Is a Revenue Miss Coming for China Medical Technologies?

There's no foolproof way to know the future for China Medical Technologies (Nasdaq: CMED  ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result. Rest assured: Even if you're not monitoring these metrics, short-sellers are.

A cloudy crystal ball
I often use accounts receivable (AR) and days sales outstanding (DSO) to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- days worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like China Medical Technologies do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is China Medical Technologies sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully-reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter (EOQ) receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars (DSO) indicates a trend worth worrying about. As another reality check, it's reasonable to consider what a normal DSO figure might look like in this space.

Company

LFQ Revenue

DSO

 China Medical Technologies $30 147
 Qiagen (Nasdaq: QGEN  ) $274 68
 PerkinElmer (NYSE: PKI  ) $419 76
 Beckman Coulter (NYSE: BEC  ) $894 80

Source: Capital IQ, a division of Standard & Poor's. DSO calculated from average AR. Data is current as of last fully-reported fiscal quarter. LFQ = last fiscal quarter. Dollar figures in millions.

Differences in business models can generate variations in DSO, so don't consider this the final word -- just a way to add some context to the numbers. But let's get back to our original question: Will China Medical Technologies miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, China Medical's year-over-year revenue grew 21.5%, and its AR grew 4.8%. That looks OK. End-of-quarter DSO decreased 13.8% from the prior-year quarter. It was down 0.2% versus the prior quarter. Still, I'm no fortune teller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

What now?
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt the market's best returns. However, some investors actively seek out companies on the wrong side of AR trends in order to sell them short, profiting when they eventually fall. Which way would you play this one? Let us know in the comments below, or keep up with the stocks mentioned in this article by tracking them in our free watchlist service, My Watchlist.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.  


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  • Report this Comment On December 01, 2010, at 2:18 PM, zoagra wrote:

    Presumably, CMED will have to explain this aspect of their business model to potential buyers of the private placement announced on November 29. The spike in DSO occurred during rough times in the middle of FY09. Although DSO remains elevated, the more recent relative decline in AR is reassuring. Thanks for reminding us to look under the hood at those revenues.

  • Report this Comment On December 02, 2010, at 3:48 AM, chinaivd wrote:

    Thanks for another very insightful article that counters some of the "feel good" press releases from CMED. In the end it will be revenue and profitability that will tell the tale.

    I own a market research firm in Beijing and have been following CMED for some time, since the days when HIFU was promoted as being their future. We visited their reference accounts then and found that many of the units where under shrouds, not in use. We knew in advance that the HIFU could not be successfully registered with SFDA again after Mr. Zheng, the Director General of SFDA, met his demise.

    We have never been able to confirm the total China FISH market to be anywhere near the reported CMED revenues for FISH, and we visit Clinical labs all over China. We found, in one CMED FISH reference account, that CMED was only used for student practice, but the Abbott was used in any research projects or patient testing. Abbott has not actively promoted their FISH system in China because they say the market is still too small, but they will when the time comes, and become a really stong competitor, as they are in other IVD markets in China. CMED ran an internet program where they were giving away the FISH and reagents for testing. PCR reagents are growing, so it is good that CMED are trying to supplement revenue with their entry into this crowded, generic, but fast growing market.

    As for their previously "glamor" business (after the HIFU "glamor" business) in Immunoassay ECLIA, I visit their competitors and have been told that the problems CMED faced were not pricing but value. Customers left them for higher priced products from Autobio and others. The announced 30% price cut, overnight, should have been seen months ahead, if that was really the issue, and gradually adjusted. I also have talked with the former CMED dealers.

    IVD, in general, is growing at 30% per year in China, so the opportunities are astounding and more and more Chinese IVD companies are appearing and growing fast. Roche IVD grew by over 50% last year in China and they were already the leader in the high end markets. However, CMED will have a very rough time convincing users to switch from mostly flouresence detection for NAT to their SPR technology. There are already so many open systems and probes on the market for the exisiting NAT users, based on fluourescence.

    And, very creative new technological advances are being made, right here in China, that will obsolete traditional extraction and amplification hardware that is also incorporated into the CMED offering.

    CMED has had some very good government relationships (and Guanxi $$), in the past, that have helped them, but China is slowly changing. My educated guess is that CMED is going to continue to have challenges with real revenue growth (without creative accounting). Unless they can put together another inflated purchase (SPR was completely unknown, and had sold nothing, until CMED paid $348 million US for them) that puts money in somebody's pocket who can buy up the products, they will need big time emergency financing.

    I suppose it is possible to recover from past indisgressions, but they have a long way to go. Good advice to keep an eye on them. Maybe even SEC should keep an eye on them. My guess is that they can only place these SPR systems for free and hope for reagent revenue. It might be worthwhile to look into who they actually sell the equipment to. It would not suprise me to find that Mr. Wu Xiaodong, the CEO, also owns a leasing company. He has still not paid all the money ($53 million) owed to CMED for his buy-back of the HIFU business (which is now defunct).

  • Report this Comment On December 02, 2010, at 10:50 AM, deagertm wrote:

    CMED reported earnings 15 days ago. They earned 37 cents, up 6 cents(Q2). They think they will make 42 cents this quarter(Q3) and $1.60 for the year. To make $1.60 for the year CMED would have to make 50 cents in Q4. It looks like CMED thinks revnues are going up over the next two quarters.

  • Report this Comment On December 15, 2010, at 12:16 PM, griderX wrote:

    chinaivd: Great Feeback...thanks for the write up. Wondering if you have any feedback or opinion on Mindray (MR)?

    I have been very hesitant to put any real money in CMED for a while...glad I followed my gut on this one. There were just too many red flags that kept on appearing every time I looked at the financials. I've been invested in MR for many years and plan to hold on to it for the long haul.

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