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China Medical Technologies Q3 2005 Earnings Call (CMED)

February 13, 2006

Executives:

Tip Fleming, Investor Relations Advisor from Christensen

Charles Zhu, VP of Business Development and Investor Relations

Takyung (Sam) Tsang, Chief Financial Officer

Analysts:

Vicky Chen with UBS

Alex Baez with Neon

Alex Burk with Millennium Partners

Robin Kurtz with RJKurtz

Operator

Good day and welcome ladies and gentlemen to the September China Medical Technologies Earnings Conference Call. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. If at any time during the call, you require assistance press “*” followed by “0” and an operator will be more than happy to assist you. As a reminder ladies and gentlemen, this conference is being recorded for replay purposes. I’d now like to turn the call over to Tip Fleming, China Medical Investor Relations Advisor at Christensen. You may proceed.

Tip Fleming, Investor Relations Advisor, Christensen

Hello. I’m pleased to welcome you to China Medical’s 3rd Quarter earnings conference call. China Medical announced its 3rd quarter results two hours ago. If you have not seen it already, you may find a copy of the press release on the conference website at www.chinameditech.com.

Today, your speakers will be Charles Zhu, VP of IR and Business Development and Sam Tsang, China Medical’s CFO. After they finish with 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 contain will contain forward-looking statements made under the safe harbor provision of the US private securities 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 the public filings with the US Securities and Exchange commission. China Medical does not undertake any obligation to update any forward looking statements except when it’s required by applicable law. As a reminder, this conference call is being recorded. We will replay this conference call, and it will be available via web cast on China Medical’s website. Now, let me turn the call over to Charles Zhu.

Charles Zhu, VP of Business Development and Investor Relations

Thank you Tip. Hello everyone and welcome. Thank you for joining us on our 3rd quarter earnings call. The October to December period marks the third quarter of our fiscal year. Overall, we are pleased with our results and are continuing in the long term. Topline revenue increased 61.5% year over year and 25.4% from the previous quarter to $110.5 million. The net income increased 41.8% and 32.6%, respectively, to $56.9 million. Now I will go through the details of our results with your shortly. Before that I’d like to share with you some of the recent developments in our business.

For high intensity focus on . We’re investing more resources in R&D to improve and upgrade our HIFU technology. Our third generation HIFU machine that features a real time measurement function is on track and going through the clinical validation process now. We expect to commercially launch this product in 2006.

We are continually looking to develop new generations of HIFU products. Some of the areas we are currently researching are at locations that will allow the machines to treat an even broader range of humans while making treatment even more focused and precise.

While we are upgrading the functionalities of our HIFU systems, we are also concentrating on the ongoing clinical settings. We expect to reach an agreement with the Ministry of Health or MOH in China to and its long-term efficacy. It’s expected the MOH will designate about 30 leading hospitals in China to conduct studies using our HIFU system. The study will be leady by a group of medical practitioners in the Oncology field in China and we expect that the project will play a significant role in promoting the use of HIFU technology and increasing its acceptance levels among hospitals in China.

For enhanced chemiluminescence immunoassay or our ECLIA products, we continue to develop more immune agents. In addition to the agents we are studying right now, we have a number of additional reagents in development as well, including a test for HIV.

Development of our is on track and we aim to have that available by the end of this year. We believe that it will be well positioned to compete in both the high end and value product segments in China.

We have also been adding more distributors to sell our existing and future products in an effort to penetrate the Chinese market effectively. Right now, we have over 680 distributors across China and we are in the process of adding more. A very important initiative for our ECLIA business is to set up labs in large hospitals in each to ensure that reagents are used properly and to provide technical support to hospitals in the region. We believe this effort will help to enhance the acceptance rate of our analyzers, which is critical for the future growth of our ECLIA business.

At this time, I’d like to turn the call over to Sam so he can give you an overview of our third quarter results.

Takyung (Sam) Tsang, Chief Financial Officer

Thank you Charles and welcome everyone.

Most of you have seen our earnings release by now. I will try to keep my comments short. I will be happy to take your questions afterwards.

Our financial performance in the third quarter demonstrates our continued growth. We have revenues up 61.5% year over year and 25.4% sequentially to RMB$110.5 million or US $13.7 million. The company’s revenues are divided between our HIFU system and our ECLIA system, which includes sales of ECLIA Analyzers and reagent kits. Revenues from the sales of the company’s HIFU system were up 39.3%, year over year and 29.2% sequentially to RMB $76.6 million or US $9.5 million. The increase in HIFU system sales result from the increase awareness and acceptance of the company’s HIFU therapy system in the medical community as well as seasonality in the HIFU business. As discussed in our previous earnings call the December quarter is typically the best quarter for the sales of our HIFU therapy system in the financial year.

Revenue from the sales of the ECLIA system doubled year over year and increased 17.4% sequentially to RMB $33.7 million or US $4.3 million.

For the ECLIA year over year increased most likely because our system was accepted in the community after the product launch in September 2004. We will have substantially increased the number of distributors for our ECLIA system. The growth was primarily attributed to the increase in sales of ECLIA analyzers and increasing recurring revenue from the sales of our ECLIA analyzers and an increasing recurring revenues from the sales of ECLIA reagent kits that are used with our ECLIA analyzers. Currently, we offer 38 types of reagents kits and we are developing reagent kits for other applications.

Grow margin increased slightly to 70.4% this quarter from 69.8% in the previous quarter.

Our operating expenses increase more than three times, year over year and 74.4% sequentially to RMB 21.8 million or US $2.7 million. These increases in operating expenses were due primarily to the addition of headcount as the result of the expansion of operations since the commencement of our sales of ECLIA system in September 2004. In addition, we are in the initial stage of applying for US FDA approval four our HIFU therapy system. The costs associated with the start of these activities, as well as the costs related to continued corporate development for our HIFU therapy system, our ECLIA analyzer and reagents kits increased marketing activities and expenses incurred as a result of becoming a public company also contributed to the increase in operating expenses. Operating expenses as a percentage of revenues increased to 19.7% for this quarter.

Other income was up more than double year over year and RMB 3.8 million or US $0.5 million. The increase was primarily the result of several non-refundable grants that we received from the PRC government in recognition of the development of our HIFU therapy systems. Each one .

Interest income increased significantly to RMB 5.8 million or US $0.7 million. The increase was due primarily to interest income that was generated from the net proceeds receive from our initial public offering in August 2005.

Income tax expense increased to RMB 8.6 million or US$1.1 for this quarter. It increased primarily due to an increase in taxable income and the expiration of certain income tax concessions on December 31, 2004, which result in an increase of the income tax rate from 7.5% to 15%.

However, our PRC subsidiary received an approval from the tax authorities for the extension of its income tax concession. The income tax rate for the subsidiary is reduced from 15% to 10% for a period of three years, starting in January 2005. As a result of the tax concession received recently we will reverse the income tax accrual of December 31, 2005 of approximately RMB8.8 million or US$1.1 million and credit to our income tax expenses in our next quarterly consolidated financial statements.

As a result of the of the reversal I just mentioned, our net income increased 41.8% year over year and 32.6% sequentially to RMB56.9 million or US$7.1 million.

Our cash flow from operating activities was RMB38.1 million or US$4.7 million for this quarter. As of December 31, 2005, the company’s cash balance was RMB765.1 million of US $94.8 million.

Looking forward our full fiscal year results. We maintain our guidance on estimated annual revenues and net income. We believe our full year revenue will fall in a range that should be between RMB 360 million and RMB 400 million or US $44.6 million and US$49.6 million. Our full year net income should fall in a range between RMB175 million and RMB 190 million or US $21.7 million and US $23.5 million.

This concludes our remarks. Now we will be happy to take your questions.

Questions-and-Answer Sesssion

Operator:

Thanks. Ladies and gentlemen, if you wish to ask a question as this time, please press * “1” from your touch tone telephone. If that question has been answered or you wish to remove yourself from the cue, you may then press * “2”. Again, * “1” at this time for any questions.

And Sir we have a question from the line of Vicky Chen with UBS.

Vicky Chen.

Hi Charles, Sam. Happy New Year first and congratulations on the strong quarter. I just have a couple of questions. First of all, for HIFU, in terms of HIFU the new generation of HIFU Charles just mentioned, it’s going to be launched in 2006. Do you know which quarter that is going to be?

Sam Tsang.

Hi Nick its Sam. Because right now we are going through clinical validations, we want to try to collect more data to validate the software and the algorithms. But, we are confident that we can commercially launch this by end of calendar year 2006. But, there is some here, so we can not indicate the specific quarter to launch this. But as I mentioned, we’re confident that it should be available by the end of this year.

Vicky Chen.

And in terms of price, is it going to be a much higher price than the current one?

Sam Tsang.

Actually, it’s going to be an upgrade to the existing system and currently, we don’t expect to charge a premium price on this function.

Charles Zhu.

Actually, we have on the current price for our new gen3ration HIFU system.

Vicky Chen.

And a lot of the investors have also asked me some questions regarding your clinical study in the US. The status. Has the pre-clinical started?

Sam Tsang.

The one system has been installed in Washington for animal tests and the primarily investigator is actually in China to start the animal tests here first. And, right now, the status is we have completed the preparation for CIDE documentation and our legal counsel for is reviewing the document and we expect to submit the document in about 2-3 weeks. And, it will take a couple of weeks for the FDA to turn it around and after that we will schedule a meeting with the FDA officials to discuss the clinical and methodologies. We expect to start the human clinical trial after we get the approval, sometime third quarter of this calendar year.

Vicky Chen.

Third quarter calendar year of ’06, right?

Sam Tsang.

Right.

Vicky Chen.

And regarding your international sales of HIFU, also you previously talked about Korea approval. Has that, how is that going?

Sam Tsang.

For the Korean approval, we are still waiting for the current government. The was signed for the Korean market and they just informed us that they are being pressed by the Korean FDA to supply some supplementary documents. And we have , so we’re still waiting for the final clearance.

Vicky Chen.

Okay. And regarding ECLIA, in terms of sales breakdown between equipment and consumable, do you have a rough idea of what is the breakdown in terms of the percentage of sales generated by either equipment or consumables?

Sam Tsang.

This quarter we see equipment or analyzer sales composed about 60% of the total revenue. Sixty percent.

Operator:

Again ladies and gentlemen, as a reminder you may press * “1” to ask a question.

We have a question from the line of Alex Baez with Neon.

Alex Baez.

Hi, a quick question. What companies would you guide us to as being comparable type entities to yours?

Sam Tsang.

I’m sorry; could you repeat that question again?

Alex Baez.

Sure, what other listed comps would you suggest we look at to understand your company better?

Sam Tsang.

Other comparable companies? For the HIFU business, actually there is no direct, comparable company except one small company called EDAP, from France. They manufacture a designed HIFU system for treating prostate cancer only. And that’s the only listed company for HIFU business. For the ECLIA business, there are a lot of players in this field, including some of the large players like Roche, Bayer, Johnson & Johnson. Their product line is very diversified and their are much more bigger than us. In terms of the Chinese companies, there is no listed company directly comparable to us.

Operator:

Again ladies and gentlemen as a final reminder, please press * “1” to ask a question.

And Sir we have a question from the line, again from Vicky Chen.

Vicky Chen.

Yes. I think somehow the line was lost. I have some continuing questions regarding the tax rate. I think Sam you may be able to help me. You said the tax rate will be reduced 10% instead of 15%. So going forward does it mean the effective tax rate will be close to 10%, rather than close to 15%, which we previously seen in the ’06 fiscal year?

Sam Tsang.

Because we just received an approval document from which highlights the expired income tax concession is now extended for a third year, starting from January 2005. So, with this extension of income tax concession, the income tax rate for the company will be reduced from 15% to 10% for each fiscal year until the end of 2007.

Vicky Chen.

How likely is it, this 10% tax rate will continue from ’07 and onward?

Sam Tsang.

So, at the beginning of 2008, we are supposed to take 15% income tax rate.

Vicky Chen.

So that will just terminate, okay. Now, also, regarding your semi-automatic ECLIA system, when are you going to launch the new automatic equipment?

Charles Zhu.

It’s going to be ready by the end of this year.

Vicky Chen.

Calendar year ’06?

Charles Zhu.

Right.

Vicky Chen.

Okay. And I also saw your financial statement. It seems that general and administrative expenditures have increased significantly, as well as R&D. I understand R&D is probably partially attributable to the FDA preparation, but why GMA?

Sam Tsang.

It’s basically caused by expenses for the company because we added more people and we also had the expense accrual for the company.

Vicky Chen.

The last question and I just want to understand it correctly, is it right, correct, that the lockup expiration date is being postponed because you announced the earnings today. Is that within the period of 16 days of the end of initial lockup expiration day?

Sam Tsang.

Yeah, you’re right. has been extended to 30 March.

Vicky Chen.

30 March, okay. I have no further questions, thank you very much.

Operator:

And sir, our next question is from the Robert Eudid with Principal Capital.

Robert Eudid.

Thank you for taking my question. Could you give me an approximate split of your sales by geographies either from last fiscal year or on a year to date basis?

Charles Zhu.

Currently all the sales are in China. You are saying in terms of the geography, locations within China? To answer your questions, most of the HIFU sales, all the sales are in China. Particularly, we are focusing on the eastern region of China where most of the population is and are located.

Operator:

And Sir, our next question is from the line of Alex Baez with Neon.

Alex Baez.

Thank you. Could you just repeat the name of that HIFU comp? NDAP? Is that right?

Sam Tsang.

It’s EDAP.

Alex Baez.

EDAP. Thank you.

Operator:

And Sir, we have a question from the line of Alex Burk with Millennium Partners.

Alex Burk.

Hi. I have just a question about your balance sheet. It looks like the accounts receivable is a fairly large number. It looks like a quarter and a half of revenue. Could you explain what that is?

Sam Tsang.

Are you asking us…?

Alex Burk.

Your accounts receivable?

Sam Tsang.

Accounts receivable?

Alex Burk.

Yeah, usually you don’t see numbers that are quite that large.

Sam Tsang.

It’s quite normal, because you can see we generate $110.5 million revenue, if you account for the grow revenue, which includes there’s an increase in the accounts receivable from $116 million to $149 million; it’s a quite healthy increase in our accounts receivable. And currently we do not of any accounts in our accounts receivable and their .

Operator:

And Sir, our next question is from the line of Robin Kurtz with RJKurtz investments.

Robin Kurtz.

It seems to me that right now you’re developing products and the other part of what could be extremely valuable is that you’re building a sales and distribution network for the products. I’m wondering if in the future value to multinationals who want to market medical technology products in China, if that might also be an area of future growth? Could you give me a little color on that?

Sam Tsang.

I’m sorry, are you asking about the locking strategy for the global markets?

Robin Kurtz.

I’m thinking of multinationals who would like to market medical technologies for the distribution network. So you have the network now, you have distribution channels for your products. Wouldn’t that be a great way for these foreign multinationals to enter China?

Sam Tsang.

Currently, we are concentrating on adding more distributors for selling our own products. That’s our priority for the short term. And, of course, there’s some possibilities in the future that we might consider consolidating the distribution network and provide the distribution service for the other multinational companies that you mentioned. But that’s something in the long term.

Charles Zhu.

And it also depends on what kind of product the multinational wants to market. Because currently our HIFU and ECLIA system distributors are different. The sell to medium sized and large hospitals and other companies are selling to small hospitals with much smaller capital expenditures.

Operator:

And again ladies and gentlemen, one last reminder, * “1” for any questions, please. And gentlemen, we have no further questions at this time.

Tip Fleming.

Okay, thank you everyone for joining our call today. If you have any further questions please do not hesitate to contact me. Again my name is Tip Fleming, or contact Charles at China Medical. For a replay of the call, you can look on China Medical’s website. And that concludes our call today.

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Source: China Medical Technologies F3Q05 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (CMED)
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