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WuXi PharmaTech (Cayman) Inc. (NYSE:WX)

Q2 2008 Earnings Call Transcript

August 14, 2008 8:00 am ET

Executives

Hai Mi – VP of IR

Ge Li – Chairman and CEO

Benson Tsang – CFO

Edward Hu – COO

Analysts

Bin Li – Morgan Stanley

Hongbo Lu – Piper Jaffray

Jinsong Du – Credit Suisse

Charles Rhyee – Oppenheimer

Andrew Weinberger – Galleon

Tycho Peterson – JP Morgan

Jodie Wehner – Global Hunter Securities

Shaojing Tong – Merrill Lynch

Tim Evans – Jefferies & Company

Nam Park – HSBC

Noah Yosha – South Core [ph]

Janet Sun – UBS

Operator

Good day everyone and welcome to WuXi PharmaTech’s second quarter 2008 results conference call. This call is being recorded. For opening remarks, I would now like to turn the conference over to Dr. Hai Mi, Vice President of Corporate Communications. Dr. Mi, please go ahead, sir.

Hai Mi

Thank you, operator. Good morning, and for some of you, good evening. Thank you for joining us for WuXi PharmaTech’s second quarter 2008 results conference call. Joining the call today are our chairman and CEO, Dr. Ge Li; our CFO, Mr. Benson Tsang; and Mr. Edward Hu, our COO. This conference call is also being broadcast on the Internet and is available through the investor relations section of the company website. We have provided a summarized presentation that may be downloaded from our website, and which we will refer to during the course of the call.

Before the management's presentation, I would like to refer to the Safe Harbor statement in connection with today's conference call and our earnings press release. During the course of this conference call we may make forward-looking statements, statements that are not historical facts, including statements about our future expectations, plans and prospects. Forward-looking statements involve inherent risks and uncertainties, and a number of important factors could cause the results to differ materially from those contained in any forward-looking statements. Further information regarding these and other risks are included in our filings with the SEC. Additionally, we will be discussing non-GAAP financials during this call. We believe these non-GAAP numbers help investors to better understand our core operating results and future prospects, consistent with the manner in which management measures and forecasts the company's performance. These non-GAAP numbers exclude share-based compensation, amortization of acquired intangible assets, and the deferred tax impact of acquired intangible assets. Investors should refer to the reconciliation of non-GAAP measures to GAAP measures for the indicated period attached to our Q2 earnings release that can be found in the investor relations section of the company website. Following management's prepared remarks, we'll open the lines for a brief Q&A session. With that, I'd like to turn the call over to our chairman and CEO, Dr. Ge Li.

Ge Li

Thank you, Hai, and good morning and good evening everyone. I will start my comments on slide four, which illustrates the financial highlights of the second quarter of 2008. Benson will go into details later. I will first comment on non-GAAP numbers as a reflection of our operating performance. In the second quarter, we delivered net revenue of $70.8 million, an increase of 134%, compared to the second quarter of 2007. Our core lab services business delivered an 80% increase to $45.2 million, and the research and manufacturing recorded a 400% increase to $25.6 million compared to the second quarter of 2007. Compared to the second quarter of 2007, our non-GAAP operating income increased 90% to $17 million, and the non-GAAP net income increased 81% to $15.5 million. And our non-GAAP diluted earnings per ADS were $0.21 for the second quarter of 2008. This result indicates the strength of our integrated service model and the global service platform.

Slide five, please. Slide five details our lab services business, which continues to demonstrate a strong trajectory. We have expanded a new three-year collaboration agreement with AstraZeneca to further expand AstraZeneca's global compound collection. Additionally, our vision of serving customers that fit their current outsourcing business model continues. Our FTE-based and fee-for-service programs are increasing, and we have enabled additional capacity for expansion of five existing FTE-based contracts, as well as established four new ones. Our animal [ph] facility expansion in St. Paul completed in late June and started providing more parts of [ph] services for both medical device and small molecule safety testing.

We believe our ability to offer integrated services will catalyze continued penetration of our core customers, and also lead to addition of new customers. We have undergone further integration with discovery biology, toxicology and other services. We have begun to promote this integrated R&D solution to our clients, and as a result, we have already signed a broad multi-year integrated discovery and development program for a big pharma. Also, our broadening capabilities have resulted in the signing of eight new medchem programs, which require more knowledge and skills than routine synthetic chemistry products. With this, we are realizing our vision of providing world-class capabilities to customers with unparalleled capacity to improve the success of research and shorten the development time.

Slide six please. As an integral part of our integrated service platform, our small molecule manufacturing service continued to grow, and we'll reap the benefits of the research driven model and the integrated capabilities. As our research customers become manufacturing customers, we too will move along to be awarded with large manufacturing contracts. I'm very pleased to tell you that we have already signed a commercial-scale manufacturing contract with a major biopharma company that began as a customer of WuXi lab services a few years ago.

We believe the biological manufacturing business at its core is very attractive, and we remain firm on the fundamentals of our acquisition of AppTec. We plan to leverage knowledge, know-how we obtained through our acquisitions to replicate our capabilities in biologics, manufacturing, and the process development service in China. Our biological manufacturing business was affected by product delays during the quarter. The majority of our biological customers are small biotech companies. The issues like cell line performance and funding flexibility in the current tightening [ph] financing environment caused the delay. As such, we have started to establish in-house cell line development capabilities to de-risk future cell line performance issues. My colleague, Ed Hu, will give you more details. We've also started to cross sell our biologics capabilities to big pharma clients.

Our manufacturing service overall experienced lumpiness during the quarter, as a key point of differentiation from our established commercial manufacturing service providers. Our manufacturing service division is a very much research driven, flexible, and small scale in nature, and we are sensitive to contract laws and the nature of the projects we undertake.

Our mix of stage and types of contracts often makes our quarter-on-quarter performance fluctuate. On this slide, we take a long term view of our research and manufacturing model of both small molecules and the biologics will yield future commercial manufacturing contracts, and as an important part of our integrated service offerings to shorten the development time for the customers.

Turning to slide seven, we received a number of awards and recognitions during the second quarter of 2008. First, we were named as one of the top 20 most innovative enterprises in China. We're also pleased to be the recipient of the Frost & Sullivan award for best in class outsourced R&D in pharmaceuticals and biotechnology. The award recognized WuXi for our exceptional leverage of China's advantage, high tech expertise, and world-class management, robust and expanding service portfolio, adherence to strict quality control, and a commitment to intellectual property rights protection. Our customers confirm this confidence in us with three customers giving us the acknowledgment, including (inaudible).

I would like to add that in order to further strengthen our management team, we have hired and identified four experienced industry veterans to lead our HR, business development, medicinal chemistry and strategy.

Finally, we continue to execute our growth plans. In the quarter, we announced an MOU to form a joint venture with Covance to provide world-class pre-clinical services from the Suzhou facility currently under construction. We are actively working to reach final agreement with Covance on the terms of this joint venture.

Now I would like to turn over to our COO, Ed Hu, to share with you progress on the integration. Ed, please.

Edward Hu

Thank you, Dr. Li. Since we closed acquisition of AppTec, we are making headway in our integration efforts. Please turn to slide eight. We have seen continued growth and the expansion of our customer bases. And we have signed a first small molecule toxicological study as a result of the integration. As part of the integration, we are leveraging WuXi's relationship to penetrate larger pharmaceutical companies with biologic drug development services. This enables us to reach a different set of customers with our biologics capability. Traditionally, AppTec focuses on biopharmas business development with small biotech companies. Going forward, by leveraging WuXi's relationship with big pharmas, we are working on establish long term collaborations with big pharma customers to provide integrated cell line, process development and early stage clinical manufacturing services, including a full spectrum of biosafety testing services.

In the second quarter, we won two commercial biological large release testing contracts with two big WuXi customers of big pharmas, and we are in active discussion with several others. Importantly, we are also leveraging our US capability in biologics and medical device to build this service capability in China. For example, we are building a new molecular biology lab in Shanghai with support from our Philadelphia colleagues. And we are planning to build a microbiology and packaging testing laboratory in China to provide service for the medical device industry that our customers came to us for. That is in addition to the cell line capability that is being built in China, as Dr. Li mentioned briefly.

We have strengthened the leadership in our Philadelphia site with the appointment of Dr. Garry Takle. He is going to head the Philadelphia site operations. And then Dr. Joseph Hughes, he is the VP of biological testing. Dr. Takle and Dr. Hughes will jointly manage our biological manufacturing and testing business. They will also play an important role to transfer the biological capability to China. We have also underway consolidation of sourcing and logistics, as well as implementation of a global IT system that will enable us to operate more efficiently and serve our customers better. I'm also very glad to say that the cross training has begun in our global sites, so that will continue to build our world-class workforce globally.

Now I would like to turn back the conference to Dr. Li.

Ge Li

Thanks, Ed. On slide ten and 11 we continue to see a global consolidation as well as the continued trend in global outsourcing, the dynamics of the growing pace of biologics, the large number of important new medicines in the pipeline. Despite recent news about pharma acquiring biopharma, also indicates the increasing importance of biologics.

Turning to slide 12, I will quickly comment on the industry trends that continue to favor WuXi's integrated service business model. Global pharma, biotech and the medical device companies, R&D spending continues to grow. Outsourced R&D volume continues to increase at a high rate. Customers increasingly take sophisticated and integrated end-to-end outsourcing solution providers, increasing the importance of biologics in pipeline and the product portfolio, increasing demand for biosafety testing services. Again, given this favorable trend, we remain firm on our AppTec acquisition and our build strategy that we'll become a global fully integrated service provider, and continue to invest for the future.

Slide 13 reiterates our goal shared with you before, which is to provide fully integrated pharmaceutical and medical device R&D services with world-class capabilities and unparalleled capacity. As we expanded our service offerings and developed a full cycle R&D services and increase our capability and capacity for research, we will surely continue to establish long-term partnerships with all of our customers. Now Benson will give you more color on our financial performance. Benson, please.

Benson Tsang

Thank you, Dr. Li. Good morning and good evening everyone, and welcome again to our Q2 results conference call. Dr. Li has shared with you some of the financial highlights on slide 15, and I would like to drill into this with a description of our top line performance and session reviews.

As mentioned in our earnings release, despite a softening global economy, the global trend in R&D outsourcing continued to propel our business, enabling us to achieve revenue growth of greater than 100% from that of Q2 2007. Net revenues from laboratory services increased 80% to $45.2 million. Net revenue from manufacturing services increased approximately 400% to approximately $25 million.

To get a better sense of our underlying performance in the service lines, on slide 16 we illustrate a breakdown of our group results. As you can see from the slide, both our business segments maintained a growth momentum as compared to the corresponding period in 2007 and the immediately prior quarter. We anticipate lumpiness in our manufacturing segment, but are still optimistic on the growth momentum of the company overall in the remaining quarters of 2008.

Please turn to slide 17. Our integrated services platform and commitment to providing top-quality customer service has allowed us to further deepen our collaboration efforts with our top ten customers. At the same time, the diversification of our customer base to other customers represent future opportunity for sustained growth as these customers take on other services.

Now please turn to slide 18. As Dr. Li mentioned earlier in the call, we believe our non-GAAP data reflects better our underlying performance. As shown in the slide, there are two non-cash items, which impact our Q2 results. One is the share-based compensation charge, which have been consistently excluded in our non-GAAP data. Second one is the amortization of acquired intangible assets resulting from the AppTec acquisition. On a non-GAAP basis we achieved a gross profit of approximately $29 million representing a gross margin of about 40%.

In the appendix, we have provided the historical quarterly non-GAAP data starting Q1 2007 for your information. On the margin, on a non-GAAP basis, we achieve 40% in Q2 2008 as compared to 45% in Q1 2008. Our margin for laboratory segment remains relatively stable at about 50%, despite of the salary increase and appreciating R&D. This is a result of mainly our staff productivity and material deficiency. For the manufacturing segment the margin drops to 24% from 31% in Q1 2008. This is because of the mix of small molecule projects and the related R&D costs invested in these projects for the future profits, and an increase of revenue mix from biologics manufacturing.

For our biologics service, as we mentioned earlier in the call, despite the improvement on our facility utilization, our revenue is still behind the budget due to the cell line quality issue, and our client funding challenge. Going forward, we expect our laboratory segment to remain stable and the margin should be in the range of 45% to 50% in the remaining two quarters of 2008.

For our manufacturing segment, we are a research- based service provider. We anticipate our revenue will remain lumpy and our margin may vary according to the small molecule project mix. As to our biologics manufacturing, we expect the contributions to both the revenue and margin will continue to improve in the remaining quarters of 2008.

I want to draw your attention to the appendices. We have provided summary of our applicable tax rates, share count information, summary of our foreign exchange gain and loss, and also an example how we actually arrive at the mark-to-market following contract gains and loss. We believe these are useful information for your reference.

Finally, our guidance is described on slide 18. Given our update to you today, we will maintain 2008 full-year net revenue guidance in the range of $280 million to $300 million.

Now I would like to turn back to Dr. Li to close.

Ge Li

Thanks, Benson. In closing, I want to let everyone know that we feel stronger than ever about our build model, which is to continue to build capacity and the capability to provide fully integrated services to help our partners to improve the success of discovery and the shortened development time. We have the right state of business service, and our customers will benefit from quality, time saving and cost. As we continue to execute on quality R&D services, our growing customer base and operational streamlining, we are confident that we will continue to capitalize on outsourcing trends for the coming years.

Hai Mi

Now we'd like to open the line for questions.

Question-and-Answer Session

Operator

(Operator instructions) We'll first hear from Bin Li, Morgan Stanley.

Bin Li – Morgan Stanley

Hi, thanks. Good evening, everyone. Just want to ask a question actually a question on the gross margins. And you mentioned, Benson, in your opening remarks that the margin – some of the reasons for the margins. I want to drill down a little bit. If you could comment on the gross margin for your AppleTec business and for your WuXi standalone business compared to the past quarters, and that will be the first part of my question. Also, the second part of my question is, according to your slide 18, like you said, you have gross margin for lab service was about 50%, and the manufacturing margin was about 24%. What was the comparable number last quarter, and can you comment on the moving parts we need to understand in order for us to consider the margins going forward?

Benson Tsang

As we showed you in our financial reporting in the earnings release, we actually run the company by business segment. So we don't really run like WuXi China, or AppTec US. We mainly run the business by laboratory segment and the manufacturing segment. As I shared earlier in the call, the growth momentum for both segments are good. And regarding to margin that on a non-GAAP basis, we are comfortable going forward in the next two quarters we'll maintain 40% to 50%. And back to your question regarding the margin for the AppTec. Right now the AppTec business will actually brining into for the laboratory, mainly the safety evaluation testing business and also the medical device business. Some of you may have seen in the 2007 historical financials of AppTec the margins were 38%, and currently the margins we achieved for those services are in line with the historical figure.

Operator

Thank you. (Operator instructions) We'll now hear from Hongbo Lu, Piper Jaffray.

Hongbo Lu – Piper Jaffray

Thank you. Good evening and good morning. I probably will follow up on Bin's question on the biologics AppTec manufacturing side, so drill down a little bit as well. This quarter did you actually break even for the biologics manufacturing?

Ge Li

Ed, do you want to take this question?

Edward Hu

As Benson said, we really don't run the business by geographic sites, we run on a global basis. And, as we indicated before, we do experience a lower utilization in the first half of 2008 and – but as the revenues ramping up, we definitely will see margin improvements going forward.

Operator

We'll now hear from Jinsong Du, Credit Suisse.

Jinsong Du – Credit Suisse

Hi. There are a lot of new contracts and new projects you guys just signed in the second quarter. Could you give us a little bit more detail? Like, for example, for the broad integrated services contracts with a major pharma, could you elaborate? And how broad like you know, what kind of services that they include. And also the commercial manufacturing contract with a major biopharma is this contract a natural extension from the phase II, phase III manufacturing contract, you know, existing contract extended to commercial. Things like that, could you elaborate a little bit? Thank you.

Ge Li

Hi, Jinsong. Thanks for asking the questions. To comment on the broad integrated service agreement with big pharma, we can talk about a lot of details, but basically this broad services contract will cover from discovery and all the way to development. And namely to cover discovery chemistry and development and some tough work at CMPK [ph] and the formulation. And also product research and API manufacturing.

Operator

We'll now hear from Charles Rhyee, Oppenheimer.

Charles Rhyee – Oppenheimer

Hi, thanks for taking my questions. Just a couple of quick ones here. First, a follow-up on that last question. Is that to say that this contract is – does that mean that you have two commercial manufacturing contracts or is this just one? And then secondly, more on the manufacturing again. Can you give us a sense – you talked about the mix shift in the small molecule manufacturing. When we look at the gross margin decline in the quarter, can you give us a sense of how much is really just from higher revenues in AppTec, and how much of it was the mix shift on the small molecule? And can you give us a sense of how that will trend? And also an update on the Jinshan facility, is that still – when is that expected to open? Are we still looking at a 4Q launch – a 4Q opening? And then, Benson, just one thing on the taxes. The annual benefit, I saw in the appendix it looks like you'll get $11.4 million, but you talked about a limit per year. Can you give us a sense of how much – sort of when you expect that to run out? Thanks.

Ge Li

On the commercial manufacturing contract, we have been working with these customers since a number of years ago starting from lab service. And to comment on the project mix, and on small molecule side, again in the script, we talk about we are research based, a research manufacturing service provider, and the margin will depend on the product inflows.

Operator

We'll now hear from Andrew Weinberger, Galleon.

Andrew Weinberger – Galleon

Yes, hi guys. A couple of quick questions. One is on your revenue guidance that you're maintaining for the year, it seems like first half year revenue is sort of a little below what I was expecting. What is sort of the key variables between – is it still feasible to hit the high end of the range? And what are the key variables between sort of the high and the mid point and the low end of the revenue range?

Benson Tsang

This is Benson. We acknowledge actually there are business and operational risks there. But given our operational experience gained in the past seven to eight years, we are comfortable to achieve our full year revenue within the guidance range. Sorry, I just want to get back to you Charles. I think there was a question about the tax. I think for the tax, I think many of you may have seen the earning release. You see a pretty big credit. Let me just take this chance to give some clarity to that. Included in the 3 – approximately $3 million credit in Q2 2008, we have a deferred tax credit of about $2.3 million resulting from the acquired intangible asset of AppTec. We have actually identified that in the earning release. The remaining, approximately about $0.8 million credit is actually a mixture of tax expenses we actually incur in our PRC operating subsidiaries, and other benefits arising from different things – many different things. That includes mark-to-market, foreign currency, forward contract loss, the tax allowance in accounting depreciation on equipment and other assets, the famous FIN 48 and FIN 18 US GAAP adjustment and assessment. And due to the net loss carry forward in our AppTec, there is no tax incurred in our US operations. Next question, please.

Operator

We'll now hear from Tycho Peterson, JP Morgan.

Tycho Peterson – JP Morgan

Hi, thanks for taking the call. In the prepared comments, you talked a little bit about the in-house cell line capabilities. Can you just give us a sense as to how big an opportunity this could be? And it sounds like maybe there are some near term challenges with the cell lines. Can you just kind of clarify what the comments were around that?

Edward Hu

Tycho, this is Ed. I'll take this question. So what have we seen is that many of the small biotech companies, they essentially try to go cheaper. So they went to those cell line development companies who did not provide quality cell lines. And that caused delays in actually scale up and manufacturing. So we feel it's very important to have the cell line development capability as part of our integrated service offering and, therefore, we went ahead and we are in the process of setting up a lab in China right now, and hired a world expert in the cell line development to heading this effort. So we expect to bear some fruits next year when our customer cell line development project yields benefits.

Operator

We now hear from Jodie Wehner, Global Hunter Securities.

Jodie Wehner – Global Hunter Securities

Yes, hi everyone. Thank you for taking the call. My question regarding the intangible asset and deferred tax; also the foreign exchange laws. I guess, Benson, how do we expect going forward, how do we estimate this? How much is one-time, how much we have to carry forward?

Benson Tsang

For the deferred tax, unfortunately, I have to admit to the team here, it's a very complex US issue, and we need to make – the management need to make a lot of management estimates in order to arrive to the deferred tax. It's very difficult for the company to provide clear guidance on the deferred tax. What we have been trying to do in the appendix, we actually provide the two tax summary table. One is actually sharing with the market the applicable PRC tax rate to our PRC operation subsidiaries. As you can see in the appendix, applicable to our PRC subsidiaries is about 9% to 11%. As for our US operations, as we have losses carried forward of approximately $29 million, and about $14 million will be applicable to our 2008, and so we do not expect we'll have any US tax payable in 2008. And the remaining $15 million is actually available for the future profitable year. And then regarding your question also on the mark-to-market, I also included in the appendix actually two slides. One is actually showing to the market how we actually come up with this figure on a quarterly basis. We also use a little example at the very last page to demonstrate the determination of this accounting loss and realized loss is really subject to the future fall back [ph] rates of US dollars against renminbi, which is something the company is not in a position to anticipate what will be the direction. Going forward this could be a gain and could be a loss. That's why we just want to highlight in this time to the analysts, to the investor, and you can have a fair assessment on those items.

Operator

And I'd like to remind our audience to please limit themselves to one question and one follow-up question. We'll now hear from Shaojing Tong, Merrill Lynch.

Shaojing Tong – Merrill Lynch

Hi, and thanks for taking my question. I just have one quick question. I just want you to confirm that you did say that the lab service revenue for the remaining two quarters of the year will be stable, that meaning flat. Is that true?

Benson Tsang

No, my comment on the revenue is actually on the gross margin. We anticipate for the remaining two quarters the margin will be in the range of 45% to 50%.

Shaojing Tong – Merrill Lynch

Okay, thank you.

Benson Tsang

You're welcome.

Operator

We'll now hear from Tim Evans, Jefferies & Company.

Tim Evans – Jefferies & Company

Hi, this is on behalf of senior analyst, David Windley. I just wanted to get a little bit of clarification on organic growth. Did you either give organic growth rates in each of the segments, or if you prefer, talk about the relative revenue contribution of AppTec to each segment?

Ge Li

Well, I think we've already gave the numbers under our two segments, lab service and research and manufacturing.

Operator

We'll now hear from follow-up, Bin Li, Morgan Stanley.

Bin Li – Morgan Stanley

Yes, thanks for taking my follow-up questions. I'd like to come back to the non-GAAP margin for the manufacturing services for the second quarter, which was 24%, and what was the comparable figure for 1Q? And also my understanding is this is a decline from one quarter. Now this decline, is it due to – excuse me, a decline in the AppleTec business or a decline in the – in your WuXi facility, or a little bit of both, or some other reasons?

Benson Tsang

Bin, this is Benson. For the manufacturing business, as we indicated earlier, the revenue growth on a quarter-on-quarter basis is actually very strong. The decline in the margin, as I mentioned earlier is, one, is due to the mix of the revenue meaning contribution from the chemistry and the biologics. And for the biologics, the – as I mentioned earlier, right now the current run rate is actually behind the budget. But going forward we anticipate the utilization will start to pick up, and we expect the margin will continue to improve for the next two quarters. And you also mentioned about in Q1 about the revenue figure. As we reported earlier, the Q1 manufacturing revenue is $18.6 million and the Q2, the revenue figure for manufacturing is $25.6 million. So I think in terms of the nature of the manufacturing segment we remain the same, and I think the difference is mainly because of the mix and the shortfall as we can see temporarily from our biologics manufacturing.

Operator

And we'll take our follow-up question from Jinsong Du, Credit Suisse.

Jinsong Du – Credit Suisse

Hi, thank you. I just want to understand more about the hedging effect. I understand, Benson, you have a slide showing the renminbi full contract translation. But going forward – for example in '09 what will be your method to hedging the renminbi appreciation, and what will be the impact probably?

Benson Tsang

As I shared in previous earning calls, the company started to evaluate different methods. We tried to reduce the US dollar against RMB exposure. Under the different alternatives the company evaluates, we are yet to decide which on is the best, because in fact there are not that many available in China, and there are many creative products outside. But unfortunately, the one very attractive also is the one creating a lot of accounting issues. So currently, the company still believes the best approach as of today is still the foreign exchange forward contract. And going forward to 2009, until the company finds the best alternate hedging product, the company will probably take the same approach; enter into forward, currency forward contracts to reduce our US dollar against RMB exposure.

Operator

We'll take a follow-up question from Charles Rhyee, Oppenheimer.

Charles Rhyee – Oppenheimer

Thanks. I just wanted to get a clarification on the NOLs, Benson, thanks for the clarifications you gave, but I also want to know what – you mentioned in the slide that there's a limit to the annual – how much you can recognize in any given year, and where you see AppTec at this point. How long do you think that will take to recognize?

Benson Tsang

Charles, I think for the losses carried forward, essentially there is a limitation on the annual dollar value, but a full $29 million, there will be no restriction. The company will have – like whatever years we need to actually realize the losses carry forward benefits.

Operator

Hongbo Lu, Piper Jaffray; follow-up.

Hongbo Lu – Piper Jaffray

On the small molecule manufacturing, we understand the lumpiness of the nature of the business; therefore, the margin. This quarter my estimate for the small molecule manufacturing is probably around low or mid thirties, and historically we have been doing as well as 68%. So I just want to get a sense going forward if this is the range that we should think for small molecule manufacturing, or you can get much better or much worse?

Benson Tsang

For the manufacturing segment, I think Dr. Li mentioned earlier, the way we see our manufacturing segment is actually an integral part of our service platform. So in the company when we looked at the manufacturing segment, we looked at it as one group rather than separate business units. I think in terms of the overall margin, as we've shown in the Q1 financials, currently we achieved 24%, and we do expect that biologic will continue to improve in utilization, and thereby will also improve the margins.

Ge Li

And Hongbo Lu, an add-on, we believe in our research manufacturing model. Near term, we may see fluctuations because of the product inflows, the product mix, but long term the model will improve for sure.

Operator

Another follow-up, Andrew Weinberger, Galleon.

Andrew Weinberger – Galleon

Yes, hi. I just wanted to also figure out just, you mentioned I guess 17% tax rate as you go through the tables and add them add them all together as what you guys comfortable long term. Is that still the case? I'm trying to reconcile these tables and come out. You've all these subsidiaries; I'm trying to figure out what type of tax rate we should be using for 2009 because this 2008 tax rate is a bit confusing?

Benson Tsang

This is Benson. I think the tax rate 17% you refer to probably is from our previous quarter, and as you can see in the appendix, we actually show two tax summary tables, and as you know, because we do operate our different business units through a legal entity. So from that perspective we are subject to PRC and US tax. For the PRC as we indicated in the appendix, based on the revenue mix generated from different subsidiaries, we expect for the PRC entity, the revenue or the profit generated from those subs we expect the rate will be 9% to 11%. And for the US, and based on the losses carried forward we have, we do not believe we'll have any taxes payable in 2008. And based on the current forecast, only probably a portion of our 2009 profit generated from the US will be subject to tax.

Operator

We'll take a follow-up from Jinsong Du, Credit Suisse.

Jinsong Du – Credit Suisse

Yes just on the Jinshan expansion, Benson could you give us an update on the timeline and in terms of when you'll come online and in what kind of schedule, because that actually is a key factor for the manufacturing utilization rate?

Benson Tsang

I think for the Jinshan, the current facility we're basically running near capacity. And for our new facility, according to our current plan, we plan to start the testing in December 2008. And in Q1 2009, we probably will open approximately 10% of the new facility for production. And depending on the running and the production schedule, we shall open the remaining facility by stages over the remaining of 2009.

Operator

We will have time –.

Ge Li

And, Jinsong let me add a couple of points, because I'm sure you know we built this facility for a reason. It is open to meet the demand from customers.

Operator

And we'll have time for three more additional questions, Nam Park, HSBC.

Nam Park – HSBC

Hello, thank you for taking the question. I have just one quick question. Can you just clarify for us your amortization policy for the AppTec goodwill and the impact of the upcoming SFAS 141R, if any, on the company's numbers? Thank you.

Benson Tsang

Yes, on the amortization of the acquired intangibles, the total intangible assets according to the professional evaluation, it is actually about $46 million, or rounding $47 million. Within that intangible asset, there are many – three categories. One is the customer list, and one is the customer backlog, and then there is also another pool customer list on a general basis. The amortization policy is four, three and two years, and the total amount to be amortized in 2008, it will be approximately about $14 million, and in 2009 it will be approximately about $15 million, and in 2010 and it will be about approximately $10 million. And the remaining will be in 2011.

Operator

Noah Yosha, South Core [ph], has our next question.

Noah Yosha – South Core

Hi, is AppTec making money now?

Ge Li

Yes, definitely.

Noah Yosha – South Core

And how profitable is it on the EBIT line or on cash flow?

Ge Li

On the lab service we are in line with last year, and manufacturing, obviously, we're probably less than last year.

Operator

And we'll take our final question, Janet Sun, UBS.

Janet Sun – UBS

Hello everyone, good evening. I have one question for Dr. Li regarding the collaboration with Covance. How do you think about the potential competition between the JV and Covance's US business?

Ge Li

Well, actually, due to the agreement with our partners, and we can't really share much details before the definitive agreement is signed. I'm sorry for that.

Operator

And that is all the time we have for questions today. Dr. Li, I'll turn the conference back over to you for any closing or additional remarks sir.

Ge Li

Thank you, operator, and I would like to thank everyone for their questions and comments today. If you have more questions throughout the quarter, feel free to give me a call, and I look forward to seeing you on the road during the third quarter. Good night.

Operator

And that concludes today's conference. We do appreciate your participation. Have a great day and evening.

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Source: WuXi PharmaTech (Cayman) Inc. Q2 2008 Earnings Call Transcript
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