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China Pharma Holdings, Inc. (CPHI)

Q4 2006 Earnings Call

March 29, 2007 9:00 am ET

Executives

Leslie Richardson - IR, CCG Elite

Zhilin Li - President and CEO

Xinhua Wu - CFO

Donald Xu - VP of Strategic Planning and Business Development

Analysts

Dennis Spurtzen

Boyd Hines

Mike Schellinger

Avi Zhi

Peter Siris

Richard Kim

Ajit Gehlot

John Herold

Presentation

Operator

Good day ladies and gentlemen and welcome to the fourth quarter and year-end China Pharma 2006 conference call. My name is Shaquana and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Ms. Leslie Richardson. Please proceed ma'am.

Leslie Richardson

Good morning ladies and gentlemen. My name is Leslie Richardson from CCG Elite, Investor Relations. And now I would like to welcome you to China Pharma Holdings fourth quarter and year-end 2006 conference call.

Joining us today from China are China Pharma's President and CEO, Ms. Zhilin Li and Chief Financial Officer, Mr. Xinhua Wu.

Joining us from San Diego is Vice President of Strategic Planning and Business Development, Donald Xu. Donald will present the prepared remarks for Ms. Li and Mr. Wu.

Michelle Fang is also joining us from CCG Elite's Hong Kong office and will provide translation for the question-and-answer period, following the prepared remarks for the quarter.

I would like to remind our listeners that in this call management's prepared remarks contain forward-looking statements, which are subject to risks and uncertainties, and management may make additional forward-looking statements in response to your questions.

Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today, due to such risks including, but not limited to, unanticipated changes in product demand, increased competition, failure to obtain or maintain intellectual property protection, downturns in the Chinese economy, uncompetitive levels of research and development, failure to obtain regulatory approvals, and other risk factors detailed from time to time in the company's future filings and filings with the United States Securities and Exchange Commission.

Accordingly, although the company believes that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct.

In addition, any projections as to the company's future performance represent management's estimates as of today, March 29, 2007. China Pharma assumes no obligation to update these projections in the future, as market conditions change.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast on China Pharma's website for 90 days. Also, an audio replay of this call will be available for seven days. Information about the webcast audio replay is available in the press release issued earlier today.

And with that, I'd now turn the call over to Donald Xu, Vice President of Strategic Planning and Business Development, who will present the management discussion section on behalf of China Pharma's President and CEO, Ms. Zhilin Li.

TRANSCRIPT SPONSOR

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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Donald Xu

Thank you, Leslie. Welcome and thank you for attending China Pharma's fourth quarter and year-end 2006 conference call. We are pleased to announce that China Pharma achieved record revenue for the quarter and full year 2006. Moreover, this was the company's third consecutive quarter of top and bottom-line growth. We feel that these results exemplify our ability to execute efficiently and effectively, including a quality portfolio of therapeutics and delivering them to the market.

I'd like to start by saying that the fourth quarter of the year is typically our strongest quarter, as the winter season contributed to strong sales of the pharmaceutical products.

As such, our revenue in the fourth quarter of 2006 was $8.1 million, up 62% sequentially from $5 million in the third quarter of 2006 and up 46% year-over-year from the $5.6 million in the fourth quarter of 2005.

Our net income for the quarter was $3.5 million, up 104% sequentially from $1.7 million and up 9.4% from net income of $3.2 million in the fourth quarter of 2005.

Fully diluted earnings per share were $0.10 compared to fully diluted earnings per share of $0.05 in the third quarter of 2006 and $0.10 in the fourth quarter of 2005.

I am happy to add that during the quarter, China Pharma was approved by the government for the five-year tax holiday as a foreign enterprise. I will go into more detail on this later on the financial section of the call.

For the full year 2006, revenue was $21.8 million, ahead of our guidance of $20 million and up 152% from revenue of $8.7 million generated from the date of incorporation or January 12, 2005 through December 31, 2005.

Our net income for the year also came in ahead of our guidance of $8 million at $8.6 million, up 126% from $3.8 million during the period from January 12, 2005 to the end of the year 2005.

During the quarter, we continued to see strong growth from our portfolio as a whole. This has been and continues to be our core strategy to build an extensive and diversified portfolio in which we are not dependent on any one therapeutic for our revenue growth.

While the majority of our drugs performed well in the quarter, I would like to highlight a few of our top performers. Gastrodin injection, which was launched in the fourth quarter 2005, had a strong market acceptance as our fastest growing drug, increasing 443% year-over-year.

Our second largest percentage gainer was cefaclor tablets, which increased 224% from a year ago.

In the second half of 2006, we constructed a new facility dedicated to the production of antibiotics, which increased our ability to expand our market for the drug. AFGF was another strong performer with a year-over-year increase of 193%.

During the year 2006, we launched two new therapeutics, hepatocyte growth-promoting factor and ozagrel. Both were well accepted in the market and subsequently contributed to our growth for the quarter, representing 8% and 7% of the revenue respectively.

Overall, no single drug represented more than 15% of our total revenue.

Before I talk about our growth strategy for 2007, I would like to briefly address the Chinese State Food and Drug Administration anti-corruption campaign.

For those of you who have not been following the pharmaceutical industry in China closely. Last year, the SFDA launched a new anti-corruption campaign, targeted at drug and device manufacturers and distributors in an effort to crackdown on commercial bribery.

The SFDA's anti-corruption campaign was launched in response to the discovery of bribes given by some drug manufacturers to certain officials within the SFDA. We view this action taken by the SFDA as a very positive step for our industry, which will result in a safe and fair market environment for pharmaceutical companies.

For China Pharma, specifically, we feel that tighter controls and oversight of the drug approval process play into our strength. Especially, given our track record of fair dealing and the fact that our manufacturing facility have be in compliance with the good manufacturing practices or GMP in accordance with the World Health Organization standards of 2003.

While in the short term, there is some uncertainty as to the timing of the approval process for new drugs, we are not concerned about obtaining new drug approvals for our current pipeline. We've successfully obtained approvals for four drugs during 2006 and we expect to receive additional approvals in 2007.

With that being said, we feel we have a strong market position going into 2007. We have developed a small and diversified portfolio of therapeutics that we intend to use to penetrate new markets.

Also, we intend to launch during the second quarter of this year, granisetron hydrochloride, which we received approval before SFDA's anti-corruption campaign went into effect.

Granisetron is commonly used for the prevention of nausea and vomiting associated with radiation treatment and chemotherapy in cancer patients. While the sale statistics for granisetron products in China are not available, the market is valued over $1 billion in US and Canada.

However, I would like to note that as with all our products launches, it takes about six months after the initial launch, before we start seeing a meaningful contribution to our top-line.

One of our major initiatives setup in 2007 is to increase our presence in the rural areas of China. So, those of you who are not aware, in recent years the Chinese government started a new type of Rural Cooperative Medical-care System to provide healthcare to the country's rural population. This medical care system currently covers about 50% of the country's regions and is expected to cover up to 80% by the end of 2007.

The PRC has pledged $1.3 billion a year to this program and intends to cover the entire country by the year 2010. The New Rural Cooperative Medical-care System or CMS program offers the opportunity for China Pharma to expand our reach to over 900 million individuals.

We see this as an important means of growth and have been dedicating our resources to work closely with the central and the local governments to build our strategic position in rural areas.

We are building our distribution network for the CMS program by demonstrating the benefits of our therapeutics, as well as actively promoting the benefits of the CMS programs to the rural population. We look forward to providing regular updates, as we make progress with this program.

Now, I will discuss the fourth quarter and year-end results in greater detail. Afterwards, I'll have some additional remarks, and then we'll open the call for questions.

Fourth quarter financial results. As I mentioned at the beginning of the call, we are very pleased to announce record revenue for fourth quarter of $8.1 million or a sequential increase of 62% from revenues of $5.0 million and a year-over-year increase of 46% from revenue of $5.6 million.

Our gross profit in this fourth quarter 2006 was $3.5 million, up 41% sequentially from $2.5 million in the third quarter of 2006, and up 5.6% from gross profit of $3.3 million in the fourth quarter of 2005.

Gross margin was 43% in the fourth quarter of 2006, compared to almost 50% in the third quarter of 2006 and 60% in the fourth quarter of 2005. The unusually high gross margin in the fourth quarter of 2005 was the result of a one-time product for which we received approval, but decided not to manufacture on our own.

Selling expenses during the quarter were $46,800 or about 0.6% of revenue, down slightly from close to $59,000 or 1.1% of the revenue in the fourth quarter of 2005.

G&A expenses in the fourth quarter were $785,000 or 9.7% of the revenue. Operating income in the fourth quarter of 2006 was $2.7 million or 3% increase sequentially, and down 20.8% from $3.4 million in the fourth quarter of 2005.

As I had mentioned earlier, we are very happy to have been approved for the benefit of receiving favorable tax treatment for a five-year period as a foreign enterprise. With this approval, we are exempt from income tax for the first two profitable years and will receive a 50% reduction on income tax payable for the following three years.

Additionally, Hainan Province is considered a developing economic region, and as such has a reduced tax rate of 15%. Therefore, our tax holiday rate is expected to be 7.5% for the last three years of the tax holiday. The recognition of the tax holiday recorded a $730,000 income tax benefit during the fourth quarter of 2006. This is for the reversal of tax provisions recognized in the first three quarters of the year.

Our net income for the quarter was $3.5 million, up 104% from net income of $1.7 million in the third quarter of 2006, and up 9.4% from net income of $3.2 million in the same period a year ago.

Fully diluted earnings per share were $0.10 for the last quarter of 2006, compared to fully diluted earnings per share of $0.05 in the third quarter of 2006 and $0.10 in the fourth quarter of 2005.

For the full year 2006, our revenue was $21.8 million, up 152% from revenue of $8.7 million. This was generated from the date the company was incorporated or January 12, 2005 through December 31, 2005.

Our gross profit for the full year 2006 was $10.1 million or an increase of 125% from gross profit of $4.5 million generated from the inception to year-end 2005. Gross margin was 46.2% in 2006 compared to 51.9% in 2005.

Operating income for the full year 2006 was $8.6 million up a 103% from $4.2 million generated from inception to year-end 2005. Operating margin was 39.5% in 2006 compared to 49% in 2005.

Our net income in 2006 was $8.6 million or $0.25 per fully diluted earnings per share. This was an increase of 126% from net income of $3.8 million or $0.34 per fully diluted earnings per share during January 12, 2005 to December 31, 2005.

Now, I would like to cover some highlights from our balance sheet. As of December 31, 2006, China Pharma had $656,000 in cash and cash equivalents and the working capital of $18 million. Our cash flow from operations in the fourth quarter 2006 was $487,000.

Days sales outstanding or DSOs for the fourth quarter of 2006 were 134 days, down from DSOs of 203 in the third quarter of 2006. For the entire year of 2006, our DSOs were 199 days.

The significant decline in DSOs for the quarter is a result of the increased year-end collections, as the norm in the industry is for many of our customers to pay their invoices at the end of the year. We expect to have the same quarterly pattern for DSOs during 2007 as we experienced in 2006.

Total liabilities, including short-term borrowings, stood at $7.7 million, while shareholders' equity totaled $20.9 million. This compares to a total liability of $5.8 million and shareholders' equity of $11.7 million on December 31, 2005.

I would also like to note that in February, China Pharma completed a private placement of 2.5 million shares of common stock and 2.5 million in Class A 3-year warrants to purchase an aggregate of 1.25 million shares of common stock. This transaction generated approximately $3.8 million in net proceeds, which we plan to use to develop new drugs and fund our working capital.

Now, I would like to discuss our business outlook for 2007. We are projecting to achieve a net income growth of 30% for the year. We feel this is achievable through a combination of growth from our current portfolio and the launch of our granisetron hydrochloride injection product.

We have made significant progress in reaching new areas of China over the last year and expect this market expansion to continue.

We also expect to benefit from participation in the country's CMS program, as a greater number of people will have access to medical care. As a result, we expect to achieve healthy growth from the current portfolio in the coming year.

With that, I'd like to thank you all for your continued interest in China Pharma. We look forward to updating you on China Pharma's progress next quarter.

We will now open the call to any questions you may have for Ms. Zhilin Li, President and CEO and Mr. Xinhua Wu, Chief Financial Officer. Michelle Fang will provide the translation.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of [Dennis Spurtzen]. Please proceed.

Dennis Spurtzen

Yes, very good quarter. Question for you on G&A expense and may be I didn’t hear this in the conference call. But for the fourth quarter, it was $783,000 and in the prior year period it was a negative $125,000, for the full year it was $1.2 million. So, I am uncertain as to why it was so heavily weighted in the fourth quarter and what it consists of?

Xinhua Wu

[Translated]. Well, the difference between G&A expense is really due to the bad debt expenses. For example, like for the last quarter as you see the number is inactive, because they have offset the bad debt expenses they have accrued before. So, actually it is the income rather than expenses for this quarter because the bad debt expense they accrue is bigger than that. So that's why the number as you see is increased.

Dennis Spurtzen

Do they expect the number to be the same next year?

Xinhua Wu

[Translated]. Well, the G&A expenses will grow slightly if you compare with this year and it will grow in line with our top-line.

Dennis Spurtzen

Okay. Thank you very much.

Zhilin Li

You're welcome.

Operator

Your next question comes from the line of [Boyd Hines]. Please proceed.

Boyd Hines

Hi, good morning. I have a question about your gross margin. They fluctuated a bit this past year quarter-to-quarter. Can you give us a range of what you expect gross margin to be in 2007?

Xinhua Wu

[Translated]. Well, in general, we think the gross margin of China Pharma is kind of stable in the past year, although, as you see, it has fluctuations quarter-by-quarter. As you know in this industry, we do have the seasonality issue. And regarding 2007, we think that the gross margin is in line with 2006 or maybe a slight decrease.

Boyd Hines

Okay. And when you introduce your new drugs throughout the year in 2007, how should we expect that to hurt or benefit your operating margin?

Xinhua Wu

[Translated]. Well, we will expect, as you know, a very positive impact for both top line and the bottom-line with the launch of new drugs.

Boyd Hines

Okay. That's all my questions for now. Thank you.

Zhilin Li

Thank you.

Operator

(Operator Instructions). At this time, we have no further questions. I am sorry; we have a question from the line of [Mike Schellinger]. Please proceed.

Mike Schellinger

Yes. I've read recently that the Chinese government has instituted some price ceilings on traditional Chinese medicine. And I believe that mostly or completely that doesn't apply to you. But I was wondering if you could confirm that it does not apply? And if it does apply to what extent it might apply? And if that has been factored into your guidance?

Zhilin Li

[Translated]. So, we just want to clarify your question, you are talking about price, right?

Mike Schellinger

Yeah.

Zhilin Li

[Translated]. Well, we're going to say that all the drugs in both, our portfolio and the pipeline don't have an impact of this type of controls from the China Government.

Mike Schellinger

Okay. Thank you very much. Excellent quarter.

Zhilin Li

Thanks.

Operator

Your next question comes from the line of [Avi Zhi]. Please proceed.

Avi Zhi

Hello. Hi, Leslie. This is [Avi Zhi] here from Northeast Securities.

Leslie Richardson

Hi.

Avi Zhi

Hi. My question is regarding launching the new drugs in 2007. What's the forecast and if you can give us any idea about the revenue for each one of them?

Xinhua Wu

[Translated]. Okay. Well, first of all, what we can definitely confirm is that the launch of the new drug will surely have a very positive impact on both the top line and the bottom line. But in terms of the detailed revenue it can generate, it's really hard for us to give you an expectation at this moment. As you know that first of all, any new drugs when they are launched into the market, the market needs some time to adapt to this new drug.

And needless to say, as you know, that the Chinese Government at this moment, they are doing some anti-corruption program for the pharmaceutical companies. So, it will have an impact for the drug application approval from SFDA. So, this is going to have the impact on our timeline for us to launch the new drug as well.

So, overall there were different factors that are going to impact our new drug launch. So, it is quite hard for us to give you a detailed number at this moment.

Avi Zhi

Okay. Thank you very much and please keep up the good work.

Zhilin Li

You are welcome.

Operator

Your next question comes from the line of [Peter Siris]. Please proceed.

Peter Siris

Hi it's Peter Siris. First, I just wanted to thank you, thank the management for taking the time to take us through the facts and spending the time showing all the facilities and everything. It was very enlightening. So, that’s my first comment.

And the second question was, there was a female speaker at the SFDA conference in Hainan -- everybody was talking about tightening the controls. Doesn't tightening the controls really benefit you because it will drive out a lot of the companies that have much less sophisticated facilities and much less good research of solid products than you do? Won't this process in the end make it better for you?

Zhilin Li

[Translated]. In general, we will take the actions that SFDA are doing now, positively. We think that in the long run, this is definitely a good signal for the overall industry as we do need the standardization for the whole industry and a better operating environment. And we are going to see a fair platform for all the players on this platform.

In the short run, it might happen that the impact of the application will slowdown the timeline for us. But as you know, this is going to be a very temporary impact.

So, in the long run, as I just mentioned, it is going to create a better and fair operating environment for all the pharmaceutical companies. And at the same time, optimize the business operation environment and try to secure better quality for the products and for the patients. So, we think this is a good action and we support the government's action.

Peter Siris

And I also wanted to ask about the timing of generic Lipitor. I guess Lipitor has come off patent? Is that a product you are interested in?

Zhilin Li

[Translated]. Okay. Well we are quite interested in this product, and as a matter of fact we have already done some initial research on this product. As you know, this is a very good product and we are sure that it is going to have a very good market in China as well.

Peter Siris

Thank you.

Zhilin Li

Thank you.

Operator

Your next question comes from the line of [Richard Kim]. Please proceed.

Richard Kim

Thank you. I had just one question on taxes. I read something about proposed changes in taxes of companies in China. Will this have any affect on you and your future tax payments?

Xinhua Wu

[Translated]. Well, as far as we know that the new tax policy from the central government will not have any impact for us. At the same time, as you know, we are also in a special zone of Hainan island. So, we don't see impact in terms of the tax policy for us.

Richard Kim

So, for the year I don't think you paid any taxes, but for the fourth quarter you have like a 26% rate, I believe. Looking at 2007, for the current year, what tax rate do you think you would be paying?

Xinhua Wu

[Translated]. Well, as you know that we are enjoying two-year tax free and a three-year half tax rate for us. And the government is still in the process of approval of our application, so for 2007 our tax rate will either be 7.5%, which is the 50% of tax rate or 0%. So, it will be depending on the approval of the government. Once again, it will be either 0% or 7.5%.

Richard Kim

Thank you.

Zhilin Li

You're welcome.

Operator

Your next question comes from the line of [Ajit Gehlot]. Please proceed.

Ajit Gehlot

Yes, hi. I'd like to ask about the short-term note payable of $6.5 million and if you can comment on, when is that payable and the terms of that, et cetera?

Xinhua Wu

[Translated]. Well, this amount of money is in fact the promise that we gave to our old shareholders that we're going to pay them some reasonable profit after we have reached a good revenue on that income. So, we haven’t paid to those shareholders yet, which we agreed with those shareholders. So, that's why we put our current liability item.

Ajit Gehlot

Yeah, but it increased about $2.2 million from last year. So, would it increase every year by a certain amount?

Xinhua Wu

[Translated]. Okay. So, the dividend that we promised to the old shareholders is around $4 million. So the difference between $6.5 million and $4 million, that's in fact short-term debts from the banks.

Ajit Gehlot

Okay. Thank you.

Zhilin Li

You are welcome.

Operator

You have a follow-up question from the line of [Boyd Hines], please proceed.

Boyd Hines

Hi, can you just discuss what your current capacity is for the drugs that you have in your pipeline and you expect to manufacture for 2007?

Zhilin Li

[Translated]. We think our production capacity can fully support granisetron, the new drug launch.

Boyd Hines

Okay. And in terms of your guidance for 2007, how much of that is dependent upon these new drugs that you have mentioned, the four new drugs that you expect to go into production in 2007? How much of that guidance is based on just the new drugs?

Xinhua Wu

[Translated]. Well, when we calculate the 30% growth, we really take very minimal impact from our new drug. As we know that usually it takes time for the new drug to really generate the profit. So, when we do the calculation we will more rely on our existing portfolio.

Boyd Hines

Okay. And you did a private placement earlier this year and I noticed in your 10-K that in terms of the risks you've noted that you still expect to raise more funds in the future? Do you have any plans at this point later in the year to do another private placement?

Zhilin Li

[Translated]. At this moment we don't have any detail plans for the fundraising.

Boyd Hines

Okay, thank you very much.

Zhilin Li

You're welcome.

Operator

(Operator Instructions). At this time we have no further questions.

Leslie Richardson

I think that concludes our call for today.

Operator

We have a question from the line of John Herold. Please proceed.

John Herold

Just one final question. Does your company plan on some sort of share buyback over the 2007 period?

Zhilin Li

[Translated]. At this moment we don't have any plan on that.

John Herold

Okay. Thank you.

Zhilin Li

You are welcome.

Operator

At this time, there are no further questions.

Zhilin Li

Thank you.

Operator

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

TRANSCRIPT SPONSOR

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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