Executives
Hai Mi - IR
Ge Li – Chairman, CEO
Benson Tsang - CFO
Analysts
Jinsong Du - CreditSuisse
Tycho Peterson – JP Morgan
Bin Li - Merrill Lynch
Dave Windley - Jefferies
 |
WuXi PharmaTech(WX) Q3 2007 Earnings Call November 13, 1969 2:00 AM ET
Hai Mi
Thank you, operator. Good morning and good evening. Thankyou for joining us for WuXi PharmaTech investor conference call on our thirdquarter 2007 results. Joining the call today are our Chairman and CEO, Ge Li,and our CFO, Benson Tsang. This conference call is also being broadcast on theInternet and is available through the investor relations section of the companywebsite. We also have provided a summarized presentation which may bedownloaded from our website.
Before the management's presentation, I would like to referto the Safe Harborstatement in connection with today's conference call and our earnings pressrelease. During the course of this conference call, we may make forward-lookingstatements, statements which that not historical facts, including statementsabout our future expectations, plans and prospects. Forward-looking statementsinvolve inherent risks and uncertainties and a number of important factors couldcause the results to differ materially from those contained in anyforward-looking statements. Further information regarding these and other risksare included in our filings with the SEC.
Additionally, we may be discussing non-GAAP financialsduring this call. We believe these non-GAAP numbers help investors to betterunderstand our core operating results and the future prospects, consistent withthe manner in which management measures and forecasts the company'sperformance. These non-GAAP financials exclude the stock-based compensationexpense and investors should refer to the reconciliation of non-GAAP measuresto GAAP measures for the indicated period attached to our Q3 earnings pressrelease that can be found in the investor relations section of the companywebsite.
Following management's prepared remarks, we will open theline for a brief Q&A session.
With that, I would like to turn the call over to ourChairman and CEO, Dr. Li.
Ge Li
Thank you. Good morning and good evening, everyone and welcometo our third quarter 2007 earnings call. Before I start to discuss our thirdquarter results, I would like to take this opportunity to give you an overviewof WuXi PharmaTech, since some of you may be hearing our story for the firsttime.
WuXi PharmaTech is the leading China-based drug R&Doutsourcing service company. As noted on slide 2, the company was founded inDecember 2000 with the mission to transform the drug R&D industry and avision to provide fully integrated drug R&D services to improve the successof research and shorten the time of development.
Our company is headquartered in Shanghai.We provide pharmaceutical and biotechnology companies around the world with afull spectrum of drug R&D services under two segments: laboratory servicesand research and manufacturing. WuXi PharmaTech has experienced strong growthsince our inception by delivering a high quality of services to our customers,leveraging the cost and talent pool advantage of operating in China,and by capitalizing on the strong demand of the global drug R&D offshoreoutsourcing.
A key testament to the strength of our company is thequality of our customer base. We have worked with 80 customers so far in 2008,including nine of the top ten global pharmaceutical companies and we haveexperienced 100% repeat business from our top ten customers over the last threeyears.
Slide 3. Inline with our vision to be the leading, fully integrated and scalable drugR&D service provider, we now provide a wide range of services including discoverychemistry, service biology, toxicology, bioanalytical and analytical services,pharmaceutical development, process development and research manufacturingservices.
We're going to continue to grow our core service capacities,expand our manufacturing capability and capacity and develop significantpreclinical and biology capabilities.
Now let me turn to our third quarter performance. Pleaseturn to slide 4. Our strong third quarter performance demonstrates the strengthof our business model and our strong execution ability to capitalize on growingmarket demand for drug R&D outsourcing services.
Both laboratory services and the research and manufacturingsegments performed well during the quarter, as net revenues increased 78% to$34 million, and the net income tripled to $8.6 million over the same period oflast year. The robust revenue increase is mainly driven by our top ten customers,whose average revenue contribution grew to $7.4 million for the first ninemonths of 2007, an increase of 126% over $3.3 million for the same period oflast year.
On the operational front, we continued to execute on ourstrategy, aimed at delivering long-term, profitable growth by delivering high qualityservices to our customers. As part of this effort, we broke ground on September29th to build our GLP preclinical drug safety evaluation center in Suzhou, China, which is about 60 kilometers from Shanghai.
It will be a 267,000 square foot,state-of-the-art facility and expected to be China'slargest modern drug evaluation center, providing comprehensive preclinical andtoxicology services. The Suzhoucenter will be completed in 2009. At the same time, our interim facility in Suzhouis already operational.
In Shanghai, weare on schedule with our expansion plan for our 220,000 square footmanufacturing facility in the Jinshan district. It will quadruple the current productionvolume after its completion in 2008.
Both projects are expected to augment our current servicecapacities and the capabilities to provide better and more services to ourcustomers.
Lastly, we have begun providing formulation services fromour newly completed 22,000 square foot GMP quality formulation lab in Shanghai.
Now I would like to turn the call over to Benson Tsang, ourCFO, to discuss the financials and our revised full year guidance.
Benson Tsang
Thank you, Dr. Li. Asyou have all seen our earnings release by now, I will focus on the mainhighlights for the quarter. We continue to benefit from the strength of ourbusiness model and strategies, and have posted a strong set of financialresults characterized by the solid top and bottom line growth.
As noted on slide 4, net revenues were $34 millionrepresenting a 77.8% year-over-year increase. Net income was up 205% year over year.Laboratory services remained our main revenue driver for the quarter. Netrevenues increased by 59% to $26.7 million in the third quarter of 2007,compared to $16.8 million in the third quarter of 2006. Our laboratory servicesbusiness accounted for 79% of our net revenues in Q3.
Our second business line, research manufacturing, generated$7.3 million in revenue, accounting for 21% of total net revenues in the thirdquarter. This represents a 212% increase in revenue over the same period oflast year, compounded with an improved profit margin due to the increasedscalability.
Gross profit increased 76% to $16 million in the thirdquarter of 2007. Overall gross margin was 47% in the third quarter of 2007,slightly lower than the third quarter of 2006, mainly attributable to the costsrelated to our expanded facilities such as rentals and depreciation for ourequipment. As we are growing steadily, operating expenses are increasing. Theygrew by 38% to $8.5 million in the third quarter of 2007, up from $6.2 millionin the third quarter of 2006. This increase was primarily a result of ourbusiness expansion, increased hiring and growing service capabilities.
Nevertheless, as a result of our ongoing efforts to maximizecost efficiency in our operations, expenses have declined as a proportion ofrevenue, decreasing to 25% for the third quarter 2007 from 32% in the prioryear period. We will track the figure going forward to ensure we are keepingour costs and profitability in line.
Moving to slide 5, our solid balance sheet had cash balancesof $213 million. We have not used any of our proceeds from our IPO and thesefunds are generating interest income for the company. Diluted earnings per ADSwas $0.12 for the third quarter of 2007. However, our share-based compensationexpenses decreased by $1 million to $1.5 million U.S.in the third quarter of 2007 from third quarter 2006. Diluted earnings per ADS,excluding share-based compensation charges, on a non-GAAP basis was $0.15 forthe third quarter of 2007.
Finally for our guidance, please turn to slide 6. Due to oursolid results in the third quarter and better visibility into market conditionsand our business growth, we are raising our full-year revenue guidance to therange of $131 million to $135 million.
Now, let me turn it back to Dr. Li.
Ge Li
Thank you, Benson. In closing, we have maintained the samestrategic directions and focus on building our capability and the capacity inorder to provide fully integrated, high-quality drug R&D outsourcingservices to our customers. We continue to benefit from positive macroenvironments, including the increase in R&D expenditure, growing globaloutsourcing trends and the sustained advantage of doing business in China.
Together, we believe the combination of these external andinternal factors provide a strong basis for our long-term growth.
Thank you and we'll be happy to take your questions.
Question-and-AnswerSession
Operator
Your first question comes from Jinsong Du - Credit Suisse.
Jinsong Du - Credit Suisse
Congratulations on the results. You mentioned in the slidesthat you now have 80 clients. I remember during the IPO road show that it was at70. I understand you may not be able to disclose the specific names of the additionalclients, but could you share with us these additional ten clients, whether theyare mainly for research manufacturing or for the lab services? Also, whetherthey are major pharmaceutical companies or small biotech companies, please?
Ge Li
Hi, Jinsong. Thank you for your questions. During the lastnine months indeed we had new customers. The customers are from both laboratoryservices and the research manufacturing. Mainly, we have added some largebiotech companies and also some small biotech companies.
Jinsong Du - Credit Suisse
Is it very wellspread, in the sense of 50-50, or is it geared more towards one segment?
Ge Li
I would say about 80-20 and more towards our laboratoryservices.
Operator
Your next question comes from Tycho Peterson – JP Morgan.
Tycho Peterson - JP Morgan
Starting out with the manufacturing business, you talkedlast quarter about some of the issues in Europe andVertex not taking delivery of the API. Can you give us a sense of whetherthat's been worked through? The underlying question stems around the fact thatI guess the deferred revenue balance increased a little bit.
Benson Tsang
For the deferred revenue, if you look at our balance sheetwe have $19.9 million as of September 30, 2007. This represents primarily payment from our customers forservices provided and material we manufactured. A significant portion of thebalance is actually from our manufacturing customer. We are in discussions withthe customer right now about the shipment schedule. We actually have started a shipmentin Q3 and we expect to ship the remaining goods in our inventory in the nextfew months.
Tycho Peterson - JP Morgan
Has your visibility around that customer changed at all?There's been some noise on the competitive front from Vertex. Has there beenany kind of underlying change in the level of visibility you have? It soundslike the drug is supposed to move forward in the first quarter next year now.
Ge Li
Well Tycho, as our company policy, we don't discusscustomers' information without the consent from the customer.
Tycho Peterson - JP Morgan
On the gross margins, if you can give us a sense,particularly on the manufacturing side, as to how we should think about thesustainability of the margins and the underlying margin trends going forward,that would be helpful.
Benson Tsang
Our overall margin is 47% for Q3 2007, and versus Q3 2006it's 47.4%. For our research manufacturing business, our gross margin actuallyimproved from 8.2% in 2006 to 14.3% in 2007. This is the direct result of ourgrowth in the project and also the achievement of economies of scale andefficiency on our production facilities. We will continue to focus on theoperational efficiency both in terms of labor and material and to maximize costand production efficiency on our manufacturing facilities.
For the margin I would also like to draw your attention toour operating margin. It increases from 12.6% in 2006 to 21.2% in 2007 for thenine month period. Our effort is not only limited to the cost of sales line, wealso monitor our SG&A expenditure closely to ensure we can maximize theefficiency. Thank you.
Tycho Peterson - JP Morgan
Benson, can you break out that $1.5 million between 123 Rand stock?
Benson Tsang
It's actually 100% FAS 123.
Tycho Peterson - JP Morgan
I don't know if you gave the CapEx numbers and depreciation,I know you talked about some of the general CapEx spending, but if you couldquantify those that would be helpful, too.
Benson Tsang
Up to Q3 2007, we had invested approximately $30 million inCapEx. Approximately $6 million is for our manufacturing and Suzhouprojects. The rest is actually for equipment purchases and laboratory facilityexpansion; that is about $24 million. As you know, we budget about $18 millionfor both the Jinshan and the Suzhouprojects -- that is the manufacturing and the drug evaluation center. So thismoney shall likely be spent in the next two years.
Depending on the eventual payment schedule, we expect a fairamount will be spent in 2008 and for the maintenance CapEx, we shall spend inaccordance with our business growth. Thank you.
Operator
Your next question comes from Bin Li - Merrill Lynch.
Bin Li - Merrill Lynch
A follow-up question on the gross margin; Benson, youmentioned the manufacturing gross margin has expanded significantlysequentially and the lab service gross margin declined at the same time. Youattribute the gross margin decline to increased depreciation and theappreciation of RMB. I was wondering whether you can quantify the impact of thedepreciation and the RMB separately?
Benson Tsang
Bin, I don't have the data with me. I can get that to youlater on.
Bin Li - Merrill Lynch
Perhaps more importantly, how should we think about thesetwo factors going forward? Is the negative impact of depreciation here to stay?As for the RMB appreciation, in light of the strong RMB, what is yourexpectation on RMB impact to your gross margin going forward?
Benson Tsang
For the RMB, during the period from January 1, 2007 to September 30, 2007 the Chinese currency has appreciatedabout 4.2%. From the company perspective, we have purchased foreign exchangeforward contracts to minimize our U.S. dollar/RMB exposure. We have been ableto achieve better results during this period. Currently, there are very limitedeffective tools that we can actually minimize the exposure. We shall continueto purchase foreign exchange forward contracts and we believe it is the mosteffective way, a no-risk tool.
Bin Li - Merrill Lynch
Are you fully hedgedwith the forward contract, or partially?
Benson Tsang
Partially.
Bin Li - Merrill Lynch
A continued question on the margin, you mentioned operatingmargin has improved significantly, which is very encouraging. Now, can youidentify for us what other line items within your operating expense can bereduced? Also, can you tell us how should we think about further reduction inthat line?
Benson Tsang
For the operating expenditure, since day one we have beenvery, very cautious in spending items in the operating category. I think whatactually we're trying to get at is the overall efficiencies. We invest in ouroperating expenditure, but we are squeezing all the efficiency we can get to maximizethe outputs. We'll continue to do so and we are comfortable we can continue tomonitor well.
Operator
Your next question comes from Vicky Chen - UBS.
Vicky Chen - UBS
Congratulations on the strong quarter. Looking at thequarterly earnings for last year, '06, what I see here is that there is asequential growth and the last quarter was the strongest quarter we saw. Forthis year, is it because of the seasonality or it's just the sequential growththat you saw last year specifically? Are we going to see this pattern showingthis year or for the years going forward?
Ge Li
I don't think we see seasonality. Actually, last yearprobably is last-year specific because the sequential growth has a lot to dowith customers' spending patterns last year.
Vicky Chen - UBS
How many people or scientists have you recruited this yearas of now?
Ge Li
Well, as of September 30th we have over 2,700 employees,including slightly over 2,100 staff members [inaudible].
Vicky Chen - UBS
So for this year alone, how many people? I guess I wasn'tclear in asking this question.
Ge Li
It's almost a net addition of 1,000 people up to now.
Operator
Your next question comes from Dave Windley - Jefferies.
Dave Windley - Jefferies
I wanted to follow-up on the stock charge. Benson, you saidthat 100% of that is actually FAS 123R?
Benson Tsang
Yes, share-basedcompensation charge.
Dave Windley - Jefferies
Does that mean then that 100% of it relates to ordinaryshares as opposed to any that would be attributable to the preference sharesfor the portion of the quarter?
Benson Tsang
Correct, 100% commonshare or options.
Dave Windley - Jefferies
Following up on the labor question, I got your number. Froman acceptance rate standpoint, Dr. Li, have you seen your number of offersbeing accepted remaining at about the same rate, or has that increased ordecreased this year?
Ge Li
Actually, our reported acceptance rate is better than in thepast years.
Dave Windley - Jefferies
My angle there is competition and I guess WuXiis seen as a preferable place to work relative to the competition. Are you ableto differentiate yourselves in that respect?
Ge Li
I would like to thinkso, yes.
Dave Windley - Jefferies
On the labor rates,are you seeing any acceleration in the labor rates from the new hire base?
Ge Li
David, I'd like to report to you I am happy, actually. In2007, we strengthened our leadership position in China,because to the best of our knowledge, the revenue difference, the number ofcustomers between WuXi and othercompanies in Chinaactually are widening. So we feel very comfortable about our leading position.
Dave Windley - Jefferies
Did I understand correctly that the average revenuegenerated year-to-date by the top ten was $7.4 million. Was that right?
Ge Li
Yes.
Dave Windley - Jefferies
The top ten revenue concentration on a year-to-date basis ishow high?
Ge Li
It's around 75%.
Operator
Your next question comes from Jinsong Du - Credit Suisse.
Jinsong Du - Credit Suisse
Specifically on the Vertex project, could you share with us inthe research manufacturing revenue in the third quarter, what percent is fromthis single largest contract with Vertex.
Ge Li
Jinsong, it's our company policy we don't discuss customers’specific information without consent from our customers.
Jinsong Du - Credit Suisse
Could you tell us then -- because this quarter the grossmargin from research manufacturing, my calculation was 42.4% which is higherthan in the past. So is that mainly Vertex-related projects having a highermargin than other research manufacturing projects, or are they similar?
Benson Tsang
They are similar. Infact, Jinsong, I just want to highlight with different projects we may have alittle bit of variation in the gross margin, but overall it's about the samerange.
Jinsong Du - Credit Suisse
Going forward for the research and manufacturing, do weexpect more than 40% gross margins or even improving gross margins goingforward for research and manufacturing?
Benson Tsang
Jinsong, as I mentioned earlier, we will continue to focuson the operating efficiency including the cost and production efficiency of ourmanufacturing facilities.
Jinsong Du - Credit Suisse
New clients you signed up for both lab services and researchmanufacturing, did you manage to basically because of the appreciation of theRMB, did you manage to pass the impact of the RMB appreciation into the ASP youare quoting to the clients? Basically, do we see an increase in the generalpricing with the new customers?
Ge Li
Jinsong, I'm sorry,we don't comment on commercial details of our contracts with the customers.
Operator
Your next question comes from Bin Li - Merrill Lynch.
Bin Li - Merrill Lynch
I want to follow-up on the Vertex question and I hope youdon't mind because I think you appreciate this is something that's going on ina lot of investors minds as well. On that, can you tell us from yourunderstanding from your partner, Vertex, on the drug production schedule forPhase III and presumably for early commercialization batch, is there any changein your delivery schedule? Can you tell us that?
Ge Li
Bin, again, as our company policy, we don't discusscustomers’ confidential information without consent from the customer. But I'dalso like you to pay attention on our revised annual results, because in 2007we revised up our annual guidance from $128 million to $132 million to $131million to $135 million.
Bin Li - Merrill Lynch
The bigger question for me is when you will have a betteridea on whether you will become the long-term supplier for this contract, forthe commercialization of Vertex's drug?
Ge Li
Well, again, it's our company policy that we don't discusscustomer information without consent from the customer.
Bin Li - Merrill Lynch
Presumably you're also seeking other manufacturing contractsto increase revenue stream and to diversify risk. I was wondering whether you can give us someupdates on the progress on that effort/
Ge Li
Bin, if you remember, we built our research andmanufacturing to take advantage of our strong process research capabilities. Thisyear we expanded our process capacity and we see more projects coming in and wecertainly hope in the future we will have more Vertex-like projects.
Operator
Your next question comes from Tycho Peterson – JP Morgan.
Tycho Peterson - JP Morgan
I'm just wondering if you can comment generally aboutpricing trends, to the extent you've had any increases or how you view yourability to command pricing from your customers going forward?
Ge Li
I think since day one we focused on building our capabilityand capacities to provide value-added, high quality service to our customers. Ithink during the past six or seven years we have demonstrated ourselves. Ithink our customers acknowledge that and again, we don't comment on commercialdetails of the contracts with our customers.
Operator
There are no further questions at this time. At this timeI'd like to turn the call back over to management for any additional or closingremarks.
Ge Li
Thank you, everyone for joining WuXi PharmaTech's thirdquarter 2007 earnings conference call. See you next quarter. Good morning.
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