China-Biotics: Roth Capital Conference Presentation Transcript

China-Biotics, Inc. (CHBT)

Roth Capital Conference

February 20, 2007 5:00 pm ET

Executives

John Ma - International Research Analyst at Roth Capital

Henry Tai - SVP of Corporate Development

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John Ma

The next company is China-Biotics. This is a company specializing in probiotics. And with us today is the Company's Chairman and CEO, Mr. Jinan Song, the CFO, Raymond Li, and Mr. Henry Tai, who is the Senior Vice President for Corporate Development. And he will give a presentation for us. And I would like Henry to take over.

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Henry Tai

Thank you, John. Good afternoon, ladies and gentlemen. I'm Henry Tai, VP of Corporate Development of China-Biotics. Welcome to our presentation. I'll spend about 20 minutes or so presenting about our company, and then I'll be able to take some questions at the end.

First of all, our mission. Our mission is to become the dominant supplier of naturally occurring probiotics bacteria in China. Now, first of all, what are probiotics? Well, in my own three words, probiotics are simply beneficial live bacteria. But there is a definition defined by the FAO of the United Nations for whoever wants to have a more technical definition.

Now, why -- there is nothing new about probiotics. It was discovered in the early 1900s in Bulgaria, and the benefits are widely documented. But only in the last 10 years has there been a breakthrough in the extraction and preservation technology that will see more widespread use of probiotics in China and in the rest of the world.

If you to go to foodnavigator.com and just type in "probiotics," you'll see a slew of articles talking about the benefits of probiotics as well as the companies that are making probiotics in the world like Dansk Droge, Dannon, Hansen, [Brocare]. This is a French -- these are French companies and Danish companies.

Now, what are the benefits of probiotics? Well, we need probiotics; i.e., beneficial live bacteria to help our digestion and absorption of food from the day we're born to the day we die. If we don't keep a good balance of beneficial live bacteria in our systems, we would end up having diarrhea, constipation. And as we grow older, our system tends to be less -- we do a worse job in keeping the balance.

And therefore, we need replenishment, once we reach the mid-40s onwards. And then, if we don't have a good balance of probiotics in our system, what happens is that in our system are harmful bacterial as well as beneficial bacteria. If we don't have enough -- if we don't have a good balance of the good bacteria, we'd end up having toxins created from the food being worked on by the bad bacteria.

Now, what does that do? In the long run, I think, our liver would go into -- we will have (inaudible), and then it would increase the risk of having cancers, if we don't have a good balance. We also contrast probiotics with antibiotics. Antibiotics, as you all know, are used to kill bad bacteria. Until probably five or ten years ago, it's been so widely used that we're now seeing the bad effects.

I remember ten years ago if I went to see a doctor and said, "hey, doc, I've got a flu," he'd say, "no problem, I'll give you some antibiotics." Of course, nowadays, the doctors do not prescribe that anymore. However, the bacteria have also learned a lesson and they are now becoming antibiotic resistant. So we now have a problem to deal with, and we'll see later on how the Chinese -- what the Chinese government is doing to address this issue which will in turn help our business.

Then, I would like you to take a look at the Company's overall performance and give you an overview. We are one of the largest suppliers of probiotics in China. Our Shining Essence brand is a very recognized brand, one of the most recognized brands, in fact, in the nutrient market in Shanghai.

We have proprietary technology that gives us significant cost and portfolio advantage. And we have achieved consistent strong growth in the last couple of years. In the nine months through the end of December, our topline increased 47.6% to $22.2 million, and our net profit increased 32.7% to $8.1 million.

And then fiscal year ended March '06 compared with the year before, we did $21.9 million from $14.4 million topline and bottomline of $8.4 million. We have in fact very strong gross margin of 70%. And at the end of December, the Company had net cash of $25 million.

Our current facility has got a capacity of about 9 tons of probiotics per annum production capacity. Our current utilization is about 7 tons. We currently only manufacture probiotics in capsule form in the Shanghai -- Greater Shanghai area only.

Now, we think about it. Last year, our topline sales was about US$22 million. At the retail level, that probably translates into maybe US$35 million. And this is the sales probiotics in capsule form in the Greater Shanghai area only.

From this year onwards, we do plan to go sell this product in the other cities in China. Initially, probably, we’ll be targeting a couple of cities of like Beijing, Harbin, Shenyang and Heilongjiang, four cities. So far we have been selling our products in the Greater Shanghai area via distributors only.

Starting from 2006, we are starting a new retail strategy to try to sell our products through network marketing. In that connection, we have opened nine, what we call, retail store or logistics and training centers in Greater Shanghai.

The idea is that over time, we will develop a nationwide distribution infrastructure. And I think that would be a significant competitive advantage to us when it’s built, because we would be able to sell different products through our channels throughout China.

At the same time, we are also expanding our product distribution into new directions of sales. We are now targeting the bulk additive business, by which we mean, right now, probiotics are added in baby milk powder and are used widely in yogurt manufacturing.

China doesn’t have really the capacity to produce this stuff, and they import most of it. Right now, we are building a plant that has got 150 tons of capacity. And hopefully, most of that will be targeting the bulk business using the capacity from that particular plant.

Next, I’d like to just recap on our capital structure. We have 17 million shares in issue, market cap of US$120 million. About 60% of our shares are held by management and directors, and about 35% held by institutions with March year end date, and our auditors is BDO.

Next, I’d like to take a look at the markets in which we operate and see why do we experience such a good growth potential and what is the potential going forward. What is driving our sales?

I think firstly, the Chinese affluence has driven the sales of health products and is expected by year 2010 the health care products market in China will total $10 billion. And that’s a very big market. Right now, our sales are only US$22 million out of $10 billion potential in a couple of years’ time.

As the Chinese become more affluent, they tend to spend more on healthy food as well as health care products. And that’s the trend we are seeing in China right now.

At the same time, the second major driver is the increase in the sales of dairy products. Yogurt has been the fastest growing segment -- food segment in China over the last two years. Last two years, in fact, they -- in each year, the sales of yogurt products has gone up by more than 25% per annum and is expected that the demand for yogurt drinks and dairy products to increase 10-fold from 2007 through 2015.

Just last month, Goldman Sachs and Morgan Stanley invested $3 million in a Chinese lactobacillus yogurt drink manufacturer. And it’s reported that currently that 150,000 tons of yogurt is being manufactured in China right now.

So what does that all mean? It means that we are operating in a market where there is significant underlying growth and we’re just riding on it.

Then if we look at the supply side, right now, the bulk additive business, as I call it, which is the use of probiotics in the manufacture of yogurt and baby milk powder, they've all been imported. The problem with importing probiotics are twofold -- (a) it's costly. And secondly, bacterias don't travel well, and you get less live bacteria as you travel from one country to another in global customs and all of that.

So what does that all mean? Again, it means that there is significant potential for us, when our plant is up and running, to capture a lot of this market that has currently been imported.

I said earlier that the Chinese government is taking measures to address the overuse of antibiotics. In fact, in 2004, the government slashed the retail price of antibiotics in China by 60%, with a duty price reducing the number of suppliers.

And in July 2005 -- I think, I've probably made a mistake here -- in July 2005, the antibiotics were made prescription drugs. So the Chinese no longer can just go to the shop or drug store and buy antibiotics.

Now, again, what does it all mean for us? I think with people not having the ability to just go to the counter and buy antibiotics makes them wanting to spend money on healthcare products and consuming more healthy food such as yogurt. Again, it all means good news for us.

There are no statistics in China about the probiotics usage or consumption, right now, and -- but we've been able to get some statistics, projections that have been published, just to illustrate the size of the market. This forecast is done by Beijing Leadership Management Consulting Company.

It shows that in year 2006 the probiotics usage in China totaled 3,400 tons, of which about 60% or about 2,000 tons was used in the diary production industry -- I guess, mainly yogurt and yogurt drinks. And it's projected that by 2010, the total consumption usage would increase to 10,600 tons. Again, roughly 60% of that would be used by the diary industry. While these figures, I wouldn't put my money on them, but it does give an indication of the size of the market and the growth potential.

Then, I want to take a look at our financial performance. In the three months ended December 2006, we had a 31% increase in our sales compared with the year before and a 23% increase in our net profit compared with the year before. Our gross margin -- we achieved 71% and we achieved a net margin of 41%.

And then if we look at the three quarters through the end of December 2006, our topline increased 47% to $22.2 million and our net profit increased 32% to $8.1 million. And then if we look at our fiscal year ended March, 2006 compared to the year before, if you look at the bottom left-hand corner, you see that last year, the full year, we did $21.9 million in sales and $8.4 million net profits. So our profit for the first three quarters through the end of December has more or less already matched our performance of the years before.

And if you look at the margins, our margins have been very stable at roughly at gross level of about 70% and a net level of about -- over 30%. So we've been achieving, I'd say, very consistent strong growth and very healthy margins.

Then, next, I'd like you to take a look at our production facility and our production capabilities. I'll probably go to Slide 11 first.

On the right hand side there is summary of our production process. We manufacture -- produce probiotics basically -- through a multistage proprietary fermentation process from a test tube into a pellet, into a container and then into a solid.

And then we will spin dry the extracted solid and then we add additives to it, mainly sugar to keep the bacteria alive and make it into granule and capsule form. That's a quick summary of our production process.

Our manufacturing facility is currently leased with 9 tons of capacity. Currently, we produce up -- on average about 22 million capsules per month. And I'd say going forward, we will -- we are building a 150 ton facility mainly targeting the bulk market. Currently, the -- we understand the imported probotic prices about $3,750 per kilogram.

Because of our significant cost advantage, even if we have to sell at a fraction of that price -- but what does that mean? It means that there is significant potential for us to gain market share in bulk simply by displacing the current imports.

And then, I'd like to you show you the drawing for the facilities that are under construction. This is a 150 ton facility already built and expandable to 300 tons and we expect it to come online in probably mid 2008. At the -- at that kind of gross sum, we expect that direct new potential for this facility at the 150 tons level to be about US$90 million.

Then, I'd like to take a look at our distribution and our products. These are our foremost popular products. The very first one is Shining Essence, it accounts for about 70% of our sales. But all of the product sales are growing and the percentage contribution by Shining Essence keeps dropping.

We've released six new products and right now we are developing and we'll continue to develop new products with a bulk added business i.e. formulation for baby milk powder as well as yoghurt drinks. And at the same time, we expect that we will release about 10 new products in year 2007.

So far, we have sold our products through 11 large distributors in Shanghai, with which we've done over five years of business with each of them. The products will be sold in department stores -- sorry -- drug stores and hypermarkets.

At the same time in 2006, I was saying that we have opened nine logistics and training centers, as you can see, at the bottom left-hand corner. That's a picture of our logistics and training center.

When the new plant is up and running and we're doing the bulk business, we will be selling to yogurt manufacturers, yogurt trade manufacturers as well as the baby milk powder manufacturers. Right now, the large baby milk powder, such as Nestlé and Mead Johnson -- their baby milk powder in China already contain probiotics.

Just wanted to take a quick look at our balance sheet. I think we have a very healthy balance sheet. We don't have any debt. We had, at the end of December 19, 2006, $25 million of net cash. We have a shareholders' fund of about US$20 million.

Lastly, our management team is led by Mr. Song Jinan, who is the Founder and CEO of our company. He also spearheads the R&D efforts. So he is a scientist by training background. Mr. Raymond Li, our CFO, is a qualified accountant with 20 years of finance and accounting experience, and he was Financial Controller of a Hong Kong listed company before.

And then, myself -- I'm also an accountant, been an accountant by training, also with 20 years of finance and accounting experience. And then with our three independent Directors, Mr. Simon Yick is again a finance professional, who heads up our audit committee.

And then we have got two other guys, who are very strong in the government side as well as on some technical side who would be able to help us with government relations as well as product development.

Well, gentlemen, that concludes my presentation. And I will be happy to address any questions that you may have. Thank you.

Question-and-Answer-Session

John Ma

Questions?