Wuxi Pharmatech Q2 2011 Earnings Conference Call Transcript

The following is excerpted from the question-and-answer section of the transcript.

Answer By: Ron Aldridge - Wuxi PharmaTech - Director of IR

Question: Ingrid Yin - Oppenheimer - Analyst: Hi. Good morning and good evening. Thank you for taking my questions. It's a great quarter; congratulations. It's very encouraging to see you raised full-year guidance. When we look at it, majority is driven by faster growth in your manufacturing business. So your guidance for China Lab changed slightly down, from 14% to 18% to mid-teen growth. And we also saw, for US Lab growth rate, you also toned down a little bit. Can you share what you have seen and what kind of visibility you have for the second half for your business in manufacturing, China and US Lab Service, so that you give this kind of guidance? And one more is about your expectation for the tox business. Thank you.

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Ingrid Yin - Oppenheimer - Analyst: Okay. Great. A quick follow-up on tox business. If we're expecting revenue contribution from the segment next year, what kind of size of revenue should we think about?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Ingrid Yin - Oppenheimer - Analyst: Okay. Great. ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Ingrid Yin - Oppenheimer - Analyst: Okay. Thank you for taking my questions.

Question: Bin Li - Morgan Stanley - Analyst: Thanks for taking my questions. And it's really good to see you exceed the milestone of revenue of $100m. My question is about the gross margin progression and follow-up is also on the forecast. So the question is, when I look at this quarter, the Manufacturing gross margin improved pretty substantially, from 27% to 31%. So what are you looking at for the full-year gross margin, or fourth quarter to be exact? And what kind of level we're expecting for 2012 and beyond, as we're seeing your manufacturing contract for Vertex, i.e. telaprevir, is growing pretty nicely?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: So you're talking about the next year ramping up from other manufacturing services. Would that help or would that drag down your gross margin, because you're already at very high level for the Manufacturing business?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay. So my follow-up question is also on the Manufacturing Services. As I mentioned, obviously Vertex telaprevir is outperforming its competitor. If we look at weekly prescription, it's almost four times of Merck's boceprevir, and I guess that's the reason -- that's one of the reasons you're raising your guidance for the Manufacturing business. What is your outlook for next year and beyond for that? How much upside from there -- from here, given that we have a pretty strong ramp-up of this product?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Bin Li - Morgan Stanley - Analyst: Okay. Thanks.

Question: Liping Cai - William Blair - Analyst: Hi. Good evening. Thanks for taking the question. I'd like to hear you talk a little bit more about your expansion into clinical, and I think that's something new for us. And could you talk about why now, and also the steps you expect to take to build up this capability? And also, do you expect to work with the US pharmaceutical companies or China-based clients, after you build up the capabilities? Thank you.

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Liping Cai - William Blair - Analyst: And a follow-up to that. Do you expect to build up this organically or maybe through an acquisition? And also, on the, I guess, investment required this year and maybe in the next couple of years for this?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Liping Cai - William Blair - Analyst: Thanks for sharing your thoughts, Dr. Li.

Question: Dave Windley - Jefferies & Company - Analyst: Hi. Thanks for taking the questions. What -- how should we think about the beneficial impact to your margin from the Wuhan expansion? I guess I'd be interested in perhaps the revenue capacity of that campus or that building and how -- again, how that would come on from a gross margin standpoint.

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Dave Windley - Jefferies & Company - Analyst: Thanks, Ed. Would you be able to say what the difference in labor cost is?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Dave Windley - Jefferies & Company - Analyst: 20% lower?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Dave Windley - Jefferies & Company - Analyst: Yes. Okay. The follow-up question for me is a follow-up to the clinical question. And just to clarify, are you talking about expanding into Phase I clin pharm, or are you talking about a full-blown expansion into distributed Phase II/III trial management and support? ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Dave Windley - Jefferies & Company - Analyst: Super. If I could just slide in one more, your sales and marketing commentary about building out some sales and marketing teams, could you elaborate on that a little bit? Where are they and what lines of business will they be primarily focused on selling?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Dave Windley - Jefferies & Company - Analyst: Okay. Thank you.

Question: Paul Knight - CLSA - Analyst: Congratulations on the quarter. Could you talk about the level of bidding activity in the overall business? Has it changed any in the second quarter from first quarter, or is it the same?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Paul Knight - CLSA - Analyst: And then, financially, are you seeing any changes in research demands based on the amount of genetic sequencing activity going on in the marketplace, like more demand for cellular-based assays? Do you see that affecting your business yet?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Paul Knight - CLSA - Analyst: Okay. Thank you.

Question: Tycho Peterson - JPMorgan - Analyst: Hi. Thanks for taking the question. On the manufacturing, your more positive outlook here, can you just talk about how much of that is a function of telaprevir versus other products in the pipeline? And then, are you also able to comment on your visibility on inventory levels at Vertex at this point?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Tycho Peterson - JPMorgan - Analyst: Okay. On the delays that you talked about in China-based Lab Services, can you just talk about how widespread this was? And what gives you conviction that they're delays and not permanent cancellations or permanent postponements?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Tycho Peterson - JPMorgan - Analyst: Okay. And then just one last one, if I may. You walked through a lot of the new key hires in one of the slides. Where are we from hiring from a senior management perspective? Was this the bulk of the senior hires that needed to be done? Or can you just talk to how we should think about senior staffing going forward? ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Tycho Peterson - JPMorgan - Analyst: Okay. Thank you.

Question: Shaojing Tong - Bank of America-Merrill Lynch - Analyst: Hi. Thank you very much for answering my questions. First, I just want to give an update on your Jinshan capacities, your utilization rate.

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Shaojing Tong - Bank of America-Merrill Lynch - Analyst: Yes. That's my next question is regarding your expansion for Jinshan capacity. Is that for the existing projects or is that for the potential future projects?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Shaojing Tong - Bank of America-Merrill Lynch - Analyst: Okay. Good. And lastly, since you are already at full capacity, close to full capacity on this Jinshan capacity, can I interpret that the 31% gross margin you reached for manufacturing facility is pretty much at the top?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Shaojing Tong - Bank of America-Merrill Lynch - Analyst: Okay. Great. Thank you very much. ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Question: Jack Hu - Deutsche Bank - Analyst: Yes. Thank you. My first question is on inventory. Your inventory almost doubled, actually more than doubled for the last four quarters. Can you tell us what's going on here?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Jack Hu - Deutsche Bank - Analyst: Okay. And a second question about renminbi appreciation. So at the beginning of the year you mentioned you assumed this 3%. And so what's the assumption embedded in the new guidance? And are you still actively hedging?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Jack Hu - Deutsche Bank - Analyst: Thank you.

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Thanks for taking my follow-up questions. Still a follow-up to the previous question on currency. Do I understand correctly that you're assuming 5% RMB appreciation this year? ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay. For the full year. Now, if that were the case, what would be the currency impact to your earnings? (Multiple speakers).

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay. Okay. All right. So let's say if you have 5% and currency it -- theoretical hit is going to be 2.5%, and that will be offset partially by the hedging programs. So what's the net, if you were to estimate it?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay, okay, okay. Great. The follow-up question is also on the operating margin and gross margin. When I look at your current guidance versus previous guidance, you're guiding up for Manufacturing Services, which means in the product mix the low-margin business is a high proportion in the product mix, which theoretically should bring down your gross margin. But I think you're saying your gross margin should be the same, i.e. the current gross margin versus previous gross margin. So can you help us to understand what is driving that?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay. I see. Now, also on the operating margin, you're guiding towards the low end of the previous guidance. Is it because of the SG&A items that you've mentioned, or is there anything else going on? ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay. Great. And as a follow-up question on the biological capability that you were talking about, it may be just a question to Dr. Li. Can you give us any update on the progress of your Wuxi facility, the small-scale biological manufacturing facility? Can you tell us where you are now and just give us some updates on that?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Bin Li - Morgan Stanley - Analyst: Sure.

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: So what about the project selection, where you are at right now?

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Bin Li - Morgan Stanley - Analyst: Okay. Thank you very much.

Answer By: Ron Aldridge - Wuxi PharmaTech - Director of IR

Question: Katherine Lu - Cowen & Company - Analyst: Hi, Dr. Li, Ed and Ron. Thank you for taking my question. I apologize; my line actually was disconnected when Bin Li was asking the first question. So if my question was answered before, I apologize for that. So my first question is if I look at your 3Q guidance and your full-year guidance and I can back out some outlook for the 4Q, I realize in that outlook you're probably assuming a substantial sequential uptick in 4Q this year. So I'm just wondering if there's any significant projects that you expect to sign on in the next few months that will contribute to the substantial uptick in Laboratory Services, both in China as well as in the US in 4Q, or should we interpret it that you're overly conservative on the 3Q guidance?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Katherine Lu - Cowen & Company - Analyst: Okay.

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO

Question: Katherine Lu - Cowen & Company - Analyst: Okay. Great. Thank you. And also, you mentioned in your prepared remarks that you probably have a couple of projects that could be delayed to start 'til the end of 4Q. I'm just wondering, can you talk about the nature of those projects? Do they fall into the toxicology area or medicinal chemistry or in the downstream testing area?

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Katherine Lu - Cowen & Company - Analyst: Discovery. Okay. If I can sneak in one more. Dr. Li, you mentioned this quarter we see the revenue exceeded $100m, so certainly it's a significant milestone for the Company. And then you also mentioned you're excited and looking forward to achieve more milestones next year or in the coming years. I'm just wondering, can you talk about what kind of milestones are you expecting the Company to achieve? ¬2011 Thomson Reuters. All rights reserved. Republication or redistribution of Thomson Reuters content, including by Client Id: 43

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Question: Katherine Lu - Cowen & Company - Analyst: Okay. Thank you very much.

Answer By: Ron Aldridge - Wuxi PharmaTech - Director of IR

Answer By: Ge Li - Wuxi PharmaTech - Chairman & CEO

Answer By: Edward Hu - Wuxi PharmaTech - COO & Acting CFO