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Concord Medical Services Holdings Ltd. (NYSE:CCM)

Q3 2012 Earnings Call

November 21, 2012 8:00 AM ET

Executives

Vickie Zhao – IR

Adam Sun – CFO

Jianyu Yang – Chairman and CEO

Analysts

Sean Wu – JP Morgan

Chris Lui – Morgan Stanley

Jack Hu – Deutsche Bank

[Presentation session will be updated shortly]

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from the line of Sean Wu from JP Morgan. Please ask your question.

Sean Wu – JP Morgan

Hello, Jianyu and Adam, congratulations on a great quarter. I think you guys have made a great progress with the hospital operations. I do have – I’m not very familiar with Chang’an Hospital, the operation into margins etcetera. So, you have like about 15% of gross margin for hospital business. So, what are the components – the major components of the cost of goods, cost of services industry, you have three lines of business like pharmacy, inpatient outpatient. What are the overall margins for each segment? And what do you think about your overall like margin, 13.7 is it good, like can it get better or like its above hospital average compared to other hospitals? I’ll just stop here.

Adam Sun

Thank you Sean, and thanks for your question. So, as for the components of the cost of services, we – as you know we don’t breakdown in our press release. And so, here I would like to discuss in general about the components and give you some top line numbers, hope that will be helpful for your analysis.

So, as you know the cost of service for hospital is mainly composed of obviously salary and compensation and depreciation of the fixed assets. And also another major component of the cost of services obviously is pharmacy and other consumables. So, among the – to give you a rough idea, in our Q3 number, the cost for pharmacy and consumables accounted to about 50% of the total cost of services. And salary and compensation benefits accounted for about 15%, and depreciation is about another 10% to 12%, so those are mostly the major components of our cost of services.

So, looking down the road, we need to do a better analysis about each component. And generally my impression is that things – the cost of pharmacy accounted for major component of the cost of services. I think the gross margin level should remain around this level. And we are not expecting to see volatility on either side in the near – in the next couple of quarters. Hope that’s helpful?

Sean Wu – JP Morgan

That’s great, thanks a lot. So, I have another question for Mr. Yang Jianyu, so I know like Yang has been in this position for long time. So, can he give us more details about some of the new policy development like how do you think you compete against other players like China Resources and even the (inaudible) is trying to acquire hospitals so the difference between you’re building a Greenfield hospital in Guangzhou versus (inaudible) current hospitals? (Foreign Language).

Jianyu Yang

(Interpreted). First I would like to discuss about the medical service – Medicare service policy in China. The overall direction for the current medical service reform is very clear, that is the government will dedicate its resource to provide basic services to the general public, while the service sector for mid-to-higher tier patients will be open to private and overseas capital. So, this provides a great opportunity for companies like Concord Medical to invest in the healthcare service sector in China.

So, we’re glad to see many players started to enter into this field. And my general understanding is, the market demand is way outweighs the current supplier. So, there would be a shortage in supply in the very long term. So, we believe that there will be sufficient opportunities for each player in this field in the very long period.

So, under this situation, so we’re very glad to see that many players are entering to this field. So, we’ll dedicate to our general policy that is do what we feel our advantage, do what we are most experienced with, which is to establish an outreach hospitals in the oncology specialty field.

As you know that there are three major treatments for oncology – for cancer which is certainly chemotherapy and radiotherapy. So, Concord Medical has accumulated over 15 years of experience in radiotherapy and accumulated great assets in technology and management experience. So, we are applying these, expertise to our future projects.

As you noticed planned hospital in Guangzhou is a joint venture between CCM and Dr. Sun Yat-Sen Hospital, considered one of the best local hospitals in the local markets. So, each party, the CCM and our local best hospital partner brings we are comparative advantages to this project.

And as we explained before, our current products to establish specialty health business is not a fundamental change of our business model, rather we consider it as a transformation and evolution. So, basically down the road we expect that our China business is going to grow strongly. At the same time, we’ll look forward to see more contribution of our hospital business. So, we will combine our 134 centers around the country with our specialty hospitals to contribute to the cost of providing the best treatment for patients in China. Thank you very much.

Sean Wu – JP Morgan

Thanks a lot, that’s very helpful. I’m getting back to the queue.

Adam Sun

Thank you.

Operator

Thank you. Our next question comes from the line of Chris Lui from Morgan Stanley. Please ask your question.

Chris Lui – Morgan Stanley

Hi, thanks for taking my questions.

Adam Sun

Hi Chris.

Chris Lui – Morgan Stanley

My first question relates, hi, relates to goodwill. Concord has about 300 million of written-off in 2011, and now is the 230 million in third quarter ‘12. Can you tell us specifically what is and its risk compared to 300 million we saw last year?

Adam Sun

Sure, thank you Chris. The goodwill – our balance sheet now is related to the Chang’an Hospital Acquisition, which we closed in the second quarter. After the closing of the acquisition we have engaged an appraisal firm to conduct Purchasing Price Allocation, PPA work. The PPA results is due preliminary and subject to changes in the future. So, during the PPA test, we have identified value of the fixed assets, intangible assets and the rest of the consideration is in the goodwill sector.

So, among the intangible assets, we have identified include land usage rights, information system, healthcare qualification of Chang’an Hospital and its Oncology operation licensees, valued at around RMB185 million. So, based on the growth prospect of Chang’an Hospital, we do not see any impairment risk at all for the goodwill so far. And let me repeat, the appraisal work is due at a preliminary stage so the results of our earnings release should be considered as the preliminary and is due subject to change.

Chris Lui – Morgan Stanley

Okay. When should we expect the official number you announced?

Adam Sun

Because as you know that we closed the deal and then it is a very short timeframe from the – for the third quarter. So, we expect the final number definitely will come out in – when we announce our next earnings release for next quarter – for the current quarter.

Chris Lui – Morgan Stanley

I see, please let me have a follow-up question. Can you tell us your CapEx plan for this year and next year and also the operating cash flow for third quarter 2012?

Adam Sun

First, let me answer the operating cash flow question first. As you know, we do not disclose the official number operating cash flow. But one of the best estimates just to give you estimates about our the first three quarters of the year operating number, and we put that number roughly at around 80 million. To reason for that is – we’re now doing – since the beginning of the year we have strengthened our collection efforts.

So, basically the cash collected during the first three quarters of the year, pretty much equals to our sales revenue so which contributed greatly to the strong – very strong cash position at the end of the third quarter. So, we believe that our capital resources including our cash as well as available bank credit will be very sufficient to support our growth plans.

So, for the CapEx question, for the fourth quarter, we – for the third quarter we see our CapEx number going up to 131 million compared to the first two quarters. And the reason for that is that we have put down deposits for a couple of centers during this quarter. So, the fourth quarter, we believe that the total CapEx number will be lower than the number we see in the third quarter. And while, we do not give out specific guidance – CapEx number for fourth quarter, so we believe that the guidance we issued at the beginning of the year is schematic.

Chris Lui – Morgan Stanley

All right, thanks. I’ll get back to the queue.

Adam Sun

Okay, thank you.

Operator

Thank you. And our next question comes from the line of Jack Hu from Deutsche Bank. Please ask your question.

Jack Hu – Deutsche Bank

Hi, thank you for taking my question. I have only one question on the hospital front. If we look at the patient status, what percentage of the patients, have insurance and what distributes insurance composition? Thanks.

Adam Sun

Sure Jack. So, for Chang’an Hospital it accepts, as a private general hospital it accepts all kinds of government issued insurance programs, including as you know that there are three major insurance programs in China right now as you may know, including urban resident insurance, which covers people living in the cities without work. And there is another insurance program called urban employee insurance which basically is working employer sponsored insurance program.

And also, another big part of the insurance program right now in China is the new rural cooperative medical insurance, which it covers basically all the rural companies in China. So, Chang’an Hospital accepts all three forms of this sponsor – government sponsor insurance. And while, we did not the specific insurance or insurance number, so in general the revenue contribution from insurance program is about 50% of our total net revenue in the third quarter.

And the insurance – the current insurance in China is pretty complicated. So, as yearly favors the inpatient service for hospital. And for outpatients yearly its – because yearly – under all these three insurance programs there is self-paid portion. And so for most of the outpatients if the expenditure is below the hurdle, yearly is not reimbursed. So, that’s why the percentage for insurance so far is about 50%.

Jack Hu – Deutsche Bank

Thank you. I have a follow-up question, I mean, we had about global budgeting reimbursement, the cost to insure nationwide, so we are actually expecting something could happen in December. So, right now we’re getting into the almost the last of November. Have you seen anything actually changed or do we approach yearend on reimbursement front?

Adam Sun

I’m sorry Jack, I didn’t quite catch your first part of your question, can you repeat it again?

Jack Hu – Deutsche Bank

I’ll do it in English and then translate into Chinese.

Adam Sun

Okay.

Jack Hu – Deutsche Bank

Basically we heard that – so nationwide right now we have our global budgeting in reimbursement of cost control. So, my question is, that have we seen anything different when we approach year end? (Foreign Language).

Jianyu Yang

(Interpreted). In general, the impact of the general control you mentioned is not obvious because for our centers, the radiotherapy is considered a major illness – potentially it’s in the major illness list. So, and is basically covered under the insurance program. So, from our prior experience during the past years, even in the months of December we don’t really see obvious impact of this measure.

Jack Hu – Deutsche Bank

Thank you.

Adam Sun

Thank you.

Operator

Thank you. And next, we have a follow-up question from the line of Chris Lui from Morgan Stanley. Please ask the question.

Chris Lui – Morgan Stanley

Hi, thanks for taking my follow-up question. Can you tell us the opportunities and risks in each of the two sectors, network and hospital? And if possible can you quantify the upside and downside risk of them as well? Thanks.

Adam Sun

Okay, Chris. As you know there are both similarities and differences between the two segments. So, on the one hand, both our segments network and in the hospital provide services to the general public patients. As Dr. Yang mentioned in his remarks, the policy changed recently in China including a strengthening social insurance program and emphasizing the law of government in providing basic healthcare. We’ll benefit both of our centers and Chang’an Hospital as well.

China accepts all forms of government sponsoring insurance as I mentioned before. And the per capita pay-off are growing steadily year-over-year. And for our network business, we’re targeting to build a nationwide network of centers linked with our planning, China medicine infrastructure. So if it is successful, we would be able to make our network business more scalable.

So for Chang’an Hospital, I think the opportunity is to build it into a general hospital with a strong specialty, especially in oncology, which will increase the, per patient contribution. The strategic agreement with Fox Chase which we announced in July is the very first – important first step. So, for the upside of our network business is to achieve an overall 10% year-over-year growth while we’re seeing a pretty much flat growth in this quarter.

So, part of the reason is that during the – since the beginning of the year, we have started to see some of our hospitals partners demanding that the contract terms be revised. So now the situation has pretty much stabilized, so we don’t see it’s going to happen in the large scale from here on. So, we think that the overall trend for revenue for network is stable and slightly up from here on.

Chris Lui – Morgan Stanley

Okay, thank you.

Adam Sun

Thank you.

Operator

Thank you. (Operator Instructions). We have a follow-up question from the line of Jack Hu from Deutsche Bank. Please ask your question.

Jack Hu – Deutsche Bank

Yeah, thank you for taking my question again. So, actually I do have one follow-up question regarding Sean’s question on hospital gross margin side. And so, the gross margin about 15% here is slightly below my expectation and also actually below industry average. Can I understand how – give me some color how this works and then where do we see improving the opportunity going forward?

Adam Sun

Sure. So, I do know the major – the major revenue – the revenue components of our hospital revenue, which we disclosed in the press release is the pharmacy contributed about 40%, a little bit above 40% of our total revenue. And outpatient contributed about 20%, and then the inpatient contributed about 40%.

So, among three different components of our revenue, they have different gross margin situations obviously as we can see. So, for instance, the pharmacy side, the gross margin yearly is 15% or slightly below, because as you know there is government price guideline, which is 15% surcharge. So, that’s a pretty much very universal across all hospitals you’ll see.

So, as for the inpatient, the inpatient business early is the most profitable business for our hospital, because that the hospital yearly makes most of its money from inpatient services. And outpatient you can consider it as pretty much a lost leader, because you need to provide general services to the public so that you can improve your patient traffic.

So, the current margins we’re seeing right now is pretty much a weighted average of the all three of these service lines. So, one way to improve our gross margin is to improve the outpatient services, we’ve seen – in fact the most difficult job for a hospital in China, because to improve – one way to do that is to strengthen the specialty for this hospital so that patients will start to visit the hospital more often. So, that is a process that yearly advances cost. So, for Chang’an Hospital, it is the great – it’s pretty much entering it’s – the phase of 40% plus growth.

And as the hospital becomes more established in the neighborhood and in the community, so we expect to see the contribution from outpatients to be more and the per patient contribution to improve so that’s one way that we can see the gross margin generally trending up.

And 16% is – we are – is pretty much in line with our expectations. And also part of our – part of the – I think we expected to grow gradually. And I think the after limit should be close to 20%. But anything above that really need to change the business model of the hospital fundamentally.

Jack Hu – Deutsche Bank

Thank you.

Adam Sun

Thanks

Operator

Thank you. And next, we have a follow-up question from the line of Sean Wu from JP Morgan. Please ask your question.

Sean Wu – JP Morgan

Okay, I have another follow-up question for Jack’s question. So, now that we have sold far more deposit with gross margin. So, like, a bit more about your net margin your operating margin in (inaudible) right, you do have like a driver which you kind of – if it’s only – reimbursement (inaudible) charged at 15% mark up. If you like could walk us from real (inaudible) which are not covered by medical insurance. Do you only still kind of one charge at 15% of mark up? And like, so, this is one question.

Another question about contributing form inpatient, so what is your overall like per bed growth for patient and also like what’s the margin there? And also like you said you would like to grow this 40% a year FDA, so that your bed occupancy appears to be quite a high order rate. So, if you’re growing like outpatient business, the margins are not going to be very favorable. So, what is an overall like numbers behind the 40%, if like growth kind of – sales growth of 40% what is your goal for profit growth? Okay, I know that’s a lot of questions.

Adam Sun

Sure. Yes, it’s very comprehensive, let’s try to cover all aspects of it. So, just, I know the market is very – it’s paced a lot of attention to the margin and trust me we do too. So, we monitor the margin situation of both our network as well as the hospital spirit carefully. So, to answer the first question, there are some high priced drugs that are not on the essential drug list which, the company – the hospital will be able to charge a higher mark up.

But the general guidance for the hospital management is to rely less on pharmacy sales. So, our target generally is to limit the contribution in revenue from the pharmacy side to about 40%. And one way to improve our revenue, the reason that we have confidence in going to achieve the revenue growth of 40% year-over-year is that – you’re right that the bed utilization rate is pretty high, it’s above 90 but we see that the general minutes of stay in the hospital is long.

So, in order to – now it’s about 10 days on average so, one way to improve the contribution from the in-patient service is to accelerate the bad turnover – so that for instance instead of average patients stay in hospital for 10 days, if we improve it by to eight or nine days, to overall capacity for our in-patient is going to grow – you can do the math, it’s going to grow from there.

So, that’s one way that we need to grow our top line. And for out-patients growth, so the assumption is that first we’re going to improve the patient pay-off which is at very low level at this moment. So, if we improve that – that’s going to have a contribution to our revenue growth. And once the revenue for out-patient – per capital level which is threshold – going to see improvement on gross margin.

While the SG&A for the hospital is pretty stable, so we’re now going to see line by line growth from the SG&A expense. So, that is why we’re confident that the profit margin, the net profit for our hospital is still growing next year as well.

Sean Wu – JP Morgan

Well, thank you. I think you answered my question was well covered. Only the net margin and operating margin side, can you elaborate a little bit more?

Adam Sun

The net margin, I would say, the 10% estimate is pretty accurate.

Sean Wu – JP Morgan

Okay, thanks.

Adam Sun

On the net margin side, I think 10% is a pretty good estimate. Thank you.

Operator

Thank you. (Operator Instructions). There are no further questions at this time. And we are now approaching the end of the conference call. I would now turn the call over to Vickie Zhao from Solebury Communications for the closing remarks.

Vickie Zhao

Once again, thank you for joining us today. Please don’t hesitate to contact us if you have any further questions. Thank you for your continued support.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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