China Pharma Holdings, Inc. — Q2 2015 Form 10-Q
Business and period: The company’s PRC subsidiary manufactures and markets generic and branded pharmaceuticals and biochemical products, primarily to hospitals and private retailers. This unaudited report covers the quarter and six months ended June 30, 2015, compared with the same 2014 periods. Amounts below are U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $5.67 million | $6.13 million | $11.37 million | $13.24 million |
| Gross profit (loss) | $(0.06) million | $2.42 million | $1.00 million | $5.08 million |
| Gross margin | (1)% | 39% | 9% | 38% |
| Operating loss | $(3.80) million | $(8.53) million | $(11.47) million | $(10.86) million |
| Net loss | $(4.12) million | $(8.64) million | $(12.09) million | $(11.03) million |
| Basic and diluted loss per share | $(0.09) | $(0.20) | $(0.28) | $(0.25) |
Q2 revenue fell 7%; first-half revenue fell 14%. First-half operating and net losses worsened year over year, despite lower bad-debt and R&D expenses. Q2 losses narrowed chiefly because bad-debt expense was lower than in the prior-year quarter.
For the six months, net cash used in operating activities was $0.52 million, versus $2.41 million provided in 2014. Investing activities used $0.26 million, compared with $4.54 million; there was no financing cash flow, versus $0.61 million provided in 2014. Cash and cash equivalents declined to $4.55 million from $5.30 million at year-end 2014.
Financial position and material changes
- At June 30, cash was $4.55 million and current assets were $44.35 million; current liabilities were $14.45 million. Total assets were $121.24 million and total liabilities were $26.24 million.
- Debt included $4.93 million of short-term bank notes, $1.64 million current and $11.50 million non-current under the construction loan facility. The short-term line was fully drawn, due November 24, 2015, and bore 6.16% interest. The construction loan’s rate reset to 5.94% on July 10, 2015; principal installments began July 11, 2015.
- Net trade receivables were $17.18 million, down from $24.85 million at December 31, 2014. The doubtful-account allowance rose to $42.84 million from $33.35 million. Management reported $16.5 million of receivables past due, with 69.4% of the aging distribution over 720 days.
- Inventory declined to $13.62 million from $15.32 million, including an obsolescence reserve of $7.22 million. The company recorded $1.42 million of inventory obsolescence in the first half, including $1.22 million in Q2; it began recording the allowance quarterly in 2015 rather than annually.
- Advances for purchases of intangible assets were $43.14 million. The company obtained no CFDA production approvals for medical formulas during the first half; management described typical approval timelines of two to five years.
Management commentary, outlook and risks
- Management attributed weaker sales to market fluctuations, prior GMP-related disruption and missed drug tenders. The largest first-half category, anti-infection/respiratory products, declined 15%; digestive-disease products declined 54%. Higher sales of Vitamin B6 for Injection supported the “Other” category.
- Higher GMP-related production costs, including energy and depreciation, lower-margin product mix and inventory obsolescence reduced gross margins. Management estimated first-half gross margin would have been approximately 21% excluding obsolescence.
- The company had received new GMP certificates for four injectable lines in its new factory and tablet and capsule lines in its old factories. It planned further upgrades by year-end 2015 and expected to upgrade an old-factory dry-powder injectable line the following year.
- Management believed operating cash flow would cover operating needs and anticipated capital spending for the next 12 months, but cautioned that a failure to meet its plan could require additional capital or spending reductions. No assurance was given that financing would be available on acceptable terms.
- Liquidity is affected by the fact that all $4.55 million of cash was considered indefinitely reinvested in the PRC subsidiary and not expected to be available to the parent or shareholders. PRC currency conversion and remittance controls may restrict transfers outside China.
- Other risks include pressure on drug prices and healthcare spending controls, lengthy or unsuccessful CFDA approvals, customer and supplier concentration, foreign-exchange and PRC regulatory risks. Two customers represented 17.3% and 10.7% of receivables; one customer represented 12.7% of first-half sales, and one supplier represented 25.7% of raw-material purchases.
- The company reported approximately $4.2 million of future payments under formula-acquisition contracts, contingent on completion of contract phases. It also disclosed a $1.35 million related-party payable to a board member, bearing 1% interest and payable December 31, 2015.
- Management reported disclosure controls were effective and no material changes in internal control over financial reporting during the quarter. No off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Whether the company can collect its heavily reserved, long-aged receivables and generate positive operating cash flow.
- Whether sales and gross margins recover as GMP-compliant capacity comes online, and whether further inventory write-downs are needed.
- Cash availability for the parent, refinancing or repayment of the November 2015 short-term loan, and scheduled construction-loan principal payments.
- Progress, timing, remaining commitments and commercial prospects for the CFDA formula approvals represented by the $43.14 million advance balance.
- Potential impact of drug-price reform, PRC remittance restrictions and customer and supplier concentration.