AOB Downgraded to Hold

AOB: Downgraded to Hold on Performance & Outlook

First quarter 2009 financials fell short  

Early this week, American Oriental Bioengineering Inc. (AOB - Analyst Report) reported first quarter 2009 financials which fell short of our expectations.

Total revenue in the first quarter of 2009 increased 18.9% year over year to $46.1 million from $38.8 million. Excluding distribution revenue of $2.5 million in the 1Q09 (there was no distribution revenue for 1Q08), revenue only grew by 12.7%, compared to a growth rate of 50.5% for 1Q08.

Total revenue for 1Q09 was way below our estimate of $71 million. Although the first quarter is usually the weakest one in the year due to the Chinese Spring Festival holidays, the sharp decline in sales growth rate for is still a big surprise to us since our model already discounted the seasonality.

Revenue from pharmaceutical products increased 8.9% to $34.7 million from $31.9 million in the prior year's first quarter, $20 million less than our estimate of $55 million. Prescription pharmaceutical products revenue increased 14.5% to $16.2 million during the first quarter of 2009, boosted by prescription formulation Jinji and CCXA products, which offset declines in Shuanghuanglian Injection Powder (SHL). OTC pharmaceutical products generated $18.5 million in revenue during the first quarter of 2009, roughly flat to the prior year period.

Nutraceutical products generated revenue of approximately $8.9 million in the first quarter of 2009, up 29.0% from the prior year period, reflecting continued demand for peptide products and an expanded distribution network versus the prior year's first quarter. This is the only business unit which exceeded our estimate of $7.5 million.

The Company generated $2.5 million in distribution revenue in the first quarter of 2009 from Nuo Hua's majority-owned subsidiary. Distribution revenue was also way below our estimate of $8.5 million.

Gross profit in the first quarter of 2009 increased 8.1% to $28.4 million from $26.3 million in the first quarter of 2008. But gross margin declined to 61.7%, compared with 67.8% in the prior-year period, reflecting lower margin distribution revenue and CCXA's generic product sales. We expect further margin erosion going forward.

Operating income in the first quarter was $11.2 million compared with $12.0 million in the prior-year period, reflecting a 20.2% increase in operating expenses to $17.2 million in the first quarter of 2009 from $14.3 million in the prior-year period.

Net income for the first quarter of 2009 declined to $7.9 million, compared to $9.4 million in the prior-year period. Net income per diluted share was $0.09 in the first quarter of 2009 compared to $0.12 per diluted share in the first quarter of 2008.

As of March 31, 2009, the Company had $73.9 million in cash and generated approximately $3.6 million of operating cash flow during the quarter. The company also held $115 million in convertible notes on its balance sheet at the end of March.

AOB has been doing well both financially and operationally since 2003. Total revenue crossed the $100 million mark in fiscal year 2006 with $110 million in revenue, a 101% increase over revenue in 2005. Revenue reached $160.5 million in fiscal 2007, up 45.7% from $110 million one year ago. AOB has enjoyed a compound annual growth rate (CAGR) of 66.2% from 2003 to 2008 in terms of revenue growth. Revenue growth in the past few years has been mainly driven by key product sales in the PBP sector and PBN sector.

However, we are concerned about the growth in 2009 and beyond. Top-line growth in 1Q09 dramatically declined to 19% (13% if excluding distribution revenue which did not exist in 1Q08). We think the economic downturn in China is the ultimate culprit. Therefore, we lowered our estimates for 2009. We expect total revenue in fiscal 2009 will be $307 million, up only 16% year over year. Net income and EPS in 2009 will decline compared to 2008.

Based on our forecast, we downgrade AOB shares from Buy to Hold with a price target of $5.5.

Read the full analyst report on AOB