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Executives

Jing Lou – Chief Executive Officer

Bo Tan – Chief Financial Officer

Tom Folinsbee – Director of Investor Relations

Analysts

Ingrid Yin – Oppenheimer

Chris – Morgan Stanley

[Yves Ken – Agis Capital]

Austin Hopper – AWH Capital

3SBio, Inc. (SSRX) Q3 2012 Earnings Call November 12, 2012 8:00 AM ET

Operator

Good morning and welcome to the 3SBio Q3 2012 Earnings Conference Call. (Operator instructions.) Please be advised that this conference is being recorded today, November 12, 2012. I would now like to hand the conference over to your speaker today, Tom Folinsbee, IR Director. Thank you, sir, please go ahead.

Tom Folinsbee

Hi everyone, and thank you for joining us for the call. We’d like to remind you that this presentation may contain forward-looking statements which involve risks, uncertainties and assumptions. 3SBio’s actual financial condition and operating results may differ materially from these forward-looking statements so please see the Safe Harbor statement section in the earnings press release for more information. And as the management team proceeds through their remarks they will refer to our Q3 results presentation which can be downloaded from www.3sbio.com in the “Investors” section under “Webcasts.” And after their opening comments we will open the floor to questions. I’ll now turn the call over to 3SBio’s CEO Dr. Jing Lou. Dr. Lou, please go ahead.

Jing Lou

Thank you, Tom, and hello everyone and thank you for joining our Q3 2012 conference call. With me today is Bo Tan, our Chief Financial Officer, and we’ll briefly comment on our operating and financial results and then we’ll take your questions.

Over the past quarter we have continued to maintain a consistent focus on key objectives for 2012 which you can find listed on Slide 21 of our Q3 presentation. We remain optimistic about the long-term market potential in China for our core products EPIAO and TPIAO. However, in the near term our markets still face some uncertainties. As everyone knows, the NDRC recently cut the retail price ceilings, which has put a lot of pressure on the [tendered] prices. For example, the recently completed military hospital tender resulted in price cuts of 20% for both EPIAO and TPIAO. The impact on oncoming provincial tenders remains uncertain.

On a more positive side, our EPIAO and TPIAO volume growth remains strong. Access to dialysis treatment in China continues to improve and this underpins our long-term optimistic view of the China market. Due to the growing demand for dialysis services, we recently started the construction of a facility in Benxi, Liaoning Province, to manufacture dialysis-related consumables. The new facility is expected to commence operations in 2015 or 2016.

To sum up, our core business is performing well and we’re on track to achieve our full-year guidance of $99 million to $108 million. I will now turn the call over to Bo Tan, our CFO, who will review our financial results; and then we’ll be pleased to answer your questions. Bo, please go ahead.

Bo Tan

Thank you, Dr. Lou, and hello again to everyone on the call. As I go through some financial highlights you can find more details on Slides 8 through 12 as well as in the press release. I’m also going to use US dollars throughout but you can find the RMB figures in the press release as well. For the year-on-year growth rate calculation, this is all based on RMB numbers as no currency fluctuation is accounted for in the growth rate calculation.

First, a couple of key items in the income statement: our total net revenue increased by 22.5% over Q3 2011 to $28.7 million. The increase was primarily attributable to an increase in sales of our core EPIAO and TPIAO products which increased year-on-year 16.2% and 24.2% respectively in Q3 2012. For the first nine months of 2012 net revenue increased by 26% over the first nine months of 2011, to $80.5 million.

Gross profit rose by 20.6% to $25.7 million in Q3 where gross margin decreased by 1.4 percentage points to 89.6%. It was 91.0% in Q3 2011. The change was primarily due to the lasting price impact from the government’s pricing cut actions on the tendering process. First nine months gross profit rose by 26.4% to $72.1 million where gross margin increased to 89.6% from 89.2% in the first nine months of 2011.

Q3 operating expenses increased to 31.6% year-on-year from $14.7 million to $19.7 million. As a percentage of sales, operating expenses increased from 63.8% to 68.5%. R&D costs was $30.4 million or 11.7% of our total revenue compared to $1.7 million or 7.2% of net revenue for the same period last year. The increase in R&D expenses is primarily attributable to preparation of our pipeline products including NuPIAO and Anti-TNF.

Sales, marketing and distribution expenses for Q3 this year was $13.3 million or 46.5% of net revenue compared to $10.7 million or 46.3% of net revenue for the same period in 2011. G&A expenses were $3.0 million or 10.4% of net revenue, compared to $2.4 million or 10.5% of net revenue for the same period in 2011. Our operating income for Q3 was $6.1 million a 5.1% decrease over the $6.3 million earned in the same period last year. Our operating margin for Q3 was 21.1%.

First nine months’ operating expense increased 27.8% year-on-year from $41.2 million to $53.4 million. As a percentage of sales, operating expenses rose from 65.4% to 66.5%. The operating income for the first nine months was $18.7 million, a 22.8% increase over the $15.0 million earned in the same period last year. Operating margin was 23.1% for the first nine months of this year.

Looking at the bottom line, GAAP net income for Q3 was $3.5 million, a 34.5% year-on-year decrease over the same period in 2011. Non-GAAP net income for Q3 was $5.0 million, a 7.6% year-on-year decrease over the same period in 2011. The difference between GAAP and non-GAAP net income is due to a $1.45 million write down in the available for sale securities following a decline deemed to be other than temporary in the market value of 3SBio’s $4.5 million investment in the publicly traded common shares of Isotechnika. After taking the write down of $1.8 million in Q2, the current carrying value of our investment in Isotechnika is $1.3 million.

GAAP net income for the first nine months was $13.6 million, a 1.1% year-on-year decrease over the same period in 2011. Non-GAAP net income for the first nine months was $16.8 million, a 22.5% year-on-year increase over the same period in 2011. Turning now to our cash position, 3SBio has cash, cash equivalents and deposits of $135.7 million as of September 30, 2012.

As Dr. Lou mentioned, with our past performance and our view of the future economic environment and the market conditions, we reiterate a total net revenue target of between $99 million and $108 million for the fiscal year 2012. Thank you, and now we’d be pleased to take any questions. Operator, back to you.

Question-and-Answer Session

Operator

(Operator instructions.) Your first question will come from the line of Ingrid Yin with Oppenheimer.

Ingrid Yin – Oppenheimer

Hi, good evening. My first question is on EPIAO sales. It looks like it has slowed down, the growth has slowed down from previous quarters 15% in Q3 versus 25% in Q1-Q2. I’m just wondering what is the volume and price change in this quarter? And if the slowdown is due to the price change, do you see the demand increasing with lower price? And I also want to get an idea on the current market share of EPIAO for 3SBio and what is EPIAO’s sales contribution from nephrology and oncology respectively?

Bo Tan

Sure, Ingrid, this is Bo here. Basically the EPIAO market in China still delivered I think very solid growth. If you look at the MS data in our presentation slides, there is 16% year-on-year increase. It is still a good growth number, and as you know the NDRC recently cut the price and the provincial tendering process is still ongoing. So that impact resulted anywhere from a 6% to 10% impact on the EPIAO top line revenue sales.

And in terms of the fundamental volume growth, we still think that it’s very strong especially in the dialysis segment. However, as we mentioned on the previous conference calls, in the large cities, in the tier one cities and in the large hospitals, that’s where traditionally our strong base is. That growth is not as strong as the growth that we are seeing in some of the lower-tier cities and the smaller hospitals.

As we mentioned, we are exploring different ways to capture the growth from those lower-tier cities, from the smaller hospitals. We’re still in the process of doing that and we think we’re making some progress but clearly our current strong point is still in the large centers and in the tier one cities.

In terms of the split between the nephrology and the oncology, based on our internal data it’s still roughly very similar to the previous quarters – 70% to 75% nephrology and 25% to 30% oncology.

Ingrid Yin – Oppenheimer

That is great. I’m just wondering for TPIAO, for this quarter it’s still very strong. The growth is 24%. What is the volume and price change for this product?

Bo Tan

For this product the pricing impact is slightly better than EPIAO but it’s still roughly around 6%, 6% to 8% pricing impact. The volume growth is the key driver here for this product.

Ingrid Yin – Oppenheimer

I see. So you mentioned that the military hospital price cut, is this fully reflected in Q3 results or are we only seeing a partial effect? And for the provincial tenders you are preparing and participating, do you still expect something similar to the military tender price cut or it’s a bit better?

Bo Tan

Sure, the military tender impacts have not been reflected in the Q3 results yet. It could be reflected in Q4. In terms of the other provincial tendering process, again, it’s still quite uncertain right now. We will hope they are not as severe as the military tendering process but very simply we don’t know – it’s still quite uncertain right now how they will do their tendering process individually.

Ingrid Yin – Oppenheimer

Okay, I see. So we’ve seen gross margin very stable and even though it’s slightly down from the previous very high level, going forward do you expect that coming down with price cuts? And also if you could comment on R&D expenses: we’ve seen an increase this quarter. Should we expect similar for Q4 and next year full year?

Jing Lou

Ingrid, we don’t provide guidance on gross margin as well as sort of the fiscal expense ratios. But in terms of the R&D expense for Q4 as well as the first half of the year, as you know we have made some good progress this year in terms of our pipeline products – Anti-TNF as well as the (inaudible) NuPIAO. They’re all moving as originally planned when we set out our objective at the beginning of the year. So going forward we still would like to look for as you know innovative products as well as supporting our pipeline product development.

Ingrid Yin – Oppenheimer

Great. My last question is on the manufacturing facility. Are the products you are manufacturing, are these acquired from other companies or do you intend to develop this internally? And what kind of capacity are you building and what are you thinking as far as the consumables revenue and profit contribution? And what will be the (inaudible) to view the facility, and do you need a separate sales team for the consumables? And will these mainly be sold at dialysis centers or do you (inaudible) together?

Bo Tan

Sure, Ingrid. As Dr. Lou just mentioned we remain very optimistic about the overall dialysis market development in China. There is low penetration currently in the Chinese market, and if you look at the total dialysis market there are several key segments. So there is the service part which we still see a lot of regulations, either challenges or changes in that segment; and there is the dialysis-related pharmaceuticals which we are one of the leading nephrology companies in this segment. And there is another large segment, that’s the dialysis consumables segment or dialysis equipment. Currently we’re not in the dialysis equipment and through this Benxi plant we will also get into the dialysis consumables market.

When we look at the market it’s sort of quite fragmented into this China market. There are some large domestic as well as international players but we do feel that there is still room for the good quality players to play in the future. Despite the fact that it’s going to be a much lower margin business compared to the pharmaceuticals we feel that we can somehow leverage our expertise in the nephrology segment to penetrate into this dialysis consumables market.

Specifically for the Benxi plant, our current CAPEX budget is approximately $8 million to $10 million and the product we’re going to be making there is quite simple. It’s the dialysis (inaudible) as well as the water treatment machines. So those will be the three key product categories and we expect to receive approvals, if everything goes well, goes as planned by 2015-2016. As you know, it’s an $8 million to $10 million investment in a manufacturing facility. In terms of the specific contribution, we currently don’t have the projection yet but we think that with high-quality products we should have a place in the market.

Ingrid Yin – Oppenheimer

Excellent. Thank you for taking my questions. I’ll go back to the queue.

Bo Tan

Thank you.

Operator

Your next question is from the line of Bin Li with Morgan Stanley.

Chris – Morgan Stanley

Hi, this is Chris on behalf of Bin. Can you tell us the exact top and bottom line impact of the military tenders this quarter, and also if your earnings outlook changed in light of the risk that you are talking about? Thanks.

Bo Tan

Sure. The military hospital cuts roughly around 10% to 12% of our total revenue. So if we are able to [wheel] a tender, as you know we’re still in the observational period right now; if we do get our tender, win the bid it’s a 20% price cut from the previous years. So you can calculate the impact to our bottom line. But regardless, when we gave the annual revenue guidance at the beginning of the year we factored in the price cut impact already. We’re getting closer to the end of the year and we’re not changing our revenue guidance at this point.

Chris – Morgan Stanley

Okay, and also one more quick question: what was the price cut on EPIAO in terms of high dose and low dose, and also can you give us a timeline for other provincial tenders?

Bo Tan

On average the EPIAO was cut by the NDRC roughly slightly over 20%. In terms of the different provincial tendering processes, roughly we see that on an annual basis there is one-third of the provinces that will be going through this tendering process. This is one aspect. Another aspect is that whenever the NDRC cuts the price then we’ll have nationwide impacts as well.

Chris – Morgan Stanley

Okay, alright. Thanks.

Bo Tan

Thank you.

Operator

Your next question is from the line of [Yves Ken with Agis Capital].

[Yves Ken – Agis Capital]

Thank you for taking my questions. My first question is can you update us on the status of the appeal as to whether you have started dosing (inaudible) patients for the NuPIAO trial?

Jing Lou

For the NuPIAO trial we are in preparation to start the first dose of the patients. No, we have not dosed the first patients yet.

[Yves Ken – Agis Capital]

Okay, thank you. My second question is you still have $1.3 million holding in Isotechnika's balance sheet. Do you anticipate to further write that down in Q4?

Bo Tan

I think it really depends on how the Isotechnika business will turn around or how the stock will be doing, and Isotechnika is also a publicly listed company. And I think you can also find the publicly disclosed information on their website. It really depends on how they will be trending, or sort of how their stock will turn around or not. But I’d like to remind you that when we made the investment we really paid attention and put a lot of focus on the product. We’re still quite confident in the potential of this product and [we follow it closely]. We have filed for the SFDA approval to initiate the China arm of the global Phase III trial, and as soon as our partners in Isotechnika can initiate the bid, their Phase III trial either in the US or in the European Union, we should be able to initate our China arm of the Phase III trial.

[Yves Ken – Agis Capital]

Thank you. The final question is can you update us on the status of the (inaudible)?

Bo Tan

For that we cannot comment on that. We have selected, the Board has appointed a special committee that handles it. I think they have been sending out a few press releases to update the market about the progress as well as the status of that process.

[Yves Ken – Agis Capital]

Okay, thank you, that’s all.

Bo Tan

Thank you.

Operator

Your next question comes from the line of Austin Hopper with AWH Capital.

Austin Hopper – AWH Capital

Thanks, my question was answered.

Operator

You have a follow-up question from the line of Bin Li with Morgan Stanley.

Chris – Morgan Stanley

Hi, thanks for taking my follow-up question. I see there’s about RMB 5 million other losses. Can you tell us more about it?

Bo Tan

Yeah, it’s RMB 5 million. It’s all a result of... As you know we signed a deal with [Diveture] beginning of this year and it’s quite a complicated deal process. For this quarter we have to dispose certain… As Jung mentioned it’s going to be only about 70%. We own about 30% of the JV so the increase in the (inaudible) is really due to the assignment of the rights to the (inaudible)-related equipment and facilities with that joint venture with [Diveture]. So it’s a non-cash item where we could get paid back once there are more clinics open in the future.

Chris – Morgan Stanley

Okay, so it is a non-cash item.

Bo Tan

Right.

Chris – Morgan Stanley

Okay, I see. So that’s not in the non-GAAP number, is that right?

Bo Tan

No, it’s not included in the non-GAAP number, right.

Chris – Morgan Stanley

Okay, I’ve got it. Thank you.

Bo Tan

Thank you.

Operator

(Operator instructions.) There are no further questions at this time. Management, do you have any closing remarks?

Jung Lou

Okay, it looks like no more questions. Thank you again for joining today’s call. We look forward to updating you on our progress in the near future. Goodbye.

Operator

Thank you for participating in today’s conference call. You may now disconnect.

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