Concord Medical Services Holdings Limited (CCM) Q4 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Q4 2014 Concord Medical Services Holdings Limited Earnings Conference Call. At this time all participants are in listen-only mode. Following the presentation, there will be a question-and-answer session. [Operator Instructions] I must advice you that this conference is being recorded today, Tuesday, March 24, 2015. I would now like to hand the conference over to Mr. Bill Zima from ICR. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and welcome to Concord Medical's fourth quarter and full year 2014 earnings conference call. Concord Medical's earnings release is distributed earlier today and you could find a copy on our Web site as well as on Newswire services. Today, you will hear from Dr. Jianyu Yang, Concord Medical, Chairman and Chief Executive Officer; Mr. Adam Sun, Chief Investment Officer. After their prepared remarks, Dr. Yang and Mr. Sun along with Mr. Kong Yap, the company's Chief Financial Officer 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 Web site. With that said, I will now turn the call over to Concord Medical's Chairman and CEO, Dr. Jianyu Yang. Dr. Yang, please go ahead.

[Foreign Language] Hello, everyone, and welcome to Concord Medical's 2014 fourth quarter and full year earnings conference call. [Foreign Language] During 2014, our network of radiotherapy and diagnostic imaging centers continued to develop progressively contributing to total net revenue of RMB606.9 million, a 7.8% increase from RMB563.1 million in 2013. At December 31, 2014, Concord Medical operated a network of 139 centers in 56 cities in China. Throughout the year, our network business contributed steady cash flow to our growth. Adjusted EBITDA non-GAAP which RMB348 million in 2014 representing 9.1% increase from RMB318.9 million in 2013. [Foreign Language] In terms of hospital construction, we are focused on the execution of our established corporate strategy to gradually build Concord into a leading operator of specialized cancer hospitals in China. We achieved some important accomplishments in 2014. It is a multiyear plan to construct and operate one premium cancer hospital in each of three core cities Beijing, Shanghai and Guangzhou, the network will be supported by a number of free-standing Level-II to cancer hospitals as well as our current national network of radiotherapy and diagnostic imaging centers. [Foreign Language] In the first half of 2014, we received the approval for building Shanghai's Concord Cancer Hospital in Shanghai, New Hongqiao Medical Center after receiving approval; we engaged an internationally renowned architecture firm, HDR and have completed the overall design and construction plan. We also consulted with many experts during the planning period particularly these medical and management team at MD Anderson, once complete, our new hospital in Shanghai will be an advanced platform of cutting-edge cancer treatment services emphasizing multiple disciplinary treatments MDT, strong patient experience and [humanistic] [ph] approach treatment method. [Foreign Language] Construction on our Shanghai hospital is to start in the second half of 2015 and this construction period is expected to be around three years. Once complete, this hospital will serve as the hub of Concord Medical Plan national network through extensive collaboration with MD Anderson; we will be able to provide international treatment centers and services to Chinese patients including the advanced MDT diagnosis and treatment. [Foreign Language] In the first quarter of 2014, we received approval for free standing Level-II cancer hospital province in Datong City, Shanxi province. The Datong Meizhong Jiahe Cancer Center or Datong Center as we call it for short will provide advanced best practice diagnostic and radiotherapy services in the region with 100 patients set available once construction is completed. This center will apply to join the local social insurance coverage. Datong Center is currently undergoing infrastructure construction and interior design and is expected to open during the third quarter of 2015. During 2015, we plan to build five to ten independent radiotherapy centers in key areas of China, gradually transforming our current centers and accomplishing with public healthcare department to free-standing centers. [Foreign Language] In the fourth quarter of 2014, we announced divestments of Chang'an Hospitals 22% equity. The transaction was closed at the end of this year and we have collected all proceeds from the transaction as the general hospital, Chang'an Hospital differs with Concord strategic direction in its effort to develop specialized cancer hospitals after the divestment of Chang'an Hospital, our financial position has improved. It has been a pleasure to work with members of Chang'an Hospital since June 20, 2012 and we are grateful for their contribution to Concord in terms of staff training and hospital management. [Foreign Language] Concord is making good progress in its effort to become a leading operator of cancer specialty hospital and radiotherapy and diagnostic centers in China. We are capitalizing on our deep industry knowledge and talent resources accumulated in our radiotherapy and diagnostic sector for the past 18 years to achieve our corporate goal and extend our market position in the coming years. [Foreign Language] We believe the overall level of domestic oncology treatment in China is far behind other Western countries in terms of early diagnostic rate, five-year survival rate as well as overall patient treatment. We also believe this gap is becoming more significant. Concord is uniquely positioned to improve the overall level of domestic oncology treatment in China given our operating history and experience. We also benefit from our strategic partnership with MD Anderson in various oncology treatment areas. Efforts from MD Anderson has made significant contributions to our current cancer hospitals particularly in areas of hospital design, department settings and staffing as well as the operations of our Shanghai hospital. [Foreign Language] Moving forward, we intend to report our cooperation with MD Anderson and introduce MDT into China through Concord Medical Network. MDT represents the most-advanced international cancer treatment techniques that will encourage Chinese cancer patients. This comprehensive strategic partnership will be critical to Concord Medical's long-term development and growth. We expect to provide consistent updates on this corporation to the market regularly going forward. [Foreign Language] Finally, we would like to acknowledge the continuous support to Concord and investment in China's healthcare industry by organizers. As always we welcome your feedback and interaction and appreciate any industry development insights or market news. Once again, thank you. At this point, I will turn the call over to our Chief Investment Officer, Mr. Adam Sun to review our financial results.

Thank you, Dr. Yang. Welcome everyone to our call. First, I would like to review the highlights of our full year financial results. Please note, that all reported financial results exclude the financial contribution from Chang'an Hospital. This was because in December of 2014, we announced that we plan to sell 52% equity interest in Chang'an Hospital for total consideration of RMB398 million or US$64.8 million. This 100% cash transaction closed on December 31, 2014 and as the financial result of Chang'an hospital for Q4 and the full year 2014 is included under discontinued operation in our financial statement. For 2014, total net revenues were RMB606.9 million or $97.8 million representing a 7.8% increase from RMB563.1 million in 2013. This increase was mainly due to the increased revenue contribution from our diagnostic equipment patients. Gross profit in 2014 was RMB332.2 million or $53.6 million representing a 3.8% decrease from RMB345.5 million in 2013. Gross profit margin in 2014 was 54.8% compared to 61.3% in 2013. The gross margin was under some pressure due to the following reasons. First, the new equipment we added during the past years was depreciating at a comparatively shorter period. So the depreciation expenses for each are higher. Secondly, the consumable cost for the new equipment such as robotic surgeon and the CyberKnife higher on the per patient basis. Thirdly, the label costs of the vendors have gone up during the past years. Adjusted EBITDA for the full year was RMB348.6 million or $56.2 million in 2014 representing a 9.3% increase from RMB318.9 million in 2013. Net income attributable to ordinary shareholders in 2014 was RMB124.7 million or $28.1 million, 44.5% increase from RMB86.3 million in 2013. The net profit margin in 2014 was 15.6% compared to 14.3% in 2013. Income tax expense in 2014 was RMB80.9 million or $13 million compared to RMB63.8 million in 2013. The effective tax rate in 2014 was 46%. Basic and diluted earnings per ADS in 2014 were RMB2.77 or US$0.46 and RMB2.76 or US$0.45 respectively. The number of treatments and the diagnostic patients' cases was 30,323 for the full year representing a 6.5% increase and 2% increase over 2013 respectively. The revenue breakdown between treatment and the diagnostic centers in 2014 was 60% and 40% respectively. Now, I would like to walk through some highlights of our Q4 results. For the fourth quarter, the net revenue of our network business was RMB160.3 million or $25.8 million, 8.3% decrease from $174.8 million in the fourth quarter of 2013. This was primarily due to decrease treatment and the diagnostic patient cases as a result of the closure two centers due to contract expiration. As of December 31, 2014, the company operated a network of 139 centers in 56 cities in China and had entered into agreement to establish three additional centers. Fourth quarter gross profit in the network business was RMB86.9 million or $14 million representing a 26.6% decrease from RMB118.4 million in the fourth quarter of 2013. The gross profit margin in the fourth quarter of 2014 was 54.3% compared to 67.8% for the fourth quarter of 2013. The lower gross margin was due to the same reason as I discussed earlier both basic and diluted earnings per ADS for the fourth quarter of 2014 was RMB0.64 or US$0.10 each ADS represents three ordinary shares. Adjusted EBITDA was RMB101.7 million or $16.4 million for the fourth quarter of 2014 representing 14% increase from the fourth quarter of 2013. Turning the attention to our balance sheet, accounts receivable was RMB265 million or $42.7 million as of December 31, 2014, compared to RMB272.3 million as of December 31, 2013. The average period of sales outstanding for accounts receivable also known as days sales outstanding was 159 days in 2014. Capital expenditure were RMB107.8 million, or $17.4 million in 2014 compared to RMB159.8 million in 2013. As of December 31, 2014, the company have cash and cash equivalent of RMB478.7 million or $77.2 million and the restricted cash of RMB392.3 million or $63.2 million compared to RMB283 million and RMB422.1 million respectively as of December 31, 2013. As of December 31, 2014, the company had bank credit line totaling RMB2.8 billion or US$446.3 million of which RMB943.6 million or US$152.1 million were utilized. Looking ahead, we expect 2015 to be another year of important accomplishment for Concord Medical. We expect to open our first specialized cancer hospital back home in the third quarter of 2014. This will be a state-of-the-art oncology facility once complete. We also expect our hospitals in Guangzhou and Shanghai to also break ground in 2014. We intend to provide more discussion about our 2015 revenue situation and revenue growth on the – during the first quarter 2015 conference call in May, as we will have more detail timing on how our specialized hospitals will contribute to our full year financial performances for the coming year. Thank you, again, for your attention. Now, we would like to open up to questions. Operator, please go ahead.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Isabella Zhao from Morgan Stanley. Please ask your question.

Thank you. [Foreign Language] I will translate my question to English. My first few questions is to Mr. Yang regarding the future growth strategy. Number one, I noticed the company is doing the transition from third-party centers to the self-owned operated centers. And I also noticed we closed two centers in the 4Q. I want to get better color on the center expansion plan in 2015, also the more detailed on the cooperation with MD Anderson. And the last question is about the gross margin trend, we noticed the gross margin has declined significantly in 4Q, I want to get a sense what we should expect the gross margin to be in 2015. Thank you.

[Foreign Language] First, thank you for the questions. It's actually covers a lot of issues we would like to talk about. I will be answering your first three questions and the last one will – I will pass to our CIO, Mr. Adam Sun. [Foreign Language] First, I would like to say that everybody has noticed that in China, new round of healthcare reform has been carried out. [Foreign Language] We see a lot of opportunities in the ground of healthcare reform. The government is now encouraging credit capital to – in fact in healthcare sector. [Foreign Language] In this healthcare reform, we got opportunity; we got a chance to open our Datong Free-standing Cancer Treatment Center in some key cities and we could register this free-standing centers at Level-II hospitals. [Foreign Language] This new development of CTM is based on the current resources we have accumulated during the past 18 years cooperating with our public hospital panels. [Foreign Language] We are glad to tell every investors that we during 2014, we have got all the government approval needed by the Meizhong Jiahe Cancer Specialty Hospital. [Foreign Language] Our plan in 2015 is to open five to ten free-standing self-owned Level-II cancer specialty hospital which will focus on radiotherapy. [Foreign Language] This new kind of business model has some terminology as we are used to do in the cooperating centers but we are trying to build the hospitals to be advanced best practice cancer specialty hospitals. [Foreign Language] The answer to this question, we will deepen our collaboration with MD Anderson. [Foreign Language] We all know that MD Anderson is one of the best cancer hospital in the United States. [Foreign Language] We have been talking to MD Anderson and cooperating with MD Anderson for about four years. We hope that we could introduce MD Anderson's experience; their cutting-edge technology in cancer treatment and their experience in hospital management into China into our hospitals. [Foreign Language] Moving forward, we will collaborate with MD Andersen in terms of staff training, academic exchange, the government setting in the hospital design and probably some potential grand corporation. [Foreign Language] We are now still talking with MD Anderson on some new corporate issues to deepen our relationship. Hopefully, in the future we could have some updates to share with you. [Foreign Language] We hope our growth – our comprehensive strategic partnership with MD Anderson, we will not only bring special treatment for cancer patient in China, but also we can do something for the new healthcare reform in China. [Foreign Language] We will build our self-owned premium cancer specialty hospital in core cities in China, Beijing, Shanghai and Guangzhou. [Foreign Language] Beijing, Shanghai, Guangzhou are considered in China. They are not only the largest and most developed cities China. They also have the most medical resources and the most patients. [Foreign Language] We will fully apply our corporation outcome with MD Anderson in our three premium hospitals. [Foreign Language] To this specific, both Concord Hospital in Guangzhou has already break ground and we have completed the preliminary design with HDR for their Shanghai Concord Hospital. And we expect Shanghai Concord Hospital to break ground in the second half of 2015. [Foreign Language] For the Beijing Concord Hospital, we also have signed agreements with local government and this hospital will be located in the international medical center in Dongcheng district of Beijing. [Foreign Language] We hope that we could introduce best international center treatment to our patients and bring good patient experience to them through our premium hospitals. [Foreign Language] Now, I please welcome our CIO to answer your number four question.

Thank you, Dr. Yang. And thank you, Isabella for your question. So regarding the gross margin, I have explained in my prepared remarks that there are three major reasons for the gross margin trends year-over-year, number one is, the increasing depreciation expenses and if you look at our financials, depreciating expenses accounted for about 40% of our total cost of goods sold. And as I explained in the – previously, for the new centers we added during the past year relatively speaking the overall causation here is shorter, so which resulted in the higher expenses in Q4. If you see our corporation, for instances if the corporation terms tends upon the ten years to eight years. You are going to see like 25% increase in depreciating expenses year-over-year. So that explains the part of the reason why our corporate gross margin for 2014 was about 5% lower in 2014. Another major contributor to the higher gross cost and lower gross margin is that some of the new equipment we added to our network in the past few years, you really concur a higher consumable cost on the per patient basis. For instance, for the robotic surgeon that we are currently operating in Shanghai hospital, each blade, the blade is usually a one-time kind of a throwaway kind of equipment, so that in order to promote the services, usually we give the patient a discount on this consumable which resulted in the lower per patient cost margin on each phase. That's another reason, the higher consumable cost especially for the higher consumable expense equipment such as robotic surgeon and CyberKnife. And another reason for this higher gross margin is of course, the labor cost was going up over the board in the past few years and you see that in many, many other industries as well. But, on the other hand, if you look at overall EBITDA contribution margin for our network business, so for 2014, the gross EBITDA margin in terms of the EBITDA versus total revenue was based above the same level and even 5% improvement in 2014. This supports that even the gross margin is under pressure; our business is still contributing on a stable basis in terms of EBITDA and the cash flow, which we are going to use to fund our future expansion. Hope that answers your questions Isabella.

Thank you. Sure, sure. That's all my questions. Thank you, again.

Thank you.

And your next question comes from the line of Philip Ehrmann from Manulife. Please ask your question.

Hello, good evening. My question is really trying to understand how the reduction of two diagnostic centers can result in such a material fall in revenues and earnings for that part of the business. You claim to have 139 centers in 56 cities thereabout. And therefore, I'm rather surprised that the ebb and flow to 2013 and something, can have such an impact perhaps you can explain what's going on there please. [Foreign Language]

Hi, Philip. And our total – on the one hand, our total net revenue for the full year, we did see an increase of about 8% in 2014, the total net revenue was RMB607 million versus RMB563 million in 2013. So on a year-over-year basis, in 2015 8% increase and which is pretty much in line with our overall increase in the previous years. And in 2014, we are seeing a decrease of 8% and partly that is contributed to the close of our centers especially there is one large first, the centers we closed in the quarter was not all diagnostic centers. There is one treatment center which is located in a city in Southern part of China and that center has been very high contributing center in our network and we have been cooperating with that partner for the past 12 years. And that contract expires at the end – effective October. So that we now see the full results of that impact before us. And then, so that explains substantially the decrease we are seeing quarter-over-quarter. But, in general we are still confident that we are going to see this – the same stable growth of our revenue and we now expect to see any – there might be some quarter-over-quarter volatility. But, we will try our best to manage the revenue so that to see we are maintaining a stable growth situation for network business.

Can you just talk a little bit more about process whereby relationships you had for 12 years material relationship comes to an end. Interesting to know, what replaced it, whether this was declining margins, less profitable, you walked away, they walked away, can you perhaps talk a little bit about that?

As you know each of our 139 centers is based on the contract between Concord Medical and our hospital partners. That specific center, we talk about they have like a long-term contract and then at the end of the term, the hospital prefers to take contract internally and operated. And the strategy we are adopting right now is to find suitable locations in the close by city – in the close by area, so that we can gradually convert these centers into a free-standing centers. We have announced one-such plan in Datong city, Shanxi province and in 2015, we have plans to build and start operate 5 to 10 such standalone centers. So it is normal business relationship, we have some centers successfully renewed contract for instance we have renewed a major contract and entered into another 15-year of co-operation. And we will also have some centers that hospitals prefer to take the operation internally.

Okay. Thank you.

All right. Thank you.

Thank you. [Operator Instructions] There is no more questions at the moment. I would like to hand the call back to management for closing remarks.

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

Ladies and gentlemen, that does conclude the conference for today. Thank you for your participation. You may now disconnect. Have a nice day.