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10-Q 1 d350830d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-24624

CHINDEX INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)


DELAWARE		13-3097642
(State or other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

4340 East West Highway, Suite 1100,

Bethesda, Maryland

20814

(Address of principal executive offices)

(Zip Code)

(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 x No ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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 ¨ No x

The number of shares outstanding of each class of the registrant’s common equity, as of August 8, 2012, was 15,886,890 shares of Common Stock and 1,162,500 shares of Class B Common Stock.

CHINDEX INTERNATIONAL, INC.

INDEX

FORM 10-Q

PART I—FINANCIAL INFORMATION



Item 1.	Financial Statements (Unaudited):
	Consolidated Condensed Balance Sheets at June 30, 2012 and December 31, 2011	3
	Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2012 and 2011	4
	Consolidated Condensed Statements of Comprehensive Income for the three and six months ended June 30, 2012 and 2011	5
	Consolidated Condensed Statements of Stockholders’ Equity for the six months ended June 30, 2012	6
	Consolidated Condensed Statements of Cash Flows for the six months ended June 30, 2012 and 2011	7
	Notes to Consolidated Condensed Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	33
Item 4.	Controls and Procedures	33

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3.	Defaults Upon Senior Securities	34
Item 4.	Mine Safety Disclosures	34
Item 5.	Other Information	34
Item 6.	Exhibits	34

Signatures		36
Exhibits Index

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

CHINDEX INTERNATIONAL, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands except share data)

(Unaudited)


	June 30, 2012		December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents	$	31,624	$	33,755
Investments		—		26,394
Accounts receivable, less allowance for doubtful accounts of $9,662 and $8,300, respectively		17,662		13,947
Receivables from affiliates		12,053		10,984
Inventories of supplies, net		2,061		2,307
Deferred income taxes		3,531		3,887
Other current assets		5,104		4,652

Total current assets		72,035		95,926
Restricted cash and sinking funds		20,658		1,030
Investments		—		100
Investment in unconsolidated affiliate		33,775		33,728
Property and equipment, net		77,030		65,465
Noncurrent deferred income taxes		674		424
Other assets		2,726		2,719

Total assets	$	206,898	$	199,392

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,351	$	3,957
Payable to affiliates		11,822		9,404
Accrued expenses		11,433		11,735
Other current liabilities		7,047		5,549
Income taxes payable		2,253		2,141

Total current liabilities		37,906		32,786
Long-term debt and convertible debentures		23,903		23,818
Long-term deferred tax liability		288		287

Total liabilities		62,097		56,891

Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.01 par value, 500,000 shares authorized, none issued		—		—
Common stock, $.01 par value, 28,200,000 shares authorized, including 3,200,000 designated Class B:
Common stock—15,886,890 and 15,652,917 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively		159		157
Class B stock—1,162,500 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively		12		12
Additional paid-in capital		120,447		118,930
Retained earnings		15,770		14,491
Accumulated other comprehensive income		8,413		8,911

Total stockholders’ equity		144,801		142,501

Total liabilities and stockholders’ equity	$	206,898	$	199,392

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

CHINDEX INTERNATIONAL, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(in thousands except share and per share data)

(Unaudited)


	Three months ended June 30,						Six months ended June 30,
	2012			2011			2012			2011
Healthcare services revenue	$	39,117		$	29,465		$	71,629		$	53,650


Operating expenses
Salaries, wages and benefits		21,309			15,473			39,925			30,228
Other operating expenses		5,345			4,237			10,109			8,556
Supplies and purchased medical services		4,812			3,227			9,050			5,862
Bad debt expense		630			498			1,395			930
Depreciation and amortization		1,820			1,057			3,471			2,194
Lease and rental expense		1,834			1,599			3,687			2,799

		35,750			26,091			67,637			50,569


Income from operations		3,367			3,374			3,992			3,081

Other income and (expenses)
Interest income		134			218			273			360
Interest expense		(91	)		(78	)		(215	)		(181	)
Equity in income of unconsolidated affiliate		114			729			212			582
Miscellaneous income (expense)—net		10			(25	)		—			(67	)

Income before income taxes		3,534			4,218			4,262			3,775
Provision for income taxes		(1,724	)		(1,275	)		(2,983	)		(2,062	)

Net income	$	1,810		$	2,943		$	1,279		$	1,713

Net income per common share—basic	$	.11		$	.18		$	.08		$	.11

Weighted average shares outstanding—basic		16,317,841			16,129,328			16,304,816			16,102,735

Net income per common share—diluted	$	.11		$	.17		$	.08		$	.11

Weighted average shares outstanding—diluted		17,399,066			17,522,106			17,538,732			17,437,933

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

CHINDEX INTERNATIONAL, INC.

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)


	Three months ended June 30,					Six months ended June 30,
	2012			2011		2012			2011
Net income	$	1,810		$	2,943	$	1,279		$	1,713

Other comprehensive (loss) income:
Foreign currency translation adjustment		(433	)		422		(334	)		985
Share of other comprehensive income of unconsolidated affiliate		(270	)		—		(164	)		361

Other comprehensive (loss) income		(703	)		422		(498	)		1,346

Comprehensive income	$	1,107		$	3,365	$	781		$	3,059

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

CHINDEX INTERNATIONAL, INC.

CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands except share data)

(Unaudited)


	Common Stock					Common Stock Class B				Additional Paid In			Retained		Accumulated Other Comprehensive
	Shares			Amount		Shares		Amount		Capital			Earnings		Income			Total
Balance at December 31, 2011		15,652,917		$	157		1,162,500	$	12	$	118,930		$	14,491	$	8,911		$	142,501
Net income		—			—		—		—		—			1,279		—			1,279
Other comprehensive loss		—			—		—		—		—			—		(498	)		(498	)
Stock based compensation		—			—		—		—		1,601			—		—			1,601
Purchase and retirement of restricted stock for tax witholding		(10,621	)		—		—		—		(98	)		—		—			(98	)

Options exercised and issuance of restricted stock, net of restricted stock forfeited		244,594			2		—		—		14			—		—			16

Balance at June 30, 2012		15,886,890		$	159		1,162,500	$	12	$	120,447		$	15,770	$	8,413		$	144,801

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

CHINDEX INTERNATIONAL, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)


	Six months ended June 30,
	2012			2011
OPERATING ACTIVITIES
Net income	$	1,279		$	1,713
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,471			2,194
Inventory write down		38			3
Provision for doubtful accounts		1,396			930
Loss on disposal of property and equipment		6			77
Equity in income of unconsolidated affiliate		(212	)		(582	)
Deferred income taxes		92			(1,454	)
Stock based compensation		1,601			1,668
Foreign exchange loss (gain)		242			(257	)
Amortization of debt issuance costs		5			5
Amortization of debt discount		124			124
Changes in operating assets and liabilities:
Restricted cash		—			300
Accounts receivable		(5,182	)		(2,101	)
Receivables from affiliates		(1,069	)		8,898
Inventories of supplies		200			(260	)
Other current assets and other assets		(514	)		724
Accounts payable, accrued expenses, other current liabilities and deferred revenue		2,173			339
Payable to affiliates		2,419			2,899
Income taxes payable		119			570

Net cash provided by operating activities		6,188			15,790

INVESTING ACTIVITIES
Purchases of short-term investments and CDs		—			(21,271	)
Proceeds from redemption of CDs		26,526			22,837
Purchases of property and equipment		(14,968	)		(11,157	)

Net cash provided by (used in) investing activities		11,558			(9,591	)

FINANCING ACTIVITIES
Restricted cash for IFC RMB loan sinking funds		(10,968	)		—
Restricted cash for Exim loan collateral		(8,664	)		—
Repurchase of restricted stock for income tax withholding		(98	)		—
Proceeds from exercise of stock options and warrants		16			114

Net cash (used in) provided by financing activities		(19,714	)		114

Effect of foreign exchange rate changes on cash and cash equivalents		(163	)		263

Net (decrease) increase in cash and cash equivalents		(2,131	)		6,576
Cash and cash equivalents at beginning of period		33,755			32,007

Cash and cash equivalents at end of period	$	31,624		$	38,583

Supplemental disclosures of cash flow information:
Cash paid for taxes	$	2,765		$	2,973

Non-cash investing and financing activities consist of the following:
Change in property and equipment purchases included in accounts payable	$	288		$	100

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

CHINDEX INTERNATIONAL, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 1. BASIS OF PRESENTATION

Chindex International, Inc. (“Chindex” or “the Company”), founded in 1981, is an American healthcare company providing healthcare services in China through the operations of United Family Healthcare (“UFH”), a network of private care hospitals and affiliated ambulatory clinics. UFH currently operates in Beijing, Shanghai, Tianjin and Guangzhou.

The accompanying unaudited consolidated condensed financial statements of Chindex International, Inc. 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 and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Policies and procedures

Consolidation

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

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 condensed 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, and deferred tax valuation allowances.

Revenue Recognition

All revenue is derived from providing healthcare services. Revenue related to services provided is net of contractual adjustments or discounts and is recognized in the period services are provided. The Company makes an estimate at the end of the month for certain inpatients that have not completed service. This estimate reflects only the cost of care up to the end of the month. Revenue is dependent on seasonal fluctuations related to epidemiology factors and the life styles of the expatriate community.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2011-05, which provided guidance on comprehensive income. This guidance is intended to increase the prominence of other comprehensive income in financial statements by presenting it in either a single statement or two-statement approach. This guidance was effective for us beginning January 1, 2012. We adopted this guidance on January 1, 2012, and the adoption did not have a material impact on our consolidated results of operations, financial position or cash flows.

Note 2. INVESTMENTS

The following table summarizes the Company’s investments, including accrued interest, as of June 30, 2012 and December 31, 2011 (in thousands):


	June 30, 2012		December 31, 2011
Current investments:
Certificates of deposit	$	—	$	18,812
U.S. Government Sponsored Enterprises		—		1,575
Corporate bonds		—		6,007

Total current investments	$	—	$	26,394


Noncurrent investments:
Corporate bonds	$	—	$	100

Total noncurrent investments	$	—	$	100

The Company has no investments as of June 30, 2012.

The Company’s current investments as of December 31, 2011 include $18,812,000 of Certificates of Deposit, with a fixed interest rate of 0.55% issued by HSBC, a large international financial institution. The Company’s investments in Certificates of Deposit are intended to be held to maturity. Other than Certificates of Deposit, the Company’s current investments also include available-for-sale securities at fair value, which approximates cost, of $1,575,000 issued by U.S. Government-sponsored enterprises and corporate bonds of $6,007,000, which mature within the next twelve months. 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. The Company’s noncurrent investments of $100,000 as of December 31, 2011, consist of corporate bonds which mature in 38 months.

Note 3. INVENTORIES OF SUPPLIES, NET

Inventories of supplies consist of medical supplies and pharmaceuticals in the amounts of $2,061,000 at June 30, 2012 and $2,307,000 at December 31, 2011.

Note 4. INVESTMENT IN UNCONSOLIDATED AFFILIATE

Background — Chindex Medical Limited

On December 31, 2010, Chindex and Shanghai Fosun Pharmaceutical (Group) Co., Ltd. (“FosunPharma”) , a leading manufacturer and distributor of Western and Chinese medicine and devices in China, completed the first closing (the “Initial Closing”) of the formation of Chindex Medical Limited (“CML”) to independently operate certain combined medical device businesses, including Chindex’s Medical Products division. The formation of CML represents

a basis of the strategic alliance between the two companies, which aims to capitalize on the long-term opportunity presented by medical product sectors in China. CML is focused on marketing, distributing, selling and servicing medical devices in China, including in Hong Kong, as well as activities in R&D and manufacturing of medical devices for the Chinese and export markets. CML is owned 51% by FosunPharma and 49% by Chindex.

Upon the Initial Closing, CML became the owner of the Company’s former Medical Products division. On June 24, 2011, CML became the holder of legal title to the FosunPharma-contributed businesses. Notwithstanding this transfer, the registration with and approval of Shanghai Administration of Foreign Exchange (SAFE) was required in order for CML to exercise certain of the rights and benefits as shareholder of such businesses, but CML was entitled to such benefits on a contractual basis under an entrusted management agreement. The registration with and approval of SAFE was received on March 7, 2012, and all legal formalities related to the final closing of the joint venture formation were completed as of March 30, 2012.

Deconsolidation

FosunPharma has a controlling financial interest in CML. The Company was required to deconsolidate the contributed businesses when it ceased to have a controlling financial interest in the applicable subsidiaries. As explained below, the Company concluded that CML is a voting interest entity, rather than a variable interest entity. Therefore, the reduction of the Company’s interest to 49% indicated that it no longer had a controlling financial interest and needed to deconsolidate under Accounting Standards Codification (“ASC”) 810. Accordingly, Chindex deconsolidated its Medical Products division from its consolidated balance sheet, effective December 31, 2010.

Variable Interest Entity Analysis

ASC 810-10-20 defines a variable interest as an investment or other interest that will absorb portions of a variable interest entity’s (“VIE’s”) expected losses or receive portions of the entity’s expected residual returns. An equity interest is considered to be a variable interest in a company and as such, the Company’s interest in CML is a variable interest. A holder of a variable interest in an entity is required to determine whether the entity is a VIE and, if so, whether it must consolidate the entity.

In its VIE analysis, the Company considered the five characteristics of a VIE described in ASC 810-10-15-14. Management evaluated the characteristics of its investment in CML and believes that CML would not be deemed a VIE. Management concluded that FosunPharma effectively contributed its businesses to CML as of the formation date since the entrusted management agreement (the “Entrustment Agreement”) entered into by a subsidiary of CML, FosunPharma and a subsidiary of FosunPharma provides CML with unilateral control over Shanghai Chuangxin (as defined in the Entrustment Agreement). Although the legal form of the transaction is that FosunPharma initially delivered a promissory note in exchange for its interest in CML, Management notes that this was required solely due to a timing delay in receiving regulatory approvals. The substance of the arrangement is that FosunPharma has irrevocably arranged the contribution of Shanghai Chuangxin in exchange for its equity interest in CML particularly because the probability of governmental approvals was high (and in fact has already been obtained). Accordingly, Management believes that FosunPharma’s investment would be deemed equity at risk and that the combined equity of CML would be sufficient to permit the entity to finance its activities without additional subordinated financial support. It should be noted that CML has been financed 100% with equity and does not have any other forms of subordinated financial support, which justifies the position that the amount of equity is sufficient to conduct operations.

Management also considered certain characteristics related to control and expected economics of CML to support the conclusion that CML is not a VIE. The Company and FosunPharma control CML, as they have the ability to elect all of the members of the Board of Directors of CML, and there are no other interests that provide its holders with participating rights over the activities that most significantly impact CML’s economic performance. Accordingly, the group of holders of the equity investment at risk has the power to direct the activities of CML that most significantly impact CML’s economic performance. Additionally, Management concluded that, pursuant to the agreements entered

into in connection with the formation of CML, the voting rights held by both FosunPharma and the Company are proportional to their economic interests in CML. Management further noted that FosunPharma and the Company have both the obligation to absorb the losses and the right to receive the expected residual returns of CML as there are no other interests that either protect them from absorbing expected losses or cap their residual returns. Therefore, Management has concluded the entity is not a VIE and must be assessed under the voting interest model.

It is generally understood that when a company owns less than 50% of an entity that is not considered a VIE, the company is precluded from consolidating its investee. Specifically, ASC 810-10-25-1 states that the usual condition for a controlling financial interest is ownership of a majority voting interest. Since the Company owns 49% of CML (whereas a single entity, FosunPharma, owns 51%), and does not have control over the entity through the Board of Directors (whereas FosunPharma has the power to appoint a majority of such Board of Directors), the Company should not consolidate CML. Conversely, FosunPharma obtained control through its majority stock ownership and Board of Directors representation upon the Initial Closing. Therefore, the Company’s investment in CML is accounted for as an equity method investment.

Summarized Financial Information for CML

Beginning with the commencement of CML operations on January 1, 2011, Chindex follows the equity method of accounting to recognize its 49% interest in the net assets and the net earnings of CML on an on-going basis. Summarized financial information for the unconsolidated CML affiliate for which the equity method of accounting is used is presented below on a 100 percent basis. The assets and liabilities of CML as of June 30, 2012 and December 31, 2011 were as follows (in thousands):


	June 30, 2012		December 31, 2011
Current assets	$	97,779	$	104,726
Noncurrent assets		17,828		18,261

Total assets	$	115,607	$	122,987


Current liabilities	$	51,130	$	59,941
Noncurrent liabilities		1,778		1,539

Total liabilities		52,908		61,480
Stockholders’ equity		62,699		61,507

Total liabilities and stockholders’ equity	$	115,607	$	122,987

The operating results of CML for the three and six months ended June 30, 2012 and 2011 were as follows (in thousands):


	Three months ended June 30,				Six months ended June 30,
	2012		2011		2012		2011
Revenue	$	30,475	$	38,066	$	57,498	$	64,153
Income before income taxes		761		2,055		1,399		2,299
Net income		496		1,748		958		1,711

CML is a 51%-owned subsidiary of FosunPharma. The assets, liabilities and stockholders’ equity in the summarized financial data table presented above for CML have been prepared on a stand-alone basis, with the assets and liabilities of the entities contributed to CML by FosunPharma reported on a historical cost basis, while the assets and liabilities acquired from Chindex have been recorded on a fair value basis. In reporting its 49% interest in the net assets and net earnings of CML using the equity method of accounting, Chindex includes its 49% interest in the stand-alone financial statements of CML, and also records adjustments to reflect the amortization of basis differences attributable to the fair values in excess of net book values of identified tangible and intangible assets contributed by FosunPharma to

CML at its formation date. In addition, certain employees of CML participate in Chindex stock-based compensation programs. The expense for these stock options or restricted stock is recognized by CML as the services are provided. The total stock-based compensation expense recognized by CML for three months ended June 30, 2012 and 2011 were $263,000 and $402,000, respectively. The total stock-based compensation expense recognized by CML for the six months ended June 30, 2012 and 2011 were $500,000 and $681,000, respectively.

For the three and six months ended June 30, 2012, Chindex recognized income of $114,000 and $212,000, respectively,for its 49% equity in the operating results of CML. This consisted of income of $243,000 and $469,000, respectively, for its 49% interest in the stand-alone net income of CML (after recognition of stock-based compensation expense) and after deducting $129,000 and $257,000, respectively, for the amortization of basis differences attributable to acquired intangibles. For the three and six months ended June 30, 2011, Chindex recognized income of $729,000 and $582,000, respectively, for its 49% equity in the operating results of CML. This consisted of income of $858,000 and $840,000, respectively, for its 49% interest in the stand-alone net income of CML (after recognition of stock-based compensation expense) and after deducting $129,000 and $258,000, respectively, for the amortization of basis differences attributable to acquired intangibles.

As of June 30, 2012 and December 31, 2011, Chindex had a receivable from CML entities of $12,053,000 and $10,984,000, respectively, primarily related to advance payments for procurement of medical equipment supplied under a logistics service agreement whereby CML serves as an agent for Chindex. As of June 30, 2012 and December 31, 2011, Chindex had a payable to CML entities of $11,822,000 and $9,404,000, respectively, which represented the actual purchases of medical equipment by CML on behalf of Chindex under the logistics service agreement. It is expected that the medical equipment will be purchased within one year.

Services Agreement

CML and Chindex entered into a services agreement (the “Services Agreement”), effective January 1, 2011. Under the Services Agreement, Chindex provides advice 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, advice relating 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. For the three months ended June 30, 2012 and 2011, total expenses recognized by CML under the services agreement were $991,000 and $786,000, respectively, in addition to stock-based compensation. For the six months ended June 30, 2012 and 2011, total expenses recognized by CML under the services agreement were $1,717,000 and $1,839,000, respectively, in addition to stock-based compensation.

Note 5. RESTRICTED CASH AND SINKING FUNDS

Restricted cash and sinking funds at June 30, 2012 and December 31, 2011 consist of the following:



(in thousands)	June 30,2012		December 31, 2011

IFC RMB loan sinking fund	$	11,994	$	1,030
China Exim loan collateral - Certificate of Deposit		8,664		—

	$	20,658	$	1,030

The IFC RMB loan sinking fund consists of Certificates of Deposit for the advance funding of the loan principal and interest for the Company’s 2005 RMB loan from the International Finance Corporation (IFC). As of June 30, 2012, the Certificates of Deposit totaled $11,994,000, and are recorded in long-term restricted cash and sinking funds. The RMB debt is also classified as long-term and will be paid off as originally scheduled on October 15, 2012.

The Company is in the process of entering into loans, to be used for the purchase of medical equipment at our newly expanded hospital facilities in Beijing. As qualified government-sponsored projects under financing agreements between the U.S. Export-Import Bank and China’s Ministry of Finance, this would allow the Company to import equipment into China on a duty and VAT free basis. The loans would have a term of seven years, carry an interest rate of 2.15% and require a collateral cash deposit of approximately $8.7 million. The Company has not yet made a draw under the loan agreements. However, Certificates of Deposit in a restricted account have been opened to provide the collateral for the expected draws of $11.1 million under the loan agreements.

Note 6. PROPERTY AND EQUIPMENT, NET


(in thousands)	June 30, 2012			December 31, 2011
Property and equipment, net consists of the following:
Furniture and equipment	$	29,740		$	25,376
Vehicles		272			240
Construction in progress		16,179			21,463
Leasehold improvements		50,026			34,566

		96,217			81,645
Less: accumulated depreciation and amortization		(19,187	)		(16,180	)

	$	77,030		$	65,465

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 and six months ended June 30, 2012 primarily related to the expansion of the Company’s existing Beijing hospital campus and to the Beijing rehabilitation hospital project. Capitalized interest on construction in progress was $158,000 and $272,000 during the six months ended June 30, 2012 and 2011, respectively. Depreciation and amortization expense for property and equipment for the three and six months ended June 30, 2012 were $1,820,000 and $3,471,000, respectively. Depreciation and amortization expense for property and equipment for the three and six months ended June 30, 2011 were $1,057,000 and $2,194,000, respectively.

Note 7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES


(in thousands)	June 30, 2012		December 31, 2011
Accrued expenses:
Accrued expenses- rent	$	3,941	$	3,775
Accrued compensation		5,220		6,056
Accrued expenses- other		2,272		1,904

	$	11,433	$	11,735

Other current liabilities:
Accrued other taxes payable- non-income	$	927	$	717
Customer deposits		4,163		3,117
Other current liabilities		1,957		1,715

	$	7,047	$	5,549

Note 8. DEBT

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


	June 30, 2012				December 31, 2011
	Short term		Long term		Short term		Long term
Long term loan	$	—	$	10,258	$	—	$	10,297
Convertible notes, net of debt discount		—		13,645		—		13,521

	$	—	$	23,903	$	—	$	23,818

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 (“RMB”) (approximately $8,000,000) (the “IFC 2005 RMB Loan”). The term of the loan is 10 years at an initial interest rate of 6.73% with the borrowers required to make annual payments into a sinking fund with the first payment in September 2010. Deposits into the sinking fund would have accumulated until a lump sum payment was made at maturity of the debt in October 2015. The interest rate would have reduced to 4.23% for any amount of the outstanding loan on deposit in the sinking fund.

Effective March 14, 2012, the Company entered into an Amendment and Restatement Agreement to the 2005 RMB Loan Agreement, and a Certificate of Deposit Retention and Pledge Agreement. The agreements were necessary in order to incorporate the effects of the expansion of the Beijing hospital campus on the collateral and loan covenant provisions of the original IFC 2005 RMB Loan Agreement. The revised terms of the agreements provide for (1) advance funding by the Company of the full principal and interest amounts by the purchase of a series of certificates of deposit

having a face amount equal to the full principal and interest amount and the subsequent pledge of such Certificates of Deposit to the IFC, and (2) elimination of loan covenants required under the original loan agreement. The advance funding of the loan principal and interest by the Company into restricted accounts rather than paying off the debt was necessary in order to avoid significant prepayment penalties. As of June 30, 2012, the Certificates of Deposit totaled $11,994,000 and are recorded in long-term restricted cash and sinking funds. The RMB debt is classified as long-term and will be paid off as originally scheduled on October 15, 2015.

As of June 30, 2012, the outstanding balance of this debt was 64,880,000 RMB (current translated value of $10,258,000) and was classified as long-term. As the advance funding of the sinking fund does not extinguish 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 is similarly 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 included in the Investor Rights Agreement between the Company and JPM, which expires on November 6, 2012, 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 in Beijing and Guangzhou (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.

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 $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, 2012 and December 31, 2011, the unamortized financing cost was $50,000 and $54,000, respectively, and is included in Other Assets in the consolidated condensed balance sheets.

The Company accounts for convertible debt in accordance with 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, 2012 and December 31, 2011 was $1,355,000 and $1,479,000, respectively. Amortization of the discount was approximately $62,000 for each of the three months ended June 30, 2012 and 2011. Amortization of the discount was approximately $124,000 for each of the six months ended June 30, 2012 and 2011.

International Finance Corporation and DEG-Deutsche Investitions und Entwicklungsgesellschaft

In 2007 and 2008, we entered into two US Dollar loan facilities with International Finance Corporation (IFC) and DEG-Deutsche Investitions und Entwicklungsgesellschaft (DEG) to supplement the financing of expansion projects in China. These facilities were never used and at this time are not available. We are in the final stages of negotiating successor facilities with these lenders related to expansion projects at our flagship hospital in Beijing. As of the date of this report, we expect to be able to draw down approximately $11 million in the aggregate from these two successor facilities (approximately $6 million from IFC and approximately $5 million from DEG). There can be no assurances as to the amounts, if any, that may be finally available under these successor facilities or whether such facilities will be finally achievable on terms acceptable to us and the lenders. If the negotiations are unsuccessful and these successor facilities are not established for the expansion projects in Beijing, then, in the absence of an alternative source of financing, there could result a material adverse effect on our operations and our ability to complete our proposed expansion projects on time or at all.

Debt Payments Schedule

The following table sets forth the Company’s debt obligations as of June 30, 2012:


	(In thousands)

	Total		2012		2013		2014		2015		Thereafter
Long term loan	$	10,258	$	—	$	—	$	—	$	10,258	$	—
Convertible notes		15,000		—		—		—		—		15,000

Total	$	25,258	$	—	$	—	$	—	$	10,258	$	15,000

Note 9. TAXES

We recorded a $1,724,000 provision for taxes in the three months ended June 30, 2012 compared to a provision for taxes of $1,275,000 for the three months ended June 30, 2011. We recorded a $2,983,000 provision for taxes in the six months ended June 30, 2012 compared to a provision for taxes of $2,062,000 for the six months ended June 30, 2011. 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 and ASC 740-270 and the effect of valuation allowance for deferred tax assets.

The Company’s effective tax rate is higher in the three and six months ended June 30, 2012 than in the three and six months ended June 30, 2011. The table below provides detail into our consolidated pretax income (loss) and provision for income tax by separating this information into three categories: operating entities, start-up entities and corporate entities. Our operating entities consist of our established hospitals and clinics in China, and which therefore record tax expense at the China statutory rate of approximately 25%. Our start up entities in the table below consist of our newly-opened hospital in Tianjin and the rehabilitation hospital in Beijing, which is still in development, and no tax benefit has been recorded for the effect of the start up losses for those entities. Our parent company and subsidiary holding companies, referred to as the corporate entities in the table below, have incurred losses for which no tax benefits were recorded.

(in thousands)

Period ended June 30, 2012


	Three months								Six months
	Income (loss) Before Income Taxes			Provision for Income Taxes		Effective Tax Rate			Income (loss) Before Income Taxes			Provision for Income Taxes		Effective Tax Rate
Operating Entities	$	6,296		$	1,697		27	%	$	10,886		$	2,956		27	%
Start-Up Entities		(1,829	)		—		0	%		(4,933	)		—		0	%
Corporate Entities		(933	)		27		-3	%		(1,691	)		27		-2	%

Total	$	3,534		$	1,724		49	%	$	4,262		$	2,983		70	%

Period ended June 30, 2011


	Three months								Six months
	Income (loss) Before Income Taxes			Provision for Income Taxes		Effective Tax Rate			Income (loss) Before Income Taxes			Provision for Income Taxes		Effective Tax Rate
Operating Entities	$	4,370		$	1,197		27	%	$	6,863		$	1,986		29	%
Start-Up Entities		(181	)		—		0	%		(321	)		—		0	%
Corporate Entities		29			78		269	%		(2,767	)		76		-3	%

Total	$	4,218		$	1,275		30	%	$	3,775		$	2,062		55	%

We recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2012 and December 31, 2011, we had no accrued interest or penalties related to uncertain tax positions.

Note 10. EARNINGS PER SHARE

The Company follows ASC 260 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 (in thousands, except for share and per share data):


	Three months ended June 30,				Six months ended June 30,
	2012		2011		2012		2011
Basic net income per share computation:
Numerator:
Net income	$	1,810	$	2,943	$	1,279	$	1,713
Denominator:
Weighted average shares outstanding—basic		16,317,841		16,129,328		16,304,816		16,102,735
Net income per common share—basic:	$	.11	$	.18	$	.08	$	.11


Diluted net income per share computation:
Numerator:
Net income	$	1,810	$	2,943	$	1,279	$	1,713
Interest expense for convertible notes		62		62		124		124

Numerator for diluted earnings per share	$	1,872	$	3,005	$	1,403	$	1,837


Denominator:
Weighted average shares outstanding—basic		16,317,841		16,129,328		16,304,816		16,102,735
Effect of dilutive securities:
Shares issuable upon exercise of dilutive outstanding stock options, conversion of convertible debentures, vesting of restricted stock and exercise of warrants:		1,081,225		1,392,778		1,233,916		1,335,198

Weighted average shares outstanding-diluted		17,399,066		17,522,106		17,538,732		17,437,933

Net income per common share—diluted:	$	.11	$	.17	$	.08	$	.11

For the three months ended June 30, 2012 and 2011, there were 858,434 and 150,618 shares, respectively, which were not included in the calculation of diluted net income per share as the effect would have been antidilutive. For the six months ended June 30, 2012 and 2011, there were 1,073,603 and 128,656 shares, respectively, which were not included in the calculation of diluted net income per share as the effect would have been antidilutive.

Note 11. STOCKHOLDERS’ EQUITY

Stock-Based Compensation

The Company incurred stock based compensation expense of $987,000 for the three months ended June 30, 2012 and $466,000 for the three months ended June 30, 2011 for Company employees and outside directors. The Company incurred stock based compensation expense of $1,601,000 for the six months ended June 30, 2012 and $1,668,000 for the six months ended June 30, 2011 for Company employees and outside directors.

In 2011 and 2012, the Company generally granted stock options that vest over a three or five year period to certain 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.

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.

The following table summarizes the stock option activity during the six months ended June 30, 2012:


	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value (in thousands)*
Options outstanding at December 31, 2011		1,206,439		$	10.35
Granted		—			—
Exercised		(9,024	)		1.78
Canceled		(2,900	)		13.26
Expired		(12,375	)		11.49

Options outstanding at June 30, 2012		1,182,140		$	10.40		5.10	$	1,969

Options exercisable at June 30, 2012		1,065,511		$	10.05		4.84	$	1,969

*	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, 2012 ($9.80) and the exercise price of the underlying options.

During the six months ended June 30, 2012 and 2011, the total intrinsic value of stock options exercised was $70,000 and $112,000, respectively, and the actual cash received upon exercise of stock options was $16,000 and $114,000 respectively. The unamortized fair value of the stock options as of June 30, 2012 was $581,000, the majority of which is expected to be expensed over the weighted-average period of 1.58 years.

The following table summarizes activity relating to restricted stock for the six months ended June 30, 2012:


	Number of shares underlying restricted stock			Aggregate Intrinsic Value of Restricted Stock (in thousands) *
Outstanding at December 31, 2011		525,800
Granted		240,715
Vested		(115,010	)
Forfeited		(5,145	)

Outstanding at June 30, 2012		646,360		$	6,334

Expected to vest		605,518		$	5,934

*	The aggregate intrinsic value on this table was calculated based on the closing market price of the Company’s common stock on June 30, 2012 ($9.80).

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, 2012, the unamortized fair value of the restricted stock was $6,788,000. This unamortized fair value is expected to be expensed over the weighted-average period of 2.65 years. Restricted stock is valued at the stock price on the date of grant.

Long-Term Incentive Plan

On March 28, 2012, the Company’s Compensation Committee, with the assistance of its independent executive compensation consultant, adopted a newly-designed long-term incentive program under our 2007 Stock Incentive Plan (“LTIP”) for 2012 grants to executive officers and other key employees of performance-based restricted stock units (“PRSUs”), subject to shareholder approval, which was received on May 31, 2012. The new program closely aligns the equity compensation paid to participants with the achievement of pre-set quantitative metrics. The new program also is intended to enable our equity awards to be deductible as performance-based compensation in accordance with Section 162(m) of the Internal Revenue Code.

The awards under the new program are initially expressed as a target number of units. The target number of units will be adjusted to reflect the attainment of Company performance metrics during the performance period for the award, which in the case of the awards granted in 2012 is calendar year 2012. The 2012 awards became effective upon our shareholder approval of the amendment and restatement of the Company’s 2007 Stock Incentive Plan at our May 31, 2012 annual meeting. The performance metrics used for these awards are Revenue and Adjusted EBITDA Margin, with the adjustment to the target number of units based on a combination of the level of performance on these metrics, ranging from zero if performance does not meet specified levels up to a maximum of 150% of the target number of units. The number of units so determined will be increased or decreased by up to 25% based on the Company’s stock performance during 2012 relative to the performance of the Halter USX China Index (an index calculated by the NYSE Arca of selected companies whose common stock is publicly traded in the United States and the majority of whose business is conducted within the People’s Republic of China, that have an average market capitalization greater than $50 million for the preceding 40 days, and that trade on the NYSE or NASDAQ). The number of units earned after this adjustment is subject to vesting based on continued employment, with one-third of the units vesting at the end of each of 2013, 2014, and 2015, subject to accelerated vesting in specified events. Upon the vesting of a unit, the award holder will receive one share of our common stock in settlement of that unit. The number of target PRSUs awarded in 2012 under the LTIP is 214,000. Upon the completion of the service period, vested PRSUs will be settled by the delivery of Chindex common stock. Compensation expense will be based on the estimated fair value of the PRSUs at the grant date, using a Monte Carlo simulation and will be recognized over the combined performance and service periods of approximately 3.6 years, beginning on June 1, 2012. The Company recognized expense of $101,000 for the LTIP in the three months ended June 30, 2012. There was no comparable expense in the prior year period.

Note 12. STOCK PURCHASE AGREEMENT – FOSUNPHARMA

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. (“FosunPharma”). Pursuant to the Stock Purchase Agreement, the Company agreed to issue and sell to Investor a total of 1,990,447 shares (the “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.

Pursuant to the Stock Purchase Agreement, the sale of the Shares would be completed in two closings. The initial closing occurred on August 27, 2010, at which the Company issued 933,022 Shares to Investor for an aggregate purchase price of $13,995,330. At the second closing (the “Second Closing”) under the Stock Purchase Agreement, the Company would sell the remaining 1,057,425 Shares to Investor for an aggregate purchase price of $15,861,375. The Second Closing has been subject to the consummation of CML, which was initially formed effective December 31, 2010

and recently fully consummated. CML engages in the businesses of, among other things, (i) the marketing, distribution and servicing of medical equipment in China and Hong Kong (except that sales and distribution related activities in relation to sales and servicing in China and Hong Kong may take place in other jurisdictions) and (ii) the manufacturing, marketing, sales and distribution of medical devices and medical equipment and consumables, including our former Medical Products division. CML is 51%-owned by FosunPharma and 49%-owned by the Company. The Stock Purchase Agreement further provides that in the event that CML were not consummated within a prescribed period, then the Stock Purchase Agreement may be terminated by either party solely with respect to the Second Closing, provided the absence of such consummation was not principally caused by the terminating party. Although the prescribed period elapsed prior to the consummation of CML, no party has terminated the Stock Purchase Agreement, which remains in full force and effect. Nonetheless, as a practical matter, as a result of such elapse, either party may elect such termination (subject to such proviso) and thus there may be no obligation to consummate the Second Closing.

At the initial closing under the Stock Purchase Agreement, the Company, Investor and FosunPharma also entered 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 a 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, Investor would have the right to, among other things, nominate two designees for election to the Company’s Board of Directors, which would be increased to nine members. Further, such final portion of the Shares to be purchased by FosunPharma would be subject to the terms of the Stockholder Agreement, which currently governs other shares of the Company’s common stock held by Fosun entities. In order to induce Investor to enter into the transaction and without any consideration therefore, each of the Company’s chief executive officer, secretary and chief financial officer holding such offices as of the date of the Stock Purchase Agreement, in their capacities as stockholders of the Company, 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.

The Company evaluated whether this contingent Stock Purchase Agreement should be accounted for as a derivative instrument or whether it qualified for a scope exception under ASC 815-10. The Company concluded that the contract qualified for the scope exception because the contract was indexed to the Company’s own stock and was classified in stockholders’ equity.

Note 13. 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 non-cancelable operating leases consist of the following (in thousands):


Six months ending December 31,
2012	$	3,608
Year ending December 31,
2013		6,678
2014		5,894
2015		5,779
2016		4,710
Thereafter		42,474

Net minimum rental commitments	$	69,143

The above leases require the Company to pay certain pass through operating expenses and rental increases based on inflation.

Rental expense was approximately $1,834,000 and $1,599,000 for the three months ended June 30, 2012 and 2011, respectively. Rental expense was approximately $3,687,000 and $2,799,000 for the six months ended June 30, 2012 and 2011, respectively.

Note 14. FAIR VALUE OF FINANCIAL INSTRUMENTS

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 following table presents the balances of investment securities measured at fair value on a recurring basis by level (in thousands):

As of June 30, 2012:

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

—

Corporate Bonds

—

Total

—

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	$	1,575	$	—	$	1,575	$	—
Corporate Bonds		6,107		—		6,107		—

Total	$	7,682	$	—	$	7,682	$	—

The valuation of these investment securities are obtained from a financial institution that trades in similar securities.

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable and accounts payable 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.

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, 2012, 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 $23.9 million, and the estimated fair value was

$25.0 million. Since the full principal amount of the IFC 2005 RMB Loan of $10.3 million has been funded into a restricted account for the benefit of the lender, that amount has been used as the fair value. 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.

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 December 31, 2011. 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

The preparation of the consolidated 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 collectability, and deferred tax valuation allowances.

RESULTS OF OPERATIONS

Three months ended June 30, 2012 compared to three months ended June 30, 2011

Overview of Consolidated Results

We own and operate the United Family Healthcare network of private hospitals and clinics in the People’s Republic of China. United Family Healthcare currently operates hospitals and affiliated clinic facilities in the Beijing, Shanghai, Tianjin and Guangzhou markets. Our network operations in the Beijing, Shanghai and Guangzhou market have earned the accreditation of the Joint Commission International. Our current network operations include the following facilities:

•

Beijing Market

•

Beijing United Family Hospital main campus

•

120 licensed beds

•

As of the close of the recent period, 70 available beds

•

Four affiliated satellite clinics

•

Shanghai Market

•

Shanghai United Family Hospital main campus

•

50 licensed beds

•

As of the close of the recent period, 30 available beds

•

Two affiliated satellite clinics

•

Two managed clinics

•

Tianjin Market

•

Tianjin United Family Hospital main campus

•

26 licensed beds

•

As of the close of the recent period, 25 available beds

•

Guangzhou Market

•

One affiliated clinic

We have undertaken a number of market expansion projects in our current markets:

In Beijing, expansion at our flagship hospital campus, where we recently more than doubled our licensed beds, and continued expansion of existing affiliated clinics.

In Beijing, development of the rehabilitation hospital for expansion of our services for those seeking quality premium care when recovering from surgeries or debilitating illnesses in the neurological cardiac and orthopedic areas, as well as the initial planning for future additional clinics affiliated with our flagship hospital campus.

In Shanghai, continued expansion at our flagship hospital campus in Puxi and the recently opened affiliated clinic, as well as at our managed clinic in the Pudong district.

In Tianjin, expansion through development of a freestanding clinic that will coordinate services with our newly opened hospital.

In Guangzhou, expansion of our existing affiliated clinic services and development of a new hospital expected to open in 2014-2015.

In connection with our expansion plans outlined above, over the next twelve months we have planned capital expenditures of up to $38 million for construction, equipment and information systems (see “Liquidity and Capital Resources”). During the three months ended June 30, 2012, the development, pre-opening and start up expenses, including post-opening expenses, for these projects were $2,538,000 compared to $1,249,000 in the comparable prior year period, reflecting primarily expenses incurred for the Beijing, Tianjin and Pudong projects.

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. Nevertheless, expansions of our existing facilities as well as new hospital and affiliated clinic projects are complex, requiring several phases over extended periods of time. The projects are subject to delays routinely encountered in complex construction projects in regulated industries and are subject to, among other things, the receipt of (i) medical-related approvals from local health authorities and in some cases the Ministry of Health at the national level, (ii) foreign invested joint venture health facility approvals from the local Bureau of Commerce and Trade, and (iii) local construction and safety approvals. Accordingly, we give windows of expected completion of our expansion projects, the exact timing of which are subject to the actual receipt of the various government licenses and permits.

Our discussion and analysis below relates to the revenue and expenses of our healthcare services business for the three months ended June 30, 2012 compared to the comparable prior year period.

Net Revenue

(in thousands)


	Three months ended June 30,
	2012		2011		Change
Healthcare services net revenue	$	39,117	$	29,465		33	%

Our healthcare services revenue for the three months ended June 30, 2012 was $39,117,000, a 33% increase from the three months ended June 30, 2011 revenue of $29,465,000. The increase in net revenue is attributable to growth in both inpatient and outpatient services.

The table below identifies the relative contribution of inpatient and outpatient services to gross revenue:


	Three months ended June 30,
	2012			2011
Inpatient/Outpatient gross revenue percentages
Inpatient services as percent of gross revenue		41	%		42	%
Outpatient services as percent of gross revenue		59	%		58	%

		100	%		100	%

The table below identifies the primary service lines contributing to gross revenue:


	Three months ended June 30,
	2012			2011
Gross revenue by service line (hospital facilities only):
Surgical services		21.1	%		18.1	%
OB/GYN		13.5	%		14.1	%
Pediatrics		7.5	%		8.4	%
Ancillary services
Laboratory		9.9	%		10.0	%
Radiology		10.6	%		11.1	%
Pharmacy		11.4	%		11.5	%
All other services		26.0	%		26.8	%

		100	%		100	%

Operating expenses

(in thousands)


	Three months ended June 30,
	2012		2011		Change
Salaries, wages and benefits		21,309	$	15,473		38	%
Other operating expenses		5,345		4,237		26	%
Supplies and purchased medical services		4,812		3,227		49	%
Bad debt expense		630		498		27	%
Depreciation and amortization		1,820		1,057		72	%
Lease and rental expense		1,834		1,599		15	%

	$	35,750	$	26,091		37	%

Salaries, wages and benefits increased 38% in the recent period compared to the comparable prior year period primarily due to the increased headcount of 34.7% associated with the revenue increases and development activities. The increase in headcount was due to both increased activities in our existing facilities as well as for hiring new personnel to staff our expanded Beijing and new Tianjin facilities.

Other operating expenses increased by $1,108,000, or 26%, primarily due to increased foreign exchange loss of $266,000, marketing expenses of $200,000, building utilities of $150,000, and other outside services of approximately $346,000.

Supplies and purchased medical services increased by $1,585,000, or 49%. Supplies expense increased approximately $1,544,000, or 56%, primarily due to increased usage of medical supplies and pharmaceuticals related to higher volume of patient procedures as well as initial stocking of operating supplies for departments in the new Tianjin hospital and other new services in Beijing. Purchased medical services increased approximately $42,000, or 9%.

Bad debt expense increased by $132,000, and, as a percentage of net revenue, bad debt expense was 1.6% in 2012, compared to 1.7% in the comparable prior year period, both of which are in line with our historic averages.

Depreciation and amortization expense increased by $763,000, or 72%, to $1,820,000, primarily due to the opening of expanded facilities, which are now being depreciated.

Lease and rental expense increased to $1,834,000 in the recent period compared to $1,599,000 in the prior year period, primarily due to the increase in the total building space utilized in the expanded operations of our hospital and clinic network.

Other Income and Expenses

Interest income during the three months ended June 30, 2012 and 2011 were $134,000 and $218,000, respectively, as interest rates on cash balances continued to be very low.

Interest expense during the three months ended June 30, 2012 and 2011 were $91,000 and $78,000, respectively, due to decreases of capitalized interest.

Equity in income of unconsolidated affiliates in the amount of $114,000 and $729,000 for the three months ended June 30, 2012 and 2011, respectively, represents our 49% interest in the net income of CML.

Taxes

We recorded a provision for taxes of $1,724,000 (an effective tax rate of approximately 49%) in the three months ended June 30, 2012, compared to a provision for taxes of $1,275,000 (an effective tax rate of approximately 30%) in the three months ended June 30, 2011. The effective tax rate for our operating entities was 27% compared to 28% in the comparable prior year period. The remaining portion of the variance in the effective tax rate in the current quarter is primarily due to the effect of losses in start-up entities and corporate entities for which we cannot recognize tax benefit.

Six months ended June 30, 2012 compared to Six months ended June 30, 2011

Overview of Consolidated Results

•

Beijing Market

•

Beijing United Family Hospital main campus

•

120 licensed beds

•

As of the close of the recent period, 70 available beds

•

Four affiliated satellite clinics

•

Shanghai Market

•

Shanghai United Family Hospital main campus

•

50 licensed beds

•

As of the close of the recent period, 30 available beds

•

Two affiliated satellite clinics

•

Two managed clinics

•

Tianjin Market

•

Tianjin United Family Hospital main campus

•

26 licensed beds

•

As of the close of the recent period, 25 available beds

•

Guangzhou Market

•

One affiliated clinic

We have undertaken a number of market expansion projects in our current markets:

In Beijing, expansion at our flagship hospital campus, where we recently more than doubled our licensed beds, and continued expansion of existing affiliated clinics.

In Shanghai, continued expansion at our flagship hospital campus in Puxi and the recently opened affiliated clinic, as well as at our managed clinic in the Pudong district.

In Tianjin, expansion through development of a freestanding clinic that will coordinate services with our newly opened hospital.

In Guangzhou, expansion of our existing affiliated clinic services and development of a new hospital expected to open in 2014-2015.

In connection with our expansion plans outlined above, over the next twelve months we have planned capital expenditures of up to $38 million for construction, equipment and information systems (see “Liquidity and Capital Resources”). During the six months ended June 30, 2012, the development, pre-opening and start up expenses, including post-opening expenses, for these projects were $5,741,000 compared to $2,047,000 in the comparable prior year period, reflecting primarily expenses incurred for the Beijing, Tianjin and Pudong projects.

Our discussion and analysis below relates to the revenue and expenses of our healthcare services business for the six months ended June 30, 2012 compared to the comparable prior year period.

Net Revenue

(in thousands)


	Six months ended June 30,
	2012		2011		Change
Healthcare services net revenue	$	71,629	$	53,650		34	%

Our healthcare services revenue for the six months ended June 30, 2012 was $71,629,000, a 34% increase from the six months ended June 30, 2011 revenue of $53,650,000. The increase in net revenue is attributable to growth in both inpatient and outpatient services.

The table below identifies the relative contribution of inpatient and outpatient services to gross revenue:


	Six months ended June 30,
	2012			2011
Inpatient/Outpatient gross revenue percentages
Inpatient services as percent of gross revenue		40	%		40	%
Outpatient services as percent of gross revenue		60	%		60	%

		100	%		100	%

The table below identifies the primary service lines contributing to gross revenue:


	Six months ended June 30,
	2012			2011
Gross revenue by service line (hospital facilities only):
Surgical services		20.1	%		18.0	%
OB/GYN		14.2	%		14.5	%
Pediatrics		7.6	%		8.0	%
Ancillary services
Laboratory		10.0	%		10.2	%
Radiology		10.8	%		11.2	%
Pharmacy		11.8	%		11.6	%
All other services		25.5	%		26.5	%

		100	%		100	%

Operating expenses

(in thousands)


	Six months ended June 30,
	2012		2011		Change
Salaries, wages and benefits		39,925	$	30,228		32	%
Other operating expenses		10,109		8,556		18	%
Supplies and purchased medical services		9,050		5,862		54	%
Bad debt expense		1,395		930		50	%
Depreciation and amortization		3,471		2,194		58	%
Lease and rental expense		3,687		2,799		32	%

	$	67,637	$	50,569		34	%

Salaries, wages and benefits increased 32% in the recent period compared to the comparable prior year period primarily due to the increased headcount of 34.7% associated with the revenue increases and development activities. The increase in headcount was due to both increased activities in our existing facilities as well as for hiring new personnel to staff our expanded Beijing and new Tianjin facilities.

Other operating expenses increased by $1,553,000, or 18%. primarily due to increased foreign exchange loss of $499,000, building utilities of $313,000, marketing expenses of $244,000, and other outside services of approximately $400,000.

Supplies and purchased medical services increased by $3,188,000, or 54%. Supplies expense increased approximately $2,976,000, or 59%, primarily due to increased usage of medical supplies and pharmaceuticals related to higher volume of patient procedures as well as initial stocking of operating supplies for departments in the new Tianjin hospital and other new services in Beijing. Purchased medical services increased approximately $211,000, or 27%.

Bad debt expense increased by $465,000, and, as a percentage of net revenue, bad debt expense was 1.9% in 2012, compared to 1.7% in the comparable prior year period, both of which are in line with our historic averages.

Depreciation and amortization expense increased by $1,277,000, or 58%, to $3,471,000, primarily due to the opening of expanded facilities, which are now being depreciated.

Lease and rental expense increased to $3,687,000 in the recent period compared to $2,799,000 in the prior year period, primarily due to the increase in the total building space utilized in the expanded operations of our hospital and clinic network.

Other Income and Expenses

Interest income during the six months ended June 30, 2012 and 2011 were $273,000 and $360,000, respectively, as interest rates on cash balances continued to be very low.

Interest expense during the six months ended June 30, 2012 and 2011 were $215,000 and $181,000, respectively, due to decreases of capitalized interest.

Equity in income of unconsolidated affiliates in the amount of $212,000 and $582,000 for the six months ended June 30, 2012 and 2011, respectively, represents our 49% interest in the net income of CML.

Taxes

We recorded a provision for taxes of $2,983,000 (an effective tax rate of approximately 70%) in the six months ended June 30, 2012, compared to a provision for taxes of $2,062,000 (an effective tax rate of approximately 55%) in the six months ended June 30, 2011. The effective tax rate for our operating entities was 27% compared to 29% in the comparable prior year period. The remaining portion of the variance in the effective tax rate in the current quarter is primarily due to the effect of losses in start-up entities and corporate for which we cannot recognize tax benefit.

LIQUIDITY AND CAPITAL RESOURCES

The following table sets forth our cash, investments, and accounts receivable as of June 30, 2012 and December 31, 2011 (in thousands):


	June 30, 2012		December 31, 2011
Cash and cash equivalents	$	31,624	$	33,755
Investments		—		26,394
Accounts receivable		17,662		13,947
Receivables from affiliates		12,053		10,984

Cash Flows

The following table sets forth a summary of our cash flows from operating activities for the six months ended June 30, 2012 and 2011 (in thousands):


	Six months ended June 30,
	2012			2011
OPERATING ACTIVITIES
Net loss	$	1,279		$	1,713
Non cash items		6,763			2,708
Changes in operating assets and liabilities:
Restricted cash		—			300
Accounts receivable		(5,182	)		(2,101	)
Receivable from affiliates		(1,069	)		8,898
Inventories		200			(260	)
Accounts payable, accrued expenses, other current liabilities and deferred revenue		2,173			339
Payable to affiliates		2,419			2,899
Other		(395	)		1,294

Net cash provided by operating activities	$	6,188		$	15,790

Operating cash flow for the six months ended June 30, 2012 was lower than the six months ended June 30, 2011, primarily due to the increase in accounts receivable and receivable from affiliates.

The following table sets forth a summary of our cash flows from investing activities for the six months ended June 30, 2012 and 2011 (in thousands):


	Six months ended June 30,
	2012			2011
INVESTING ACTIVITIES
Purchases of short-term investments and CDs	$	—		$	(21,271	)
Proceeds from redemption of CDs		26,526			22,837
Purchases of property and equipment		(14,968	)		(11,157	)

Net cash provided by (used in) investing activities	$	11,558		$	(9,591	)

In the six months ended June 30, 2011, the Company purchased short-term investments and Certificates of Deposits of $21 million; there was no comparable investing activity in the six months ended June 30, 2012 as the Company utilized cash to fund the IFC RMB loan sinking funds of $11 million and to fund restricted cash for the Exim loan collateral of $9 million.

Investing activities for the six months ended June 30, 2012 included acquisitions of property and equipment in connection with our ongoing development and expansion of the United Family Healthcare network of private hospitals and clinics, and redemption of Certificates of Deposits were reinvested in comparable instruments.

The following table sets forth a summary of our cash flows from financing activities for the six months ended June 30, 2012 and 2011 (in thousands):


	Six months ended June 30,
	2012			2011
FINANCING ACTIVITIES
Restricted cash for sinking fund		(10,968	)	$	—
Restricted cash for Exim loan collateral		(8,664	)
Repurchase of restricted stock for income tax withholding		(98	)
Proceeds from exercise of stock options and warrants		16			114

Net cash (used in) provided by financing activities	$	(19,714	)	$	114

As of June 30, 2012, the Company utilized cash to fund the IFC RMB loan sinking funds of $11 million and to fund restricted cash for the Exim loan collateral of $9 million.

Capital Resources and Financing Requirements

Over the next twelve months, we anticipate total capital expenditures of up to approximately $38 million related to the maintenance and expansion of our business operations. Of this amount, up to approximately $5 million would be for maintenance and organic growth at our existing facilities in Beijing and Shanghai and up to approximately $1 million would be primarily related to network IT investment. Expansion projects would be expected to account for up to approximately $32 million of the remaining expenditures. Specifically, we anticipate final payments related to the expansion of the Beijing hospital main campus, New Hope clinic and Shunyi clinic to be approximately $8 million; final payments related to the opening of the Tianjin hospital to be approximately $2 million; and expenditures to be approximately $22 million for the Beijing Rehabilitation project. We intend to fund these expenditures through corporate capital reserves, anticipated loan financings as described below and cash flow from operations. Registered foreign debt is expected to be secured by each operating foreign invested joint venture upon obtaining required governmental and credit approvals.

The expansion projects in the Beijing, Shanghai, Tianjin and Guangzhou markets are underway in various states of progress. In particular, 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 2014 and beyond.

In 2007 and 2008, we entered into two US Dollar loan facilities with International Finance Corporation (IFC) and DEG-Deutsche Investitions und Entwicklungsgesellschaft (DEG) to supplement the financing of expansion projects in China. These original facilities were never used and at this time are not available. We are in the final stages of negotiating successor facilities with these lenders related to expansion projects at our flagship hospital in Beijing. As of the date of this report, we expect to be able to draw down approximately $11 million in the aggregate from these two successor facilities (approximately $6 million from IFC and approximately $5 million from DEG), which amount is less than the amounts originally negotiated under the original facilities. There can be no assurances as to the amounts, if any, that may be finally available under these successor facilities or whether such facilities will be finally achievable on terms acceptable to us and the lenders. If the ongoing negotiations are unsuccessful and these successor facilities are not established for the expansion projects in Beijing, then, in the absence of alternative sources of financing, there could result a material adverse effect on our operations and our ability to complete our proposed expansion projects on time or at all.

In addition, we have applied for and received all necessary approvals for approximately $11 million in loans at our hospital facilities in Beijing secured in part by U.S. Export-Import Bank guarantees. As of the date of this report, we are in the final stages of preparation to draw down the loan amounts. As qualified government-sponsored projects under financing agreements between the U.S. Export-Import Bank and China’s Ministry of Finance, the loans, to be used for the purchase of medical equipment at our newly expanded facilities in Beijing, would allow us to import equipment into China on a duty and VAT free basis. The loans would have a term of seven years, carry an interest rate of 2.15% and require a collateral cash deposit of approximately $8.7 million.

Since the financial events of 2007, there have been continuing and significant disruptions in the world financial markets including those in China. 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. Our daily operations generate significant 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 an economic slowdown and to the extent their assets are affected, this will likely not impact their decision making on healthcare purchases. Our current expansion projects as described above are expected to be funded with corporate capital reserves, cash flow from operations and the credit facilities described above, provided that there can be no assurances that such facilities will be established, available or sufficient for our intended purposes or that the preconditions to disbursements under the facilities will be satisfied.

Based on the foregoing, we believe that our existing capital resources are sufficient to fund our working capital and capital expenditure requirements for the next 12 months, although there can be no assurances to this effect. We will require additional financing arrangements to meet our capital expenditures beyond this period. Although we regularly consider and evaluate possible additional or alternative financing opportunities, no such financing currently is in place or under substantive negotiations. We will continue to evaluate a wide range of such opportunities, including both debt and equity-based financings in which we may borrow funds and/or share with one or more financial, institutional or strategic partners the ownership interest in one or more projects.

We may not be able to raise adequate capital to complete some or all of our business strategies, including our ongoing expansion projects, or to react rapidly to changes in technology, products, services or the competitive landscape. Healthcare service and medical product providers in China often face high capital requirements in order to take advantage of new market opportunities, respond to rigorous competitive pressures and react quickly to changes in technology. Many of our competitors are committing substantial capital and, in many instances, are forming alliances to acquire or maintain market leadership. There can be no assurance that we will be able to satisfy our capital requirements in the future. In particular, our strategy of expanding our healthcare facilities and services includes the establishment and maintenance of healthcare facilities, which require particularly significant capital. In addition, CML plans to expand its distribution capabilities for medical products. In the absence of sufficient available capital, we would be unable to establish or maintain healthcare facilities as planned, and the joint venture would be unable to expand its distribution business as planned.

TIMING OF REVENUES

Our revenue is dependent on seasonal fluctuations related to epidemiology 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. 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 100% of our revenue and generate approximately 97% 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 six months ended June 30, 2012, the RMB appreciated approximately 0.4% against the USD, resulting in an exchange loss of $242,000.

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, 2012, indicated that if the USD uniformly increased in value by 10% relative to the RMB, we would have experienced a 21% decrease in net income. Conversely, a 10% increase in the value of the RMB relative to the USD at June 30, 2012, would have resulted in a 26% increase in net income.

Based on the Consumer Price Index, for the three months ended June 30, 2012, the average annual rate of inflation in China and the United States was 2.9% and 1.9%, respectively. For the six months ended June 30, 2012, the average annual rate of inflation in China and the United States was 3.3% and 2.4%, respectively. The average annual rate of inflation over the three-year period from 2009 to 2011 was 2.7% in China and 1.5% 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 and 15d-15, 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. A control deficiency exists when the design or operation of a control does not allow management or employees, in the ordinary course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the Company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with GAAP, such that there is a more than remote likelihood that a misstatement of the Company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. 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, 2012, and has concluded that there was no change that occurred during the three months ended June 30, 2012 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

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 December 31, 2011, 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. MINE SAFETY DISCLOSURES

Not Applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS



3.1		Amended and Restated Certificate of Incorporation of the Company dated October 28, 2004. Incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2005.

3.2		Amendment to Certificate of Incorporation dated July 9, 2007. Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed July 10, 2007.

3.3		Amended and Restated Bylaws of the Company dated September 21, 2011. Incorporated by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K filed September 23, 2011.

3.4		Certificate of Designations of Series A Junior Participating Preferred Stock of the Company. Incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2007.

4.1		Form of Specimen Certificate representing the Common Stock of the Company. Incorporated by reference to Exhibit 4.2 to the Registrant’s Registration Statement on Form SB-2 (No. 33-78446) (the “IPO Registration Statement”).

4.2		Form of Specimen Certificate representing the Class B Common Stock of the Company. Incorporated by reference to Exhibit 4.3 to the IPO Registration Statement.

4.3		Rights Agreement, dated as of June 7, 2007, between the Company and American Stock Transfer & Trust Company, as Rights Agent, which includes a form of Right Certificate as Exhibit B and a Summary of Rights to Purchase Preferred Stock as Exhibit C. Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed June 7, 2007.

4.4		Amendment No. 1 to Rights Agreement, dated as of November 4, 2007, between the Company and American Stock Transfer & Trust Company, as Rights Agent. Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed November 7, 2007.

4.5		Amendment No. 2 to Rights Agreement, dated as of June 8, 2010, between the Company and American Stock Transfer & Trust Company, as Rights Agent. Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed June 14, 2010.



10.1		Form of Executive Officer Performance-based Restricted Stock Unit (PRSU) Grant Letter. Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed June 14, 2012.

31.1		Certification of the Company’s Chief Executive Officer Pursuant to Rule 13a-14(a) (filed herewith)

31.2		Certification of the Company’s Chief Financial Officer Pursuant to Rule 13a-14(a) (filed herewith)

31.3		Certification of the Company’s Principal Accounting Officer Pursuant to Rule 13a-14(a) (filed herewith)

32.1		Certification of the Company’s Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 (filed herewith)

32.2		Certification of the Company’s Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (filed herewith)

32.3		Certification of the Company’s Principal Accounting Officer Pursuant to 18 U.S.C. Section 1350 (filed herewith)

101.INS		XBRL Instance Document (furnished herewith)

101.SCH		XBRL Taxonomy Extension Schema Document (furnished herewith)

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)

101.LAB		XBRL Taxonomy Extension Labels Linkbase Document (furnished herewith)

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)

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.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting Company