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Edited Transcript of KANG earnings conference call or presentation 17-Mar-17 12:00pm GMT

Thomson Reuters StreetEvents

Q3 2016 iKang Healthcare Group Inc Earnings Call

Beijing Mar 17, 2017 (Thomson StreetEvents) -- Edited Transcript of iKang Healthcare Group Inc earnings conference call or presentation Friday, March 17, 2017 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christy Xie

iKang Healthcare Group Inc. - Director of IR

* Ligang Zhang

iKang Healthcare Group Inc. - Chairman & CEO

* Luke Chen

iKang Healthcare Group Inc. - CFO

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Conference Call Participants

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* Patrick Yang

QVT Financial LP - Analyst

* Ethan Li

Elses - Analyst

* Peter Ashworth

Panmure Gordon & Co. Limited - Analyst

* Cyril Pritchard

Altimo - Analyst

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Presentation

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Operator [1]

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Good morning, and thank you for standing by for iKang's third quarter FY16 earnings conference call. (Operator Instructions). Today's conference is being recorded.

I would now like to turn the meeting over to your host for today's conference, Christy Xie, Director of Investor Relations.

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Christy Xie, iKang Healthcare Group Inc. - Director of IR [2]

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Thank you, operator. Good morning and good evening. Welcome to iKang's fiscal third quarter 2016 earnings call for the period ended December 31, 2016. I'm Christy Xie, Director of Investor Relations, and with me today on the call are Mr. Li Zhang, our Chairman and CEO, and Mr. Luke Chen, our CFO.

As a reminder, today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available on our website following the call. By now, you should have received a copy of our press release that was distributed on March 16, 2016, after market close Eastern Time. If you haven't, it is available on our Investor Relations section of our website.

Before we get started, let me review the forward-looking statements regarding this conference call. That is, statements related to future, not past, events, often address expected future business and financial performance and financial condition and often contain words such as will, estimate, project, intent, potential, plan or go. iKang may also make written or oral forward-looking statements in other reports, in presentations, in material delivered to shareholders and in press releases.

In addition, iKang's representatives may also make oral forward-looking statements. Forward-looking statements, by their nature, address matters that are, to different degrees, uncertain, such as statements about the Company's goals and strategies, its future business development, financial condition and results of operations; its ability to retain and grow its customer base and network of medical centers; the growth of, and trends, in the markets for its services in China; the demand for, and market acceptance of, its brand and services; competition in its industry in China; relevant government policies and regulations relating to the corporate structure, business and industry; fluctuations in general economic and business conditions in China.

Further information regarding these and other risks is included in iKang's filing with the Securities and Exchange Commission. iKang undertakes no duty to update any forward-looking statements except as required under applicable law.

During this call, we will be referring to GAAP and non-GAAP financial measures. We believe that non-GAAP measures are more representative out of how we measure the business internally, and they are reconciled to GAAP in the tables attached to our press release, which can also be found on our Investor Relations website. Please note that all numbers are in US dollars and all comparisons refer to year-over-year comparisons unless otherwise stated.

With that, I will turn the call over to our Chairman and CEO, Li Zhang. Li, please.

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [3]

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Thank you, Christy. Good morning and good evening, everyone. Our continued solid performance this quarter, in the midst of economic slowdown, keeps us confident that our leading market position can lead us to great opportunities ahead.

Let me begin with our performance over the quarter, followed by Luke, our CFO, to provide you more details on the financials before we take your questions. If you have the presentation in front of you, please go straight to slide 5 on the highlights of this quarter, as well as our performance of the nine months ended December 31, 2016.

As you can see on slide 5, net revenues achieved a strong growth of more than 24% for the quarter and 25% over the last nine months on RMB basis. Gross profit up 8.2% for the quarter and 10.8% for nine months, while operating income up 10.2% for the third quarter, even though we continued our investment in ramping up acquired medical centers, while expanding our network with investments in self-built. I will leave it to Luke to share more colors on this later in his section.

On slides 6 and 7, you can see the growth performance remained strong across all business. Our customer base, along with visitation, has continued to expand with a year-over-year increase of 20.5% for the quarter and 23.3% over the nine-months period.

On slide 8, as compared to December 31, 2015, we have opened 20 new medical centers and expanded into eight new cities, bringing our network to 104 medical centers in 32 cities as of today.

Our growth momentum has been driven by the continued investment in expanding our nationwide network coverage and initiative to deepen market penetration in fast-growing Tier 2 and 3 cities, which have achieved 45% revenue growth year over year on fiscal third quarter. Moreover, we're excited to report that two more new self-built medical centers are expected to be operational by fiscal yearend on December 31, 2017.

The management is fully committed to continue the strategical imperatives of expanding nationwide network, ramping up the utilization of our medical centers, and broadening our service portfolio, to maintain growth momentum for our core business while setting priorities to drive the next phase of growth.

With that, I will turn it over to our CFO, Luke Chen, for the financials.

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Luke Chen, iKang Healthcare Group Inc. - CFO [4]

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Thank you, Li. Moving to the financials; as the details for the fiscal third quarter results and the fiscal nine-month results ended December 31, 2016, are available in our earnings release, I would like to highlight the key business and financial metrics, and focus on our year-over-year comparisons, with all the numbers in US dollars unless otherwise stated.

If you have not already done so, I would encourage you to download from the investor section of our website in the financial slides we post concurrently with our press release early today. My prepared remarks will be focused on section 2, the business and the financial review of fiscal third quarter of 2016 ended December, from slides 9 to 20.

For the quarter, net revenue was $154.6 million, up 16.2%. On a local currency RMB basis, the growth would be 24.2%. On a nine-months basis, net revenue was $375.6 million, growing 18.1%, or 25.3% on a local currency RMB basis. The result in this quarter remains to be solidly driven by the robust growth across all service categories.

Revenues from medical examination in the quarter were $129.3 million, up 14.2%, accounting for 83.7% of total net revenue. On a nine-months basis, revenue grew 16.9% to $314.5 million.

Revenues from disease screening in the quarter were $12.7 million, up 28.1%, representing 8.2% to the total net revenue. On a nine-months basis, revenue grow 29.2% to $29 million.

Revenues from dental services in the quarter were $3.2 million, up 60.9%, to account for 2.1% of total net revenue. On a nine-months basis, revenue grew 35.4% to $6.9 million.

Revenues for other services in the quarter were $9.3 million, up 19.1%, and accounting for 6% of total net revenue. For the nine-months period, revenue was up 17% to $25.1 million. Other services mainly include services such as outpatients service, medical consultancy service, and vaccination service.

Turning to the cost of revenue on slide 12; cost of revenue in the quarter was $81.4 million, an increase of 24.5%. Cost of revenue for the nine months were $203.6 million, up 25.1%, higher than net revenue growth at 18.1%, which was mainly due to the increased labor costs, rental, and depreciation and amortization expenses associated with the newly acquired and self-built medical centers.

Gross profit in the quarter increased by 8.2% to $73.1 million. Gross margin was 47.3% as compared to 50.8% in the same quarter last year. On a nine-months basis, gross profit was $172 million, representing a 10.8% increase. Gross margin for the period was 45.8%, as compared to 48.8% in the same period last year. Gross margin was diluted mainly due to the additions of the newly acquired and self-built medical centers, which have a lower gross margin as they were still in the ramping up period.

Turning to slide 14 for detailed breakdown of our operating costs; in the quarter, total operating expenses were $46.2 million, up 7%. On a nine-months basis, operating cost was $123.9 million, up 23.4%.

Selling and marketing expenses for the quarter were $21.5 million, up 6.5%, representing 13.9% of net revenue, as compared to 15.2% in the same quarter last year. On nine-months period, selling and marketing expenses were $56.4 million, up 15.9%, accounting for 15% of total net revenue, as compared to 15.3% in the same period last year.

G&A for the quarter was $23.9 million, up 9%, representing 15.4% of net revenues, as compared to 16.5%. On a nine-months period, G&A was $65 million, up 32.8%, representing 17.3% of net revenue, as compared to 15.4%. The increase was mainly due to the payroll and rental cost increase which were associated with our expansion into new geographic areas. The professional service expenses relating to the going private process also contribute to the increase.

Continuing on slide 15, our operating income for the quarter was $26.9 million, up 10.2%. Operating margin at around 17.4%, as compared to 18.4% in the same quarter last year. On nine-months period, income from operations was $48.1 million, down 12.3%, with operating margin at around 12.8%, as compared to 17.2% in the same period last year. We are pleased that, despite all the challenges, we have managed to stabilize the operating income margin in the latest quarter.

Slide 16 gives you an overview of our performance on a non-GAAP basis. Non-GAAP EBITDA for the quarter was $36.8 million, up by 12.4%. And non-GAAP EBITDA margin was at 23.8% this quarter, as compared to 24.6% in the same quarter last year. Non-GAAP net income was $14.5 million, down 30%. And net margin was at 9.4% this quarter, as compared to 15.6% in the same quarter last year. On a nine-months period, non-GAAP EBITDA was $77 million, down 2% and non-GAAP net income was $23.5 million, down 46.6%. Please refer to the table in earnings release or slide 19 for the reconciliation between EBITDA and the net income on a GAAP to a non-GAAP basis.

Although our net margin was impacted by the accelerated new city expansion, as well as one-time costs associated with the privatization, we have strong confidence that our focus on building new capacity and new capability in existing and new cities will yield pleasing results in the years ahead.

A quick note. Our cash and balance in slide 17 as of December 31, 2016, the Company's cash and cash equivalents, restricted cash and term deposit totaled $128.5 million, as compared to $72 million as of September 30, 2016.

To conclude, we have a solid quarter with strong revenue growth and a stabilized operating income margin. In the quarter, we have seen accelerated growth in second tier and third tier cities and we have been able to improve the operation efficiency and effectiveness of the newly acquired and self-built medical centers. We fully believe that this initiative has laid down the foundation for scalable and sustainable business in the long run.

That concludes my remarks and I turn it back to Li to conclude our presentation session. Li?

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [5]

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Thank you, Luke. With a newly released rules on doctors' multisite practice by the Chinese Government, we believe there are tremendous opportunities for the private healthcare service providers. We'll continue our growth momentum by expanding our presence across the country and quality customer base, and we are confident that iKang will ensure lasting returns for our shareholders in the future.

Thank you very much. Operator, we are ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Patrick Yang, QVT.

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Patrick Yang, QVT Financial LP - Analyst [2]

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I have two questions here. One is for Luke and one, Li, so first of all, a question for Luke. Our revenue growth has been very strong but EBITDA margin has declined year over year, as you mentioned. How should investors think about the long-term normalized EBITDA margin of the Company?

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Luke Chen, iKang Healthcare Group Inc. - CFO [3]

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Patrick, it's a good question, yes. Our business, we provide the medial examination service and we have to provide that service through medical centers. And one of our growth strategies is expanding into new cites, or building new medical centers within existing cities. Now so far, we have 104 medical centers in 32 cities. It's very significant, compared to three years ago; when we get listed, we only have 42 medical centers in 13 cities. So you compare it; in three years we've been growing, more medical centers getting into more cities.

However, with more medical centers, it takes time to ramping up. In our model, it normally takes three years to get to we call mature medical center. And before that, the new medical center has a lower margin because the utilization is not up to the standard. And because you get into new cities, the operating leverage is not there. Our operating leverage is mostly in a city [level], like Shanghai, Beijing, Guangzhou, we have multiple medical centers. There's very high operating leverage.

So if you look at the additions of our new medical centers, you will see that, this year, we added 20, and last year, we added 26. So it's a significant addition and shows that we are speeding up expansion, which means our margin is inevitably impacted because of those new medical center, the rentals, salary benefits, DNAs, etc., etc.

But you will see that in this quarter, actually, the operating margin, gross margin and operating margin and EBITDA, percentage is being stabilized, with the good utilization, because this latest quarter is the peak season. So moving ahead, our estimate is when we continue to beef up those newly built medical centers, and control the pace of the new additions, we should be able to achieve a reasonable net margin. Our estimates are around, like, 8% to 10% and the EBITDA margin I think around 24%.

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Patrick Yang, QVT Financial LP - Analyst [4]

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Got it. Thank you very much. And my second question is for Chairman Li. Li, as the largest shareholder of the Company, can you share with us your thoughts on how much you think the stock should be worth? And how should investors think about the valuation of the Company? Thank you.

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [5]

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I think, as a shareholder of the Company, or founder of the Company, basically, I think we are on the same page. Also the Company will be valued at the price it should be, but I think at this point, the Company is growing. Also, we went through the situation last year, so I think we are going to wait to see for the next few years what's going to happen. And, as management, I'm just going to work with our management and try to move the strategy and access strategy. I think that's what we can do at this point.

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Patrick Yang, QVT Financial LP - Analyst [6]

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Any numbers that you can share with us?

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [7]

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I have no comment.

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Patrick Yang, QVT Financial LP - Analyst [8]

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Okay. Thank you.

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Operator [9]

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(Operator Instructions). [Ethan Li, Elses].

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Ethan Li, Elses - Analyst [10]

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My question is regarding the ASP. Do we see pressure on the ASP with a competitor, or the simple question is, is there a pricing [war] in Q3, fiscal?

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Luke Chen, iKang Healthcare Group Inc. - CFO [11]

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Because there's competition, there are always competition on the pricing as well, the competitors. So there's a pressure on the pricing. And when we expand into second tier, third tier cities, the average starting ASP is not as high as the first tier cities. But not necessarily the price, however the cost, like people cost, rental cost, normally is also cheaper in second tier, third tier cities, so which means the margin around the same.

So what we try to do is that we focus on those high value customers who are willing to pay a higher price, because the service quality, the type of equipments, (inaudible), all the facility we use, as compared to most of competitors, is much higher. So our position is mid to high-end customer segment with the higher price. And through the custom mix that we've been able to increase the price, or at least maintain the price, but there are price pressures from price competition. I think your point is true.

We hope now more and more companies are paying attention to their employees' health and wellness, and more individuals paying attention to their health and wellness, and they're willing to pay actual money for additional testing items so that they can get a more comprehensive checkup which is beneficial to their health, and that will help us to further increase our ASP.

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Ethan Li, Elses - Analyst [12]

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Yes. I just want to ask how many new centers we are looking to acquire or to build ourself in the calendar year 2017?

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Luke Chen, iKang Healthcare Group Inc. - CFO [13]

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We normally plan in the fiscal year so our fiscal year started from April 1. We have a plan to build and deliver 12 to 15 new medical centers in the next 12 months, at least. So that's in our plan. We need to plan ahead because it normally takes six to eight months to build a medical center, to get all the approvals, then all the decorations, put in all the equipment and team, so it takes time to -- so that's why we need to plan ahead. And there's a leader time to build medical centers. So our plan is, in the next 12 months or in the next fiscal year, we plan to add at least 12 to 15 new medical centers.

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Ethan Li, Elses - Analyst [14]

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So how are we planning to fund those new centers? Do we need to raise additional debt, or are the existing cash plans or operating cash flow would be sufficient for the expansion?

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Luke Chen, iKang Healthcare Group Inc. - CFO [15]

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To build one medical center, it normally costs [RMB15 million], so it's about less than $3 million, $2.5 million something like that. So we are talking about $30 million or $32 million for the new medical centers. And on that scale, we will be able to self-fund.

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Ethan Li, Elses - Analyst [16]

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What is the net debt to EBITDA ratio we have now?

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Luke Chen, iKang Healthcare Group Inc. - CFO [17]

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I'm sorry, what was the question again?

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Ethan Li, Elses - Analyst [18]

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The question is, what is the net debt to EBITDA ratio we have now?

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Luke Chen, iKang Healthcare Group Inc. - CFO [19]

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I have not done the calculation on that. But if you like, you can do the calculation because in the earnings release, we have posted balance sheet and the P&L as well.

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Ethan Li, Elses - Analyst [20]

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So we expect around 24%?

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Luke Chen, iKang Healthcare Group Inc. - CFO [21]

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We have some debt. You are right; we have some debt.

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Ethan Li, Elses - Analyst [22]

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We expect a normalized 24% adjusted EBITDA margin in the long run, is that correct?

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Luke Chen, iKang Healthcare Group Inc. - CFO [23]

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Yes.

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Ethan Li, Elses - Analyst [24]

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I see. That's my question. Thank you.

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Operator [25]

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(Operator Instructions). [Peter Ashworth, Panmure].

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Peter Ashworth, Panmure Gordon & Co. Limited - Analyst [26]

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I have a quick question for Chairman Li. It seemed like this is a great secular growth opportunity in China that you offer, yet I am surprised to see, in the Company press release, citing the economic slowdown in China as a factor on your growth. I'm wondering how you can reconcile this. Is the secular growth prospect an opportunity not as strong as anticipated? And, if so, why?

Or secondly, maybe you can explain how the general slowdown of the economy in China, which is still almost 7% growth per annum on a GDP basis, affects your business? That's my first question.

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [27]

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Our service, as you know, is offered as an employee benefit and, at this point, the B2B business accounts for roughly about 80% of revenue for this Company. And you can see there are some transformation for all sectors in China with technology, with Internet. Also, we see, actually, many of the multinational company are shrinking their employment force in China. And the new growth has really come from local Chinese companies, so that's why I think when the multinational companies are under pressure, naturally, to the benefit side, sometime will be question as well for the company budget.

So I think, for the past few years, we witnessed fast growth and where we are at this point. But as you can see, for our business, we need to make continuous investment in new medical centers. So starting from a couple of years ago, we look into how we're able to monetize the customer we have already, not just provide one service a year. And that's why we start looking to new areas such as dental services, because we tried to convert those body screening, check out the customer into additional service offering.

Also, we start look into outpatient services because, based on what we have screened, we know exactly what [condition people have] and we can make an additional service on that. So the Company has been really focusing on how we're able to monetize and transform the customer into additional service offerings. So I think that's what we have been focusing on for past few years.

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Peter Ashworth, Panmure Gordon & Co. Limited - Analyst [28]

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Thank you. And I may have missed this as I came on a little late, but is there any insight or outlook for investors regarding the Yunfeng proposal? What can we expect, and is there any guidance that you can provide us on that? Thank you.

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [29]

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Well, the special committee is solely responsible for the privatization initiative, as well as you referred to Yunfeng Capital offer. So it is really entirely up to the special committee to take the time needed to try to ensure the proposal put forward in the best interest of shareholders. So I'm sure they will supply additional information when it is available.

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Peter Ashworth, Panmure Gordon & Co. Limited - Analyst [30]

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Okay. Thank you, Chairman Li.

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Operator [31]

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[Cyril Pritchard, Altimo].

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Cyril Pritchard, Altimo - Analyst [32]

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Actually, my question is the same as the previous one, it's regarding privatization. So we are shareholders since a long time and as you said, you are incurring charges related to going private offer from Yunfeng Capital, which is not normal is that the special committee to take a decision because the spot doesn't trade on fundamentals, which is a shame. You mean [average stock] price [should] trade on fundamentals based on the financial results of the Company and prospects. So actually, [you don't need] to answer it to me because you already answered to this question previously, but it was just a comment. Thank you.

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [33]

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I'm sure that the special committee will update the markets when any of the additional information is available. And our thanks for the patients, for the shareholders, have been supporting us for past few years.

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Cyril Pritchard, Altimo - Analyst [34]

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Thanks.

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Operator [35]

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I would now like to turn the call back to your host for any additional or closing remarks.

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Ligang Zhang, iKang Healthcare Group Inc. - Chairman & CEO [36]

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Thank you very much for joining this conference call. We wish you a good day and a good evening.

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Operator [37]

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That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.