# China Pharma Holdings, Inc.: Form 10-Q for the period ended Sep 30, 2013

- Company: [China Pharma Holdings, Inc.](/companies/cphi.md) (CIK 1106644)
- Form: 10-Q
- Filed: 2013-11-14
- Accepted by EDGAR: Nov 14, 2013, 16:26 ET
- Period: 2013-09-30
- Accession: 0001010549-13-000676
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1106644/000101054913000676/cphi10q093013.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1106644/000101054913000676/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2013-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2013-07-01 to 2013-09-30 | $8.1m | us-gaap:Revenues |
| Revenue | 9 months, 2013-01-01 to 2013-09-30 | $24.4m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2013-07-01 to 2013-09-30 | $5.9m | us-gaap:CostOfRevenue |
| Cost of revenue | 9 months, 2013-01-01 to 2013-09-30 | $17.8m | us-gaap:CostOfRevenue |
| Gross profit | 3 months, 2013-07-01 to 2013-09-30 | $2.2m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2013-01-01 to 2013-09-30 | $2.8m | us-gaap:GrossProfit |
| Operating income | 3 months, 2013-07-01 to 2013-09-30 | −$2.7m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2013-01-01 to 2013-09-30 | −$10.4m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2013-07-01 to 2013-09-30 | −$89.2k | us-gaap:InterestExpense |
| Interest expense | 9 months, 2013-01-01 to 2013-09-30 | −$263.7k | us-gaap:InterestExpense |
| Income tax | 3 months, 2013-07-01 to 2013-09-30 | $472.5k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2013-01-01 to 2013-09-30 | $1.1m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2013-07-01 to 2013-09-30 | −$2.3m | us-gaap:ProfitLoss |
| Net income | 9 months, 2013-01-01 to 2013-09-30 | −$9.6m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2013-07-01 to 2013-09-30 | −$0.05 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2013-01-01 to 2013-09-30 | −$0.22 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2013-07-01 to 2013-09-30 | −$0.05 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2013-01-01 to 2013-09-30 | −$0.22 | us-gaap:EarningsPerShareBasic |
| Operating cash flow | 9 months, 2013-01-01 to 2013-09-30 | $3.7m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2013-01-01 to 2013-09-30 | −$90.1k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2013-09-30 | $4.5m | us-gaap:Cash |
| Current assets | at 2013-09-30 | $98.3m | us-gaap:AssetsCurrent |
| Total assets | at 2013-09-30 | $162.5m | us-gaap:Assets |
| Current liabilities | at 2013-09-30 | $13.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2013-09-30 | $19.6m | us-gaap:Liabilities |
| Shareholders' equity | at 2013-09-30 | $142.9m | us-gaap:StockholdersEquity |
| Shares outstanding | at 2013-09-30 | 43,579,557 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 34,093 characters.

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 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 some of which are discussed in our other filings with the Securities and Exchange Commission. 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.

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, except as required by applicable law or regulation.

### Business Overview & Recent Developments

China Pharma Holdings, Inc. is a specialty pharmaceutical company that develops, manufactures, and markets pharmaceutical products for human use for a wide range of high incidence and high mortality conditions in China, including cardiovascular, central nervous system (“CNS”), infectious and digestive diseases. The Company has a broad and expanding distribution network across 30 provinces, municipalities and autonomous regions. The Company is currently organized under the laws of the State of Nevada in the United States. Hainan Helpson Medical & Biotechnology Co., Ltd. (Helpson), located in Haikou City, Hainan Province, China, is a wholly-owned subsidiary of China Pharma Holdings, Inc.

In the third quarter of 2013, we continued to execute our prudent marketing strategy to implement a more stringent screening of existing and potential distributors and hospital customers in terms of speed of payment in order to gradually improve our trade turnover, especially in terms of the collection of our accounts receivable. This strategy temporarily impacts our sales in the current period.

The CFDA promulgated *Good Manufacturing Practices for Pharmaceutical Products* (2010 revised version) (the “new GMP”) on February 12, 2011, which became effective on March 1, 2011. The new GMP standards outline the basic principles and standards for the manufacturing of pharmaceutical products and the management of quality controls in the manufacturing process in the PRC. Pursuant to those mandatory requirements, the upgrading of our two injectable product lines must be accomplished by the end of 2013. While management expects to see the completion of such product lines within the required time line, we cannot assure it will in fact occur. To the extent delay is caused by factors beyond our control, it may have a material adverse effect on our business, financial condition and results of operations. We have already completed the overall architectural structure of our new five-floor facility. We are progressing according to our plan to construct the new GMP facility and ancillary projects. We have also made down payments for the purchase of important equipment and facilities for the new production lines in the new building. We are confident that the new GMP upgrading will be accomplished in good quality.

The products in our pipeline have progressed slowly but steadily in the development process, and are getting closer to product launch. The CFDA is also revising its production approval criteria and processes, resulting in longer approval times for new production applications across all of our product types. In some cases, it is adding additional requirements for products already under review.

The following is a list of the current status of some of our pipeline products:

Ÿ Candesartan - We launched Candesartan, a front-line drug therapy for the treatment of hypertension, in November 2013 and expect this product to generate revenue in the fourth quarter of 2013.

Ÿ 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, due to the improved regulatory requests for clinical works.

Ÿ 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.

Ÿ Heart Disease Drug - We have a liquid oral medicine for the treatment of coronary heart disease in our new product pipeline. This product comes with a patented Traditional Chinese Medicine (TCM) formula and is currently in Phase III clinical trials due to the improved regulatory requests for clinical works.

### Market Trends

The Chinese pharmaceutical industry has been a key contributor to the PRC’s economic growth. Chinese pharmaceutical market reached CNY 926.1 billion in 2012 according to "*Medicine Blue Book: China Pharmaceutical Market Report (2012)*" ("Blue Book") published by the Chinese Academy of Social Sciences (CASS) on December 28, 2012. The Blue Book noted that the compound growth rate of China's pharmaceutical market was over 20% from 2005 to 2010 and forecasted that it would continue its rapid expansion at an average rate of 12% from 2013 to 2020. The Blue Book pointed out that the Chinese pharmaceutical market is showing features of rapid expansion, fierce competition, low concentration, and is greatly influenced by government policies. It further mentioned that the pharmaceutical market expansion was supported by increased demand for medicine associated with population aging, improved social welfare and residents’ enhanced purchasing power along with economic development.

The Healthcare Reform program announced by the Chinese government in late 2009 is having a significant impact on all healthcare related industries in China, including the pharmaceutical industry. Overall, the government plans to provide a basic, universal healthcare coverage to all citizens of China. We believe that the volume expansion will continue as the government subsidies to rural communities expand further. While pricing is generally set at the central government level, provincial government intervention has added complexity to the pricing-volume interaction. In addition to Essential Drug List ("EDL") products, we have also seen pricing pressure on most of the drugs we sell. 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 not only survive but thrive in this environment.

### Results of Operations

### Three Months Ended September 30, 2013 and 2012

#### Revenue

For the three months ended September 30, 2013, our sales revenue was $8.1 million, a decrease of 33%, compared to $12.2 million for the same period in the previous year.

Set forth below are our revenues by product category in millions USD for the three months ended September 30, 2013 and 2012.

| Product Category | Three Months Ended September 30 2013 | 2012 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 1.8 | $ 3.2 | -$ 1.4 | -44% |
| Anti-Viro/ Infection & Respiratory | $ 4.2 | $ 5.2 | -$ 1.0 | -19% |
| Digestive Diseases | $ 0.8 | $ 1.2 | -$ 0.4 | -35% |
| Other | $ 1.3 | $ 2.5 | -$ 1.2 | -48% |

Given the capital expenditure pressure from the 2013 new GMP upgrade project, we have had to control credit expansion in the market, and the resulting marketing strategy with emphasis on credit tightening has negatively impacted our revenue. Our sales decreased throughout our major product categories. In terms of dollar amount, the most significant revenue decrease of $1.4 million was in our “CNS Cerebral & Cardio Vascular” product category, which generated $1.8 million in sales revenue in the three months ended September 30, 2013 compared to $3.2 million for the same period of the prior year. The decrease was mainly due to a decrease in the sales of Gastrodin and the CFDA recall notice on Bufomedil. In March 2013 the CFDA issued a nationwide notice which required the cessation of the production, sale and use of Buflomedil effective immediately. Consequently, the Company ceased the production and sale of this product. Sales of the “Anti-Viro/Infection & Respiratory” category decreased by $1.0 million to $4.2 million in the three months ended September 30, 2013 compared to $5.2 million for the same period of the prior year. Our “Other” product category sales for the three months ended September 30, 2013 fell to $1.3 million from $2.5 million, a decrease of $1.2 million Sales of our “Digestive Diseases” category generated $0.8 million in sales in the three months ended September 30, 2013, compared to $1.2 million in the same period of the previous year, a decrease of $0.4 million.

| Product Sales by Category/Total Sales | Three Months Ended September 30, 2013 | 2012 |
| --- | ---: | ---: |
| CNS Cerebral & Cardio Vascular | 22% | 26% |
| Anti-Viro/ Infection & Respiratory | 52% | 42% |
| Digestive Diseases | 10% | 10% |
| Other | 16% | 21% |

In the three months ended September 30, 2013, our revenue breakdown by product category showed some changes mainly due to marketing changes and the CFDA notice. Sales of the “CNS, Cerebral & Cardio Vascular” category represented 22% and 26% of total sales in the three months ended September 30, 2013 and 2012, respectively. Sales of the “Anti-Viro/Infection & Respiratory” products category represented 52% and 42% of total sales in the three months ended September 30, 2013 and 2012, respectively. The “Digestive Diseases” category represented 10% of total revenue in each of the three months ended September 30, 2013 and 2012. The “Other” category represented 16% and 21% of total revenue in the three months ended September 30, 2013 and 2012 respectively.

### Cost of Revenue

For the three months ended September 30, 2013, our cost of revenue was $5.9 million, or 72% of total revenue, which represented a decrease of $3.1 million from $8.9 million, or 73% of total revenue, for the three months ended September 30, 2012. The decrease in cost of revenue during the third quarter of 2013 was almost proportionate to the decrease in revenue.

### Inventory Obsolescence

The Company recognized an inventory obsolescence expense in the amount of $15,747 for the three months ended September 30, 2013. There was no comparable expense for the three months ended September 30, 2012.

### Gross Profit and Gross Margin

Gross profit for the three months ended September 30, 2013 was $2.2 million, while gross profit for the three months ended September 30, 2012 was $3.2 million. Our gross profit margin in the third quarter of 2013 was 28%, compared to 27% in the third quarter of 2012. Our gross profit margin in the third quarter of 2013 was 28%, compared to 27% in the third quarter of 2012. The decrease in gross profit was in line with the performance of revenue in this period, and our gross margin stayed stable.

### Selling Expenses

Our selling expenses for the three months ended September 30, 2013 were $0.9 million, unchanged compared to $0.9 million for the same period of the prior year. Selling expenses accounted for 11% of the total revenue for the three months ended September 30, 2013 compared to 7% for the three months ended September 30, 2012. Due to many adjustments in our selling processes resulting from the healthcare reform policies, despite the decrease in sales, we still needed to maintain necessary personnel and expenses to support sales and the collection of accounts receivable.

### General and Administrative Expenses

Our general and administrative expenses for the three months ended September 30, 2013 were $0.7 million, an increase of $0.1million compared to $0.6 million for the same period of the prior year. General and administrative expenses accounted for 9% and 5% of our total revenues for the three months ended September 30, 2013 and 2012, respectively. This increase was mainly due to the expenses incurred related to technology upgrades and production process improvements for some of our existing marketed products.

### Bad Debt Expense and Accounts Receivable

In general, our normal credit or payment terms extended to customers are 90 days. This has not changed in recent years. Due 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. Our customers are primarily pharmaceutical distributors who sell to mostly government-backed hospitals; therefore, the age of our receivables from our customers tends to be old. Although these customers typically pay after the due date of the receivables, management believes that the deferred payments from state-owned hospitals are secure and will eventually be collected since the majority of hospitals in China are backed by the government. So far, we have always been able to collect our receivables and have not written-off any receivables in our 19-year history of doing business with hospitals.

The amount of accounts receivable that were past due (or the amount of accounts receivable that were more than 90 days old) was $48.1 million and $62.1 million as of September 30, 2013 and December 31, 2012, respectively. The following table illustrates our accounts receivable aging distribution in terms of percentage of total accounts receivable as of September 30, 2013 and December 31, 2012:

| Accounts Receivable Aging: | September 30, 2013 | December 31, 2012 |
| --- | ---: | ---: |
| 1 - 90 Days | 8.4% | 12.1% |
| 91 - 180 Days | 7.8% | 12.8% |
| 181 - 360 Days | 24.6% | 32.4% |
| 361 - 720 Days | 45.9% | 42.7% |
| \> 720 Days | 13.2% | 0.0% |
| Total | 100% | 100% |

In order to support the capital expenditures required by the new-GMP upgrading, we adjusted our marketing strategy to favor distributors with good accounts receivable collection patterns, and gradually decreased the credit granted to distributors in general. In addition to the foregoing, our sales revenue has decreased in the recent quarters. These two factors materially impacted the numerator and the denominator for the calculation of the aging distribution table above, causing the accounts receivable over two-years-old to be a greater share of the total balance.

In addition, although Healthcare reform implementation has been underway for some time, we observed a delay in its impact on the payment cycle of accounts receivable.

Although we have not written off any receivables thus far in our history, we do set aside an allowance for doubtful accounts. Our bad debt allowance estimate is currently calculated as 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 that are greater than 720 days old.

For the three months ended September 30, 2013, the Company recognized $3,277,780 of bad debt expense, compared to $171,508 in the same period of 2012. The increase was primarily a result of our large accounts receivable balance aging more than 720 days as the table above indicates. Please see additional discussion on bad debt expense under the heading “Bad Debt Expense” of the section herein entitled “Nine Months Ended September 30, 2013 and 2012” hereafter.

### Income (Loss) from Operations

Our operating loss for the three months ended September 30, 2013 was $2.7 million, compared to operating income of $1.6 million for the three months ended September 30, 2012, a decrease of $4.3 million. The main reasons for the decrease in operating income were lower revenue and an increase in bad debt expense.

### Net Interest Expense

Net interest expense for the three months ended September 30, 2013 and 2012 was $87,010 and $77,919, respectively.

### Income Tax Benefit (Expense)

In the three months ended September 30, 2013 and 2012, we paid income tax at the rate of 15%. Income tax benefit was $0.5 million for the three months ended September 30, 2013; and income tax expense was $0.2 million for the three months ended September 30, 2012. We have net operating loss carry forwards of $2.8 million which, under Chinese tax law can be “carried forward” for 5 years. We believe that we will have sufficient taxable income in the near future to utilize this tax benefit. We renewed our "National High-Tech Enterprise" status ("National HT Status") from the PRC government in the third quarter of 2013. With this designation, we will continue to enjoy a preferential tax rate of 15% for the years ending December 31, 2014, 2015 and 2016, which is notably lower than the statutory income tax rate of 25%.

### Net Income (Loss)

Net loss for the three months ended September 30, 2013 was $2.3 million, a decrease of $3.6 million, from the net income of $1.3 million in the three months ended September 30, 2012. The decrease in net result was mainly due to the decrease in revenue and the increase in bad debt expense.

For the three months ended September 30, 2013, loss per basic and diluted common share was $0.05, compared to earnings of $0.03 per share for the three months ended September 30, 2012.

The number of basic and diluted weighted average outstanding shares used to calculate earnings per share were 43,579,557 for each of the three months ended September 30, 2013 and September 30, 2012.

### Nine Months Ended September 30, 2013 and 2012

### Revenue

For the nine months ended September 30, 2013, our sales revenue decreased by $18.5 million, or 43%, to $24.4 million from the sales revenue of $42.9 million for the corresponding period of 2012.

Set forth below are our revenues by product category in millions USD for each of the nine months ended September 30, 2013 and 2012.

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

| Product Category | Nine Months Ended September 30, 2013 | 2012 | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | $ 5.9 | $ 12.2 | -$ 6.3 | -51% |
| Anti-Viro / Infection & Respiratory | $ 12.9 | $ 18.7 | -$ 5.8 | -31% |
| Digestive Diseases | $ 2.6 | $ 5.4 | -$ 2.9 | -52% |
| Other | $ 2.9 | $ 6.6 | -$ 3.6 | -55% |

During the first nine months of 2013, our overall sales revenue decreased by 43% on a year-over-year basis, led by the CNS Cerebral & Cardio Vascular and Anti-Viro/Infection & Respiratory categories. Sales in the CNS Cerebral & Cardio Vascular category dropped by $6.3 million, or 51%, to $5.9 million from $12.2 million. Our performance in this category was impacted by a sales decrease for Gastrodin Injection due to adverse market conditions and the loss of sales of Buflomedil Hydrochloride due to the CFDA Notice. During the nine months ended September 30, 2013, the sales in Anti-Viro/Infection & Respiratory category decreased by $5.8 million, or 31%, to $12.9 million from $18.7 million for the corresponding period of 2012. Sales of the “Other” category decreased by $3.6 million, or 55%, to $2.9 million from $6.6 million for the same period in 2012. Sales in Digestive Diseases category decreased by $2.9 million, or 52%, to $2.6 million from $5.4 million in the same period in 2012.

### Gross Margin and Gross Profit

Gross profit for the nine months ended September 30, 2013 was $2.8 million, which was approximately 78% lower when compared to gross profit of $12.7 million the nine months ended September 30, 2012. Our gross margin for the first nine months of 2013 was 12%, compared to 30% for the corresponding nine months of 2012. Without the negative effect of inventory obsolescence in the first nine months of 2013, management estimates that our gross profit would have been approximately $6.6 million, and gross margin would have been 27% for the first nine months of 2013.

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

### Selling Expenses

Our selling expenses for the nine months ended September 30, 2013 were $2.4 million, a decrease of 7% compared to $2.6 million for the nine months ended September 30, 2012. Selling expenses were approximately 10% of revenue for the first nine months of 2013 compared to 6% during the corresponding period of the prior year.

### General Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2013 were $2.9 million, an increase of $0.8 million, or 40%, compared to $2.1 million for the corresponding period of 2012. This increase was mainly due to the expenses incurred related to technology upgrades and production process improvements of some of our existing marketed products in this period.

### Bad Debt Expense

Our bad debt expense for the nine months ended September 30, 2013 was $7.9 million, compared to $0.7 million for nine months ended September 30, 2012. Please see additional discussion of bad debt and account receivables in the section above entitled "Bad Debt Expense and Accounts Receivable".

To the extent that our current allowance for doubtful accounts is lower than that of the previous period, we recognize a bad debt benefit for the difference during the current period, and when the current allowance is higher than that of the previous period, we recognize a bad debt expense for the difference. The allowance for doubtful accounts was $12.5 million and $4.4 million as of September 30, 2013 and December 31, 2012, respectively. The increase in the allowance was mainly due to the increase in our accounts receivable aging. The increase in the allowance was mainly due to an increase in our accounts receivable that is beyond 720 days old, and was recognized as bad debt expense during the nine months ended September 30, 2013. The changes in the allowance for doubtful accounts for the nine months ended September 30, 2013 and 2012 were as follows (there were no write-offs or recoveries):

| Changes in the Allowance for Doubtful Accounts: | For the Nine Months Ended September 30, 2013 | 2012 |
| --- | ---: | ---: |
| Balance, beginning of period | $4,429,945 | $3,536,405 |
| Bad debt expense (benefit) | 7,910,583 | 724,745 |
| Foreign currency translation adjustment | 190,690 | 7,206 |
| Balance, end of period | $12,531,218 | $4,268,356 |

23

### Income from Operations

Our operating loss for the nine months ended September 30, 2013 was approximately $10.4 million, compared to an operating income of $7.2 million for the same period in 2012, which represented a decrease of $17.7 million, or 244%. The decreased operating performance was primarily due to lower revenue, inventory obsolescence and a higher bad debt expense in the current period compared to the corresponding period of the prior year.

### Income Tax Benefit (Expense)

Our Income tax benefit for the nine months ended September 30, 2013 was $1.1 million, compared with an income tax expense of $1.1 million in the same period a year ago.

### Net (Loss) Income

Our net loss for the nine months ended September 30, 2013 was $9.6 million, which represented a decrease of $15.4 million, or approximately 263%, from net income of $5.9 million for the nine months ended September 30, 2012. This decrease was mainly due to the decrease in revenue, an increase in bad debt expense, and an inventory obsolescence incurred in the first nine months of 2013.

### Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations, short-term bank loans and our construction loan facility. Our cash and cash equivalents was $4.5 million, which represents 2.8% of our total assets as of September 30, 2013, compared to $4.0 million, which represents 2.5% of our total assets as of December 31, 2012. At September 30, 2013, a total of $4.8 million is considered to be reinvested indefinitely in Helpson and is not expected to be available for payment of dividends, for other payments to our parent company or to its shareholders. As of September 30, 2013, we had a principal balance of $4.9 million in short-term bank loans. In addition, we entered an eight-year construction loan facility with a bank on June 21, 2013. The total loan facility amount is RMB 80,000,000 (approximately $13 million). We utilized RMB 58,511,900 (approximately $9.54 million) of the facility through November 7, 2013. The cash flow generated from operating activities and the newly executed construction loan facility is being used to fund the construction of our new GMP upgrading project.

During the third quarter of 2013, we continued our vigorous collection efforts from our customers and achieved good results. While we have made progress, improvement of our accounts receivable collection continues to be a focus of our management team and we expect to make further progress in the quarters to come.

At September 30, 2013, the Company was obligated to pay laboratories $6.0 million upon their completion of the various phases of contracts to provide CFDA production approval for more than 10 medical formulas. Those payments are expected to be made out of the Company’s cash flow from operations ratably over approximately the following 48 months, depending on the progress of the various contracts. A typical contract requires an upfront deposit and then two to three additional milestone payments plus a final payment when the CFDA approval is obtained. Since the payments are progress driven, it is difficult to calculate the timing of the payments with any precision; however, management expects that the payments will be somewhat even over the payment period given the number of contracts in progress. The funding obligation is not expected to have an undue negative impact on the liquidity of the Company given the Company’s historical cash flows and estimated future cash flows from operating activities.

Based on our current operating plan, management believes that our cash provided by operations, short-term bank loans and the construction loan facility we obtained recently will be sufficient to meet our working capital needs and our anticipated capital expenditures, including expenditures for new formula acquisitions and new GMP upgrading related construction and equipment, for the next twelve months. However, if events or circumstances change and we do not meet our operating plan as expected, we may be required to seek additional capital and/or to 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 as necessary for expansion purposes and when we believe market conditions are most advantageous, 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.

### Operating Activities

Net cash provided by operating activities was $3.7 million in the nine months period ended September 30, 2013 compared to $3.0 million for the same period in 2012.

At September 30, 2013, our accounts receivable was $52.5 million, a decrease of $13.7 million from $66.2 million at December 31, 2012. Our receivables decreased due to decreased sales, the improved performance of our collection of accounts receivable and an increase in our allowance for doubtful accounts. For the nine months ended September 30, 2013, $1.1 million was generated from decreases in accounts receivable, compared to $2.4 million was used to fund increases in accounts receivable in the comparable period a year ago.

At September 30, 2013, total inventory was $32.6 million, a decrease of $3.7 million from $36.4 million at December 31, 2012. This decrease was mainly due to the inventory obsolescence recognized pursuant to the CFDA notice on Buflomedil in March of 2013.

### Investing Activities

During the nine months ended September 30, 2013, net cash used in investing activities was $9.8 million, an increase of $7.4 million, compared to $2.4 million for the nine months ended September 30, 2012. The investment spending in the first nine months of 2013 was mainly for the new GMP upgrading related construction and equipment.

### Financing Activities

There was $6.4 million cash flow generated from financing activities in the nine months ended September 30, 2013 and there was $0.4 million generated from financing activities in the nine months ended September 30, 2012. The financing activities that occurred in the first nine months of 2013 were related to the construction loan facility described under the section entitled “Liquidity and Capital Resources”.

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, 2012 and 2011, the net assets of Helpson were $142,597,000 and $135,748,004, 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 $7,935,122 and $7,863,490 (50% of registered capital) for the fiscal years ended December 31, 2012 and 2011. Since the amount that Helpson must set aside for the statutory surplus fund only accounts for 5.6% and 5.8%, respectively, of its total net assets, this reserve does not have a major impact on our liquidity. There were no allocations to the statutory surplus reserve accounts during the nine months ended September 30, 2013.

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

As of September 30, 2013, we did not have any off-balance sheet arrangements.

### Commitments

At September 30, 2013, we were obligated to pay laboratories and others approximately $6.0 million over approximately the next four years upon completion of the various phases of contracts to provide CFDA production approval of medical formulas.

We entered into purchase and construction agreements during fiscal year 2012 in connection with the construction of a new facility and required manufacturing improvements. Future minimum commitments under the agreements are as follows:

| For the Years Ending December 31 (in millions): |  |
| --- | ---: |
| 2013 | $11.3 |
| 2014 | 1.9 |
| Total | $13.2 |

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### Critical Accounting Policies

Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. The discussion of our critical accounting policies contained in Note 1 to our consolidated financial statements, “Organization and Significant Accounting Policies”, is incorporated herein by reference.

## 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, 2013.
Source: SEC EDGAR, the filing index for accession 0001010549-13-000676. Last ingested by Listed: Nov 11, 2026, 00:23 ET. No prices; not investment advice.