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Concord Medical Services Holdings Limited (NYSE:CCM)

Q1 2012 Earnings Call

May 22, 2012 08:00 am ET

Executives

Tony Tian – Investor Relations Manager

Jianyu Yang – Chairman of the Board and Chief Executive Officer

Adam J. Sun – Chief Financial Officer

Zheng Cheng – President and Chief Operating Officer; Director

Analysts

Christopher Lui – Morgan Stanley Asia Ltd.

Yale I. Jen – ROTH Capital Partners LLC

Sean Wu – JPMorgan Securities (Asia Pacific) Ltd.

Operator

Hello and thank you for standing by for Concord Medical’s first quarter 2012 earnings conference call. At this time, all participants are in listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections you may disconnect at this time.

I would now like to turn the meeting over to your host for today’s conference, Tony Tian, Investor Relations Manager of Concord Medical.

Tony Tian

Hello everyone and welcome to Concord Medical’s first quarter 2012 earnings conference call. Concord Medical’s earnings release was distributed earlier today and you can find a copy on our website as well as on newswire services.

Today, you will hear from Dr. Jianyu Yang, Concord Medical’s Chairman and Chief Executive Officer, and Mr. Adam Sun, Chief Financial Officer. After their prepared remarks, Dr. Yang and Mr. Sun will be available to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995 and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include but are not limited to those outlined in our public filings with the SEC. Concord Medical does not undertake any obligation to update any forward-looking statement, except as required under applicable law.

Both our earnings release and remarks made during this call include discussions of certain unaudited non-GAAP financial measures. Our earnings release contains a reconciliation of the unaudited non-GAAP measures to the most directly comparable unaudited GAAP measures. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will also be available on Concord Medical’s website.

I will now turn the call over to Concord Medical’s Chairman and CEO, Dr. Jianyu Yang.

Jianyu Yang

First of all, I would like to welcome everyone to our 2012 First Quarter earnings conference call.

Concord Medical has made solid progress in the first quarter of 2012. Total net revenues were RMB 106.7 million ($16.9 million), a 22.1% increase from the first quarter 2011. Net income in the first quarter 2012 was RMB 25.0 million ($4.0 million), a 9.2% increase from the first quarter 2011. This is the first time Concord Medical realized first quarter revenue of over RMB 100 million. This is a significant achievement as we were able to achieve this despite having fewer days in the first quarter due to the spring festival and a highly competitive market. We are very proud of our achievement, which will help pave the way to accomplishing our 2012 fiscal year business objectives. I would like to thank our operational team for the hard work.

Our focus for the remainder of 2012 is to continue our current strategies - on one hand, to improve the cost control and operational efficiency of our existing centers; and on the other hand, to improve the operations of newly opened centers which have been in operation for less than a year and help those centers reach their investment targets.

Many investors have inquired us about the status of our acquisition of Chang’an Hospital. I am happy to share that all government approval processes are progressing as planned. We will have a Board meeting in the near future to discuss the final steps to close the transaction. We expect to complete the acquisition within the first half of 2012, and consolidate financial results of Chang'an Hospital beginning in the third quarter of 2012.

Chang’an Hospital has made great progress in its information system infrastructure. The China’s Ministry of Health organized reviews of Electronic Medical Record (NYSE:EMR) capabilities among hospitals, and Chang’an Hospital was ranked No.1 twice. In May, Chang’an Hospital was accredited with Stage 6 of EMR capabilities by U.S. Healthcare Information and Management Systems Society (HIMSS).

We will hold an Investor/Analyst day in Chang’an Hospital on May 31, 2012. This event will be an opportunity for management to showcase the hospital, as well as provide an updated strategic and operating outlook for the company. So far we’ve seen enthusiastic responses from investors, and we look forward to communicating with the investment community at Chang’an Hospital at the end of May.

In this quarter, we established a Tele-radiotherapy Business Department, in collaboration with Jinwei Medical Services, Inc., a leading telemedicine company in China. We will utilize the excellent resources of medical professionals in large cities and hospitals to build up core healthcare services for partner hospitals, doctors and patients, which include remote diagnosis, training, and two-way referrals.

The ongoing healthcare reform in China will provide Concord Medical significant development opportunities. By 2015, it is projected that the number of private hospitals will increase to approximately 20% of the total number of hospitals in China, according to China’s Ministry of Health. We plan to take advantage of this growing trend and build several cancer specialty hospitals with focus on radiotherapy, -. These projects are moving forward according to plan. We expect to obtain the license of at least one cancer specialty hospital in 2012, and begin construction as soon as possible.

As a leading healthcare service provider in China, Concord Medical offers high-quality radiotherapy and diagnostic imaging services to patients and hospital partners, and has developed a solid reputation in the market. With the aging Chinese population, accelerating urbanization, serious environmental pollution, including rising concerns over food safety, cancer has increasingly become a major threat to the health of the Chinese population. As an enterprise with social responsibility, Concord Medical is committed to contributing to China’s cancer treatment and prevention process. Thank you for your continued support to us.

I will now turn the call over to Adam Sun, our CFO, who will walk you through our financials.

Adam Sun

Thank you Dr. Yang and hello everyone. And thank you for joining us today.

Let’s look at some key financial results for the first quarter of 2012.

By now, I hope everyone has seen the 6K that was filed by the company which contains the full financials, and so I will just go through some of the key highlights and then open the call to questions.

Net revenues were RMB 106.7 million in 1Q12, up 22.1% from 1Q 2011. As Dr. Yang mentioned, this marks the first time we achieved revenue over RMB 100 million in the first quarter of any year. During the quarter, our treatment and diagnostic business lines have seen strong growth in number of patient cases, especially for diagnostic equipment.

During the quarter we have received 7,860 and 44,527 patient cases for the treatment and diagnostic equipment. Revenue from the diagnostics accounted for 31% of the total revenue of the quarter. Specifically, numbers of patient cases from PET-CT and MRI increased by 63% and 41% respectively over 1Q 2011. We expect the strong growth momentum to be sustainable during the remainder of the year, as first, basic diagnostic services such as MRI and CT are covered by government insurance programs, such as NRCMS; and secondly people are becoming more health conscious and willing to pay out-of-pocket for high-end diagnostic services such as PET-CT.

Our gross profit margin was 58.4% versus 62.6% in 1Q11. Let me give you some more colors on the gross margin change. 1) Diagnostics, our fastest growing business line, usually have higher cost of revenue compared to treatment, due to higher per patient consumable and film expenses. 2) We have seen uneven center growth during the quarter. Among the centers opened less than a year, performance level varies from center to center. We will review the performance of each of the new centers, and our operation department is working on turn-around plans for the under-performing centers.

Our operating expenses consist of selling expenses and general and administrative expenses, and were RMB24.9 million as compared to RMB19.9 million in 1Q11. Operating expenses accounted for 23% of total revenue, approximately the same level compared to 1Q11. This indicates that our cost control initiatives have generated desired results. During the quarter, we spent RMB2.5 million in web-based marketing expenses. Web-based marking is a cost-efficient way to expand our reach to patients, and further lower our selling expenses. We expect overall cost ratio will improve during the remainder of the year.

Our net income was RMB 25 million, growing 9.2% over 1Q11. With projected double-digit top-line growth for 2012 and our cost-control initiatives gradually taking effects, we will see bottom line growth remain strong for the year as well.

Before I open up for questions, I will add a few words on our accounts receivable situation. As you see, our AR level has increased slightly from 4Q11. There are seasonality factors. However, we are strengthening our collection efforts in order to lower the DSO level significantly for the remainder of the year. Our working capital level has improved during the quarter, which is a positive sign.

Overall, we feel confident about our growth prospect and we have reaffirmed our business and financial guidance for 2012.

Now I will open the call to questions. Operator?

Question-And-Answer Session

Operator

Thank you. Ladies and gentlemen, the question-and-answer session of this conference call will start in a moment. (Operator Instructions) And now your first question comes from the line of Chris Lui from Morgan Stanley. Please ask the question.

Christopher Lui – Morgan Stanley Asia Ltd.

Hi, thanks for taking my question. Can you talk about different drivers of your revenue lines, the managed hospitals and the lease, of course, and also can you talk about your strategies in 2012 on cost controls and also on the AR, accounts receivable days, how you’re going to lower it? Thanks.

Adam J. Sun

All right, Chris. So let me take the question first, and then I will pass to Dr. Yang for his comments. First of all, looking forward to the remainder of 2012, we believe that the following factors are going to drive our revenue growth.

First, the new centers, as we gradually improve the overall performances, the new centers in our network contributed about 11% of our total lease and management revenues in the first quarter. Among these quarters, the performance level is very uneven as I mentioned before.

There are about seven to eight centers due to various reasons such as geographical, management and expertise reasons that performed far below our investment projection. So our key task right now is to improve the revenue contribution of these underperforming centers as I mentioned in the prepared remarks. As these new centers deliver better results, we’ll see our revenue growth maintain a strong momentum as we have witnessed in the first quarter.

And also enhancing the performance of these new centers, we have witnessed improved gross margin as well. Our center networks these underperforming centers have low or even negative margin due to fact that our gross margin of 58% in the first quarter is below our historical level. If the revenue contribution from these new centers (inaudible) impact our gross margin gradually. The lower gross margin is also attributable to the fact that we are seeing faster growth in diagnostics services, which has a lower gross margin due to higher drug, consumables, and field costs on a per patient cases basis.

So looking forward in 2012, we believe that our growth strategy is composed of the following factors. First, we’ll continue to pursue the strategy to open oncology hospitals so as to transform Concord Medical into a leading hospital management company, acquisition of Chang'an Hospital is the first step towards that goal.

And secondly, we will expand our current network business while focusing on improving the operating efficiency of the existing and new centers to healthy top line growth, by gradually improving the profitability of our center business.

And thirdly, finally, we’re implementing new business initiatives, such as tele-radiotherapy and web-based marketing to further improve our operating leverage and efficiency.

Now, it’s time to call Dr. Yang and he’s going to talk about our strategies regarding the hospital business.

Jianyu Yang

[Foreign Language]

So, I’d like to add two points to what Adam said earlier. One, we have maintained solid growth last two years and growth is normal under the market circumstances.

So you probably have noticed that the profit growth has not been exactly in line with the top line growth. This actually we’re not a unique company. This has been problem with most of the Chinese companies in the last year. One thing, the price inflation in China has been pretty substantial.

Within our company, we have been trying our best to improve our operation and management level and to lower the cost, operation cost. And so make sure, our profit growth will soon catch up with the top line growth.

Christopher Lui – Morgan Stanley Asia Ltd.

All right. Thank you.

Adam J. Sun

Thanks.

Operator

The next question comes from the line of Sean Wu from JPMorgan. Please ask your question.

Sean Wu – JPMorgan Securities (Asia Pacific) Ltd.

Hello, Jianyu Yang, Zheng Cheng, congratulations on a great quarter. This quarter seasonally, normally your first quarter is a weak quarter, but this quarter appears that you have done very well. So I just have a quick question about your current new line of business, it’s tele-radiotherapy stuff. So can you explain a bit more about why China we need these kind of services, and how do you plan to monetize such services?

Jianyu Yang

[Foreign Language]

So, first of all, telemedicine or the tele-radiotherapy has a lot of, there is a lot of demand in China right now.

As a country with such a large area and population actually distribution of medical services, medical resources is not so even. So, there is a lot of demand and shortages of the expertise and resources from the smaller hospitals in smaller cities.

As you can see, our current 130 centers are distributed mostly in large cities and in areas that has dense population. So within our center network, there is a great synergy and inter-collaboration ongoing.

As telemedicine has received a lot of attention in China or worldwide, actually, we, Concord Medical, our business model fits the telemedicine, tele-radiotherapy the most, because as you know once patients get diagnosed and the information of their diagnosis can be transferred over the Internet between different locations and doctors and patients don’t even have to see each other in person to move forward with the treatment processes. So in that sense, what we do actually fits the telemedicine pretty well.

As you see, there is so much demand on the telemedicine or remote diagnosis. So Concord Medical has started the preparation work about a year ago. In the first stage, we’ve seen so much demand within our center network between the centers and so we’ve worked on that. And at the same time, we also see much more demand from the hospitals outside of our center network who contacted us and they are eager to join us, join our hospital in kind of a collaboration for this telemedicine, tele-radiotherapy.

So tele-radiotherapy has enabled some of the centers in our network to offer additional services for the other centers. And so tele-radiotherapy will be a new business model in the field and we very much look forward to the success on this new model.

Thank you.

Operator

Thank you. Your next question comes from the line of Yale Jen from ROTH Capital. Please ask your question.

Yale I. Jen – ROTH Capital Partners LLC

Thank you for taking the question, and good evening. My question is that, you have the diagnostic portion grow rather fast so far and do you anticipate that process will be faster compared to the treatment and how – what kind of impact that might have on the gross margin if that’s the case? Thanks.

Adam J. Sun

Okay. Yeah, let me answer this question. The question is about our revenue mix, and in this quarter, we have noticed faster growth from the diagnostic business line. The reason, as I mentioned in the prepared remarks, is that diagnostic relatively, there are two drivers for the higher demand for diagnostic services in China.

On the one hand, the low-to-mid end diagnostic services such as MRI or CTs, are gradually becoming coverable under the government-sponsored insurance program, such as the new rural area cooperative insurance program. So this opened up a lot of demand that’s been depressed before. So, we are seeing very strong growth, almost 40% year-over-year patient cases growth in our MRI line.

And for the PET-CT lines, I think the driver behind, it’s a little bit different, but basically in the same line, which is people are becoming more health conscious and for PET-CTs mostly, we see the demand coming from the high income population, who are willing to pay a little bit more out of their pocket to do a thorough physical test for themselves or for their family members.

So we believe that this will be the pattern, moving forward, the demand for the diagnostic services are going to be more available, met. Relatively speaking, the pre-requisite for diagnostic center is relatively faster to accomplish than treatment centers such as LINAC or Gamma Knife. And on the other hand, there is issue of license for Gamma Knife, which has been suspended for the past two years already. So we are seeing a lot of centers ready, but without licenses yet.

So moving forward for the remainder of 2012 and looking forward, we believe that, we’re still going to see faster growth on a per-patient basis, as well as on the revenue side from the diagnostic business line. And the kind of impact it has on gross margin with regards on a center-by-center basis, if you compare the gross margin of diagnostic centers, especially our PET-CT centers, it has the highest operating cost ratio among all our equipments, because of the per case, the per patient needs to be – has had the drug, the consumables, as well as the films or sometimes multiple films per patient. So all this will have some kind of a downward pressure I think on our gross margin.

So what kind of a impact, offset impact our cost control initiatives have, it remains to be seen. But we believe that it will have some kind of impact upon gross margin, but it basically will be offset by the faster revenue growth as well.

Hope that answers your question.

Yale I. Jen – ROTH Capital Partners LLC

Okay, great. Thanks a lot and congrats on a good quarter.

Operator

Thank you. (Operator Instructions) We have a follow-up question from the line of Yale Jen from ROTH Capital. Please ask your question.

Yale I. Jen - ROTH Capital Partners LLC

Thanks for taking the follow-up question. Could you give a little bit more color in terms of building up our – getting the license for the next hospital this year. I know that partly because it’s contemplated but overall is there any more color you can give us? Thanks.

Adam J. Sun

So, Tony, why don’t you translate the question and I will let Dr. Yang answer.

Tony Tian

Sorry, Yale. Do you mind repeating the question, the line is not that clear.

Yale Jen – Roth Capital Partners LLC

Okay, no problem. For the year you’ll anticipate getting, potentially advance the licensing, getting the licensing for the second hospital. So could you give us a little bit more color in terms of the development for the remaining of the year?

Jianyu Yang

[Foreign Language]

So a year ago, we announced that we were establishing a joint venture with the Sun Yat-Sen University Cancer Center to build a new cancer specialty hospital. And that project has been ongoing and we expect to make some substantial progress by the end of this year.

Yale Jen – Roth Capital Partners LLC

Okay, great. Thanks, I appreciate it.

Adam J. Sun

Thank you.

Operator

Next a follow-up question from the line of Sean Wu from JPMorgan. Please ask your question.

Sean Wu – JPMorgan Securities (Asia Pacific) Ltd.

Hello. You guys mentioned that you’re on track to close the hospital acquisition by the end of June. And so, can you give us some rough idea, you do provide a sales guidance, but what is the operating margin like gross margin and net margin we can expect from the hospital operations in this year and potentially like when the hospitals fully ramp up, what is the expected margins for hospital services?

Adam J. Sun

Sure, Sean. Let me try to answer that question. And as usual the acquisition of Chang'an Hospital is moving forward as we planned and we will start the financial consolidation in the third quarter of this year as we mentioned before. As for the operating margin as well as the net margin of the hospital business, first of all, it will be obviously a different current line of business.

So, as for the specific result, I think, it is a little bit early I think to really give an exact number at this moment. But generally speaking, let me give you some rough ballpark which you can use to analyze our potential hospital business. Average net profit margin for public hospitals in China is about 5% and this is (inaudible) all kinds of data sources. On the other hand, the average net margin for specialty hospital in China is between, it’s about 15% to 20%, I think I’ve seen that number before.

So we believe that the Chang'an Hospital’s margins probably will be higher, and obviously it will be higher than public hospital’s net margin. The 50% is kind of like the half limit, I think, you can use in your model. So one thing I can say at this moment is Chang'an Hospital has entered on substantial capital expenditures in the past few years. It just opened up its second phase of its operation and it has increased its number of beds to about 1,100.

So we are seeing a very healthy growth momentum of the hospital business so far this year. And so we feel pretty comfortable about the guidance number we had given at the beginning of the year, which is the hospital to contribute between RMB190 million to RMB210 million in the beginning of the second half of this year, if I remember it correctly.

So that is still our target and we feel very comfortable that the hospital will deliver that kind of result for the year. So as we move forward and as we integrate more closely with the financial departments and operating departments of the hospital, we will be able to give you more details and more reliable guidance as for the retail and operating margin.

Sean Wu – JPMorgan Securities (Asia Pacific) Ltd.

Thank you.

Adam J. Sun

Thank you.

Operator

Thank you. (Operator Instructions) All right, we’re now approaching the end of today’s conference call. I would now turn the call over to Concord Medical’s Investor Relations Manager, Mr. Tony Tian for his closing remarks.

Tony Tian

Once again, thank you very much for joining us today. Please don’t hesitate to contact us if you have any further questions. Thank you for your continued support.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect. Good day.

Jianyu Yang

All right. Thank you.

Adam J. Sun

Thank you.

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