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Chindex International 10-Q 2010 Documents found in this filing:Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
OR
For the quarterly period ended June 30, 2010
Commission file number 0-24624
CHINDEX INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
(301) 215-7777
(Registrant’s telephone number) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to the filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate website, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large
accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
The number of shares outstanding of each class of the registrant’s common equity, as of July
26, 2010, was 13,765,611 shares of Common Stock and 1,162,500 shares of Class B Common Stock.
CHINDEX INTERNATIONAL, INC.
INDEX
FORM 10-Q
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHINDEX INTERNATIONAL, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands except share data)
(Unaudited)
The accompanying notes are an integral part of these consolidated condensed financial statements.
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CHINDEX INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands except share and per share data)
(Unaudited)
The accompanying notes are an integral part of these consolidated condensed financial
statements.
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CHINDEX INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
The accompanying notes are an integral part of these consolidated condensed financial statements.
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CHINDEX INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the three months ended June 30, 2010
(in thousands except share data)
(Unaudited)
The accompanying notes are an integral part of these consolidated condensed financial statements.
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CHINDEX INTERNATIONAL, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of Chindex
International, Inc. (the “Company”) have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted in the United States
for complete financial statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have been included.
Operating results for the three months ended June 30, 2010 are not necessarily indicative of the
results that may be expected for the year.
References to “Chindex”, “we”, “us” and “our” refer to Chindex International, Inc. and
subsidiaries, unless the context otherwise requires.
For further information, refer to the consolidated financial statements and footnotes thereto
included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010.
Policies and procedures
FASB Accounting Standards Codification
The Financial Accounting Standards Board (FASB) has established the FASB Accounting Standards
Codification (ASC or Codification) as the single source of authoritative U.S. generally accepted
accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities.
Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of
federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB does
not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task
Force Abstracts. Instead, it issues Accounting Standards Updates, which serve to update the
Codification.
Consolidation
The consolidated condensed financial statements include the accounts of the Company, its
subsidiaries and variable interest entities in which the Company is the primary beneficiary, if
any. All intercompany balances and transactions are eliminated in consolidation.
Use of Estimates
The preparation of the consolidated condensed financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates, judgments, and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenue and expenses during the reporting period. Because of the use of estimates
inherent in the financial reporting process, actual results could differ from those estimates.
Areas in which significant judgments and estimates are used include revenue recognition, receivable
collectibility, inventory obsolescence, accrued expenses, deferred tax valuation allowances and
stock-based compensation.
Revenue Recognition
The Company earns revenue from providing healthcare services and sales of products.
Substantially all revenue in the Healthcare Services division is from providing services and
substantially all revenue in the Medical Products
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division is from the sale of products. (See Note 13 for further information on sales and
revenue, gross profit by division, and income (loss) from operations before foreign exchange.)
Revenue related to services provided by the Healthcare Services division is net of contractual
adjustments or discounts and is recognized in the period services are provided. The Healthcare
Services division makes an estimate at the end of the month for certain inpatients who have not
completed service. This estimate reflects only the cost of care up to the end of the month.
Revenue related to the sale of medical equipment, instrumentation and products to customers in
China by our Medical Products division is recognized upon product shipment. Revenue from sales to
customers in Hong Kong is recognized upon delivery. We provide installation, warranty, and training
services for certain of our capital equipment and instrumentation sales. These services are viewed
as perfunctory to the overall arrangement and are not accounted for separately from the equipment
sale. Costs associated with installation, training and standard warranty are not significant and
are recognized in cost of sales as they are incurred, while costs associated with non-standard
warranties are accrued. Revenue from the separate sale of extended warranties is deferred and
recognized over the warranty period. Sales involving multiple elements are analyzed and recognized
under the guidelines of SEC Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition” and ASC
605-25, “Revenue Recognition – Multiple Element Arrangements.” From time to time, the Company
supplies products and services to its customers which are delivered over time. In some cases, this
can result in deferral of revenue to future periods. Deferred revenue was $3,571,000 and $3,517,000
as of June 30, 2010 and March 31, 2010, respectively.
Additionally, the Company evaluates revenue from the sale of equipment in accordance with the
provisions of ASC 605-45, “Revenue Recognition – Principal Agent Considerations” to determine
whether such revenue should be recognized on a gross or a net basis. All of the factors in ASC
605-45 are considered with the primary factor being that the Company assumes credit and inventory
risk and therefore records the gross amount of all sales as revenue.
In the Healthcare Services division, our revenue is dependent on seasonal fluctuations related
to epidemiology factors and the life styles of the expatriate community in China. In the Medical
Products division, sales of capital equipment often require protracted sales efforts, long lead
times, financing arrangements and other time-consuming steps. As a result of these factors
impacting the timing of revenues, our operating results have varied and are expected to continue to
vary from period to period and year to year.
Recent Accounting Pronouncements:
In September 2009, the FASB ratified the consensus reached in EITF Issue No. 08-1, “Revenue
Arrangements with Multiple Deliverables,” now codified as Accounting Standards Update ASU 2009-13.
The EITF reached a consensus to eliminate the residual method of allocation and the requirement to
use the relative selling price method when allocating revenue in a multiple deliverable
arrangement. When applying the relative selling price method, the selling price for each
deliverable shall be determined using vendor specific objective evidence of selling price, if it
exists, otherwise third-party evidence of selling price. If neither vendor specific objective
evidence nor third-party evidence of selling price exists for a deliverable, the vendor shall use
its best estimate of the selling price for that deliverable when applying the relative selling
price method. The Company adopted the amendments in ASU 2009-13 on April 1, 2010. The adoption of
ASU 2009-13 did not have a material impact on our consolidated condensed financial statements.
In December 2009, FASB issued ASU 2009-17, “Consolidations (Topic 810) — Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities,” which codifies SFAS
No. 167, “Amendments to FASB Interpretation No. 46(R.)” ASU 2009-17 represents a revision to former
FASB Interpretation No. 46 (Revised December 2003), “Consolidation of Variable Interest Entities,”
and changes how a reporting entity determines when an entity that is insufficiently capitalized or
is not controlled through voting (or similar rights) should be consolidated. ASU 2009-17 also
requires a reporting entity to provide additional disclosures about its involvement with variable
interest entities and any significant changes in risk exposure due to that involvement. The Company
adopted ASU 2009-17 on
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April 1, 2010. The adoption of ASU 2009-17 did not have a material impact on our consolidated
condensed financial statements.
In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic
820) – Improving Disclosures about Fair Value Measurements.” This ASU requires new disclosures and
clarifies certain existing disclosure requirements about fair value measurements. ASU 2010-06
requires a reporting entity to disclose significant transfers in and out of Level 1 and Level 2
fair value measurements, to describe the reasons for the transfers, and to present separately
information about purchases, sales, issuances and settlements for fair value measurements using
significant unobservable inputs. The Company adopted ASU 2009-17 on April 1, 2010. The adoption of
ASU 2010-06 did not have a material impact on our consolidated condensed financial statements.
Note 2. INVESTMENTS
The following table summarizes the Company’s investments, including accrued interest, as of
June 30, 2010 and March 31, 2010 (in thousands):
The Company’s current investments as of June 30, 2010 include $33,513,000 of Certificates
of Deposit, with fixed interest rates between 0.15% and 2.25% issued by HSBC, a large international
financial institution, and by large financial institutions in China. The Company’s current
investments also include available-for-sale securities at fair value, which approximates cost, of
$2,956,000 issued by U.S. government-sponsored enterprises and corporate bonds of $2,586,000, which
mature within one year from the date of purchase. The Company’s current investments are recorded at
fair value, and the difference between fair value and amortized cost as of June 30, 2010 was de
minimis. The Company’s noncurrent investments consist of corporate bonds which mature in 13 to 23
months.
The Company’s current investments as of March 31, 2010 include $33,322,000 of Certificates of
Deposit with fixed interest rates between 0.15% and 2.25% issued by HSBC, and by large financial
institutions in China. The Company’s current investments also include available-for-sale securities
at fair value of $3,263,000 issued by U.S. government-sponsored enterprises and corporate bonds of
$622,000, which mature within one year from the date of purchase. The Company’s current investments
are recorded at fair value, and the difference between fair value and amortized cost as of March
31, 2010 was de minimis.
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Note 3. INVENTORIES, NET
The inventory valuation allowance for spare parts was $279,000 at June 30, 2010 and $276,000
at March 31, 2010. The allowance for sales demonstration inventory was $2,573,000 at June 30, 2010
and $2,397,000 at March 31, 2010.
Note 4. PROPERTY AND EQUIPMENT, NET
Construction in progress relates to the development of the United Family Healthcare
network of private hospitals and health clinics in China, including facilities and systems
development. Construction costs incurred during the three months ended June 30, 2010 primarily
related to the completion of the New Hope Oncology Center and expansion of the Company’s existing
Beijing hospital campus including facilities which will provide neurosurgical and orthopedic
surgery services. Capitalized interest on construction in progress in the three months ended June
30, 2010 was $35,000; no interest expense was capitalized in the comparable prior year period.
Depreciation and amortization expense for property and equipment for the three months ended June
30, 2010 and June 30, 2009 were $959,000 and $971,000, respectively.
Note 5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
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Note 6. DEBT
The Company’s short-term and long-term debt balances are: (in thousands)
Vendor financing – Product Sales
In the prior year, the Company had a financing agreement with a major vendor which has
expired. The final payment under the agreement is due in September 2010.
Line of credit - M&T Bank
The Company has a $1,750,000 credit facility with M&T Bank, and we had borrowings of $106,000
and $0, respectively, as of June 30, 2010 and March 31, 2010 under the facility. The borrowings
under that credit facility bear interest at 1.00% over the three-month London Interbank Offered
Rate (LIBOR). At June 30, 2010, the interest rate on this facility was 1.54%. Balances outstanding
under the facility are payable on demand, fully secured and collateralized by government securities
acceptable to the Bank having an aggregate fair market value of not less than $1,945,000. As of
June 30, 2010 and March 31, 2010, there were letters of credit outstanding in the amounts of
$441,000 and $186,000, respectively.
Long
term loan - IFC 2005
In October 2005, Beijing United Family Hospital (BJU) and Shanghai United Family Hospital
(SHU), majority-
owned subsidiaries of the Company, obtained long-term debt financing under a program with the
International Finance Corporation (IFC) (a division of the World Bank) for 64,880,000 Chinese
Renminbi (approximately $8,000,000). The term of the loan is 10 years at an initial interest rate
of 6.73% with the borrowers required to begin making payments into a sinking fund beginning in
September 2010. Deposits into the sinking fund will accumulate until a lump sum payment is made at
maturity of the debt in October 2015. The interest rate will be reduced to 4.23% for any amount of
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the outstanding loan on deposit in the sinking fund. The loan program also includes certain other
covenants which require the borrowers to achieve and maintain specified liquidity and coverage
ratios in order to conduct certain business transactions such as pay intercompany management fees
or incur additional indebtedness. As of June 30, 2010, the Company was in compliance. Chindex
International, Inc. guaranteed repayment of this loan. In terms of security, IFC has, among other
things, a lien over the equipment owned by the borrowers and over their bank accounts. In addition,
IFC has a lien over Chindex bank accounts not already pledged, but not over other Chindex assets.
As of June 30, 2010, the outstanding balance of this debt was 64,880,000 Chinese Renminbi (current
translated value of $9,554,000, see “Foreign Currency Exchange and Impact of Inflation”) classified
as long-term. At March 31, 2010, the outstanding balance was $9,505,000, classified as long-term.
As the annual deposits into the sinking fund do not extinguish a portion of the long-term debt
liability, the entire loan is expected to be classified as long-term until a financial reporting
date that is less than one year from final maturity. The balance sheet classification of the
sinking fund assets will similarly be noncurrent, until a date that is less than one year from the
lump sum payment.
Convertible Notes- JPM
On November 7, 2007, the Company entered into a securities purchase agreement with Magenta
Magic Limited, a wholly owned subsidiary of J.P. Morgan Chase & Co organized under the laws of the
British Virgin Islands (JPM), pursuant to which the Company agreed to issue and sell to JPM: (i)
538,793 shares (the “Tranche A Shares”) of the Company’s common stock; (ii) the Company’s Tranche B
Convertible Notes due 2017 in the aggregate principal amount of $25 million (the “Tranche B Notes”)
and (iii) the Company’s Tranche C Convertible Notes due 2017 in the aggregate principal amount of
$15 million (the “Tranche C Notes” and, with the Tranche B Notes, the “Notes”) at a price of $18.56
per Tranche A Share (for an aggregate price of $10 million for the Tranche A Shares) and at face
amount for the Notes for a total purchase price of $50 million in gross proceeds (the “JPM
Financing”).
The Tranche B Notes had a ten-year maturity, bore no interest of any kind and provided for
conversion into shares of the Company’s common stock at an initial conversion price of $18.56 per
share at any time and automatic conversion upon the Company entering into one or more newly
committed financing facilities (the “Facilities”) making available to the Company at least $50
million, pursuant to which Facilities all conditions precedent (with certain exceptions) for
initial disbursement had been satisfied, subject to compliance with certain JPM Financing
provisions. The Facilities as required for conversion of the Tranche B Note had to have a minimum
final maturity of 9.25 years from the date of initial drawdown, a minimum moratorium on principal
repayment of three years from such date, principal payments in equal or stepped up amounts no more
frequently than twice in each 12-month period, no sinking fund obligations, other covenants and
conditions, and also limit the purchase price of any equity issued under the Facilities to at least
equal to the initial conversion price of the Notes or higher amounts depending on the date of
issuance thereof. In January 2008, the Tranche B Notes were converted into 1,346,984 shares of our
common stock.
The Tranche C Notes have a ten-year maturity, bear no interest of any kind and are convertible
at the same conversion price as the Tranche B Notes at any time and will be automatically converted
upon the completion of two proposed new and/or expanded hospitals in China (the “JV Hospitals”),
subject to compliance with certain JPM Financing provisions. Notwithstanding the foregoing, the
Notes would be automatically converted after the earlier of 12 months having elapsed following
commencement of operations at either of the JV Hospitals or either of the JV Hospitals achieving
break-even earnings before interest, taxes, depreciation and amortization for any 12-month period
ending on the last day of a fiscal quarter, subject to compliance with certain JPM Financing
provisions.
The JPM Financing was completed in two closings. At the first closing, which took place on
November 13, 2007, the Company issued (i) the Tranche A Shares, (ii) the Tranche B Notes and
(iii) an initial portion of the Tranche C Notes in the aggregate principal amount of $6 million,
with the closing of the balance of the Tranche C Notes in the
aggregate principal amount of $9 million subject to, among other things, the approval of the
Company’s stockholders. At the second closing, which took place on January 11, 2008, following such
stockholder approval, the Company issued such balance of the Tranche C Notes.
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In connection with the issuance of the Notes, the Company incurred issuance costs of $314,000,
which primarily consisted of legal and other professional fees. Of these costs, $61,000 is
attributable to the Tranche A shares, $159,000 is attributable to Tranche B Notes which converted
in January 2008 and the remaining of $94,000 is attributable to the Tranche C Notes and has been
capitalized to be amortized over the life of the Notes. As of June 30, 2010 and March 31, 2010, the
unamortized financing cost was $69,000 and $71,000, respectively, and is included in “Other
Assets.”
The Company accounts for convertible debt in accordance with the provisions of ASC
470-20. Accordingly, the Company recorded, as a discount to convertible debt, the
intrinsic value of the conversion option based upon the differences between the fair value of the
underlying common stock at the commitment date and the effective conversion price embedded in the
note. Debt discounts under these arrangements are usually amortized over the term of the related
debt to their stated date of redemption. So, in respect to the Notes, this debt discount would be
amortized through interest expense over the 10 year term of the Notes unless earlier converted or
repaid. In fiscal 2008, under this method, the Company recorded (i) a discount on the Tranche B
Notes of $2,793,000 against the entire principal amount of the Notes; and (ii) a discount on the
Tranche C Notes of $2,474,000 against the entire principal amount of the Notes.
The debt discount pursuant to the Notes as of June 30, 2010 and March 31, 2010 was $1,850,000
and $1,912,000, respectively. Amortization of the discount was approximately $62,000 and $61,000
for three months ended June 30, 2010 and 2009, respectively.
Loan Facility- IFC 2007
The Company has a loan agreement with IFC (the “IFC Facility”), designed to provide for loans
(the “IFC Loans”) in the aggregate amount of $25 million to expand the Company’s United Family
Hospitals and Clinics network of private hospitals and clinics in China, subject to the
satisfaction of certain disbursement conditions, including the establishment of Joint Venture
entities (the “Joint Ventures”) qualified to undertake the construction, equipping and operation of
the proposed healthcare facilities, minimum Company ownership and control over the Joint Ventures,
the availability to IFC of certain information regarding the Joint Ventures and other
preconditions. The IFC Loans would fund a portion of the Company’s planned $105 million total
financing for the expansion program. There can be no assurances that the preconditions to
disbursements under the IFC Facility will be satisfied or that, in any event, disbursements under
the IFC Facility will be achieved. As of June 30, 2010, the IFC Facility was not available.
The IFC Loans would be made directly to the Joint Ventures. As of the date of this report, we
have experienced delays in the development timeline and certain changes in project scope for the
proposed healthcare facilities due to the fluctuations and uncertainties in the real estate markets
in China resulting from the global economic downturn and as a result the Joint Ventures have yet to
be formally approved. We entered into an amendment to the IFC Loans
in July 2010 extending the initial draw
down date to October 1, 2010. Nonetheless, draws under the IFC facility remain subject to lender
agreement to project scope, collateral and other provisions. As initially negotiated, the term of
the IFC Loans would be 9.25 years and would bear interest equal to a fixed base rate determined at
the time of each disbursement of LIBOR plus 2.75% per annum. The interest rate may be reduced to
LIBOR plus 2.0% upon the satisfaction of certain conditions. The loans would include certain other
covenants that require the borrowers to achieve and maintain specified liquidity and coverage
ratios in order to conduct certain business transactions such as pay intercompany management fees
or incur additional indebtedness. Mutual agreement or amendment of these terms will be required in
addition to the formation and approval of the Joint Ventures and finalization of conditions
precedent, as to which there can be no assurances.
The obligations of each borrowing Joint Venture under the IFC Facility would be guaranteed by
the Company pursuant to a guarantee agreement with IFC, would be secured by a pledge by the Company
of its equity interests in the borrowing Joint Ventures pursuant to a share pledge agreement by the
Company with IFC and would be secured pursuant to a mortgage agreement between each borrowing Joint
Venture and IFC.
The IFC Facility contains customary financial covenants, including maintenance of a maximum
ratio of liabilities to tangible net worth and a minimum debt service coverage ratio, and covenants
that, among other things, place limits on the Company’s ability to incur debt, create liens, make
investments and acquisitions, sell assets, pay dividends, prepay subordinated debt, merge with
other entities, engage in transactions with affiliates, and make capital expenditures. The IFC
Facility also contains customary events of default. As of June 30, 2010, the Company was in
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compliance with the loan covenants as amended.
Loan Facility- DEG 2008
Chindex China Healthcare Finance, LLC (“China Healthcare”), a wholly-owned subsidiary of the
Company, has a Loan Agreement with DEG-Deutsche Investitions und Entwicklungsgesellschaft (DEG) of
Cologne, Germany, a member of the KfW banking group, designed to provide for loans (the “DEG
Loans”) in the aggregate amount of $20 million to expand the Company’s United Family Hospitals and
Clinics network of private hospitals and clinics in China (the “DEG Facility”), subject to
substantially the same disbursement conditions as contained in the IFC Facility. The DEG Loans
would fund a portion of the Company’s planned $105 million total financing for the expansion
program. There can be no assurance that the preconditions to disbursements under the DEG Facility
will be satisfied or that, in any event, disbursements under the DEG Facility will be achieved. As
of June 30, 2010, the DEG Facility was not available.
The DEG Loans would be made directly to the Joint Ventures. As of the date of this report, we
have experienced delays in the development timeline and certain changes in project scope for the
proposed healthcare facilities due to the fluctuations and uncertainties in the real estate markets
in China resulting from the global economic downturn and as a result the formal Joint Venture
entities have yet to be formally approved. We entered into an amendment to the DEG Loans
in July 2010 extending the initial draw down date to October 1, 2010. Nonetheless, draws under the
DEG Facility remain subject to lender agreement to project scope, collateral and other provisions.
As initially negotiated, the DEG Loans are substantially identical to the IFC Loans, having a
9.25-year term and an initial interest rate set at LIBOR plus 2.75%. Mutual agreement on or
amendment of these terms will be required in addition to the formation and approval of the Joint
Ventures and finalization of conditions precedent, as to which there can be no assurances.
The obligations under the DEG Facility would be guaranteed by the Company and would be senior
and secured, ranking pari passu in seniority with the IFC Facility and sharing pro rata with the
IFC in the security interest granted over the Company’s equity interests in the Joint Ventures, the
security interests granted over the assets of the Joint Ventures and any proceeds from the
enforcement of such security interests.
The Company’s guarantee of the DEG Facility contains customary financial covenants, including
maintenance of a maximum ratio of liabilities to tangible net worth and a minimum debt service
coverage ratio, and covenants that, among other things, place limits on the Company’s ability to
incur debt, create liens, make investments and acquisitions, sell assets, pay dividends, prepay
subordinated debt, merge with other entities, engage in transactions with affiliates, and make
capital expenditures. The DEG Facility contains customary events of default. As of June 30, 2010,
the Company was in compliance with the loan covenants as amended.
In connection with the issuance of the IFC and DEG Facilities, the Company incurred issuance
costs of $1,019,000, which primarily consisted of legal and other professional fees. These issuance
costs have been capitalized and will be amortized over the life of the debt. As of June 30, 2010,
the balance of the unamortized financing costs was$1,019,000 and is included in other assets.
Debt Payments Schedule and Restricted Cash
The following table sets forth the Company’s debt obligations and sinking fund requirements as
of June 30, 2010:
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Restricted cash of $2,648,000 as of June 30, 2010, primarily represents collateral
related to performance bonds issued in connection with the execution of certain contracts for the
supply of medical equipment in our Medical Products division. Scheduled expiration of these bonds
is from July 2010 through August 2014. Restricted cash of $3,024,000 as of March 31, 2010,
primarily represents collateral related to performance bonds issued in connection with the
execution of certain contracts for the supply of medical equipment in our Medical Products
division. Scheduled expiration of these bonds is from July 2010 through September 2011.
Note 7. TAXES
We recorded a $1,012,000 provision for taxes in the three months ended June 30, 2010 as
compared to a provision for taxes of $1,573,000 for the three months ended June 30, 2009. The
effective tax rate was calculated in accordance with ASC 740-270. Our tax expense includes the
effect of losses in entities for which we cannot recognize a benefit in accordance with the
provisions of ASC 270, “Interim Reporting” and ASC 740-270 and the effect of valuation allowance
for deferred tax assets.
We recognize interest and penalties related to uncertain tax positions in income tax
expense. As of June 30, 2010 and March 31, 2010, we had no accrued interest or penalties related to
uncertain tax positions.
Note 8. NET EARNINGS PER SHARE
The Company follows ASC 260, “Earnings Per Share,” whereby basic earnings per share excludes
any dilutive effects of options, restricted stock, warrants and convertible securities and diluted
earnings per share includes such effects. The Company does not include the effects of stock
options, restricted stock, warrants and convertible securities for periods when such an effect
would be antidilutive.
The following is a reconciliation of the numerators and denominators of the basic and diluted
Earnings per Share (EPS) computations for net income and other related disclosures:
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For the three months ended June 30, 2010 and 2009, there were 617,454 and 740,662 shares,
respectively, which were not included in the calculation of diluted net income per share as the
effect would have been antidilutive.
Note 9. STOCKHOLDERS’ EQUITY AND WARRANTS
Stock-Based Compensation
Compensation costs related to equity compensation, including stock options and restricted
stock, for the three months ended June 30, 2010 were $664,000 and for the three months ended June
30, 2009 were $689,000. No amounts relating to the share-based payments have been capitalized in
either the recent or prior periods
The Company generally grants stock options that vest over a three or four year period to
senior, long-term employees. Option awards are granted with an exercise price equal to the market
price of the Company’s stock on the date of grant. Stock options have up to 10-year contractual
terms. The Company recognizes expense ratably over the vesting period of the stock options or restricted stock, net of estimated forfeitures. The Company will record additional
expense if the actual forfeitures are lower than estimated and will record a recovery of prior
expense if the actual forfeitures are higher than estimated. During
the three months ended June 30, 2010, an adjustment of $320,000
was made to reduce stock-based compensation expense related to stock
options that were forfeited in the fourth quarter of the fiscal year
ended March 31, 2010. Management believes the impact of this is
immaterial to each applicable period.
The Company calculates grant-date fair values using the Black-Scholes option pricing model. To
calculate fair market value, this model utilizes certain information, such as the interest rate on
a risk-free security maturing generally at the same time as the expected life of the option being
valued and the exercise price of the option being valued. It also requires certain assumptions,
such as the expected amount of time the option will be outstanding until it is exercised or it
expires and the expected volatility of the Company’s common stock over the expected life of the
option.
There were no options granted during the three months ended June 30, 2010. The weighted
average fair value of options granted during the three months ended June 30, 2009 was $8.44.
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The following table summarizes the stock option activity during the three months ended June
30, 2010:
The aggregate intrinsic value on this table was calculated based on the positive
difference between the closing market price of the Company’s common stock on June 30, 2010 ($12.53)
and the exercise price of the underlying options.
During the three months ended June 30, 2010 and 2009, the total intrinsic value of stock
options exercised was $0 and $145,000 respectively. The actual cash received upon exercise of stock
options was $0 and $65,000 respectively. The unamortized fair value of the stock options as of June
30, 2010 was $3,383,000, the majority of which is expected to be expensed over the weighted-average
period of 2.07 years.
The total fair value of options vested during the three months ended June 30, 2010 and 2009
was $375,000 and $471,000, respectively.
The following table summarizes activity relating to restricted stock for the three months
ended June 30, 2010:
The weighted average remaining contractual term of the restricted stock, calculated based on
the service-based term of each grant, is approximately two years. As of June 30, 2010 and 2009, the
unamortized fair value of the restricted stock was $1,256,000 and $890,000, respectively. This
unamortized fair value is expected to be expensed over the weighted-average period of 2.25 years.
Restricted stock is valued at the stock price on the date of grant.
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Security Issuances – Warrants Exercised
The Company issued warrants in 2004 and 2005 in connection with the sale of common stock. No
additional warrants were issued in subsequent years. The balance of outstanding warrants was 0 and
131,425 as of June 30, 2010 and 2009, respectively.
The Company implemented EITF 07-5, “Determining Whether an Instrument (or an Embedded Feature)
is Indexed to an Entity’s Own Stock,” (included in ASC 815-40-15) effective April 1,
2009. EITF 07-5 provides that an entity should use a two-step approach to evaluate whether an
equity-linked financial instrument (or embedded feature) is indexed to its own stock, including
evaluating the instrument’s contingent exercise and settlement provisions. The Warrant Agreement
provided for adjustments to the purchase price for certain dilutive events, which included an
adjustment to the conversion ratio in the event that the Company made certain equity offerings in
the future at a price lower than the conversion prices of the warrant instruments. Under the
provisions of EITF 07-5, the warrants were not considered indexed to the Company’s stock because
future equity offerings or sales of the Company’s stock are not an input to the fair value of a
“fixed-for-fixed” option on equity shares, and equity classification is therefore precluded.
Accordingly, effective April 1, 2009, the warrants were recognized as a liability in the Company’s
consolidated balance sheet at fair value and were marked-to-market each reporting period.
The fair value of the warrants as of April 1, 2009, estimated to be $141,000, was recognized
as a cumulative effect of a change in accounting principle and charged against retained earnings,
based on the Black-Scholes formula using the following assumptions: exercise price of $6.07, the
Company’s stock price as of April 1, 2009 of $4.97, volatility of 76.8%, and discount rate of
1.67%. During the three months ended June 30, 2009, the estimated fair value of the warrants
increased to $882,000, primarily due to an increase in the Company’s stock price, and the change in
fair value of $741,000 was recorded in Miscellaneous (expense) income. The assumptions used in the
fair value calculation for the warrants as of June 30, 2009 were: exercise price of $6.07, Company
stock price as of June 30, 2009 of $12.37, volatility of 76.8%, and discount rate of 2.56%.
Due to exercises of the warrants in fiscal 2010, the Company no longer has warrants
outstanding as of June 30, 2010.
Note 10. STOCK PURCHASE AGREEMENT AND JOINT VENTURE
On June 14, 2010, the Company entered into a stock purchase agreement (the “Stock Purchase
Agreement”) with Fosun Industrial Co., Limited (the “Investor”) and Shanghai Fosun Pharmaceutical
(Group) Co., Ltd (the “Warrantor”). Pursuant to the Stock Purchase Agreement, the Company has
agreed to issue and sell to Investor up to 1,990,447 shares of the Company’s common stock
(representing approximately 10% of all outstanding common stock after such sale, based on the
number of outstanding shares as of the date of the Stock Purchase Agreement) at a purchase price of
$15 per share, for an aggregate purchase price of $30 million, the net proceeds of which are
expected to be used, among other things, to continue expansion of the Company’s United Family
Healthcare network.
The sale of the shares of common stock to Investor would be completed in two closings, each of
which would relate to approximately one-half of the shares to be purchased and be subject to
certain customary closing conditions, including that no material adverse change shall have occurred
with respect to the Company. In addition, the second closing is subject to the consummation of a
joint venture (the “Joint Venture”) between the parties to be comprised of the Company’s Medical
Products division and certain of Investor’s medical device businesses in China. The initial closing
is expected to occur in the second quarter of fiscal 2011 and the occurrence of the second
closing will depend on, among other things, the time required to consummate the Joint Venture. The
terms of the Joint Venture are outlined in a term sheet contained in the Stock Purchase Agreement
and remain subject to the negotiation and execution of definitive agreements. The Joint Venture is
expected to include equity participation bonus opportunities for existing Company executives in the
event of a qualified initial public offering or certain other events.
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At the initial closing under the Stock Purchase Agreement, the Company, Investor and Warrantor
would enter into a stockholder agreement (the “Stockholder Agreement”). Under the Stockholder
Agreement, until the first to occur of (i) Investor holds 5% or less of the outstanding shares of
common stock, (ii) there shall have been a change of control of the Company as defined in the
Stockholder Agreement, and (iii) the seventh anniversary of the initial closing, Investor has
agreed to vote its shares in accordance with the recommendation of the Company’s Board of Directors
on any matters submitted to a vote of the stockholders of the Company relating to the election of
directors and compensation matters and with respect to certain proxy or consent solicitations. The
Stockholder Agreement also contains standstill restrictions on Investor generally prohibiting the
purchase of additional securities of the Company. The standstill restrictions terminate on the same
basis as does the voting agreement above, except that the 5% standard would increase to 10% upon
the second closing. In addition, the Stockholder Agreement contains an Investor lock-up restricting
sales by Investor of its shares of the Company’s common stock for a period of five years following
the date of the Stockholder Agreement, subject to certain exceptions.
Upon the second closing under the Stock Purchase Agreement, Investor will have the right to,
among other things, nominate two representatives for election to the Company’s Board of Directors,
which will be increased to nine members, and pledge its shares, subject to certain conditions. In
order to induce Investor to enter into the proposed transaction and without any consideration
therefor, each of the Company’s chief executive, operating and financial officers, in their
capacities as stockholders of the Company, has agreed to certain limitations on his or her right to
dispose of shares of the Company’s common stock and to vote for the Investor’s board nominees.
Note 11. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office space, warehouse space, and space for hospital and clinic operations
under operating leases. Future minimum payments under these noncancelable operating leases consist
of the following (in thousands):
The above leases require the Company to pay certain pass through operating expenses and
rental increases based on inflation.
Rental expense was approximately $1,300,000 and $1,010,000 for the three months ended June 30,
2010 and 2009, respectively.
Note 12. FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a
framework and gives guidance regarding the methods used for measuring fair value, and requires
disclosures about fair value measurements. ASC 820 clarifies that fair value is an exit price,
representing the amount that would be received to sell an asset or paid
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to transfer a liability in
an orderly transaction between market participants. As such, fair value is a market-based
measurement that should be determined based on assumptions that market participants would use in
pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes a
three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
(Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than
the quoted prices in active markets that are observable either directly or indirectly; and (Level
3) unobservable inputs in which there is little or no market data, which require us to develop our
own assumptions. This hierarchy requires us to use observable market data, when available, and to
minimize the use of unobservable inputs when determining fair value.
The following table presents the balances of investment securities measured at fair value on a
recurring basis by level as of June 30, 2010 (in thousands):
As of June 30, 2010:
As of March 31, 2010:
The valuations of the investment securities are obtained from a financial institution
that trades in similar securities.
The carrying amounts reported in the consolidated balance sheet for cash and cash equivalents,
accounts receivable, accounts payable, and short-term vendor financing approximate fair value
because of the short-term maturity of these instruments.
The fair value of debt under ASC 820 is not the settlement amount of the debt, but is based on
an estimate of
what an entity might pay to transfer the obligation to another entity with a similar credit
standing. Observable inputs for the Company’s debt such as quoted prices in active markets are not
available, as the Company’s long-term debt is not publicly-traded. Accordingly, the Company has
estimated the fair value amounts using available market information and commonly accepted valuation
methodologies. However, it requires considerable judgment in interpreting market data to develop
estimates of fair value. Accordingly, the fair value estimate presented is not necessarily
indicative of the amount that the Company or holders of the debt instruments could realize in a
current market exchange. The use of different assumptions and/or estimation methodologies may have
a material effect on the estimated fair values.
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The fair value of the Company’s convertible debt was calculated based on an estimate of the
present value of the debt payments combined with an estimate of the value of the conversion option,
using the Black-Scholes option pricing model. For the Company’s other long-term debt, the fair
value was calculated based on an estimate of the present value of the debt payments. As of June 30,
2010, the carrying value of the Company’s convertible debt, net of debt discount, and the long-term
debt outstanding for the IFC 2005 RMB loan was $22.7 million, and the estimated fair value was
$26.5 million. The carrying amounts of the remaining debt instruments approximate fair value, as
the instruments are subject to variable rates of interest or have short maturities.
The Company previously reported the fair value of warrants outstanding as Level 3 liabilities.
Due to exercises of the warrants, the Company no longer has warrants outstanding as of June 30,
2010.
The following table provides a summary of changes in fair value of the Company’s Level 3
financial liabilities for the three months ended June 30, 2010 and June 30, 2009:
Note 13. SEGMENT INFORMATION
The Company operates in two businesses: Healthcare Services and Medical Products. The Company
evaluates performance and allocates resources based on income or loss from operations before income
taxes, not including foreign exchange gains or losses. All segments follow the accounting policies
described above in Note 1. The following segment information has been provided as per ASC 280,
“Segment Reporting” (in thousands):
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Statements contained in this quarterly report on Form 10-Q 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 currently
anticipated due to a number of factors, which include, but are not limited to, the factors set
forth under the heading “Risk Factors” and in other documents filed by the Company with the
Securities and Exchange Commission from time to time, including, without limitation, the Company’s
annual report on Form 10-K for the year ended March 31, 2010. 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 the Company believes that the expectations
reflected in the forward-looking statements are reasonable, the Company cannot guarantee future
results, levels of activity, performance or achievements. The Company has no obligation to update
these forward-looking statements.
Critical Accounting Policies
A summary of critical accounting policies is presented in Item 7, “Management’s Discussion and
Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” of the
Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2010.
RESULTS OF OPERATIONS
Quarter ended June 30, 2010 compared to quarter ended June 30, 2009
Overview of Consolidated Results
Our consolidated revenue for the three months ended June 30, 2010 was $41,488,000, a 8%
decrease from the three months ended June 30, 2009 revenue of $45,331,000. We recorded income from
operations of $1,895,000 for the recent quarter, as compared to income from operations of
$5,274,000 for the same quarter last year. We recorded net income of $836,000 for the recent
quarter, as compared to net income of $3,253,000 for the same quarter last year.
In the three months ended June 30, 2010, we incurred an unrealized foreign exchange loss of
$1,188,000 compared to an unrealized foreign exchange gain of $906,000 in the same quarter of the
prior year. As further described below, the unrealized exchange loss in the first three months of
fiscal 2011 was incurred in our Medical Products division and was primarily caused by the
substantial weakening of the Euro against the U.S. dollar during the period. This increased the
translated cost basis of U.S. dollar-denominated intercompany debt owed from our German subsidiary
to the Chindex U.S. parent. The loss recorded by the German subsidiary on the increased
intercompany debt was included in general and administrative expense. In the same quarter of the
prior year, the reverse situation occurred, as the Euro strengthened against the U.S. Dollar and
our German subsidiary recorded a gain on U.S. dollar intercompany debt. The Company does not hedge
intercompany debt which is expected to be settled in the course of ordinary business (see “Foreign
Currency Exchange and Impact of Inflation”).
Healthcare Services Division
This division operates the Company’s United Family Healthcare network of private hospitals and
clinics. United Family Healthcare currently owns and operates hospitals and affiliated clinic
facilities in the Beijing, Shanghai and Guangzhou markets. The division also operates a managed
clinic in the city of Wuxi, south of Shanghai. We have undertaken a number of market expansion
projects in our current markets. In Beijing, we expect to significantly increase service offerings
and more than double our available beds through expansion currently underway at our existing
hospital campus as well as from the opening of two additional affiliated clinics during the current
fiscal year. In Tianjin, a city
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just to the southeast of Beijing, United Family Healthcare has begun the development of a
maternity hospital facility of approximately 25 beds which is also expected to open in the current
fiscal year. In Shanghai, expansion projects are expected to include increased services at the
current hospital campus and the geographic expansion into the Pudong district with an affiliated
clinic established through a strategic joint venture management initiative during the current
fiscal year. In Guangzhou, the Company intends to build a main 125-bed hospital facility expected
to open in fiscal 2013. The Chinese Government’s healthcare reform program encourages private
investment, such as Chindex’s United Family Healthcare, as the primary source for development of
specialty and premium healthcare services within the Chinese healthcare system.
For the three months ended June 30, 2010, revenue from the division was $24,749,000, an
increase of 12% over the three months ended June 30, 2009 revenue of $22,048,000. (For information
on how the timing of our revenue may be affected by seasonality and other fluctuations, see “Timing
of Revenues”). The increased revenue is substantially attributable to growth in patient services in
the Shanghai market. In the Beijing market, revenue was approximately the same as the prior year
due to the effect of expansion construction projects on the hospital campus. We expect the negative
impact of the expansion work to continue through the opening of the new facilities, currently
planned for late in 2010. In the Guangzhou market, our clinic experienced significant growth in its
first full year of operations.
Expenses for the Healthcare Services division for the three months ended June 30, 2010 was
$20,092,000, a increase of 12% from the three months ended June 30, 2009 expenses of $17,923,000,
primarily due to increases in the expenses for salaries ($884,000), facility rent ($749,000), bad
debt ($500,000) and direct patient care ($298,000), offset by a decrease in business tax expense
($1,109,000). During 2009, the Chinese government revised its Business Tax regulations to clarify
that for-profit healthcare services entities are exempt from the previously-assessed five percent
business tax on revenues, retroactive to January 1, 2009, with continuing exemption for future
periods. Salary expense represented 46.1% of division revenue in the recent period and 45.8% of
revenue in the prior period. Cost allocated from the parent company to the division decreased
$59,000, primarily for stock based compensation.
During the three months ended June 30, 2010, the development and start up expenses, including
post-opening operating losses, for the division were $388,000 compared to $329,000 in the prior
period, reflecting primarily results in Guangzhou clinic operations and Beijing expansion
expenses.
The Healthcare Services division had income from operations after corporate allocations and
before foreign exchange gains of $4,657,000 for the three months ended June 30, 2010 compared to
$4,125,000 for the three months ended June 30, 2009.
Medical Products Division
This division markets, distributes and sells select medical capital equipment, instrumentation
and other medical products for use in hospitals in China and Hong Kong on the basis of both
exclusive and non-exclusive agreements with the manufacturers of these products. The division
revenues are generated through a nation-wide direct sales force that also manages local sub-dealers
regionally throughout the country. The division’s distribution business provides supply chain
management and logistics services to both divisions of the Company. Divisional growth is expected
through increasing sales of our existing product portfolio, the addition of new product lines and
the continued offering of government-backed financing instruments to our customers in China.
For the three months ended June 30, 2010, this division had revenue of $16,739,000, a 28%
decrease from revenue of $23,283,000 for the three months ended June 30, 2009. The change in
revenue was primarily due to a reduction in revenue recognized under government-backed loan
programs, with $63,000 recognized in the current period compared to $3,513,000 in the prior period,
the continuing impact of Chinese government regulatory review of import approvals for sales of our
robotic surgical systems to public hospital customers in China as well as yet to be released
pricing standards for consumable products related to the robotic systems and delays in expected
sales of diagnostic ultrasound systems in the Hong Kong market.
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In general, we continue to experience a slow down in customer purchases due to uncertainties
about the timing of Chinese government spending under the ongoing healthcare reform program
announced in April 2009. However, we expect our revenue performance to improve significantly in
the coming quarters of this fiscal year. Specifically we expect the Chinese government to release
approvals for purchases of our robotic surgical systems to People’s Liberation Army and public
hospital customers during the fiscal year and that the order flow for robotic surgical systems will
achieve our announced expectation of one to two systems per quarter on average over time. We
believe the Chinese Government’s ongoing healthcare reform program continues to positively impact
the market for medical devices from bottom to top and serve to deepen our market penetration in the
medium term.
Gross profit for the Medical Products division decreased to $5,095,000 for the three months
ended June 30, 2010 from $5,814,000 for the three months ended June 30, 2009. As a percentage of
revenue, gross profit from the Medical Products division was 30%, a 5% increase compared to 25% for
the same period last year. Gross profit margins for the division vary from period to period,
depending primarily on the relative mix of sales across product lines.
Expenses for the Medical Products division increased 20% to $6,669,000 for the three months
ended June 30, 2010 from $5,571,000 for the three months ended June 30, 2009, including increases
in selling expenses ($424,000) and salary expense ($97,000). Cost allocated from the parent company
to the division increased $519,000, primarily including stock based compensation ($452,000).
The division had a loss from operations before foreign exchange of $1,574,000 for the three
months ended June 30, 2010, compared with income from operations before foreign exchange of
$243,000 for the three months ended June 30, 2009.
Other Income and Expenses
Interest expense during the recent quarter was $208,000 as compared to interest expense of
$273,000 in the same quarter of the prior year due to decreases of short-term debt and
capitalization of interest.
Interest income during the recent quarter and prior period was $165,000 and $472,000,
respectively, primarily due to lower interest rates on the investments.
Miscellaneous expense during the recent quarter was $4,000 and prior period was $647,000. The
expense in the prior period was substantially due to the change in fair value of warrants of
$741,000.
Taxes
We recorded a provision of $1,012,000 for taxes in the three months ended June 30, 2010, as
compared to a provision for taxes of $1,573,000 for the three months ended June 30, 2009. The
effective tax rate in the current period was 54.8%. In the three months ended June 30, 2009, the
effective tax rate was 32.6%. Compared to the prior period, the effective tax rate increased primarily due to increases in losses in entities for which we cannot recognize a tax benefit.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth our cash, investments, and accounts receivable as of June 30,
2010 and March 31, 2010 (in thousands):
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The following table sets forth a summary of our cash flows from operating activities for
the three months ended June 30, 2010 and 2009 (in thousands):
The following table sets forth a summary of our cash flows from investing activities for
the three months ended June 30, 2010 and 2009 (in thousands):
The following table sets forth a summary of our cash flows from financing activities for
the three months ended June 30, 2010 and 2009 (in thousands):
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In December 2007, we entered into a loan agreement with IFC (the “IFC Facility”) that
provides for loans in the aggregate amount of $25 million directly to our future healthcare joint
ventures in China (the “IFC Loans”), subject to the satisfaction of certain disbursement
conditions, including the establishment of joint venture entities (the “Joint Ventures”) qualified
to undertake the construction, equipping and operation of the proposed healthcare facilities,
minimum Company ownership and control over the Joint Ventures, the availability to IFC of certain
information regarding the Joint Ventures and other preconditions. There can be no assurances that
the preconditions to disbursements under the IFC Facility will be satisfied or that, in any event,
disbursements under the IFC Facility will be achieved. As of the date of this report, we have
experienced delays in the development timeline and certain changes in project scope for the
proposed healthcare facilities due to the fluctuations and uncertainties in the real estate markets
in China resulting from the global economic downturn, and as a result the formal Joint Ventures
have yet to be finally approved. We entered into an amendment to the IFC Loans in July 2010 extending the
initial draw down date to October 1, 2010. Nonetheless, draws under the IFC Facility remain subject
to the lender agreement as to project scope, collateral and other provisions. As initially
negotiated, the term of the IFC Loans would be 9.25 years and would bear interest equal to a fixed
base rate determined at the time of each disbursement of LIBOR plus 2.75% per annum. The interest
rate may be reduced to LIBOR plus 2.0% upon the satisfaction of certain conditions. The loans would
include certain other covenants that require the borrowers to achieve and maintain specified
liquidity and coverage ratios in order to conduct certain business transactions such as pay
intercompany management fees or incur additional indebtedness. Mutual agreement or amendment of
these terms will be required in addition to the formation and approval of the Joint Ventures and
finalization of conditions precedent, as to which there can be no assurances. The obligation of
each borrowing joint venture under the IFC Loans would be guaranteed by the Company. In terms of
security, IFC would have, among other things, a pledge of the Company’s equity interest in the
borrowing joint ventures and a lien over the equipment owned by the borrowing joint ventures, as
well as a lien over their bank accounts. As of June 30, 2010, the IFC Facility was not available.
We have a loan agreement with DEG-Deutsche Investitions und Entwicklungsgesellschaft (DEG) of
Cologne, Germany (a member of the KfW banking group) (the “DEG Facility”) providing for loans in
the aggregate amount of $20 million for our future healthcare joint ventures in China (the “DEG
Loans”), subject to substantially the same disbursement conditions as contained in the IFC
Facility. There can be no assurance that the preconditions to disbursements under the DEG Facility
will be satisfied or that, in any event, disbursements under the DEG Facility will be achieved. As
of the date of this report, we have experienced delays in the development timeline and certain
changes in project scope for the proposed healthcare facilities due to the fluctuations and
uncertainties in the real estate markets in China resulting from the global economic downturn, and,
as a result, the formal Joint Ventures have yet to be finally approved. We entered into an
amendment to the DEG Loans in July 2010 extending the initial draw down date to October 1, 2010. Nonetheless,
draws under the DEG Facility remain subject to the lender agreement as to project scope, collateral
and other provisions. As initially negotiated, the DEG Loans are substantially identical to the IFC
Loans, having a 9.25-year term and an initial interest rate set at LIBOR plus 2.75%. Mutual
agreement on or amendment of these terms will be required in addition to the formation and approval
of the Joint Ventures and finalization of conditions precedent, as to which there can be no
assurances. The DEG Loans would also be made directly to one or both of the future healthcare joint
ventures in China, neither of which has been formed yet. The obligations under the DEG Loans would
also be guaranteed by the Company and would be senior and secured, ranking pari passu in seniority
with the IFC Loans and sharing pro rata with the IFC Loans in the security interest granted over
the Company’s equity interests in the future healthcare joint ventures, the security interests
granted over the assets of the borrowing joint ventures and any proceeds from the enforcement of
such security interests. As of June 30, 2010, the DEG Facility was not available.
In October 2005, BJU and SHU obtained long-term debt financing under a program with the IFC.
As of June 30, 2010, the outstanding balance of this debt was 64,880,000 Chinese Renminbi (current
translated value of $9,554,000 and is classified as long-term). The term of the loan is 10 years at
an initial interest rate of 6.73% with the borrowers required to begin making payments into a
sinking fund beginning in September 2010. The interest rate will be reduced to 4.23% for any amount
of the outstanding loan on deposit in the sinking fund. The loan program also includes certain
other covenants which require the borrowers to achieve and maintain specified liquidity and
coverage ratios in order to conduct certain business transactions such as pay intercompany
management fees or incur additional indebtedness. As of June 30, 2010, the Company was in
compliance with the loan covenants as amended. Chindex International, Inc. guaranteed repayment of
this loan. In terms of security, IFC has, among other things, a lien over the equipment owned
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by the borrowers and over their bank accounts. In addition, IFC has a lien over Chindex bank
accounts not already pledged, but not over other Chindex assets.
We have a $1,750,000 credit facility with M&T Bank, and we had borrowings of $106,000 and $0,
respectively, as of June 30, 2010 and March 31, 2010 under the facility. The borrowings under that
credit facility bear interest at 1.00% over the three-month London Interbank Offered Rate (LIBOR).
At June 30, 2010, the interest rate on this facility was 1.54%. Balances outstanding under the
facility are payable on demand, fully secured and collateralized by government securities
acceptable to the Bank having an aggregate fair market value of not less than $1,945,000. As of
June 30, 2010 and March 31, 2010, there were letters of credit outstanding in the amounts of
$441,000 and $186,000, respectively.
Restricted cash of $2,648,000 as of June 30, 2010, primarily represents collateral related to
performance bonds issued in connection with the execution of certain contracts for the supply of
medical equipment in our Medical Products division. Scheduled expiration of these bonds is from
July 2010 through August 2014. Restricted cash of $3,024,000 as of March 31, 2010, primarily
represents collateral related to performance bonds issued in connection with the execution of
certain contracts for the supply of medical equipment in our Medical Products division. Scheduled
expiration of these bonds is from July 2010 through September 2011.
Over the two years, there have been continuing and significant disruptions in the world
financial, credit and foreign exchange markets including those in China. As of the date of this
report, we have not experienced significant negative impacts to operating activities as a result of
these events. We have taken steps to ensure the security of our cash and investment holdings
through deposits with highly liquid, global banking institutions and government-backed insurance
programs in the United States and elsewhere. Our daily operations in the Healthcare Services
division generate operating cash flows and have not been dependent upon credit availability. Our
patient base in our current facilities are by and large considered to be in the wealthiest segment
of society, for whom healthcare spending represents a very small percentage of their income and
therefore is expected to be less impacted by the economic slowdown and to the extent their assets
are affected, this will likely not impact their decision making on healthcare purchases. The UFH
development projects to establish and build hospitals in China are expected to be funded with
existing cash and credit facilities as described above, provided that there can be no assurances
that such facilities will be available or sufficient, that the preconditions to disbursements under
the facilities will be satisfied or that, in any event, disbursements under the IFC/DEG Facilities
will be achieved. Our Medical Products division is somewhat dependent upon credit availability for
the opening of bid and performance bonds and the extension of credit terms to our Chinese customers
through our government-backed financing packages. However, the budgeting and procurement cycle for
large capital purchases by our customers could be impacted by the economic slowdown or the Chinese
government reform and stimulus programs related to the health care industry in China. In general,
the recent periods’ results were negatively impacted by our customers uncertainties about the rate
of Chinese government spending under the healthcare reform program announced in April 2009.
Over the next twelve months we anticipate total capital expenditures of approximately $47
million related to the maintenance and expansion of our business operations.
In our three operating markets of Beijing, Shanghai and Guangzhou, our Healthcare Services
division plans capital expenditures of approximately $13.0 million for maintenance, development of
existing facilities and implementation of a new healthcare information system platform. In
addition, the expansion projects in the Beijing market are planned for capital expenditures of
approximately $34.0 million for construction and equipment. These expansions will be funded through
corporate capital reserves, cash flow from operations and limited short-term vendor financing
arrangements.
Our Medical Products division intends to finance approximately $100,000 in capital
expenditures for market expansion programs, including investment in equipment seeding programs from
cash flows from operations and corporate capital reserves.
In addition, as described above, we have raised capital reserves and established future debt
facilities, which are currently not available as described above, the principal purpose of which is
to fund expansion of our United Family
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Healthcare network. The expansion projects in the Beijing and Guangzhou markets are underway.
Due to the timing of the development process for the planned joint venture hospital in Guangzhou,
significant expenditures for that project are not expected until fiscal 2012 and beyond. There can
be no assurances that any of the foregoing projects will be completed, that the actual costs or
timing of the projects will not exceed our expectations or that the foregoing expected sources of
financing, including the IFC and DEG debt facilities, will be available or sufficient for any
proposed capital expenditures.
TIMING OF REVENUES
The timing of our revenue is affected by several factors.
In the Healthcare Services division, our revenue is dependent on seasonal fluctuations related
to epidemiological factors and the life styles of the expatriate community. For example, many
expatriate families traditionally take annual home leave outside of China during the summer months
of June through August.
In the Medical Products division, sales of capital equipment often require protracted sales
efforts, long lead times, financing arrangements and other time consuming steps, including delays
due to the Chinese government regulation of medical device sales. For example, many end users are
required to purchase capital equipment through a formal public tendering process, which often
entails an extended period of time before the sale can be completed. Further, in light of the
dependence by purchasers of capital equipment on the availability of credit, the timing of sales
may depend upon the timing of our or our purchasers’ abilities to arrange for credit sources,
including loans from local Chinese banks or financing from international loan programs such as
those offered by the U.S. Export-Import Bank and the German KfW Development Bank. In addition, a
relatively limited number of orders and shipments may constitute a meaningful percentage of our
revenue in any one period.
As a result of these factors impacting the timing of revenues, our operating results have
varied and are expected to continue to vary from period to period and year to year.
FOREIGN CURRENCY EXCHANGE AND IMPACT OF INFLATION
Because we receive over 65% of our revenue and generated 67% of our expenses within China, we
have foreign currency exchange risk. The Chinese currency (RMB) is not freely traded and is
closely controlled by the Chinese Government. The U.S. dollar (USD) has experienced volatility in
world markets recently. During the three month period ended June 30, 2010, the RMB increased
approximately 0.1% against the USD. During the same period, the Euro depreciated approximately
10.1% against the USD which resulted in unrealized exchange losses of $1,188,000 which are included
in general and administrative expenses on our consolidated condensed statements of operations.
This unrealized foreign exchange loss of $1,188,000, compared to an unrealized foreign
exchange gain of $906,000 in the prior year was primarily caused by the substantial weakening of
the Euro against the U.S. dollar during the period. This increased the translated cost basis of
U.S. dollar-denominated intercompany debt owed from our German subsidiary to the Chindex U.S.
parent. The Company does not hedge intercompany debt which is expected to be settled in the course
of ordinary business.
As part of our risk management program, we also perform sensitivity analyses to assess
potential changes in revenue, operating results, cash flows and financial position relating to
hypothetical movements in currency exchange rates. Our sensitivity analysis of changes in the fair
value of the RMB to the USD at June 30, 2010, indicated that if the USD uniformly increased in
value by 10% relative to the RMB, we would have experienced a 32% decrease in net income.
Conversely, a 10% increase in the value of the RMB relative to the USD at June 30, 2010, would have
resulted in a 45% increase in net income.
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Based on the Consumer Price Index, for the three months ended June 30, 2010, inflation in
China was 2.9% and inflation in the United States was 1.8%. The average annual rate of inflation
over the three-year period from 2008 to 2010 was 3.3% in China and 2.1% in the United States.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company holds the majority of all cash assets in 100% principal protected AA/Aa or higher
rated accounts. Therefore, the Company believes that its market risk exposures are immaterial and
reasonable possible near-term changes in market interest rates will not result in material
near-term reductions in other income, material changes in fair values or cash flows. The Company
does not have instruments for trading purposes. Instruments for non-trading purposes are operating
and development cash assets held in interest-bearing accounts. The Company is exposed to certain
foreign currency exchange risk (See “Foreign Currency Exchange and Impact of Inflation”).
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable
assurance that information required to be disclosed by us in the reports that we file or submit to
the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”), is recorded, processed, summarized and reported within the time periods
specified by the SEC’s rules and forms, and that information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure.
In accordance with Exchange Act Rules 13a-15(e) and 15d-15(e), we carried out an evaluation,
under the supervision and with the participation of management, including our Chief Executive
Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this report. Based on that evaluation, our
CEO and CFO have concluded that, as of the end of the period covered by this quarterly report on
Form 10-Q, the Company’s disclosure controls and procedures were effective to provide reasonable
assurance that information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in
the SEC’s rules and forms.
Changes in Internal Control over Financial Reporting
Our management, including our principal executive and principal financial officers have
evaluated any changes in our internal control over financial reporting that occurred during the
three months ended June 30, 2010, and has concluded that there was no change that occurred during
the three months ended June 30, 2010 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 1A. RISK FACTORS
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In addition to the other information set forth in this report, you should carefully consider
the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the
year ended March 31, 2010, which could materially affect our business, financial condition or
future results. The risks described in our Annual Report on Form 10-K are not the only risks facing
our Company. Additional risks and uncertainties not currently known to us or that we currently deem
to be immaterial also may materially adversely affect our business, financial condition and/or
operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. (RESERVED)
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
The exhibits listed below are filed as a part of this quarterly report:
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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