China Cord Blood's CEO Discusses F1Q 2014 Results - Earnings Call Transcript

Aug.27.13 | About: China Cord (CO)

China Cord Blood Corporation (NYSE:CO)

F1Q 2014 Earnings Conference Call

August 27, 2013 08:00 ET

Executives

Joeling Law - Investor Relations

Tina Zheng - Chief Executive Officer

Albert Chen - Chief Financial Officer

Analysts

Scott Henry - Roth Capital

Brian Tanquilut - Jefferies

Yi Chen - Aegis Capital

Operator

Welcome everyone to China Cord Blood Corporation’s Earnings Call for the First Quarter of Fiscal Year 2014. All participant lines will be placed on mute during the presentation, after which there will be a question-and-answer session.

And now, I would like to introduce Ms. Joeling Law to begin the presentation.

Joeling Law

Good morning, everyone. Welcome to our earnings conference call for the first quarter of fiscal 2014. A press release discussing our financial results has already been released and a 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 risks and uncertainties and actual results could be materially different from these forward-looking statements. Kindly refer to our SEC filings for detailed discussions of potential risks. In the interest of time, we will begin with our CEO’s English remarks. After discussing our first quarter financial performance, 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. Welcome to our earnings conference call for the first quarter of fiscal 2014 and thank you for your continuous support to CCBC. For years, we have demonstrated our ability to accomplish various corporate objectives by continuously protecting our strategy and campaign techniques. Fiscal 2014 is our year of expanding capacity and heightening quality brand awareness, which in turn will set the stage for future growth in the years to come. Since our Beijing subsidiary received the AABB accreditation, we have dedicated efforts to promote our high-quality services and concentrate resources to penetrate deeply into our target mid-to-high end customer segments.

The implementation of the new pricing policy aligns with our premium quality services positioning and quality focused brand image, which gives us even stronger traction recruiting the target premium clientele and optimizing cash inflow. As expected, we continued to experience a positive market perception towards our new pricing policies. As a result of our extensive hospital coverage along with the hard work and dedicated efforts of our sales and marketing team, we managed to record 15,260 new subscribers in the first quarter of fiscal 2014 and reached an accumulated subscribers base of 327,242. In fact, such encouraging result is also a testimony of the management competencies to accurately predict time and penetrate each underlying markets across different stages.

As compared to the robust growth of the prior year period during the Dragon Year, our new subscriber numbers has returned to a more normalized trend in this quarter. Our upward pricing strategy has not only have offset the impact of the reduction in new subscriber numbers, but also maintained our operating cash flow at a steady level. The benefit of stronger cash flow due to our new pricing initiatives is likely to continue throughout this fiscal year. In order to meet the rising market demand in both Guangdong and Zhejiang markets, we launched two infrastructure expansion plans during fiscal 2013. I am pleased to report that this facility construction in Guangdong is progressing smoothly and is expected to be – to put into service in the near term providing us with the necessary capacity to capture the surging demand in the Guangdong market.

On the other hand, we are speeding up the constructions of the Zhejiang Bank hopefully completing project within fiscal 2014. The establishments of these facilities will look our previous constraints in those regions and will become the catalyst of our growth in these two affluent markets. Meanwhile, we will continue to reinforce our premium brand image in the market, expand our hospital network, and strengthen our sales force with the means to further penetrate into our mid to high end target customer and consequently improve the penetration rate in our two core markets of Beijing and Guangdong.

Fiscal 2014 is not free from challenges with the new birth volume continues to decrease following an exceptional year of the Dragon baby boom in the fiscal 2013. As a reflection of such seasonal decline in newborns, the management team would like to adjust the fiscal 2014 new subscribers target to 60,000, 65,000. Such a transitional period provides a window of opportunity for us to align our corporate strategy and focus on penetrating the target mid to high end segments. As we continue to benefit from favorable factors such as one license per region policy, our dominant industry position and an expanding user base the management team is excited and optimistic about the outlook and long-term growth of CCBC.

This concludes my overview of the first quarter of fiscal 2014. I would like to once again thank you for your support of CCBC, and I look forward to sharing our developments with you in our next earnings call. Now, let me turn the call to our CFO, Mr. Albert Chen to review the financial highlights.

Albert Chen

Good morning everyone. As highlighted in our CEO remarks, we continued to experience a retreat to normalized birth levels as the impact of the last year Dragon Year baby boom sailed away. At the same time, both the market and the company are still adapting to the higher pricing, which was implemented during the first quarter of fiscal 2014. Despite the mild headwind, we are still pleased to report that we managed to add 15,260 new subscribers in the first quarter of this fiscal and successfully extended our accumulated subscriber base to more than 327,000.

Total revenues for the quarter increased approximately 12% year-over-year to RMB128.7 million. Two key factors were behind our top line growth. First, higher pricing cuts bridged the revenue gap at our new subscriber number retreated seasonally. Secondly, our recurring revenue generated from storage fees are becoming increasingly robust, because of our large and growing subscriber base. During the quarter, revenue generated from processing fees and storage fees increased by 2.9% and 38.4% year-over-year respectively. Revenue related to storage fees, which accounted for less than 25% of the total revenue during the first quarter of last year now represented more than 30% of our total revenue in the first quarter of fiscal 2014. Increased labor cost and a moderate increase in depreciation expense offset the cost reduction as a result of lower subscriber volume leaving our overall direct cost relatively flat on a year-over-year basis remaining at the RMB24.5 million level.

First quarter gross profit increased by approximately 15% year-over-year to RMB104 million and gross margin expanded to 81% as compared to 78.9% in the prior year period. The 210 basis point improvement was a result of higher pricing and rising contribution from the higher margin storage-related revenue. In our line of business, sales and marketing has always been the key towards winning subscribers, and we continue to take hold and concentrate resources to expand coverage and increase brand awareness. During the quarter, we continued to add new employees to our Beijing division, Guangdong division, and more noticeably to our Zhejiang division as well in anticipation of a more aggressive rollout in the next fiscal year.

We also increased our marketing activities such as participation in conferences, exhibitions, promotions, and other events, which serve as a positive marketing platform for us to further enhance our outreach to targeted mid-to-high end customer segments. As a result, sales and marketing expenses in the first quarter increased to RMB28 million as compared to RMB19 million in the prior year period. Sales and marketing expenses represented approximately 22% of our total revenues, but we do anticipate that sales and marketing expenses as a percentage of revenue will be trended to a slightly higher level in fiscal 2014 as a whole as compared to fiscal 2013.

In terms of general and administrative expenses, G&A as a percentage of total revenue, our first quarter G&A expenses maintained at approximately 21%, which was consistent to the prior year period, but despite high labor cost, we implemented tight cost control measures to combat against the rising cost. As a result, G&A for the first quarter was approximately RMB27 million, which was stable as compared to the third and fourth quarter of last fiscal year. All-in, we recorded a solid operating margin of 35.6% and operating income increased to RMB45.9 million for the first quarter of fiscal 2014. After taking into account the increase in revenue due to price adjustments, gross margin expansion coming from the higher contribution of storage revenue and our stepped up marketing effort. Depreciation and amortization expenses for the first quarter increased slightly to RMB8.6 million.

In terms of non-operating items, we recorded an interest expense of approximately RMB15 million during the first quarter of fiscal 2014 largely attributable to the convertible note issued to KKR and Golden Meditech as compared to RMB10 million in the prior year period. The interest expenses recorded during the first quarter of fiscal 2014 was substantially less than average, because during the period, we capitalized approximately RMB8.5 million of interest expense in relation to the construction of the new company, new storage facilities “namely in Guangdong and Zhejiang.”

During the first quarter, we also recorded the net income of approximately RMB8.7 million from our equity investment in Shandong Cord Blood Bank and Cordlife Group Limited. Taking into account, the effect of improved operating income along with dividend income, which combined partially offset the increase in interest expense, we reported a 10.5% increase in our profit before tax for the first quarter of 2014 to approximately RMB44 million. Net income attributable to the company’s shareholders increased 5.8% to RMB32.9 million in the first quarter representing a net margin of approximately 26%. Basic and diluted earnings per share for the first quarter were RMB0.40.

Now, in terms of cash flows, first quarter operating cash inflow remained robust and stood at RMB108.7 million but please note that during the quarter, we made a coupon payment of approximately RMB28 million, which was related to our convertible notes issued to KKR. I think in the interest of time, I will stop my presentation here and turn the call over to the operator, which we can go right into the Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And your first question comes from the line of Scott Henry from Roth Capital. Please go ahead.

Scott Henry - Roth Capital

Thank you, and good morning. A couple of questions for starters, and I think you hit on this a little bit in the prepared remarks, but expense guidance was higher in the first quarter, did you want to give guidance on what we should expect going forward with regards to for the rest of fiscal year 2014 with regards to selling and marketing and G&A and possibly even any comments on the gross margins, which were strong in the first quarter?

Albert Chen

Well, thank you Scott for the questions. I will answer that one by one. In terms of the sales and marketing expenses as I highlighted in the remarks notice that during the first quarter, the sales and marketing expenses is relatively high as compared to the historical level and partly because we have moved up our timetable in terms of recruitment and promotion activities largely and to anticipate a more aggressive rollout of our Zhejiang operation in fiscal 2015. Now, in light of a more aggressive marketing and promotion activities and campaign going forward, I would suspect that a slightly higher percentage, in terms, let me rephrase it, if one way to look at our sales and marketing expenses as a percentage of revenue, I would suspect that will be slightly higher as compared to last year at a level of let’s say higher than 20% of total revenue will be a fair assumption based on the evidence available to us and our internal budgets. And this is as I mentioned in my remarks is the level, which is slightly higher as compared to the last fiscal year. In terms of the general and administrative expenses, we do exercise all means necessary trying to contain the cost with the underlying fundamental of the underlying factors such as, for example, inflations higher – just higher – many other ongoing expenses and professional fees continue to escalate. We do try to contain cost at the current levels. As you look at our G&A expenses for the past two quarters, let’s say, I think it has been ranging between let’s say RMB27 million – to roughly about RMB26 million to RMB28 million kind of in that range. And hopefully, we can continue to stay at that range in the near term.

Now, for the gross margins itself right now, the first quarter gross margin is relatively high at 81%. We do believe that in the near-term, margin will continue to be high, but you have to be aware of these upcoming additional costs, which we anticipate after the commencement of the new facilities. For example, we do anticipate margin in fiscal ‘15 to be slightly lower after we commence the operation of these new facilities, which will bring in additional depreciation expenses. And at the same time, right now among the three banks which we operate, only Beijing Cord Blood Bank is AABB accredited, and our intention is to enlarge as well as heighten our quality platforms, and by doing so, we are now moving out the possibility that the Guangdong Cord Blood Bank as well as the Zhejiang Cord Blood Bank will eventually obtain the AABB accreditation and should that be the case, it also means a potential increase in cost structure going forward, but given the fact that the new Guangdong facilities and the new Zhejiang facilities have not yet completed this construction base, I don’t believe that the cost hike as a result of AABB accreditation will happen in the current fiscal year. Scott, I am hoping that this information would be helpful to you.

Scott Henry - Roth Capital

Okay, that is helpful. And just a couple other questions, when I look at kind of calculated processing revenue per subscriber and storage revenue per subscriber, for the first quarter, the pricing was pretty strong, but I know you did have a price increase. How should I think about the first quarter pricing relative to the rest of the year?

Albert Chen

That’s excellent question, Scott. I think from as you know our client hasn’t signed up prior to their babies are actually delivered. So, a lot of new subscribers, which we recorded during the first quarter of fiscal 2014 actually signed up prior to our price adjustment, that’s how when we workout the average processing revenue per subscriber. It is not exactly at the RMB6800 level. That is because the new subscriber we recorded during the quarter is a combination of old clients as well as new clients. So, I am not sure if this is helpful enough, but I think going forward as we are going into the second and third quarter etcetera, we will see a more imminent impact on the price adjustments when it comes to average processing revenue per sub.

Scott Henry - Roth Capital

And do you expect that to be a downward adjustment?

Albert Chen

I think right now the first quarter is kind of low. So, I think it should somewhat be upward adjustment instead.

Scott Henry - Roth Capital

Okay. The pricing will get even better than the first quarter, so that should continue?

Albert Chen

In the second quarter going forward, because of the timing of the events, clients who signed up price with the price adjustment and deliver the baby during the first quarter I mean they are only eligible to pay the old processing fees. And in first quarter, we have a combination of both clients who signed up price with the price adjustment and people who signed up after the price adjustment. That’s why the average processing revenue per sub has not truly reflected the full impact of the price adjustment.

Scott Henry - Roth Capital

Okay, thank you. That is helpful.

Albert Chen

Okay, thank you.

Scott Henry - Roth Capital

And the final question if I could, the final question on new subscribers, we are looking at a decline of about 10% in 2014 kind of coming out of that Year of the Dragon hangover, what would you expect, when you think about 2015, do you expect to return back to significant growth, how should we think of that transition once we get a normalized year on 2014 out to 2015?

Albert Chen

I think when you are looking into comparing let’s say fiscal 2013 and fiscal 2014, on one hand, you will have basically a more or less of the apples-to-apples comparison, because there is no longer a seasonality effect in between. And secondly, it’s because if everything progressing according to plan, the new Zhejiang storage facility should be up and running at the end of the fourth quarter of the current fiscal year or by latest the first quarter of the next fiscal year. So, by any means, the establishment of the new storage facility will allow us to truly reflect our marketing muscle and aggressively rollout into the Zhejiang market, which well, Zhejiang market being a catalyst, I think it is fair to assume that the company will resume a normalized growth trend.

Scott Henry - Roth Capital

Okay, great. Alright, well thank you, Albert for taking the questions.

Albert Chen

Thank you, Scott.

Operator

Your next question will come from Brian Tanquilut from Jefferies.

Brian Tanquilut - Jefferies

Hey, Albert. Good evening. How are you doing?

Albert Chen

Good. How are you?

Brian Tanquilut - Jefferies

Yes, hi. The question for you is the adjustment on the guidance for new subscriber additions, how should I think about that in terms of what the motivate, who was there and the level of conservatism that you have baked into the 65,000 life guidance?

Albert Chen

Well, Brian, thank you for the questions. And first of all, the reason that we have revised or adjust our guidance for fiscal 2014 is basically of a larger than anticipated market contraction due to the Dragon Year hangover event I should say, because as of now we are still seeing a contraction in terms of the market size. So, if I am to guess also expect that the market, which we are currently serving is likely to be heading towards a 10% to 15% contraction, and that’s why we are taking a proactive approach in revising or adjusting our guidance. Now, some may argue that we are only like one quarter into the year and it maybe too prudent or conservative to adjust our guidance as of now, but I know or we know that the market really hate the prices, and we will rather to be transparent to the market and revise or adjust our guidance as we see the market change. Now, I mean, I really move out the possibility is that we may adjust the guidance further upward or downward, I mean if the market changes, but based on all the facts available to us, we do believe that the market contraction within China is likely to continue. And at the same time, I also want to mention the fact that because of the pricing adjustment the market will still take a little bit time to adapt or absorb to new pricing. So, with this (double renminbi) effect, that’s why we believe that it is only prudent to revise down our current year new subscriber target to 55,000, but this is….

Brian Tanquilut - Jefferies

Okay.

Albert Chen

A hangover effect being the primary factor.

Brian Tanquilut - Jefferies

Okay, that makes sense. And then on the cash flow side, you did pretty well during the quarter, how should I think about cash flows for the rest of the year?

Albert Chen

That you maybe going tired of listening to me speaking. So, I will let my colleague to handle the cash flow questions.

Tina Zheng

For the capital of the current…

Albert Chen

Cash flows.

Tina Zheng

For the cash flow, we – for the operating cash flows of current year is RMB108 million for the current year and then which has been RMB39 million for the purchase of fixed assets.

Albert Chen

I guess for the record, please stop complaining that I am not being very clear in my answers, neither you have experienced work, just kidding, but cash flow for the quarter is above RMB108 million and I also highlighted the fact that in this quarter it’s somewhat awkward, because that operating cash inflow we recorded during the quarter is actually less than our average cash flow, and that is largely because we have paid a coupon payment of approximately RMB28 million during the quarter. So, I mean, if you are to let’s say to a pro forma cash flows, you can actually add back the RMB28 million coupon payment, which we paid to the holder of the convertible notes “KKR” in that way, you will get a more normalized cash flows. Now, while you mention this, I also need to remind you that the cash flow for this quarter may not be entirely indicative to a certain extent, because we have a huge portion of new clients who choose to pay storage fees upfront. So, this actually inflated our cash flow even further, but if you are looking a more normalized level, I guess the RMB108 million plus RMB28 million should give you a sense about what normalized level will be like.

Brian Tanquilut - Jefferies

Hey, Albert to that point, since you are seeing a lot of new client space upfront, let’s say the upfront payment option, does that mean, is that what you are seeing and does that mean that going forward we should see cash flows remain fairly healthy, if they are all paying upfront?

Albert Chen

Well, first of all, I would like to see more and more clients paying upfront, but well, right now, it’s just me talking, but for the sellers side, I think this quarter is kind of strange, because if you track our previous performance, you will notice that people who choose to pay upfront normally would account for anywhere between let’s say 40%, 45% of our total new subscribers. This quarter, I think it’s about 50% of new clients who choose to pay upfront and partly because they know if they pay upfront, then we no longer need to fear about the potential of future price adjustment going forward. So, this kind of incentivize them to actually pay upfront, but I will not move out the possibility that in, for example, going into the second and third quarter, our revenue or our client payment methodology mix may somehow be fought back to a more normalized level, which is above 30% to 35% people pay upfront, but with the new price adjustment, I am still convinced that our cash flow generated from operating activities will continue to be healthy and robust.

Brian Tanquilut - Jefferies

Okay, got it. And then last question for you, you have a lot of cash in your balance sheet and obviously you have allocated some of that for CapEx this year, but outside of that, I mean, how are you thinking about capital deployment at this point?

Albert Chen

We have long been the followers of our M&A strategies, and we continue to rollout our M&A initiatives in view and try to become deconsolidated of the industry and that position and policy as well as strategy has been changed. I admit that some of the M&A initiatives have taken longer than it should be, but we have to at least continue to struggle and try to strike for the best few available, but right now, I think the outselling the current capital and hence will be primarily deployed for two purposes, one of which will be the continued build out of our facilities “in Guangdong and Zhejiang” both of which are supposed to be completed in the current fiscal year. And also the remaining will be for M&A initiatives. So, as highlighted in our CEO remarks, this year will be – we will see a lot of capital expenditure outflow for the build out as this is a pretty much a build out year.

Brian Tanquilut - Jefferies

I got it. Okay, thank you.

Albert Chen

Thank you, Brian.

Operator

(Operator Instructions) Your next question comes from the line of Yi Chen from Aegis Capital.

Yi Chen - Aegis Capital

Hi, thank you for taking my questions. First question is can you remind us how many subscribers will at a normalized level will choose to pay the fee at a regular payment schedule instead of paying audit fees upfront?

Albert Chen

At the normalized level right?

Yi Chen - Aegis Capital

Right.

Tina Zheng

Hi, thanks for your question. In this quarter for the normal payment subscriber, well, we have around 47….

Albert Chen

Well, I mean, Yi, at a normalized level, I guess normal payment will probably constitute above 50%, anywhere between let’s say 50% to 55% of the subscriber mix, people that choose normal payments and people that choose upfront payment will be anywhere between 40% to 45%. And then you have the remaining gain others, so we will have different new payment initiatives. So, that’s kind of the normalized level. For the first quarter of fiscal 2014 is somewhat different, right.

Tina Zheng

Yes, this quarter we have around 47% of normal payment subscribers and for the upfront payment subscribers, we have 50% and the remaining purposes is to add payment subscribers.

Yi Chen - Aegis Capital

Okay, thank you. My second question is as you just mentioned that for the current quarter, the cash flow, the operating cash flow is affected by a coupon payment to KKR. So, can I think of that in the third quarter, sorry, in the third quarter of fiscal year 2014, the operating cash flow will be affected by a coupon payment to go to Meditech?

Albert Chen

That is the right assumption, Yi.

Yi Chen - Aegis Capital

Okay. My final question is regarding CapEx, so how much money do you anticipate to spend going forward in fiscal year 2014 for the Guangdong facility and Zhejiang facility?

Albert Chen

In terms of the capital, right now as far as I can remember, I think we spend optimally closely between the RMB70 million, that’s inclusive of the land and building we purchased in Guangdong, and that’s about like RMB108 million already. And then there is RMB88 million for the land and building, which we have purchased in Zhejiang. On top of that, we also as of now I think we spend about almost RMB70 million in terms of the renovations, majority of that are related to Guangdong Bank while a modest amount of RMB30 million is actually related to the Zhejiang Bank. So, all-in-all, I think the amount that we have spent so far should be about RMB250 million give or take, sorry RMB270 million give or take. And we do anticipate that for the remaining of the year assuming that the construction in progress, the construction of the new facilities are progressing as planned, then a total maximum outlay of about RMB230 million that we intend to spend on capital expenditure to complete the two projects. Of the RMB230 million, I would say more than half is related to Zhejiang.

Yi Chen - Aegis Capital

Okay. And we can expect both facilities to be fully operational by the end of fiscal year 2014, is that correct?

Albert Chen

Well, I mean, this is what we intended to accomplish. We intend to get the new Guangdong storage facility up and running before the end of the current calendar year. So, you are looking at December pretty much, November or December of 2013 calendar year. Now, in terms of the Zhejiang storage facilities, we obtained get this up and running no later than March of 2014. Now, I mean, obviously there are unforeseen factors, I mean, but in the absence of any variables, I should say that we should be on track to get it done in the current fiscal year. So, that, that will allow us to really I would say unravel the two of these that are currently available in the Zhejiang market, which even up to now hasn’t been a key contributor to our group yet.

Yi Chen - Aegis Capital

Okay, thank you.

Albert Chen

Thank you, Yi.

Operator

(Operator Instructions) And it appears there are no further questions today and that does conclude our conference. Thank you for joining us.

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China Cord Blood (CO): FQ1 EPS of $0.07 beats by $0.03. Revenue of $21M misses by $0.62M. (PR)