10-Q/A: CHINA PHARMA HOLDINGS, INC.

(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The statements contained in this report with respect to our financial condition, results of operations and business that are not historical facts are forward-looking statements. Forward-looking statements can be identified by the use of forward-looking terminology, such as "anticipate", "believe", "expect", "plan", "intend", "seek", "estimate", "project", "could", "may" or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the readers of the forward-looking statements that any such statements that are contained in this report reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors, including, but not limited to, economic, competitive, regulatory, technological, key employees, and general business factors affecting our operations, markets, growth, services, products, licenses and other factors, some of which are described in this report and 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

The China Food and Drug Administration ("CFDA") promulgated Good Manufacturing Practices for Pharmaceutical Products (2010 revised version) (the "New GMP Standards") on February 12, 2011, which became effective on March 1, 2011. The New GMP Standards outlines 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 sterilization production lines were required to be completed by the end of 2013; and the upgrading of our oral solution production lines is required to be completed by the end of 2015. In November 2014, we received new GMP certificates for the four new injectable production lines in our new factory and initiated production on those lines. In January 2015, we also received new GMP certificates for the tablet and capsule production lines in our old factories. We are upgrading the granule and cephalosporin production lines in our old factories, and expect to receive new GMP certificates for them by the end of 2015. While the dry powder injectable production line in our old factory is expected to be upgraded next year.

The new products in our pipeline have experienced delays. The CFDA enhanced its approval criteria and processes, resulting in additional supplemental materials and trials, higher cost, and longer approval time for certain applications across all pharmaceutical products including all of our product types. We commenced leading formulation screening, a new technology exploration and technical criteria improvement activity in 2013. We expect this new model will accelerate our development timelines and expand our exploration channels for our pipeline products.

The status of our pipeline products remains the same as we reported in our Annual Report on Form 10-K/A for the year ended December 31, 2014.

Market Trends

It is noteworthy that in 2014 there were certain state policy changes, such as the intention to release control over drug prices, the release of restrictions on Internet drug sales, and the promotion of market-oriented reform of health care, which invigorated the traditional Chinese medicine industry. The logic behind these policies was to allow market to play a decisive role in the allocation of resources, so as to improve operational efficiency and solve the inaccessibility problem of medicine and medical care that was experienced by a lot of people. The development of the pharmaceutical industry seems to fit the characteristics of the new Chinese economy routine: the growth enters into a shift period, from high-speed growth to the medium-speed growth and the development of the industry relies on reformation, restructuring and innovation.

Currently, the health insurance fund spending accounts for more than 30% of China's total health expenditure, which is one of the main forces driving the development of the pharmaceutical industry in recent years. However, faced with huge health care expenses, the health insurance fund shortfall problem needs to be addressed promptly. Medicare cost control has been the focus of the government. The National Development and Reform Commission issued "Promote Drug Price Reform Program (Draft)" on November 25, 2014, which intends to control medical costs through Medicare spending and bidding, form drug prices by market competition, and from January 1, 2015, abolished the maximum retail price restriction of drugs. Some analysts believe that, when this reform program is fully implemented, medicare rights will be enhanced and the bargaining power of medical institutions and other relevant parties will also be improved. Consequently, the whole industry will face heavier price pressure.

China's pharmaceutical industrial output growth continued to slow down from the second half of 2013. In addition, the industry growth in 2014 experienced significant decline compared to the previous years due to certain medicare cost controls, and the upgrading requirements under the New GMP Standards. The Company believes that this trend will continue. In the conference held early November 2015 Southern Medicine Economic Institute promulgated by CFDA announced that China's pharmaceutical industry output growth was 11.7% for the nine months ended September 30, 2015 and further adjusted its forecast for 2015 annual pharmaceutical industry output growth from 15% to 12%. We also noticed that the growth of China's macro-economy keeps slowing down and the size of the pharmaceutical industry in China is shrinking due to governmental medicine spending control, restricted use of antibiotics, and price control.

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

Revenue

Revenue for the Three Months Ended September 30, 2015 was $4.5 million, a decrease of 20% from $5.6 million for the three months ended September 30, 2014. This was mainly because we were in the middle of the GMP upgrading process in 2014 which completed in late 2014. The upgrading work resulted in our missing certain drug tenders in several provinces, affecting the sales of the subsequent quarters. In addition, the uncertainties of PRC's health reform, cost-control and policy instability also contributed to this decrease. These effects are likely to continue. The Company will continue to open up the market in order to mitigate the impact of the elements mentioned above.

Set forth below are our revenues by product categories in millions USD for the Three Months Ended September 30, 2015 and 2014:

 Product Category Three Months Ended September 30, Net Change % Change 2015 2014 CNS Cerebral & Cardio Vascular 0.60 1.17 (0.57) -49% Anti-Viro/ Infection & Respiratory 2.84 3.60 (0.76) -21% Digestive Diseases 0.19 0.29 (0.10) -36% Other 0.85 0.51 0.34 67% 

"Other" category increased by $0.34 million to $0.85 million in the third quarter of 2015 compared to $0.51 million in the same period 2014, which was mainly due to the sales increase in Vitamin B6 for Injection.

The most significant decrease in revenue was in our "Anti-Viro/Infection & Respiratory" product category, which generated $2.84 million in sales revenue in the third quarter of 2015 compared to $3.60 million in the same period a year ago, a decrease of $0.76 million. This decrease was mainly caused by the decrease in sales of Cefaclor due to market fluctuation.

Sales of the "CNS Cerebral & Cardio Vascular" category was $0.60 million in the third quarter of 2015, compared to $1.17 million in the same period a year ago, a decrease of $0.57 million. This decrease was mainly caused by the decrease in sales of Ozagrel due to market fluctuation.

Sales of the "Digestive Diseases" decreased by $0.10 million to $0.19 million in the third quarter of 2015 compared to $0.29 million in the same period of 2014, mainly due to the decrease in sales of Tiopronin and Omeprazole, which were primarily affected by market volatility.

In the three months ended September 30, 2015, revenue breakdown by product category showed certain changes compare to the condition in the same period of 2014. Sales of the "Anti-Viro / Infection & Respiratory" products category represented 64% of total sales in the three months ended September 30, 2015, compared to 65% in the same period last year. The "CNS, Cerebral & Cardio Vascular" category represented 13% of total revenue in the three months ended September 30, 2015, compared to 21% in the same period last year. The "Other" category represented 19% of total revenue in the three months ended September 30, 2015, compared to 9% in the same period last year. The "Digestive Diseases" category represented 4% and 5% of revenues in three months ended September 30, 2015 and 2014, respectively.

Cost of Revenue

For the three months ended September 30, 2015, our cost of revenue was $3.7 million, or 83% of total revenue, which represented a decrease of $0.3 million from $4.1 million, or 73% of total revenue, from the third quarter of 2014. The increase in the percentage of cost to revenue in the third quarter of 2015 was mainly caused by the compliance with the new GMP standards for quality control improvement, which lead to an increase in our production costs, such as energy consumption, and depreciation.

Inventory Obsolescence

There was $0.4 million of inventory obsolescence recorded for the three months ended September 30, 2015, and no inventory obsolescence for the three months ended September 30, 2014. We previously tested and recorded inventory obsolescence allowance on an annual basis. We started recording inventory obsolescence allowance on a quarterly basis during the first quarter of 2015 as we believe otherwise it may result in material modification in our financial statements at the interim periods.

Gross Profit and Gross Margin

Gross profit for the three months ended September 30, 2015 was $0.03 million, compared to $1.5 million in the same period of 2014. Our gross profit margin in the third quarter of 2015 was 7.2% compared to 27.1% in the same period of 2014. Without considering the effect of inventory obsolescence in the three months ended September 30, 2015, management estimates that our gross profit margin would have been approximately 16.9% in this period. The decrease in gross profit margin was mainly due to the increase in production costs incurred to comply with the new GMP requirements, as well as the inventory obsolescence incurred in the third quarter 2015.

Selling Expenses

Our selling expenses for the three months ended September 30, 2015 were $1.2 million, compared to $0.7 million in the same period last year. Selling expenses accounted for 25.8% of the total revenue in the third quarter 2015 compared to 13.4% in the same period 2014. Due to many adjustments in our selling processes under healthcare reform policies, despite the decrease in sales, we still rely on fixed personnel and expenses to support our revenue and collection of accounts receivable. In addition, after receiving new GMP certificates, we are aiming to recover our market share and therefore require\s more sales expenses and marketing efforts.

General and Administrative Expenses

Our general and administrative expenses for the three months ended September 30, 2015 and 2014 were both $0.4 million. General and administrative expenses accounted for 8.6% and 7.6% of our total revenues in the three months ended September 30, 2015 and 2014, respectively.

Research and Development Expenses

Our research and development expenses for the three months ended September 30, 2015 were $0.4 million, compared to $0.2 million in the same period last year. The change in research and development expenses was mainly due to the costs related to some consumption goods purchased by our laboratory incurred in this quarter; while no comparable expenses incurred in the third quarter 2014.

Bad Debt Expense (Benefit)

Our bad debt expense (benefit) for the three months ended September 30, 2015 and 2014 were ($3.2 million and $3.9 million, respectively.

In general, our normal credit or payment term extended to customers is 90 days. This has not changed in recent years. Due to the peculiarity of the Chinese pharmaceutical market environment, deferred payment to pharmaceutical companies by state-owned hospitals and local medicine distributors is a normal phenomenon. Our customers are primarily pharmaceutical distributors who sell products to mostly government-backed hospitals. Therefore, the age of our receivables from our customers tends to be long. Despite the increased proportion of our long aging accounts receivable, the Company will continue to make every effort in the goal to recover all outstanding arrears of accounts receivable.

The amount of accounts receivable that were past due (or the amount of accounts receivable that were more than 90 days old) was $11.4 million and $23.6 million as of September 30, 2015 and December 31, 2014, respectively. The following table illustrates our accounts receivable aging distribution in terms of percentage of total accounts receivable as of September 30, 2015 and December 31, 2014.

 September 30, December 31, 2015 2014 1 - 90 Days 3.0 % 5.2 % 90 - 180 Days 2.3 % 4.5 % 180 - 360 Days 7.2 % 6.9 % 360 - 720 Days 9.7 % 29.7 % > 720 Days 77.8 % 53.7 % 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.

In order to collect cash to support the construction of our new plant to meet the policy requirements for new GMP upgrading, we have shifted to prudent sales strategies in the recent two years. This strategy strengthened the preference on sales to customers with good credit performance, while reduced the supplies to customers with poor credit. On the one hand, this strategy contributed to the recovery of funds; on the other hand, it negatively impacted our sales and indirectly prolonged the payment from the estranged customers. These two factors resulted in increased proportion of our older-aged accounts receivable balance.

Subsidy Income

The Company received USD 1.6 million subsidy income in the three months ended September 30, 2015, mainly in the name of an interest discount due to the technological innovation we have received and industrial upgrading related to our new GMP; while in the same period 2014, we received USD 0.07 million subsidy income.

Income (loss) from Operations

Our operating income for the three months ended September 30, 2015 was $3.2 million, compared to operating loss of ($6.0) million in the same period of 2014. The decrease in operating loss was primarily due to the increase in subsidy income, decrease in bad debt expense and partially offset by the decrease in revenue in the third quarter of 2015.

Income Tax (Benefit)

For the three months ended September 30, 2015 and 2014, our income tax rate was 15%. Income tax benefit was ($0.02) million for the three months ended September 30, 2015 and 2014. The income taxes recognized for the three months ended September 30, 2015 and 2014 were related to net changes in long-term deferred tax assets and liabilities. We renewed our "National High-Tech Enterprise" status ("National HT Status") from the PRC government in the third quarter of 2013. With this designation, for the years ended December 31, 2015 and 2016, we will continue to enjoy a preferential tax rate of 15% which is notably lower than the statutory income tax rate of 25%.

Net Income (Loss)

Net income (loss) for three months ended September 30, 2015 and 2014 were $2.9 million and ($6.3) million, respectively. The decrease in net loss was primarily due to the increase in subsidy income, adecrease in bad debt expense and partially offset by the decrease in revenue in the third quarter of 2015.

For the three months ended September 30, 2015, income per basic and diluted common share was $0.07, compared to loss per basic and diluted share of ($0.15) for the same period in 2014.

The number of basic and diluted weighted-average outstanding shares used to calculate loss per share was 43,579,557 for the three months ended September 30, 2015 and 2014, respectively.

Nine Months Ended September 30, 2015 and 2014

Revenue

For the nine months ended September 30, 2015, our sales revenue was $15.8 million, which represented a decrease of $3.0 million, or 16%, from the $18.8 million in the corresponding period of 2014.

Set forth below are our revenues by product categories in millions USD for each of the nine months ended September 30, 2015 and 2014.

Sales Revenue by Major Category (Dollars in Millions) Product Category Nine Months Sep. 30, Net Change % Change 2015 2014 CNS Cerebral & Cardio Vascular 2.21 3.07 (0.86) -28% Anti-Viro/Injection & Respiratory 10.63 12.75 (2.12) -17% Digestive Diseases 0.54 1.06 (0.52) -49% Other 2.46 1.92 0.54 28% 

"Other" category increased by $0.54 million to $2.46 million in the nine months ended September 30, 2015 compared to $1.92 million in the same period of 2014 and the increase was mainly due to the sales increase in Vitamin B6 for Injection.

The most significant decrease in revenue was in our "Anti-Viro/ Infection & Respiratory" product category, which generated $10.63 million in sales revenue in the nine months ended September 30, 2015, compared to $12.75 million in the same period a year ago, a decrease of $2.12 million. This decrease was mainly caused by the decrease in sales of Cefaclor due to market fluctuation.

Our "CNS Cerebral & Cardio Vascular" category generated $2.21 million of sales in the nine months ended September 30,2015, compared to $3.07 million in the same period last year, which represented a decrease of $0.86 million. This decrease was mainly do the sales decrease of Candesartan due to market fluctuation.

Sales of the "Digestive Diseases" decreased by $0.52 million to $0.54 million in the nine months ended September 30, 2015, compared to $1.06 million in the same period of 2014, mainly due to the decrease in sales of Tiopronin, which were primarily affected by market volatility.

Cost of Revenue

For the nine months ended September 30, 2015, our cost of revenue was $12.7 million, or 80% of total revenue, which represented an increase of $0.5 million from $12.2 million, or 65% of total revenue, in the same period of 2014. The increase in cost of revenue in the nine months ended September 30, 2015 was mainly due to the new GMP standards for quality control improvement, which lead to an increase in our production costs, such as energy consumption, and depreciation.

Inventory Obsolescence

There was $1.9 million inventory obsolescence recorded for the nine months ended September 30, 2015, and no inventory obsolescence for the same period 2014. We previously tested and recorded inventory obsolescence allowance on an annual basis. We started recording inventory obsolescence allowance on a quarterly basis since the first quarter of 2015 as we believe otherwise it may result in material modification to our financial statements at the interim periods.

Gross Margin and Gross Profit

Gross profit for the nine months ended September 30, 2015 was $1.3 million, compared to $6.6 million in the same period of 2014. Gross profit margin for the nine months ended September 30, 2015 and 2014 were 8.4% and 35%, respectively. Without considering the effect of inventory obsolescence in the nine months ended September 30, 2015, management estimates that our gross profit margin would have been approximately 20%. The decrease in gross profit margin was mainly due to the increase in production costs incurred to comply with the new GMP requirements, as well as the inventory obsolescence incurred in the nine months ended September 30, 2015.

Selling Expenses

Our selling expenses for the nine months ended September 30, 2015 were $3.2 million, an increase of $1.0 million, or 44%, compared to $2.2 million for the same period 2014. This increase was mainly due to many adjustments in our selling processes under healthcare reform policies. Despite the decrease in sales, we still rely on comparable personnel and expenses to support our revenue and collection of accounts receivable. In addition, after receiving new GMP certificates, we are aiming to recover our market share and therefore require more sales expenses and marketing efforts.

General Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2015 were $1.3 million, an increase of $0.1 million, or 7%, compared to $1.2 million for the same period 2014.

Research and Development Expenses

Our research and development expenses for the nine months ended September 30, 2015 were $0.7 million, compared to $2.8 million in the same period 2014. The change in research and development expenses was mainly due to the costs related to testing of the new production lines in the nine months ended September 30, 2014, while no such expenses incurred in this period because we have received the GMP certificates for those production lines.

Bad Debt Expenses

Our bad debt expenses for the nine months ended September 30, 2015 were $6.0 million, compared to $15.3 million for the same period 2014. Please see additional discussion of bad debt and account receivables in the section above named "Bad Debt Expenses (Benefit)".

We recognize bad debt expenses 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 bad debt expenses for the difference between the two periods; when the current allowance is lower than that of the previous period, we recognize bad debt benefits for the difference. The allowance for doubtful accounts was $48.7 million and $44.4 million as of September 30, 2015 and December 31, 2014, respectively. Therefore, the changes in the allowance for doubtful accounts during the nine months ended September 30, 2015 and 2014 were as follows:

 For the Nine Months Ended September 30, 2015 2014 Balance, Beginning of Period $ 44,347,451 13,301,622 Bad debt expense (benefit) 6,045,352 15,280,588 Charged to reserve - collection discount - -531,382 Foreign currency translation adjustment -1,712,543 -138,649 Balance, End of Period $ 48,680,260 27,912,179 

Loss from Operations

Our operating loss for the nine months ended September 30, 2015 was approximately $15.4 million, compared to $16.9 million for the same period of 2014, which represented a decrease of $1.5 million. The decrease in operating loss was primarily due to lower R&D expenses and no loss from nature disaster , while partially offset by the decrease in revenue and increase in inventory obsolescence in the current period compared to the corresponding period one year ago.

Net Loss

Our net loss for the nine months ended September 30, 2015 and 2014 was $8.3 million and $17.4 million, respectively, a decrease of $9.1 million in net loss year over year. The decrease in net loss was primarily due to lower bad debt expense and R&D expenses and the nonoccurrence of any loss from nature disaster (which occurred the same period last year), while partially offset by the decrease in revenue and increase in inventory obsolescence in the current period compared to the corresponding period one year ago.

Liquidity and Capital Resources

Our principal sources of liquidity are cash generated from operations and short-term bank loans. Our cash and cash equivalents were $5.7 million, which represents 5.3% of our total assets as of September 30, 2015, as compared to $5.3 million, which represents 4.4% of our total assets as of December 31, 2014. All of the $5.7 million of cash and cash equivalents at September 30, 2015 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, 2015, we had a principal balance of $4.7 million in short-term bank loans. The amounts advanced under the line of credit were originally due on November 24, 2015. We subsequently renewed our line of credit, with $2.35 million due on September 16, 2016, and another $2.35 million due on October 19, 2016. In addition, we have $3.1 million of short-term debt related to the current portion of our construction loan facility. The loan requires interest only payments for the first two years. Beginning July 11, 2015 and over the next six years, the balance of the principal will be due annually. The due date of each installment is a date prior to July 10 of the year following such an installment payment until July 11, 2021. No principal payments have been made under the facility as of the date of this report on Form . . .

Dec 28, 2015

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