China Medical Technologies, Inc. Q4 2009 Earnings Call Transcript

Mar. 3.10 | About: China Medical (CMEDQ)

China Medical Technologies, Inc. (CMED) Q4 2009 Earnings Call Transcript March 3, 2010 8:00 AM ET

Executives

Winnie Yam – Assistant Manager, IR

Charles Zhu – SVP, Operations

Sam Tsang – CFO

Xiaodong Wu – Chairman and CEO

Analysts

Bin Li – Morgan Stanley

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 China Medical Technologies Incorporated earnings conference call. My name is Shiquana and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Miss. Winnie Yam. Please proceed, ma'am.

Winnie Yam

Thank you. Hello, everyone. I am pleased to welcome you to China Medical's earnings conference call. China Medical already announced its third fiscal quarter results ended December 31, 2009. A copy of the press release is also available on the company's website at www.chinameditech.com.

Today your speakers will be Mr. Xiaodong Wu, CEO, Mr. Sam Tsang, CFO and Mr. Charles Zhu, Senior VP of Operations. After they 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 discussions today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Legislation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in the company's public filing with the U.S. Securities and Exchange Commission. China Medical does not undertake any obligations to update any 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 Charles, who will give remarks on behalf of Mr. Wu. Charles?

Charles Zhu

Thank you, Winnie. Ladies and gentlemen, welcome to our earnings call. We achieved sequential growth in our business in the past quarters. Despite the challenges, we encountered in the first nine months of the fiscal year 2009, our turnaround has started as the year continues which is demonstrated by robust growth in our molecular diagnostic business and stabilization in our immunodiagnostic business in the past quarter.

We have witnessed stabilizing pricing environment for ECLIA reagent kits and growth of end user demand for both our FISH probes and ECLIA reagents. Meanwhile, we completed the trial launch of our SPR system in December 2009 and from January 2010, we began a formal full launch of our SPR system to target at least 30 top tier hospitals each quarter.

Besides, we are waiting for SFDA approval for several new products in both molecular diagnostic business and immunodiagnostics business in 2010 which will expand our product offering and strengthen our product portfolio. I'm glad to say that the worst is over and the company should experience another phase of accelerated growth in later quarter.

In the past quarter, our ECLIA business started to stabilize and we have seen growth in test volume. Recall last September, we cut our price by about 30% together with inventory drawdown by our distributor customers prior to the price reduction as well as bad debt provision for a few accounts fills the implementation of new pricing.

Those remaining customers reduced their inventory and we believe their inventory level has come back to normal. Thus in following quarters, we did not expect inventory rebuilding to contribute to volume growth. Besides, we have added several new distributor customers to replace those we locked. However, we anticipate their ramp-up to be gradual.

Due to these complications, it is difficulty to quantify contribution from inventory rebuilding versus end user demand growth for the past quarter. For the upcoming quarters, we anticipate organic growth largely derived from end-user demand growth because inventory fluctuation will be minimal.

Based on our marketing research, we believe we have already reached the bottom of our ECLIA business. In addition, we have become increasingly competitive based on new pricing structure and the fact that we have the most comprehensive ECLIA reagent manual and the larger installment with mid-size and small-size hospitals in China.

With these advantages, we expect our ECLIA business to assume organic growth in the near-future. Likewise, FISH business already assumed normal growth. Currently our leading market position in this field is supported by the largest footprint we have, in terms of the number of approved FISH probes, and the coverage in top tier hospitals.

Our direct sales force have covered more than 400 top tier hospitals, and our goal is to expand to 500 top tier hospitals by end of 2010. And eventually it's about 800 applicable top tier hospitals in China. Those top tier hospitals represent not only the best hospitals in China in terms of quality, but also represent most profitable hospitals. Our sales force continued to focus on deeper penetration of the existing hospital customers by promoting clinical benefits our FISH probes among various departments of our hospital customers.

On R&D front, we have several new probes in development and the cutout probes than the SFDA assessment. Regarding the launch of our SPR system, we already received SFDA approval for our SPR equipment, and are expecting SFDA approval on related HPV-DNA chip around June, 2010.

Starting from January 2010, we’ve began equipment installation among top tier hospitals with a target of at least 30 hospitals each quarter. Depending end-user feedback, we may adjust the speed of installation.

We will continue to expand our direct sales force as well as our technical support team. As a reminder, the SPR equipment is free for our customers and we expect minimal revenue contribution from HPV chips in March quarter, but more minimal revenue in later quarters.

One of our major business strategies is to position our product portfolio to capture rapid growth of molecular diagnostic sector in China. Targeting high-end molecular diagnostic market is a key focus of our growth strategy. For example, our molecular diagnostic business consists of mainly prenatal and cancer test.

Comparing other disease detecting diagnostics, our test are either targeting prognosis, potential cancer patients or existing cancer patients who require tests for applicable treatment drug. They are unique patient populations with much higher tendencies to be willing and capable of paying out of pocket in China. For example, due to the one-child policy in China, most middle class parents are extremely careful in many aspects of early pregnancies, in particular those high-risk women.

Compare to traditional genotyping that generally required two to four weeks for outcome in China. FISH clinical test is much faster and could yield results the next day. All sufficient patients are recognizing this obvious advantage at the critical period of pregnancy.

Additionally, these couples who visit Tokyo hospitals are exactly those with ability to pay out of pocket of about $200 to $300 for a genetic FISH test, for the only child they will ever have.

Likewise, most patients require cancer diagnosis in Tokyo hospitals either have ability to pay out of pocket or work with large state own enterprises, which normally reimburse their employees' medical bills in full.

We have been successful in developing and expanding FISH market among top tier hospitals and we firmly believe there are greater potential in many other tests such as HPV.

In order to execute our growth strategy, we tend to leverage our initial success by applying the sources together. Specifically, our FISH direct sales force will promote our SPR based HPV test and we will continue to invest in this area.

In summary, I’m very pleased with our turnaround effort, particularly the organic potential growth we achieved in the past quarter, which I expect to continue from now. We also remain highly optimistic on enormous opportunities ahead of us and we are well positioned to capitalize these opportunities.

I have finished with those remarks and I'd like to turn the call over to Sam, and he will give you an overview of our results for the recent quarter. Sam?

Sam Tsang

Thank you, Charles. And welcome, everyone. Let's talk our financial results in the past quarter. Our 3Q '09 revenues were down 23.5% year-over-year to RMB172.3 million or $25.2 million but increased by 3.8% sequentially.

Our 3Q '09 loss from continuing operations was RMB22 million or $3.2 million. Our 3Q ’09 non-GAAP income from continuing operations was down 61.9% year-over-year to RMB45.6 million or $6.7 million but increased by 158.2% sequentially. Our 3Q '09 non-GAAP diluted earnings from continuing operations per down 61.8% year-over-year to RMB1.74 or $0.25 but increased by 159.7% sequentially.

Let's highlight certain financial numbers. First, our ECLIA revenue only declined slightly in the past quarter. Even though, we had the full impact from the certain price reduction on ECLIA reagent kits. Our FISH revenue already resumed growth in the past quarter.

The space stabilization in our ECLIA business, the resumed growth in our FISH business and a former launch of our SPR equipment to top-tier hospitals are all positive size for our business. Second, our gross margin declined sequentially from 65.4% to 63.4%, mainly due to the impact of the price reduction in ECLIA reagent kits.

We have adopted top new control measures for ECLIA reagent kit production and expect the gross margin for ECLIA reagent kits to improve in coming quarters. Third, our SG&A decreased 28.2% sequentially from RMB62.6 million to RMB44.9 million or $6.6 million. The increase was mainly because we did not have cost for the internal investigation and the position for bad debt was substantially lower in 3Q '09.

Next, our unusual effective tax rate was primarily due to certain expenses such as stock compensation, amortization of high intangible assets and interest expenses of convertible notes, a lot deductible for tax purpose as well as accrual for reporting income tax on distributable earnings generated during the quarter in the PRC.

Next, our cash and cash equivalents at the end of December was about RMB830 million or $122 million. This sequential decrease in cash and cash equivalents was mainly due to the final payment for the SPR acquisition, the payment of annual cash dividends and the repurchase of our ADS under our share repurchase program.

Although, we made a GAAP loss of RMB22 million or $3.2 million in December quarter. Our non-GAAP income for the quarter was RMB45.6 million or $6.7 million representing a sequentially increase of 158.2%. Our non-GAAP diluted EPS was RMB1.74 or $0.25 representing a sequential increase of 159.7%.

Besides, we generated cash flows of RMB80.4 million or $11.8 million from our operations in the past quarter. Our net accounts receivable at the end of December decreased 5.4% to RMB300.8 million or $44.1 million from RMB317.9 million at September 30, 2009.

We spend our $5 million to repurchase about 390,000 ADS in the past quarter. Though repurchased ADS represent about 1.5% of estimated fee both of 25 million ADS. We continue to repurchase our ADS depending on market conditions. Last, but not the least, although the two Chinese holidays in January and February 2010 reduced about 10% of our normal working days in 4Q '09.

We still estimate a sequential growth in our business. We estimate our target revenues for 4Q '09 to be more than RMB175 million or $25.6 million. We estimate a target non-GAAP income from continued operations for 4Q'09 to be more than RMB47 million or $6.9 million.

The target non-GAAP diluted earnings from continued operations for ADS for 4Q'09 is expected to be more than RMB1.79 or $0.26. Meanwhile, we expect a higher sequential growth in our business in 1Q '10. The above targets are subject to change. This concludes our remarks and we are welcome to your questions. Operator, please.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Bin Li with Morgan Stanley. Please proceed.

Bin Li – Morgan Stanley

Thanks. Hi, everyone. Thanks for taking my call. I have a question on ECLIA. You mentioned that you've add a few new distributors. Can you give us more color how many new distributors you have add and what's the contribution of new distributors? Is it bit a too small to quantify? Also if you could talk about the competitive landscape post your price cuts. And now, you have two quarters of low price and has your competitor reacted to that and what's the adaption of your end-user customer to your price cut?

Sam Tsang

Hi, Bin. This is Sam. I will address your questions first and then Mr. Wu probably to add for your questions. And we have increased the number of distributors, customers after the price reduction. We mentioned that we lost about 15% of our major customers before the price reduction. And it has been about five to six months after the price reduction in September and we have increased our new distributors actually in terms of numbers it's more than the number we lost but the problem is this – these distributors are new and they are small for the time being but we are competent that they will pick up, become bigger customers for the time and also our existing customers also try to pull out end user which are managed by the previous distributor before the price reduction.

So we expect actually new customers and whom you'll help us to grab more end user demand in the future. And for competitions, I understand, basically, after we adjusted the price, our price we mentioned already which are more – much – basically in line with the market and are more competitive. And so far, we have not seen any significant price adjustment from our competitors and so we will wait but we don't expect there will be any significant price adjustment from our competitors. And so, we will wait but we don't expect there will be any significant price adjustment from our competitors. So, I would ask Mr. Wu to add some more on your questions.

Xiaodong Wu

[Foreign Language]

Sam Tsang

Mr. Wu just wants to add one comment that our end-user from hospitals their feedback is positive regarding the price reduction.

Xiaodong Wu

[Foreign Language] One of the most important purposes for us to reduce our price is trying to replace the older ECLIA technologies with more of chemiluminescence diagnostics technologies in China.

And so far we have seen some good development. Some hospital users are already replacing the ECLIA reagents for the hepatitis test in their hospitals with our ECLIA reagent. So this is very positive sign after our price reductions. That's it.

Bin Li – Morgan Stanley

Okay. If I could follow-up with few questions. I think you mentioned Sam, in your remarks that inventory level now is back to normal and you are not expecting any restocking, so going forward the sales growth will be coming from end-user demand.

Now, but also I thought you mentioned about, if you are bookings some bad debt allowance for this quarter. Now, I thought in the third quarter, in the September quarter, you booked some. And can you tell us what was the magnitude of your bad debt this quarter and are you expecting any thing going forward and why there's still some bad debt lingering around?

Sam Tsang

Right. You can see that G&A expenses which increased substantially. So, one of the reasons, in addition to the internal investigation, bad debt provision was substantially lower. The reason is because in the September quarter and June quarter, we had to record specific bad debt provision for the FISH user customer. We can issue those customers which like us.

But in December quarter, we did not have any such kind of specific provision. So instead of that, we just had to make some general provision on some overdue receivable, which is relatively small in amount. But, because we have the track record of the bad debt provisions. So we think is conceptive to make some general bad debt provisions on some overdue accounts. So you can see that it is very small. And, so that's why our G&A expenses decreased substantially in December quarter compared to the September quarter.

And I don't expect we will have to make such similar type of specific provision in the future for large account because we see that basically after the price adjustment and also the – after the internal investigation, our customers are much more stable and really confident that we will – really, we want new, certainly, such big customer in the future. And also we will have more measures to avoid such kind of collection problem or the major ECLIA accounts in the future.

So, I will expect we will have to make some small amount of general bad debt provision in future quarters, which is small amount. But I will expect we will still have to make such kind of small general provision in the future.

Bin Li – Morgan Stanley

Thanks. I just have one more question and I'll go back to queue. You mentioned that you are launching SPR and you are targeting 30 hospitals per quarter. Can you talk about the progress in this quarter because now it's, or two-thirds of quarter already. Can you talk about that?

And then, can you talk about when we should be able to see sales from SPR on your annual report?

Sam Tsang

Right. We finished trial launch in the December quarter for our SPR equipment and we received quite a number of constructive feedback from trial user hospitals, which are very usually for us to make some minor modification to make the equipment at in that give us a perspective. And we targeted 30, at least 30 customers top tier hospital, which are typically our exiting FISH customer initially each quarter. And as we mentioned you may adjust a speed. And for the time being, we have basically scheduled or have believe, SPR equipment which we believe we are chip is 30 units in this quarter.

And but at the same time, the major Chinese New Year holiday in February. So even though we believe first some of the equipments to hospitals use that we have to schedule the installation and training after the time this New Year holiday in May, February or March.

So we are in a process of installation and also to train the hospital and also we will give some free samples for the hospital to test to inform the test, HPV test. And so that the SPR equipments are provide free of charge to these hospitals and they are closed systems. So the hospitals user, have to use our chips. And so we expect the sales of HPV chips, which we will start probably in May and March or early April.

So we expect that maybe no revenue or only minimal revenue from the sales of chips in March quarter that you saw 4Q '09, that we expect these users will start facing orders with us. And so there in March or in late March or early April and so there will be more meaningful revenues starting from June quarter based 1Q '10 and half of this.

Bin Li – Morgan Stanley

Okay. Thank you. I will go back to queue.

Sam Tsang

Bye.

Operator

(Operator Instructions) You have a follow-up question from the line of Bin Li with Morgan Stanley. Please proceed.

Bin Li – Morgan Stanley

Okay. I will just continue. So can you also talk about that the impact of giving out free machine, free SPR machine. What is the cost of good impact, I understand your agent or your chip margin is about 70%. But does that – I assume does not such in that the stock you have to give away and the machines? So can you talk about the cost of the machines and where you booking at and if you are factoring that what would be the costs for that franchise?

Sam Tsang

Right. That’s why the SPR equipment is free of charge and the costs of each SPR equipment is about $20,000. So if the target of 30 units in this quarter or subsequent quarters and so that means 30 units times $20,000 which is about $600,000 and which is about RMB4 million RMB. So these costs will be recorded in – as one-time expenses including in our cost of revenue. And so we expect we will have these RMB4 million to be recorded in 4Q '09. And also the upcoming quarters, so this we'll increase the costs of revenue. And you are correct on the gross margin for HPV chip. The HPV chips the estimated 70% gross margin does not take into account the costs of equipment that represent the gross margin could be generated from the sales of HPV chips.

Bin Li – Morgan Stanley

Okay. If I could switch gear to ask, again, the ECLIA franchise. I think earlier you mentioned that it's – you still want to launch the fully automated machine. Right now you have semi-automated machines. Can you tell us are you still working on a fully-automated machine and what's your timeline of launching that? Is this really a big push internally or is it something that you think – you might just want to take time and see their competitive dynamics, whether you absolutely need to launch the machine or not. Because I think you have – you have worked on this fully automated machine for at least before last few – quarters?

Sam Tsang

Right. We are developing this fully automated equipment and we have submitted the approval to SFDA for our fully-automated equipment. And we also have showed the prototype of the equipment in the exhibition. And we expect, we can receive the SRP approval for this fully automated equipment later this year together with the SRP approval for the related reagents kits because we not only require approval for the fully automated ECLIA system but also each reagent kit used with this co-system of fully automated ECLIA system. So in addition to waiting for approval for the equipment, we are also waiting for the approval for our number of reagent kits and we expect we have to release at least 30 to 40-approvals, approval for, SFDA approval for 30 to 40 commonly used reagent kit, which we are targeting including the equipment and the reagent to large hospitals which are new customer groups for our ECLIA business, because our semi-automatic ECLIA system, even though we have the very large installment base of over 3,000 hospitals but they are mainly mid-size to small size hospitals.

And so we expect the fully automated ECLIA system can face some of the existing semi-equipment user price those larger mid-size hospitals. But the major target of our fully automated ECLIA system the large top tier hospitals. And so these new customer which is – very which is the same customers. We are selling our FISH probes and also the SPR HPV chips. So we expect we will be able to leverage our existing direct sales force to promote a fully automated ECLIA system to these large top tier hospitals, which are currently use multiple units of fully automated ECLIA system made by international player like Beckman, Roche, Abbott, J&J et cetera.

Bin Li – Morgan Stanley

Okay. And if I could ask one more question on the revenue outlook for your SPR franchise as well as the FISH franchise. I’m looking at performance of this quarter quite clear, it is almost flat versus last quarter. In one way, it does stabilized on the other hands I think my question is when did you see that franchise was really good growth and what kind of growth you think should be reasonable going forward and what is the timing for growth?

And the same question applies to the FISH franchise where we reduce the sequential growth as well as year-on-year growth. But the year-on-year growth is it single-digit which is still below the historical pre-investigation growth rate of 30%-ish. So how should we think about that business growth going forward?

Sam Tsang

Right, Bin. For the ECLIA system, we have seen some stabilization in the ECLIA business and we have seen the end-user demand grow. And so, we expect, the worst case is that this is the ECLIA business. We’ll stay at the current level and should have growth from the end-user demand due to the price reduction and due to the speedup of the process to replace the ECLIA volume, the older diagnostic technology, which is still mostly used in quite a number of small hospitals and some big size hospitals in China.

So we expect – we probably will have seen those has been stabilization in the ECLIA business and we should see more positive contribution from the end-user growth in volume, which we'll support in ECLIA business in later quarters.

And for the FISH I think the single-digit growth is because of the interruption we experienced in June and September quarters during the internal investigation and it's over and you see we have achieved a pretty good sequential growth in our FISH business, and we see there is still a lot of potential in the FISH business. And in FISH business we had a very strong dominant position in the marketplace. We only have one competitor, which is Abbott and we have very much big market share in this market.

And so, the FISH business is completely different from the ECLIA business, where in the ECLIA business there are lot of players in the market and the technology is competitive whereas the – you know the ECLIA is older technology, but – in the immunoassay technologies, while FISH is a molecular diagnostic which is advance and also difficult to laboratory and ECLIA in our laboratory in the global marketplace. And so it has a very different story, I mean, especially in terms of competition, in terms of pricing, in terms of our sales channel, we are using our direct sales force to sell the products and you know we have five approved FISH probe application while our competitor currently have only one. And so any new comer which will take sometime to get SFDA approval for the FISH probe even though you will see it appear in China market. So we see there is a lot of room for the growth here in the FISH market. And I will let Mr. Wu to add some more comments on the potential in the FISH market.

Xiaodong Wu

(inaudible)

Sam Tsang

So it is about what I've told Bin.

Bin Li – Morgan Stanley

Okay. Just one last question from me, it's housekeeping items. The stock repurchase program, can you tell us where you are in terms of how much money you have spent or if you can remind us what’s the total pool that was allocated for the stock repurchase and how much you have stock repurchased so far and how much you did in last quarter?

Sam Tsang

Well, we approved share repurchase programs in September which commenced in October 2009 and up to the end of December, we have repurchased 390,000 ADS in the open market and with the total cost of about $5 million. So given the 30 million program, we still have 25 million available to repurchase our ADS, of course, depending on market conditions.

Bin Li – Morgan Stanley

Do you have an expiration date for the third quarter?

Sam Tsang

Yes, effective for one year. So October 2009 to September 2010.

Bin Li – Morgan Stanley

Okay. Great. Thank you.

Xiaodong Wu

Thank you.

Operator

(Operator Instructions) I would like to turn the call over to Sam for closing remarks.

Sam Tsang

Right. Once again, thank you for joining us today. Please don't hesitate to contact us if you have any further questions. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.

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