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China Cord Blood Corporation (NYSE:CO)

F3Q 2014 Earnings Conference Call

February 25, 2014 08:00 ET

Executives

Tina Ting - Chief Executive Officer

Albert Chen - Chief Financial Officer

Analysts

Yi Chen - Aegis Capital

Scott Henry - ROTH Capital

Huchen Zhang - Macquarie

Brian Tanquilut - Jefferies, LLC

Alberto Bassetto - Jayhawk Capital

Operator

Welcome everyone to China Cord Blood Corporation’s Earnings Call for the Third Quarter and First Nine Months of Fiscal Year 2014. All participant lines will be placed on mute during the presentation. (Operator Instructions)

Now, I would like to introduce Mr. (Kevin Zhang) to begin the presentation.

Unidentified Company Speaker

Good morning, everyone. Welcome to our earnings conference call for the third quarter and first nine months of fiscal 2014. A press release discussing our financial results has already been released and a copy is available on our 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 risks and uncertainties and actual results maybe 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, followed by our CFO’s remarks on our third quarter financial performance. Then both our CEO and CFO will be available to answer questions during the Q&A session.

Let’s begin our presentation.

Tina Ting - Chief Executive Officer

Good morning, ladies and gentlemen. Welcome to our third quarter fiscal 2014 earnings conference call. Overall, we continued to deliver solid business performance in the third quarter, which subsequently grew our accumulated subscriber base to nearly 360,000 as of December 31, 2013 with 16,317 new subscribers added during the quarter. While our year-over-year comparison of quarterly new subscriber was impacted due to lower number of newborns compared to the Dragon year as well as from increased subscriber fees, we were pleased to have maintained steady sequential growth.

In the third quarter, we achieved record quarterly revenues, attributable to our upward pricing adjustment implemented in the beginning of our current fiscal year and from the sound execution of our sales and marketing strategy. In the third quarter, the one-time payment option remained the preferred choice among our new subscribers, which contributed to our robust cash flow, which improved over the first and second quarters. Since we raised our service fees in the beginning of our current fiscal year, we have closely monitored the market reception and get its feedback from our new subscribers. Based on the sequential increase in demand that we have experienced in the previous two quarters, we believe that the markets have largely adapted to our new fee levels.

Our key operating regions Beijing, Guangdong and Zhejiang, each (continent have) demand among our economically affluent target region segment. CCBC will continue to capitalize on our exclusive operating license and brand awareness in culminating the appropriate marketing strategy to further penetrate our market share in each of these regions. Significant progress has been made with our capacity expansion plans in Guangdong and Zhejiang. Both of these facilities are in their final stages of construction and I expect it to be completed by the beginning of our upcoming fiscal year.

The company has grown its market presence study over the last few years, especially in the Guangdong market, which accounts for more than half of our new subscribers now. We view the current environment in Zhejiang as comparable with Guangdong a few years ago with a relatively low penetration rate or with the capacity to grow rather quickly and become a key growth area for CCBC in the future. Upon the completion of our capacity expansions, we plan to enhance our marketing efforts to view our both opportunities within each region.

Having advanced through three challenging quarters following the Dragon year baby boom, we maintained our full year guidance of 65,000 new subscribers and we are trying our very best to meet each target in spite of seasonal weakness due to the Chinese Lunar New Year and the fiscal fourth quarter.

This concludes my overview of our third quarter results and developments. I want to thank you for you support of CCBC. At this point I will turn the call over to our CFO Mr. Albert Chen to review our financial highlights.

Albert Chen - Chief Financial Officer

Good morning everyone. Thank you for joining our call today. Our third quarter fiscal 2014 performance was nothing, but solid both operationally as well as financially. We recorded 16,317 new subscribers during the quarter representing a steady quarter-over-quarter improvement. We believe our year-over-year comparison is not the most appropriate because we are comparing our fiscal 2014 third quarter to the best performing quarter of last year baby boom Dragon Year. Our accumulated subscriber base continued to raise reaching 359,487 as of December of 2013 representing a 21% increase year-over-year. While the number of newborns in China has contracted after the Dragon Year and the number of new subscriber has decreased on a year-over-year basis, we still managed to report a record breaking revenue of RMB150.6 million, which was largely attributable to the higher pricing we implemented back in April 2013 and from the expansion of our accumulated subscriber base.

Since April 2013 we have begun to implement a higher processing fee which helped to minimize the impact of lower processing revenues caused by the decline in new subscriber. However, revenues generated from higher margin storage fees were a major highlight for the quarter. Because of our subscriber base business model revenues generated from storage fees have grown in tandem with our expanding accumulated subscriber base. For the third quarter we recorded a solid 27.8% year-over-year increase in revenues from storage fee, as a percentage of total revenues, revenue from storage fees increased by more than six percentage points to 28.7%. While our cost base has increased since early 2013 after the AABB accreditation, we have implemented stringent cost control and adjusted prices upwards to offset the effect of reduced volumes and rising costs which resulted in a lucrative 82% gross margin and one percentage point improvement over the same period of last year and also representing steady improvements from the first and second quarters of fiscal 2014 as well.

On the SG&A front, third quarter sales and marketing expenses noticeably increased while third quarter administrative expenses remained in the RMB27 million to RMB28 million range. Sales and marketing expenses increased approximately 14% year-over-year or 2% quarter-over-quarter to approximately RMB28 million as we increased our ongoing promotional and marketing activities to attract new subscribers. As we broadened our marketing efforts we continued to incentify our sales force to meet and exceed their growth targets. Consequently we expect our sales and marketing expenses to continue to grow in line with our sales activity.

We continued to monitor our sales and promotional activities to ensure high sales efficiency and effective allocation of our resources. Such efforts result in continuous improvement in sales and marketing expenses as a percentage of revenue, which stood at 18.7% for the third quarter compared to 22.1% and 19.5% for our first and second quarters. Thanks to the team’s effort to control fixed cost and improve administrative efficiency, G&A expenses for the third quarter remained relatively flat at RMB27.2 million or 18.1% of total revenue, representing a modest improvement over the second quarter. Third quarter operating income of RMB65.7 million is not a record breaking amount due to the increase in sales and marketing expenses. However, it represented a satisfactory operating margin of approximately 44% due to the rising contribution from our storage revenue components, lucrative gross margin and the cost control measures in place.

Depreciation and amortization expenses in this quarter increased to RMB9.9 million from RMB8.4 million in the same period of last year as we begin to ramp up part of our new facilities in Guangdong and Zhejiang. As discussed in our CEO remarks, the construction work at our new facilities is in its final stages. Therefore, the amount of interest expense that we capitalized in the third quarter was less than our first and second quarters. We expect interest expense to return to historical levels, which largely consist of the interest on our convertible notes.

Third quarter income before tax totaled RMB49.2 million represented a 1.4% and 10.1% improvement over the prior year and prior quarter respectively. Net income attributable to the company’s shareholders increased by 2.7% year-over-year to RMB34.6 million in the third quarter representing a net margin of 22.9%. Basic and diluted earnings per share for the third quarter were RMB0.41. Cash flow continued to remain healthy as majority of new subscribers prefer the one-time payment option. As a result, net operating cash flow for the third quarter amount to RMB169 million.

This concludes our remarks for today. Operator, we are ready to take some questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) Your first question comes from the line of Yi Chen from Aegis Capital. Please go ahead.

Yi Chen - Aegis Capital

Hi, thank you for taking my questions. My first question is can we assume that the new facilities in Guangdong and Zhejiang will be fully operation-ready in the first quarter of fiscal year 2015? And what is the capital expenditure that kind of Cord Blood will invest in the coming quarter, which is the last quarter of fiscal year 2014? Hello.

Tina Ting

(Foreign Language)

Albert Chen

Yes, I will translate for Ms. Ting. For the construction of the new facilities we installed is progressing on track and we believe that most of the things that we can done, have been complete already. So the only uncertainty right now is that after completion of the construction work, those laboratories will still require to be examined and approved by the authorities. And this approval process is to a certain extent out of our control. So this may introduce some sort of uncertainty, but hopefully with everything going according to plan, we will have the facilities available and up and running up probably in the first quarter of fiscal 2015. As for your question concerning the outstanding capital expenditure to complete the project, we believe that the outstanding amounts now is closer about RMB10 million, which will likely to be recorded as capital expenditure in the quarter ending March of 2014.

Yi Chen - Aegis Capital

RMB10 million in terms of RMB or…

Albert Chen

RMB10 million in terms of RMB.

Yi Chen - Aegis Capital

Okay, my second question is what percentage of new subscribers in the past quarter choose to – chose the one-time payment plan?

Albert Chen

I will take the financial question and as for the quarter ending December of 2013 new subscriber does choose the new – the one-time payment option accounted for like 50 – approximately 52%. And then customers that opt for the normal payment option is approximately 39%.

Yi Chen - Aegis Capital

Okay, thank you.

Operator

Your next question comes from the line of Scott Henry from ROTH Capital. Please go ahead.

Scott Henry - ROTH Capital

Thank you for taking the questions and good morning. Just one question today, I believe I heard the guidance was maintained at 65,000 new subscribers in fiscal 2014, should we think about that is kind of a stretch target given the difficulties as the year of the Dragon and we are already three quarters in and it certainly looks while a goal perhaps a little bit more of a difficult target to reach, is that how I should think of it?

Tina Ting

As we mentioned in our comments, the challenges still lays ahead. Given the fact that after the post Dragon Year baby boom, I mean it’s apparently that the contractions of the number of babies born in our target regions had somewhat exceeded our original estimations. So much as I said we believe that the 65,000 new subscriber target may be somewhat challenging, but we will strive for our very best to try to achieve as close as we can.

Scott Henry - ROTH Capital

Great, thank you for giving that color. And thank you for taking the question.

Operator

We will now move on to next question from the line of Huchen Zhang from Macquarie. Please go ahead.

Huchen Zhang - Macquarie

Hi. Just wondering could you update on the progress of Zhejiang province in terms of say subscriber, revenue and profit?

Albert Chen

I will take those questions. In terms of the progress itself, as mentioned by – in our CEO remarks that the construction work has been progressing as planned. And we do believe that everything progressing accordingly, we will probably completed the work and hopefully obtained the clearance from the local authority to start utilizing the left – the newly constructed laboratories during the first quarter of the next fiscal year “as the quarter ending June of 2014.” With that being said, I believe that the lack of operational capacity to take on the true Zhejiang market right now the contribution from Zhejiang remain relatively small from the new subscriber mix perspective. It currently accounts only nearly about 7% of our total new subscribers. But given the fact that those of you who have been following our company you understand that we used to face this processing capability bottleneck issue, which limits our ability to market the service broadly within the profits. Now hopefully with the completion of new facilities coming in, in the near future that issue will soon be addressed.

Huchen Zhang - Macquarie

Thanks. And just the second question, we have seen like countries over the region rolling out core tissue products, just wondering has China Cord Blood got any plan to rollout this kind of product in future? Hello.

Tina Ting

(Foreign Language)

Albert Chen

Well, I mean, as pointed out in your remarks that there are other couple of the banks who are providing tissue banking in the regions, but unfortunately within the China context, the PRC government has not really explicitly spell out the policy when it comes to cord tissue banking. So to a certain extent, this is a gray area. And from a company perspective, we continue to explore new opportunities and new revenue streams. Obviously, any breakthrough that we will be more than happy to make a public announcement, but I guess as of today, I guess it is prudent to say that we are still looking into this interesting area.

Huchen Zhang - Macquarie

Okay, thanks. Thanks for taking the questions.

Operator

Our next question comes from the line of Darren Wang from (indiscernible) Asset Management. Please go ahead.

Unidentified Analyst

Hi, good morning, Albert. First of all, congratulations of the good quarter we have. And yes, I have couple of questions. The first one is geographically what percentage of the new subscribers are from Beijing, Guangdong and Zhejiang just now you already mentioned Zhejiang is about 7%, what about Beijing and Guangdong?

Albert Chen

Hey, Darren. From Beijing, it’s about 31%. And as I pointed our early on, the new subscriber from Zhejiang is 7%.

Unidentified Analyst

Okay, thank you. Last question is regarding the cost control and we can see that the company has done very well….

(Technical Difficulty)

Albert Chen

….you all know, that Beijing is a much smaller region in terms of geographical space. However, I mean, we given all that we have learned in the past, we can pretty much copy from our existing marketing structure and the marketing promotion package and just parachuted down to the Guangdong as well as the Zhejiang region. And in doing so, we actually cut out a lot of necessary time cost as well as a necessary cost incur. That also help us to control cost as well. So I think to summarize its scale and although it’s a standardized profit and at the same time is a – is you get copying the Beijing role model into other regions which save lot of time and cost as well. So these are probably the three key points.

Unidentified Analyst

Thank you very much, Albert and Ms. Ting. That’s all I want to ask.

Operator

Your next question comes from the line of Brian Tanquilut from Jefferies, LLC. Please go ahead.

Brian Tanquilut - Jefferies, LLC

Hi, good morning, Tina. First question for you as I think about volume (Technical Difficulty) think your outlook given where you are today for next year and for the rest of this year?

Tina Ting

(Foreign Language).

Albert Chen

As we pointed out early on in response to one of the questions previously mentioned. As part of the post 10 year contractions, it seems like our prior assumption have kind of underestimated the magnitude of the contraction in terms of the number of new bonds in our target regions. So to fulfill the outstanding or the remaining target for the rest of the year is still somewhat challenging but we’ll try our very best to try to get as close as we can. As for the outlook itself even though there has been some favorable past being previously published such as for example having the second child and so forth, the feedback from our customer survey as well as from our frontline sales people, it seems like the part of this impact may yet to be – due to be realized. So given the fact that we are now moving away from the year with negative yield of course, we can only assume that the near-term growth will likely to stay at a more logical or reasonable range rather than what we have experienced during the Year of the Dragon. So we do not anticipate a rapid radical growth in the near term.

Brian Tanquilut - Jefferies, LLC

So Albert from a – as I think about I know when I go into guidance – but as I think about growing, volumes going forward with the new facility Guangdong and Zhejiang coming online, what sort of reasonable to think when you say that it’s going to be in line with kind of like historical average, what’s the reasonable growth rate to think of?

Albert Chen

Actually this is as we – as our firm pass we intend to update the – we intend to update the full year guidance for the next fiscal year when we announce the full year fiscal results in June of this year. So it is not our policy to make prior announcements. However we do like to share our view is that going forward I mean in the good old days where the company tend to grow at like 20%, 30% year-over-year. It seems like those golden days are pretty much behind us because you need to take into account that the – even with the new Zhejiang facilities coming online it will still take a reasonable amount of time before the sales can be materialized. So again to reiterate the point we believe that the growth in the near term will likely to be logical as well as reasonable but it won’t be nothing exponential.

Brian Tanquilut - Jefferies, LLC

Okay guys. And then last question for you as I think about the new facilities coming online, how should I think about your depreciation obviously it should go up, but what kind of depreciation schedule are you looking at for those facilities?

Albert Chen

We expect that decreased Zhejiang expense on a quarterly basis will probably increase from the current RMB8 million to RMB9 million a quarter to probably now fall RMB10.5 million to RMB11 million.

Brian Tanquilut - Jefferies, LLC

Got it, okay.

Tina Ting

They may be per quarter.

Operator

Your next question comes from the line of Alberto Bassetto from Jayhawk Capital. Please go ahead.

Alberto Bassetto - Jayhawk Capital

Yes. Albert good evening, can you hear me?

Albert Chen

Good morning, Alberto.

Alberto Bassetto - Jayhawk Capital

Okay. I have these questions for you. If you look at individual Beijing, Guangdong, and Zhejiang, what kind of penetration or if you prefer in terms of babies per year, do you think you can achieve kind of target going forward?

Albert Chen

My apology for that, actually we have difficulty hearing you, do you mind speak up a little bit?

Alberto Bassetto – Jayhawk Capital

Yes, I will try one more time, can you hear me now?

Albert Chen

Yes, but it will be nice or if you can speak up a little bit bigger tone.

Alberto Bassetto – Jayhawk Capital

I am trying as much as possible. I was asking or following if you look at the Beijing, Guangdong, and Zhejiang, what do you think the penetration or if you prefer how many babies per year each of these regions can achieve when they are full capacity if you want?

Albert Chen

Actually you raised a very good point because if you look at the growth momentum that we have been affording even though the pace of growth is different across various regions given the fact that Beijing for example is the longest, is the bank with longest operating history and Guangdong is relatively younger and Zhejiang is actually the youngest. They are all at different stages in their lifecycle and it is fair to say that all three banks are still reporting growth at a different range or at different percentage. So it is hard to conclude definitely where the – which bank is reaching at a maturity stage or which bank is reaching the toe end of percentage. But if you benchmark against where we are right now, I believe I already on – I have given the way the breakdown in terms of new subscriber numbers. And the number of babies born in each region was actually pubic information. For example in the context of Beijing its about 150,000 to 170,000 babies, Guangdong is about 1.1 million potential lives and Zhejiang is about 0.5 million. And you can pretty much work out the penetration at the current stage. And it is fair to say that Guangdong will become – will remain the major growth driver in the near-term, while Zhejiang is ramping up.

Alberto Bassetto - Jayhawk Capital

Okay, thank you very much.

Operator

At this point, there appears to be no further questions. I will now turn the call back to Mr. Kevin Zhang.

Unidentified Company Speaker

This concludes our earnings conference call for the third quarter and first nine months of fiscal 2014. Thank you for your participation and ongoing support. Have a good day. Operator?

Operator

That does conclude our conference for today. Thank you for participating. You may all disconnect.

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