Universe Pharmaceuticals(UPC) - 2022 Q4 - Annual Report

PART I Item 3. Key Information This section outlines significant investment risks, including business and industry challenges, operational risks in China, and risks related to the company's ordinary shares Risk Factors The company faces substantial risks across its business, China operations, and publicly traded shares, including supply chain reliance, regulatory uncertainties, and potential delisting - Key business risks include price increases in raw materials, reliance on a complex supply chain, and operating in a highly competitive industry[13][19][25] - The company faces significant risks related to doing business in China, including potential government intervention, uncertainties in the legal system, and the possibility of delisting under the Holding Foreign Companies Accountable Act (HFCA Act) if the PCAOB cannot inspect its auditors[15][72][76] - The company's auditor is headquartered in California and has not been inspected by the PCAOB, but is expected to be inspected on a regular basis, and is not subject to the PCAOB's December 2021 determination regarding firms in China and Hong Kong[78][82] - Risks related to the company's ordinary shares include significant price volatility and a potential delisting from Nasdaq, though it regained compliance with the minimum bid price requirement in November 2022 after a July 2022 notification[18][170][171] - The company is a 'controlled company' as its CEO, Mr. Gang Lai, holds more than 50% of the voting power, allowing reliance on exemptions from certain corporate governance requirements[178] - A material weakness in internal control over financial reporting was identified as of September 30, 2022, related to a lack of accounting staff with appropriate knowledge of U.S. GAAP and SEC reporting requirements[191] Item 4. Information on the Company This section details the company's history, corporate structure, and business operations, focusing on its PRC subsidiaries' manufacturing and distribution of Traditional Chinese Medicine Derivatives History and Development of the Company Universe Pharmaceuticals INC is a Cayman Islands holding company operating solely through PRC subsidiaries, facing significant legal and operational risks in China, with limited cash transfers to the holding company and dividend restrictions - The company is a Cayman Islands holding company with no operations of its own; all business is conducted by its PRC subsidiaries, and it does not utilize a VIE structure[208] - For the year ended September 30, 2022, the Cayman holding company received a cash transfer of $303,746 from its Hong Kong subsidiary for director compensation and professional fees, with no dividends or distributions from PRC subsidiaries[214] - The company's ability to pay dividends is restricted by PRC regulations, which require PRC subsidiaries to set aside at least 10% of after-tax profits into a statutory reserve until it reaches 50% of registered capital, and these reserves are not distributable as cash dividends[216][115] Business Overview The company manufactures and distributes 13 Traditional Chinese Medicine Derivative (TCMD) products, with Guben Yanling Pill as its signature product, and also distributes approximately 2,785 third-party medical products across China - The company manufactures 13 types of TCMD products, categorized as chronic condition treatments and cold/flu medications, and also distributes around 2,785 third-party products, including biomedical drugs and medical instruments[231][233] Revenue Contribution by Product Type (FY2020-2022) | Product Category | FY2022 Revenue Share | FY2021 Revenue Share | FY2020 Revenue Share | | :--- | :--- | :--- | :--- | | Guben Yanling Pill | 42.5% | 40.3% | 38.2% | | Other Manufactured Products | 17.3% | 21.3% | 21.6% | | Third-Party Products | 40.2% | 38.4% | 40.2% | - The company's customer base decreased slightly from 2,708 as of Sep 30, 2021, to 2,651 as of Sep 30, 2022, due to delivery issues caused by COVID-19 resurgence[234][265] - Key growth strategies include building a strong national brand image for 'Bai Nian Dan (百年丹)', enhancing the distribution network, integrating manufacturing capabilities, and growing R&D capacity for products targeting the elderly[242][243][244][245] - As of September 30, 2022, the company had 224 employees, with the largest departments being Manufacturing (38%) and Marketing (25%)[280][281] Item 5. Operating and Financial Review and Prospects This section analyzes the company's financial performance, noting a significant revenue decrease and net loss in FY2022 due to increased selling expenses, contrasting with strong growth in FY2021, while assessing liquidity for future capital commitments Operating Results The company experienced a significant downturn in FY2022, with revenue falling 16.3% and a net loss of $8.7 million due to a massive increase in advertising expenses, contrasting sharply with FY2021's 56.3% revenue growth and $11.3 million net income Consolidated Results of Operations (FY2022 vs FY2021) | Metric | FY 2022 | FY 2021 | Change (%) | | :--- | :--- | :--- | :--- | | Revenue | $40,143,151 | $47,982,031 | (16.3)% | | Gross Profit | $21,891,336 | $25,326,177 | (13.6)% | | Gross Margin | 54.5% | 52.8% | +1.7 p.p. | | Operating Expenses | $29,330,134 | $11,736,037 | 149.9% | | Net (Loss) Income | $(8,736,566) | $11,319,952 | (177.2)% | - The decrease in FY2022 revenue was driven by a 37.2% drop in sales volume of self-manufactured TCMD products due to COVID-19 disruptions, partially offset by a 29.1% increase in their average selling price[365][380][382] - Selling expenses surged by 541.8% in FY2022 to $19.1 million, primarily due to a $16.2 million increase in advertising expenses related to new TV and media campaigns[400] - Research and development expenses increased by 39.9% in FY2022 to $7.6 million, mainly for the development and testing of eight new Chinese medicine products[404] Consolidated Results of Operations (FY2021 vs FY2020) | Metric | FY 2021 | FY 2020 | Change (%) | | :--- | :--- | :--- | :--- | | Revenue | $47,982,031 | $30,703,960 | 56.3% | | Gross Profit | $25,326,177 | $14,093,820 | 79.7% | | Gross Margin | 52.8% | 45.9% | +6.9 p.p. | | Operating Expenses | $11,736,037 | $3,842,095 | 205.5% | | Net Income | $11,319,952 | $7,558,222 | 49.8% | - The 56.3% revenue growth in FY2021 was driven by a 22.6% increase in customers, higher sales volume of TCMD products, and significant price increases for both self-manufactured (46.3%) and third-party (79.6%) products[412][366] Liquidity and Capital Resources As of September 30, 2022, the company had $28.4 million in working capital, deemed sufficient for short-term needs, despite significant future capital commitments for construction and a potential acquisition, with net cash used in operating activities improving to $1.3 million Cash Flow Summary (FY2020-2022) | Cash Flow Activity | FY 2022 | FY 2021 | FY 2020 | | :--- | :--- | :--- | :--- | | Operating Activities | $(1,312,346) | $(2,055,847) | $6,115,157 | | Investing Activities | $(3,908,105) | $(27,059,958) | $(51,798) | | Financing Activities | $3,317,943 | $26,581,809 | $470,136 | | Net Change in Cash | $(2,366,450) | $(1,980,294) | $6,880,881 | - As of September 30, 2022, the company had $5.7 million in cash and $13.1 million in liquid short-term investments, with a total working capital of $28.4 million[445][451] - The company has significant capital commitments, including an estimated $13.5 million remaining for a construction-in-progress (CIP) project expected to be completed in December 2024, and a $10.1 million letter of intent for a 51% equity acquisition of Yunnan Faxi[447][450][472] - Net cash used in operating activities in FY2022 was $1.3 million, primarily due to a net loss of $8.7 million, offset by non-cash charges and a $7.4 million decrease in prepaid advertising[454][455] - Net cash used in investing activities in FY2021 was $27.1 million, largely due to the purchase of $15.3 million in short-term investments and $10.6 million in prepayments for the CIP project[462] - Net cash from financing activities in FY2021 was $26.6 million, primarily from the $25.6 million net proceeds of its IPO[463][464] Item 6. Directors, Senior Management and Employees This section provides information on the company's leadership and governance, including its five-member board with three independent directors, CEO Gang Lai's controlling shareholder status, and aggregate executive compensation - The board of directors consists of five members: Gang Lai (Chairman & CEO), Lin Yang (CFO & Director), and three independent directors (Jiawen Pang, H. David Sherman, Ding Zheng)[501][502][503] - The company is a 'controlled company' under Nasdaq rules because CEO Gang Lai beneficially owns approximately 57.38% of the aggregate voting power[512][534] - Aggregate compensation paid to executive officers and directors for the fiscal year ended September 30, 2022, was $121,000[514] - The company has established an Audit Committee, a Compensation Committee, and a Nominating and Corporate Governance Committee, each composed of the three independent directors[517][518][519] Item 7. Major Shareholders and Related Party Transactions This section details CEO Gang Lai's controlling shareholder status and significant related party transactions, including working capital advances, loan guarantees, and a property purchase prepayment from an entity previously linked to the CEO - Mr. Gang Lai is the controlling shareholder, beneficially owning 12,480,000 ordinary shares, which represents 57.38% of the voting power[534][535] - As of September 30, 2022, the company had a balance of $3,379,263 due to related parties, primarily consisting of non-interest-bearing working capital advances from CEO Mr. Gang Lai[539] - In May 2021, the company entered an agreement to purchase property from Jiangxi Yueshang, an entity in which CEO Mr. Gang Lai owned a 5% interest, making a prepayment of RMB 16 million (approx. $2.25 million), with Mr. Lai divesting his interest in January 2022[540][541] - The company's controlling shareholder, Mr. Gang Lai, and other related parties have provided personal and corporate guarantees for the company's bank loans[542] Item 8. Financial Information This section confirms no material legal proceedings and outlines the company's dividend policy, which currently involves no payouts due to a focus on business expansion and significant PRC regulatory restrictions on profit repatriation - The company has not declared or paid any dividends since its IPO and does not plan to in the foreseeable future, intending to retain earnings for business expansion[546] - The ability to pay dividends is heavily restricted by PRC regulations, which only permit dividends to be paid out of accumulated profits determined under Chinese accounting standards and require setting aside funds for a statutory reserve[549] - The PRC government imposes controls on the conversion of RMB into foreign currencies and remittance out of China, which could hinder the company's ability to pay dividends to foreign shareholders[550] Item 10. Additional Information This section details the company's share capital structure, memorandum and articles of association, and a comprehensive overview of tax implications in the PRC, Hong Kong, and the United States, including potential PFIC status for U.S. investors - The company's authorized share capital is $312,500, divided into 90,000,000 ordinary shares and 10,000,000 preferred shares, with a par value of $0.003125 per share[562] - Under PRC's Enterprise Income Tax (EIT) Law, the company's PRC subsidiaries are generally subject to a 25% tax rate, but key subsidiaries Jiangxi Universe and Universe Trade qualify as High and New Technology Enterprises (HNTEs) and enjoy a reduced rate of 15%[845][343] - Dividends paid from PRC subsidiaries to the Hong Kong holding company are subject to a 10% withholding tax, which may be reduced to 5% under the China-Hong Kong tax treaty if certain conditions are met[624] - The company believes it is not currently a Passive Foreign Investment Company (PFIC) for U.S. federal income tax purposes, but its status is determined annually and could change depending on the composition of its income and assets, as well as its market capitalization[643][185] Item 11. Quantitative and Qualitative Disclosures About Market Risk The company is exposed to foreign exchange risk due to RMB-denominated revenues and USD-quoted shares, with a hypothetical 10% USD depreciation impacting cash by RMB 4.05 million, alongside credit and interest rate risks - The company's primary market risk is foreign exchange risk, as revenues are denominated in RMB while financial statements are reported in USD, and the RMB is not freely convertible[661] - As of September 30, 2022, the company held US$5.7 million in USD-denominated cash; a hypothetical 10% depreciation of the USD against the RMB would result in a decrease of RMB 4.05 million in cash[663] - The company is exposed to credit risk from its unsecured accounts receivable, which it mitigates through creditworthiness assessments and monitoring[664] PART II Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds This section details the use of the company's March 2021 IPO net proceeds of $25.6 million, with approximately $9.5 million allocated to R&D, manufacturing upgrades, and brand marketing as of September 30, 2022 - The company's IPO in March 2021 raised net proceeds of approximately $25.6 million[672] Use of IPO Proceeds as of September 30, 2022 | Use Category | Amount Used (Approx.) | | :--- | :--- | | Research and Development | $3.2 million | | Upgrading Manufacturing Facilities | $3.4 million | | Brand Marketing | $2.9 million | Item 15. Controls and Procedures Management concluded that as of September 30, 2022, the company's disclosure controls and procedures were ineffective due to a material weakness in internal control over financial reporting, stemming from a lack of adequately knowledgeable accounting staff - Management concluded that disclosure controls and procedures were ineffective as of September 30, 2022[673] - A material weakness was identified in internal control over financial reporting due to a lack of accounting staff with adequate U.S. GAAP and SEC reporting knowledge[676] - The company's remediation plan includes recruiting qualified accounting personnel, implementing U.S. GAAP training, and setting up an internal audit function[677] Item 16. Corporate Governance and Accountant Services This section covers corporate governance, including the audit committee financial expert, code of ethics, principal accountant fees, and the December 2021 change in certifying accountant, noting the company's adherence to Cayman Islands home country practices as a foreign private issuer - Mr. H. David Sherman is designated as the 'audit committee financial expert'[680] Principal Accountant Fees (YCM CPA INC.) | Fee Category | FY 2022 | FY 2021 | | :--- | :--- | :--- | | Audit fees | $210,000 | $200,000 | | Audit-related fees | - | - | | Tax fees | - | - | | All other fees | - | - | | Total | $210,000 | $200,000 | - On December 7, 2021, the company appointed YCM CPA INC. as its independent registered public accounting firm, replacing Friedman LLP, a change not due to any disagreement on accounting principles or practices[687] - As a foreign private issuer, the company follows its home country (Cayman Islands) practice in lieu of certain Nasdaq corporate governance standards, such as the requirement for shareholder approval for certain equity issuances[690][691] PART III Item 18. Financial Statements This section presents the audited consolidated financial statements for Universe Pharmaceuticals INC. and its subsidiaries for fiscal years 2020-2022, including balance sheets, income statements, cash flow statements, and accompanying notes, along with independent auditor reports Consolidated Balance Sheet Highlights | Metric | As of Sep 30, 2022 | As of Sep 30, 2021 | | :--- | :--- | :--- | | Total Assets | $59,539,875 | $70,144,781 | | Total Current Assets | $41,505,680 | $50,481,064 | | Total Liabilities | $13,097,552 | $11,210,428 | | Total Current Liabilities | $13,097,552 | $11,210,428 | | Total Shareholders' Equity | $46,442,323 | $58,934,353 | Consolidated Income Statement Highlights | Metric | FY 2022 | FY 2021 | FY 2020 | | :--- | :--- | :--- | :--- | | Revenue | $40,143,151 | $47,982,031 | $30,703,960 | | Gross Profit | $21,891,336 | $25,326,177 | $14,093,820 | | Income from Operations | $(7,438,798) | $13,590,140 | $10,251,725 | | Net (Loss) Income | $(8,736,566) | $11,319,952 | $7,558,222 | | EPS (Basic & Diluted) | $(0.40) | $0.60 | $0.47 | Consolidated Cash Flow Highlights | Metric | FY 2022 | FY 2021 | FY 2020 | | :--- | :--- | :--- | :--- | | Net Cash from Operations | $(1,312,346) | $(2,055,847) | $6,115,157 | | Net Cash from Investing | $(3,908,105) | $(27,059,958) | $(51,798) | | Net Cash from Financing | $3,317,943 | $26,581,809 | $470,136 | | Cash at End of Year | $5,711,458 | $8,077,908 | $10,058,202 |