# China Pharma Holdings, Inc.: Form 10-Q for the period ended Sep 30, 2016

- Company: [China Pharma Holdings, Inc.](/companies/cphi.md) (CIK 1106644)
- Form: 10-Q
- Filed: 2016-11-14
- Accepted by EDGAR: Nov 14, 2016, 16:07 ET
- Period: 2016-09-30
- Accession: 0001010549-16-000787
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1106644/000101054916000787/cphi10q093016.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1106644/000101054916000787/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2016-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2016-07-01 to 2016-09-30 | $3.1m | us-gaap:Revenues |
| Revenue | 9 months, 2016-01-01 to 2016-09-30 | $10.3m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2016-07-01 to 2016-09-30 | $2.7m | us-gaap:CostOfRevenue |
| Cost of revenue | 9 months, 2016-01-01 to 2016-09-30 | $8.6m | us-gaap:CostOfRevenue |
| Gross profit | 3 months, 2016-07-01 to 2016-09-30 | $350.0k | us-gaap:GrossProfit |
| Gross profit | 9 months, 2016-01-01 to 2016-09-30 | $1.5m | us-gaap:GrossProfit |
| Research and development | 3 months, 2016-07-01 to 2016-09-30 | $99.1k | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 9 months, 2016-01-01 to 2016-09-30 | $289.2k | us-gaap:ResearchAndDevelopmentExpense |
| Operating income | 3 months, 2016-07-01 to 2016-09-30 | −$1.5m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2016-01-01 to 2016-09-30 | −$5.1m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2016-07-01 to 2016-09-30 | $213.7k | us-gaap:InterestExpense |
| Interest expense | 9 months, 2016-01-01 to 2016-09-30 | $699.9k | us-gaap:InterestExpense |
| Income tax | 3 months, 2016-07-01 to 2016-09-30 | −$20.8k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2016-01-01 to 2016-09-30 | −$65.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2016-07-01 to 2016-09-30 | −$1.7m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2016-01-01 to 2016-09-30 | −$5.8m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2016-07-01 to 2016-09-30 | −$0.04 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2016-01-01 to 2016-09-30 | −$0.13 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2016-07-01 to 2016-09-30 | −$0.04 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2016-01-01 to 2016-09-30 | −$0.13 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2016-07-01 to 2016-09-30 | 43,579,557 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2016-01-01 to 2016-09-30 | 43,579,557 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2016-01-01 to 2016-09-30 | $1.4m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2016-01-01 to 2016-09-30 | $86.3k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Current assets | at 2016-09-30 | $21.0m | us-gaap:AssetsCurrent |
| Total assets | at 2016-09-30 | $87.4m | us-gaap:Assets |
| Current liabilities | at 2016-09-30 | $13.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2016-09-30 | $22.5m | us-gaap:Liabilities |
| Shareholders' equity | at 2016-09-30 | $64.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 35,235 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 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, products and other factors, some of which are described in this report and some of which are discussed in our other periodic 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

In order to implement the requests from Central Committee of the Communist Party of China and State Council to take the strictest standard to monitor and regulate food and drug, to further rectify and standardize the order of drug distribution, and to take severe measures against illegal business activities, the China Food and Drug Administration ("CFDA") issued "*Notice on Rectification Against Illegal Operation on Drug Logistic & Distribution*" on May 3, 2016. As it had become the top priority for all pharmaceutical distributors, including our distributors, to take measures to comply with this government policy, their time and efforts had been arranged around the inspection from CFDA, which delayed their ordinary promoting practices, purchase and distribution activities, and further negatively impacted the sales performance of our company during the second and third quarter of 2016. In addition, due to the fact that we only received new GMP certificate for the injectable production lines at our new manufacturing facility in November 2014, we missed drug biddings in several provinces prior to November 2014. Those missed biddings negatively impacted our market shares previously secured in those provinces, and dragged our sales in 2015 and extended its impact to this year.

In order to support our existing product mix on the market, we have continuously focused on pipeline development. However, we have experienced delays in obtaining approvals for products in our pipeline due to revisions and enhancements in the approval criteria and processes issued by CFDA. These revisions result in additional supplemental materials and trials, higher cost, and longer approval time for certain applications of various types of our new products. On March 5, 2016, the PRC State Council issued "*Opinions on Carrying out Consistency Evaluation on Quality and Efficacy of Generic Drugs*" (the "Opinions"). The Opinions require all chemical generic pipeline products to carry out "Consistency Evaluation" before receiving the final registration approval, which has further prolonged the procedures for our pipeline products obtaining the final approvals. "Consistency Evaluation" requires currently marketed generic products to prove consistency in terms of quality, therapeutic effect, and substitutability during clinical trials with the original drug.

As a result, the status of our pipeline products remains the same as we reported in our Annual Report on Form 10-K for the year ended December 31, 2015.

### Market Trends

Per the Report on the "Work of the Government" delivered by Premier Li Keqiang at the Fourth Session of the 12th National People's Congress of the People's Republic of China on March 5, 2016, the government aimed to realize full coverage of the serious disease insurance plan, and increase government funding for the plan to reduce the financial burdens on more people suffering from serious diseases. The central government will allocate RMB16 billion for medical assistance and subsidies in both rural and urban areas, an increase of 9.6% over last year. The government would merge the basic medical insurance systems for rural and non-working urban residents and raise government subsidies for the plan from RMB380 to RMB420 per capita per annum. The government reforms the methods for making medical insurance payouts and expedite the building of a nationwide network for basic medical insurance so that medical expenses can be settled wherever they are incurred via basic medical insurance accounts. The government would carry out trials for tiered medical services in around 70% of prefecture-level cities, increase basic annual per capita government subsidies for public health services from RMB40 to RMB45, and ensure that more medical resources are channeled toward rural areas.

In addition, the Chinese People's Political Consultative Conference ("CPPCC") held a special meeting titled "To Deepen Health Reform" in Beijing on May 10, 2016 with National Development and Reform Commission (NDRC), Ministry of Finance (MOF), CFDA and other governmental departments participated. The participants concluded that China's healthcare reform had achieved significant initial results; however, the results so far had not fulfilled people's expectations. To be specific, the problems of inadequate and overly expensive medical services have not been fundamentally resolved. The participants therefore suggested:

(a) deepen the reform of management model and compensation system of healthcare institutions;

(b) promote the reform of medical insurance payment;

(c) strengthen basic-level health care services, and promote the establishment of diagnosis and treatment hierarchy;

(d) strengthen medical and health information technology to promote the realization of information sharing among different healthcare institutions; and

(e) strengthen the leadership of healthcare reform to reduce cost and create synergy.

The policy named "Clinical Trial Data Verification Upon 1622 Drugs with Production or Import Application" issued on July 22, 2015 by CFDA preluded Chinese drug review policy reform and stricter quality control. Since then, several important policies have been issued, such as marketing authorization holder pilot implementation, generic drug consistency evaluation, chemical drug registration classification reform, normalization of drug clinical trial data on-site verification. Those drug review and healthcare reform-related policies issued by CFDA, with its unprecedented efficiency and implementation intensity, are expected to have subversive impact upon Chinese pharmaceutical market, and an industry reshuffle appears to be on the horizon.

We believe that the pharmaceutical industry is still facing a lot of challenges, but with the continuous improvement of the national pharmaceutical management system and pharmaceutical companies to enhance their own strength, as well as China's huge pharmaceutical consumer market, the pharmaceutical industry still has bright prospects for development.

### Results of Operations for the Three Months Ended September 30, 2016 and 2015

Under the industrial reform and modification background guided by the government's healthcare reform policies, we have actively completed the new GMP upgrading for the majority of our current production facility, and have been aggressively promoting our sales to regain our original market shares. Although there was no immediate reversal of sales trends so far due to the special characteristics of pharmaceutical industry, we strongly believe that our current operations and financial position will allow us to have a foundation for steady business growth in the future.

Net loss for the three months ended September 30, 2016 was $1.7 million, compared to net income of $2.9 million for three months ended September 30, 2015. The difference in performance between the third quarters in 2016 and 2015 was mainly due to the decrease in revenue, bad debt benefit and subsidiary income in the three months ended September 30, 2016, compared to the same period in 2015.

### Revenue

Revenue decreased by 30.2% to $3.1 million for the three months ended September 30, 2016, as compared to $4.5 million for the three months ended September 30, 2015. This decrease was primarily due to the rectification and standardization upon drug distributors by CFDA as discussed under "Business Overview & Recent Developments" section, whose significant negative impact upon distributors had continued in the three months ended September 30, 2016. which also impacted the sales performance in the third quarter of upstream suppliers like us. In addition, the government's healthcare-price-controls also maintained continuous pressure upon our sales.

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

Set forth below are our revenues by product category in millions USD for the three months ended September 30, 2016 and 2015:

| Product Category 2016 | Three Months Ended September 30, 2015 |  | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | 0.57 | 0.60 | -0.03 | -6% |
| Anti-Viro/ Infection & Respiratory | 1.78 | 2.84 | -1.06 | -37% |
| Digestive Diseases | 0.22 | 0.19 | 0.03 | 15% |
| Other | 0.56 | 0.85 | -0.29 | -34% |

The most significant revenue drop in terms of dollar amount was in our "Anti-Viro/Infection & Respiratory" category which has decreased by $1.06 million to $1.78 million in the third quarter of 2016 as compared to $2.84 million in the same period of 2015, which was mainly affected by the market fluctuation caused by CFDA rectification and standardization upon the drug distributors as discussed under "Business Overview & Recent Developments".

Our "Digestive Diseases" category generated $0.22 million of sales in the third quarter of 2016 as compared to $0.19 million in the same period of the previous year, which represented an increase of $0.03 million.

"Other" product category, which generated $0.56 million in sales revenue in the third quarter of 2016, as compared to $0.85 million in the same period of 2015, a decrease of $0.29 million. This decrease was mainly due to the decrease in sales of Vitamin B6 in this category, which was caused by loss of market shares as discussed above.

Sales in our "CNS Cerebral & Cardio Vascular" category generated $0.57 million in sales revenue in the third quarter of 2016 as compared to $0.60 million in the same period of 2015, a decrease of $0.03 million.

| Product Category 2016 | Three Months Ended September 30, 2015 |  |
| --- | ---: | ---: |
| CNS Cerebral & Cardio Vascular | 18% | 13% |
| Anti-Viro/ Infection & Respiratory | 57% | 63% |
| Digestive Diseases | 7% | 4% |
| Other | 18% | 19% |

For the three months ended September 30, 2016, revenue breakdown by product category remained comparable to that of the prior year. Sales of the "Anti-Viro/Infection & Respiratory" products category represented 57% and 63% of total sales in the three months ended September 30, 2016 and 2015. The "CNS, Cerebral & Cardio Vascular" category represented 18% and 13% of total sales in the three months ended September 30, 2016 and 2015. The "Other" category represented 18% and 19% of total sales in the three months ended September 30, 2016 and 2015. The "Digestive Diseases" category represented 7% of total revenue in the third quarter of 2016 compared to 4% in the third quarter of 2015.

### Cost of Revenue

For the three months ended September 30, 2016, our cost of revenue was $2.7 million, or 86.3% of total revenue, which represented a decrease of $1.0 million from $3.7 million, or 83.1% of total revenue in the same period of 2015. The decrease in cost of revenue during the third quarter of 2016 was due to the revenue decrease.

### Inventory Obsolescence

We have had decreases in the sales estimates between the time when raw materials were purchased and the time when the sales performance is realized for certain products. We assess the inventory obsolescence levels on a quarterly basis. As a result, we determined that certain inventory was slow moving or obsolete. Based on the developed estimates, we recognized an inventory obsolescence expense of $0.1 million and $0.4 million for the three months ended September 30, 2016 and 2015, respectively.

### Gross Profit and Gross Margin

Gross profit was $0.3 million for each of the three months ended September 30, 2016 and 2015. Our gross profit margin in the third quarter of 2016 was 11.2% compared to 7.2% in the same period 2015. Without the effect of inventory obsolescence, management estimates that our gross profit margin would have been approximately 13.8% in the third quarter of 2016 and 17.0% in the third quarter of 2015. The decrease in gross profit margin was mainly because the Company sold more products with lower gross margin in this period.

### Selling Expenses

Our selling expenses for the three months ended September 30, 2016 was $0.9 million, which accounted for 29.7% of the total revenue in the third quarter of 2016 as, compared to $1.0 million for the same period 2015, which accounted for 25.8% of the total revenue in the third quarter of 2015. Due to many adjustments in our selling processes under healthcare reform policies, despite the decrease in sales, we still need to maintain personnel and continue our sales activities to support the sales and collection of accounts receivable, therefore our selling expenses did not decrease proportionally to our sales.

### General and Administrative Expenses

Our general and administrative expenses for the three months ended September 30, 2016 were $0.3 million as compared to $0.4 million in the three months ended September 30, 2015. General and administrative expenses accounted for 9.4% and 8.6% of our total revenues in the third quarter of 2016 and 2015, respectively.

### Research and Development Expenses

Our research and development expenses for the three months ended September 30, 2016 were $0.1 million, a decrease of $0.3 million from $0.4 million in the three months ended September 30, 2015. Research and development expenses accounted for 3.2% and 9.1% of our total revenues in the third quarters of 2016 and 2015, respectively.

### Bad Debt Benefit

Our bad debt benefit for the three months ended September 30, 2016 was $0.1 million, compared to $3.2 million in the three months ended September 30, 2015. The change was due to our revision of estimate of allowance for doubtful accounts in 2015, which resulted in the decrease in aged accounts receivable balance that hadn't been allowed prior to the third quarter of 2015, and therefore incurred the bad debt benefit in that period.

In general, our regular 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 our products to mostly government-backed hospitals. Therefore, the aging of our receivables from our customers tend to be long.

The amount of accounts receivable that were past due (or the amount of accounts receivable that were more than 90 days old) was $2.8 million and $5.6 million as of September 30, 2016 and December 31, 2015, respectively.

The following table illustrates our accounts receivable aging distribution in terms of percentage of total accounts receivable as of September 30, 2016 and December 31, 2015:

|  | September 30, 2016 | December 31, 2015 |
| --- | ---: | ---: |
| 1 - 90 Days | 2.8% | 4.0% |
| 90 - 180 Days | 3.3% | 2.2% |
| 180 - 360 Days | 3.4% | 7.9% |
| 360 - 720 Days | 11.6% | 14.6% |
| \> 720 Days | 78.9% | 71.3% |
| Total | 100.0% | 100.0% |

Our bad debt allowance estimate is currently the sum of 10% of accounts receivable that are less than 365 days old, 70% of accounts receivable that are between 365 days and 720 days old and 100% of accounts receivable that are greater than 720 days old.

We recognize bad debt expense per actual write-offs as well as the changes of allowance for doubtful accounts. 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. The allowance for doubtful accounts was $29.4 million and $28.6 million as of September 30, 2016 and December 31, 2015, respectively.

### Impairment of Long-Term Assets

During the third quarter of 2016, the Company reviewed the contracts relating to advances made for purchases of intangible assets with independent laboratories and determined that the advances made by the Company for one formula to one of the independent laboratories were impaired. As a result, the Company recognized an impairment loss for the advances made to this laboratory in the amount of $644,696.

### Income (Loss) from Operations

Our operating loss for the three months ended September 30, 2016 was $1.5 million, compared to operating income of $3.2 million in the same period 2015. The deterioration in operating result for this period is mainly due to the decrease in revenues, impairment loss and lower subsidy income.

### Interest Expense

Interest expense for the three months ended September 30, 2016 was $0.2 million, compared to $0.3 million in the same period 2015, which represented a decrease of $0.1 million.

### Income Tax Expense

For the three months ended September 30, 2016 and 2015, our income tax rate was 15%. Income tax expense was $0.02 million for each of the three months ended September 30, 2016 and 2015. We renewed our "National High-Tech Enterprise" status from the PRC government in the third quarter of 2013. With this designation, for the years ending December 31, 2014, 2015 and 2016, we have enjoyed a preferential tax rate of 15% which is notably lower than the statutory income tax rate of 25%.

The recent net loss result has put the Company in an unfavorable position for the potential renewal of "National High-Tech Enterprise" status in 2017. After evaluating the feasibility of the renewal, the Company has decided not to renew this status.

### Net Income (Loss)

Net loss for three months ended September 30, 2016 was $1.7 million, compared to net income of $2.9 million for the three months ended September 30, 2015. The change in the net result was mainly due to the decrease in revenues, impairment loss and lower subsidy income in the third quarter of 2016 as compared to the same period of 2015.

For the three months ended September 30, 2016, loss per basic and diluted common share was $0.04, compared to net income per basic and diluted share of $0.07 for the three months ended September 30, 2015.

The number of basic and diluted weighted-average outstanding shares used to calculate loss per share was 43,579,557 for both the three months ended September 30, 2016 and 2015.

### Results of Operations for the Nine Months Ended September 30, 2016 and 2015

### Revenue

For the nine months ended September 30, 2016, our sales revenue was $10.3 million, which represented a decrease of $5.5 million, or 35%, from the $15.8 million in the corresponding period of 2015. This decrease was primarily due to several missed provincial tenders back in 2014 due to the fact that our new GMP certificates were not received until November 2014. As a result, we lost related market shares and negatively impacted sales afterwards. To be specific, the original tender practice actually lasted until April 2015 given the necessary process and timing of tender. The sales decrease in the nine months ended September 30, 2016 compared to its corresponding period in 2015 reflected the outcome of that event. In addition, the government's healthcare-price-controls also maintained continuous pressure upon our sales.

Set forth below are our revenues by product categories in millions USD for each of the nine months ended September 30, 2016 and 2015.

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

| Product Category 2016 | Nine Months Ended September 30, 2015 |  | Net Change | % Change |
| --- | ---: | ---: | ---: | ---: |
| CNS Cerebral & Cardio Vascular | 1.78 | 2.21 | -0.44 | -20% |
| Anti-Viro/ Infection & Respiratory | 6.76 | 10.63 | -3.87 | -36% |
| Digestive Diseases | 0.58 | 0.54 | 0.04 | 6% |
| Other | 1.19 | 2.46 | -1.27 | -51% |

The most significant decrease in revenue in terms of dollar amount was in our "Anti-Viro/ Infection & Respiratory" product category, which generated $6.76 million in sales revenue in the nine months ended September 30, 2016, compared to $10.63 million in the nine months ended September 30, 2015, a decrease of $3.87 million. This decrease was mainly caused by the loss of market share due the missed drug tenders in 2014.

"Other" category decreased by $1.27 million to $1.19 million in the nine months ended September 30, 2016 compared to $2.46 million in the same period of 2015 and the decrease was mainly due to the sales decrease in Vitamin B6 for Injection due to the missed tenders in 2014.

Our "CNS Cerebral & Cardio Vascular" category generated $1.78 million of sales in the nine months ended September 30, 2016, compared to $2.21 million in the same period of 2015, which represented a decrease of $0.44 million. This decrease was mainly due to the sales decrease of Ozagrel product due to market fluctuation.

Sales of the "Digestive Diseases" generated $0.58 million and $0.54 million in the nine months ended September 30, 2016 and 2015, respectively.

### Cost of Revenue

For the nine months ended September 30, 2016, our cost of revenue was $8.6 million, or 84% of total revenue, which represented a decrease of $4.0 million from $12.7 million, or 80% of total revenue, in the same period of 2015. The decrease in cost of revenue in the nine months ended September 30, 2016 was mainly due to the decrease in revenue.

### Inventory Obsolescence

There was $0.2 million inventory obsolescence recorded for the nine months ended September 30, 2016, compared to $1.9 million for the nine months ended September 30, 2015. We started recording inventory obsolescence allowance on a quarterly basis since the first quarter of 2015, and this practice helped us to better monitor and assess our inventory condition and future needs.

### Gross Margin and Gross Profit

Gross profit for the nine months ended September 30, 2016 was $1.5 million, compared to $1.3 million in the same period of 2015. Gross profit margin for the nine months ended September 30, 2016 and 2015 were 14% and 8%, respectively. Without considering the effect of inventory obsolescence, management estimates that our gross profit margin would have been approximately 16% for the nine months ended September 30, 2016, and 20% for the nine months ended September 30, 2015.

### Selling Expenses

Our selling expenses for the nine months ended September 30, 2016 were $2.8 million, a decrease of $0.4 million, or 13%, compared to $3.2 million for the same period of 2015. Selling expenses accounted for 26.7% and 20.0% of the total revenue in the first nine months of 2016 and 2015 respectively. This increase in percentage to revenue was mainly due to many adjustments in our selling processes under healthcare reform policies in the recent quarters. Despite the decrease in sales, we still rely on comparable personnel and expenses to support our revenue and collection of accounts receivable. In addition, once received new GMP certificate for our new building, we intended to recover our market share and that requires additional selling expenses and marketing efforts.

### General Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2016 were $1.4 million, an increase of $0.1 million, or 6%, compared to $1.3 million for the same period of 2015. The increase in general and administrative expenses in this period was mainly due to the property tax incurred for our new GMP building since the first quarter of 2016, as well as the increased professional service expenses in the first half of 2016 as compared to the same period of 2015.

### Research and Development Expenses

Our research and development expenses for the nine months ended September 30, 2016 was $0.3 million, compared to $0.7 million in the same period of 2015.

### Bad Debt Expenses

Our bad debt expenses for the nine months ended September 30, 2016 was $1.0 million, compared to $6.0 million for the same period of 2015. Please see additional discussion of bad debt and account receivables in the section above named "Bad Debt Benefit". The changes in the allowance for doubtful accounts during the nine months ended September 30, 2016 and 2015 were as follows:

|  | For the Nine Months Ended September 30, 2016 | 2015 |
| --- | ---: | ---: |
| Balance, Beginning of Period | $28,644,398 | $44,347,451 |
| Bad debt expense | 1,005,949 | 6,045,352 |
| Foreign currency translation adjustment | (270,150) | (1,712,543) |
| Balance, End of Period | $29,380,197 | $48,680,260 |

### Impairment of Long-Term Assets

During the nine months ended September 30, 2016, the Company reviewed the contracts relating to advances made for purchases of intangible assets with independent laboratories and determined that the advances made by the Company for three formulas to three of the independent laboratories were impaired. As a result, the Company recognized an impairment loss for the advances made to these laboratories in the amount of $1.5 million.

### Loss from Operations

Our operating loss for the nine months ended September 30, 2016 was approximately $5.1 million, compared to $8.3 million for the same period of 2015, which represented an improvement of $3.2 million. The decrease in operating loss was primarily due to lower inventory obsolescence and lower bad debt expense in the current period as compared to the corresponding period in the prior year.

### Net Loss

Our net loss for the nine months ended September 30, 2016 and 2015 was $5.8 million and $9.2 million, respectively, which represented an improvement of $3.4 million. The decrease in net loss was primarily due to lower inventory obsolescence and lower bad debt expenses in the current period compared to the corresponding period in the prior year.

### Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations and short-term bank loans. Our cash and cash equivalents was $3.7 million, which represents 4.2% of our total assets as of September 30, 2016, as compared to $6.2 million, which represents 6.4% of our total assets as of December 31, 2015. All of the $3.7 million of cash and cash equivalents as of September 30, 2016 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, 2016, we had a principal balance of $2.2 million in short-term bank loans. The line of credit is payable in two equal installments of RMB 15,000,000 (approximately $2.2 million) payable on September 16, 2016 and October 19, 2016 and were both paid back per the contract. We are currently renewing the line of credit with our bank. There can be no assurances that this line of credit will be renewed on terms acceptable to the Company. In addition, we entered into an eight-year construction loan facility with a bank on September 21, 2013. The total loan facility amount is RMB80,000,000 (approximately $13 million), which had been fully utilized through May 7, 2014. The cash flow generated from operating activities was used to fund the remaining construction of our GMP upgrading project in our new facility. Both the short-term bank loan and the construction loan facility are from the same bank. The current portion of the construction loan facility is $1.5 million as of September 30, 2016. Beginning July 11, 2015, the balance of the principal is and will be due in annual installments which are due prior to July 10 of the following year over the next six years through July 11, 2021. The Company has made all required principal payments under the construction loan facility as of the date of this report.

Based on our current operating plan, management believes that our cash provided by operations will be sufficient to meet our working capital needs and our anticipated capital expenditures, including expenditures for new formula acquisitions and the remaining new GMP upgrading related construction and equipment in our prior facility for the next twelve months. However, if 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 $1.4 million in the nine months ended September 30, 2016 compared to $0.7 million for the nine months ended September 30, 2015.

As of September 30, 2016, our accounts receivable was $4.0 million, compared to $5.9 million as of December 31, 2015.

As of September 30, 2016, net inventory was $8.6 million, compared to $9.7 million as of December 31, 2015. This decrease was mainly due to the decrease in purchases in the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015.

### Investing Activities

During the nine months ended September 30, 2016, net cash used in investing activities was $86,350, primarily for the purchase of fixed asset, compared to $3,343 for the nine months ended September 30, 2015.

### Financing Activities

Cash flow used in financing activities was $3.8 million in the nine months ended September 30, 2016, which related to the payment of the construction term loan and the payment on the line of credit, while there was no comparable activity incurred in the nine months ended September 30, 2015.

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 September 30, 2016 and December 31, 2015, the net assets of Helpson were $60,800,000 and $68,240,000 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 $8,145,000 and $8,145,000 (50% of registered capital) as of September 30, 2016 and December 31, 2015 respectively. Since the amount that Helpson must set aside for the statutory surplus fund only accounts for 13.4% and 11.9%, respectively, of its total net assets as of September 30, 2016 and December 31, 2015, 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, 2016.

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, 2016, we did not have any off-balance sheet arrangements.

### Commitments

As of September 30, 2016, we were obligated to pay laboratories and others approximately $4.4 million over approximately the next four years upon completion of the various phases of contracts to provide CFDA production approval of medical formulas.

### Critical Accounting Policies

Management's discussion and analysis of our 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, 1,924 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 our disclosure controls and procedures were effective as of September 30, 2016.

### 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, 2016.
Source: SEC EDGAR, the filing index for accession 0001010549-16-000787. Last ingested by Listed: Oct 30, 2026, 16:51 ET. No prices; not investment advice.