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China Cord Blood Corporation (NYSE:CO)

F3Q 2013 Earnings Conference Call

February 27, 2013 08:00 ET

Executives

Joeling Law - Investor Relations

Ting Zheng - Chief Executive Officer

Albert Chen - Chief Financial Officer

Analysts

Yi Chen - Aegis Capital

Brian Tanquilut - Jefferies

Alberto Bassetto - Jayhawk Capital

Operator

Welcome everyone to China Cord Blood Corporation’s Earning Call for the Third Quarter and first nine months of fiscal year 2013. All participants lines will be placed on mute during the presentation, after which there will be a question-and-answer session.

Now I’d like to introduce Ms. Joeling Law to begin the presentation.

Joeling Law - Investor Relations

Good morning everyone. Welcome to our earnings conference call for the third quarter of fiscal 2013. And press release discussing our financial results as already been released and the copy is available on the company’s website. During the call, our management team will summarize corporate developments and financial highlights for the quarter. A question-and-answer session will follow.

Before we begin, please note that today’s discussion will contain forward-looking statements that are subject to certain risk and uncertainties and actual results could be materially different from these forward-looking statements. Kindly refer to our SEC filings for detailed discussion of potential risk. In the interest of time, we will begin with our CEO’s English remark. After discussing about the third quarter financial performance Mr. Albert Chen will be available to answer questions during the Q&A session.

Let’s begin our presentation.

Ting Zheng - Chief Executive Officer

Good morning everyone and welcome to our earnings conference call. I’m very pleased to report impressive performance in the third quarter of fiscal 2013 and share with you our splendid accomplishments as a result of management continuous efforts to improve market positioning and optimize business strategies. Our revenues, operating income, cash flow and new subscriber numbers have all reached the new heights in this quarter.

Achievements in this quarter are especially highlighted by our new subscriber numbers, as they exceeded the 20,000 mark for the first time, making both a new quarterly record and the base to high since CCBC was established. And a list of strong market demand, our management team continues to swiftly employ various sales and marketing strategies and successfully developed our new customer recruitment efforts. Our new record of 21,218 new subscribers in the third quarter of fiscal 2013 represents a 65% year-over-year increase and an approximately 15% quarter-over-quarter growth.

With the additions in new signups this quarter our accumulated subscriber base has extended to a total of nearly 300,000 and 295,923. The relative growth in new subscribers along with the successful implementation of our high-end focused pricing strategy not only filled our revenues to reach RMB149 million but also posted substantial cash flow for the group.

In the first three quarters of this fiscal year we have already recorded accumulated operating and cash inflow of approximately RMB424 million. Such strong cash flow enables us to accelerate our China expansion plan and it is also a testimony to the effectiveness of our business model in generating both lucrative profits and enormous cash inflow.

Our continuous accomplishments represent the hard work, to the dedication and efforts management team has put in nurturing CCBC. This year’s of extensive experience in the industry and self-knowledge about Cord Blood Banking Services. In conjunction with our ability to accurately predicting these three trends and approximately - appropriately capture market demand. We have constantly delivered exciting performance and reached new highs, truly distinguishing our results from our peers because of our fundamental standard. With swiftly implementation of market development strategy combined with the exclusivity state has brought by the “one license per region policy”. We have successfully established strong brand recognition in our existing markets and continued to reinforce brand awareness.

Building on such solid foundation our business continues to devote resources in expanding our markets. And through innovating and the diversified pricing strategies we are committed to raise that the awareness in the Cord Blood Banking Services along our targeted customer segment.

Last but not least in light of the baby boom in the “Dragon Year” these efforts all propelled our record growth in new subscriber numbers. Not only that we are pleased with our robust financial achievements we are also excited about our accomplishments of various strategic milestones.

Having set out both long-term and short-term goals, we have laid our solid foundation for the future expansions through improved corporate structuring not only that we have increased our ownership to wholly own our long-term operation but also increased our equity interest in the Shandong Cord Blood Bank to 24%. Step by step we have achieved the short-term goals of our geographic expansion plan.

Following strategic investments from KKR and having Mr. Kam as our Chairman. We have strengthened our capital base as well as gained valuable managerial expertise to further improve management and operational efficiency, service quality and corporate governance, benefiting from trends such as the authorization of the first year Chinese (cities) and the China’s one-child policy. We will continue to invest in our marketing channels for the purpose of defending our market penetration in Beijing, actively monitoring the expansion of the Guangdong facility and preparing for the construction of a new facility in Zhejiang. A site from our existing regions, we are close – also closely following potential expansion opportunities in other regions within China, aiming to fulfill the medium term objectives in our China expansion plan.

Although, we have laid a solid foundation in our operational structure approving hospital network and have an effective marketing strategy in place. Our management team is committed to maximize shareholders value through continuously refining our market strategies in-housing our service quality and reversing our sales and payment methods to respond to dynamic market conditions.

This concludes my overview of the third quarter of fiscal 2013. I look forward to share our developments with you in our next earnings call. I would like to once again thank you for your support of China Cord Blood Corporation.

Now let me turn the call to Mr. Albert Chen to review the financial highlights of the third quarter.

Albert Chen - Chief Financial Officer

Good morning everyone. Further to our CEO remarks, let me reiterate that the astonishing financial and operational accomplishments recorded during the third quarter is not a simple function of the “Dragon Year” baby boom. But also the outcome of our years of dedicated efforts to grow and nurture our addressable market in China, all which are starting to pay off now.

New subscriber sign-ups for the third quarter jumped 65% year-over-year to 21,218, representing approximately 15% quarter-over-quarter increase. Guangdong remained the major contributor in terms of new subscribers, meanwhile the customer mix in terms of payment methodology remains largely similar compared to both the first and the second quarter of fiscal 2013.

With new subscribers continue to ramp up, accumulated subscriber base reached 295,923 as of December 31, 2012, representing more than 31% increase year-over-year. Revenue generated from processing fees and storage fees grew 67% year-over-year and 32% year-over-year respectively.

Total revenues for the third quarter searched more than 57% to approximately RMB149 million. Primarily driven by the robust growth in new subscribers, if you notice that there have been change in the revenue mix with processing fees accounting for more than 77% of third quarter top-line, as compared to the 72.9% of the same period last year. This is attributable to a crowding out effect, due to the search in new subscriber numbers. Storage fee now accounted for a lower 22.6% of third quarter total revenues, compared to approximately 27% in the same period last year.

We also reported a four percentage points increased in gross margins to approximately 81%. The model expansion is largely driven by economies of scale, given the huge search in new subscriber numbers and effective cost control measures, which offset the impact of higher labor cost and raw material cost.

Third quarter gross profit went up more than 65% year-over-year to approximately RMB121 million. We continue to invest in our sales and marketing network to support ongoing business growth and rising market demand. By bringing up our sales force, we aim to cast even wider network, so that we can soon better capture and tap market opportunities especially in markets such as Guangdong and Zhejiang. As our sales and marketing effort become increasingly cost effective sales and marketing expenses grew as a slow pace of approximately 47% year-over-year.

Meaningfully less than our 65% year-over-year increase in new subscriber numbers. Third quarter sales and marketing expenses as a percentage of total revenues trended down to approximately 16.6% less than the 17.9% as reported a year ago which is inline with management expectations. The combined effect of our robust top line growth and economies of scales have offset the higher label cost and transactional cost incurred in relation to the copper restructuring exercise.

As a result third quarter general, administrative expenses as a percentage of total revenue declined to approximately 18% compared to 24% in the same period of last year. In terms of absolute dollar amount we recorded approximately RMB27 million in third quarter general and administrative expenses, representing a RMB2 million cost reduction as compared to the second quarter of fiscal 2013 which is again consistent with our expectation.

As a result of the increased new subscribers higher operational efficiency effective marketing and promotion activities and prudent cost controls. Operating income search is more than 112% to RMB67.1 million for the third quarter of fiscal 2013. Our operating margin also expand to 45% as compared to 33.2% in the prior year period not to mention it’s up from 36.6% in the previous quarter as well.

Depreciation and amortization expense for the third quarter increased modestly to RMB8.4 million that largely because of our new Guangdong facility build out. In terms of non-operating items a few areas we’re highlighting including higher interest expense which largely relates to the convertible notes issued to KKR and Golden Meditech during fiscal 2013. This amount includes the convertible notes annual coupon interest payments of RMB12.7 million and the amortization charge of other related costs of RMB10 million.

No such cost was recorded during the third quarter of fiscal 2012. In this quarter we also recorded a dividend income contributed by our Singapore listed affiliate Cordlife Group Limited while no such dividend income was recorded in the same period of last year. Lastly we also recorded a RMB1 million exchange loss in the third quarter of fiscal 2013 compared to approximately RMB3.5 million exchange gain of last year.

Looking at the profit before tax line we recorded a solid 30% year-over-year increase in profit before tax as our strong fundamental business growth outpace the increase in non-operating related expenses. In the third quarter of last year we recorded an one-time tax benefit when our PRC subsidiaries receives the high and new technology accreditations from the local PRC types authority. Resulting in a positive tax credit being added back to last year bottom line or same period last year’s bottom line. No write back was recorded in the third quarter of this year. Now due to the absence of such tax write back net income attributable to the company for the third quarter of fiscal 2013 trended down on a year-over-year basis to a RMB33.6 million.

Now, basic and diluted earnings per share for the third quarter were RMB0.42. In terms of operating cash flows, operating cash flow remained robust in light of the favorable climate and stable adoption of upfront payment scheme. Third quarter operating cash inflow, net operating cash inflows totaled RMB144.1 million.

I think before, I wrap up, let me reiterate the whole point. We are very pleased with our third quarter performance and remain optimistic about the prospect across our various operating regions. We have made tremendous progress in our facility build out and also streamlined our corporate structure, which enable us to better read the wide ranging opportunities of both – of both the booming Guangdong market and to better capture the emerging opportunities in the Zhejiang market as well. Ultimately we aim to bring even better services to our clients and generate high and even more lucrative return to our shareholders.

I think that’s pretty much concludes my overview, and I think, we can now move on to Q&A session.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we’ll now begin the question-and-answer session. (Operator Instructions) Your first question comes from the line of Mr. Yi Chen from Aegis Capital. Please ask your question.

Yi Chen - Aegis Capital

Hi, thank you for taking the question. My first question is now that we are in the year of Snake how do you anticipate the performance of this quarter will be and how do you anticipate the performance of the coming fiscal year 2014 will be? Thank you.

Albert Chen

Well Yi, hi. Yi, thanks for the questions. It was a good question after all and well as the impact of the ride of the dragon year baby boom is kind of gradually facing out so we’re now moving into the year of the Snakes. When I provided the guidance early on back in June of last year, I recall that guidance that we offered to all the – in the earnings call for fiscal year 2013 was approximately 64,000 new subscribers. Well now that we’re three quarters into the year and I think, we still are somewhere along the line about like 56,000 new subscribers already.

I’ll prudently suggest that you think that our previous - previously provided full year guidance seems to be slightly edging on the conservative side. Now but with that being said you’ll need to be aware that the January, February and March quarter tend to be a low season based on our historical experience and so this is not surprise to see a sequential decline by comparing the March quarter to the December quarter, which is normal in our case. But I think, I think, we’re recently optimistic about the fourth quarter performance and even though our previously provided guidance for fiscal 2013 may seem to be edging on the conservative side it is also not our policy to revise our previously provided guidance I hope you can understand that.

Yi Chen - Aegis Capital

Okay.

Albert Chen

On your questions regarding fiscal 2014 let’s just say that I think by as we get more and more feedback from our (frontline) and also based on the discussion that we have internally let’s just say that we’re becoming increasingly optimistic or positive or even more also I use the word upbeat regarding the outlook of our – regarding our operational outlook for fiscal 2014. The guidance for fiscal 2014 won’t be available until June so I hope you understand.

Yi Chen - Aegis Capital

Okay. My second question is regarding the fairly new Chinese government policy that if the husband and wife of a company for both sides of a couple and if they are – they are the only child of their respective families then they can probably have a second child? So, I don’t know if that policy has any effect for your – any impact on your revenue especially in the regions that you cover in China?

Albert Chen

You actually bring out a very good point, Yi. This - the exemption which we called has been enacted not officially though but we have seen exceptions being granted in several parts of the countries and even in regions where we operate, but funny thing is that for example you are seeing Guangdong and Zhejiang as an example.

Probably because of the, I mean internal and even though this is not official like statistically accurate question I’ll answer for that I tried to answer to that as the best I can. But these and these are experiences that even though the parents both let’s say from a single-child family they are eligible to apply to and have a second child. But the funny enough is that most of the people choose not to have a second child because of various reasons some of that may be because of the cost of living and some of that may be because of various economical reasons.

Now, with that being said, I think based on now that we are in probably the 10th year since we commenced the operations. We as far as we can tell we haven’t seen a material impact in terms of our line of businesses and one will have to speculate that okay so if every family is eligible to have two child let’s say so instead of having one again and wait for have a second one. Would it mean that China will all of a sudden become a country that generate 32 million babies per annum is $16 million that is the substantial exponential increase in terms of addressable market. So I tend to look at it that way.

Yi Chen - Aegis Capital

Okay, My final question is regarding the share buyback program, could you update us on how much is lapsed currently?

Albert Chen

These mandate that we get from the report are still valid, so we have the, I’ll say the mandates to purchase no more than US$8 million worth of the equity from the open market. And that’s what’s left for the mandate until the mandate get renewed. I think based on where we are right now because we just recently completed the restructuring exercise with Cordlife, our total share count as of the end of December is about 73.1 million shares.

Yi Chen - Aegis Capital

Okay, thank you.

Albert Chen

Thank you.

Operator

Thank you for your questions. Your next question comes from the line of Brian Tanquilut from Jefferies. Please ask your question.

Brian Tanquilut - Jefferies

Hey Albert, congratulations.

Albert Chen

Hey Brian.

Brian Tanquilut - Jefferies

A follow up on these questions on the 2014 target that you made and thanks by the way for making those comments, is it safe to assume that volume growth or a new subscriber growth will be positive in fiscal 2014 even with the Dragon Year expired?

Albert Chen

I think it is a fair assumptions I noticed that there are, there may be some people who potentially anticipate a sequential decline in terms of new subscriber number where we moved into fiscal 2014. I will suggest that based on all the evidence that we have gathered so far and the feedback that we have is definitely not the case. So, we seem that we are definitely look forward we’ll continue to be committed to seek growth in as we move into the fiscal 2014. I think like I said I mean with all the discussions and also the market responses and market feedback we are actually getting increasingly more and more upbeat about this outlook into fiscal 2014.

And if you look beyond the seasonality of moving into, moving away from Dragon Year into the Year of the Snake I think overall we still try to maintain a steady and healthy growth momentum and I think right now based on our level of penetration in the Guangdong market as well as the and Zhejiang market I think we are reasonably comfortable to continue to deliver reasonable growth to our investor.

Brian Tanquilut - Jefferies

Okay, thank you for the comment and then, because you mentioned that Guangdong market, do you mind providing us an update on the progress on your new facility in that market?

Albert Chen

Oh okay, in terms of the new facility build out in the Guangdong market we have entered into the, I’ll say renovation and refurbishment phase right now, now that the property has been acquired. We based on the estimated timeline right now prudently I would suggest that we look it at a completion time sometime in between the fourth quarter of the current calendar year. So that’s like the prudent assumption.

Brian Tanquilut - Jefferies

Okay got it, and then last one for you gross margin was really strong this quarter just wondering what your thoughts are in terms of how we should be forecasting margins going forward I know you guys are doing a good job controlling expenses but I just wanted to hear your thoughts on how we should plan ahead?

Albert Chen

Okay, the in terms of the gross margin this – the gross margin start an expansion in the third quarter has something to do with the searching volume as well as the cost control measure that we have in place. But I think it is reasonable to assume that in light of the fact that – we are now moving into the March quarter. And like I mentioned early this is fair to assume a sequential decline by comparing the fourth quarter to the third quarter so I guess it is reasonable to assume that the margin or the gross margin should trend down modestly back to the more normalized level. If you look at our historical gross margin which has been gradually increasing on a year-over-year basis but it trends to, are they are the recent the most recent normalized range will be somewhere between 77% to 79%.

Brian Tanquilut - Jefferies

Okay.

Albert Chen

We do anticipate this is fair to assume a slight modest retraction in terms of the gross margin.

Operator

Thank you for your questions. (Operator Instructions) We got the next question coming from the line of Mr. Alberto Bassetto from Jayhawk Capital. Please ask your question.

Alberto Bassetto - Jayhawk Capital

Hey Albert congratulation for the quarter.

Albert Chen

Thank you, Alberto.

Alberto Bassetto - Jayhawk Capital

Couple of questions, can you comment on the quarter CapEx and along with that can you also provide an update on the Zhejiang expand development I would say?

Albert Chen

In terms of capital expenditure which incurred in the third quarter of fiscal 2013 CapEx wise we incurred about approximately RMB44 million in this quarter and all of them are related to the construction of the new facility and or the expansion of our Guangdong facilities. Now, we make some really promising and positive progress in terms of the Zhejiang facility build out and I am hoping that this is something that can be materialized in the very near term. Once we announce the transaction I’ll be able to provide the details or more color on that but I think for time being lets just say that we are making significant progress in that development I think it wont be long before we actually make a meaningful move.

Alberto Bassetto - Jayhawk Capital

Okay. And okay and then different question is a can you tell me the it seem like last question for the quarter the breakdown in terms of payment regular upfront and the installment?

Albert Chen

In terms of the new customer breakdown by payment methodology is approximately 56% of new clients chose the standardized or normal payment scheme which is upfront processing fee and then they pay the annual storage fee every year. Approximately 37% of new subscriber chose bullet payment which is consistent with our patent as reported in the prior quarter as well and approximately only above 7% people do the installment now.

Alberto Bassetto - Jayhawk Capital

Okay. It’s pretty stable as we got strength.

Albert Chen

Yeah it has to be relatively stable.

Alberto Bassetto - Jayhawk Capital

Okay. And my last thing I would just more asking for a comment, is that fair to assume that the healthy cash flow that you generate this quarter or you’ve been generating for many quarters at this point should be kind of sustainable going forward would you comment on that and that is my last question.

Albert Chen

The amount of operating cash flow generated from our daily operations is to a certain extent a function of subscriber side. So it will probably overall trend up or down in line or in consistent with our new subscriber numbers. Now with that being said we have make this very clear that even since 2011 we have repositioned ourselves and going after the mid to high end income bracket within our addressable market and with that in mind right now I think it is prudent to assume that the customer pattern or payment methodology pattern are likely to stay. So with that in mind, I’m reasonably comfortable to – and to expand that the cash flow we generated from daily operations should be sustainable unless we change our business model once again.

Alberto Bassetto - Jayhawk Capital

Okay.

Albert Chen

But right now there is no avenues leading me to believe that.

Alberto Bassetto - Jayhawk Capital

Okay that’s great. Thank you very much.

Operator

Thank you for your questions. (Operator Instructions) We appear to have no further question at this time. Now I like to hand the call back to Ms. Joeling Law for closing.

Joeling Law - Investor Relations

This concludes our earnings conference call for the third quarter of fiscal 2013. Thank you for your participation and ongoing support. Have a good day.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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