Quarterly Report Q1 1/1-3/31 2006
May 12th
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the information contained in the condensed consolidated financial statements of the Company and the notes thereto appearing elsewhere herein and in conjunction with the Management's Discussion and Analysis set forth in (1) the Company's Annual Report on Form 10-KSB for the year ended December 31, 2005 and (2) the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2005. Readers should carefully review the risk factors disclosed in Form 10-KSB for the year ended December 31, 2005 and other documents filed by the Company with the SEC.
As used in this report, the terms "Company", "we", "our", "us" and "AOBO" refer to American Oriental Bioengineering, Inc., a Nevada corporation.
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report contains forward-looking statements within the meaning of the federal securities laws. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as "anticipate," "expect," "intend," "plan," "will," "we believe," "AOBO believes," "management believes" and similar language. The forward-looking statements are based on the current expectations of AOBO and are subject to certain risks, uncertainties and assumptions, including those set forth in the discussion under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report. Actual results may differ materially from results anticipated in these forward-looking statements. We base the forward-looking statements on information currently available to us, and we assume no obligation to update them.
Investors are also advised to refer to the information in our previous filings with the Securities and Exchange Commission (SEC), especially on Forms 10-KSB, 10-QSB and 8-K, in which we discuss in more detail various important factors that could cause actual results to differ from expected or historic results. It is not possible to foresee or identify all such factors. As such, investors should not consider any list of such factors to be an exhaustive statement of all risks and uncertainties or potentially inaccurate assumptions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This section should be read together with the Summary of Significant Accounting Policies included as Note 3 to the consolidated financial statements included in our annual report for 2005 filed with the SEC on form 10-KSB.
ESTIMATES AFFECTING ACCOUNTS RECEIVABLE AND INVENTORIES
The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect our reporting of assets and liabilities (and contingent assets and liabilities). These estimates are particularly significant where they affect the reported net realizable value of the Company's accounts receivable and inventories.
At March 31, 2006, the Company provided a $155,978 reserve against accounts receivable pertaining to the operations of its subsidiary Heilongjiang Songhuajiang Pharmaceutical Limited (HSPL). Management's estimation of the appropriate reserve on accounts receivable at March 31, 2006 was based on the aged nature of some of these accounts receivable. In making its judgment, management assessed its customers' ability to continue to pay their outstanding invoices on a timely basis, and whether their financial position might deteriorate significantly in the future, which would result in their inability to pay their debts to the Company.
At March 31, 2006, the Company provided an allowance against its inventories amounting to $842,112, of which $107,364 was provided against the inventories of its subsidiary Harbin Bioengineering and $734,748 was provided against the inventories of HSPL. Management's estimation that this allowance is needed is based on potential impairments to the current carrying value of the inventories due to potential obsolescence of aged inventories. In making its estimate, management considered the probable demand for our products in the future and historical trends in the turnover of our inventories.
While the Company currently believes that there is little likelihood that actual results will differ materially from these current estimates, if customer demand for our products decreases significantly in the near future, or if the financial condition of our customers deteriorates in the near future, the Company could realize significant write downs for slow-moving inventories or uncollectible accounts receivable.
POLICY AFFECTING RECOGNITION OF REVENUE
Among the most important accounting policies affecting our consolidated financial statements is our policy of recognizing revenue in accordance with the SEC's Staff Accounting Bulletin ("SAB") No. 104. Under this policy, all of the following criteria must be met in order for us to recognize revenue:
1. Persuasive evidence of an arrangement exists;
2. Delivery has occurred or services have been rendered;
3. The seller's price to the buyer is fixed or determinable; and
4. Collectibility is reasonably assured.
The majority of the Company's revenue results from sales contracts with distributors and revenue is recorded upon the shipment of goods. The Company's pricing structure is fixed and there are no rebate or discount programs. Management conducts credit background checks for new customers as a means to reduce the subjectivity of assuring collectibility. Based on these factors, the Company believes that it can apply the provisions of SAB 104 with minimal subjectivity.
In August 2005, we established a subsidiary in Hong Kong with a specialty store to sell some of our products. Our subsidiary in Hong Kong also sells certain products to certain customers on consignment. We record revenue from consignment transactions when the consignee sells the product to the end user.
REPORTING CHANGE
Effective September 1, 2005, the Company is no longer eligible to file reports with the SEC as a small business reporter on Form 10-QSB under Regulation S-B but is subject to the reporting requirements of Form 10-Q under Regulation S-K.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2006 AS COMPARED TO THREE
MONTHS ENDED MARCH 31, 2005
The following table sets forth selected statement of income data as a percentage of revenues for the years indicated.
THREE MONTHS ENDED
MARCH 31,
2006 2005
--------- ---------
Revenues 100.00% 100.00%
Cost of Goods Sold 34.10% 37.58%
Gross Profit 65.90% 62.42%
Selling and Distribution Expenses 8.91% 6.79%
Advertising 11.66% 8.44%
General and Administrative Expenses 9.85% 12.69%
Depreciation and Amortization 2.03% 3.16%
Interest Income (Expenses), Net 0.43% -0.95%
Income Taxes 8.11% 7.77%
Net Income 25.76% 22.62%
Revenues, Cost of Goods Sold and Gross Profit
---------------------------------------------
Revenues for the three months ended March 31, 2006 were $19,086,901, an
increase of $9,434,119 from $9,652,782 for the three months ended March 31,
2005. The increases in sales of our two main categories of products were as
follows:
Three months ended March 31, Increase /
Product 2006 2005 (Decrease)
--------------------------- ----------- ----------- -----------
PBP products $12,180,157 6,005,099 6,175,058
PBN products 6,906,744 3,647,683 3,259,061
----------- ----------- -----------
TOTAL $19,086,901 9,652,782 9,434,119
=========== =========== ===========
In the first quarter of 2006, the sales of our Plant Based Pharmaceutical (PBP) products increased by $6,175,058, or 103%, as compared to the same period of 2005. This was mainly due to an increase in our sales of the Cease Enuresis Soft Gel by 144% from $1,696,749 in the first quarter of 2005 to $4,132,647 in the same period of 2006. The increase in sales of this product was due primarily to our continuous marketing efforts on the Cease Enuresis Soft Gel together with the growing demand for the product in the Chinese market. The sales of our Shuanghuanglian Injection Powder increased from $2,742,788 in the three months ended March 31, 2005 to $5,530,654 in the corresponding period of 2006, or 102%. This increase is due to the full integration of HSPL into our company, including full access to our sales channels, since the first quarter of 2005, when HSPL was a newly acquired subsidiary, as well as our continuous marketing efforts since that time. Sales revenue from our UrinStopper Patch, a new product in 2005, also increased from $326,147 in the first quarter of 2005 to $680,180 in the same quarter of 2006, or 109%. This was attributable to improved recognition of our new product supported by our marketing campaigns. Sales revenues from other PBP products in the same period also increased by $597,262, or 48%, due primarily to the increased sales of our Double Ginseng Yishen Grain product.The sales revenue from our Plant Based Neutracentral (PBN) products increased to $6,906,744 in the first quarter of 2006 from $3,647,683 in the same period of 2005, representing a growth of 89%. During the first quarter
of 2006, sales of our Protein Peptide series of products increased by 123%, from $2,511,668 in the three months ended March 31, 2005 to $5,610,492 in the same period of 2006. This increase was mainly attributable to increased sales of two products, peptide coffee and peptide tablets, of $348,358 and $2,721,150, respectively, in the quarter ended March 31, 2006 as compared to the same quarter 2005. Sales of our Compound Bio-functional beverage series decreased from $758,203 in the first quarter of 2005 to $576,588 in the same quarter 2006, representing an decrease of 24%. Management believes that this decrease resulted from reduced marketing efforts made for this product during the period. Other PBN products recorded an increase in sales from $377,812 in the first quarter of 2005 to $719,664 in the same period of 2006, or an increase of 90% due primarily to increased sales of our Vitalmate nutritional oral liquid product.
Cost of goods sold for the quarter ended March 31, 2006 were $6,509,411, an increase of $2,881,847 from $3,627,564 for the same period 2005. The increases by product categories were as follows:
Three months ended March 31, Increase /
Product 2006 2005 (Decrease)
--------------------- ---------- ---------- ----------
PBP products $4,197,859 2,337,904 1,859,955
PBN products 2,311,552 1,289,660 1,021,892
---------- ---------- ----------
TOTAL $6,509,411 3,627,564 2,881,847
========== ========== ==========
The cost of goods sold as to PBP products increased by $1,859,955, or 80%, in the three months ended March 31, 2006 compared to the same quarter of 2005. This increase resulted from our increase in sales (reflected in a 103% increase in sales revenue) from our PBP products in the first quarter of 2006 compared to the first quarter of 2005, described above.
The cost of goods sold as to PBN products increased by $1,021,892, or 79%, in the first quarter of 2006 compared to the same period of 2005. This increase resulted from our increase in sales (reflected in an 89% increase in sales revenue) of our PBN products in the first quarter of 2006 compared to the first quarter of 2005, described above.
Our overall gross profit margin increased from 62.4% in the quarter ended March 31, 2005 to 65.9% in the same period of 2006. This was mainly due to the improved gross profit margin of HSPL from 54.6% in the first quarter of 2005 to 61.2% in the same period of 2006. The improved gross profit margin of HSPL was due primarily to improved operational efficiency after one year of integration of HSPL.
Selling and Distribution Expenses
Selling and distribution expenses, including marketing expenses, increased from $655,375 in the three months ended March 31, 2005 to $1,701,280 in the same quarter of 2006, representing a 160% increase. The details of our sales and distribution expenses were as follows:
3 Months ended March 31,
Increase/
2006 2005 (Decrease)
----------- --------- ----------
Payroll $ 194,292 183,864 6%
Transportation 434,731 198,698 119%
Promotional materials and fees 346,683 94,090 268%
Offices and sundries 143,234 67,172 113%
AOBO Hong Kong marketing 23,638 2,923 709%
AOBO US marketing 0 53 (100%)
Other 558,702 108,575 415%
----------- ---------
TOTAL $ 1,701,280 655,375 160%
=========== =========
Our increase in selling and distribution expenses in the quarter ended March 31,2006 against the same quarter of 2005 was as a result of increased selling and distribution expenses in our AOBO Hong Kong, Harbin Bioengineering and HSPL operations.
AOBO HONG KONG OPERATIONS
In the first quarter of 2006, our sales and distribution expenses for AOBO Hong Kong increased by 709%. This was because AOBO Hong Kong opened a specialty store in August 2005, and introduced products into many chain stores owned by chain pharmacies. To support the sales of these stores, as well as to increase our brand recognition, we engaged in substantial marketing activities during the first quarter of 2006; we engaged in no such activities in the first quarter of 2005.
HARBIN BIOENGINEERING AND HSPL OPERATIONS
The details of our sales and distribution expenses incurred in Harbin
Bioengineering and HSPL are as follows:
Three Months ended March 31,
------------------------------------
Increase/
PAYROLL 2006 2005 (Decrease)
---------- --------- ----------
Harbin Bioengineering $ 176,737 168,453 5%
HSPL 17,555 15,412 14%
---------- ---------
TOTAL $ 194,292 183,865 6%
========== =========
In the quarter ended March 31,2006, our payroll expenses for Harbin Bioengineering increased by 5%. Payroll expenses for HSPL increased by 14% compared with the same quarter of 2005 due to an increase in the number of employees working in marketing and distribution from 110 in the first quarter of 2005 to 152 in the same period of 2006.
Transportation, Promotional and Office Expenses
The details of our transportation, promotional and office expenses incurred in Harbin Bioengineering and HSPL are as follows:
Three Months ended March 31,
Increase/
2006 2005 (Decrease)
------------ ---------
Transportation
Harbin Bioengineering $ 177,051 181,576 (2%)
HSPL 257,680 17,122 1405%
Promotional materials and fees
Harbin Bioengineering 346,683 94,090 268%
HSPL 0 0 0%
Offices and sundries
Harbin Bioengineering 8,775 64,419 (86%)
HSPL 134,459 2,753 4784%
Other
Harbin Bioengineering 424,808 67,883 526%
HSPL 133,894 40,691 229%
------------ ---------
TOTAL non payroll $ 1,483,350 468,534 217%
============ =========
Transportation expenses for Harbin Bioengineering decreased by 2% in the first quarter of 2006 against the same period of 2005. This was a result of improved efficiency in our delivery system. However, transportation expenses for HSPL increased by 1,405%. This increase resulted primarily from the growth in sales reflected in the increase in our sales revenue.
Harbin Bioengineering increased its promotional materials and fees expenses by 268% in the quarter ended March 31, 2006 compared to the same quarter of 2005. This increase represented increased spending in marketing communications to increase market awareness of our brand and products. The increase in percentage terms occurred as revenues grew at a faster rate than expenses.
Harbin Bioengineering reduced its offices and sundries expenses by 86% in 2005 compared to 2004. This was because in 2005 our spending on office sundries covered a portion of our requirements in 2006 and as a result, our spending in the first quarter of 2006 was reduced as compared to the same quarter of 2005. HSPL, however, increased its expenses in office sundries by 4,784% in the first quarter of 2006 as compared to the same period of 2005. The increase resulted primarily from the cost related to continued development and implementation of HSPL's branding and marketing campaigns.
As a result of the increase in selling and distribution expenses in HSPL, our overall selling and distribution expenses increased by 217% in the first quarter of 2006 as compared to the same quarter of 2005.
Advertising Expenses
Advertising expenses increased by $1,410,454, from $814,733 in the first quarter of 2005 to $2,225,187 in the same quarter of 2006. The increase in advertising expenses resulted from an increase in advertising and promotional efforts in the first quarter of 2006 to promote the Company's Shuanghuanlian Injection powder and Protein Peptide product series as well as our new products the Urinstopper Capsule and UrinStopper Patch. Our Hong Kong branch also increased advertisement on brand building and name recognition in the Hong Kong market in the first quarter of 2006 compared to the first quarter of 2005.
General and Administrative Expenses
-----------------------------------
General and administrative expenses increased from $1,225,393 in the
first quarter of 2005 to $1,880,964 in the same quarter this year, or a 53%
increase. The details of general and administrative expenses were as follows:
Three Months ended March 31,
Increase/
2006 2005 (Decrease)
------------ ------------ -----------
Payroll $ 277,836 202,364 37%
Directors' remuneration 114,250 91,750 25%
Stock compensation - directors 78,450 0 100%
Stock compensation - consultants 245,258 257,308 (5%)
Office rental 93,669 11,177 738%
Professional fees 480,143 235,759 104%
Office sundries 146,634 61,428 139%
Transportation 4,287 594 622%
Vehicles 21,701 49,445 (56%)
Utilities 57,433 38,317 50%
Research 172,895 95,594 81%
Entertainment 69,505 40,537 71%
Recovery of bad debts (115,082) -- (100%)
Miscellaneous 233,985 141,120 66%
------------ ------------
TOTAL $ 1,880,964 1,225,393 53%
============ ============
Our increase in general and administrative expenses in the quarter
ended March 31, 2006 against the same quarter of 2005 was as a result of
increased general and administrative expenses in our AOBO US, AOBO Hong Kong,
Harbin Bioengineering and HSPL operations, as described below.
AOBO US AND AOBO HONG KONG OPERATIONS
For the quarter ended March 31, 2006, the details of our general and
administrative expenses incurred in the AOBO US and AOBO Hong Kong offices were
as follows:
Three Months ended March 31,
Increase/
2006 2005 (Decrease)
---------- --------
AOBO Hong Kong $
Payroll 46,587 39,423 18%
Office rental 64,577 3,677 1656%
Professional fees 20,033 1,077 1760%
Office sundries 4,366 3,355 30%
Other 18,899 13,253 43%
---------- --------
TOTAL AOBO Hong Kong $ 154,462 60,785 154%
========== ========
23
AOBO US
Payroll $ 42,000 19,000 121%
Directors remuneration 114,250 91,750 25%
Stock compensation - directors 78,450 -- 100%
Stock compensation - consultants 245,258 257,308 (5%)
Office rental 29,092 7,500 288%
Professional fees 460,110 234,682 96%
Office sundries 505 183 176%
Other 24,539 13,345 84%
---------- --------
TOTAL AOBO US $ 994,204 623,768 59%
========== ========
For the quarter ended March 31, 2006, general and administrative expenses incurred in the AOBO Hong Kong office increased by 154% as compared to the same quarter of 2005. The increase resulted primarily from additional personnel and facility expenses as well as fees paid for professional services related to our growth.
For the quarter ended March 31, 2006, general and administrative expenses incurred in the AOBO US office increased by 59% as compared to the same period last year. In the second half of 2005, we increased the number of employees in AOB US from three to five, and we increased the number of offices occupied by AOBO US from one to two. As a result, there were increases in expenses in the payroll, office rental, office sundries and other expense categories in the first three months of 2006 as compared to the same period of 2005. Director remuneration increased by 25% as a result of the appointment of a new independent director in the second quarter of 2005, and stock-based compensation for directors was also initiated during that time. Stock-based compensation for consultants, however, decreased by 5% because some of the expenses for consultants were fully amortized earlier and as a result, such expenses did not recur in the first quarter of 2006. Professional fees for the first quarter of 2006 increased by 96% as compared to the same quarter of 2005 as a result of an increase in our use of audit and consultancy services in connection with the listing of our stock on the American Stock Exchange and a $60.0 million private placement in December 2005.
HARBIN BIOENGINEERING AND HSPL OPERATIONS
For the quarter ended March 31,2006, the details of our general and
administrative expenses incurred in Harbin Bioengineering and HSPL were as
follows:
Three Months ended March 31,
Increase/
2006 2005 (Decrease)
---------- ---------- ----------
Payroll
Harbin Bioengineering $ 127,771 $ 110,560 16%
HSPL 61,478 33,381 84%
---------- ---------- ----------
Payroll Total $ 189,249 $ 143,941 31%
========== ========== ==========
Non-Payroll
Research
Harbin Bioengineering $ 171,154 92,757 85%
HSPL 1,741 2,837 (39%)
---------- ----------
Research Total $ 172,895 95,594 81%
========== ========== ==========
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