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China Pharma Holdings, Inc. (NYSEMKT:CPHI)

Q1 2007 Earnings Call

May 15, 2007 10:00 am ET

Executives:

Crocker Coulson – President, CCG Elite

Leslie Richardson - IR, CCG Elite

Zhilin Li - President and CEO

Xinhua Wu – CFO

Analysts:

Mike McKarsky – China Pharma

Jim Feld – Feld Corporation

Peter Siris - Guerilla Capital

Boyd Hines – Private Investor

Michael Otto – PC.com

Presentation

Operator

Welcome to the China Pharma Holdings first quarter earnings conference call. My name is Dan and I’ll be your operator for today. At this time, all participants are in listen only mode. We will conduct a question and answer session towards the end of this conference. If at any time during the call, you require assistance, please Star Zero and an operator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Miss Leslie Richardson from CCG Elite. Please proceed.

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Leslie Richardson

Good morning ladies and gentleman. My name is Leslie Richardson from CCG Elite Investor Relations, and I’d like to welcome you to China Pharma Holdings’ first quarter 2007 conference call. Joining us today from China, are China Pharma’s President and CEO, Miss Zhilin Li, the company’s Chief Financial Officer, Mr. Xinhua Wu, and Crocker Coulson, President of CCG Elite.

Crocker will present the prepared remarks for Miss Li, and 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’d like to remind our listeners that in this call management’s prepared remarks contain forward looking statements which are subject to risk and uncertainties, and management may make additional forward looking statements in response to your question. 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, downturn in the Chinese economy, and competitive level of research and development, failure to obtain regulatory approvals, and other risk factors detailed from time to time in the company’s filing and future filing 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 financial performance represent management’s estimates as of today, May 15th, 2007. China Pharma assumes no obligations 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 at the webcast link and audio replay is available in the press release issued earlier today.

And with that, I will now turn the call over to Crocker Coulson who will present the management’s discussions we have on behalf of China Pharma’s President and CEO, Miss Zhilin Li.

Crocker Coulson

Thanks a lot Leslie. Welcome everyone and thanks for joining us on China Pharma’s first quarter 2007 call. China Pharma got off to a strong start in 2007 with excellent performance by our portfolio of therapeutics. The market environment in China remains strong and this favorable environment provided an excellent platform for growth.

Our revenue for the first quarter of 2007 was $7.2 million, up 52.8% from the first quarter of 2006. On a sequential basis, revenue declined 10.9% from the fourth quarter which is typically our strongest of the year due to fact that colder weather weakens that immune system and results in increased incidents and infections and other illnesses treated by our therapeutics.

Gross profit increased 49.5% during the first quarter to $3.3 million. Gross margin was 45.6% down slightly from 46.6% in the first quarter of 2006. The variation in gross margin was due to minor changes in our product mix. Overall, the pricing for our products remain strong and our portfolio was relatively un-impacted by the Chinese government’s recent price control initiatives.

Our net income grew by 46.6% to $2.4 million, and this included a net gain of about $700,000. (Inaudible) cents compared to $0.05 in the first quarter of 2006. Our strong revenue growth speaks to our increasing penetration in one of the most important emerging pharmaceutical markets in the world. Industry drivers remain strong and China’s well poised to become the fifth largest drug market by 2010, due to its aging population and the government’s commitment to provide health care to the country’s rural population. China’s $11.5 billion pharmaceutical industry has grown at a rapid pace over the last five years, and recent research projects it will reach $46.6 billion by 2010. In addition to strong growth outlook, our industry is still highly fragmented with the top ten manufacturers accounting for 13% of total sales revenue.

In more mature markets, the top ten manufacturers account for about 40-50% of total sales. This dynamic creates a very strong opportunity for China Pharma to aggressively capture market share. We have several competitive advantages that have allowed us to consistently increase our market penetration. At the forefront is our diversified portfolio of products. Our portfolio addresses a large and growing market of health problems, and includes therapeutics that treat the central nervous system and neurological problems, infectious diseases, cardio-vascular diseases, and nutritional supplements.

To update you on a few of our top performing drugs, Gastrodine remains one of our fastest growing therapeutics with sales increasing over 250% from the first quarter of 2006. Cefalcor also showed two-fold increase in sales as we increased production capacity for this therapeutic at the end of 2006. AFGF showed healthy year over year growth of 30%. Our two therapeutics launched in 2006, hepatocyte, a growth-promoting factor, and sodium ozagrel for injection further increased our market penetration, and were the largest contributors to our growth for the quarter, representing 10.7% and 8.5% of revenues respectively. Overall, no single drug represented more than 15% of our total sales in the quarter.

Before going over our financial performance in more detail, I’d like to briefly touch on the reforms that are currently underway at the SFDA. As part of its anti-corruption campaign, the SFDA is in the process of implementing tighter controls and oversight over the drug approval process. We are very much in favor of these actions, and feel they will create a competitive environment favorable to China Pharma as more stringent industry oversight will increase the credibility of those companies that remain in the industry.

However, in the short term, the environment has created some uncertainty regarding the timing of new drug approvals. In response, we made this strategic decision in the first quarter to sell two development stage pharmaceuticals, generating an income at about $1.5 million. In the future, we may decide to sell additional formulas if we determine that we can realize a higher return on investment by selling them rather than bringing the drugs to market.

That being said, we have a rich pipeline of therapeutics, and we’re going to continue to invest them and bring them to market. We also remain optimistic that the remaining long term outlook for our industry, and we’re confident that we’ll continue to launch a variety of therapeutics once the industry and approval process has moved beyond this transitional period.

We also have a significant opportunity to increase our market share by taking advantage of the government’s commitment to provide health care to the country’s population via the new Rural Cooperative Medical Care System or CMS system. This program currently covers 51% of the country’s regions and specifically targets the elderly and the poor. China’s central and local governments have invested about $2.4 billion into the program to date, and have pledged to spend another $1.3 billion in 2007.

By the end of 2008, the new rural Cooperative Medical System will be available to 80% of Chinese counties, and by 2010, the country will have renovated 22,000 village clinics, 1,300 county level general hospitals, 400 county level or traditional or ethnic hospitals, and 950 county level maternity and childcare institutes. CMS offers China Pharma the opportunity to expand our reach to over 900 million individuals, and we plan to aggressively pursue the opportunities provided by this program. And now I’d like to talk in a little more depth about our financial performance for the quarter.

Our revenue for the first quarter of 2007 was $7.2 million, up 52.8% year over year from $4.7 million. The increase in revenue was led by growth in sales of Gastrodine, which increased 200% and Cefalcor which increased over 100% in first quarter of 2006. Growth profit for the quarter was $3.3 million, up 49.5% from $2.2 million in the first quarter of 2006. Gross margin 45.6% compared to 46.6% from the same period a year ago.

Selling expenses were $0.1 million for the quarter or 2% of revenue, compared to also $0.1 million or 1.9% of revenue in the same quarter of last year. During the quarter, we recognized $800,000 in research and development expenses and the R&D expense represents cost associated with the sale of our two technological formulas. G&A expense was $1.4 million or 19.1% of revenue in the quarter compared to $0.3 million or 5.6% of revenue in the same period a year ago.

I'd like to point out the G&A expense does include a $1 million write-off of bad debt, because the pharmaceutical company in China does have typically has long collection cycles, the company writes off 50% of any receivables outstanding for more than 12 months.

However, I should point out that historically China Pharma has been successful in recovering outstanding long-term receivables.

Our income from operations was $900,000, compared to $1.9 million in the first quarter of 2006.

As I mentioned earlier, we decided to sell a few development stage formulas which resulted in other income of $1.5 million. This income was partially offset by the $800,000 in research involved in expenses, resulting in a net impact of $700,000 on our first quarter financial results.

Our net income was $2.4 million. It was up 46.6% from $1.6 million in the first quarter of 2006, and fully diluted shares were $0.07 compared to fully diluted earnings per share $0.05 in the year ago period.

Our fully diluted shares were $37.2 million for the first quarter, compared to $34.7 million in the first quarter of 2006.

And now to touch briefly on our balance sheet.

As of March 30, 2007, we had $3 million in cash and cash equivalents, total liabilities of $8.1 million and a working capital of $24.5 million.

Industry wide DSO are standing close to 200 days but our internal target for DSO are standing at approximately 180 days. I am pleased to say the DSO's were 174 days in the first quarter of 2007.

Our shareholders equity stood at $27.2 million, up from $20.9 million at year end.

Our business outlook for the remainder of 2007 is to achieve net income growth of at least 30%. We will continue to work with our internal sales agents and independent sale contractors in the marketing of our existing portfolio, and expanding our customer base.

We are also expecting pre-participation in the CMS program, which will expand the number of individuals who have access to medical care. And we plan to launch a (inaudible) and hydrochloride in the second half of 2007, for which we obtained approval late last year.

In terms of capital expenditures, we do not have any material amounts of capital expenditures planned at this point for the balance of the year.

To conclude, China is clearly one of the bright spots in the global pharmaceutical market place, with the world's largest population and a rapidly growing economy.

Our pharmaceutical market is already the ninth largest in the world. Given the expanding middle class population of 1.3 billion, with the increasing number of them reaching their senior years and no dominant industry players, China Pharma has a number of opportunities to build our portfolio, and deepen our market penetration.

We are paying attention to some of the short term disruptions associated with the reforms of the SFDA. However, we still feel the (inaudible) pharmaceutical industry is in its golden age, given the company's demographics, political economy, and healthcare environments.

With that I'd like to thank you for your continued interests in China Pharma. We're now going to open up to your questions, and Michelle will be translating your questions for Ms Li and Mr. Wu.

I'll now turn it over for questions.

Question-and-Answer Session

Operator

Ladies and Gentlemen, if you wish to ask a question please press Star One. If your question has been answered, or you wish to withdraw your question, press Star Two. Questions will be taken in the order received.

The first question comes from the line of Mike McKarsky from China Pharma. Please proceed.

Mike McKarsky – China Pharma

Yes guys, I have a question for your regarding your guidance. Does your guidance include, I guess my question is going back, you had 30% income guidance, but that was before you sold those two products and had to gain for this quarter.

Does your guidance for the remainder of the year include any additional (inaudible) of those products in the pipeline?

Xinhua Wu

[Translated]

Mike, hello, yes we will say that we will feel very confident to offer our fully return net income increase of this year, and it will be 100% of our own organic growth which is the sales on drugs.

Mike McKarsky – China Pharma

So the 30% is net of any gains?

Xinhua Wu

[Translated]

No we didn't include this element.

Mike McKarsky – China Pharma

You did not?

Xinhua Wu

[Translated]

No.

Mike McKarsky – China Pharma

And the other question I had for, as Mr. Crocker mentioned the selling of G&A looks like it was off significantly year-over-year, and that was due to write off of uncollectible expenses. Do you anticipate that to be the case going forward?

Xinhua Wu

[Translated]

Mike, yeah your understanding is right. We have 50% of accounts receivable that is basically one year. So we have 50% to back that, so that's the main reason for the G&A increase.

Mike McKarsky – China Pharma

OK.

Crocker Coulson

And Mike, let me just say real quickly, that they evaluate their bad debts at the beginning of the fiscal year, so this is something that they look at once a year closely, and that's how they anticipate the write offs going forward, although we can't say specifically each quarter how much is going to be written off.

Mike McKarsky – China Pharma

OK, but it sounds like the future quarters may not have as great an impact.

Xinhua Wu

[Translated]

Exactly.

Mike McKarsky – China Pharma

Thank you.

Mr. Xinhua Wu

[Translated]

You're welcome.

Operator

Your next question comes from the line of Jim Feld of Feld Corporation. Jim, please precede sir.

Jim Feld – Feld Corporation

Yes, I have a number of questions, and maybe the first two could just be a little more clarification of the previous ones.

The bad debts were 14% of sales for the first quarter. What percent of sales do you think they will be going forward?

Xinhua Wu

[Translated]

OK, so we think that going forward the bad debts expenses versus the sales…we will try and control it within 10%.

Jim Feld – Feld Corporation

Now do you have net income of 2006 of $9.15 million?

Xinhua Wu

[Translated]

(Stumbles) that's the net income, right. Sorry, so again, what's your question?

Jim Feld – Feld Corporation

The 30% increase, I guess the question is does that come from 30% above $9.15 million, so we could look for $11.9 million for this year.

Xinhua Wu

[Translated]

We think that the number your bring out probably is not $9.11 million, but you're absolutely right that the basics is based on the net income of 2006 and the 30% increase will rise from that number.

Jim Feld – Feld Corporation

And what is the net income for 2006?

Xinhua Wu

[Translated]

It’s $8.6 million.

Jim Feld – Feld Corporation

And how many shares do you estimate you’ll have at the end of this year?

Xinhua Wu

[Translated]

We think it will remain at the same level, which is $37.2 million.

Jim Feld – Feld Corporation

Last question, you mentioned that the 4th quarter is the strongest quarter. How are the other quarters ranked normally, from strongest to weakest?

Xinhua Wu

[Translated]

We think the ranking should be Q4, Q1, Q2 and Q3. Basically in Q2 and Q3 the sales are roughly the same.

Operator

Peter Siris from Guerilla Capital. Please proceed.

Peter Siris - Guerilla Capital

First I’d like to thank Ms. Zhilin Li for taking me around their wonderful facility in Haiko. I want to ask about the SFDA. I wonder if Ms. Li can talk about the process it’s going through now and where she thinks it’ll end up in the next year. My understanding is that in tightening up the regulations, the government will get rid of a lot of smaller companies. This is a short term negative, but it should be a long term positive. Am I figuring that correctly?

Zhilin Li

[Translated]

As you mentioned, we do view with all the policies and programs of the SFDA, that they are leading the whole industry towards a more positive and standardized trend. As one of the leading players in the industry, we do feel that.

So from our point of view it is definitely positive to the overall industry. It will stabilize the pharmaceutical industry while (inaudible) the competitive barriers. For a pharmaceutical company like us it will provide better conditions and it is even harder for any new players to get into the industry.

At the same time, we think that the atmosphere will have even stricter conditions to approve any new drugs. So it will be an opportunity for us. There a lot of issues in this industry, which will provide more space for a company like us.

Peter Siris - Guerilla Capital

So with the government increasing health care expenditures by 70-80% this year and with the new rules, does that say that next year and into the future, the growth rate should be faster than 30%?

Zhilin Li

[Translated]

While we take it positively for the overall policy and trend, because there’s a lot of different effects to bring the results and we are still in the process of getting the results, so we think it’s premature to forecast any growth for our company at this moment. But what we can be share is that with this positive trend, we will keep on making more efforts in our own development, and try to maximize the return for the shareholders.

Peter Siris - Guerilla Capital

Last question. When does Mr. Wu say that the market will, that a lot of these bad companies will be shaken out, and the profitability of the overall market will improve?

Xinhua Wu

[Translated]

Peter, as you know, the pharmaceutical industry is a very big and fragmented industry. So we think, from the point of view of the government, they will take the initiative, step by step, to standardize the overall industry. It will not be an overnight dream; it will definitely take time. And for us, as an industry player, we cannot see that any time line or time schedule for the overall process. But we think that we see the commitment and the dedication of the government policy, as well as our own efforts and experience in this industry, that we are sure that we will continue to have successful, as well as sustainable improved profitability.

Peter Siris - Guerilla Capital

Great, Thank you very much.

Xinhua Wu

[Translated]

You're welcome.

Operator

Your next question comes from the line of Boyd Hines, private investor. Please precede sir.

Boyd Hines – Private Investor

Hi, good morning. I also have some questions about the regulatory environment right now in China. It seems that you have not been directly impacted by the price cuts that the SFDA has passed. But I'm wondering, has that affected you in any other way, from raising prices? Are you very conscious of government intervention, and are you concerned that they could come in and cut prices on the drugs that you're currently offering?

Xinhua Wu

[Translated]

OK, in this industry normally, the regulatory department has quite a big control of the pricing of the drugs, so in a way that they have the decision-making for the pricing. But you're absolutely right that for the current regulation, they don't have any impact on the drugs of China Pharma, which means that China Pharma can still enjoy a relatively high price compared to other peers.

Boyd Hines – Private Investor

I see. And have you been able to increase prices at all in the last year?

Xinhua Wu

[Translated]

No, we didn't increase any ASP on drugs. Once again, it is more last (inaudible) controlled by the government.

Boyd Hines – Private Investor

OK, let me ask you a question about your bad debt expense. Can you give us a little more color, a little more detail on where that was generated from? Was it a hospital? Was it a reseller? Where was the problem this quarter?

Xinhua Wu

[Translated]

Most of them are from the hospitals.

Boyd Hines – Private Investor

OK, and are you still selling products to the same customers?

Xinhua Wu

[Translated]

Once again, sir, what's your question?

Boyd Hines – Private Investor

My question is, you had to incur $1 million in bad debt expense due to the hospitals. What steps are you taking to help reduce this problem? That's one general question. And the second question is, are you still actively selling drugs right now to these same hospitals?

Xinhua Wu

[Translated]

OK, so first of all, that we are still selling drugs to those hospitals, but the industry way is that normally they will settle the accounts receivable that they owe us before, and then probably they will have new accounts receivable. So, it is kind of a circle. So we are still selling drugs to those kinds of hospitals.

And secondly, as you probably know, we will try to improve the standard of DSO, which is a key focus for China Pharma, and we have been making efforts to try to administer that part in-house.

Boyd Hines - Private Investor

OK, thank you very much.

Xinhua Wu

[Translated]

You're welcome.

Operator

As a reminder, press Star One to ask a question. At this time there are no further questions in the queue.

We have a question form the line of Michael Otto from PC.com, please proceed.

Michael Otto – PC.com

I’m interested in knowing when the general operations will generate a positive cash flow.

Right now you have $3 million worth of cash in your balance sheet, and you have a negative cash flow for the quarter. I’m interested in knowing when you anticipate a positive cash flow going forward from operations.

Xinhua Wu

[Translated]

OK Mike, we have always been making an effort on the parts of the cash flow of our own operating activities and according to our own estimation starting from the third quarter or the fourth quarter this year we think the cash flow is going to be positive.

Michael Otto – PC.com

Thank you.

Xinhua Wu

[Translated]

You’re welcome.

Operator

At this time there are no further question in the queue.

Leslie Richardson

OK, thank you guys for attending our conference call this morning and we look forward to answering any of your questions. If you want, you can contact either Crocker or myself.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. 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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