Winne Yam - Assistant Manager, IR
Xiaodong Wu - CEO
Sam Tsang - CFO
Zhong Chen - CTO
Charles Zhu - SVP of Operations
Bin Li - Morgan Stanley
Jack Hu - Deutsche Bank
China Medical Technologies, Inc. (CMED) F2Q2010 (Qtr End 09/30/2010) Earnings Call Transcript November 17, 2010 8:00 AM ET
Good day, ladies and gentlemen. And welcome to the China Medical Technologies second quarter 2010 earnings conference call. (Operator Instructions) At this time, I would now like to turn the call over to Ms. Winnie Yam.
Good day, ladies and gentlemen. I am pleased to welcome you to China Medical’s earnings conference call. China Medical already announced its second fiscal quarter results ended September 30, 2010. A copy of the press release is also available on the company’s web site at www.chinameditech.com.
Today, your speakers will be Mr. Xiaodong Wu, CEO; Mr. Sam Tsang, CFO; Dr. Zhong Chen, CTO; and Mr. Charles Zhu, Senior VP of Operations. After they finish 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 discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation 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 filings with the US Securities and Exchange Commission. China Medical does not undertake any obligation 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 web site. Now, allow me to turn the call over to Charles, who will give remarks on behalf of Mr. Wu. Charles?
We are seeing growth in each business line in the past quarter. We will continue to focus on execution of our business initiatives and expect to achieve sustainable growth in all of our three business lines.
For FISH, our direct sales growth continues to drive the sales of recurrent FISH growth revenue from three areas, first, by increasing the tests usage in the existing FISH applications in this hospital user; second, by expanding FISH applications to other clinical departments in the existing hospital users; and third, by adding new Tier 1 hospital users.
Besides, we have collaborated with the largest and reputable Medical Association in China, Chinese Medical Association, to organize a group of leading hospitals to conduct study on certain important clinical areas, where our FISH test can provide significant clinical benefit, such as cervical cancer screening, leukemia, urology, prenatal, miscarriage, et cetera.
The studies will be conducted by these leading hospitals starting in early 2011 and targeted to finish within one year. The studies will achieve two goals by working with the leading Medical Association and top preliminary doctors in their respective field.
First of all, to promote the prudent clinical benefit of FISH in a broader coverage area, so that the use of FISH test will be further increased and accepted by more large hospitals. Secondly, to include FISH test in the guidelines of the diagnostic manuals in relevant clinical applications for physicians in the respective fields through the large number of studies conducted in medical leading hospitals, which will build the foundation for a long-term sustainable and increasing usage for FISH test in China.
For SPR analyzers and HPV-DNA chips, we installed another 30 units of SPR analyzers during the past quarter. We have received strong interest on our SPR analyzers for many of our top hospital customers. And will continue to place our analyzers with these hospitals in accordance with our plan.
We have seen the contribution to the company from the sales of HPV-DNA chips and expect to see substantial growth in the sales of HPV-DNA chips, based on the positive feedback from the hospital users and large purchase orders of our chip from certain hospital users. We believe the fast growing HPV test market in China continues to present an excellent market opportunity for us, which will generate recurring and fast growing revenue to us in the next few years.
Revenue from our ECLIA business has resumed growth on year-over-year basis. Many of our existing and new ECLIA distributors and hospital users have expressed interest in our fully automatic ECLIA analyzer. We express to launch the fully automatic ECLIA likely in the second half of 2011, after the completion of trial use by a selected group of hospitals.
As we mentioned in our previous quarter earnings call, continuous investment in R&D for future growth is always one of our important strategic imperatives. We have eight new FISH application, are either under development stage or in SFDA approval process.
The initial success of using SPR for HPV detection, also gave us great confidence that SPR technology can be utilized in broader application areas. And our R&D team is developing three new DNA chips on SPR platform. Another milestone is our first self-developed PCR-based EGFR Assay has been recently approved by SFDA. This assay is a companion diagnostic test for non-small cell lung cancer patients to determine the use of the use of lung cancer targeted drugs such as Iressa and Tarceva.
This is the first PCR-based EGFR Assay approved by the SFDA, our hospital customers can benefit from this newly approved assay to help lung cancer patients to determine the use of effective but expensive targeted drugs.
This new product can be introduced to our over 400 hospital customers very quickly through our direct sales network of over 300 direct sales personnel.
Together with our EGFR Fish probe which is under SFDA approval process we will be offering 2 complementary technologies as a package to provide optimal clinical benefit to lung cancer patients. This is an example of the synergy we wanted to achieve among different product lines.
Going forward we will keep building up our PCR based product portfolio and leverage our strong sales channels to offer more complete molecular diagnostics solutions to our customers.
To summarize each individual business is on track which demonstrated the success of our business transformation. We have transformed ourselves from a large capital medical equipment company to a pure advance IVD company with focus on high end molecular diagnostic products where 100% of our revenue is coming from return on diagnostic consumables used by the hospitals on daily basis. We believe the current businesses will provide us with long term stable stream of cash flows and sustainable growth.
I have finished with Wu’s remarks and I like to turn the call over to Tsang who will review our financial results.
Let’s talk about our financial results in the past quarter, our 2Q ‘10 revenues increased by 21.5% year-over-year to RMB 201.8 million or US$30.2 million. Our 2Q ‘10 non-GAAP net income which excludes stock compensation expense, amortization of acquired intangible assets and non-cash expense of convertible notes increased 270.1% year-over-year to RMB 65.4 million or US$9.8 million.
Our 2Q ‘10 non-GAAP diluted earnings per EDS increased 237.1% year-over-year to RMB 2.50 or U.S $0.57. We generated our cash from operations in the amount of RMB 67.3 million or US$10.1 million in 2Q ‘10.
Let’s highlight certain financial results. First, our ECLIA revenue achieved an 8.7% increase year-over-year, and our FISH revenue achieved a 28.4% increase year-over-year. Our sales of SPR-based HPV-DNA chips increased from RMB 18,000 of 1Q ‘10 to RMB 3.8 million of 2Q ‘10. We expect substantial growth in HPV chip contribution in 3Q ‘10 and 4Q ‘10. We installed 79 SPR analyzers with our top tier hospital customers by the end of September.
Second, the overall non-GAAP gross margin which excludes stock compensation expense and amortization of acquired intangible assets, increased to 79.7% in 2Q ‘10 mainly due to more contribution from the sales of FISH probes which generated higher gross margin. We expect there is still room for improvement in our non-GAAP due to the increase in contribution from FISH probes.
Third, our total R&D and SG&A expenses were down 20.4% year-over-year from RMB 72.1 million to RMB 57.4 million or US$8.6 in 2Q ‘10. The decrease was mainly due to little cost of independent internal investigation and lower allowance for doubtful accounts in 2Q ‘10. We expect slightly moderate increase in selling expense in 2Q ‘10.
In addition, our high effective tax rate was primarily due to certain expenses such as stock compensation expense, amortization of acquired intangible assets and interest expense of convertible notes not deductible for China income tax purpose as well as the accrual for withholding income tax on distributable earnings generated in China during 2Q ‘10.
Besides, our cash position at the end of September was RMB 805.9 million or US$120.5 million. We generated net cash flows of RMB 67.3 million or US$10.1 million from our operations, and used RMB 1.2 million or US$0.2 million for our investing activities in 2Q ‘010. We did not have any cash flow for financing activities in 2Q ‘010.
We have received an early payment of US$8 million in November from Chengxuan, a major shareholder in connection with a receivable of US$30 million for the sale of our HIFU business to Chengxuan. Chengxuan has indicated that the remaining US$22 million will be paid on before the due date of December 31, 2010.
We tried an offering of high-yield senior notes of US$200 million in late September 2010, to refinance our existing convertible notes. We postponed our offering because of the higher than expected coupon. We are currently working with the high-yield underwriters in order to lower the coupon.
Last but not the least, our outlook for 3Q ‘010 and the fiscal year 2010, we estimate our revenues for 3Q ‘010 to be more than RMB 220 million or US$32.9 million, representing a year-over-year growth of more than 27.7%. We estimate our non-GAAP net income for 3Q ‘010 to be more than RMB 74 million or US$11.1 million, representing year-over-year growth of more than 62.2%. Our non-GAAP diluted earning per ADS for 3Q ‘010 is estimated to be more than RMB 2.82 or US$0.42, representing a year-over-year growth of more than 62.1%.
We estimate our revenue for fiscal year 2010 to be more than RMB 846 million or US$126.4 million, representing a year-over-year growth of more than 17%. The year-over-year growth rate of annual revenue is lower than that of 3Q ‘010, primarily due to a 10.9% year-over-year decline in quarterly revenue in 1Q ‘010.
We estimate our non-GAAP net income for fiscal year 2010 to be more than RMB 280 million or US$41.9 million, representing a year-over-year growth of more than 49.5%. Our non-GAAP diluted earnings per ADS for fiscal year 2010 is estimated to be more than RMB 10.69 or US$1.60, representing a year-over-year growth of more than 49.9%. The estimates are based on our current views of operating and market conditions and are subject to change.
This concludes our remarks. Now, we are welcome to your questions. Operator.
(Operator Instructions) Your first question comes from the line of Bin Li with Morgan Stanley.
Bin Li - Morgan Stanley
First is on the convertible bonds, I just want to get more clarity, Sam, you mentioned previously, your action before and then your action right now. But if you can lay out a few options that you have; lets assume that you would not come out and do another fund raising before the due date. I would just like to understand what are the options in your hand to deal with convertible bonds, which are expiring a year from now?
The second question is on the FISH and Mr. Wu mentioned that you’re working with the government to conduct a few clinical studies. I’d like to understand it a more about the size of the study and the cause of the study? And perhaps also along the way, if you could highlight a couple of interesting ones that would come out first, and what’s your expectation of those to help yourselves? That’s the second question.
The third question is on the PCR. You mentioned briefly on the PCR, you’re working on PCR. If you could give us more color on where you are and which group, and how did you get the technology? And what’s your plan to move this forward to complement your existing IVDs?
I will answer your first question and I would ask Charles to translate your second and third questions from Mr. Wu. For the first question is about we financing our convertibles notes. First I’ll lead you to highlight that, we have two convertible notes. The one which will mature in November 2011, that is one year later. The outstanding amount is US$135 million. So based on our cash position and operating cash and also the receivable from Chengxuan, we can adjust the November 2011 convertible notes.
The reason we come to the market to in May, September to try to offer this prior year senior notes is basically to adjust our refinancing this for the 2013 convertible notes, because the size of the 2013 August maturity convertible notes, the size is US$248 million. And so based on the cash flow we will lead to refinance, that 2013 convertibles.
So instead of we waiting to course through the maturity of 2013, we think that it is in the best interest of the company to refinance this bigger convertible notes due 2013 earlier, so we can manage the maturity proactively and also raise the money at lower cost of borrowing. So that’s why, even though we can proceed with the high offering in September, but the problem is the interest we’re paying there. We have to pay so much higher than we expect.
So we can afford to postpone, because the reasons for refinancing is just to proactively manage the maturity, a lot meaning that we have immediate refinancing needs. So we are still working with our high-yield underwriters to try to reduce the coupon before the complete offering of high-yield.
So I would ask Mr. Wu to answer your second and also third question.
In terms of the clinical studies project, we are going to collaborate with the largest Medical Association, the Chinese Medical Association in China for those projects. The Chinese Medical Association is the most reputable and positioned in medical fields. They have about 80 sub associations under the organization. And they publish more than a 120 professional journals in different fields of medicines.
And for each of the projects, currently we are planning to organize six to seven projects covering cervical cancer, urology, nephrology, birth defects and prenatal and hematology-related applications that involve the usage of FISH test. And for each of the test, we will engage the leading preliminary doctors in each field. For example for the cervical cancer, we are going to principal investigators for this project, and will be the Chairman of the OB-GYN Association under the Chinese Medical Association. And he will engage each of the leading hospitals in each of the thirty provinces in China to conduct the related projects.
And the same pattern for the other five to six studies; we will all engage the Chairman of the related association in this field as the principal investigator. And also for each of the project, we will engage these thirty leading hospitals from thirty provinces of to conduct the projects. And in terms of the project itself, we arranged it so that the purpose is to summarize the clinical benefits and the results that we calculated from the experience of two years usage of FISH clinical diagnosis to promote those clinical benefits to the larger numbers of hospitals in China.
So through those projects, we will be engaging more that 200 leading doctors in each field. And those leading doctors, they will have the ability to influence to a total of these and other 2,000 doctors in China. So this way we can promote the usages of FISH test to cover the existing over 400 hospitals FISH user in China. And get grater acceptance from the hospitals and the related doctors in China.
And the second purpose of this project is because the Chinese Medical Association is responsible for the making of clinical guidelines for each application. And while hoping through those clinical studies projects, using the FISH technologies for the related applications will be eventually included in the guidelines in China, so that enables to set the foundation for a long-term growth for the FISH test in China markets.
In terms of the cost of the study, we invested US$3 million into especially in (AIDS) front for Chinese Medical Association. And this US$3 million fund is going to extend over 3 years on different projects. As we mentioned, we are hoping that we’ll be engaging and influencing more than 2,000 famous doctors in China in the related medical fields that have substantial use of FISH applications.
And we estimate if each of those doctors eventually generate 400,000 to 500,000 revenue in terms of the FISH revenue, then we estimate we can generate a total amount of US$100 million revenue for FISH this year as the benefit from those clinical studies.
And currently we have designed six studies. But in the future, we are adding more products. For example, as we are adding new technologies like PCR-based technology products. We will add some more study projects.
As you can see that our first PCR-based Assay has been approved by Chinese FDA, and this Assay is developed by ourself. We used two to three years to develop the first PCR Assay.
We think as a molecular diagnostic technology company, the product portfolio is not very complete without PCR-based technology.
In terms of the PCR instrument, since it’s already very established and widely used by the customers, we are not going to spend resources to acquire the technologies for PCR instrument.
In terms of the technology for different PCR reagent assays, we are doing more research to determine the best way for us to get those technologies to either develop the PCR-based Assay through our internal R&D in order to get the technology through licensing arrangement from domestic companies or academic institutions or foreign companies.
Since our company has already established very strong (inaudible) channel through FISH technology, we believe PCR products will to us another growth driver of the total business.
Bin Li - Morgan Stanley
I just have two quick follow-up questions. One is on HPV. You said, you installed 30 machines this quarter, can you tell approximately what was the sales was in the past quarter? Then you mentioned that you’re expecting significant increased sales from this business in the third quarter and fourth quarter. Can you also tell us how much sales you have factored in, in your guidance right now?
Second question is, I think you mentioned you are expecting to launch fully automatic ECLIA machines. Can you tell us if there are any changes in your plan in terms of your targeted audience? I think previously you mentioned that you want to go into higher-end hospitals. Is that the plan or you have it in your plan?
For the sales of HPV this September quarter, the second 2Q we generated revenue of about RMB 3.8 million. And the previous quarter, June quarter we only had RMB 18,000 revenue. So we have a substantial increase from HPV sales. And we are expecting a substantial growth on this RMB 3.8 million basis in the next two quarters because of the existing installment base and also strong interest from our FISH hospitals which are eager to get SPR equipment and also from the existing users which have used our HPV chips on regular basis. We received quite significant purchase orders from these users. And so we are confident of the growth from the HPV sales at least in the next two quarters, and this has been factored in our guidance for the next quarter and also the full year.
For the questions about fully automated ECLIA equipment, we do not have any change in our plan because when we received the SFDA approval for this fully automated ECLIA equipment I think several months ago, the target is the large hospitals in China and also the high-volume mid-sized hospital user, which are currently our semi-automatic ECLIA user.
We do not have any change in plan. We already selected several hospitals which are using our fully automated ECLIA equipment and given us feedback on the use and also how we can serve this a little bit different group or different users better when we formally launched fully automated ECLIA in the second half of 2011. These large hospitals, they have very large consumption or usage of the ECLIA reagent kit, and also they have used imported high-throughput fully automated equipment for many years, and so it’s important for us to understand their needs and their expectations.
And also, our strategy as we discussed before, we have some very specific China-focused ECLIA reagent kits such as liver fibrosis reagent kits which are not offered by the international payers and which also have very good market potential because China has the biggest or largest hepatitis infected population. And so, we believe that (inaudible) to use our existing direct sales network. We have over 400 top tier hospitals in China which have heavy use of ECLIA reagent kits. And also with China-specific reagent kits we believe we can use these strategies to open up this market for our fully automated ECLIA products.
Your next question comes from the line of Jack Hu with Deutsche Bank.
Jack Hu - Deutsche Bank
I actually have one question first of your guidance. So you increased the guidance to 17% year-over-year growth and you also gave the guidance for next quarter for topline (inaudible) RMB 220 million. So you have only one quarter left, and you did not give guidance which is accounting the quarter of 1Q of 2011. Just based on all of this math, I’m calculating your next quarter growth rate will be 28%. The quarter after next quarter will be 36% year-over-year growth. So next quarter, you have 22% growth.
So if I look at the trajectory of the growth, how should we think of your growth momentum going into 2011?
I think that the growth momentum this September quarter 22% year-over-year growth, next quarter 28% year-over-year growth. And we estimate or calculate the March quarter to have something like 36% year-over-year growth.
And so the company’s current business model is based on the recurring revenues from all over three business lines. And also, previously we did not provide full year guidance because the HPV business is in very early stage, wrap-up stage, and now we have more visibility in this business. We have a larger customer base. We have received significant purchase orders for our HPV chips. And we are more able to predict our future revenues.
So we already discussed the FISH strategies, and FISH is going well and we have new initiatives like the Chinese Medical Association studies, and which we believe will help us to have sustainable and longer term growth with this initiative. And also, we have new products, something like the PCR-based assays. And also, the HPV is still in the early stage. We are expecting substantial growth in the next two quarters at least.
And even, the more much mature ECLIA business, we have already resumed year-over-year growth in this quarter. And also, we have new growth drivers such as the fully automated ECLIA equipment in a new hospital, which we have a relationship with them through our more mature diagnostic products such FISH and HPV chips. So we are pretty optimistic for the trend of the business of the company in the future in fiscal year 2011.
Jack Hu - Deutsche Bank
The next question actually is on your pipeline.
I do understand that some of your products, you may want to keep that actually as a commercial secret. But can you just explain maybe as much as you can your pipeline for FISH and also for your SPR platform. If I hear you correctly, you said that you are developing three new DNA chips based on the SPR technology platform. Can you maybe give us a little color what they are and then what are the indications?
What we are doing right now based on the FISH platform, there are several major products under development right now. First one is hematological is also related such as for lymphoma. So under lymphoma we have bunch of products under development and also for some soft-tissue sarcoma such as like synovial sarcoma, you know all this kind of soft-tissue sarcoma and also some related to tuberculosis and also some related to reproductive medicine.
So these three major areas are probably the potential growth driver for future. And in terms of the products, under SPR platform, we have two actively under development for some kind of infectious disease or bacterial detection related to product which can be used for a disaster situation such as earthquake or some flooding situation. So it would detect the four or five very typical disaster-related bacteria such as coccus bacilli and these kind of very real disaster-related bacteria.
A lot of products that we are developing right now is related to coagulating related disorders. So we’ll detect the bunch of the gene polymorphism to predict a risk which can be related to coagulating disorders. So this is what we have right now.
Jack Hu - Deutsche Bank
Question actually for your disaster related material, do you actually have an order from the government for this kind of a national strategic reserve, or are you collaborating with any government agency on this product? I would assume, even you successfully develop this drug, it should have been limited to commercial usage, should be used for national strategic reserve, right?
As you know, the major earthquake in Sichuan, Wenchuan has killed a lot of people. And actually a lot of the deaths is probably related to not immediate to the detection of the bacteria infecting the person. So if we have a tool to answer that question, we probably can save a lot of lives.
After the Wenchuan earthquake and several very important institutions, hospitals contact us to be aware of such detection to approach. And because of confidentiality, we cannot tell or why or elaborate in detail the names of the institutions. However, what I can tell you is that its importance, and if I feel this approach can be very important in the future.
And as a manufacturer, as I was speaking today, we are very close to the completion of the development stage and right now, we are in the final stage of R&D.
And also this project has been supported by the national science foundation major project under the category of the major product. So the major projects has been supported and granted by the government.
Jack Hu - Deutsche Bank
If we look at DSO and the base of inventory you had, actually it’s (inaudible) and the inventory. In this quarter, you had some improvement. Should we expect this kind of improvement to continue, or is this in a normal fluctuation range?
I think the level of accounts receivable which we’ll rely more from the receivable for the direct sales, we’ve hospital for FISH and also for HPV chips. And you know these are large hospitals. They are very sonic and have a very strong financial position. But at the same time they do not pay the receivable quickly even though there is basically no reason for it.
So we think that the current level of accounts receivables can be maintained as well as the level of inventories and even though we may have some increasing inventories level, but given that we have very high gross margins, the increasing inventory level (with) us. Even though, we not have any much increase in the working capital requirement for us given the relatively high margin for the status.
At this time we have no further questions. I would now like to turn the call back over to Sam for closing remarks.
Thank you for joining our call. Please do not hesitate to contact us if you have any further questions. Have a nice day. Thank you.
Ladies and gentlemen, this concludes the presentation. You may now disconnect, Thank you, and have a great day.
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