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Chindex International Inc. (NASDAQ:CHDX)

Q4 2007 Earnings Call

February 8, 2008 10:00 am ET

Executives

Roberta Lipson – Co-founder, CEO, Pres

Larry Pemble – CFO

Analysts

Eugene Teel – Private Investor

Hamed Khorsand - BWS Financial

Anthony Petrone - Maxim Group

Roberta Lipson

It is my pleasure to welcome you to this conference call in which we will discuss the Chindex International Fiscal Year 2008 Third Quarters results. As in the past, we have prerecorded our initial comments, which will be followed by live Q&A session.

Joining me on the call today is Larry Pemble, our CFO.

Before we proceed to the summary of operating results for the period and an update on recent events, I will like Larry to read the Safe Harbor Statement and then we will turn to Q&A. Larry, please read the Safe Harbor Statement.

Larry Pemble

Thank you, Roberta and good morning everyone. Statements made in this conference call relating to plans, strategies, objectives, economic performance and trends and other statements that are not descriptions of historical facts may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended the "Securities Act", and Section 21E of the Securities Exchange Act of 1934, as amended the "Exchange Act". Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those anticipated due to a number of factors, which include, but are not limited to, the factors set forth and documents filed by us with Securities and Exchange Commission from time to time including without limitation in our annual report on Form 10-K for the year ended March 31, 2007, and interim reports on Form 10-Q. Forward-looking statements may be identified by terms such as "may", "will", "should", "could", "expects", "plans", "intends", "anticipates", "believes", "estimates", "predicts", "forecasts", "potential", or "continue" or similar terms or the negative of these terms. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We have no obligation to update these forward- looking statements.

Roberta Lipson

We announced our December 31, 2007 results in the press release this morning which included our full income statement, balance sheet and divisional results for the period. Please refer to the press release for the specific numbers. As in the past, I will use this call to summarize operational results for the quarter and give updates on the current and upcoming issues in each division of the business.

Our consolidated performance for the Third Quarter Fiscal 2008 was really excellent. Re reported 19% consolidated top-line growth, 473% increase in net income and 400% increase in basic earnings per share. Our consolidated performance for the nine-month period was also excellent. We reported 17% consolidated top-line growth, 206% increase in net income and 150% increase in basic earnings per share. A portion of the improvement net income and EPS relates to our tax provisions for the period which Larry will comment on in more detail in a moment.

Most divisions performed well in the third quarter and we are gratified to report profitable performance in the medical products division for the second quarter in a row. Our objectives for fiscal 2008 are to continue strong same historical growth and revenues, and increase profitability in the healthcare services division while initiating a new generation of future growth through major expansion of the UFH network and to regain historical growth rate and profitable operations in the medical products division through the existing business platforms and strategic partnerships.

I am pleased to report that we are on track to meet our objectives for the year in both divisions.

We reported another good quarter in the healthcare services division, which were increased in operating profits of over $3.2 million on revenues of $17.7 million. Revenue growth was 39% increase over the prior period. The increase in operating income was a tremendous 187%. Expenses increased 25% quarter-on-quarter and we continued to improve against the expected operating standards for hospitals of our size and staffing model.

At our last earnings call, we were very happy to announce a major strategic investment program with JP Morgan. Since that time, we have completed a series of equity and debt financing as well including the JP Morgan transaction and equity and debt transaction with IFC and a debt transaction with DEG that will provide us with a total of $105 million and financing. Larry will have some comments on the details of these transactions in a moment.

As you know, the purpose of the financing is to provide funds for the expansion of our healthcare system in China, including two new joint venture hospitals, one in Beijing and one in Guangzhou. Since finalizing these transactions, we have turned our focus to moving forward on these projects. There are many steps in the process of securing the necessary government approvals to build foreign-invested hospitals in China. We are at the very beginning of the process in each project. I will have operating updates for you in future quarters. At this stage, together with our intended JV partners in the process of finalizing land use rights.

During the third quarter, we have made significant progress on new clinic facilities for United Family Outpatient Centers in the Pudong side of Shanghai and in Guangzhou. We are planning for both clinics to open in June 2008. The Wuxi United Family International Healthcare Center, which we have been contracted to manage is close to opening. We view this facility as both a further expansion of our footprint in Eastern China, a theater-clinic which will bring new inpatient business to our Shanghai Hospital as well as an opportunity to explore the model of the United Family Management of Non-Owned Facilities.

Moving on now to the Medical Products Division, in the quarter, we reported revenues of $18.3 million or 4% increase from the prior year and income from operations of $197,000.00. We had strong sales during the period in colored Doppler Ultrasound scanning systems and delivered another da Vinci Surgical Robot System in Hong Kong. After several periods where the market conditions for medical devices has been very challenging in China, we saw a substantial normalization of the market in this quarter.

I would not say that the negative factors that have been impacting us are completely gone. We still face significant delays overall in the division due to continued delays in product registration and public tendering to name two prominent areas. However, we do see the pent up demand in the market reflected in our increased sales volume again this quarter.

In addition to the ultrasound and surgical product areas, we are also seeing improvements in sales of aesthetic laser systems and clinical chemistry analyzers. As we have mentioned in previous calls, the registration process for the da Vinci Surgical Robot System has been ongoing now for more than one year for the product registration from Mainland China. We had some very encouraging news last week when we passed the review of the Expert Committee that had been charged with reviewing the application. While the official process is ongoing and we have not received the final approval, this Expert Committee meeting was a major hurdle in the process. What remains is substantially documentary review which we are hoping will move forward quickly. We can look forward to incremental revenue contributions from da Vinci sales in China in our next fiscal year.

We have finished the administrative and commercial processes needed for the execution of the $5.2 million US Ex-Im Bank backed contract we announced earlier this year. The letters of credit which will allow us to ship the product are currently in the process of being opened. We are expecting a substantial portion of the current contracts to be delivered in the fourth quarter. These are the first contracts to be executed under the new Bilateral Government Umbrella Lending Agreement and we have experienced a series of minor delays in getting all of the various parties in line.

Once we have tested the whole process and overcome the bureaucratic hurdles in the first project related to the new Ex-Im Program, future contracts will execute much more rapidly. As we had mentioned in previous calls, the future we see in government backed financing programs for both US and German source funds is very exciting.

I would like to conclude my comments by saying that our continued strong consolidated performance is the result of our well developed national brand recognition for both the Chindex and United Family Hospital Brand, mature management team and first mover advantage in both of our divisions. This puts us in an excellent position to reap the benefits of the accelerating China healthcare market. This concludes my update, but before opening to Q&A, Larry will give an update on finance related issues.

Larry Pemble

The 10-Q will be filed on Monday, at December 31, we show $56 million in cash. As of the end of the period, we had received $41 million as a result of the JP Morgan transaction. In January, we received an additional $19 million which included the final portion of the JP Morgan transaction and the $10 million equity purchase of common stocks by the IFC, the International Finance Corporation. We also finalized the loan agreements with both the IFC and DEG for future borrowings of up to $45 million. These transactions have been filed already on 8-Ks and details are included in the 10-Q. With the finalization of the IFC and DEG transactions, we met the conditions for the conversion of the first of the two convertible notes issued to JP Morgan. This B note has converted and the 897,989 shares have been issued to JP Morgan.

In the fourth quarter, we will book a non-cash expense of approximately $2.7 million which represents the value of the beneficial conversion feature of this note. A few additional comments on the 12/31 balance sheet, equipment receivables are up slightly due to shipments concentrated at the period end. Base receivables have increased due to revenue increases, merchandise inventories up due to stock goods unable to ship at quarter end as well as a reclassification of demonstration assets in the inventory which accounts also partially for the drop in PP&E during the period.

The large increase in other assets is due to the accrued financing expenses, APN accrued were up in line with the increase in revenue for the period. Short-term debt decreased as we paid off the current portion of vendor financing and because of the fluctuations in the working capital lines in the US. The increase in income taxes payable was due to increased taxable income at the hospital entities in China as well as the current period adjustments in our 10.18 effective tax rate. Long term debt is largely composed of the two JP Morgan notes and as I have mentioned $25 million of that has converted to equity in Q4.

Additional paid in capital reflects the cash from the issuance of common stocks from financial conversion feature to convertible notes and the stock option exercises. On the income statement, the only comment I would make relates to the tax provision in the period, the decrease in the effective tax rate in the current period was substantially due to an increase in our net deferred tax asset which resulted from an increase in the projected profitability in future periods of entities in the US and China which makes it more likely than not that we will utilize and increase a portion of our deferred tax assets.

Roberta that concludes my comments.

Roberta Lipson

Thanks, Larry. This concludes the prerecorded portion of our call and we will now open the floor for live Q&A.

Question and Answer Session

Operator

(Operator Instructions)

Our first question is coming from Eugene Teel, a Private Investor. Please state your question.

Eugene Teel – Private Investor

Congratulations on amazing results. I am a former McKinsey consultant and a former CFO of a medical robotic company. I find your results as to be extraordinary. The question is how significant is Intuitive Surgical going to be to your future success.

Roberta Lipson

Thank you, Mr. Teel. We are really excited about the potential for Intuitive in China. Most of our sales so far have been in Hong Kong because there was not a need for a separate product registration in that jurisdiction, but as I mentioned on the call, we have been waiting for the final registration and approval here in China and we only have one unit installed within the Mainland at the 301 Hospital, which is the unit that has been designated for investigation purposes for the state’s Food and Drug Administration approval process.

We have seen amazing productivity out of that unit and as you know, the Intuitive Surgical also has a trailing considerable income stream, so if that is anything, any sign of things to come with future customers, I think it is going to be very rewarding. We have been working on increasing the product awareness in the market here and of course our super user who has already been using the robot in Beijing for the last six months has done lots of academic presentations, so we know that there is a substantial pipeline there. We expect it to be a real important product, but that having been said, we do not like to base our results. We try hard to spread it over the portfolio of products and it will certainly be important to us, but it will be one among many great products and product lines.

Operator

Our next question is coming from Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial

Great quarter! My question is regarding the ordering trends during the quarter. You said that most of it occurred in the period where your accounts receivables went up. Was there a specific event that caused that, is there a change in the ordering sequence from your customers?

Larry Pemble

No, we did not. Actually, I mean this quite regularly. We see it is particularly in the Capital Equipment and in the Medical Products Division obviously where we see significant fluctuation in the emerging inventory in AR and AP from period to period. Obviously, this was the calendar yearend. There was a great deal of pressure to have our revenue cycle completed by yearend and in the event of the holidays and all that kind of things, so it is quite normal for us to have in the sales environment like that to have an accumulation of orders at the end of the period and the resulting overflow if you will into inventory that then gets subsequently shipped in the following quarter and as well as an increase in AR and AP.

Hamed Khorsand - BWS Financial

Is there any change in the timeline for the two facilities being opened? The hospitals in Beijing and Guangzhou?

Roberta Lipson

No, I think that we are on course so far. Things are moving along nicely. As I mentioned, we are at the beginning of the process and so it is hard to say what will happen over the two and somewhat year in the development process of these two large projects, but we expect so far so good, we are moving along well.

Hamed Khorsand - BWS Financial

Your increase in patients visiting your hospitals during the quarter, is that coming from insurance allowances, what is driving that that patients are coming to you?

Roberta Lipson

Well, I think that as our brand becomes more and more well known as the Chinese economy continues to boom and more and more people can afford premium healthcare. We have and we will continue to see our patient numbers grow. There has been no change in the level of reimbursements or the amount of patients that are covered by insurance, except we do see a growing number of local Chinese patients being covered by insurances as insurance become more available in China, but in general, I think it is just following the trend of the product becoming better known. Our hospital brand becoming better known and improved economy here.

Operator

(Operator Instructions)

Our next question is coming from Anthony Petrone with Maxim Group.

Anthony Petrone - Maxim Group

Congratulations on the quarter. Just a couple of housekeeping here, what was the impact from foreign currency translation in the quarter?

Larry Pemble

Foreign currency translation, well if you look on the segment note, I think you can pull out the FEx gained in the quarter was $517,000.00.

Anthony Petrone - Maxim Group

In terms of moving on to da Vinci, in terms of the registrations there, is that for both generations of da Vinci, both the S and the standard generation?

Roberta Lipson

Right, the process right now we believe will end up at the end of the process with the S registration.

Anthony Petrone - Maxim Group

You have recently mentioned timetables on that and you mentioned you could see some impact in Mainland China before the end of the year, would you be expecting I guess to hear back from regulatory bodies before the second half?

Roberta Lipson

Our fiscal year is April 1 and so what we mentioned was that we will see revenues in the coming fiscal year as a result of the registration. There is a huge backlog at the FDA right now and it is hard to say exactly when we will see the paperwork, but we did just pass a really important hurdle and there was an expert committee review process. I think it was about a week ago and we passed that process, and now what is left is really documentary review and pushing the papers through the system and if there were no backlog, that would happen in three weeks, but we are not sure exactly when we will see those papers through, and there is no explaining or telling in advance what the delay will be so, we will be sure to let you know as soon as we get the approval in our hands.

Anthony Petrone - Maxim Group

I guess in the way of that, how much would you comparing I guess the sales force and how much marketing will you be doing upon approval or will you begin that process before?

Roberta Lipson

Well we have already been well into the process of educating the market. There is so much that we can do from an academic standpoint and our customers have been attending international meetings and hearing all about the great successes that 301 Hospital and also with our users in Hong Kong, so the market is well primed and our sales force is chomping at the bit.

Anthony Petrone - Maxim Group

Moving on, I was reading the transcript from last quarter and you have mentioned, or from several quarters ago about Chinese policy and an issue pushed there to consolidate the distribution industry, which is still fragmented with a lot of small distributors, one of the things you mentioned was the possibility that the government is pressuring small players by not renewing licenses, have you seen this trend develop at all and if not, what kind of changes are you seeing in the marketplace?

Roberta Lipson

Yes, so I do not have firm numbers on it, but I really do think it is a process that is happening and I have heard that there are little things about licenses not being renewed and certainly, they brave the bar for good distribution practices, a nice accreditation et cetera, for the distributors so it is harder and harder for some of these small groups to get approved.

Anthony Petrone - Maxim Group

Finally, on the license agreements, any new developments with additional license agreements and just to follow up what was the contribution from I guess the existing management agreement in Wuxi.

Roberta Lipson

Still no revenue contribution, they are still waiting for their final local approvals for opening.

Anthony Petrone - Maxim Group

Any additional developments with other clinics?

Roberta Lipson

Moving along on both the Pudong Clinic and Guangzhou clinic, with opening in sight for next quarter, meaning, our Q1 Fiscal 2008.

Operator

(Operator Instructions)

It appears we have no further questions, I would like to turn the floor back over to management for any closing comments.

Roberta Lipson

Well, I would like to thank you all for listening and hopefully, we can continue to issue sparkling reports quarter after quarter, thanks a lot and Happy Chinese New Year to you all.

Operator

Thank you, ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. We thank you for your participation.

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