# China Pharma Holdings, Inc.: Form 10-Q for the period ended Mar 31, 2010

- Company: [China Pharma Holdings, Inc.](/companies/cphi.md) (CIK 1106644)
- Form: 10-Q
- Filed: 2010-05-10
- Accepted by EDGAR: May 10, 2010, 17:08 ET
- Period: 2010-03-31
- Accession: 0001010549-10-000294
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/1106644/000101054910000294/cphi10q033110.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1106644/000101054910000294/

## Management's discussion and analysis

As filed, 23,355 characters.

#### Disclosure Regarding Forward-Looking Statements

*The statements contained in this report with respect to our financial condition, results of operations and business that are not historical facts are forward-looking statements. Forward-looking statements can be identified by the use of forward-looking terminology, such as "anticipate", "believe", "expect", "plan", "intend", "seek", "estimate", "project", "could", "may" or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the reader of the forward-looking statements that any such statements that are contained in this report reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors, including, but not limited to, economic, competitive, regulatory, technological, key employee, and general business factors affecting our operations, markets, growth, services, products, licenses and other factors discussed in our other filings with the Securities and Exchange Commission, and that these statements are only estimates or predictions. No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of risks facing our company, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events.*

*These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. Some of these risks are described in “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008, as amended.*

*These risk factors should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. All written and oral forward looking statements made in connection with this report that are attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given these uncertainties, we caution investors not to unduly rely on our forward-looking statements. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. Further, the information about our intentions contained in this report is a statement of our intention as of the date of this report and is based upon, among other things, the existing regulatory environment, industry conditions, market conditions and prices, the economy in general and our assumptions as of such date. We may change our intentions, at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.*

### Business Overview

We manufacture and distribute high-quality generic and branded pharmaceutical products for a wide range of high incidence and high mortality conditions in China. We have a strong focus on bringing new and first-to-market generic medicines to market through the purchase of medical formulas from research institutions as well as our own in-house research and development activities. Over the past 17 years we have successfully commercialized 20 products that have received approval from the Chinese State Food and Drug Administration of China (the “SFDA”, which is the Chinese equivalent of the Federal Food and Drug Administration in the United States).

Our diverse portfolio of pharmaceutical products includes products for the treatment of central nervous system diseases, cerebral and cardio vascular disorders, infectious diseases and respiratory and digestive illnesses. We believe we have developed a cost-effective, high margin business model that is driven by market demand and supported by our eight scalable Good Manufacturing Practice (“GMP”)-certified production lines covering our major dosage forms or products. We have a broad and expanding distribution network covering 30 provinces and municipalities in China. Hainan Helpson Medical & Biotechnology Co., Ltd (“Helpson”), located in Haikou City in Hainan Province, China, is our principal operating unit and wholly-owned subsidiary of our company.

**Strong Revenue Growth and High Margins** - We have experienced rapid growth in sales of our therapeutics. Historically, our gross profit margin has exceeded 40% and our comparatively flat marketing and selling network and distribution system has enabled us to keep our net income margin (net income as a percentage of total revenue) above 30%. We are able to compete in the highly competitive pharmaceutical industry through our diversified product line, cost control measures and a strong sales network. Our experienced management team with sharp market insights and the strong in-house and collaborative third-party research resources enable us to establish and launch new products based on market demand.

**Proven Record of Success** - We have a proven track record of success and believe our core strength as a company is our ability to commercialize research results. Over the years, we have strengthened our ability to identify key therapeutic areas and the compounds with the highest potential, manage the process obtain various regulatory approvals required to commercialize those compounds, and finally to produce and sell the medicinefinished pharmaceutical product developed from those compounds to hospitals. We seek to focus on the largest segments of China's pharmaceutical market and currently have a portfolio of over 30 specifications of drugs that focus on the treatment of: Central Nervous System disorders, cardiovascular diseases, cerebrovascular diseases, infectious diseases, digestive diseases and other therapeutic areas of high incidence in China. In addition, our growth strategy is supported by the needs of a dynamic pharmaceutical industry and should benefit from government reforms to increase the population covered by national medical insurance.

We also have eight different types of modern production lines with capacity to meet our current and future demands. Our facilities received five-year Good Manufacturing Practices (GMP) re-Certification from the SFDA during 2008.

**Clear Strategy for Growth –** We believe we are positioned in a rapidly growing industry in the fastest growing economy in the world. Within the Chinese economy, medical care expenditures represent only about 4.5% of the Chinese GDP (compared to approximately 17% in the United States). As a result, it is anticipated that the healthcare segment in China will experience faster growth. Furthermore, the recently announced Healthcare Reform in China implies significant additional revenue opportunities for pharmaceutical enterprises supported by government initiatives. We believe the increase in demand from these sources will provide a very healthy growth environment for us. Aside from our current portfolio of products, new products from our pipeline (such as Candesartan and the generic version of Crestor, and Rosuvastatin) present us with very exciting growth opportunities once these products come on line.

Finally, the Healthcare Reform will change the current landscape of the Chinese pharmaceutical industry which we think will create many attractive acquisition opportunities. We plan to use these opportunities to the fullest extent possible and hope to continue our rate of growth in the future.

As of March 31, 2010, in addition to our portfolio of 20 commercialized products, we had nine drugs at different stages of registration process, including three which had passed SFDA technical analysis and entered clinical trials (including a new anti-drug-resistance antibiotic product), and three drugs waiting for SFDA production approval.

We received SFDA approval to enter clinical trials for Candesartan – a front-line therapy in the treatment of hypertension during 2009. This clinical program was completed in January of 2010 and we have submitted an application for production. We have completed the on-site trial production review by SFDA and are currently waiting for the final production approval..

In addition to these products, we have several others pending SFDA technical review and plan to initiate additional clinical trials in 2010 that focus on our main therapeutic areas. We are also evaluating additional opportunities on an ongoing basis, directed by the organic growth and market demands of China's pharmaceutical market. We are working closely with several pharmaceutical research institutions and remain focused on creating a steady increase in revenue. Through strategic mergers and acquisitions (M&A) and through capitalization of this fragmented market, we will improve our product portfolio and push our integrated growth; maintain and develop new marketing channels; and use our existing retailing network in the newly expanded market to raise our overall market share. The organic growth of the Chinese pharmaceutical market has already and will continue to direct the company's development.

### Recent Developments

During the first quarter we completed the clinical trials for Candesartan – a front-line therapy in the treatment of hypertension. We have submitted an application for production. We have completed the on-site trial production review by SFDA and are currently waiting for the final production approval.

The clinical trial for Rosuvastatin (generic form of Crestor) continues to receive very positive feedback from the patients.

The clinical trial for our Anti-Drug resistant Anti-Biotic combination drug is also progressing on schedule.

### Market Trends

The growth of China’s pharmaceutical market is driven by China’s rapid economic growth. Increased healthcare spending by the Chinese government to reform the healthcare system has already greatly improved the accessibility to and desire for medical care. Important additional factors include: the aging of the population and the resulting increase in age-related disorders; the urban migration of the population; and improved awareness of self-health care. Credit Suisse estimates that Chinese pharmaceutical market will grow at a compounded annual growth rate of 15.5% from 2008 to 2015, stemming from 2008 market size base of $32 billion.

The recent Healthcare Reform program announced by the Chinese government will have a real and significant impact on all healthcare related industries in China, including the pharmaceutical industry. Over all, the government plans to provide a basic, universal healthcare system to all citizens of China. While the government was slow to announce specifics of the plan, the recent release of the final Essential Drug List (the “EDL”) was the first major concrete step to implement the reform. The implementation of the EDL is expected to be phased in next few years gradually, and products on the EDL are expected to experience an increase in volume while having their margins lowered. That being said, the price adjustments announced by the government have been milder than the market originally anticipated. It is also important to realize that the government wants to set a pricing range target (high and low), in making sure that the prices of essential drugs are affordable on the one hand, and allow drug companies a fair profit on the other. We believe the effect of the Reform will be significant if not immediate. We are making ourselves more nimble and are ready to modify our strategies to the new environment when it becomes a reality. We are adjusting our sales and marketing strategy, to further penetrate the lower-tier healthcare facilities market which is one of the focuses of the current Healthcare Reform.

### Results of Operations

The following table presents our results of operations for the three months ended March 31, 2010 and 2009.

### Results of Operation

|  | For the Three Months Ended March 31, 2010 | 2009 | % Chg |
| --- | ---: | ---: | ---: |
| Revenue | $15,102,510 | $12,991,982 | 16% |
| Cost of revenue | 8,968,302 | 7,063,227 | 27% |
| Gross profit | 6,134,208 | 5,928,755 | 3% |
| Selling expenses | 582,888 | 602,760 | -3% |
| General and administrative expenses | 652,748 | 488,047 | 34% |
| Bad debt expense | 70,906 | 774,932 | -91% |
| Income from operations | 4,827,666 | 4,063,016 | 1 % |
| Interest income | 6,757 | 10,589 | -3 % |
| Interest expense | (50,490) | (38,236) | 3 % |
| Income tax expense | (489,279) | (357,722) | 36% |
| Net income | $4,294,654 | $3,677,647 | 17% |

|  |  |  |  |
| --- | ---: | ---: | ---: |
| Basic earnings per share | $0.100 | $0.087 | 15% |
| Basic weighted average shares outstanding | 43,128,023 | 42,278,938 | 2% |
| Diluted earnings per share | $0.098 | $0.087 | 13% |
| Diluted weighted average shares outstanding | 43,602,261 | 42,278,938 | 3% |

### Revenue

For the three months ended March 31, 2010, our revenues increased by $2.1 million, or 16% to $15.1 million from the $13.0 million we generated in the corresponding period of 2009.

During the first quarter, Anti-Viro/Infection & Respiratory product category continues to lead in category sales growth by rising 32% over the same period a year ago to approximately $5.4 million. Our CNS and Cerebral & Cardio Vascular drugs performed steadily by generating $5.3 million of revenue during the first quarter, compared to $5.3 million in the same period of 2009. Our Digestive product sales rose by 291% to $1.7 million, mainly due to the sales contribution from our new products Tiopronin and Omeprazole. During this quarter we saw Tiopronin generating close to $850,000 in sales and Omeprazole contributed $260,000. Our Other Products category generated $2.7 million dollars of revenue compared to last year’s $3.2 million, a decrease of about 15%, mainly due to a stellar performance in this category a year ago.

### Cost of Revenue

For the three months ended March 31, 2010, Cost of revenue was $9.0 million or 59% of total revenue, compared to the corresponding period of 2009, which was $7.1 million or 54% of total revenue.

### Gross Profit

Gross Profit for the three months ended March 31, 2010 was $6.1 million, which is approximately 3.5% higher compared to the $5.9 million for the first quarter of 2009. Gross profit margin for the current quarter is 41%, compared to 46% in the first quarter of 2009. The lower gross profit margin in the first quarter of 2010 was mainly due to higher volume of lower margin products sold compared to the same period a year ago. Specifically, of our four product categories, the Anti-Viro/Infection category has had the highest growth. On a relative basis, this category also has a lower gross margin compared to the other three. Our current strategy is to maintain our gross margin at a healthy level by balancing sales growth of lower margin products with the higher ones. This is one of our priorities going forward.

### Selling Expenses

Our selling expense for the three months ended March 31, 2010 was approximately $0.58 million, a decrease of approximately $20,000, or 3%, compared to approximately $0.60 million for the three months ended March 31, 2009. Selling expenses was approximately 3.9% of revenue this quarter compared to 4.6% a year ago.

### General Administrative Expense

The general and administrative expenses for the three months ended March 31, 2010 was $0.65 million, an increase of $0.16 million, or 34%, compared to $0.49 million for the same period in 2009. The rise in G&A expense was in part due to higher amortization expenses for our drug formulas during the quarter ending March 31, 2010 compared to the same quarter a year ago.

### Bad Debt Expense

As to the peculiarity of the Chinese pharmaceutical market environment, deferred payments to pharmaceutical companies by state-owned hospitals and local medicine distributors are a normal phenomenon. Over 90% of our drugs are sold to state-owned hospitals and local medicine distributors, which creates slow collections of our trade receivables. Since the majority of hospitals in China are backed by the government, management believes that the deferred payments from state-owned hospitals are secure and will eventually be collected. So far, China Pharma has not lost any receivables in its 15 years history of doing business with hospitals.

As of March 31, 2010, our bad debt allowance was $2.78 million compared to $2.72 million on December 31, 2009. This represents a bad debt expense of $70,906 for the quarter ending March 31, 2010.

### Income from Operation

Our operating income for the three months ended March 31, 2010 was approximately $4.8 million, compared to $4.0 million for the same period in 2009, an increase of $0.75 million, or 19%. The main reasons for our higher operating income in the first quarter of 2010 was higher gross profit and lower bad debt expense in such quarter.

### Interest Income

The interest income for the three months ended March 31, 2010 was $6,757 from our bank deposit. In the first quarter of 2009 we had interest income of $10,589.

### Interest Expense

Interest expense for the three months ended March 31, 2010 is approximately $50,490, compared to $38,236 of the same period of 2009.

### Income Tax Expense

Income Tax expense for the three months ended March 31, 2010 is $0.49 million, compared to $0.36 million in the same quarter a year ago.

### Net Income

Our net income for the three months ended March 31, 2010 was approximately $4.3 million, which was $0.62 million higher than that for the three months ended March 31, 2009, of approximately $3.7 million, which represented an increase of about 17%.

### Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations and short term bank loans. As of March 31, 2010, cash and cash equivalents were $4,784,582, an increase of $1.1 million from $3,634,753 as of December 31, 2009. As of March 31, 2010, we had a balance of $3,803,338 in short-term bank loans.

During the first quarter of 2010, we continued our vigorous collection efforts from our customers and achieved good results. While we have made progress, improving accounts receivable collection continues to be a focus of the management team and we expect to make further progress in the quarters to come.

Based on our current operating plan, management believes that our cash provided by operations plus the proceeds from our existing bank loans will be sufficient to meet our working capital, new formula acquisitions, and our anticipated capital expenditures for the next twelve months. However, if events or circumstances occur and we do not meet our operating plan as expected, we may be required to seek additional capital and/or reduce certain discretionary spending, which could have a material adverse effect on our ability to achieve our business objectives. Notwithstanding the foregoing, we may seek additional financing, which may include debt and/or equity financing. There can be no assurance that any additional financing will be available on acceptable terms, if at all. Any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants.

### Cashflows for Three Months ended March 31, 2010 and 2009

|  | Three Month Ended March 31 2010 | 2009 |
| --- | ---: | ---: |
| **Net Cash Provided (Used by) Operating Activities** | 1,123,331 | 1,117,135 |
| **Net Cash Used in Investing Activities** | (2,557,029) | (2,899,929) |
| **Net Cash Provided by Financing Activity** | 2,583,000 | - |
| **Effect of Exchange Rate Changes on Cash** | 527 | 7,527 |
| Cash and Cash Equivalents at Beginning of Period | 3,634,753 | 6,927,149 |
| **Cash and Cash Equivalents at End of Period** | $4,784,582 | $5,151,882 |

16

#### Operating Activities:

Net cash provided by operating activities was $1.12 million in the three-month period ended March 31, 2010 compared to $1.12 million in the same period in 2009. The overall flattish operating cashflow growth masks the strong improvement in cash collection from receivables. Increase in net trade receivables is about $1.2 million in the quarter ended March 31, 2010 compared to $5 million in the corresponding quarter a year ago, even as sales revenue grew by 16%.

#### Investing Activities:

Net cash used in investing activities in the three months ended March 31, 2010 was $2.6 million. The majority of this cash usage was for our investments in a number of new drug formulas during the quarter. This was a decrease of $0.34 million compared to the same period in 2009 of $2.9 million.

#### Financing Activities:

During the quarter ended March 31, 2010, we issued approximately 1.1 million shares of common stock for total proceeds of $2.58 million from the exercise of warrants that were issued in our 2007 offering of equity units. During the comparable quarter a year ago, we had no cash flows from financing activities.

### Off-Balance Sheet Arrangements

There were no off-balance sheet arrangements during the three months ended March 31, 2010.

### Commitments

At March 31, 2010, the Company had no material commitments except for those expenditures incurred in the ordinary course of business.

### Critical Accounting Policies and Estimates

Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2009, for disclosures regarding our critical accounting policies and estimates. The interim financial statements follow the same accounting policies and methods of computations as those for the year ended December 31, 2009. There were no new accounting policies and estimates during the period ended March 31, 2010 which affected the Company.

***Recently Enacted Accounting Standards -*** In October 2009, the FASB issued a new accounting standard which provides guidance for arrangements with multiple deliverables. The new standard requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices. In addition, the new standard eliminates the use of the residual method of allocation and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue for an arrangement with multiple deliverables. In October 2009, the FASB also issued a new accounting standard which changes revenue recognition for tangible products containing software and hardware elements. If certain requirements are met, revenue arrangements that contain tangible products with software elements that are essential to the functionality of the products are scoped out of the existing software revenue recognition accounting guidance and will be accounted for under the multiple-element arrangements revenue recognition guidance discussed above. Both standards will be effective for us in the first quarter of 2011. Early adoption is permitted. We do not expect the adoption of these accounting standards will have a material impact on our consolidated financial statements.

## Controls and procedures

As filed, 2,215 characters.

### Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, has concluded that our disclosure controls and procedures were effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.

### Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act (a) is recorded, processed, summarized and reported within the time periods specified in the

Securities and Exchange Commission’s rules and forms and (b) is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

A system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the system will meet its objectives. The design of a control system is based, in part, upon the benefits of the control system relative to its costs. Control systems can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. In addition, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. In addition, the design of any control system is based in part upon assumptions about the likelihood of future events.

Filed May 10, 2010.
Source: SEC EDGAR, the filing index for accession 0001010549-10-000294. Last ingested by Listed: Oct 30, 2026, 16:51 ET. No prices; not investment advice.