NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
NOTE 1 – DESCRIPTION OF BUSINESS
AND BASIS OF PRESENTATION
American Oriental Bioengineering,
Inc. (“AOB” or “the Company”) is a fully integrated pharmaceutical company dedicated to improving health
through the development, manufacture, commercialization and distribution of a broad range of pharmaceutical and healthcare products
in the People’s Republic of China (the “PRC”).
Basis of presentation
The accompanying unaudited
interim condensed consolidated financial statements of the Company and its subsidiaries as of and for the three months ended March
31, 2012 and 2011 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the ”SEC”)
that permit reduced disclosure for interim periods and include, in the opinion of management, all adjustments (consisting of normal
recurring adjustments and reclassifications) necessary to present fairly the financial position, results of operations and cash
flows as of March 31, 2012 and for all periods presented. Information as of December 31, 2011 has been derived from the audited
consolidated financial statements of the Company for the year ended December 31, 2011. These unaudited condensed consolidated financial
statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K for the year ended
December 31, 2011 filed with the SEC on January 7, 2013.
Basis of Consolidation
The unaudited consolidated
financial statements include the financial statements of American Oriental Bioengineering, Inc. and its wholly owned subsidiaries.
Intercompany accounts and transactions have been eliminated in consolidation. Results of acquired subsidiaries are consolidated
from the date on which control is transferred to the Company and are no longer consolidated from the date that control ceases.
Going Concern
The accompanying consolidated
financial statements are prepared under
a going concern basis in accordance with U.S. generally accepted
accounting principles (“GAAP”) which contemplates the realization of assets and discharge of liabilities and commitments
in the normal course of business.
For the three months ended March 31, 2012, the Company recorded a loss from operations
of $15,090,018 and
utilized cash in operations of $21,579,250.
As
of March 31, 2012, the Company had working capital of $4,530,421. In addition, the Company was in default of its convertible
notes (the “Notes”) due July 15, 2015 (see Note 12), which had a balance of $108,500,000 as of March 31, 2012 and $49,161,000
as of the date of this filing. On April 8, 2013, four of the holders of the Notes (the “Plaintiffs”) filed an action
claiming a default under the Notes, which allegedly resulted in an acceleration of the maturity of the Notes. The Plaintiffs had
previously commenced a similar action in federal court in New Jersey, which action was withdrawn and the present action interposed.
The action seeks payment of $20,378,608 plus prejudgment interest and other fees and costs. The Company has been served with the
complaint, and Plaintiffs agreed to extend the Company’s time to answer. When that time passed on June 3, 2013, Plaintiffs
refused to grant additional time and have now made a motion seeking entry of a default. The Company filed its answer on June 5,
2013 (see Note 14). The Company presently does not have the ability to pay these Notes. The Company’s ability to continue
as a going concern is dependent upon its ability to return to profitability or to develop additional sources of financing or capital.
These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. As a result,
the Company’s independent registered public accounting firm, in their report on the Company’s 2012 consolidated financial
statements, raised substantial doubt about the Company’s ability to continue as a going concern. The Company’s financial
statements do not include any adjustments that might result from the outcome of these uncertainties.
Historically, the Company’s
main source of cash was through the sales of its products, proceeds from the issuance of common stock, and debt financing. However,
due to the decrease in sales, the Company’s ability to meet contractual obligations and payables depends
on its ability to implement cost reductions effectively and obtain additional financing. The Company believes that
the ongoing economic challenges and uncertainties experienced in 2012 and the first quarter of 2013 will continue to negatively
impact its business in the remainder of 2013. Thus, the Company expects that for 2013 it will continue to generate losses
from operations, and its operating cash flows will not be sufficient to cover operating expense; therefore, the Company expects
to continue to incur net losses.
To meet its capital
needs, the Company is considering multiple alternatives, including, but not limited to, additional debt financing and credit
lines, delaying capital spending for future periods, and/or operating cost reductions. The Company believes it
can utilize its currently unencumbered buildings and land use rights located in Beijing, PRC with an aggregate net book value
of approximately $105,000,000 (as of March 31, 2013) to secure financing. No assurance can be given that the financing
will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able
to obtain additional financing, it may contain undue restrictions on its operations, in the case of debt financing or cause substantial
dilution to shareholders, in the case of equity financing.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
Use of Estimates
The preparation of
financial statements in conformity with generally accepted accounting principles in the United States of America requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the
reporting period. Significant estimates reflected in the consolidated financial statements include, but are not limited to, the
recoverability of the carrying amount of property, plant, and equipment and intangible assets, allowance for accounts receivable,
realizable values for inventories and capitalized agricultural costs, valuation allowance of deferred tax assets, and valuation
of share-based compensation expenses. Changes in facts and circumstances may result in revised estimates. Actual results could
differ from these estimates.
NOTE 2 – SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Fair Value of Financial Instruments
FASB ASC 820 “Fair
Value Measurements and Disclosures” establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring
fair value. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value
are observable in the market.
These tiers include:
|
·
|
Level 1 - defined as observable inputs such as quoted prices in active markets;
|
|
|
|
|
·
|
Level 2 - defined as inputs other than quoted prices in active markets that are either directly
or indirectly observable; and
|
|
|
|
|
·
|
Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring
an entity to develop its own assumptions
|
The carrying amounts
of financial assets and liabilities, such as cash and cash equivalents, accounts and notes receivable, short-term bank loans, accounts
payable, notes payable and other payables, approximate their fair values because of the short maturity of these instruments. The
carrying values of long-term loans approximate their fair values due to the fact that the interest rates on these loans are reset
each year based on prevailing market interest rates. The convertible notes are initially recognized based on residual proceeds
after allocation to the derivative financial liabilities, if any, at fair value and subsequently carried at amortized cost using
the effective interest rate method, with any accrued and unpaid interest included under other payables and accrued expenses.
Earnings per share
Basic earnings per
share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding
during the year. The diluted earnings per share calculation gives effect to all potentially dilutive common shares outstanding
during the year. The following is a reconciliation of the numerator and denominator used in the calculation of basic and diluted
earnings per share available to common shareholders:
|
|
Three Months Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
EPS Numerator:
|
|
|
|
|
|
|
|
|
Net income (loss), as adjusted
|
|
$
|
(17,156,925
|
)
|
|
$
|
812,054
|
|
|
|
|
|
|
|
|
|
|
EPS Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding - basic
|
|
|
39,476,274
|
|
|
|
37,493,687
|
|
Effect of dilutive instruments: common stock awards to be issued
|
|
|
–
|
|
|
|
515,594
|
|
Weighted average common shares outstanding - diluted
|
|
|
39,476,274
|
|
|
|
38,009,281
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share - Basic
|
|
$
|
(0.43
|
)
|
|
$
|
0.02
|
|
Earnings (loss) per share - Diluted
|
|
$
|
(0.43
|
)
|
|
$
|
0.02
|
|
As of March 31, 2012,
common stock equivalents were composed of options convertible into 883,639 shares of the Company’s common stock and notes
convertible into 13,428,218 shares of the Company’s common stock, which have been excluded from the calculation of earnings
per share as their effect is anti-dilutive.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
Impairment
In evaluating long-lived
assets for recoverability, including finite-lived intangibles and property and equipment, the Company uses its best estimate of
future cash flows expected to result from the use of the asset and eventual disposition. To the extent that estimated future, undiscounted
cash inflows attributable to the asset, less estimated future, undiscounted cash outflows, are less than the carrying amount, an
impairment loss is recognized in an amount equal to the difference between the carrying value of such asset and its fair value.
Assets to be disposed of and for which there is a committed plan of disposal, whether through sale or abandonment, are reported
at the lower of carrying value or fair value less costs to sell.
In evaluating capitalized
agriculture costs, the Company uses its best estimate of the future cash flows expected to result from future market values, yields
and costs to harvest. To the extent that estimated future cash inflows attributable to the asset, less estimated future, cash outflows,
are less than the carrying amount, an impairment loss is recognized in an amount equal to the excess of the carrying value over
the estimated fair values of the capitalized agricultural costs.
The Company’s
annual impairment testing is performed in the fourth quarter of each year.
In the fourth quarter
of 2012, the Company had impairment write-offs to property and equipment and land use rights of $12,577,507 and $10,255,550, respectively,
based on their annual review. Also in the fourth quarter of 2012, the Company recorded a write-off related to the estimated recoverability
of capitalized agriculture costs of $8,525,587.
In the fourth quarter
of 2011, the Company had impairment write-offs to property and equipment, goodwill, and acquired intangible assets of $733,688,
$33,164,121, and $6,928,064, respectively, based on their annual review.
Recent Accounting Pronouncements
In July 2012, FASB issued
ASU No. 2012-02, “Intangibles – Goodwill and Other”. This update presents an entity with the option to first
to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired
as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30,
“Intangibles – Goodwill and Other – General Intangibles Other than Goodwill”. The more-likely-than-not
threshold is defined as having a likelihood of more than fifty percent. ASU No. 2012-02 will be effective for annual and impairment
tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company’s adoption
of this update did not have a material effect on its consolidated financial statements.
In January 2013, the
FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.
This ASU clarifies which instruments and transactions are subject to the offsetting disclosure requirements established by ASU
2011-11. This guidance is effective for annual and interim reporting periods beginning January 1, 2013. We do not believe the adoption
of this update will have a material effect on our financial position and results of operations
In February 2013, the
FASB issued ASU No. 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income.” The new guidance requires entities to report the effect of significant reclassifications out of accumulated
other comprehensive income on the respective line items in net income unless the amounts are not reclassified in their entirety
to net income. For amounts that are not required to be reclassified in their entirety to net income in the same reporting period,
entities are required to cross-reference other disclosures that provide additional detail about those amounts. The new guidance
is effective prospectively for all interim and annual periods beginning after December 15, 2012, with early adoption permitted.
The Company’s adoption of this update did not have a material effect on its consolidated financial statements.
Other recent accounting
pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and SEC did not or are not believed by
management to have a material impact on the Company's present or future consolidated financial statements.
NOTE 3 – CONCENTRATION OF RISKS
Concentration of credit risks
Assets that potentially
subject the Company to significant concentration of credit risk primarily consist of cash and cash equivalents, accounts receivable
and prepaid forward repurchase contract. As of March 31, 2012, substantially all of the Company’s cash and cash equivalents
were deposited in financial institutions located in PRC, which management believes are of high credit quality. Accounts receivable
are typically unsecured and mainly derived from revenue earned from customers in the PRC, which are exposed to credit risk. The
risk is mitigated by credit evaluations the Company performs on its customers and its ongoing monitoring process of outstanding
balances. The Company maintains reserves for estimated credit losses, which have generally been within its expectations.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
Current vulnerability due to certain
other concentrations
The Company’s
operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government
has been pursuing economic reform policies for more than 30 years, no assurance can be given that the PRC government will continue
to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership,
social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions.
There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.
Currency convertibility risk
The Company transacts
the majority of its business in the Renminbi (“RMB”), which is not freely convertible into foreign currencies. On January
1, 1994, the PRC government abolished the dual rate system and introduced a single rate of exchange as quoted daily by the People’s
Bank of China (the “PBOC”). However, the unification of the exchange rates does not imply that the RMB may be readily
convertible into United States dollars or other foreign currencies. All foreign exchange transactions continue to take place either
through the PBOC or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the PBOC. Approval
of foreign currency payments by the PBOC or other institutions requires submitting a payment application form together with suppliers’
invoices, shipping documents and signed contracts. Additionally, the value of the RMB is subject to changes in central government
policies and international economic and political developments affecting supply and demand in the PRC foreign exchange trading
system market.
NOTE 4 – ACCOUNTS RECEIVABLE
Accounts receivable
consist of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Accounts receivable
|
|
$
|
68,976,968
|
|
|
$
|
69,551,171
|
|
Allowance for doubtful accounts
|
|
|
(16,461,940
|
)
|
|
|
(16,354,873
|
)
|
Accounts receivable, net
|
|
$
|
52,515,028
|
|
|
$
|
53,196,298
|
|
Accounts receivable arise from sales to our customers and are
generally due on terms ranging from 30 to 180 days beginning after the invoice date. The Company assessed distributors’
credit history, operation performance, financial position and reputation among peers to assign credit terms. The Company’s
management reviews credit terms and conditions of the account receivable balance for each distributor on a quarterly basis. The
Company estimates that the remaining net receivables will be collected.
From time to time we
receive bank acceptance notes that are payable to the Company from our customers, for goods we sell to those customers. If
the notes are not yet due and payable, we may exchange them at a bank in exchange for notes payable to our suppliers, and deliver
those notes to our vendors.
NOTE 5 – INVENTORIES
Inventories are summarized
as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Raw materials
|
|
$
|
8,836,600
|
|
|
$
|
6,228,319
|
|
Work in process
|
|
|
3,135,562
|
|
|
|
3,652,867
|
|
Finished goods
|
|
|
17,176,214
|
|
|
|
9,633,260
|
|
Total inventories
|
|
|
29,148,376
|
|
|
|
19,514,446
|
|
Less: provision against slow-moving inventories
|
|
|
(595,014
|
)
|
|
|
(624,516
|
)
|
Inventories, net
|
|
$
|
28,553,362
|
|
|
$
|
18,889,930
|
|
Capitalized agricultural costs are summarized
as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Growing crops
|
|
$
|
13,322,154
|
|
|
$
|
993,126
|
|
Payments for long-term crop contracts
|
|
|
–
|
|
|
|
17,012,586
|
|
Prepaid land leasing costs for long-term supply contracts
|
|
|
12,509,068
|
|
|
|
4,328,225
|
|
Capitalized agricultural costs
|
|
$
|
25,831,222
|
|
|
$
|
22,333,937
|
|
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
The Company has reflected
capitalized agriculture costs for Millettia and Xanthoceras Sorbifolia Bge (“XSB”) as a long term asset as it does
not expect to utilize these assets currently. These pre-harvest agricultural costs usually require substantial investment in the
early stages, gradually decreasing to maintenance costs during the growing stage. During the three months ended March 31, 2012
and 2011, pre-harvest agricultural costs incurred during the period of $3,395,407 and nil, respectively, were capitalized.
NOTE 6 – ADVANCES TO SUPPLIERS
AND PREPAID EXPENSES
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Advances to suppliers
|
|
$
|
15,438,380
|
|
|
$
|
15,591,318
|
|
Prepaid expenses
|
|
|
291,425
|
|
|
|
943,873
|
|
Advances to suppliers and prepaid expenses
|
|
$
|
15,729,805
|
|
|
$
|
16,535,191
|
|
Advances to suppliers
mainly represent interest-free cash deposits paid to suppliers for future purchases of raw materials. Prepaid expenses mainly relate
to the prepaid research and development expenses to external contractors.
NOTE 7 – PROPERTY, PLANT AND EQUIPMENT
Property, plant and
equipment consist of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Original cost:
|
|
|
|
|
|
|
|
|
Buildings
|
|
$
|
146,774,742
|
|
|
$
|
146,410,665
|
|
Machinery and equipment
|
|
|
27,471,174
|
|
|
|
25,851,084
|
|
Motor vehicles
|
|
|
2,109,151
|
|
|
|
2,105,105
|
|
Office equipment
|
|
|
3,222,856
|
|
|
|
3,162,305
|
|
Other equipment
|
|
|
2,273,174
|
|
|
|
1,812,266
|
|
Construction in progress
|
|
|
25,622,890
|
|
|
|
25,264,200
|
|
|
|
|
207,473,987
|
|
|
|
204,605,625
|
|
Less: Accumulated depreciation
|
|
|
(35,968,124
|
)
|
|
|
(34,071,175
|
)
|
Property, plant and equipment, net
|
|
$
|
171,505,863
|
|
|
$
|
170,534,450
|
|
Depreciation expense
for the three months ended March 31, 2012 and 2011 was $1,684,604 and $1,395,159, respectively. As of March 31, 2012 and December
31, 2011, the net book value of property, plant and equipment pledged as collateral for bank loans was $4,979,939 and $6,249,074,
respectively (see Note 11). As of March 31, 2012, the Company had entered into capital commitments for $22,477,168 for manufacturing
facilities under construction in the PRC due within one year, and $6,798,741 after one year but within three years (see Note 14).
NOTE 8 – LAND USE RIGHTS
Land use rights consist
of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Cost of land use rights
|
|
$
|
173,144,004
|
|
|
$
|
172,055,852
|
|
Less: Accumulated amortization
|
|
|
(15,107,552
|
)
|
|
|
(14,127,700
|
)
|
Land use rights, net
|
|
$
|
158,036,452
|
|
|
$
|
157,928,152
|
|
Amortization expense
for the three months ended March 31, 2012 and 2011 was $891,151 and $854,523, respectively.
As
of March 31, 2012 and December 31, 2011
, the net book value of land use rights pledged as collateral was $21,024,087 and
$21,020,381, respectively (see Note 11).
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
NOTE 9 – ACQUIRED INTANGIBLE
ASSETS
Acquired intangible
assets are summarized as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
At cost:
|
|
|
|
|
|
|
|
|
Product licenses
|
|
$
|
9,529,915
|
|
|
$
|
9,470,024
|
|
Trademarks
|
|
|
6,694,885
|
|
|
|
6,652,810
|
|
Patents
|
|
|
3,404,784
|
|
|
|
3,383,385
|
|
Software
|
|
|
187,214
|
|
|
|
134,259
|
|
Liaoning Baicao pharmaceutical trade license
|
|
|
5,555,995
|
|
|
|
5,521,077
|
|
|
|
|
25,372,793
|
|
|
|
25,161,555
|
|
Less: Accumulated amortization
|
|
|
|
|
|
|
|
|
Product licenses
|
|
|
(7,456,078
|
)
|
|
|
(7,195,886
|
)
|
Trademarks
|
|
|
(4,949,757
|
)
|
|
|
(4,791,570
|
)
|
Patents
|
|
|
(2,443,199
|
)
|
|
|
(2,400,412
|
)
|
Software
|
|
|
(100,636
|
)
|
|
|
(45,029
|
)
|
Liaoning Baicao pharmaceutical trade license
|
|
|
–
|
|
|
|
–
|
|
|
|
|
(14,949,670
|
)
|
|
|
(14,432,897
|
)
|
Acquired intangible assets, net
|
|
$
|
10,423,123
|
|
|
$
|
10,728,658
|
|
Amortization expense
for the three months ended March 31, 2012 and 2011 was $374,529 and $836,853, respectively.
The
Company conducts impairment tests on a regular basis to determine if the carrying values of acquired intangible assets are in excess
of the fair value, and that such assets are active, being used in production of products, or are intended to be utilized in future
production. No impairment charges were recognized in the three months ended March 31, 2012 or 2011.
NOTE 10 – INVESTMENTS IN AND ADVANCES
TO EQUITY METHOD INVESTMENTS
At March 31, 2012,
the Company owned a 33.7% equity interest in AXN and a 40% equity interest in Jinji. For the three months ended March 31, 2012,
the changes in investments in and advances to equity method investments are summarized as follows:
|
|
AXN
|
|
|
Jinji
|
|
|
Total
|
|
Balance, December 31, 2011
|
|
$
|
5,751,495
|
|
|
$
|
182,927
|
|
|
$
|
5,934,422
|
|
Advances
|
|
|
9,900
|
|
|
|
(53,940
|
)
|
|
|
(44,040
|
)
|
Income (loss)
|
|
|
(191,810
|
)
|
|
|
360
|
|
|
|
(191,450
|
)
|
Foreign currency translations
|
|
|
–
|
|
|
|
(3,937
|
)
|
|
|
(3,937
|
)
|
Balance, March 31, 2012
|
|
$
|
5,569,585
|
|
|
$
|
125,410
|
|
|
$
|
5,694,995
|
|
NOTE
11 – DEBT
At March 31, 2012 and
December 31, 2011, bank acceptance notes to vendors were $3,599,399 and $502,912, respectively and due at
various
dates from April 2012 to September 2012. These s
hort-term notes payable are lines of credit extended by the banks, which
in turn issue to the Company a bank acceptance note that can be endorsed and assigned to vendors as payments for purchases. The
short-term notes payable are generally payable within three to six months, and guaranteed by the bank. The banks do not charge
interest on these notes, but usually charge a transaction fee of 0.05% of the total note value. In addition, the banks usually
require the Company to deposit a certain amount of cash at the bank as a guarantee deposit which is classified on the balance
sheet as restricted cash. At March 31, 2012 and December 31, 2011, restricted cash as a guarantee for the notes payable amounted
to $1,900,063 and $264,031, respectively.
At March 31, 2012 and
December 31, 2011, short-term loans obtained from local banks were $6,798,741 and $6,756,014, respectively. The short-term loans
payable are due on various dates through February 19, 2013, with interest ranging from 6.56% to 7.22% per annum, and secured by
property, plant and equipment and land use rights owned by the Company. At March 31, 2012 and December 31, 2011, the short-term
loans are secured by property, plant and equipment owned by the Company of $4,979,939 and $6,249,074, respectively, and land use
rights owned by the Company of $21,024,087 and $21,020,381, respectively.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
At March 31, 2012 and
December 31, 2011, the Company had an outstanding long-term bank loan of $602,311 and $618,030, respectively. The long-term bank
loan bears interest at 2.50% per annum, is due December 31, 2021, and is secured by property, plant, and equipment with a
net book value of $1,253,844 at March 31, 2012.
NOTE 12 – CONVERTIBLE NOTES
On July 15, 2008 the
Company issued $115,000,000, 5% unsecured senior convertible notes (the “Notes”), due July 15, 2015, for net proceeds
of $110,358,550. The Notes are in default, which was caused by the delisting of the Company’s common stock by the New York
Stock Exchange (“NYSE”) as described in the Form 25NSE filed on April 16, 2012 by the NYSE; and by the non-payment
of the semiannual interest payment due on July 15, 2012 and January 15, 2013.
The Notes are convertible,
at the option of the holder, at an initial conversion price of $9.29 per share, adjusted to $8.08 on January 15, 2009. The
conversion rate is subject to certain adjustments. Holders may require the Company to repurchase all or a portion of their Notes
on July 15, 2013 for cash at a price equal to 100% of the principal amount of the notes to be purchased, plus accrued and
unpaid interest, if any, up to, but excluding, the repurchase date.
The effective interest
rate of the Notes for the three months ended March 31, 2012 and 2011 was 5.94% and interest cost recognized for the three
months ended March 31, 2012 and 2011 was $1,356,250 and $1,437,500, respectively.
Note issuance costs
incurred by the Company were deferred and are recognized using the effective interest rate method over the term of the Notes. As
of March 31, 2012 and December 31, 2011, the unamortized portion of the deferred financing fees was $1,129,183 and $1,347,735,
respectively.
NOTE 13 – SHAREHOLDERS’
EQUITY
Common Stock Awards
During the three months
ended March 31, 2012 and 2011, the Company recorded selling, general and administrative expenses of $351,697 and $227,954, respectively,
of stock based compensation cost based on the vesting of the common stock awards granted to employees in prior periods. The total
fair value of the stock awards granted to employees at the respective grant dates was $5,665,538, of which the unrecognized portion
of $3,289,979 at March 31, 2012 is expected to be recognized following the straight-line method over the remaining weighted average
vesting period of 3.2 years.
During the three months
ended March 31, 2012 and 2011, the Company recorded research and development costs of $25,000 and $54,175, respectively, of stock
based compensation cost based on the vesting of the common stock awards granted to consultants in prior periods. The unamortized
value of $8,750 as of March 31, 2012 is expected to be recognized following the straight-line method over the remaining weighted
average vesting period of 0.3 years.
During the three months
ended March 31, 2012 and 2011, the Company recorded selling, general and administrative expenses of $53,250 and $84,500, respectively
of earned director share-based compensation. Independent directors earned common stock awards on a monthly basis, with grants
generally made in the following year for shares earned. Shares earned but not granted are reflected in “Common Stock to
be issued” on the accompanying condensed consolidated financial statements. During the three months ended March 31, 2012
and 2011, the Company did not issue any shares of common stock related to the director awards.
Stock options
The Company calculates
the estimated fair value of granted options on the grant date, using the Black-Scholes-Merton Option Pricing Model. During the
three months ended March 31, 2012 and 2011, the Company recorded selling, general and administrative expenses of $294,190 and $474,638,
respectively, of stock based compensation based on the vesting of options granted to employees in prior periods. The total fair
value of the options granted to employees at the respective grant dates was $9,194,987, of which the unrecognized portion of $1,214,877
is expected to be recognized following the straight-line method over the remaining weighted average vesting period of 0.9 years
as of March 31, 2012.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
The following table
summarizes the stock option activities of the Company:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
Activity
|
|
|
Exercise Price
|
|
Outstanding as of January 1, 2012
|
|
|
|
883,639
|
|
|
$
|
15.70
|
|
Granted
|
|
|
|
–
|
|
|
|
–
|
|
Exercised/ Cancelled/Forfeited
|
|
|
|
–
|
|
|
|
–
|
|
Outstanding as of March 31, 2012
|
|
|
|
883,639
|
|
|
|
15.70
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest as of March 31, 2012
|
|
|
|
883,639
|
|
|
|
|
|
The following table
summarizes information about stock options outstanding as of March 31, 2012:
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
|
|
Weighted
|
|
|
|
|
Average
|
|
Remaining
|
|
|
|
Average
|
|
|
Number of
|
|
Exercise
|
|
Contractual Life
|
|
Number of
|
|
Exercise
|
Range of Exercise Prices
|
|
Shares
|
|
Price
|
|
(in years)
|
|
Shares
|
|
Price
|
$17.08 - 21.48
|
|
416,350
|
|
$
|
20.04
|
|
5.17
|
|
333,080
|
|
$
|
20.04
|
$9.90 - 16.70
|
|
323,040
|
|
$
|
13.53
|
|
6.32
|
|
193,824
|
|
$
|
13.53
|
$8.02
|
|
144,249
|
|
$
|
8.02
|
|
6.79
|
|
57,700
|
|
$
|
8.02
|
|
|
883,639
|
|
|
|
|
|
|
584,604
|
|
|
|
Options granted have
no intrinsic value at the grant date and at the date of these financial statements as the exercise price of all vested and unvested
options was greater than the market price of the Company’s Common Stock.
The weighted average
value per share of the 883,639 options issued under the Company’s 2006 Plan is $10.41 per share.
Treasury Stock
During the three months
ended March 31, 2012, the Company repurchased 1,003,336 shares of its common stock at a total cost of $1,270,603 that were retired
in June 2012.
NOTE 14 – COMMITMENTS AND CONTINGENCIES
Commitments
As of March 31,
2012, the Company had entered into capital commitments for the manufacturing facilities under construction in the
People’s Republic of China. The capital commitments were $29,275,909, of which $22,477,168 was due within one year and
$6,798,741 was due between one and three years. In addition, the Company had research and development commitments of
$4,021,060 within one year and $nil after one year but within three years, and purchase commitments for Millettia of
$2,346,859 within one year and $4,441,820 after one year but within three years.
The Company also has
an unconditional purchase commitment in connection with the Millettia long-term supply contracts, which is not expected to be
harvested until after 2018 (See Note 5). The purchase amount will be based on fair value discounted at a pre-determined rate pursuant
to the long-term supply contracts. At March 31, 2012, the Company had a commitment to pay maintenance fees of approximately $111,000
(RMB 700,000) per year from 2013 to 2019 related to the XSB long-term supply contract.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
Legal proceedings
As of March 31, 2012
and December 31, 2011, the Company was subject to various legal proceedings and claims. Management continues to evaluate the lawsuit
discussed below and based on the stage of this proceeding, management is unable to reasonably estimate the likelihood of any loss
or the amount or range of any potential loss that could result from the litigation. Therefore, at March 31, 2012 and December
31, 2011, no accrual has been established for any potential loss in connection with this lawsuit. Should the Company fail to prevail
in any of these legal matters or should several of these legal matters be resolved against the Company in the same reporting period,
the operating results of a particular reporting period could be materially adversely affected.
On June 23, 2010, Haining
Zhang asserted breach of contract, fraudulent dealing, and breach of fiduciary duty claims against the Company and its Chief Executive
Officer, Shu Jun Liu (together “Defendants”). Zhang’s claims arose out of an alleged 2003 investment banking
advisory and consultant agreement, whereby Zhang allegedly arranged for the Company to receive an equity line of credit and was
allegedly given the exclusive right to arrange financing transactions for the Company for a period of one year. Zhang sought
damages for allegedly unpaid financing commission and advisory compensation in the amount of $2,410,000, plus interest and expenses.
On September 12, 2011, the District Court granted a motion by Defendants to dismiss Zhang’s claims as either barred by the
applicable statute of limitations or as failing to state a claim. Zhang filed a notice of appeal on October 11, 2011.
On April 23, 2013, the Second Circuit Court of Appeals affirmed the District Court’s dismissal of Zhang’s claims.
Although Zhang has 90 days from the date of the Second Circuit’s decision in which to seek an appeal to the United States
Supreme Court, the Company does not believe the Supreme Court would hear an appeal of Zhang’s case.
See Note 17 for a
description of additional legal proceedings against the Company initiated subsequent to March 31, 2012.
NOTE 15 – SEGMENT REPORTING
For the three months
ended March 31, 2012 and 2011, the Company’s segments were as follows:
|
|
Three Months Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
Manufacturing Segment
|
|
|
|
|
|
|
|
|
Revenue from pharmaceutical products
|
|
$
|
14,223,255
|
|
|
$
|
38,961,981
|
|
Revenue from nutraceutical products
|
|
|
1,925,252
|
|
|
|
9,785,800
|
|
Total manufacturing revenue
|
|
|
16,148,507
|
|
|
|
48,747,781
|
|
Cost of sales
|
|
|
9,283,679
|
|
|
|
23,835,153
|
|
Depreciation and amortization expense
|
|
|
1,562,214
|
|
|
|
1,309,671
|
|
Selling, general and administrative expenses, research
and development costs and advertising costs
|
|
|
16,213,137
|
|
|
|
15,012,588
|
|
Provision for reserves and doubtful accounts-manufacturing segment
|
|
|
666,136
|
|
|
|
–
|
|
Operating (loss) income of manufacturing segment
|
|
|
(11,576,659
|
)
|
|
|
7,004,715
|
|
Distribution Segment
|
|
|
|
|
|
|
|
|
Distribution revenue
|
|
|
9,596,769
|
|
|
|
3,254,329
|
|
Cost of sales
|
|
|
8,779,775
|
|
|
|
3,091,047
|
|
Depreciation and amortization expense-distribution segment
|
|
|
49,341
|
|
|
|
24,872
|
|
Provision for reserves and doubtful accounts-distribution segment
|
|
|
–
|
|
|
|
–
|
|
Operating (loss) income of distribution segment
|
|
|
(58,182
|
)
|
|
|
65,916
|
|
|
|
|
|
|
|
|
|
|
Reconciliation to Consolidated Net Income Attributable to Controlling Interest:
|
|
|
|
|
|
|
|
|
Net (loss) income for reportable segments
|
|
|
(11,634,841
|
)
|
|
|
7,070,631
|
|
Net loss for non segment subsidiaries
|
|
|
(5,522,084
|
)
|
|
|
(6,258,577
|
)
|
Consolidated Net (Loss) Income Attributable to
Controlling Interest
|
|
$
|
(17,156,925
|
)
|
|
$
|
812,054
|
|
All operating revenues
comprise amounts received from external third party customers. All of the Company’s operations are located in the PRC.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
As of March 31, 2012 and December 31, 2011,
total assets of the manufacturing and distribution segments are as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Manufacturing
|
|
$
|
339,257,771
|
|
|
$
|
396,854,361
|
|
Distribution
|
|
|
18,729,677
|
|
|
|
51,672,762
|
|
Corporate
|
|
|
191,879,595
|
|
|
|
116,453,934
|
|
Total assets
|
|
$
|
549,867,043
|
|
|
$
|
564,981,057
|
|
NOTE 16 – INCOME TAX
The provisions for
income taxes for the three months ended March 31, 2012 and 2011 are summarized as follows:
|
|
Three Months Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
Current tax provision-PRC
|
|
$
|
378,556
|
|
|
$
|
3,241,467
|
|
Deferred taxes-PRC
|
|
|
64,512
|
|
|
|
(116,612
|
)
|
Total provision for income taxes
|
|
$
|
443,068
|
|
|
$
|
3,124,855
|
|
The reconciliation
of tax computed by applying the statutory income tax rate applicable to the PRC operations to income tax expenses was as follows:
|
|
Three Months Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
Income tax (benefit) provision at PRC statutory tax rate of 25%
|
|
$
|
(4,185,923
|
)
|
|
$
|
983,476
|
|
Preferential PRC tax rate of 10%
|
|
|
1,124,653
|
|
|
|
47,796
|
|
Effect of different tax rates on non-PRC operations
|
|
|
572,665
|
|
|
|
624,983
|
|
Non-recognition of income tax benefit for current period losses
|
|
|
1,950,513
|
|
|
|
882,806
|
|
Provision for taxes on deemed interest income
|
|
|
364,925
|
|
|
|
473,106
|
|
Non-deductible expenses in current period
|
|
|
165,480
|
|
|
|
–
|
|
Other permanent differences
|
|
|
450,755
|
|
|
|
112,688
|
|
Total provision for income taxes
|
|
$
|
443,068
|
|
|
$
|
3,124,855
|
|
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
The tax effects of temporary differences
that give rise to the Company’s net deferred tax liabilities as of March 31, 2012 and December 31, 2011 were as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
Provision for doubtful accounts receivable
|
|
$
|
985,786
|
|
|
$
|
2,751,092
|
|
Expenses not deductible in current period
|
|
|
2,260,804
|
|
|
|
474,711
|
|
Total current deferred tax assets
|
|
|
3,246,590
|
|
|
|
3,225,803
|
|
Non-current
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
41,891
|
|
|
|
79,151
|
|
Impairment of fixed assets
|
|
|
221,697
|
|
|
|
183,958
|
|
Total non-current deferred tax assets
|
|
|
263,588
|
|
|
|
263,109
|
|
Total deferred tax assets
|
|
|
3,510,178
|
|
|
|
3,488,912
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
Excess accrual of welfare
|
|
|
(63,783
|
)
|
|
|
(63,382
|
)
|
Other
|
|
|
–
|
|
|
|
(26,688
|
)
|
Total current deferred tax liabilities
|
|
|
(63,783
|
)
|
|
|
(90,070
|
)
|
Non-current
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
(7,193,047
|
)
|
|
|
(948,322
|
)
|
Depreciation
|
|
|
(431,962
|
)
|
|
|
(128,771
|
)
|
Step up of acquired assets
|
|
|
(7,059,548
|
)
|
|
|
(13,495,399
|
)
|
Total non-current deferred tax liabilities
|
|
|
(14,684,557
|
)
|
|
|
(14,572,492
|
)
|
Total deferred tax liabilities
|
|
|
(14,748,340
|
)
|
|
|
(14,662,562
|
)
|
Net deferred tax liabilities
|
|
$
|
(11,238,162
|
)
|
|
$
|
(11,173,650
|
)
|
The Company has not
recorded a provision for U.S. federal income tax for the three months ended March 31, 2012 and 2011 due to the cumulative tax net
operating losses in the United States. As of March 31, 2012, the Company had net operating tax losses carried forward of approximately
$44,000,000, $29,000,000 and $8,000,000 in the U.S., PRC, and Hong Kong, respectively. Those losses carried forward in the U.S.
expire between years 2025 and 2030, and in the PRC expire between years 2015 and 2018. Losses incurred in Hong Kong are carried
forward indefinitely. In the PRC and Hong Kong the subsidiaries with loss carryforwards are taxed on a separate return basis and
the Company has determined all amounts should have full valuation allowances. At March 31, 2012, the tax benefit of the loss carryforwards
had not been recorded and therefore is not presented in the table above.
The Company’s PRC subsidiaries that
are deemed “high technology” enterprises are subject to preferred tax rates (tax holiday). The table below shows the
effect of using the higher rates and earnings per share.
|
|
Three Months Ended March 31,
|
|
|
|
2012
|
|
|
2011
|
|
Income (loss) per common share-basic
|
|
$
|
(0.43
|
)
|
|
$
|
0.02
|
|
Effect of tax holiday
|
|
|
(0.00
|
)
|
|
|
0.00
|
|
Pro forma income (loss) per common share-basic
|
|
$
|
(0.43
|
)
|
|
$
|
0.02
|
|
Accrued Taxes
Effective January
1, 2007, the Company adopted guidance for accounting for uncertainty in income taxes which prescribes a more-likely-than-not threshold
for financial statement recognition and measurement of a tax position taken in the tax return. As of March 31, 2012, the Company
has recorded an accrued tax of $9,429,412 mainly related to tax positions associated with deemed interest on non-trade intercompany
transactions. It is possible that the amount accrued will change in the next 12 months; however, an estimate of the range of the
possible change cannot be made at this time. The accrued taxes, if ultimately recognized will impact the effective tax rate.
The Company has various
open tax years between 2006 and 2011 in its significant operating jurisdictions.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
All of the Company’s
operations are conducted in the PRC. At
March 31, 2012
, the Company’s unremitted foreign
earnings of its PRC subsidiaries totaled approximately $191 million and the Company held approximately
$59.2
million
of cash and cash equivalents in the PRC. These unremitted earnings are planned to be reinvested indefinitely
into the operations of the Company in the PRC. While repatriation of some cash held in the PRC may be restricted by local
PRC laws, most of the Company's foreign cash balances could be repatriated to the United States but, under current U.S. income
tax laws, could be subject to U.S. federal income taxes less applicable foreign tax credits. Determination of the amount
of unrecognized deferred U.S. income tax liability on the unremitted earnings is not practicable because of the complexities associated
with this hypothetical calculation, and as the Company does not plan to repatriate any cash in the PRC to the United States, no
deferred tax liability has not been accrued for cash to be repatriated.
NOTE 17 – SUBSEQUENT EVENTS
On June 22, 2012, a
putative class action complaint was filed by Kevin McGee against American Oriental Bioengineering Inc., Eileen Brody, Binsheng
Li, Yangchun Li, Tony Liu, Cosimo Patti, Xianmin Wang, and Lawrence Wizel alleging violations of Section 10b of the Securities
Exchange Act of 1934 and liability pursuant to Section 20(a) thereunder. The complaint, as subsequently amended (see below) centers
on the accounting treatment of the sale of an interest held by the Company’s subsidiary, Nuo Hua Investment Company Limited
and the Company’s Restatement filed on November 14, 2011. Several motions were filed for appointment as lead plaintiff, and
on October 16, 2012, the Court appointed lead plaintiff, consolidated the cases, and ordered that a consolidated complaint be filed,
which occurred on November 19, 2012. The served defendants (AOB, Brody, Wizel and Patti) moved to dismiss the consolidated complaint,
and on March 25, 2013 those motions were granted with leave to amend. On April 15, 2013, Plaintiffs filed a Second Amended Complaint,
which the served Defendants moved to dismiss on May 15, 2013. In the interim, the Court granted Plaintiffs’ motion for leave
to serve most of the remaining Defendants by alternative means, and on May 15, 2013, the parties entered into a stipulation consenting
to the filing of a Third Amended Complaint (“TAC,” setting forth no new paragraphs), deeming the TAC served on all
defendants, deeming the motion to dismiss the Second Amended Complaint interposed against the TAC, and reserving all rights of
the un-served Defendants.
On October 1, 2012,
Peter Barbato filed a shareholder derivative Complaint against Tony Liu, Yanchun Li, Binsheng Li, Lawrence Wizel, Cosimo Patti,
Xianmin Wang, Eileen Brody, Jun Min, and Baiqing Zhang (collectively, “Defendants”), and the Company as a nominal Defendant.
The Complaint asserts causes of action for Breach of Fiduciary Duty and Unjust Enrichment. These claims similarly arise out
of alleged accounting errors that were made the Company’s financial statements for in the periods between the third quarters
ending September 30, 2009 and September 30, 2011, which were filed with the SEC. The alleged accounting errors were related
to the Company’s sale of an interest held by the Company’s subsidiary, Nuo Hua Investment Company Limited, and were
disclosed in the Company’s Restatement filed on November 14, 2011. The Complaint also alleges that its claims arise
out of alleged inconsistencies that the Company’s then auditor, Ernst and Young Hua Ming, discovered throughout the course
of the Company’s audit for the year ending 2011. The Parties have agreed that Defendants need not respond to the complaint
until motions to dismiss the class action Complaint filed against the Company in the Central District of California are resolved.
On December 6, 2012,
David Bravetti filed a shareholder derivative Complaint against Tony Liu, Yanchun Li, Binsheng Li, Jun Min, Lawrence Wizel, Cosimo
Patti, Xianmin Wang, Baiqing Zhang, Eileen Brody (collectively, “Defendants”). Because the complaint sets forth a shareholder
derivative claim, the Company is named as a nominal Defendant, although no relief is sought for the Company and any relief obtained
from the Defendants would inure to the benefit of the Company. The Complaint asserts causes of action for breach of fiduciary
duty, waste of corporate assets, and unjust enrichment. Bravetti’s claims arose out of alleged accounting errors that
were made in the Company’s financial statements for the periods between the third quarters ending September 30, 2009 and
September 30, 2011, which financial statements were included in filings made with the SEC. The alleged accounting errors
were related to the Company’s sale of an interest held by the Company’s subsidiary, Nuo Hua Investment Company Limited
and were disclosed in the Company’s Restatement filed on November 14, 2011. The Complaint also alleges that its claims
arise out of alleged inconsistencies that the Company’s then auditor, Ernst and Young Hua Ming, discovered throughout the
course of the Company’s audit for the year ending 2011. Although the Complaint claims that jurisdiction is proper in
federal court in New Jersey because of diversity of citizenship, according to the Complaint, Bravetti is a New Jersey citizen,
as is one of the Defendants. The Company did not file a responsive pleading to Bravetti’s Complaint, and subsequent to seeking
and obtaining a default against the Company, Bravetti agreed to dismiss his claim and file elsewhere. Subsequently, however, Bravetti
“corrected” his complaint now to claim to be a Florida citizen. On March 26, 2013, Bravetti undertook to provide Defendants
proof of his citizenship. That proof has been provided, and Defendants have not come to a conclusion whether this was sufficient.
On February 19, 2013,
the Company received a notice of acceleration under the terms of the Company’s 5.00% Convertible Senior Notes due 2015 (the
“Senior Notes”) issued pursuant to an Indenture, dated as of July 15, 2008, between the Company and Wells Fargo Bank,
National Association, as Indenture Trustee (the “Indenture”). The notice was sent by certain holders of the Senior
Notes that together hold more than 25% of the aggregate principal amount of the Senior Notes. The notice states that the default
is the result of the Company’s failure to (A) pay to the holders under the terms of the Indenture accrued interest due and
payable on each of July 16, 2012 and January 15,2013, which failure to pay continued for a period of thirty (30) days after July
16, 2012 and January 15, 2013, respectively, and (B) provide, pursuant to the terms of the Indenture, a notice of the termination
of trading and delisting of the Company’s common stock by the New York Stock Exchange. As of March 4, 2013, the aggregate
principal amount of the Senior Notes, and unpaid, but accrued interest was $53,010,424. The notice of acceleration resulted in
the principal amount of the Senior Convertible Notes plus accrued and all unpaid interest and accrued and unpaid Additional Interest
(as defined in the Indenture) on the Notes through February 19, 2013, to become immediately due and payable.
AMERICAN ORIENTAL BIOENGINEERING, INC.
AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2012 AND
2011
On April 8, 2013, four
of the holders of the Company’s 5% senior convertible notes issued July 15, 2008 (the “Notes”) filed this action
claiming a default under the Notes, which allegedly resulted in an acceleration of the maturity of the Notes. The Plaintiffs had
previously commenced a similar action in federal court in New Jersey, but that action was withdrawn and the present action was
interposed. The action seeks payment of $20,378,608 plus prejudgment interest and other fees and costs. The Company has been served
with the complaint, and Plaintiffs agreed to extend the Company’s time to answer. When that time passed on June 3, 2013,
Plaintiffs refused to grant additional time and have now made a motion seeking entry of a default. The Company filed its answer
on June 5, 2013.