China Cord Blood Corporation (NYSE:CO)
Q2 2017 Earnings Conference Call
November 18, 2016 08:00 ET
Kathy Bian - VP, Corporate Finance
Albert Chen - CFO
Michael Schmitz - Jayhawk Capital
Kent McCarthy - Jayhawk Capital
Welcome everyone to the China Cord Blood Corporation Earnings Conference for the Second Quarter of Fiscal 2017. All participants' lines will be placed on mute during the presentation. After which there will be a question-and-answer session. Now I would like to introduce Ms. Kathy Bian, VP of Corporate Finance to begin the presentation.
Good morning, everyone. Welcome to our second quarter fiscal 2017 earnings conference call. A press release discussing our financial results has been published 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 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 interest of time, we will begin with our CEO's remarks followed by a detailed report of our second quarter fiscal 2017 financial performance by our CFO, Mr. Albert Chen. Our management will be available to answer questions during the Q&A session.
Today, on behalf of our CEO, Tina, I will read her prepared remarks. Let's begin our presentation.
Good morning, ladies and gentlemen. Welcome to our second quarter fiscal 2017 earnings conference call. New subscriber numbers during the second quarter increased by 7.7% year-over-year to 18,037. This growth was led by our performance in Guangdong as we added the largest number of new subscribers from this market. Despite a competitive market environment in Guangdong during the second quarter, we remain successful in acquiring new clients through the refinement of our salesforce and enhancements to our marketing program effort. In Beijing, our market performance continues to report steady progress, largely due to our stable customer base and the local brand recognition.
Looking at our Zhejiang market, we maintained our strong position in the hospital channel and launched new marketing initiatives tailored for the local fertility population which also contributed to our overall subscriber recruitment effort. During the second quarter, there were no substantial changes to our payment mix and all renew subscriber growth was in line with the management projections.
The second quarter was a period in which we continue to experience a relatively weak macro economy and faced industry policy uncertainty. While China's economy grew at a 6.7% GDP growth rate during the reporting period, foreign exchange volatility and tightened foreign exchange system curbed consumer spending. Meanwhile, the ongoing potential medical obligation of stem cells continues to draw attention from both, global investors and researchers alike. However, as it relates to China market in the absence of corresponding booth and regulations to support the industry - the clinical application advancement of stem cells in China is exacted to remain slow.
While such conditions hindered our growth, our management team continues to improve CCBCs operational and financial results in a consistent steady manner, the adjustments made to our salesforce and our marketing programs enable us to target new subscribers more effectively and help optimize our results. Looking ahead, we believe we can achieve this year's target of new subscribers through our concentrated subscriber recruitment efforts. We also intend to prudently explore new business opportunities to optimize the utilization of our existing resources and further expand revenue and profit growth.
This concludes my remarks regarding our second quarter fiscal 2017 financial results. I'd like to thank you for your ongoing support of CCBC. At this point, I would turn the call over to our CFO, Mr. Albert Chen to review our second quarter financial performance in greater detail.
Good morning, everyone. As mentioned in our CEO remarks, even though we three uncertainties in the regulatory policy in China and lukewarm consumer sentiment, we manage to achieve pleasing results during the second quarter of fiscal 2017 with dedicated efforts. In the reporting period, revenues increased to RMB184 million representing a 7.4% increase year-over-year. Such increase in revenues was achieved by successful recruitment of new subscribers and the according growth of our total subscriber base.
We recorded 18,037 new subscribers signed up during the second quarter, representing a 7.7% year-over-year growth. Consequently, revenue generated from processing fees and other services increased to RMB115 million from RMB111 million of last year. Revenues generated from processing fees now accounted for 63% of our total revenue, compared to 65% of last year. During the second quarter, we reclassified 2,065 cord blood units as donated cord blood units because we view their recoverability to be relatively remote. As a result, we adjusted down our cumulated subscriber base to 536,877 as of September 30, 2016.
Revenue generated from storage fees, increased by nearly 15% to RMB69 million, and accounted for approximately 37% of our total revenue. Gross profit for the second quarter increased by 8% year-over-year to RMB145 million. Gross margin increased from 78% to 79%. Sales and marketing expenses for the second quarter was RMB40 million compared to RMB37 million of last year. The rising number reflected that company's marketing effort to acquire new subscribers despite weak market sentiment in China. As a percentage of revenues, sales and marketing expenses remained stable at 22% levels.
General and administrative expenses for the second quarter amounted to RMB48 million compared to RMB43 million of last year. The increase in G&A expenses was largely due to the non-cash write-off of RMB3.6 million as a result of the reclassification of cord blood units. Excluding this impact, general administrative expenses as a percentage of revenue actually dropped from 25% of last year to 24% of this year. Operating income for the second quarter increased by 4.3% to RMB55 million. Operating margin was slightly down to 30% compared to 31% in the prior year period. This was mainly influenced by the non-cash write-off.
Depreciation and amortization expenses for the reporting quarter were RMB13 million, same as last year. Share-based compensation expense was RMB16 million for the reporting quarter compared to RMB15 million in the prior year period. Operating income before depreciation and amortization and share-based compensation expenses totaled RMB83 million, up 4% year-over-year. Interest expense was RMB30 million, compared to RMB26 million in the prior year period and it was mainly related to the company outstanding convertible notes denominated in U.S. dollars.
The increase in interest expense was due to the compounding interest effect of the convertible notes, as well as the effect of that depreciation of RMB against U.S. dollars. As the increase in operating income was offset by the increase in interest expense and the absence of a dividend income during the second quarter of fiscal 2017, income before tax for the reporting quarter amounted to RMB30 million compared to RMB32 million of last year. Income tax expense for the reporting quarter remained stable at about RMB13 million. Net income attributable to the company shareholders for the second quarter of fiscal 2017 was RMB17 million compared to RMB19 million of last year.
Net margin for the second quarter went down by two percentage points to 9%. Basic and diluted earnings per share for the second quarter were RMN0.22. In terms of operating cash flow, net cash provided by operating activities for the second quarter was RMB136 million after taking into account the interest payment made to the company convertible notes.
These are the financial highlights for the second quarter, and we can now turn to the floor for any questions.
[Operator Instructions] We will now take our first question from Jeff Morrison [ph]. Please go ahead, your line is open.
Thank you. Yes, I'm a private investor, and clearly, you have a company that can generate a pretty significant amount of cash flow, that's something to be the issue here. With all the potential sales and real private information that's been going on, it seems like that - the little guys like me are getting lost in the shuffle. You've got a business that has over $400 million in cash. If you can retire that convertible debt, buyback $300 million worth of stock, you had a company with 20 million plus shares outstanding generate a $100 million in operating cash flow for a year, you've got significant value there. Clearly, the board is tying the hands of management to make simple decisions to help us. So if the board is listening, this is really executive dynamics [ph], I know you can't talk about anything that's going on, in regards to any sort of transaction that may or may not happen but this is really directed at the board and special committees to make the right decision and think of the minority shareholders. Thank you.
Appreciate the questions and we will surely direct that to the special committees and make sure that they are well over considerations of evaluation that they are looking at; we'll have to take into account interest of the company as a whole. And also understand that I'm not in a position to make comments about those transaction which may or may not be happening but as pointed out in our CEO remarks, we are looking at ways to improve the income stream, as well as the revenue stream of the company through organic growth as well as potential expansion opportunities. I guess at the current moment I will probably just leave it at that.
We will now take our next question from Michael Schmitz from Jayhawk Capital. Please go ahead.
Hi, Albert. If you adjust the GAAP net income numbers by backing out the incentive share-based compensation and the interest expense from the convertible notes, both of which I think go away after next year, you're on pace to make about $40 million this year which at the current stock price would mean that on a fully diluted basis, the stock is only trading at like three times net income and cash flow even better than that. Plus, the net cash on the balance sheet, so - which is $4 a share right now. It doesn't seem to me there is any legitimate business purpose for holding on to that much cash. So I think the best use of that would be to start buying back shares as the previous caller mentioned. In addition to being the right thing to do, seem it would push the benefit you guys and the directors and all the shareholders - everyone shares will be worth more at the end of the day if that's done. Do you and the rest of the board - do you only take orders from Mr. Kim or are you able to exercise independent judgment as well, because it seems like the only one standing in the way of this would be Mr. Kim, the Chairman of Golden Meditech. So I'd like you to explain if you could how - how buying back shares would not be a good use of at least some of the companies - hundreds of millions of dollars of excess cash in the balance sheet. Thank you.
Well, I think the decisions - and the corporate decisions will have to be made collectively at the board levels and members of the board will have to contribute their input, their insight into any transactions or potential capital transactions. As you are aware, we have a share repurchase program in place, and also as I mentioned in my previous earnings call - we look at the capital structure of the company, if there is way to improve the capital structure, I mean we will surely take into considerations as to when and in what form - I think that remains to be determined by the board; so we will surely take into your comments into account.
As a member of the board yourself, can you comment on your feelings about initiating share - actually using the share buyback program that's already in place?
Let's say I'm not against improving the return on equity on the company.
Can you think of any arguments of why someone would not want to buy back shares? I guess that's part of my main question is, out of - what is the holdup I guess in terms of why would people not want to see that happen?
I don't mean to answer the questions on behalf of my board but I think in making any decisions couple of factors needs to be taken into considerations, especially when it comes to deployment of capitals, whether there is any other potential benefits on the usage of the existing capitals, whether the capital will result in a near-term improvement in the capital structure or long-term improvement on the company business as a whole. So I think it's not a simple question but again, I look at your questions and we will take it to the board and we would continue the discussions internally as well.
We will now take our next question Ling Yang [ph] from FM Capital. Please go ahead.
Hi, Albert. I think operationally you guys are doing well. I think another question for me is more directed towards independent board, so my question is, it's been a year and a half since the former special committee to consider these accounts offer. And I just don't know how long are we going to hear from the different board or ever? Frankly, how difficult is it to reject $6.4 dollars offer on this company? And if we're having here for a year and a half, soon the special committee is dissolved and go back to their business. If you look at a lot of Chinese CDR buyouts; and the ones that didn't complete and the share price actually in most cases enough to be - 30% to 50% higher than the deal break price. So I think there is a lot of potential in seal [ph] but the share prices are being capped by the current offer on the table. So to the extent you can come around that - please provide us with some color on this.
Well, given in my because I am not part of the special committee as you know and - so it becomes hard to comment on where they stand on what the view are with respect to proposed offer. But I understand that there has been - it has been quite a while since the proposal was announced, it goes back in April 2015. I guess enough time has drawn and as of the current moment, I have received no indication that the special committees have arrived at any definitive answer. But should they have arrived at any definitive answer, I believe they will make the announcement and publication accordingly. Now with that being said, I understand the frustrations, and I believe that the - if this is - if there is any conclusion to be drawn, I think it will help to address the market concern, and the uncertainty as well.
I hope you understand that my questions are - frustrations is not directed at you, it's more because it's been a year and a half, our shareholder didn't hear any conclusion. Frankly, we don't know when - it doesn't seem there is to be a deadline. So maybe am I going to hear the answer after I retire or something? So that's really the issue. Just preliminarily, they should say something; either it's a yes or no. I mean it's not that difficult to make a decision based on that.
Fair enough, fair enough. I understand that your question is not addressing to me and I'll make sure that you're addressing - your question is also being heard as well. But I really should restrain myself from commenting about how they work and the process of the privatizations or the proposed offer.
And the last question is, is it possible to bring one of the special committee member to the conference call next time because frankly, at this stage everyone knows our CEO is very undervalued, and operationally you guys are doing well; so that's not really the focus right now - the focus has always been on the offer - on the current offer and the company's capital structure going forward, and this question is I think best addressed by the special committee member. So please pass on this message, we hope to speak of them on the call and publicly as well.
Understood. I will make that - I'll let them know and I will then only see whether they will participate in next call.
Okay, thank you very much.
We will now take our next question from Kent McCarthy from Jayhawk Capital. Please go ahead.
Hey Albert, how you're doing?
Good, how are you?
Good, good. I think it was - we've known each other for 20 years, I think it was 10 years ago we rang the bell to put this company public at $6.50 a share. Now as the other callers sort of alluded to - you got about $500 million cash, $600 million market cap, i.e. $100 million where company generating $100 million. This is no longer about fundamentals it's about the deal that's on the table, the one that looks like it's coming down the pipe. The only reason this stock is selling for what it is, is because of the massive dilution including a convertible bond issued at $2 and then bought back through some insider trades at $5 or $6 costing the minority shareholders well over $100 million. You know it, I know it, Sam Power knows it, everybody else knows this company is worth $30 to $35 a share or they wouldn't pay that equivalent for the Cord Life Singapore. These shareholder transactions have been awful - you know it, and I knew it.
So we get two ways to go here, Golden Med needs to sell their shares, they are clearly going to sell them below the value - maybe they will sell them at $14 or $15 but there were $20 or $25. Why? Because they need the money, one; but two, they are cutting side deals with the buying company that are non-economic, that put more Gold Med's pocket, so they accept less for these shares. The fact that the stock - you guys are pushing the stock down, it will not under came in the New York will allow this to happen. So what I'd like you to think about it and I'd like you to comment on it is, there is obligation - not just on the independent, boards clearly - they have some problems here, serious problems and I think someone at New York - U.S. assets, I think they are U.S. citizens but you do as well, you're my friend. There is two ways to go here - negotiate fairly with us, arm's length transaction or we'll all be tied up in court for 10 years. I've spent 20 years on this company, lost a fair amount of money between it and Golden Med never squawked as you know about this type of stuff. Negotiate out a fair price, it can be a below value price as far as I'm concerned but it has to be a fair price, all right.
And then we can all go home and get this all worked. Other than that it's going to be a long sticky mess with court cases in the Caymans [ph], in this and honestly, it appears Golden Med needs the money within two years to pay their debts, and that will never happen. So I want you to think about it and talk to Mr. Kim because he is pulling the strings. All these things are out in documents, they are complicated but they can put together. You know I've never said this to you bluntly but there is two ways to go, collaborative and work together, get us the minority shareholders of fair price. Keep it public and buy that share and make it worth $30, $35, $40 within 10 months, all right. Its stock trading at 10 times cash flow would be $40, $50 once you refuse to shareholder base.
That would be the best option. I understand that Mr. Kim needs the money but in a year before all these debts were due, he can sell-off enough stock at $25 a share to pay his debts. So there is really three ways to go; fair deal for us, doing the right thing, keeping it for you guys and your incentive options which are also extremely dilutive to us which ties you in.
And thirdly, or third - we go into massive 10-year losses and I don't know how Golden Med survives it, and I don't think management and the independent board will survive. There is pretty strong laws as you know on this stuff, so again, hopefully I'll write you a letter, hopefully we can come together and negotiate a fair price because I think Kim has to sell at the Golden Med level. My preferred outcome - I think other shareholders from the questions on this call would prefer share repurchase and keeping an independent, working together.
There is no question if you bought back shares and you removed the stains that overhangs this company of diluting the shareholders, you'd have a much higher price. If you can't comment on my question, great, but if not, take it as a statement and hopefully, please reflect on it. We've been friends for a long time but much rather have this thing end, working together and then begin a big fight for 10 or 12 years. Thanks for your time Albert; you're a very nice man.
Thank you, Kent for the comments but understand that I don't want to second guess the transaction between good amount, again the potential buyer because after all it's still a different company but I noted your comments and also as I address it to the other questions early on in the call, I believe that all these proposed transactions does create some sort of frustrations and uncertainty in the marketplace and I - certainly, it's not one of the person that's enjoying it, so I will make sure that the frustration is being passed to the board, the board is aware of this and also the research committee is also aware of this as well. We will continue to work with the shareholders to create the value for the company, we'll continue to hopefully - our operation will continue to perform and I think - I think we will try to get from there.
[Operator Instructions] We will now take our next question from Elizabeth Wilkerson [ph] from Wilkerson Foundation. Please go ahead.
Hi, there. My question is about the $7 million restricted stock units. Can you confirm what portion of the $7 million RFUs are expected to be solely invested by next fiscal year due to the pro forma conditions being met or do you believe the company is on pace to reach those conditions or majority of RFUs? And if so, can you please help us shareholders understand what benefit do the company - they will have - or will have been achieved? There is not appearing to be much growth in the subscriber's revenue operating efficiency, their profits or justify approximately 10% of the company being given away through this program. So essentially for what - for giving all that up, giving us all that ownership, what's the shareholder getting returned? It appears like the previous caller said that incentive shares are just another example of management diluting the shareholder.
As you recall, in the previous earnings call we have talked about the market or the local PRC market moving out from some down years in terms of number of babies born. But that impact wasn't directly transpired into a massive fluctuations in terms of value subscribers, partly because of our efforts and try to maintain and to push as hard as we can in recruiting new subscribers. So despite the volatility in the market and the poor market sentiment, we still manage to remain steady as a revenue growth; we're steady new subscriber signs up improvement. So I think this is not entirely fair to not giving credit to the team for doing this hard work despite those down years. Now with that being said, the RSU is launched - was launched at the end of 2014, it will last till 2017 as perspired, sorry, 2018 I presume. If I've not - if not - if I'm not mistaken. And then right now I think we are still on-track in terms of achieving those various parameters; some I think - some staff are doing better than the others and some are not.
At this point, there appears to be no further questions. I will now turn the call back to Ms. Kathy Bian.
Thank you, Julia. This concludes our earnings call for the second quarter of fiscal 2017. Thank you all for your participation and going forward. Have a great day. Operator, you may now disconnect. Thank you.
Thank you. That concludes the conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.
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