Lotus Pharmaceuticals Responds to Investor Concerns in Exclusive Interview

A full transcript of the interview is below:

Q: First, congratulations on the Company's recent quarterly and fiscal year-end results. Lotus has been executing well, with solid double-digit growth in both its retail and wholesale segments. Presently, the Company's focus appears to be on completing the construction of your new headquarters in Beijing. You mentioned that construction may be delayed till year's end, an additional six months from your earlier guidance. Do you expect to meet the new deadline?

A: Yes. I recently visited the site and spoke with the builder. He believes they will still meet the June 2011 deadline, but to my untrained eye, there appears to be a fair amount of work that still needs to be done. After discussing with the management team, we decided to extend the timeline by six months to ensure the quality of the facility and buffer any unforeseeable delays. I thought it prudent to inform shareholders that an extra six months may be needed. We prefer to be conservative when providing timelines.

Q: For the benefit of those reading this interview, please clarify why the new Lotus headquarters is so important to the future of the Company.

A: The primary reason is that it provides us with the opportunity to market to hospitals in Beijing. Pharmaceutical companies are required to maintain warehousing facilities large enough to guarantee shipment on designated dates. The current minimum size requirement is 5,000 square meters. Once our new building is operational, we will meet the requirement and can enter the bidding for hospitals in the Beijing area.

Please note that over 70% of our 2010 revenue came from our wholesale division, and this was without selling to Beijing hospitals. At the same time, we estimate that pharmaceutical sales in Beijing will account for two-thirds of our total sales in northern China, or approximately one-third of our total domestic sales in 2011. So the opportunity is significant for Lotus.

Q: In 2008, Lotus paid $32.6 million to acquire property in Mongolia, which is about a two-hour drive from Beijing, to build your headquarters. Shortly thereafter, Lotus received permission to upgrade its manufacturing facility in Beijing. Chairman Liu and the board decided the new building in Beijing makes more sense due to its closer proximity to your target hospitals, which I agree. On the March 30 earnings call, some of your shareholders requested Chairman Liu sell the property in Mongolia, using the proceeds to buy back stock and concentrate on selling higher-margin pharmaceutical products. Can you provide us with the estimated value of that property today and the main reason Lotus has decided not to sell, but to develop 10% of the property?

A: We recently spoke with the local Land Resource and Trade Center and estimate the property's value at $60 million to $80 million. When we invested in the land in Inner Mongolia, we received a favorable tax benefit with the first 8-year full exemption and the second 8-year half exemption. Lotus received tax breaks of $5 million in 2009 and $6 million in 2010. As a return, we are obliged to make a further investment in this property. We plan to use approximately 10% of the land, or approximately 100 square meters, to build a pharmaceutical distribution center serving primarily the five northwestern provinces in China. We are negotiating with several potential collaborators to share the cost of building the distribution center and receive rights to develop the other 90% of the land as payment. By doing this, we can preserve the tax breaks. Alternately, we could sell 90% of the property outright and use the sales proceeds to pay for the distribution center. No matter which transaction we decide to pursue, we intend to coordinate with related parties to ensure that we will continue to enjoy the tax break with the transaction.

Q: You wrote off the $6.2 million used to improve the Mongolian property this quarter. Why not sell and take the gross profit of approximately $20 million to $40 million [not including the tax benefit for 2009-10]?

A: The value of building a distribution center in Mongolia is clear: to serve as a base for our continued sales growth into the five northwestern provinces, which remain underdeveloped and will be a major contributor to China's growth in the coming years. In addition, as mentioned above, the tax advantages amounted to $11 million in the last two years and will extend to 2024. Furthermore, the land purchase came with an obligation to develop this site. To put all this together, we believe it makes sense to implement our plan instead of pocketing the short-term gain.

Q:  With China's central bank raising interest rates for the sixth time this year, coupled with increased reserve rate requirements to cool both inflation and the real estate market, are you concerned that the value of the property will fall and potentially reduce your profit on the Mongolian land, or that Lotus may be unable to sell the property?

A: Let me be clear: we did not obtain the land in Mongolia for a land trade. Both projects, Beijing and Inner Mongolia, were undertaken after considerable thought. We are in discussions with several potential collaborators for the Inner Mongolia land and will provide cost information and start and completion date estimates once we complete the process.

Q: Companies listed in the U.S. referred to as "China reverse mergers" have been under considerable pressure lately. A number of small-cap Chinese companies have had their stock halted from trading due to concerns about the alleged overstatement of their revenue and earnings. How are you different from these companies? 

A: We are comfortable with our financial reporting. In preparation to uplist to a senior exchange, we have strengthened our required internal control measures, including the audit committee and independent directors. Additionally, we have a good working relationship with our auditing firm, Friedman LLP. Friedman has been operating for over 85 years and has offices in both the U.S. and Beijing, so its auditing and accounting staff is thoroughly familiar with U.S. and Chinese regulatory requirements.

Q: One of the drugs being developed by Lotus, R-bambuterol, is currently in clinical trials. You mentioned that controlled-release gliclazide and isosorbide mononitrate are waiting for SFDA approval to start clinical trials, yet will only require one phase of clinical trials. Please give us some sense of the R&D costs associated with bringing three drugs to market during the 2013-2014 period.

A: Our lead candidate in the pipeline, R-bambuterol for asthma, is currently in Phase I trials, and we expect Phase I data this quarter. R-bambuterol is a Class 1 new drug and will therefore need to go through Phase I to III clinical trials before we can submit the application for approval to the SFDA. We estimate the total clinical trial cost will be approximately RMB 50 million, or roughly $8 million. Controlled-release gliclazide for diabetes and isosorbide mononitrate for cardiovascular indications are currently awaiting approval to start clinical trials, but the approval will come after our manufacturing facility becomes functional. These two candidates will only need to run one trial each for regulatory approval, as they are branded generics. We estimate the clinical trial cost for those two candidates will be RMB 10 million, or roughly $1.5 million.

Q: With clinical trials for R-bambuterol estimated to cost $8 million, two other drugs in development, and two building projects underway in Beijing and Mongolia, is there any concern that Lotus has taken on too much at one time? Also, please tell us about financial provisions taken to provide for unexpected cost overruns with clinical trials or construction in Beijing and Mongolia, or both.

A: Those projects are part of our growth plan, and frankly we do not have the resources to take them all on at the same time. Our plan is to work on them one or two at a time, so the expense will be spread out over the years. This year, our focus is on completing the construction of our Beijing facility. After that, we will focus our resources on building our pipeline. As for the project in Inner Mongolia, we plan to fund it through the sale of our land assets there.

Q: With the addition of an OTC sales team as well as a new sales manager, Jinzhong Han, and the Beijing and Mongolian facilities coming online soon, are there plans to increase sales distribution of foreign drugs, acting as a broker? If so, are there plans to further leverage your sales force to sell third-party medical devices?

A: After we complete the construction in Beijing, we will focus on two things: first, to establish and improve our sales platform to Beijing hospitals. With a new and modern storage warehouse, we will be well-positioned for this large market, but it will still take time to build relationships and grow our reputation in the new field. Second, we will continue to strengthen our pharmaceutical offerings, focusing on drugs for which we can obtain patent protection or exclusive rights. We believe as the industry evolves and matures, we will have to build our proprietary drug pipeline to stay competitive. On this front, we will actively seek new opportunities, including collaboration with foreign companies trying to expand in China and local companies with limited distribution, as well as in-licensing promising candidates or products.

Q. Please discuss your international sales plans for self-branded drugs.

A: That is in our growth plan as well, although it is more complicated as those drugs will need regulatory approval from equivalent foreign agencies. Our new manufacturing facility in the new corporate building is designed to comply with U.S. and European regulatory standards, so we will have the capability to manufacture and sell drugs internationally if we overcome the regulatory hurdle.

Q: When does Lotus expect to be uplisted to a senior exchange?

A: We are still working with a senior exchange for an uplisting. However, probably due to the recent shakeout in the Chinese small-cap sector, the senior exchange is taking more time to scrutinize applications these days. We have not yet received guidance from the senior exchange on the timeline.

Q: Is there any plan to switch to a Big 4 or Big 6 accounting firm in the near future?

A: We have no immediate plan to upgrade our auditor. As a small company with limited resources, we believe our current auditor, Friedman, meets our needs at this time. We understand the potential positive impact of an upgrade on investor confidence, but on the other hand, an upgrade will not change our fundamentals. If we continue to grow and someday our current auditor no longer meets our needs, we will make a change.

Additional Information

Dr. Shen presented on behalf of Lotus on April 20, 2011 at the RedChip Small-Cap Equities Virtual Conference. The full presentation is available for viewing here. For more information on Lotus Pharmaceuticals, please visit http://www.redchip.com.

About Lotus Pharmaceuticals, Inc.

Lotus Pharmaceuticals, Inc. is a fast-growing, profitable developer and producer of drugs and a licensed national seller of pharmaceutical items in the People's Republic of China (PRC). Lotus operates its business through its two controlled entities: Liang Fang Pharmaceutical, Ltd. and En Ze Jia Shi Pharmaceutical, Ltd. Lotus' current drug development is focused on the treatment of cerebro-cardiovascular diseases, asthma and diabetes. Liang Fang sells drugs directly and indirectly through its national sales channels to hospitals, clinics and drugs stores in 30 provinces of the PRC.

Information Regarding Forward-Looking Statements

Except for historical information contained herein, the statements in this press release are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause our actual results in future periods to differ materially from forecasted results. These risks and uncertainties include, among other things, product demand, market competition, and risks inherent in our operations. These and other risks are described in our filings with the U.S. Securities and Exchange Commission.

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