ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward
Looking Statements
This
section of the report includes a number of forward-looking statements that reflect our current views with respect to future events
and financial performance. Forward-looking statements are often identified by words like: believe, expect, estimate, anticipate,
intend, project and similar expressions, or words which, by their nature, refer to future events. Actual results could differ
materially from those anticipated in these forward looking statements as a result of any number of factors, including those set
forth in this Quarterly Report, and in the Company’s most recent Annual Report on Form 10-K filed on March 20, 2020.
All
written and oral forward-looking statements made in connection with this Quarterly Report on Form 10-Q that are attributable to
us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given the uncertainties
that surround such statements, you are cautioned not to place undue reliance on such forward-looking statements, which apply only
as of the date of this quarterly report. These forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from historical results or our predictions.
Overview
The
following discussion is an overview of the important factors that management focuses on in evaluating our businesses, financial
condition and operating performance and should be read in conjunction with the financial statements included in this Quarterly
Report on Form 10-Q.
The
Company is subject to a number of risks similar to other companies in the medical device industry. These risks include but are
not limited to rapid technological change, uncertainty of market acceptance of our products, uncertainty of regulatory approval,
competition from substitute products and larger companies, the need to obtain additional financing, compliance with government
regulation, protection of proprietary technology, product liability, and the dependence on key individuals.
Our
Business
We
are engaged in the business of designing, developing, manufacturing and marketing of biomaterial internal fixation devices. We
hold one medical device permit from the National Medical Products Administration of the PRC (“NMPA”) for our product
- polymer orthopaedic internal fixation screws and two patents issued by the State Intellectual Property Office of the P.R.C.
(“SIPO”). Our polyamide materials, their uses and manufacturing processes are protected by Patent No. ZL971190739.
A new patent, No. ZL201410647464.1 titled “Bone Fracture Plate Made of High Polymer Materials” was granted to us in
January 2018. Our polyamide materials are used in producing screws, binding wires, rods and related products. These products are
used in a variety of applications including orthopaedic trauma, sports related medical treatment, or cartilage injuries, and reconstructive
dental procedures. At this time, our company is the sole patent holder and market permit holder of PA technologies in China, as
well as the only company currently engaged in clinical trials, manufacturing and marketing for PA orthopaedic internal fixation
devices in the PRC. Our products are made of a very unique material called PA6-P(MMA-CO-NVP)-HA (“PA”). Our PA products,
such as screws, binding wires, rods, suture anchors and rib-pins consist of enhanced fibers and high molecular polymers which
are designed to facilitate quick healing of complex fractures in many areas of the human skeletal system.
Our
products offer a number of significant advantages over existing metal implants and the first generation of degradable implants
(i.e. PLLA) for patients, surgeons and other customers including:
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1.
|
A
notably reduced need for a secondary surgery to remove implant due to post-operative complications, therefore avoiding unnecessary
risk and expense on all patient care;
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2.
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Enhancing
the performance of the materials by manufacturing them to be easily fitted to each patient, forming an exact fit;
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3.
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Improving
the biological activity of materials. Clinical trial results have shown that PA implants promote a progressive shift of load
to the new bone creating micro-motion and thereby avoiding bone atrophy due to ‘stress shielding’;
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4.
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Reducing
the chance of post-operative infection;
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5.
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Stimulate
bone tissues to facilitate effective biological integration, benefitting the regeneration of bone;
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6.
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Ease
of post-operative care i.e. no distortion during x-ray imaging;
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7.
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Simple
and cost-effective to manufacture.
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Our
products are designed to replace the traditional internal fixation device made of stainless steel and titanium and overcome the
limitations of previous generations of products such as PLA and PLLA. Our laboratory statistics show that our PA products have
a higher mechanical strength, last longer in degradation ratio and are more evenly absorbed form outer layer inwards as compared
with similar materials such as PLA and PLLA. Thus PA allows increased restoration time for bone healing and re-growth. The Company’s
polymer orthopaedic internal fixation screws received approval from the National Medical Products Administration of the PRC (“NMPA”)
in April 2018. We launched our sales campaign at the end of our fiscal year ended October 31, 2019 and achieved a milestone in
the Company’s history by generating revenue through the sales of our PA Screws.
NMPA
Application Process and Approval for Polymer Screws
The
Company first submitted its application for PA Screws to the NMPA (formerly the SFDA/CFDA) in 2008. The application has been withheld
by the NMPA pending additional clinical trial cases. This is due to the amended NMPA regulations, which unlike previous regulations
require the applicant to specify the position on the body where the clinical trial is carried out. Our amended NMPA application
has specified the ankle fracture as the body part of our clinical trial. This is because bones around this part carry most of
the body weight.
Due
to the uniqueness of our material, there were no established NMPA Product Standards that we could follow during our application
process for our PA Screws. To establish our own Product Standards, the Company had been carrying out extra tests. The Company
submitted its Product Standards and supplementary reports to the NMPA in 2014. In December 2016, the Company received a notice
from the NMPA requesting supplementary report as part of the review process. The Company completed the supplementary report and
submitted it to the NMPA in June 2017.
In
April 2018, the Company’s application for its PA Screws was approved by the NMPA in China (Medical Device Certification
Number: 20183460133).
Process
of Human Trials
As
of January 31, 2020, for medical study and comparison purpose, the Company has completed a total of 83 successful clinical human
trial cases, including 71 cases on ankle fractures and 57 successful PA Binding Wire trial cases. We have been conducting human
trials at the 6 state level hospitals recognized by NMPA for clinical trials in different cities throughout China; including Nanchang,
Changsha, Luoyang, Nanning and Tianjin. The cities and provinces where our clinical trial hospitals are based will be the initial
target regions on our marketing plan. These regions are both densely populated and have experienced high or above medium economic
growth. The clinical trials for the Company’s PA Screws have been completed with 100 percent success rate. Having gained
NMPA approval for PA Screws, the Company is planning to start clinical trials on series of orthopaedic products the Company has
developed using the same unique biomaterial.
Government
Regulation
Medical
implant devices/products manufactured or marketed by the Company in China are subject to extensive regulations by the NMPA. Pursuant
to the related laws and acts, as amended, and the regulations promulgated there under (the “NMPA Regulations”), the
NMPA regulates the clinical testing, manufacture, labeling, distribution and promotion of medical devices. The NMPA also has the
authority to request repair, replacement, or refund of the cost of any device manufactured or distributed by the Company.
Under
the NMPA Regulations, medical devices are classified into three classes (class I, II or III), the basis of the controls deemed
necessary by the NMPA to reasonably assure their safety and efficacy. Under the NMPA’s regulations, class I devices are
subject to general controls (for example, labeling and adherence to Good Manufacturing Practices (“GMP”) requirements)
and class II devices are subject to general and special controls. Generally, class III devices are those which must receive premarket
approval by the NMPA to ensure their safety and efficacy (for example, life-sustaining, life-supporting and certain implantable
devices, or new devices which have not been found substantially equivalent to legally marketed class I or class II devices). The
Company is classified as a manufacturer of class III medical devices. Current NMPA enforcement policy prohibits the marketing
of approved medical devices for unapproved uses.
Before
a new device can be introduced into the market in China, the manufacturer generally must obtain NMPA marketing clearance through
clinical trials. Since the Company is classified as a manufacturer of Class III medical devices, the Company must carry out all
clinical trials in pre-selected NMPA approved hospitals.
Manufacturers
of medical devices for marketing in China are required to adhere to GMP requirements. Enforcement of GMP requirements has increased
significantly in the last several years and the NMPA has publicly stated that compliance will be more strictly scrutinized. From
time to time the NMPA has made changes to the GMP and other requirements that increase the cost of compliance. Changes in existing
laws or requirements or adoption of new laws or requirements could have a material adverse effect on the Company’s business,
financial condition and results of operations. There can be no assurance that the Company will not incur significant costs to
comply with applicable laws and requirements in the future or that applicable laws and requirements will not have a material adverse
effect upon the Company’s business, financial condition and results of operations.
Regulations
regarding the development, manufacturing and sale of the Company’s products are subject to change. The Company cannot predict
the impact, if any, that such changes might have on its business, financial condition and results of operations.
Results
of Operations
The
“Results of Operations” discussed in this section merely reflect the information and results of the Company for the
period from September 25, 2002 (Shenzhen Changhua’s date of inception) to January 31, 2020 and 2019.
Revenues
The
Company achieved a milestone in its history by generating sales revenue at the end of the fiscal year ended October 31, 2019.
As of January 31, 2020, the Company’s net sales increased from $11,657 to $60,501 compared with previous quarter. Due to
the COVID-19 pandemic, non-essential operations have been cancelled in hospitals nationwide in China. We expect the sales of our
PA Screws to fall in the second quarter of 2020, and gradually recover during the third quarter as the COVID-19 cases ease off
in China.
Our
management team is continuously looking for fundraising possibilities for sales and marketing expansion, product improvement,
machinery upgrades, facility expansions and continuous research and development.
Our
facility is located in Shenzhen, China, which is built to meet the GMP standards. Our facility covers about 865 square meters,
which includes the combined facilities of offices, laboratories, and workshops. There is one production line for the PA Screw
and another production line for the PA Binding Wire. The annual production capabilities of each production line are 100,000 pieces
for PA Screw, and 240,000 packs for the PA Binding Wires. Both production lines, at their maximum production capacities are capable
of generating approximately $30,000,000 in annual revenue.
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Estimate current production lines in full capacity
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Output Quantity (Max.)
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Price at ex-factory ($)
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Total Turnover ($)
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PA Screw
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100,000
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(piece)
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180
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18,000,000
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PA Binding Wire
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240,000
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(pack)
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50
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12,000,000
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Total:
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30,000,000
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China’s
Marketing Analysis:
We
have established long term relationships with many hospitals and national distributors in China. Ms. Hui Wang, the Company’s
CEO, has over 25 years’ sales experience in medical distribution. Professor Shangli Liu, our chief medical advisor, is one
of the highest ranked orthopedic doctors in China as well as being highly renowned in the rest of the world. He will assist the
Company in nationwide product promotion and joint projects with associated academic institutions and medical schools. During product
development and clinical trial stages, we developed close relationships with many major national hospitals. We expect these relationships
to boost our revenue generation.
China’s
market for PA devices depends on 3 major conditions:
-
Patients
-
Advanced technology level
-
Performance and price of the materials
China
has gradually entered the Old Age Society. It is expected that there will be 245 million people over 60 years of age by 2020,
and, according to the survey of 50 years old, the incidence of osteoporosis is as high as 60%, accompanied by osteoporosis, fracture,
bone necrosis, disability and other diseases, resulting in continued high demand of orthopaedic implant medical devices. (Source:
The UN; Shenwan Hongyuan Securities research report).
The
Company has advantages and more opportunities over others competitors due to:
-
No other similar patent registrations in China.
-
We are the only company to receive market approval and permission to perform PA clinical trials by the NMPA to the best of our
knowledge.
-
We have a timing advantage over other Chinese companies; other companies would need to successfully complete preclinical testing
for the NMPA in order to obtain clinical trial permits.
-
Under new regulations by the NMPA, it will take at least 5-10 years for clinical trials of new materials.
-
Our patented material enables us to rapidly diversify our product line according to market trend and demand.
Number
of Hospitals at the end of February 2020 Statistic and Census report by the National Health Commission of the People’s Republic
of China.
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Statistic and Census report by the National Health Commission of the People’s Republic of China
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(February 2020)
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February 2020
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February 2019
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Increase / (Decrease)
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Total No. of Hospitals
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34,104
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33,125
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979
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Public Hospital
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11,915
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11,960
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(45
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)
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Private Hospital
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22,189
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21,165
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|
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|
1,024
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Hospital Rating
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AAA
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2,762
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|
2,582
|
|
|
|
180
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AA
|
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|
9,730
|
|
|
|
9,061
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|
|
|
669
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|
A
|
|
|
11,153
|
|
|
|
10,850
|
|
|
|
303
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Unrated
|
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|
10,459
|
|
|
|
10,632
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|
(173
|
)
|
In
general, technological advancements and the marketing potential within Asia are the biggest factors in driving significant growth
within the global orthopedic devices market. Another major factor that positively influences this market is the growing number
of aging baby boomers with active lifestyles. This sector represents a large portion of the total population.
Research
and Development
Research
and development costs related to both present and future products are expensed as incurred. Total expenditure on research and
development charged to general and administrative expenses for the quarter ended January 31, 2020 and 2019 was $56,780 and $16,979.
We
expect research and development expenses to grow as we continue to invest in basic research, clinical trials, product development
and in our intellectual property. The Company will be working closely with medical institutions and research universities to expedite
future clinical trials of upcoming series of polymer fixation devices, including Intramedullary Nailing Fixation, Binding Wires,
Micromodule Screws & Plates, Maxillofacial & Craniofacial Plates, and Rib Pins.
Marketing
Strategy
The
Company has been conducting Pre-Market Research before its PA Screws application was approved by the NMPA in April 2018. The research
is intended to estimate the potential market success of the company’s products that can be expected. The research also beyond
the Company’s initial market - China, and covers international markets. Based on the results of our Pre-Market Research
and the positive feedbacks we have received from trade shows and industrial conferences, it is the Company’s intention to
apply for additional international regulatory approvals in due course.
The
Company will market its products through a hybrid sales force comprised of a managed network of independent regional distributors/sales
agents (80%) and direct sales representatives (20%) in China.
There
are two ways the Company will generate revenue, 1) through our nationwide and regional distributors and 2) through our direct
sales channels.
The
Company is currently working to have its products registered on multiple provincial Group Purchasing Organization (GPO) platforms.
A few distributors have made deposit payment. The Company is working with distributors to develop sales channels and have its
products reaching hospitals.
Impact
of COVID-19 Outbreak
The
Company’s primary business is carried out through its subsidiary, Shenzhen Changhua Biomedical Engineering Co., Ltd. (“Shenzhen
Changhua”), based in Shenzhen, China, where the COVID-19 pandemic started in January 2020.
The
Company has identified the following areas that have been adversely affected by COVID-19 pandemic:
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1.
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Operation:
Our facilities in China were not fully staffed due to COVID-19 lockdown, travel restrictions and quarantine requirements.
This affected our accounting and marketing departments mostly because a large number of staff couldn’t come back to
office as they were not allowed to travel or have 14-day quarantine before they come back to work. As the crisis is easing
off in China, we expect our operation to gradually be back to normal.
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2.
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Manufacturing:
We have sufficient raw material stock for 2 months and our production should not be affected. However, if COVID-19 pandemic
persists and continues beyond May 2020, our supply chain will be affected, and we may be short of raw material supply.
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3.
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Marketing:
We launched our sales campaign in November 2019 and our sales increased in the quarter ended January 31, 2020. Our sales and
marketing plans have been disrupted by COVID-19 pandemic because almost all the hospitals in China have been dealing with
COVID-19 and non-essential operations have been postponed or cancelled.
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The
Company has been working with its business partners and workforce through crisis planning, effective communication and co-operation
to minimize the negative impact of the COVID-19 pandemic.
Finance
Costs
As
of January 31, 2020 and October 31, 2019, a stockholder and four related parties had loaned a total of $5,044,984 and $4,916,638
respectively to the Company as unsecured loans repayable on demand and interest is charged at 7% per annum on the amount due.
Total interest expenses on advances from a stockholder and the related parties accrued for the three months ended January 31,
2020 and 2019 were $80,254 and $75,507 respectively.
As
of January 31, 2020 and October 31, 2019, the Company owed $298,911 and $280,514 respectively to the directors for advances made
on an unsecured basis, repayable on demand. Total imputed interest expenses on advances from directors, calculated at 5% per annum,
recorded as additional paid-in capital amounted to $3,389 and $3,148 for the three months ended January 31, 2020 and 2019 respectively.
Net
Loss
The
net loss attributable to common stockholders for the three months ended January 31, 2020 and 2019 were $63,789 and $252,523 respectively.
We started to generate revenue at the end of our fiscal year from inception to October 31, 2019 before our sales campaign was
disrupted by the COVID-19 pandemic, but we have to incur operating expenses for the upkeep of the Company and the clinical trials.
Liquidity
and Capital Resources
We
had a working capital deficit of $6,780,031 and $6,577,273 as of January 31, 2020 and October 31, 2019 respectively. Our working
capital deficit is due to the fact that we received the NMPA approval for one product in April 2018 and we are in the process
to produce, market and sell our product in China. We only started our sales campaign and our sales revenues were not able to cover
our expenses and we relied on loans from our related parties and stockholders.
Cash
Flows
Net
Cash Used in Operating Activities
Net
cash used in operating activities was $51,860 and $199,767 in the three months ended January 31, 2020 and 2019 respectively. This
amount was attributable primarily to the net loss after adjustment for non-cash items, such as depreciation, loss on disposal
of property and equipment, imputed interest on advances from directors, and others like charges in other receivables and prepaid
expenses and other payables and accrued expenses.
Net
Cash Used in Investing Activities
We recorded net cash used of $525
and $25,043 in investing activities in the three months ended January 31, 2020 and 2019 respectively. This amount reflected
purchases of property and equipment, primarily for research and development to our facilities.
Net
Cash Provided by Financing Activities
Net cash provided by financing activities
in the three months ended January 31, 2020 and 2019 was $54,805 and $234,622 respectively, which represented advances from
a stockholder, directors and related parties, loan repayment to directors and advances to a related company.
Operating
Capital and Capital Expenditure Requirements
Our
ability to continue as a going concern and support the commercialization of current products is dependent upon our ability to
market our product while obtaining additional financing in the near term. We anticipate that such funding will be in the form
of marketing of our products and equity financing from sales of our common stock. However, there is no assurance that we will
be able to raise sufficient funding from the sale of our products and common stock to fund our business plan should we decide
to proceed. We anticipate our sales revenue will not meet our financial needs in 2020 and we need to rely on advances from our
related parties and stockholders in order to continue to fund our business operations.
We
believe that our existing cash, cash equivalents at January 31, 2020, will be insufficient to meet our cash needs. Our minimum
cash requirement for the next 12 months is projected to be $100,000,000. This amount may increase if we decide to start clinical
trials on new products. The management is actively pursuing additional funding and strategic partners, which will enable the Company
to implement our business plan, business strategy, to continue research and development, clinical trials or further development
that may arise.
We
intend to spend more to support the commercialization of current products and on research and development activities, including
new products development, regulatory and compliance, clinical studies, and the enhancement and protection of our intellectual
property portfolio.
OFF-BALANCE
SHEET ARRANGEMENTS
We
do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources that are material to our investors.
CRITICAL
ACCOUNTING POLICIES
The
preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate
our estimates, including but not limited to those related to income taxes and impairment of long-lived assets. We base our estimates
on historical experience and on various other assumptions and factors that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources. Based on our ongoing review, we plan to adjust to our judgments and estimates where facts and circumstances
dictate. Actual results could differ from our estimates.
We
believe the following critical accounting policies are important to the portrayal of our financial condition and results and require
our management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the
effect of matters that are inherently uncertain.
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1.
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Property
and equipment
|
Property
and equipment are stated at cost, less accumulated depreciation. Expenditures for additions, major renewals and betterments are
capitalized and expenditures for maintenance and repairs are charged to expense as incurred.
Depreciation
is provided on a straight-line basis, less estimated residual value over the assets estimated useful lives. The estimated useful
lives of the assets are 5 years.
In
accordance with FASB Codification Topic 360 (ASC Topic 360), “Accounting for the impairment or disposal of Long-Lived Assets”,
long-lived assets and certain identifiable intangible assets held and used by the Company are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating
the recoverability of long-lived assets, the recoverability test is performed using undiscounted net cash flows related to the
long-lived assets. The Company reviews long-lived assets to determine that carrying values are not impaired.
Inventory
is stated at the lower of cost (using weighted average basis) and net realizable value.
|
|
4.
|
Fair
value of financial instruments
|
FASB
Codification Topic 825 (ASC Topic 825), “Disclosure About Fair Value of Financial Instruments,” requires certain disclosures
regarding the fair value of financial instruments. The carrying amounts of other receivables and prepaid expenses, other payables
and accrued liabilities and due to a stockholder, directors and related parties approximate their fair values because of the short-term
nature of the instruments. The management of the Company is of the opinion that the Company is not exposed to significant interest
or credit risks arising from these financial statements.
The
Company accounts for income taxes under The Financial Accounting Standards Board (FASB) Codification Topic 740-10-25 (“ASC
740-10-25”). Under ASC 740-10-25, deferred tax assets and liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under ASC 740-10-25, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized as income in the period included the enactment date.
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6.
|
Research
and Development
|
Research
and development costs related to both present and future products are expensed as incurred.
|
|
7.
|
Foreign
currency translation
|
The
reporting currency of the company’s financial statements is the US dollar. The financial statements of the Company’s
subsidiary denominated in currencies other than the US dollar are translated into US dollars using the closing rate method. The
balance sheet items are translated into US dollars using the exchange rates at the respective balance sheet dates. The capital
and various reserves are translated at historical exchange rates prevailing at the time of the transactions while income and expenses
items are translated at the average exchange rate for the year. All exchange differences are recorded within equity.
ADOPTION OF NEW ACCOUNTING STANDARD
Leases
The
Company has initially adopted ASU No. 2016-02, Leases (Topic 842) as of 1 November 2019 using the modified retrospective method.
In addition, the Company elected the transition method permitted under the ASU 2018-11 issued in July 2018, which allowed the
Company to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening
balance of accumulated deficits in the period of adoption.
The
cumulative effect of the changes made to the consolidated balance sheet as of 1 November 2019 for the adoption of the new leases
standard was as follows:
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|
Balances at
|
|
|
Adjustments
|
|
|
Balances at
|
|
|
|
|
October 31,
|
|
|
on adoption of
|
|
|
November 1,
|
|
|
|
|
2019
|
|
|
ASU 2016-02
|
|
|
2019
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Right-of-use assets
|
|
$
|
-
|
|
|
$
|
74,139
|
|
|
$
|
74,139
|
|
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease liabilities, current portion
|
|
|
-
|
|
|
|
(43,732
|
)
|
|
|
(43,732
|
)
|
|
NON-CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease liabilities, net of current portion
|
|
|
-
|
|
|
|
(33,333
|
)
|
|
|
(33,333
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative-effect adjustment to opening balance of
accumulated deficit
|
|
$
|
-
|
|
|
$
|
(2,926
|
)
|
|
$
|
(2,926
|
)
|
In determining the lease liability and
corresponding right-of-use asset for each lease, the Company calculated the present value of future lease payments using the Company’s
incremental borrowing rate. The incremental borrowing rate was determined with reference to the interest rate applicable to borrowings
from related parties disclosed in Note 4, Related Parties Transactions.
The
reported results for the three months ended January 31, 2020 reflect the adoption of ASC 842 guidance while the reported results
for the three months ended January 31, 2019 were prepared and continue to be reported under the guidance of ASC 840, Leases.
