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Mindray Medical International Ltd. (NYSE:MR)

Q4 2006 Earnings Call

March 12, 2007 8:00 am ET

Executives

Xu Hang - Chairman and the Co-CEO

Li Xiting - President and the Co-CEO

Joyce Hsu - CFO

Lisa Lee - IR Manager

Analysts

Bin Li - Merrill Lynch

Amit Hazan - CIBC Capital

Jinsong Du - Credit Suisse

Joy Yuan - Goldman Sachs

Vicky Chen - UBS

Christie Ju - J.P. Morgan

Bill Quirk - Piper Jaffray

Robin Roberts - Jayhawk Capital Management

Mike Tray- Civic Healthcare

Presentation

Operator

Good evening and thank you for standing by for Mindray's Fourth Quarter and Full Year 2006 Earnings Call. At this time all participants are in a listen-only mode. After management's prepared remarks, there will be 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, [Lisa Lee], Mindray's Investor Relations Manager. Please proceed ma'am.

Lisa Lee

Hello everyone. Welcome to Mindray's fourth quarter and full year 2006 earnings conference call. Our fourth quarter and full year 2006 earnings results were released earlier today and are available on the company's website, as well as on newswire services. In addition, an archived website of this conference call will be available on the Investor Relations section of our website at www.mindray.com.

Today, you will hear from Mr. Xu Hang, our Chairman and the Co-Chief Executive Officer; Mr. Li Xiting, our President and the Co-Chief Executive Officer; and Ms. Joyce Hsu, our Chief Financial Officer. After their prepared remarks, they will be available to answer your questions.

Before we continue, please note that 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, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. Mindray does not undertake any obligation to update any forward-looking statement, except as required under applicable law.

I would now turn the call over to Mindray's Chairman and the Co-Chief Executive Officer, Mr. Xu Hang. Mr. Xu?

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Xu Hang

Thank you, Lisa. Hello, everyone. Thank you for joining us today. I am now in Europe for a business trip today. I'm pleased to report that Mindray posted record results in both revenues and net income for the first quarter and the full year 2006, driven by significant revenue growth across all three of our business segments.

In year 2006 we introduced several products across our business segments. We are particularly encouraged by the [enthusiastic] customer response we've seen for our first color Doppler ultrasound imaging system, the DC-6, which was introduced in September of 2006. This product has already obtained SFDA in China, CE Mark in Europe and FDA clearance in United States. And we are expecting that sales will continue to outperform in 2007.

And in September, we introduced the BC-5500, the first five-part hematology analyzer, developed by a Chinese company. Not only does this represent a significant R&D breakthrough, it makes us one of the fewer than ten medical device manufacturers worldwide to produce five-part hematology analyzers.

In December 2006 we launched out WATO-50, an anesthesia machine that together with our patient monitoring devices allow us to provide a more comprehensive life support suite. And in October 2006, we introduced the customizable BeneView T8. This product's modular design is capable of tracking up to 20 physiological parameters and displaying multiple shared hospital records, such as patient medical history and diagnostic images.

The BeneView T8 continues to gain shares in international markets such as Germany, France, Italy and the UK, and in the high-end medical equipment segments in rapidly growing emerging markets, such as Brazil, India, Mexico, Russia and Turkey.

The quality of our products and the strengths of our sales and the distribution network can be seen by our ability to quickly gain traction in markets worldwide. In fact, in February 2007 we were honored to receive the Frost & Sullivan 2006 Global Market Penetration Leadership Award in the patient monitoring market. We now distribute our products in more than 135 countries. And in the fourth quarter of 2006, our ratio of revenues from international market reached 52.7% of our total net revenues.

In 2007, we will continue to grow next year internationally through our strategy of leveraging low cost China based operations, developing high quality and reliable products and applications through world class R&D and building our global distribution network.

We also plan to introduce at least six more across our three business segments. R&D is key to our ability to maintaining a strong new product pipeline. Today we believe we have one of the largest R&D teams of any medical device manufacturer in China with a staff of more then 700 engineers.

And we plan to add another 300 R&D staff this year as part of our planned expansion in 2006, we have established an R&D facility in Seattle Washington to commercialize new and more advanced products together with our R&D staff in China.

We view our robust research capability as being essential to maintaining and exciting product up line and we will continue to invest significantly in this area.

I will stop here and now turn to Mr. Li, our President and Co-CEO to discuss our sales and distribution network expansion plans.

Li Xiting

Good evening everybody, thank you again for joining us on the call tonight.

Please allow me to introduce ourselves in the distribution performance in both domestic and international markets in 2006.

Currently, we sell our products internationally through more than 800 distributors and more than 90 international sales personnel. We have also sold over 200,000 devices worldwide.

And as we expand our international market share, we will continue to accelerate our pace in building operations closer to our end users, so we can provide better services to both our end users and distributors.

In the first quarter of 2007, we have already opened an office in Mumbai, India, and within this year we plan to open offices in four more locations in Moscow, Brazil, Mexico, and Holland.

We will also continue to add additional international sales headcounts in both the headquarters as well as the local and international offices.

We are particularly optimistic with the growth potential in Europe and in the US this year.

We have already relocated two very Senior Vice President of Sales and Marketing to be in charge of each of the North American and Western European markets.

We believe after years of cultivation and brand promotion, our own brand sells in these two markets with our high-quality product will continue to gain market acceptance in the international marketplace.

We also have what we believe to be one of the largest nationwide sales and distribution network for any medical device manufacturer in China.

We have over 1800 distributor and 650 direct sales and sales support personnel in China.

And to-date, our products have been purchased by more than 27000 hospitals, clinics and healthcare facilities in China.

Overall, we are very pleased with our performance for the full year 2006, especially given the difficult domestic environment in the later part of the year relating to the Chinese government’s anti-corruption campaign, targeting at hospital procurement as well as, extending Chinese SFDA approval period.

Our achievement in fourth quarter 2006 with more than RMB477 million in sales has enabled us to exceed sales growth of more than 40% for the full year to reach RMB1.5 billion in sales.

In 2007, we believe the main driver of growth for the medical equipment market in China will be the government's continued and increasing investment in small and medium sized hospitals as well as rural area hospitals and clinics. Our products continue to enjoy significant competitive advantages due to higher performance to price ratio than other players in the market.

And in 2007, we believe our high-end patient monitors five-part hematology analyzers and color ultrasound will continue to help us further penetrating high-end markets as we continue to leverage our domestic distribution network to quickly bring new products in the market and service this growing demand.

We had delivered in 2006, a record year in both sales and net income figures. We have also added to our track record an operating cash flow of more than RMB500 million in 2006, which greatly exceeded our original expectation.

Also, as you can see in our press release, earlier today we announced our Board’s decision to declare a cash dividend of $0.15 per share in dividends payable in April this year.

As we ended the year with a strong and debt free balance sheet with more than $200 million in total cash and cash equivalents. We are confident that the Board’s decision to declare a dividend allows us to increase shareholder return on investment while maintaining the strategic and financial flexibility necessary to consider all options available to us.

This dividend is in line with what we had stated since our IPO and reflects our confidence in our ability to consistently generate operating cash flow. Of course our Board will continue to assess how best we can play our cash on a periodic basis.

Now I would turn the call over to Miss I-Yin Hsu, our CFO to take you through the financial highlights.

Joyce Hsu

Thank you Mr. Li and welcome again everybody on the call. As Mr. Xu and Mr. Li mentioned earlier, we delivered another set of solid results, demonstrated clearly by our strong net revenue growth and our ability to maintain high profitability.

Now I will walk you through the contributors to our fourth quarter 2006 results and some financial highlights for the year. Please note that we have reported fourth quarter and full year 2006 net income on the non-GAAP basis excluding share-based compensation expenses. And the fourth quarter 2006 expense and amortization of acquired intangible assets of RMB34.1 million or $4.4 million related to the April 2006 acquisition of minority interest in our operating subsidiaries Shenzhen Mindray.

This figure includes RMB31.8 million which we took as in-progress R&D expense in fourth quarter 2006 as low as amortization of some other minor intangible item. This was included under selling expenses. As stated in our prospectus, the aggregate purchase price paid in excess of net asset acquired was previously accounted on our balance sheet as goodwill in April 2006, pending the completion of purchase price allocation exercise which took place in late 2006.

We believe these non-GAAP operating profit and net income figures provide better reflection of the underlying business performance and overall operational trends. We will continue to report operating profit and net income on a non-GAAP basis going forward. You can find a reconciliation of the non-GAAP figures to GAAP figures in the financial tables at the end of our press release released earlier today.

Overall, fourth quarter 2006 revenues were well diversified over the three business segments. In patient monitoring, fourth quarter 2006 net segment revenues increased by 33% year-over-year to RMB189 million or $24 million. For the full year 2006, net segment revenues was RMB600 million or $77 million compared to RMB497 million in 2005.

Full year segment contribution to total net segment revenue was 40.1% in 2006 compared to 47.8% in 2005. We continue to hold largest market share in China's domestic patient monitoring market with approximately 40% in market share and we are also the largest exporters of patient monitoring from China with more than 60% in export market share in 2006.

In diagnostic laboratory instruments our fourth quarter 2006 net segment revenues increased by 66% to RMB134 million or $17 million from RMB81 million in the fourth quarter of 2005.

For the full year 2006, the net segment revenues were RMB438 million or $56 million compared to RMB263 million in 2005. Full year segment contribution to total net segment revenue was 29% in 2006 compared to 25% in 2005. The addition of our five-part hematology analyzer in third quarter of last year will continue to help generate additional demand in this category in both domestic and international market as we move forward in 2007.

And lastly in our ultrasound imaging systems segment. Fourth quarter 2006, net segment revenues increased 51% to RMB140 million or $18 million from RMB93 million in the fourth quarter 2005.

For the full year 2006, net segment revenues were RMB438 million or $56 million compared to RMB264 million in 2005. Full year segment contribution to total segment, net segment revenue was approximately 29% in 2006 compared to 25.5% in 2005. We are very optimistic with the growth potential of this segment given that we have just introduced our color ultrasound, which has received very good feedback from both our domestic and international end users and distributors.

Consolidated gross margin for the fourth quarter 2006 was 53.8% compared to 53.1% in the fourth quarter 2005. For the full year, consolidated gross margin was 54.6% compared to 54.3% for the full year 2005. As you may recall, we received a value-added tax refund, VAT refund for our self-developed software in both fourth quarter 2005 as well as in the full year 2005 in the amount of RMB9.4 million and RMB32 million respectively.

Such VAT refunds were recognized as a component of our revenues in previous years. However, in 2006, since the PRC government changed the regulation, our integrated software no longer qualified for the VAT refunds.

If we were to look at our gross margin trends excluding the impact from such VAT refunds, the consolidated gross margin excluding the VAT refunds would have been 51.8% for the fourth quarter 2005 and 52.9% for the full year 2005 indicating more than 200 basis points in overall gross margin expansion in the fourth quarter of 2006.

Selling expenses for the fourth quarter 2006 were RMB62 million or $8.0 million, representing an increase of 21.6% from the third quarter 2006. As a percentage of the total net revenues, selling expenses decreased to 13.1% from 13.7% in the third quarter 2006.

Fourth quarter 2006 increase in selling expenses is inline with our expectation of growing our selling expense faster than our net revenues as we continue to increase our investments in expanding our sales and distribution channels overseas.

For the full year 2006, selling expenses accounted for 14% of net revenues. General and administrative expenses for the fourth quarter 2006 were RMB33 million or $4.2 million, representing an increase of 109% from the fourth quarter 2005. As a percentage of total net revenue, G&A expenses increased to 6.9% in fourth quarter 2006 from 5.1% in the third quarter 2006.

The increase in G&A expense ratio reflects accrual for additional expenses related to costs of being public company, as well as accrual for year-end bonus payment. For the full year 2006, G&A expenses accounted for 5% of net revenues.

R&D expenses for fourth quarter 2006 were RMB46 million or $5.9 million, representing an increase of 26% from third quarter 2006. As a percentage of total net revenues, R&D expenses decreased to 9.6%, from 9.9% in the fourth quarter 2005. For the full year, R&D expenses accounted for 9.8% of net revenues. Our ongoing strategy is to continue to invest approximately 10% of net revenues in R&D activities.

Total share-based compensation expenses, which were allocated to cost of goods sold as well as related operating expenses, increased to RMB6.5 million or $0.8 million in the fourth quarter 2006. In the fourth quarter 2005, we did not incur any share-based compensation charges. For the full year, total share-based compensation expenses were RMB26 million or $3.3 million, compared to RMB71 million reported for the full year 2005.

Fourth quarter 2006 non-GAAP net income increased 65.6% year-over-year to RMB142 million or $18 million. Full year 2006 non-GAAP net income increased 51% to RMB417 million or $53.4 million.

Fourth quarter 2006 non-GAAP basic and diluted earnings per share were RMB1.34 per share or $0.17 per share. For the full year, the non-GAAP diluted EPS were RMB4.33 per share or $0.55 per share.

Lastly, on the business outlook for 2007, we expect total net revenues for the full year 2007 to be in the range of RMB2.12 billion to RMB2.15 billion. Full year 2007 non-GAAP net income is expected to be between RMB570 million to RMB585 million. This translates into RMB5.09 to RMB5.22 per fully diluted share, assuming an estimated 112 million total shares outstanding.

We expect our capital expenditure for 2007 to be approximately RMB435 million. This figure reflects the building of our new R&D centers at our Shenzhen head office, as well as continued expansion of our manufacturing facility. We estimate total share-based compensation expense in 2007 to be approximately RMB37 million, based on the share options that have already been granted as of today.

Total expense and amortization of intangible assets related to the April 2006 acquisition of minority interest will be approximately RMB19 million in 2007.

As a reminder, our practice is to provide guidance on a full-year basis, and this forecast reflects our current and preliminary views, which are subject to change. We will update our investors to basic outlook for the year and for the earnings call.

With this, we have concluded our prepared remarks. Now, I will turn the call over to the operator to begin the Q&A session. Operator?

Question-and-Answer Session

Operator

The question-and-answer session at this conference call will start in a moment. (Operator Instructions). And your first question comes from the line of Bin Li of Merrill Lynch. Please proceed.

Bin Li - Merrill Lynch

Thanks and good morning and good afternoon, everyone. Great quarter. I just have a couple of questions, if I could. First of all, your reported number for the quarter was stronger than your pre-announced number and can you tell us what the main reason is for that?

Joyce Hsu

The pre-announced number was based on the closing of our management account and that was prior to any audit adjustment, as well as the finalization of share-based compensation. As you know, our share-based compensation is performance based, so we couldn't really allocate the final option number until we had the full year results. By the time we had finished such exercise, it was already late January.

Bin Li - Merrill Lynch

Great. And in terms of the guidance for next year, I appreciate that you are providing total revenue guidance and not breaking down the split between China and international market. But I was wondering whether you can provide any more color may be in not the specific number, but how should we think about international growth this year. Would that be consistent with for example '06 growth rate which is roughly 63%, domestic growth rate would be roughly consistent with the '06, 24%?

Joyce Hsu

I think in 2006, international growth rate would be in good proxy of what we are hoping to achieve in 2007.

Bin Li - Merrill Lynch

Okay, what about the domestic 24%?

Joyce Hsu

For domestic businesses, you can note it from our press release earlier today, the domestic business grew roughly around 24% and that this is largely I think the slight underperformance vis-à-vis the previous year. It was largely due to the anti-commercial campaign which we experienced in third quarter and fourth quarter last year and we are hoping to achieve a better growth rate then what we have achieved in 2006.

Bin Li - Merrill Lynch

Okay, great. I will jump back to queue, thanks.

Operator

Your next question comes from the line of Amit Hazan with CIBC Capital. Please proceed.

Amit Hazan - CIBC Capital

Thanks very much and good evening guys. I also just have a couple of questions on guidance which would be if you can help us a little bit with the selling expenses having increased. Is that something that we should continue to model as we go forward into 2007 and likewise if you can make any helpful comment on gross margins and where we should think of those for '07 that would be great?

Joyce Hsu

I think if you look at our, let me answer your second part of the question first. If you look at our gross margin trend for the last three years, it has been very consistent; the last four years have been very consistent. In fact, from '03 to '05, our overall gross margin has been precisely 54.3% for each of these given years. In 2006, we expanded our gross margin to 54.6% for the overall year, and we expect with the introduction of the new products made last year, we will be able to ramp up starting in second quarter of this year. We anticipate it will have a positive impact on our gross margin expansion.

Going back to the selling expenses question, as we have noted in many of the meetings with people on the call previously, our goal is really to continue to invest further in expanding our international sales and distribution network. With such, we expect the overall selling expenses to increase as a ratio of the net revenues. Last year, we closed the year at 14% and we would anticipate over the next couple of years this percentage point to move up at least 100 to 200 basis points.

Amit Hazan - CIBC Capital

That's very helpful. And my one follow-up would be, you mentioned that the US would be a good area for growth for you in 2007. I am just curious if you can give us more color on what product specifically you are hoping that will grow, or will you be using a distributor, or is there anything new that you are planning in 2007 that you can share for us?

Joyce Hsu

I will turn this question to Mr. Xu.

Xu Hang

Okay. US market is expecting market for fast growth in year 2007. We introduced our color system in the United States and also we expect to add more sales staff in the United States. So we are expecting much higher growth rates in other places of the area.

Amit Hazan - CIBC Capital

Okay. Thank you very much.

Operator

Your next question comes from the line of Jinsong Du of Credit Suisse. Please proceed.

Jinsong Du - Credit Suisse

I just have one quick question regarding the fourth quarter domestic sales. You mentioned that because of the anticorruption movement in China, the growth is not as good as previous quarters, but expected to be better for ‘07. I would just like to understand a little bit more for the fourth quarter, is it the impact of the movement mainly, as I mentioned previously, maybe in the patient monitoring systems, or did you find any other weaknesses, maybe in other segment or other products. And since we are already in March, do you see in terms of the orders right now in the first quarter, do you see any of those products orders picking up?

Joyce Hsu

Let me just talk a little bit, and let me translate that for Mr. Li.

Li Xiting

[Translated] Last year the anti-corruption campaign initiated by the Chinese government have had a negative impact on the overall medical device market in China. But mostly the negative impact is due to postponement of purchase decision, but not complete stoppage of the purchase.

In the long-term for a company like ourselves, who has always committed to legitimate activity, it’s a very long-term beneficial movement.

If you look at our fourth quarter performance domestic sales, we can say that it was already in recovery mode.

And starting in January this year, we have seen a pick-up in government tenders align with the local hospitals as well as provinces.

So, we think the impact on ourselves was temporary and the long lasting impact should be profitable for us. It actually pushes a lot of hospitals to procure our products rather than some second-tier and third-tier domestic products.

Jinsong Du - Credit Suisse

[Foreign Language]

Joyce Hsu

Let me just translate what Jinsong has followed up with. He just mainly wanted to clarify, whether or not the impact was largely on patient monitors or does it also impact other product lines.

Mr. Li’s answer is that, because we have the highest market share in China in terms of patient monitoring sales. Therefore the impact we felt as a result of anti-corruption campaign, movement is also greater in this product segment versus the other two product segments. Nonetheless, we believe that it also impacted the potential sales growth in the other two segments.

Jinsong Du - Credit Suisse

Alright. Just one quick question regarding the ASPs, could you may be shed more light on the ASP trends, generally both in domestic and international markets, please?

Joyce Hsu

Actually we don’t disclose any ASP trends. But we can discuss the general pricing trends. Overall, we have probably discussed previously, every year in terms of our products the product experiences a pricing decrease of anywhere from 5% to 10%. On the other hand, we have been able to consistently improve our cost of goods sold structure by more than 10% to 15% on a year-on-year basis. And therefore net-net, what you are seeing is we are able to maintain a steady gross margin. And starting last year we actually saw a pick up and expansion in our gross margin.

Jinsong Du - Credit Suisse

Alright thanks a lot.

Joyce Hsu

Thank you.

Operator

Your next question comes from the line of Joy Yuan of Goldman Sachs. Please proceed.

Joy Yuan - Goldman Sachs

Hi, Joyce.

Joyce Hsu

Hi.

Joy Yuan - Goldman Sachs

Hi, Joyce, I have got a couple of questions. First of all I saw a big expense item of 31.8 million as expense of in-progress, research and development. I probably missed it Probably you have explained the thing when you gave the overview. But, could you explain a bit more on where this item comes from?

Joyce Hsu

Actually, altogether the charge we took in fourth quarter 2006 was RMB34.1 million, and this charge is related to [expense] and over amortization of the intangibles, that we have allocated as part of the purchase price allocation. And this purchase price allocation is based on the aggregate price we have paid to acquire 8.9% minority interest back in April 2006. As you recall, when we bought that minority interest last year, there was no cash transaction. We exchanged share for share. Therefore, net-net there was no cash impact and this was largely an accounting treatment to reflect the intangibles that we have acquired as part of this transaction in buying back the remaining on-shore.

Joy Yuan - Goldman Sachs

Okay. So, this is an aggregate amount for the full year?

Joyce Hsu

This is aggregate amount for the full year 2006. In 2007, they will continue to be remaining intangibles on our balance sheet that has to be amortized. And we estimate in 2007 that such figure would be around RMB19 million.

Joy Yuan - Goldman Sachs

Okay. I see. I’ve got another question. So, in terms of '07 guidance, why management chose to guiding an annual format instead of quarterly format? Since, I believe I was told before that the business has a pretty good three months forward visibility?

Joyce Hsu

I think we told you on our call last time that our Board and also management doesn't believe in that it is healthy for a company to be giving out a quarterly guidance. We wanted to make sure that when people looked at our performance, they look at it on the more longer term basis, i.e., at least over one year. There are a lot of fluctuations in terms of our quarterly performance. It’s highly dependent on our new product introduction timing and as well as seasonality as you have noted.

As we have noted previously, for example, fourth quarter usually it’s our strongest quarter given that in medical device market there is a typical budget flush in both domestic and international market. And our first quarter is typically our slowest quarter given that there is Chinese Lunar New Year in the February. So, we do not want to have to manage our business about this type of seasonality. And therefore, our Board has decided that when we give out the guidance, we will only be updating investors with our full year guidance.

Joy Yuan - Goldman Sachs

Okay. Thanks. And just as an extension to that question. So on the growth outlook for the first quarter and the second quarter, first half '06 was particularly strong and second half relatively weak. So I think growth could be backend loaded in '07. Looking into the first quarter and the second quarter, what's the outlook from year-on-year perspective with the high base?

Joyce Hsu

I think you are right. As our first quarter -- as our first half last year, embedded in those numbers were certain sales kind of that we had to adjust by the end '05 to '06. And as well as there were a couple of huge government tenders, which we had secured in '05, but was only fulfilled in '06. So, we're starting off at relatively high base in first half of this year. And therefore, I think, it's probably safe to assume that if our annual goal is to achieve, let’s say, 40% growth, most of the growth will be more back ended than front loaded.

Joy Yuan - Goldman Sachs

Thanks Joyce.

Joyce Hsu

Thank you.

Operator

Your next question comes from the line of Vicky Chen of UBS. Please proceed.

Vicky Chen - UBS

[Foreign Language].

Joyce Hsu

Hi, Vicky. Vicky, you may want to move closer to the microphone. We have a difficulty in hearing you.

Vicky Chen - UBS

How about it now?

Joyce Hsu

It is better.

Vicky Chen - UBS

Okay. Well, congratulations on this quarter. Actually without taking in consideration of that 34.1 million, the quarter's earning looks really good. I actually have a question, a very simple question on tax rate. Now going forward in '07, and probably you can comment on ‘08 as well. What is the tax rate, effective tax rate going to be? Starting ‘08 considering there is going to be a tax unification, are you expecting that your normal tax rate will be changed? And in ‘07 is it going to be around 7.5% or 10%?

Joyce Hsu

As you know in the last six years, we have been paying a corporate income tax rate of about 7.5%. And that is a reduced rate from the statutory tax rate for a company based in Shenzhen. Starting in this year, I would actually use 15% as a normal statutory rate for Shenzhen. And then we actually are in the process applying for a special tax holiday that would potentially entitle us to a reduced rate of 10%. But that is not going to be finalized until the second half of this year. So just to be on a conservative side, we have used 15% in coming up with our annual budget.

And starting in 2008, as people have been talking about maybe that there is going to be a unification of two tax rate system. But from what we know and also from our conversation with local tax bureau officials, there is no clear indication as to how our tax rate will be migrated to the 25% bracket. Overall, the government has come out and said that there is going to be a five-year migration period. But we don't know how fast the migration will be, and we don't know as of this time whether or not there will be any [great bothering] of the existing tax rate given that we were an FIE. So I would just stay tuned until there is further announcement hopefully coming out of the People’s Congress in this couple of months.

Vicky Chen - UBS

Okay, great. But the potential 10% is going to be determined in the second half of '07. Now that 10%, is it going to be just applied, if you get that 10%, is it going to be applied in '07 only or it's going to be for a few years?

Joyce Hsu

It will be applied in '07. It’s subject to annual application.

Vicky Chen - UBS

Okay, thank you. No further questions.

Joyce Hsu

Thank you.

Operator

Your next question comes from the line of Christie Ju of J.P. Morgan. Please proceed.

Christie Ju - J.P. Morgan

Yes. My question is regarding the distribution. I was wondering, given the anti-corruption changes, have you seen any changes to the processing pattern for your distributors in domestic in China? And then also in terms of your international distribution, now that you are setting up your branch offices overseas, are you getting more and more involved in terms of direct sales, any changes to the pattern? And then also with your new product, I understand every product line may have different distributors. If you can also comment, if there any changes, given that you have those annual contracts with your distributors?

Li Xiting

Currently, it is not impossible for us to conduct a direct sales model in the international market. In China, as we set out to renew our annual contract with distributors, there haven't been any major changes in the expected distributors that we are going after. For those, some of the minor distributors who have got into trouble with the anti-corruption campaign, we have not renewed our contract with them.

Christie Ju - J.P. Morgan

[Foreign Language]

Joyce Hsu

Sorry, Christie, just let me translate the question and the answer. Christie's question was, because of the anti-corruption campaign, have you experienced any change in the distributor purchase behavior? For example, do they come with cash and previously that they would make purchase once-a-month basis and then now their purchase behavior has changed to make the purchase every three months.

The answer was, first of all, most of our distributors are not allowed to pay with cash directly. They mostly have to come with money orders or a wire from the bank. And secondly, we have not seen any changes in the distributor behavior. We do not encourage distributors to accumulate too much inventories in the channel. In fact, because we do require them to pay most of the shipment upfront, they only have the working capital to take up no more than one month worth of inventory on their side.

Christie Ju - J.P. Morgan

[Foreign Language]

Joyce Hsu

The question was whether or not because as a result of the anti-corruption campaign whether or not there were any distributors who declared paying up and therefore impacted the number of distributors who were able to renew our contract with. Our answer is that as we have stated earlier in some of our presentations, last year we had exclusive distributors in China of more than 650 distributors and this year we are expecting such number to increase to 1000.

And in addition what Mr. Li was saying that we are also seeing pick up in the government tenders in a lot of local offices, for example in our [Shian] office in the first quarter alone they had already completed more then 95% of what their annual budget is. So we believe that even though they would, there are still some lingering effects of the anti-corruption campaign, but overall the government is promoting better official welfare for its people and therefore they will continue to invest heavily into the healthcare sector and we believe that for us it’s a very low term beneficial movement for them to do so.

Operator

Your next question comes from the line of Bill Quirk of Piper Jaffray. Please proceed.

Bill Quirk - Piper Jaffray

Yes, thank you, and good evening.

Joyce Hsu

Hi Bill.

Bill Quirk - Piper Jaffray

Couple of questions Joyce. First of, I believe I heard you correctly that the 15% tax rate is what we are using in terms of guidance. The guidance did not assume that we shift down to lower 10% rate in that--

Joyce Hsu

That's correct.

Bill Quirk - Piper Jaffray

Okay. And then just a follow-up to that, should we assume that hypothetically in, say, the third quarter of 2007, is in fact you reach an agreement for the holiday that we should have a one-time if you will catch up to get us back to the 10% range?

Joyce Hsu

Yeah, it will both likely come in the form of subsidies.

Bill Quirk - Piper Jaffray

Okay. But in terms of, for thinking about recognition on the profit & loss statement that would be on the tax line correct Joyce, that wouldn't be on…

Joyce Hsu

That's correct.

Bill Quirk - Piper Jaffray

Okay. Got it. And then two other quick questions. Just a follow-up to the Anti-Corruption Act question, have we taken any stab at trying to estimate how much that impacted the business over the second half of 2006?

Joyce Hsu

As we have said in the previous calls, it's actually quite difficult for us to estimate how much our sales were impacted by it. The only comparison we can really provide is that previously our domestic sales have been growing at least 30% a year, and last year because of anti-corruption our overall growth was little less than 25%. So --

Bill Quirk - Piper Jaffray

It would be reasonable to assume Joyce had we not had that we should have seen the number closer to the 30% type.

Joyce Hsu

It will be a number closer to the 30% rather than to the 25%.

Bill Quirk - Piper Jaffray

Okay. Understood. And then just last question is, you talked a little bit about 2007 product launches, can you give us little bit insight into what we should be expecting here?

Joyce Hsu

Mr. Xu do you want me to answer your question regarding the

Xu Hang

Yeah, go ahead, please.

Joyce Hsu

Okay. In 2007, we are expecting to release at least six more new products and most of these products are all within our three product categories. We will be introducing a lower-end version of five-part hematology analyzer. And we with this lower-end version we will be able to go after the small-to medium-end hospitals, particularly the government tender market.

We will also be introducing a lower-end color ultrasound. Again with the same kind of philosophy that there will be huge demand coming up from the low-to mid-end of the market in China. We will also be introducing a higher-end biochemistry analyzer. This would increase our tests per hour from the current 203 tests per hour machines to 400 tests per hour.

And lastly, we anticipate by the end of this year we would be introducing our first portable color ultrasound.

Xu Hang

And also we have something in Beneview series.

Bill Quirk - Piper Jaffray

An extension of Beneview series, okay, understood. Thank you very much.

Joyce Hsu

Thank you.

Operator

(Operator Instructions). And your next question comes from the line of Robin Roberts of Jayhawk Capital Management.

Robin Roberts - Jayhawk Capital Management

Hi. Looking at your 72% of revenue growth in the international market, how much of that is coming from new country entrants versus same country growth?

Joyce Hsu

I think, I would say a large part of it is coming from same country growth given that we are already in 135 countries. Most of the countries add in terms of the sales is still quite small. For example, the largest country was Germany last year, and the total sales for the country is around $5 million.

So, it's still very small for us and we do anticipate that going forward most of the growth will continue to be coming from our further penetration into existing countries.

Robin Roberts - Jayhawk Capital Management

Okay. So, in 2007, you are going to open up four new international offices. Should we look at 72% of growth plus additional growth from new country entrants?

Joyce Hsu

No, the 70.2% --

Xu Hang

Joyce, the 72% is last quarter, it is over --

Robin Roberts - Jayhawk Capital Management

I am sorry.

Joyce Hsu

Yes. For the full year, it was around 60 --

Robin Roberts - Jayhawk Capital Management

63%.

Joyce Hsu

Yes.

Robin Roberts - Jayhawk Capital Management

Okay. So, you are saying that next year is it still going to be about 63% growth international.

Joyce Hsu

Yes, I think that will be a good proxy.

Robin Roberts - Jayhawk Capital Management

Okay. And the fourth quarter domestic growth is 13.7% growth and mostly was down from a full year of 24%. And so that was caused by the anti-corruption. But as you know, even though if your deal is delayed, your sales people still have to pay attention to close the delayed deals and therefore new deals in the pipeline are still probably going to be further delayed.

From that perspective I am wondering, for the first quarter or second quarter of '07, are you expecting the domestic growth continuing to be around the 13.7% range or is that going to be better?

Joyce Hsu

Our target is to do better than that. If you look at it on a sequential basis, our fourth quarter domestic sales actually had already picked up 30% quarter-on-quarter from the third quarter. In third quarter our domestic south was actually down on a year-on-year basis.

Robin Roberts - Jayhawk Capital Management

Thank you.

Joyce Hsu

Thank you.

Operator

Your next question comes from the line of [Mike Tray of Civic Healthcare]. Please proceed.

Mike Tray- Civic Healthcare

Hi, thanks for taking the question. I was wondering if I take your '07 guidance and the 15% tax rate and the higher interest income and I back in to an implied EBIT. Is the EBIT margin for 2007 roughly flat with the EBIT margin that you saw in 2006?

Joyce Hsu

Yes. I think we actually do anticipate the EBIT margin to be slightly lower or at least flat given that we do anticipate there is going to be increased salary expense ratio in 2007.

Mike Tray- Civic Healthcare

Okay, and the 18.8 million amortization that you mentioned; how much of that is in-process versus actual amortization expense? Is it all amortization expense?

Joyce Hsu

What do you mean, in process?

Mike Tray- Civic Healthcare

How much of is it one time charge versus ongoing?

Joyce Hsu

We have taken only one-time charge in 2006.

Mike Tray- Civic Healthcare

Okay.

Joyce Hsu

So, that’s amortization.

Mike Tray- Civic Healthcare

Pure amortization expense, okay. And then the last question is, in 2008 and beyond would you expect that your EBIT margin would expand or still stay flat roughly. Is your long-term goal to keep it around current levels?

Joyce Hsu

Well our goal is really to keep it about the same level, whether through expansion of gross margin to offset the increase in the operating expenses or through better operating expenses.

Mike Tray- Civic Healthcare

Okay, thank you.

Operator

Your next question comes from the line of Bin Li of Merrill Lynch. Please proceed.

Bin Li - Merrill Lynch

Thanks for taking my follow-up questions. Just a couple of quick questions. Number one on the cash dividend; how should we think about your cash dividend policy going forward? Is it just one-time thing or would this be a continued thing?

Joyce Hsu

I think as we stated in our prospectus, we always have had the history of paying dividends in the past, even as the private company. And the management and Board are very confident with our ability to continue to generate healthy cash flow through operations. So, we will continue to pay dividends. But as to how much that dividend rate will be is subject to our requirement and also our Board's assessment of how the cash should be deployed going forward.

Bin Li - Merrill Lynch

Understood. What about the frequency of cash dividend?

Joyce Hsu

It would be on an annual basis.

Bin Li - Merrill Lynch

Okay, and also a follow-up question regarding the quarterly pattern. You have commented on the seasonality of the business. But, I was wondering whether you can comment on your operating expense. Whether we should think this is steady, evenly spread across all quarters, or whether it’s a function of seasonality as well?

Joyce Hsu

It’s definitely a function of seasonality, because we don’t withhold our international sales expansions because first quarter is going to be a slower quarter. And therefore, as the revenue number grow throughout the quarter, you will see the expense ratio in the beginning of the year tending to be larger than the end of the year.

Bin Li - Merrill Lynch

Okay. Great. Thanks.

Joyce Hsu

Thank you.

Operator

Your next question comes from the line of Jinsong Du of Credit Suisse. Please proceed.

Jinsong Du - Credit Suisse

Hi, Joyce. It seems that according to a lot of questions and answers just now, it seems that it is fair for us to expect a very strong first quarter for '07 given that we were told a lot of orders were simply delayed from the fourth quarter last year to this year. And also by [mid May] you also mentioned that that is one of the reasons as you reported, have already got the orders as fueled by the full year beginning the first quarter. So, we see a much higher year-on-year growth for the first quarter of '07 comparing to the full year guidance?

Joyce Hsu

No. Actually, as I was responding to Joy's question earlier. We are actually starting off a relatively high base last year in the first Q '06. There was a couple of government tenders that was leftover from '05, and there was also $50 million of sales that was adjusted from '05 revenue to '01 due to audit adjustments. So, I would say that even though we are seeing all the positive signs from the domestic market, and given that I would be very cautious in giving the first quarter outlook. It is typically our slowest quarter and given the Chinese New Year and given that we are coming off from much higher base in first quarter '06.

Jinsong Du - Credit Suisse

Right. And also about your revenue, also your guidance for the full year, the net income growth seems to be much higher than the revenue growth. Is it mainly from health side, the new products or if there is any other --

Joyce Hsu

I think if you look at the comparative number, you should be comparing the 570 to [585 to the 416] number. It is non-GAAP to non-GAAP. So, actually I would say, the net income growth is slightly lower than our expected top line growth given that, as I’ve said earlier, we do anticipate the operating expense ratio to increase as a result of international sales channels expansion.

Jinsong Du - Credit Suisse

I see. Thank you.

Joyce Hsu

Thank you.

Operator

We are now approaching the end of the conference call. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

Joyce Hsu

Thank you.

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