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China Biologic Products, Inc. (NASDAQ:CBPO)

Q2 2014 Earnings Conference Call

August 6, 2014 8:00 a.m. ET

Executives

Bill Zima – ICR Inc.

David Gao – Chairman and CEO

Ming Yin – SVP

Analysts

Jessica Li – Jefferies

Yi Chen – Aegis Capital

Operator

Good morning and welcome to the China Biologic Products Q2 2014 Earnings Conference Call.

[Operator Instructions] Please note this event is being recorded.

Now I would like to turn the conference over to Bill Zima. Mr. Zima, please go ahead.

Bill Zima

Thank you, operator. Hello everyone and thank you for joining us on today's call. China Biologic announced its quarterly financial results on August 5th after the market closed. An earnings release is now available on the company's website.

Today you will hear from China Biologic's Chairman and CEO, Mr. David Gao, who will start off the call with a review of recent company developments, strategies and basic operating results, followed by the company's Senior Vice President Mr. Ming Yin who will address financial results in more details. The company's CFO Mr. Ming Yang is also on the call and will be available during the Q&A session that follows prepared remarks.

Before we proceed, I would like to remind you of our Safe Harbor statement. Our conference call may include forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Although we believe that the expectations reflected in our forward-looking statements are reasonable as of today, those statements are subject to risks and uncertainties that could cause the actual results to differ dramatically from those projected. There could be no assurance that those expectations will prove to be correct.

Information about the risks associated with investing in China Biologic is included in our filings with the Securities and Exchange Commission. We encourage you to review it before making an investment decision. The company does not assume any obligation to update any forward-looking statement as a result of new information, future events, changes in market conditions or otherwise, except as required by law.

The company will also discuss non-GAAP measures which are more thoroughly explained and reconciled to the most comparable measures reported under Generally Accepted Accounting Principles in the company's earnings release and filings with the SEC. Be reminded that such non-GAAP measures should not be viewed in isolation or as an alternative to the equivalent GAAP measure and that non-GAAP measures are not uniformly defined by all companies, including those in the bio-pharma industry.

With that said, I'm now pleased to present Mr. David Gao, Chairman and CEO of China Biologic Products. David, please go ahead.

David Gao

Thank you, Bill. Hello everyone and welcome to China Biologic second quarter 2014 conference call.

As you saw in the press release issued yesterday after the market closed, China Biologic reported a solid financial results for the second quarter. Market demand for plasma products remained strong in the quarter and we continued to make progress with our sales penetrating into first-tier cities in the high-end markets in China, by collaborating with these new distributors.

Total sales for the quarter increased 12.1% to $60.1 million, while non-GAAP adjusted net income attributable to the company increased 17.9% to $20.5 million.

Increased sales in the quarter were mainly driven by strong sales momentum of Shandong Taibang, partially offset by declined sales volume at Guizhou Taibang. The decrease in the sales volume at Guizhou Taibang was primarily due to the depletion of its inventory of finished products as most newly-produced albumin products were still awaiting government batch approval after Guizhou Taibang assumed production in March 2014.

This temporary shortage to our inventory resulted in a 9.4% decrease in sales volume in human albumin products in the second quarter. As new batches of products are approved, we expect sales of Guizhou to pick up in the following quarters to previous levels.

We experienced solid performance across our entire product portfolio. As a percentage of total sales, human albumin products revenue was 34.1%, IVIG revenue was 44%, and other immunoglobulin products contributed 8.3%. Our placenta polypeptide products experienced a significant increase of 137% in sales volume, and contributed 11.8% to our total sales in the second quarter.

On operational level, selling expenses increased 98 basis points to 5.5% of total sales due to increased sales of placenta polypeptide products. Compared with other products, placenta polypeptide has relative higher per unit selling expenses. G&A expenses decreased 470 basis points to 11.8% of total sales.

We continued our investment in research and development for select pipeline products, although operating profit margin increased 90 basis points to 48.1%, which led to very healthy margin -- net margin of 32.8%. We expect to receive product approval for human prothrombin complex concentrate out of our Shandoing Taibang facility in the second half of 2014. This product is a major treatment for Hemophilia B in China, which I believe can be materially contribute to our financial results over time.

We've strengthened our market leadership in human coagulation products, including Factor VIII which are robust product portfolio powering human albumin immunoglobulin products and the coagulation factor products which together represent the three major classes along with our strength in sales and distribution, we're well-positioned to benefit from continued growth momentum in the coming quarters. And we anticipate closing this year with even stronger fundamentals in the enhanced profitability.

Additionally, our recent announcement regarding adjustment in the value-added tax rate will have a favorable impact on sales of all plasma-based products and contribute to our future growth and development.

Finally, we are pleased to complete our follow-on offering and raised net proceeds of approximately $33.2 million. The proceeds will be used for channel cooperative purposes or funding potential acquisition or investment if appropriate opportunities arise. Through this transaction, we further broadened our shareholder base and improve the liquidity in our stock. We are encouraged with our opportunities for continued growth as we move forward.

I will now turn the call over to Ming Yin, our Senior Vice President, to review second quarter financial results. Ming, please go ahead.

Ming Yin

Thank you, David, and hello everyone. As David mentioned, sales and net income both achieved double-digit growth in the quarter. Now let me walk you through the key P&L items for the second quarter of 2014.

Total sales were $60.1 million, representing an increase of 12.1% from the same quarter of 2013. The increase was primarily attributable to volume increase in certain plasma-based products and placenta polypeptide product.

During the second quarter, human albumin products and IVIG products remained our largest two sales contributors. The average price for the two products declined 1.4% and 2.7%, respectively, during the quarter, mainly because we increased market share of our human albumin products and IVIG products in tier 1 cities through distributors by lower sales price.

As a percentage of total sales, human albumin products accounted for 34.1%, while IVIG accounted for 44%. Sales volume of human albumin products decreased as David explained, primarily due to the deflation of inventory out of Guizhou Taibang as most of the newly produced albumin products were still awaiting government approval after Guizhou Taibang resumed the production in March 2014.

In the second quarter of 2014, the sales volume of IVIG products increased by 1.82%, mainly due to increased sales through distributors in tier 1 cities. In addition, the outburst of hand, foot and mouth disease also contributed to the increase in the sales volume of IVIG during the first half of 2014.

Gross -- our gross profit was up by 9.9%, reaching $41.2 million in the second quarter of 2014. Gross margin remained relatively stable at 68.5%.

For the second quarter of 2014, selling expenses increased by 37.5% to $3.3 million, or 5.5% of total sales. The increase was primarily due to increased sales of placenta polypeptide products. Compared with other products, polypeptide product has relatively higher per unit selling expenses.

G&A expenses for the second quarter decreased by 20.2% to $7.1 million, compared to last year. This decrease was mainly due to a decrease in legal expenses. In addition, the company incurred amortization expenses in the three months ended June 30, 2013, with respect to GMP certificates and certain other intangible assets which were part of the acquisition of Guizhou Taibang in 2008. Because such intangible assets had been fully amortized by the end of 2013, the company did not incur corresponding expenses in three months ended June 30, 2014. G&A expenses as a percentage of total sales declined to 11.8% from 16.5% from the same quarter of 2013.

R&D expenses were $1.8 million in the second quarter of 2014, compared to $0.8 million in the same quarter 2013. The increase was primarily due to the expenditure paid for certain clinical trial programs and engagement of external experts for select pipeline products. As a percentage of total sales, R&D expenses accounted for 3.1%.

Operating income was $20.9 million, representing an increase of 14.2% from the second quarter of 2013. Operating margin increased to 48.1% from 47.2% in the second quarter of 2013.

Net income attributable to the company increased by 21.6% to $19.7 million, resulting in net margin of 32.8%. Fully diluted net income per share was $0.79 per share, compared to $0.57 in the second quarter of 2013. Non-GAAP adjusted net income attributable to the company was $20.5 million or $0.82 per diluted share. Non-GAAP adjusted net income and diluted earnings per share excluded $0.8 million of non-cash employee share-based compensation expenses.

For the first half of 2014, total sales were $116.3 million, an increase of 8.1% from the same period 2013. The increase in sales was primarily driven by increased sales at Shandong Taibang, partially offset by reduced sales volume at Guizhou Taibang during the period. The increased sales volume of placenta polypeptide products also contributed to the sales increase. As a percentage of total sales, sales from human albumin products and IVIG products were 38.1% and 40.4%, respectively, in the first half of 2014, compared to 40.2% and 43.5% in the prior-year period.

Gross profit increased by 6.4% to $79.7 million, resulting in gross margin of 68.5%. Operating income was $66.9 million, an increase of 10.9% from same period of 2013. Net income attributable to the company increased by 22.2% to $38 million. Net margin were 32.7% for the first half 2014.

Non-GAAP adjusted net income attributable to the company was $39.6 million or $1.53 per diluted share. Non-GAAP adjusted net income and diluted earnings per share in the six months ended June 30, 2014 excluded $1.6 million of non-cash employee share-based compensation expenses.

Now I would like to turn to the balance sheet and cash flow items. We end the second quarter of 2014 with approximately $103.2 million in cash and cash equivalents. Restricted deposit was $102.1 million as of June 30, 2014, compared to $30.5 million as of December 31, 2013. The increase was primarily due to a deposit of $72.3 million as cash collateral for certain long-term bank loans in connection with a payment of $70 million for cash -- for share repurchase.

Net cash provided by operating activities for the six months ended June 30, 2014 was $39 million as compared to $37.9 million for the same period of 2013. The increase in net cash provided by operating activities was primarily due to the increase in net income for the six months ended June 30, 2014, as compared to the same period in 2013, partially offset by increase of accounts receivable and the inventories during this period.

Accounts receivable increased by $7.5 million, which was in line with the sales increase during the six months ended June 30, 2014, as compared to $6.3 million during the same period in 2013. Inventories increased by $6.9 million during the six months ended June 30, 2014, as compared to $3.6 million during the same period in 2013. This increase was primarily due to the increase in working process as a result of most newly produced albumin products were still awaiting government batch approval after Guizhou Taibang resumed production in March 2014.

Net cash used in investing activities was $3 million for the first half 2014. Net cash used in financing activities was $76.2 million. Our working capital on June 30, 2014 was $176 million, and our current ratio was 3.0.

Total shareholders' equity was $286.5 million as of June 30, 2014, compared with $304 million as of the December 31st, 2013. The decrease was primarily the result from 2.5 million shares repurchased by the company completed in late January 2014 for a consideration of $70 million.

The company recently completed public offering and raised net proceeds of approximately $33.2 million. We believe that the company has sufficient cash on hand to meet our future operational goals and will continue to generate positive cash inflow from existing operations.

And now, to our financials forecast, I would like to remind investors that our net income and net margin may fluctuate quarter by quarter. As we see favorable factors that may impact our outlook in the positive way, we cannot rule out upside potential for certain operational costs and tax expenses for the remainder of the year. As always, we'll keep monitoring the market and evaluate positive [ph] impact.

At this moment we comfortably reaffirm our full-year financial guidance of total sales in the range of $230 million to $240 million, and non-GAAP adjusted net income in the range of $67 million to $69 million. This estimate assumes only organic growth and excludes acquisition and necessarily assumes no significant adverse product price change during 2014.

That concludes our prepared remarks. We will now open up the call for the questions.

Question-and-Answer Session

Operator

And the first question comes from Jessica Li with Jefferies.

Jessica Li – Jefferies

Hi. Good evening. Congratulations on a great quarter. I have several questions for David or Ming. First, could you please elaborate on your overall M&A strategy, what type of targets are you thinking and how do you see yourself positioned, or in other words, how do you stack up against your competitors in attracting these potential targets?

Second question, I'd like to better understand the commercial potential for PCC, your new product to be launched in the fourth quarter. So, just want to understand a little bit better, and what kind of sales or -- and profit impact should this product have near term as well as longer term.

Lastly, there's been some speculation on the fact that NDRC could potentially remove price ceilings for plasma products. Could you please comment on how likely this would happen or when? If that's the case, how this impacts your sales and profitability. Thank you.

Ming Yin

Hi, Jessica, this is Ming. And let me try to answer your question one by one.

The first, you know, for the M&A, the strategy, as we, you know, stating, you know, the SEC filings or the investment presentation materials, the company's mission is to become the first-class pharmaceutical, you know, company in China. To achieve this objective, one of the most important strategy is through the M&A. We have successfully implemented such strategy a few times in the past few years already. We acquired the Guizhou Taibang in 2008 and we made equity investment in Jiangwei Genpact [ph] in 2009 as well.

China's current landscape of plasma products producer is relatively fragmented. However, factors such as stringent regulations, high quality control and heavy capital expenditure requirements have contributed to increased industry consolidation trend in recent years. We believe that market leader position -- our market leader position in respect of -- in terms of in stable plasma supplies complemented by further collection expansion potentials, strong product portfolios and robust research will benefit us to further solidify our position by catching the consolidation trend.

More importantly, we want to reiterate our strategy to pursue the M&A targets. We will consider rational price and also we want to make sure the M&A target or acquisition will be earnings accretion. We're actively monitoring the market for suitable candidates, but we don't have anything specific at this moment to share at this time. So hopefully I answered your question for the M&A strategy for the first question.

Jessica Li – Jefferies

That was very good, thank you.

Ming Yin

Thank you. The second question, for PCC, as David mentioned, we -- our PCC facility in Shandong has been inspected by the CFDA, and we expect to receive the CFDA manufacture approval in October or early the last quarter of 2014. Therefore we expect the PCC to start to deliver meaningful contributions to our financial performance starting in 2015.

And currently there are only two producers in China produce -- capable of producing prothrombin complex. And last year the total sales -- products available to the market was approximately only 260,000 vials [ph] which is a very, very small quantity.

And I want to share with you the indication for PCC currently, our products registered [ph] for the indication for PCC is prophylaxis and the treatment of bleeding in patients with single or multiple deficiency of Factor II and Factor X in patients with single or multiple required PCC factor deficiency, requiring partial or completed reversal.

And David mentioned that currently the primary indication in China for PCC is B type hemophilia. We believe we have -- we can leverage our marketing platform to commercialize this opportunity, specifically with the well-established sales channel, we have more than 1,000 hospitals we can shorten the new products ramp-up period. And more importantly, we believe we can actually leverage our sales channel and the hospital networks can carry out the additional clinical promotions for new indications such as surgical bleeding areas which we believe will have a better -- greater market potential for the PCC. Hopefully that answers your second question.

You know, we actually recently -- we saw some, you know, we source the, you know, the financial websites have this kind of the announcement, but we couldn't trace the official, the source from the NDRC website. So at this moment we could not actually speculate whether the NDRC is pursuing this or it's in the [indiscernible] or we could not speculate the timing for the implementation if implemented. But I believe this will be a favorable or positive impact to overall plasma-based industry.

The example will be the -- most of our products right now have NDRC pricing. For example, the -- for the product, human albumin product, right now the 10 grams, the same price cap is RMB378 per 10 gram. As you might well [ph], there is the retail market or sometimes referred as black market, the price in that market sometimes trades, at the moment, is over $500 -- RMB500 per 10 gram. So from that perspective, if the government, NDRC, lift the price ceiling on the product, you know, plasma-based products, definitely will create the upside pricing potential for all our products.

Jessica Li – Jefferies

That's great. Thank you.

Ming Yin

Hopefully that answers your question.

Jessica Li – Jefferies

Yes. Very much so.

David Gao

Thank you.

Jessica Li – Jefferies

Thank you very much.

Operator

Thank you. And the next question comes from Yi Chen of Aegis Capital.

Yi Chen – Aegis Capital

Hello?

Operator

Yes. Please go ahead.

Yi Chen – Aegis Capital

Hi. Thank you for taking my questions. First of all, can you update us on the current situation with the imported human albumin?

Ming Yin

Yes. Through the first six months 2014 data, the imported albumin volumes since increased about 5.8%, still accounting for 60% of market share. Overall, albumin, the volume increased approximately 4% as of first half 2014. The domestically produced albumin volume remained flat as compared to the same period of 2013.

And recently, it's very interesting, we saw some multinational companies in the earnings announcement state that they have diverted portion of their albumin into other markets instead of China such as Europe and the Middle East. Our question is whether those company will start to ship larger volume of albumin back to China in the second half. It still remains uncertain at this moment.

However, where one of the major international company has just resolved their albumin registration issue with the Chinese government and expect to increase their albumin supply in China in the second half of 2014. Actually it's already happened. So our view on the pricing perspective, it remains some pricing -- potential pricing pressure if the -- in the second half of 2014 all the major international companies start to ship larger volume of albumin to China.

But if, you know, as you may be aware, most of our sales are directly to the hospitals, so at this moment we maintain relatively stable pricing, because our hospital clients have less pricing sensitivity. Hope that answers your question, Yi.

Yi Chen – Aegis Capital

Yes, thank you. My second question is, could you update us on the -- on your raw material supply, the trend of the supply at your plasma collection centers? Thank you.

Ming Yin

Yeah. Before I answer that, I just want to actually stress the plasma raw material collection is always -- is very important to us. And our ability in securing and expanding our plasma supply is, which is a critical raw material to our operation, is always being our key strength. We operate eight plasma collection stations in Shandong Province, two in Guangxi Province, and another two in Guizhou.

Shandong Province has one of the largest population, and Guangxi and Guizhou Province among the least economic developed regions in China, both favorable characteristics underpinning the strong and stable plasma supply.

And as we list, you know, stating our -- the SEC filings, we continue to seek innovative ways to access and attract potential donors. And we have been spreading out the message, focused on promoting the life-saving and other social contribution aspects of plasma donation. And we regularly organize a variety of community events to express our message, while regularly review our donor compensation to ensure that's remain competitive. And in addition, we actively seek to expand the geography territories, our existing centers collection base to gain the access to additional donor population. So all those strategy works pretty well for us. And so I can share with -- instead of specific number, I can give you the general -- the big picture. The overall collection volume of this -- of the company in the first half of this year is on track with our internal budget. I hope that answers your question.

Yi Chen – Aegis Capital

Okay. Thank you.

Operator

Thank you. The next question comes from Bin Li with Morgan Stanley.

Unverified Participant

Hello. This is Isabela [ph] on behalf of Bin. And I would like to ask two questions.

The first question is regarding for the ASP. We noticed the ASP erosion in the first Q. I would like to ask the management to comment the ASP trend for the -- for your products in the 2Q and the rest of 2014.

And also, my second question is regarding for the margin trend. And we noticed that gross margin has been improved in the first Q, but the management just mentioned the margin [indiscernible] in the rest of the year. So I would like to get a sense of how the margin will be in terms of the gross margin and the operating margin for the rest of the year. Thank you.

Ming Yin

Isabela [ph], the first question, as David mentioned, the ASP for our major products was -- since have a little bit erosion during the quarter. It's because we initiated strategy to penetrate into the tier 1 cities. I think, you know, we want to actually address the few very strategic components for the rationale while we're pursuing that strategy.

We, just like most of Chinese plasma products company, has very limited plasma supply and limited amount of products to serve all the national hospitals. So China Biologic only has limited plasma. And in the past we only serve the local hospitals or the tier 2 or tier 3 cities around our, you know, the production facility, specific, you know, and our Shandong facility mostly serve the hospitals around the region in the Shandong area or in the province next to Shandong. Guizhou has a territory in the southwest.

And start, you know, last year, the management just initiated a new strategy to penetrate into the tier 1 cities, because we want to actually upgrade our -- the brand name from the regional brand to the national brand. And we want to actually upgrade our customer base from the local tier 2, tier 3 hospitals to the top hospitals in the tier 1 cities. The reason is because the doctors in the tier 1 cities hospitals are more conservative -- are more adaptive to the western medical practice, and those doctors has better understanding of the plasma products. For example, the tier 1 cities like Beijing, those big hospitals, the doctors have a better understanding of IVIG indications, how IVIG used in the western countries.

So we found it's important for us to penetrate in the tier 1 cities, to actually -- to increase our -- the market potential. Why we said that is because, just look at this way, we believe it will be much more easier to pursue the promotions for new IVIG indications that widely accepted in the developed countries but less than among the second tiers or below the -- second tiers, the cities, the hospitals.

By the same level of promoting efforts, inputs, tier 1 cities hospitals will generate higher volume and demand and greater future growth potential than the tier 2 or below or tier 3 cities, by introducing the new indications. And with consideration of our plasma products growth in the future, we need to have better hospitals client base to ensure the sufficient demand potential to accommodate on future volume growth.

And to answer your question, yes, we do have some -- the temporary, the price erosion, but we believe the strategy we'll pursue will be -- create some long-term, you know, value, strategic value, like upgrade our brand to the national brand. And so for the ASP for this quarter or probably the remaining of the year, probably will follow the same trend. But for the next year, if the volume will pick up very healthily, so maybe we will have a better bargaining power with distributors, hopefully we can actually increase the expected price. So that's the first question.

For the second question, you mentioned about the gross margin, the pressure. Yes. As we stated in the 10-Q, specific in the MD&A section, for the first half of 2014, our gross margin was higher than 2013 average gross margin. It's due to the higher contribution from the higher-than-expected albumin pricing due to short supply situation. And additionally, our increased volume of high-margin rabies immunoglobulin product also benefit us with margin improvements.

But for the second half, our gross margin may have some pressure because of our increased raw material -- raw plasma collection. And we expect that next year [ph] the total fee increase will gradually climb [ph] to the first [ph] quarter's gross margin.

And additionally, the rabies product used to be in high demand during the spring and summer sessions -- seasons. And further, our remodeled Guizhou facility is expected to full-scale production. We expect higher manufacturing costs, specifically depreciation cost, goes to the production cost, and which will all impact our -- the margin performance.

So, some of those above-mentioned reasons, our margins may have certain pressure in the second half. At this moment we could not actually give a very detailed margin, you know, the erosion level, unfortunately.

Isabela [ph], I hope I answered your questions.

Unverified Participant

Yes. Thank you. That's all my questions. Thanks. Congratulations for the quarter. Thanks.

David Gao

Okay. Thank you for your participation and ongoing support for China Biologic. Have a good day.

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Source: China Biologic Products (CBPO) CEO David Gao on Q2 2014 Results - Earnings Call Transcript

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