Concord Medical Services Holdings Ltd (CCM) 2012 Q3 法說會逐字稿

Hello, and thank you for standing by for the Concord Medical third-quarter 2012 earnings conference call. At this time, all participants are in a 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, Vickie Zhao from Solebury Communications. Ms. Zhao, you may begin.

Thank you. Hello, everyone, and welcome to Concord Medical's third-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 we'll 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 US 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 statements except when 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 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.

(Interpreted). Welcome, everyone, to the CCM third-quarter 2012 financial results conference call.

Starting from this quarter, CCM has consolidated the financial results of Chang'an Hospital, which we closed the acquisition of 52% equity earlier this year. The combined revenue reached CNY206m, a growth of over 65% from the same quarter of 2011. CCM has become the only China-based company listed in the US that owns a controlling interest in private general healthcare in China.

In our total revenue of CNY206m, network business contributed 55% and Chang'an Hospital contributed 45%. We expect that Chang'an Hospital will maintain its revenue growth of around 40% in 2013, which will contribute strong support to the overall growth of CCM and a balanced cash flow.

In September, Chang'an Hospital has celebrated its 10-year anniversary. As one of the largest private hospitals in China, with a long operating history, Chang'an Hospital has experienced a successful and exciting 10 years, which witnessed the growth and development of private hospitals in China. Chang'an Hospital has made significant contributions to the cost of enhancing the overall medical standard in North Western China, helping to solve the long-lasting problems of lack of medical resources in the area.

In 2012, Chang'an Hospital is expected to achieve an overall medical revenue of over CNY360m, growing by over 40% from 2011. This revenue is projected to reach CNY500m in 2013.

At the same time, we're glad to see that the network business of accounting maintained its development. During 2012, we have implemented fully the measures to control cost and improve ROI. All costs and expenses items were controlled and monitored closely. Our philosophy is to make return on assets a key ratio, continue to control costs and expenses and enhance the overall operating efficiency. We will ensure that the current operation generates sufficient cash flow to support the planned projects.

Regarding the hospital construction, the Guangdong (inaudible) Hospital, our JV with Sun Yat-Sen Hospital in Guangzhou, has received the necessary medical institution approvals and other related government licenses. The hospital will be a specialty cancer hospital with the most advanced radiotherapy equipment, operating 400 patient beds. We have acquired the land use rights for the hospital and will start the pre-construction design work. Construction of the hospital will begin in second half of 2013, and the construction period will be around three years.

To build and operate a greenfield cancer specialty hospital means the transformation of our current business model. There will be both opportunities and challenges, which we're fully aware of. Chang'an Hospital will become a training ground for our hospital management team. Also we are seeking opportunities to establish partnership with well-known medical institutions in the USA that will provide support for our planned hospitals in terms of training, medical protocol, hospital management and technology. More details of these plans will be disclosed at appropriate opportunities.

Regarding government policy and regulations, we are seeing more and more favorable policies encouraging private investment in the healthcare services sector. More government resources will be dedicated to increased demand for services, including a more comprehensive social insurance program. Both our network business and Chang'an Hospital will benefit.

China's healthcare service industry is welcoming a golden decade. Concord Medical, as a leading company in China's healthcare services sector, is looking at a bright and confident future. Here, to all investors and shareholders that have supported CCM since our IPO, I would like to express my greatest gratitude and appreciation, wish everyone a wonderful Thanksgiving holiday.

Now I would like to invite Mr. Adam Sun, our CFO, to go through the financial results.

Thank you, Dr. Yang, and thanks for joining us today.

I would like to focus my discussion on the following issues. First, I would like to comment on the business status of our network business, which contributed CNY114m in revenue during the quarter, 55% of the total net revenue. We have emphasized on improving operational efficiency and cost control since the beginning of 2012, and have successfully stabilized our gross margin at 61.3%, compared to 58.4% and 68.7% during the first two quarters. Gross margin will continue to improve as the newly opened centers, which accounted for 10% of our network revenue this quarter, start to contribute more in the future.

Also, during the third quarter, many of our hospital partners were undergoing the review of 3A hospital status, so the operation of our centers was impacted temporarily. The effect will gradually be mitigated in the fourth quarter.

As for the accounts receivable from the network business situation, the DSO from the network business during the quarter was 167 days, compared to 159 days in Q2, in line with our previous targets. We will keep up with our collection efforts to bring the DSO further down.

As for the rest of the balance sheet, our cash position totaled CNY294m in Q3, up from CNY219m at the beginning of 2012 and CNY131m at the end of the second quarter. The Company believes that its existing cash and available bank borrowing capacity are sufficient to finance its capital investments in new facilities and working capital needs over the next 12 months.

Next, I would like to discuss the operation of Chang'an Hospital. Since earlier this year, the Company has initiated various measures, imposed merger integration projects and has fully integrated the hospital operation. Chang'an Hospital has fully opened its Phase 2 facility, with close to 1,000 beds in operation right now.

During the first nine months, Chang'an Hospital had total revenue of around CNY270m or $43m, with overall bed utilization rate about 90%. The total medical revenue for 2012 will be around CNY360m, or about 40% higher than 2011.

Look forward to the fourth quarter of 2012, we have issued our revenue guidance in the press release. Total net revenue will reach between CNY193m to CNY210m, with network revenue of CNY105m to CNY115m, and Chang'an Hospital revenue will reach CNY88m to CNY91m (sic - see press release "CNY95m"). The full-year revenue of 2012 will be between CNY643m and CNY678m, or $102m to $107m.

In the end, we feel very encouraged by our business growth, various strategic initiatives that are going on under the policy and the positive policy environment in China, favoring private health service companies like CCM. We will continue to improve our return on investment capital and deliver value to our shareholders.

Thanks, everyone, and have a nice Thanksgiving holiday. Now we would like to open up to questions. Operator, please.

Thank you. (Operator Instructions). Your first question comes from the line of Sean Wu from JPMorgan. Please ask your question.

Hello, Yang [Zhong], Adam. Congratulations on a great quarter. I think you guys have made great progress with your hospital operations. I just have a very -- I'm not very familiar with Chang'an Hospital, the operation margin, etc. So you have about 15% of operating -- gross margin for hospital business. So what are the components, the major components of the cost of goods or cost of services in this regard? You have three lines of business, like pharmacy, in-patient, out-patient. What are the overall margins for each segment?

And what do you think about the overall margin, 15%? Is it good or can you get it better, or it's above hospital average compared to other hospitals? I'll just stop here.

Thank you, Sean, and thanks for your question. So, as for the components of the cost of services, as you know, we don't break down in our press release, and so here I would like to discuss in general about the components and give you some top line numbers. Hope that will be helpful for your analysis.

So, as you know, the cost of service for hospital are mainly composed of obviously salary and compensation and depreciation of the fixed assets. And also, another major component of the cost of services obviously is pharmacy and the consumables. So amount, give you the rough idea, in our Q3 number the cost for pharmacy and consumables accounted for about 50% of the total cost of services, and salary and compensation benefits accounted for about 15%. And depreciation is about another 10% to 12%. So those are mostly the major components of our cost of services.

So, looking down the road, we need to do a better analysis about each component. And generally, my impression is that things -- the cost of pharmacy accounted for the major component of the cost of services. I think the gross margin level should remain around this level, and we are not expecting to see volatility on either side in the near -- in the next couple of quarters. Hope that's helpful.

That's great. Thanks a lot. So I have a question for Mr. Yang Zhong. So now Yang Zhong has been in this business for a long time, so can he give us more detail about some of the new policy development, like how do you think you compete against other players like China Resources, and even like Fosam is trying to acquire hospitals? So the difference between your building a greenfield hospital in Guangzhou versus other people buying current hospitals. (Spoken in Chinese)

(Interpreted). First, I would like to give sense about the medical service -- Medicare service policy in China. The overall direction for the current medical service reform is very clear, that is that the government will dedicate its resources to provide basic services to the general public, while the service sector for mid- to higher-tier patients will be opened to private and overseas capital. So this provides a great opportunity for companies like Concord Medical to invest in the healthcare service sector in China.

So we're very glad to see many players started to enter into this field. And my general understanding is the market demand is way -- outweighs the current supply. So there will be a shortage in supply in the very long term. So we believe that there will be sufficient opportunities for each player in this field in the very long period.

So, under this situation, so we're very glad to see that many players enter into this field. So we will dedicate to our general policy, that is do what we feel our advantage, do what we are most experienced with, which is to establish and operate hospitals in the oncology specialty field.

As you know, that there are three major treatments for cancer, which is surgery, chemotherapy and radiotherapy. So Concord Medical has accumulated over 15 years of experience in radiotherapy and accumulated great assets in technology and management experience. So we're applying this expertise to our future products.

As you notice, planned hospital in Guangzhou is a joint venture between CCM and Sun Yat-Sen Hospital, considered one of the best local -- hospitals in the local market. So each party, CCM and our local based hospital partner, brings competitive advantages to this project.

And as we explained before, our current projects to establish specialty hospitals is not a fundamental change of our business model; rather we consider it as a transformation and evolution. So basically, down the road we expect that our center business is going to grow strongly. At the same time, we will look forward to see more contribution from our hospital business. So we'll combine our 134 centers around the country with our specialty hospitals, to contribute to the cost of providing the best treatment for patients in China. Thank you very much.

Thanks a lot. That's very helpful. I'm getting back to the queue now.

Thank you.

Thank you. Our next question comes from the line of Chris Lui, from Morgan Stanley. Please ask your question.

Hi. Thanks for taking my question. My first question --

Hi, Chris.

-- relates to goodwill. Concord has about CNY300m of goodwill written off in 2011, and now we see CNY230m in the third quarter of '12. Can you tell us specifically what it is, and a split, compared to the CNY300m we saw last year? Thanks.

Sure. Thank you, Chris. The goodwill is -- the goodwill on our balance sheet now is related to the Chang'an Hospital acquisition, which we closed in the second quarter. After the closing of the acquisition, we have engaged an appraisal firm to conduct purchasing price allocation, PPA work. The PPA result is still preliminary and subject to changes in the future. So, during the PPA test, we have identified the value of the fixed assets, intangible assets, and the rest of the consideration is in the goodwill sector.

So, among the intangible assets we have identified include the land usage rights, information system, healthcare qualification of Chang'an Hospital and its oncology operation licenses, valued at around CNY185m. So based on the growth prospect of Chang'an Hospital, we do not see any impairment risk at all for the goodwill so far. And let me repeat, the appraisal work is still at a preliminary stage, so the result on our earning release is to be considered as preliminary and still subject to change.

Okay. When should we expect the official number to be announced?

Because, as you know, that we closed the deal and then it is a very short timeframe for the third quarter. So we expect the formal number definitely will come out during the -- when we announce our next earning release for next quarter -- for the current quarter, I mean.

I see. Please let me have a follow-up question. Can you tell us your CapEx plan for this year and next year, and also the operating cash flow for third quarter 2012?

Firstly, let me answer the operating cash flow question first. As you know, we do not disclose the official number of operating cash flow, but one of the best estimates -- just to give you estimate about our -- the first three quarters of the year operating number, we put that number roughly at around CNY80m.

The reason for that is since the beginning of the year we have strengthened our collection efforts, so basically the cash collected during the first three quarters of the year pretty much equals to our sales revenue, which contributed greatly to the very strong cash position at the end of the third quarter. So we believe that our capital resource, including our cash, available bank credit, will be very sufficient to support our growth plans.

So for the CapEx -- for your CapEx question for the fourth quarter, for the third quarter we see our CapEx number going up to CNY131m, compared to the first two quarters. And the reason for that is we have put down deposits for a couple of centers during this quarter. So the fourth quarter we believe that the total CapEx number will be lower than the number we see in the third quarter. And while we did not give out specific guidance for CapEx number for fourth quarter, we believe that the guidance we issued at the beginning of the year is still valid.

I see. Thanks. I'll get back to the queue.

Okay. Thank you.

Thank you, and the next question comes from the line of Jack Hu from Deutsche Bank. Please ask your question.

Hi. Thank you for taking my question. I have only one question, on the hospital front. If we look at the patient status, what percentage of the patients have insurance and what's their -- insurance composition? Thanks.

Sure, Jack. For Chang'an Hospital, it accepts -- as a private general hospital, it accepts all kinds of government issued insurance programs, including, as you know, that -- there are three major insurance programs in China right now, as you may know, including Urban Resident Insurance, which covers the people leaving the cities without work. And there is another insurance program called Urban Employee Insurance, which basically is working -- the employer sponsored insurance program. And also, another big part of the insurance program right now in China is the new Rural Cooperative Medical Insurance, which covers basically all the rural population in China.

So Chang'an Hospital accepts all three forms of this sponsored -- government sponsored insurance. And while we do not disclose the specific insurance (technical difficulty) insurance number, so in general the revenue contribution from insurance program is about 50% of our total net revenue in the third quarter.

And the insurance -- the current insurance mechanism in China is pretty complicated, so it usually favors the inpatient service for hospital, and for outpatients usually it -- because usually, under all these three insurance programs there is a self-paid portion. And so for most of the outpatients, if the expenditure is below the hurdle, usually it's not reimbursed. So that's why the percentage for insurance so far is about 50%.

Thank you. I have a follow-up question. We heard about global budgeting reimbursement cost control nationwide, so we are actually expecting something could happen in December. So right now we're getting to the -- almost the last week of November. Have you seen anything actually change as we approach yearend on reimbursement front?

I'm sorry, Jack. I didn't quite catch your first part of your question. Can you repeat it again?

Sure. I'll do it in Chinese, translate it into Chinese. So basically we heard that -- so nationwide right now we have global budgeting reimbursement cost control. So my question is that have we seen anything different when we approach yearend? (Spoken in Chinese).

(Interpreted). In general, the impact of the general control you mentioned is not obvious, because for our centers the radiotherapy is considered a major illness. The category is in the major illness list, and it's basically covered under the insurance program. So from our prior experience during the past years, even in the month of December we don't usually see obvious impact of this measure.

Thank you.

Thank you.

Thank you. Next we have a follow-up question from the line of Chris Lui from Morgan Stanley. Please ask your question.

Hi. Thanks for taking my follow-up question. Can you tell us the opportunities and risks in each of the two sectors, network and hospital, and if possible can you quantify the upside and downside risk of them as well? Thanks.

Okay, Chris. As you know, there are both similarities and differences between the two segments. So on the one hand both our segments, the network and the hospital, provide services to the general public patients. As Dr. Yang mentioned in his remarks, the policy changes recently in China, including strengthening social insurance program and emphasizing the role of government in providing basic healthcare, will benefit both of our centers and Chang'an Hospital as well. Chang'an accepts all forms of government sponsored insurance, as I mentioned before, and the per capita payoffs are growing steadily, year over year.

For our network business, we are targeting to build a nationwide network of centers, linked with our planning [China] medicine infrastructure. So if it is successful, we will be able to make our network business more scalable. So for Chang'an Hospital, I think the opportunity is to build it into a general hospital with a strong specialty, especially in oncology, which will increase the per-patient contribution. The strategic agreement with Fox Chase which we announced in July is a very first -- important first step.

So for the upside of our network business is to achieve an overall 10% year-over-year growth, while we are seeing a pretty much flat growth in this quarter. So part of the reason is that during the -- since beginning of the year we have started to see some of our hospital partners demanding that the contract terms be revised. So now the situation has pretty much stabilized, so we don't see it's going to happen in the large scale from here on. So we think that the overall trend for our revenue from our network is stable and slightly up from here on.

Okay. Thank you.

Thank you.

Thank you, ladies and gentlemen. (Operator Instructions). Next we have a follow-up question from the line of Jack Hu from Deutsche Bank. Please ask your question.

Yes. Thank you for taking my question again. So actually I do have one follow-up question, regarding Sean's question on hospital gross margin side. So the gross margin, about 16% here, is slightly below my expectation and also actually below industry average. Can I understand how -- can you give me some color how this works and then where we see improvement going forward?

Sure. So, as you know, the major -- Jack, the major revenue -- the revenue components of our hospital revenue which we disclose in the press release is the pharmacy contributed about 40% -- a little bit above 40% of our total revenue and outpatient contributed about 20%, and then the inpatient contributed about 40%. So, among the three different components of our revenue, they have different gross margin situations, obviously, as we can see.

So, for instance, the pharmacy side, the gross margin usually is 15% or slightly below because, as you know, there is government price guideline, which is a 15% surcharge. So that's pretty much -- they are universal across all hospitals you're going to see.

So, as for the inpatient, the inpatient business usually is the most profitable business for our hospital, because the hospital usually makes most of its money from inpatient services. And outpatient you can consider it as pretty much a loss leader, because you need to provide general services to the public so that you can improve your patient traffic.

So the current margin we are seeing right now is pretty much a weighted average of all three of these service lines. So one way to improve our gross margin is to improve the outpatient services, which is in fact the most difficult job for a hospital in China, because to improve the -- one way to do that is to strengthen the specialty for this hospital, so that patients will start to visit the hospital more often. So that is a process that usually runs its course.

So for Chang'an Hospital, it's pretty much entering its -- the phase of 40% plus growth. And as the hospital becomes more established in the neighborhood and in the community, so we expect to see the contribution from outpatients to be more and the per-patient contribution to improve. So that's one way that we are going to -- we can see the gross margin generally trending up.

And 16% is -- it's pretty much in line with our expectation, and also part of our -- I think we should expect it to grow gradually. And I think the upper limit should be close to 20%, but anything above that you really need to change the business model of the hospital fundamentally.

Thank you.

Thank you.

Thank you. And next we have a follow-up question from the line of Sean Wu from JPMorgan. Please ask your question.

Okay. I have another follow-up question to Jack's question. So now that we have solved the problem with your gross margin, so I'd like a bit more about your net margin, your operating margin, in hospital side.

And as for pharmacies, you do have drivers which you can -- if it's on the reimbursement list, you charge a 15% markup. If you (inaudible) some (inaudible) or other drugs, the higher (inaudible) drugs, it's based on oncology drugs which are not covered by medical insurance. Do you only still charge a 15% markup?

So this is one question. Another question is about your contribution from the inpatient. So what is your overall per-bed gross for the patients, and also what's the margin there?

And also, you said you would like to grow this 40% year after year, but your bed occupancy appears to be quite high already. So if you are growing outpatient business, the margin is not going to be very favorable. So what is the overall numbers behind this 40%? If sales grow 40%, what is your goal for profit growth? Okay. I know that's the last question.

Yes, it's very comprehensive. Let's try to cover all aspects of it. I know the market is very -- it pays a lot of attention to the margin, and trust me, we do too. So we monitor the margin situation of both our network as well as hospitals very carefully.

So to answer the first question, there are some high-priced drugs that are not on the essential drug list which the Company -- the hospital will be able to charge a higher markup. But the general guidance for the hospital management is to rely less on pharmacy sales. So our target generally is to limit the contribution in revenue from the pharmacy side to about 40%.

And one way to improve our revenues, the reason that we have confidence we are going to achieve the revenue growth of 40% year over year, is that as you -- you are right, that utilization rate is pretty high; it's about 90%. But we see that the general length of staying in the hospital is long. So in order to -- now it's about 10 days on average.

So one way we're going to improve the contribution from the inpatient service is to accelerate the bed turnover, so that, for instance, instead of, on average, a patient staying in the hospital for 10 days, if we improve it by -- to eight or nine days, the overall capacity for our inpatients is going to grow. You can do the maths. It's going to grow from there. So that's one way that we're going to grow our top line.

And for outpatient growth, the assumption is that first we're going to improve the per-patient payoff, which is at a very low level at this moment. So, if we improve that, that's going to have a contribution to our revenue growth. And once the revenue for outpatient -- the per capita level reaches a threshold, we're going to see improvement on our gross margin.

The SG&A for the hospital is pretty stable, so you are not going to see line-by-line growth from the SG&A expense. So that is why we are confident that the profit margin -- the net profit for our hospital is going to grow next year as well.

Right. Thank you. I think you've got my questions well covered. Only the net margin and operating margin side, can you elaborate a little bit more, what (multiple speakers)?

The net margin, I think the 10% estimate is pretty accurate.

Okay. Thanks.

On the net margin side, I think 10% is a pretty good estimate. Thank you.

Thank you. (Operator Instructions). There are no further questions at this time, and we are now approaching the end of the conference call. I will now turn the call over to Vickie Zhao from Solebury Communications for the closing remarks.

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

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

Portions of this transcript that are noted Interpreted were interpreted on the conference call by an Interpreter present on the live call. The Interpreter was provided by the Company sponsoring this Event.