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China Cord Blood Corp (NYSE:CO)

F4Q 2013 Earnings Call

June 19, 2013, 8:00 am ET

Executives

Joeling Law - Investor Relations

Tina Zheng - Chief Executive Officer, Director

Albert Chen - Chief Financial Officer, Director

Analysts

Paul Nouri - Noble Equity Fund

Yi Chen - Aegis Capital

Brian Tanquilut - Jefferies

Alberto Bassetto - Jayhawk Capital

Operator

Welcome everyone to China Cord Blood Corporation's earnings call for the fourth quarter and full year of this full 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 would like to introduce Ms. Joeling Law to begin the presentation.

Joeling Law

Good day, everyone. Welcome to our earnings conference call for the fourth quarter and full year 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 a detailed discussion of potential risks. In the interest of time, we will begin with our CEO’s English remark. After discussing our fourth quarter financial performance, Mr. Tina Zheng, our CEO and Mr. Albert Chen, our CFO will be available to answer questions during the Q&A session.

Let’s begin our presentation.

Tina Zheng

Good morning, ladies and gentlemen. It is my pleasure to give everyone a warm welcome to CCBC's earnings conference call and together with stellar result of our fourth quarter and has been an eventful fiscal year of 2013 with many accomplishments. We still have our fiscal 2013 target of 64,000 new subscribers by a significant margin which was due to effective sales and marketing strategies and from our success in penetrating the high-end market segment.

In terms of strategic expansion, we consolidated our corporate structure and now wholly own the Guangdong blood bank and its subsidiary. We have also increased our stake in the Shandong cord blood bank to 24% to meet the rising demand in the regions in which we operate. The construction of our new Guangdong facility is well underway and the preparation work of building the Zhejiang facility is also in full swing.

Moreover, we are pleased to announce that our Beijing subsidiary was granted the internationally recognized the AABB Accreditation, as a demonstration of our long term commitment to continued improvement of quality services to our customers. Although we have moved away from the Year of Dragon in the fourth quarter, we believe that our cord blood banking services will continue to be in strong demand due to the increase in public awareness and brand recognition among the general public. With years of dedicated efforts in the industry, CCBC's leading position is notable through its solid foundation and development.

The group maintained a steady growth in the fourth quarter of fiscal year 2013 adding 16,059 new subscribers during the quarter and a 12% increase year-over-year. Our total new subscribers in fiscal 2013 were up 34% year-over-year to 72,228 and the accumulated subscribers have already exceeded 300,000 as of March 24, 2013 to a total of 311, 982.

Looking ahead to fiscal 2014, it will be a year of both challenges and opportunities. After the Year of Dragon, we expect the birth rate in China to return to a normalized level following an exceptional year in fiscal 2013 facing a decline in birth rate. The management team will focus on improving market penetration in our core markets of Beijing and Guangdong. Furthermore, the construction of the Zhejiang facility has already begun and we aim to accelerate this facility to operational state as quickly as they can, in order to reap the economic benefits of our Zhejiang operation.

Meanwhile, we are also pleased to reach the capital expansion progress at our Guangdong facility. Upon completion of the expansion, the Guangdong storage facility will possess a capacity of approximately 800,000 units in (inaudible). We hope that this new facility will be fully functional by the end of the year alleviating our previous capacity constraints and providing us with additional capacity for growth as we penetrate deeper into the Guangdong market.

For the full year of fiscal 2013, the capital expenditure on both facility construction projects in Guangdong and Zhejiang exceeded RMB210 million. Our strong commitment to quality and such recognition has raised the bar for the group to also set top level quality services at both facilities of Guangdong and Zhejiang. To harmonize our marketing strategies, we believe that it is now appropriate to implement unified pricing across our core markets of Beijing, Guangdong and Zhejiang. As a way to match rising production costs and to balance the additional costs incurred for improving our quality services, we have upwardly adjusted our pricing starting from April 1, 2013, representing the first price adjustment since April 2011.

Our new processing fee has increased approximately 17% to RMB6,800 and the new annual payment is up approximately 58% to RMB990. The new pricing will not only consolidate our reputation as the premium cord blood banking service operator, as we continue to march for higher quality assurance for our customers but also maintain our overall profitability, leveraging on CCBC's dominant market leadership in China in (inaudible) industry, sound financial strength and well received emphasis on quality. The management remain optimistic about attracting the middle to high-end market.

While we will see fiscal 2014 as a challenging year with anticipated decline in subscriber growth, we are committed to maintain a steady and consistent growth in the coming year by optimizing our sales and marketing strategies, enhancing our sales force, expanding our hospital network in both Guangdong and Zhejiang, and to further rationalize our cost structure. Additionally, we believe that current market trends and policies such as China's one license per region policy, rising public awareness of cord blood banking services, recognize the brand quality, as well as the recent upward price adjustment, would be favorable to our business.

Taking all these factors into consideration, the management team maintains cautiously optimistic regarding our outlook in upcoming fiscal year. The target to find up 69,000 to 72,000 new subscribers in the fiscal 2014. I would like to once again thank you for your support of China Cord Blood Corporation. I look forward to sharing our department's resolute in the next earnings call.

Now let me turn the call to our Chief Financial Officer, Mr. Albert Chen to review the financial highlights of the fourth quarter and fiscal year 2013.

Albert Chen

Good day, everyone. For the fourth quarter, we reported a very solid growth in terms of operational as well as financial performance. As a quick overview, in the fourth quarter of fiscal 2013, we recorded approximately north of 15,000 new subscribers during that three-months period. Despite the diminishing effect of the Dragon Year baby boom which has less influence to our subscriber growth in this quarter, but our effective marketing strategy, strong brand reputation and sizeable accumulated subscriber base continued to help us to gain good traction in recruiting new subscribers.

With the healthy increase in new subscriber numbers and the accumulated subscriber base approaching 312,000 mark our group recorded approximately RMB133 million in total revenues during the quarter, which represented approximately 33% year-over-year growth. Revenues from processing fees represented a significant 72% of our total revenue mix, while revenue from storage fees also grew fast, accounting for 28% of the total revenue for fourth quarter.

Fourth quarter gross margin expanded to 79.8% as compared to 76.6% in the prior year period. The 3.2 percentage points improvement in gross margin reflected better economies of scale due to strong subscriber volumes, rising contribution from our storage revenues and effective cost control measures, which in all offset the impact of higher labor cost, depreciation cost, as well as higher raw material cost. Fourth quarter gross profit grew by nearly 39% year-over-year to approximately RMB106 million.

Our sales and marketing expenses increased during the quarter driven by our enhanced market development efforts. In the past few years, we have built a deep and solid foundation in the Beijing and Guangdong markets to increase brand awareness and to penetrate deeply into these affluent core markets. As we move away from the Dragon Year during the fourth quarter of fiscal 2013, we continue to strengthen our sales and marketing efforts by building up our sales force and broadening our reach to targeted middle to high end segment through network expansion.

Sales and marketing expenses in the fourth quarter were approximately RMB26 million, which will result of rising sales activities, as well as our enlargement of sales force. Total sales force in the fourth quarter increased by more than 17% year-over-year. Such an increase underscore our strategy to deepen market penetration in the Beijing and Guangdong regions, as well as tentatively developing the Zhejiang market. As our sales and marketing expenses continue to rise in tandem with our revenue growth, we continue to monitor the efficiency and effectiveness of our marketing efforts and implement cost control measures whenever necessary. As a result, sales and marketing expenses remained at less than 20% of our total revenue, which is consistent with our overall planning.

Fourth quarter G&A expenses as a percentage of total revenues were approximately 20%, a decline from 23% in the prior year period. Despite the higher labor cost and the increase in headcount, we also implement tight cost control measures to combat against the rising cost. As a result, G&A for the fourth quarter was approximately RMB27 million, which was consistent with the G&A expenses reported during the second and third quarter of fiscal 2013.

Operating income increased by approximately 46% to RMB50.7 million for the fourth quarter of fiscal 2013, largely attributable to the increase in new subscriber numbers, improved operational efficiency, prudent cost control, as well as margin expansion. Operating margin expanded to 38.2% as compared to 34.9% in the same period last year.

Depreciation and amortization expenses for the fourth quarter were RMB11.3 million. In terms of nonoperating items, we recorded an interest expense of approximately RMB22 million during the fourth quarter. That was largely attributable to the convertible notes issued to KKR and Golden Meditech, as compared to less than RMB1 million in the prior year period.

The higher income tax expenses pretty much mirrors the robust performance of onshore subsidiaries. However, since a significant portion of our interest expense was incurred outside of the PRC, it resulted in an increase in our overall effective tax rate. At the same time, net income attributable to noncontrolling interest declined year-over-year after we completed our restructuring exercise with our affiliate company Cordlife Group Limited, resulting in our previously non-wholly owned Guangdong subsidiary becoming fully owned by CCBC group starting from November 2012.

Taking all these into account we reported RMB23 million in net income attributable to the company for the fourth quarter of fiscal 2013. For the same period, basic and diluted earnings per share were approximately RMB0.32. Net operating cash inflow for the quarter stood at approximately RMB155 million.

Before moving on to the Q&A session, I just want to conclude that we are very pleased with our fourth quarter and full year fiscal 2013 results, both in terms of financial performance as was operational performance. Although fiscal 2014 is expected to be a challenging year, we are confident that the implementation of our upward pricing strategy and high-quality positioning will allow us to continue to maximize our profitability. We also excited about the progress of our Guangdong and Zhejiang facilities expansion. Our plan to accelerate the capacity build out remains one of the top priorities in the near term. This pretty much wraps up my remarks and I think we are ready to move on to the Q&A session.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions). Your first question is from the line comes from Paul Nouri from Noble Equity Fund. Please ask your question.

Paul Nouri - Noble Equity Fund

The sales and marketing expense over the past couple of years has ramped up on an absolute basis and as a percent of sales. now, I was wondering if the number this quarter reflects your full investment in sales and marketing or if you expect to put more in to it in 2014?

Albert Chen

Allow me to translate that question for my chairman. I will just talk to my CEO and I will respond right away.

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

Addressing to your questions regarding the sales and marketing expenses as a percentage of revenue, we have continued to invest in our sales and marketing network and the continued increase in the past couple of reporting periods pretty reflects our commitment to continue to expand our coverage in both Beijing and Guangdong, as well as our ongoing gradual development with respect to the Zhejiang market. Now, in light of the fact that we are still building up our network in one Guangdong as well as Zhejiang, I think it is fair to assume in terms of absolute amount in nominal value basis that the sales and marketing expense is likely to increase in tandem with the revenue. But if you also look at the percentage, you the sales and marketing expenses as a percent of total revenue, it has been increasing gradually but the fluctuations has not been tremendous. I think it is fair to assume a gradual increase as a percentage is reasonable. But again management does not anticipate a major fluctuation in that percentage.

Operator

(Operator Instructions) Your next question comes from Yi Chen from Aegis Capital. Please ask your question.

Yi Chen - Aegis Capital

My first question is, what is your expected capital expenditure going forward for fiscal year 2014?

Albert Chen

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

As you know that we are still currently in a process of building out our infrastructure, including the capacity expansion in Guangdong as well the establishment of new facilities in Zhejiang as well. Now, taking that into account, we do believe, that by the time the capacity expansion project are both completed, the total storage capacity in the Guangdong province should increased to approximately 800,000 and while the Zhejiang storage facilities is currently in the startup phase in terms of the build out, we do believe we do try to increase our capacity to a possibility of above 400,000 in terms of storage capacity. So with that being said, it is fair to assume that the company will have to continue to put in capital resources for the build out. So, in a worst case scenario, the company would still have to devote approximately US$43 million in terms of capital expenditure just to complete the existing two projects.

Yi Chen - Aegis Capital

My second question is, could you tell us your tax rates in PRC going forward for fiscal 2014, whether there will be any more preferential tax treatment from the government?

Albert Chen

In terms of the tax rate itself, currently our Beijing subsidiary is still in a period of enjoying the high and new tax enterprise status. So as a result of that, the Beijing subsidiary is currently paying a tax rate of approximately 15% and the preferential tax treatment should expire on December 31, 2013, which again, up on the expiration of that, we will have to renew our status once again. This is not the first time we have renewed our preferential tax status. As for Guangdong, Guangdong preferential tax treatment has expired on December 31, 2012. We are currently paying a higher tax rate of 25% and again, we are currently in the process of renewing the high and new tax status and once we obtain that status, we will promptly announce it to the market. For your information, our subsidiary in Zhejiang is entitled to a tax rate of 25%.

Operator

Your next question comes from Brian Tanquilut from Jefferies. Please ask the question.

Brian Tanquilut - Jefferies

Good morning, Albert and Tina. Congratulation. A very good quarter, a very good year. So as I think about 2014, obviously you have given your commentary and volumes but how should I think about the outlook for China Cord beyond this coming fiscal year in terms of volumes and pricing as I think about the next, especially three to five years.

Albert Chen

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

As you know that we are currently still in the early stages, in terms of Zhejiang development, so it is fair to assume that with the establishment of the new facility, the contribution from the Zhejiang subsidiaries will be a key growth driver to our group. Assuming that the current regulatory environment didn’t change, I would still like to give a fairly similar outlook as I have given before which is, we try to maintain a steady growth in terms of new subscriber numbers in a normalized market situation. So anywhere north 10% is something that we believe is definitely achievable.

Brian Tanquilut - Jefferies

Got it, Albert, and then in the terms of your labor cost, how should I think about that going forward?

Albert Chen

In terms of the labor cost itself, if you look at our press release for the fourth quarter as well as our third quarter, we have highlighted in several different places trying to alert market about the increase in overall labor costs in the local market itself. That is partly due in light of the rising living standards as well as the cost of labor. So I think the rising labor cost itself is inevitable. However, that being said, the impact on the higher label cost, we have always able to pass on the impact thanks to the economies of scale. So we will continue to try to mitigate the impact of higher labor cost by increasing adding volume or like what we have mentioned in the earnings release that a more flexible and more market accommodating pricing strategies. So we will look at various measures and try to mitigate the impact of higher labor cost.

Brian Tanquilut - Jefferies

Got it, and then last question for you, Albert. In reading the press release, you made some commentary about expanding in new markets in China. So, if you don’t mind, just giving us some commentary on where you stand in terms of M&A and your views on pursuing acquisitions of either maybe your Shandong partner or other providers in China?

Albert Chen

I will differ that question to my CEO.

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

As mentioned early on in the conference call, we suggested, in light of the current regulatory environment, making a lot of things interesting as was possible and also providing a certain level of exclusivity as well. Now, this is kind of a double edged sword when you come to think about it because on one hand, as management, we are very keen on maintaining this kind of level of exclusivity and also providing certain kinds of input and law being, depends on how you look at it, to the relevant authorities and try to maintain the existing industry dynamics which undoubtedly is to our favor. But as we continue to pave all these groundwork and build a more favorable regulatory environments, the same, I will say, that while other peers are also beneficiaries of our hard work as well. This is kind of also putting us in a more difficult position when negotiating with them, because as I pointed out early on, not only we are the exclusive operator in the region where we serve it, they also have their own exclusivities in their local market as well. So in light of the company's current valuation, this has been a little bit, this has kind of set back the discussion a little bit to a certain extent. However, we have not given up in terms of our M&A effort and we are seeing that there is still room to maneuver. So let us just say that we remain hopeful in terms of our M&A strategies but as you know that the M&A strategy itself, it takes a long time to actually it before materialize, and also at the same time that the discussion somehow get affected by many of these factors which are beyond our control.

Operator

(Operator Instructions). Your next question comes from Alberto Bassetto from Jayhawk Capital. Please ask your question.

Alberto Bassetto - Jayhawk Capital

A couple of questions. The first one is, can you tell me the breakdown of the different payment options in the fourth quarter regular upfront installment?

Albert Chen

Alberto, I presume what you are referring as regular is probably a normal payment scheme, right?

Alberto Bassetto - Jayhawk Capital

Yes.

Albert Chen

Okay, in terms of the breakdown, itself, people that choose the regular or normal payment scheme account for approximately 53% of our total new subscribers. New subscriber who choose a upfront payment options, or what we call the bullet payment option, account for approximately 41%, and then I will say, the other payment option which are categorize as other will be 6%.

Alberto Bassetto - Jayhawk Capital

Okay, that’s very good. And as beck for the current year 2014, those percentages will change materially or it should be pretty much unchanged?

Albert Chen

We do not anticipate a material change in terms of client mix, which also entail that we do believe a significant change in payment as well, at least based on the current evidence available to us.

Alberto Bassetto - Jayhawk Capital

Okay, great. Thank you. My second question has to do with the price increase that you guys announced. So if the price is increasing quite significantly, which is good, can you elaborate a little bit how that will translate to the margins? I think when I think about margin, I am thinking about the gross profit margin and also operating margin.

Albert Chen

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

Okay, Alberto, I would just translate what Ms. Zheng just mentioned early on. As you know, we just recently enforced or implemented our new pricing strategy and also, as you know, as I pointed out in my field transcript that the new subscriber numbers that we envision for fiscal 2014 so far is kind of steady as compared to fiscal 2013, which is a significant improvement considering that of the wear off of the Dragon Year baby boom effect as well as the price hike that we announced. So either taking those factors into account, I also want to alert you to take into consideration the reason AABB Accreditation as well, because that will also result in the potential cost increase on a per unit basis. So if you looking at the profitability of CCBC as a whole in the near term, I think the one-time increase in processing fees, the benefit will probably be offset by the increase in direct costs as a result the AABB Accreditation and the change in our process. However, we think the cash flow itself should improve. I also want to add on an additional point is that, if you notice that our recent price adjustment, it involved the increase in processing fees as well as the storage fee itself. So at the current fiscal, assuming that we are doing the same number of new subscribers, the incremental benefit from the processing fee increase may not be significant, meaning that the overall margin improvement for CCBC group as a whole may not be material. However, with that being said, the long-term benefits, because of the higher storage revenue will kick in beyond 2014 because that’s when the recurring income of client paying a higher storage fees going forward will be realized and materialized. There is also, I want to point out that, for a subscriber which is paying storage fee upfront, the increase in storage fee itself will result in an increase in net operating cash inflow and that impact will probably hit fiscal 2014.

Alberto Bassetto - Jayhawk Capital

Okay, I got it. Actually, it was a very good answer. Thank you. My last thing, only if you can share some light on that, we are almost at the end of the first quarter, that is ending here in a week or so. Can you share how it looks like in terms of new babies, only if you can? That would be my last question. Thank you very much.

Albert Chen

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

I think if you look at the figures, I think it is pretty much in line with management expectations. You have to take into account the headwind as a result of the higher pricing as well as moving away from the Dragon Year into the Year of the Snake. Taking those two impacts into account, we believe that the performance in April and May is pretty much consistent with our thinking. But just as a reminder that as we move into the Year of the Snake as we gradually announce our quarterly performance for fiscal 2014, when you do a year-over-year performance, don’t forget that fiscal 2013 has a lot of benefit from the Dragon Year baby boom. So you will just have to keep that in mind. But overall, I think we are pleased with the performance and that is consistent with our planning, our thinking.

Operator

Your next question from the line comes from Yi Chen from Aegis Capital. Please ask the question. Please make the line for Yi Chen. Your line is open. Please ask the question.

Yi Chen - Aegis Capital

Thank you for taking my additional question. So regarding the price increase, does that provide any additional hurdle for new subscribers going forward? Or is the price increase not much of a difference for the target population of your services?

Albert Chen

[FOREIGN LANGUAGE]

Tina Zheng

[FOREIGN LANGUAGE]

Albert Chen

Based on what we have observed so far, the performance in April and Ma, it is fair to conclude that the new pricing will be gradually accepted by the market because on one hand, we notice that there has been an increase in terms of subscribers choosing the upfront payment, which also bores well for our company but at the same time it also reflected that the segment that we are after does not seem to be affect by the new pricing and I think with the new pricing in place, it is actually to our (inaudible) because it then tells to the market that if they chose to pay upfront now, they will literally be risk free going forward in case we are going to adjust pricing again going forward.

Operator

Your next question comes from Paul Nouri from Noble Equity Fund. Please ask your question.

Paul Nouri - Noble Equity Fund

When did you initiate the price increase? Or are you going to do it in the future?

Albert Chen

Hi, Paul. The price increase took place in April 1 for Guangdong and Zhejiang and May 1 in Beijing.

Paul Nouri - Noble Equity Fund

And you haven’t noticed that it has affected demand at all?

Albert Chen

As my CEO just mentioned, the impact on pricing has been gradually kicked in but at the end of the day, it depends on which market segment that we going after. I mean, as you know, our service is more appealed to mid to higher income spectrum and those type of segment, it is fair to assume that they will be relatively less price-sensitive as compared to, I would say, low end income bracket. We do not say that the higher pricing will not affect demand at all but what we are saying is that we are seeing the higher pricing and so far sign up has been consistent with our planning and also consistent with the target we gave to the street a moment ago.

Paul Nouri - Noble Equity Fund

And how many diluted shares did you have at the end of the quarter?

Albert Chen

That would be the two convertible notes issued to KKR and Golden Meditech. Aside from those two convertible notes, we don’t have any outstanding warrants or options or anything like that.

Operator

(Operator Instructions). At this point, there appears to be no further questions. I would now like to turn the call back to Ms. Joeling Law.

Joeling Law

Thank you. This concludes our earnings conference call for the fourth 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 participating. You may all disconnect.

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