CHINA PHARMA HOLDINGS, INC. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2019

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from ____________ to ____________

Commission File Number 001-34471

CHINA PHARMA HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

+86- 898-6681-1730 (China)

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of November 8, 2019, there were 43,579,557 shares of common stock, $0.001 par value per share, issued and outstanding.

CHINA PHARMA HOLDINGS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

CHINA PHARMA HOLDINGS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

CHINA PHARMA HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHINA PHARMA HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE LOSS

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHINA PHARMA HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHINA PHARMA HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

NOTE 1 – ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Liquidity and Going Concern

As of September 30, 2019, the Company had cash and cash equivalents of $0.8 million and an accumulated deficit of $7.2 million. During the nine months ended September 30, 2019, the Company’s Chairperson, Chief Executive Officer and Interim Chief Financial Officer advanced an aggregate of $722,405, including $674,405 in July, 2019, to provide working capital and enable the Company’s required payment of $2.0 million related to its construction loan facility. The Company anticipates operating losses to continue for the foreseeable future due to, among other things, costs related to the production of its existing products, costs for its pipeline products, debt service costs and costs of selling and administrative organization. These conditions raise substantial doubt about its ability to continue as a going concern within one year after the date that the financial statements are issued. To alleviate the conditions that raise substantial doubt about the Company’s ability to continue as a going concern, management plans to enhance the sales model of prepayment, and further strengthen its collection of accounts receivable. Further, the Company is currently exploring strategic alternatives to accelerate the launch of nutrition products. In addition, management believes that the Company’s existing fixed assets can serve as collateral to support additional bank loans. While the current plans will allow the Company to fund its operations in the next twelve months, there can be no assurance that the Company will be able to achieve its future strategic alternatives raising substantial doubt about its ability to continue as a going concern.

Pursuant to the requirements of Accounting Standards Codification (ASC) 205-40, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern management must evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. This evaluation initially does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date the financial statements are issued. When substantial doubt exists under this methodology, management evaluates whether the mitigating effect of its plans sufficiently alleviates substantial doubt about the Company’s ability to continue as a going concern. The mitigating effect of management’s plans, however, is only considered if both (1) it is probable that the plans will be effectively implemented within one year after the date that the financial statements are issued, and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued.

Under ASC 205-40, the strategic alternatives being pursued by the Company cannot be considered probable at this time because none of the Company’s current plans have been finalized at the time of filing this Quarterly Report on Form 10-Q and the implementation of any such plan is not probable of being effectively implemented as none of the plans are entirely within the Company’s control. Accordingly, substantial doubt is deemed to exist about the Company’s ability to continue as a going concern within one year after the date these financial statements are issued.

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the ordinary course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of the uncertainties described above.

Organization and Nature of Operations – China Pharma Holdings, Inc., a Nevada corporation, owns 100% of Onny Investment Limited (“Onny”), a British Virgin Islands corporation, which owns 100% of Hainan Helpson Medical & Biotechnology Co., Ltd (“Helpson”), a company organized under the laws of the People’s Republic of China (the “PRC”). China Pharma Holdings, Inc. and its subsidiaries are referred to herein as the Company.

On December 31, 2012, China Pharma Holdings, Inc. consummated a reincorporation merger for the purpose of changing its state of incorporation from Delaware to Nevada, pursuant to the terms and conditions of an Agreement and Plan of Merger dated December 27, 2012. The reincorporation merger was approved by stockholders holding the majority of the Company’s outstanding shares of common stock on December 21, 2012.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

On June 30, 2019, Catalogue of Encouraging Foreign Investment Industries (2019 Edition) (the “2019 Encouraged Catalogue”) and Special Administrative Measures for Foreign Investment Access (Negative List) (2019 Edition) (the “2019 Negative List”) were jointly released by China’s Ministry of Commerce and the National Development and Reform Commission and became effective on July 30, 2019. Industries listed in the 2019 Encouraged Catalogue are the encouraged industries. On the other hand, industries listed in the 2019 Negative List are subject to special management measures. Establishment of wholly foreign-owned enterprises is generally allowed in industries outside of the 2019 Negative List. Foreign investors are not allowed to invest in industries that are expressly prohibited in the 2019 Negative List. The industries that are not expressly prohibited in the Negative List are subject to government approvals and certain special requirements. The majority of pharmaceutical manufacturing industry including the segments under which the Company conducts its business is not included in the 2019 Negative List. Helpson manufactures and markets generic and branded pharmaceutical products as well as biochemical products primarily to hospitals and private retailers located throughout the PRC. The Company believes Helpson’s business is not subject to any ownership restrictions prescribed under the Catalogue. Onny acquired 100% of the ownership in Helpson on May 25, 2005, by entering into an Equity Transfer Agreement with Helpson’s three former shareholders. The transaction was approved by the Commercial Bureau of Hainan Province on June 12, 2005 and Helpson received the Certificate of Approval for Establishment of Enterprises with Foreign Investment in the PRC on the same day. Helpson received its business license evidencing its WFOE (Wholly Foreign Owned Enterprise) status on June 21, 2005.

The Company has acquired and continues to acquire well-accepted medical formulas to add to its diverse portfolio of Western and Chinese medicines.

Consolidation and Basis of Presentation – The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and are expressed in United States dollars. The accompanying consolidated financial statements include the accounts and operations of the Company including its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidation.

Helpson’s functional currency is the Chinese Renminbi. Helpson’s revenue and expenses are translated into United States dollars at the average exchange rate for the period. Assets and liabilities are translated at the exchange rate as of the end of the reporting period. Gains or losses from translating Helpson’s financial statements are included in accumulated other comprehensive income, which is a component of stockholders’ equity. Gains and losses arising from transactions denominated in a currency other than the functional currency of the entity that is party to the transaction are included in the results of operations.

Accounting Estimates - The methodology used to prepare the Company’s financial statements is in conformity with the accounting principles generally accepted in the United States of America, which requires the management of the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Therefore, actual results could differ from those estimates.

Cash and Cash Equivalents – Cash and cash equivalents include interest bearing and non-interest bearing bank deposits, money market accounts, and short-term banker’s acceptances notes purchased with maturities of three months or less.

Restricted Cash – Restricted cash includes cash that has been deposited with a bank to satisfy obligations outstanding under banker’s acceptance notes issued by the Company as discussed in Note 7.

Trade Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivables are carried at the original invoiced amounts less an allowance for doubtful accounts. The allowances for doubtful accounts are calculated based on a detailed review of certain individual customer accounts and an estimation of the overall economic conditions affecting the Company’s customer base. The Company reviews a customer’s credit history before extending credit to the customer. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additions to the allowance would be required. A provision is made against accounts receivable to the extent they are considered unlikely to be collected. Charges to bad debt expense totaled $31,304 and $1,129,105 for the three months ended September 30, 2019 and 2018, respectively and $54,708 and $1,481,786 for the nine months ended September 30, 2019 and 2018, respectively.

Trade accounts receivable that have been fully allowed for and determined to be uncollectible are charged against the allowance in the period the determination is made. The Company charged off uncollectible trade accounts receivable balances in the amount of $0 against the allowance for the three and nine months ended September 30, 2019 and 2018, respectively. Customer balances outstanding for more than one year are allowed for at a greater rate than more current balances when calculating the allowance for doubtful accounts.

Advances to Suppliers and Advances from Customers – Common practice in the PRC is to make advances to suppliers for materials and to receive advances from customers for finished products. Advances to suppliers are applied to trade accounts payable when the materials are received. Advances received from customers are applied against trade accounts receivable when finished products are sold. The Company reviews a supplier’s credit history and background information before advancing a payment. If the financial condition of its suppliers were to deteriorate, resulting in an impairment of their ability to deliver goods or provide services, the Company would recognize bad debt expense in the period they are considered unlikely to be collected.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

Inventory – Inventory consists of raw materials, work in process and finished goods and is stated at the lower of cost or net realizable value. Cost is determined using a weighted average. For work in process and manufactured inventories, cost consists of raw materials, direct labor and an allocated portion of the Company’s production overhead. The Company writes down excess and obsolete inventory to its estimated net realizable value based upon assumptions about future demand and market conditions. For finished goods and work in process, if the estimated net realizable value for an inventory item, which is the estimated selling price in the ordinary course of business, less reasonably predicable costs to completion and disposal, is lower than its cost, the specific inventory item is written down to its estimated net realizable value. Net realizable value for raw materials is based on replacement cost. Provisions for inventory write-downs are included in the cost of revenues in the consolidated statements of operations. Inventories are carried at this lower cost basis until sold or scrapped.

Valuation of Long-Lived Assets – The carrying values of long-lived assets are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying values may not be recoverable. When such an event occurs, the Company projects the undiscounted cash flows to be generated from the use of the asset and its eventual disposition over the remaining life of the asset. If projections indicate that the carrying value of an asset will not be recovered, it is reduced by the estimated excess of the carrying value over the projected discounted cash flows estimated to be generated by the asset. If there is uncertainty both in timing and amount, the Company will use the projected discounted cash flows to be generated by the asset. There was no impairment loss recognized for the three and nine months ended September 30, 2019 and 2018.

Property, Plant and Equipment – Property, plant and equipment are stated at cost. Maintenance and repairs are charged to expenses as incurred and major improvements are capitalized. Gains or losses on sale, trade-in or retirement are included in operations during the period of disposition. Depreciation relating to office equipment was included in general and administrative expenses, while all other depreciation was included in cost of revenue.

Revenue Recognition – Revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration that an entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amount of revenue that is recorded reflects the consideration that the Company expects to receive in exchange for those goods. The Company applies the following five-step model in order to determine this amount: (i) identification of the promised goods in the contract; (ii) determination of whether the promised goods are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.

The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. Once a contract is determined to be within the scope of ASC 606 at contract inception, the Company reviews the contract to determine which performance obligations the Company must deliver and which of these performance obligations are distinct. The Company recognizes as revenues the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. Generally, the Company’s performance obligations are transferred to customers at a point in time, typically upon buyer’s designated carrier or the buyer picks up the goods at the Company’s warehouse.

For all reporting periods, the Company has not disclosed the value of unsatisfied performance obligations for all product revenue contracts with an original expected length of one year or less, which is an optional exemption that is permitted under the adoption rules.

Cost of Revenues – Cost of revenues includes wages, materials, depreciation, handling charges, and other expenses associated with the manufacture and delivery of products.

Research and Development – Research and development expenditures are recorded as expenses in the period in which they occur.

Basic and Diluted Loss per Common Share - Basic loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted loss per share is calculated to give effect to potentially issuable dilutive common shares.

There were no potentially dilutive common shares outstanding during the three and nine months ended September 30, 2019 and 2018, respectively.

Credit Risk – The carrying amount of accounts receivable included in the balance sheet represents the Company’s exposure to credit risk in relation to its financial assets. No other financial asset carries a significant exposure to credit risk. The Company performs ongoing credit evaluations of each customer’s financial condition. The Company maintains allowances for doubtful accounts and such allowances in the aggregate have not exceeded management’s estimates.

The Company has its cash in bank deposits primarily at state owned banks located in the PRC. Historically, deposits in PRC banks have been secured due to the state policy of protecting depositors’ interests. The PRC promulgated a Bankruptcy Law in August 2006, effective June 1, 2007, which contains provisions for the implementation of measures for the bankruptcy of PRC banks. Company bank accounts in China are not subject to a certain insurance coverage and will follow the provisions set forth in the PRC Bankruptcy Law should any bank where the Company has accounts declare bankruptcy.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

Interest Rate Risk – The Company is exposed to the risk arising from changing interest rates, which may affect the ability of repayment of existing debts and viability of securing future debt instruments within the PRC.

Recent Accounting Pronouncements

Recently Implemented Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases, a new standard on accounting for leases. Effective January 1, 2019 the Company adopted this standard. The ASU introduces a right-of-use (“ROU”) model that requires a lessee to record an ROU asset and lease liability on the balance sheet for all leases with terms longer than twelve months, as well as disclose key information regarding leasing arrangements. Adoption of this standard resulted in the recognition of right-of-use assets of $236,055 and related lease obligations of $236,055 as of January 1, 2019. The adoption of this standard did not have a material impact on the Company’s operating results or cash flows.

As permitted by the transition guidance of ASU No. 2016-02, the Company adopted the standard by applying the modified retrospective method without the restatement of comparative periods. The Company elected the package of practical expedients, which permits a lessee to not reassess under the new standard its prior conclusions regarding lease identification, lease classification and initial direct costs. The Company did not elect the practical expedient which permits the use of hindsight when determining the lease term and assessing right-of-use assets for impairment. As permitted by the transition guidance, the Company used the remaining lease term as of the date of adoption of this standard to estimate discount rates. As permitted by this standard, the Company elected, for all asset classes, the short-term lease exemption. A short-term lease is a lease that, at the commencement date, has a term of twelve months or less and does not include an option to purchase the underlying asset. See Note 9 for additional information on the Company’s leases.

Accounting Policy for Leases –The Company determines if an arrangement contains a lease at inception. The Company elected the practical expedient, for all asset classes, to account for each lease component of a contract and its associated non-lease components as a single lease component, rather than allocating a standalone value to each component of a lease. For purposes of calculating operating lease obligations under the standard, the Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise such option. The Company’s leases do not contain material residual value guarantees or material restrictive covenants. Operating lease expense is recognized on a straight-line basis over the lease terms.

The discount rate used to measure a lease obligation should be the rate implicit in the lease; however, the Company’s operating leases generally do not provide an implicit rate. Accordingly, the Company uses its incremental borrowing rate at lease commencement to determine the present value of lease payments. The incremental borrowing rate is an entity-specific rate which represents the rate of interest a lessee would pay to borrow on a collateralized basis over a similar term with similar payments.

Recently Issued Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which introduces new guidance for the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The pronouncement will be effective for public business entities that are SEC filers in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early application of the guidance will be permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements and related disclosures.

From time to time, the FASB or other standards setting bodies issue new accounting pronouncements. Updates to the FASB ASCs are communicated through issuance of ASUs. Unless otherwise discussed, the Company believes that the recently issued guidance, whether adopted or to be adopted in the future, is not expected to have a material impact on its condensed consolidated financial statements upon adoption.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

NOTE 2 – INVENTORY

Inventory consisted of the following:

NOTE 3 – PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following:

Depreciation is computed on a straight-line basis over the estimated useful lives of the assets as follows:

Depreciation relating to office equipment was included in general and administrative expenses, while all other depreciation was included in cost of revenue. Depreciation expense was $677,395 and $942,555 for the three months ended September 30, 2019 and 2018, respectively and $2,212,731 and $2,405,396 for the nine months ended September 30, 2019 and 2018, respectively.

NOTE 4 - INTANGIBLE ASSETS

Intangible assets represent the cost of medical formulas approved for production by the China Food and Drug Administration (“CFDA”). The Company did not obtain CFDA production approval for any medical formulas during the nine months ended September 30, 2019 and 2018 and no costs were reclassified from advances to intangible assets during the nine months ended September 30, 2019 and 2018, respectively.

Approved medical formulas are amortized from the date CFDA approval is obtained over their individually identifiable estimated useful life, which range from ten to thirteen years. It is at least reasonably possible that a change in the estimated useful lives of the medical formulas could occur in the near term due to changes in the demand for the drugs and medicines produced from these medical formulas. Amortization expense relating to intangible assets was $8,536 and $26,861 for the three months ended September 30, 2019 and 2018, respectively, and $49,070 and $93,718 for the nine months ended September 30, 2019, respectively, which was included in the general and administrative expenses. Medical formulas typically do not have a residual value at the end of their amortization period.

The Company evaluates each approved medical formula for impairment at the date of CFDA approval, when indications of impairment are present and also at the date of each financial statement. The Company’s evaluation is based on an estimated undiscounted net cash flow model, which considers currently available market data for the related drug and the Company’s estimated market share. If the carrying value of the medical formula exceeds the estimated future net cash flows, an impairment loss is recognized for the excess of the carrying value over the fair value of the medical formula, which is determined by the estimated discounted future net cash flows. No impairment loss was recognized during the nine months ended September 30, 2019 and 2018.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

Intangible assets consisted solely of CFDA approved medical formulas as follows:

NOTE 5 – ADVANCES FOR PURCHASES OF INTANGIBLE ASSETS

In order to expand the number of medicines the Company manufactured and marketed, it entered into contracts with independent laboratories and others for the purchase of medical formulas. Although CFDA approval had not been obtained for these medical formulas at the dates of the respective contracts, the objective of the contracts was for the Company to purchase CFDA-approved medical formulas once the CFDA approval process is completed. The Company holds the title to one valid patent that is related to one of its medical formulas. With respect to the other patent title the Company held, the management decided not to renew the patent during 2019 as it did not have any practical value because the related advance purchase to this pipeline product was written off as of December 31, 2018.

Prior to entering into contracts with the Company, laboratories are typically required to complete all research and development to determine the content of the medical formula and the method to produce the generic medicine. The application to the CFDA for production approval must be made by the production facility that will produce the related product. As a result, a contract typically provides that the Company buys the medical formula from the laboratory and the laboratory is required to assist the Company in applying for and obtaining the production approval from the CFDA.

In order to promote the standard of the pharmaceutical industry in China in line with international standards, significant changes have taken place in the policies and regulations in this industry in recent years. A series of policies on consistency evaluation and drug review process have been issued, and more potential reforms and adjustments are underway. In this context, the Company believes that the uncertainties in the timetables for obtaining CFDA production approvals for products under research are increasing.

Under the new regulations and policy environment, the criteria for formulations’ development are more stringent. The Company must supplement and improve the corresponding processes and standards to meet the latest requirements of CFDA in accordance with the requirements of consistency evaluation. As a result, the Company anticipates an extended timeline on the approval process of its current pipeline products.

Under the terms of the contracts, the laboratories are required to assist the Company in obtaining production approval for the medical formulas from the CFDA. Management monitors the status of each medical formula on a regular basis in order to assess whether the laboratories are performing adequately under the contracts. If a medical product is not approved by the CFDA, as evidenced by their issuance of a denial letter, or if the laboratory breaches the contract, the laboratory is required under the contract to provide a refund to the Company of the full amount of the payments made to the laboratory for that formula, or the Company can require the application of those payments to another medical formula with the same laboratory. As a result of the refund right, the Company is ultimately purchasing an approved medical product. Accordingly, payments made prior to the issuance of production approval by the CFDA are recorded as advances for purchases of intangible assets.

To date, no formula has failed to receive CFDA production approval nor has the Company been informed or been made aware of any formula that may fail to receive such approval. However, there is no assurance that the medical products will receive production approval, and if the Company does not receive such approval, it will enforce its contractual rights to receive a refund from the laboratory or have the payments applied to another medical formula with the same laboratory.

As of September 30, 2019, the Company was obligated to pay laboratories and others approximately $0.3 million upon the completion of various phases of contracts to obtain CFDA production approval of medical formulas.

NOTE 6 – RELATED PARTY TRANSACTIONS

A member of the Company’s board of directors (“Board”) had previously advanced the Company an aggregate amount of $1,354,567 as of September 30, 2019 and December 31, 2018 which are recorded as “Other payables – related parties” on the accompanying condensed consolidated balance sheets. The advances bear interest at a rate of 1.0% per year. Total interest expenses for each of the three months ended September 30, 2019 and 2018 were $3,386 and $3,386, respectively. Total interest expenses for the nine months ended September 30, 2019 and 2018 were $10,159 and $10,159, respectively.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

The Company received advances totaling $722,405 and $278,696 from its Chairperson, Chief Executive Officer and Interim Chief Financial Officer. These amounts are recorded as “Other payables – related parties” on the accompanying condensed consolidated balance sheets as of September 30, 2019 and December 31, 2018, respectively. An aggregate of $230,696 was repaid during the nine months ended September 30, 2019. On July 8, 2019 the Company entered into a loan agreement to borrow cash of RMB 4,770,000 ($674,405) from its Chairperson, Chief Executive Officer and Interim Chief Financial Officer. The loan bears interest at a rate of 4.35% and is payable within one year of the loan agreement. Total interest expense related to the loan for the three and nine months ended September 30, 2019 were both $3,896. Compensation payable to the Chairperson, Chief Executive Officer and Interim Chief Financial Officer is included in “Other payables” in the accompanying condensed consolidated balance sheets totaling $2,063,186 and $2,051,186 as of September 30, 2019 and December 31, 2018, respectively.

NOTE 7 – BANKER’S ACCEPTANCE NOTES PAYABLE

In April 2016, the Company entered into a Banker’s Acceptance Note Agreement with a bank. Pursuant to the terms of the agreement, the Company can issue banker’s acceptance notes to any third party as payment of amounts owing to that third party. The Company is required to deposit with the bank an amount equal to the amounts represented by the banker’s acceptance notes issued to the third parties. The amount of these deposited balances is shown as “Restricted cash” on the accompanying condensed consolidated balance sheets as of September 30, 2019 and December 31, 2018. The maximum amount that the Company can issue under this agreement is limited to the lesser of RMB30,000,000 (approximately $4.5 million) or the amount of cash available to deposit against the banker’s acceptance notes. In addition, the agreement calls for the payment of fees equal to 0.05% of the note amount to the bank. As of September 30, 2019 and December 31, 2018, the Company had outstanding banker’s acceptance notes in the amount of $489,208 and $1,273,940, respectively.

NOTE 8 – CONSTRUCTION LOAN FACILITY

The Company obtained a construction loan facility, dated June 21, 2013, in the aggregate amount of RMB 80,000,000 (approximately $13 million). The loan facility is for an eight-year term, which commenced on July 11, 2013, the initial draw-down date. The proceeds of the loan were used for and are collateralized by the construction of the Company’s new production facility and the included production line equipment and machinery. The loan bears interest based upon 110% of the PRC government’s eight-year term rate effective on the actual draw-down date, subject to annual adjustments based on 110% of the floating rate for the same type of loan on the anniversary from the draw-down date and its subsequent anniversary dates. On July 10, 2016, 2017 and 2018 the interest rate was adjusted to 5.39%, 5.39% and 5.39%, respectively. The loan required interest only payments for the first two years. Beginning July 11, 2015, the principal was due in at least two (2) annual installments with the first annual payment due within six month period after July 10, 2015 and the second annual payment due July 10, 2016 and each following year over the next five years through July 11, 2021 on the identical terms as described above for 2015. The Company has made all required payments due under the loan. As of September 30, 2019, the Company had no additional amounts available to it under this facility. During the nine months ended September 30, 2019, the Company made principal payments in the amount of $2,188,463 (RMB15,000,000). All required payments have been made pursuant to the terms of the loan.

Principal payments required for the remaining term of the loan facility as of September 30, 2019 are as follows:

Fair Value of Construction Loan Facility – Based on the borrowing rates currently available to the Company for bank loans with similar terms and maturities, the carrying amounts of the construction loan facility outstanding as of September 30, 2019 and December 31, 2018 approximated its fair value because the underlying instrument bears an interest rate that approximated current market rates.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

NOTE 9 - LEASES

The Company has leases for certain office and production facilities in the PRC which are classified as operating leases. The leases contain payment terms for fixed amounts. Options to extend are recognized as part of the lease liabilities and recognized as right to use assets when management estimates to renew the lease. There are no residual value guarantees, no variable lease payments, and no restrictions or covenants imposed by leases. The discount rate used in measuring the lease liabilities and right of use assets was determined by reviewing the Company’s incremental borrowing rate at the initial measurement date. For the three and nine months ended September 30, 2019, operating lease cost was $20,349 and $66,804, respectively and cash paid for amounts included in the measurement of lease liabilities for operating cash flows from operating leases was $21,629 and $71,005, respectively. As of September 30, 2019, the Company reported operating lease right of use assets and operating lease liabilities of $157,177 and $159,948, respectively. As of September 30, 2019, its operating leases had a weighted average remaining lease term of 1.77 years and a weighted average discount rate of 4.75%.

Minimum lease payments for the Company’s operating lease liabilities were as follows for the twelve month periods ended September 30:

The Company has leases with terms less than one year for certain provincial sales offices that are not material.

NOTE 10 - INCOME TAXES

Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect of a change in tax laws or rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

Liabilities are established for uncertain tax positions expected to be taken in income tax returns when such positions are judged to meet the “more-likely-than-not” threshold based on the technical merits of the positions. Estimated interests and penalties related to uncertain tax positions are included as a component of other expenses. Through December 31, 2018, the Company has not identified any uncertain tax positions that it has taken. U.S. income tax returns for the years ended December 31, 2015 through December 31, 2018 and the Chinese income tax return for the year ended December 31, 2018 are open for possible examination.

Under the current tax law in the PRC, the Company is and will be subject to the enterprise income tax rate of 25%.

The provision for income taxes consisted of the following:

As of September 30, 2019, the Company had net operating loss carryforwards for PRC tax purposes of approximately $52.6 million which are available to offset any future taxable income through 2024. Approximately $3.8 million of these carryforwards will expire in December 2019. The Company also has net operating losses for United States federal income tax purposes of approximately $5.9 million of which $5.1 million which are available to offset future taxable income, if any, through 2038, and $0.6 million are available for carryforward indefinitely subject to a limitation of 80% of taxable income for each tax year.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

Recent U.S. federal tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the “U.S. Tax Reform”), was signed into law on December 22, 2017. The U.S. Tax Reform significantly modified the U.S. Internal Revenue Code by, among other things, reducing the statutory U.S. federal corporate income tax rate from 35% to 21% for taxable years beginning after December 31, 2017; limiting and/or eliminating many business deductions; migrating the U.S. to a territorial tax system with a one-time transition tax on a mandatory deemed repatriation of previously deferred foreign earnings of certain foreign subsidiaries; subject to certain limitations, generally eliminating U.S. corporate income tax on dividends from foreign subsidiaries; and providing for new taxes on certain foreign earnings.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those differences become deductible or tax loss carry forwards are utilized. Management considers projected future taxable income and tax planning strategies in making this assessment. Based upon an assessment of the level of historical taxable income and projections for future taxable income over the periods on which the deferred tax assets are deductible or can be utilized, management believes it is not likely for the Company to realize all benefits of the deferred tax assets as of September 30, 2019 and December 31, 2018. Therefore, the Company provided for a valuation allowance against its deferred tax assets of $26,735,211 and $26,990,951 as of September 30, 2019 and December 31, 2018, respectively.

The Company also incurred various other taxes, comprised primarily of business taxes, value-added taxes, urban construction taxes, education surcharges and others. Any unpaid amounts are reflected on the balance sheets as accrued taxes payable.

NOTE 11 – FAIR VALUE MEASUREMENTS

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, a hierarchy has been established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows: Level 1 – Quoted prices in active markets for identical assets or liabilities; Level 2 – Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; and Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The Company uses fair value to measure the value of the banker’s acceptance notes it holds at December 31, 2018. The banker’s acceptance notes are recorded at cost which approximates fair value. The Company held the following assets and liabilities recorded at fair value:

NOTE 12 - STOCKHOLDERS’ EQUITY

The Company is authorized to issue 95,000,000 shares of common stock, $0.001 par value, and 5,000,000 shares of preferred stock, $0.001 par value. The preferred stock may be issued in series with such designations, preferences, stated values, rights, qualifications or limitations as determined solely by the Company’s Board.

Employee Stock Options

2010 Incentive Plan

On November 12, 2010, the Company’s Board adopted the Company’s 2010 Incentive Plan (the “Plan”), which was then approved by stockholders on December 22, 2010. The Plan gave the Company the ability to grant stock options, restricted stock, stock appreciation rights and performance units to its employees, directors and consultants, or those who will become employees, directors and consultants of the Company and/or its subsidiaries. The Plan currently allows for equity awards of up to 4,000,000 shares of common stock. Through September 30, 2019, there were 175,000 shares of restricted stock granted and outstanding under the Plan. No options were outstanding as of September 30, 2019 under the Plan.

CHINA PHARMA HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018 (UNAUDITED)

There were no securities issued from the Plan during each of the nine months ended September 30, 2019 and 2018.

The Company recognized no compensation expense related to the awards of common shares and the grants and modifications of stock options during each of the three and nine months ended September 30, 2019 and 2018.

The fair value of each option award is estimated on the date of grant using the Black-Scholes Option Pricing Model. Expected volatility is based on the historical volatility of the Company’s common stock prices. The Company uses historical data to estimate employee termination rates. The expected term of options granted is determined by the simplified method, which is one-half of the original contractual term. The simplified method is used due to the lack of historical share option exercise data to provide a reasonable basis upon which to estimate expected term. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

As of September 30, 2019, there was no remaining unrecognized compensation expense related to stock options or restricted stock grants.

NOTE 13 – COMMITMENTS AND CONTINGENCIES

Economic environment - Substantially all of the Company’s operations are conducted in the PRC, and therefore the Company is subject to special considerations and significant risks not typically associated with companies operating in the United States of America. These risks include, among others, the political, economic and legal environments and fluctuations in the foreign currency exchange rate. The Company’s results from operations may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. The unfavorable changes in global macroeconomic factors may also adversely affect the Company’s operations.

In addition, all of the Company’s revenue is denominated in the PRC’s currency of Renminbi (RMB), which must be converted into other currencies before remittance out of the PRC. Both the conversion of RMB into foreign currencies and the remittance of foreign currencies abroad require approval of the PRC government.

NOTE 14 – CONCENTRATIONS

For the nine months ended September 30, 2019, no customer accounted for more than 10% of sales and two customers accounted for 49.5% and 10.7% of accounts receivable. Two suppliers accounted for 21.7% and 19.3% of the Company’s raw material purchases.

For the nine months ended September 30, 2018, no customer accounted for more than 10% of sales and two customers accounted for 47.3% and 14.0% of accounts receivable. Three suppliers accounted for 23.6%, 20.5% and 13.5% of raw material purchases.

NOTE 15 – SUBSEQUENT EVENTS

In accordance with ASC 855-10 the Company’s operations were reviewed by management subsequent to September 30, 2019 to the date these condensed consolidated financial statements were issued, and have determined the Company not have any material subsequent events to disclose in these condensed consolidated financial statements.

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,” or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the readers that any such forward-looking statements 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 filings with the Securities and Exchange Commission (the “SEC”). 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 the 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 the 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 continue to have sustained pressure from the heightened requirements of drug registration standards, consistency evaluations, and the rising costs of clinical trials in the third quarter of 2019. At the same time, the improvement of environmental protection, tax law, air, water and soil pollution control standards and the strengthening of supervision bring about the increase of environmental protection costs. In this context, the shortage of Active Pharmaceutical Ingredients (APIs) and intermediates leads to the increase of raw materials costs.

On March 5, 2016, the Chinese State Council issued “Opinions on Carrying out Consistency Evaluations of the Quality and Efficacy of Generic Drugs” (the “Opinions”). The Opinions defined the objectives of evaluations, established deadlines, determined selection criteria for reference drugs, called for a rational selection of evaluation methods, identified pharmaceutical manufacturers as the principle generic drug consistency evaluations, and set forth corresponding incentives. Subsequently, in May of 2016, the China Food and Drug Administration (the “CFDA”) issued “Comments from the General Office of the State Council on the Consistency Evaluations of the Efficacy and Quality of Generic Drugs”, which further elaborated on assessment processes and related technical rules. Consistency evaluations apply to the majority of our current existing marketed and pipeline products. In this environment, based on the management team’s assessment of each pipeline product based on (i) the adjusted CFDA approval criteria and clinical trial requirements, (ii) the estimated additional investment needed for consistency evaluations and (iii) the potential return on investment for such pipeline product once launched into the market, the management team decided to terminate the progress of certain pipeline products. Complying with consistency evaluations has and will become our core task in the near future and will therefore significantly impact our operations as well as our industrial structure.

In order to support our existing products package we remain focused on development of our pipeline products. We have experienced delays in obtaining approval for certain products in our pipeline because of revisions of and enhancements to CFDA approval criteria and processes. These revisions have resulted in additional supplemental materials and trials, higher costs, and longer approval times for certain applications.

The status of our pipeline products as of September 30, 2019 remains the same as we have reported in our Annual Report on Form 10-K filed with the SEC on March 28, 2019.

Market Trends

Consumer demand for medicine is relatively stable and is generally unaffected by seasonal business cycles. However, we have noticed that the growth rate of the pharmaceutical manufacturing industry has been higher than GDP growth rates in China. According to the data released by the State Council of China, the national budget for health care in 2018 was RMB1,529 billion, which represented an increase of RMB84 billion over the previous year, an increase of 2.5% over that of the national financial expenditure, and accounting for 7.3% of the entire national financial expenditure. On top of that, from 2013 to 2017, the cumulative expenditure on medical and health care in China totaled RMB5,950 billion, which represented an average annual increase of 11.7%, and 2% higher than that of the national financial expenditure in the same period.

The rapid development of the pharmaceutical industry in China has been driven by the continuous growth of total healthcare costs, the establishment and improvement of the universal health-care insurance system, the increases in medical expenditures per capita, the aging population, and the changes in the disease spectrum. However, development has been negatively impacted by factors like health-care insurance cost controls and price pressure in drug tenders in recent years.

The Central Committee Political Bureau of the Communist Party of China approved the “Healthy China 2030 Plan” in August 2016, which proposed reducing personal hygiene spending to approximately 28% of total healthcare expenditures by 2020 and 25% of total healthcare expenditures by 2030.

In order to achieve the objectives of the above-mentioned Healthy China 2030 Plan in the context of an aging population and an improving universal health-care insurance system, we believe that the hygiene spending proportion of total fiscal expenditures to be sponsored by government will increase and that net annual health-care insurance expenditures will increase as well. We anticipate that the use of generic drugs as a cost-effective medical solution will be further promoted as a way to reduce the payment pressures of health-care insurance. As a generic drug company we are presented with a huge domestic market, and through further upgrades, in conjunction with consistency evaluations, could allow us to meet European and American production standards, enabling us to export our products to overseas markets.

In general, demand for pharmaceutical products is still experiencing steady growth in China. The ongoing generic drug consistency evaluations and reform of China’s drug production registration and review policies will have major effects on the future development of our industry and may change its business patterns. We will continue to actively adapt to state policy guidance and further evaluate market conditions for our current existing products, pipeline products and competition in the market in order to optimize our development strategy.

Results of Operations for the Three Months Ended September 30, 2019 Compared to the Three Months Ended September 30, 2018

Revenue

Revenue increased by 3.4% to $2.4 million for the three months ended September 30, 2019, as compared to $2.3 million for the three months ended September 30, 2018.

Set forth below are our revenues by product category in millions (USD) for the three months ended September 30, 2019 and 2018:

Sales in the “CNS Cerebral & Cardio Vascular” product category increased by 37%, to $0.59 million in the three months ended September 30, 2019, as compared to $0.43 million for the same period in 2018. Such increase was mainly due to the increase in sales of Candesartan. Sales of “Anti-Viral/ Infection & Respiratory” product category generated $1.16 million of sales in both the three months ended September 30, 2019 and 2018. Our “Digestive Diseases” product category sales decreased by $0.04 million to $0.12 million in the three months ended September 30, 2019 from $0.16 million for the same period in 2018, which was mainly due to the decrease in sales of Compound Ammonium Glycyrrhetate S for Injection. Our “Others” product category, which generated $0.51 million in sales revenue in the three months ended September 30, 2019 compared to $0.54 million for the same period a year ago, which is a decrease of $0.04 million. This decrease was mainly due to the decrease in sales of Vitamin B6 as a result of the market fluctuation.

For the three months ended September 30, 2019, revenue breakdown by product category showed a few changes to that of the same period in 2018. Sales of the “Anti-Viral/Infection & Respiratory” products category represented 49% and 51% of total sales in the three months ended September 30, 2019 and 2018, respectively. The “CNS Cerebral & Cardio Vascular” product category represented 25% and 19% of total revenue in the three months ended September 30, 2019 and 2018, respectively. The “Digestive Diseases” product category represented 5% and 7% of total revenue in the three months ended September 30, 2019 and 2018, respectively. The “Other” product category represented 21% and 23% of revenues in 2019 and 2018, respectively.

Cost of Revenue

For the three months ended September 30, 2019, our cost of revenue was $2.0 million, or 84% of total revenue, while cost of revenue was $1.8 million, or 78% of total revenue, for the same period in 2018. The increase in cost of revenue was mainly due to the increase in sales. The percentage of cost to revenue also increased in this period, which was mainly due to the stable nature of fixed cost.

Gross Profit and Gross Margin

Gross profit for the three months ended September 30, 2019 was $0.4 million, as compared to $0.5 million during the same period in 2018. Our gross profit margin in the three months ended September 30, 2019 was 15.7% as compared to 22.3% during the same period in 2018. The decrease in our gross profit margin was mainly due to the increased ratio of fixed cost to revenue.

Selling Expenses

Our selling expenses for the three months ended September 30, 2019 and 2018 were $0.6 million and $0.9 million, respectively. Selling expenses accounted for 25.8% of the total revenue in the three months ended September 30, 2019, as compared to 40.3% during the same period in 2018.

General and Administrative Expenses

Our general and administrative expenses were $0.3 million for each of the three months ended September 30, 2019 and 2018. General and administrative expenses accounted for 14.0% and 14.2% of our total revenues in the three months ended September 30, 2019 and 2018, respectively.

Research and Development Expenses

Our research and development expenses for the three months ended September 30, 2019 were $0.04 million, as compared to $0.06 million in the same period in 2018. Research and development expenses accounted for 1.7% and 2.7% of our total revenues in the three months ended September 30, 2019 and 2018, respectively. The consistency evaluations discussed under the “Business Overview & Recent Developments” section hereof is expected to have a significant impact on all generic products not only in our pipeline products, but also throughout the existing Chinese market for similar generic products. Because of the continuous introduction of detailed implementation rules under this policy, our pipeline products did not experience any further development in the third quarter of 2019.

Bad Debt Expenses

Our bad debt expenses for the three months ended September 30, 2019 was $0.03 million, as compared to $1.13 million for the same period in 2018. The decrease of bad debt expenses in this period was mainly due to the decrease in the amount of accounts receivable that is turning to over 2 years old in this period. Our bad debt allowance estimate requires 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.

We increased our customer credit or payment terms from 90 days to 180 days in the fourth quarter of 2018 in order to better reflect our actual operating environment. Due to the peculiar circumstances affecting the Chinese pharmaceutical market, deferred payments to pharmaceutical companies by state-owned hospitals and local medicine distributors are a normal phenomenon. Our customers are primarily pharmaceutical distributors that sell our products to mostly government-backed hospitals. Therefore, the aging of our receivables from our customers tends to be longer-term.

The amount of accounts receivable that were past due (or the amount of accounts receivable that were more than 180 days old) was $0.17 million and $0.22 million as of September 30, 2019 and December 31, 2018, respectively.

The following table illustrates our accounts receivable aging distribution in terms of percentage of total accounts receivable as of September 30, 2019 and December 31, 2018:

In the fourth quarter of 2018, our bad debt allowance estimate was updated to a policy which requires no allowance of accounts receivable recognized that are within 180 days old, 10% of accounts receivable that are between 180 days and 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. Prior to that, our policy was no allowance of accounts receivable recognized that are within 90 days old, 10% of accounts receivable that are between 90 days and 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.

We recognize bad debt expenses per actual write-offs as well as 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 $17.4 million and $17.8 million as of September 30, 2019 and December 31, 2018, respectively. The changes in the allowances for doubtful accounts during the nine months ended September 30, 2019 and 2018 were as follows:

Loss from Operations

Our operating loss for the three months ended September 30, 2019 was $0.6 million, compared to an operating loss of $1.9 million during the same period in 2018.

Net Interest Expense

Net interest expense for the three months ended September 30, 2019 and 2018 was $0.06 million and $0.09 million, respectively.

Income Tax expense

Our income tax rate for our wholly owned subsidiary, Hainan Helpson Medical & Biotechnology Co., Ltd.(“Helpson”) was 25% for both the three months ended September 30, 2019 and 2018. We did not have any income tax expense for the three months ended September 30, 2019, while the income tax expense was $0.16 million for the three months ended September 30, 2018. Helpson’s tax rate for 2019 was 25% and will remain at this rate for the foreseeable future.

Net Loss

Net loss for the three months ended September 30, 2019 was $0.7 million, as compared to a net loss of $1.9 million for the same period a year ago. The decrease in net loss was mainly the result of controls on expenditures outweighed the impact of decrease in gross profit margin.

For the three months ended September 30, 2019 and 2018, loss per basic and diluted common share were $0.02 and $0.04, respectively.

The number of basic and diluted weighted-average outstanding shares used to calculate loss per share was 43,579,557 for both the three months ended September 30, 2019 and 2018.

Results of Operations for the Nine Months Ended September 30, 2019 Compared to the Nine Months Ended September 30, 2018

Revenue

 For the nine months ended September 30, 2019, our sales revenue was $7.9 million, which represented a decrease of $1.2 million, or 13.3%, from the $9.1 million in the corresponding period of 2018.

Set forth below are our revenues by product categories in millions USD for each of the nine months ended September 30, 2019 and 2018.

Sales Revenue by Major Category (Dollars in Millions)

The most significant decrease in revenue in terms of dollar amount was in our “Anti-Viro/ Infection & Respiratory” product category, which generated $4.48 million in sales revenue in the nine months ended September 30, 2019, compared to $4.97 million in the nine months ended September 30, 2018, representing a decrease of $0.49 million. This decrease was mainly caused by the decrease in sales of Cefactor, due to market fluctuation.

Our “Other” category decreased by $0.45 million to $1.41 million in the nine months ended September 30, 2019, compared to $1.85 million in the same period of 2018. This decrease was mainly a result of a decrease in sales of Vitamin B6 for Injection, due to market fluctuation.

Sales of the “Digestive Diseases” generated $0.35 million and $0.58 million in the nine months ended September 30, 2019 and 2018, respectively. This decrease was mainly a result of decrease in sales of Omeprazole, due to market fluctuation.

Our “CNS Cerebral & Cardio Vascular” category generated $1.67 million of sales in the nine months ended September 30, 2019, compared to $1.68 million in the same period of 2018.

For the nine months ended September 30, 2019, revenue breakdown by product category showed certain changes as compared to that of the prior year. Sales of the “Anti-Viro/Infection & Respiratory” products category represented 57% and 55% of total sales in the first nine months ended September 30, 2019 and 2018. The “CNS, Cerebral & Cardio Vascular” category represented 21% and 19% of total sales in the first nine months ended September 30, 2019 and 2018. The “Other” category represented 18% and 20% of total sales in the first nine months ended September 30, 2019 and 2018. The “Digestive Diseases” category represented 4% and 6% of total revenue in the first nine months ended September 30, 2019 and 2018, respectively.

Cost of Revenue

For the nine months ended September 30, 2019, our cost of revenue was $6.7 million, or 84.9% of total revenue. This represented a decrease of $0.3 million from $6.9 million, or 76.4% of total revenue, in the same period of 2018. The decrease in cost of revenue in the nine months ended September 30, 2019 was mainly a result of the decrease in revenue. However, the percentage of cost to revenue increased in this period, which was mainly due to the stable nature of fixed cost.

Gross Margin and Gross Profit

Gross profit for the nine months ended September 30, 2019 was $1.2 million, compared to $2.1 million in the same period of 2018. Gross profit margins for the nine months ended September 30, 2019 and 2018 were 15% and 24%, respectively.

Selling Expenses

Our selling expenses for the nine months ended September 30, 2019 were $1.6 million, compared to $2.3 million for the same period of 2018. Selling expenses accounted for 20.3% and 25.5% of the total revenue in the first nine months of 2019 and 2018 respectively.

General Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2019 and 2018 were $1.1 million and $1.2 million, respectively.

Research and Development Expenses

Our research and development expenses for the nine months ended September 30, 2019 and 2018 were $0.2 million and $0.1 million, respectively.

Bad Debt Expenses

Our bad debt expenses for the nine months ended September 30, 2019 were $0.05 million, compared to $1.48 million for nine months ended September 30, 2018. Please see additional discussion of bad debt and accounts receivable in the section above named “Bad Debt Expense”. The changes in the allowance for doubtful accounts during the nine months ended September 30, 2019 and 2018 were as follows:

Loss from Operations

Our operating loss for the nine months ended September 30, 2019 was approximately $1.7 million, compared to $2.9 million for the same period of 2018.

Income Tax Expense

Our income tax rate for our wholly owned subsidiary, Helpson, was 25% for both the nine months ended September 30, 2019 and 2018. We did not have any income tax benefit expense for the nine months ended September 30, 2019, and our income tax expense was $0.11 for the nine months ended September 30, 2018.

Net Loss

Our net losses for the nine months ended September 30, 2019 and 2018 were $2.0 million and $3.2 million, respectively, which represented an improvement of $1.2 million for the period in 2019. This improvement was mainly due to the decrease of bad debt expenses in this period.

Liquidity and Capital Resources

Our principal source of liquidity is cash generated from operations and advances and a loan from our Chairperson, Chief Executive Officer and Interim Chief Financial Officer. Our cash and cash equivalents were $0.8 million, representing 1.9% of our total assets, as of September 30, 2019, as compared to $1.2 million, representing 2.6% of our total assets as of December 31, 2018. All of the $0.8 million of cash and cash equivalents as of September 30, 2019, is considered to be reinvested indefinitely in the Company’s Chinese subsidiary, Helpson and is not expected to be available for payment of dividends or for other payments to its parent company or to its shareholders. We entered into an eight-year construction loan facility on September 21, 2013. The total construction loan facility amount was RMB80 million (approximately $11.7 million), which had been fully utilized through May 7, 2014. The construction loan installments to be repaid within the next 12 months are about $2.1 million as of September 30, 2019. On July 10, 2019, we repaid such principal and accumulatively repaid the principal of RMB 50 million (approximately $7.2 million) of the construction loans, per the payback schedule. Our Chairperson , Chief Executive Officer and Interim Chief Financial Officer had advanced $278,696 for working capital at December 31, 2018. We have repaid $209,726 to the Chairperson in the first half of 2019. In July 2019, our Chairperson, Chief Executive Officer and Interim Chief Financial Officer advanced cash to us of RMB 4.77 million (about $ 0.67 million) for the construction loan repayment. Cash flow generated from operating activities and the above mentioned loan were used to fund our daily operating expenses as well as the repayment of our loan facility.

Based on our current operating plan, management believes that cash provided by operations will be sufficient to meet our working capital needs and our anticipated capital expenditures, including expenditures for consistency evaluations and new formula acquisitions for the next twelve months. However, if circumstances change and we do not follow 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, which may include debt and/or equity financing when we believe market conditions are most advantageous. As discussed above, our Chairperson has been supporting us financially for the repayment of our loan facility. Nor can there be any assurance that any additional financing will be available on acceptable terms, if at all.

Operating Activities

Net cash provided by operating activities was $1.4 million in the nine months ended September 30, 2019, as compared to $1.0 million for the same period in 2018.

As of September 30, 2019, our net accounts receivable were $0.7 million, as compared to $0.9 million, as of December 31, 2018.

Total inventory was $4.0 million, as of September 30, 2019, and $5.1 million as of December 31, 2018.

Investing Activities

During the nine months ended September 30, 2019, net cash used in investing activities was $0.09 million as compared to $0.03 million for the nine months ended September 30, 2018.

Financing Activities

Cash flow used in financing activities was $1.7 million in the nine months ended September 30, 2019, as compared to $2.3 million in the nine months ended September 30, 2018. The financing activities that occurred in the nine months ended September 30, 2019 were primarily payments to related party payables, the scheduled payments of the construction loan facility described in the first paragraph of this section entitled “Liquidity and Capital Resources” and as discussed in Note 8 to the condensed consolidated financial statements. In addition, our Chairperson, Chief Executive Officer and interim Chief Financial Officer loaned cash to us of RMB 4.77 million (about US$ 0.67 million) for the construction loan repayment.

According to the relevant laws of the People’s Republic of China (the “PRC”), companies registered in the PRC, including our PRC subsidiary, Helpson, are required to allocate at least ten percent (10%) of their after-tax net income, as determined under accounting standards and regulations in the PRC, to statutory surplus reserve accounts until the reserve account balances reach fifty percent (50%) of the companies’ registered capital prior to their remittance of funds out of the PRC. Allocations to these reserves and funds can only be used for specific purposes and are not transferrable to the parent company in the form of loans, advances or cash dividends. As of September 30, 2019 and December 31, 2018, Helpson’s net assets totaled $24,997,000 and $27,485,000, respectively. Due to the restriction on dividend distribution to overseas shareholders, the amount of Helpson’s net assets that was designated for general and statutory capital reserves, and thus could not be transferred to our parent company as cash dividends, was $8,145,000 and $8,145,000 (50% of registered capital) as of September 30, 2019 and December 31, 2018, respectively. Since the amount that Helpson must set aside for the statutory surplus fund only accounts for 32.6% and 29.6%, respectively, of its total net assets, this reserve does not have a major impact on our liquidity. There were no allocations to the statutory surplus reserve accounts during the nine months ended September 30, 2019.

The Chinese government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China.  Our businesses and assets are primarily denominated in RMB.  All foreign exchange transactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requires the submission of a payment application form together with certain invoices and executed contracts. The currency exchange control procedures imposed by Chinese government authorities may restrict the ability of Helpson, our Chinese subsidiary, to transfer its net assets to our parent company through loans, advances or cash dividends.

Off-Balance Sheet Arrangements

As of September 30, 2019, we did not have any off-balance sheet arrangements.

Commitments

As of September 30, 2019, we were obligated to pay laboratories and other service providers approximately $0.30 million over approximately the next four years upon completion of various phases of contracts required to obtain CFDA production approval for our medical formulas.

Critical Accounting Policies

Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our financial statements reflect the selection and application of accounting policies that require management to make significant estimates and judgments. The discussion of our critical accounting policies contained in Note 1 to our consolidated financial statements, “Organization and Significant Accounting Policies”, is incorporated herein by reference.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this item.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and interim Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act (a) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (b) is accumulated and communicated to management, including our Chief Executive Officer and interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as described above. Based on this evaluation, our Chief Executive Officer and interim Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2019 to satisfy the objectives for which they are intended. This was due to the material weakness in our internal control over financial reporting, with respect to our lack of accounting financial reporting personnel who were knowledgeable in U.S. GAAP, as disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on March 28, 2019. Notwithstanding the aforementioned material weakness, management has concluded that our consolidated financial statements included in this report are fairly stated in all material respects in accordance with U.S. GAAP for each period presented herein.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 6. Exhibits

The exhibits required by this item are set forth in the Exhibit Index attached hereto.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBIT INDEX

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