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Executives

Jinsheng Ren - CEO

Peng Wang - CSO

Frank Zhao - CFO

Analysts

Shaojing Tong - Bank of America-Merrill Lynch

James Tong - Roth Capital

Bin Li - Morgan Stanley

Katherine Lu - Oppenheimer

Hongbo Lu - Piper Jaffray

Ding Ding - SIG

Simcere Pharmaceutical Group (SCR) Q2 2009 Earnings Call August 18, 2009 8:00 AM ET

Operator

Welcome to the Simcere Pharmaceutical Group second quarter 2009 Earnings Call. Our second quarter 2009 results were released earlier today and are available on the company's website, as well as on web newswire services. In addition, an archive webcast of this conference call will be available on the Investor Relations section of our website, at www.simcere.com.

Joining today's call are Mr. Jinsheng Ren, our Chairman and Chief Executive Officer; Mr. Frank Zhao, our Chief Financial Officer; and Mr. Xiaojin Yin, our Senior Vice President of R&D and Dr. Peng Wang, our Chief Scientific Officer.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. Simcere does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

I will now turn the call over to Simcere's CEO, Mr. Jinsheng Ren.

Jinsheng Ren

[Foreign Language]

Good morning, everyone, and welcome to today's earnings call. Simcere's fundamentals remained stable during the second quarter, while our sales continued to face pressure. On the whole, we are unsatisfied with our second quarter results.

While gross margin for the quarter was stable, total revenues and gross profit declined slightly by 2.7% and 2%, respectively. On sales, we have two pieces of good news to report. Sales of Edaravone product, our single largest revenue contributor saw solid growth in the quarter. We were also encouraged by Sinofuan's exceptional growth, which was in line with our expectations.

Unfortunately, there were two areas that didn't do quite so well. Performance of Endu and other generic drugs was weaker than expected. As in the first quarter, Endu sales declined primarily due to ineffective sales team adjustments and the limited payment ability of self-paid patients.

During the second quarter we also made some adjustments to our sales force for our other generic drugs. As well as providing more stringent examinations for our sales force, we are focusing more of our marketing efforts on drug stores and middle to small sized hospitals. We believe that the upcoming medical reform will stimulate the faster growth of generic drug sales in community markets and in the rural areas, and we will continue to consider adjustments to our sales strategy that allow us to take advantage of this.

We have a piece of important news to update you with. Just two hours ago the China's National Ministry of Health released the essential drug list or EDL in relation to recommendation for establishment of a national drug policy. We are pleased to note that seven of Simcere's generic including, Zailin, Anqi, Tianji, Yingtaiqing, Biqi, Nanyuan, [Baobao Ning] are included in the EDL. We will be looking closely at the best way to update our strategy and planning in light of this new development.

Looking to some of our recent business development activities, our stakes in Jiangsu Yanshen and Shanghai Celgen are two important components of Simcere's middle to long term development. The clinical trials of the Yanshen's H1N1 flu vaccine are almost complete and the Shanghai Celgen is gearing up for the launch of its major biogeneric etanercept drug in anticipation of GMP certification and new drug approval from the SFDA.

Over the following quarters, we will maintain our focus on Simcere's middle to long-term development. We will continue to build our sales and marketing teams, maintain our investment in promotional activities and R&D, actively seek investment and cooperation opportunities, and leverage the opportunities brought by the China's medical reform to enhance Simcere's future competitiveness.

Our Chief Scientific Officer, Dr. Peng Wang will update you on the latest development in R&D.

Now, I'll turn the call to our CSO, Mr. Wang.

Peng Wang

It is very nice to meet you on this conference call. Since this is the first time I talk with you, first of all I'd like to briefly introduce myself. I obtained my Ph.D. from the University of Tokyo, School of Pharmaceutical Sciences. I then worked for Schering-Plough in New Jersey, US for more than 18 years on new drug discovery, playing a leadership role in a number of programs from discovery to early clinical development.

While working in US I realized that there is great potential for pharmaceutical R&D in China, based on the relatively higher level of unmet medical needs and lower development costs. Innovative R&D will be more and more important to future growth of large Chinese pharma companies like Simcere. However, from western view point in Chinese pharma industry there are few R&D leaders with extensive experience in innovative R&D. I believe, such experience R&D leaders from the west can form a strong R&D team together with people who have been doing good R&D work at a limited number of Chinese pharma companies like Simcere.

So far Simcere has been more focused on small molecule products. Our R&D pipeline compounds Iguratimod and Palonosetron have completed their clinical trials and are now awaiting SFDA approval. In the future, we would like to have more and more efforts on biologics and vaccine.

We are starting to build more research labs and hire more scientists. In particular, one of my top priorities since joining Simcere has been to recruit people with extensive experience in the western pharma industry as leaders of various R&D functional areas at our company.

Thank you. And I look forward to updating you personally on our progress in the months and the quarters ahead.

Now, I turn the call to our CFO, Mr. Frank Zhao.

Frank Zhao

As Mr. Ren and Dr. Wang have already discussed elements relating to sales and R&D, I will now spend little bit of time talking us through few balance sheet and few P&L item. Even though net earnings declined as the result of increase in the sales and marketing expenses during the quarter, gross margin was stable at 82.3%. This is a result of increased revenue contribution from the higher gross margins (inaudible) marketed drugs like the Edaravone and the Sinofuan, sales of our lower margined other generic drugs decreased.

Sales and the marketing expenses for the quarter increased significantly as a result of additional expenses required for the launch of new drugs like the Sinofuan, Anqi, [Yingtaiqing], and as we increased our sales force to reach out for a broader range of end users and to strengthen the marketing efforts for our first-to-market product.

Since the beginning of the year we have added over 400 new sales professionals and the management staff to our team. We believe our complete new efforts in restructuring our sales force will help create a strong foundation for Simcere's long term stable growth.

Breaking it down compared to Q2 last year we had additional staffing totaling approximately RMB70 million, additional sales and marketing promotional activities totaling approximately RMB22 million and additional R&D expenses of RMB11.8 million, primarily because of our latest collaborations and the licensing activities of new products.

The Board believes the common share price does not reflect company's current value and to meet the long term potentials. They have approved a new share repurchase program. In addition to our program announced last November, it allows Simcere to purchase further $50 million of issued and outstanding ADSs. We do not expect this share repurchase program to affect our ongoing M&A activities and the regular business activities and they feel is in the best interest of our shareholders. As of June 30, 2009 we bought back approximately 5.8 million ADSs. We will continue to repurchase our outstanding ADSs on open market.

As of June 30, 2009 Simcere had cash, cash equivalents and restricted cash of RMB636 million and bank node of RMB310 million, which can be drawn upon at any time. The company also had established credit line with several commercial banks with the total of RMB800 million. We are confident that our strong cash position and healthy cash flow from operations are sufficient to support working capital needs.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Shaojing Tong.

Shaojing Tong - Bank of America-Merrill Lynch

I just want to focus on this brand generic portfolio, whose sales fall substantially lower than the average normal level. You explained somewhat, but my focus was beyond going forward with this potential booming of generic market, what do you expect in the remainder of the year and you also mentioned that your sales force is more focused on so called third end market, do you start to see the effect of (inaudible)?

Jinsheng Ren

[Foreign Language]

No doubt the health care reform and also today announced the EDL list will be a help out in a long-term. In short term there are going to be additional, supplemental or matching policies along with this EDL list, also some of the local clinic authorities they are going to observe the progress of this the EDL. So I think the non-material impact in to us in short term. There are still some uncertainties remained at this stage, but in long term this is going to be benefiting for us.

Operator

Your next question comes from the line of James Tong of Roth Capital.

James Tong - Roth Capital

I wonder, if you can give me update of the current mid-term or short-term possibly accretive research projects that the product can be in market entry or can be accretive in the next six months or 12 months?

Jinsheng Ren

Dr. Wang has given you a brief introduction of the R&D and I believe to your question, we have two drugs, one is Iguratimod and other is Palonosetron, its in the process of SFDA approving, but on the exact timing is not defined at this stage, because it is in their hand.

Another product now on the approving process by SFDA is our H1N1 vaccine, developed by Yanshen Pharmaceuticals, which are affiliated company of ours. Of course, we expect it may be approved by SFDA this year, but again we are not really quite confirmed when it's going to be approved. It also depends on the flu situations in China and also the authority's view of the health care.

The last one is, number four is etanercept, which is developed by Celgen Pharmaceuticals, which is another affiliated company of Simcere, it has filed for SFDA already, but still don't know when its going to be approved. Thank you, for your interest in our pipeline products and also reminding us that we need to make more effort in the R&D and in the pipeline products.

Operator

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

Bin Li - Morgan Stanley

Just want to ask a question on the essential drug list. I think still fresh, so I let me just ask question on that. First, can you repeat to me and I apologize I missed what you said about, how many of your drugs are included on the EDL? That's first part of my question. Second part is can you tell us how is your drug priced relative to competitor's or similar drugs?

Third part of my question is a follow-up to Jinsheng's comment, I think you are evaluating different options, but I was hoping whether you can lay out the options for us, for example, whether you want to stay out of EDL or want to raise price, low price can you just lay out your different options?

Jinsheng Ren

[Foreign Language]

We have about seven products included in the EDL. For some of the products included in the EDL list the pricing is little bit higher than other competitor's product. Several of the products since now have been promoted had a delay in the past with low volume. So it's not comparable. As to the volume and the pricing of those drugs included in the EDL list is going to be more clear in the near future as we see more announcement on them, peer publications in the health care.

Frankly speaking the EDL list just (inaudible) a couple of hours ago, but the truth is we have started to focus on the strategies of EDL in the generic sales starting from Q2. Our original sales structure for the generic is basically formed by first tier distributors and second tier distributors.

Starting from Q2 we realized that our existing sales structure for the generics. We will not fit into the healthcare reform, a direction to make the healthcare treatment penetrating down to the community and the clinics level. And that's why we started shifting our sales stock from disproven channels to the more lower peer terminals including community health stores and the clinics. There are a lot of material changes externally as to our pharmaceutical companies in China in this year.

For Simcere we built a solid foundation for generic drug sales, but in last couple of years; therefore focus on our strategies in the first-to-market and new drugs. In the coming quarter of the year, we still want to focus on our strategy in terms of our focus on the first-to-market and innovative new drug, but we will take our opportunities from those generic products, which can be benefited from healthcare reform including the EDL list.

We expect now two kind of products, the fact sales growth from two kind of products; one is those products including the EDL list and another group of products, which could be including in the National Medical Insurance catalogue, which is going to be updated by November - coming November this year. [Actually the timing] limits, I can only see this far enough, but we are going to put in more efforts in most engines about our strategies in generics and in this [coagulated growth nutrients].

Operator

And your next question comes from the line of Katherine Lu of Oppenheimer. You may proceed.

Katherine Lu - Oppenheimer

Hi. Thank you for taking my question. Actually my question is regarding our Edaravone. Edaravone franchise did very well this quarter. I'm just wondering if you can elaborate what are the major driving force for the sequential increase, was that mainly due to the market growth or market share gain, and if you can remind us the inventory level -- the channel inventory level at the end of the 2Q versus 1Q and 4Q '08 that will be great.

And Mr. Ren, you also mentioned about potential update of our China's National Medical reimbursement catalogue by the end of this month. I'm just wondering if you can also comment on the potential of inclusion of Edaravone that catalog, what kind of probability do you see this to happen, and what kind of feedback did you get from the government, so far? Thank you.

Jinsheng Ren

[Foreign Language].

In general, the sales or the market of Edaravone is now growing. I'll caution now, we can field in our competition pressure from our competitor products to our Edaravone products [Etanercept], but is not as hard as we expected. And we expect now, we are going to have a sustainable growth of Edaravone products in the near future. As to the inventory levels we are comfortable about our current inventory levels. Of course, I think the growth increase was partially due to the increase in marketing effort and staff in 02.

As far as we know the national insurance catalogue will be released by the end of November this year. Actually this document has been admitted to most of the provisional level insurance catalogue. I believe now when the authorities discuss about the Edaravone's potential they are going to take this as an important element. I believe if Edaravone can be admitted to the national insurance catalogue it's going to be very positive to us, since now we still have nine provinces not covered by the insurance catalogue so far. If it's not going to be admitted to the national insurance catalog, we believe there are more opportunities for us entering into the provisional catalogues for those provinces not covered. My judgment is that even without been admitted to the national insurance catalog, we still believe Bicun, the Edaravone will be the market leader, and of course, we have to wait three months to see the results.

Operator

And your next question comes from the line of Hongbo Lu of Piper Jaffray.

Hongbo Lu - Piper Jaffray

My question actually is going to be one EDL. One question, three parts; one is, I might have missed it, what percentage of the revenue would be from those seven drugs that's included on the EDL at current level, in the past quarter or even in 2008? That's first question.

The second one is, we know near term (inaudible) going to remain for the implementation of EDL, but Jingdong, I believe you probably have made discussions with the government, can you give us some metrics as far as to asses the potential impact in a bad case or worst case scenario, what kind of pricing change that we should be looking for and what kind of volume change that we should be looking for? In terms of growth for this part of the product portfolio would it be driven mainly by the overall market expansion, or you're taking more shares from competitors?

And last question is for the other generic portfolio. In the first quarter it was up 17%, in the second quarter it was down 25%, so it's little bit volatile. I want to understand if there is any kind of destocking happened in the second quarter?

Jinsheng Ren

[Foreign Language]

Just a bit for the media, now the Management has discussed briefly about the contributions from on the [these] drugs including the EDL, just about 36%, as our comment about 80% of our other generics drugs, the sales of other generic drugs as a whole. I totally agree with you now, there are still uncertainties that run the EDL list, but [looking] at the long-term, I believe you know the sales are driven by the EDL list, they will be growing much faster than average.

As just the EDL list is just released, I think it is still too early to charge the impact on the pricing of those products, but one thing that I believe is the impact will be different from one driver to another, since it depend on the manufacturers and how many manufacturers, the quantities, and the market of competitions. But I think, the new drug EDL list, the pricing for the EDL list of the product will be under our guidance build, i.e., we started to buy a national development and the reform bureau, and underway it should, the drug will be entering to our [pending] progress, as Europe, but I think the impact on the pricing is going to be rather has not happened in one day.

But I feel now if the product in the EDL or the pricing of those drugs is too low, that is going to impact the quality of this product, impact manufacturer waiting to produce this product, the cost eventually now is going to be impacted by clinical demand in those local community hospitals and clinics.

As to the Q1 and Q2 performance, you can see now our earnings capacity, or earning power is not really high, it's kind of low and we don't have too much of room to take in that and deepen the pricing comp. Now I see the same situations for most of the pharmaceutical companies in China. For the generics, the fluctuation between Q1 and Q2 of those generic sales, and internally now, our drug is still relatively stable.

We made a big move now in our generic sales force in Q2 by shifting almost half of our sales task from those who work as distributors to the frontlines to work in the (inaudible) community hospitals and clinics. One way to cover this health care reform change, which we are penetrating the health care treatment is from lower tier facilities. We feel now, we need to learn more how to keep more steady this up-trend growth line of our product sales.

Hongbo Lu - Piper Jaffray

[Foreign Language]

Hongbo's question is what's the market share of our selling product included in the EDL list?

Jinsheng Ren

[Foreign Language]

For those seven products each product has a different scope of manufactures and that they are different. Few of the products only have may be a handful of manufacturers around the country and other products in kind of ways more than 100 may be. We'll see more clearly as to the market shares and the trends.

Operator

Your next question comes from the line of Ding Ding of SIG.

Ding Ding - SIG

I have two questions on your equity ownership of Yanshen and Shanghai Celgen. For Yanshen you have mentioned H1N1 vaccine potentially could launch this year, do you have a rough estimate of what its contribution now will be? On other vaccines you have with the Yanshen, specifically influenza and rabies vaccine, what's your trend in terms of topline and margin this year on the year-over-year basis? We learned that rabies vaccine sales were affected this year because of the safety instance from last year. Is that still the case? Hepatitis A vaccine launch schedule is that still expected to be early 2010 and how do you compete with other domestic vaccine company, such as Sinovac? I will follow-up with question on Shanghai Celgen.

Jinsheng Ren

Taking about a second for our interest in vaccine, since we only have about a 35% stake in Yanshen and based on the accounting treatment it is not going to be impacting our P&L or bottom line in the near term. For the H1N1 vaccine, to our knowledge in the next couple of weeks we will complete our clinical trials and file with SFDA for approval and also they have already produced too many packages. Seems we do know the government holders status is all, is for harder expect the P&L impact in this year or revenue impact of this year.

This still give a normal production and normal growth for the flu vaccines at Europe; as for the rabies vaccines at you pointed now, they still have some challenges in terms of techniques and qualities. As to the hyper A vaccines, they expect to know that a vaccine can be approved by FDA in next year, but on this stage is still, just expectations is - and certainly, no way it's going to be approved.

I have to know -- in fourth year is, the reason now we've taken stakes in the vaccine companies and entering to the vaccine business, because we're feeling that it leads to long term growth in these factors, not really want to see now quick profit in the near term, in the next six month line.

Ding Ding - SIG

The second question on Shanghai Celgen, have you looked in to what additional investment may need to make in terms of manufacturing before or after the commercialization? Secondly, with the ongoing R&D cost for the other six early stage product with Shanghai Celgen? Thirdly, in terms of approval generic Enbrel approval timing? And last you mentioned by early 2010, and my assumption is we need to add additional six months or so of time for GMP certification is that the, that will take us to launch by second half of 2010 is that still a realistic timeframe? Lastly, in terms of differentiation of your facilities versus that [Jiangsu Yanshen] facility in terms of manufacturing capacity and production efficiency any comments on that would be very much appreciated? Thank you.

Jinsheng Ren

[Foreign Language]

As to now, [what you tell us] and that now you have mentioned value in the process out for making the kind of product line qualify with GMP qualification. For the maintenance cost is the ongoing cost, but therefore you must, we don't expect and no, significant additional investment in making available capable for manufacturing the product. For those ongoing R&D projects associated with antibody they are all in early stage. There is an ongoing R&D investment. Recently we are working with the management of Celgen to meet out our mid to little-long term R&D program. As to the approving time for a SFDA is whether it's going to be the first half or second half of 2010, yes we are familiar with this process too. I believe most likely may be in our second half of 2010. As I said the SFDA have the same level of concern, I mean we foresee our product will make it out quicker, could get approved quicker.

Since we are going to (inaudible) our competitors, as we launch our products, I don't feel now comfortable to make any comment to our potential competitor. The only thing I can disclose at this stage is that our GMP certified manufactured product line we have a capacity of between 600,000 to 1 million. One more thing I can share with you is for etanercept produced by (inaudible). The sales growth of their product has been very promising in 2008. To my knowledge they have about 20 to 50 million on the sales. Hence comparing to the potential patients and new [sales] they have in each year, the sales (inaudible) our potential market is still very low. I believe the key elements driving us to invest in Celgen are the potential market for these products.

Operator

Your next question comes from the line of Katherine Lu of Oppenheimer.

Katherine Lu - Oppenheimer

Jinsheng, actually I think Simcere puts a lot of efforts in terms of strategically shifting your sales and marketing sales force, sales and marketing efforts to better position yourself for China's health care reform. You decided to shift from the distribution mode to targeted marketing for your generic base portfolio, and you also decided to expand your sales and marketing sales force. I'm just wondering, where do you stand on the front of sales and marketing force expansion? How many headcounts should we be expecting for the rest of the year? Also, if you can help us to look forward, when do you think your sales and marketing strategy will come into fruition?

Jinsheng Ren

[Foreign Language]

We are going to continue increasing our sales staff in both ends. First is to the Endu and the Bicun-like product, all those hospital products and also for the generics, which is to sell to the end users. As to the, first-to-go strategies, we are going to wait for the first of the EDL list out already, and also we are going to wait for the national insurance catalogue coverage, the insurance catalog will be out by end of November. I believe now this is true, the insurance coverage is going to impact our decisions. I believe, in the next couple of months or so we are going to see a lot of positive change on the new regulations subsequent to those EDL, the insurance coverage and we're going to trend in accordingly, so we can maintain our continued growth.

Operator

This concludes the question-and-answer session. I would now like to turn the call over to Mr. Jinsheng Ren for closing remarks.

Jinsheng Ren

Thank you so much to our shareholders and those analysts for your interest in our company and we are going to continue to grow our company as expected.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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