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China Medical Technologies, Inc. (CMED)

F2Q06 Earnings Call

November 13, 2006 6:00 pm ET

Executives

Winnie Fan - Senior Manager of Finance and IR

Charles Zhu - VP of Business Development

Sam Tsang - CFO

Analysts

Bin Li - Merrill Lynch

Vickie Chen - UBS

Bo Tan - Lehman Brothers

Jim Sanku - Credit Suisse

Chang Qiu - Forun Technology Research

Luke Langford - Langford Capital Management

Matthew Buten - Sapphire Capital

Presentation

Operator

Good morning and welcome to China Medical Technologies Second Quarter Earnings Call for the fiscal year ending March 31, 2007. At this time, all participants are in a listen-only mode. After the call, we will conduct a question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the meeting over to your host for today’s conference Ms. Winnie Fan, China Medical's Senior Manger of Finance and Investor Relations.

Winnie Fan

I am pleased to welcome you to China Medical's second quarter earnings conference call. China Medical announced its September quarter results about two hours ago. If you haven't seen it, you can find a copy of the press release at our website at www.chinameditech.com.

Today, your speaker will be Charles Zhu, VP of Business Development; and Sam Tsang, CFO. After they finish their remarks, they will be available to answer your questions.

Before we continue, please bear with me as I take you through the company’s Safe Harbor policy. The discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in the company's public filings with the U.S. Securities and Exchange Commission. China Medical does not undertake any obligation to update any forward-looking statement, expect as required by applicable law.

As a reminder, this conference call is being recorded. A replay of this conference call will be available via webcast on our website.

Now, allow me to turn over the call to Charles Zhu. Charles.

Charles Zhu

Thank you, Winnie, and thank you all for joining us today. Before I start, for those of you who don’t know, I would like to formally introduce you to Winnie Fan. Winnie joined us in September of this year as our Senior Manager of Finance and Investor Relations. If any of you have any questions following this call or at any point in the future, please do not hesitate to contact her directly.

Now moving on, I will go over some recent development in our business. Following that, I will turn the call over to Sam, for a recap of our financial results. In our HIFU business, I am happy to report that we recently introduced our third generation HIFU equipment to the market, and we think it marks a major milestone in the development of business. We also think it demonstrates the progress we have made in accelerating the acceptance of HIFU technology in the treatment of cancer and it should further strengthen our competitive advantages over our competitors in China.

The upgrade mainly includes real-time temperature monitoring and respiration control in our treatment protocol software. With these new features, we increased the selling price of HIFU equipment by about 6%. As for our progress on U.S. FDA approval, we completed animal testing at the University of Washington in support of our FDA IDE application for the treatment of pancreatic cancer using our HIFU equipment. The animal testing results demonstrated that it is feasible and safe to treat pancreatic cancer with our system. And it can achieve the desired lesion formation when the appropriate protocol is followed. We expect to submit IDE documents to the FDA in early January 2007.

Last on HIFU, as some of you might have seen, we just announced a new initiative in which we have signed a 10-year agreement with the China Academy of Science, Institute of Acoustics to establish a medical research laboratory to develop new HIFU products and other acoustic medical devices.

We are excited about this partnership and we think this collaboration will lead to the development of a number of new technologies that can be commercialized into successful products. This collaboration will enhance our company's research capabilities and expedite the progress to introducing new products.

For the ECLIA business, we launched a model of semi-automatic ECLIA analyzer with higher level of automation in October 2006. We plan to sell the analyzer at similar price to the old analyzer, though the material cost is about 60% higher. We are doing this because it is our objective to maintain our sales momentum so that we can benefit from the increasing and the recurring revenue from the reagent kit sales.

The second ECLIA development is that we submitted an application to the Chinese FDA for our fully automatic analyzer, and it is currently being processed. We expect it will be approved by mid-2007. This is slightly later than we planned, because of the backlog of applications at FDA and a number of new requirements they have imposed. We plan to target large and medium size hospitals with this new system, which will effectively place us in competition with some of the large global players. We think we will be well positioned to take on this new competition, given our strong distribution network and cost advantages on both analyzer and reagent kits. Our efforts to develop a broad range of reagents are also a major part of our strategy to expand our presence in the high-end market, to penetrate those imported system installed base with different reagent offering.

The third item I would like to review is, in addition to our reagent kit line up, we are particularly pleased to announce that we have successfully developed the first HIV reagent in China using ECLIA technology. The two reagents -- the two HIV reagent kits are now in the Chinese FDA approval process. The company has been advised that its application for the HIV reagent is entitled to a fast-track approval process and expects to obtain the relevant approval in less than 12 months. We are now selling 56 types of reagent kits, and we are aiming to reach to the total about 70 reagents within the next 12 months. Some of these new reagents includes test for hepatitis related diseases, fertility and Downs Syndrome.

The last item that I would like to mention is that our new reagent kit production facility is under construction. We expect to complete the GMP facility in early 2007, and to substantially enlarge our kit production capacity to meet the growing demand.

Now, I would like to turn the call over to Sam. He will walk you through our financial results. Sam?

Sam Tsang

Thank you, Charles, and welcome everyone. Overall, we had a very strong quarter, and we are very happy with our performance. Net revenues were up 49.2% year-over-year and 44.5% sequentially to RMB131.4 million, or $16.6 million. The company's revenues are divided between our HIFU therapy system and our ECLIA system, which includes sales of ECLIA equipment and reagent kits.

Revenues from the sales of the company's HIFU therapy system increased 34.7% year-over-year and 66.3% sequentially to RMB18 million, or $10.1 million. We sold 28 HIFU units this quarter compared to 21 units in Q2 '05 and 17 units in Q1 '06. As Charles mentioned, we recently launched our third generation HIFU therapy system with new features, including real-time temperature measurement technology. We increased our selling price by about 6% from the second generation system and the positive effect will be fully reflected in our third quarter.

Revenues from the sales of our ECLIA system were up 79.1% year-over-year, and increased 20.1% sequentially, to RMB51.4 million, or $6.5 million. ECLIA revenue accounts for about 40% of the total revenues in this quarter. For ECLIA equipment, we sold 298 units this quarter compared to 228 units in Q2 '05 and 292 units in Q1 '06.

We expect the sales of equipment to stabilize in the following quarters as our accumulated sales of the equipment exceeds 2,000 units.

The new semi-automatic ECLIA equipment was just launched and is equipped with new functions. The selling price of the new equipment remains little changed from that of the existing equipment. While the cost of materials to produce the new equipment will be about 60% higher, this strategy is to maintain the sales momentum of our equipment with a view to increasing recurring reagent kit revenue.

The key driver in our ECLIA operation is the recurring revenue from the sales of reagent kits. We have seen increasingly higher reagent revenue through the -- the reagent revenue already exceeds equipment revenue. Reagent revenue represents about 60% of total ECLIA revenues in this quarter. We expect this trend to continue because of the increasing number of equipment installed and the greater number of reagent kits offer.

Gross margin increased to 71.9% this quarter, compared to 69.8% in Q2 '05 and 70.7% in Q1 '06. The increase was mainly because of the increase in HIFU selling price in September and higher revenue contribution from ECLIA reagent kits, which are selling at higher gross margin.

Operating expenses increased 15.4% to RMB24.9 million compared to Q1, '06. Sales and marketing expenses and G&A expenses remain relatively stable, while RMB expenses increased by 42.9%. Compared to the last quarter, RMB expenses were mainly impacted by our MOH project and also FDA application. We are fairly confident that our investment in R&D will lead to the continuous development and goals of our businesses.

Operating expenses as a percentage of revenue are 18.9% in this quarter, compared to 23.8% last quarter. The higher percentage in last quarter was due to the lower HIFU revenue as a result of seasonality.

Interest income increased 2.9% sequentially to RMB8 million, or $1 million. Other income of RMB1.1 million, or $0.1 million related to the government grant received by the company will support of our ECLIA product development. The income tax expenses was RMB7 million, or $0.9 million, and our income tax concession will remain in place until the end of 2007; have given us a tax of 10%.

Net income increased 67% year-over-year, and 56% sequentially, to RMB71.6 million, or $9.1 million. The main reasons for the higher growth is net income compared to revenues, were due to the higher gross margin, lower increase in overall operating expenses, other income from government grant and income tax concession discussed above.

Our cash flow from operating activities was RMB86.4 million, or $10.9 million in this quarter. And the company’s cash balance at this quarter end was RMB937.2 million, or $118.6 million. Capital expenditures in this quarter RMB12.1 million, or $1.5 million, in respect of our construction of new reagent manufacturing facilities.

Accounts receivable increased 7.2% sequentially, to RMB180.4 million, or $22.8 million. The balance is in a healthy condition, taking into account our credit terms and aging this within one year. We did not have bad debts for the past few years.

Looking forward to the full 2006 fiscal year, we had strong performance in Q1 and Q2 and we are confident in our performance in the following Q3 and Q4, which typically comprise a higher proportion of our annual revenues, due to bad quarterly sales for HIFU system in the second half as a result of seasonality.

Currently, we are maintaining our guidance, and we will assess the guidance when we report our Q3 results. The slight increase in our guidance numbers in US dollar relates to the RMB appreciation against US dollar during this quarter.

To begin the question-and-answer session of our call, I would like to look that we issued a press release earlier this afternoon, announcing $100 million convertible bond offering. Because these convertible bonds will be offered pursuant to rule 144A, we will not be able to answer any questions regarding the offering on this call. Please refer to the past release announcing the offering for more information.

This concludes our prepared remarks. Now, we will be happy to take your questions. Operator, please.

Question-and-Answer Session

Operator

Yes, sir. (Operator Instructions). Our first question comes from the line of Bin Li with Merrill Lynch. Please proceed.

Bin Li - Merrill Lynch

Hi, how are you?

Sam Tsang

Hi, good. [Thanks].

Bin Li - Merrill Lynch

Zhu, my first question is on the anti-corruption campaign, and did you see any cancellation or delay of your purchased HIFU because of the anti-corruption campaign in the quarter?

Charles Zhu

Actually, we did see several delay after orders from our distributors, who is selling our system to the hospitals. Actually we had another kind of distributor who is renting the system and share the profit with the hospitals. And this kind of distributors, their business model is more favored by hospitals right now, so overall it kind of offsets. So in general, we don't see any impact on our HIFU business. And we don't see any impact on our ECLIA business.

Bin Li - Merrill Lynch

Can you quantify the number of delays for us and how long are they delayed?

Charles Zhu

In fact the delay situation is not very serious, because most of the times the distributors will place orders with us when they already sign contract with hospitals, all in value stage of the negotiation. So the number of delay is not really a significant piece or quite small in number. And that the many time -- normally they will say they are still talking with hospitals for some details and it may take, say, two or three months. But then there are also cases that our distributors, they will convert this delay order to other kind of contract working together with the leasing company.

Bin Li - Merrill Lynch

Okay, thanks. I think next is on the gross margin, obviously you had a good gross margin improvement, about 120 basis point, and Sam you talked about the drivers behind the improvement. Now, my question is really, your comment on further margin expansion in the new few quarters. Are these drivers you think will still be in place and what's your outlook really for the rest of the year?

Sam Tsang

I discussed the price increase in our -- the price increase in HIFU system is one [matters] to the increase in gross margin in this quarter, and the price increase is, it was made in September. So, in the upcoming quarter, i.e. December quarter, the impact will be fully factored. But at the same time we thought about a launch of the new semi-automatic ECLIA equipment and we do not increase the price, the same price for this equipment, but cost of materials is about 60% higher. So, we believe the positive impacts from the HIFU price increase will be sufficient to offset the impact for the increasing material cost for in this better -- of the new semi-automatic equipment.

Bin Li - Merrill Lynch

Okay, thanks. And my last question is on your guidance, and I guess your guidance on the US dollar has increased. But really it's a function of, as you said, it is a function for RMB is getting stronger against the US dollar since you haven't changed your guidance on the -- on RMB. And so my question is really, given that your well above consensus for the quarter, are you just being conservative for the whole year guidance or are we missing something for the second half of the year?

Sam Tsang

I mentioned we will -- we assess the guidance when we report our Q3 numbers, because typically the second half revenue is higher than the first half revenue. So, we want to be more conservative and -- when revising the guidance number.

Bin Li - Merrill Lynch

Okay, thanks.

Charles Zhu

Thank you.

Operator

Our next question comes from the line of Vickie Chen with UBS. Please proceed.

Vickie Chen - UBS

Hi, Charles and Sam, congratulation for an exceptionally good quarter. And my questions are fairly simple actually. I just want to know, how many HIFU units are sold for this quarter and how many ECLIA units are sold, if you have the number for that?

Sam Tsang

Hi, Vickie. The HIFU units we sold in this quarter is 28 units, and ECLIA equipment is 298 units.

Vickie Chen - UBS

Okay. And my next question is really related to the HIFU IDE. Now, has that IDE been filed and sent to FDA at the moment?

Charles Zhu

Not yet. We are still preparing for the IDE documentation, and also considering the factor of how they are seasonally coming up, we have decided to wait until early January to submit the IDE.

Vickie Chen - UBS

Okay. And the last question I have -- well, second last question, is about accounts receivable. Now, the accounts receivable this quarter is coming -- well, looks like still quite high if you look at the half year revenue. Going forward, it seems you are selling actually a lot of more kits right now. Will that be going down, I mean, in terms of percentage of revenue?

Sam Tsang

As we discussed, the reagent revenue is increasing.

Vickie Chen - UBS

Right

Sam Tsang

And so, the credit terms for the reagent kits is about 90 days. And so, considering our '04 four to five month turnover days, actually this is quite normal considering our credit terms. But, due to the change in this revenue mix, there is more revenue coming from recurring reagent kits. We expect turnover days -- accounts receivable turnover days will go down in upcoming quarters and years.

Vickie Chen - UBS

Okay. And the last question, I understand that you are not going to talk about the convertible bonds thing. But I just want to ask, I don’t know whether this is appropriate. Why -- I mean, you have a lot of cash right now, right, why at this moment you want to issue convertible bonds?

Sam Tsang

I think the details about the convertible bond, including the use of 100 million, is mentioned in the press release. So, you can refer to the press release, because this transaction is 144A transaction and we are restricted to comment about that.

Vickie Chen - UBS

Okay, understand. Well, thank you very much. I have no further questions.

Charles Zhu

Thank you.

Sam Tsang

Thank you.

Operator

Our next question comes from the line of [Bo Tan] with Lehman Brothers. Please proceed.

Bo Tan - Lehman Brothers

Hi. Just one quick question. What number of HIFU units sold last quarter was based on the profit sharing distribution method? And also, going to the next quarter, roughly what percentage of the HIFU units sold will be based on that distribution method? Thank you.

Sam Tsang

For this quarter, a high proportion of HIFU sales coming from publisher and distributors is over 70% coming from publisher and distributors. And we expect this group of distributors will be contributing a significant portion of our revenue. And we already see there is increasing orders from selling distributors again, and typically the December quarter is our best quarters for HIFU sales. And so, it's hard to determine the proportion of selling distributors and publisher and distributors at this moment.

Operator

Our next question comes from the line [Jim Sanku] with Credit Suisse. Please proceed.

Jim Sanku - Credit Suisse

Hi, Sam.

Sam Tsang

Hi.

Charles Zhu

Hello

Jim Sanku - Credit Suisse

Hi. Actually, most of my questions have been answered already, but I'd like to look at the timeline of your -- I understand that you cannot comment on the CB right now, but could you give us an indication as in, when will be the earliest date for you to elaborate more on this?

Sam Tsang

We will have press release and so you can be refer to the press release for more information.

Jim Sanku - Credit Suisse

Okay, all right. And what would be the next -- I understand that this question has been asked earlier, but in terms of any possible revision to the yearly guidance, what will be the earliest date for you guys to, kind of, have a reconfirm or revise the full year guidance?

Sam Tsang

I think, the time when we report the Q3 numbers, we will have a good basis to our assess or to make revision to our annual guidance.

Jim Sanku - Credit Suisse

All right, thanks.

Sam Tsang

Thanks.

Operator

Our next question comes from the line of Chang Qiu with Forun Technology Research. Please proceed.

Chang Qiu - Forun Technology Research

Yes, good morning, Sam and Charles. And also congratulations to this very good quarter.

Charles Zhu

Thank you.

Sam Tsang

Thank you.

Chang Qiu - Forun Technology Research

Yes. I have few questions, just actually clarifications. For the semi-automatic system, you said the cost is 6% higher or 60% higher?

Sam Tsang

60.

Chang Qiu - Forun Technology Research

60?

Sam Tsang

Yes. Material cost 60% higher than the old semi-automatic equipment.

Chang Qiu - Forun Technology Research

And what about the old system?

Charles Zhu

In direct cost, will not have much change, so it's basically the material cost -- direct material cost.

Chang Qiu - Forun Technology Research

Okay. And also a clarification with the earlier questions, because you've said the HIFU system increased the price in September, and then the semi-automatic increased the cost also in this current quarter, and also you think the growth across the margin will be stable for this current quarter?

Sam Tsang

I referred to the HIFU price increase, which will be fully reflected, i.e. the 6% price increase, will be fully reflected in December quarter. And at the same time because of this new semi equipment, the cost is higher, but we [will] increase to certain parts because we want to keep the sales momentum of our equipment with an aim to increasing the growing recurring revenue from reagent kits. And so, the negative impact on the cost increase in selling our new semi ECLIA equipment, we believe will be offset from the positive impact of the HIFU price increase.

Chang Qiu - Forun Technology Research

Okay. And also, what's the number or how many are reagent you sold? How many kinds of reagent you sold in the last quarter?

Sam Tsang

We are currently offering 56 types of reagent kits to our customers. And as mentioned previously, in this quarter, reagent revenue is above 60% of the total reagent -- of the total ECLIA revenue in this quarter.

Chang Qiu - Forun Technology Research

Okay. So, which means the total number is the same as last quarter, but each of this reagent you sold much more than last quarter, basically?

Sam Tsang

Yes, you see, we sold about 300 units of equipment this quarter and also last quarter. And this new installed equipment will generate revenues, reagent revenues for us. And, of course, the increasing use of the existing installed equipment will also contribute to the reagent sales increase.

Chang Qiu - Forun Technology Research

Okay. And also for the two HIV reagents, you -- basically the timeline is more like one year from now we should anticipate real revenues, is that about right?

Charles Zhu

Yes. That's right.

Chang Qiu - Forun Technology Research

Okay. All right. Okay. Thanks.

Sam Tsang

Thank you.

Charles Zhu

Thank you.

Operator

Our next question comes from the line of [Luke Langford] with [Langford Capital Management]. Please proceed.

Luke Langford - Langford Capital Management

Hi, guys. Charles and Sam, how are you doing? Congratulation on a great quarter first of all.

Charles Zhu

Thank you.

Luke Langford - Langford Capital Management

A couple of questions. I realize you guys probably can breakout the specifics, but would you say that the gross margin on the HIFU is any higher or lower on the profit sharing customer -- distributors or can you comment on that?

Sam Tsang

We do not -- we do not think there is a -- actually there is no significant difference in gross margin between the HIFU selling distributors and HIFU profit sharing distributors, plus we [do not] charge different price based on how they -- based on whether they resell the unit or whether they upgrade the profit sharing program with hospitals.

Luke Langford - Langford Capital Management

Okay, excellent. So, the second question. On the FDA, is there any plans -- if we look forward, a year or two going forward, is there any plans to maybe go after other areas beside the pancreatic, or is there any plans you guys have in-house to move forward on the HIFU side in the US market?

Charles Zhu

Yes. Probably our next indication for FDA will be [used in] thyroid.

Luke Langford - Langford Capital Management

Thyroid, okay. Third question, and I know this may put you on a spot, so I don’t mean do that. But could you quantify for the rest of Wall Streett the -- what you see as the ECLIA opportunity for the HIV kit, as well as units? When you guys look forward, the size of the market there for HIV testing and China, could you sort of quantify how you see the market evolving?

Charles Zhu

Right now it is quite difficult to quantify this, because a lot of the -- it is related to the government policies, and also related to the -- how far we can replace the older technologies for the HIV screening and diagnosis. And right now most of the HIV diagnosis or screening is done by the CDC Laborites with the Elisa Technologies and Western Blot, and we think our technology has the advantages in terms of the cost and also a bit of speed. We can -- we believe we can use this new HIV technology for the diagnosis of HIV in one step instead of performing four ELISA tests, which is the common practice in China. So, we need to promote this new method to the CDC and the related government, and to -- and so the future market size will be also related to the authority.

Luke Langford - Langford Capital Management

Okay, excellent, and last question. Would you say that any of your HIFU sales are really strong here in a second quarter at 28? Would you say any of that was your hospital customers, your in customers acting -- I know that, we have followed you guys for quite a while. I mean, we know that third and fourth quarter is typically your strongest. So, we are wondering is this -- people acting early over there or is this just representative of the strength of your product and your cost advantage and the market opportunity?

Sam Tsang

The 28 units we believe the -- we follow that is low penetration of the HIFU equipment in the Chinese hospital market and also the efforts of our distributors.

Luke Langford - Langford Capital Management

Okay. So as long-term investors, we really appreciate the effort and thanks again for a fabulous quarter.

Sam Tsang

Thank you.

Operator

Our next question comes from the line of Matthew Buten with Sapphire Capital. Please proceed.

Matthew Buten - Sapphire Capital

Hi, and also congratulations on a great result. I wanted to ask you about the third generation HIFU and what the distinct advantages are? And as you look forward the next couple of quarters, what mix do you think will be of third generation?

Charles Zhu

The key differentiation from the previous version is the real-time temperature measurement capability. We think this is the key milestone, not only for us; it's a key milestone for HIFU technology is using ultrasound as the imaging system. This is the first time in the world that we can use ultrasound to detect the temperature of the tissue at real time using non-invasive technologies. So, this gives a lot of -- more guidance information for the physicians performing the procedures. So, I think this will be very important competitive advantage for us over our existing competitors.

Luke Langford - Langford Capital Management

And so, what mix do you envision will be third generation?

Sam Tsang

We do not sell second generation any more.

Luke Langford - Langford Capital Management

Okay. And as it relates to ECLIA, how do you see the mix of the semi-automatic product?

Sam Tsang

Mix between the equipment and reagents?

Luke Langford - Langford Capital Management

No. No, mix between semi and non-automated over the next couple of quarters?

Sam Tsang

Non-automated --

Charles Zhu

Actually, we need to clarify this. Our first ECLIA system is also a kind of semi-automatic system. And right now we are introducing the new semi-automatic system to replace the older semi-automatic system.

Luke Langford - Langford Capital Management

So, it's also 100%.

Charles Zhu

Right.

Luke Langford - Langford Capital Management

And you mentioned the 60% higher cost to manufacture, did you mention -- is there a higher reagent utilization with the next generation ECLIA for same reagent utilization?

Charles Zhu

The reagent utilization is also related to the hospitals. We think with this higher automation analyzer, it's easier for us to use this system to penetrate the medium size hospitals. And medium size hospitals, of course, the utilization rate will be higher than the small size hospital.

Luke Langford - Langford Capital Management

Are you referring to the fully automated or just the next -- the most recent semi-automatic?

Charles Zhu

The semi-automatic.

Luke Langford - Langford Capital Management

Okay. And so, throughput would be how much for the old system and how much for the new system?

Charles Zhu

There is no significant difference on the throughputs. The key difference is the process of adding substrate is down automatically right now by the machine, and this reduced the error made by the lab technician. So, it will increase the consistent rates for the result.

Chang Qiu - Forun Technology Research

Okay, thank you very much.

Charles Zhu

Thank you.

Operator

Our next question is a follow-up from the line of Bin Li with Merrill Lynch. Please proceed.

Bin Li - Merrill Lynch

Yes, hi. Thanks for taking my questions again. I just have a couple. First, I apologize to come back to the ECLIA gross margin. Can you remind us what's the current -- what's the gross margin for the current ECLIA system, and what is the gross margin for the new system?

Sam Tsang

As the 60% increase in the [build] cost, the impact to the gross margin of the equipment will be -- the gross margin for the ECLIA equipment will be about 5% to 10% lower than the pervious ECLIA equipment.

Bin Li - Merrill Lynch

And what's the current gross margin on the system -- on the ECLIA system?

Sam Tsang

Which is about 65% to 70%.

Bin Li - Merrill Lynch

Okay, great. Okay, thanks. And then next question is really on the backlog of HIFU units. Can you tell us what's the backlog as of the end of September and how does that number compare to last quarter?

Sam Tsang

The backlog numbers by the end of September is over 30 units, and backlogs in the last quarter ended June and which is close to 30. So, the backlog numbers is just slightly higher.

Bin Li - Merrill Lynch

Okay, great. And the next question is on the D&A cost. You mentioned that your GMP facility is going to be coming online. What's the cost of -- what's the CapEx for that facility, and when we should expect to see D&A cost associated with that showing up on the P&L?

Sam Tsang

We expect the facility will be ready in the first quarter of 2007 and estimated total construction cost for this facility is about $6 million.

Bin Li - Merrill Lynch

Okay.

Sam Tsang

And so the cost will -- impact should be in the second quarter of 2007; that is the first quarter of our 2007 fiscal year.

Bin Li - Merrill Lynch

Okay. Great, thanks. And one last question is really on the company's overall strategy. You just mentioned an R&D relationship or partnership with a Chinese research institute on HIFU and other acoustic business. Can you comment on the other acoustic business -- acoustic business part just to give us more color on that?

Charles Zhu

Right now our acoustic business is all on high intensity focus, such as that we think there are a lot of great potential on other acoustic related devices. It could be used for non-oncology application and also it could be used for other diagnosis purposes. But at current stage, we are evaluating the market potential and feasibilities of developing those new technologies, and later on we will disclose more detailed information.

Bin Li - Merrill Lynch

Okay, great. Thanks.

Charles Zhu

Thank you.

Operator

Our next question is a follow-up from [Jim Sanku] with Credit Suisse. Please proceed.

Jim Sanku - Credit Suisse

Hi, Sam and Charles. Sorry, could you just remind us the plans, timeline for the launch of the automatic ECLIA system? Is it calendar year or financial year '07?

Charles Zhu

It's the calendar year '07.

Jim Sanku - Credit Suisse

In the first half -- during the first half or --

Charles Zhu

It's probably in the middle half of '07.

Jim Sanku - Credit Suisse

In the middle half of '07, calendar year?

Charles Zhu

Yes.

Jim Sanku - Credit Suisse

Okay. And also could you comment on -- I think, lot of investors have interest in the potential acquisitions, so could you comment on that, any progress so far?

Charles Zhu

We are looking into some opportunities. Right now our primary focus is to look in the opportunities in IVD segment. We believe IVD is a very attractive segment. And first it has very high growth; and secondly, it can bring recurring revenue for the company. So, we are looking to acquire some of the more advanced IVD technologies that has the higher growth within IVD segments, such as molecular related diagnosis technologies. Basically we want to acquire some of the technologies, which is proven in US or Europe market, but it hasn't -- it doesn’t have any penetration in China yet. So, we can leverage our cost advantages from our manufacturing capability, and also our distribution network to penetrate the China market.

Jim Sanku - Credit Suisse

Okay. Thanks, Charles.

Charles Zhu

You are welcome. Thank you.

Operator

Our next question is follow-up from the line of Vickie Chen with UBS. Please proceed.

Vickie Chen - UBS

Hi, Charles. Actually I want to clarify on the gross margin of the new semi-automatic units. You mentioned that the gross margin will be 5% to 10% lower than the current existing one.

Charles Zhu

Yes.

Vickie Chen - UBS

Okay. But you said that the cost is going to go up 60%, is that correct?

Charles Zhu

It's the material cost.

Vickie Chen - UBS

The material cost will go up 60%. So it's not the whole cost, right?

Charles Zhu

Yes.

Vickie Chen - UBS

Okay. Now the other thing is, the collaboration with Institute of Acoustics Studies. Now, I assume the R&D expenditure will increase because of that collaboration. Do I understand it right or -- and then, if so, how much in terms of R&D as an expenditure of the revenue that you guys will incur going forward?

Charles Zhu

The way we work together with Acoustics Institution is to assess each individual product development plan and determine the fund that is needed to support this development. And then, the payment will be made by -- in different stages as they achieve different milestones. So, in short term, we don’t expect that R&D will increase a lot because of this collaboration.

Vickie Chen - UBS

Okay, great. Thank you.

Charles Zhu

Thank you.

Operator

Our next question is a follow-up from the line of Chang Qiu with Forun Technology Research. Please proceed.

Chang Qiu - Forun Technology Research

Yes, good morning, Charles and Sam. Thanks for taking a question. The question is, among your patients who are using HIFU procedures, do you know how many percent of them are covered by medical insurance?

Charles Zhu

Right now, HIFU is not approved or HIFU is not covered by all the medical insurance in China. But most of the coastal areas and key cities, like Beijing and Shanghai, HIFU is under medical insurance coverage. And if the person is under the insurance coverage, they can be reimbursed about 70%.

Chang Qiu - Forun Technology Research

Okay. Also for the convertible bond, what should we model for the increased expense going forward?

Sam Tsang

As we mentioned, because this convertible bond is 144A transaction and we are not allowed to comment about that because that will be in violation of value funds securities law, so we advise you to refer to the press release which is published for more information.

Chang Qiu - Forun Technology Research

I know. Looks like it's not -- that’s not mentioned, whether it's zero coupon or any other expense.

Sam Tsang

Yes. We will give the press release about the final terms of the convertible, because we don’t know now.

Chang Qiu - Forun Technology Research

Okay. All right, thank you.

Charles Zhu

Thank you.

Operator

(Operator Instructions). There are no further questions at this time. I would now like to turn the call back over to management for any closing remarks. Please proceed, gentlemen.

Charles Zhu

Once again, thank you for joining us today. Please don't hesitate to contact us if you have any further questions. Good bye.

Sam Tsang

Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect.

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Source: China Medical F2Q06 (Qtr End 9/30/06) Earnings Call Transcript
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