China Medical Passes the Test

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The China story isn't over yet. At least not for China Medical Technologies (Nasdaq: CMED), which jumped more than 17% yesterday after releasing its fiscal fourth-quarter earnings.

China Medical's revenue was up an impressive 74% year over year. Not all of that jump trickled down to the bottom line, though. Adjusted earnings per share were only up 38% to $0.66 per share -- but the company has good excuses. A new, higher tax rate, as well as gross margins slipping 900 basis points, hampered the bottom-line growth. The company can't really control taxes, and the gross margins were hurt because the company had to factor in assets associated with the launch of its new fluorescent in situ hybridization (FISH) diagnostic-test platform. China Medial doesn’t make that much selling the microscopes that run the tests, but the company makes up for it to some extent by selling the higher-margin tests that run on the microscopes.

When a company beats even its own revenue estimate -- revenue was 12% higher this quarter than the high end of China Medical's range -- it's often helpful to figure out why that's the case. You can spot not only the potential future driving forces for the company, but also where the whole industry is headed.

China Medical used to be primarily concerned with its high-intensity focused ultrasound machines that are used to kill tumor cells, but the company has turned its attention to diagnostic tests. It looks like the move paid off; sales of its enhanced chemiluminescence immunoassay (ECLIA) tests, which look at diagnostic markers in blood and other bodily fluids, were up 70% year over year, and its FISH test is off to a raging start. The two segments combined make up about 60% of revenue, and that number should only pick up as the company designs more tests to run on the two systems.

China Medical's success -- in addition to Hologic's (Nasdaq: HOLX) acquisition of Third Wave Technologies' (Nasdaq: TWTI), as well as Illumina's (Nasdaq: ILMN) and Affymetrix's (Nasdaq: AFFX) push into developing tests -- makes it pretty clear to me that diagnostic tests are the next big growth area in the health-care field. It might be time to jump on board, Fools.