Total		$	5,337,033			$	1,417,516

These amounts arose primarily from previous cash advances from related parties such as management fees due to related parties and various operational transactions incurred with related parties.

During the first quarter of 2011, the Company received $7,815,470 and $3,500,600 as working capital from Tianshi Group and Tianshi Engineering, respectively. As of March 31, 2011, $4,566,000 had been repaid to Tianshi Group.

Other Transactions with Tianshi Engineering

On November 20, 2009, Biological entered into two lease agreements with Tianshi Engineering that enable Tianshi Engineering to share the use of certain of Biological’s production equipment to manufacture products which Tianshi Engineering owns, or jointly owns, with Biological. Each of the two agreements was effective as of January 1, 2010 and expired on December 31, 2010. On December 3, 2010, the lease agreement for health products production equipment and the lease agreement for personal care product production equipment were renewed by Biological and Tianshi Engineering for 2011. Rent revenue accrued from these leases amounted to $53,590 and $51,854 for the three months ended March 31, 2011 and 2010, respectively.

 

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Other Transactions with Tianshi Group

On January 1, 2010, Biological and Life Resources each entered an office and facilities lease agreement with Tianshi Group. Under the terms of the agreements, Biological and Life Resources’ annual rents are equal to 1% of their gross revenues. The two agreements expired on December 31, 2010 and renewed on January 1, 2011, for 2011. Under the new lease agreements, Biological and Life Resources have rights to use ORACLE and KM systems, and receive technical support from Tianshi Group’s IT department. The rent is the same as the agreements for 2010. Rent expense totaled $150,031 and $159,226 for the three months ended March 31, 2011 and 2010, respectively.

On January 1, 2009, each of Biological and Life Resources entered a Lease Agreement with Tianshi Group pursuant to which Biological and Life Resources will have the right to use and occupy the workshop spaces being transferred under the Property Transfer Agreement. The leases are rent-free, except that Biological and Life Resources are required to pay Tianshi Group for utility charges and maintenance costs on the buildings. The leases continue until the earlier of the date that Biological and Life Resources acquire use of alternate facilities or the land use rights on the underlying property expire. For the three months ended March 31, 2011 and 2010,  Biological and Life Resources recorded $84,834 and $81,749 of the rent expense, which is not paid to Tianshi Group, but recorded as paid in capital based upon market price.

 

Transactions with Tianshi Pharmaceuticals

On December 15, 2009, the Company entered into a one-year lease agreement with Tianshi Pharmaceutical. Under the terms of the lease agreement, the Company leased equipment for the fee of RMB25,383 (or US$3,853) per month. In addition, the Company is obligated to pay insurance, maintenance and other expenses related to the equipment. Upon expiration on December 31, 2010, the lease agreement was extended for an additional one year period. Rent expense totaled $11,559 and $11,139 for the three months ended March 31, 2011 and 2010, respectively.

Note 11– Additional product sales information

The Company has a single operating segment. All of the Company's revenues were generated from related parties. Summarized enterprise-wide financial information concerning the Company’s revenues based on product groups is shown in the following table:

Revenue by Product Group:

		Three months ended March 31,
		2011				2010
Wellness products		$	12,087,841			$	10,165,740
Dietary supplement products			962,384				1,237,623
Total		$	13,050,225			$	11,403,363

Note 12 - Income taxes

The Company is subject to income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which each entity is domiciled. The Company's subsidiary, Tianshi Holdings, was incorporated in the British Virgin Islands and is not liable for income taxes.

 

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The Company's subsidiaries, Biological and Life Resources, are Sino-Foreign Joint Ventures incorporated in the PRC. According to US GAAP, the following are the income tax credits granted by the Chinese government, which are significant components of income taxes associated with continuing operations required to be disclosed.

Beginning January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”). The new standard EIT rate of 25% will replace the 33% rate currently applicable to both DES and FIEs. According to the new EIT, high-tech companies could be subject to a special reduced tax rate of 15%. The qualification of a high-tech company is to be reviewed annually. Biological currently qualifies as a high-tech company. However, as there is no detailed regulation regarding the implementation of the new EIT, for the year of 2009 and 2010, Biological was required by the local tax authority to prepay income tax at a tax rate of 25%. In June, 2010, the prepaid income tax $582,480 for the year of 2009 was fully refunded.

According to the new EIT law, Life Resources could still be fully exempt from PRC income taxes for two years starting from January 1, 2008, followed by a 12.5% reduced tax rate for the next three years.

Provisions for income taxes were all current income tax expenses and for the three months ended March 31, 2011 and 2010 were $446,299 and $609,502, respectively.

The following table reconciles the U.S. statutory rates to the Company's effective tax rate:

		Three months ended March 31,
		2011								2010
		Biological				Life Resources				Biological				Life Resources
U.S. Statutory rate			34.0	%			34.0	%			34.0	%			34.0	%
Foreign income not recognized in			(34.0	)			(34.0	)			(34.0	)			(34.0	)
China income taxes			25.0				25.0				25.0				25.0
Effect of reduced tax rate			(10.0	)			(12.5	)			(10.0	)			(12.5	)
Total provision for income taxes			15.0	%			12.5	%			15.0	%			12.5	%

The estimated tax savings due to the reduced tax rate for the three months ended March 31, 2011 and 2010 amounted to $373,404 and $508,897, respectively. The net effect on earnings per share if the income tax had been applied would decrease earnings per share for the three months ended March 31, 2011 and 2010 by $0.005 and $0.01, respectively.

Note 13 – Retirement plan

Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all employees. All Company employees are entitled to a retirement pension amount calculated based upon salary at retirement and length of service in accordance with a government managed pension plan. The PRC government is responsible for the pension liability to the retired staff.

The Company is required to make contributions to the state retirement plan at 20% of the employees' monthly salaries. Employees are required to contribute 8% of their salaries to the plan. Total pension expense incurred by the Company amounted to $294,757 and $261,632 for the three months ended March 31, 2011 and 2010, respectively.

The Company also has an unemployment insurance plan for its employees. The plan requires each employee to contribute 1% of his or her salary to the plan. The Company matches the contributions in an amount equal to two times the contribution of each participant. The Company made contributions to the unemployment insurance plan of $28,871 and $25,308 for the three months ended March 31, 2011 and 2010, respectively. All contributions are paid to a PRC insurance company, which in turn, is responsible for the unemployment liability. Pursuant to the Company’s medical insurance plan for its employees, the Company is required to pay an amount equal to 10% of its employees' salaries to a PRC insurance company, which amounted to $147,124 and $131,667 for the three months ended March 31, 2011 and 2010, respectively.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

In this Quarterly Report on Form 10-Q, references to “dollars” and “$” are to United States Dollars and references to “renminbi” or “RMB” are to the People’s Republic of China Renminbi. References to “we”, “us”, “our”, the “Company” or “Tiens” include Tiens Biotech Group (USA), Inc. and its subsidiaries, except where the context requires otherwise.

 

FORWARD-LOOKING STATEMENTS

The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are intended to identify “forward-looking statements”. Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources”; and (e) whether Tianshi Engineering, our affiliate who sells our products in China, obtains a direct selling license in China. Statements made herein are as of the date of the filing of this Form 10-Q with the Securities and Exchange Commission and should not be relied upon as of any subsequent date.

Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

 

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-Q.

 

OVERVIEW

 

Tiens researches, develops, manufactures, and markets nutrition supplement products, including wellness products and dietary supplement products. Our operations are conducted from our headquarters in Tianjin, People’s Republic of China (“China” or the “PRC”) through our 80% owned subsidiary, Tianjin Tianshi Biological Development Co. Ltd. (“Biological”) and our wholly-owned subsidiary, Tianjin Tiens Life Resources Co., Ltd. (“Life Resources”). We sell our products to affiliated companies in China and internationally.

 

Tiens is a Delaware corporation. We own 100% of Tianshi International Holdings Group Ltd., a British Virgin Islands company (“Tianshi Holdings”). Tianshi Holdings owns 80% of Biological and 100% of Life Resources.

 

Tianjin Tianshi Biological Engineering Co., Ltd. (“Tianshi Engineering”), a Chinese company and the entity to which we sell all of our products for consumption in China, owns the remaining 20% of Biological. Tianshi Engineering is 100% owned by Tianjin Tianshi Group Co., Ltd. (“Tianshi Group”).  Tianshi Group is 90% owned by Jinyuan Li, our Chairman, President, Acting CFO and CEO, and 10% owned by Baolan Li, Jinyuan Li’s daughter and a member of our Board of Directors.

 

Life Resources is currently constructing research and development, manufacturing and logistic facilities, and administrative offices in Tianjin, China totaling approximately 420,000 square meters. We moved our administrative offices to the newly constructed Industrial Park on October 16, 2010. We expect to complete the move of all our other facilities, including our corporate headquarters at the end of 2011.

 

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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2011 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2010

		Three months ended March 31,
		2011				2010
		(Unaudited)				(Unaudited)				Change
REVENUE-RELATED PARTIES		$	13,050,225			$	11,403,363				14.4	%
COST OF SALES			4,136,399				3,440,881				20.2	%
GROSS PROFIT			8,913,826				7,962,482				11.9	%
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES			4,870,886				3,497,547				39.3	%
INCOME FROM OPERATIONS			4,042,940				4,464,935				-9.5	%
Interest expense			(131,636	)			-
Interest income			7,992				1,872				326.9	%
Other expense			(529,185	)			(253,710	)			108.6	%
OTHER EXPENSE, NET			(652,829	)			(251,838	)			159.2	%
INCOME BEFORE PROVISION FOR INCOME TAXES			3,390,111				4,213,097				-19.5	%
PROVISION FOR INCOME TAXES			446,299				609,502				-26.8	%
NET INCOME			2,943,812				3,603,595				-18.3	%
LESS: Net income attributable to the noncontrolling interest			190,204				342,057				-44.4	%
NET INCOME ATTRIBUTABLE TO TIENS BIOTECH GROUP		$	2,753,608			$	3,261,538				-15.6	%
WEIGHTED AVERAGE NUMBER OF SHARES, BASIC AND DILUTED			71,333,586				71,333,586
EARNINGS PER SHARE, BASIC AND DILUTED		$	0.04			$	0.05

Revenue .  For the first quarter of 2011, revenue was $13.1 million, an increase of 14.4% compared to $11.4 million for the same period in 2010.

The increase in revenue for the first quarter of 2011 was mainly due to the increase in domestic sales. For the first quarter of 2011, domestic revenue was $8.2 million, an increase of 21.2% compared to $6.8 million for the same period of 2010. The reasons for the increase in domestic revenue include, but are not limited to the following: (1) The distributors stocked additional products at the lower prices as Engineering increasing the prices of some products from March, 2011. (2) Engineering was granted a direct selling license by the Ministry of Commerce of the People's Republic of China in the first quarter of 2011, which help to boost the sale of the distributors, and we expect it will enhance our sales in the long term.

For the first quarter of 2011, international revenue was $4.8 million, an increase of 4.6% compared to $4.6 million for the same period in 2010. The increase was mainly reflected in the increase of sales to South Africa.

Cost of Sales . Cost of sales for the first quarter of 2011 increased to $4.1 million, an increase of 20.2% compared to $3.4 million for the same period in 2010. This increase was mainly due to the increase in sales for the period.  However, the increase in cost of sales was at a higher rate than the increase in revenues. This is mainly attributable to the decreased sales percentage of certain products, such as Cordyceps Capsules, which have a higher profit margin.

 

Gross Profit . Gross profit for the first quarter of 2011 was $8.9 million, an increase of 11.9% compared to $8.0 million for the same period in 2010. This increase reflects the increase in sales. The gross profit margin for the first quarter of 2011 was 68.3%, compared to 69.8% for the same period in 2010.

 

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Selling, general and administrative expenses . Selling, general and administrative expenses were $4.9 million for the first quarter of 2011, an increase of 39.3% compared to $3.5 million for the same period in 2010.  The increase was primarily due to increases in depreciation. From the fourth quarter of 2010, Life Resources started to transfer its construction in progress to fixed assets, which increased the depreciation for the first quarter of 2011. The selling and administrative expenses as a percentage of sales was 37.3 % for the first quarter of 2011, compared to 30.7% for the same period in 2010.

Other income (expense), net.   Other expense was $0.7 million for the first quarter of 2011, compared to $0.3 million of expense for the same period in 2010. The increase is primarily attributed to the transfer in March 2011 of a part of the plant, in the industrial park in which the Company’s facilities are located, into a parking lot, that was valued at $0.6 million and recorded as other expense . Additionally, amortization of deferred income in the amount of $0.15 million for the first quarter of 2011 also contributed to the increase.

 

Provision for income taxes .  Provision for income taxes was $0.4 million for the first quarter of 2011 compared to $0.6 million for the same period in 2010.

Net income . Net income for the first quarter of 2011 was $2.9 million, a decrease of 18.3% compared to $3.6 million for the same period in 2010. The decrease was mainly due to the increase of $1.4 million in selling, general and administrative expenses.

Financial Condition, Liquidity and Capital Resources

We have historically met our working capital and capital expenditure requirements, including funding for expansion of operations, through net cash flow provided by operating activities. Our principal source of liquidity is our operating cash flow. From the fourth quarter of 2010, due to the large amount of cash required for construction in progress  and materials purchases by Life Resources, we obtained  bank loans.

On February 14, 2011, under the loan agreement (see note 9) Life Resources obtained RMB30,000,000 (USD$4,554,000) from Agricultural Bank which is recorded as short-term debt, to fund Life Resources’ construction in progress and should be repaid before October 8, 2011. The interest rate is 6.06% from February 14, 2011 to March 31, 2011.

Net cash provided by operating activities was $6.2 million for the three months ended March 31, 2011, compared to net cash provided by operating activities of $13.0 million for the same period of 2010. This decrease was primarily due to the Company not only collected all account receivable from Tianshi Engineering, but also received large amount of advance from it, during the first quarter of 2010.

As of March 31, 2011, we had negative working capital of $15.5 million. Cash was $9.7 million as of March 31, 2011, compared to $10.2 million as of December 31, 2010.

Net cash used in investing activities increased by $6.1 million for the three months ended March 31, 2011 compared to the same period of 2010. During the first three months of 2011, we paid $7.8 million to contractors as construction deposits, compared to $0.6 million for the same period in 2010. In addition, we used $2.7 million in construction in progress for the first quarter of 2011.

Going forward, our primary requirements for cash consist of:

· construction by Life Resources of new research and development, manufacturing and logistic facilities and administrative offices;

· the continued production of existing products and general overhead and personnel related expenses to support these activities;

· the development costs of new products; and

· expansion of production scale to meet the demands of our markets.

 

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Critical Accounting Policies

Management’s discussion and analysis of its financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our financial statements reflect the selection and application of accounting policies, which require management to make significant estimates and judgments. See Note 2 to our consolidated financial statements, “Summary of Significant Accounting Policies.” Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations.

 

Revenue recognition .

 

We sell both semi-finished products and finished products to Tianshi Engineering domestically.   Revenue from the sale of  semi-finished products is recognized at delivery point, when the semi-finished products are sold to Tianshi Engineering. Revenue from the sale of finished products is recognized only when the related party Chinese distributor recognizes sales of our products to unaffiliated third parties. Revenues in both cases are net of value added taxes.

 

For overseas sales, we sell mostly finished products. We recognize revenue from international sales (outside of China) to affiliated parties, net of value added taxes, as goods are shipped and clear review by the customs department of the Chinese government.

We are generally not contractually obligated to accept returns. However, on a case by case negotiated basis, we permit customers to return products. Revenue is recorded net of an allowance for estimated returns. Such reserves are based upon management’s evaluation of historical experience and estimated costs. The amount of the reserves ultimately required could differ materially in the near term from amounts included in the accompanying consolidated financial statements. As we did not receive any returns of products during the past three years, and management does not anticipate allowing any returns in 2011 related to previous revenues, no allowance for estimated returns has been recorded as of March 31, 2011.

 

Bad debts .

Our trade accounts receivables are mainly due from related companies. We have made full provision for accounts receivable-related parties aging over one year and a general allowance for doubtful debts of 0.5% of the remaining accounts receivable-related parties.  Management reviews its accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each year-end, paying particular attention to the age of receivables outstanding.

Inventories .

 

Inventories are stated at the lower of cost or market, using the moving average basis. We review our inventory annually for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

We market most our products through various domestic and international business entities that are related to us through common ownership. As a result, most of our consolidated sales are to related parties.

In China, we sell our products to Tianshi Engineering, an affiliated company. Tianshi Engineering, in turn, markets and sells the products to customers through its branches and affiliated companies and at chain stores owned by individual distributors.

 

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We have a sales contract with Tianshi Engineering which requires Tianshi Engineering to purchase all of our products to be sold in China. We sell our finished products to Tianshi Engineering at a price equal to 25% of the Chinese market price for the products. This 25% figure was negotiated between the parties in 2003, before we acquired Tianshi Holdings, and we believe that it is a reasonable sales price for us to receive. The price of semi-finished goods sold to Tianshi Engineering was originally set at the beginning of 2006 to provide us with a 75% gross profit margin. However, based on fluctuations in the cost of raw materials and quantities produced, the gross profit margin percentage varied during the year. This 75% figure was negotiated between the parties, and we believe that it is reasonable. The goal of this new pricing policy was to try to maintain our gross margins on semi-finished goods at a similar level to historical gross margins for finished goods. All of Tianshi Engineering’s Chinese affiliated companies are owned in whole or in part by Jinyuan Li’s immediate family members.

Internationally, we sell our products directly to overseas affiliates located in 45 countries, who in turn re-package the products to meet the needs of the local markets and sell to independent distributors or end users of our products.  Our CEO, Jinyuan Li, owns or controls these overseas related companies. Due to the common ownership, there are no formal sales or administrative agreements among us and those overseas related parties. The business operations among these related entities are regulated through internal policies.

Our related party transactions are required to be reviewed and approved or ratified by a majority of our non-interested Board of Directors. The following tables are provided to facilitate your understanding of the transactions and outstanding balances between those related parties and our company.

		March 31, 2011				December 31, 2010
Accounts receivable, trade–related parties, net of allowance for doubtful accounts of $4,152,284 and $3,869,617 as of March 31, 2011 and December 31, 2010, respectively		$	11,279,779			$	10,012,861
Other receivables–related parties		$	17,327,387			$	17,376,522
Advances from customers–related parties		$	7,546,016			$	8,688,877
Other payables–related parties		$	5,337,033			$	1,417,516

Revenue-Related Parties

The details of revenue-related parties are as follows:

		Three months ended March 31,
		2011				2010
Tianshi Engineering		$	8,218,691			$	6,783,273
Overseas Related Companies			4,831,534				4,620,090
Total		$	13,050,225			$	11,403,363

Accounts Receivable, Trade-Related Parties

The details of accounts receivable, trade–related parties are as follows:

		March 31, 2011				December 31, 2010
Tianshi Engineering		$	984,290			$	1,803,688
Overseas Related Companies			14,447,773				12,078,790
Allowance for Doubtful Accounts			(4,152,284	)			(3,869,617	)
Total		$	11,279,779			$	10,012,861

 

Other Receivables-Related Parties

Other receivables-related parties are generated by our making various cash advances and short term loans, the allocation of various expenses to related parties, and amounts transferred from accounts receivable. The details of other receivables-related parties are as follows:

 

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		March 31,				December 31,
		2011				2010
Tiens Life Science Co., Ltd.		$	11,598,376			$	11,525,219
Tianshi Group			3,002,895				-
Tianshi Engineering			2,470,399				5,603,197
All-Legend Property Service (Tianjin) Co., Ltd.			161,461				155,798
All-Legend Hotel Co., Ltd.			38,627				37,856
Tianshi Yinshi Hotel			38,050				37,810
Tianshi Indonesia Logistic & Trade Co., Ltd.			9,865				9,902
Tianshi Taijisheng Health Management Co., Ltd.			5,735				5,459
Shengshi Real Estate Development			1,201				1,072
Others			778				209
Total		$	17,327,387			$	17,376,522

Historically, Tianshi Engineering remitted payment to us upon sales to third party customers. However, to support Tianshi Engineering’s marketing efforts in anticipation of receiving a direct selling license in China, we agreed to allow Tianshi Engineering to defer payment. The credit terms provide an interest-free credit term of three months. Any amounts exceeding this term are transferred from accounts receivable-related parties to other receivable-related parties.  Other receivables-related parties become interest bearing at the interest rate, on the date the loan commences, that is stipulated by the People’s Bank of China for a loan of the same level. During the first quarter of 2011, we did not convert any accounts receivables-related parties to other receivables-related parties.

Our company and Tianshi Group use common meters at our headquarters for electricity and water, and also use the same employee insurance account. When making payments to these outside parties, we usually pay the fees first and then are reimbursed by Tianshi Group. These pro-rated amounts relating to Tianshi Group are categorized as other receivables-related parties.

A portion of the construction in progress at an amount of RMB83,263,708 (US$12,672,736), which is recorded and paid for by Life Resources is built on the land controlled by Tianshi Life Science. In addition, a portion of the construction in progress at an amount of RMB5,245,839 (US$798,417), which is recorded and paid for by Tianshi Life Science  is built on the land controlled by Life Resources. Tianshi Life Science and Life Resources intend to reimburse each other for the cost of the above construction in progress. The agreement is currently being drafted. The balance of RMB78,017,869 (US$11,874,320) has been reclassified as other receivable-related party as of March 31, 2011 and December 31, 2010, accordingly.

During the first quarter of 2011, the Company provided Tianshi Group with $3,500,600 to fund its operating activities. As of March 31, 2011, the amounts had been reclassified as other receivable-related party, accordingly.

Advances from Customers-Related Parties

Advances from related party customers were $7,546,016 and $8,688,877 as of March 31, 2011 and December 31, 2010, respectively. These advances represented prepayments made to us to insure that customers could obtain enough of our products to meet their market demands.

 

Other Payables-Related Parties

These amounts arose primarily from previous cash advances from related parties such as management fees due to related parties and various non-operational transactions incurred with related parties. The details of other payable-related parties are as follows:

 

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		March 31, 2011				December 31, 2010
Tiens Group		$	3,535,048			$	639,529
Tianshi Engineering			1,448,472				431,400
Tianshi Germany Co., Ltd.			105,654				99,759
Tianjin Tianshi Global International Trade Co., Ltd.			97,408				96,794
Tianyuan Capital Development Co., Ltd.			84,359				84,359
Beijing All-Legend Travel Co., Ltd.			66,077				65,660
Tianshi Administrative Committee of Industrial Park			15				15
Total		$	5,337,033			$	1,417,516

These amounts arose primarily from previous cash advances from related parties such as management fees due to related parties and various operational transactions incurred with related parties.

During the first quarter of 2011, the Company received $7,815,470 and $3,500,600 as working capital from Tianshi Group and Tianshi Engineering respectively. As of March 31, 2011, $4,566,000 had been repaid to Tianshi Group.

Other Transactions with Tianshi Engineering

On November 20, 2009, Biological entered into two lease agreements with Tianshi Engineering that enable Tianshi Engineering to share the use of certain of Biological’s production equipment to manufacture products which Tianshi Engineering owns, or jointly owns, with Biological. Each of the two agreements was effective as of January 1, 2010 and expired on December 31, 2010. On December 3, 2010, the lease agreement for health products production equipment and the lease agreement for personal care product production equipment were renewed by Biological and Tianshi Engineering for 2011. Following is a summary of the monthly rent payable to Biological under the two leases Biological entered into on December 3, 2010.

Lease Agreement		Monthly rent
Lease Agreement for Health Products Production Equipment		$	11,680
Lease Agreement for Personal Care Product Production Equipment		$	6,183

Rent revenue accrued from these leases amounted to $53,590 and $51,854 for the three months ended March 31, 2011 and 2010, respectively.

Other Transactions with Tianshi Group

On January 1, 2010, Biological and Life Resources each entered an office and facilities lease agreement with Tianshi Group. Under the terms of the agreements, Biological and Life Resources’ annual rents are equal to 1% of their gross revenues. The two agreements expired on December 31, 2010 and renewed on January 1, 2011, for 2011. Under the new lease agreements, Biological and Life Resources have rights to use ORACLE and KM systems, and receive technical support from Tianshi Group’s IT department. The rent is the same as the agreements for 2010. Rent expense totaled $150,031 and $159,226 for the three months ended March 31, 2011 and 2010, respectively.

On January 1, 2009, each of Biological and Life Resources entered a Lease Agreement with Tianshi Group pursuant to which Biological and Life Resources will have the right to use and occupy the workshop spaces being transferred under the Property Transfer Agreement. The leases are rent-free, except that Biological and Life Resources are required to pay Tianshi Group for utility charges and maintenance costs on the buildings. The leases continue until the earlier of the date that Biological and Life Resources acquire use of alternate facilities or the land use rights on the underlying property expire. For the three months ended March 31, 2011 and 2010,  Biological and Life Resources recorded $84,834 and $81,749 of the rent expense, which is not paid to Tianshi Group, but recorded as paid in capital based upon market price.

 

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Transactions with Tianshi Pharmaceuticals

 

On December 15, 2009, we entered into a one-year lease agreement with Tianshi Pharmaceutical. Under the terms of the lease agreement, we leased equipment for the fee of RMB25,383 (or US$3,853) per month. In addition, we are obligated to pay insurance, maintenance and other expenses related  to the equipment. Upon expiration on December 31, 2010, the lease agreement was extended for an additional one year period. Rent expense totaled $11,559 and $11,139 for the three months ended March 31, 2011 and 2010, respectively.

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no off-balance sheet arrangements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness, as of the end of the period covered by this report, of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e). Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective.

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the first quarter of 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS

The exhibits listed on the Exhibit Index are provided as part of this report.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 16, 2011
	/s/ Jinyuan Li
	Jinyuan Li
	Chief Executive Officer, Acting Chief Financial Officer and President
	(Principal Executive Officer, Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

Exhibit No.		Description
10.1		Agreement, dated January 1, 2011 by and between Tianjin Tianshi Biological Development Co., Ltd. and Tianjin Tianshi Group Co. Ltd.
10.2		Agreement, dated January 1, 2011 by and between Tianjin Tiens Life Resources Co., Ltd. and Tianjin Tianshi Group Co. Ltd.
31.1		Certification of the Principal Executive Officer and the Principal Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of the Chief Executive Officer and Acting Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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