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TPI > SEC Filings for TPI > Form 10-K on 26-Sep-2013All Recent SEC Filings

Show all filings for TIANYIN PHARMACEUTICAL CO., INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for TIANYIN PHARMACEUTICAL CO., INC.


26-Sep-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

FORWARD-LOOKING INFORMATION

This report contains forward-looking statements regarding our plans, expectations, estimates and beliefs. Actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Forward-looking statements are identified by words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may," and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We have based these forward-looking statements largely on our expectations.


Forward-looking statements are subject to risks and uncertainties, certain of which are beyond our control. Actual results could differ materially from those anticipated as a result of the factors described in the "Risk Factors" and detailed in our other Securities and Exchange Commission filings.

Due to these risks and uncertainties, the forward-looking events and circumstances discussed in this report or incorporated by reference might not transpire. Factors that cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in the "Risk Factors" section and elsewhere in this report.

We did not conduct any operations during periods up through the date of the Share Exchange. However, we have included elsewhere in this report the historical consolidated financial statements of the Company and its subsidiaries, which we own as a result of the Share Exchange. The following discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" section of this report. Actual results may differ materially from those contained in any forward-looking statements.

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the financial statements of TPI for the fiscal years ended June 30, 2013 and 2012 and should be read in conjunction with such financial statements and related notes included in this report.

Overview

We are engaged primarily in the development, manufacturing, marketing and sale of patented biopharmaceuticals, branded generics, modernized Chinese medicines and other pharmaceuticals in China. We currently manufacture and market a comprehensive portfolio of 58 products approved by the CFDA including the patented Gingko Mihuan Oral Liquid ("GMOL"), 24 of which are included in the National Reimbursement List. Furthermore, we have 6 trademarks granted and 16 trademarks pending. Chengdu Tianyin Pharmaceutical Co., Ltd ("Chengdu Tianyin"), was established in 1994 in Chengdu, China as a pharmaceutical company that manufactures and sells modernized traditional Chinese medicines and branded generics. The current management of Chengdu Tianyin acquired 100% of the equity interest of the Company in 2003. On October 30, 2007, Grandway completed the acquisition of the 100% of the equity interest and now owns 100% of the equity interest of Chengdu Tianyin that operates our business.

In June 2009, to optimize our business model through stronger distribution channels, Chengdu Tianyin invested $0.7 million to establish a wholly-owned trading subsidiary, Chengdu Tianyin Medicine Trading Co., Ltd ("TMT") for sales and distribution of medicine produced by Chengdu Tianyin and other pharmaceutical companies.

On August 21, 2009, Chengdu Tianyin, Sichuan Mingxin Pharmaceutical and an individual investor established Sichuan Jiangchuan Pharmaceutical Co., Ltd ("JCM"), whose major business is to produce macrolide antibiotic active pharmaceutical ingredients (API). Total registered capital of JCM is approximately $2.9 million, of which Chengdu Tianyin accounts for approximately 87%. JCM is considered a cornerstone in the foundation we are building for a broader strategy to establish a significant presence by the Company in the macrolide antibiotics industry in China.

In order to facilitate the relocation of Chengdu Tianyin's business operation to Qionglai County and to secure land use rights for the relocation of manufacturing facilities, Chengdu Tianyin needed to establish its presence at Qionglai County during the process of construction, while all operating subsidiaries of Chengdu Tianyin are registered outside of Qionglai. Therefore, the Company decided to acquire a pharmaceutical distribution company and registered it in Qionglai County as a subsidiary of Chengdu Tianyin. On August 29, 2012, Chengdu Tianyin entered into a Share Transfer Agreement with the shareholders of Sichuan Hengshuo Pharmaceutical Co., Ltd ("Sichuan Hengshuo" or "HSP"), a PRC pharmaceutical trading company, to acquire 100% ownership of HSP for a total consideration of approximately $0.2 million (RMB 1.3 million). The share transfer was closed on November 30, 2012, pursuant to which Chengdu Tianyin now owns 100% of HSP and Dr. Guoqing Jiang has become the legal representative of HSP.

In preparation for the new Good Manufacturing Practice (GMP) standards stipulated by the PRC government in early 2011, TPI initiated a process to optimize the manufacturing facilities and production lines of the Company in compliance with the new GMP standards. We received our current GMP certificate for both of our pre-extraction plant and formulate facilities on August 27, 2013 for the next three years until the end of 2015. In addition, under the guidance by provincial government, our facility is scheduled to be relocated to Qionglai County, south of Chengdu, which is designated for the pharmaceutical industry. The Qionglai facility (QLF) post-relocation is approximately 18 miles from the Company's recently completed JCM facility. The proposed relocation project also includes our TCM pre-extraction plant which is currently located near the center of the city of Chengdu surrounded by a rapidly expanding residential area. Both the pre-extraction plant and the formulation plant will subsequently be relocated to Qionglai County to become a combined QLF plant, which is estimated to be 80 mu or approximately 13 acres. The combined QLF plant, designed and constructed according to the latest GMP standards, is expected to relieve the current capacity saturation at the current facilities. The re-location cost for Phase I is estimated at $25 million, which, when completed, is expected to expand the current capacity by approximately 30%. If the Company decides to further expand the capacity, Phase II QLF, an additional $10 million may be invested to double the current capacity. Since the official start of the relocation project in February 2012, the construction of the QLF project has been progressing on schedule. The Phase I of relocation of pre-extraction plant is expected to complete by the end of 2013 calendar year.


Competitive environment

The market for pharmaceutical products is highly competitive. Our operations may be affected by government policies, post-market studies, pipeline development, technological advance by competitors, industrial consolidation, patents granted to competitors, competitive combination products, new products offered by our competitors, as well as new information provided by other marketed products and/or other post-market studies. In addition, the ongoing healthcare reform in China provides opportunities as well as challenges to our pipeline development and market expansion.

Development and Growth Strategy

Research and Development

The cornerstone of our business development strategy relies upon our partnership-based research and development (R&D) efforts, which support us in developing and commercializing our product pipeline and ultimately with our marketing and sales through our expanding distribution network. Under this R&D model, we are entitled to purchase the exclusive ownership and intellectual properties of new drugs developed by research institutes upon CFDA approval. Prior to our purchase, the institutes take the full financial responsibility for the costs incurred during the R&D phase. The purchase price for these drugs ranges from $250,000 to $800,000 per candidate, which is based upon the development costs for individual products and the expected revenue from the product. Usually, we expect the material net cash inflows from drugs in late stage development to begin within three years upon CFDA approval. Since the projects are targeted for well defined marketable products and TPI will retain the full ownership of these CFDA-approved products and related intellectual properties, the subsequent commercialization is expected to be accretive upon new products' market entry. In addition, we are able to leverage these R&D resources to further facilitate market recognition and commercialization of these products. With this strategy in place, we increased market penetration and sales and marketing growth in the past years. Part of this strategy involves increasing and improving our marketing and sales activities to enhance the market leadership of our key leading products and to increase the sales of other products by expanding our sales force, solidifying our distribution network and expanding our market segment coverage, while increasing our marketing and promotional activities.

This R&D model reduces the financial risks from a prolonged or uncertain approval process and limits the impact on our financial position and liquidity by the unexpected delay of any individual drug approval. The uncertainties in receiving the approval involve endpoint measurement in these clinical trials. To facilitate successful trials, we assist our partnership institutes with development during the early stage of the trials, including patient and control group selection, trial design, endpoint measurement and etc. A successfully run trial depends on a variety of well-calibrated scientific and technical indices that are required for CFDA approval. If some of these indices are unable to yield satisfactory results, we can either troubleshoot or terminate the development in the early stage, which will not significantly impact us financially.

We usually begin drug commercialization preparation within 6 months after the CFDA approval. However, there are several factors that may lead to delays in this process including: mass manufacturing capacity readiness, marketing network preparedness and the indication seasonality. On average, the material positive net cash flow is expected from new market entries within two years to two and half years after their market entry.

Management plans to selectively pursue strategic acquisitions and licensing opportunities as effective means to broaden our product portfolio, leverage our resources and expand our market coverage.

R&D for additional indications of flagship product Gingko Mihuan (GMOL)

Our flagship product Gingko Mihuan Oral Liquid (GMOL, CFDA certification number:
H20013079; patent number: 20061007800225) contributed approximately 39% to our total revenue in fiscal year 2013. Clinical application and information gathered from our physicians showed that in addition to our approved indication for GMOL:
cardiovascular disorders, coronary heart disease and cerebral ischemic attack including strokes, off-label use of GMOL have been indicated in hepatic diseases and ophthalmological diseases. The validity of these observations is currently being investigated.


Jiangchuan Macrolide Facility ("JCM")

In April 2009, we entered into a land supply agreement with the Sichuan Xinjin County Government to acquire 100 mu (approximately 66,700 square meters) of land within the Xinjin Chemical Industrial Park to establish a manufacturing plant for Active Pharmaceutical Ingredients ("API") of macrolides antibiotics. In August 2009, we partnered with Sichuan Mingxin Pharmaceutical Co., Ltd. in the launch of a new joint venture, Sichuan Jiangchuan JV ("JCM"), which primarily engages in the R&D, manufacturing, sales and marketing of API and chemical intermediates of macrolide antibiotics. The joint venture is 87% owned by TPI. The JCM construction was completed in 2011.

In January 2012, JCM was approved for its GMP certification designated as "CHUAN M0799," which is valid for the period of December 31, 2011 until December 31, 2015. JCM has started producing macrolide API for TPI's production of Azithromycin Dispersible Tablets (CFDA No: H20074145) since July 2012. Currently the monthly production capacity of JCM is 10 tons of Azithromycin macrolide API. As of September 26, 2013, the JCM facility has been in operation and mainly supporting TPI's production of Azthromycin tablets. Our third party sales from our JCM facility for our fiscal year 2013 was $0.9 million.

Tianyin Medicine Trading Distribution Business ("TMT")

We have been developing the distribution portfolio of TMT which distributes products manufactured by both TPI and other pharmaceutical companies to fuel our expanding sales network as well as to provide synergy to our existing organic product portfolio. TMT has been distributing mainly TPI's own products since its inception in 2009. In 2010 we signed a distribution contract with Jiangsu Lianshui Pharmaceutical, one of the most celebrated national brand injection pharmaceutical manufacturers to distribute approximately 15 Lianshui-branded generic injection products including cough suppressant, antibiotics, anti-inflammatory medicines and products for other healthcare indications. The distribution contract was successfully extended for the following year until 2014 with possible renewal for additional years when the current contract expires. The annual distribution revenue from TMT reached approximately $16.2 million for the fiscal year 2013.

Guidance

Our revenue of approximately $67.5 million came below our previously estimated 5% growth projection year over year. This was mainly due to the tightened pricing control of generic medicines in China amid the healthcare reform and from the government's efforts to promote lower margined essential drugs (EDL) that simultaneously compressed our margins as well as our sale volumes of those generic products. Those factors, together with the negative market environment of Azithromycin API pricing led to intensified market and pricing competition combined with an excess of capacity that may continue to last for a few years.

Our net margin guidance met our estimated 10% goal and delivered net income for our fiscal year 2013 of $6.8 million, a growth of 6% from fiscal year 2012. This was primarily attributable to the improvement of our gross margins driven by growth in our core product sales growth.

The following factors, in our opinion, will influence the future growth perspectives of our Company:

1) Market expansion and revenue growth of TPI's core product portfolio led by flagship product Gingko Mihuan Oral Liquid (GMOL) and other major products;
2) Gradual ramp up of JCM revenue in the fiscal year 2014;
3) The stabilization of generic sales following the progressive pricing restrictions as a result of the ongoing healthcare reform;
4) Steady TMT distribution revenue contribution; and
5) QLF relocation and smooth transition of production capacity.

Considering the continuous generic pricing pressure going forward, along with gradual development of our JCM business and the TMT distribution revenue for the following year, we forecast that the revenue growth for TPI may range from 0% to 5% for the coming year, along with a 10% net margin. (The forecasted net income guidance excluded any non-cash expenses associated with stock compensation plans or stock option expenses.)


Our current facilities operate at approximately 90% of the total capacity on a 24 hours per day schedule. We are in the process of optimizing the usage of the remaining capacity and expanding the existing capacities to meet the increasing market demand.

Management will continue to evaluate the Company's business outlook and communicate any changes on a quarterly basis or as when appropriate.

Discussion on Operating Results

Comparison of results (in $ million) for the fiscal years ended June 30, 2013
and 2012

Years Ended June 30                                     2013        2012
Sales                                                  $ 67.5      $ 69.6
Cost of Sales                                          $ 41.5      $ 45.3
Gross profit                                           $ 26.0      $ 24.3
Selling, general and administrative and R&D expenses   $ 16.7      $ 15.8
Other income (expenses)                                $ (0.3 )    $  0.1
Income taxes                                           $  2.4      $  2.4
Net income attributable to TPI                         $  6.6      $  6.4

Sales for the fiscal year ended June 30, 2013 was $67.5 million, decreased by 3.0% from $69.6 million for the fiscal year 2012, as a result of generic pricing pressure, coupled with prolonged JCM production ramp up. We witnessed a 4% reduction of total revenue from TPI's own products which excludes the distribution revenue, from $53.0 million for the fiscal year ended June 30, 2012 to $51.0 million for the fiscal year ended June 30, 2013. We are currently exploring and implementing various strategies to stabilize our generic sales. In addition to introducing distribution revenue from TMT and JCM macrolide API revenue, we are also focusing on expanding sales efforts at tier 3 and tier 2 rated hospitals in major cities of China to strengthen our high-end hospital pharmaceutical market segment. Our top five products by sales in fiscal year 2013 are:

Product Description                                                  Amount
Ginkgo Mihuan Oral Liquid (GMOL) for cardiovascular diseases     $ 26.1 million
Mycophenolate mofetil capsules (MM) for renal transplant         $  6.9 million
Azithromycin Dispersible Tablets (AZI) for infectious diseases   $  4.6 million
Qingre Jiedu Oral Liquid (QRE) for viral infections              $  3.6 million
Yanyan Tablets (YY) for throat inflammation                      $  1.6 million

The core product portfolio totaled $42.7 million or 83.8% of the organic portfolio revenue.

Cost of Sales for the fiscal year ended June 30, 2013 was approximately $41.5 million or 61.5% of the revenue, compared with $45.3 million or 65.1% of the revenue for the fiscal year ended June 30, 2012. Our cost of sales primarily consists of the direct raw material costs, labor, depreciation and amortization of manufacturing equipment and facilities and other overhead. The percentage decrease of our cost of sales from the previous year was the combined results of increased sales of higher margined core products and decrease of low margined generic sales, which was discussed in the following "Gross profit" segment.

Gross profit for fiscal year ended June 30, 2013 was approximately $26.0 million with 38.5% gross margins an increase of 7% year over year, compared with $24.3 million with 35.0% gross margin for fiscal year ended June 30, 2012. The improvement in gross margins was mainly attributable to the increase of the sales of GMOL by 53.0% year over year from $17.1 million in fiscal year 2012 to $26.1 million, along with other core products revenue growth that totaled $42.7 million with higher margins. This offset the prevailing generic pricing pressure and the lower margined TMT distribution revenues, whose gross margins average about 10%. During the fiscal year 2013, our organic product portfolio delivered approximately 51.6% gross margins, a significant improvement from 45.0% in fiscal year 2012. Provided the blend of core product sales growth along with TMT lower margin distribution revenue and lower margin generic sales as the current pricing trend continues, we anticipate our overall gross margin in the near term to stabilize above 36% for the fiscal 2014, influenced by the revenue mix of TMT revenue and JCM macrolide API revenue, as compared to the core product portfolio performance. The factors that influence the gross margins of our major products include raw material price (85% of the cost of goods sold) and production cost (15% of the cost of goods sold).

Operating and R&D Expenses were $16.7 million in fiscal year ended June 30, 2013, compared with $15.8 million in fiscal year ended June 30, 2012. The increase is associated with the increase of selling and marketing expenses. We expect the operating expenses percentage to stabilize between 20 - 25% of the revenue for the coming year.


Net income was $6.6 million in fiscal year ended June 30, 2013, an increase of 6.0% from $6.2 million in fiscal year ended June 30, 2012. The growth was primarily the result of margin improvement driven by core products sales from the previous year which was discussed in the "Gross profit" segment.

Foreign Currency Translation Adjustment. Our reporting currency is the US dollar. We have evaluated the determination of its functional currency based on the guidance in ASC Topic, "Foreign Currency Matters," which provides that an entity's functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment in which an entity primarily generates and expends cash. We have raised financings in the U.S. dollar, paid operating expenses primarily in the U.S. dollar, paid dividends to its shareholders of common stock and expected to receive any dividends that may be declared by its subsidiaries in U.S. dollars. Therefore, it has been determined that our functional currency is the U.S. dollar based on the expense and financing indicators, in accordance with the guidance in ASC 830-10-85-5. However, the functional currency of Chengdu Tianyin, our indirectly owned operating subsidiary is Renminbi (RMB). Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People's Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders' equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

Currency translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to $10.2 million as of June 30, 2013. The balance sheet amounts with the exception of equity as of June 30, 2013 were translated at 6.1728 RMB to 1.00 US dollars as compared with 6.30915 RMB to 1.00 US dollars as of June 30, 2012. The equity accounts were stated at their historical rate. The average translation rates applied to income statement accounts for the years ended June 30, 2013 and 2012 were the average exchange rates during the years.

Comprehensive Income was $8.7 million in fiscal year ended June 30, 2013, compared with $8.3 million in fiscal year ended June 30, 2012.

Liquidity and Capital Resources
Discussion of cash flow

                                        For the fiscal years
                                           ended June 30,
In $ millions                            2013            2012
Cash flow from operating activities   $      8.2        $   7.9
Cash flow from investing activities   $    (16.1 )      $  (5.1 )
Cash flow from financing activities   $     (1.1 )      $ (0.13 )

Operating activities

As of June 30, 2013, we had working capital totaling $35.9 million, including cash and cash equivalents of $26.8 million. Net cash generated from operating activities was $8.2 million for fiscal year ended June 30, 2013 as compared with $7.9 million for fiscal year ended June 30, 2012. The increase was mainly due to the increase of net income. At the end of fiscal year 2013, the accounts receivable was $10.1 million, 15.0% of the total revenue, improved from $11.3 million, or 16.2% of the total revenue for fiscal 2012, which is mainly due to the shortened payment cycle by distributors driven by core products revenue performance. We believe that TPI is adequately funded to meet all of our working capital and capital expenditure needs for fiscal year 2014.

Investing activities

Net cash used in investing activities for the fiscal year ended June 30, 2013 totaled $(16.1) million compared with $(5.1) million in the fiscal year ended June 30, 2012 which are mainly related to the construction and equipment purchase of the QLF project. We anticipate that in the first half of fiscal year 2014 the capital expenditure will be approximately $10 million due to our QLF relocation.

Financing activities

Net cash used in financing activities for fiscal year ended June 30, 2013 totaled $(1.1) million compared with $(0.13) million for fiscal year 2012. This was predominately due to the restriction of cash of $(0.9) million and the payment of a short term bank loan of $6.1 million offset by new short term bank loan borrowing of $5.8 million.


Borrowings and Credit Facilities

The short-term bank borrowings outstanding as of June 30, 2013 and 2012 were $5.9 million and $6.0 million, respectively. There is no significant change in the loan amount. The slight difference was primarily due to the currency conversion rate fluctuation between the fiscal years 2013 and 2012. We paid an average interest rate of 7.327% and 7.755% per annum, respectively. These loans were made from CITIC bank and secured by the property and equipment or certificate deposit of Chengdu Tianyin. They do not contain any additional financial covenants or restrictions. The borrowings have one year terms and contain no specific renewal terms.

Critical Accounting Policies and Estimates

Our consolidated financial information has been prepared in accordance with generally accepted accounting principles in the United States, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets and liabilities, (2) the disclosure of our contingent assets and liabilities at the end of each fiscal period and (3) the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

When reviewing our financial statements, you should consider (1) our selection of critical accounting policies, (2) the judgment and other uncertainties affecting the application of those policies, and (3) the sensitivity of reported results to changes in conditions and assumptions. We believe the following . . .

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