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Skystar Bio-Pharmaceutical Company, (NASDAQ:SKBI)

Q4 2013 Earnings Conference Call

April 1, 2014, 7:45 AM EST

Executives

Christopher Chu – Director-Investor Relations

Bing Mei – Chief Financial Officer

R. Scott Cramer – Director-Corporate Development and U.S. Representative

Analysts

Richard E. Greulich – REG Capital LLC

Operator

Greetings and welcome to the Skystar Bio-Pharmaceutical Reports Fiscal 2013 Results Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Chris Chu, Director of Investor Relations for Skystar. Thank you. You may begin.

Christopher Chu

Thank you, operator. Good morning everyone and welcome to the Skystar’s fiscal 2013 results conference call. Joining us on the call today is Skystar’s Chairman and CEO, Weibing Lu; Skystar’s CFO, Bing Mei and company Director, Corporate Development and U.S. Representative, Scott Cramer. Scott and Bing will provide an overview of Skystar’s 2013 results. And then we’ll open up the call to your questions for Mr. Lu.

Before we begin, I would like to remind you that certain statements made during today’s call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the use of forward-looking terminology, such as belief, expect, may, will, should, project, intend, or the negative thereof or comparable terminology. Such statements typically involve risks and uncertainties and may include financial projections or information regarding the progress of new product development.

Actual results could differ materially from the expectations reflected in such forward-looking statements, as a result of a variety of factors, including the risks associated with the effect of changing economic conditions in The People's Republic of China, variations in cash flow, reliance on collaborative retail partners on new product development, variations in new product development, risks associated with rapid technological change and the potential of introduced or undetected flaws and defects in products and other risk factors detailed in reports filed with the SEC.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this earnings call. All forward-looking statements are qualified in their entirety by this cautionary statement. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

I would now like to turn the call over to Scott Cramer. Scott?

R. Scott Cramer

Thank you, Chris and good morning everyone. thank you for joining us today on this early results conference call. I will be delivering prepared comments for fiscal 2013. and as a reminder, Mr. Lu, Skystar’s Chairman and CEO will be available for question and answers after the prepared remarks.

The company's audited 10-K was released yesterday, and I trusted everybody have had time to review the results. additionally, the financial results were released early this morning. If you do not have a copy of the release, please contact Chris Chu, our external Investor Relations rep and he will assist you in getting any of the two documents.

So let’s begin. On behalf of Mr. Lu and the rest of the Skystar team, we are pleased to report the full year results with the market. It has truly been an exciting journey for Skystar and its shareholders, leading up to this reporting period. as a background to the company’s corporate history, the company raised roughly $20 million in a placement for facilities’ expansions and manufacturing facilities, following Skystar’s uplifting to NASDAQ in 2009.

Since these events, the company has maintained a simple and steadfast business model, which is to provide niche products that improve the profitability and efficiency of small and medium animal farmers in China, while delivering exceptional service to meet our farmers need, and while being observer into the changing trends within China’s animal husbandry industry.

In this manner, Skystar’s animal pharmaceutical business has been blessed with market demands for its products. This has allowed Skystar to couple of facility expansion and larger manufacturing capabilities with a wide distribution footprint across all 29 farm producing provinces in China.

Our distribution channel includes almost 2,900 agents in its network of which 1100 are direct customers and 360 are independently owned franchise stores with which we have exclusivity agreements. The goal of Skystar remains the same, and that is to utilize its knowledge of the market demand for our products to create the right product mix for distribution, to ensure that its manufacturing facilities can meet market product demand and then we can execute on our sales and distribution of our premium branded products across the total of the 29 farming districts within China.

Since 2009 Skystar has been able to modernize and expand its primary Kunshan manufacturing facilities which produces GMP certified veterinary medication and vaccines, while at the same time we acquired two other manufacturing facilities to support its product lines. In addition, Skystar has been able to successfully navigate the evolving regulatory standards of the Ministry of Agriculture, whose goal was to industrialize and standardized the animal husbandry space, in an effort to adequately supply the nutritional demand of China with the improved safety.

Delving deeper in 2011 the Ministry of Agriculture participated in China’s greater 12 Five Year Plan this is an initiative that overhauled the nation’s GMP veterinary inspection agencies, the Ministry of Agriculture adopted systematic changes including tighter regulatory over side and mechanisms for controlling diseases and improving safety.

As a result, facilities producing veterinary products underwent stricter quality control standards. In addition to the facility inspection – supervision and inspection, the GMP inspection is subsequently revamping of Skystar’s newly built GMP grade veterinary vaccine medication facilities were subsequently delayed as a result of the Ministry of the Agriculture’s slow rollout of this evolving regulatory and safety standards.

However, crested with this hurdles, today Skystar is in full compliant with these government initiatives and believes that it is a stronger well protected position to take advantage of market demand for Huxian and Jingzhou products, including on-site disease testing kits, vaccines for disease treatment, control and prevention and immunity enhancing booster kits, which will continue to be important parts of the company's expansion strategy.

Finally, the company finished strongly for the year with its revenues up over 26% for year-over-year as a result of production resuming at the Huxian facility – medicines facility. I’m sorry. Resuming at the Huxian veterinary medicines facilities, this was after successfully completing the GMP recertification for that facility and receiving more veterinary medication product permits from the Ministry of Agriculture.

Net income was up over 69% year-over-year in 2013, adjusting through its changing product mix as new production permits from the Ministry of Agriculture became available to us. Complete de-sales of Skystar’s list and approved products waiting for production permits and R&D projects are listed in our most recent Annual Report on Form 10-K. Going forward, Skystar will continue to develop its product lives, including animal feed, probiotics and soon to be launched marine agricultural products as part of its strategy to provide a total 360 degree field of products for its customers.

We would like to provide a brief facility update of Skystar’s four manufacturing campuses before reviewing the year’s financial. The veterinary medication and vaccine manufacturing facilities in Huxian both have fiscal GMP certificate issued by China’s Ministry of Agriculture. The facility has 58 production permits and eight permits in application. The company has also submitted five veterinary vaccine production permits to the Chinese Ministry of Agriculture which are waiting [ph] approval before Skystar can begin production of the vaccines in the Huxian facility.

The renewed GMP certification for the veterinary medication facility was received in 2012, while the vaccine GMP certificates were fiscally received in the fourth quarter of 2013; both GMP certificates are valid for five years from the date of issuance. The Sanqiao Plant housing Skystar's Micro-Organism facilities went to cooperation with experts from the Microbiology Institute of Shaanxi Province and the Northwest Agro-Forestry Sci-tech University and a feed additive manufacturing facility are currently in operation.

Lastly, Kunshan’s Plant slated for microorganism probiotics production is currently undergoing equipment installation, refilling and testing. Efforts to complete this facility are progressing very well. however, this facility is not operational at this point.

With that I would like to turn the call over to Skystar’s CFO Bing Mei, who will go over Skystar’s full year results. Bing?

Bing Mei

Thank you, Scott. For the year ended December 31, 2013, we had revenue of $42.5 million as compared to revenue of $33.6 million for the prior and full year ended December 31 of 2012. This is an increase of roughly $8.9 million of only $6.5 from the prior year. The increase in product line revenue was largely due to our resumed production at Huxian Veterinary medication facility, so we successfully completed GMP certification.

Here is a breakdown of the full year revenue by production lines. Revenues from sales of our veterinary medication which accounts for about 60% of our total sales increased by $14.9 million or 139.4% from $10.6 million in 2012 to $25.5 million in fiscal year 2013. Revenues from micro-organisms sales, which accounts for about 32% of our total sales, decreased $1.8 million or 11.8% to $13.5 million in 2013, as compared to $16.3 million in 2012. Feed additive product line which accounts for about 4% of the total sales decreased by $2.2 million or 65.5% to $1.8 million in 2013 as compared to $4 million in 2012.

Revenue from vaccine product lines which accounts for 4% of our total sales increased by $1.9 million or 54.1% to $1.6 million in fiscal year 2013 as compared to $3.5 million in 2012. Our total gross profit for the year was $21.5 million, up $3 million or $16.3 from 2012. Gross margin was 53.6% as compared to 55.1% in the same period a year ago. The decrease of the gross margin was largely because of the majority of our revenue this year came from less profitable veterinary medication sales. At the Kunshan facility production, we resumed the production.

Operating expense for 2013 decreased to $1.4 million or 14.7% to $8.5 million as compared to $9.9 million in 2012. The efficiency rate and R&D cost of $1 million or 2% of the revenue for fiscal year 2013 as compared to $3.2 million in 2012, a decrease of $1.2 million or 55.6%. The decrease was primarily due to less R&D efforts undertaking and offsets by government subsidies during the 2013.

Selling expense totaled $3.5 million or 8% of the total revenue for fiscal year 2013 as compared to $3 million in 2012, an increase of $0.5 million or $16.9, primarily due to the increase in sales commissions as a result of our increase of sales in 2013.

G&A expense totaled $3.9 million or 9% of the total revenue for fiscal year 2013 as compared to $4.7 million in 2012, a decrease of $0.8 million or 16.4%. The higher G&A expense in 2012 was mainly due to a practice for compensation expense of $1 million or tough rates from April 2012.

Operating income for fiscal year 2013 was $30 million, increased $4.5 million or 52.2% from the prior year. Operating margins was 30.6% as compared to 25.5% in the year ago period. Net income for the fiscal year 2013 was $10.5 million or $1.37 for this yea as compared to net income of $6.2 million or $0.83 for this year for fiscal year 2012. As of December 31, 2013, Skystar had approximately $8.1 million in cash, current assets, $88.2 million and the current liability of $25 million, which result in a net working capital of $63.6 million.

With that, I would turn the call back over to Scott. Scott?

R. Scott Cramer

Yes, hi Bing. Thank you so much. With this I would like to provide management’s concluding remarks. Skystar would like to thank all of our investors. Fiscal 2013 was another year of great progress for Skystar in terms of infrastructure build out and from a financial perspective. While the company has been historically bottom line profitable since the company’s listing on our U.S. exchange, fiscal 2013 marked near normalized operations for Skystar, where the majority of the company’s facilities are operational and available for the company’s use from a regulatory standpoint.

Having cleared the Ministry of Agriculture’s GMP certification procedures, under the agency’s new regulatory standards established in 2011, Skystar anticipates growing revenues and profitability of its core products line as well as the new areas of product development such as aquaculture and our vaccine lines. As such, Skystar is optimizing facility planning and resources to accommodate the additional anticipated capacity coming online as more drug control numbers receive approval on an ongoing basis.

Skystar believes the regulatory changes, including compulsory animal vaccinations, stricter animal bio-pharmaceutical manufacture regulations, and industry standardization have become limiting factors to new competition and in the future will ultimately benefit Skystar, which was an early entrant into the animal husbandry space. In terms of financial forecast, Skystar currently anticipates delivering an 8% to 18% year-over-year top-line revenue increase for 2014 as compared to the prior year. The expected revenue range is $46 million to $50 million with a gross margin of roughly 50% for fiscal 2014.

With that, I would like to turn the call over to the operator and then open the call to Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of [indiscernible] with AGS Capital. Please proceed with your question.

Unidentified Analyst

Hi, thank you for taking my questions. My first question is looking at the revenue of fourth quarter compared to the revenue of third quarter for both 2013 and 2012 there were a drop. So, is it kind of seasonality that we should expect to see going forward?

R. Scott Cramer

Yeah, hi good morning. Thank you for that. Yes, our revenue picture is very seasonal. Q3 is always our biggest revenue quarter, Q4 is our second biggest, Q2 is third biggest and Q1 is always our widest.

Unidentified Analyst

Okay, thank you. My second question is, so compared to 2012 the revenue of feed additives and vaccines had a drop in 2013, is that because of the GMP certification process?

R. Scott Cramer

It was because of the GMP certification, but it was also because of our product mix, as our veterinary medicine facility became certified we were able to more of our resources and more of our sales efforts into that product line, because we had been offline for that for the better part of the year and a half, we were able to direct resources to that.

In addition to that, our vaccine line has been being made we literally don’t have a plan we were making those in a lab by hand, and we finally got GMP approval for our vaccine lines and that’s really where we want to shift the production from the lab to our newly certified facility, so within intentional product mix change coupled with the facility build outs.

Unidentified Analyst

Okay, so you just mentioned that you got it sort of top line revenue would have 18% growth in 2014, so can you provide sort of rough for example, for those four categories revenue generation?

R. Scott Cramer

Yes, we can and understand this could be subject to change, but our veterinary medication line, we’re looking somewhere in the $27 million to $28 million range about 40% of our total revenue. Our Micro-Organism line about $14 million to $15 million, 70% feed additives, about I am sorry I was giving you gross margin numbers, $28 million for veterinary medications, Micro-Organism, $14 million revenue, feed additives, $1.8 million and vaccines, $1.7 million that’s going to get us to the low end of our revenue.

Unidentified Analyst

Okay, thank you. My final question is research and development expenses and general and administrative expenses in terms of percentage of revenue, what’s your expectation for 2014?

R. Scott Cramer

We were absolutely, I think you’re going to see our R&D costs go up this year, I don’t have a reduction for you right now. We may have at the end of Q1 on that call, however, because we have just bought our vaccine facility online this is truly an overall game changer for us. This is going to start changing our product mix and the way that we market our products. This is going to move Skystar to the next level, what we’re able to do is our vaccine line produces our vaccine I am sorry – our vaccine production at the end of the day, it’s going to be operating on 70% margin, so we’re going to replace some of the veterinary medicines with our vaccines.

So as a result we have to apply to get product permits and we have to find methodologies for manufacturing these new vaccines. This does cost money to do so. But this is part of Skystar’s five and 10 year long range plans to shift more of the production to its highly margined vaccine line and replace some of the other products out of – replaced product set of our veterinary medication lines which are not as profitable. I know that was ambiguous, but the short version is yes, we’re going to increase the R&D and the reason is because, we have new GMP certifications with our vaccines we have to get more approvals and that is going to cost money.

Bing Mei

This is Bing, I can give you a roughly estimate. We expect to spend $0.04 to $0.08 of the total revenue on R&D in 2014. And such as we will spend the most money on the vaccine line.

Unidentified Analyst

So for G&A cost, do you have an estimate?

Bing Mei

Pretty much the same.

Unidentified Analyst

Okay, got it. That’s all, thank you.

R. Scott Cramer

Thank you, so much.

Operator

Thank you (Operator Instructions) Our next question comes from the line of John Harold [ph] with Harold & Associates. Please proceed with your question.

Unidentified Analyst

Yes, good morning. I believe it was the third quarter earnings conference call which I asked about you need to raise capital and I believe the answer was certainly wealth management. Again on December 4, I saw that and that’s re-filed with a shelf of $35 million and with the stock that of now, do you plan on doing a capital raise I guess to use it to pay some expenses for your vaccine facility expansions?

R. Scott Cramer

Yes. So John to be clear, and I appreciate the question, by the way as what we said is we don’t need a capital raise for working capital that was the answer that we had given you, we have since the filed the shelf we are potentially, we have the shelf in place in case we need dollars, hence we would need dollars for. And this is what we said on the other call, anything that we do would be accretive, it was to build out a different facility the vaccine plant is built out, just so we are clear.

The Kunshan Plant is not quite built out, if were to do that, if we were to raise capital we could potentially use capital to do the final build out, because that would be very, very, very accretive to our bottom line. If we were going to do with acquisition that would also be a reason that we may want to raise capital. Other things that we could potentially use capital for is, when you did talk about the vaccine line, if there was a veterinary – I mean I’m sorry, a vaccine license out there that we could purchase from another company, and put it on to our vaccine facility production line that would also be very accretive. So if were to raise capital those are the types of things that we would be using it for. We don’t need capital to run the day-to-day operations of our business.

Unidentified Analyst

So, any rising of capital would be associated with something accretive?

R. Scott Cramer

Absolutely.

Unidentified Analyst

Okay. All right, appreciate it. Thanks.

R. Scott Cramer

Thank you.

Operator

Thank you. Our next question comes from the line of Richard Greulich with RAG Capital Advisors. Please proceed with your question.

Richard E. Greulich – REG Capital LLC

Thank you. A couple of questions; this year, you benefitted from interest income by the 2% interest charge, you had on your suppliers where you prepaid. Do you anticipate that continuing into 2014?

R. Scott Cramer

Do you mean, are you asking do we continue to charge them interest or do we continue to do increase the prepaid?

Richard E. Greulich – REG Capital LLC

Well, are you going charge them interest first of all.

R. Scott Cramer

Yes, yes. First off, we are going to continue to charge interest on our prepaids, like in these – above this to anticipate the second part of that question. We do not plan to increase our prepaids in fact; we are going to be looking to decrease that over the course of this year.

Richard E. Greulich – REG Capital LLC

Will that allows you to pay off your debt?

R. Scott Cramer

To which debt are you referring?

Richard E. Greulich – REG Capital LLC

Well let’s see. You have short-term loans of – in September, they were 10. I’m not sure what they were in December.

R. Scott Cramer

Yes. So the answer to your question is – and here is the question that we anticipated, and this is a very fair question. Hey, look, you guys are prepaid so much, but yet, you’ve taken out short-term loans, why do you take out loans at a higher interest rate and prepay dollars, I mean that’s really what you are coming down to, right?

Richard E. Greulich – REG Capital LLC

Well, I understand why you may want to do it.

R. Scott Cramer

Yeah.

Richard E. Greulich – REG Capital LLC

But the question is, are you going to continue doing it?

R. Scott Cramer

Yes. So what we want to do is reduce the prepays, and what’s happened here is especially with the inflationary pressures in China. Our prepays has really saved us about eight to 10 points on our margin, believe it or not. So that’s why we do it that’s why we’ve done it. We’re starting to see a leveling out of raw material costs and other costs in China. So we don’t think that the prepays are going to become as important. clearly, we are going to be doing that. So as a result, if those kinds of things happen, we will have more dollars into cash flow. We will be able to pay off the loans that you referenced and we will not have to take as many if any other loans.

Richard E. Greulich – REG Capital LLC

Okay. I was – actually had a little problem with my computer when Bing was talking last and so maybe he addressed this. For 2014, where do you anticipate your G&A expenses to be?

R. Scott Cramer

He said it would be about the same.

Richard E. Greulich – REG Capital LLC

Okay. And the R&D, I caught him say it was a 4% to 8%, I couldn’t tell.

R. Scott Cramer

Yes. 4% to 8% of total revenues.

Richard E. Greulich – REG Capital LLC

Revenues, okay. How much in the way of government subsidies for R&D does that include?

R. Scott Cramer

That’s – hey Bing.

Bing Mei

Half million, half million.

Richard E. Greulich – REG Capital LLC

Half million?

Bing Mei

Half million, $0.5 million in 2013.

Richard E. Greulich – REG Capital LLC

Okay. And the tax rate overall should continue to be somewhere what 15%, 17%?

R. Scott Cramer

Yes.

Richard E. Greulich – REG Capital LLC

Okay. There was a 13D filed by SJ Investments, a short while ago.

R. Scott Cramer

Yes.

Richard E. Greulich – REG Capital LLC

Have you had any specific conversations with them, regarding their interest or why they took a position?

R. Scott Cramer

No. I don’t even know what to say about that, because – and we have – we reached out to them the other day.

Richard E. Greulich – REG Capital LLC

Okay. So they’ve never really mentioned – the reason I ask is, to most people SJ Investments means nothing at all, but in fact, its investment vehicle arm by the Gregory family, which ran King Pharmaceuticals. They took that company zero to like sold up for $2.5 billion, not long ago and had made other successful investments.

So I’m just kind of curious as to whether they have any thoughts of what the company should be doing strategically.

R. Scott Cramer

No as much as I would like to tell you that we’ve been in contact in this some power play that we know of that we are going to have a take over, they are going to sell us or we truly had zero contract with them, clearly we were very happy to see so many of their stature take a large position on our stock. And we have reached out to them to see if that we can have some discussions with management.

Richard E. Greulich – REG Capital LLC

Yes I don’t know them personally, but I would suggest that would be a great opportunity, because one of the things that they were very successful doing was in taking other drugs and marketing to their distribution system and I think that would be obviously an opportunity for Skystar, if you could figure out how to do that?

R. Scott Cramer

Absolutely

Richard E. Greulich – REG Capital LLC

Thank you.

R. Scott Cramer

We’ve are making heads up on that.

Richard E. Greulich – REG Capital LLC

Okay, thank you.

Operator

Thank you. Mr. Cramer there are no further questions at this time, I would like to turn the floor back to you for closing comments.

R. Scott Cramer

Okay, thank you operator and thank you everybody for joining us on the call today. Skystar appreciates your participation and support, we hope that you carry Skystar’s wishes with you and hope for a strong and successful year in 2014. And we look forward to sharing our results with investors during the next conference call. Thank you and on behalf of Skystar, our Chairman Mr. Lu, good bye and happy New Year.

Operator

Thank you, this concludes today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

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