China Pharma Holdings, Inc. — FY 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; comparisons are with FY 2012. The filing was signed March 20, 2014. The company develops, manufactures, and sells prescription pharmaceuticals in China through its operating subsidiary. Its 20 marketed products span several therapeutic areas.
Financial performance
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Revenue | $32.8 million | $54.5 million |
| Gross profit (loss) | ($0.5 million); (1.5%) margin | $14.1 million; 25.8% margin |
| Operating income (loss) | ($18.6 million) | $5.9 million |
| Net income (loss) | ($20.0 million); ($0.46) per share | $4.6 million; $0.11 per share |
| Cash from operations | $8.6 million | $3.6 million |
| Cash and cash equivalents at year-end | $6.0 million | $4.0 million |
| Investing cash flow | ($19.1 million) | ($5.0 million) |
Revenue fell 40%. Every reported product category declined: CNS/cerebral and cardiovascular sales decreased 53% to $7.2 million; anti-infection and respiratory sales fell 26% to $18.2 million; digestive disease sales fell 58% to $2.9 million; and other sales fell 43% to $4.5 million.
The company reported $9.9 million of inventory-obsolescence expense, including approximately $3.7 million related to Buflomedil, and $10.8 million of bad-debt expense. Management estimated gross margin would have been about 29% in both years excluding inventory obsolescence; this is a management estimate, not the reported GAAP margin. R&D expense rose to $1.7 million from $0.4 million.
Liquidity, debt, and balance sheet
- At year-end, current assets were $84.0 million and current liabilities were $12.0 million. Trade receivables, net, were $45.1 million, down from $66.2 million; inventory, net, was $24.7 million, down from $36.4 million.
- Receivables remain a significant collection risk: $40.1 million were more than 90 days past due, and 61.3% of receivables were over 360 days old. The allowance for doubtful accounts was $13.3 million, compared with $4.4 million a year earlier. A fourth-quarter settlement program collected approximately $5.85 million on aged balances after discounts totaling approximately $2.1 million.
- Debt included $4.9 million of short-term notes payable and a $12.5 million construction loan. The eight-year construction facility totals RMB 80 million (approximately $13 million); approximately $0.6 million remained available at year-end. It bears a floating rate and requires interest-only payments for the first two years, followed by scheduled principal payments.
- Operating cash flow improved despite the net loss, aided by lower receivables and inventory and noncash expenses. Investing outflow primarily funded construction and equipment for the new GMP facility. Financing provided $12.3 million, principally from the construction loan.
- Management stated that operating cash flow, short-term borrowing, and the construction facility were expected to cover working capital and planned capital expenditures for at least the next 12 months. Cash held in China was considered indefinitely reinvested; currency controls and statutory restrictions limit transfers to the parent.
Material changes, outlook, and risks
- Injectable production interruption: The company missed the new GMP upgrade deadline for its dry-powder and liquid injectable lines and suspended production at the old lines effective January 1, 2014. It was installing and commissioning equipment at a new facility and expected to apply for a new GMP certificate in the second quarter of 2014. The filing gives no quantified estimate of the interruption’s sales impact.
- Buflomedil cessation: In March 2013, China’s regulator ordered production, sale, and use of Buflomedil to cease nationwide. The company stopped sales, recalled products, and recorded the related inventory write-off; it said the notice did not impose manufacturer liability if its requirements were followed.
- Pipeline and product launch: Candesartan received production approval and launched in November 2013. Rosuvastatin was awaiting production approval and supplemental work; a combination antibiotic remained in Phase II clinical trials, and a coronary heart disease product was in Phase III. Regulatory review criteria and timelines had become more demanding. No quantified revenue or earnings guidance was provided.
- Pricing and competition: Management cited continuing government and market pricing pressure, particularly for generic drugs, and expected pressure on gross margins. Sales also reflected stricter screening of distributors and hospital customers and limits on credit sales.
- Financial reporting controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at year-end because of a material weakness concerning inventory-obsolescence reporting and insufficient U.S. GAAP expertise. Training was underway. The independent auditor issued an unqualified opinion on the financial statements but did not audit internal-control effectiveness.
- Other exposures: The business is concentrated in China and exposed to PRC regulation, currency conversion and remittance limits, product-liability and regulatory risks, and distributor and customer credit risk. Two customers represented 14.5% and 11.2% of year-end receivables. A director’s related-party loan balance was $1.35 million, bearing 1% interest and due December 31, 2014. The company reported no material legal proceedings and no off-balance-sheet arrangements.
- The company renewed its high-tech tax status and expects a 15% PRC income tax rate through 2016. It does not anticipate cash dividends in the foreseeable future.
Key facts for investors to verify
- Whether the new facility received GMP certification and when the suspended injectable lines resumed production; assess resulting capacity, sales, and cash needs.
- Recoverability and subsequent collections of aged receivables, the adequacy of the doubtful-account allowance, and the status of customer settlement discounts.
- Whether inventory write-downs and obsolescence estimates are complete, particularly following the Buflomedil cessation and production-line changes.
- Construction-loan drawdowns, floating-rate terms, collateral, repayment capacity, and completion costs for the GMP facility.
- Progress and approval prospects for Rosuvastatin and other pipeline products, and the commercial contribution from Candesartan.
- Remediation of the material weakness and whether subsequent filings report effective controls.