Exhibit 10.48

CHINDEX MEDICAL LIMITED

AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2011

AND FOR THE YEAR THEN ENDED

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Chindex Medical Limited

We have audited the accompanying consolidated balance sheet of Chindex Medical
Limited (the Company) as of December 31, 2011 and the related consolidated
statement of operations, stockholders’ equity, and cash flows for the year then
ended. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company’s internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Chindex
Medical Limited at December 31, 2011, and the consolidated results of its
operations and its cash flows for the year then ended, in conformity with U.S.
generally accepted accounting principles.

/s/ Ernst & Young Hua Ming

Beijing, PRC

March 9, 2012

 

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CHINDEX MEDICAL LIMITED

CONSOLIDATED BALANCE SHEET

(in thousands of U.S. Dollars except share data)

 

     December 31, 2011   ASSETS   

Current assets:

  

Cash and cash equivalents

   $ 23,025   

Restricted cash

     1,397   

Investments

     2,162   

Accounts receivable, less allowance for doubtful accounts of $1,676

     34,613   

Receivables from affiliates

     2,896   

Inventories, net

     33,178   

Deferred income taxes

     622   

Other current assets

     6,833      

 

 

 

Total current assets

     104,726   

Restricted cash

     12   

Investments in unconsolidated affiliate

     330   

Property and equipment, net

     11,634   

Noncurrent deferred income taxes

     3   

Trade name and trademarks

     4,457   

Prepaid land use rights and other assets

     1,825      

 

 

 

Total assets

   $ 122,987      

 

 

  LIABILITIES AND STOCKHOLDERS’ EQUITY   

Current liabilities:

  

Short-term debt and current portion of long-term debt

   $ 2,387   

Accounts payable

     19,152   

Payable to affiliates

     17,142   

Accrued expenses and other current liabilities

     17,187   

Deferred revenue

     3,186   

Income taxes payable

     887      

 

 

 

Total current liabilities

     59,941   

Long-term deferred revenue

     804   

Long-term deferred tax liabilities

     735      

 

 

 

Total liabilities

     61,480      

 

 

 

Commitments and contingencies

  

Stockholders’ equity:

  

Ordinary shares, HKD$10.00 par value, 20,000,000 shares authorized, including
10,000,000 designated Class A and 10,000,000 designated Class B:

  

Ordinary Shares, Class A: 7,650,000 shares issued and outstanding at
December 31, 2011

     9,815   

Ordinary Shares, Class B: 7,350,000 shares issued and outstanding at
December 31, 2011

     9,430   

Additional paid-in capital

     31,506   

Retained earnings

     7,921   

Accumulated other comprehensive income

     2,690      

 

 

 

Total Chindex Medical Limited stockholders’ equity

     61,362   

Noncontrolling interest stockholders’ equity

     145      

 

 

 

Total stockholders’ equity

     61,507      

 

 

 

Total liabilities and stockholders’ equity

   $ 122,987      

 

 

 

 

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CHINDEX MEDICAL LIMITED

CONSOLIDATED STATEMENT OF OPERATIONS

(in thousands of U.S. Dollars)

 

     Year Ended
December 31, 2011  

Revenues

   $ 126,778   

Cost of revenues

     89,273      

 

 

 

Gross profit

     37,505   

Selling, general and administrative expenses

     31,669   

Research and development expenses

     946      

 

 

 

Income from operations

     4,890   

Other income and (expenses)

  

Interest income

     214   

Interest expense

     (157 )    

 

 

 

Income before income taxes

     4,947   

Provision for income taxes

     (1,594 )    

 

 

 

Net income

     3,353   

Net income attributable to noncontrolling interest stockholders

     15      

 

 

 

Net income attributable to Chindex Medical Limited stockholders

   $ 3,338      

 

 

 

 

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CHINDEX MEDICAL LIMITED

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands of U.S. Dollars)

 

     Year Ended
December 31, 2011  

OPERATING ACTIVITIES

  

Net income

   $ 3,353   

Adjustments to reconcile net income to net cash (used in) operating activities:

  

Depreciation and amortization

     877   

Depreciation for demonstration inventory

     428   

Inventory provision

     80   

Provision for doubtful accounts

     (29 ) 

Loss on disposal of property and equipment

     32   

Deferred income taxes

     89   

Stock based compensation

     1,224   

Changes in operating assets and liabilities:

  

Restricted cash

     1,256   

Accounts receivable

     (2,009 ) 

Receivables from affiliates

     (2,896 ) 

Inventories

     (10,608 ) 

Other current assets and other assets

     (2,631 ) 

Accounts payable, accrued expenses, other current liabilities and deferred
revenue

     6,291   

Payable to affiliates

     1,177   

Income taxes payable

     220      

 

 

 

Net cash (used in) operating activities

     (3,146 ) 

INVESTING ACTIVITIES

  

Purchase of 46% noncontrolling interest in STT

     (6,088 ) 

Reduction in cash due to Qitian deconsolidation

     (29 ) 

Deposit received from FosunPharma

     20,000   

Refund of deposit received from FosunPharma

     (20,000 ) 

Purchases of property and equipment

     (2,605 )    

 

 

 

Net cash (used in) investing activities

     (8,722 ) 

FINANCING ACTIVITIES

  

Repayment of debt

     (633 )    

 

 

 

Net cash (used in) financing activities

     (633 ) 

Effect of foreign exchange rate changes on cash and cash equivalents

     312      

 

 

 

Net (decrease) in cash and cash equivalents

     (12,189 ) 

Cash and cash equivalents at beginning of year

     35,214      

 

 

 

Cash and cash equivalents at end of year

   $ 23,025      

 

 

 

Supplemental disclosures of cash flow information:

  

Cash paid for interest

   $ 157   

Cash paid for taxes

   $ 4,575   

Non-cash investing and financing activities consist of the following:

  

Property and equipment additions included in accounts payable

   $ 15   

The accompanying notes are an integral part of these consolidated financial
statements.

 

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CHINDEX MEDICAL LIMITED

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Year Ended December 31, 2011

(in thousands of U.S. Dollars, except share data)

 

                                 Additional
Paid-in
Capital     Retained
Earnings      Accumulated
Other
Comprehensive
Income      Noncontrolling
Interests     Total        Ordinary Shares      Ordinary Shares                 
   Class A      Class B                     Shares      Amount      Shares     
Amount               

Balance at December 31, 2010

     510         1         490         1         50,795        4,583         956
        5,237        61,573                            

 

 

 

Net income

     —           —           —           —           —          3,338        
—           15        3,353   

Foreign currency translation adjustment

     —           —           —           —           —          —          
1,734         7        1,741                            

 

 

 

Comprehensive income

     —           —           —           —           —          —           —  
        —          5,094                            

 

 

 

Issuance of shares

     7,649,490         9,814         7,349,510         9,429         (19,243 ) 
    —           —           —          —     

Stock-based compensation

     —           —              —           1,224        —           —          
—          1,224   

Acquisition of non-controlling interest in STT

     —           —           —           —           (1,270 )      —          
—           (4,817 )      (6,087 ) 

Deconsolidate Qitian due to equity interest below 50%

     —           —           —           —           —          —           —  
        (297 )      (297 )    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Balance at December 31, 2011

     7,650,000       $ 9,815         7,350,000       $ 9,430       $ 31,506     
$ 7,921       $ 2,690       $ 145      $ 61,507      

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial
statements.

 

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CHINDEX MEDICAL LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2011

1. BACKGROUND AND ORGANIZATION

Chindex Medical Limited (“CML” or “the Company”) is a joint venture that was
formed effective at the close of business on December 31, 2010, and it commenced
operations on January 1, 2011. CML was formed by Shanghai Fosun Pharmaceutical
(Group) Co., Ltd. (“FosunPharma”), a leading manufacturer and distributor of
western and Chinese medical devices throughout China and in export markets, and
by Chindex International, Inc. (“Chindex”), an American distributor of medical
products and provider of healthcare services in China. FosunPharma holds a 51
percent controlling equity interest in CML, while Chindex holds a 49 percent
equity interest in CML. The formation of the joint venture represents the basis
of a strategic alliance between the two companies, which aims to capitalize on
the long-term opportunity presented by growing medical product sectors
throughout China and abroad.

Business

CML is a joint venture formed to independently operate certain medical device
businesses, consisting initially of FosunPharma’s medical device companies and
Chindex’s Medical Products division (“MPD”). CML is focused on marketing,
distributing, selling and servicing medical devices in China and Hong Kong, as
well as activities in R&D and manufacturing of medical devices for the Chinese
and export markets.

The primary operating FosunPharma medical device companies contributed to the
CML joint venture were:

 

  •  

Shanghai Transfusion Technology (“STT”), a manufacturer and distributor of
devices for the collection of blood

 

  •  

Huaiyin, a manufacturer and exporter of sutures and surgical blades

 

  •  

Foshion Dental and Fuji Dental (90%-owned), distributors of dental equipment.

The primary operations contributed to the CML joint venture by Chindex consisted
of the former MPD division of Chindex, which included marketing, distribution,
sale, and service of select medical equipment, instrumentation and products for
use in hospitals in China and Hong Kong in the following areas:

 

  •  

Diagnostic color ultrasound imaging devices (primarily distribution of Siemens
medical equipment)

 

  •  

Robotic surgical systems and instrumentation (primarily the Intuitive da Vinci
robotic system)

 

  •  

Women’s health, including mammography and breast biopsy devices

 

  •  

Other areas, including lasers for cosmetic surgery.

The former Chindex MPD division operates from offices in the United States,
Germany, China and Hong Kong. In its role as an exporter from the United States
and Germany, the CML U.S. and German companies have been able, for certain
contracts, to facilitate government-backed financing packages for its Chinese
buyers.

In addition to the medical equipment described above, CML expects to continue to
expand the breadth of its product offerings over time, by a combination of
additional distribution agreements, development and manufacture of new products,
and potential acquisitions or strategic investments.

 

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Additional information on the organization, management, products and services of
the CML operating companies is available at www.chindexmedical.com.

Formation of the CML Joint Venture

On June 14, 2010, Chindex and FosunPharma entered into an agreement regarding
the formation of a joint venture, with Chindex contributing its Medical Products
division and FosunPhama contributing its medical device companies. The formation
of the proposed joint venture, Chindex Medical Limited., was conducted through a
series of definitive agreements as further described below.

Chindex Medical Limited, is a Hong Kong limited liability company that was
initially formed during 2010 as a 100%-owned subsidiary of Chindex
International, Inc. Chindex subsequently transferred the ownership of its legal
entities included in the Chindex Medical Products Division to CML. At the close
of business on December 31, 2010, the first closing (“Initial Closing”) of the
formation of the joint venture was completed, in which FosunPharma acquired a
51% ownership interest in CML for its contribution of a secured note of $20
million to the joint venture, which was paid in cash in January 2011. During the
period between the Initial Closing of the joint venture in December 2010 and the
issuance by the Chinese government of certain amended business licenses relating
to the FosunPharma-contributed businesses on June 24, 2011, CML legally
controlled and operated the FosunPharma medical device companies under an
Entrustment Agreement.

At the time of the Initial Closing, CML was the owner of the Chindex-contributed
businesses (MPD), but not the FosunPharma-contributed businesses. On August 30,
2011, following the payment by CML of the purchase price for the
FosunPharma-contributed businesses, CML became the holder of legal title to the
FosunPharma-contributed businesses. Notwithstanding this transfer and payment,
the registration with and approval of State Administration of Foreign Exchange
(“SAFE”) was required in order for CML to obtain certain of the rights and
benefits as shareholder of such businesses, including the right to receive
dividends declared by the FosunPharma-contributed businesses or the proceeds of
the sale of a company included in the FosunPharma-contributed businesses. Until
such registration was received on March 7, 2012, CML was entitled to such
benefits on a contractual basis under the Entrustment Agreement and other
agreements relating to the joint venture. Following and based on the receipt of
such registration on March 7, 2012, CML is entitled to such benefits as a matter
of Chinese law as the registered owner of the FosunPharma-contributed
businesses.

As of December 31, 2010, CML owned the Chindex-contributed businesses
(principally MPD) and was entitled to a pending and obligatory final investiture
of the FosunPharma-contributed businesses. The FosunPharma-contributed
businesses were segregated and, until the issuance of the amended business
licenses on June 24, 2011, were operated and managed by the joint venture under
the Entrustment Agreement. As of December 31, 2011, CML owns, operates and
manages both the Chindex-contributed businesses and the FosunPharma-contributed
businesses and is entitled to full management rights with respect to both the
Chindex-contributed businesses and the FosunPharma-contributed businesses. Upon
the completion of the registration with and approval of SAFE, CML became
entitled under Chinese law to receive dividends from and proceeds of any sale of
the FosunPharma-contributed businesses without regard to the Entrustment
Agreement. It is expected that the formal closing with respect to the
investiture of the FosunPharma-contributed businesses will occur and the
Entrustment Agreement will terminate in the first or second quarter of 2012.

 

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The joint venture arrangement provides that FosunPharma has a 51% controlling
voting interest, a majority of the Board of Directors, certain key management
roles, and other powers. Accordingly, FosunPharma has a controlling financial
interest in CML. Given that FosunPharma is the controlling stockholder of the
Company, the transfer of FosunPharma-contributed businesses was accounted for as
a transaction between entities under common control, with the net assets carried
over at historical costs and reflected in the historical financial statements of
the Company. The net assets related to the Chindex-contributed businesses were
recorded at fair value upon formation of the joint venture on December 31, 2010
because the transaction resulted in a change in control of the
Chindex-contributed businesses. The fair value of the net assets of MPD as of
December 31, 2010 were as follows (in thousands of U.S. Dollars):

 

Cash and short-term investments

   $ 27,606   

Accounts receivable

     24,017   

Inventories

     15,261   

Tradename and trademark

     4,457   

Other assets

     3,151      

 

 

 

Total assets

     74,492   

Accounts payable

     (15,758 ) 

Other liabilities

     (22,395 )    

 

 

 

Fair value of net assets

     36,339   

Book value of net assets

     31,882      

 

 

 

Excess of fair value over book value

   $ 4,457      

 

 

 

Trademark License

The Company was granted the right to use the “Chindex” name which is utilized in
the name of the joint venture, together with related trademarks. The brand name
and trademarks are owned by Chindex, which has granted a perpetual license to
the Company to use the brand name and trademark. The trademark license was
recognized as an intangible asset upon the formation of the Company and has been
recognized at its estimated fair value of $4,457,000. The license does not
require the payment of a royalty fee unless Chindex’s interest in the Company is
reduced below 30%. Since the license is non-exclusive and terminates only upon
(1) bankruptcy of the Company; (2) violation of the terms of the license
agreement; (3) breach of the minority rights provisions in the Joint Venture
Governance and Shareholders Agreement (the “Shareholders Agreement”); or (4) the
liquidation or dissolution of the Company, the Company believes that the license
would be viewed as a perpetual license as the Company does not have the
unilateral ability to terminate the license. Thus, the intangible asset has an
indefinite life for accounting purposes, and, accordingly, will not be amortized
but will be subject to periodic reviews for potential impairment.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Use of Estimates

The accompanying consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles (“U.S.
GAAP”).

 

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The preparation of consolidated financial statements in conformity with U.S.
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosures of contingent assets and
liabilities at the balance sheet dates and the reported amounts of revenues and
expenses during the reporting periods. Significant estimates and assumptions
reflected in the Company’s financial statements include, but are not limited to,
revenue recognition including estimates of selling prices for allocations of
multiple-deliverable contracts, allowance for doubtful accounts, useful lives of
property, plant and equipment, inventory obsolescence, accrued expenses,
deferred tax valuation allowances, and the valuation of the Company’s acquired
tangible and intangible assets. Actual results could materially differ from
those estimates.

Consolidation

The consolidated financial statements include the accounts of the Company and
its subsidiaries. The Company does not have interests in variable interest
entities. All intercompany balances and transactions are eliminated upon
consolidation. Entities in which the Company has less than a 50 percent
ownership interest in, or does not have a controlling financial interest, but is
considered to have significant influence are accounted for using the equity
method.

Foreign Currency Translation and Transactions

The Company’s subsidiaries determine their functional currencies to be the
Chinese Renminbi (“RMB”), HongKong Dollar (“HKD”) or Euros (“Euro”) based on the
criteria of ASC subtopic 830-10, Foreign Currency Matters, Overall. The Company
has elected to use the US dollar (“USD”) as its reporting currency. The Company
uses the monthly average exchange rate for the year and the exchange rate at the
balance sheet date to translate the operating results and financial position,
respectively. Translation differences are recorded in accumulated other
comprehensive income, a component of shareholders’ equity.

Transactions denominated in foreign currencies are translated into the
functional currency at the exchange rates prevailing on the transaction dates.
Foreign currency denominated financial assets and liabilities are remeasured at
the exchange rates prevailing at the balance sheet date. Exchange gains and
losses are included in the consolidated statement of operations.

Cash and Cash Equivalents

The Company considers unrestricted cash on hand, deposits in banks, certificates
of deposit, money market funds and short-term marketable securities with an
original or remaining maturity at the date of acquisition of three months or
less to be cash and cash equivalents.

Restricted Cash

Short-term and long-term restricted cash represent collateral required to be
maintained pursuant to certain contractual financing arrangements the Company
has entered into with certain financial institutions. Restricted cash is not
immediately available to the Company to meet its liquidity requirements (see
Note 9).

 

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Accounts Receivable and Allowance for Doubtful Accounts

The Company considers many factors in assessing the collectibility of its
receivables due from its customers, such as age of the amounts due, the
customer’s payment history, and credit-worthiness. An allowance for doubtful
accounts is recorded in the period in which collection of the amount is no
longer considered probable. Accounts receivable balances are written off after
all collection efforts have ceased.

Prepaid Land Use Rights

Prepaid land use rights represent amounts paid for the right to use land in the
People’s Republic of China (“PRC”) and are recorded at purchase cost less
accumulated amortization. Amortization is recorded on a straight-line basis over
the term of the land use rights agreement.

Acquired Intangible Assets and Impairment Testing of Long-Lived Assets and
Intangibles

Acquired intangible assets consist of the acquisition of the rights to use the
Chindex brand name and trademarks. The asset consists of a perpetual license and
was recorded at fair value at the inception of the CML joint venture, which was
also the date of acquiring control of CML. This intangible asset is not
amortized, but is subject to impairment testing. No impairment charge has been
recognized in 2011, as management did not believe that any events or
circumstances in 2011 indicated that the carrying amount of the assets might not
be fully recoverable.

The Company evaluates its long-lived assets or asset group including acquired
intangibles with finite lives for impairment whenever events or changes in
circumstances (such as a significant adverse change to market conditions that
will impact the future use of the assets) indicate that the carrying amount of a
group of long-lived assets may not be fully recoverable. When these events
occur, the Company evaluates the impairment by comparing the carrying amount of
the assets to future undiscounted cash flows expected to result from the use of
the assets and their eventual disposition. If the sum of the expected
undiscounted cash flows is less than the carrying amount of the assets, the
Company recognizes an impairment loss based on the excess of the carrying amount
of the asset group over its fair value, generally based upon discounted cash
flows. No impairment charge has been recognized in 2011, as management did not
believe that any events or circumstances in 2011 indicated that the carrying
amount of the assets might not be fully recoverable.

Revenue Recognition

The Company earns revenue primarily from sales of products used in healthcare
services. In recognizing revenue, the Company follows the four principles of
Staff Accounting Bulletin No. 104, Revenue Recognition. Revenue from product
sales is recognized when the title and risk of ownership has been transferred,
provided that persuasive evidence of an arrangement exists, the selling price is
fixed or determinable, collectability is reasonably assured and the remaining
obligations are insignificant, and not essential to functionality of the already
delivered items.

The evidence of an arrangement generally consists of an approved customer
contract and purchase order. Transfer of title and risk of ownership most often
occurs when the product is shipped to the customer or less frequently when the
customer receives the product. The selling price for all sales are fixed and
agreed to with the customer in advance prior to shipment and are based on
established price lists or agreed quotes. The Company’s customers have no return
rights or post-sale rights, other than limited warranty privileges.

 

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Revenue related to the sale of medical equipment, instrumentation and products
to customers in China is recognized upon product shipment or, in certain cases,
upon installation and/or acceptance by the end user when installation and/or
customer acceptance is deemed as substantive. Revenue from sales to customers in
Hong Kong is recognized upon delivery. We provide installation, standard
warranty, and training services for certain of our medical equipment and
instrumentation sales. These services are viewed as perfunctory to the overall
arrangement and are not accounted for separately from the equipment sale except
in the case of certain complex surgical systems where installation is considered
essential to the functionality of the equipment, in which case, revenue is
recognized upon the completion of the installation and receipt of customer
acceptance. Costs associated with installation, training and standard warranty
are not significant and are recognized in cost of sales as they are incurred.
Revenue from the sale of extended warranties is deferred and recognized over the
warranty period.

From time to time, the Company sells an extended warranty together with the
medical equipment. The Company also sells multiple medical equipment and
instrumentation and products together which are delivered over a period of time.
Such arrangements are treated as multiple-element arrangements with revenue
being allocated to each unit of accounting using relative fair value method in
accordance with ASC 605-25, Multiple-Element Arrangements and recognized under
the guidelines of Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition.

On January 1, 2011, the Company adopted ASU 2009-13 issued by the Financial
Accounting Standards Board for revenue arrangements with multiple-elements. The
Company adopted this guidance on a prospective basis applicable for transactions
originating or materially modified after the date of adoption. This guidance
changed the criteria for separating units of accounting in multiple-element
arrangements and the way in which an entity is required to allocate revenue to
these units of accounting. Revenue is allocated to each unit of accounting on a
relative fair value basis based on a selling price hierarchy. The selling price
for a deliverable is based on its vendor-specific objective evidence (“VSOE”) if
available, third party evidence (“TPE”) if VSOE is not available, or best
estimate of selling price (“BESP”) if neither VSOE nor TPE is available. The
Company determines VSOE primarily by considering the historical analysis of
stand alone sales contract for the products where it is the vendor. The Company
determines TPE primarily through use of market stand alone selling price
evidence obtained from the OEM of the products being valued. The Company
determines BESP by considering multiple factors including but not limited to,
competitive and market conditions, internal costs, gross margin objectives and
pricing practices. After considering all of these factors, BESP is established
using a cost-plus margin approach.

Additionally, the Company evaluates revenue from the sale of equipment and
products in accordance with the provisions of ASC 605-45, Principal Agent
Considerations, to determine whether such revenue should be recognized on a
gross or a net basis. Pursuant to ASC 605-45, the Company recorded the gross
amount of sales as revenue because the Company is the primary obligor in the
arrangement, the Company has credit and inventory risk and the Company has
latitude in establishing its own selling price. If the Company serves as only an
agent providing logistics services, it recognizes revenue on a net basis. For
the year ended December 31, 2011, the Company has recognized revenue of
approximately $511,000, on a net basis for its sales to a related party (see
Note 17) as the Company is not the primary obligor in these sales arrangements.

Shipping costs charged to customers are included in revenues and the associated
expense is included in cost of revenues in the consolidated Statement of
Operations. Shipping costs charged to customers are not significant for the
periods presented.

 

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Sales of medical equipment often require protracted sales efforts, long lead
times, contingent on customers qualifying for suitable external financing
arrangements, and other time-consuming steps. As a result of these factors
impacting the timing of orders and related revenues, and therefore our operating
results are expected to vary from period to period and year to year.

Deferred Revenue and Warranties

The Company provides its customers with the option to purchase an extended
warranty on certain equipment that it sells. We determine the deferred revenue
depending on whether the warranty is sold on a stand-alone basis or whether it
is sold as part of a multiple deliverable arrangement. For stand alone sales of
an extended warranty, the deferred revenue is amortized on a straight-line basis
over the warranty term. In multiple deliverable arrangements, in which a
customer purchases the equipment and an extended warranty, the deferred revenue
related to the warranty is determined based on relative selling prices, and the
deferred revenue is amortized on a straight line basis over the warranty term.

Inventories

Inventories include raw materials, work in progress, and finished goods,
including those purchased to fill executed sales contracts, consignments and
items that were stocked for future sales, including sales demonstration units
and service parts. Inventory is recorded at its actual cost when obtained, and a
monthly weighted average cost method is used for inventory on hand or issued
from inventory. At the end of each period, the inventory is recorded at the
lower of net realizable value and its historical cost. If the net realizable
value is less than the cost, the difference is charged to an inventory valuation
reserve. Inventory valuation is reviewed on a quarterly basis, and adjustments
are charged to the provision for inventory, which is a component of cost of
revenues. Demonstration inventories are depreciated over their useful life of
five years.

Property and Equipment

Property and equipment are stated at historical cost. The costs of additions and
improvements are capitalized, while maintenance and repairs are charged to
expense as incurred. Depreciation is computed on the straight line method over
the estimated useful lives of the related assets. Buildings are depreciated over
40 years. Useful lives for office equipment, vehicles and furniture and fixtures
range from 5 to 7 years. Leasehold improvements are amortized on the
straight-line method over the shorter of the estimated useful lives of the
improvements or the lease term.

Property, plant and equipment that are purchased or constructed which require a
period of time before the assets are ready for their intended use are accounted
for as construction-in-progress. Construction-in-progress is recorded at
acquisition cost, including installation costs and associated interest costs.
Construction-in-progress is transferred to specific property and equipment
accounts and commences depreciation when these assets are ready for their
intended use. The capitalization of interest costs, if any, commences when
expenditures for the asset have been made, activities that are necessary to get
the asset ready for its intended use are in progress and interest cost is being
incurred. The capitalization period ends when the asset is substantially
complete and ready for its intended use.

 

13

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The Company assesses the impairment of long-lived assets when indicators of
impairment are identified. The Company records impairment charges based upon the
difference between the fair value and carrying value of the original asset when
undiscounted cash flows indicate the carrying value will not be recovered. No
impairment losses have been recorded in the accompanying consolidated Statement
of Operations.

Income Taxes

The Company’s provision for income taxes is computed for each entity in the
consolidated group at applicable statutory rates based upon each entity’s income
or loss, giving effect to temporary and permanent differences.

In accordance with ASC 740, Income Taxes, provisions for income taxes are based
upon earnings reported for financial statement purposes and may differ from
amounts currently payable or receivable because certain amounts may be
recognized for financial reporting purposes in different periods than they are
for income tax purposes. Deferred income taxes result from temporary differences
between the financial statement amounts of assets and liabilities and their
respective tax bases. A valuation allowance reduces the net deferred tax assets
when it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The Company recognizes, in its consolidated
financial statements, the impact of a tax position if that position is not more
likely than not to be sustained upon examination, based on the technical merits
of the position. It is our policy to recognize interest and penalties related to
income tax matters provision for income taxes.

Stock-Based Compensation

CML does not grant stock options or provide any other share-based payments to
its employees. However, in cases where employees of Chindex provide services to
CML, the services agreement between CML and Chindex provides that certain
compensation costs (including monetary and nonmonetary) of the specific Chindex
employees will be charged to CML, which will include the cost of stock-based
compensation on a noncash basis, if applicable. In addition, certain former
Chindex employees that are now employees of CML retained options to purchase
Chindex’s common stock. These options are remeasured to fair value at each
reporting date with an adjustment for fair value recorded to the current period
expense in order to properly reflect the cumulative expense based on the current
fair value of the vested awards over the vesting periods. These costs are
recorded in the Company’s consolidated statement of operations as selling,
general and administrative expenses with a corresponding credit to additional
paid-in capital.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standard Board (“FASB”) issued ASU
No. 2011-05, Presentation of Comprehensive Income, ASU 2011-05 which eliminates
the current option to report other comprehensive income (OCI) and its components
in the statement of changes in stockholders’ equity. This guidance is effective
for the Company’s interim and annual periods after December 15, 2011. For
nonpublic entities, the amendments are effective for fiscal years ending after
December 15, 2012, and interim and annual periods thereafter, with early
adoption permitted. The Company will early adopted ASU 2011-05 effective for the
reporting period ending on December 31, 2012. This adoption will not have an
impact on the Company’s financial position, results of operations or cash flows
as it only requires a change in the format of the Company’s current
presentation.

 

14

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3. INVESTMENTS

The Company’s current investments as of December 31, 2011 include
available-for-sale securities at fair value of $2,162,000 of government bonds,
with fixed interest rate of 0.02% issued by M&T Bank, a large U.S. financial
institution. The Company’s current investments are recorded at fair value, and
the difference between fair value and amortized cost as of December 31, 2011 was
de minimis.

4. ACCOUNTS RECEIVABLE

(in thousands of U.S. Dollars)

 

     December 31, 2011  

Product sales, other than government - secured sales

   $ 23,686   

Government-secured sales

     12,603      

 

 

 

Product sales receivables

     36,289   

Less: Reserve for uncollectible accounts

     (1,676 )    

 

 

 

Net accounts receivable

   $ 34,613      

 

 

 

CML facilitates government-secured sales contracts to help hospitals in China
finance their purchases of medical equipment. CML serves as a facilitator only,
it does not borrow or loan money related to these projects and it does not
guarantee any of the government-secured financing. In the past, such financing
has included loans and loan guarantees from the U.S. Export-Import Bank and the
German KfW Development Bank as well as commercial financing that was guaranteed
by the Chinese Government but without foreign government participation.

5. INVENTORIES, NET

(in thousands of U.S. Dollars)

 

     December 31, 2011  

Inventories, net, consist of the following:

  

Merchandise and finish goods inventory, net

   $ 24,168   

Consignment inventory, net

     818   

Demonstration inventory, net

     949   

Raw materials

     2,240   

Work in process

     2,264   

Spare parts, net

     2,739      

 

 

     $ 33,178      

 

 

 

During the year ended December 31, 2011, the Company recognized $508,000 in
expense for inventory valuation, which included amortization of demonstration
inventory and provisions for obsolete or slow-moving inventories.

 

15

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6. INVESTMENT IN UNCONSOLIDATED AFFILIATE

As of January 1, 2011, investment in unconsolidated affiliates consisted of a
66.67 percent interest in Suzhou Qitian, a small manufacturing company in China.
In March 2011, the Company sold a 35 percent interest in Qitian to a third party
for consideration of RMB2,100,000, thereby reducing its ownership interest in
Qitian to 31.67 percent. As a result of the disposition, the Company no longer
had control of Qitian. Accordingly, Qitian was deconsolidated and is now
accounted for using the equity method. The gain or loss resulted from the
deconsolidation of Qitian was inconsequential. As of December 31, 2011, the
investment in Qitian was approximately $330,000, and net income recorded using
the equity method accounting by CML for its interest in Qitian was $2,000.

7. PROPERTY AND EQUIPMENT, NET

(in thousands of U.S. Dollars)

 

     December 31, 2011  

Property and equipment, net consists of the following:

  

Buildings

   $ 8,478   

Plant and machinery

     4,331   

Office equipment and furniture

     2,124   

Vehicles

     758   

Construction in progress

     1,352   

Leasehold improvements

     446      

 

 

       17,489   

Less: accumulated depreciation and amortization

     (5,855 )    

 

 

     $ 11,634      

 

 

 

Construction in progress relates to development projects underway in the Dental
subsidiaries in China. There was no capitalized interest recorded in the period,
as the amount would have been immaterial.

Depreciation and amortization expense for property and equipment for the year
ended December 31, 2011 was $877,000.

 

16

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8. PREPAID LAND USE RIGHTS AND OTHER ASSETS

(in thousands of U.S. Dollars)

 

     December 31, 2011  

Prepaid land use rights and other assets:

  

Prepaid land use rights - STT

   $ 780   

Prepaid land use rights - Huaiyin

     439      

 

 

       1,219   

Less: prepaid land use rights amortization

     (183 )    

 

 

       1,036   

Other assets

     789      

 

 

     $ 1,825      

 

 

 

The prepaid land use rights for Shanghai Transfusion Technology are for land
located in Shanghai. The purchase cost was $780,000, which is being amortized
over 48 years on a straight-line basis.

The prepaid land use rights for Huaiyin are for land located in Jiangsu
province, for its manufacturing operations. The purchase cost was $439,000,
which is being amortized over 50 years on a straight-line basis.

Other assets are primarily composed of security deposits in the amount of
approximately $608,000.

9. DEBT

The Company’s short-term and long-term debt balances are (in thousands):

 

     December 31, 2011        Short term      Long term  

Bank loan

   $ 1,905       $ —     

Line of credit

     482         —        

 

 

    

 

 

     $ 2,387       $ —        

 

 

    

 

 

 

Bank loan

For STT, the company has a loan from Bank of China for RMB 12 million
($1,905,000) with an interest rate of 6.56% per annum which is collateralized by
the five company buildings, and the term of the loan is from August 19, 2011 to
August 18, 2012.

Line of credit

CML has a $1,750,000 credit facility with M&T Bank. The borrowings under that
credit facility bear interest at 1.00% over the three-month London Interbank
Offered Rate (LIBOR). As of December 31, 2011, there was a $482,000 outstanding
loan balance under the facility. 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 December 31, 2011, there were $51,000 letters of credit
outstanding.

 

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Debt Payments Schedule and Restricted Cash

The following table sets forth the Company’s debt obligations as of December 31,
2011:

(in thousands of U.S. Dollars)

 

     Total      2012      2013      2014      2015      2016      Thereafter  

Bank loan

   $ 1,905       $ 1,905       $ —         $ —         $ —         $ —         $
—     

Line of credit

     482         482         —           —           —           —           —  
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,387       $ 2,387       $ —         $ —         $ —         $ —         $
—        

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Restricted cash of $1,409,000 as of December 31, 2011, consists of $1,397,000
for collateral for performance bonds issued in connection with the excution of
certain contracts for the supply of medical equipment. Such bonds are fully
collateralized and are required to be effective for the duration of the product
warranty period under the applicable contracts.

10. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following:

(in thousands of U.S. Dollars)

 

     December 31, 2011  

Accrued expenses:

  

Accrued expenses- goods received not invoiced

   $ 5,474   

Accrued compensation

     3,930   

Accrued expenses- other

     2,484   

Accrued taxes payable other than income tax

     1,029   

Customer deposits

     1,345   

Other current liabilities

     2,925      

 

 

     $ 17,187      

 

 

 

11. DEFERRED REVENUE

 

     December 31, 2011        Short term      Long term  

Deferred revenue, service contract and extended warranty

   $ 3,186       $ 804      

 

 

    

 

 

 

 

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12. STOCKHOLDERS’ EQUITY

Ordinary Stock and Stockholders’ Agreement

CML was incorporated as a limited liability company under the Hong Kong
Companies Ordinance. The authorized capital is HK$200 million divided into two
classes, designated as 10 million “A” ordinary shares of HK$10 each and
10 million “B” ordinary shares of HK$10 each. As of December 31, 2011, 7,650,000
Class A ordinary shares and 7,350,000 Class B ordinary shares have been issued
and are outstanding. The Class A shares have been issued to Ample Up Limited, a
Hong Kong subsidiary of FosunPharma. The Class B ordinary shares have been
issued to Chindex Medical Holdings (BVI) Limited, a subsidiary of Chindex, The
rights and power of the shareholders are enumerated in the stockholders’
agreement. The Class A shares and Class B shares have equal voting rights with
each share having one vote and equal economic rights in matters of dividend
distribution and liquidation.

Entrustment Agreement

From January 1, 2011 until June 24, 2011, the FosunPharma-contributed businesses
were managed by CML under the Entrustment Agreement (see Note 1).

Noncontrolling Interests

As of December 31, 2011, all of the subsidiaries of CML are wholly owned, with
the exception of one dental subsidiary which is 90% owned. During January 2011,
the Company purchased the 46% noncontrolling interest in STT for $6.1 million
which increased its ownership percentage to 100%. As of December 31, 2010, CML
owned a 66.67% interest in Suzhou Qitian. In March 2011, CML sold a 35%
ownership interest in Suzhou Qitian, reducing its ownership interest to 31.67%.
Since the ownership interest of CML in Suzhou Qitian was reduced below 50%,
Suzhou Qitian was deconsolidated, and the related noncontrolling interest was
eliminated from the CML consolidated financial statements.

Stock-Based Compensation

On December 31, 2010, CML was formed. In connection with the transaction,
certain employees of the Chindex became employees of CML. Those individuals that
transferred to CML retained 101,239 options to acquire Chindex’s common stock,
of which 62,353 options were vested and 38,886 were nonvested stock options
previously issued by Chindex. These costs are recorded in the Company’s
consolidated statement of operations as selling, general and administrative
expenses

 

19

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with a corresponding credit to additional paid-in capital. In addition, certain
Chindex employees provide services to the Company under a services agreement
between the Company and Chindex. A portion of their costs, including stock-based
compensation is charged to the Company. For the year ended December 31, 2011,
stock-based compensation charged to CML by Chindex International, Inc. was
$1,224,000. This amount consists of approximately $913,000 for services provided
by Chindex International, Inc. employees under a services agreement with CML and
approximately $311,000 for services provided directly by CML employees.

13. INCOME TAXES

Income before income taxes for the year ended December 31, 2011 was composed of
the following (in thousands of U.S. Dollars):

 

     December 31, 2011  

People’s Republic of China (PRC)

   $ 2,088   

Non-PRC

     2,859      

 

 

 

Total

     4,947      

 

 

 

For the year ended December 31, 2011, the provision for income taxes consists of
the following (in thousands):

 

     December 31, 2011  

Current:

  

PRC

   $ 1,157   

Non-PRC

     348      

 

 

 

Total current

     1,505   

Deferred:

  

PRC

     78   

Non-PRC

     11      

 

 

 

Total deferred

     89      

 

 

 

Total provision

   $ 1,594      

 

 

 

 

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For the year ended December 31, 2011, the provision for income taxes differs
from the amount computed by applying the PRC statutory income tax rate to the
Company’s income from operations before income taxes as follows:

 

     December 31, 2011  

Income tax expense at the China statutory rate

     25.0 % 

Foreign rate differentials

     (9.9 )% 

Change in valuation allowance

     8.7 % 

Other permanent differences

     8.4 %    

 

 

       32.2 %    

 

 

 

Deferred income taxes reflect the net tax effects of the temporary differences
between the carrying amounts of the Company’s assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company’s deferred tax assets and liabilities are
as follows as of December 31, 2011 (in thousands of U.S. Dollars):

 

     December 31, 2011  

Deferred tax assets, net:

  

Allowance for doubtful accounts

   $ 294   

Inventory

     657   

Accrued expenses

     734   

Net operating loss carryforwards

     741   

Depreciation and amortization

     3   

Other

     51      

 

 

       2,480   

Valuation allowance

     (1,855 )    

 

 

 

Deferred tax assets, net of valuation allowance

   $ 625      

 

 

 

The Company has losses from China of which approximately $2.7 million will
expire between 2012 and 2016.

Management assessed the realization of its deferred tax assets throughout each
of the quarters of the twelve month period ended December 31, 2011. Management
records a valuation allowance when it determines based on available positive and
negative evidence, that it is more likely than not that some portion or all of
its deferred tax assets will not be realized. The valuation allowance as of
December 31, 2011 was $1,855,000.

The new PRC Corporate Income Tax Law published in 2007 imposes a 10% withholding
income tax, subject to reduction based on tax treaty where applicable, for
dividends distributed by a foreign invested enterprise to its immediate holding
company outside China. Such dividends were exempted from PRC tax under the
previous income tax law and regulations. The foreign invested enterprise will be
subject to the withholding tax starting from January 1, 2008.

As of December 31, 2011, the Group intended to reinvest permanently the retained
earnings of its PRC subsidiaries. The amount of unrecognized deferred tax
liabilities for temporary differences related to investments in foreign
subsidiaries is not determined because such a determination is not practicable.

The Company’s tax expense reflects the impact of varying tax rates in the
different jurisdictions in which it operates. It also includes changes to the
valuation allowance as a result of management’s judgments and
estimates concerning projections of domestic and foreign profitability and the
extent of the utilization of net operating loss carry forwards. As a result, we
have experienced significant fluctuations in our world-wide effective tax
rate. Changes in the estimated level of annual pre-tax income, changes in tax
laws particularly related to the utilization of net operating losses in various
jurisdictions, and changes resulting from tax audits can all affect the overall
effective income tax rate which, in turn, impacts the overall level of income
tax expense and net income.

For the foreign jurisdictions, the Company is no longer subject to local
examinations by the tax authorities for years prior to 2006.

 

21

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As of December 31, 2011, the Company had no unrecognized tax benefits, nor did
it have any that would have an effect on the effective tax rate. The Company’s
policy is that it would recognize interest and penalties accrued on any
unrecognized tax benefits as a component of provision for income taxes. As of
December 31, 2011, the Company had no accrued interest or penalties related to
uncertain tax positions.

14. COMMITMENTS

Leases

CML and its subsidiaries lease office space and space for distribution and
manufacturing operations under operating leases. Future minimum payments under
these noncancelable operating leases as of December 31, 2011, consist of the
following: (in thousands):

 

Year ending December 31:

  

2012

   $ 1,408   

2013

     878   

2014

     772   

2015

     705   

Thereafter

     116      

 

 

 

Net minimum rental commitments

   $ 3,879      

 

 

 

Rental expense was approximately $1,779,000 for the year ended December 31,
2011.

15. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company adopted ASC 820, which defines fair value, establishes a framework
and gives guidance regarding the methods used for measuring fair value, and
expands disclosures about fair value measurements. It clarifies that fair value
is an exit price, representing the amount that would be received to sell an
asset or paid 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 valuations of the investment securities are obtained from a financial
institution that trades in similar securities.

 

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The following table presents the balances of investment securities as of
December 31, 2011 measured at fair value on a recurring basis by level (in
thousands of dollars):

 

As of December 31, 2011:            

Description

   Total      Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)      Significant
Other
Observable
Inputs
(Level 2)      Significant
Unobservable
Inputs
(Level 3)  

Assets

           

U.S. Government Sponsored Enterprises

   $ 2,162       $ —         $ 2,162       $ —        

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,162       $ —         $ 2,162       $ —        

 

 

    

 

 

    

 

 

    

 

 

 

The carrying amounts reported in the consolidated balance sheet for cash and
cash equivalents, accounts receivable, accounts payable, and short-term loans
approximate fair value because of the short-term maturity of these instruments.

16. CONCENTRATIONS OF RISK

Credit Risk

Financial instruments which potentially subject the Company to concentrations of
credit risk consist primarily of cash and cash equivalents and accounts
receivables. Substantially all of the Company’s cash and cash equivalents and
restricted cash of $24.4 million at December 31, 2011 were held by ten Chinese
banks and three international banks.

Supplier Risk

Supplier relationships which potentially subject the Company to concentrations
of supplier risk consist primarily of relationships where supply of raw
materials may be in short supply or controlled by a limited number of channels,
pricing for commodity products subject to market fluctuations or technologies
critical to the Company’s business are substantially controlled by one supplier
with whom the Company has an exclusive, or restrictive, distribution rights. The
Company has one significant supplier, Siemens, which accounted for 36% of total
product cost of goods sold.

Currency Convertibility Risk

Some of the Company’s operating activities are transacted in RMB, which is not
freely convertible into foreign currencies. All foreign exchange transactions
take place either through the People’s Bank of China or other banks authorized
to buy and sell foreign currencies at the exchange rates quoted by the People’s
Bank of China. Approval of foreign currency payments by the People’s Bank of
China or other regulatory institutions requires submitting a payment application
form together with suppliers’ invoices, shipping documents and signed contracts.

Foreign Currency Exchange Rate Risk

The functional currency of certain entities of the Company is RMB, and the
reporting currency is USD. Since July 21, 2005, RMB has been permitted by the
PRC government to fluctuate within a managed band against a basket of certain
foreign currencies. The depreciation of the USD against RMB was 4.9% during the
year ended December 31, 2011. Any significant revaluation of RMB may materially
and adversely affect the cash flows, operating results and financial position of
the Company.

 

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17. RELATED PARTY TRANSACTIONS

CML is owned by two investors, FosunPharma and Chindex International, Inc. CML
completed its first year of operations in 2011, and it has used certain
resources available from its two owners, as detailed below.

Services Agreement

CML and Chindex entered into a services agreement, effective on January 1, 2011.
Under the services agreement, Chindex provides advisory and support services as
requested by CML. The services include management and administrative support
services for marketing, sales and order fulfillment activities conducted in the
United States and China, order processing and exporting of goods sold to
customers in China, assistance with respect to the marketing of products sold in
China by CML, analysis of sales opportunities and other assistance including
services such as payroll, database administration, internal auditing, accounting
and finance that will assist CML in carrying out its activities in the United
States and China. In 2011, the service expenses charged by Chindex to CML were
$3,451,000.

Lease Agreements with Related Parties

CML leases office space in Beijing from a real estate company affiliated with
FosunPharma. Rent expense for this building was $579,000 in 2011.

Transactions with Affiliates and Balances to/from Affiliates

Transactions with affiliated companies outside CML in 2011 was as follows:

 

     December 31, 2011  

Sales to affiliates

  

FosunPharma - Scientific Import & Export and Suzhou Laishi

   $ 521   

Chindex

     1,826      

 

 

 

Total

   $ 2,347      

 

 

 

Purchases from affiliates

  

FosunPharma - Scientific Import & Export and Suzhou Laishi

   $ 3,420   

Chindex

     3,451      

 

 

     $ 6,871      

 

 

 

 

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Balances with affiliated companies as of December 31, 2011 were as follows:

 

     December 31, 2011  

Receivables from affiliates

  

FosunPharma

   $ 3   

Chindex

     2,893      

 

 

 

Total

   $ 2,896      

 

 

 

Payable to affiliates

  

FosunPharma

   $ 6,168   

Chindex

     10,974      

 

 

     $ 17,142      

 

 

 

18. SUBSEQUENT EVENTS

Subsequent events have been evaluated through March 9, 2012, which was also the
date that the financial statements were available to be issued, and there were
no subsequent events requiring disclosure.

 

25