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

- Company: [China Pharma Holdings, Inc.](/companies/cphi.md) (CIK 1106644)
- Form: 10-Q
- Filed: 2012-11-14
- Accepted by EDGAR: Nov 14, 2012, 16:07 ET
- Period: 2012-09-30
- Accession: 0001010549-12-001213
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1106644/000101054912001213/cphi10q093012.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1106644/000101054912001213/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2012-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2012-07-01 to 2012-09-30 | $12.2m | us-gaap:Revenues |
| Revenue | 9 months, 2012-01-01 to 2012-09-30 | $42.9m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2012-07-01 to 2012-09-30 | $8.9m | us-gaap:CostOfRevenue |
| Cost of revenue | 9 months, 2012-01-01 to 2012-09-30 | $30.2m | us-gaap:CostOfRevenue |
| Gross profit | 3 months, 2012-07-01 to 2012-09-30 | $3.2m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2012-01-01 to 2012-09-30 | $12.7m | us-gaap:GrossProfit |
| Operating income | 3 months, 2012-07-01 to 2012-09-30 | $1.6m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2012-01-01 to 2012-09-30 | $7.2m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2012-07-01 to 2012-09-30 | −$79.5k | us-gaap:InterestExpense |
| Interest expense | 9 months, 2012-01-01 to 2012-09-30 | −$235.5k | us-gaap:InterestExpense |
| Income tax | 3 months, 2012-07-01 to 2012-09-30 | −$244.5k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2012-01-01 to 2012-09-30 | −$1.1m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2012-07-01 to 2012-09-30 | $1.3m | us-gaap:ProfitLoss |
| Diluted EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.03 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2012-01-01 to 2012-09-30 | $0.13 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.03 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2012-01-01 to 2012-09-30 | $0.13 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2012-07-01 to 2012-09-30 | 43,560,305 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2012-01-01 to 2012-09-30 | 43,560,305 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2012-01-01 to 2012-09-30 | $3.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2012-01-01 to 2012-09-30 | −$81.4k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2012-09-30 | $5.1m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2012-09-30 | $118.7m | us-gaap:AssetsCurrent |
| Total assets | at 2012-09-30 | $166.0m | us-gaap:Assets |
| Current liabilities | at 2012-09-30 | $16.5m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2012-09-30 | $16.7m | us-gaap:Liabilities |
| Shareholders' equity | at 2012-09-30 | $149.3m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 38,536 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 September 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.

Like the other Chinese pharmaceutical manufacturers, we are required to upgrade our manufacturing and quality control facility to the new GMP standards, which were published by the Ministry of Health of China on February 12, 2011, effective March 1, 2011. The new GMP standards significantly raised the standards in the PRC and present stricter, mandatory requirements for, among other things, our manufacturing and quality control processes, key manufacturing and quality control personnel, and our supply and logistics chains. Per those mandatory requirements, the upgrading of our two injectable product lines must be accomplished by the end of 2013. We have completed the planning, design and an environment contamination evaluation, and commenced construction relative to certain required facilities and equipment. We continue to evaluate and implement the additional requirements of the standards.

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 1,500 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 September 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:

- Candesartan. Candesartan is an angiotensin II receptor antagonist serving as a first-line treatment for hypertension. The hypertension population in the PRC has reached 200 million, and the market size for angiotensin II receptor antagonist was approximately CNY2.65 billion ($0.42 billion) in 2010, according to *Report on Cardiovascular Diseases in China*. We received the production approval from the SFDA in November 2012 and plan to start production in the first quarter of fiscal 2013.
- 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.
- 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 trial 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 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 expand and 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 (“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 fluctuations in sales volume in 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 pricing 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.

### Results of Operations

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

|  | Three Months Ended September 30 2012 | 2011 | Change | % Chg |
| --- | ---: | ---: | ---: | ---: |
| Revenue | $12,176,344 | $20,987,725 | $(8,811,381) | -42% |
| Cost of Revenue | 8,932,552 | 13,472,804 | (4,540,252) | -34% |
| Gross Profit | 3,243,792 | 7,514,921 | (4,271,129) | -57% |
| Selling Expenses | 856,172 | 1,006,815 | (150,643) | -15% |
| General and Admin Expenses | 598,258 | 621,336 | (23,078) | -4% |
| Bad Debt Expense | 171,508 | (76,187) | 247,695 | -325% |
| Government subsidy income | - | 968 | (968) | -100% |
| Income from Operations | 1,617,854 | 5,963,925 | (4,346,071) | -73% |
| Net Interest Income (Expense) | (77,919) | (61,197) | (16,722) | 55% |
| Income Tax Expense | (244,452) | (927,845) | 683,393 | -74% |
| **Net Income** | **$1,295,483** | **$4,974,883** | **$(3,436,766)** | **-74%** |
| Basic Net Income per Share | $0.03 | $0.11 | $(0.08) |  |
| Basic Weighted Average Shares Outstanding | 43,560,305 | 43,529,557 | 30,748 |  |
| Diluted Net Income per Share | $0.03 | $0.11 | $(0.08) |  |
| Diluted Weighted Average Shares Outstanding | 43,560,305 | 43,529,557 | 30,748 |  |

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

### Revenue

For the three months ended September 30, 2012, our revenue decreased by $8.8 million, or 42%, to $12.2 million from $21.0 million in the corresponding period of 2011. The revenue decreased mainly because the implementation of the ever-changing Healthcare Reform policies and the associated pricing adjustments. In addition we reduced our sales-on-credit in order to control our accounts receivables.

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

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

| Product Category | Three Months Ended September 30 2012 | 2011 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 3.2 | $ 7.2 | -$ 4.0 | -56% |
| Anti-Viro/ Infection & Respiratory | $ 5.1 | $ 8.2 | -$ 3.1 | -37% |
| Digestive Diseases | $ 1.2 | $ 3.2 | -$ 2.0 | -62% |
| Other | $ 2.5 | $ 2.3 | $ 0.2 | 8% |

During the third quarter of fiscal 2012, our overall sales revenue fell by 42% on a year-over-year basis. Most of the decline was from our CNS Cerebral & Cardio Vascular category where sales fell by $4.0 million, or 56% to $3.2 million from $7.2 million for the quarter ended September 30, 2012. Shortfalls 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 $3.1 million or 37% to $5.1 million from $8.2 million in the prior year period. The “Digestive” category sales revenues edged lower by $2.0 million, or 62% to $1.2 million from $3.2 million in the same period prior year. This was mainly because sales across this category were significantly influenced by the NDRC’s price adjustment targeting digestive drugs specifically in the first half of this year. Sales of “Other” category increased by $0.2 million, or 8% to $2.5 million from $2.3 million in third 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 believe pricing pressure from the Healthcare Reform will continue for some time.

| Product Sales by Category/Total Sales | Three Months Ended September 30, 2012 | 2011 |
| --- | ---: | ---: |
| CNS Cerebral & Cardio Vascular | 26% | 34% |
| Anti-Viro/ Infection & Respiratory | 42% | 39% |
| Digestive Diseases | 10% | 15% |
| Other | 21% | 11% |

Anti-Viro Infection & Respiratory was our largest category by sales in the third quarter of 2012 by capturing 42% of total revenue compared to 39% a year ago. CNS Cerebral & Cardio Vascular category came in second, representing 26% of total sales compares to 34% in the corresponding quarter a year ago. Sales of Other category represented 21% of total sales in the latest quarter compared to 11% a year ago. Sales of our Digestive Disease category were 10% of total sales in the third quarter of 2012 compared to 15% last year.

### Gross Profit

Gross profit for the three months ended September 30, 2012 was $3.24 million, which was 56.8% lower compared to $7.51 million in the third quarter of 2011. Our gross margin for the third quarter of 2012 was 26.6%, compared to 35.8% in the corresponding quarter of 2011. Price controls plus rising pharmaceutical materials costs have been squeezing our profit. We expect current challenging pricing environment to persist for some time.

| Gross Profit Margin | Three Months Ended September 30, 2012 | 2011 |
| --- | ---: | ---: |
| CNS Cerebral & Cardio Vascular | 23% | 43% |
| Anti-Viro/ Infection & Respiratory | 28% | 24% |
| Digestive Diseases | 36% | 45% |
| Other | 23% | 42% |

In terms of our gross margins by major categories, Anti-Viro/Infection & Respiratory category was 28% in the third quarter of 2012, compared to 24% in the third quarter 2011 and 26% in the second quarter of 2012. Gross margin for our CNS Cerebral & Cardio Vascular category margins was 23% in the third quarter of 2012, compared to 43% in the third quarter 2011 and 30% in the second quarter of 2012. The margin decrease of this category was mainly due to several rounds of pricing cutting by NDRC on products including this category since last year. This has created certain negative impact on margins of products in this category. In addition, Gastrodin Injection, which was most severely impacted by this margin pressure, contributed to a much more significant share to total sales of this category in the third quarter 2012 compared to the same period last year. Nevertheless, we believe the fluctuation due to periodic performance of any single product does not predict any trend by itself. Gross margin for our Digestive Diseases category was 36% in the third quarter of 2012, compared to 45% in the third quarter 2011 and 28% in the second quarter of 2012. And gross margin for our Other category was 23% in the third quarter of 2012, compared to 42% in the third quarter 2011 and 34% in the second quarter of 2012.

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. We’ve received the production approval for Candesartan from the SFDA during November 2012, and plan to start production in the first quarter of fiscal 2013.

### Selling Expenses

Our selling expenses for the three months ended September 30, 2012 were $0.86 million, a decrease of 15%, compared to $1.01 million for the three months ended September 30, 2011. Selling expenses were approximately 7.0% of revenue in the third quarter of 2012 compared to 4.8% during the comparable quarter a year ago.

### General Administrative Expenses

Our general and administrative expenses for the three months ended September 30, 2012 were approximately $0.60 million, or 4.9% of total revenue, a decrease of $0.23 million, compared to $0.62 million, or 3.0% 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 third quarter 2012 general administrative expenses were in line with historical norms.

### Bad Debt Expense and Account Receivables

Bad debt expense for the three months ended September 30, 2012 was $0.17 million, compared to bad debt benefit of $0.08 million for the three months ended September 30, 2011. The increase is due to higher accounts receivable in the current quarter and increases due to higher allowance rates due to the composition of the accounts receivable aging.

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 $64.6 million and $51.4 million as of September 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 September 30, 2012 and December 31, 2011:

|  | September 30, 2012 | December 31, 2011 |
| --- | ---: | ---: |
| 1 - 90 Days | 13.0% | 29.9% |
| 91 - 180 Days | 16.4% | 21.8% |
| 181 - 360 Days | 35.9% | 27.9% |
| 361 - 720 Days | 34.7% | 20.4% |
| Over 720 Days | -% | -% |
| Total | 100% | 100% |

Although we have not had to write off any receivables so far in our 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 360 days old, 10% of accounts receivable that are between 360 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 September 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 September 30, 2012, our allowance for doubtful accounts was $4.27 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 nine months ended September 30, 2012 of $724,745. By comparison, we recognized a bad debt benefit of $185,463 during the quarter ended September 30, 2011. The changes in the allowance for doubtful accounts during the nine months ended September 30, 2012 and 2011 were as follows (there were no write-offs or recoveries):

|  | For the Nine Months Ended September 30, 2012 | 2011 |
| --- | ---: | ---: |
| Balance, Beginning of Period | $3,536,405 | $3,317,017 |
| Bad debt expense (benefit) | 724,745 | (185,463) |
| Foreign currency translation adjustment | 7,206 | 90,172 |
| Balance, End of Period | $4,268,356 | $3,221,726 |

### Income from Operations

Our operating income for the three months ended September 30, 2012 was approximately $1.62 million, compared to $5.96 million for the same period in 2011, which represented a decrease of $4.35 million, or 73%. The decrease in operating income was mainly due to lower gross revenue, gross profit and higher bad debt expense partially offset by lower selling and general administrative expenses in the current period compared to the corresponding quarter one year ago.

### Income Tax Expense

Income tax expense for the three months ended September 30, 2012 was $244,000, compared with $928,000 in the same quarter a year ago. The Company’s statutory tax rate of 15% for the three months ended September 30, 2012 and 2011 reflects our classification status as a “National High-tech Enterprise” within the PRC, through which we obtained favorable tax rates for 2011 through 2013. Differences from the statutory rates are primarily due to the deferred tax impact of changes in the allowance for doubtful accounts for accounts receivable.

### Net Income

Our net income for the three months ended September 30, 2012 was $1.30 million, a decrease of $3.68 million, or 74%, from $4.97 million for the three months ended September 30, 2011. The main reasons for the decrease in our net income are the decrease in sales revenue and falling gross margins.

### Nine Months Ended September 30, 2012 and 2011

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

Results of Operations

|  | Nine Months Ended September, 30 2012 | 2011 | Change | % Chg |
| --- | ---: | ---: | ---: | ---: |
| Revenue | $42,861,478 | $58,708,134 | $(15,846,656) | -27% |
| Cost of Revenue | 30,174,983 | 37,041,618 | (6,866,635) | -19% |
| Gross Profit | 12,686,495 | 21,666,516 | (8,980,021) | -41% |
| Selling Expenses | 2,632,177 | 2,410,516 | 221,661 | 9% |
| General and Admin Expenses | 2,087,401 | 2,525,230 | (437,829) | -17% |
| Bad Debt Expense | 724,745 | (185,463) | 910,208 |  |
| Government subsidy income | 0 | 146,415 | (146,415) | -100% |
| Income from Operations | 7,242,172 | 17,062,648 | (9,820,476) | -58% |
| Net Interest Income (Expense) | (232,447) | (179,218) | (53,229) |  |
| Derivative Gain | 0 | 934,260 | (934,260) | -100% |
| Income Tax Expense | (1,147,965) | (2,670,115) | 1,764,784 |  |
| **Net Income** | **$5,861,760** | **$15,147,575** | **$(9,043,181)** | **-61%** |
| Basic Net Income per Share | $0.13 | $0.35 | $(0.21) |  |
| Basic Weighted Average Shares Outstanding | 43,560,305 | 43,463,165 | 30,748 |  |
| Diluted Net Income per Share | $0.13 | $0.35 | $(0.21) |  |
| Diluted Weighted Average Shares Outstanding | 43,560,305 | 43,463,165 | 30,748 |  |

### Revenue

For the nine months ended September 30, 2012, our sales revenue decreased by $15.9 million, or 27%, to $42.9 million from the $58.7 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 nine months ended September 30, 2012 and 2011.

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

| Product Category | Nine Months Ended September 30, 2012 | 2011 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 12.2 | $ 18.6 | -$ 6.5 | -35% |
| Anti-Viro/ Infection & Respiratory | $ 18.7 | $ 23.3 | -$ 4.6 | -20% |
| Digestive Diseases | $ 5.4 | $ 8.4 | -$ 3.0 | -35% |
| Other | $ 6.6 | $ 8.3 | -$ 1.7 | -21% |

During the first nine months of fiscal 2012, our overall sales revenue decreased by 27% on a year-over-year basis, led by the CNS Cerebral & Cardio Vascular and the Anti-Viro/ Infection & Respiratory category. Sales in the CNS Cerebral & Cardio Vascular category decreased by $6.5 million, or 35%, to $12.2 million from $18.6 million. Our performance in this category was impacted by sales decrease of Ozagrel Sodium for Injection and Buflomedil Hydrochloride. Sales in the Anti-Viro/ Infection & Respiratory category decreased by $4.6 million, or 20%, to $18.7 million from $23.3 million. Our performance in this category was impacted by decreases in sales of Roxithromycin Dispersible Tablet and PuSenOK™. The Digestive Diseases category decreased by $3.0 million, or 35%, to $5.4 million from $8.4 million. Sales of “Other” products decreased by $1.7 million, or 21%, to $6.6million from $8.3 million.

### Gross Margin and Gross Profit

Gross profit for the nine months ended September 30, 2012 was $12.7 million, which was approximately 41% lower compared to $21.7 million in the first nine months of 2011. Our gross margin for the first nine months of 2012 was 29.6%, compared to 36.9% in the corresponding nine 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.

### Selling Expenses

Our selling expenses for the nine months ended September 30, 2012 were $2.63 million, an increase of 9.2%, compared to $2.41 million for the nine months ended September 30, 2011. The implementation of the healthcare reform and the impact of changes to the 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. Selling expenses were approximately 6.1% of revenue in the first nine months of 2012 compared to 4.1% during the comparable period a year ago.

### General Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2012 were $2.09 million, a decrease of $0.44 million, or 17%, compared to $2.53 million for the same period in 2011. We believe this is a periodic anomaly which does not suggest any trend.

### Bad Debt Expense (Benefit)

Our bad debt expense for the nine months ended September 30, 2012 was $725,000 compared to a bad debt benefit of $185,000 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 nine months ended September 30, 2012 was approximately $7.24 million, compared to $17.06 million for the same period in 2011, which represented a decrease of $9.82 million, or 58%. The decrease in operating income 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 $934,000 during nine months ended September 30, 2011. The warrants which were subject to derivative liability expired in May, 2011 thus there was no comparable expense during the nine months ended September 30, 2012.

### Income Tax Expense

Income tax expense for the nine months ended September 30, 2012 was $1.15 million, compared with $2.67 million in the first nine months a year ago. The Company’s statutory tax rate of 15% for the nine months ended September 30, 2012 and 2011 reflects our classification status as a “National High-tech Enterprise” within the PRC, through which we obtained favorable tax rates for 2011 through 2013. Differences from the statutory rates are primarily due to the deferred tax impact of changes in the allowance for doubtful accounts for accounts receivable.

### Net Income

Our net income for the nine months ended September 30, 2012 decreased by $9.29 million, or approximately 61%, to $5.86 million from $15.15 million for the nine months ended September 30, 2011.

### Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations and short-term bank loans. As of September 30, 2012, our cash and cash equivalents outstanding was $5.06 million, which represents 3.1% of our total assets, an increase of $1.01 million from $4.05 million as of December 31, 2011. Of the $5.43 million of cash and cash equivalents and Banker’s Acceptances at September 30, 2012, a total of $5.43 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 September 30, 2012, we had a principal balance of approximately $3.96 million in short-term bank loans. On October 18, 2012, the Company fully paid the amount due under this line of credit and on October 26, 2012, it matured and was not renewed. On October 30, 2012, the Company entered into a new revolving line of credit with another bank in the amount of approximately $4.75 million. The related note payable bears interest at an annual rate of 6.90% (based upon 115% of the PRC government’s current short term rate of 6.00%). Advances on the line of credit are due one year from the date of the advance and are collateralized by certain land use rights and buildings. The outstanding balance due under the revolving line of credit was approximately $4.75 million as of November 9, 2012.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 Nine Months Ended September 30, 2012 and 2011

| Cashflow from Operations | Nine Months Ended September 30, 2012 | 2011 |
| --- | ---: | ---: |
| Net Income | 5,861,760 | 15,147,575 |
| Depreciation & Amortization | 1,096,641 | 1,081,890 |
| Changes in Assets & Liabilities |  |  |
| Trade Accounts Receivable | (2,443,587) | (9,507,941) |
| Advances to Suppliers | 1,385,889 | 228,319 |
| Inventory | (5,911,799) | (274,331) |
| Trade Accounts Payable | 1,661,109 | (1,933,820) |
| **Net Cash Provided by Operating Activities** | **2,969,934** | **5,410,267** |
| **Cashflow from Investing Activities** |  |  |
| Advances for purchases of property & equipment and intangible assets | (1,020,731) |  |
| Advances for purchases of intangible assets | (1,272,956) | (4,334,490) |
| Purchase of property and equipment | (81,352) | (280,645) |
| **Net Cash Used by Investing Activities** | **(2,375,039)** | **(4,745,270)** |
| **Net Cash Provided by Financing Activities** | **393,004** | **347,919** |
| Effect of Exchange Rate change on Cash | 23,013 | 147,738 |
| **Net Increase in Cash and Cash Equivalents** | **1,010,912** | **1,160,654** |
| Cash & Equivalent Beginning Balance | 4,050,854 | 3,692,086 |
| Cash & Equivalent Ending Balance | $ 5,061,766 | $ 4,852,740 |

#### Operating Activities:

Net cash provided by operating activities was $2.97 million in the nine months period ended September 30, 2012 compared to $5.41 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 in the period ended September 30, 2012 compared to the corresponding period in 2011. This is partially offset by decreases in the growth of accounts receivable and increases in accounts payable in the period ended September 30, 2012 compared to the corresponding period in 2011.

At September 30, 2012, our accounts receivable was $69.8 million, an increase of $0.1 million from $69.7 million at December 31, 2011, and a decrease of $1.6 million from $71.4 million at June 30, 2012. The balances of our accounts receivable in the second and third quarters 2012 were both lower compared to their previous quarters. For the first nine months in fiscal 2012, $2.44 million was used to fund increases in Account Receivables, compared to $9.51 million was used to fund increases in Account Receivables in the comparable period a year ago.

At September 30, 2012, total inventory was $37.8 million, an increase of $7.4 million from $30.4 million at December 31, 2011. Most of the inventory increase in the first nine months of 2012 was due to increased purchases of raw material inventory as well as a temporary rise in finished goods. In order to avoid any negative impact from the production facility new GMP upgrading and construction, we’ve steady raised our inventory to a relatively high level. Cash usage on Inventories for the nine months period ended September 30, 2012 was $5.91 million as compared to $0.27 million in the comparable period for 2011.

For the period ending September 30, 2012, the increase in our accounts payable was responsible for a cash addition of $1.66 million while in the same period in 2011 a decrease in accounts payable resulted in cash usage of $1.93 million.

#### Investing Activities:

Net cash used in investing activities in the nine months ended September 30, 2012 was $2.38 million. The majority of the cash was used for our investments in new drug formulas and property and equipment during the period. This was a decrease of $2.37 million compared to the same period in 2011 of $4.75 million which was mainly used to purchase new drug formulas. This decrease was mainly due to the decrease in periodic payment for new drug formulas in the nine months ended September 30, 2012 compared to the same period last year. And approximately $1.4 million pertained to the construction for facilities upgrading in order to comply with the new GMP standards.

#### Financing Activities:

During the first nine months of 2012, a related party advanced our company $393,004 at an interest rate of 1% per annum and a due date of 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 nine-month periods ended September 30, 2012 or 2011.

### Commitments

At September 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 September 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, 1,951 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 interim 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 Nov 14, 2012.
Source: SEC EDGAR, the filing index for accession 0001010549-12-001213. Last ingested by Listed: Nov 11, 2026, 00:23 ET. No prices; not investment advice.