China Medical Technologies, Inc. FY4Q06 (Qtr Ending Mar 31, 2006) Earnings Conference Call Transcript (CMED)

| About: China Medical (CMEDQ)

China Medical Technologies Incorporated (CMED)

FY4Q06 Earnings Conference Call

June 16, 2006 9:00 am EST


Tip Fleming - Medical Investor Relations Advisor

Xiaodong Wu - Chairman and Chief Executive Officer

Charles Zhu - VP of Business Development and Investor

Sam Tsang - Chief Financial Officer


Vicky Chen - UBS

Patrick Lin - Primarius Capital

Beau Tan – Lehman Brothers

Good morning and welcome to China Medical Technologies fourth quarter earnings conference call for the fiscal year ending March 31, 2006.

(Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Mr. Tip Fleming, China Medical Investor Relations Advisor from Christensen.

Please proceed sir.

Tip Fleming

Hello everyone. I’m pleased to welcome you to China Medical’s fourth quarter earnings conference call. The Company announced its fourth quarter and full year results about two hours ago. A copy of the press release is also available on the Company’s website at

Today, your speakers will be Mr. Xiaodong Wu, China Medical’s CEO; Charles Zhu, VP of Business Development and Investor Relations; and Sam Tsang, CFO. After they are finished with their remarks they will be available to answer your questions.

Before we continue, please bear with me as I take you through the Company’s Safe Harbor policy. The discussion today will contain forward-looking statements made under the Safe Harbor Provisions for the US Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties; as such results may be materially different from the views expressed today. A number of potential risk and uncertainties are outlined in the Company’s public filings with the US Securities Exchange Commission. China Medical does not undertake any obligation update forward-looking statements except as required by applicable law.

As a reminder, this conference call is being recorded. A replay of this conference call will be available via webcast on China Medical’s website.

Now allow me to turn the call over to Mr. Wu. Mr. Wu will speak in Chinese and Charles will translate Mr. Wu’s remarks in English.

Xiaodong Wu


Ladies and gentlemen, welcome to China Medical Technologies conference call. We will share some of our achievements for the fiscal year ending March 2006.

In the past fiscal year, net revenue and net income increased 70.9% and 68.1% respectively from the last fiscal year. Net income exceeds the top end of the guidance we provided last year by 5%.

I’m also very confident that we will maintain a healthy growth momentum in the coming fiscal year. My confidence is mainly based on the following three drivers:

First of all, I’m very proud, as our engineering team has managed to develop a series of novel technologies. Its source improvement makes for more precise cancer treatment for our HIFU. The biggest breakthrough has been in the non-invasive temperature measurement technology that can collect normal data as the focal point of the treatment area in real time. This technology will be available with our third generation product that we plan to introduce around September of this year.

To our ECLIA business: we have been successfully executing our strategy to rapidly penetrate the low-end IVD market. We are also expanding our selections of reagents to 56 in this quarter. This is to cover most of the common amino acid tests.

These strategies have helped position us as the market leader in the low-end [IVD] markets and better prepare us to enter the high-end markets to compete with the multi-national companies once we introduced the fully automatic systems by the end of this calendar year.

In addition to our organic growth strategy, I want to also share with you my thoughts about our M&A strategy. We are domestically screening and positioning targets which complement our strategy of growth. We would particularly like to get into the molecular diagnostic areas to capture the large and untapped market opportunity in China.

We have also identified several other potential applications for our HIFU technologies and hope to extend the target market to other non-oncology related departments within the hospital. We will research these trends in more details once we reach the stage that is appropriate for more disclosure. Thank you.

(Translation ends)

Charles Zhu

Thank you, Mr. Wu. Next, I will discuss our business and operations in more details.

As mentioned by Mr. Wu, both of our business lines have demonstrated strong growth in terms of sales performance as well as new technology delivery. During the fourth quarter that ended in March 2006, top line revenue increased 50.5% year-over-year to RMB111.7 million; and net income increased 75.1% year-over-year to RMB69 million .

Sam will go through the details of our results with you shortly. Before that, I would like to highlight some of the most interesting developments in our business.

For the high intensity focused ultrasound, or our HIFU business, to further promote the acceptance of HIFU in the medical community, we are sponsoring a nationwide study done with initiatives by Ministry of Health, or MOH, and China Medical Association.

The MOH will designate 20 leading hospitals in China to carry out a clinical study. The goal of this study is to set up standards and unified treatment chronicles that are consistent with the international standards for HIFU treatment and to summarize years of clinical experience from over 200 hospitals. With this campaign we hope to establish HIFU as one of the mainstream cancer treatment methods.

Another important topic within the scope of the study will be to verify a biosynergy between HIFU and radiation and chemotherapy. The result of this study is expected to create additional commercial opportunities for the Company in the future.

As HIFU becomes more accepted by the medical community, we do see more companies that are becoming attracted to the market including some multinationals and domestic companies. However, our engineering team has been leveraging their almost ten years of HIFU experience and continue to develop innovative technologies ahead of our competitors.

In addition to the real-time temperature measurement technology, we are also improving our other aspects of our HIFU system by introducing a more precise treatment planning software and a respiration tracking system that adjusts the transmitting pulse as the as the patient breathes. As we are upgrading our systems, we are also planning to increase our selling price by 5% for the third generation product.

In the past, about two-thirds of our HIFU sales came from large hospitals and the remaining from medium-sized hospitals. This year we’ve seen the trend that more and more medium-sized hospitals are buying our HIFU systems.

Now the percentage of purchases from mid-size hospitals has increased to over 40% of total sales. We increased the number of distributors to 20 to better penetrate the 6,000 large and medium-sized hospitals in China. We have been able to maintain our market share above 70%, despite more competition from new entrants.

Lastly for HIFU, we continue in our preparation for the FDA clinical trial. We had a meeting with the FDA officials in early May to confirm this first intended use and the indication for FDA trials. We will start this study on pancreatic cancer for end-points including pain variation, improvement of quality of life and the extension of survival period.

Our primary investigator from the medical school of the University of Washington is doing animal tests and hopes to get approval to start a clinical trial on patients towards the end of this year or early next year.

As for our in-house ECLIA IVD business, this year is the first full year results for this business, which was launched in September, 2004. Since then, we have been growing this business rapidly, and it now makes up about 34% of our total revenue this fiscal year, which is a very significant jump from 20% last year.

We achieved several milestones in product development, as well as expanding our distribution network. We produced the first ten units of fully automated systems that are running test trials now. We expect to get SFDA approval by the end of this year, and then formally launch this product to market. This product will effectively expand our target customer segment to all 18,000 small, medium and large hospitals in China.

In order to cover such a large target market, we have increased the number of distributors to about 100 across China.

As the strategy to increase our competitiveness, we are expanding our reagent offering rapidly to 56 different types in this quarter, including many of the most common tests for amino acids such as thyroid disorders, pituitary, infectious diseases and others. By the end of this fiscal year, we are targeting to offer over 80 reagents, which makes us one of the most complete reagent providers in the industry.

Our new HIV test reagent has completed development, in collaboration with the Center of Disease Control in China and is now going through clinical trials. We will promote this product to 3,000 CDC offices in China, in addition to the hospital labs.

In the upcoming fiscal year, we will continue to drive our market penetration as well as the utilization of these installed bases to generate higher recurring revenue from the reagent sales. We are confident that our ECLIA product will become an even bigger contributor for our Company’s business in the near future.

At this time I would like to turn the call over to Sam so he can give you an overview of our first quarter results.

Sam Tsang

Thank you, Charles and welcome everyone. Since most of you have seen our earnings release by now, I will try to keep my comments short. We will be happy to take your questions afterwards. Our financial performance in the fourth quarter demonstrates our continued growth. Net revenues were up 50.5% year-over-year, and 1.1% sequentially to RMB111.7 million, or $13.9 million.

The Company’s revenues are divided between our HIFU system and our ECLIA system, which includes sales of ECLIA analyzers and reagent kits. Revenues from the sales of the Company’s HIFU system were up 34.1% year-over-year, but decreased 3.8% sequentially to RMB73.9 million or $9.2 million.

The slight decrease in HIFU system sales compared to the third quarter was due to seasonality in the HIFU business. As discussed in our previous earnings calls, the December quarter – which is the third quarter in our fiscal year – is typically the best quarter for the sales of our HIFU therapy system. Our June quarter is typically the slowest quarter. Therefore, HIFU therapy system sales in the June quarter, our next quarter, will be impacted by seasonality again and will show a lower amount of revenue compared to the fourth quarter.

Revenues from the sales of the ECLIA system were up 97.9% year over year and increased 12.2% sequentially to RMB37.8 million or US$4.7 million. The significant year over year increase in the Company’s ECLIA system sales primarily is attributed to the increase in recurring revenue from the sales of our ECLIA reagent kits that are used with our ECLIA analyzers. We were selling 38 types of reagent kits and we will offer a number of new reagent kits for other applications in the near future.

Overall, our full year revenues were up 70.9% year over year to RMB371.8 million or $46.4 million. The full year net revenues were within our guidance range.

The gross margin decreased slightly to 70.1% this quarter from 70.4% in the previous quarter. The full year gross margin did not change and remained at 70.3%.

Our operating expenses increased more than two times year over year and 15.1% sequentially to RMB25.1 million or $3.1 million. These increases in operating expenses were primarily due to headcount additions as a result of the expansion of operations; the costs associated with the initial stage of applying for U.S. FDA approval for our HIFU therapy system; the costs related to continued product development for all our products; increased marketing activities; expenses incurred as a result of becoming a public company; and higher performance bonuses to employees.

Operating expenses as a percentage of revenue increased to 22.5% for this quarter. Full year operating expenses also increased to RMB68.0 million or $8.5 million, which accounted for 18.3% of our full year revenues.

Other income was up significantly year over year at 55.3% sequentially, to RMB5.9 million or $0.7 million. The increase was primarily a result of the fee received from the arrangement of the secondary offering of the Company’s ADS that were sold by certain shareholders in March 2006. Full year other income was increased significantly to RMB9.8 million or $1.2 million.

Interest income increased significantly to RMB7.2 million or $0.9 million for this quarter. The increase was primarily due to interest income that was generated from the net proceeds received from our IPO in August 2005 and an increase in bank interest rates. Full year interest income also increased significantly to RMB14.0 million or $1.7 million.

The income tax credit of RMB2.8 million or $0.3 million for this quarter was primarily due to our PRC subsidiary which received an approval from the tax authority in February 2006 for the extension of its income tax concession. The income tax rate for the subsidiary was reduced from 15% to 10% for a period of three years, starting from January 2005.

As a result of the tax concession, we reversed the income tax accrual as of December 31, 2005 by approximately RMB8.8 million and credit to our income tax expenses in this quarter. The full year income tax expenses was up 52.1% to RMB18.1 million or $2.3 million as a result of higher income before tax.

As a result, the cumulative effect of the factors that I just mentioned for the quarter was a 75.1% year over year increase and 21.3% sequential increase in our net income to RMB69.0 million or US$8.6 million.

Full year net income was up 68.1% to RMB199 million or $24.8 million. The net income exceeds the high end of our guidance range by 4.7%.

Our cash flow from operating activities was RMB83.9 million or $10.5 million for this quarter; and RMB176.5 million or $22 million for this fiscal year. At March 31st 2006 the Company’s cash balance was RMB843.8 million, or $105.3 million. Accounts receivable at March 31st, 2006 was RMB155.8 million or $19.4 million. The accounts receivable balance was in a healthy condition. The [turnover days were about 45 months] and are in line with our credit terms.

Because we monitor our accounts receivable and do not have significant overdue accounts, we expect the turnover days to go down because of high revenue generated from ECLIA reagents in the future.

The credit terms of ECLIA reagents are softer than those of our HIFU system and ECLIA analyzer.

We will provide our guidance for estimated annual net revenues and annual net income for the fiscal year ending March 31st 2007 when we report our June quarter’s financial results.

This concludes our remarks. Now we are happy to take your questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Vicky Chen - UBS.

Vicky Chen - UBS

Hi, good morning over there. I would like to ask a few questions. I actually just want to ask about the HIFU and ECLIA. For each category of product, how many units have been sold in the last quarter for each category?

(Question translated to Mandarin)

Sam Tsang

The HIFU units we sold in March quarter is 27 units.

Vicky Chen - UBS


Sam Tsang

27. We sold 28 units in our December quarter. For ECLIA analyzers we sold over 280 units this quarter.

Vicky Chen - UBS

On the split of the revenue, sales between kits and the machine sales in ECLIA, do you have that split?

Sam Tsang

Right. The proportion of revenue from ECLIA reagents composed the whole of the ECLIA revenue, actually increased this quarter to slightly over 50%.

Vicky Chen - UBS

Okay. Thank you

Sam Tsang

Thank you.


Our next question comes from Patrick Lin - Primarius Capital .

Patrick Lin - Primarius Capital

Hi. A great quarter, guys, as far as performance. Can you please tell me; you guys have grown 55%, 60%, 65% -- if not 70% over the last several years. I know you’re not giving guidance until after June, but in terms of your Company’s corporate goals for growth over the next year or two, is there a percentage number -- whether it’s 40%, 45% or more -- that you feel comfortable in terms of shooting for as a target or goal?

Charles Zhu

Hi, Patrick, this is Charles. We will give out the guidance later next quarter, but in terms of the growth rates you mentioned, we’re very confident that we can achieve at least a 40% growth for the next one to two years.

Patrick Lin - Primarius Capital

Great, thank you. I’ll get back in the queue.


(Operator Instructions) We have a follow-up question from Patrick Lin.

Patrick Lin - Primarius Capital

That’s what happens when the operator makes you ask only one question. I wanted to find out a little bit more here about the plans that you have for the reagents side of the business.

Traditionally, you have had a lot of products that are available already. Were there some proprietary reagents that you were working on, possibly in the AIDS area? Maybe you could talk a little bit about that? Then I have a quick follow-up.

Charles Zhu

Right now all of the reagents we are offering cover the most common tests, but as we mentioned, we are also developing the HIV test reagent. This is very unique technology, based on the ECLIA technology platform. It should be a unique technology. [I don’t know all of the sensors] we would get –

[Inaudible – break in transmission]

through the CDC network, as well as to the hospital labs. So for those reagents, we are doing test trials right now and we hope we can get the fast-track approval from the Chinese government and launch to market this year.

Patrick Lin - Primarius Capital

Okay. In looking at your balance sheet, it looks like you have a little bit over $4 per share in cash, and your stock is trading right now at about $22 and change.

We get about $18 of enterprise value here that is going to make $1.40 or $1.50 this year. Only about 12X or 13X PE for growing 40%. So I am curious, what do you think might be some of the investment pieces or things that U.S. investors might be missing? Because usually medical companies growing at 40% plus do not have a 15X PE number. The stock right now is down about 7%.

Charles Zhu

First, we are a very young company, a public company. This is the first annual results we have delivered as a public company. I think this actually demonstrates more of a track record of delivering our results, as the investors were getting more confidence in the Company.

Also, we are starting the clinical trials in the U.S. and there will be more clinical benefits results coming out of U.S. hospitals. We are also discussing with some leading hospitals in the U.K. to carry out the applications trial as well.

We are expecting that we will deliver more clinical study results to the medical and investment community to prove the clinical benefits of our HIFU technology.


The next question comes from Vicki Chen – UBS.

Vicki Chen – UBS

I have another question regarding the acquisition previously talked about. Have you identified the target, the final targets being ready to pursue, or is it still in the process to seek the right target?

Charles Zhu

For both business lines we have identified several targets and right now, we are in the stage of learning more about their products and technologies. We expect we will get to the next stage of evaluation this year for one of the projects.

Vicki Chen – UBS

So is it a Company acquisition, or is it more like a project-based acquisition?

Charles Zhu

It is a Company acquisition.

Vicki Chen – UBS

Thank you.

Charles Zhu

Thank you.


Our next question comes from Beau Tan – Lehman Brothers.

Beau Tan – Lehman Brothers

Hi. Just a quick question on the reimbursement situation. Can you talk a little bit more about the reimbursement situation for both products? Thank you.

Charles Zhu

For the HIFU technology, right now in China we have eight provinces in the eastern and southern regions of China that have already included HIFU treatment in the reimbursement policies. Most of the provinces in China have also submitted the pricing guidance for the HIFU treatment.

So once each province has the price guidance, they will start the reimbursement policy for HIFU treatment. So we expect for the more HIFU penetrated region in the eastern area of China, there will be more provinces that include HIFU into their reimbursement policy. So once it is covered by this policy, the patient will get 70% reimbursed for the HIFU treatment.

For the ECLIA diagnostic, actually this is already an established technology in the large hospital segment. This diagnostic service is already included in all of the reimbursement policies in China.


At this time there are no more questions. I would like to turn the call over to Charles Zhu. Please proceed, sir.

Charles Zhu

Okay. Thank you everybody for joining the conference call. Have a good day.


Thank you for your participation in today’s conference. This concludes the presentation. Have a wonderful day.

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