American Oriental Bioengineering Inc. Q1 2008 Earnings Call Transcript

May.26.08 | About: American Oriental (AOBI)

American Oriental Bioengineering Inc. (AOB) Q1 2008 Earnings Call May 7, 2008 8:00 AM ET

Executives

Wilfred Chow - SVP of Finance

Tony Liu - Chairman and CEO

Li Lily - COO and CFO

Analysts

Julie Chen - CRT Capital Group

Catherine Liu - Oppenheimer

Hongbo Liu - Piper Jaffray

Shaumo Sadhukhan - Lotus Partners

Operator

Good day, ladies and gentlemen, and welcome to the American Oriental Bioengineering first quarter for 2008 Earnings Call. My name is Jahida and I will be your coordinator for today. At this time, all participants are in listen-only mode and we will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Wilfred Chow, Senior Vice President of Finance. Please proceed.

Wilfred Chow

Thank you. Good morning, everyone, and welcome to the AOB first quarter 2008 conference call. On our call today is Tony Liu, Chairman and CEO; Miss. Li Lily, Chief Operating Officer and CFO; and myself, Wilfred Chow, SVP of Finance.

Before we begin, I would like to mention that this conference call may contain forward-looking statement within the meaning of the federal security laws. Forward-looking statements include statements concerning plans, objectives, goals, strategy, future events, our performance and underlying assumptions and other statements that are historical in nature.

These forward-looking statements are based on management current expectations and are subject to risks and uncertainties that may result in expectation being realized, and which may cause actual outcomes to differ materially from the expectations reflected in those forward-looking statements.

Potential risks and uncertainties include products, service, demand and acceptance, change in technology or economic conditions, the impact of competition on price, the impact on governmental regulation and other risks contained in the report filed by the company with the SEC.

For more information on this matter, we encourage you to review the company's most recent 10-Q filings.

With that said, I would like to turn the call over to Tony. Tony, please.

Tony Liu

(Interpreted)

Good morning, everyone. Welcome to our Q1 2008 conference call.

Typically, the first quarter is our seasonally slowest quarter due to Chinese New Year celebrations. However, this year I am pleased to report to you that we ended the first quarter of 2008 with strong financial performance and met our expectations.

Our Q1 financial results reflect, in particular, the continued increasing demand for OTC and prescription pharmaceutical products. Our brand recognition continues to improve and our distribution capabilities continue to expand into untapped rural areas throughout China.

In addition, we have begun to realize the synergies of our acquisition. CCXA and Boke contributed approximately $10 million to revenues this quarter; an increase of approximately 35% from the fourth quarter of 2007.

The results of this quarter indicate solid progress towards fulfilling our goal of being one of China's leading pharmaceutical companies. In order to be successful, we are convinced that we must build a company that can maintain flexibility in a constantly changing and evolving healthcare market in China. In this regard, we are focused on integrating and building our operations to ensure the self-sufficiency required to maintain such flexibility in this changing environment.

With our alliance and equity investment in China Aoxing, we have access to an exciting high growth and new product line in pharmaceutical narcotics and pain management products. Their product line not only diversifies our portfolio of products, but it is also high growth and has a high barrier to entry business.

We certainly will collaborate with the China Aoxing. We are extremely excited about entering into the pain management market and we view this alliance as yet another major step towards achieving our goal of becoming one of the top pharmaceutical companies in China.

So, AOBO would thank you all of you for your continued support. I now will turn the call over to Lily.

Lily Li

Thank you, Tony. I will first highlight some key points from our first quarter financial results. I will review our business strategy and our opinion of China's healthcare market today. At the end, we will discuss our outlook for the year.

As Tony mentioned, we are pleased with our results for the first quarter 2008 and we achieved all our expectations. We generated net sales of $38.8 million for the first quarter, which represents a 51% year-over-year increase.

Net income increased 46% to $9.4 million and our diluted earnings per share was $0.12 for the first quarter, even while the number of weighted average shares outstanding increased by approximately 11.6 million shares during the period.

Our strong revenue growth continued to reflect the expansion and diversification of our product portfolio and distribution capabilities, as well as our acquisitions.

In particular, our organic growth of 12% primarily represents performance from our leading OTC pharmaceutical brand, including our Jinji series, but it also includes positive performance from our prescription pharmaceutical products, such as SHL and our CE Gel. This is an improvement over our performance in the first quarter of last year.

In addition, the revenue performance of CCXA and Boke was significant. CCXA contributed $4.3 million for the quarter, while Boke revenues were $5.7 million. Our combined business $10 million of revenue from these newly-acquired businesses compared to $7.4 million in the fourth quarter of 2007, representing a 35% increase.

Let me point out a few additional key items for the first quarter.

We were pleased with our prescription pharmaceutical product revenue. It was typically a weak quarter for prescription pharmaceutical sales. Prescription sales increased 10% year-over-year to $10.6 million. We are so pleased with the integration of CCXA and Boke, and this drove our OTC pharmaceutical product revenue which was exceptionally strong and increased 138% to $21.2 million during this period.

On the balance sheet, you will see that we recorded a $16 million prepayment much like our GLP acquisition in the past. We decided to put down refundable deposits for certain acquisitions, although now we are not yet at the point where we can give you detailed information regarding this acquisition.

Please note, that we are very aggressively pursuing opportunities with the several target companies. We are looking forward to updating you in the future.

We are so excited about the acquisition pipeline right now. Let me take a minute and bring you up to date with our opinion of the landscape in China's healthcare market today.

We have always prided ourselves on our ability to stay very close to the ground so that we really understand our market, our competition and our customers. We have the strongest distribution relationship. We believe that our active sales force now numbers more than 2,300 professionals. So we keep an active focus on the landscape and, importantly, we see several transformative macroeconomic changes going on right now.

The FSDA in enacting more and more regulations on quality in China's healthcare sector and this is very positive for the industry as a whole. Regulation focused on rewarding the highest quality companies creates a more efficient environment that is more conducive to innovation than in the past. And it ensures that the highest quality products succeed.

We also expect that on top of regulation the government will continue to increase healthcare expenditure. This will allow companies like AOBO to benefit from the government's healthcare investment and will likely increase demand for the best products over time.

The strict regulation and the increased investment from China's government signals to us the importance of scale. In our industry being the biggest and the best is extremely compelling. Scale ensures pricing power as we bring our products to the consumer. And scale allows us to reinforce our brand.

Scale [drives] our ability to be a tough negotiator when we pursue acquisitions, and it evens allows for more favorable politics from the government. Scale could also allow us to define technological standards for different therapeutic categories in China's healthcare market so that we dictate the product specification and, ultimately, control the barriers to entry.

Also, if we want to pursue licensing opportunities, scale is extremely important because the world's leading pharmaceutical companies will seek out the Chinese partner with the deepest and the most powerful presence in the healthcare sector. So we intend to broaden our business beyond traditional Chinese medicines to ensure that we can achieve all of the benefits of being the biggest and best.

We have a proven history in plant-based pharmaceuticals and this is a fantastic platform to launch into new areas of Chinese healthcare market to ensure that we have all of the benefits of scale. We started this strategy with our recent China Aoxing alliance. We view them as potentially the leaders in China's developing narcotic market and our initial project of 38% of the company is a starting point for a larger presence in the pain management category.

Together, we have planned to commercialize the select FSDA approved pain management products and this include Naloxone, Oxycodone and Tilidine. Each of their products represents an exciting market opportunity in China's evolving pain management market.

Additionally, only a few manufacturers are designated by the State FDA to operate in a highly regulated narcotic industry, and China Aoxing is one of the few companies that have been approved by the State FDA. We particularly like the high barrier around this business.

We feel now more than ever the healthcare market is evolving very quickly and the balance of power around manufacturers, distributors, providers and the retailers is shifting dramatically.

The companies that are well diversified and that have the largest presence throughout the manufacturing distribution, as well as in branding and at the point of sale, will ultimately succeed as the leader in China. And this is our goal.

Moving on to our guidance. Today, we giving you our guidance expectations for the full year. We will focus on our long-term performance on an annual basis. We continue to anticipate organic growth of at least 30% in 2008.

But, more importantly, we expect to reach total revenue of at least $245 million in a full year 2008. This 50% plus anticipated year-over-year top-line growth reflects continued demand for our leading products and, particularly, our success with CCXA and the Boke integration.

We also anticipate net income performance of at least $62 million, which reflects anticipated year-over-year net income growth of more than 43%. As always, this guidance excludes any potential acquisitions.

That concludes our prepared remarks for today. Operator, we are reedy to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Julie Chen with CRT Capital Group. Please proceed.

Julie Chen - CRT Capital Group

Thank you. Good morning Tony, Lily and Wilfred. I have three questions to start with, sorry about that.

Lily Li

Okay, excuse me, Julie. Good morning, first. Would you please speak a little louder, yes?

Julie Chen - CRT Capital Group

Sorry, is this better?

Lily Li

Okay, that's perfect. Thank you.

Julie Chen - CRT Capital Group

Thank you. In terms of acquisitions, I see that you have a refundable deposit that you talk about which is $16.4 million. Just a clarification; this a deposit for one acquisition, or this a deposit for the multiple in your pipeline that you mentioned?

Lily Li

(Interpreted) Actually, this is for more than one acquisition and, as we can see from the refundable deposit, AOBO is very aggressive in making further acquisitions.

Julie Chen - CRT Capital Group

Thank you. My second question is on the overall macro environment. SFDA has been reabsorbed under the Ministry of Health. The overall macro environment, as you have mentioned earlier Lily, is that the regulations are getting tighter. There is stricter monitoring by government for safety. Would this environment be much more benefit for AOB, not only just on the scale standpoint, but from drug approval standpoint?

From my understanding, CCXA and Boke has multiple drugs currently under approval process. With this re-absorption there's an indication that a pipeline is opening for approvals. Would this guide you down the road? Is that what we should be seeing in terms of trends of product extensions coming out of AOB?

Lily Li

(Interpreted). So, as you may understand and have an idea that now we are having the healthcare reform here in China. I think this is good news for AOBO. Actually, the policy lists are being reduced and also it's very good news for us in terms of the drug approval, and we certainly need a well regulated environment for the whole sector.

Julie Chen - CRT Capital Group

Thank you. My last question is just on overall strategy which also tightening to your first quarter results. Is there an overall the anticipation on the new pharmaceuticals as AOB continues to move on as a big top five pharma company in China?

Lily Li

(Interpreted). As you may know, Julie, and also other investors, I believe that the healthcare market here in China is indeed one of the most important highlighted spot in the whole world. And it is estimated that by the year 2010 China's healthcare market will be the fifth largest market in whole world and, by the year 2020, it will be the third largest market. So it is a very good timing for us to further pursue the strategy of being the top pharmaceutical company in China, and we will focus on the execution of such a strategy.

Julie Chen - CRT Capital Group

Thank you very, very much.

Lily Li

Thank you, Julie.

Operator

(Operator Instructions). Your next question comes from the line of [Catherine Liu] with Oppenheimer. Please proceed.

Catherine Liu - Oppenheimer

Hello, good morning. Thank you for taking my questions. I'd to like to follow up on your acquisition strategy. Lily, you talked about scale is very important for company's long-term growth. I am just wondering what is AOB's competitive advantage in entering Western drug areas?

And also, going forward, I would imagine would be very selective in your acquisition target selections. What will be the criterias you're going to use in terms of chemical drug acquisitions?

Lily Li

(Interpreted). So, I think it is a very good question. And I should say that we are, indeed, very proud of our competitive advantages, which have been accumulated over more than the last 10 years. We have very good brand recognition and we have very stable customer bases, and we have very good manufacturing facilities which comply with the GNP requirements here in China. And we have very good distribution team and network. And all those can guarantee that we can enter into the non-plant based pharmaceutical sector very quickly. And what is unique with AOBO is our capability in terms of integrating the acquired companies.

So I think that all these competitive advantages ensure that we can enter into the non-plant based pharmaceutical product areas, as well as the Western medicine areas. And also it ensures that we can further pursue our strategy of being one of the top pharmaceutical companies in China.

Catherine Liu - Oppenheimer

Thank you. And also, for China Aoxing investment, you shifted from your past acquisition style to strategic investment. I am wondering if we're going to see more strategic investment going forward. And through strategic investment, how would you be able to influence the business operation of those investments? And how are you going to help them to grow their profit?

Lily Li

(Interpreted). Yes, indeed, you are very correct in saying that we have shifted a little bit from our 100% acquisition of the [top three company] to the current strategic alliance with China Aoxing. And I think that this is, indeed, one of the trends you can see in the future of our investment. Actually, China Aoxing is a listed company, and AOBO will not be allowed to acquire China Aoxing according to the regulations. So I think that we have complementarities in terms of the competitive advantages with China Aoxing and, therefore, we can have collaboration with each other.

I think in the future the AOBO certainly will have diverse forms of investments. According to the requirements of AOBO, we certainly will have different forms of guidance for the performance and operations of the partners. For example, for China Aoxing, we are very focused on the R&D capabilities of China Aoxing. And we focus on the pipeline of their products. For some other companies, probably we certainly will pay great attention to the brand recognition or some specific capabilities.

So I think that in the near future you certainly can expect the diverse forms of investments, as well as the different collaborations with our partners.

Catherine Liu - Oppenheimer

Thank you. My last question is from guidance. Your sales guidance is very strong. Does this number include any future acquisition revenues? And also, what is the driving force for the sales growth this year? Should we be thinking about any new product launches or any price increases, or is there any additional revenues through your recent investment in China Aoxing?

Wilfred Chow

I would like to say that our guidance for our 2008 full year financial guidance of $245 million revenue does not include any potential acquisitions, and we include a reasonable amount of new product launch on our product guidance. And the growth of the company, as measured in our press release and earlier by Lily, is going to come from our organic growth. And we also see very successful integration from CCXA and Boke.

Catherine Liu - Oppenheimer

Okay, great. Thank you very much.

Lily Li

Thank you.

Operator

Your next question comes from the line of [Hongbo Liu] with Piper Jaffray. Please proceed.

Hongbo Liu - Piper Jaffray

Thank you. Good morning, good evening. Actually, I have a question just to quickly follow Julie's question on the guidance. The $245 million, does that include any revenue contribution from China Aoxing?

Wilfred Chow

Our equity investment in Aoxing is currently at 38%. Our [planned equipment] for Aoxing investment is going to be based on equity accounting. And the equity accounting will not take up revenue on the top line. We are going to pick up a percentage share of their net income of net losses as investment income. And that is going to be underneath the operating income line.

Hongbo Liu - Piper Jaffray

Thank you, Wilfred. I have two more additional questions, if I may.

Secondly, can you elaborate on your current prescription or hospital-based sales force? How many are there, and where are their focuses; in a rural area or larger hospitals? The reason I ask this is if you were going to enter chemical drug market, especially those high margin product categories, coastal areas and large hospitals are primary targets, I would assume. So do you think you would need to grow your sales force, and how would you do that?

Lily Li

(Interpreted). So currently, as you can see, AOBO has around 2,300 professionals in terms of distribution teams. And they are located in the large cities as well as in rural areas, and they focus mainly on the OTC market. And, as for the hospital, we certainly have pretty good advantages in terms of our channels for the hospitals.

In order to enter into the high-end market, the high-margin market, we need to enter the top level hospitals. We will pursue different strategies and we certainly will further enhance our capabilities in terms of the distribution channels for the hospitals.

Hongbo Liu - Piper Jaffray

Thank you, Lily. And, if I may, probably just to end a nitty-gritty question on the expenses line. I noted, for advertising, your expenses actually went down compared to the fourth quarter of 2007. I am just curious, are you still running the TV ad campaign for Boke and Jinji Series products?

Wilfred Chow

Yes, we are currently still doing advertising on Boke products. And I would also like to add in here, is of the percentage of advertising revenue as a percentage of total advertising cost, as a percentage of total revenue reduced in the first quarter 2008. This is mainly because of more a shift of advertising strategy by doing more direct sales and promotional activities. This is the fact that I think all the companies in China are facing with the Olympic coming 2008, the media advertising rates all increased.

Hongbo Liu - Piper Jaffray

Thank you.

Lily Li

Thank you.

Operator

(Operator Instructions). You have a question from the line of Shaumo Sadhukhan with Lotus Partners. Please proceed.

Shaumo Sadhukhan - Lotus Partners

I take your guidance for the year and I make some assumptions about Boke and CCXA. It seems like it will grow for the year on an organic basis, between 30% and 34%. Can you talk about how much of that you expect to come from prescription products, how much you expect to come from OTC products, and how much you expect to come from new products that you might introduce during the year?

Wilfred Chow

I would like to encourage our investors to focus on our overall total growth year-over-year; it's over 50%. And the growth again is going to come from organic growth as well as contributions from the newly acquired businesses, Boke and CCXA.

And currently, we are not able to provide further detail regarding how much our growth is going to come from each of the business segments. That is because the market is changing very fast and we also have a reasonable amount of new products we've be launching into the market. But I would like to have all the investors to concentrate on the overall growth.

Shaumo Sadhukhan - Lotus Partners

Okay. Can you talk about in terms of the CAXG acquisition, what the time frame is for more aggressive rollout of Tilidine and some of these other narcotics products that CAXG sell? When do you expect that to happen?

Wilfred Chow

We currently own approximately 38% of China Aoxing and we have significant influences of that company. But China Aoxing is currently a publicly listed company and it's not in my position here right now to give more detail about the product launch of the company.

Shaumo Sadhukhan - Lotus Partners

Okay, that's all. Thank you. I appreciate it.

Lily Li

Okay, thank you.

Operator

Ladies and gentlemen, at this time we do not have any more questions in the queue. And I would like to turn the call back over to management for closing remarks.

Lily Li

Okay, thank you everyone for participating in this call. We are looking forward to talking to you in next quarter's conference call. Thank you, everyone.

Wilfred Chow

Thank you.

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