# China Pharma Holdings, Inc.: Form 10-Q for the period ended Jun 30, 2012

- Company: [China Pharma Holdings, Inc.](/companies/cphi.md) (CIK 1106644)
- Form: 10-Q
- Filed: 2012-08-14
- Accepted by EDGAR: Aug 14, 2012, 16:06 ET
- Period: 2012-06-30
- Accession: 0001010549-12-000896
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1106644/000101054912000896/cphi10q063012.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1106644/000101054912000896/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2012-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2012-04-01 to 2012-06-30 | $14.6m | us-gaap:Revenues |
| Revenue | 6 months, 2012-01-01 to 2012-06-30 | $30.7m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2012-04-01 to 2012-06-30 | $10.5m | us-gaap:CostOfRevenue |
| Cost of revenue | 6 months, 2012-01-01 to 2012-06-30 | $21.2m | us-gaap:CostOfRevenue |
| Gross profit | 3 months, 2012-04-01 to 2012-06-30 | $4.1m | us-gaap:GrossProfit |
| Gross profit | 6 months, 2012-01-01 to 2012-06-30 | $9.4m | us-gaap:GrossProfit |
| Operating income | 3 months, 2012-04-01 to 2012-06-30 | $2.2m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2012-01-01 to 2012-06-30 | $5.6m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2012-04-01 to 2012-06-30 | −$78.5k | us-gaap:InterestExpense |
| Interest expense | 6 months, 2012-01-01 to 2012-06-30 | −$156.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2012-04-01 to 2012-06-30 | −$372.9k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2012-01-01 to 2012-06-30 | −$903.5k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2012-04-01 to 2012-06-30 | $1.8m | us-gaap:ProfitLoss |
| Diluted EPS | 3 months, 2012-04-01 to 2012-06-30 | $0.04 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2012-01-01 to 2012-06-30 | $0.10 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2012-04-01 to 2012-06-30 | $0.04 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2012-01-01 to 2012-06-30 | $0.10 | us-gaap:EarningsPerShareBasic |
| Operating cash flow | 6 months, 2012-01-01 to 2012-06-30 | $1.9m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2012-01-01 to 2012-06-30 | −$67.7k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2012-06-30 | $4.9m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2012-06-30 | $118.2m | us-gaap:AssetsCurrent |
| Total assets | at 2012-06-30 | $164.9m | us-gaap:Assets |
| Current liabilities | at 2012-06-30 | $16.6m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2012-06-30 | $16.7m | us-gaap:Liabilities |
| Shareholders' equity | at 2012-06-30 | $148.2m | us-gaap:StockholdersEquity |
| Shares outstanding | at 2012-06-30 | 43,529,557 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 35,802 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 readers 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 employees, and general business factors affecting our operations, markets, growth, services, products, licenses and other factors, some of which are described in this report and in “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission (“SEC”) and some of which are discussed in our other filings with the SEC. 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.*

*These forward-looking 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. 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, except as required by applicable law or regulation.*

### Business Overview

We are principally engaged in the development, manufacture, packaging, marketing and distribution of generic and branded pharmaceutical products for a wide range of high incidence and high mortality conditions in The People’s Republic of China (the “PRC”). All of our operations are conducted in the PRC, where our 8,000-square-meter manufacturing facility is located. With eight different production lines, we have the capability to manufacture pharmaceutical products in the form of dry powder injectables, liquid injectables, tablets, capsules, oral solutions and granules. Over 90% of our pharmaceutical products are sold on a prescription basis and have been approved for at least one or more therapeutic indications by the Chinese State Food and Drug Administration (the “SFDA”) based upon demonstrated safety and efficacy.

At June 30, 2012, we manufactured 20 pharmaceutical products for a wide variety of diseases and medical indications, each of which may be classified into one of three general categories: a basic generic drug, which is a common drug in the PRC marketplace for which there is a very large market, a “super” or “first to market” generic drug, which is a generic Western drug that is new to the PRC marketplace, and a modern Traditional Chinese Medicine, which generally is a non-synthetic, plant-based medicinal compound of the type that has been widely used in the PRC for thousands of years, to which we apply modern production techniques to produce a pharmaceutical product in different formulations, such as tablets, capsules or powders. In selecting generic drugs to develop and manufacture, we consider several factors, including the number of other manufacturers currently producing the particular drug, the size of the market, the proposed or required method of distribution, the existing and expected pricing for the particular drug in the marketplace, the costs of manufacturing that drug, and the costs of acquiring or developing the formula for that drug. We believe we have historically selected to manufacture generic drugs that have very large addressable markets and higher profit margins relative to other drugs being manufactured and distributed in the PRC.

In 2002, we built, and we currently own and operate, an approximately 8,000-square-meter manufacturing facility in Haikou, Hainan Province that supports eight modern, scalable production lines. We implement quality control procedures in compliance with standards for Good Manufacturing Practice, or GMP standards, and applicable SFDA regulations to ensure consistent quality in our products.

We market and sell our products through 16 sales offices covering all major cities and provinces in China. To comply with applicable Chinese law relating to sales of prescription drugs to certain hospitals and clinics, we also use a distribution system comprised of approximately 1,800 independent regional distributors.

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 of June 30, 2012, in addition to our portfolio of 20 commercialized products, we had a number of drugs at different stages of the SFDA registration process.

Below we list the current status of some of our pipeline products:

- Antibiotic Combination. We completed the Phase I clinical trials of our novel cephalosporin-based combination antibiotic in the third quarter of 2010. We are currently in Phase II of the clinical trial and it is progressing well.
- Rosuvastatin. Rosuvastatin is a generic form of Crestor, a drug for indication of high blood cholesterol level. Clinical trials for this generic drug were completed in the fourth quarter of 2010 and we have submitted an application for production approval.
- Candesartan. We originally submitted application for production approval of Candesartan, a front-line drug therapy we developed for the treatment of hypertension in 2010. We received request for additional procedures in the fourth quarter of 2011 and we have since completed all newly requested procedures and are currently waiting for the final production approval from the SFDA.

Heart Disease Drug. We are developing a medicine for the treatment of coronary heart disease. This product comes with a patented TCM formula and we are currently conducting Phase III clinical trials for this drug. We anticipate the completion of the clinical trail for this product to be completed by the end of 2012.

In addition to the products listed above, we have a number of other new products (also with focus on our main therapeutic areas) pending in various stages of SFDA technical review. We are also evaluating additional opportunities on an on-going basis, directed by the organic growth and market demands of China's pharmaceutical market. We are working closely with several pharmaceutical research institutions and universities to help us identify existing drugs and formulas that would fit well with our business model, thus paving the way to generate new products to support our revenue growth in the future. We remain focused on improving our product portfolio and increasing our internal growth, maintaining and developing new marketing channels, and using our existing sales network in the expanding markets in the PRC to raise our overall market share. The organic growth of the Chinese pharmaceutical market has had a positive effect on, and will continue to direct, our company's development.

The growth of China’s pharmaceutical market has largely been 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.

The Healthcare Reform program announced by the Chinese government in late 2009 is currently having a significant impact on all healthcare related industries in China, including the pharmaceutical industry. The pressure of price control from National Development and Reform Commission’s (NDRC) is continuously transmitted to pharmaceutical manufacturers. Furthermore, we observed that there are significant variations in timing and market reaction to the new environment, causing fluctuation in sales volume in some of the affected products. While pricing is generally set at the central government level, provincial government intervention has added complexity to the pricing-volume interaction. In addition to products listed on the Essential Drug List (“EDL”), we are also experiencing pricing pressure on most of our products. While these changes have more impact on pharmaceutical distribution companies, manufacturers of pharmaceutical products are also affected. We believe the general implication is that gross margins for pharmaceutical products will continue to be under pressure for some time. That being said, we believe a pharmaceutical manufacturer with experienced management and the ability to react quickly to changes will survive in this environment.

Like the other Chinese pharmaceutical manufacturers, our Company is required to upgrade our facility to the new GMP standards, which were published by the Ministry of Health of China on February 12, 2011, effective March 1, 2011. This round of upgrading is a challenge for all players, and also means survival of the fittest. The new GMP standards refer relevant E.U. standards and U.S. FDA standards, combined with the actual situation in China, present stricter requirements regarding the manufacturing process – particularly protecting against bacterial contamination, logistics chains, and workers’ abilities. They significantly raised the GMP standards in China. Existing drug manufacturers like us, depending on the risks of the products we manufacture, were given a grace period of up to three to five years to comply with the GMP standards. We are under the pressure of man power, material resources and timing to complete this upgrading.

### Results of Operations

The following table presents our results of operations for the three-month period ended June 30, 2012 and 2011.

|  | Three Months Ended June 30, 2012 | 2011 | Change | % Chg |
| --- | ---: | ---: | ---: | ---: |
| Revenue | $14,598,403 | $19,600,852 | $(5,002,449) | -26% |
| Cost of Revenue | 10,460,047 | 12,318,868 | (1,858,821) | -15% |
| Gross Profit | 4,138,356 | 7,281,984 | (3,143,628) | -43% |
| Selling Expenses | 881,945 | 799,220 | 82,725 | 10% |
| General and Admin Expenses | 812,741 | 986,949 | (174,208) | -18% |
| Bad Debt Expense | 233,139 | (118,704) | 351,843 |  |
| Government subsidy income | - | 145,447 | (145,447) |  |
| Income from Operations | 2,210,531 | 5,759,966 | (3,549,435) | -62% |
| Net Interest Income (Expense) | (77,681) | (58,768) | (18,913) |  |
| Derivative Gain | - | 256,762 | (256,762) |  |
| Income Tax Expense | (372,932) | (888,890) | 515,958 | -58% |
| **Net Income** | **$1,759,918** | **$5,069,070** | **$(3,309,152)** | **-65%** |
| Basic Net Income per Share | $0.04 | $0.12 | $(0.08) | -67% |
| Basic Weighted Average Shares Outstanding | 43,571,590 | 43,454,008 | 117,582 |  |
| Diluted Net Income per Share | $0.04 | $0.12 | $(0.08) | -65% |
| Diluted Weighted Average Shares Outstanding | 43,571,590 | 43,454,008 | 117,582 |  |

### Three Months Ended June 30, 2012 and 2011

### Revenue

For the three months ended June 30, 2012, our sales revenue decreased by $5.0 million, or 25.5%, to $14.6 million from the $19.6 million in the corresponding period of 2011. The revenue decreased mainly because we reduced our sales-on-credit in order to improve the collection of accounts receivables. In addition, there have been disruptions from the implementation of the ever-changing Healthcare Reform policies. Volatile profit margins at various links in the distribution chain are affecting our products sales structure in unpredictable ways and negatively impacting our revenues.

Set forth below are our revenues by product category in millions USD for each of the three months ended June 30, 2012 and 2011.

### Sales Revenue by Major Category (Dollars in Millions)

| Product Category | Three Months Ended June 30 2012 | 2011 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 4.1 | $ 6.0 | -$ 1.9 | -32% |
| Anti-Viro/ Infection & Respiratory | $ 6.7 | $ 8.1 | -$ 1.4 | -17% |
| Digestive Diseases | $ 1.7 | $ 2.6 | -$ 0.9 | -36% |
| Other | $ 2.1 | $ 2.9 | -$ 0.8 | -27% |

During the second quarter of fiscal 2012, our overall sales revenue fell by 25.5% on a year-over-year basis. Most of the decline was from our CNS Cerebral & Cardio Vascular category where sales fell by $1.9 million, or 31.7% to $4.1 million from $6.0 million for the quarter ended June 30, 2012. Short fall in sales of Ozagrel Sodium for Injection and Buflomedil Hydrochloride were major contributors for the decline. Sales in the Anti-Viro/ Infection & Respiratory category fell by $1.4 million or 16.7% to $6.7 million from $8.1 million in the prior year period. The “Digestive” category sales revenues edged lower by $0.9 million, or 35.6% to $1.7 million from $2.6 million in the same period prior year. Sales of “Other” category fell by $0.8 million, or 27.1% to $2.1 million from $2.9 million in 2nd quarter of 2011.

The impact of the implementation of the Healthcare Reform has affected pricing of our products throughout the distribution chain. These changes are causing unpredictable volatility in sales because pricing changes are not uniform across all geographical areas. As margins decline due to pricing pressures, every link of the distribution chain is being squeezed and becoming less active. We think pricing pressure from the Healthcare Reform will continue for some time.

Anti-Viro Infection & Respiratory was our largest category by sales in the second quarter of 2012 by capturing 46% of total revenue compares to 41% a year ago. CNS Cerebral & Cardio Vascular category came in second, representing 28% of total sales compares to 31% in the corresponding quarter a year ago. Sales of Other category represented 16% of total sales in the latest quarter compared to 15% a year ago. Sales of our Digestive Disease category were 10% of total sales in the second quarter of 2012 compared to 13% last year.

### Gross Margin and Gross Profit

Gross profit for the three months ended June 30, 2012 was $4.14 million, which was 43.2% lower compared to $7.28 million in the second quarter of 2011. Our gross margin for the second quarter of 2012 was 28.3%, compared to 37.2% in the corresponding quarter of 2011. We are seeing pricing pressure on most of our products, although the pressure is not uniform across product lines. We expect current challenging pricing environment to persist for some time.

Pricing pressure has become more evident over the past few quarters as the effect of the Chinese government healthcare reform is being felt across all pharmaceutical products, especially in EDL related products.

In terms of our gross margins by major categories, Anti-Viro/Infection & Respiratory category was 26.1% compared to 26.2% in the second quarter 2011. Gross margin for our CNS Cerebral & Cardio Vascular category margins fell to 29.8% from the second quarter 2011 gross margin of 42.9%.Gross margin for our Digestive Diseases category decreased to 28.3% from 45.7%, and gross margin for our Other category fell to 33.7% from 42.5%.

In the coming quarters, we expect to see continued pricing pressures, but believe our new products, such as Candesartan and Rosuvastatin, can help to support overall gross margin once they are launched.

### Selling Expenses

Our selling expenses for the three months ended June 30, 2012 were $0.88 million, an increase of 10%, compared to $0.80 million for the three months ended June 30, 2011. Selling expenses were approximately 6.0% of revenue in the second quarter of 2012 compared to 4.1% during the comparable quarter a year ago. The implementation of the healthcare reform and EDL requires more man power and material resources to do the marketing, which led the increase in selling expenses. Expansion of sales team in the grass-root healthcare institutions as well as rising wages contributed to the overall rising labor cost.

### General Administrative Expenses

Our general and administrative expenses for the three months ended June 30, 2012 were $0.81 million, or 5.6% of total revenue, a decrease of $0.17 million, compared to $0.99 million, or 5.0% of total revenue, for the same period in 2011. Our general and administrative expenses tend to fluctuate at around 5% of total revenue, and our second quarter 2012 general administrative expenses were in line with historical norms.

### Bad Debt Expense and Account Receivables

In general, our normal credit or payments terms extended to customers are 90 days. This has not changed in recent years. Our customers are pharmaceutical distributors who sell to mostly government backed hospitals. Since hospital pharmacies in China typically take a very long time to pay for their pharmaceutical products, the age of our receivables from our customers tends to be long as well. Although these customers typically pay after the due date of the receivables, we have always been able to collect our receivables and have never had an uncollectible receivable from these customers.

The amount of accounts receivable that were past due (or the amount of accounts receivable that were more than 90 days old) was $59.7 million and $51.4 million as of June 30, 2012 and December 31, 2011, respectively. The following table illustrates our accounts receivable aging distribution in terms of percent of total accounts receivable as of June 30, 2012 and December 31, 2011:

|  | June 30, 2012 | December 31, 2011 |
| --- | ---: | ---: |
| 1 - 90 Days | 16.3% | 29.9% |
| 90 - 180 Days | 20.0% | 21.8% |
| 180 - 360 Days | 33.8% | 27.9% |
| 360 - 720 Days | 29.9% | 20.4% |
| Total | 100% | 100% |

Although we have not had to write off any receivables so far in our Company’s history, we do set aside an allowance for doubtful accounts. Our bad debt allowance estimate is currently the sum of 3.5% of accounts receivable that are less than 365 days old, 10% of accounts receivable that are between 365 days and 720 days old and 100% of accounts receivable amounts that are greater than 720 days old (although there were no amounts over 720 days old at June 30, 2012 or December 31, 2011).

To the extent that our current allowance for doubtful accounts is higher than that of the previous period, we recognize a bad debt expense for the difference during the current period, and when the current allowance is lower than that of the previous period, we recognize a bad debt benefit for the difference. As of June 30, 2012, our allowance for doubtful accounts was $4.11 million compared to $3.54 million as of December 31, 2011. The increase in the allowance was mainly due to an increase in our accounts receivable that is between 360 days old and 720 days old, and was recognized as bad debt expense during the six months ended June 30, 2012 of $553,237. By comparison, we had the bad debt benefit of $109,276 during the quarter ended June 30, 2011. The changes in the allowance for doubtful accounts during the six months ended June 30, 2012 and 2011 were as follows (there were no write-offs or recoveries):

|  | For the Six Months Ended June 30, 2012 | 2011 |
| --- | ---: | ---: |
| Balance, Beginning of Period | $3,536,405 | $3,317,017 |
| Bad debt expense (benefit) | 553,237 | (109,276) |
| Foreign currency translation adjustment | 17,379 | 328,664 |
| Balance, End of Period | $4,107,021 | $3,536,405 |

### Income from Operations

Our operating income for the three months ended June 30, 2012 was approximately $2.21 million, compared to $5.76 million for the same period in 2011, which represented a decrease of $3.55 million, or 61%. The decrease in operating income was mainly due to lower gross revenue, higher operating expenses in the current period compared to the corresponding quarter one year ago; and the one-time government subsidy income we got in the second quarter of 2011.

### Derivative Gains (Losses)

Changes to the derivative warrant liability are recognized in the results of operations. A derivative gain of $0.26 million was recorded during three months ended June 30, 2011. Our warrants which were subject to derivative liability expired in May of 2011 and we had no derivative profit or loss in three months period ended June 30, 2012.

### Income Tax Expense

Income tax expense for the three months ended June 30, 2012 was $0.37 million, compared with $0.89 million in the same quarter a year ago. When our favorable income tax rate of 11% ended on December 31, 2010, our tax rate was going to increase to 24% in 2011 and ramp up to the final statutory rate of 25% in 2012 and 2013. However, because we obtained the “National High-tech Enterprise” status, our tax rate has remained at 15% since 2011 and will remain at 15% until the end of 2013.

### Net Income

Our net income for the three months ended June 30, 2012 was $1.76 million, a decrease of $3.31 million, or 65%, from $5.07 million for the three months ended June 30, 2011. The main reasons for the decrease in our net income are the decrease in sales revenue, falling gross margins and higher operating expenses. Our net income for the second quarter of 2011 also included a positive effect of $0.26 million derivative gains.

### Six Months Ended June 30, 2012 and 2011

The following table presents our results of operations for the six-month period ended June 30, 2012 and 2011.

|  | Six Months Ended June 30, 2012 | 2011 | Change | % Chg |
| --- | ---: | ---: | ---: | ---: |
| Revenue | $30,685,134 | $37,720,409 | $(7,035,275) | -19% |
| Cost of Revenue | 21,242,431 | 23,568,814 | (2,326,383) | -10% |
| Gross Profit | 9,442,703 | 14,151,595 | (4,708,892) | -33% |
| Selling Expenses | 1,776,005 | 1,403,701 | 372,304 | 27% |
| General and Admin Expenses | 1,489,143 | 1,903,894 | (414,751) | -22% |
| Bad Debt Expense | 553,237 | (109,276) | 662,513 | -606% |
| Government subsidy income | - | 145,447 | (145,447) | -100% |
| Income from Operations | 5,624,318 | 11,098,723 | (5,474,405) | -49% |
| Net Interest Income (Expense) | (154,528) | (118,021) | (36,507) | 31% |
| Derivative Gain | - | 934,260 | (934,260) | -100% |
| Income Tax Expense | (903,513) | (1,742,270) | 838,757 | -48% |
| **Net Income** | **$4,566,277** | **$10,172,692** | **$(5,606,415)** | **-55%** |
| Basic Net Income per Share | $0.10 | $0.23 | $(0.13) | -57% |
| Basic Weighted Average Shares Outstanding | 43,550,573 | 43,429,419 | 121,154 |  |
| Diluted Net Income per Share | $0.10 | $0.23 | $(0.13) | -57% |
| Diluted Weighted Average Shares Outstanding | 43,550,573 | 43,429,419 | 121,154 |  |

21

### Revenue

For the six months ended June 30, 2012, our sales revenue decreased by $7.0 million, or 19%, to $30.7 million from the $37.7 million we generated in the corresponding period of 2011.

Set forth below are our revenues by product category in millions USD for each of the six months ended June 30, 2012 and 2011.

### Sales Revenue by Major Category (Dollar in Millions)

| Product Category | Six Months Ended June 30, 2012 | 2011 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 8.9 | $ 11.4 | -$ 2.5 | -22% |
| Anti-Viro/ Infection & Respiratory | $ 13.5 | $ 15.1 | -$ 1.6 | -11% |
| Digestive Diseases | $ 4.2 | $ 5.2 | -$ 1.0 | -19% |
| Other | $ 4.1 | $ 6.0 | -$ 1.9 | -32% |

During the first half of fiscal 2012, our overall sales revenue decreased by 19% on a year-over-year basis, led by the CNS Cerebral & Cardio Vascular and the “Other” categories. Sales in the CNS Cerebral & Cardio Vascular category drop by $2.5 million, or 22%, to $8.9 million from $11.4 million. Our performance in this category was impacted by sales drop of Ozagrel Sodium for Injection and Buflomedil Hydrochloride. Sales in the “Other” category drop by $1.9 million, or 32%, to $4.1 million from $6.0 million. Our performance in this category was impacted by sales drop of Vitamin B6 for Injection. The Anti-Viro/Infection & Respiratory category decreased by $1.6 million, or 11%, to $13.5 million from $15.1 million. Sales of “Digestive” products decreased by $1.0 million, or 19%, to $4.2 million from $5.2 million.

### Gross Margin and Gross Profit

Gross profit for the six months ended June 30, 2012 was $9.4 million, which was approximately 33% lower compared to $14.2 million in the first six months of 2011. Our gross margin for the first half of 2012 was 30.8%, compared to 37.5% in the corresponding six months of 2011. We are seeing steady pricing pressure on many of our products, although the pressure is not uniform across product lines. We expect current uncertain pricing environment to last for some time.

While sales growth in our new and relatively higher-margin products helped to support overall margin, it was not enough to offset the sales growth of our lower-margin products. In the coming quarters, we expect to see continued pricing pressures, but believe our new products, such as Candesartan and Rosuvastatin, can help to support overall gross margin once they are launched.

### Selling Expenses

Our selling expenses for the six months ended June 30, 2012 were $1.78 million, an increase of 26.5%, compared to $1.40 million for the six months ended June 30, 2011. Selling expenses were approximately 5.8% of revenue in the first half of 2012 compared to 3.7% during the comparable period a year ago.

### General Administrative Expenses

Our general and administrative expenses for the six months ended June 30, 2012 were $1.49 million, a drop of $0.41 million, or 22%, compared to $1.90 million for the same period in 2011.

### Bad Debt Expense (Benefit)

Our bad debt expense for the six months ended June 30, 2012 were $0.55 million, compared to a bad debt benefit of $0.11 million for the same period in 2011. Please see additional discussion of bad debt and account receivables in the section above named "Bad Debt Expense and Account Receivables"

### Income from Operations

Our operating income for the six months ended June 30, 2012 was approximately $5.62 million, compared to $11.10 million for the same period in 2011, which represented a drop of $5.47 million, or 49%. The decreasing operating income performance was primarily due to lower revenue, lower gross profit and higher operating expenses in the current period compared to the corresponding period one year ago.

### Derivative Gains (Losses)

Changes to the derivative warrant liability are recognized in the results of operations and resulted in a derivative gain of $0.93 million during six months ended June 30, 2011. Our warrants which were subject to derivative liability expired in May of 2011 and we had no derivative profit or loss in six months period ended June 30, 2012.

### Income Tax Expense

Income tax expense for the six months ended June 30, 2012 was $0.90 million, compared with $1.74 million in the first half a year ago. The corporate tax rate for our operating subsidiary in China was 11% in 2011, but increased to 15% for fiscal 2012. When our favorable income tax rate of 11% ended on December 31, 2010, our tax rate was going to increase to 24% in 2011 and ramp up to the final statutory rate of 25% in 2012 and 2013. However, because we obtained the “National High-tech Enterprise” status, our tax rate has remained at 15% since 2011 and will remain at 15% until the end of 2013.

### Net Income

Our net income for the six months ended June 30, 2012 decreased by $5.61 million, or approximately 55%, to $4.57 million from $10.17 million for the six months ended June 30, 2011.

### Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations and short-term bank loans. As of June 30, 2012, our cash and cash equivalents outstanding was $4.87 million, which represents 3.0% of our total assets, an increase of $0.82 million from $4.05 million as of December 31, 2011. Of the $5.28 million of cash and cash equivalents and Banker’s Acceptances at June 30, 2012, a total of $5.28 million is considered to be reinvested indefinitely in Helpson and is not expected to be available for payment of dividends, or other payments to our parent company or to its shareholders. As of June 30, 2012, we had a principal balance of $3.96 million in short-term bank loans. The combination of cash flow generated from operating activities and cash flow from financing activities funded the new purchases of our intangible assets (drug formulas).

### Selected Cashflows for Six Months ended June 30, 2012 and 2011

| Cashflow from Operations | Six Months Ended June 30, 2012 | 2011 |
| --- | ---: | ---: |
| Net Income | 4,566,277 | 10,172,692 |
| Depreciation & Amortization | 729,167 | 890,895 |
| Changes in Assets & Liabilities |  |  |
| Account Receivables | (3,756,396) | (2,632,631) |
| Advances to Suppliers | 1,873,778 | 110,882 |
| Inventory | (4,552,918) | (3,086,326) |
| Accounts Payable | 1,768,420 | (2,204,755) |
| **Net Cash Provided by Operations** | **1,894,385** | **3,607,089** |
| **Cashflow from Investing Activities** |  |  |
| Advances for purchases of property & equipment and intangible assets | (1,270,399) | (2,434,004) |
| **Net Cash Used by Investing Activities** | **(1,338,121)** | **(2,892,694)** |
| **Net Cash Provided by Financing Activities** | **293,004** | **187,919** |
| Effect of Exchange Rate change on Cash | (28,571) | 93,257 |
| **Total Change in Cash** | **820,697** | **995,571** |
| Cash & Equivalent Beginning Balance | 4,050,854 | 3,692,086 |
| Cash & Equivalent Ending Balance | $4,871,551 | $4,687,657 |

#### Operating Activities:

Net cash provided by operating activities was $1.89 million in the six months period ended June 30, 2012 compared to $3.61 million for the same period in 2011. The decrease in cash provided by operating activities was mainly due to lower net income, and increases in inventory and accounts receivable in the period ended June 30, 2012 compared to the corresponding period in 2011. This is partially offset by decreases in advances to suppliers and increases in accounts payable in the period ended June 30, 2012 compared to the corresponding period in 2011.

At June 30, 2012, our accounts receivable was $71.4 million, an increase of $1.7 million from $69.7 million at December 31, 2011. Our receivables increased because our collection was not enough to offset account receivable increases as a result of new sales. For the first half in fiscal 2012, $3.76 million was used to fund increases in Account Receivables, compared to $2.63 million was used to fund increases in Account Receivables in the comparable period a year ago.

At June 30, 2012, total inventory was $36.4 million, an increase of $6.0 million from $30.4 million at December 31, 2011. Most of the inventory increase in the first half of 2012 was due to increased purchase of raw material inventory as well as a temporary rise in finished goods. Cash usage on Inventories for the six months period ended June 30, 2012 was $4.55 million as compared to $3.09 million in the comparable period for 2011.

For the period ending June 30, 2012, the increase in our accounts payable was responsible for a cash addition of $1.77 million while in the same period in 2011 a decrease in accounts payable resulted in cash usage of $2.20 million.

#### Investing Activities:

Net cash used in investing activities in the six months ended June 30, 2012 was $1.34 million. The majority of the cash was used for our investments in new drug formulas during the period. This was a decrease of $1.55 million compared to the same period in 2011 of $2.89 million which also was used to purchase new drug formulas.

#### Financing Activities:

During the first half of 2012, a related party lent our company $293,004 at an interest rate of 1% per annum and expiration date at December 31, 2012.

According to relevant PRC laws, companies registered in the PRC, including our PRC subsidiary, Helpson, are required to allocate at least ten percent (10%) of their after-tax net income, as determined under accounting standards and regulations in the PRC, to statutory surplus reserve accounts until the reserve account balances reach fifty percent (50%) of the companies’ registered capital prior to their remittance of funds out of the PRC. Allocations to these reserves and funds can only be used for specific purposes and are not transferrable to the parent company in the form of loans, advances or cash dividends. As of December 31, 2011 and 2010, the net assets of Helpson were $135,748,004 and $110,804,607, respectively. Due to the restriction on dividend distribution to overseas shareholders, the amount of Helpson’s net assets that were designated for general and statutory capital reserves, and thus could not be transferred to our parent company as cash dividends, were $7,863,490 and $7,562,237 (50% of registered capital) for the fiscal years ended December 31, 2011 and 2010. Since the amount that Helpson must set aside for the statutory surplus fund only accounts for 5.8% and 6.8%, respectively, of its total net assets, this reserve does not have a major impact on our liquidity.

The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. Our businesses and assets are primarily denominated in RMB. All foreign exchange transactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requires submitting a payment application form together with applicable invoices and signed contracts. These currency exchange control procedures imposed by the PRC government authorities may restrict the ability of Helpson, our PRC subsidiary, to transfer its net assets to our parent company through loans, advances or cash dividends.

### Off-Balance Sheet Arrangements

There were no off-balance sheet arrangements during the six-month periods ended June 30, 2012 or 2011.

### Commitments

At June 30, 2012 and 2011, we 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, 2011, 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, 2011. There were no new accounting policies and estimates during the three-month period ended June 30, 2012 that affected us in any material respect.

## Market risk

As filed, 139 characters.

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this item.

## Controls and procedures

As filed, 1,943 characters.

### Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and interim Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report. 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. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as described above. Based on this evaluation, our Chief Executive Officer and interim Chief Financial Officer concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective.

### 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.

Filed Aug 14, 2012.
Source: SEC EDGAR, the filing index for accession 0001010549-12-000896. Last ingested by Listed: Oct 30, 2026, 16:51 ET. No prices; not investment advice.