A closer look at Q1

It's time to look at the numbers a bit more closely and broach thoughts and questions for discussion purposes. Nawar, please feel free to correct me and/or make comments as it pertains to the estimates that you made before the quarter...

First, here is a summary of the numbers in the press release. I organized some major figures and included percent changes as necessary. I also compared the actual figures to the estimates Nawar generated before the conference.

http://spreadsheets.google.com/ccc?key=pcct1snXYPGD0n2TVzJY8Ew&hl=en&pli=1

Highlights are (all numbers are yoy and look at RMB not USD):
Revenue Increase:
Total: 66.57%
Hifu: 20.48%
Eclia: 84.66%

Operating Income:
50.8%

Non GAAP earnings:
37.44%

GAAP Earnings
12.79%

These are some really good numbers!
However, lets give some further analysis:

A. GAAP vs non GAAP. The difference here was large (16,886 RMB for the quarter). This comes from two sources:
1. Stock compensation expense. My interpretation of this is that it includes paying interest on previously issued convertible bonds and on converting bonds to stocks. Since the bonds have not reached maturity I would think that they did not pay the money back in cash at this time on bonds, but maybe they have (I did not see more on this). I was also wondering if this may include stock options to employees? If anyone knows please comment. The stock compensation cost was 1279 RMBs, which represents a 300% increase over last year.

2. Amortization of intangible assets. This is the biggest expense by far as it pertains to GAAP vs non GAAP. This was 15,607 RMBs, a 319% increase over last year. This is due largely to the FISH acquisition. What does this mean in plain English? Well, for patents on drugs each year the intangible intellectual property rights decreases. For example, if the patent on a drug is expected to make a company $100 million before reaching patent expiration and the patent expires in 10 years then each year there is a loss of $100/10 = $10 million for the patent right. For the FISH business it is not as clear-cut as this. The idea is that, as of right now, CMED is the only major provider of FISH in China. This gives it a large, "intangible" asset advantage. However, over time other competitors may move in. Thus, each year the FISH technology is worth less. Quantifying how much FISH will be worth over the years and how much the competitive effect may influence this is vague at best. In fact the company has stated it is going to keep reassessing these numbers over time. The main question to ask here is: will this cost be the same each year or will it start to lessen (think of depreciation on a car... the car loses the most value in the first few years then the amount lost declines). I think for now they will assume a linear decrease (same each year). That means that the crimp on margins for GAAP earnings is here to stay (50% to 34% yoy). However, it is unlikely to go up so the fixed cost should not affect growth numbers in future quarters. Also, the questions remains: will analysts focus primarily on GAAP or non GAAP numbers in their estimates? Something to watch but importantly these are as of now accounting figures and do not affect cash flow.

B. Operating income vs. non GAAP earnings
Operating income increased 51% but non GAAP earnings increased 37% yoy. This was due largely to increases in non operational expenses (R&D and marketing). I think that as the company becomes bigger and as it attempts to maintain a competitive advantage this may very well be the trend. For these reasons I think that it is reasonable to look for growth in the upcoming years to be in the mid to upper 30s before calculating in any currency affects. Although we should remember that the 37% non GAAP is also reduced by the stock compensation numbers. I don't know if these will increase or decrease over time.

If growth does end up in this range then the company is doing just fine.

Questions, comments, opinions? Please feel free to argue/agree. I will compare Nawars' numbers on another post.

Best,
Jon