China Pharma Holdings, Inc.: Form 10-Q for the period ended Sep 30, 2020

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,” or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the readers that any such forward-looking statements 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 (the “SEC”). 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

We are principally engaged in the development, manufacture and marketing of pharmaceutical products for human use in connection with a variety of high-incidence and high-mortality diseases and medical conditions prevalent in the People’s Republic of China (the “PRC”). All of our operations are conducted in the PRC, where our manufacturing facilities are located. We manufacture pharmaceutical products in the form of dry powder injectables, liquid injectables, tablets, capsules, and cephalosporin oral solutions. The majority of our pharmaceutical products are sold on a prescription basis and all have been approved for at least one or more therapeutic indications by the National Medical Products Administration (the “NMPA”, formerly China Food and Drug Administration, or CFDA) based upon demonstrated safety and efficacy.

China’s consistency evaluation of generic drugs had continued to proceed in 2020. The supporting policies from central and provincial governments have been constantly issued. We have always taken the tasks of facilitating the consistency evaluation as our top priority, and worked on them actively. However, due to the continuous dynamic changes of the detailed policies, future market, expected investment, and return of investment (“ROI”) for each drug’s consistency evaluation, the whole industry, including us, has been making slow progresses in terms of the consistency evaluation.

We have to take a more cautious and flexible attitude towards the initiating and progressing any project for an existing product’s consistency evaluation and to cope with the changing macro environment of drug sales in China. On one hand, since “4 + 7” (refers to 11 selected pilot cities, including 4 municipalities and 7 other cities) trial Group Purchasing Organization (“GPO”) activities initiated in 2018, third rounds of GPO activities had been carried out by October 2020, which significantly reduced the price of the drugs that won the bids. On the other hand, the consistency evaluation has been adopted as one of the qualification standards for participating in the GPO activities. As a result, we need to balance at least the two factors above before making decisions for any project.

In addition, we continue to explore in the field of comprehensive healthcare. Comprehensive healthcare is a general concept proposed according to the development of the times, social needs and changes in disease spectrum. It focuses on people’s daily life, aging and disease, pays attention to all kinds of risk factors and misunderstandings affecting health, and calls for self-health management, and advocates the comprehensive care of the entire process of life. It covers all kinds of health-related information, products and services, as well as actions taken by various organizations to meet the health needs. We launched Noni enzyme, a natural, healthy and nutrition-rich food supplement at the end of 2018, and wash-free sanitizer and mask in early 2020 to address the market needs caused by COVID-19 in China.

We will continue to optimize our product structure and actively respond to the current health needs of human beings.

Market Trends

As the medical reform deepens, the GPO program has been expanded from pilot cities to the whole country, which pressed hospitals to control drug prices to reduce overall costs. The pressure of price reduction has been further transmitted to pharmaceutical manufacturers. We believe that the price control is still one of the key themes in the pharmaceutical industry in the future; and pharmaceutical manufacturing companies’ revenues are under obvious pressure.

Novel coronavirus pneumonia (COVID-19) refers to the pneumonia caused by the 2019 novel coronavirus infection. World Health Organization (WHO) convened the COVID-19 Emergency Committee for the fifth time to assess the global outbreak situation and provide recommendations for response on October 29, 2020. WHO then announced that the outbreak of COVID-19 continues to constitute a “public health emergency of international concern” on October 30, 2020. As of November 4, 2020, there were 47,745,960 accumulated COVID-19 confirmed cases, and 12,548,272 current cases worldwide, according to the WHO and official announcements from various countries. Due to the impact of COVID-19 pandemic, there has been a “people dare not go to the hospital” phenomenon. The decline in the number of hospital outpatients has created a negative pressure on sales for pharmaceutical companies, including ours.

As a generic drug company we are presented with a huge domestic market. We believe that through further upgrades and consistency evaluations, we will be able to meet the European and American production standards, which enables us to export our products to overseas markets. In the future, cost management and control ability will gradually become an important factor in determining the competitiveness of generic pharmaceutical enterprises. Although price control leads to a decline in the profitability, the GPO’s winning enterprise has a good chance of achieving price-for-volume in order to increase its market share and support its continuous innovation transformation. In addition, consumption upgrading in China drives the increase of optional consumption. With the improvement of residents’ quality of life, the healthcare demand is also changing. We believe that there are a large number of unmet demands in comprehensive healthcare and Internet healthcare sectors.

In general, demand for pharmaceutical products is still experiencing steady growth in China. We believe the ongoing generic drug consistency evaluations and reform of China’s drug production registration and review policies will have major effects on the future development of our industry and may change its business patterns. We will continue to actively adapt to the national policy guidance and further evaluate market conditions for our existing products, and competition in the market in order to optimize our development strategy.

Results of operations for the three months ended September 30, 2020

Revenue

Revenue was both $2.4 million in the three months ended September 30, 2020 and 2019, respectively.

Set forth below are our revenues by product category in millions (USD) for the three months ended September 30, 2020 and 2019:

Sales in the “CNS Cerebral & Cardio Vascular” product category was $0.63 million in the three months ended September 30, 2020, as compared to $0.59 million for the same period in 2019, which represented an increase of $0.04 million. This increase was mainly due to the increase in sales of Alginic Sodium Diester Injection.

Sales in our “Anti-Viral/ Infection & Respiratory” product category was $1.18 million and $1.16 million in the three months ended September 30, 2020 and 2019, respectively.

Our “Digestive Diseases” product category generated $0.13 million and $0.12 million in the three months ended September 30, 2020 and 2019, respectively.

“Others” product category generated $0.46 million in sales revenue in the three months ended September 30, 2020 compared to $0.51 million for the same period a year ago, which represented a decrease of $0.05 million. This decrease was mainly due to the sales decrease of Vitamin B6 for Injection.

Cost of Revenue

For the three months ended September 30, 2020, our cost of revenue was $2.4 million, or 98% of total revenue, comparing to $2.0 million, or 84% of total revenue, for the same period in 2019. The increase in cost of revenue was mainly due to declining production in the third quarter in addition to constant fixed costs leading to higher costs per unit of products and therefore higher sales costs of revenue in the third quarter of 2020.

Gross Profit and Gross Margin

Gross profit for the three months ended September 30, 2020 was $0.05 million, as compared to $0.37 million during the same period in 2019. Our gross profit margin in the three months ended September 30, 2020 was 2.0% as compared to 15.7% during the same period in 2019. The decrease in our gross profit margin was mainly due to the increased cost of revenue in the third quarter of 2020.

Selling Expenses

Our selling expenses for the three months ended September 30, 2020 and 2019 were $0.7 million and $0.6 million, respectively. Selling expenses accounted for 27.2% of the total revenue in the three months ended September 30, 2020, as compared to 25.8% during the same period in 2019. Because of the adjustments in our sales practices and the reformation of healthcare policies, we reduced the number of personnel and expenses to efficiently support our sales and the collection of accounts receivable.

General and Administrative Expenses

Our general and administrative expenses were both $0.3 million for the three months ended September 30, 2020 and 2019, respectively. General and administrative expenses accounted for 12.1% and 14.0% of our total revenues in the three months ended September 30, 2020 and 2019, respectively.

Research and Development Expenses

Our research and development expenses for the three months ended September 30, 2020 and 2019 were both $0.04 million. Research and development expenses accounted for 1.6% and 1.7% of our total revenues in the three months ended September 30, 2020 and 2019, respectively. These expenditures were mainly for the consistency evaluations of our existing products.

Bad Debt Expenses

Our bad debt expenses for the three months ended September 30, 2020 were $17,386, as compared to $31,304 for the same period in 2019. This decrease was mainly because that we have collected more longer aged accounts receivable in the three months ended September 30, 2020 as compared to the same period last year.

Our customers are primarily pharmaceutical distributors that sell our products to mostly government-backed hospitals. Therefore, the aging of our receivables from our customers tends to be longer-term.

The amount of accounts receivable that was past due (or that was more than 180 days old) was $0.13 million and $0.15 million as of September 30, 2020 and December 31, 2019, respectively.

The following table illustrates our accounts receivable aging distribution in terms of percentage of total accounts receivable as of September 30, 2020 and December 31, 2019:

Since the fourth quarter of 2018, our bad debt allowance estimate has been updated to a policy which requires no allowance of accounts receivable shall be recognized for accounts receivable that is within 180 days old, 10% of accounts receivable that is between 180 days and 365 days old, 70% of accounts receivable that is between 365 days and 720 days old, and 100% of accounts receivable that is greater than 720 days old. Prior to that, our policy was that no allowance of accounts receivable shall be recognized for accounts receivable that is within 90 days old, 10% of accounts receivable that is between 90 days and 365 days old, 70% of accounts receivable that is between 365 days and 720 days old, and 100% of accounts receivable that is greater than 720 days old.

We recognize bad debt expenses per actual write-offs as well as 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 $18.0 million as of September 30, 2020 and $17.6 million as of December 31, 2019. The changes in the allowances for doubtful accounts during the three months ended September 30, 2020 and 2019 were as follows:

Loss from Operations

Our operating loss for the three months ended September 30, 2020 was $1.0 million, compared to $0.6 million during the same period in 2019.

Net Interest Expense

Net interest expense was both $0.06 million for the three months ended September 30, 2020 and 2019, respectively.

Net Loss

Net loss for the three months ended September 30, 2020 was $1.0 million, as compared to net loss of $0.7 million for the same period a year ago. The increase in net loss was mainly due to the increased cost of revenue in this period.

Loss per basic and diluted common share was both $0.02 for the three months ended September 30, 2020 and 2019, respectively.

The number of basic and diluted weighted-average outstanding shares that was used to calculate loss per share was 43,579,557 for both the three months ended September 30, 2020 and 2019.

Results of operations for the nine months ended September 30, 2020

Revenue

Revenue was both $7.9 million for the nine months ended September 30, 2020 and 2019, respectively.

Set forth below are our revenues by product category in millions (USD) for the nine months ended September 30, 2020 and 2019, respectively, excluding the one-time revenue of USD1.7 million (approximately RMB12.0 million) from the trading of COVID-19 testers during such period:

The most significant revenue decrease in terms of dollar amount was in our “Anti-Viral/ Infection & Respiratory”, which generated $3.33 million in sales revenue in the nine months ended September 30, 2020 compared to $4.48 million in the same period a year ago, a decrease of $1.15 million. This decrease was mainly due to sales decrease of Cefaclor.

Sales of our “Other” product category generated $1.18 million in sales revenue in the nine months ended September 30, 2020 compared to $1.41 million in the same period a year ago, which represents a decrease of $0.23 million, which was mainly due to the decrease in sales of Vitamin B6 for Injection.

Our “CNS Cerebral & Cardio Vascular” category generated $1.45 million in sales revenue in the nine months ended September 30, 2020 compared to $1.67 million in the same period a year ago, a decrease of $0.22 million. This decrease was mainly due to sales decrease of Ozagrel Sodium for Injection.

Sales of our Digestive Diseases category also decreased by $0.06 million to $0.29 million in the nine months ended September 30, 2020 from $0.35 million in the same period in 2019, which was mainly due to the decrease in sales of Omeprazole.

19

Cost of Revenue

For the nine months ended September 30, 2020, our cost of revenue was $6.5 million, or 82.5% of total revenue, comparing to $6.7 million, or 84.9% of total revenue, in the same period in 2019. The decrease in cost of revenue was mainly due to a foreign trade of COVID-19 testers we completed in the second quarter of 2020 partially offset the increase in cost of revenue.

Gross Profit and Gross Margin

Gross profit for the nine months ended September 30, 2020 was $1.4 million, compared to $1.2 million in the same period in 2019. Our gross profit margin in the nine months ended September 30, 2020 was 17.5% compared to 15.1% in the same period in 2019. The increase in our gross profit margin was mainly due to a foreign trade of COVID-19 testers we completed in the second quarter of 2020 partially offset the increase in cost of revenue.

Selling Expenses

Our selling expenses for the nine months ended September 30, 2020 and 2019 were $1.7 million and $1.6 million, respectively. Selling expenses accounted for 21.5% of the total revenue in the nine months ended September 30, 2020 compared to 20.3% in the same period in 2019.

General and Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2020 were $1.0 million, as compared to $1.1 million in the same period in 2019. General and administrative expenses accounted for 12.6% and 13.9% of our total revenues in the nine months ended September 30, 2020 and 2019, respectively.

Research and Development Expenses

Our research and development expenses for the nine months ended September 30, 2020 and 2019 were $0.12 million and $0.18 million, respectively, representing a decrease of $0.06 million compared to the same period of last year.

Bad Debt Expenses

Our bad debt expenses were $0.04 million for the nine months ended September 30, 2020, and $0.05 million for the nine months ended September 30, 2019.

The changes in the allowances for doubtful accounts during the nine months ended September 30, 2020 and 2019 were as follows:

20

Loss from Operations

Our operating loss for the nine months ended September 30, 2020 was $1.5 million, compared to $1.7 million in the same period in 2019.

Net Interest Expense

Net interest expense for the nine months ended September 30, 2020 was $0.18 million, compared to $0.22 million for the same period in 2019. The decrease in net interest expense was mainly due to the decreased interest rates of the new credit lines we entered in 2020 as compared to the interest rates of our loans in the same period last year.

Net Loss

Net loss for the nine months ended September 30, 2020 was $1.7 million, as compared to net loss of $2.0 million for the nine months ended September 30, 2019. The decrease of net loss was mainly due to a foreign trade of COVID-19 testers we completed in the second quarter of 2020.

Loss per basic and diluted common share was $0.04 for the nine months ended September 30, 2020 and 2019, respectively.

The number of basic and diluted weighted-average outstanding shares that was used to calculate loss per share was 43,579,557 for each of the nine months ended September 30, 2020 and 2019.

Liquidity and Capital Resources

Our principal source of liquidity is cash generated from operations and bank lines of credit. Our cash and cash equivalents were $0.3 million, representing 1.6% of our total assets, as of September 30, 2020, as compared to $1.1 million, representing 4.8% of our total assets as of December 31, 2019. All of the $0.3 million of cash and cash equivalents as of September 30, 2020 are considered to be reinvested indefinitely in the Company’s Chinese subsidiary, Helpson and is not expected to be available for payment of dividends or for other payments to its parent company or to its shareholders. In April 2020, the Company obtained a line of credit from Postal Savings Bank of China for an aggregate amount of RMB 10,000,000 (approximately $1.4 million), of which RMB 8,000,000 (approximately $1.2 million) have been advanced at September 30, 2020. The loan bears interest at a rate of 4.25% per annum. Advances on the line of credit shall be repaid in installments semi-annually for two years from the date of the advance; and the first repayment of RMB 500,000 (approximately $0.07 million) was made on October 20, 2020. The Company has an additional RMB 2,000,000 (approximately $0.3 million) available under the line, subject to a risk review and approval by the third party guarantee company. On June 30, 2020 the Company obtained a line of credit with Bank of Communications for an aggregate amount of RMB 8,500,000 (approximately $1.3 million), all of which have been advanced. The loan bears interest at a rate of 4.05% per annum. In addition, we entered into an eight-year construction loan facility on September 21, 2013. The total construction loan facility amount was RMB 80 million (approximately $13 million), which had been fully utilized through May 7, 2014. As of June 30, 2020, the construction loan installments to be repaid within the next 12 months are approximately $2.2 million. On July 10, 2020, we repaid such principal and accumulatively repaid the principal of RMB 65 million (approximately $9.2 million) of the construction loans per the payback schedule. The total balance of the construction loan facility is RMB 15 million ($2.2 million) as of September 30, 2020, which is all due within 12 months. The Company also obtained a line of credit of RMB 3,200,000 (approximately $0.5 million) from China CITIC Bank in September 2020 and obtained an advance of RMB 2,343,340 (approximately $344,098), and the remaining of RMB 856,660 (approximately $125,793) in October under this line. The loan bears interest at a rate of 4.50% per annum. The line of credit is due in one year on the anniversary date of the advance. Cash flow generated from operating activities and lines of credit were used to fund our daily operating expenses as well as the repayment of our loan facility.

Our net accounts receivable was $0.5 million and $0.6 million as of September 30, 2020 and December 31, 2019.

Total inventory was $3.5 million as of September 30, 2020 and $3.6 million as of December 31, 2019.

Based on our current operating plan, management believes that cash provided by operations, in addition to the newly obtained line of credit in April, June, and September 2020 may be sufficient to meet our working capital needs and our anticipated capital expenditures for the next twelve months. There can be no assurance that the Company will be able to achieve its future strategic alternatives which raises substantial doubt about its ability to continue as a going concern. We may seek debt or equity financing as necessary when we believe the market conditions are the most advantageous to us and/or reduce certain discretionary spending, which could have a material adverse effect on our ability to achieve our business objectives. Although our Chairperson and Chief Executive Officer had advanced funds for working capital during 2019 and the first nine months of 2020, there can be no assurances that this will be the case in the future. There can be no assurance that any additional financing will be available on acceptable terms, if at all.

Operating Activities

Net cash used by operating activities was $0.4 million in the nine months ended September 30, 2020, as compared to net cash provided by operating activities was $0.6 million for the same period in 2019. This change was due primarily to our use of working capital.

Investing Activities

During the nine months ended September 30, 2020, net cash used in investing activities was $1.1 million as compared to $0.09 million for the same period in 2019. The increase was mainly due to the purchase of mask production lines.

Financing Activities

Cash flow generated by financing activities was $0.6 million in the nine months ended September 30, 2020, as compared to cash flow used in financing activities of $1.7 million in the same period in 2019. The financing activities that occurred in the nine months ended September 30, 2020 were primarily new credit lines we obtained from banks as discussed above and in Note 8.

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 the 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, 2020 and December 31, 2019, Helpson’s net assets totaled $$6,059,000 and $7,189,000, respectively. Due to the restriction on dividend distribution to overseas shareholders, the amount of Helpson’s net assets that was designated for general and statutory capital reserves, and thus could not be transferred to our parent company as cash dividends, was 50% of Helpson’s registered capital, which is $8,145,000 as of September 30, 2020 and December 31, 2019, respectively. There were no allocations to the statutory surplus reserve accounts during the nine months ended September 30, 2020.

The Chinese government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China. 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 the submission of a payment application form together with certain invoices and executed contracts. The currency exchange control procedures imposed by Chinese government authorities may restrict the ability of Helpson, our Chinese subsidiary, to transfer its net assets to our parent company through loans, advances or cash dividends.

Off-Balance Sheet Arrangements

As of September 30, 2020, we did not have any off-balance sheet arrangements.

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 accounting principles generally accepted in the United States. Our financial statements reflect the selection and application of accounting policies that 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”, and the Annual Report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission on March 30, 2020 is incorporated herein by reference.

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.

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 not effective as of September 30, 2020 to satisfy the objectives for which they are intended. This was due to the material weakness in our internal control over financial reporting, with respect to our lack of accounting financial reporting personnel who were knowledgeable in U.S. GAAP, as disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on March 30, 2020.

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.