(EDGAR Online via COMTEX) -- ITEM 7. 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 including in "Risk Factors" in Item 1A and some of which are discussed in our other filings with the Securities and Exchange Commission. These forward-looking statements are only estimates or predictions. No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of risks facing our company, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events.
These risk factors should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. All written and oral forward looking statements made in connection with this report that are attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given these uncertainties, we caution investors not to unduly rely on our forward-looking statements. We do not undertake any obligation to review or confirm analysts' expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as required by applicable law or regulation.
Business Overview & Recent Developments
We have experienced tough challenges and made remarkable achievements in 2014:
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. During the period from January 1, 2014 to November 3, 2014, we had suspended such two production lines as they did not then meet the GMP upgrading deadline. In this production-suspended state, we controlled our market by limiting our credit sales and executed a prudent marketing strategy and specifically by screening our existing and potential distributors and hospital customers based on their payment speed in order to gradually improve our trade turnover, especially in terms of the collection of our accounts receivable. This strategy has temporarily impacted our sales in the current period by limiting our credit sales.
A once-in-forty-year 16 grade super typhoon Rammasun hit Haikou on July 18, 2014. This typhoon caused considerable damage to our manufacturing facilities and inventory. Part of the warehouse was flooded; our new facility was damaged and the several days long suspension of water and electricity supply caused a brief halt to our production activities and a delay in obtaining the new GMP certificate. We have taken emergency measures to restore and recover post-typhoon and have restored the facility to operational mode at the fastest speed. The Company's losses from the natural disaster were approximately $2.3 million (RMB14.2 million).
The products in our pipeline have experienced delays. The CFDA has enhanced its approval criteria and processes, resulting in additional supplemental materials and trials, higher cost, and longer approval time for certain applications across all the pharmaceutical products including all of our product types. We commenced leading formulation screening, new technology exploration, technical criteria improvement activities in 2013. We expect this new model will improve our exploration channels for the pipeline products.
The following is a list of the current status of some of our pipeline products:
? Antibiotic Combination - We completed the Phase I clinical trials of our novel cephalosporin-based combination antibiotic. We are currently in Phase II of the clinical trial, due to the higher regulatory requests for clinical works.
? Rosuvastatin - Rosuvastatin is a generic form of Crestor, a drug for the treatment of high blood cholesterol levels. Clinical trials for this generic drug were completed in the fourth quarter of 2010 and we have submitted an application for production approval, and are performing supplemental trials of related materials pursuant to the new criteria.
? Heart Disease Drug - We developed an oral solution for the treatment of coronary heart disease in our new product pipeline. This product comes with a patented Traditional Chinese Medicine (TCM) formula and is currently approaching the end point of Phase III clinical trials.
We have completed the upgrading of our existing tablets and capsules production line in our old facility and received new GMP certificate in January 2015. And we have begun reforming and upgrading our existing dry powder injectables production line, cephalosporin production line, and granules production line in 2015 to meet the New GMP Standards.
The year of 2014 was a year of adjustments, challenges and opportunities for the pharmaceutical industry in China. With the demographic dividend (due to the fact that the working-age population accounts for a relatively large proportion of the total population and the dependency ratio is relatively low, the favorable population conditions for economic development with high savings, high investment and high growth is created) gradually receded, the pharmaceutical industry is facing many challenges: external pressures from health care expenditure and drug price controls, internal fierce competition among pharmaceutical companies, and the growth pressure within the pharmaceutical companies. Southern Medicine Economic Institute Data promulgated by CFDA indicates that in 2014 the pharmaceutical industry output growth is expected to be only about 13%, far below over the 20% growth in the past.
It is noteworthy that in 2014 there were certain state policy changes, such as the intention to release the control over drug prices, the restriction release on Internet drug sales, and the promotion on market-oriented reform of health care, which invigorated the traditional Chinese medicine industry. The logic behind these policies was to allow the market to play a decisive role in the allocation of resources, so as to improve operational efficiency and solve the problem of the inaccessibility of medicine and medical care which was experienced by a lot of people. The development of the pharmaceutical industry seems to fit the characteristics of the new normal Chinese economy: growth enters into the 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 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 urgently. Medicare cost control has been the focus of the market. From the current situation, it will become a trend. 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 abolish the maximum retail price restriction of drugs from January 1, 2015. Some analysts believe that, when this reform program is implemented, the weight of Medicare rights will be enhanced and the bargaining power of medical institutions and other relevant parties will also be improved. Consequently, our whole industry will face even more severe 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. Southern Medicine Economic Institute promulgated by CFDA predicts by 2015 China's pharmaceutical industry output growth of 15%, sales growth of 13%, and profit growth of 11%. Concerning the terminal market, China's pharmaceutical terminal market is expected to reach RMB 1.2457 trillion in 2014, up 13.4%; 2015 pharmaceutical terminal market will reach RMB 1.407 trillion, an increase of 12.9%.
Results of Operations for the Fiscal Year Ended December 31, 2014
China provides a unique opportunity to its pharmaceutical industry; however, real challenges remain, from temporary production suspension due to certain compulsory new GMP upgrading requirements and rising pricing pressure, to extended regulatory review time for new medical production applications. Each of these challenges impacted our performance negatively in 2014, causing us to experience a significant decrease in our financial results.
Net loss for the year ended December 31, 2014 was $26.0 million, compared to net loss of $20.0 million for the year ended December 31, 2013.Our net loss for the year ended December 31, 2014 was mainly due to a significant decrease in revenue and an increase in bad debt expense.
Revenue Revenue decreased by 24% to $24.9 million for the year ended December 31, 2014, as compared to $32.8 million for the year ended December 31, 2013. This decrease primarily resulted from decreases in sales of our CNS Cerebral & Cardio Vascular products and our Anti-Viro/Infectious & Respiratory products. Set forth below are our revenues by product category in millions USD for the years ended December 31, 2014 and 2013: Twelve Months Ended December 31, Product Category 2014 2013 Net Change % Change CNS Cerebral & Cardio Vascular $ 4.38 $ 7.18 $ -2.81 -39 % Anti-Viro/ Infection & Respiratory 16.43 18.18 -1.75 -10 % Digestive Diseases 1.31 2.94 -1.63 -55 % Other 2.82 4.51 -1.69 -37 %
The most significant revenue decrease in terms of dollar amount was in our "CNS Cerebral & Cardio Vascular" product category, which generated $4.4 million in sales revenue in 2014 compared to $7.2 million a year ago, a decrease of $2.8 million. This decrease was mainly due to having injectables as the main product in this category. The suspension of the two injectables product lines during 2014 negatively impacted our sales performance.
Sales of the "Anti-Viro/Infection & Respiratory" category decreased by $1.8 million to $16.4 million in 2014 compared to $18.2 million in 2013, which was mainly due to the decrease in sales of Andrographolide and Clarithromycin, primarily affected by market demand volatility. Our "Digestive Diseases" category generated $1.3 million of sales in 2014, compared to $2.9 million in the previous year, a decrease of $1.6 million. Our "Other" product category sales fell to $2.8 million from $4.5 million, a decrease of $1.7 million.
For year ended December 31, 2014, revenue breakdown by product category showed some changes. Sales of the "Anti-Viro & Respiratory" products category represented 66% of total sales in the year ended on December 31, 2014, compared to 55% in 2013. The "CNS, Cerebral & Cardio Vascular" category represented 18% of total revenue in 2014 and 22% in 2013. The "Digestive Diseases" category represented 5% of total revenue in 2014 compared to 9% in 2013. The "Other" category represented 11% and 14% of revenues in 2014and 2013, respectively.
Cost of Revenue
For the year ended December 31, 2014, our cost of revenue was $17.2 million, or 69% of total revenue, which represented a decrease of $6.2 million from $23.4 million, or 71% of total revenue, in 2013. The decrease in cost of revenue during 2014 was approximately proportional to the revenue decrease.
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 have also assessed the fair value of our raw material. As a result, we determined that certain inventory was slow moving or obsolete. Based on the developed estimates as of December 31, 2014 and 2013, we recognized an additional inventory obsolescence expense of $2.3 million and $9.9 million for the years ended December 31, 2014 and 2013, respectively.
Gross Profit (Loss) and Gross (Loss) Margin
Gross profit for the year ended December 31, 2014 was $5.5 million, compared to gross loss of $0.5 million in 2013. Our gross profit margin in 2014 was 22.0% compared to gross loss margin of (1.5)% in 2013. Without the effect of inventory obsolescence, management estimates that our gross profit would have been approximately 30.9% in 2014 and 28.7% in 2013. The healthcare reform instituted by the Chinese government since 2009 contains pricing controls, which have resulted in margin compression in most pharmaceutical products on the market today, especially in the generic space where many of our products are sold. Going forward, we expect to see continued pricing pressures on most products, while new products could help support overall gross margin once they are launched.
Our selling expenses for the year ended December 31, 2014 and 2013 were both $3.3 million. Selling expenses accounted for 13.4% of the total revenue in 2014 compared to 10% in 2013. Due to many adjustments in our selling processes under healthcare reform policies, despite the decrease in sales, we still need additional personnel and expenses to support the sales and collection of accounts receivable.
General and Administrative Expenses
Our general and administrative expenses for the year ended December 31, 2014 were $1.7 million, a decrease of $0.7 million from $2.4 million in 2013. General and administrative expenses accounted for 6.9% and 7.3% of our total revenues in 2014 and 2013, respectively.
The main reason for this decrease was due to adjustments of amortization expense in 2013 and 2014 which created an approximately $0.4 million difference under general and administrative expenses and an approximately $0.2 million expense under the consulting service agreement we entered in 2013 for which no comparable expense exists in 2014.
Research and Development Expense
Our research and development expenses for the year ended December 31, 2014 were $2.8 million, an increase of $1.1 million from $1.7 million in 2013. Research and development expenses accounted for 11.2% and 5.1% of our total revenues in 2014 and 2013, respectively. The change in research and development expenses was mainly due to the costs related to testing of the new production lines. In addition, we commenced leading formulation screening, new technology exploration and technical criteria improvement activities since 2013. As a result, the expenses related to such activities increased in 2014.
Bad Debt Expense
We recognized bad debt expense resulting from an increase in the allowance for doubtful accounts relating to trade accounts receivable and other receivables of $20.6 million and $10.8 million during the years ended December 31, 2014 and 2013, respectively.
During the third quarter of 2014, the Company offered two of its largest customers a discount of 30% on payments for accounts receivable that were older than one year. The amount of the outstanding accounts receivable balance the discount was applied to was approximately $1.8 million. As a result, the Company recognized additional bad debt expense of approximately $0.53 million for the year ended December 31, 2014. During 2013, Management negotiated settlement offers with certain customers with approximately $8.0 million in accounts receivable balances that were greater than one (1) year past due. The offers to these customers were comprised of discounts ranging from 15% to 30% of the total past due balance in exchange for payment in full by December 31, 2013. As a result, the Company was able to collect cash of approximately $5.85 million, and recognized additional bad debt expenses for the negotiated discounts of approximately $2.1 million for the year ended December 31, 2013.
In general, our normal credit or payment terms extended to customers are 90 days. This has not changed in recent years. Due to the peculiarity of the Chinese pharmaceutical market environment, deferred payments to pharmaceutical companies by state-owned hospitals and local medicine distributors are a normal phenomenon. Our customers are primarily pharmaceutical distributors who sell our products to mostly government-backed hospitals. Therefore, the ages of our receivables from our customers tend to be long. Although these customers typically pay after the due date of the receivables, since the majority of hospitals in China are backed by the governments, management believes that the deferred payments from state-owned hospitals are relatively secured.
The amount of accounts receivable that were past due (or the amount of accounts receivable that were more than 90 days old) was $23.6 million and $40.1 million as of December 31, 2014 and 2013, respectively. The following table illustrates our accounts receivable aging distribution in terms of percentage of total accounts receivable as of December 31, 2014 and 2013:
December 31, December 31, 2014 2013 1 - 90 Days 5.2 % 8.0 % 90 - 180 Days 4.5 % 7.4 % 180 - 360 Days 6.9 % 23.3 % 360 - 720 Days 29.7 % 61.3 % > 720 Days 53.7 % 0.0 % Total 100.0 % 100.0 %
Our bad debt allowance estimate is currently the sum of 3.5% of accounts receivable that are less than 365 days old, 10% 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 $33.4 million and $13.3 million as of December 31, 2014 and December 31, 2013, respectively. The changes in the allowance for doubtful accounts during the years ended December 31, 2014 and 2013 were as follows:
For the Fiscal Years Ended December 31, 2014 2013 Balance, Beginning of Year $ 13,301,622 $ 4,429,945 Bad debt expense 20,643,035 10,752,991 Charged to reserve -531,598 -2,160,527 Foreign currency translation adjustment -62,950 279,213 Balance, End of Year $ 33,350,109 $ 13,301,622
Loss from Natural Disaster
We suffered losses of $2,276,519 relating to a tropical typhoon during the twelve months ended December 31, 2014 as discussed fully in Note 2 to the consolidated financial statements. There was no comparable expense in the prior year period.
Loss from Operations
Our operating loss for the year ended December 31, 2014 was $25.3 million, compared to operating loss of $18.6 million in 2013. The main reasons for the increase in loss were lower revenue and higher bad debt expenses in 2014.
Net Interest Expense
Net interest expense for the year ended December 31, 2014 was $785,804, compared to $340,239 in 2013, an increase of $437,108. The increase is primarily due to the additional interest incurred in conjunction with the Construction loan facility as discussed in Note 10 to the consolidated financial statements.
Income Tax Expense
For the years ended December 31, 2014 and 2013, our income tax rate was 15%. Income tax expense was $0.8 million and $1.1 million for the years ended December 31, 2014 and 2013, respectively. 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 enjoy a preferential tax rate of 15% which is notably lower than the statutory income tax rate of 25%.
Net Loss for year ended December 31, 2014 was $26.0 million, compared to net loss of $20.0 million for the year ended December 31, 2013. The increase in net loss was mainly due to the decrease in revenue and increase in bad debt expense.
For the year ended December 31, 2014, loss per basic and diluted common share was $(0.60), compared to loss per basic and diluted share of $(0.46) for the year ended December 31, 2013.
The number of basic and diluted weighted-average outstanding shares used to calculate loss per share was 43,579,557 for both 2014 and 2013.
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 $5.3 million, which represents 4.0% of our total assets as of December 31, 2014, as compared to $6.0 million, which represents 3.8% of our total assets as of December 31, 2013. All of the $5.3 million of cash and cash equivalents as of December 31, 2014 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 December 31, 2014, we had a principal balance of $4.9 million in short-term bank loans. This loan is due on November 24, 2015. In addition, we entered into an eight-year construction loan facility with a bank on September 21, 2013. The total loan facility amount is RMB 80,000,000 (approximately $13 million), which had been fully utilized through May 7, 2014. The current portion of the construction loan facility is $1.6 million as of December 31, 2014. Both the short term bank loan and the construction loan facility are from the same bank. The cash flow generated from operating activities was used to fund the remaining construction of our GMP upgrading project in our new facility.
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 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.
Net cash provided by operating activities was $4.6 million in the year ended December 31, 2014 compared to $8.6 million for 2013.
As of December 31, 2014, our accounts receivable was $24.9 million, a decrease of $20.3 million from $45.1 million as of December 31, 2013. Our receivables decreased due to our increased allowance for doubtful accounts and decrease in sales. For the year ended December 31, 2014, $3.4 million was used to fund accounts receivable, compared to $3.6 million generated from decrease in accounts receivable in the comparable period a year ago.
As of December 31, 2014, total inventory was $15.3 million, a decrease of $9.4 million from $24.7 million as of December 31, 2013. This decrease was mainly due to decreased purchases of raw materials for injectable products and the increased inventory obsolescence recognized in 2014.
During the year ended December 31, 2014, net cash used in investing activities was $5.9 million, a decrease of $13.2million, compared to $19.1 million for the year ended December 31, 2013. The investment spending in 2014 and 2013 was mainly for the new GMP upgrading related construction and equipment.
Cash flow provided from financing activities was $0.6 million and $12.3 million in the year ended December 31, 2014 and 2013, respectively. The financing activities that occurred in 2014 and 2013 were primarily related to the construction loan facility described under the first paragraph under this section entitled "Liquidity and Capital Resources".
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Mar 30, 2015
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