China Pharma Holdings, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. The company develops, manufactures, and markets pharmaceutical products in China. Financial amounts below are in U.S. dollars.
Financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $2.401 million | $2.377 million | $7.935 million | $7.876 million |
| Gross profit / margin | $47,196 / 2.0% | $372,759 / 15.7% | $1.391 million / 17.5% | $1.193 million / 15.1% |
| Operating loss | $952,494 | $645,204 | $1.477 million | $1.732 million |
| Net loss | $1.010 million | $700,954 | $1.658 million | $1.957 million |
| Net loss per share | $0.02 | $0.02 | $0.04 | $0.04 |
| Operating cash flow | Not presented quarterly | $(377,128) | $630,414 |
Liquidity, debt, and balance sheet
- At September 30, cash and cash equivalents were $346,611, down from $1.075 million at December 31, 2019. Cash, including restricted cash, decreased by $838,276 over the first nine months.
- Current assets were $5.034 million versus current liabilities of $11.554 million. Total liabilities were $13.266 million; stockholders’ equity was $7.859 million.
- Construction-loan principal outstanding was $2.203 million, all current. Lines of credit totaled $2.767 million, of which $1.827 million was current. Scheduled principal payments for the 12 months after September 30 totaled $4.030 million.
- Net accounts receivable was $535,060, against an allowance for doubtful accounts of $17.958 million. Approximately 96.7% of receivables were over 720 days old. Inventory was $3.514 million.
- Financing cash flow was $634,258, mainly from new bank credit lines, while investing cash outflow was $1.100 million, principally for mask production lines.
Material changes and operating developments
- Q3 revenue was nearly flat year over year, but gross profit fell to $47,196 as cost of revenue rose to 98% of revenue, versus 84% a year earlier. Management attributed the margin deterioration to lower production against largely fixed costs.
- Nine-month reported revenue included a one-time $1.701 million export sale of COVID-19 test kits in Q2. Excluding that sale, domestic pharmaceutical revenue was $6.234 million versus $7.876 million in 2019; declines included anti-infective/respiratory products, particularly Cefaclor.
- Nine-month gross margin improved to 17.5%, which management attributed mainly to the test-kit trade. Net loss narrowed year over year, also attributed mainly to that transaction. Operating cash flow shifted from a $630,414 inflow to a $377,128 outflow.
- The company reported COVID-19-related disruption to travel, distribution, and operations early in 2020; its facility reopened and operations ramped up in Q1. Management also cited reduced hospital outpatient visits as pressure on pharmaceutical sales.
Outlook, risks, and other notable items
- Going concern: Management disclosed substantial doubt about the company’s ability to continue as a going concern within one year after issuance of the financial statements. It expects continuing operating losses and relies on plans including improved advance-payment sales and receivable collection, strategic alternatives for nutrition products, and possible additional borrowing. Management said current operations and credit lines may cover the next 12 months, but plans were not sufficiently finalized or within its control to alleviate substantial doubt.
- Funding dependence: The CEO, who is also chair and interim CFO, advanced funds for working capital; the filing states an aggregate $0.8 million advanced as of September 30. The company cautioned that future advances or other financing are not assured. Cash held in the Chinese subsidiary was considered indefinitely reinvested and not expected to be available to the parent or shareholders.
- Market and regulatory risks: China’s group purchasing program has driven drug-price reductions, while generic-drug consistency evaluations and changing policies may delay product development and approvals. The company said it was taking a cautious approach to evaluation spending. No new medical-formula production approvals were obtained in the nine-month period.
- Concentration and currency risks: One customer represented 21.6% of nine-month sales; two customers accounted for 50.2% and 10.8% of receivables. Two suppliers represented 19.5% and 14.8% of raw-material purchases. The company has no currency hedges and is exposed to PRC currency conversion and remittance controls.
- Tax assets: Approximately $21.6 million of PRC tax-loss carryforwards were scheduled to expire in December 2020; the company maintained a $31.636 million valuation allowance against deferred tax assets.
- Controls: Management concluded disclosure controls were not effective at September 30, 2020 due to a material weakness involving insufficient personnel knowledgeable in U.S. GAAP. No material changes in internal control were reported during the quarter.
- No off-balance-sheet arrangements were reported. The filing provided no quantitative revenue or earnings guidance.
Investor verification points
- Track cash generation, access to additional financing, debt maturities, and whether management’s going-concern mitigation plans become actionable.
- Assess the age, collectability, and concentration of receivables, including the large allowance and the very high share of balances over 720 days old.
- Separate recurring pharmaceutical sales and margins from the one-time COVID-19 test-kit transaction; monitor product volumes, fixed-cost absorption, and pricing pressure.
- Verify repayment schedules and terms for construction debt, bank credit lines, and related-party funding, including any collateral or personal guarantees.
- Monitor remediation of the material weakness in U.S. GAAP reporting controls and the status of expiring PRC tax-loss carryforwards.