Mindray Medical International Ltd. (NYSE:MR) Q1 2014 Earnings Conference Call May 6, 2014 8:00 AM ET
Cathy Gao – Senior Manager, IR
May Li – CIO
Alex Lung – CFO
Wang Jianxin – Chief Administrative Officer
Jack Hu – Deutsche Bank
Wei Du – Goldman Sachs
Iris Wang – Credit Suisse
Good morning everyone and thank you for standing-by and welcome to Mindray’s First Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, we will conduct a question-and-answer session. Today’s conference is being recorded for replay purposes. If you have any objections, you may disconnect at this time.
Now, I’d like to turn the call over to your host for today’s conference, Ms. Cathy Gao, Mindray’s Senior Manager of Investor Relations. Please proceed, Ms. Gao.
Thank you. Hi, everyone. Welcome to Mindray’s 2014 First Quarter Earnings Conference Call. We released our financial results last night and they are now available on the Company’s website and Newswire Services. There will also be an archived webcast of this conference call on our Investor Relations website.
Joining today’s call are, Mr. Li Xiting, our President and the Co-CEO; Mr. Minghe Cheng, our Co-CEO and CSO; Mr. Wang Jianxin, our CAO; Mr. Alex Lung, our CFO; and Ms. May Li, our CIO.
In a moment, Ms. May Li will provide an update of the Company’s operational performance and Mr. Alex Lung will review the detailed financial results as well as the Company’s outlook for 2014. After that the management team will be happy to take your questions.
Before we continue, please note that this call will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Statements made and the views expressed here which are not historical facts are forward-looking statements. You should be cautioned that, these forward-looking statements are only predictions and may involve inherent risks and uncertainties. As such, our actual results may be materially different from the statements and the views expressed here today due to a variety of factors.
A number of such risks, uncertainties and the factors are outlined in our public filings with the SEC. In particular, please refer to risk factors beginning on Page 5 of our Annual Report on Form 20-F. Any projections made here today are based only on limited information currently available to us, and are subject to change. Mindray does not undertake any obligations to update any forward-looking statements except as required under the applicable law.
I will now turn the call over to our CIO, Ms. May Li.
Thank you, Cathy. Good morning and good evening, ladies and gentlemen. Thank you for joining us today. In the first quarter, we’ve reported US$264.8 million in total revenues, growing 9.4% year-over-year. Excluding the tax benefits, our non-GAAP net income was US$44.7 million, slightly lower than US$45.2 million in the same period of last year.
As we stated in March, the dynamics in various key markets continued to be challenging for our business during the quarter. Nevertheless, we are pleased with our Europe sales performance which recorded double-digit revenue growth as well as our IVD region sales increased. Our China sales were US$115.8 million, which grew 4% year-over-year and represented 43.7% in our total net revenues.
As we discussed in the past, the purchasing and marketing activities in the healthcare sector remains sluggish. Outside of China, our international sales reached US$148.9 million. Overall emerging market sales performance was mixed and lower than expected, but we are optimistic about the region’s gross potential and we’re continue to invest this year.
In this quarter, we are also pleased to launch a few new products including the M9, a premium portable ultrasound system and the CAL 8000, a cellular analysis line. These products have received positive customer feedbacks at the recent CMEF trade show.
Looking at other items, our cash conversion cycle was 105 days, compared to 110 days in the first quarter of 2013. We continue to be active in repurchasing our shares during the first quarter. Since November last year, we have purchased around US$110 million of shares. This continues to highlight our confidence in Mindray’s prospect as well as our intention to return capital to our shareholders.
Now, let’s look at our detailed first quarter performance by geography and segment respectively. Starting with China and the emerging markets then on to the developed markets. Our first quarter domestic sales increased 4% year-over-year. As mentioned, we were seeing some early signs of recovery but such trends are yet to materialize. However, we’re optimistic that the industry fundamentals remained solid. As a domestic leader, we also support a more regulated and the complaint environment, which we think will be beneficial for the entire industry. We are hopeful that the market sentiment will gradually improve overtime.
Overall, our IVD region sales continue to climb thanks to our high-end product such as the BC-6800 and the BS-800. We are speeding up the development of two new plans in Shenzhen and Nanjing, mainly dedicated to LED product manufacturing to meet future expansion. With the introduction of new products like the Chemiluminescence, CL-2000i and cellular analysis line CAL-800 as well as the sales ramp up of several important products like the high-end of our chemistry analyzers BS-2000, we remains optimistic about the prospect of this segment based on the growing recognition of our brand and attractive product performance.
In terms of market perspective, we expect county level hospitals to remain a big focus for the government, as we continue to see sustainable investment activities. As part of the healthcare reform, the number of county level hospitals to be upgraded to reach 1,000 by the end of year 2014 from the current estimated number of 300. This will undoubtedly benefit Mindray given our dominant presence in county levels. Private hospitals demands are also poised to grow rapidly based on government initiatives and the private investments.
In such, it is expected that, private hospitals will account for 20% of all national healthcare services in China by 2015, compared to the current level of 9%. It was our compelling value proposition to private hospital customers, this segment will be an important strategic focus for us going forward. We will also continue to improve our sales program and extend our direct service and platform in China. This allowed our expenses, credit offerings continues to put us in a very strong position in a domestic marketplace.
Our international sales recorded 13.9% year-over-year growth in the first quarter. Overall, emerging market sales as a whole were lower than expected and grew mid-single digit from the same period last year. This is largely due to the weak performances in selected countries, mostly resulting from continued political and FX issues. In the first quarter, Eastern Europe and Africa were the highest gross regions delivering over 35% year-over-year sales growth.
In the Middle East, large tender sales in Turkey last year presented a tough comparison for us. In Asia Pacific, Indonesia was the highest gross region. However, political scenario in Thailand offset some of our strength in the area. Looking ahead though, the market potential in Asia Pacific remains promising. For Latin America, we had strong growth in Brazil and Peru where sales were up over 30%, offsetting this was a continued weaker sales in countries such as Venezuela, with tighter currency and the import policies as well as political instabilities remained as headwinds. However, the long-term underlying demand in these countries are still strong.
In the CIS region, the lower tender activities in Russia impacted our business there. However, the overall sales decline has moderated compared to the same period last year. Our outlook and strategy in emerging markets has not changed. We remained optimistic about the region’s growth potential though we are subject to FX and geopolitical risks.
In key countries, we will further enhance our platforms to promote our brand and better serve local customers. For example, we are trying to set up sales offices in the Philippines and South America to capture new growth opportunities. We will also work on expanding our local coverage by increasing direct sales efforts and optimizing related support infrastructures such as logistic, IT, finance and other services.
We’re confident that these plans will help us to develop strong competitive positions in the key markets. Sales in the developed market grew by more than 25% year-over-year in the first quarter, which included a contribution from Zonare. We’re happy to again report strong results in Western Europe where we posted double-digit year-over-year sales increase. We did well in key countries including Italy, Spain and the UK. Our investments over the past few years in Western Europe continued to payoff and we have gained valuable experience by competing with top international players in this region.
Looking ahead, we are confident that our strategy for working well and our long-term prospect in Western Europe looked promising. In North America, sales in this region rose 30% largely due to the contribution from Zonare. Our organic business also improved. Going forward, we expect our U.S. business to stabilize and we’ll continue to focus on accelerating our product development and improving operational efficiency to enhance our long-term competitive position.
Now, let me give you a breakdown about different business segments in the first quarter. Net revenues from the Patient Monitoring and Life Support segment declined by 1.4% year-over-year. This decrease was largely due to the slowdown in certain key emerging markets in China, which impacted our P&L line the most. Patient monitor and Life Support is the most mature segment among our three business lines. Over the last two decades, we have gradually transformed from a product provider to total solutions provider. We’re now able to provide integrated solutions for clinicians from critical care to sub-acute settings across the emerging room or ICU and CCU departments.
Going forward, we’ll further improve product functions and continue to launch new products, which are increasingly important for us to compete better in various markets. In our IVD segment, sales increased 6.8% year-over-year. The reagents biochemistry analyzers and the CL-2000i were the main contributors to growth in this quarter. We introduced our first immunoassay product the CL-2000i along with several reagents in late 2013. The product received very good feedbacks from our customers.
Going forward, we will continue to invest in order to penetrate into the fast growing immunoassay segment more quickly. At the recent 71st China International Medical Equipment Fair in Shenzhen, we also showcased the CAL-8000, a high end hematology analyzer targeting large hospitals. We have high hopes that this product will further enhance our ability to compete with the MNCs. As the installation base for products such as the BS-800, the BC-6800 and BS-2000 and CL-2000i continue to ramp up, we expect our IVD business will improve and will continue to drive growth for the company.
For the Medical Imaging segment, the year-over-year net revenues growth for this quarter was 27.1%, which included Zonare’s revenue contribution. Apart from that, color ultrasound did well and led out sales growth in this quarter. At the CMES Conference, we demonstrated a newly launched M9, a premium portable color ultrasound system combining high-end imaging technology from Zonare. As we continue to integrate Zonare’s business, we will focus on managing the stability of our business, leveraging the combined entities to accelerate the launch of next generation high-end ultrasound product, further grow the business and improve our products.
Our Others net revenues grew 23.6% year-over-year in the first quarter. This was mainly because of increasing revenues from after sales services in our organic business as well as the Zonare acquisition.
I will now turn the call over to Alex for financial details as well as our outlook for 2014.
Thanks, May. In the first quarter, our top line recorded a 9.4% year-over-year increase to $264.8 million. China net revenues were $115.8 million, a 4% year-over-year decrease. International net revenues were $148.9 million, a 13.9 % year-over-year growth. This represents 56.6% of our total net revenues.
Non-GAAP gross margin was 55.9%, compared to 58.1% in the first quarter of 2013 and 56.5% in the fourth quarter of 2013. The year-over-year decrease was mainly due to product mix and the inflation of Zonare. Our non-GAAP selling expenses were 19.7% of total net revenues higher than last year’s level of 18.5%. This was mainly due to an increase in our investment initiative as well as the consolidation of Zonare.
Non-GAAP general and administrative expenses were 9.3% lower than 10% in the same period of last year. We have continued to invest in R&D over the past quarter. Our non-GAAP net R&D expenses were 11% of total net revenues, compared to 10.5% in the same period of last year.
Non-GAAP operating income declined 8.7% year-over-year to $42.2 million, primarily resulting from Zonare’s acquisition. GAAP operating income decreased 19.8% compared to the same period of last year mainly due to higher share-based compensation expenses and consolidation. According to tax benefits non-GAAP net income dropped 1.2% over the same period of last year to $44.7 million.
GAAP net income declined 37.9% year-over-year. This was primarily due to the recognition of expenditure in relation to the nationwide key software enterprise assets for the calendar year 2011 and 2012. This was recognized in the first quarter of 2013. In terms of margins, our non-GAAP operating margin was 16%, compared to last year’s level of 19.1%. Our non-GAAP net margin was 17.4% for the first quarter, compared to 26.7% in the same period last year, again primarily due to much higher expenditures.
Excluding the tax benefits, our non-GAAP net margin was 15.9% for the first quarter, compared to 18.7% in the same period last year. Our cash conversion cycle was 105 days in the first quarter, down from 110 days a year ago. Our accounts receivable days were at 59 days versus 66 days in the same period last year and 50 days in fourth quarter. The inventory turnover days were at 114 days, compared to 103 days in the first quarter of 2013 and 79 days in the prior quarter. This was primarily a result of lower than expected sales in this third quarter. We are satisfied with our DSO and inventory levels and going forward we will continue to adapt cautious credit policies and enforce insurance protections in our key markets worldwide.
We generated net operating cash of $19.7 million in this quarter, a 53.6% decline from last year level. A year-over-year decline was largely due to the consolidation of Zonare business as well as overall increase in working capital. Our working capital expenditure was $27.9 million, up 39% from the same period last year, primarily because we accelerated the construction of new manufacturing facilities.
Let’s move on to discuss our financial outlook for 2014. We are maintaining our guidance of more than 15% year-over-year sales growth. In terms of geographies, the outlook remains largely the same as we discussed in March. We continue to anticipate that, the market environment in China will gradually improve and the prospect will remain favorable for us. Having said that, the timing of government funding and tender activities are typical for us to predict.
We also expect Western Europe and certainly emerging markets to deliver strong performance, thanks to our increasing brand awareness, emerging private and profit opportunities as well as our better sales and service offerings. However, we are mindful of the geopolitical issues and the currency risks in some emerging countries. In U.S. the macro uncertainties such as the healthcare reform remained as potential headwind, but we otherwise anticipate our North American business to be stable.
As we also discussed extensively in our last conference call, in order to support and sustain our long-term growth, this year we seed up our investments primarily across sales, marketing and distribution as well as product innovations. Mainly all the investment initiative are already well underway. As such, we project our 2014 non-GAAP net income at the similar level to last year, and this figure excludes any tax benefits and assume a corporate income tax rate of 15% for our Shenzhen subsidiary.
Our consistent investment in the past has successfully made us a diverse and global medical technology player to-date. We are confident that, our investment strategy will help us to further grow and strengthen our market positions. We expect our capital expenditure to be around $160 million for the year. This guidance excludes potential M&A expenditures.
We will continue to seek external M&A opportunities that could bring complementary technology or product to our company. Separately, today we announce that, our Chief Operating Officer Mr. Jie Liu as resigned from his position for personal reasons. Our Chief Operating Officer and now be the Chief Operating Officer and will focus on research and development, China sales and marketing, manufacturing and team management as well as other operations.
In addition as Minghe Cheng our Co-Chief Executive Officer and Chief Strategic Officer will take on his position with previous responsibility including international sales and marketing and North America operations.
That’s all for now from me and I would like to turn the call back to Cathy.
Thanks, Alex. We will now open the line for questions. Operator, please go ahead.
(Operator Instructions). The first question comes from the line of Bin Li from Morgan Stanley. Please ask your questions
Hi. This is – who asking questions on behalf of Bin. Thanks for taking my questions. My first question is on the gross margin. For what extent of the China business and ex-China business do you expect for this year? And the high cost magnitude for this year higher than in previous years, so if you expect similar cost cut every year going forward and which business line cost cut mainly are?
And second question, can you give us more color on your CapEx spends for this like year like a breakdown for the 150 million? Thank you.
Hi. This is Alex. Thank you for the question. In terms of the gross margin trend for us, we have been pretty consistent for both China and outside China as compare to the past year. Actually we do actually we are having gross margin dilution as a result of the acquisition of Zonare and you are aware that the Zonare business mostly in U.S. and also other international markets.
So, that is in general the gross margin trends. In terms of the pricing, I think for us we have been exercising our pricing strategy very consistently in the past. As you know May Li will try to maintain price competitive in order to gain market share and it is our strategy to maintain a mid-50 range kind of vision of gross margin level. And then for question about CapEx, as we had constructing in manufacturing part for our agents, manufacturing in both Nanjing and Shenzhen and also building R&D center in Belgium. So, that will be the primarily spending of our CapEx also will in continuation of this.
Okay. Thank you.
Thank you for your question. The next question comes from the line of Richard Yeh from Citigroup. Please ask your question.
Thank you for taking my question and this is Chen reading questions on behalf Richard. And actually we have two questions and first one is on the China sales China sales grows, and in the first quarter the growth was 4% and if I remember correctly that management actually guided a high teen sales growth for the full year for China sales, which implies that will be like over 20% growth in the upcoming quarters. So, is that still like achievable and what could be key drivers if we are trying to deliver the high teen growth for the full year for the China market?
And we dig more on the question, we trying to understand the hospitals purchase trends in March, April and versus January, February and second half of last year. As management mentioned, we see some early sign of recovery in the China sales or in order. So could you elaborate more on that side? And also trying to follow-up on the price cut question.
So the non-GAAP gross margin was about like 56% in the first quarter. So, I wish you targeting if we are talking about mid-50 for the full year, so we can expect gross margin decline sequentially quarter-over-quarter in the upcoming quarters due to that the price cut? I mean, the impact of the price cut might not be fully reflect in the first quarter and we try to understand what are the magnitude of the price cut on average? Thank you very much.
So first quarter sales weakness was concentrated in China and emerging markets, and for China, we think there is despite the challenges we think we can still think for high teen type of full year growth despite of particularly first quarter. The macros are – there are obviously evidence in the first quarter that has given us such confidence. We are seeing some recovery of prudential level tender activities and that’s something that we have seeing over the last few months.
And this year like I said earlier, there is going to be acceleration of country level of hospital upgrade and we are seeing a very strong growth trend in the private hospitals. The Chinese Government investments towards public hospital and support for public hospital house care reforms are being strengthened as well.
So these are the macro trends that are supporting a gradually improving operating environment in China. And company specifically, we are seeing acceleration in some new product ramp ups. The customer feedbacks for our newly launched CAL-8000 cellular analysis line was very positive, which give us a lot of confidence and we are seeing a much faster ramp up both BC-3000 installation in the market place throughout the first quarter as well, and this will surely result in higher reagent contribution in the following quarters. So, we are seeing some encouraging signs but it’s yet to be reflected in the quarterly financials.
Hi. This is Alex. In terms of your question on the price cuts and margins, well, basically the company has plan in place so to strategically how to gain market share and some of the strategy will be more of a price competitive. It’s going to be come into the competition. So, I think the most important part is that how to actually get strategy in place effectively, while we are actually looking price competitive at the same time, we gain market share that will be the principal driver for the motivation of price cuts. But having said that, it is also important for us to maintain the mid-50 gross margin range which is our corporate target.
Thank you very much. Thank you.
Thank you for your questions. The next question comes from the line of Jack Hu from Deutsche Bank. Please ask your question.
Jack Hu – Deutsche Bank
Good evening. Thank you for taking my question. I have two from here. First is on your hiring. I recall previously, we were talking about actually 200 additional hiring in the field of the marketing team as a part of the investment. So, have that hiring being completed in the first quarter?
Secondly, it’s kind of unclear to me for the previous COO Mr. Liu. Is he still with the company? Thanks.
So part of the addition in headcount, hiring of 200 that being completed in the first quarter. But because some of the hiring we’ll have to wait to probably June, July timeframe because it’s targeting the new graduates. So, it will be a few quarters effort.
Regarding Mr. Jie Liu’s departure, he has his recognition has taken effect and Ms. Li was basically – Mr. Jie Liu has left the company due to personal reasons and he has made four arrangements before his departure and it shouldn’t impact operations of the company. Mr. Jie Liu has left the company on good terms.
There is neither reasons in conjunction was complying or any breach of regulation on the company’s part or on his part that led to his departure or there is not major disagreement between the company and himself. We thank for his contributions to the company over the last 10 years and wish him good luck in his future endeavors.
Thank you for your questions. The next question is comes from the line of Wei Du from Goldman Sachs, please ask your question.
Wei Du – Goldman Sachs
Hi, this is Chris asking for Wei’s behalf. Just one question quick one on strong growth area of Africa and where I just want to confirm it and how deep are the percentage of sales on the high growth regions for the first quarter? Thank you.
Hi. This is Wang Jianxin. In terms of Africa region sales is less than 5% of the total region for the first quarter. For Eastern Europe again is also less than 5%.
Thank you. The next question comes from the line of Sean Wu from JPMorgan. Please ask your question.
Thank you management for taking my question. This is – on behalf of Sean Wu. I have this question about sales growth in medical imaging. I know this one has – dynamics. If you exclude this equation from organic growth, that can flat year-over-year. So, whether you have commitment overseas like for new products – And also I have question about gross margin for Alex.
You margin go down by 2.3% on a year-over-year but actually in first quarter your gross margin went up year-over-year by 2.5% as a percentage point. So, could you elaborate why your margin inch up and can it went down from there? And I wonder this can be trend. What comparable mix although you see in gross margin on sales?
Hi. I think the first quarter medical imaging is at high, that’s right. Exclude Zonare contribution which you have high single-digit growth most contributor to it.
Hi Sean. This is Alex. You got to the gross margin question, actually the decline was entirely in relation to the Zonare acquisitions as we explained in our previous call because of some of these manufacturers, so the business gross margin is lower than our Group average. Actually for the first quarter I think the other factors is due to the unfavorable product mix and we had some good growth in our IVD segment and the mix within the segment itself was favorable so gross margin for products.
Great. Thank you for your questions. The next question is comes from the line of [inaudible] Shah from Merrill Lynch. Please ask your question.
Thanks you for taking my question. I just have one question here regarding to your each product line. It seems like PMB has a decrease this quarter and having the only increase by 7%. So I just want to know what your outlook for whole year for each product line? Are these two segment going to go back to the regular like double-digit growth in the future? Thanks.
Hi. This is Alex. Thank you for the questions. I think for the patient monitor lines that May previously mentioned, we have a lot of headwind from the China domestic market and also from some of the key countries in the emerging market as well. As May also mentioned earlier, I think for the rest of this year in particular for China, we do see a potential about market demand about the addition of medical equipment to support development and patient monitor will definitely one of the required equipment. And also for the international market, we believe that in Q1, we go some of the key countries and also political uncertainty in the CIS region that actually causes us have some on the patient monitor side as well.
So, we believe that, down the line, when these emerging market countries be less exposed to the credential impact or the political situation improved then definitely the demand of these products should be comfortable as well.
Thank you for your question. The next question comes from the line of Iris Wang from Credit Suisse. Please ask your question.
Iris Wang – Credit Suisse
Thank you for taking my question. I’m just curious about your progress of the post-acquisition integration of Zonare. Have you transferred any technology to your China office on platform and what is your expectation about the timeline of trend for the manufacturing from third party to Mindray’s own manufacturing plant? Thank you.
For the Zonare integration and on the IVD side the progress going very well and plant in Monterio and Shenzhen was together. We expect we will launch our high-end of products in the future. That is our plan. And also for more manufacture, the China is still in the process has not completed. We expect we will finish in a year in next 12 months probably. Still this is a small company. As we mentioned, this still rolling money in the first quarter, so we expect that it will be improving in the next few quarter.
Iris Wang – Credit Suisse
Thank you. I have another question about your plan of enhancing the penetration into the low tier margin and to capture the opportunity to private hospital and improving public hospital purchase. Recently the multinational brand have launch low end product which is designed to compete with these local brands in the government tender. So how that Mindray view with intensive competition and what is your strategy to differentiate yourself?
Well, it is true that, the multinationals have rolled out to mid to low end products series and I am just being patient, ultra sound as well and there is nothing new. It’s been going on for years. However, we think for Mindray there is distinguish advantage in competing with multinational product and multinational companies, especially Tier 2 and below Tier 2 the margin segment including government tender business.
We have our specifically developed marketing and sales strategies to create a distinction in the product and pricing and in the functionality of our products in competing with different competitors to make sure that we have a very unique value proposition. And so, we have the very unique solution to serve to Tier 2 customers and so far we have been quite successful in doing so and we have emphasized over the past few quarters that, we will be even more competitive in the low end segment going forward with increased product rollouts and with a more competitive pricing strategy this should continue to give us success in the low end segment.
Iris Wang – Credit Suisse
Thank you very much.
(Operator Instructions). We have no further question at this time. I’d like to hand the call back to Ms. Cathy Gao for any closing remarks.
Thank you operator and thank you everyone for participating in today’s call. As always, we appreciate your support at the Company. The replay of today’s webcast will be available later today and our management team and the IR team will be available for questions.
Thank you, again, for joining us and we look forward to speaking with you soon. Thank you very much.
Thank you, ladies and gentlemen that does conclude our conference for today. You may all disconnect your lines.
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