STOCKHOLDERS' EQUITY

9 Months Ended

Sep. 30, 2011

NOTE 11 – STOCKHOLDERS’ EQUITY

February 2008 Preferred Stock and Warrant Purchase Agreement

On February 25, 2008 (“Closing Date”), pursuant to a Convertible Redeemable Preferred Share and Warrant Purchase Agreement (the “Purchase Agreement”) by and among the Company, Dr. Zhongyi Liu and Mrs. Zhenghong Song (the “Founders”), and accredited investors (each a “Purchaser” and collectively, the “Purchasers”), the Company issued to the Purchasers an aggregate of 5,747,118 shares of the Company’s Preferred Stock, par value $0.001 per share, at a price equal to $0.87 per share (the “Preferred Shares”). In February 2008, the convertible redeemable preferred stock was deemed debt due to the mandatory redeemable feature of the Preferred Stock according to ASC 480 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. In addition, the Company issued to the Purchasers warrants to purchase up to 1,436,777 shares of the Company’s common stock in the aggregate. The Warrants have an exercise price of $2.41. The warrants are exercisable for a period of five years from the closing date. Holders of the warrants may not exercise the warrants if the exercise would result in the holder beneficially owning more than 4.99% of the Company’s outstanding common shares. That limitation may be waived by a holder of the warrants upon not less than 61 days written notice to the Company.

Each of these Preferred Shares was convertible into 0.5 share of the Company’s common stock (as adjusted for stock splits, stock dividends, reclassification and the like), pays an 8% dividend annually, payable in additional Convertible Preferred Shares and also pays any dividend to be paid on the common shares on an as-converted basis. Until May 25, 2010, the Preferred Shares could be redeemed at the option of the Purchasers at the redemption price of $0.87 per share (as adjusted for stock splits, stock dividends, reclassification and the like), and no other capital stock of the Company may be redeemable prior to the Preferred Shares. Holders of Preferred Shares may not convert Preferred Shares to common shares if the conversion would result in the holder beneficially owning more than 4.99% of the Company’s outstanding common shares. That limitation may be waived by a holder of Preferred Shares upon not less than 61 days written notice to the Company. The Preferred Shares vote with the common stock on an as converted basis, except that the Preferred Shares are not entitled to vote for directors. The Company is prohibited from taking certain corporate actions, including, without limitation, issuing securities senior to the Preferred Shares, selling substantially all assets, repurchasing securities and declaring or paying dividends, without the approval of the holders of a majority of the Preferred Shares then outstanding.

Under the designations of related agreements, rights and preferences of the Preferred Stock, the Company could be required to redeem the Preferred Stock at the option of the holder for a period of 90 days beginning on February 25, 2010. The redemption price which is equal to $0.87 per share plus any accrued but unpaid dividends must be paid in cash, in one lump sum within one month from the end of the 90 days period. Following the end of said 90 days period, the Series A Preferred Stock is not redeemable. None of the preferred stockholders required the redemption of the Preferred Stock by the end of the applicable redemption period. Since the redemption feature of the Preferred Stock lapsed, the Company reclassified the existing carrying amount of the convertible Preferred Stock from debt to equity on May 26, 2010 in accordance with the provisions of ASC 480. Accordingly, the 684,176 shares of outstanding convertible Preferred Stock were recorded as equity on May 26, 2010.

In February 2011, the Company issued 12,717 shares of Preferred Stock to the holders of Series A Preferred Stock for their dividends. These Preferred Shares have the same terms as the Preferred Shares issued in February 2008 per the February 2008 Preferred Stock and Warrant Purchase Agreement.

During the period from May 26, 2010 through September 30, 2011, 77,069 shares of preferred stock were converted into 38,535 shares of common stock.

Common Stock

In January 2011, the Company issued 5,000 shares of its common stock to a lawyer in connection with legal service rendered. The shares were valued at the fair value of $2.27 per share on the grant date. In connection with the issuance of these shares, the Company reduced accrued expense by $11,350.

In January 2011, the Company issued 80,000 shares of its common stock to its four newly appointed directors in connection with service rendered and to be rendered. The shares were valued at the fair value of $2.05 per share on the grant date. In connection with the issuance of these shares, the Company recorded director fees of $164,000.

In January 2011, the Company issued 340,000 shares of its common stock to four consultants in connection with services rendered and to be rendered. The shares were valued at the fair value of $2.05 per share on the grant date. In connection with the issuance of these shares, the Company recorded consulting expense of $697,000.

In January 2011, the Company issued 30,000 shares of its common stock to its vice president of corporate development in connection with services rendered and to be rendered. The shares were valued at the fair value of $2.05 per share on the grant date. In connection with the issuance of these shares, the Company recorded stock-based compensation of $61,500.

In January 2011, the Company issued 47,383 shares of its common stock to its chief executive officer in connection with services rendered. The shares were valued at the fair value of $2.216 per share on the grant date. In connection with the issuance of these shares, the Company reduced accrued expense by $105,000.

In January 2011, the Company issued 451,263 shares of its common stock to its chief executive officer in connection with services rendered and to be rendered. The shares were valued at the fair value of $2.216 per share on the grant date. In connection with the issuance of these shares, the Company recorded stock-based compensation of $1,000,001.

In February 2011, the Company issued 30,000 shares of its common stock to a key person in connection with services rendered. The shares were valued at the fair value of $1.92 per share on the grant date. In connection with the issuance of these shares, the Company recorded compensation expense of $57,600.

In July 2011, the Company issued 26,847 shares of its common stock to an attorney in connection with legal service rendered. The shares were valued at $0.45 per share on the grant date based on market price. In connection with the issuance of these shares, the Company recorded professional fees of $102,081.

In August 2011, the Company issued 9,724 shares of its common stock to an attorney in connection with legal service rendered. The shares were valued at $0.617 per share on the grant date based on market price. In connection with the issuance of these shares, the Company recorded professional fees of $6,000.

In September 2011, the Company issued 17,225 shares of its common stock to an attorney in connection with legal service rendered. The shares were valued at $0.351 per share on the grant date based on market price. In connection with the issuance of these shares, the Company recorded professional fees of $6,046.

Statutory Reserve

The Company is required to make appropriations to a statutory reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (“PRC GAAP”). Appropriations to the statutory reserve is required to be at least 10% of the after tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entities’ registered capital.

The statutory reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of shares currently held by them, provided that the remaining statutory reserve balance after such issue is not less than 25% of the registered capital.

The Company’s statutory reserve has reached 50% of its registered capital as of March 31, 2010. As such, no additional reserve was recorded during the nine months ended September 30, 2011. The Company’s statutory reserve was $6,240,202 at September 30, 2011 and December 31, 2010.

Stock Warrants

There were no stock warrants issued, terminated/forfeited and exercised during the nine months ended September 30, 2011.

The following table summarizes the shares of the Company’s common stock issuable upon exercise of warrants outstanding and exercisable at September 30, 2011:


Warrants outstanding and exercisable
Exercise price		Number outstanding at September 30, 2011	Weighted average remaining contractual life (years)	Weighted average exercise price
$	1.74	62,500	0.37	$	1.74
	2.40	1,436,777	1.41		2.40
	2.41	301,723	1.41		2.41
	3.00	125,000	0.32		3.00
$	3.82	75,000	3.28		3.82
		2,001,000	1.38	$	2.47

- Definition

The entire disclosure for shareholders' equity, comprised of portions attributable to the parent entity and noncontrolling interest, if any, including other comprehensive income (as applicable). Including, but not limited to: (1) balances of common stock, preferred stock, additional paid-in capital, other capital and retained earnings; (2) accumulated balance for each classification of other comprehensive income and total amount of comprehensive income; (3) amount and nature of changes in separate accounts, including the number of shares authorized and outstanding, number of shares issued upon exercise and conversion, and for other comprehensive income, the adjustments for reclassifications to net income; (4) rights and privileges of each class of stock authorized; (5) basis of treasury stock, if other than cost, and amounts paid and accounting treatment for treasury stock purchased significantly in excess of market; (6) dividends paid or payable per share and in the aggregate for each class of stock for each period presented; (7) dividend restrictions and accumulated preferred dividends in arrears (in aggregate and per share amount); (8) retained earnings appropriations or restrictions, such as dividend restrictions; (9) impact of change in accounting principle, initial adoption of new accounting principle and correction of an error in previously issued financial statements; (10) shares held in trust for Employee Stock Ownership Plan (ESOP); (11) deferred compensation related to issuance of capital stock; (12) note received for issuance of stock; (13) unamortized discount on shares; (14) description, terms, and number of warrants or rights outstanding; (15) shares under subscription and subscription receivables, effective date of new retained earnings after quasi-reorganization and deficit eliminated by quasi-reorganization and, for a period of at least ten years after the effective date, the point in time from which the new retained dates; and (16) retroactive effective of subsequent change in capital structure.

+ References

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+ Details

Lotus Pharmaceuticals, Inc. 10-Q