Feb 26, 2015
Executives
Kathy Bian - VP Corporate Finance Tina Zheng - CEO Albert Chen - CFO
Analysts
Brian Tanquilut - Jefferies Scott Henry - ROTH Capital Alberto Bassetto - Jayhawk Capital Darren Wang - River Valley Asset Management
Operator
Welcome everyone to China Cord Blood Corporation's Earnings Conference Call for the Third Quarter and First Nine-Month of Fiscal 2015. All participants’ lines will be placed on mute during the presentation, after which there will be a question-and-answer session.
Now I would like to introduce Ms. Kathy Bian, VP of Corporate Finance to begin the presentation.
Please go ahead.
Kathy Bian
Thank you, Steve. Good morning, everyone.
Welcome to our third quarter fiscal 2015 earnings conference call. A press release discussing our financial results has already been published and the copy is available on our company’s website.
During the call, our management team will summarize corporate developments and financial highlights for the quarter. A question-and-answer session will follow.
Before we begin please note that today's discussion will contain forward-looking statements that are subject to certain risks and uncertainties and actual results could be materially different from those forward-looking statements. Kindly refer to our SEC filings for detailed discussions of potential risks.
In the interest of time, I will begin with our CEO's remarks followed by detail report of our third quarter financial performance by our CFO, Mr. Albert Chen, and our management will be available to answer questions during the Q&A session.
Today on behalf of our CEO, Tina, read the prepared remarks let’s begin our presentation.
Tina Zheng
Good morning, ladies and gentlemen. Welcome to our third quarter fiscal 2015 earnings conference call.
We recorded solid performance in the third quarter fiscal 2015 with more than 17,600 new subscribers recruited, representing a year-on-year increase of 8% and a quarter-on-quarter increase of 13%. As of the end of December 2014, the company’s accumulated subscriber base exceeded 425,000.
The ramp up of the new subscriber number show achievement of the recording marketing measures taking the second quarter. Aside from strengthening the existing marketing channel management also implored new media to broaden our reach for the purpose of improving brand awareness and market coverage.
While adjusting our marketing tactic we are committed to our core value proportions focusing on the need of those health conscious individuals by delivering premium quality precautionary healthcare service. In term, Guangdong market was few carried significant weight as we deepen our local market penetration.
At the same time we will also prudently ramp up our commercialization effort in the Zhejiang market. Although the macro-economic conditions remain uncertain to a certain extent we are confident that we can overcome such challenges by being flexible in developing and deploying our marketing resources and adjusting our marketing strategy and platform in a timely manner.
All in all we remain cautiously optimistic to what's the outlook for the remaining fiscal year. As many of you may noticed we have recently enter into memorandum of understanding with Cord Blood registry a company which provides stem cells storage services in U.S both CCBC and CBR are strongly committed towards aiding patients and clients in respect to its jurisdictions.
And this collaboration efforts will enable us to further support our client and clinical research communities both domestically and aboard. We're excited about this development and we strongly believe our client and patient in China will benefit from this joint effort over the long run.
This concludes my remarks for third quarter fiscal result and recent development. I want to thank you for your ongoing support for CCBC at this point I will turn the call over to our CFO Mr.
Albert Chen to review our third quarter financial performance in greater detail.
Albert Chen
Good morning, everyone. Thank you for joining our call today.
As piloted in our CEO remarks in this quarter we have achieved more than 10% year over year increase in dollar revenues. Revenue for the third quarter amounted to approximately RMB167 million factored by healthy increase in new subscriber sign ups.
We have managed to add 17,622 new subscribers in the third quarter of fiscal 2015 which represented an 8% annual growth and 13% sequential improvement from the previous quarter. This results prove that the effectiveness of our measures taken to solidify our existing market and further explore and penetrating to new geographical and segmented markets.
Revenue from storage fees continue to rise noticeably as our accumulated subscriber base expanded to North of 425,000 by the end of December 2014. In the current quarter revenue from storage fees increased significantly by more than 20% to RMB52 million accounting for approximately 31% of our total revenue as compared to about 29% in the prior year period.
Driven by the growth in new subscriber sign up our revenue from processing fees increased to approximately RMB115 million. In terms of revenue mix revenues from processing fees now accounted for approximately 69% of our total revenue.
Gross profit for the quarter remained healthy and amounted to approximately RMB131 million reflecting almost 6% increase from the prior year period. We look to increase in depreciation expense as a result of the completion of our new facilities and higher raw material cost gross margin stood at approximately 78% in this quarter.
In the third quarter our sales and marketing expense edged up which is pretty much in line with our top line growth. Sales and marketing expenses amounted to approximately RMB30 million as compared to RMB28 million in the prior year period.
To support ongoing business growth we devoted additional marketing resources and effort to deepen our penetration in operating regions. We also monitored the efficiency and effectiveness of sales and marketing activities and implemented cost control measures whenever necessary.
As such sales and marketing expenses remain in check residing in the 19% range as a percentage of revenue. G&A expenses rose to approximately RMB30 million from RMB27 million in the prior year period.
The increase was mainly attributable to a higher depreciation expense and the first time recognition of share based compensation expense related to the restricted share units granted in December of 2014. As a percent of revenue G&A expenses remain at the 18% range which was consistent with the prior year period.
Despite a higher depreciation expense and share based compensation expense operating income for the third quarter increased modestly by approximately 3% year-over-year to RMB68 million compared to RMB66 million in the prior year period. Now depreciation and amortization expense for the third quarter amounted to RMB13 million last year was RMB10 million.
Share based compensation for the third quarter was approximately RMB2 million, but no such expense was incurred in the prior year period. All in, operating income before depreciation and amortization and share based compensation expenses showed a healthy 10% year-over-year increase to RMB83 million.
Operating margin and EBITDA margin before share based compensation expense was approximately 41% and 50% respectively. Now, in terms of non-operating items interest expense increased to RMB26 million in the third quarter as compared to RMB22 million in the prior year period.
The increase was due to the absence of interest capitalization associated with the construction of our new facilities in Guangdong and Zhejiang which are now completed. Approximately RMB4 million interest expense was capitalized in the prior year period.
We expect interest expense, which are largely tied to our outstanding convertible notes to remain at the current level going forward. As more of this operating income growth offsets by higher interest expense third quarter profit before tax decreased slightly by 4% year-over-year to RMB47 million.
Net income attributable to the company’s shareholders also decreased slightly to RMB33 million in the third quarter of fiscal 2015. Basic and diluted earnings per share for the third quarter were RMB0.41.
With our continuous execution of sales strategy that focuses on high end customers who favor the upfront payment option, the company’s cash generation continues to be robust. Net operating cash flow amounted to approximately RMB153 million for the third quarter of fiscal 2015 after taking into account the interest payment or the coupon payment made to the company convertible note holder.
This summarize my presentation and we are happy to take any questions concerning the third quarter results or with regard to the company latest development.
Kathy Bian
Operator, please start the Q&A session.
Operator
Thank you, Ms. Bian.
The question-and-answer session will be conducted electronically (Operator Instructions). And the first question comes from the line of Brian Tanquilut from Jefferies.
The line is open. Please go ahead.
Brian Tanquilut
First question for you, so I know you’ve expressed your confidence in achieving your targets for the fiscal year. But as we think about the calendar year for 2015 and with the Chinese New Year now behind us, just wanted to ask what your outlook is for calendar 2015?
Albert Chen
Brian, thanks for the question, and I believe what those of you who actually follow our company’s earnings and our earnings conference call I remember mentioning the fact that as we move away from the year of the horse and into the year of the goat or year of the sheep, depends on how you look at it, we are actually -- this is one of those seasonal cycle which kind of happen once every 12 years and transitionally speaking in the year of a goat or year of the sheep the number of babies born in China as a whole tend to shrink of contract a little bit. So past experience suggest the market side or in terms of number of babies born in China may be somewhat less anywhere between like 10% or 15% decline year-over-year.
So this is we are actually expecting I would say a shrink in the market size by moving into the year the goat with that being said this is one of the traditional things which happen once every 12 years so some people look at it as a seasonal cycle, some -- but whether we like or not it’s just things this is how things work in China. So the way that we try to counteract the contraction in the market that is to ramp up our penetration in Zhejiang as highlighted in my remarks we now completed our construction and we’ve moved into the new facilities which in the Zhejiang -- for the Zhejiang province.
So with that in mind we believe that the ramp up in Zhejiang to a certain extent may help to counter offset some of the impact brought forth by the strength in the market size. Generally speaking, we want to alert the investment community about this seasonal factor, but at the same time we do not believe this to because it's dropping.
Brian Tanquilut
Albert and then obviously you have a lot of cash in the balance sheet you’ve generated a lot of cash as well, so I just wanted to hear what or how you guys are thinking about capital deployment, what to do with that cash? And also if you don’t mind to share with us your ability to pull cash out of China if you have acquisition opportunity oversees or if you wanted to pay a dividend to your investors?
Albert Chen
The deployment of capital has been a constant topic that we discuss internally as mentioned previously, the capital on hand will be either deployed for the expansion or “potential M&A opportunities” if they are available or then if there is no opportunities available then we will consider all kind of options including for example share repurchase of dividend just to find the best way to deploy our capital in a most efficient manner. Now in terms of how to pull capital out from China as we have been surfacing our coupon payments to our convertible notes holders, we will normally dividend up earnings from our onshore subsidiaries to our holding company and every time we do that, this normally incurs about 10% withholding tax because we are viewed as a wholly owned foreign entity.
But we dividend up earnings from onshore subsidiaries normally we have to pay that 10% withholding tax. And we have been doing that in the past two years just to pay the coupons with respect to our convertible notes.
So it's not possible to pull capital out, you just have to pay the tax which is [light].
Brian Tanquilut
And then in your prepared remarks or in Tina’s prepared remarks, there was a comment about the uncertainty in the economy, the macro condition. If you don’t mind just sharing with us your views on how that impacting your business and how you guys are preparing or adjusting to that macro influence on your business today?
Albert Chen
I think there are certain -- while the slowdown in the Chinese economy is no doubt and as everybody have seen it by all these financial figures reported by the authorities and from our perspective the impact currently is not material, but we do from -- see that from our frontline, these sales team do seem to indicate that people are having second thoughts before they actually sign up for the [surveys] or before -- or even before they incur a significant expenditure items. So, right now if I am to comment about the uncertainty I would say, this is like something that’s kind of -- you kind of anticipate but you haven’t felt the impact yet.
This is like -- how should I put it, this is like standing in the middle of Union Square where you stand and look at the clear sky but at the far end of the sky you see a dark cloud looming so that’s kind of exactly how I am feeling right now. If the consumption behavior slows down significantly, I have no doubt that we will also be affected, but I think there is something to keep at the back of our mind when it comes to pricing and also when it comes to marketing.
So to counteract on the somewhat the uncertainty we do enter into active discussions with various consultant and try to look for new media plus on to recruit additional clients. I talk about this in the previous quarter, where we try to work with others I’ll say ex-provider and solution providers and try to expand our marketing reach.
So this is something that we try to adopt and try to counteract potential -- I’ll say potential decline in consumer -- in subscriber signed up as a result of the economic uncertainty. But I just want to reiterate the fact that even though we see uncertainty in the market, we haven’t felt the impact yet.
But this is something that we have to keep at the back of our mind that something is definitely looming.
Brian Tanquilut
And Albert to that point, I mean structurally are there -- is there anything about your business whether it's insurance, the health insurance that you provide or just the idea of Cord Blood banking that you think kind of shields you from the macro?
Albert Chen
I think the good thing about our business is that because is a consumption choice where you only have once in a lifetime to make. So a lot of people may be able to get through their heads and make this time for serious -- concerning this like one time event for them and this is a -- you only give child birth once, so this I think just help a lot of people who get through that economic uncertainties or hesitation, but at the same time I think the bundling of our service with the medical insurance, it certainly helps for the not so economically well off individuals because it now become very strong and forceful marketing pitch in a situation where for example, I mean not only signing up for services but also you can actually get a loan off your medical trial -- medical expense claim or reimburse by the insurance company.
So people they are less economically better off, this bundling our services to become a very strong marketing pitch so more so than ever we think that this bundling makes sense in the situation like this.
Brian Tanquilut
Last question from on the regulatory front you remind just giving us some insights on what you're seeing with the relaxation of the one child policy and also giving us an update on the licensing rules for the different market for year end?
Albert Chen
With respect to relaxation of single child policy -- let me give you some facts. In the past second child probably account for 1% or 2% of value subscriber based.
Nowadays it account for 4% to 5% of our new subscriber mix. So from a proportion perspective, got more.
However, there is no clear indication that at the result of the relaxation of single child policy we're going have more new subscribers. I think still it’s a little bit too early to tell, but we are definitely monitoring the situations and in terms of the licensing policy the existing licensing policy will likely expire at the end of 2015.
Right now we have no indication how the new policy is going look like. We will definitely keep the market alert if there any material developments.
But if history holds any truth then maybe there is a possibility where the new policy will become a probably after 2015. So last time when they extended the policy they did it in beginning of 2011, when the old policy expired at the end of 2010.
So well the policy expiring now as about the end of 2015, it is possible that something come out probably in the first quarter of next year.
Brian Tanquilut
Just a quick follow up. So your comment on the one child policy am I right in thinking that, you are thinking that it's a positive for you that this is been relaxed.
Albert Chen
I think over the long run there is definitely a positive element. But I think for that thing in the near term I just don’t have the evidence to conclude that the relaxation of single child policy will have the material benefit of it to China Cord.
Operator
The next question comes from Scott Henry from ROTH Capital. Your line is open.
Please go ahead.
Scott Henry
Albert just a couple questions on the income statement, first of all the share based comp expense. How should we think about that as an incremental cost going forward?
What would be the annual burden of that cost?
Albert Chen
In terms of the share based compensation expenses, that’s expense incurred in mid-December. So for the third quarter results there is only about two and two and half week of share based compensation expense incurred during that period.
But going forward this non-cash expense will probably be around roughly 800,000 U.S per month.
Scott Henry
And the shares outstanding what number should we think about when we lookout to '16. What's a good shares outstanding number on the bottom line?
Albert Chen
From a slightly different interpretation in terms of outstanding share accounts from accounting standpoint versus from a legal standpoint. So from accounting standpoint you notice that in our disclosure we feel still calculate our earnings per share based on 73 million shares which is the shares issued outstanding from accounting perspective.
However we did issue 7.08 million shares in mid-December issued to the trust. So from the legal standpoint the total number of shares outstanding should be 73 million plus 7.08 million shares.
So that brings you about 80 million shares. But if you are calculating on the fully diluted basis then you should add additional 40 million shares on to the on to the base.
So that is a total of 120 million shares.
Scott Henry
So I should expect G&A U.S $800,000 a month would be close to 9 million to 10 million in additional G&A. Is that the correct math that seems high?
Albert Chen
800,000 month because the amortizations of share based compensation is calculated based on straight line. So roughly it’s about just 800,000 a month and multiplied by 12 and I’m quoting accounts by the way.
Scott Henry
In Q3 it looks like cost of goods sold went up a little bit and selling and marketing expense went down a little bit. Anything going on there to cause those somewhat notable deviations between the first two quarters.
Albert Chen
A good question, the reason that the raw material expenses or the direct cost goes up is because as I highlighted in my remarks, this is partly because of higher depreciation expense as a result of the new facilities and also an increase in raw material cost. Now, part of the increase in raw material cost related to our preparation for the AABB accreditation for our Guangdong and Zhejiang facilities, but one way or the other the higher raw material costs is likely here to stay, but I think the good thing is that the current gross margin level should serve as a good reference point going forward.
And in terms of the certain marketing expenses partly because of the expansion in new subscriber sign up in the third quarter so from a percentage spend point comes out a little bit, but just -- don’t get me wrong, we are not easing off our marketing efforts. So the marketing efforts continued and I think looking into for example the remaining of the year and even for next year we will probably do the same, even more marketing.
Operator
(Operator Instructions) We will now move on to the next question from the line of Alberto Bassetto from Jayhawk Capital. Your line is open.
Please go ahead.
Alberto Bassetto
One question first could you explain why you carry around the US$10 million in bank loan and the balance sheet, where on the other side you have US$340 million in cash?
Albert Chen
I guess you are referring to our onshore borrowing and the reason that we have that onshore borrowing -- first of all that onshore borrowing has a due date of it -- is the annually matured bank borrowing so normally we have to repay every year and draw it down. We certainly have the flexibility and the financial strength to pay off the onshore borrowing and no borrowing it again.
However, I just need to remind you that because we are not a Private Enterprise and borrowing from private enterprise in China it’s not something that can be easily done. So do think of this onshore bank loan as a reporting line of credit.
So it helped us to maintain our relationship with the bank if we doesn’t like it we can just pay it off. But I just need to alert you that if we pay it off and next time we’ll try to start the new loan or new lending facilities or borrowing facilities in China, will be somewhat challenging.
Alberto Bassetto
Understood, that makes sense and of the 17,600 babies that you guys sign up in the December quarter can you break it down by regions of Beijing, Guangdong and Zhejiang if you don’t mind?
Albert Chen
New subscriber sign up from Beijing account for about 34%, of the total new subscribers sign up during the quarter, subscriber -- new subscribers from Guangdong-Zhejiang account for about 53% and 12%.
Alberto Bassetto
So maybe Zhejiang implies that 2,300 -- here is a question for you that goes back to what you were talking before in terms of expansion, so 2,300 for the quarter am I right if I think along these lines despite the rear of the shift, et cetera Zhejiang start from a very small scale, is expanding its penetration, so am I right if I think that on a quarter-over-quarter base going forward Zhejiang can only expand so the 2,300 become 2,700; 3,000 and go along that line?
Albert Chen
Well, obviously with the completion of the new Zhejiang facilities we have basically removed all the previous processing capacity following that issue. So it’s fair to say that the hardware are now good to go, so we also have moved in and actually used the new facilities now.
So the hardware is ready, but the software was still take time because we still take time for the local hospitals to warm up to our way of conducting businesses and also to really starting to grow out our marketing effort and signing on more hospitals. So we’ll probably so it gradually and by phases, but it is fair to assume that with Zhejiang coming in at such a low base the growth in Zhejiang operating would definitely be very high, growing at relative fast pace.
So we do hope that with the ramp up in Zhejiang which will help to counter offset some of the contraction that we anticipate that because of the year of the goat.
Alberto Bassetto
And Albert just to elaborate I think that concept on Guangdong because you referred to Zhejiang as the engine to counter the seasonality of the market, but Guangdong also if I remember correctly is still far below in terms of the penetration that you guys believe you can achieve. So Guangdong is in still a very expansion mode, isn’t it?
Albert Chen
Obviously Guangdong is still growing but because Guangdong has may in operating for almost seven, eight years now, so the growth rate that Guangdong recorded is obviously not as fast as they used to be and also I want to alert the market the fact that the contraction in terms of number of babies born on China is happening and across the board. So while some geographical regions may contract more than the other, but as I mentioned earlier on in one of the questions being raised by the investment community, we are looking at a market size decrease anywhere between 10%, 15%.
Still little bit too early to tell, but I think the contraction is definitely happening as we speak.
Alberto Bassetto
And my last question is in the prior quarter overlooking the number of the customers paying the entire contract up from was around 52%, can you reconfirm the breakdown in terms of payment for this quarter and basically still more to 50% of the people pay upfront? And that is my last question.
Albert Chen
New subscriber who chose to pay upfront is about 52%, new subscriber who chose to pay by normal payment method which is the processing fee and then annual historic fee year by year is about 36% and the remaining is of installment payment.
Operator
Your next question comes from the line of [indiscernible]. Your line is open.
Please go ahead.
Unidentified Analyst
A few questions, the question I have first one is on the restricted share units, so I read in the disclosure that you guys gave out 7.08 million in RSUs, right. So just quick question regarding that is that supposed to last for some time, so basically they are up of investment or is it about to be invest over a number of years or how does that -- can you give me more information about the RSUs scheme?
Albert Chen
Well first of all, the number of RSUs that we have issued is actually a total of 7.3 million RSUs. So one RSU give the right to basically subscribe or own a share, but we have basically issued only 7.08 million shares on to a trust and employees, and executive, and directors are beneficiary to the trust.
To answer your question is that no, those shares have not been invested. There will be investing conditions imposed on each executive employee.
So based on their functions, their investing conditions are different, the investing conditions has basically a benchmark, you're looking at fulfilling three years of performance target before you get to shares.
Unidentified Analyst
So basically is expected to invest, so basically you said 7.3 million RSUs have been issued, 7.08 are now in a plot, so the remainder has been invested, right?
Albert Chen
The remaining 220,000 RSU has yet to be invested. So basically all 7.3 million shares -- all 7.3 million RSU are not invested at this point.
Unidentified Analyst
And you guys saying the investing period is expected, so at end of three years from now, I understand what you said just now is that they’re all supposed to have been invested by the end of three years?
Albert Chen
By the end of three years assuming on investing targets and investing condition are filled then the trust can’t release the shares.
Unidentified Analyst
I see so in three years. And do we know -- I look through your proxy statements, I don’t think I saw the incentive targets for -- so what kind of target, I understand this is a kind of special scheme for further key employees; it's not for the entire workforce right?
So was it disclosed anywhere what are the type of the incentives that are needed to for this RSU to invest?
Albert Chen
RSU, the investing conditions for different employees are very different, for example we have different targets for this other marketing force, as well as for example in my case Department of Finance and also the team that runs the laboratory, so everybody [indiscernible] is slightly different, for example the sales and marketing guys they have new subscriber target that they need to fulfill, on my side I have cost target which I need to fulfill. So everybody target is different.
Unidentified Analyst
So just last one question about this expense line because it's new on the income statement, so is expense at for this Q3 US$400,000 and then just now you also made a comment that says that you can roughly expect that to be running at a US$100,000 a month?
Albert Chen
US$800,000 a month roughly, because the reason is because the RSU were issued in the middle of December, so when we recorded the share based compensation expense there is only about two weeks of fairly more than two weeks were the expense ratio actually incurred during the third quarter.
Unidentified Analyst
So my question is little bit more maybe too detailed, like how do we come up to 800,000, I mean roughly how -- what divided by what gives you $800,000 a month?
Albert Chen
First, you just take 7.3 million RSU, multiply it by 4.15 which was the share price at the day of the issuance and then divided by approximately 39 months.
Unidentified Analyst
Okay I see, that’s great. So in three years this will last for about three years and -- okay that’s good.
The other question I have for you is that the operating cash flow I mean it's a great quarter and a lot of things year on year, quarter on quarter grew. But operating cash flow seems to have decreased about 10% compared to the prior period -- compared to Q3 2014.
Operating cash flow seems to have come down maybe 10% even though revenues, everything went up, sometimes a low double digit figures, so why is that?
Albert Chen
Actually it’s just the timing as to when we made the coupon payment. If I'm not mistaken I think in the prior year period the coupon payment from on the date where is a topic -- where is the banking holiday.
So we have no choice but actually make the payment one day earlier. And it just happens that's coupon payment to be recorded in the second quarter instead of third quarter of fiscal 2014, but in 2015 the banking holiday doesn’t really affected our payment state.
So we actually make a payment in accordance on the third quarter. Supposing the coupon payment supposed to be made on third quarter.
Unidentified Analyst
The coupon payment was about to be missed, so last year we benefited in just a Q3 period we benefited because it was paid in Q2 is that way you think last year?
Albert Chen
That was pay on the last day of Q2 actually.
Unidentified Analyst
So last year the coupon payment was paid on Q2 which is why the Q3 cash flow was a little bit higher than normal and then this year --. So going forward on a recurring basis this coupon should be paid in Q3, so this is more like the current operating cash flow for this quarter it's more represented by the type of business that we have -- for the level of business that we have?
Albert Chen
Correct and also if you want to compare on apple to apple basis, the coupon payment that we made in October -- actually it’s beginning October are supposed to above 3.5 million U.S. So that number didn’t changed, it’s the same number last year and same number this year so you can use that compare.
Unidentified Analyst
So just a very last question and it’s about the convertible note. So basically I understand that the convertible note -- I know the company is required to guarantee a performance of 4% IR for the convertible holders’ right?
Albert Chen
Correct.
Unidentified Analyst
But interest that’s accrued is beneath the payout at 7% annually. So for the whole year we have mainly a 105 million in the principle for the convertible note and we need to pay out 7% annually interest on their principle right?
Albert Chen
Correct, actually the outstanding principle for the convertible note combined together is U.S $115 million. And you are exactly right we have to honor the 12% IR and the 12% IR actually include the 7% coupon.
So basically on top of the 7% coupon is the addition of 5%. So we accrued that amount on to our convertible note as you can see from our balance sheet.
The outstanding convertible note amount actually increased over time, that’s because of adjustment of 5% IIR.
Unidentified Analyst
So basically that’s what I'm trying to understand. So we accrue at 12% because the income statement that the big interest expense line item.
That’s the 12% on the 115 million of the principle roughly. Most of that is the 12% right, of which 7% we need to actually pay out in cash twice a year.
And the remaining 5% we put under the balance sheet?
Albert Chen
Yes.
Unidentified Analyst
So basically in 2017 can you just quickly run to the two situations if they convert -- if the holder convert and if the holder does not convert. What happens to the growing -- we have a big line item on the balance sheet as well, 130 million or something.
So what happens in the two situations to that line item?
Albert Chen
In the situation where those equity gaps converted then those become equities. So the number -- total number of share account will then increase by about 14 million and then the convertible notes which currently exist as a non-current liability item, will disappear.
If they don’t convert then we will redeem the convertible note using capital on hand. And then we will just basically buy them all.
Unidentified Analyst
So I guess my question is a little more specific that you said that we are accruing the 5%, the guaranteed performance net of the cash interest that we paid out, the 5% that we are accruing we are putting it under the balance sheet means I think it’s a good thing to do, but is it some part of the restricted cash account or is it just lumped into the cash line that we have?
Albert Chen
We are not required to actually side the capital for the payment of the convertible notes. So currently we have not side any cash to buy out the convertible note.
Unidentified Analyst
So it’s just accruing liability?
Albert Chen
Correct.
Unidentified Analyst
We are not fighting the fight with the cash, right?
Albert Chen
Certainly.
Unidentified Analyst
Thank you very much.
Operator
(Operator Instructions) And next question comes from the line of Darren Wang of River Valley Asset Management. Your line is open.
Please go ahead.
Darren Wang
Just want to check with you what caused the direct costs this quarter increase in 33% and which material cost is the main cost driver for this item?
Albert Chen
Two reasons for the increase in direct cost, on one hand it’s the increase in the depreciation expense, on the other hand it’s the increase in raw material cost. As you know currently among our three subsidiaries only the Beijing Cord Blood Bank has received its AABB Accreditations, but it is our intention to actually broaden our AABB Accreditations and have our Guangdong subsidiaries as well as our Zhejiang subsidiaries qualify for the AABB Accreditations.
So the increase in more [indiscernible] cost reflected the fact that we basically not only changing how we handle samples, but also we are also using more import materials and also changing the way we handle that samples. In the past a semi-automated process, now it becomes fully automated process.
And a lot of these consumables have to be imported from the states so which can increase the raw material cost.
Darren Wang
Which item in the P&L segment do you account for the 2.5 million share based compensation? Because from the segment I do not see where they are.
Albert Chen
That amount get allocated across direct cost marketing expenses as well as G&A, but mostly in G&A. So that’s why --.
Darren Wang
Actually but --.
Albert Chen
It’s still up between different departments based on the functions. So normally I would suggest that you look at -- you see operating income as a basis and allocate the adding back in on cash cost tied into it to calculate our EBITDA before share based compensations.
Darren Wang
But within the three departments do you have any percentage allocation for this going on?
Albert Chen
I think we have allocated a significant portion of it in the general and administrative expense.
Darren Wang
Okay, then just a follow up on the share based compensation the value. Just now you mentioned that from March we will account for USD800,000; if I am not wrong that it’s approximately RMB5 million per month.
So this increase is 15 million per quarter and am I right to say that?
Albert Chen
Yes, I guess it depends on which exchange rate you are using if you are using just the 800,000 multiply it by 6.25 multiply it by 3 then you have the quarterly number.
Darren Wang
Okay, great. Then my last question is regarding Zhejiang, because previously I think Zhejiang still pending for the approval from the authorities.
My question is has the company already gotten the approval?
Albert Chen
The hardware has been approved so we moved in and the facility is now fully functional.
Darren Wang
Okay, so is now already ready to ramp up the business?
Albert Chen
Yes we are using it now.
Operator
Your next question comes from the line of [Avril] Whitman from Whitman Capital. Your line is open.
Please go ahead.
Unidentified Analyst
My question relates to the restricted units that you issued because of the materiality as measured by size as a percentage of total shares outstanding and total potential shares, I’d like to get some more data from you as to what the requirements are to earn those? Your answer was that everybody is different but I hope you could answer it in the aggregate.
That is what are the targets for the group in the aggregate, for revenues, for expense increases, how much is tied to change if any to the stock price and what has been the history of it and what are your plans in the future to issue more of these units?
Albert Chen
The history of the plan date back to I think 2010 when we get the shares approval back then. But no shares have been issued since then.
The 7.3 million RUS accounts for about 10% of the total share base outstanding, but on the fully diluted base I think is about 5%, 6%, every share is different, for example the self-target assigned to the Beijing team as well as the Guangdong team is [Audio Gap] different.
Unidentified Analyst
I appreciate that, would it be possible to give us the aggregate numbers and to help us understand what achievements the total firm has to develop in order to earn these units and what happens if they don’t earn them. Have you accrued for events that would then be put into the income statement at the end of the third year?
Albert Chen
The expense has been -- we’re basically recognizing the expanding relation to the share based compensation or straight line basis. But if the performance target are not matched, then those shares -- the individual employees will not be getting those shares and the trust will not release those shares to the employees.
The reason why I can’t say as it’s a rather complicated calculation because if the individual cannot make in the first year, but they can make it up in the second, third year they would still be okay. And this is truly across the board where other function for example, laboratory staff they have a different calculation matrix, so everybody is rather different and there is a backup calculation just in case they can’t make it.
But in any case if the shares are not made -- the investing conditions are not fulfilled, they are not getting the shares.
Unidentified Analyst
Well, I just got back to the materiality of this issue and you're not giving us any details to be able to judge what your expectations are and you’ve just issued a very large percentage of the shares and it borders on the outer bands of what other companies issue, so we hope that you could be able to generalize instead of giving us information about each division, but to characterize the company as a whole so that we could understand what your expectations are to determine if that matches our own as investors.
Albert Chen
Fair enough and I think if I’m to aggregate generally speaking, you notice that our -- we try to maintain a continued growth anywhere between 10%, 15% which is on internal pockets. So, if I am just to aggregate the overall performance, I think this will be a good reference point -- new subscriber numbers by the way.
Unidentified Analyst
Say again? I’m sorry, please repeat.
Albert Chen
We try to maintain a target of new subscriber number growth anywhere between 10% to 15% as our CAGR target. So just to generalize this maybe a very good reference point.
Unidentified Analyst
And could you give us more information on the yield that you were able to execute with the American company, could you describe?
Albert Chen
I guess you're referring to our collaboration with Cord Blood Registry, while because both companies are still under a confidential obligation, well I guess at this point as we highlighted in our press release the collaboration remains aimed to drive forward the clinical applications of umbilical cord blood stem cell and in hope with the higher medical value and umbilical cord blood can bring forth, induce more people to store umbilical cord blood stem cell. In terms of immediate revenue impact, I am afraid that we do not anticipate material revenue contributions as a result of this collaboration, in the very near-term.
But we believe this collaboration is definitely worth brining to investors’ attention because of two things; first of all, it helps to bring together the two largest cord blood bank in the world to join forces and also -- and this help to add a lot of credentials not only within the industry, but also among the clinical research community as well. And second thing is that, this collaboration should kick start a much larger platform and you tend to recruit more cord blood bank to join us.
Unidentified Analyst
And my last question relates to gross margin, do you anticipate the actions you're taking will help restore the gross margins to what they were last year?
Albert Chen
If you're referring to our average margin level which is about 80%-81%, I don’t think the recent decline is substantial and as I pointed out in my -- in the question raised by the previous gentleman, the reason that we have the higher raw material expenses and higher direct cost is because of depreciation in raw material mainly. But I don’t envision a major deterioration in our gross margin levels and as the economy of scale kicks in I think we should to be able to gradually improve from this point on wards.
Operator
At this point they appear to be no further question. I will now turn the call back to Ms.
Kathy Bian for any additional or closing remarks.
Kathy Bian
This concludes our earnings conference call for the first quarter of fiscal 2015. Thank you for your participation and ongoing support.
Have a great day. Operator you may now disconnect.
Operator
And this concludes today's conference. Thank you for participation.
You may all disconnect.