China Biologic Products' (CBPO) CEO David Gao on Q2 2017 Results - Earnings Call Transcript

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China Biologic Products, Inc. (NASDAQ:CBPO) Q2 2017 Earnings Conference Call August 3, 2017 7:30 AM ET


Bill Zima - IR, ICR

David Gao - Chairman & CEO

Ming Yin - SVP

Ming Yang - CFO


Jack Hu - Deutsche Bank

Lilian Wan - Bank of America Merrill Lynch

Iris Wang - Credit Suisse

Yolanda Hu - Morgan Stanley


Welcome to the China Biologic Products Holdings Second Quarter 2017 Earnings Conference Call. For the first part of this call, all participants will be in a listen-only mode and afterwards there will be a question-and-answer session. Today's conference is being recorded.

At this time, I would like to turn the call over to Mr. Bill Zima at ICR for opening remarks and introductions. Please go ahead, sir.

Bill Zima

Thank you, Operator. Hello everyone, and thank you for joining us on today's call. China Biologic Products Holdings announced its quarterly financial results on August 2 after the market closed and earnings release is now available on the company's website.

Today, you will hear from China Biologic Products Holdings' Chairman and CEO Mr. David Gao, who'll start off the call with a review of recent company developments, strategies, and basic operating results; followed by the company's Senior Vice President, Mr. Ming Yin, who will address financial results in more details. Chief Financial Officer of the company, Mr. Ming Yang, is also on the call and will be available during the Q&A session that follows the prepared remarks.

Before we proceed, I would like to remind you of our Safe Harbor statement. Our conference call may include forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Although we believe that the expectations reflected in our forward-looking statements are reasonable as of today, those statements are subject to risks and uncertainties that could cause the actual results to differ dramatically from those projected. There can be no assurance that those expectations will prove to be correct.

Information about the risks associated with investing in China Biologic Products Holdings is included in our filings with the Securities and Exchange Commission, which we encourage you to review before making an investment decision. The company does not assume any obligation to update any forward-looking statement as a result of new information, future events, changes in market conditions, or otherwise, except as required by law.

The company will also discuss non-GAAP measures, which are more thoroughly explained and reconciled to the most comparable measures reported under Generally Accepted Accounting Principles in the company's earnings release and filings with the SEC. You are reminded that such non-GAAP measures should not be viewed in isolation or as an alternative to the equivalent GAAP measure and that non-GAAP measures are not uniformly defined by all companies, including those in the biopharmaceutical industry.

Now with that said, I'm pleased to present Mr. David Gao, Chairman and CEO of the company. David, please go ahead.

David Gao

Thank you, Bill. Hello everyone, and welcome to China Biologics' second quarter 2017 conference call. During the second quarter, we experienced total sales growth of 3% in RMB terms or a decrease of 3% in U.S. dollar terms, along with non-GAAP adjusted net income growth of 15% in RMB terms or 9% in U.S. dollar terms.

Our growth was impacted by several factors, including government health reform measures limiting hospital purchasing power in the second quarter of 2017, including: the zero mark-up for drugs policy, and the greater control over the ratio of drug sales to total hospital revenue; intensified competition among distribution channels, as a result of faster than expected implementation of the two-invoice policy nationwide as well as higher albumin import volume; slower volume growth as we build-up our plasma inventory to prepare for the plant production suspension at our Shandong facility.

However, we experienced a number of developments in the second quarter, which supported our growth. We continued to benefit from solid hospital direct to sales coverage that provided us a stabilized pricing for our albumin and IVIG products as compared to the more competitive distributor channel.

Additionally, we have been actively exploring new sales channels and pursuing new strategic partners including new distributors in the retail pharmacy chains.

We were pleased to experience year-over-year improvement in gross margin and non-GAAP net margin in the second quarter of 2017. The improvement was attributable to several factors, including: greater concentration of products made from company collected plasma instead of higher cost of third-party plasma; strong sales volume growth from our higher margin hyper-immune products, and coagulation factor products; and greater financial contribution from our increased equity interest in Guizhou Taibang and non-controlling interest at Xi'an Huitian.

Additionally, we continue to move forward with our planned operational initiatives, including new facility construction. The timeline to launch our new Shandong facility remain unchanged. We have completed the fourth phase of production suspension at our facility to pursue the new facility stimulation test and the second phase of production suspension for trial operation remains on track.

We continue to expect completion of the GMP certificate inspection and the commencement of operations at the new sites by the end of this year. The cumulative production suspension between our existing and the new Shandong facility is still expected to total within three months.

With respect to our research and development initiatives, we expected to receive the final approval of Fibrinogen by CDFA in the third quarter and aim to generate the sales before the end of the year. We're making good progress for our new products like a Human Coagulation Factor IX for which we have initiated clinical trial. We believe these new products will further improve our plasma fractionation utilization and contribute to our sustainable financial growth over the long-term.

For the second half of 2017, we are expecting the implementation of certain government healthcare policies that could potentially result in positive impacts on our business, including broadened reimbursable indications in the higher reimbursable maximum for our major plasma products, once various revised provincial drug reimbursement lists are implemented. We also expect to improve the pricing in Shandong and Jiangsu at the conclusion of the tendering process.

We remain focused on completing our new plant construction, shortening our production shutdown time for GMP approval at our Shandong facility, maximizing market share within existing distribution channels, developing new strategy to expand our sales channels, successfully managing public tenders in various local markets to secure optimized pricing opportunities, further investing in our medical marketing platform to accelerate the sales volume for newly launched products, introducing promising products at clinical-stage to the market and exploring new business growth opportunities.

Finally, we reiterate our full-year financial forecast and believe we can enhance our total sales and operating efficiency to meet growing market demand in the quarters ahead.

This concludes my prepared remarks. I will now turn this call over to Ming Yin, our Senior Vice President, to review second quarter financial results. Ming, please go ahead.

Ming Yin

Thank you, David, and hello everyone. We are pleased with our growth in both gross margin and the net income during the second quarter of 2017. Now, allow me to walk you through key P&L items to provide more details on how we achieved this growth.

During the second quarter 2017, total sales increased by 2.5% in RMB terms or decreased by 2.3% in U.S. dollar terms to $89.3 million primarily attributable to sales increase in high premium products, mainly including human rabies immunoglobulin and human tetanus immunoglobulin, partially offset by decrease in sales of human albumin products and placenta polypeptide. During this quarter, human albumin and IVIG products remain the company's two largest sales contributors, accounting for 36.3% and 33.3% of total sales, respectively.

Sales volume of human albumin decreased by 7.4% in second quarter, 2017 while sales volume of IVIG remained stable. The average price for human albumin product decreased by 2.7% in RMB terms while the average price for IVIG products increased by 1.2% in RMB terms in the second quarter 2017.

Revenue from other immunoglobulin products increased by 54.9% in U.S. dollar terms, accounting for 14.2% of total sales in second quarter 2017 compared to 9% of total sales in the same quarter 2016, mainly due to a sales increase of human rabies immunoglobulin and the human tetanus immunoglobulin, which reflect our enhanced production volume in response to strong market demand in second quarter 2017 compared with the same period last year.

Revenue from other plasma products including Human Coagulation Factor VIII and human prothrombin complex concentrate, increased by 35.9% in U.S. dollar terms, representing approximately 5.9% of total sales in the second quarter 2017.

Revenue from placenta polypeptide products decreased by 11.1% in RMB terms or 15.6% in U.S. dollar terms, accounting for 10.3% of total sales in second quarter 2017.

Cost of sales was $30.1 million in second quarter 2017, down 4.4% from $31.5 million in the same quarter 2016. Cost of sales as a percentage of total sales was 33.7% compared to 34.4% in same quarter 2016. The decrease in cost of sales was mainly due to a greater sales proportion of higher margin hyper-immune products.

The gross profit decreased by 1.2% to $59.2 million in the second quarter 2017 from $59.9 million in the same quarter 2016. Gross margin increased slightly to 66.3% in the second quarter of this year from 65.6% in the same quarter 2016.

Selling expenses increased by 20% to $3.6 million in the second quarter 2017. As a percentage of total sales, selling expenses were 4%, primarily due to higher marketing and promotion costs related to certain hyper-immune products, coagulation factor products and placenta polypeptide products.

G&A expenses increased by 13.5% to $14.3 million in the second quarter 2017. The increase in general and administrative expenses was mainly due to a $3.4 million increase in share-based compensation expenses. We also had a one-time $1.2 million prepayment provision in second quarter of 2016. Excluding the impact of share-based compensation expenses, G&A expenses would have been 6.9% and 8.6% as a percentage of total sales in the second quarter of 2017 and 2016, respectively.

R&D expenses increased to $1.9 million in second quarter of 2017 from $1.3 million in the same quarter of 2016. As a percentage of total sales, R&D expenses were 2.2% and 1.4% in second quarter 2017 and 2016 respectively. The increase was primarily due to increased expenditure incurred for certain clinical trial programs in second quarter 2017.

Income from operations decreased by 8.4% to $39.4 million. Operating margin decreased year-over-year to 44.1% from 47.1%.

Net income attributable to the company increased by 0.6% to $31 million. Net margin was 34.8%, up from 33.6% in second quarter 2016.

Diluted earnings per share was $1.09 compared to $1.10 in second quarter 2016. Non-GAAP adjusted net income attributable to company increased by 15% in RMB terms or 9.4% in U.S. dollar terms to $38.5 million in the second quarter 2017 from $35.2 million in the same quarter 2016.

Non-GAAP net margin increased to 43.1% from 38.5% in the same quarter of 2016. Non-GAAP adjusted earnings per diluted share increased to $1.35 in second quarter 2017 from $1.26 in the same quarter 2016. Non-GAAP adjusted net income and diluted earnings per share exclude non-cash employee share-based compensation expenses of $7.5 million and $4.4 million for the three-months ended June 30, 2017 and 2016 respectively.

Now let's look at our results for the first half of 2017. Total sales in the first half of 2017 increased by 7.4% in RMB terms or 2.1% in U.S. dollar terms to $180.7 million. The increase in sales was primarily attributable to sales increase in placenta polypeptide products, certain hyper-immune products and albumin. As a percentage of total sales, sales from human albumin products and IVIG products account 38.3% and 34%, respectively for the first half 2017.

Gross profit increased by 6.2% year-over-year to $118.4 million in the first half 2017, resulting in gross margins of 65.5%.

Income from operations in the first half of 2017 decreased by 3.3% over the prior-year period to $78.2 million. Net income attributable to the company increased by 7% to $61 million for the first half 2017, resulting in net margin of 33.8%.

Non-GAAP adjusted net income attributable to company increased by 21.8% in RMB terms or 15.7% in U.S. dollar terms to $75.9 million in first half 2017. Non-GAAP adjusted earnings per diluted share increased to $2.67. Non-GAAP adjusted net income and the diluted earnings per share excluded non-cash employee share-based compensation expenses of $14.9 million for the first half 2017.

Now, I would like to turn to the balance sheet and cash flow items. As of June 30, 2017, we had $223.2 million in cash and cash equivalents, primarily consisting of cash on hand and demand deposits. Net cash provided by operating activities for the six months ended June 30, 2017 was $36.9 million as compared to $57 million for the same period 2016. The decrease was largely due to increase in accounts receivable and inventory.

Accounts receivable increased by $26.1 million during the first half 2017 as compared to $13.9 million during the same period 2016. The accounts receivable turnover days for plasma products increased to 51 days during the first six months of 2017 from 35 days in the same period in 2016. The increased turnover days reflect a combination of higher percentage of direct sales and a higher percentage of large hospital customers and large distributor customers that typically request longer credit terms.

Inventory increased by $22.8 million in first half 2017, mainly comprising of increasing outsourced and self-collected raw plasma. This increase was higher than the inventory increase of $12.5 million during the same period in 2016, primarily because with the company inventory stockpile to prepare for the planned temporary production suspension at its Shandong facility.

Net cash used in investing activities for the first six months ended June 30, 2017, was $16.6 million, which including a $16.6 million payment for the acquisition of property, plant and equipment, intangible assets, and land used rights for Shandong Taibang and Guizhou Taibang.

Net cash provided by financing activities for first half 2017 was $14.8 million, mainly consisting of $14.3 million short-term loan net proceeds.

Our working capital as of June 30, 2017, was $392.2 million and our current ratio was 5.21.

Total shareholders' equity was $614.9 million as of June 30, 2017, compared to $521.1 million as of December 31, 2016.

Lastly, turning to the full-year guidance. As David mentioned in his opening remarks, we are reiterating our full-year forecast of total sales for 2017 to grow 13% to 15% in RMB terms and expect non-GAAP adjusted net income to grow 18% to 20% in RMB terms over 2016 financial results. This guidance also factor in the impacts associated with cumulative production delay of approximately three months at our Shandong facility, as we transition to a new facility. This guidance does not factor in any potential foreign currency translation impact.

We adopt the exchange rate of approximately RMB 6.63 equal to $1 based on weighted average quarterly exchange rate in 2016 when translating our 2016 financial results and expect that total sales and non-GAAP adjusted net income in U.S. dollar terms in 2017 will be adversely affected by foreign currency translation impact.

This guidance also assumes organic growth and excludes acquisition, and necessarily assumes no significant adverse price change during 2017. This guidance reflects the company's current and preliminary views, which are subject to change.

That concludes our prepared remarks. We will now take questions. Operator, we're now ready to take some questions.

Question-and-Answer Session


We will now begin the question-and-answer session. [Operator Instructions].

The first question comes from Jack Hu with Deutsche Bank. Please go ahead.

Jack Hu

Thanks for taking my question. I understand there are many question and I -- so I'm just going to ask two questions in the front. The first question I believe everybody is wondering is, why you keep the guidance intact. So what gave you the confidence that you can catch-up in the second half of the year? My second question is really regarding the drivers behind the business in 2Q. So can you share with us what drivers are sustainable, which will continue in the middle to long-term and what drivers are temporary factors? Thank you.

Ming Yin

Thanks, Jack. I think your first question regarding the guidance and I understand your concern about we -- the confidence to keep the guidance intact. Although our performance in the first half 2017 was negatively impacted by the healthcare reform measures and intensified competition. We do expect a faster growth in second half 2017 based on the preliminary estimate [ph] on the revenue growth drivers in second half of the year, which were slightly different from the first half of 2017.

Based on the current market condition, we expect our plasma products revenue might slightly decrease as compared to our prior estimate at the beginning of the year, while the revenue contribution from our non-plasma products, placenta polypeptide products will increase proportionately and offset the shortfall from the plasma products from the accelerated implementation of the two-invoice system in the country. And so that's just our overall assumption.

I think the second question regarding the -- what's happening in the second quarter and what factors is temporary, what factors could be probably lasting to the future quarters? I think during the second quarter, we probably, already reported in our first half results, you already seen our performance was negatively impacted by the few factors, as David mentioned.

Number one is the government's recently the healthcare reform measures was implemented. Actually at the beginning of the year, the central government held a meeting in the late-March requiring all public hospitals across the country to prepare a timetable to cancel the regular 15% of drug sales mark-up before the end of June and to implement before end of September 2017.

By the end of June, we observed that certain local governments already implemented new policy, including the few largest areas, which we have a busy presence like Beijing, Shanghai, Guangdong, Shandong, and Hebei. And in the meantime, we do observe the governments also implemented or requested the public hospitals across the country to control the revenue from the drug selling to within 30% of total the hospital revenue by end of this year.

From the second quarters, our experience, the implementation of this policy so far demonstrate the mixed results across the different hospital peers. The top-tier hospital, in the Tier 1 and Tier 2 cities demonstrates a better performance than the lower tier hospitals. And specifically, all product sales to those top-tier hospital has been impacted less, since they have a better ability to generate more service income, so their respective drug sales percentage are not impacted, while the smaller hospitals have less surgical income or rely more on the drug sales income.

So from our experience, all the hospital we have directly dealt was, the near-term, we believe lower tier hospital could be subject to either the volume and also the pricing may face some of the policy headwinds for the continue -- for the short-term basis.

And but just want to actually point out, our -- the company kind of actually differentiate all. We have a kind of unique sales model in the China plasma industry. It because we have a very diversified origin of the customer base. We serve close to 500 hospitals, and over -- the 500 hospitals we're directly serving with, we had about 60% of revenue directly generate from those direct sales hospitals. For albumin, our sale concentrated from direct hospital even higher. We have close to 80% the direct sales -- the coverage for the albumin. And for the IVIG, we utilize the direct sales model and also, we utilize the Tier 1 cities, the top ranking distributor to help us to generate -- to actually penetrating the Tier 1 cities, the big hospitals and we, by adding those top-tier cities distributor's sales contribution, we have about similar 70% to 80% of IVIG sales coming from the direct sales or what we can call as the sales channel where we actually have the direct control in the hospitals -- control of the hospitals.

So we believe that's our unique advantage. So we think, in channel even we encounter the government healthcare reform initiative, which actually negatively impact industry in general, but we believe -- because our -- the unique sales model actually benefit us to actually have a minimized impact compared with other peer companies.

And also, for the second quarter what we want to actually point out is the import patient volume, actually surged in June, in typical months, actually resulting the -- overall the importation volume increased by 56% year-over-year compared with last second quarter and resulting the overall, the albumin -- the importation growth rate close to 35% for the second quarter. And I think that could be another reason what we think it's actually a -- what David mentioned earlier that could be the driver actually -- further actually causing certain -- the inventory build-up among the importation channels and which could be the reason, could be panic -- the certain the local distributors to actually destock their inventory or kind of hold on their purchase in the second quarter, because they want to the gain the further visibility on the price in the second half of 2017.

And also we believe the two-invoice system actually have some impact on the second quarter. I think we have to admit, we underestimate the impacts to our plasma products carried out by the distributor with the influence of the two-invoice system implementation. There are many manufacturers in China, in the plasma industry who are heavily relying on the small to medium sized regional distributor in the past, because they are the products in -- because of the vaccine schedule in 2016 and also the government the rapid, the implementation of the two-invoice system actually further afflicted many plasma manufacturer who used to have a heavy exposure to distribution channel.

And but right now, they found a sudden distribution channel disruption. So they're trying to gain the access to the main sales channel, which they actually have never deal with before. So what they did is actually, they're trying to aggressively negotiate with the large size distributor and with longer credit terms or the heavy discounts or promised discount. Even we think the price, in general has not declined much, but they probably give some indication they might kind of just dropped the price. So that could be the driver temporarily caused certain large distributor -- even some distributor we work with, kind of just hold on their purchases in second quarter.

They want to wait for the price visibility before they can start to purchase the plasma products. For this factor, we don't believe this impact could be very long-lasting, because given the nature of the plasma products, lifesaving nature that hospital -- critical to hospitals, the storage we believe -- once those distributor destock their inventory, they will resume their purchase. Jack, so hopefully I answered your questions.


The next question comes from Jessica Li with Bank of America Merrill Lynch. Please go ahead.

Lilian Wan

Good morning and good evening. This is Lilian Wan squeezing on behalf of Jessica Li. Actually I have two questions. First, Ming can you give us some updates on the overall pipeline situation analysis for albumin and IVIG respectively? And my second question is on your inventory days. It seems that inventory days rose quite high this quarter, so what are the main reasons behind? And can you speak on the impact from inventory reserve and the impacts from two-invoice policy? And so, what will be -- which impacts will be sustainable and which one will be temporary? That's my questions. Thank you.

Ming Yin

Lilian, I just want to clarify, was your question regarding the inventory, can you actually repeat that?

Lilian Wan

Inventory days?

Ming Yin

Yes. So you want actually to -- us to explain whether the current inventory days will be sustainable or we will actually decrease inventory days in the future. Is that what you wanted to ask?

Lilian Wan

Yes, exactly. Thank you.

Ming Yin

Okay, thanks. So regarding the albumin and IVIG, I just briefly touch up on the batch approval data for the first -- for the second quarter actually. The importation volumes greatly increased in June, so resulting about 56% growth in the second quarter and 33% year-over-year growth for the reporting quarter.

So besides the importation volume surge and just now we just talked about the elevated competition among the distribution channel for the albumin market, also actually could be another reason to behind the intensified competition and because those manufacturers used to have rely on the distributors -- main distributors are very, relatively small and they used to actually have no direct -- the hospital customers, and because of implementation of the two-invoice system and the government required to eliminate the multiple layers between the manufacturer and hospital that action caused many distributors out of the business, because they no longer can compliance with the new regulation.

That's why -- it could be the reason to cause certain inventory, we used to call those are the buffer, because the distributor used to purchase certain level of the inventory, because of the elimination of certain layers in distributor. So that's why in between the distributor and the hospital, we suddenly see certain peer company in China could cause their factories inventory increase because their counterpart distributors, no longer in business. So that could be the reason to cause the supply -- the reason cost of supply increased.

And from the demand perspective, even we don't believe the overall supply/demand imbalance condition has been fully resolved cross-nation, especially in the lower tiers -- the market. But we do believe the ongoing healthcare reforms matters initiated by the government to public hospitals, including the control, the drug selling, percentage of the total revenue of hospitals, and also has canceled the mark-up on the drug sales, do actually have a certain amount of impact on the hospital, the purchase perspective.

And I think the -- another aspect that we want to talk for albumin is pricing. For ourselves, we cannot speak for the industry, but for ourselves, we actually have about 2.7% of the price decrease in second quarter and year-over-year base, but that 2.7% mainly come from two factors. Number one is, we reduce the five-grams, the dosage concentration to hospitals about, last year we saw about 40% of our albumin is in five-grams, but this quarter only 30%. So about 10% drop in the dosage cost, the equivalent ASP decreased. But in the real hospital channel, the price is pretty much stable. And also, we talked about the distribution channels competition result in certain, the price pressure and that resulting of our overall about 5% of price decrease in the distribution channel. So that's overall resulting about close to 3% of price drop for albumin.

And for IVIG, I think with our second quarter, even the volume or the revenue perspective, this is weaker -- might be a little bit weaker than expected. But if you look at the regular IVIG and hyper-immune products as a total, we had about 9% of the growth during the second quarter compared with last year. And our hyper-immune product sales contribution increased to 14% from 9% from the second quarter. And we believe our IVIG sales in general has been very healthy. Even the zero-markup policy on the control on the ratio of drug sales, due to the hospital revenue, that has been negatively impacted for albumin sales. But IVIG still maintain the good performance in the hospital channels. And you can see our price increase that's mainly reflect that solid demand and even for distribution channel, we experienced certain growth.

And overall, the hospital channel, we increased by 8% in the second quarter and certain best performing hospitals, even have about 20% year-over-year growth in the second quarter.

And for distribution channel, we do actually have certain smaller distributors who actually, because of two-invoice systems, the impact, they have volume drop. But for the large distributors, we still actually maintain the stabilized growth. So for the ASP for the IVIG, so I mentioned even there is about 1.2% of their price increase, which comes from about stabilized pricing in the hospitals and the distribution channel is priced very similar to the albumin, which reflects about 5% of the price discount to distributor, as the margin. That's just my answer to the first question.

And second question regarding the inventory, I think the, if you look at the balance of the overall inventory, the balance increase is about $27 million, is because mainly reflect the increase in our raw materials and work-in-process. The finished goods balance is actually comparable with the end of last year. And there is two reasons for our raw material and work-in-process increase. Number one is our Shandong facility faced the capacity constrain, so, and also, we had about 1 month shutdown in June and so that's why our raw material -- the materials, the build up when we have shutdown.

And because we were trying to prepare for the second phase of shutdown in September, so that's why we're building additional inventory in the work-in-process. That's another reason for the work-in-process, the increase. But we had them, in general, because of intensified competition for the albumin and also the two-invoice impact, which reflects little bit higher, the finished goods inventory.

As if you count it by the months of sales, the inventory or end of June, the inventory reflects additional, about a one-and-a-half months inventory compared with the end of last year. So we have about two months inventory, in general, for the sales. We hold on the finished goods for sales. But end of June, we have about, little bit under four months of inventory, which we believe that inventory levels too are lower than our peer company in China. And we don't believe that inventory days are sustainable. We believe once we have the new plant to launch by end of the year, the overall, the inventory turnover days should back to industry level, about less than 400 days. So that's my answer to your question.


The next question comes from Iris Wang with Credit Suisse of Hong Kong. Please go ahead.

Iris Wang

Thank you for taking my questions. So you just mentioned, you reiterate the full-year guidance then compare the market condition early this year. So what has been improving? What has been negative on your bottom-line for 2017?

Ming Yin

So, yes, so you want to know what's actually our assumption behind the guidance.

Iris Wang

That's right.

Ming Yin

Yes. So I think you're absolutely correct, the first half especially the second -- late second quarter, the competition among distribution channel especially for albumin has been intensified. So we do acknowledge that competition. So, even the second quarter outperformed just might be negative impact because of distribution channels competition. But what we review, what we should do in the second half is, what changes. So overall in the second half, we do still believe there might be continuing challenge.

But as a company we already updated our, the marketing strategy. We're trying to do; we're trying to actually do more to actually to kind of to minimize the competition. For example, as I mentioned earlier we used to serve to the 4,000 hospitals. So currently we only serve close to 500 hospitals. And so I think, that's our one of the advantage. So we do actually have lot of hospital customers. We actually have ability to resume the distribution relationship in the future -- in the short future, because right now, it's very difficult for any competitors to open the new account with hospitals. So that's our advantage.

So we want to actually in the short future, trying to resume the hospital we used to do to cover it, because in the past, we have limited inventory, we cannot sell to all hospitals. So that's why, unfortunately, we have to disconnect certain of the supply relationship with certain hospitals. Even those hospitals could be -- our average size could be small, but we do believe on the average base, those hospitals more than adds up to meaningful. So that's one of the strategy we want to pursue. And additionally, we want to capture the new market opportunities in the region where we complete public tenders.

For example, we only sell few largest hospital in Jiangsu Province. So once the tendering process is complete, we will capture the market opportunity, trying to deep penetrating that province, which means we should actually have better presence in Jiangsu than today. So that's our growth potential. And besides hospital channel in 2017, we think we want to explore the new distribution channels in our market, which we never had a presence before. For example, like Jiujiang Province.

Right now we just started relationship with one of the largest local distributor there and we believe this kind of new distributor collaboration will actually enable us to actually have a better opportunity to actually capture one of the largest the healthcare or the drug purchase province in China. And also besides the channel, the hospital and distribution channels, we want to actually explore into the additional or new sales channel like a drug -- chain of drug stores and/or the pharmacy formerly associated with hospitals or the private hospital customers, which we believe those are potential, the channel we want to explore. And that's just the new channel we want to pursue.

For the albumin, I think overall, very fast, we want to actually expect the higher volume growth for the second half, because we want to pursue the new channel and therefore stabilize ASP for hospital customer, but what might change in the second half is distribution channels pricing. So I think that could be controllable. From our perspective, we don't want to match with whomever in Asia, company who want to actually dramatic a price discount. We want to still maintain the low-single-digit price if there is price cut in that channel. So that's our ASP for albumin.

For IVIG, so our view is pretty much the high volume than the second half, because like I mentioned in the second half, we believe the new channel is going to help us to increase volume and also we want to maintain the very stabilized pricing for the IVIG.

For the albumin product, I think in general, in the second half of 2017, we believe the volume perspective might come down compared with the first half. So from that perspective, we believe that regular IVIG volume is going to up and the albumin percentage decrease. So that could actually consequently result in our lower gross margin in second half. But even the lower the gross margins still actually going to bring the overall 60% to 62% of gross margin, as we talked about for the plasma products at the beginning of the year. And besides of a product mix change, we do expect to utilize more the outsourced Xinjiang plasma in the second half. So that actually going to actually another hit for the gross margin.

For the blood plasma product, the polypeptide product, we believe with acceleration of the implementation of the two-invoice system across the country, we're expecting the potential; the negative impact on volume might be -- might happen for second half. But that the positive side is higher pricing and higher revenue and which will contribute both the positive impact for revenue and the higher margin, the both the gross margin and net margin. So the -- that's just my answer to your question, Iris.

Iris Wang

Thank you, Ming. So, I know that you have a lot of cash on your balance sheet, so how would you spend on it?

Ming Yin

Yes. So I think that's a very good question. As you might know the right now -- the largest CapEx the expenditure project related to build the new facility in Shandong has pretty much substantially complete and so therefore majority of the CapEx project has being at the capital or the capital expenditure has been paid.

The management are actively evaluating various options to more effectively utilize the company's strong balance sheet. We will be closely monitoring the market for any suitable candidates that could be accretive or bring us any synergy in order the sustainable growth in the future. But we're also evaluating other options to put our capital to work to maximize the shareholders their value.


The next question comes from Yolanda Hu with Morgan Stanley. Please go ahead.

Yolanda Hu

Thanks for fitting in my questions. I have two shorter ones. First, so if competitors like Hualan decided to clean-up their inventories within this year, how do you think it's going to affect the overall sales volume growth in the second half? Do you think there is still any like downside to your current guidance in terms of the volume growth? Secondly, under the two-invoice system policy, do you need to revise the factory price of PP. Can you first let us know, how much do you expect will be representative of overall PP to be adjusted by 2017 year-end. And then secondly, help us quantify the impact on gross margin and also net profit in maybe 2017, also 2018, especially for this year, since you've maintained this full-year guidance unchanged. So if PP may contribute more profit, it means plasma segment is actually liquid and they have fierce competition, I just wanted to understand this better. Thank you.

Ming Yin

I think, I'll try to answer your first question regarding the Hualan. So I think, we actually haven't too much information about them, but since they have not reported their first half years results and but based on the batch four data and what they just did to lower their first half guidance, so we believe they could actually are in the position of building up more inventory, so that's what we notice.

But from I think overall, we don't actually have a much -- the connection with Hualan or they have a much influence on us because we have a pretty much, a different sales channel and a customer base. And we have about 60% direct sales, which they have but I think, according to their analyst report, only 20% sales and 80% is the distributor. Also distributors, we don't utilize same distributor and we utilize most of those, the largest top ranking distributors in the country, but some of them, the Shanghai, Guangdong pharma they utilize pretty much all those regional distributors, so we don't actually have a much distributor conflict as well.

So I don't think Hualan, whatever they claim or their future potential action has much impact on our pricing strategy. But we do believe what they did; the current price could influence other Asia company or smaller company without channel. But in general, we don't actually believe their action could actually have much impact on our 2017 guidance or our ability to actually execute our performance.

For the second question is still regarding the polypeptide, I think, the second quarter, we have a little volume decline although the revenue declined from polypeptide product. But for the first quarter, we have about 90% of revenue increase from this product, which actually resulting in 50% of revenue for the first half 2017. And just like I mentioned, the overall, because of the first half, there is about less than 10% of revenue reflected as the higher price in compliance with two-invoice system, but there is only four province in China actually carry out the two-invoice system. But the recent government policy order, we believe there is close to 30 provinces in China already detailed their timetable to ask you the two-invoice system.

So we believe in the second half, the acceleration of the compliance for two-invoice will actually, will be faster than our prior estimation. So that's why resulting probably higher volume of the polypeptide products, so actually it could be under the new regulation.

So I think overall, we believe, overall second half based on the preliminary estimation, but volume-wise, we believe overall the revenue growth and volume growth should actually maintain the similar growth pattern as the first half of 2016. So the second half will probably have the same growth pattern and but the compensation of what we believe the proportion from the increased products, the percentage is going to definitely increase, because most of the province is going to implement two-invoice session. So, pretty much I think about pretty much over 50%, probably close to 60% of that revenue probably generated from the higher price, the invoice strategy.

So I think overall, that's just but for the gross margin perspective, I think the impact could be within overall with the 60% of whatever products if actually have a higher price, will result in about overall about 65% gross margin. As I described earlier, the plasma products, the margin can go down because of the product mix changes and the cost of plasma changes in second half. But the polypeptide products could bring in additional probably 300 base, approximately 300 basis of gross margin impact to our 2017 gross margin. That will be positive. So Yolanda hopefully that answers your question.

Yolanda Hu

How about the net profit?

Ming Yin

The net profit is actually, just like I mentioned earlier, because that is actually reflects about 3% to 5% of the bottom-line.


This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

David Gao

Thank you and have a nice day.


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