424B4 1 d424b4.htm FORM 424(B)(4) FORM 424(B)(4)
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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-163250

China Nuokang Bio-Pharmaceutical Inc.

LOGO

 

5,000,000 American Depositary Shares

Representing 40,000,000 Ordinary Shares

 

This is the initial public offering of China Nuokang Bio-Pharmaceutical Inc. We are offering 4,526,979 ADSs, and the selling shareholders are offering an additional 473,021 ADSs. Each ADS represents eight of our ordinary shares. We have received approval for listing the ADSs on the NASDAQ Global Market under the symbol “NKBP.”

Investing in our ADSs involves risk. See “Risk Factors” beginning on page 16.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

      Per ADS      Total

Public offering price

   $ 9.00      $ 45,000,000

Underwriting discounts and commissions

   $ 0.63      $ 3,150,000

Proceeds, before expenses, to China Nuokang Bio-Pharmaceutical Inc.

   $ 8.37      $ 37,890,814

Proceeds before expenses to the selling shareholders

   $ 8.37      $ 3,959,186

A selling shareholder has granted the underwriters the right to purchase up to 750,000 additional ADSs to cover over-allotments.

The underwriters expect to deliver the ADSs against payment on or about December 15, 2009.

 

Jefferies & Company

 

Oppenheimer & Co.

The date of this prospectus is December 9, 2009.


Table of Contents

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Table of Contents

TABLE OF CONTENTS

 

    Page

Prospectus Summary

  1

Risk Factors

  16

Forward-looking Statements

  50

Use of Proceeds

  51

Capitalization

  52

Dilution

  53

Dividend Policy

  55

Enforceability of Civil Liabilities

  56

Exchange Rate Information

  57

Selected Consolidated Financial Data

  58

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  61

Corporate Structure

  90

Business

  94

Management

  123

Principal and Selling Shareholders

  133

Related Party Transactions

  135

Regulations

  137

Description of Share Capital

  151

Description of American Depositary Shares

  160

Shares Eligible for Future Sale

  171

Taxation

  173

Underwriting

  180

Expenses Related to This Offering

  186

Legal Matters

  186

Experts

  186

Where You Can Find Additional Information

  187

Index to Consolidated Financial Statements

  F-1

You should rely only on the information contained in this prospectus. We and the selling shareholder have not, and the underwriters have not, authorized anyone to provide you with additional information or information different from that contained in this prospectus. We and the selling shareholders are offering to sell, and seeking offers to buy, our ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our ADSs.

Until January 3, 2010 (25 days after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

This summary highlights selected information appearing elsewhere in this prospectus. While this summary highlights what we consider to be the most important information about us, you should carefully read this prospectus and the registration statement of which this prospectus is a part in their entirety before investing in our ADSs, especially the risks of investing in our ADSs that we discuss under “Risk Factors” and our financial statements and related notes beginning on page F-1.

Unless the context otherwise requires, “we,” “us,” “our company,” and “our” refer to China Nuokang Bio-Pharmaceutical Inc., its predecessor entities, subsidiaries and consolidated entities; “China” or “PRC” refers to the People’s Republic of China, excluding Taiwan, Hong Kong and Macau; “ADSs” refers to American Depositary Shares, each representing eight of our ordinary shares; “Renminbi” or “RMB” refers to the legal currency of China; and “$” or “U.S. dollars” refers to the legal currency of the United States.

Overview

We are a fully integrated, profitable China-based biopharmaceutical company focused on the research, development, manufacture, marketing and sales of hematological and cardiovascular products. We currently sell a portfolio of fourteen products, including three principal products, Baquting ( LOGO®), our flagship bleeding control product, Aiduo ( LOGO®), our cardiovascular stress imaging agent, and Aiwen ( LOGO®), our anti-arrhythmic agent. We have also entered into an exclusive agreement for the marketing and distribution in China of Kaitong ( LOGO), an intravenous injectable lipid emulsion of the vasodilator alprostadil for the treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis. Our product pipeline includes four product candidates under development that seek to better address the growing market and medical needs for bleeding control, and in hematological, cardiovascular and cerebrovascular disease diagnosis, treatment and prevention.

Developed in-house and launched in 2001, Baquting is China’s leading hemocoagulase and is prescribed to hospital patients for the treatment and prevention of bleeding. A hemocoagulase is an enzyme obtained from the venom of the snake species Bothrops atrox that can be used as a plasma clotting agent for wound and tissue repairs. Baquting commanded an approximately 38% market share by volume in 2007 and maintained this market share in 2008, according to an independent study conducted by the China Pharmaceutical Association, a national organization of pharmacists and pharmaceutical scientists in China. In 2007, Baquting’s market share surpassed that of Solco Basel’s Reptilase, the long-time market leader, for the first time. Reptilase, a competing Swiss brand, had an approximately 33% market share by volume in 2007. Through September 30, 2009, we had sold an aggregate of over 38 million units of Baquting to our end-customer base of over 2,400 hospitals across China. Sales of Baquting accounted for 90.1% and 94.1% of our total net revenue in 2008 and the nine months ended September 30, 2009. Baquting’s brand is well-recognized by the medical community in China, where traditional medicine and culture emphasize the importance of blood and limiting its loss and where there are higher clinical risks related to blood transfusions than in some Western countries.

Aiduo and Aiwen are the first adenosine products to be manufactured in China. Adenosine is a nucleoside that plays important biological roles, including dilating the coronary arteries and

 

 

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regulating the pacemaker activity of the heart. Aiduo is our diagnostic stress-test agent for coronary arterial diseases and Aiwen is used in the diagnosis and treatment of paroxysmal supraventricular tachycardia (PSVT), an abnormal conduction of electrical signals that causes the heart to beat very rapidly. We entered into agreements to acquire Aiduo and Aiwen from two third parties, Shenyang Guangda Pharmaceutical Co., Ltd. (Shenyang Guangda) and Shenyang Wanjia Biotechnology Research Institute (Shenyang Wanjia), in 2004. Aiduo and Aiwen are currently manufactured by Shenyang Guangda, and we have been the exclusive distributor and marketer of Aiduo and Aiwen in China since January 2005. In order to complete the acquisition and to commence production of Aiduo and Aiwen at our Shenyang facility, we require approval from the PRC State Food and Drug Administration (SFDA) for the transfer of the production permits for these drugs from Shenyang Guangda to us and Good Manufacturing Practice (GMP) certification for our Shenyang facility. We submitted our application for the SFDA approval in July 2008. If the SFDA approval and the GMP certification are delayed or not granted at all, we will continue to be the exclusive distributor and marketer of Aiduo and Aiwen but manufacturing will continue to be conducted by Shenyang Guangda.

In December 2008, we entered into a ten-year exclusive distribution agreement with Jilin Yuhua Pharmaceutical Co., Ltd. (Jilin Yuhua) to market and distribute Kaitong exclusively in China with the exception of Jilin and Heilongjiang Provinces. Jilin Yuhua is in the process of obtaining a production permit for Kaitong to allow it to manufacture this product at its GMP-certified new facilities in Changchun, Jilin Province. If the production permit for Kaitong is delayed or not granted at all, Jilin Yuhua will not be able to commence its production and we will not be able to launch this product in the market.

We intend to continue to pursue product and technology in-licensing opportunities. For example, in June 2009 we entered into a joint venture with QRxPharma Limited, an Australian company, to develop and commercialize two bleeding control products based on technologies developed by QRxPharma and the University of Queensland. We invested $5.0 million in October 2009 for a 93% interest in the joint venture to fund clinical trials in China for the commercialization of Textilinin, an antifibrinolytic agent, and Haempatch, a potent pro-coagulant, under an exclusive royalty-free license.

Our product pipeline consists of four product candidates at various stages of development:

 

   

dipyridamole aspirin sustained release capsules, which combines the anti-clotting or blood thinning properties of aspirin with the antiplatelet and thrombus formation inhibition properties of dipyridamole, for the prevention of secondary strokes;

 

   

hemocoagulase derived from the venom of the snake species Agkistrodon acutus for bleeding control;

 

   

adenosine for myocardial protection; and

 

   

lanthanum polystyrene sulfonate for the treatment of hyperphosphatemia, or high levels of blood phosphate typically found in chronic renal failure patients undergoing dialysis.

Substantially all of our sales are made to pharmaceutical distributors, which in turn sell our products primarily to hospitals and other healthcare institutions in China. As of September 30, 2009, our end-customer base had expanded from approximately 100 hospitals in 2001 to over 2,400 hospitals in all 31 provinces in China. Our end-customer base includes approximately 80% of the Class 3A hospitals, considered the best and largest under the China Ministry of Health hospital classification system, in major Chinese cities. As of September 30, 2009, our sales force

 

 

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consisted of 24 direct sales offices with 302 sales personnel, complemented by 16 third-party marketing agents with over 200 sales personnel. We believe the reputation of our Nuokang ( LOGO) brand name and our well-known branded pharmaceutical, Baquting, enable our sales and marketing team to effectively promote our principal products and help to stimulate the sales of our other pharmaceuticals. We employ a physician-targeted marketing model that is focused on promoting our products by providing physicians and hospitals with information on the benefits and differentiating clinical aspects of our products. Our sales and marketing activities receive strong academic support from a specialist network comprising approximately 100 national key opinion leaders and physicians in various clinical areas, and over 100 peer-reviewed academic articles have been published in recognized academic magazines or periodicals regarding the use of our principal products. As of September 30, 2009, our distribution network included approximately 200 distributors.

We have built our market reputation through our strict adherence to high product safety standards and our quality control and monitoring system that spans the entire production and sales process, including inspection of raw and auxiliary materials, manufacturing, delivery of finished products, clinical testing at hospitals and ethical sales practices. Our 11,000-square-meter manufacturing facility in Penglai, China commenced operations in 2002. At this facility, we maintain five GMP-certified formulation production lines, including injectables, freeze-dried powder, aerosols, tablets and granules, and three GMP-certified active pharmaceutical ingredient production lines. In February 2008, we completed the construction of a 24,000-square-meter integrated facility in Shenyang, China. The Shenyang facility was designed to have the capacity for three additional production lines, including two formulation production lines for injectables and one active pharmaceutical ingredient production line, a new research and development center and a warehouse. Both the research and development center and warehouse are operational while the GMP certification of the three production lines is currently pending.

Our net revenue was RMB121.7 million, RMB147.9 million and RMB225.4 million ($33.0 million) in 2006, 2007 and 2008, respectively. Our net income was RMB26.3 million in 2006, RMB35.2 million in 2007 and RMB63.6 million ($9.3 million) in 2008, representing a compound annual growth rate (CAGR) of 55.5% over that period. For the nine months ended September 30, 2009, our net revenue was RMB200.1 million ($29.3 million) and our net income was RMB41.6 million ($6.1 million), compared to net revenue of RMB153.5 million and net income of RMB41.7 million for the nine months ended September 30, 2008.

Our Product Portfolio

Our Hematological Products and Product Candidates

Baquting ( LOGO®)

Baquting is our flagship hemocoagulase product. Baquting contains the proteolytic enzyme batroxobin, which is derived from the venom of the pit viper Bothrops atrox. Batroxobin’s main function is to cleave to and activate a protein called fibrinogen, and is similar in structure and function to thrombin, an endogenous human enzyme that plays a key role in the blood coagulation pathway. Baquting also contains trace amounts of a blood clotting activating factor X activator (FXA), a metalloprotease that promotes the conversion of factor X to factor Xa, which is another essential step in the coagulation pathway. Batroxobin and FXA promote the blood coagulation process, and a drug containing both is more effective than either agent

 

 

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acting alone to reduce and stop bleeding. Importantly, Baquting only catalyzes the conversion of fibrinogen to fibrin in the damaged areas of blood vessels and does not promote coagulation in healthy blood vessels and therefore can be safely administered systemically. Baquting is clinically proven to reduce and stop bleeding in various medical settings, including, but not limited to, bleeding control and bleeding disorders. It is widely used in China in the surgical setting, internal medicine, gynecology and obstetrics, ophthalmology, otorhinolaryngology and stomatology. In surgery, it is also often administered as a pre-operative prophylactic to prevent or reduce bleeding during or after an operation.

We developed Baquting in-house and were the first Chinese biopharmaceutical company to obtain regulatory approval for and introduce a form of injectable hemocoagulase into our domestic market. In November 2001, we launched Baquting in the Chinese market. We originally sold Baquting in a 1 unit/vial formulation, and in 2006 we launched two additional dosages, 0.5 unit/vial and 2 units/vial. We believe we are the first hemocoagulase manufacturer in the world to offer three distinct dosages, which provides physicians greater flexibility in prescribing the product to suit diverse patient profiles or clinical and surgical settings. Baquting is also included as one of the hemocoagulases on the national basic medical insurance catalog in China, which we believe increases both its affordability for patients who have access to medical insurance and the likelihood of its prescription by physicians. In 2006, 2007 and 2008, we sold 4.2 million, 6.3 million and 9.7 million units of Baquting, respectively. In the nine months ended September 30, 2008 and 2009, we sold 6.8 million and 9.1 million units of Baquting, respectively.

To maintain and enhance Baquting’s market leadership, we are dedicated to improving product quality and hemocoagulase production technology, and to this end we are engaged in researching product modifications and enhancements. We are utilizing an FXA quantitative measurement technology that is designed to promote the bioactivity and clinical reliability of Baquting.

Agkistrodon Acutus Hemocoagulase

In order to maintain our competitive advantage in the hemocoagulase market, we are developing a new type of hemocoagulase that is extracted and purified from the venom of Agkistrodon acutus snakes, which are indigenous to China. Similar to Baquting based on the Bothrops atrox venom, Agkistrodon acutus hemocoagulase catalyzes fibrinogen locally in damaged blood vessels without activating the blood clotting factors in healthy blood vessels. We co-developed the Agkistrodon acutus hemocoagulase with the Chinese Science Academy Kunming Animal Research Institute. We hold two PRC patents relating to Agkistrodon acutus hemocoagulase that will expire in 2021. We have completed Phase I clinical trials which demonstrated that this hemocoagulase was well tolerated, and received SFDA approval for Phase II and Phase III clinical trials. We expect to commence Phase II clinical trials by the end of 2009.

Lanthanum Polystyrene Sulfonate

We are developing a lanthanum polystyrene sulfonate product candidate for the treatment of hyperphosphatemia. Hyperphosphatemia is the presence of abnormally elevated levels of phosphate in the blood. Hyperphosphatemia occurs in at least 70% of patients with renal insufficiency or acute or chronic renal failure and may lead to hyperparathyroidism, the overactivity of the parathyroid glands resulting in excess production of parathyroid hormone and abnormal metabolic activity, and a variety of other cardiovascular complications that could

 

 

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be life-threatening. We have completed preclinical toxicity research and pharmacodynamics studies that demonstrate the potential efficacy and safety of lanthanum polystyrene sulfonate. We are continuing to conduct long-term toxicity research and other preclinical research of our lanthanum polystyrene sulfonate product candidate.

Our Cardiovascular Products and Product Candidates

Adenosine

Aiduo and Aiwen are the first adenosine products manufactured in China. Aiduo and Aiwen consist of the same compound, but are administered at different dosages. Aiduo ( LOGO®), our cardiovascular stress imaging agent, is administered at 30ml/90mg per dose, and Aiwen ( LOGO®), our product used in the diagnosis and treatment of PSVT, is administered at 2ml/6mg per dose. We are also developing an adenosine product for myocardial protection.

Aiduo ( LOGO®)

Aiduo is an injectable coronary vasodilator that is approved for use in China as a diagnostic agent in connection with myocardial perfusion imaging (MPI) stress tests. Such tests are routinely performed in a nuclear cardiology suite to diagnose coronary arterial diseases. Aiduo dilates blood vessels by activating the A2 receptor, which binds to adenosine, thereby relaxing smooth muscles, adjusting sympathetic nerve transmission and reducing blood vessel tension.

Chinese drug registration laws provided Shenyang Guangda with administrative protection for the manufacture of Aiduo as a diagnostic agent in connection with MPI stress tests in China until 2007. Administrative protection in China prevents other companies from manufacturing, importing or selling a similar drug for the same indication, unless they have received approval for clinical trials of similar drugs prior to the commencement of the protection period. We are not aware of any other adenosine product in development in China. We believe that, given the time necessary to obtain a drug registration, Aiduo will continue to be the only adenosine product approved for use as a diagnostic agent in connection with MPI stress tests in the near term. We began sales and marketing activities for Aiduo in January 2005 and sold 6,207, 13,579, 25,550 and 19,400 units in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.

Aiwen ( LOGO®)

Aiwen is an intravenous anti-arrhythmic agent approved in China for the diagnosis and treatment of PSVT. Aiwen slows the conduction of electrical impulses in the heart and helps the heart to beat regularly during supraventricular tachycardia, a type of heart rhythm disorder. While the Chinese market for Aiwen is still relatively underdeveloped, an example of the potential for Aiwen is that adenosine was designated as the drug of first choice to treat PSVT in the Guidelines for the Management of Patients with Supraventricular Arrhythmias released by the committee comprising the American College of Cardiology, the American Heart Association and the European Society of Cardiology (the ACC/AHA/ESC committee) in 2003. We began sales and marketing activities for Aiwen in January 2005.

Adenosine for Myocardial Protection

We are also developing adenosine as a myocardial protection agent in various cardiovascular-related clinical settings. We believe adenosine may be useful as a myocardial

 

 

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protection agent due to its ability to attenuate or prevent post-ischemic myocardial damage that occurs as a result of acute myocardial infarction, or a heart attack, and during and after heart surgery. According to scientific literature, adenosine can effectively mitigate reperfusion injury, which is damage to tissue caused when blood supply returns to the area after a period of ischemia, or inadequate blood supply. We have completed preclinical trials of adenosine for such application. We plan to apply to the SFDA for the commencement of clinical trials of adenosine for myocardial protection after the transfer of the production permit for Aiduo and Aiwen from Shenyang Guangda to us is approved by the SFDA. We intend to apply for Class A new medicine status for this new indication, and in April 2006 we filed a PRC patent application related to this product.

Kaitong ( LOGO)

Kaitong is an intravenous injectable lipid emulsion of alprostadil for treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis. Alprostadil has been shown to dilate blood vessels, inhibit platelet aggregation, increase pulmonary blood flow, promote vasodilation and stimulate intestinal and uterine smooth muscle contraction. Kaitong’s lipid emulsion provides it with a series of advantageous characteristics, such as specificity for the narrow segments of blood vessels, lower effective dosage and decreased side effects. It has been approved in China for (i) limb ulceration caused by chronic artery occlusion such as thromboangiitis obliterans and arteriosclerosis obliterans, pain caused by microcirculation disorders, and other cardiocerebral microcirculation disorders, (ii) use as an anti-thrombotic agent after organ transplants, and (iii) ductal-dependent congenital heart disease in the newborns, to prevent premature closure of the ductus arteriosus until surgical correction is possible.

In December 2008, we entered into a ten-year exclusive distribution agreement with Jilin Yuhua to market and distribute Kaitong exclusively in China with the exception of Jilin and Heilongjiang Provinces. Jilin Yuhua is in the process of obtaining a production permit for Kaitong to allow it to manufacture this product at its GMP-certified new facilities in Changchun, Jilin Province. If the production permit for Kaitong is delayed or not granted at all, Jilin Yuhua will not be able to commence its production and we will not be able to launch this product in the market.

Dipyridamole Aspirin Sustained Release Capsules

We are developing dipyridamole aspirin capsules in a sustained release formulation for the prevention of strokes in patients who have previously suffered a stroke. Dipyridamole and aspirin are two different antiplatelet agents that, when used together, have been clinically demonstrated to be more effective than either agent alone in the prevention of secondary strokes. The clinical efficacy of this product was demonstrated by the data from the European Stroke Prevention Study (ESPS) 2, the largest stroke prevention trial to date. This clinical study was conducted with Aggrenox, an over-the-counter dipyridamole aspirin drug that is manufactured and sold in Europe by Boehringer-Ingelheim, a German pharmaceutical company. The ESPS 2 data demonstrated that a low dose aspirin combined with an extended release dipyridamole prevented twice as many strokes as aspirin alone and also reduced the risk of stroke in patients with high blood pressure and heart disease. We submitted our bioequivalence clinical trial data to the SFDA in December 2007 and we received an SFDA request in June 2009 for supplementary research data. We are in the process of compiling these data. We expect to

 

 

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receive the SFDA approval for manufacturing and marketing this product and launch it in the market in 2010.

Our Other Products

In addition to our principal products, we also manufacture and sell 11 other medicines for various indications, including asthma, infectious diseases, cold and flu, and anemia.

Market Opportunity

The Chinese healthcare market was the seventh largest in the world in 2008 and is expected to become the fifth largest by 2010, according to Frost & Sullivan. Healthcare expenditure in China has been steadily increasing, evidenced by the rapid growth of China’s gross domestic product (GDP) and the percentage of China’s GDP spent on healthcare. In 2008, China registered an annual GDP growth rate of 9.0%, and annual healthcare spending increased to 4.2% of GDP in 2005, up from 3.7% of GDP in 1995. Frost & Sullivan estimates that annual healthcare spending in China as a percentage of GDP will further increase to 8.0% by 2010. The biopharmaceutical market in China has developed rapidly in recent years, and Frost & Sullivan expects it to grow at an annual rate of 20% to 30%. In addition, according to Frost & Sullivan, the China biopharmaceutical market, which was valued at approximately $3.8 billion in 2005, is expected to reach approximately $8.5 billion by 2010.

On April 6, 2009, the PRC government outlined a healthcare reform proposal that will involve an expenditure of approximately RMB850 billion ($124.5 billion), approximately 3% of China’s GDP, from 2009 to 2011 to revamp the healthcare system in China. The proposal covers various aspects of the healthcare system in China. Although most of the details on the implementation of the proposal have yet to be announced, we believe we will likely benefit from the PRC government’s aim to (1) extend basic medical insurance coverage and increase insurance subsidies; (2) improve the quality and reliability of patient care; and (3) promote early diagnosis of diseases.

The hematological market ranked fourth, after the anti-infective market, cardiovascular market and cancer market, among all therapeutic markets in China in terms of sales value in 2007, according to BiaoDian Medical Information Co., Ltd. (PICO), which is controlled by the SFDA Southern Medicine Economic Research Institute. According to PICO, the market for bleeding treatment in China amounted to 412 million units, or approximately RMB2.0 billion ($291.2 million) in 2008. Hemocoagulases were the most prescribed type of treatment for bleeding control in China. Hemocoagulases, such as Baquting, increased their market share by revenue from approximately 34.3% in 2004 to 49.9% in 2008 and, according to PICO, are forecast to continue to increase their market share in future years. According to PICO, the sales volume of hemocoagulase to Chinese hospitals increased from 8.4 million units in 2004 to 24.4 million units in 2008 and reached RMB991 million ($145.2 million) in total sales in 2008.

China is the largest market in Asia for cardiovascular treatments and cardiovascular drugs have the second largest market share among all the prescription drugs in China. The Chinese cardiovascular market was estimated to be worth $1.3 billion in 2004, according to Business Insights. Myocardial perfusion imaging (MPI) is a widely used diagnostic test for assessing blood flow to the heart during exercise or stress and at rest. More than eight million MPI procedures were performed in the US in 2004, according to the China Pharmaceutical

 

 

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Newspaper, and, in China, MPI is continually gaining greater acceptance. According to the China Pharmaceutical Newspaper, approximately 100,000 MPI procedures were estimated to have occurred in 2006. Adenosine, the stress agent used to facilitate MPI, was estimated to have a potential market of RMB2 billion ($293 million), which would be similar in size to the U.S. sales of $330 million in 2007, assuming the MPI market were fully developed in China.

Competitive Strengths

We believe our principal competitive strengths are as follows:

 

   

established flagship product with leading market share and recognized brand name;

 

   

established nationwide sales and marketing network;

 

   

diverse portfolio of marketed products and product candidates targeting attractive commercial opportunities in hematological and cardiovascular markets;

 

   

demonstrated research and development capabilities;

 

   

integrated biopharmaceutical operations with internal manufacturing capability to ensure quality and supply;

 

   

experienced and entrepreneurial management team; and

 

   

strong record of growth and profitability.

Strategy

Our goal is to become the leader in the commercialization of innovative biopharmaceutical products in China. To achieve our goal, we intend to:

 

   

leverage the leading position and brand name of Baquting in China to further enhance brand awareness of Baquting and our other key products and effectively launch our product candidates;

 

   

develop and commercialize candidates in our product pipeline and new in-licensed or acquired products that address growing medical needs in the commercially attractive hematological and cardiovascular markets;

 

   

increase our market share and commercial opportunities through expanding our sales and distribution network and further strengthening our science-based promotion efforts; and

 

   

acquire new technologies or companies or in-license new products or technologies.

Risk Factors

Our business is subject to numerous risks, as more fully described in the section entitled “Risk Factors” immediately following this prospectus summary. These include:

 

   

our dependence on our flagship product Baquting;

 

   

limitations in our ability to successfully maintain the selling prices of our established products or to develop and commercialize new products;

 

 

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our reliance on a limited number of suppliers and distributors;

 

   

our dependence on senior management and key research and development personnel;

 

   

our ability to access adequate working capital;

 

   

our ability to protect our intellectual property, trade secrets, and proprietary know-how;

 

   

our ability to comply with U.S. public reporting requirements, including maintenance of an effective system of internal controls over financial reporting; and

 

   

our susceptibility to adverse changes in political, economic and other policies of the Chinese government that could materially harm our business.

Corporate Structure

We conduct our business operations in China through wholly owned subsidiaries and, with respect to the distribution aspects of our business, through an affiliated entity. PRC laws and regulations currently impose different levels of restrictions or prohibitions on investment of foreign capital in the pharmaceutical distribution industry. See “Regulations—Distribution of pharmaceutical products.” Our subsidiaries in China, which are wholly foreign-owned enterprises, are limited in their abilities to distribute the pharmaceutical products that we manufacture. Accordingly, we conduct our distribution activities through Liaoning Nuokang Medicines Co., Ltd. (Nuokang Distribution), a company whose sole registered shareholder is our chairman, chief executive officer and controlling shareholder, Mr. Baizhong Xue, and other third-party distributors. Nuokang Distribution is a variable interest entity (VIE) whose results are consolidated into our financial statements. Nuokang Distribution is considered our VIE because, through contractual arrangements with Mr. Xue, we bear the economic risks and derive the economic benefits associated with its ownership.

China Nuokang Bio-Pharmaceutical Inc. was incorporated in the Cayman Islands in June 2006. Through a series of transactions in August 2006 that were accounted for as a legal reorganization of entities under common control in a manner similar to a pooling of interests, China Nuokang Bio-Pharmaceutical Inc. acquired all of the equity interests in our operating subsidiaries and intermediate holding company.

 

 

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The following diagram illustrates our corporate structure as of the date of this prospectus.

LOGO

See “Corporate Structure” for further information about our corporate structure, restructuring exercise and our contractual arrangements that enable us to control our VIE, Nuokang Distribution.

Corporate Information

Our principal executive offices are located at No. 18-1 East Nanping Road, Hunnan National New & High-tech Development Zone, Shenyang, Liaoning Province, People’s Republic of China 110171. Our telephone number at this address is +86-24-2469-6033. Our registered address in the Cayman Islands is located at the offices of Maples Corporate Services Limited at PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our agent for service of process in the United States is Law Debenture Corporate Services Inc. of 400 Madison Avenue, 4th Floor, New York, New York 10017.

Investors should contact us for any inquiries through the address and telephone number of our principal executive offices. Our corporate website addresses are www.nkbp.com and www.lnnk.com. The information contained on our website is not a part of this prospectus.

 

 

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The Offering

 

ADSs we are offering

4,526,979 ADSs

 

ADSs the selling shareholders are offering

473,021 ADSs

 

ADSs outstanding immediately after this offering

5,000,000 ADSs

 

Ordinary shares outstanding immediately after this offering

157,460,142 ordinary shares

 

The ADSs

Each ADS represents eight ordinary shares, par value $0.0005 per share.

The depositary will be the holder of the ordinary shares underlying your ADSs.

If we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares, after deducting its fees and expenses.

You may turn in your ADSs to the depositary in exchange for ordinary shares underlying your ADSs. The depositary will charge you fees for exchanges.

We may amend or terminate the deposit agreement for any reason without your consent, and if you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the deposit agreement, which is an exhibit to the registration statement of which this prospectus is a part.

 

Over-allotment option

A selling shareholder has granted to the underwriters an option, which is exercisable within 30 days from the date of this prospectus, to purchase up to 750,000 additional ADSs.

 

Use of proceeds

We estimate that the net proceeds from this offering will be approximately $32.9 million. We expect to use the net proceeds from this offering to fund the acquisition and in-licensing of new technologies, products or companies, the research and development of our product candidates and

 

 

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the expansion of our product pipeline, including clinical trials, the improvement of our production systems, the expansion of our production facilities and the enhancement of our production lines, the expansion and enhancement of our sales and marketing network and general corporate purposes.

We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

Proposed NASDAQ Global Market symbol

NKBP

 

Depositary

JPMorgan Chase Bank, N.A.

The number of ordinary shares outstanding immediately after this offering:

 

   

is based on 121,244,310 shares outstanding as of September 30, 2009, assuming the conversion of all outstanding Series A redeemable convertible preference shares into 25,796,662 ordinary shares immediately prior to the closing of this offering;

 

   

excludes 7,290,000 ordinary shares issuable upon the exercise of stock options outstanding as of September 30, 2009 with exercise prices of $0.4613 per share or $0.7250 per share and a weighted average exercise price of $0.5011 per share; and

 

   

excludes 2,248,998 additional ordinary shares reserved for future grants under our 2007 and 2008 Share Incentive Plans.

Unless otherwise indicated, all information in this prospectus assumes the issuance and sale of 36,215,832 ordinary shares in the form of ADSs by us in this offering at an initial public offering price of $1.125 per share.

This prospectus contains translations of certain Renminbi amounts into U.S. dollars at specified rates. All translations from Renminbi to U.S. dollars were made at the noon buying rate in The City of New York for cable transfers in Renminbi per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York, or the noon buying rate. Unless otherwise stated, the translation of Renminbi into U.S. dollars has been made at the noon buying rate in effect on September 30, 2009 which was RMB6.8262 to $1.00. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. See “Risk Factors—Risks Related to Doing Business in China—Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.” On December 7, 2009, the noon buying rate was RMB6.8292 to $1.00.

 

 

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Summary Consolidated Financial Data

We have derived our consolidated statement of income data for the years ended December 31, 2006, 2007 and 2008 and our consolidated balance sheet data as of December 31, 2008 from our audited consolidated financial statements included in this prospectus. We have derived our consolidated statement of income data for the nine months ended September 30, 2008 and 2009 and our consolidated balance sheet data as of September 30, 2009 from our unaudited consolidated financial statements included in this prospectus. Our financial information for the nine months ended September 30, 2008 and 2009 includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical operating results presented below are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2009 or any other future fiscal period. Our financial statements have been prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP). You should read the summary consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and related notes included in this prospectus.

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
     2006     2007     2008     2008     2009  
Consolidated Statement of Income Data:   RMB     RMB     RMB     $     RMB     RMB     $  
                            (unaudited)     (unaudited)  
    (in thousands, except share and per share data and percentages)  

Net revenue

  121,661      147,875      225,399      33,020      153,519      200,058      29,307   

Cost of revenue

  (44,083   (34,745   (30,963   (4,536   (20,602   (24,809   (3,634
                                         

Gross profit

  77,578      113,130      194,436      28,484      132,917      175,249      25,673   

Operating expenses:

             

Research and development costs

  (6,054   (7,995   (5,585   (818   (4,921   (6,392   (936

Selling, marketing and distribution expenses

  (23,173   (52,443   (92,404   (13,537   (65,179   (84,043   (12,312

General and administrative expenses

  (14,809   (16,796   (31,884   (4,671   (22,508   (30,596   (4,482
                                         

Total operating expenses

  (44,036   (77,234   (129,873   (19,026   (92,608   (121,031   (17,730
                                         

Operating profit

  33,542      35,896      64,563      9,458      40,309      54,218      7,943   

Interest income

  47      196      1,259      184      957      881      129   

Interest expense

  (1,672   (5,190   (1,309   (192   (1,620   (4,232   (620

Other (expenses) income, net

  (344   2,191      6,353      931      6,802      416      61   
                                         

Income before income tax expense and non-controlling interest

  31,573      33,093      70,866      10,381      46,448      51,283      7,513   

Income tax (expense) benefit

  (6,181   2,102      (7,246   (1,062   (4,729   (9,646   (1,414

Non-controlling interest

  912                                 
                                         

Net income

  26,304      35,195      63,620      9,319      41,719      41,637      6,099   
                                         

Accretion of Series A convertible redeemable preference shares

       (30,156   (13,403   (1,964   (10,105   (11,021   (1,615

Allocation to Series A convertible redeemable preference shares for participating rights to dividends

       (326   (9,458   (1,386   (7,131   (6,969   (1,021

Net income attributed to ordinary shares

  26,304      4,713      40,759      5,969      24,483      23,647      3,463   
                                         

Other Financial Data:

             

Adjusted net income(1)

  26,304      35,195      55,497      8,128      33,305      41,526      6,083   

 

 

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     Year Ended December 31,   Nine Months Ended
September 30,
  2006   2007   2008   2008   2009
    RMB   RMB   RMB   $   RMB   RMB   $
                    (unaudited)   (unaudited)
Consolidated Statement
of Income Data:
  (in thousands, except share and per share data)

Net income per share

             

Basic

  0.26   0.05   0.43   0.06   0.26   0.25   0.04

Diluted

  0.26   0.05   0.43   0.06   0.26   0.25   0.04

Shares used in net income per share computation

             

Basic

  100,000,000   99,850,334   95,447,648   95,447,648   95,447,648   95,447,648   95,447,648

Diluted

  100,000,000   99,850,334   95,460,841   95,460,841   95,461,505   96,461,493   96,461,493

Pro forma net income per share (unaudited)

             

Basic

    0.28   0.52   0.08   0.34   0.34   0.05

Diluted

    0.28   0.52   0.08   0.34   0.34   0.05

Shares used in pro forma net income per share computation (unaudited)

             

Basic

    125,646,996   121,244,310   121,244,310   121,244,310   121,244,310   121,244,310

Diluted

    125,646,996   121,257,503   121,257,503   121,258,167   121,258,155   121,258,155

 

     As of December 31, 2008    As of September 30, 2009
      Actual    Actual    Pro forma
as adjusted(2)
     RMB    $    RMB    $    RMB    $
               (unaudited)    (unaudited)
Consolidated Balance Sheet Data:    (in thousands)

Cash and cash equivalents

   81,837    11,989    88,590    12,978    316,742    46,401

Total assets

   405,031    59,335    469,179    68,734    691,361    101,282

Short-term bank loans

   72,430    10,611    94,180    13,797    94,180    13,797

Total current liabilities

   119,760    17,543    142,525    20,881    140,188    20,539

Total shareholders’ equity

   127,721    18,711    158,337    23,196    521,011    76,326

Total liabilities and shareholders’ equity

   405,031    59,335    469,179    68,734    691,361    101,282

 

(1) We define adjusted net income as net income excluding the effect of foreign exchange gains related to the re-valuation of our U.S. dollar-denominated preference shares issued in December 2007 against the Renminbi, our functional currency. Adjusted net income is presented solely as a supplemental disclosure because we believe it is useful information for investors to assess the operating performance of our business without the effect of non-cash foreign exchange gains related to our U.S. dollar-denominated preference shares, which will convert automatically into our ordinary shares upon the close of this offering. We review adjusted net income together with U.S. GAAP measures such as net income to obtain a full representation of our financial performance. The use of adjusted net income has limitations and you should not consider adjusted net income in isolation from or as alternatives to consolidated income data prepared in accordance with U.S. GAAP, or as a measure of profitability.

 

     The following table sets forth the reconciliation of adjusted net income, a non-U.S. GAAP financial measure, from net income, our most directly comparable financial measure presented in accordance with U.S. GAAP, for the periods indicated.

 

    Year Ended December 31,     Nine months Ended
September 30,
 
    2006   2007   2008     2008     2009  
    RMB   RMB   RMB     $     RMB     RMB     $  
                        (unaudited)     (unaudited)  
    (in thousands)  

Net income

  26,304   35,195   63,620      9,319      41,719      41,637      6,099   

Foreign exchange gains from re-valuation of preference shares

      (8,123   (1,191   (8,414   (111   (16
                                     

Adjusted net income

  26,304   35,195   55,497      8,128      33,305      41,526      6,083   
                                     

 

(2) Pro forma as adjusted to give effect to the following factors:

 

   

the automatic conversion of all of our outstanding Series A convertible redeemable preference shares into 25,796,662 ordinary shares upon the closing of this offering; and

 

 

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the issuance and sale of 36,215,832 ordinary shares in the form of ADSs by us in this offering at an initial public offering price of $1.125 per share, after deducting estimated underwriting discounts, commissions and estimated offering expenses payable by us.

 

 

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RISK FACTORS

Investing in our ADSs involves a high degree of risk. You should carefully consider the risks described below with all of the other information included in this prospectus before deciding to invest in our ADSs. If any of the following risks actually occur, they may materially harm our business and our financial condition and results of operations. In these circumstances, the market price of our ADSs could decline and you could lose all or part of your investment.

Risks Related to Our Business

We are dependent, and we expect to continue to be dependent, on the revenue contribution from our flagship product, Baquting. A reduction in Baquting sales would cause our revenues to decline and materially harm our business.

We are largely dependent on sales of our hemocoagulase product, which we market under the name of Baquting. We launched Baquting in November 2001. In 2006, 2007, 2008 and the nine months ended September 30, 2009, we sold 4.2 million, 6.3 million, 9.7 million and 9.1 million units of Baquting, respectively. Revenues from Baquting sales accounted for 94.0%, 91.5%, 90.1% and 94.1% of our total revenue in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively. We plan on dedicating further resources toward maintaining and potentially expanding Baquting’s market share, such as improved quality control and production technology and formulation and dosage upgrades and modifications. Sales of Baquting will continue to comprise a substantial portion of our revenues in the future.

Any reduction in revenues from Baquting will have a direct negative impact on our business, financial condition and results of operations. Baquting sales could be adversely affected by a variety of factors, including:

 

   

increased competition;

 

   

new product introductions;

 

   

government-imposed pricing constraints;

 

   

problems with raw materials supply;

 

   

disruptions in manufacturing or distribution;

 

   

newly discovered safety issues caused by adverse reactions or misuse of our products; and

 

   

intellectual property issues.

Because of our relative lack of product diversification, an investment in our company may entail more risk than investments in companies that offer a wider variety of products or services. Despite our efforts, we may be unable to develop or acquire new products that would enable us to diversify our business and reduce our dependence on Baquting.

The commercial success of our products depends upon the degree of their market acceptance among the medical community. If our products do not attain market acceptance among the medical community, our operations and profitability would be adversely affected.

The commercial success of our products depends upon the degree of market acceptance they achieve among the medical community, particularly among physicians and hospital administrators. Physicians may not prescribe or recommend our products to patients and

 

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procurement departments of hospitals may not purchase our products if physicians or hospital pharmacists do not find our products attractive. The acceptance and use of our products among the medical community will depend upon a number of factors including:

 

   

perceptions by physicians, patients and others in the medical community about the safety and effectiveness of our products;

 

   

the prevalence and severity of any side effects;

 

   

pharmacological benefit of our products relative to competing products and products under development;

 

   

the efficacy and potential advantages relative to competing products and products under development;

 

   

relative convenience and ease of administration;

 

   

effectiveness of education, marketing and distribution efforts by us and our distributors;

 

   

publicity concerning our products or competing products and treatments; and

 

   

the price for our products and competing products.

In addition, the continued success of Baquting depends in part upon perceptions of the risk of transfusions and the quality of blood supply in China. If our products fail to attain market acceptance among the medical community, or if our currently marketed products cannot maintain market acceptance, our results of operations and profitability would be adversely affected.

We may not be able to obtain manufacturing or marketing approvals or pass on-site inspections for our current and future products, including Aiduo, Aiwen and Kaitong, or for our production facilities and failure to obtain approvals or pass on-site inspections for our future products or production facilities could materially harm our business prospects.

All medicines must be approved by the SFDA before they can be manufactured, marketed or sold in the PRC. The SFDA requires a pharmaceutical manufacturer to successfully complete clinical trials of a new medicine and demonstrate its manufacturing capability before approval to manufacture that new medicine is granted. Clinical trials are expensive and their results are uncertain. In addition, the SFDA and other regulatory authorities may apply new standards for safety, manufacturing, labeling, marketing and distribution of future products. Complying with these standards may be time-consuming and expensive. Furthermore, our future products may not be efficacious or may have undesirable or unintended side effects, toxicities or other characteristics that may preclude us from obtaining approval or may prevent or limit their commercial use. As a result, we may not be able to obtain SFDA or other governmental approvals for our future products on a timely basis or at all.

In particular, Jilin Yuhua requires a production permit for its production facility in order to be able to produce Kaitong. If the production permit for Kaitong is delayed or not granted at all, Jilin Yuhua will not be able to commence its production and we will not be able to launch this product in the market. In addition, we submitted our bioequivalence clinical trial data for dipyridamole aspirin sustained release capsules to the SFDA in December 2007, and we received an SFDA request in June 2009 for supplementary research data. We are in the process of compiling these data. We expect to receive the SFDA approval for manufacturing and marketing this product and launch it in the market in 2010. We cannot assure you that we or

 

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Jilin Yuhua will be able to obtain any of these approvals on a timely basis, or at all. Even if we or Jilin Yuhua do obtain these approvals, we cannot assure you that such approvals will not be modified or revoked, or such approvals may be subject to limitations on the indicated uses for which we may market a product, which may limit the size of the market for such a product. We will not be able to manufacture and market the new product as planned or at all if we do not obtain the governmental approvals.

Furthermore, even after we obtain such approvals, we may not be able to pass the on-site inspections required prior to the launch of our products. We require approval from the SFDA for the transfer of the production permit of Aiduo and Aiwen from Shenyang Guangda to us and GMP certification for our Shenyang facility in order to complete the acquisition of Aiduo and Aiwen from Shengyang Gangda and to commence production of these products at our production facility. If we fail to pass the on-site inspection in connection with a production permit application, we will not be able to obtain the production permit and commence production. If we fail to pass the on-site inspection in connection with the GMP certification, we will not be able to obtain the GMP certificate, which is required for pharmaceutical production and sale. The GMP certificates are subject to review and renewal every five years. See “Business—Certificates and Permit” for a description of our current licenses and permits. Failure to obtain or renew approvals or pass on-site inspections for our existing or future products could materially harm our business prospects.

The selling prices of our products may decline over time. Our success depends on our ability to successfully develop and commercialize biopharmaceutical products. Our product development efforts may not result in commercially viable products.

As is typical in the Chinese pharmaceutical industry, the average selling prices of biopharmaceutical products may decline significantly over the life of the product. These declines principally result from increased competition and price controls. Historically, the average selling prices of our products have not declined significantly. However, we cannot assure you that there will not be a material decline of selling prices in the future. We have sought to mitigate downward pricing pressure by introducing new products or enhanced versions of existing products with higher margins. We must therefore constantly identify product candidates that can be developed into cost-effective therapeutic products. We have devoted substantial resources to our research and development efforts; however, successful product development in our industry is highly uncertain, and relatively few research and development projects produce commercially viable products. If we cannot offset any decline in revenues and margins of our marketed products with new product introductions, our overall results of operations will suffer.

Our products face substantial competition. Other companies may discover, develop, acquire or commercialize products earlier or more successfully than we do.

We operate in a highly competitive environment. Our products compete with other products or treatments for diseases for which our products may be indicated. Baquting competes with both existing hemocoagulase products and potential new drug candidates. In China, our major competitors in the hemocoagulase market include Aohong Pharma’s Bangting, Solco Basel’s Reptilase and Lee’s Pharm’s Sulejuan, which accounted for approximately 29%, 25% and 8% market share, by volume, in 2008, respectively. Our products may compete against products that have lower prices, superior performance, greater ease of administration or other advantages compared to our products. We do not have patents of any commercial significance covering many of our products and product candidates to protect these products and product

 

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candidates from direct competition. Our inability to compete effectively could reduce sales or margins, which could have a material adverse effect on our results of operations.

Certain of our competitors market products or are actively engaged in research and development in areas where we have products or where we are developing product candidates or new indications for existing products. In the future, we expect that our products will compete with new drugs currently in development, drugs approved for other indications that may be approved for the same indications as those of our products and drugs approved for other indications that are used off-label. If less expensive alternatives to our products are dispensed or prescribed to patients, our sales could be negatively impacted. An increasing number of foreign pharmaceutical companies have introduced their pharmaceutical products into the Chinese market.

Large Chinese state-owned and privately owned pharmaceutical companies and foreign-invested or foreign pharmaceutical companies may have greater clinical, research, regulatory, manufacturing, marketing, financial and human resources than we do. In addition, some of our competitors may have technical or competitive advantages over us with respect to the development of technologies and processes. These resources may make it difficult for us to compete with them to successfully discover, develop and market new products and for our current products to compete with new products or new product indications that these competitors may bring to market. There may also be significant consolidation in the pharmaceutical industry among our competitors. Alliances may develop among competitors, and these alliances may rapidly acquire significant market share.

Furthermore, in order to gain market share in China, competitors may significantly increase their advertising expenditures and promotional activities or engage in irrational or predatory pricing behavior. In addition, our competitors may engage in inappropriate competition or illegal acts, such as bribery. Third parties may actively engage in activities designed to undermine our brand name and product quality or to influence customer confidence in our products. Increased competition may result in price reductions, reduced margins and loss of market share, any of which could materially adversely affect our profit margins. We may not be able to compete effectively against current and future competitors.

Our business depends on our well-known brands such as Nuokang and Baquting, and if we are not able to maintain and enhance our brand recognition to maintain our competitive advantage, our reputation, business and operating results may be harmed.

We believe that market awareness of our Nuokang and Baquting brands has contributed significantly to the success of our business. We also believe that maintaining and enhancing the Nuokang and Baquting brands is critical to maintaining our competitive advantage. Although our sales and marketing staff will continue to further promote our brands to remain competitive, we may not be successful. If we are unable to further enhance our brand recognition and increase awareness of our products, or if we are compelled to incur excessive marketing and promotion expenses in order to maintain our brand awareness, our business and results of operations may be materially and adversely affected. Furthermore, our sales and results of operations could be adversely affected if the Nuokang and Baquting brands, or the brands of any other products or our reputation are impaired by certain actions taken by our distributors, competitors, third-party marketing firms or relevant regulatory authorities.

 

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Pricing of our principal products is subject to government approval. Changes in government control on prices of our products may limit our profitability or cause us to stop manufacturing certain products.

The prices of pharmaceutical products listed in the national medical insurance catalog and other medicines, the production or trading of which may constitute monopolies, are subject to the control of the National Development and Reform Commission (NDRC) of the PRC and the relevant provincial or local price control authorities, either in the form of fixed prices or price ceilings. From time to time, the NDRC publishes a list of medicines subject to price controls. The NDRC directly regulates retail prices of certain medicines on the list and authorizes provincial price control authorities to regulate retail prices of the remaining products on that list. Our principal product, Baquting, and the product candidate under our exclusive distributorship, Kaitong, are subject to price controls by the NDRC. Because of the price controls, which are in the form of price ceilings, it would be difficult for us to raise the wholesale prices of any products subject to such controls if their price ceilings are not raised by the NDRC. The limitation on our ability to raise the wholesale prices of our products may prevent us from absorbing or offsetting the effect resulting from any increase in the cost of raw materials or other costs, which would lower our margins. We are required to file the prices of Aiduo, Aiwen and our other products with the provincial price control authorities. In aggregate, seven out of 14 of our products are subject to price controls imposed by the NDRC and provincial price control authorities, sales of which accounted for 97.6%, 94.2% and 95.5% of our total sales in 2007, 2008 and the nine months ended September 30, 2009, respectively. Furthermore, the prices of our products may be adjusted downward by the relevant governmental authorities in the future. In response to a rapid increase in prices of medicines, in May 2007, the NDRC lowered the price ceilings of 260 medicines in China. This order, which was reported as the NDRC’s twenty-first order for nationwide price reductions for medicines since 1998, resulted in an average reduction of 19% in retail prices of those medicines affected by the order. As a result, the maximum retail price at which hemocoagulase products such as Baquting are sold to patients was reduced from RMB56.7 per unit to RMB51.6 per unit in May 2007. If we are required to lower the wholesale prices to distributors of our principal products in the future as a result of any government-mandated reduction in the price ceilings of our products, our future revenue and profitability would be adversely affected.

In addition, in order to access certain local or provincial-level markets, we are required to enter into competitive bidding processes for Baquting, Aiduo, Aiwen and our other products every year or every other year with a pre-defined price range. The competitive bidding in effect sets price ceilings for our products, thereby limiting our profitability. In some instances, if the price range designated by the local or provincial government falls below production costs, we may stop manufacturing certain products.

Reimbursement may not be available for our products, which could diminish our sales or affect our ability to sell our products profitably.

Market acceptance and sales of our products also depend to a large extent on the reimbursement policies of the PRC government. The Ministry of Labor and Social Security of the PRC or provincial or local labor and social security authorities, together with other government authorities, review the inclusion or removal of drugs from the national medical insurance catalog or provincial or local medical insurance catalogs for the National Medical Insurance Program every other year, and the tier under which a drug will be classified, both of which affect the amounts reimbursable to program participants for their purchases of those medicines. These determinations are made based on a number of factors, including price and efficacy. Depending on the tier under which a drug is classified in the provincial medicine catalog, a

 

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National Medical Insurance Program participant residing in that province can be reimbursed for the full cost of Tier 1 medicine and for 80% to 90% of the cost of a Tier 2 medicine. Our principal product, Baquting, and the product candidate under our exclusive distributorship, Kaitong, are currently included in the national medical insurance catalog as Tier 2 medicines. Aiduo and Aiwen are Tier 2 medicines in the provincial medical insurance catalogs of Zhejiang, Hubei, Gansu, Hunan and Ningxia, and in the municipal medicine catalog of Changchun. If the relevant government authorities decide to remove our products from the medicine catalogs, such removal would reduce the affordability of our products and change the public perception regarding our products which in turn would adversely affect the sales of these products and reduce our net revenue. Furthermore, if we are unable to obtain approval from the relevant government authorities to include our new products in the national, provincial or local medicine catalogs, sales of our new products may be materially and adversely affected.

The growth and success of our business depends on our ability to successfully market our principal products to hospitals and their selection in tender processes used by hospitals for medicine purchases.

Our future growth and success significantly depend on our ability to successfully market Baquting, Aiduo and Aiwen to hospitals as prescription medicines. In 2006, 2007, 2008 and the nine months ended September 30, 2009, substantially all of the end-customers of Baquting, Aiduo and Aiwen were hospitals. Hospitals may make bulk purchases of a medicine included in the national and provincial medicine catalogs only if that medicine is selected under a government-administered tender process. Each year or every two years, a bidding process is organized on a provincial or municipal basis. Whether a medicine manufacturer is invited to participate in the tender depends on the level of interest that hospitals have in purchasing this medicine. The interest of a hospital in a medicine is evidenced by:

 

   

the inclusion of this medicine on the hospital’s formulary, which establishes the scope of medicines physicians at this hospital may prescribe to their patients, and

 

   

the willingness of physicians at this hospital to prescribe this medicine to their patients.

We believe that effective marketing efforts are critical in making and keeping hospitals interested in purchasing Baquting, Aiduo and Aiwen. If our marketing efforts are not effective, hospital administrators may not want to include Baquting, Aiduo and Aiwen in their formularies or may remove them from their formularies, or physicians may not be interested in prescribing Baquting, Aiduo or Aiwen to their patients. Should this happen, it would be unlikely for us to receive an invitation to submit Baquting, Aiduo and Aiwen in the tender. Even if we are invited to do so, we cannot assure you that Baquting, Aiduo and Aiwen will be successful in the tender. As a result, we may find it difficult to maintain the existing level of sales of our products, and our revenues and profitability may decline.

Rapid changes in the pharmaceutical industry may render our products obsolete.

The pharmaceutical industry is characterized by rapid changes in technology, constant enhancement of industrial know-how and frequent emergence of new products. Future technological improvements and continual product developments in the pharmaceutical market may render our existing products obsolete or affect our viability and competitiveness. Therefore, our future success will largely depend on our ability to:

 

   

improve our existing products;

 

   

diversify our product portfolio; and

 

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develop new and competitively priced products which meet the requirements of the constantly changing market.

If we fail to respond to this environment by improving our existing products or developing new products in a timely fashion, or if our new or improved products do not achieve adequate market acceptance, our business and profitability may be materially and adversely affected.

The recent global economic and financial market crisis has had and could continue to have a material adverse effect on our business, financial condition, results of operations and cash flow.

The recent global economic and financial market crisis has caused, among other things, a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, lower consumer and business spending, and lower consumer net worth, in the United States and other parts of the world. This global economic and financial market crisis may impair our ability to raise funds through capital market transactions or enter into other financial arrangements if and when additional funds become necessary for our operations. The recent economic and financial market crisis has caused, among other things, lower customer spending across China. People may have diminished financial resources to purchase even critical medical care, which could lead to reduced demand for our products and reduced gross margins. In addition, some of our distributors and their customers, primarily hospitals and other healthcare institutions, have been adversely affected by the recent economic crisis, resulting in delays in payment to us or defaults of payments by our distributor customers. Our accounts receivable net of allowance for doubtful accounts increased from RMB71.3 million as of December 31, 2008 to RMB91.9 million ($13.5 million) as of September 30, 2009 and our receivable turnover days increased from 85 days in the nine months ended September 30, 2008 to 124 days in the nine months ended September 30, 2009. Our accounts receivable may also continue to increase in the near future. Therefore, the global economic and financial market crisis has had and could continue to have a material adverse effect on our business, financial condition, results of operations and cash flow. In addition, the timing and nature of any recovery in the economic and financial markets remains uncertain, and there can be no assurance that market conditions will improve in the near future or that our results will not continue to be materially and adversely affected.

Our limited operating history may not serve as an adequate basis to judge our future prospects and results of operations.

We commenced operations in 1997 and have gradually built up our research, development, manufacturing, sales and marketing capabilities. We have a limited operating history under our current business model upon which you can evaluate the viability and sustainability of our business. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by other China-based early stage pharmaceutical companies. If we are unsuccessful in addressing any of these risks and uncertainties, our business, financial condition, results of operations and future growth would be adversely affected.

We may not achieve our projected development goals in the time frames we announce and expect.

We set goals for, and made disclosures in this prospectus regarding, timing of the accomplishment of objectives material to our success, such as the commencement and completion of pre-clinical tests, clinical trials, anticipated regulatory submission and approval dates and timing of product launches. As a public U.S.-listed company, we anticipate that we will make additional announcements in our public reports and in press releases regarding these

 

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events. The actual timing of these events can vary dramatically due to factors beyond our control, such as delays or failures in our pre-clinical tests or clinical trials, the uncertainties inherent in the regulatory approval process and delays in achieving manufacturing or marketing arrangements sufficient to commercialize our products. There can be no assurance that our pre-clinical tests or clinical trials will be completed as planned or at all, that we will make regulatory submissions or receive regulatory approvals as planned or that we will be able to adhere to our current schedule for the launch of any of our products. If we fail to achieve one or more of these milestones as planned, the price of our shares could decline.

New product development in the pharmaceutical industry is time-consuming and costly and has a low rate of successful commercialization.

Our success will depend in part on our ability to enhance our existing products and to develop new products. The development process for pharmaceutical products is complex and uncertain, as well as time-consuming and costly. Relatively few research and development programs produce a commercial product. A product candidate that appears promising in the early phases of development may fail to reach the market for a number of reasons, such as:

 

   

the failure to demonstrate safety and efficacy in preclinical and clinical trials;

 

   

the failure to obtain approvals for intended use from relevant regulatory bodies, such as the SFDA;

 

   

our inability to manufacture and commercialize sufficient quantities of the product economically; and

 

   

proprietary rights, such as patent rights, held by others to our product candidates and their refusal to sell or license such rights to us on reasonable terms, or at all.

In addition, product development requires the accurate assessment of market trends. We cannot assure you that:

 

   

our new product research and development efforts will be successfully and timely completed;

 

   

our clinical trials on humans for our product candidate will be successful;

 

   

SFDA or other regulatory bodies will grant necessary regulatory clearances or approvals on a timely basis, or at all; or

 

   

any product we develop will be commercialized or achieve market acceptance.

Delays in any part of the development process or our inability to obtain regulatory approval of our products could adversely affect our operating results by restricting or delaying our introduction of new products. Even if we successfully commercialize new products, these products may address markets that are currently being served by our mature products and may result in a reduction in the sales volume of our mature product or vice versa. Failure to develop, obtain necessary regulatory clearances or approvals for or successfully commercialize or market potential new products or technologies could have a material adverse effect on our financial condition and results of operations.

We will not be able to commercialize our product candidates if our preclinical studies do not produce successful results or our clinical trials do not demonstrate safety and efficacy in humans.

Before obtaining regulatory approvals for the manufacturing and sale of our product candidates, we must conduct, at our own expense, extensive preclinical tests and clinical trials

 

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to demonstrate the safety and efficacy in humans of our product candidates. Preclinical and clinical testing is expensive, difficult to design and implement, can take many years to complete and is uncertain as to outcome. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and interim results of a clinical trial do not necessarily predict final results. A failure of one or more of our clinical trials can occur at any stage of testing. We may experience numerous unforeseen events during, or as a result of, preclinical testing and the clinical trial process that could delay or prevent our ability to receive regulatory approval or commercialize our product candidates, including the following:

 

   

our preclinical tests or clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional preclinical testing or clinical trials, or we may abandon projects that appear promising;

 

   

we might have to suspend or terminate our clinical trials if the participating patients are being exposed to unacceptable health risks;

 

   

regulators may require that we hold, suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements or safety concerns;

 

   

the time or cost of our clinical trials may be greater than we currently anticipate;

 

   

any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the product not commercially viable; and

 

   

our product candidates may produce undesirable side effects or may have other unexpected characteristics.

If we are required to conduct additional clinical trials or other testing of our product candidates beyond those that we currently contemplate, if we are unable to successfully complete our clinical trials or other testing or if the results of these trials or tests are not positive or are only modestly positive, we may:

 

   

be delayed in obtaining approval for our product candidates;

 

   

not be able to obtain approval; or

 

   

obtain approval for indications that are not as broad as intended.

Our product development costs will also increase if we experience delays in testing or approvals. We do not know whether planned clinical trials will begin as planned, will need to be restructured or will be completed on schedule, if at all. Significant clinical trial delays also could allow our competitors to bring products to market before we do and impair our ability to commercialize our products or product candidates.

If we are unable to protect our products through intellectual property rights, our competitors may compete directly against us.

Our success depends, in part, on our ability to protect our products from competition by establishing, maintaining and enforcing intellectual property rights. We seek to protect the products and technology that we consider important to our business by filing PRC and international patent applications, relying on trade secrets or pharmaceutical regulatory protection or employing a combination of these methods. We have patents and patent applications relating to Baquting upgrades, adenosine for myocardial protection, Kaitong, Agkistrodon acutus hemocoagulase and lanthanum polystyrene. For more details, see “Business—Intellectual Property.” However, the filing of a patent application does not mean that we will be issued a patent, or that any patent eventually issued will be as broad as

 

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requested in the patent application or sufficient to protect our technology. There are a number of factors that could cause our patents, if granted, to become invalid or unenforceable or that could cause our patent applications to not be granted, including known or unknown prior art, deficiencies in the patent application or the lack of originality of the technology. In addition, the PRC adopts the first-to-file system under which whoever first files a patent application will be awarded the patent. By contrast, U.S. patent law endorses the first-to-invent system under which whoever makes the first actual discovery will be awarded the patent. Under the first-to-file system, a third party may be granted a patent relating to a technology which we invented. For more details on the process for applying for and obtaining intellectual property protection in the PRC, see “Regulations—Regulation of patent and trademark protection.” Furthermore, the terms of our patents are limited. The patents we hold and patents to be issued from our currently pending patent applications have a twenty-year protection period starting from the date of application.

We may become involved in patent litigation against third parties to enforce our patent rights, to invalidate patents held by such third parties, or to defend against such claims. The cost to us of any patent litigation or similar proceeding could be substantial, and it may consume significant management time. We do not maintain insurance to cover intellectual property infringement.

Intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries, because, among other reasons, of the lack of procedural rules for discovery and evidence, low damage awards and lack of judicial independence. Implementation and enforcement of PRC intellectual property laws have historically been deficient and ineffective and may be hampered by corruption and local protectionism. Policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our proprietary rights or those of others. The experience and capabilities of PRC courts in handling intellectual property litigation varies, and outcomes are unpredictable. Further, such litigation may require a significant expenditure of cash and may divert management’s attention, which could harm our business, financial condition and results of operations. An adverse determination in any such litigation could materially impair our intellectual property rights and may harm our business, prospects and reputation.

If our products infringe the intellectual property rights of third parties, we may incur substantial liabilities, and we may be unable to sell these products.

Our commercial success depends significantly on our ability to operate without infringing the patents and other proprietary rights of third parties. Under the PRC Patent Law, patent applications are maintained in confidence until their publication 18 months from the filing date. The publication of discoveries in the scientific or patent literature frequently occurs substantially later than the date on which the underlying discoveries were made and patent applications are filed. Even after reasonable investigation, we may not know with certainty whether any third party may have filed a patent application without our knowledge while we are still developing or producing that product. While the success of pending patent applications and applicability of any of them to our programs are uncertain, if asserted against us, we could incur substantial costs and we may have to:

 

   

obtain licenses, which may not be available on commercially reasonable terms, if at all;

 

   

redesign our products or processes to avoid infringement; and

 

   

stop producing our products using the patents held by others, which could cause us to lose the use of one or more of our products.

 

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We are currently in the process of disputing an objection raised by a third party related to our trademark “Shunxin.” To date, we have not received any other claims of infringement by any third parties. If a third party claims that we infringe its proprietary rights, any of the following may occur:

 

   

we may have to defend litigation or administrative proceedings that may be costly whether we win or lose, and which could result in a substantial diversion of management resources;

 

   

we may become liable for substantial damages for past infringement if a court decides that our technology infringes a third party’s intellectual property rights;

 

   

a court may prohibit us from producing and selling our product without a license from the holder of the intellectual property rights, which may not be available on commercially acceptable terms, if at all; and

 

   

we may have to reformulate our product so that it does not infringe the intellectual property rights of others, which may not be possible or could be very expensive and time consuming.

Any costs incurred in connection with such events or the inability to sell our products may have a material adverse effect on our business and results of operations.

We rely on confidentiality agreements that could be breached and may be difficult to enforce, which could have a material adverse effect on our business and competitive position.

Our policy is to enter agreements relating to the non-disclosure of confidential information with third parties, including our contractors, consultants, advisors and research collaborators, as well as agreements that purport to require the disclosure and assignment to us of the rights to the ideas, developments, discoveries and inventions of our employees and consultants while we employ them. However, these agreements can be difficult and costly to enforce. Moreover, to the extent that our contractors, consultants, advisors and research collaborators apply or independently develop intellectual property in connection with any of our projects, disputes may arise as to the proprietary rights to this type of information. If a dispute arises, a court may determine that the right belongs to a third party, and enforcement of our rights can be costly and unpredictable. In addition, we rely on trade secrets and proprietary know-how that we will seek to protect in part by confidentiality agreements with our employees, contractors, consultants, advisors or others. Despite the protective measures we employ, we still face the risk that:

 

   

these agreements may be breached;

 

   

these agreements may not provide adequate remedies for the applicable type of breach; or

 

   

our trade secrets or proprietary know-how will otherwise become known.

Any breach of our confidentiality agreements or our failure to effectively enforce such agreements would have a material adverse effect on our business and competitive position.

We source our primary raw material, Bothrops atrox venom, from a single third-party supplier and any supply failure could adversely affect our ability to manufacture our products.

We source our primary raw material, Bothrops atrox venom, for the production of Baquting, from Centro De Extracão De Toxinas Animais, an unaffiliated third-party supplier in Brazil. Export of Bothrops atrox venom is subject to the laws and administrative rules and regulations

 

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related to export-control in Brazil and its import to China is also required to comply with laws, regulations and restrictions imposed by the relevant national and local authorities in China. We must receive governmental approval from PRC authorities for each shipment of Bothrops atrox venom. We may not be able to obtain such approval in time to meet our production requirements or at all. The Brazilian government may impose more stringent control over exports, and the PRC government may impose stricter restrictions on imports, which, in either case, may impair our ability to import, or prevent us from importing, Bothrops atrox venom from Brazil to China.

If there is any supply interruption for an indeterminate period of time, we may not be able to identify and obtain alternative supplies that comply with our quality standards in a timely manner. Any supply disruption could adversely affect our ability to satisfy demand for our products, and materially and adversely affect our product sales and operating results.

The manufacture of our products is an exacting and complex process, and if we or our contract manufacturers encounter problems in manufacturing our products, our business and results of operations would be materially and adversely affected.

The SFDA and foreign regulators require manufacturers to register manufacturing facilities. The SFDA and foreign regulators also inspect these facilities to confirm compliance with GMP or similar requirements that the SFDA or foreign regulators establish. We or our contract manufacturers may face manufacturing or quality control problems causing product production and shipment delays or a situation where we or contract manufacturers may not be able to maintain compliance with the SFDA’s GMP requirements, or those of foreign regulators, necessary to continue manufacturing our drug candidates. A new inspection rule for GMP certification recently became effective on January 1, 2008 that implemented more stringent GMP standards. Any failure to comply with GMP requirements or other SFDA or foreign regulatory requirements could adversely affect our ability to manufacture, market and sell our products.

We rely on our distributors for sales of our products.

We rely on a limited number of distributors for most of our net revenue. Our top five distributors in the aggregate accounted for 35.1%, 37.2%, 33.4% and 43.5% of our net revenue in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively. We expect that a relatively small number of our distributors will continue to account for a major portion of our net revenue in the near future. Our dependence on a few distributors could expose us to the risk of substantial losses if a single large distributor stops purchasing our products, purchases fewer of our products or goes out of business and we cannot find substitute distributors on equivalent terms. If any of our significant distributors reduces the quantity of the products they purchase from us or stops purchasing from us, our net revenue would be materially and adversely affected.

We do not have long-term distribution agreements with our distributors, and we compete for desired distributors with other pharmaceutical manufacturers. Consequently, maintaining relationships with existing distributors and replacing distributors may be difficult and time consuming. Any disruption of our distribution network, including failure to renew existing distribution agreements with desired distributors, could negatively affect our ability to effectively sell our products and materially and adversely affect our business, financial condition and results of operations.

 

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We enter into distribution agreements with our distributors which generally provide distribution rights for our products in a designated geographic area for a period of one year. We generally have one to three distributors in each provincial-level region. If any distributor sells our products outside its designated geographic area, harmful competition among our distributors could result, which may adversely impact our product sales activities and operating results.

If we are unable to attract, train, retain and motivate our direct sales force and third-party marketing agents, sales of our products may be materially and adversely affected.

We rely on our direct sales force and third-party marketing agents, who are dispersed across China, to market our products to hospitals and other healthcare institutions. We believe that Baquting’s current leading position in the market was the result, to a significant extent, of the dedication, efforts and performance of our direct sales force and third-party marketing agents. We believe that our future success will continue to depend on these same factors. There are only limited numbers of competent and qualified marketing agents in the Chinese pharmaceutical industry. We do not provide compensation to, or contract directly with, our marketing agents. Our marketing agents are instead compensated for their marketing and promotional activities by distributors. We therefore are unable to directly incentivize the marketing agents for their abilities. Our competitors may provide commissions or other economic incentives to third-party marketing agents significantly above the market standard, which may cause such agents to cease marketing our products. If we are unable to attract, train, retain and motivate our direct sales force and marketing agents, sales of our products may be materially and adversely affected.

Anti-corruption measures taken by the government to correct corruptive practices in the pharmaceutical industry could adversely affect our sales and reputation.

The government has recently taken anti-corruption measures to correct corrupt practices. In the pharmaceutical industry, such practices include, among others, acceptance of kickbacks, bribery or other illegal gains or benefits by the hospitals and medical practitioners from pharmaceutical distributors in connection with the prescription of a certain drug. Substantially all of our sales are made to hospitals through third-party distributors. We have no control over our third-party marketing agents and distributors, who may engage in corrupt practices to promote our products. While we maintain strict anti-corruption policies applicable to our internal sales force and third-party marketing agents and distributors, these policies may not be completely effective. If our sales staff or any of our third-party marketing agents and distributors engage in such practices and the government takes enforcement action, our products may be seized and our own practices, and involvement in the distributors’ practices may be investigated. If this occurs, our sales and reputation may be materially and adversely affected.

In addition, government-sponsored anti-corruption campaigns from time to time could have an adverse effect on our efforts to reach new hospital customers. Our sales representatives primarily rely on hospital visits to better educate physicians on our products and promote our brand awareness. Recently, there have been occasions on which our sales representatives were denied access to hospitals in order to avoid the perception of corruption. If this attitude becomes widespread among our potential customers, our ability to promote our products will be adversely affected.

If we are unable to successfully manage our growth, there could be a material adverse impact on our business, results of operations and financial condition.

We have grown rapidly and expect to continue to grow. We expect to hire more employees, particularly in the areas of research and development, regulatory affairs and sales and

 

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marketing, and enhance our facilities and corporate infrastructure, further increasing the size of our organization and related expenses. To manage our anticipated future growth, we must continue to implement and improve our managerial, operational and financial systems, expand our facilities and continue to recruit and train additional qualified personnel. Because of our limited resources, we may not be able to effectively manage the expansion of our operations or recruit and train additional qualified personnel. The expansion of our operations may lead to significant costs and may divert our management and business development resources. Any inability on the part of our management to manage growth could delay the execution of our business plans or disrupt our operations. If we are unable to manage our growth effectively, we may be unable to use our resources in an efficient manner, which may negatively impact our business, results of operations and financial condition.

We depend upon key employees and consultants in a competitive market for skilled personnel. If we are unable to attract and retain key personnel, it could adversely affect our ability to develop and market our products.

We are highly dependent upon the principal members of our management team, especially our chairman and chief executive officer, Mr. Baizhong Xue. We have employment agreements, non-compete agreements and confidentiality agreements with these key employees. Although these agreements provide for severance payments that are contingent upon the applicable employee’s refraining from competition with us, the applicable provisions can be difficult and costly to monitor and enforce. The loss of any of these persons’ services would adversely affect our ability to develop and market our products.

We also depend in part on the continued services of our key scientific personnel and our ability to identify, hire and retain additional personnel, including marketing and sales staff. We face intense competition for qualified personnel, and the existence of non-competition agreements between prospective employees and their former employers may prevent us from hiring those individuals or subject us to suit from their former employers. While we attempt to provide competitive compensation packages to attract and retain key personnel, many of our competitors are likely to have greater resources and more experience than we have, making it difficult for us to compete successfully for key personnel.

Certain of our employees and consultants were previously employed at other biotechnology or pharmaceutical companies, including our competitors or potential competitors, or at universities or other research institutions. Although no claims against us are currently pending, we may be subject to claims that these employees or consultants have, inadvertently or otherwise, used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to our management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel.

Our collaborations with outside scientists and consultants may be subject to restriction and change.

We work with chemists, biologists and other scientists at academic and other institutions, and consultants who assist us in our research, development, regulatory and commercial efforts. These scientists and consultants have provided, and we expect that they will continue to provide, valuable advice on our programs. These scientists and consultants are not our employees, may have other commitments that would limit their future availability to us and typically will not enter into non-compete agreements with us. If a conflict of interest arises

 

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between their work for us and their work for another entity, we may lose their services. In addition, we will be unable to prevent them from establishing competing businesses or developing competing products. For example, if a key scientist acting as a principal investigator in any of our clinical trials identifies a potential product or compound that is more scientifically interesting to his or her professional interests, his or her availability to remain involved in such clinical trials could be restricted or eliminated.

If we acquire companies, products or technologies, we may face integration risks and costs associated with those acquisitions that could negatively impact our business, results from operations and financial condition.

If we are presented with appropriate opportunities, we may acquire or make investments in complementary companies, products or technologies. For example, we entered into a joint venture with QRxPharma Limited, an Australian company, to develop and commercialize two bleeding control products based on technologies developed by QRxPharma and the University of Queensland. We invested $5.0 million in the joint venture for it to fund the clinical trials for the product candidates, regardless of whether we are able to obtain regulatory approvals for their production or successfully commercialize them. We may not realize the anticipated benefit of any acquisition or investment. If we acquire companies or technologies, we will face risks, uncertainties and disruptions associated with the integration process, including difficulties in the integration of the operations of an acquired company, integration of acquired technology with our products, diversion of our management’s attention from other business concerns, the potential loss of key employees or customers of the acquired business, the potential involvement into any litigation related to the acquired company, and impairment charges if future acquisitions are not as successful as we originally anticipate. In addition, our operating results may suffer because of acquisition-related costs or amortization expenses or charges relating to acquired intangible assets. Any failure to successfully integrate other companies, products or technologies that we may acquire may have a material adverse effect on our business and results of operations. Furthermore, we may have to incur debt or issue equity securities to pay for any additional future acquisitions or investments, the issuance of which could be dilutive to our existing shareholders.

The pharmaceutical industry in China is highly regulated, and future government regulation may place additional burdens on our business.

The pharmaceutical industry in China is subject to extensive government regulation and supervision. The regulatory framework addresses all aspects of operating in the pharmaceutical industry, including approval, production, distribution, licensing and certification requirements and procedures, periodic renewal and reassessment processes, registration of new drugs and environmental protection. Violation of applicable laws and regulations may materially adversely affect our business. In order to manufacture pharmaceutical products in China, we are required to obtain a pharmaceutical manufacturing permit and GMP certificate for each production line from the relevant food and drug administrative authority. We are required to obtain the drug registration certificate, which includes a drug approval number, from the SFDA for each drug manufactured by us. In addition, in order to distribute any drug in China, we must obtain a pharmaceutical distribution permit and good supply practice (GSP) certificate from the SFDA. We are required to renew the pharmaceutical manufacturing permits, the pharmaceutical distribution permits, drug registration certificates, GMP certificates and GSP certificates every five years. If we are unable to obtain or renew such permits or any other permits or licenses required for our operation, we will not be able to engage in the manufacture and distribution of our products and our business may be adversely affected.

 

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The regulatory framework regarding the pharmaceutical industry in China is subject to change and amendment from time to time. Any such change or amendment may have an adverse effect on our business. Changes to the regulatory framework could materially and adversely impact our business, financial condition and results of operations. The PRC government has released a number of announcements since April 2009 that collectively outlined a comprehensive plan to reform the healthcare system in China within the next few years, with an overall objective to expand the basic medical insurance coverage and improve the quality and reliability of healthcare services. The details of the reform have yet to be announced and the specific regulatory changes under the reform still remain uncertain. The implementing measures to be issued may not be sufficiently effective to achieve the stated goals, and as a result, we may not be able to benefit from such reform to the level we expect, if at all. Moreover, the reform could give rise to regulatory developments, such as tighter control over product pricing or more burdensome administrative procedures, which may have an adverse effect on our business and prospects.

For further information regarding government regulation in China, see “Regulations.”

The pharmaceutical industry is extremely competitive and China’s entry to the WTO may intensify this competition in China.

Our business is subject to competition from other pharmaceutical manufacturers. Local and overseas pharmaceutical manufacturers engaged in the manufacture and sale of similar products to ours in China may have more capital resources, superior research and development capabilities and more experience in manufacturing and marketing their products. China joined the WTO in December 2001. Following its entry, China lowered tariffs on certain imported pharmaceutical products as part of its obligation under the WTO framework. The reduction or removal of tariffs on imported pharmaceutical products made such products more competitive with domestic pharmaceutical products. In addition, an increasing number of foreign-invested pharmaceutical manufacturers may establish operations to engage in the manufacture or distribution of pharmaceutical products in China, which would increase the number of suppliers of pharmaceutical products in the market and intensify the competition with domestic manufacturers. If the domestic pharmaceutical manufacturers are unable to distinguish their products from imported products or products produced domestically by foreign-invested pharmaceutical manufacturers, they may lose market share to imported products or products produced domestically by foreign-invested pharmaceutical manufacturers which may be of higher quality and are sold at competitive prices. Furthermore, due to the lack of capital for the research and development of new medicines, most of the domestic pharmaceuticals are imitations of foreign products. Following China’s entry to the WTO, many more companies in Europe and the U.S. have applied for patents in the PRC, thereby increasing the likelihood of litigation for Chinese domestic pharmaceutical companies whose products may be covered by PRC patents owned by foreign companies.

Adverse publicity associated with our company or our products or similar products manufactured by our competitors could have a material adverse effect on our results of operations.

There have been recent incidents reported in the Chinese media of a significant number of patients experiencing severe adverse health consequences following their use of biopharmaceutical products manufactured by certain biopharmaceutical companies in China. A number of patients have become ill and a number of fatalities have been reported. For example, several deaths were caused by human immunoglobulin manufactured and sold by Jiangxi Boya Biopharmaceutical Co., Ltd., a PRC biopharmaceutical product manufacturer, in May 2008. We

 

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are highly dependent upon market perceptions of the safety and quality of our products. Concerns over the safety of biopharmaceutical products manufactured in China could have an adverse effect on the sale of such products, including products manufactured by us.

We could be adversely affected if any of our products or any similar products manufactured by other companies prove to be, or are alleged to be, harmful to patients. Any negative publicity associated with severe adverse reactions or other adverse effects resulting from patients’ use or misuse of our products or any similar products manufactured by other companies could also have a material adverse impact on our results of operations. We have not, to date, experienced any significant quality control or safety problems. If in the future we become involved in incidents of the type described above, such problems could severely and adversely impact our product sales and reputation.

We are subject to environmental regulations and may be exposed to liability and potential costs for environmental compliance.

We are subject to PRC laws and regulations concerning the discharge of waste water, gaseous waste and solid waste during our manufacturing processes. We are required to establish and maintain facilities to dispose of waste and report the volume of waste to the relevant government authorities, which conduct scheduled or unscheduled inspections of our facilities and treatment of such discharge. We may not at all times comply fully with environmental regulations. Any violation of these regulations may result in substantial fines, criminal sanctions, revocations of operating permits, shutdown of our facilities and obligation to take corrective measures. Our cost of complying with current and future environmental protection laws and regulations and our liabilities which may potentially arise from the discharge of effluent water and solid waste may materially adversely affect our business, financial condition and results of operations.

The government may take steps towards the adoption of more stringent environmental regulations. Due to the possibility of unanticipated regulatory or other developments, the amount and timing of future environmental expenditures may vary substantially from those currently anticipated. If there is any unanticipated change in the environmental regulations, we may need to incur substantial capital expenditures to install, replace, upgrade or supplement our pollution control equipment or make operational changes to limit any adverse impact or potential adverse impact on the environment in order to comply with new environmental protection laws and regulations. If such costs become prohibitively expensive, we may be forced to cease certain aspects of our business operations.

We may be required to defend lawsuits or pay damages for product liability claims. We do not have any liability or business disruption insurance, and a claim against us, or an interruption in our business, could adversely offset our reputation and our financial results.

The development and commercialization of pharmaceutical products entails an inherent risk of harm to the patient and, therefore, product liability. Even though there are no punitive damages under the PRC law, if a product liability claim is brought against us, it may, regardless of merit or eventual outcome, result in damage to our reputation, breach of contract with our customers, decreased demand for our products, costly litigation, product recalls, loss of revenue, and the inability to commercialize some products. We currently are not aware of any existing or anticipated product liability claims with respect to our products.

Existing PRC laws and regulations do not require us to nor do we maintain liability insurance to cover product liability claims. The insurance industry in China is still at an early

 

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stage of development. Insurance companies in China offer limited business insurance products. As a result, we do not have business liability, or in particular, product liability, or disruption insurance coverage for our operations. Any business disruption, litigation or natural disaster might result in substantial costs and diversion of resources. When and if we attempt to obtain product liability insurance for clinical trials, this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products that we or our collaborators develop.

Power shortages, natural disasters, terrorist acts or other calamities could disrupt our production and have a material adverse effect on our business, financial position and results of operations.

Baquting and our other products are produced at our manufacturing facility in Penglai, China. A significant disruption at that facility, even on a short-term basis, could impair our ability to timely produce and ship products, which could have a material adverse effect on our business, financial position and results of operations.

Our manufacturing operations are vulnerable to interruption and damage from natural and other types of disasters, including earthquake, fire, floods, environmental accidents, power loss, communications failures and similar events. If any disaster were to occur, our ability to operate our business at our facilities would be seriously impaired. In addition, the nature of our production and research activities could cause significant delays in our programs and make it difficult for us to recover from a disaster. We do not maintain any insurance other than insurance for some of our properties. Accordingly, unexpected business interruptions resulting from disasters could disrupt our operations and thereby result in substantial costs and diversion of resources.

In addition, our production process requires a continuous supply of electricity. We have encountered power shortages historically due to restricted power supply to industrial users during summers when the usage of electricity is high and supply is limited or as a result of damage to the electricity supply network. Because the duration of those power shortages was brief, they had no material impact on our operations. Interruptions of electricity supply could result in lengthy production shutdowns, increased costs associated with restarting production and the loss of production in progress. Any major suspension or termination of electricity or other unexpected business interruptions could have a material adverse impact on our business, financial condition and results of operations.

If our lease with Shandong Penglai Pharmaceutical Plant is terminated, not renewed or suspended, or if we are required to vacate the leased premises for any reason, our operations may be materially adversely affected.

Certain production facilities of Penglai Nuokang Pharmaceutical Co., Ltd. (Penglai Nuokang) are located on land leased from a third party, Shandong Penglai Pharmaceutical Plant. The lease will expire on December 31, 2014 and upon its expiration, Penglai Nuokang and Shandong Penglai Pharmaceutical Plant may negotiate to extend the lease agreement. Shandong Penglai Pharmaceutical Plant may immediately terminate the lease if Penglai Nuokang subleases or lends the land use right or buildings to any third parties without its consent or if Penglai Nuokang violates the intended use of the land or uses the land to engage in any illegal activities. Under the lease agreement, any party that unilaterally terminates the lease without cause will pay to the other party damages equal to RMB1.0 million for each year remaining under the lease agreement. In addition, Shandong Penglai Pharmaceutical Plant has not obtained the building

 

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ownership certificates for our solid formulation plant. We cannot guarantee that it will ever be able to obtain the necessary building ownership certificates or that PRC government authorities or third parties will not challenge or invalidate its ownership. If Shandong Penglai Pharmaceutical Plant’s ownership of these buildings were challenged or invalidated, we may need to vacate our existing facilities in Penglai and move these manufacturing operations to our facilities in Shenyang or find alternative facilities. Any termination, non-renewal or suspension of the lease or our eviction from the leased premises could disrupt our operations. We might suffer losses as a result of business interruptions and our operations and financial results may be materially and adversely affected.

Our future capital needs are uncertain. As a result, we may need to raise additional funds in the future.

We may require additional cash resources in the future. Our future cash needs will depend upon:

 

   

the extent to which our products are accepted in the market and generate cash flows;

 

   

the resources we devote to developing, marketing and producing our products;

 

   

the receipt of, and the time and expenses required to obtain and maintain, regulatory clearances and approvals;

 

   

our ability to identify and our desire or need to pursue acquisitions or other investments; and

 

   

changed business conditions or other future developments.

Our revenues may not be sufficient to meet our operational needs and capital requirements, and needed financing may not be available in amounts or on terms acceptable to us, if at all. Our future capital needs and other business reasons could require us to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity or equity-linked securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations or our ability to pay dividends to our shareholders. Moreover, credit arrangements in the PRC are subject to government restrictions and may not be available to us on commercially reasonable terms or at all.

If we fail to establish an effective system of internal controls, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our ADSs may be adversely impacted.

We will be subject to reporting obligations under U.S. securities laws. The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on the company’s internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, an independent registered public accounting firm must audit and report on the effectiveness of a public company’s internal control over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending on December 31, 2010. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal control and procedures over financial reporting. As a result, during the preparation and external audit of our consolidated financial statements as of and for the years ended December 31, 2006, 2007 and 2008, we and our

 

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independent registered public accounting firm have identified two material weaknesses and certain significant deficiencies in our internal control over financial reporting, as defined in the standards established by the U.S. Public Company Accounting Oversight Board. These material weaknesses, which could result in more than a remote likelihood that a material misstatement in our annual or interim financial statements would not be prevented or detected, consisted of:

 

   

the lack of an internal audit function to assist our audit committee and management in the effective discharge of their responsibilities through independent and objective review, analysis, appraisal and reporting of recommendations on our business operations and activities; and

 

   

the lack of adequate personnel with sufficient understanding of U.S. GAAP and SEC reporting requirements and adequate policies and procedures to prepare financial information in accordance with U.S. GAAP and SEC regulations.

We are in the process of implementing measures to remedy these material weaknesses and deficiencies and to prepare to meet the deadline imposed by Section 404 of the Sarbanes-Oxley Act. If we fail to timely achieve and maintain the adequacy of our internal controls, our management may conclude that our internal control over financial reporting is not effective. While we plan to expand our financial staff if we become public, we may encounter substantial difficulty attracting qualified staff with requisite experience due to the high level of competition for experienced financial professionals. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports and is important to help prevent fraud. As a result, our failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the market price of our ADSs.

We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.

We do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2009 or for any future taxable year. However, the application of the PFIC rules is subject to ambiguity in several respects, and we must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year. Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year or any future taxable year. Latham & Watkins LLP, our special U.S. counsel, expresses no opinion with respect to our PFIC status and expresses no opinion with respect to our expectations set forth in this paragraph. A non-U.S. corporation will be a PFIC for any taxable year if either (1) at least 75% of its gross income for such year is passive income or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during such year) is attributable to assets that produce passive income or are held for the production of passive income. The value of our assets for purposes of the PFIC test will generally be determined by reference to the market price of our ADSs and ordinary shares, which may fluctuate after this offering. In addition, the composition of our income and assets will be affected by how, and how quickly, we use the cash raised in this and any future offering. If we are a PFIC for any taxable year during which a U.S. Holder (as defined in “Taxation—U.S. Federal Income Taxation”) holds an ADS or an ordinary share, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. For example, such U.S. Holder may incur a significantly increased U.S. federal income tax liability on the receipt of certain distributions on our ADSs or ordinary shares or on any gain realized from a sale or other disposition of our ADSs or ordinary shares. See “Taxation—U.S. Federal Income Taxation—Passive Foreign Investment Company.”

 

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Risks Related to Doing Business in China

The PRC’s economic, political and social conditions, as well as governmental policies, could affect the financial markets in China, our liquidity and access to capital and our ability to operate our business.

Substantially all of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. More generally, if the business environment in China deteriorates from the perspective of domestic or international investors, our business in China may also be adversely affected.

Future changes in laws, regulations or enforcement policies in China could adversely affect our business.

Laws, regulations or enforcement policies in China, including those regulating healthcare and the pharmaceutical industry, are evolving and subject to frequent changes. Further, regulatory agencies in China may periodically, and sometimes abruptly, change their enforcement practices. Therefore, prior enforcement activity, or lack of enforcement activity, is not necessarily predictive of future actions. Any enforcement actions against us could have a material and adverse effect on us and the market price of our ADSs. In addition, any litigation or governmental investigation or enforcement proceedings in China may be protracted and may result in substantial cost and diversion of resources and management attention, negative publicity, damage to our reputation and decline in the price of our ADSs.

Changes in PRC government policy on foreign investment in China may adversely affect our business and results of operations.

As foreign invested enterprises, our wholly owned subsidiaries including Liaoning Nuokang Bio-pharmaceutical Co., Ltd. (Liaoning Nuokang), Shenyang Shouzheng Bio-technology Co., Ltd. (Shenyang Shouzheng) and Penglai Nuokang are subject to restrictions on foreign investment imposed by PRC laws from time to time. For instance, under the Foreign Investment Industrial Guidance Catalogue, some industries are categorized as sectors which are encouraged, restricted or prohibited for foreign investment.

According to the latest version of this Catalogue, which became effective on December 1, 2007, our business, other than the distribution of pharmaceutical products, does not belong to the prohibited or the restricted category. As this Catalogue is updated every few years, there can be no assurance that the PRC government will not change its policies in a manner that would cause part or all of our businesses to fall within the restricted or prohibited categories. If any of our businesses becomes prohibited or if we cannot obtain approval from relevant approval authorities to engage in businesses which become restricted for foreign investors, we may be forced to sell or restructure our businesses which have become restricted or prohibited for foreign investment. If we are forced to adjust our corporate structure or business line as a result

 

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of changes in government policy on foreign investment, our business, financial condition and results of operations may be materially and adversely affected.

Recent regulations relating to offshore investment activities by PRC residents may limit our ability to acquire PRC companies and could adversely affect our business, financial condition and results of operations.

In October 2005, State Administration of Foreign Exchange (SAFE) promulgated a regulation known as Circular No. 75 that states that if PRC residents use assets or equity interests in their PRC entities as capital contributions to establish offshore companies or inject assets or equity interests of their PRC entities into offshore companies to raise capital overseas, they must register with local SAFE branches with respect to their overseas investments in offshore companies. They must also file amendments to their registrations if their offshore companies experience material events involving capital variation, such as changes in share capital, share transfers, mergers and acquisitions, spin-off transactions, long-term equity or debt investments or guarantee. Under this regulation, failure to comply with the registration procedures set forth in such regulation may result in restrictions being imposed on the foreign exchange activities of the relevant PRC entity, including the payment of dividends and other distributions to its offshore parent, as well as restrictions on the capital inflow from the offshore entity to the PRC entity. Mr. Baizhong Xue, our chief executive officer and chairman of our board of directors, beneficially owned 78.7% of our outstanding share capital as of the date of this prospectus. Mr. Xue has registered with the SAFE under the relevant SAFE regulations and will be required to update his registration upon the completion of this offering. While we believe our shareholders have complied with existing SAFE registration procedures, any future failure by any of our shareholders who is a PRC resident, or controlled by a PRC resident, to comply with relevant requirements under this regulation could subject our company to fines or sanctions imposed by the PRC government, including restrictions on our subsidiaries’ ability to pay dividends or make distributions to us and our ability to increase our investment in or to provide loans to our subsidiaries.

On December 25, 2006, the People’s Bank of China promulgated the Measures for Administration of Individual Foreign Exchange, on January 5, 2007, the SAFE promulgated Implementation Rules for those measures and on March 28, 2007, the SAFE further promulgated the Operating Procedures on Administration of Foreign Exchange regarding PRC Individuals’ Participation in Employee Share Ownership Plans and Employee Stock Option Plans of Overseas Listed Companies. According to these new foreign exchange regulations, PRC citizens who are granted shares or share options by a company listed on an overseas stock market under its employee share option or share incentive plan are required to register with the SAFE or its local counterparts by following certain procedures. We and our employees who are PRC citizens and individual beneficiary owners or have been granted restricted shares or share options may be subject to these rules. The failure of our PRC individual beneficiary owners and holders of restricted shares or share options to complete their SAFE registrations according to the requirements of local counterparts of the SAFE or the new foreign exchange rules may subject these PRC citizens to fines and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute dividends to us or otherwise materially and adversely affect our business.

Uncertainties with respect to the PRC legal system could materially and adversely affect us.

We conduct our business primarily through our subsidiaries and affiliated entities in China. PRC laws and regulations govern our operations in China. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws

 

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applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their non-binding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China, regardless of outcome, may be protracted and result in substantial costs and diversion of resources and management attention.

We may not be able to pay dividends to our shareholders.

We are a holding company, and we rely on dividends paid by our wholly owned subsidiaries, Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang, for our cash needs, including the funds necessary to pay any dividends and other cash distributions to our shareholders, service any debt we may incur and pay our operating expenses. The payment of dividends in China is subject to limitations. Regulations in the PRC currently permit payment of dividends by our PRC subsidiaries only out of accumulated profits as determined in accordance with accounting standards and regulations in China. The payment of dividends by Nuokang Distribution, our VIE, is determined by its sole shareholder, Mr. Baizhong Xue, our chairman and chief executive officer, subject to Penglai Nuokang’s approval. Repayment by Mr. Xue of these dividends to Penglai Nuokang under the contractual arrangements is subject to applicable PRC laws and regulations. Each of our subsidiaries is required to allocate at least 10% of its net profit after tax to the general reserve fund until the balance of such fund has reached 50% of its registered capital. These funds are not distributable in cash dividends. If our subsidiaries are unable to pay us sufficient dividends due to statutory or contractual restrictions on their abilities to distribute dividends to us, we may not be able to pay dividends to our shareholders and our various other cash needs may not be met. In addition, our debt arrangements and those of our subsidiaries that we may enter into from time to time may impose operating and financial restrictions on us and our subsidiaries. These restrictions may limit our ability and the ability of our subsidiaries to pay dividends. In addition, if our subsidiaries incur debts or losses, such indebtedness or loss may impair their ability to pay dividends to us and limit our ability to pay dividends to our shareholders.

Our ability to declare dividends in relation to our shares will also depend on our future financial performance, which in turn depends on successfully implementing our strategy and on financial, competitive, regulatory, and other factors, general economic conditions, demand and prices for our services, costs of supplies and other factors specific to our industry or specific projects, many of which are beyond our control. The receipt of dividends from our subsidiaries may also be affected by the passage of new laws, adoption of new regulations or changes to, or in the interpretation or implementation of existing laws and regulations and other events outside our control. In particular, as our operating subsidiaries are located in the PRC, we may be adversely affected by implementation of capital and other exchange controls by the PRC Government. See “Dividend Policy” for a discussion of our dividend policy.

 

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Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

We receive all of our revenues in Renminbi, which currently is not a freely convertible currency. A portion of our revenues may be converted into other currencies to meet our foreign currency obligations, including, among others, payments of dividends declared, if any, in respect of our ordinary shares or ADSs. Under China’s existing foreign exchange regulations, our subsidiaries are able to pay dividends in foreign currencies or convert Renminbi into other currencies for use in operations without prior approval from the SAFE, by complying with certain procedural requirements. However, we cannot assure you that the PRC government will not take future measures to restrict access to foreign currencies for current account transactions.

Our PRC subsidiaries’ ability to obtain foreign exchange is subject to significant foreign exchange controls and, in the case of amounts under the capital account, requires the approval of and/or registration with PRC government authorities, including the SAFE. In particular, if we finance our PRC subsidiaries by means of foreign debt from us or other foreign lenders, the amount is not allowed to exceed the difference between the amount of total investment and the amount of the registered capital as approved by the Ministry of Commerce (MOFCOM) and registered with the SAFE. Further, such loans must be registered with the SAFE. Currently, the amount of total investment of each of Shenyang Shouzheng and Penglai Nuokang is equal to the amount of its registered capital. If we finance Shenyang Shouzheng and Penglai Nuokang by means of foreign debt, we must obtain approvals from the local MOFCOM branches to increase the amount of their total investment first. If we fail to receive approval from the local MOFCOM branches to increase the amount of our subsidiaries’ total investment, we may not finance our PRC subsidiaries by means of foreign debts. If we finance our PRC subsidiaries by means of additional capital contributions, the amount of these capital contributions must first be approved by the relevant government approval authority. These limitations could affect the ability of our PRC subsidiaries to obtain foreign exchange through debt or equity financing.

Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. The conversion of Renminbi into foreign currencies, including the U.S. dollar, has historically been set by the People’s Bank of China. On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy caused the Renminbi to appreciate approximately 21.5% against the U.S. dollar over the following three years. Since reaching a high against the U.S. dollar in July 2008, however, the Renminbi has traded within a narrow band against the U.S. dollar, remaining within 1% of its July 2008 high but never exceeding it. As a consequence, the Renminbi has fluctuated sharply since July 2008 against other freely traded currencies, in tandem with the U.S. dollar. It is difficult to predict how long the current situation may last and when and how it may change again. As we import our primary raw material from Brazil and may import certain production equipment in the future, fluctuations in the value of the Renminbi against the U.S. dollar and other currencies may affect our cost of production. In addition, as we rely entirely on dividends paid to us by our subsidiaries, any significant revaluation of the Renminbi may have a material adverse effect on our revenues and financial condition, and the value of, and any dividends payable on, our ordinary shares in foreign currency terms. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation of the Renminbi against the U.S.

 

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dollar would reduce the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making dividend payments on our ordinary shares or for other business purposes, appreciation of the U.S. dollar against the Renminbi would reduce the U.S. dollar amount available to us.

Our business benefits from certain government incentives. Expiration of, or changes to, these incentives could have a material adverse effect on our operating results by significantly increasing our tax expenses.

The PRC government has provided various incentives to foreign-invested companies, such as Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang, although these incentives are subject to the new enterprise income tax law (the new EIT law). Such incentives include reduced tax rates and other measures. Under the PRC tax laws effective prior to January 1, 2008, domestic companies typically were subject to an enterprise income tax rate of 33%. On March 16, 2007, the National People’s Congress of China enacted the new EIT law, and the implementation rules of such new EIT law were promulgated by the State Council of China on December 6, 2007. Under the new EIT law and its implementation rules, foreign invested enterprises (FIEs) and domestic companies would be subject to an enterprise income tax at a uniform rate of 25%. The new EIT law and its implementation rules became effective on January 1, 2008. Under the new EIT law, enterprises that were established and already enjoyed tax holidays of two-year tax exemption and three-year tax reduction of 50% before March 16, 2007 will continue to enjoy such preferential tax treatment until the expiration of such term.

Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang are foreign-invested companies established in 2005, 2006 and 2006, respectively, which were subject to the two-year tax exemption and three-year tax reduction of 50%. They continue to enjoy the preferential tax treatment until the expiration of such term. The tables below set forth the applicable income tax rates of our subsidiaries and Nuokang Distribution for the periods indicated.

 

Subsidiary

   2006     2007     2008     2009     2010  

Liaoning Nuokang

   0   0   12.5   12.5   12.5

Shenyang Shouzheng

   15   0   0   12.5   12.5

Penglai Nuokang

   0 %(1)    0   12.5   12.5   12.5

Nuokang Distribution

   33   33   25   25   25

 

(1) Penglai Nuokang started being fully exempted from EIT from September 2006. Prior to that, it was subject to EIT at a statutory rate of 33%.

Under the new EIT law and its implementation rules, enterprise that are “high and new technology enterprises strongly supported by the State” are entitled to a reduced EIT rate of 15%. In 2008, the relevant PRC authorities recognized Liaoning Nuokang and Penglai Nuokang as “high and new technology enterprises” through 2010, after which we plan to apply for the renewal of these qualifications. We will also apply for the “high and new technology enterprise” qualification for Shenyang Shouzheng, whose existing preferential tax treatment expires in 2011. There is no assurance that Liaoning Nuokang and Penglai Nuokang will continue to, or Shenyang Shouzheng will, be qualified as “high and new technology enterprises” and an increase in the applicable EIT rates may have a material adverse effect on our results of operations.

Any discontinuation of tax preferential tax treatment or any increase of the enterprise income tax rate applicable to our subsidiaries or Nuokang Distribution could have a material adverse effect on our financial condition and results of operations.

 

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The dividends we receive from our PRC subsidiaries and our global income may be subject to PRC tax under the new EIT law, which would have a material adverse effect on our results of operations, and dividends distributed by us to our non-PRC shareholders or any gains realized by non-PRC shareholders from transfer of our shares may be subject to PRC tax.

Under the new EIT law, dividends, interests, rents and royalties payable by a foreign-invested enterprise in the PRC to its foreign investor who is a non-resident enterprise, as well as gains on transfers of shares of a foreign-invested enterprise in the PRC by such a foreign investor, will be subject to a 10% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with the PRC that provides for a reduced rate of withholding tax. Surplus International Investments Limited (Surplus International), the 100% shareholder of Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang, is incorporated in Hong Kong. According to the Mainland and Hong Kong Special Administrative Region Arrangement on Avoiding Double Taxation or Evasion of Taxation on Income agreed between China and Hong Kong in August 2006, dividends paid by a foreign-invested enterprise in China to its direct holding company in Hong Kong will be subject to withholding tax at a rate of no more than 5% (if the foreign investor owns directly at least 25% of the shares of the foreign-invested enterprise). Therefore, if Surplus International is considered a non-resident enterprise for purposes of the new EIT law, this new withholding tax imposed on dividends paid to us by our PRC subsidiaries would reduce our net income in the event we decide to declare a dividend, which may have an adverse effect on our operating results.

Under the new EIT law, an enterprise established outside the PRC with its “de facto management body” within the PRC is considered a “resident enterprise” and will be subject to the enterprise income tax at the rate of 25% on its worldwide income. The “de facto management body” is defined as the organizational body that effectively exercises overall management and control over production and business operations, personnel, finance and accounting, and properties of the enterprise. It remains unclear how the PRC tax authorities will interpret such a broad definition. Substantially all of our management members are based in the PRC. If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our worldwide income will be subject to income tax at a uniform rate of 25%, which will decrease our earnings from operations. Notwithstanding the foregoing provision, the new EIT law also provides that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested enterprise are exempted from income tax, subject to certain conditions. Therefore, if we are classified as a resident enterprise, the dividends received from our PRC subsidiaries may be exempted from income tax. However, it remains unclear how the PRC tax authorities will interpret the PRC tax resident treatment of an offshore company having ownership interest in a PRC enterprise.

In addition, because there remains uncertainty regarding the interpretation and implementation of the new EIT law and its implementation rules, if we are regarded as a PRC resident enterprise, any dividends to be distributed by us to our non-PRC shareholders or any gains realized by non-PRC shareholders or ADS holders from transfer of our shares or ADSs may be subject to PRC tax. If we are required under the new EIT law to withhold PRC income tax on the above dividends or if investors are subject to PRC income tax on gains on sale of ADSs or shares, your investment in our shares or ADSs may be materially and adversely affected.

 

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The approval of the China Securities Regulatory Commission may be required in connection with this offering; any failure to obtain this approval, if required, could have a material adverse effect on our business, operating results and trading price of our ADSs, and may also create uncertainties for this offering. The regulation also establishes more complex procedures for acquisitions by foreign investors, which could make it more difficult to pursue growth through acquisitions.

On August 8, 2006, six PRC regulatory agencies, including the MOFCOM and the China Securities Regulatory Commission (CSRC), jointly promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006. This regulation, among other things, requires offshore special purpose vehicles, formed for overseas listing purposes through acquisitions of PRC domestic companies and controlled by PRC individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC published a notice specifying the documents and materials that are required to be submitted for obtaining CSRC approval. Our PRC counsel, Tian Yuan Law Firm, has advised us that this regulation does not apply to us and that CSRC approval is not required because we obtained approvals from the local branches of MOFCOM for the acquisition of Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang, our wholly owned subsidiaries in the PRC, before September 8, 2006, the effective date of this new regulation. Based on the advice we have received from our PRC counsel, we did not seek the CSRC approval in connection with this offering.

Although this regulation was adopted over three years ago, there remains uncertainty as to how this regulation will be interpreted or implemented. If the CSRC or other PRC regulatory authorities subsequently determine that the CSRC’s approval was required for our initial public offering, we may face sanctions by the CSRC or other PRC regulatory agencies. In that case, these regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, restrict or prohibit payment or remittance of dividends by our PRC subsidiaries, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs.

The regulation also established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. In the future, we may grow our business in part by acquiring complementary businesses. Complying with the requirements of this regulation to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the MOFCOM, may delay or inhibit our ability to complete such transactions. Any delay or inability to obtain applicable approvals to complete acquisitions could affect our ability to expand our business or maintain our market share.

We face risks related to health epidemics and outbreaks of contagious diseases.

Our business could be adversely affected by the effects of H1N1 pandemic avian flu, SARS or other epidemics or outbreaks. China reported a number of cases of SARS in April 2004. In 2005, 2006 and 2007, there have been reports on the occurrences of avian flu in various parts of China, including a few confirmed human cases and deaths. Recently, concerns have been raised with respect to the spread of avian influenza and the H1N1 pandemic in various regions of China. Any prolonged recurrence of avian flu, SARS or other adverse public health developments in China may have a material adverse effect on our business operations. These

 

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could include temporary closure of our manufacturing facilities, as well as certain sectors of the hospital industry. Such closures or impact over business of hospitals would severely disrupt our business operations and adversely affect our results of operations. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of avian flu, SARS or any other epidemic.

Risks Related to Our Corporate Structure

Our contractual arrangements with Nuokang Distribution and its shareholder may not be as effective in providing control over the entity as direct ownership.

According to the PRC Drug Administration Law and other applicable regulations, our subsidiaries in China may only sell the pharmaceutical products that we manufacture to certain distributors and we may not sell products that others manufacture. Accordingly, Mr. Baizhong Xue, our chairman and chief executive officer, established Nuokang Distribution in 1999 with four other shareholders to engage in the distribution of pharmaceutical products. Mr. Xue subsequently became the sole shareholder of Nuokang Distribution. Substantially all of our sales are conducted through Nuokang Distribution, which was the direct contracting party with most of our key distributors. We are a party to certain contractual arrangements with Nuokang Distribution which are designed to provide us with certain effective control over, and substantially all of the economic benefits of, Nuokang Distribution. If Nuokang Distribution or its sole shareholder, Mr. Baizhong Xue, refuses to make payments or otherwise refuses to perform their contractual obligations necessary for us to realize these sales contracts, we may not be able to distribute our products and our financial condition and results of operations will be materially and adversely affected.

We currently conduct our sales activities through Nuokang Distribution by means of contractual arrangements. If the PRC government determines that the contractual arrangements do not comply with applicable regulations, our business could be adversely affected.

We conduct our sales activities through contractual arrangements with Nuokang Distribution, which holds the licenses and approvals, including a pharmaceutical distribution permit that is essential for the distribution of our products. We have contractual arrangements with Nuokang Distribution and its sole shareholder, Mr. Baizhong Xue, our chairman and chief executive officer, that allow us to substantially control this entity. These contracts include business cooperation agreements, which impose certain restrictions on the conduct of Nuokang Distribution’s businesses. We cannot assure you that we will be able to enforce these contracts.

Although we believe we comply with current PRC regulations, we cannot assure you that the PRC government would agree that our arrangements with Nuokang Distribution and its sole shareholder comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future. There are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations and the PRC government may determine that the contractual arrangements were designed to circumvent the applicable PRC laws and regulations. Accordingly, we cannot assure you that our contractual arrangements with Nuokang Distribution and its sole shareholder will be enforceable. For example, under the equity pledge agreement by and between Mr. Baizhong Xue and Penglai Nuokang, Mr. Baizhong Xue has pledged all of his equity interest in Nuokang Distribution to Penglai Nuokang to guarantee the performance of Nuokang Distribution under the relevant contractual arrangements. Under the PRC Property Law effective on October 1, 2007, an equity pledge will not become effective until

 

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it is registered with local SAIC. We are still in the process of registering the equity pledge with the SAIC Liaoning branch but are experiencing delays because the implementation rules of the PRC Property Law have only recently been issued. If the PRC government determines that we are not in compliance with applicable law, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or take other regulatory or enforcement actions against us that could be harmful to our business.

The sole shareholder of Nuokang Distribution has potential conflicts of interest with us, which may adversely affect our business.

Nuokang Distribution is 100% owned by Mr. Baizhong Xue, our chairman and chief executive officer. Although Mr. Baizhong Xue owes us a duty of loyalty and care under Cayman Islands law, the potential exists for conflicts of interests between his duties to us and his ownership interests in Nuokang Distribution. In particular, Mr. Xue may be able to cause our agreements with Nuokang Distribution to be performed or amended in a manner adverse to us by, among other things, failing to remit payments to us on a timely basis or operating Nuokang Distribution so as to cause harm to our business. We can provide no assurance that if potential conflicts of interests arise, these conflicts will not result in a significant loss in corporate opportunities for us or a diversion of our resources to Nuokang Distribution, which may not be in the best interest of our company and our other shareholders.

Except for the trademarks “ LOGO®” (Baquting) and “ LOGO®” (Danya) that are owned by Penglai Nuokang, all other trademarks we are currently using are owned by Nuokang Distribution. We received long term licenses from Nuokang Distribution to use these trademarks. We may need additional licenses from Nuokang Distribution in the future if we plan to use other trademarks it owns. As a result of the conflict of interest between Nuokang Distribution and us, the terms of such licenses may not be favorable to us.

Our contractual arrangements with Nuokang Distribution may be subject to scrutiny by the PRC tax authorities and we could be required to pay additional taxes, which could substantially reduce our consolidated net income and the value of your investment.

Arrangements and transactions among related parties may be subject to audits or challenges by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities determine that our contractual arrangements with Nuokang Distribution are not arm’s-length transactions. If this were to occur, the tax authorities could adjust Nuokang Distribution’s income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions recorded by Nuokang Distribution, which could in turn increase its tax liabilities. The PRC tax authorities could also impose late payment fees and other penalties on Nuokang Distribution for under-paid taxes. In addition, any challenge by the PRC tax authorities may limit the ability of Nuokang Distribution to receive any preferential tax treatments and other financial incentives. Our consolidated net income may be materially and adversely affected if Nuokang Distribution’s tax liabilities increase or if it is found to be subject to late payment fees or other penalties.

 

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Risks Related to Our ADSs and this Offering

There has been no public market for our ordinary shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.

Prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. We have applied to list our ADSs on The NASDAQ Global Market. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

The initial public offering price for our ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for our ADSs after this initial public offering. We cannot assure you that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price.

The market price for our ADSs may be volatile.

The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to factors including the following:

 

   

actual or anticipated fluctuations in our quarterly operating results and changes or revisions of our expected results;

 

   

changes in financial estimates by securities research analysts;

 

   

announcements of studies and reports relating to the effectiveness or safety of our products or those of our competitors;

 

   

negative publicity associated with pharmaceutical companies, particularly in China;

 

   

announcements of technological or competitive developments;

 

   

any litigation, governmental investigation or enforcement proceedings brought against us by authorities and industry regulators in China or elsewhere;

 

   

announcements regarding patent litigation or the issuance of patents to us or our competitors;

 

   

addition or departure of our senior management and key research and development personnel;

 

   

changes in the economic performance or market valuations of other pharmaceutical or health care companies;

 

   

economic, regulatory or political developments in China;

 

   

release or expiration of lock-up or other transfer restrictions on our outstanding ordinary shares or ADSs; and

 

   

sales of additional ordinary shares or ADSs, or the perception that such sales might occur.

In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also have a material adverse effect on the market price of our ADSs.

 

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Because the initial public offering price is substantially higher than our net tangible book value per share, you will incur immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. Also, you will experience immediate and substantial dilution of approximately $6.74 per ADS, representing the difference between the purchase price per ADS in this offering and our net tangible book value per ADS as of September 30, 2009, after giving effect to this offering. In addition, you may experience further dilution to the extent that our ordinary shares are issued upon the exercise of stock options.

Substantial future sales of our ADSs in the public market, or the perception that such sales might occur, could cause the price of our ADSs to decline.

Sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Immediately upon completion of this offering, we will have 157,460,142 ordinary shares outstanding, including 40,000,000 ordinary shares represented by 5,000,000 ADSs. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act, except to the extent acquired by persons deemed to be our “affiliates.” In connection with this offering, we, our shareholders, and our directors and executive officers have agreed not to sell any ordinary shares or ADSs until the expiration of 180 days, after the date of this prospectus, subject to certain exceptions. Any or all of these shares may be released without notice prior to expiration of the applicable lock-up period at the discretion of Jefferies & Company, Inc. To the extent shares are released before the expiration of the applicable lock-up period and sold into the market, the market price of our ADSs could decline.

Our existing shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other shareholders.

Mr. Baizhong Xue, our chairman and chief executive officer, beneficially owned 78.7% of our outstanding share capital as of the date of this prospectus. Because of this high level of shareholding, Mr. Xue has substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. Mr. Xue may take actions that are not in the best interest of us or our other shareholders. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders.

Holders of ADSs have fewer rights than shareholders and must act through the depositary to exercise those rights.

Holders of ADSs do not have the same rights as holders of our ordinary shares and ADS holders only have such rights as are specified in the deposit agreement, which generally are more restricted than the rights of holders of ordinary shares. Under our articles of association, the minimum notice period required to convene a general meeting days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts

 

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to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested. In addition, in your capacity as an ADS holder, you will not be able to call a shareholder meeting.

You may be subject to limitations on transfers of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the United States unless we register the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. Also, under the deposit agreement, the depositary will not make rights available to you unless the distribution to ADS holders of both the rights and any related securities are either registered under the Securities Act, or exempted from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.

You may not receive cash dividends if the depositary decides that it is inequitable or impractical to make them available to you.

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property, in which event you would not receive such distribution.

We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Cayman Islands Companies Law and the common law of the Cayman Islands.

 

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The rights of shareholders to take action against the directors, the rights of minority shareholders to institute actions, and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, the latter of which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in the United States. In particular, because the Cayman Islands has no legislation specifically dedicated to the rights of investors in securities, and thus no statutorily defined private causes of action specific to investors in securities such as those found under the Securities Act of 1933 or the Securities Exchange Act of 1934 in the United States, it provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

There is uncertainty regarding whether Cayman Islands courts would:

 

   

recognize or enforce against us or our directors or officers judgments of courts of the United States predicated upon certain civil liability provisions of U.S. securities laws; and

 

   

impose liability against us or our directors or officers, in original actions brought in the Cayman Islands, based on certain civil liability provisions of U.S. securities laws or laws of any state in the U.S.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

Your ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, will be limited because we are incorporated in the Cayman Islands, because we conduct substantially all of our operations in China and because the majority of our directors and officers reside outside of the United States.

We are incorporated in the Cayman Islands, and we conduct substantially all of our operations in China through our PRC subsidiaries. Most of our directors and officers reside, and substantially all of the assets of those persons are located, outside the United States. As a result, it may be difficult or impossible for you to bring an action in the United States against us or against these individuals in the event that you believe that your rights have been violated under U.S. securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands or China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

Our articles of association will contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.

We will be adopting amended and restated articles of association that will contain provisions limiting the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or

 

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similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preference shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADSs or otherwise. Preference shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preference shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

 

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FORWARD-LOOKING STATEMENTS

This prospectus, including the sections titled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” contains forward-looking statements. Forward-looking statements convey our current expectations and views of future events. The words “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” and other similar expressions may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. These forward-looking statements include, among other things, statements about:

 

   

competition from other domestic and foreign pharmaceutical companies;

 

   

our ability to enhance existing products and develop, obtain government approvals for, and market future generations of our existing products and other new products;

 

   

the expected market growth for pharmaceutical products in China;

 

   

market acceptance of our products;

 

   

our expectations regarding hospital or patient demand for our products;

 

   

our ability to expand our production, sales and distribution network and other aspects of our operations;

 

   

our ability to diversify our product range;

 

   

our ability to effectively protect our intellectual property;

 

   

our ability to identify and acquire new medical technologies, pharmaceutical products and product candidates;

 

   

changes in the healthcare industry in China, including changes in the healthcare policies and regulations of the PRC government and changes in the healthcare insurance sector in the PRC;

 

   

fluctuations in general economic and business conditions in China; and

 

   

our ability to control Nuokang Distribution through contractual arrangements.

Any or all of our forward-looking statements in this prospectus may turn out to be inaccurate. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. They may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including the risks, uncertainties and assumptions described in “Risk Factors.” In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur as contemplated, and actual results could differ materially from those anticipated or implied by the forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this prospectus. Unless required by law, we undertake no obligation to update or revise any forward-looking statements to reflect new information or future events or otherwise. You should, however, review the factors and risks we describe in reports we will file from time to time with the SEC after the date of this prospectus. See “Where You Can Find Additional Information.”

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the 4,526,979 ADSs we are offering will be approximately $32.9 million, after deducting underwriting discounts, commissions and the estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

We intend to use the net proceeds we receive from this offering for the following purposes:

 

   

approximately $14.0 million to fund the acquisition and in-licensing of new technologies, products or companies;

 

   

approximately $5.0 million to fund the research and development of our product candidates and the expansion of our product pipeline, including clinical trials, of which approximately $0.7 is expected to be used to develop the manufacturing process of dipyridamole aspirin sustained release capsules, $1.2 for Phase II and Phase III clinical trials of hemocoagulase derived from the venom of the snake species Agkistrodon acutus, $0.7 for preclinical trials of adenosine for myocardial protection, and $1.9 for preclinical trials of lanthanum polystyrene sulfonate;

 

   

approximately $5.0 million to fund the improvement of our production systems, the expansion of our production facilities and the enhancement of our production lines;

 

   

approximately $8.0 million to fund the expansion and enhancement of our sales and marketing network; and

 

   

the balance for general corporate purposes.

We have not identified any potential acquisition candidate.

As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds from this offering. The amounts and timing of our actual expenditures may vary significantly from our expectations depending upon numerous factors, including our capital and expenditures and operating costs, and the progress of our research, development and commercialization efforts. Accordingly, we retain the discretion to allocate the net proceeds of this offering among the identified uses described above, and we reserve the right to change the allocation of the net proceeds among the uses described above as a result of contingencies such as our manufacturing requirements, the results of our commercialization efforts and the progress and results of our clinical trials and our research and development activities.

Pending the use of proceeds from this offering described above, we intend to invest the proceeds in a variety of capital preservation investments, including short-term, investment-grade, interest-bearing instruments.

In using the proceeds of this offering, as an offshore holding company, we are permitted, under PRC laws and regulations, to provide funding to our PRC subsidiaries only through loans or capital contributions and to other entities only through loans. Subject to satisfaction of applicable government registration and approval requirements, we may extend inter-company loans to our PRC subsidiaries or make additional capital contributions to our PRC subsidiaries to fund their capital expenditures or working capital. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all.

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2009:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the automatic conversion of all of our outstanding Series A convertible redeemable preference shares into 25,796,662 ordinary shares immediately prior to the closing of this offering; and

 

   

on a pro forma as adjusted basis to reflect the automatic conversion of all of our outstanding Series A convertible redeemable preference shares into 25,796,662 ordinary shares immediately prior to the closing of this offering, and the sale of 36,215,832 ordinary shares in the form of ADSs by us in this offering at an initial public offering price of $9.00 per ADS, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

 

     As of September 30, 2009
     Actual    Pro forma    Pro forma
as adjusted
     RMB    $    RMB    $    RMB    $
     (in thousands, except share and per share data)

Short-term bank loans

   94,180    13,797    94,180    13,797    94,180    13,797

Series A convertible redeemable preference shares, $0.0005 par value, 25,800,000 shares authorized and 25,796,662 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

   138,155    20,239            

Shareholders’ equity:

                 

Ordinary shares, $0.0005 par value, 474,200,000 shares authorized, 95,447,648 shares issued and outstanding, actual; 121,244,310 shares issued and outstanding pro forma and; 157,460,142 shares issued and outstanding, pro forma as adjusted

   382    56    470    69    594    87

Additional paid-in capital

   50,477    7,395    188,544    27,621    412,940    60,494

Retained earnings

   107,478    15,745    107,478    15,745    107,478    15,745

Total shareholders’ equity

   158,337    23,196    296,492    43,435    521,011    76,326
                             

Total capitalization

   390,672    57,232    390,672    57,232    615,191    90,123
                             

You should read the table above in conjunction with our financial statements and related notes appearing elsewhere in this prospectus. This table is based on 95,447,648 of our ordinary shares and 25,796,662 Series A convertible redeemable preference shares, which automatically convert into our ordinary shares at the close of this offering, outstanding as of September 30, 2009 and:

 

   

excludes 7,290,000 ordinary shares issuable upon the exercise of share options outstanding as of September 30, 2009 with exercise prices of $0.4613 per share or $0.7250 per share and a weighted average exercise price of $0.5011 per share; and

 

   

excludes 2,248,998 additional ordinary shares reserved for future grants under our share option plan.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted for each ADS you purchase to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering.

Our net tangible book value as of September 30, 2009 was approximately RMB290.6 million ($42.6 million), or RMB3.04 ($0.45) per ordinary share, and $3.57 per ADS. Net tangible book value represents the amount of our total consolidated assets, less the amount of our total consolidated liabilities and intangible assets. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the conversion of all outstanding Series A convertible redeemable preference shares into ordinary shares upon the completion of this offering, from the initial public offering price per ordinary share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

Our pro forma net tangible book value as of September 30, 2009 was RMB2.40 ($0.35) per ordinary share, and $2.81 per ADS. Pro forma net tangible book value per share represents the amount of our total consolidated assets, less the amount of our total consolidated liabilities and intangible assets, divided by the number of ordinary shares outstanding as of September 30, 2009, after giving effect to the conversion of our Series A convertible redeemable preference shares.

Giving effect to our sale of the ADSs offered in this offering and after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our adjusted pro forma net tangible book value as of September 30, 2009 would have been RMB515.1 million ($75.5 million), or RMB3.27 ($0.48) per outstanding ordinary share, and RMB26.2 ($3.83) per ADS. This represents an immediate increase in pro forma net tangible book value of $0.13 per ordinary share and $1.03 per ADS to the existing shareholders, and an immediate dilution in pro forma net tangible book value of $0.65 per ordinary share and $5.17 per ADS to investors purchasing ADSs in this offering. The following table illustrates such dilution:

 

Initial public offering price per ADS

   $ 9.00

Net tangible book value per ordinary share as of September 30, 2009

   $ 0.45

Pro forma net tangible book value per ordinary share after giving effect to the conversion of our Series A convertible redeemable preference shares

   $ 0.35

Pro forma net tangible book value per ADS after giving effect to the conversion of our Series A convertible redeemable preference shares

   $ 2.81

Pro forma net tangible book value per ordinary share after giving effect to the conversion of our Series A convertible redeemable preference shares and this offering

   $ 0.48

Pro forma net tangible book value per ADS after giving effect to the conversion of our Series A convertible redeemable preference shares and this offering

   $ 3.83

Amount of dilution in net tangible book value per ordinary share to new investors in the offering

   $ 0.65

Amount of dilution in net tangible book value per ADS to new investors in the offering

   $ 5.17

 

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The following table summarizes, on a pro forma basis as of September 30, 2009, the differences between existing shareholders, including holders of our Series A convertible redeemable preference shares that will be automatically converted into ordinary shares immediately upon the completion of this offering, and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share and ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.

 

     Total shares    Total consideration    Average
price
per
ordinary
share
   Average
price
per ADS
      Number    %    Amount
(in thousands)
   %      

Existing shareholders

   121,244,310    77.00    $ 27,690    40.46    $ 0.23    $ 1.83

New investors

   36,215,832    23.00    $ 40,743    59.54    $ 1.125    $ 9.00
                           

Total

   157,460,142    100.00    $ 68,433    100.00      
                           

The discussion and tables above assume no exercise of any outstanding share options. As of September 30, 2009, there were 6,190,000 and 1,100,000 ordinary shares issuable upon exercise of outstanding share options at an exercise price of $0.4613 and $0.7250 per share, respectively. If all of these options had been exercised on September 30, 2009, after giving effect to the conversion of all our Series A convertible redeemable shares and this offering, our net tangible book value would have been approximately $79.1 million, or $0.48 per ordinary share and $3.84 per ADS, and the dilution in net tangible book value to new investors would have been $0.64 per ordinary share and $5.16 per ADS.

 

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DIVIDEND POLICY

We have never declared or paid any dividends, nor do we have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

Our board of directors has complete discretion on whether to pay dividends, subject to the approval of our shareholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares” for more information. Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

We are a holding company, and we rely on dividends paid by our operating subsidiaries in China for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, service any debt we may incur and pay our operating expenses. The payment of dividends in China is subject to limitations. Regulations in the PRC currently permit payment of dividends by our PRC subsidiaries only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Our PRC subsidiaries are required to set aside at least 10% of their after-tax profits each year to contribute to their respective reserve funds until the accumulated balance of the reserve funds reach 50% of their respective registered capital. They are also required to reserve a portion of their after-tax profits to their employee welfare and bonus fund, the amount of which is determined by their respective board of directors. These funds are not distributable in cash dividends.

 

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ENFORCEABILITY OF CIVIL LIABILITIES

A majority of our directors and executive officers, and certain experts named in this prospectus, reside outside the United States and a substantial portion of the assets of our company and these persons are located outside the United States. As a result, it may be difficult for investors to effect service of process upon these persons within the United States or to enforce against us or these persons in U.S. courts, judgments obtained in U.S. courts, including judgments based on the civil liability provisions of the federal securities laws of the United States. In addition, it may be difficult for investors to enforce, in original actions brought in courts in jurisdictions located outside the United States, liabilities based on the U.S. federal securities laws.

We have appointed Law Debenture Corporate Services Inc., located at 400 Madison Avenue, 4th Floor, New York, New York 10017, as our agent to receive service of process with respect to any action brought against us in the United States District Court for the Southern District of New York under the federal securities laws of the United States or of any State of the United States or any action brought against us in the Supreme Court of the State of New York in the County of New York under the securities laws of the State of New York.

We have been advised by our Cayman Islands counsel, Maples and Calder, that there is uncertainty as to whether the courts of the Cayman Islands would recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of securities law of the United States or any state in the United States or entertain original actions brought in the Cayman Islands against us or our directors or officers predicated upon the securities law of the United States or any state in the United States.

A final and conclusive judgment in federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes or other similar charges, fines, other penalties or multiple damages, may be subject to enforcement proceedings as a debt in a court of the Cayman Islands under the common law doctrine of obligation.

We have been advised by Tian Yuan Law Firm, our PRC counsel, that there is uncertainty as to whether the courts of the PRC would enforce judgments of United States courts obtained against us or these persons predicated upon the civil liability provisions of the United States federal and state securities laws or in original actions brought in the PRC, liabilities against us or these persons predicated upon the United States federal and state securities laws. Tian Yuan Law Firm has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between the PRC and the country where the judgment is made or on reciprocity between jurisdictions. If there are no treaties or reciprocity arrangements between the PRC and a foreign jurisdiction where a judgment is rendered, according to PRC Civil Procedures Law, matters relating to the recognition and enforcement of the foreign judgment in the PRC may be resolved through diplomatic channels. The PRC does not have any treaties or other arrangements with the United States or the Cayman Islands that provide for the reciprocal recognition and enforcement of foreign judgments. As a result, it is generally difficult to enforce in the PRC a judgment rendered by a U.S. or Cayman Islands court.

 

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EXCHANGE RATE INFORMATION

Our business is primarily conducted in China and all of our revenues are denominated in Renminbi. Periodic reports made to shareholders will be expressed in U.S. dollars using the then current Renminbi to U.S. dollar exchange rate. Conversions of Renminbi into U.S. dollars in this prospectus are based on the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus were made at a rate of RMB6.8262 to $1.00, the noon buying rate in effect as of September 30, 2009. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On December 7, 2009, the noon buying rate was RMB6.8292 to $1.00.

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you. The source of these rates is the Federal Reserve Bank of New York.

 

     Renminbi per U.S. Dollar Noon Buying Rate

Period

   Period
End
   Average(1)    Low    High

2004

   8.2765    8.2768    8.2774    8.2764

2005

   8.0702    8.1826    8.2765    8.0702

2006

   7.8041    7.9579    8.0702    7.8041

2007

   7.2946    7.5806    7.8127    7.2946

2008

   6.8225    6.9193    7.2946    6.7800

2009

           

Nine Months ended September 30

   6.8262    6.8306    6.8470    6.8176

June

   6.8302    6.8334    6.8371    6.8264

July

   6.8319    6.8317    6.8342    6.8300

August

   6.8299    6.8323    6.8358    6.8299

September

   6.8262    6.8277    6.8303    6.8247

October

   6.8264    6.8267    6.8292    6.8248

November

   6.8265    6.8271    6.8300    6.8255

December (through December 7)

   6.8292    6.8270
   6.8292    6.8260

 

 

(1) Annual averages are calculated from month-end rates. Monthly averages are calculated using the average of the daily rates during the relevant period.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

We have derived our consolidated statement of income data for the years ended December 31, 2006, 2007 and 2008 and our consolidated balance sheet data as of December 31, 2007 and 2008 from our audited consolidated financial statements included in this prospectus. The selected consolidated statement of income data for the year ended December 31, 2005 and the consolidated balance sheet date as of December 31, 2005 and 2006 have been derived from our audited consolidated financial statements not included in this prospectus. We have derived our consolidated statement of income data for the nine months ended September 30, 2008 and 2009 and our consolidated balance sheet data as of September 30, 2009 from our unaudited consolidated financial statements included in this prospectus. Our financial information for the nine months ended September 30, 2008 and 2009 includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical operating results presented below are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2009 or any other future fiscal period. Our financial statements have been prepared in accordance with U.S. GAAP. You should read the selected consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and related notes included in this prospectus. We have not included financial information for the year ended December 31, 2004, as this information is not available on a basis that is consistent with the consolidated financial information for the periods beginning from the year ended December 31, 2005 and cannot be provided on a U.S. GAAP basis without unreasonable effort or expense.

 

     Year Ended December 31,     Nine Months Ended
September 30,
 
  2005     2006     2007     2008     2008     2009  
    RMB     RMB     RMB     RMB     $     RMB     RMB     $  
                                  (unaudited)    

(unaudited)

 
    (in thousands, except share and per share data and percentages)  

Consolidated Statement of Income Data:

               

Net revenue

  129,422      121,661      147,875      225,399      33,020      153,519      200,058      29,307   

Cost of revenue

  (52,826   (44,083   (34,745   (30,963   (4,536   (20,602   (24,809   (3,634
                                               

Gross profit

  76,596      77,578      113,130      194,436      28,484      132,917      175,249      25,673   

Operating expenses:

               

Research and development costs

  (6,422   (6,054   (7,995   (5,585   (818   (4,921   (6,392   (936

Sales, marketing and distribution expenses

  (22,427   (23,173   (52,443   (92,404   (13,537  

(65,179

 

(84,043

 

(12,312

General and administrative expenses

  (17,275   (14,809   (16,796   (31,884   (4,671   (22,508   (30,596   (4,482
                                               

Total operating expenses

  (46,124   (44,036   (77,234   (129,873   (19,026   (92,608   (121,031   (17,730
                                               

Operating profit

  30,472      33,542      35,896      64,563      9,458      40,309      54,218      7,943   

Interest income

  44      47      196      1,259      184      957      881      129   

Interest expense

  (1,248   (1,672   (5,190   (1,309   (192   (1,620   (4,232   (620

Other (expenses) income, net

  (346   (344   2,191      6,353      931      6,802      416      61   
                                               

Income before income tax expense and non-controlling interest

  28,922      31,573      33,093      70,866      10,381     

46,448

  

 

51,283

  

 

7,513

  

Income tax (expense) benefit

  (7,042   (6,181   2,102      (7,246   (1,062   (4,729   (9,646   (1,414

Non-controlling interest

  (3,359   912                                 
                                               

Net income

  18,521      26,304      35,195      63,620      9,319      41,719      41,637      6,099   
                                               

Accretion of Series A convertible redeemable preference shares

            (30,156   (13,403   (1,964   (10,105  

(11,021

 

(1,615

Allocation to Series A convertible redeemable preference shares for participating rights to dividends

            (326   (9,458   (1,386  

(7,131

 

(6,969

 

(1,021

Net income attributed to ordinary shares

  18,521      26,304      4,713      40,759      5,969      24,483      23,647      3,463   
                                               

 

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     Year Ended December 31,   Nine Months Ended
September 30,
  2005   2006   2007   2008   2008   2009
    RMB   RMB   RMB   RMB   $   RMB   RMB   $
                        (unaudited)   (unaudited)
    (in thousands, except share and per share data and percentages)
Consolidated Statement of Income Data:                

Net income per share

               

Basic

  0.19   0.26   0.05   0.43   0.06   0.26   0.25   0.04

Diluted

  0.19   0.26   0.05   0.43   0.06   0.26   0.25   0.04

Shares used in net income per share computation

               

Basic

  100,000,000   100,000,000   99,850,334   95,447,648   95,447,648   95,447,648   95,447,648   95,447,648

Diluted

  100,000,000   100,000,000   99,850,334   95,460,841   95,460,841   95,461,505   96,461,493   96,461,493

Pro forma net income per share (unaudited)

               

Basic

      0.28   0.52   0.08   0.34   0.34   0.05

Diluted

      0.28   0.52   0.08   0.34   0.34   0.05

Shares used in pro forma net income per share computation (unaudited)

               

Basic

      125,646,996   121,244,310   121,244,310   121,244,310   121,244,310   121,244,310

Diluted

      125,646,996   121,257,503   121,257,503   121,258,167   121,258,155   121,258,155

Other Financial Data:

               

Adjusted net income(1)

  18,521   26,304   35,195   55,497   8,128   33,305   41,526   6,083

 

(1) We define adjusted net income as net income excluding the effect of foreign exchange gains related to the re-valuation of our U.S. dollar-denominated preference shares issued in December 2007 against the Renminbi, our functional currency. Adjusted net income is presented solely as a supplemental disclosure because we believe it is useful information for investors to assess the operating performance of our business without the effect of non-cash foreign exchange gains related to our U.S. dollar-denominated preference shares, which will convert automatically into our ordinary shares upon the close of this offering. We review adjusted net income together with U.S. GAAP measures such as net income to obtain a full representation of our financial performance. The use of adjusted net income has limitations and you should not consider adjusted net income in isolation from or as alternatives to consolidated income data prepared in accordance with U.S. GAAP, or as a measure of profitability.

 

     The following table sets forth the reconciliation of adjusted net income, a non-U.S. GAAP financial measure, from net income, our most directly comparable financial measure presented in accordance with U.S. GAAP, for the periods indicated.

 

    Year Ended December 31,     Nine Months Ended
September 30,
 
    2005   2006   2007   2008     2008     2009  
    RMB   RMB   RMB   RMB     $     RMB     RMB     $  
                            (unaudited)     (unaudited)  
    (in thousands)  

Net income

  18,521   26,304   35,195   63,620      9,319      41,719      41,637      6,099   

Foreign exchange gains from re-valuation of preference shares

        (8,123   (1,191   (8,414   (111   (16
                                         

Adjusted net income

  18,521   26,304   35,195   55,497      8,128      33,305      41,526      6,083   
                                         

 

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     As of December 31,    As of September 30,
2009
      2005    2006    2007    2008   
           RMB                RMB                RMB                RMB                  $                  RMB                  $        
                              (unaudited)
     (in thousands)
Consolidated Balance Sheet Data:                     

Cash and cash equivalents

   18,197    2,395    112,589    81,837    11,989    88,590    12,978

Restricted cash

      2,400       20,000    2,930    21,300    3,120

Accounts receivable

   12,482    14,569    30,417    71,312    10,447    91,857    13,457

Inventories

   26,212    21,585    7,034    10,610    1,554    13,336    1,954

Property, plant and equipment

   27,294    53,614    119,029    149,679    21,927    156,227    22,886

Total assets

   112,783    152,704    320,724    405,031    59,335    469,179    68,734

Short-term bank loans

   30,580    18,380    50,380    72,430    10,611    94,180    13,797

Total current liabilities

   77,378    78,210    95,293    119,760    17,543    142,525    20,881

Total shareholders’ equity

   28,483    53,872    77,157    127,721    18,711    158,337    23,196

Total liabilities and shareholders’ equity

   112,783    152,704    320,724    405,031    59,335    469,179    68,734

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements regarding future events that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We are a fully integrated, profitable China-based biopharmaceutical company focused on the research, development, manufacture, marketing and sales of hematological and cardiovascular products. We currently sell a portfolio of 14 products, including three principal products Baquting ( LOGO®), Aiduo ( LOGO®) and Aiwen ( LOGO®). Our product pipeline includes four product candidates under development that seek to better address the growing market and medical needs for bleeding control, and in hematological, cardiovascular and cerebrovascular disease diagnosis, treatment and prevention.

We generate our revenues primarily from the sale of our flagship product Baquting, China’s leading hemocoagulase prescribed for treating or preventing bleeding in the hospital, Aiduo, our cardiovascular stress imaging agent and Aiwen, our anti-arrhythmic agent. In 2006, 2007, 2008 and the nine months ended September 30, 2009, Baquting accounted for 94.0%, 91.5%, 90.1% and 94.1% of our total net revenue, respectively, while Aiduo and Aiwen accounted for 1.3%, 2.4%, 2.8% and 2.2% of our total net revenue, respectively. Our other marketed products collectively accounted for 4.7%, 6.1%, 7.1% and 3.7% of our total net revenue in the same periods. We expect sales of Baquting will continue to grow but account for a decreasing percentage of our total net revenue as we generate additional revenues from new product launches. We will launch Kaitong ( LOGO), a lipid emulsion alprostadil product candidate for the treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis, subject to the ability of Jilin Yuhua, the manufacturer of Kaitong, to receive the production permit from SFDA. We also plan to launch dipyridamole aspirin sustained release capsules once we receive the SFDA manufacturing and marketing approval.

We have grown significantly since our inception in 1997. We have established an integrated research and development, production, and sales and marketing infrastructure. Our end-customer base has expanded from approximately 100 hospitals in 22 provinces in 2001 to over 2,400 hospitals in all 31 provinces and municipalities in China as of September 30, 2009, including approximately 80% of the Class 3A hospitals—the best and largest under the China Ministry of Health hospital classification system—in major Chinese cities. As of September 30, 2009, our sales force consisted of 24 direct sales offices with 302 sales personnel, complemented by 16 third-party marketing agents with over 200 sales personnel. Substantially all of our sales are made to pharmaceutical distributors, which in turn sell our products primarily to hospitals and other healthcare institutions in China. We sold 4.2 million, 6.3 million and 9.7 million units of Baquting and 7,001, 16,730 and 30,221 units of Aiduo and Aiwen in 2006, 2007 and 2008, respectively, representing a CAGR of 52.0% and 105.9% from 2006 to 2008, respectively. We sold 9.1 million units of Baquting and 19,400 units of Aiduo in the nine months ended September 30, 2009, respectively, compared to 6.8 million units of Baquting and 17,873 units of Aiduo in the nine months ended September 30, 2008. Our pharmaceutical products are distributed through Penglai Nuokang and Nuokang Distribution, our consolidated variable interest entity.

 

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Our net revenue was RMB121.7 million, RMB147.9 million and RMB225.4 million ($33.0 million) in 2006, 2007 and 2008, respectively. Our net income increased at a CAGR of 55.5% from RMB26.3 million in 2006 to RMB63.6 million ($9.3 million) in 2008. For the nine months ended September 30, 2009, our net revenue was RMB200.1 million ($29.3 million) and our net income was RMB41.6 million ($6.1 million), compared to net revenue of RMB153.5 million and net income of RMB41.7 million for the nine months ended September 30, 2008.

Financial Overview

Net Revenue

We derive revenue primarily from the sale of our marketed products. Our net revenue represents our total revenue from the sales of our products, less value-added taxes (VAT). In the PRC, VAT on the invoiced amount is collected on behalf of tax authorities in respect of the sales of goods. VAT collected from customers is set off by VAT paid for purchases, with the net amount recorded as a liability in the consolidated balance sheet until it is paid to the tax authorities.

Sales of our principal products Baquting, Aiduo and Aiwen accounted for substantially all of our net revenue in 2006, 2007, 2008 and the nine months ended September 30, 2009. The following table sets forth our net revenue by product, both in absolute amounts and as percentages of total net revenue, for the periods indicated.

 

    Year Ended December 31,   Nine Months Ended September 30,
    2006   2007   2008   2008   2009
    RMB   %   RMB   %   RMB   $   %   RMB   %   RMB   $   %
                                (unaudited)   (unaudited)
    (in thousands except percentages)

Baquting

  114,404   94.0   135,311   91.5   203,164   29,762   90.1   141,941   92.5   188,236   27,576   94.1

Aiduo/Aiwen

  1,606   1.3   3,511   2.4   6,318   926   2.8   4,439   2.8   4,350   637   2.2

Others marketed products

  5,651   4.7   9,053   6.1   15,917   2,332   7.1   7,139   4.7   7,472   1,094   3.7
                                               

Total

  121,661   100.0   147,875   100.0   225,399   33,020   100.0   153,519   100.0   200,058   29,307   100.0
                                               

Substantially all of our sales are made to pharmaceutical distributors, which in turn sell our products primarily to hospitals and other healthcare institutions in China. We typically enter into a distribution agreement with each distributor for one-year terms that are generally renewed annually. Our distributors do not sell our products on an exclusive basis. We rely on a limited number of distributors for most of our net revenue. In 2006, 2007 and 2008 and the nine months ended September 30, 2009, there were two, one, one and one distributor customers, respectively, that contributed 10% or more of our total net revenue. Sales to Liaoning Pacific Medicine Co., Ltd. accounted for 28.0% of our total net revenue in the nine months ended September 30, 2009. Our one-year framework distribution agreement with Liaoning Pacific, similar to our agreements with other distributors, includes general terms for the distribution arrangements, such as an annual sales target, stipulated wholesale sales prices, place and method of delivery, payment terms and geographical allocation. Each purchase is governed by purchase orders that Liaoning Pacific and we enter into from time to time. Our top five distributors in the aggregate accounted for 35.1%, 37.2% and 33.4% of our net revenue in 2006, 2007 and 2008, respectively. For the nine months ended September 30, 2009, our top five distributors in the aggregate accounted for 43.5% of our net revenue. We expect that a relatively small number of our distributors will continue to account for a major portion of our net revenue in the near future.

We adopted a new pricing policy in September 2006, which resulted in a decrease in the unit price of Baquting. Before September 2006, we primarily relied on the joint sales and

 

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marketing efforts of our direct sales offices and marketing agents to promote our flagship product Baquting, and accordingly we incurred sales and marketing expenses in connection with these joint sales and marketing activities. We did not pay any marketing fee to the marketing agents and the marketing agents were compensated by sharing the distributors’ profits from the resale of Baquting. We sold Baquting to distributors at a uniform discount to the wholesale price to hospitals and other healthcare institutions, regardless of who procured the distributors as our customers. We believe this structure did not adequately incentivize our marketing agents to promote Baquting in an increasingly competitive market.

In September 2006, we changed our sales and marketing strategy and delineated our marketing efforts into geographical regions, each covered exclusively by either our direct sales offices or third-party marketing agents. In the meantime, partly enabled by the lower costs resulting from our manufacturing technology upgrades, we began to sell Baquting to distributors procured or designated by our marketing agents at an even lower discount to expand our market share. We still do not pay any marketing fee to our agents, but leave it to them to negotiate with the distributors an allocation of the higher profits from the resale of Baquting. Accordingly, we do not incur sales and marketing expenses for the regions covered by the third-party marketing agents.

Our decision to adopt the new pricing policy was also driven by risk management considerations. As we grew our business and intensified our marketing efforts, a clear delineation between internal staff and external agents allows us to focus on ensuring ethical sales strategies of our staff without the diversion of resources that would be required to monitor the day to day activities of our marketing agents. In 2006, 2007, 2008 and the nine months ended September 30, 2009, net revenue from Baquting sales made through our direct sales offices accounted for 91.0%, 68.8%, 70.1% and 70.0%, respectively, of our total Baquting sales revenue, and net revenue from Baquting sales made through third-party marketing agents accounted for the balance of 9.0%, 31.2%, 29.9% and 30.0%, respectively.

Factors Impacting Our Revenues

Sales Volume

The primary factor impacting our revenues is the sales volume of our principal products, which is driven in part by market demand for our products. Market demand in turn depends on the perception and acceptance of our products by physicians and patients. We sold 4.2 million, 6.3 million and 9.7 million units of Baquting in 2006, 2007 and 2008, respectively, representing a CAGR of 52.0% from 2006 to 2008. We sold 9.1 million units of Baquting in the nine months ended September 30, 2009, compared to 6.8 million units of Baquting in the nine months ended September 30, 2008. We believe market demand for Baquting has been increasing over the years due to higher healthcare quality requirements, increasing healthcare spending of patients, increasing attention to risks associated with transfusion and blood supply shortage, and the inclusion of hemocoagulase in the national medical insurance catalog.

Our marketed products and product candidates target attractive commercial opportunities in the Chinese hospital market, focusing on the hematological market and cardiovascular markets. We believe there are growth opportunities in these markets. Factors driving the growth of our product revenue include increasing healthcare spending, including among rural households with greater healthcare awareness, an expanded health insurance coverage, government support of the pharmaceutical industry, higher incidence of lifestyle diseases, an aging population, and a higher prevalence of blood disorders among people over 35 years of age.

 

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Product Mix

In 2006, 2007 and 2008 and the nine months ended September 30, 2009, approximately 94.0%, 91.5%, 90.1% and 94.1% of the total net revenue was generated by sales of Baquting, respectively. Since we began sales and marketing activities for Aiduo and Aiwen in 2005, its sales revenue increased to account for 2.8% of our total net revenue in 2008 and 2.2% of our total net revenue in the nine months ended September 30, 2009. Our other marketed products accounted for approximately 4.7%, 6.1%, 7.1% and 3.7% of our total net revenue in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively. Baquting is available in three dosages, 0.5 unit/vial, 1 unit/vial and 2 units/vial, each with a different price. We launched the 1 unit/vial dosage in 2001 and the 0.5 unit/vial and 2 units/vial dosages in 2006. The three distinct dosages offer physicians the flexibility in prescribing the drug to suit different patient profiles or medical situations, which we believe provides us an advantage in the tender process. On a per-unit basis, the selling price of the 0.5 unit/vial dosage tends to be slightly higher than that of the 1 unit /vial dosage, and the selling price of the 2 units/vial tends to be lower than that of the 1 unit/vial dosage. From 2006 to 2008, sales of the 0.5 unit/vial and 2 units/vial dosages increased both in absolute amounts and as percentages of total Baquting sales.

The following table sets forth our Baquting sales revenue by dosage, both in absolute amounts and as percentages of our total Baquting sales revenue, for the periods indicated:

 

     Year Ended December 31,    Nine Months Ended September 30,
     2006    2007    2008    2008    2009
     RMB    %    RMB    %    RMB    $    %    RMB    %    RMB    $    %
                                       

(unaudited)

        (unaudited)
     (in thousands except percentages)

0.5 unit/vial

   806    0.7    3,669    2.7    8,778    1,286    4.3    6,132    4.3    11,685    1,712    6.2

1 unit/vial

   113,234    99.0    128,075    94.7    181,106    26,531    89.2    126,152    88.9    158,067    23,156    84.0

2 units/vial

   364    0.3    3,567    2.6    13,280    1,945    6.5    9,657    6.8    18,484    2,708    9.8
                                                           

Total

   114,404    100.0    135,311    100.0    203,164    29,762    100.0    141,941    100.0    188,236    27,576    100.0
                                                           

We expect our product mix to diversify as we launch new products to market. We plan to launch Kaitong after Jilin Yuhua, the manufacturer of Kaitong, receives the production permit from SFDA. We expect to launch dipyridamole aspirin sustained release capsules once we receive the SFDA approval to manufacture and market the product. As a result, we expect future sales of Baquting to continue to grow and constitute a substantial portion of our total revenues, but its sales will account for a lower percentage of our total net revenues in the future.

Market demand for bleeding control drugs has been increasing over the years due to higher healthcare quality requirements, increasing healthcare spending by patients and increasing attention to risks associated with transfusion and blood supply shortage. Due to their proven safety and efficacy, hemocoagulase products have received increasing acceptance and recognition in the Chinese medical community, have had broader clinical applications and have increased their market shares by replacing traditional bleeding control products. We believe physicians’ and patients’ knowledge and acceptance of our principal products will be further enhanced by our established physician-targeted marketing model, focusing on detailing and promoting our products by providing physicians and hospitals with information on the benefits and differentiating clinical aspects of our products.

Product Pricing and Our Ability to Complete in the Tender Processes

Price Controls and Pricing Models.    Pharmaceutical products sold in China, primarily those included in the national or provincial medical insurance catalog, are subject to price controls in

 

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the form of fixed retail prices or retail price ceilings. From time to time, the PRC government publishes and updates a list of medicines that are subject to price controls, either at the national level or the provincial or regional level. PRC government authorities impose no control over the prices at which pharmaceutical manufacturers sell their products to their distributors. Nevertheless, the prices at which pharmaceutical manufacturers, such as us, sell products to distributors are impacted by the relevant fixed retail price or retail price ceilings.

Baquting is included as one of the hemocoagulases in the national medical insurance catalog and is subject to retail price controls at the national level. Government-controlled hemocoagulase prices remained relatively stable from 2005 through 2008 in China. In 2007, the NDRC set RMB51.6 per unit as the maximum retail price at which hemocoagulase products may be sold to patients. This price ceiling continues to remain in effect. Aiduo is included in the provincial medical insurance catalog in four provinces and in the municipal medical insurance catalog in Changchun, China and is subject to price controls within the respective provinces and Changchun. We price Aiduo in these four provinces and Changchun by reference to government controlled prices. We price Aiduo in other provinces and we price other marketed products that are not subject to price controls based on the prices of competing pharmaceuticals, if any, in the market.

Tender Process.    The end-customers of our products, hospitals and healthcare institutions, purchase Baquting and Aiduo through a government-sponsored tender process every one or two years, under which we and our competitors submit pricing and other product information to local and provincial pricing control bureaus and other related authorities. Factors considered in assessing bids include, among other things, the quality and price of the medicine and the service and reputation of the manufacturers. The collective tender process for pharmaceuticals with the same chemical composition generally will be conducted at least annually. We outsourced sales and marketing efforts of our other 11 products to third-party distributors and are not directly involved in the tender process for these products.

Patent and Exclusivity.    Patent-protected drugs are placed in a separate category from GMP drugs and we believe, as a result, patent-protected drugs typically enjoy higher success rates in the tender process and are generally priced at a higher level. We were granted a patent in China for our Baquting with enhanced quality, which enabled us to be even more competitive in the tender processes since 2008.

Exclusivity provides us with a competitive advantage in the tender process in terms of pricing and success rates. Chinese drug registration laws provided Aiduo’s registered owner with administrative protection for the manufacture of Aiduo as a diagnostic agent in connection with MPI stress tests in China until 2007. Administrative protection in China prevents other companies from manufacturing, importing or selling a similar drug for the same indication, unless they have received approval for the clinical trials of similar drugs prior to the commencement of the protection period. We are not aware of any other adenosine product in development in China. We believe that, given the time necessary to obtain a drug registration, Aiduo will continue to be the only adenosine product approved for use as a diagnostic agent in connection with MPI stress tests in the near term.

 

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Cost of Revenue and Operating Expenses

The following table sets forth our cost of revenue and operating expenses, both in absolute amounts and as percentages of total net revenues for the periods indicated.

 

    Year Ended December 31,   Nine Months Ended September 30,
    2006   2007   2008   2008   2009
    RMB   %   RMB   %   RMB   $   %     RMB       %       RMB     $     %  
                                (unaudited)   (unaudited)
    (in thousands, except percentages)

Net revenue

  121,661   100.0   147,875   100.0   225,399   33,020   100.0   153,519   100.0   200,058   29,307   100.0

Cost of revenue

  44,083   36.2   34,745   23.5   30,963   4,536   13.7   20,602   13.4   24,809   3,634   12.4

Research and development costs

  6,054   5.0   7,995   5.4   5,585   818   2.5   4,921   3.1   6,392   936   3.2

Selling, marketing and distribution expenses

  23,173   19.0   52,443   35.5   92,404   13,537   41.0   65,179   42.5   84,043   12,312   42.0

General and administrative expenses

  14,809   12.2   16,796   11.4   31,884   4,671   14.1   22,508   14.7   30,596   4,482   15.3
                                               

Total operating expenses

  44,036   36.2   77,234   52.2   129,873   19,026   57.6   92,608   60.3   121,031   17,730   60.5
                                               

Cost of Revenue

Our cost of revenue include costs of raw materials, packaging, labor costs and manufacturing overhead. Our cost of revenue declined as a percentage of our net revenue from 2006 to 2008 and from the nine months ended September 30, 2008 to the nine months ended September 30, 2009 as a result of the manufacturing technology upgrades and a new supplier for Baquting in August 2006. The technology upgrades enabled us to purify and extract batroxobin from the venom of Bothrops atrox snakes in-house and purchase the venom directly from a supplier in Brazil through a Chinese trading company instead of purchasing the partially purified venom from third-party suppliers in China, which significantly lowered our costs of raw materials. The decline also reflects our increased economies of scale and higher efficiencies in our manufacturing and production processes. We expect our per unit manufacturing costs may continue to decrease to the extent that our production yields improve. Labor costs are primarily related to the production of our products. Our manufacturing overhead is primarily comprised of factory staff costs, allocated utilities and depreciation of our production facilities. We anticipate our depreciation charges to increase on a per unit basis because of our new production facility in Shenyang, particularly before the full deployment of our new plant capacity.

A third party, Shenyang Guangda, manufactures Aiduo while we work to obtain the production permit and GMP certification for our own Aiduo production facility. We expect that costs of manufacturing Aiduo will decline in the long term through efficiencies we can achieve by manufacturing Aiduo in-house.

Operating Expenses

Our operating expenses include research and development costs, selling, marketing and distribution expenses and general and administrative expenses. Our operating expenses as a percentage of our total net revenues increased in 2008 compared to 2006 and in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. This increase was due primarily to the increase in our selling, marketing and distribution expenses as a percentage of our total revenues, which was due primarily to the additional sales and marketing activities carried out by an increased number of sales personnel and our increased product offerings. Our general and administrative expenses increased by RMB8.1

 

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million, or 35.9%, from the nine months ended September 30, 2008 to the nine months ended September 30, 2009, primarily as a result of an increase of RMB1.5 million in salary expenses, RMB1.3 million in depreciation expenses and RMB1.1 million in professional service fees. Our research and development costs remained relatively stable from 2006 to 2008 and from the nine months ended September 30, 2008 to the nine months ended September 30, 2009.

Research and Development Costs.    Our research and development costs primarily consist of costs associated with the research and development for upgrades and indication expansion of our principal products, costs related to acquiring or in-licensing new technologies or products, costs related to pre-clinical studies, clinical trials and regulatory filings, and costs of manufacturing technology upgrades.

In the nine months ended September 30, 2009, research and development costs were primarily attributable to the research and development of adenosine new indications, stroke medications and other products.

In 2008, our research and development costs were primarily attributable to the pre-clinical research for lanthanum polystyrene sulfonate, the research and development of our potential product candidates and the research and development of our hemocoagulase products.

In 2007, our research and development costs were primarily attributable to the research and development regarding Baquting upgrades, Agkistrodon acutus hemocoagulase clinical trials, the research and development of the myocardial protection indication of adenosine, PGEI and lanthanum polystyrene sulfonate, research on manufacturing technology and bioequivalence trials for dipyridamole aspirin sustained release capsules.

In 2006, our research and development costs were primarily attributable to the research and development of Agkistrodon acutus hemocoagulase and Baquting manufacturing technology upgrades, the pharmacodynamics, toxicity and safety trials for the myocardial protection indication of adenosine, research on manufacturing technology and bioequivalence trials for dipyridamole aspirin sustained release capsules.

In addition, our research and development costs also include costs of employee compensation, depreciation of research and development equipment and other costs that could not be allocated to any specific research project.

We expect to incur higher research and development costs as we plan to continue to enhance our research and development efforts and capabilities. We have also received government grants for certain of our projects and such grants will be recorded as a reduction of our research and development costs after certain conditions or performance obligations attached to these grants have been satisfied as disclosed in our consolidated financial statements. We received RMB1.3 million, RMB0.4 million, RMB0.8 million ($0.1 million) and RMB0.3 million ($0.04 million) of such government grants in 2006, 2007 and 2008 and the nine months ended September 30, 2009, respectively.

Selling, Marketing and Distribution Expenses.    Our selling, marketing and distribution expenses primarily consist of salaries and related expenses for personnel engaged in sales, marketing, distribution and customer support functions and costs associated with advertising and other marketing activities. They also include the direct costs attributable to our sales and marketing activities, such as conference and seminar hosting and attendance, travel, entertainment and advertising expenses. In 2006, 2007 and 2008 and the nine months ended September 30, 2009, selling, marketing and distribution expenses increased primarily as a result of the additional sales and marketing activities carried out by an increased number of sales

 

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personnel and our increased product offerings. We expect our selling, marketing and distribution expenses to increase in absolute amounts in the future as we continue to broaden our market reach and increase revenues and results of operations by upgrading our principal products and introducing new products and by enhancing our brand awareness and recognition. However, we plan to maintain our sales, marketing and distribution expenses in line with our growth in total revenues.

General and Administrative Expenses.    General and administrative expenses primarily consist of the following:

 

   

salaries, bonuses and benefits for our administrative and management personnel, including share-based compensation;

 

   

accounting and other professional service fees;

 

   

depreciations and amortizations of equipment and facilities used for administrative purposes and real estate rental expenses; and

 

   

taxes and fees other than VAT and income tax.

We expect general and administrative expenses to increase as we recruit additional professionals and incur additional costs related to the growth of our business, including compliance-related costs to support our future operations as a U.S. listed public company.

Non-controlling Interest

Under an equity purchase agreement dated August 22, 2006, Mr. Baizhong Xue, our ultimate controlling shareholder, acquired the remaining 40% equity interest in Penglai Nuokang from Ronghai Group Beihai Co., Ltd. (Ronghai Group). Concurrently, Penglai Nuokang transferred to Shandong Penglai Pharmaceutical Plant, a wholly owned subsidiary of Ronghai Group, certain land use rights and associated property, plant and equipment, which Penglai Nuokang had a right to continue to use for a certain amount of fee until December 31, 2014. We recorded this transaction as an acquisition of non-controlling interest.

Seasonal Variations

We experience insignificant seasonal variations in the sales of our principal products. We usually experience a slow-down of businesses during each important holiday season, such as the Chinese New Year in the first quarter and the National Day in the fourth quarter, that effectively lasts more than half a month. During these holiday seasons, the number of patients and surgeries tend to decrease.

Critical Accounting Policies and Estimates

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect our reporting of, among other things, assets and liabilities, contingent assets and liabilities and revenues and expenses. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. This is especially true for certain accounting policies that require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our audited consolidated financial statements because they involve significant reliance on our management’s judgment.

 

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Revenue Recognition

We record revenue when the criteria of Staff Accounting Bulletin No. 104 “Revenue Recognition” (codified in FASB Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition”) are met. We recognize revenue from the sale of pharmaceutical products when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the sales price is fixed or determinable; and (4) collectibility is reasonably assured. The customer takes title and assumes the risks and rewards of ownership of the products upon delivery of the products, which generally occurs at destination point. The product sales price stated in the sales contract or purchase order is final and not subject to adjustment. There are no general rights of return on delivered products and no price protection is granted to customers.

Our principal products are subject to price control by the PRC government. The maximum prices of the products are published by the PRC price administration authorities from time to time. Any changes in product pricing announced by the PRC price administration authorities affect future sales transactions and do not impact sales that have already occurred, including those for which revenues have not yet been collected.

Research and Development Costs

Research and development costs are expensed as incurred. The costs of acquired technology know-how for drugs in a development stage that are purchased from others for a particular research and development project either singly, or as part of a group of assets, or as part of a business combination, and that have no alternative future uses (in other research and development projects or otherwise), are expensed as research and development costs. We have determined that for such acquired technology know-how to have an alternative future use, it should be (a) reasonably expected that we will use the technology in an alternative manner for an economic benefit and (b) the use of the technology is not contingent on further development subsequent to acquisition (that is, it can be used in an alternative manner at the acquisition date). None of our acquired technology know-how for drugs in a development stage during the periods presented was determined to have an alternative future use at the acquisition date since technological feasibility was not established and regulatory approval from the SFDA was not obtained. Further development, including additional clinical testing, was required to obtain the necessary regulatory approval before the products could be launched into the market for sale. The determination of alternative use requires judgment about the application of developed processes and know-how as well as market acceptance of related products. Different judgments regarding alternative uses could result in a change in the timing and amount of costs capitalized as materials and equipments.

Allowance for Doubtful Accounts

Our accounts receivable balance on our balance sheet is affected by our allowance for doubtful accounts, which reflects our estimate of the expected amount of the receivables that we will not be able to collect. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed our historical experience, our estimates could change and impact our reported results.

 

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Allowance for doubtful accounts amounted to RMB306,704, RMB579,559, RMB448,103 ($65,606) and RMB434,600 ($63,666) as of December 31, 2006, 2007, 2008 and September 30, 2009, respectively, representing 2%, 2%, 1% and 1% of our accounts receivable as of those dates. This allowance reflected a reduction in accounts receivable that was charged to the bad debt provision under operating expenses.

Inventories and Allowance for Obsolescence

We state inventories at the lower of cost or market value, determined using the weighted average cost method. We provide inventory allowances when conditions indicate that the selling price is less than cost due to physical deterioration, usage, obsolescence and reductions in estimated future demand. We balance the need to maintain strategic inventory levels with the risk of obsolescence due to varying customer demand levels and changing technology, although this rarely happens. Unfavorable changes in market conditions may result in a need for additional inventory reserves that could adversely impact our gross margins. Conversely, favorable changes in demand could result in higher gross margins when we sell products.

Impairment of Long-Lived Assets

We evaluate our long-lived assets or asset group for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or a group of long-lived assets may not be recoverable. When these events occur, we evaluate the impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the excess of the carrying amount of the asset group over its fair value. We generally determine fair value by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets. We did not recognize any impairment of long-lived assets for any of the periods presented.

Income Taxes

We account for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. We record a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in income, in the period that includes the enactment date.

Effective January 1, 2007, we adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109” (“FIN 48”) (codified in ASC Topic 740, “Income Taxes”). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. We record the cumulative effects of applying FIN 48, if any, as an adjustment to retained earnings as of the beginning of the period of adoption. The adoption of FIN 48 did not result in any adjustment to the opening balance of retained earnings as of January 1, 2007.

 

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We have elected to classify interest and penalties related to an uncertain position, if and when required, as part of “interest expenses” and “other expenses”, respectively, in the consolidated statements of income. No such amounts have been incurred or accrued through September 30, 2009.

Share-based Compensation

In December 2007, we adopted a share option scheme, under which we made option grants on December 19, 2007 and October 11, 2008. As of September 30, 2009, 6,330,000 and 960,000 options granted to the employees (including directors) and non-employees such as consultants and former employees, respectively, were outstanding.

In October 2008, we adopted another share option scheme. As of September 30, 2009, no options had been granted under this share option scheme.

We accounted for share options granted to employees and non-employees under SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”) (codified in ASC Topic 718, “Compensation—Stock Compensation”) and EITF Issue No. 96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” (EITF No. 96-18) (codified in ASC Topic 505-50, “Equity-Based Payments to Non-Employees”).

We determine whether a share option should be classified and accounted for as a liability award or an equity award in accordance with ASC Topic 718. All grants of share options to employees classified as equity awards are recognized in the financial statements based on their grant date fair values. All grants of share options to employees classified as liability awards are remeasured at the end of each reporting period. An adjustment for fair value is recorded to the current period expense in order to properly reflect the cumulative expense based on the current fair value of the vested options over the vesting period. We have elected to recognize compensation expense using the straight-line method for both equity and liability classified share options granted with service conditions that have a graded vesting schedule.

ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent period if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and is adjusted to reflect future change in circumstances and facts, if any. We recorded share-based compensation expense net of estimated forfeitures such that expense was recorded only for those share-based awards that are expected to vest.

We record share-based compensation expense for awards granted to non-employees in exchange for services at fair value in accordance with the provisions of ASC Topic 505-50. For the awards granted to non-employees, we record compensation expenses equal to the fair value of the share options at the measurement date.

We engaged Jones Lang LaSalle Sallmanns (Sallmanns), an independent appraiser, to determine the fair value of options granted to our employees and non-employees, although our management is ultimately responsible for the determination of all amounts related to share-based compensation recorded in our financial statements. Sallmanns applied the binomial option pricing model in determining the fair value of the options granted to employees and Black-Scholes pricing model in determining the fair value of the options granted to non-employees. These models require the input of highly subjective assumptions including the expected stock price volatility, the expected price multiple at which employees are likely to exercise share options and the expected employee forfeiture rates. Sallmanns used historical data and future expectation to estimate forfeiture rate. For expected volatilities, Sallmanns

 

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made reference to historical volatilities of several comparable companies. The risk-free rate for periods within the contractual life of the option was based on the yield of U.S. Treasury Bills with similar terms in effect at the time of grant.

Sallmanns used the income approach to assess our equity value at the grant date and each reporting date. Under this method, indications of value have been developed by discounting projected future net cash flows to their present worth at discount rates which we believe are appropriate for the risks of the business. The discount rate used is the weighted average cost of capital (WACC) to reflect the risks of the cash flows. As we were a privately held company at the grant date and each reporting date and the discount rate used was based on WACC for publicly traded comparable companies, Sallmanns applied a further discount for lack of marketability to derive our equity value. Based on this approach, our equity value was determined to be $84.0 million as of December 19, 2007, $84.0 million as of December 31, 2007, $97.9 million as of September 30, 2008, $97.9 million as of October 11, 2008, $100.6 million as of December 31, 2008 and $130.0 million as of September 30, 2009. The discount for lack of marketability applied was 20% for the December 19 and December 31, 2007 valuation dates, 26% for the September 30, October 11, and December 31, 2008 valuation dates, and 12% for the September 30, 2009 valuation date.

The equity value was allocated between ordinary shares and preference shares in accordance with “Valuation of Privately-Held-Company Equity Securities Issued as Compensation” developed by the American Institute of Certified Public Accountants. The fair value was allocated between the preference shares and the ordinary shares based on the probability-weighted average of expected future net cash flows or distributions to shareholders. This also took into consideration each of the possible future events and the rights and preferences of each class of shares.

An option-pricing method is used to allocate the equity value between the preference shares and ordinary shares under the liquidation and redemption scenarios. Under the option- pricing method, each class of shares is modeled as a series of call options with a distinct claim on our equity value, the value of which is estimated using the Black-Scholes model. The characteristics of each class of shares, including liquidation preference and conversion ratio of the preference shares, determine the claim of the preference shares on our equity. In applying the option-pricing method to the redemption scenario, non-participation clause beyond the redemption value of the preference shares are also included. The application of the option-pricing model also involved making estimates of the anticipated timing of a potential liquidity event such as a sale of our company or an initial public offering and estimates of the volatility of our equity securities. The anticipated timing was based on the plans of our board of directors and management. Furthermore, the volatilities applied in the allocation were based on the historical volatility of the shares of comparable companies.

Options Granted to Employees

We calculated the estimated fair value of the options on the grant date using the binomial option pricing model with the following assumptions:

 

     December 19, 2007    October 11, 2008

Suboptimal exercise factor

   1.5    1.5

Risk-free interest rates

   3.43% - 3.98%    2.83% - 3.86%

Expected volatility

   46.43% - 60.04%    48.27% - 57.94%

Expected dividend yield

   0%    0%

Fair value of share option

   $0.343    $0.356

Fair value per share of ordinary shares

   $0.65    $0.78

Fair value per share of preference shares

   $0.85    $0.91

 

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We calculated the estimated fair value of the options at each reporting date using the binomial option pricing model with the following assumptions:

 

     December 31,
2007
   September 30,
2008
   December 31,
2008
   September 30,
2009

Suboptimal exercise factor

   1.5    1.5    1.5    1.5

Risk-free interest rates

   3.43%-3.98%    2.83%-3.86%    1%-1.62%    2.13%-3.22%

Expected volatility

   46.34%-60.04%    48.27%-57.94%    57.63%-59.91%    62.83%-64.38%

Expected dividend yield

   0%    0%    0%    0%

The suboptimal exercise factor is defined as the price multiple at which our employees are likely to exercise their options. For example, an assumption of two times price multiple for senior management means senior management is assumed to be likely to exercise their options when the future stock price is double the exercise price for their options. One of the flexibilities and advantages of the binomial model is that it captures the value of early exercise via input assumption of the suboptimal exercise factor. However, different exercise factors will produce different estimate of option values, and eventually a different estimate of option expenses.

As of September 30, 2009, there was RMB15.9 million ($2.3 million) of unrecognized share-based compensation cost related to share options issued to employees. Deferred costs of RMB13.0 million ($1.9 million) and RMB3.0 million ($0.4 million) are expected to be recognized over a period of 2.22 years and 3.03 years, respectively, using the straight-line method. To the extent the actual forfeiture rate is different from the original estimate, actual share-based compensation related to these awards may be different from our expectations.

Share options issued to non-employees

We record compensation expenses equal to the fair value of the share options at the measurement date. The measurement date is set upon a qualified initial public offering. The lowest aggregate fair value of non-employees options is zero since none of the options will be vested absent a qualified initial public offering. The fair value of the options granted to non-employees at grant date was determined to be RMB1.4 million ($0.2 million).

We calculated the estimated fair value of the options on the grant date using the Black-Scholes pricing model with the following assumptions:

 

     December 19, 2007

Risk-free interest rates

   3.19%

Expected term

   0.8-1.2 years

Expected volatility

   37.64% - 40.83%

Expected dividend yield

   0%

Fair value of share option

   $0.218 - $0.226

Fair value per share of ordinary shares

   $0.65

Fair value per share of preference shares

   $0.85

Upon the completion of this offering and based on an offering price per share of $1.125, we expect to incur RMB4.3 million ($0.6 million) of share-based compensation expenses relating to the 960,000 options granted to non-employees. The actual compensation expense will be determined using an option pricing model which takes into account a number of variables including the fair value of our ordinary shares at the measurement date.

 

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We believe that the difference between the fair value of $0.78 per share as of October 11, 2008 and $1.125 per share, based on the initial public offering price of the ADSs, is primarily attributable to the following factors:

 

   

the imminent launch of our initial public offering, which allows us to forego the 26% lack of marketability discount used in the October 2008 valuation;

 

   

the automatic conversion of all our preference shares into ordinary shares upon the closing of our initial public offering, which allows us to allocate our equity value equally among all our outstanding shares, compared with a higher allocation to preference shares in the October 2008 valuation;

 

   

our corporate developments since October 2008 and the launch of our initial public offering give us greater visibility on the fulfillment of our business plans and enable us to increase our projected revenues and net income from those used in the October 2008 valuation; and

 

   

since our initial public offering price is determined based on a market approach with reference to comparable listed companies, the increase since October 2008 in valuations for securities of China-based companies listed on stock exchanges in the U.S., driven by improvements in investor sentiments and the global economy.

Taxation

The Cayman Islands and Hong Kong

We are a tax exempt company incorporated in the Cayman Islands. Surplus International, our wholly owned subsidiary incorporated in Hong Kong, is subject to Hong Kong corporate income tax of 17.5% on the estimated assessable profits arising in Hong Kong. We did not record any income tax expenses for Surplus International as it had no taxable income during the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009. Dividend payments are not subject to withholding tax in the Cayman Islands. The new PRC enterprise income tax law effective on January 1, 2008 provides that an income tax rate of 5% will normally be applicable to dividends from domestic PRC companies to Hong Kong incorporated companies.

PRC

Enterprise Income Tax

Our three subsidiaries, Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang, and our variable interest entity, Nuokang Distribution, are incorporated in the PRC and therefore are subject to PRC enterprise income tax, or EIT, on their taxable income as reported in their PRC statutory accounts adjusted in accordance with relevant PRC income tax laws. Prior to the effectiveness of the new PRC Enterprise Income Tax Law, or the new EIT law, on January 1, 2008, domestic companies were generally subject to the EIT at a statutory rate of 33%. The three PRC subsidiaries of our company satisfied certain condition and were granted preferential tax treatments under the tax law in effect before January 1, 2008.

The new EIT law imposes a uniform EIT rate of 25% on all domestic enterprises and foreign invested enterprises unless they qualify under certain exceptions.

Liaoning Nuokang and Shenyang Shouzheng were recognized by the relevant PRC authorities in December 2002 and December 2004, respectively, as “Hi-Tech Enterprises” located in the Shenyang Economic and Technology Development Zone in Liaoning Province of

 

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the PRC and were entitled to a preferential EIT rate of 15%. Furthermore, Liaoning Nuokang and Shenyang Shouzheng were also recognized as “Foreign Investment Manufacturing Enterprises” in December 2005 and October 2006 and were entitled to full exemption of EIT for the first two years and a 50% reduction in EIT for the following three years, commencing from January 2006 and January 2007, respectively.

Penglai Nuokang was recognized as a “Foreign Investment Manufacturing Enterprise” in September 2006 and was entitled to full exemption from EIT for the first two years and a 50% reduction in EIT for the following three years, commencing from September 2006.

Under the new EIT law, enterprises that were established and already enjoyed preferential tax treatments of two-year tax exemption and three-year tax reduction of 50% before March 16, 2007 will continue to enjoy them until the expiration of such term.

Under the new EIT law and the rules related to implementation of the new EIT law, enterprises that are “high and new technology enterprises strongly supported by the State” are entitled to a reduced EIT rate of 15%. In 2008, the relevant PRC authorities recognized Liaoning Nuokang and Penglai Nuokang as “high and new technology enterprises” through 2010, after which we plan to apply for the renewal of these qualifications. We will also apply for the “high and new technology enterprise” qualification for Shenyang Shouzheng, whose existing preferential tax treatment expires in 2011. See “Risk Factors—Risks Related to Doing Business in China—Our business benefits from certain government incentives. Expiration of, or changes to, these incentives could have a material adverse effect on our operating results by significantly increasing our tax expenses.”

The tables below set forth the applicable income tax rates of our subsidiaries and Nuokang Distribution for the periods indicated.

 

Subsidiary

   2006     2007     2008     2009     2010  

Liaoning Nuokang

   0   0   12.5   12.5   12.5

Shenyang Shouzheng

   15   0   0   12.5   12.5

Penglai Nuokang

   0 %(1)    0   12.5   12.5   12.5

Nuokang Distribution

   33   33   25   25   25

 

(1) Penglai Nuokang started being fully exempted from EIT from September 2006. Prior to that, it was subject to EIT at a statutory rate of 33%.

Value-added Tax

Our revenues are recorded net of VAT. In accordance with the relevant tax laws in the PRC, VAT is levied on the invoiced value of sales at a general rate of 17% and is payable by the purchaser. We are required to remit the VAT collected to the tax authority, but may deduct the VAT that we have paid on eligible purchases.

Internal Control over Financial Reporting

Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, we and our independent registered public accounting firm, in connection with the preparation and external audit of our consolidated financial statements for 2006, 2007 and 2008, noted two material weaknesses and certain deficiencies in our internal control over financial reporting. A “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a

 

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remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The material weaknesses observed were:

 

   

a lack of an internal audit function to assist our audit committee and management in the effective discharge of their responsibilities through independent and objective review, analysis, appraisal and reporting of recommendations on our business operations and activities; and

 

   

a lack of adequate personnel with sufficient understanding of U.S. GAAP and the SEC reporting requirements and adequate policies and procedures to prepare financial information in accordance with U.S. GAAP and the SEC.

Following the identification of the material weaknesses and other control deficiencies, we have appointed a chief financial officer, who has extensive financial reporting experience, to lead our company’s accounting and financial reporting department, and we have entered into a consulting agreement with Protiviti, a financial consulting firm. Protiviti has started working with us to improve our internal control and procedures from the fourth quarter of 2008. We also formed an audit committee in February 2009 to monitor and evaluate our financial performance, the transparency of our financial disclosure and the effectiveness of our internal control. We are taking additional remedial steps to address the above material weaknesses and other control deficiencies, including hiring additional accounting personnel and training our new and existing accounting staff. However, the process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a financial reporting system that is adequate to satisfy our reporting obligations. See “Risk Factors—Risks Related to Our Business—If we fail to establish an effective system of internal controls, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our ADSs may be adversely impacted.”

 

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Results of Operations

The following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2006     2007     2008     2008     2009  
    RMB     RMB     RMB     $     RMB     RMB     $  
                            (unaudited)     (unaudited)  
    (in thousands, except share and per share data)  

Consolidated amount of income data

             

Net revenue

  121,661      147,875      225,399      33,020      153,519      200,058      29,307   

Cost of revenue

  (44,083   (34,745   (30,963   (4,536   (20,602   (24,809   (3,634
                                         

Gross profit

  77,578      113,130      194,436      28,484      132,917      175,249      25,673   

Operating expenses

             

Research and development costs

  (6,054   (7,995   (5,585   (818   (4,921   (6,392   (936

Selling, marketing and distribution expenses

  (23,173   (52,443   (92,404   (13,537   (65,179   (84,043   (12,312

General and administrative expenses

  (14,809   (16,796   (31,884   (4,671   (22,508   (30,596   (4,482
                                         

Total operating expenses

  (44,036   (77,234   (129,873   (19,026   (92,608   (121,031   (17,730
                                         

Operating profit

  33,542      35,896      64,563      9,458      40,309      54,218      7,943   

Interest income

  47      196      1,259      184      957      881      129   

Interest expense

  (1,672   (5,190   (1,309   (192   (1,620   (4,232   (620

Other (expenses) income, net

  (344   2,191      6,353      931      6,802      416      61   
                                         

Income before income tax expense and non-controlling interest

  31,573      33,093      70,866      10,381      46,448      51,283      7,513   

Income tax (expense) benefit

  (6,181   2,102      (7,246   (1,062   (4,729   (9,646   (1,414

Non-controlling interest

  912                                 
                                         

Net income

  26,304      35,195      63,620      9,319      41,719      41,637      6,099   
                                         

 

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The following table sets forth our results of operations as a percentage of total net revenue for the periods indicated.

 

     Year Ended December 31,     Nine Months Ended
September 30,
 
     2006     2007     2008     2008         2009      
     %     %     %     %     %  

Net revenue

   100.0      100.0      100.0      100.0      100.0   

Cost of revenue

   (36.2   (23.5   (13.7   (13.4   (12.4
                              

Gross profit

   63.8      76.5      86.3      86.6      87.6   

Operating expenses

          

Research and development costs

   (5.0   (5.4   (2.5   (3.1   (3.2

Selling, marketing and distribution expenses

   (19.0   (35.5   (41.1   (42.5   (42.0

General and administrative expenses

   (12.2   (11.4   (14.1   (14.7   (15.3
                              

Total operating expenses

   (36.2   (52.2   (57.7   (60.3   (60.5
                              

Operating profit

   27.6      24.3      28.6      26.3      27.1   

Interest income

   (1)    0.1      0.6      0.6      0.4   

Interest expense

   (1.4   (3.5   (0.6   (1.1   (2.1

Other (expenses) income, net

   (0.3   1.5      2.8      4.5      0.2   
                              

Income before income tax expense and non-controlling interest

   25.9      22.4      31.4      30.3      25.6   

Income tax (expense) benefit

   (5.1   1.4      (3.2   (3.1   (4.8

Non-controlling interest

   0.8                       
                              

Net income

   21.6      23.8      28.2      27.2      20.8   
                              

 

 

(1) Less than 0.1%

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Net revenue.     Our net revenue increased by RMB46.5 million, or 30.3%, from RMB153.5 million in the nine months ended September 30, 2008 to RMB200.1 million ($29.3 million) in the same period in 2009. This increase was primarily due to an increase of RMB46.3 million, or 32.3%, in sales of Baquting and an increase of RMB0.3 million in sales of other products, partially offset by a decrease of RMB0.1 million in sales of Aiduo.

The increase in Baquting sales was primarily due to an increase in the sales volume of Baquting from 6.8 million units in the nine months ended September 30, 2008 to 9.1 million units in the same period in 2009, partially offset by a decrease in the average selling prices of Baquting from RMB20.9 per unit in the nine months ended September 30, 2008 to RMB20.7 per unit in the same period in 2009. The increase in sales volume of Baquting was attributable to the increased sales through both our direct sales offices and third-party marketing agents as a result of increased market demand. The average selling prices of Baquting decreased as a result of changes in the percentage contribution of our revenue attributable to different dosages of Baquting. Sales of 2 units/vial dosages, which tend to have a lower per-unit price compared to the other two dosages, accounted for a larger percentage of total Baquting sales in the nine months ended September 30, 2009—increasing to 9.8% in the nine months ended September 30, 2009 from 6.8% in the nine months ended September 30, 2008.

The decrease in Aiduo sales was primarily due to (1) an increase in sales volume of Aiduo to 19,400 units in the nine months ended September 30, 2009 from 17,873 units in the nine months ended September 30, 2008, and (2) a decrease in the average selling price of Aiduo from

 

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RMB241.7 per unit in the nine months ended September 30, 2008 to RMB223.3 per unit in the nine months ended September 30, 2009 as a result of decreased tender prices of Aiduo in the nine months ended September 30, 2009.

Cost of revenue.    Our cost of revenue increased by RMB4.2 million, or 20.4%, from RMB20.6 million for the nine months ended September 30, 2008 to RMB24.8 million ($3.6 million) for the nine months ended September 30, 2009. However, cost of revenue as a percentage of our net revenue decreased to 12.4% in the nine months ended September 30, 2009 from 13.4% in the nine months ended September 30, 2008. The increase in our cost of revenue was primarily due to (1) a RMB3.7 million increase in manufacturing costs related to Baquting sales, including costs of raw materials, packaging materials and other manufacturing costs as a result of the increased sales of Baquting, and (2) a RMB0.6 million increase due to an aggregate increase in sales of other marketed products.

Operating expenses.    Our operating expenses increased by RMB28.4 million, or 30.7%, from RMB92.6 million for the nine months ended September 30, 2008 to RMB121.0 million ($17.7 million) for the same period in 2009. Operating expenses as a percentage of our net revenue increased slightly from 60.3% to 60.5%.

 

   

Research and Development Costs. Our research and development costs increased by 29.9% from RMB4.9 million for the nine months ended September 30, 2008 to RMB6.4 million ($0.9 million) for the same period in 2009. This increase was primarily attributable to an increase of RMB1.7 million in expenses associated with the development of adenosine new indications.

 

   

Selling, Marketing and Distribution Expenses.    Our selling, marketing and distribution expenses increased by 28.9% from RMB65.1 million for the nine months ended September 30, 2008 to RMB84.0 million ($12.3 million) for the same period in 2009. The increase was primarily due to an increase of RMB16.4 million in expenses for academic seminars, academic conferences and other promotional activities and an increase of RMB4.5 million in salaries and other expenses related to sales personnel.

 

   

General and Administrative Expenses.    Our general and administrative expenses increased by 35.9% from RMB22.5 million for the nine months ended September 30, 2008 to RMB30.6 million ($4.5 million) for the nine months ended September 30, 2009, primarily due to an increase of RMB2.7 million in share-based compensation expenses, an increase of RMB1.3 million in depreciation expenses, an increase of RMB1.1 million in professional service fees, an increase of RMB1.1 million in management training expenses, and an increase of RMB1.4 million in other general and administrative expenses.

Interest Income.    Our interest income decreased by 7.9% from RMB957,000 for the nine months ended September 30, 2008 to RMB881,000 ($129,000) for the nine months ended September 30, 2009. This decrease was primarily due to a decrease in the average balance of interest-bearing saving accounts.

Interest expense.    Our interest expense increased by RMB2.6 million, or 161.2%, from RMB1.6 million for the nine months ended September 30, 2008 to RMB4.2 million ($0.6 million) for the nine months ended September 30, 2009. In the nine months ended September 30, 2008, amortization of deferred government grants reduced our interest expense by RMB2.0 million and we capitalized RMB0.5 million in interest expense. These events did not recur in the nine months ended September 30, 2009.

 

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Other Income.    Our other income decreased by RMB6.4 million from RMB6.8 million for the nine months ended September 30, 2008 to RMB0.4 million ($0.06 million) for the nine months ended September 30, 2009. Our other income decreased because the foreign exchange gain from the devaluation of our U.S. dollar-denominated preference shares issued in December 2007 as a result of the depreciation of the U.S. dollar against the Renminbi in the nine months ended September 30, 2008 did not recur in the nine months ended September 30, 2009.

Income tax expense.    Our income tax expense increased from RMB4.7 million for the nine months ended September 30, 2008 to RMB9.6 million ($1.4 million) for the nine months ended September 30, 2009. This increase was primarily due to an increase in our taxable income and an increase of non-deductible expenses, together with an increase in the tax rate of Shenyang Shouzheng in the nine months ended September 30, 2009.

Net Income.    As a result of the foregoing, we had net income of RMB41.6 million ($6.1 million) for the nine months ended September 30, 2009, compared to net income of RMB41.7 million for the nine months ended September 30, 2008.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Net Revenue.    Our net revenue increased by 52.4% from RMB147.9 million for the year ended December 31, 2007 to RMB225.4 million ($33.0 million) for the year ended December 31, 2008. This increase was primarily due to an increase of RMB68.1 million, or 50.4%, in net revenue from sales of Baquting, and to a lesser extent, an increase of RMB2.8 million in sales of Aiduo and an increase of RMB6.6 million in sales of 11 other products.

The increase in Baquting sales was primarily due to an increase in sales volume of Baquting from 6.3 million units in the year ended December 31, 2007 to 9.7 million units in the year ended December 31, 2008, partially offset by a decrease in average selling prices of Baquting from RMB21.3 per unit in 2007 to RMB21.0 per unit in 2008. The increase in sales volume of Baquting was attributable to the increased sales through both our direct sales offices and third-party marketing agents as a result of increased market demand. The average selling prices of Baquting decreased due to changes in the sales of different dosages of Baquting. Sales of 2 units/vial dosages, which tend to have a lower per-unit price compared to the other two dosages, accounted for a larger percentage of total Baquting sales in 2008—increasing to 6.5% in 2008 from 2.6% in 2007.

The increase in Aiduo sales was primarily due to an increase in sales volume of Aiduo to 25,550 units in 2008 from 13,579 units in 2007 from increased demand and wider acceptance by physicians of our products, partially offset by a decrease in the average selling price from RMB249.62 per unit in 2007 to RMB241.46 per unit in 2008 due to a 10.8% decrease in the bidding price of Aiduo in Guangxi Province in 2008 while the selling prices of Aiduo in other provinces remained stable.

Cost of Revenue.    Our cost of revenue decreased by 10.7% from RMB34.7 million for the year ended December 31, 2007 to RMB31.0 ($4.5 million) for the year ended December 31, 2008. Cost of revenue as a percentage of our net revenue also decreased to 13.7% in 2008 from 23.5% in 2007. This decrease was due to a significant decrease of RMB7.1 million in costs of raw materials for Baquting from 2007 to 2008, primarily as a result of manufacturing technology upgrades for Baquting that enabled us to purify and extract batroxobin from snake venom in-house at lower costs compared to purchasing partially purified venom from third parties. This decrease was partially offset by an RMB0.5 million increase in other manufacturing costs related to Baquting sales, including costs of packaging materials and shipping costs as a result of the

 

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increased sales of Baquting. For other products, cost of revenue increased by RMB2.8 million due to an aggregate increase in sales volume of those products.

Operating Expenses.    Our operating expenses increased by 68.4% from RMB77.2 million in the year ended December 31, 2007 to RMB130.0 million ($19.0 million) in the year ended December 31, 2008. Operating expenses as a percentage of our net revenue increased from 52.2% to 57.6%.

 

   

Research and Development Costs.    Our research and development costs decreased by 30.0% from RMB8.0 million in the year ended December 31, 2007 to RMB5.6 million ($0.8 million) in the year ended December 31, 2008. This decrease was primarily attributable to a decrease of RMB3.4 million in expenses associated with the research and development of hemocoagulase products from 2007 to 2008 as we completed the development of Baquting upgrades with enhanced quality at the end of 2007. The decrease was partially offset by an increase of RMB0.8 million in expenses mainly associated with the pre-clinical development of lanthanum polystyrene sulfonate.

 

   

Selling, Marketing and Distribution Expenses.    Our selling, marketing and distribution expenses increased by 76.3% from RMB52.4 million in the year ended December 31, 2007 to RMB92.4 million ($13.5 million) in the year ended December 31, 2008. The increase was primarily due to an increase of RMB32.9 million in expenses for seminars, hosting of conferences and direct promotion of our products to targeted hospitals and physicians, an increase of RMB11.4 million in salaries and social security expenses from both increased headcount of our sales personnel and their salaries and an increase of RMB1.5 million in traveling expenses incurred by our sales personnel.

 

   

General and Administrative Expenses.    Our general and administrative expenses increased by 89.9% from RMB16.8 million for the year ended December 31, 2007 to RMB31.9 million ($4.7 million) for the year ended December 31, 2008, primarily due to an increase of RMB3.5 million in professional service fees, an increase of RMB2.6 million in salary expenses due to both increased headcount of our administrative personnel and their salaries and bonus payments, and an increase of RMB2.3 million in stock option expenses.

Interest Income.    Our interest income increased by RMB1.1 million from RMB0.2 million for the year ended December 31, 2007 to RMB1.3 million ($0.2 million) for the year ended December 31, 2008. This increase was primarily due to an increased average balance of our cash in interest-bearing saving accounts.

Interest Expense.    Our interest expense decreased by 75.0% from RMB5.2 million for the year ended December 31, 2007 to RMB1.3 million ($0.2 million) for the year ended December 31, 2008. This decrease was primarily due to government grant of interest expense reimbursement associated with our short-term bank borrowings in 2008.

Other Income.    Our other income increased from RMB2.2 million for the year ended December 31, 2007 to RMB6.4 million ($0.9 million) for the year ended December 31, 2008. This increase was primarily due to the foreign exchange gains from the devaluation of our U.S. dollar–denominated preference shares issued in December 2007 as a result of the depreciation of the U.S. dollar against the Renminbi.

Income Tax (Expense)/Benefit.    We recorded an income tax benefit of RMB2.1 million for the year ended December 31, 2007 and we recorded an income tax expense of RMB7.2 million ($1.1 million) for the year ended December 31, 2008. This change was primarily resulted from

 

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the expiration in December 2007 of the two-year exemption from the EIT that Liaoning Nuokang and Penglai Nuokang enjoyed. Liaoning Nuokang and Penglai Nuokang became subject to EIT at the reduced rate of 12.5% in January 2008.

Net Income.    As a result of the foregoing, we had a net income of RMB63.6 million ($9.3 million) for the year ended December 31, 2008, compared to a net income of RMB35.2 million for the year ended December 31, 2007.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Revenue.    Our net revenue increased by 21.6% from RMB121.6 million for the year ended December 31, 2006 to RMB147.9 million for the year ended December 31, 2007. The increase in our net revenue was primarily due to an increase of RMB20.9 million, or 18.3%, in net revenue from sales of Baquting, and to a lesser extent, an increase of RMB3.4 million in sales of other products and an increase of RMB1.9 million in sales of Aiduo.

The increase in Baquting sales was primarily due to an increase in sales volume of Baquting from 4.2 million units in 2006 to 6.3 million units in 2007, partially offset by a decrease in average selling prices of Baquting from RMB27.2 per unit in 2006 to RMB21.3 per unit in 2007. The increase in sales volume of Baquting was attributable, to a larger extent, to the increased sales through direct sales offices and to a lesser extent, to the increased sales through third-party marketing agents. Before September 2006, we primarily relied on the joint sales and marketing efforts of our direct sales offices and marketing agents to promote our flagship product Baquting. In September 2006, we changed our sales and marketing strategy and delineated our marketing efforts into geographic regions, each covered exclusively by either our direct sales offices or third-party marketing agents. The new pricing policy provided more economic incentives to our third-party marketing agents and distributors and as a result, sales volume of Baquting significantly increased in regions allocated to marketing agents both in an absolute amount and as a percentage of total Baquting sales volume. However, as the selling price of Baquting to distributors in these regions was lower than the selling price before September 2006, the average selling prices of Baquting decreased from 2006 to 2007.

Sales of 0.5 unit/vial and 2 units/vial Baquting as a percentage of total Baquting sales increased from 1.0% in 2006 to 5.3% in 2007, primarily due to a significant increase in sales volume from 68,825 units in 2006 to 523,674 units in 2007.

The increase in Aiduo sales was primarily due to an increase in sales volume of Aiduo to 13,579 units in 2007 from 6,207 units in 2006 due to increased demand. The average selling price of Aiduo remained relatively stable in 2006 and 2007.

Cost of Revenue.    Our cost of revenue decreased by 21.2% from RMB44.1 million for the year ended December 31, 2006 to RMB34.7 million for the year ended December 31, 2007. Cost of revenue as a percentage of our net revenue also decreased to 23.5% in 2007 from 36.2% in 2006. This decrease was due to a significant decrease of RMB13.0 million in costs of raw materials from 2006 to 2007, which in turn was primarily attributable to manufacturing technology upgrades for Baquting implemented in August 2006 that enabled us to purify and exact batroxobin from snake venom in-house at lower costs compared to purchasing partially purified venom from third parties. The decrease was partially offset by an increase in costs as a result of the increased sales of our principal products Baquting and Aiduo.

 

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Operating Expenses.    Our operating expenses increased by 75.4% to RMB77.2 million in 2007 from RMB44.0 million in 2006. Operating expenses as a percentage of our net revenue increased to 52.2% in 2007 from 36.2% in 2006.

 

   

Research and Development Costs.    Our research and development costs increased by 32.1% from RMB6.1 million for the year ended December 31, 2006 to RMB8.0 million for the year ended December 31, 2007. This increase was primarily due to RMB1.4 million of expenses associated with the research and development of PGEI and RMB0.6 million of expenses associated with the research and development of lanthanum polystyrene sulfonate.

 

   

Selling, Marketing and Distribution Expenses.    Our selling, marketing and distribution expenses increased by 126.3% from RMB23.2 million for the year ended December 31, 2006 to RMB52.4 million for the year ended December 31, 2007. The increase was primarily due to a significant increase of RMB21.4 million in advertising and other promotional expenses in connection with the promotion of our products and an increase of RMB0.9 million in expenses of seminars and hosting of conferences.

 

   

General and Administrative Expenses.    Our general and administrative expenses increased by 13.4% from RMB14.8 million for the year ended December 31, 2006 to RMB16.8 million for the year ended December 31, 2007 primarily due to an increase of RMB1.6 million in our expenses in preparation of becoming a publicly listed company, and an increase of RMB0.7 million in salary expenses due to increased headcount of our administrative personnel and the increase in their salaries and bonus payments.

Interest Income.    Our interest income increased by 317.0% from RMB47,000 for the year ended December 31, 2006 to RMB196,000 for the year ended December 31, 2007 as a result of an increased average balance of our cash in interest-bearing saving accounts.

Interest Expense.    Our interest expense increased by 210.4% from RMB1.7 million for the year ended December 31, 2006 to RMB5.2 million for the year ended December 31, 2007. This increase was primarily due to the increased average balance of our short-term bank and shareholder borrowings in 2007.

Income Tax (Expense)/Benefit.    We had an income tax expense of RMB6.2 million for the year ended December 31, 2006, compared to an income tax benefit of RMB2.1 million for the year ended December 31, 2007. This change was primarily because Shenyang Shouzheng began being fully exempted from the EIT for two years commencing in January 2007.

Non-controlling Interest.    Our non-controlling interest was RMB0.9 million for the year ended December 31, 2006 and nil for the year ended December 31, 2007. This change was primarily because Mr. Baizhong Xue, our ultimate controlling shareholder, acquired the remaining 40% equity interest in Penglai Nuokang in August 2006.

Net Income.     As a result of the foregoing, we had a net income of RMB35.2 million for the year ended December 31, 2007, compared to a net income of RMB26.3 million for the year ended December 31, 2006, representing an increase of 33.8%.

Liquidity and Capital Resources

To date, we have financed our operations primarily through cash flows from operations, short-term bank borrowings, as well as the sale of preferred shares in private placements. As of September 30, 2009, we had RMB88.6 million ($13.0 million) in cash. We generally deposit our

 

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excess cash in interest bearing bank accounts. Although we consolidate the results of our variable interest entity Nuokang Distribution in our consolidated financial statements, we can only receive cash payments from it pursuant to our contractual arrangements with it and its sole shareholder.

As of September 30, 2009, we had RMB94.2 million ($13.8 million) in outstanding short-term bank loans and borrowings, which bore weighted-average interest rates of 6.387% per annum. These short-term bank loans and borrowings have terms ranging from three to twelve months, and expire at various times throughout the year. These facilities contain no specific renewal terms but we have historically been able to obtain extensions of some of the facilities shortly before they mature. These loans were secured by certain of our property, plant and equipment and land use rights and guaranteed by Mr. Baizhong Xue, our chairman and chief executive officer, and other third parties whose owners are business associates of Mr. Xue.

We believe that our current levels of cash and cash flows from operations and bank borrowings, combined with the net proceeds from this offering, will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we may need additional cash resources in the future if we experience changed business conditions or other developments. We may also need additional cash resources in the future if we find and wish to pursue opportunities for investment, acquisition, strategic cooperation or other similar actions. If we ever determine that our cash requirements exceed our amounts of cash and cash equivalents on hand, we may seek to issue debt or equity securities or obtain a credit facility. Any issuance of equity securities could cause dilution for our shareholders. Any incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and finance covenants. It is possible that, when we need additional cash resources, financing will only be available to us in amounts or on terms that would not be acceptable to us or financing will not be available at all.

 

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The following table shows our cash flow with respect to operating activities, investing activities and financial activities for the periods indicated:

 

     Year Ended December 31,     Nine Months Ended September 30,  
           2006                 2007           2008     2008     2009  
     RMB     RMB           RMB                   $             RMB     RMB     $  
                             (unaudited)     (unaudited)  
    

(in thousands)

 

Net cash provided by (used in) operating activities

   53,335      25,241      25,310      3,709      (4,415   17,653      2,585   

Net cash used in investing activities

   (53,766   (53,465   (56,763   (8,315   (38,843   (25,541   (3,741

Net cash (used in) provided by financing activities

   (15,371   138,418      701      101      20,701      14,641      2,145   

Net increase (decrease) in cash and cash equivalents

   (15,802   110,194      (30,752   (4,505   (22,557   6,753      989   

Cash and cash equivalents at beginning of the period

   18,197      2,395      112,589      16,494      112,589      81,837      11,989   

Cash and cash equivalents at end of the period

   2,395      112,589      81,837      11,989      90,032      88,590      12,978   

Operating Activities

Net cash provided by operating activities amounted to RMB17.7 million ($2.6 million) in the nine months ended September 30, 2009, compared to net cash used in operating activities in the amount of RMB4.4 million in the nine months ended September 30, 2008. The change is primarily attributable to our growing business as we increased our net revenue by RMB46.5 million from RMB153.5 million in the nine months ended September 30, 2008 to RMB200.1 million ($29.3 million) in the same period in 2009, while our cost of revenue and operating expenses, after deducting non-cash items and items that did not affect operations, increased only by RMB15.2 million from the nine months ended September 30, 2008 to the nine months ended September 30, 2009. Our working capital remained relatively stable from the nine months ended September 30, 2008 to the nine months ended September 30, 2009. Our paid income tax increased by RMB3.3 million and our received government grant decreased by RMB7.3 million from the nine months ended September 30, 2008 to the nine months ended September 30, 2009.

Net cash provided by operating activities increased to RMB25.3 million ($3.7 million) in 2008 from RMB25.2 million in 2007. Although our growing business generated a RMB77.5 million ($11.4 million) increase in our net revenue from 2007 to 2008, we did not generate a corresponding increase in cash inflow because changes in our accounts and bills receivables increased by RMB34.5 million for 2008 compared to 2007 as our receivable turnover days increased from 56 days to 89 days as a result of our market promotion efforts and the adverse economic environment. Our cost of revenue and operating expenses, after deducting non-cash items and items that did not affect operations, increased by RMB34.0 million from 2007 to 2008. In addition, our income tax paid increased by RMB10.2 million from 2007 to 2008.

 

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Net cash provided by operating activities decreased to RMB25.2 million in 2007 from RMB53.3 million in 2006. Although there was a 21.5% increase in our net revenue from 2006 to 2007, we did not generate a corresponding increase in cash inflow because our accounts and bills receivables increased by RMB13.9 million as its turnover days increased from 44 days to 56 days as a result of our market promotion efforts. Our cost of revenue and operating expenses, after deducting non-cash items and items that did not affect operations, increased by 27.1% from 2006 to 2007, and our cash outflow was further increased because our accounts and bills payable decreased by RMB13.1 million primarily due to our clearance of the prior year payables and our increased cash transactions with the venom supplier in Brazil.

Investing Activities

Net cash used in investing activities amounted to RMB25.5 million ($3.7 million) in the nine months ended September 30, 2009, mainly as a result of (1) our purchases of manufacturing and research and development equipment and construction of the new production facility in Shenyang for RMB14.7 million ($2.2 million), (2) the prepayment of RMB6.0 million ($0.9 million) for exclusive distribution rights, (3) the payment of RMB3.4 million ($0.5 million) for our investment in a joint venture, and (4) the payment of RMB2.0 million ($0.3 million) for our investment in an investment fund.

Net cash used in investing activities amounted to RMB56.8 million ($8.3 million) in 2008, mainly as a result of (1) our purchases of manufacturing and research and development equipment and construction of the new production facility in Shenyang for RMB51.1 million ($7.5 million), and (2) the prepayment of RMB10.0 million ($1.5 million) made for exclusive distribution rights.

Net cash used in investing activities amounted to RMB53.5 million in 2007, mainly as a result of our purchases of manufacturing and research and development equipment and construction of the new production facility in Shenyang for RMB59.4 million, partially offset by the loan repayment of RMB7.0 million from related parties.

Net cash used in investing activities in 2006 amounted to RMB53.8 million, mainly as a result of (1) our purchases of manufacturing and research and development equipment and construction of the new production facility in Shenyang for RMB25.2 million, and (2) costs related to obtain the land use right for our Shenyang facility for RMB21.9 million.

Financing Activities

Net cash provided by financing activities amounted to RMB14.6 million ($2.1 million) in the nine months ended September 30, 2009, mainly as a result of proceeds of RMB94.3 million ($13.8 million) from our short-term bank loans, primarily offset by (1) the repayment of RMB72.5 million ($10.6 million) of our short-term bank loans; and (2) the repayment of RMB5.8 million ($0.9 million) to a related party.

Net cash provided by financing activities amounted to RMB0.7 million ($0.1 million) in 2008, mainly as a result of repayment of RMB50.4 million ($7.4 million) of our short-term bank loans, partially offset by proceeds of RMB72.4 million ($10.6 million) from our short-term bank loans.

Net cash provided by financing activities amounted to RMB138.4 million in 2007, mainly as a result of (1) the net proceeds of RMB124.2 million from our placement of Series A convertible redeemable preference shares in December 2007, and (2) net proceeds of RMB32.0 million from our short-term bank loans partially offset by our repurchase of ordinary shares from a shareholder with cash consideration of RMB21.9 million.

 

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Net cash used in financing activities in 2006 amounted to RMB15.4 million, mainly as a result of our repayment of RMB30.6 million of short-term bank loans, partly offset by proceeds of RMB18.4 million from our short-term bank loans.

Capital Expenditures

We had capital expenditures of RMB47.1 million, RMB59.4 million and RMB51.1 million ($7.5 million) for the years ended December 31, 2006, 2007 and 2008, respectively. In the nine months ended September 30, 2009, our capital expenditures were RMB14.7 million ($2.2 million). Our capital expenditures were made primarily for the construction of our production facilities, obtaining land use rights and the purchases of property, plant and equipment. Our capital expenditures have been primarily funded by net cash generated from our operating activities and cash provided by financing activities. For the remainder of 2009 and in 2010, we expect to incur capital expenditures of nil and approximately $1.0 million, respectively. We expect our capital expenditures in 2010 to primarily consist of the purchases of property, plant and equipment. We expect to fund these capital expenditures by cash generated from operating and financing activities as well as net proceeds from this offering.

Contractual Obligations

The following table sets forth our contractual obligations as of September 30, 2009:

 

     Payment Due by Period

Contractual Obligations

   Total    Less than 1 year    1-3 years    3-5 years    More than 5 years
     (RMB in thousands)

Use right obligations(1)

   8,450    1,650    3,200    3,200    400

Operating lease obligations

   762    615    147      

Purchase obligations(2)

   42,018    9,250    16,595    14,376    1,797

Total

   51,230    11,515    19,942    17,576    2,197

 

(1) In connection with the acquisition of non-controlling interest in Penglai Nuokang, we have contractual future payments of RMB8.5 million ($1.2 million) to Shandong Penglai Pharmaceutical Plant for which RMB0.5 million ($0.1 million) will be made until December 31, 2009 and RMB1.6 million ($0.2 million) per annum will be made thereafter until December 31, 2014.
(2) Purchase obligations were incurred in connection with construction-in-progress, purchase of office equipment, purchase of snake venom and purchase of a product under our distributorship.

We entered into a share subscription agreement in July 2009, under which we agreed to invest $5.0 million for a 93% interest in a joint venture company in Hong Kong. We made this investment of $5.0 million in October 2009.

Off-Balance Sheet Commitments and Arrangements

Other than some of the operating obligations set forth in the table above, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

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Inflation

Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the change of consumer price index in China was 1.5%, 4.8% and 5.9% in 2006, 2007 and 2008, respectively. Although we have not in the past been materially affected by any such inflation since our inception, we can provide no assurance that we will not be affected in the future by higher rates of inflation in China. For example, certain operating costs and expenses, such as personnel expenses, real estate leasing expenses, travel expenses and office operating expenses may increase as a result of higher inflation. Additionally, because a substantial portion of our assets consists of cash and cash equivalents and short-term investments, high inflation could significantly reduce the value and purchasing power of these assets. We are not able to hedge our exposures to higher inflation in China.

Quantitative and Qualitative Disclosure about Market Risk

Interest Rate Risk

We are exposed to interest rate risk related to the interest income generated by excess cash invested in liquid investments with original maturities of three months or less. Such interest-earning instruments carry a degree of interest rate risk. We have not used any derivative financial instruments to manage our interest risk exposure. We have not been exposed to material risks due to changes in interest rates. However, our future interest income may be lower than expected due to changes in market interest rates. We are also subject to market risks due to fluctuations in interest rates on our debt. Increases in interest rates will increase the cost of new borrowing and our interest expense. Accordingly, fluctuations in interest can lead to significant fluctuations in the fair value of these debt instruments.

Foreign Exchange Risk

Substantially all of our revenues and most of our expenses are denominated in RMB. Our exposure to foreign exchange risk primarily relates to cash and cash equivalents denominated in U.S. dollars as a result of our past issuance of preferred shares through private placement. We do not believe that we currently have any significant direct foreign exchange risk and have not hedged exposures denominated in foreign currencies or any other derivative financial instruments. Although in general, our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and RMB because the value of our business is effectively denominated in RMB, while the ADSs will be traded in U.S. dollars.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. Historically, the conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 17.5% appreciation of the RMB against the U.S. dollar by October 31, 2009. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar. To the extent that we need to convert U.S. dollars we receive from this offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect

 

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on the RMB amount we receive from the conversion. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.

Recent Accounting Pronouncements

In June 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 168, “The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162” (SFAS 168) (FASB Accounting Standards Update (ASU) 2009-01, which amends ASC Topic 105, “Generally Accepted Accounting Principles”). SFAS 168 establishes the FASB Accounting Standards Codification TM (Codification) as the source of authoritative U.S. GAAP for nongovernmental entities. The Codification does not change U.S. GAAP. Instead, it takes the thousands of individual pronouncements that currently comprise U.S. GAAP and reorganizes them into approximately 90 accounting topics, and displays all topics using a consistent structure. Contents in each topic are further organized first by subtopic, then section and finally paragraph. The paragraph level is the only level that contains substantive content. Citing particular content in the Codification involves specifying the unique numeric path to the content through the topic, subtopic, section and paragraph structure. FASB suggests that all citations begin with “FASB ASC.” Changes to the ASC subsequent to June 30, 2009 are referred to as Accounting Standards Updates.

In August 2009, the FASB issued Accounting Standards Update No. 2009-5, “Measuring Liabilities at Fair Value” (ASU 2009-05). ASU 2009-05 amends Accounting Standards Codification Topic 820, “Fair Value Measurements.” Specifically, ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following methods: (1) a valuation technique that uses (a) the quoted price of the identical liability when traded as an asset or (b) quoted prices for similar liabilities or similar liabilities when traded as assets, and/or (2) a valuation technique that is consistent with the principles of Topic 820 of the Accounting Standards Codification (e.g. an income approach or market approach). ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to adjust to include inputs relating to the existence of transfer restrictions on that liability. We do not anticipate that the adoption of this statement will have a material impact on our consolidated financial statements.

In September 2009, the Emerging Issues Task Force reached final consensus on ASU 2009-13, “Revenue Arrangements with Multiple Deliverables.” ASU 2009-13 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how the arrangement consideration should be allocated among the separate units of accounting. The topic may be applied retrospectively or prospectively for new or materially modified arrangements and early adoption is permitted. We do not anticipate the adoption of this statement will have a material impact on our consolidated financial statements.

 

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CORPORATE STRUCTURE

Corporate History

China Nuokang Bio-Pharmaceutical Inc. was incorporated in the Cayman Islands as an exempted limited liability company in June 2006. We conduct our business operations in China through wholly owned subsidiaries and, with respect to the distribution aspects of our business, through an affiliated entity. Our business, founded in 1997, was originally conducted through Shenyang Sainuo Technology Development Co., Ltd., a PRC limited liability company, the predecessor company of Liaoning Nuokang. To conduct our research and development and manufacturing operation, two affiliated companies were formed, Shenyang Shouzheng in 2001 and Penglai Nuokang in 2002. Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang were wholly owned by Mr. Baizhong Xue, our chairman and chief executive officer, or nominee owners on his behalf before they were acquired by Surplus International.

In order to facilitate foreign investment in our company, Surplus International was incorporated in Hong Kong in August 2005 as an offshore holding company, wholly owned by Ms. Yuhuan Zhu, the wife of Mr. Baizhong Xue, our chairman and chief executive officer. In September 2005 and July 2006, Surplus International acquired 100% of the equity interests in Liaoning Nuokang and Shenyang Shouzheng from Mr. Xue, including interests held by nominees on his behalf, for a cash consideration of RMB11 million and RMB2 million, respectively. In August 2006, Surplus International acquired all of the equity interests in Penglai Nuokang from Mr. Xue for a cash consideration of RMB10 million. The Liaoning Nuokang acquisition was registered and approved by the relevant authority in December 2005. The Shenyang Shouzheng and Penglai Nuokang acquisitions were registered and approved by the relevant authorities in August 2006. This series of transactions from September 2005 to August 2006 were accounted for as a legal reorganization of entities under common control in a manner similar to a pooling of interests and the three PRC operating subsidiaries acquired by Surplus International were reorganized as wholly foreign-owned enterprises (WFOEs). China Nuokang Bio-Pharmaceutical Inc. acquired all of the equity interests of Surplus International from Ms. Zhu in August 2006 for a cash consideration equal to its then issued capital of Surplus International of HK$10,000 ($1,464).

 

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The following diagram illustrates our corporate structure as of the date of this prospectus.

LOGO

Contractual Arrangements with Liaoning Nuokang Medicines Co., Ltd. and Its Sole Shareholder

PRC laws and regulations currently impose different levels of restrictions or prohibitions on investment of foreign capital in the pharmaceutical distribution industry. See “Regulations—Distribution of pharmaceutical products.” Our subsidiaries in China, which are considered as WFOEs, may only sell the Pharmaceutical Products that we manufacture to certain distributors and we may not sell products that others manufacture. Accordingly, we conduct our distribution activities through Nuokang Distribution, a company whose sole registered shareholder is Mr. Xue, and other third-party distributors. Through contractual arrangements with Mr. Xue and Nuokang Distribution, we bear the economic risks, and derive the economic benefits, of Nuokang Distribution. Nuokang Distribution is our VIE and we are its primary beneficiary. The financial results of Nuokang Distribution are consolidated into our financial statements despite the lack of our majority equity interest in Nuokang Distribution. We believe the consolidation is necessary to fairly present the financial position and results of operations of our company, because of the existence of a parent-subsidiary relationship by means of contractual arrangements.

Penglai Nuokang has entered into contractual arrangements with Nuokang Distribution and its shareholder, which enable us to:

 

   

exercise effective control over Nuokang Distribution;

 

   

receive substantially all of the economic benefits from Nuokang Distribution as if we were its sole shareholder; and

 

   

have an exclusive option to purchase all of the equity interests in Nuokang Distribution.

 

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Equity Pledge Agreement

Under his equity pledge agreement with Penglai Nuokang, Mr. Xue, the sole shareholder of Nuokang Distribution, pledged all of his equity interests in Nuokang Distribution to Penglai Nuokang to secure the performance of his and Nuokang Distribution’s obligations under the business operation agreement and the exclusive technology support and management consulting service agreement described below. If Nuokang Distribution or Mr. Xue breaches any of their respective contractual obligations under these agreements, Penglai Nuokang, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. Mr. Xue has agreed not to transfer, sell, pledge, dispose of or otherwise create any new encumbrance on his equity interests in Nuokang Distribution without the prior written consent of Penglai Nuokang. The duration of the equity pledge agreement is the same as the term of the exclusive technology support and management consulting service agreement, which will be valid and effective as long as Nuokang Distribution is in existence.

Exclusive Call Option Agreement

Under the exclusive call option agreement among Nuokang Distribution, Mr. Xue and Penglai Nuokang, Nuokang Distribution and Mr. Xue irrevocably granted Penglai Nuokang or its designated person an exclusive option to purchase, when and to the extent permitted under PRC law, all or part of the equity interests in Nuokang Distribution. The exercise price for the option to buy all of the equity interests is the then total amount of Nuokang Distribution’s registered capital or such other minimum amount agreed to by all parties and permissible under PRC law. Such consideration received by Mr. Xue upon the exercise of the exclusive call option is required to be remitted in full to Penglai Nuokang. The exclusive call option agreement will remain valid and effective for ten years and is renewable at Penglai Nuokang’s sole discretion. This exclusive call option agreement provides that without Penglai Nuokang’s prior written consent:

 

   

Mr. Xue may not transfer, encumber, grant security interest in, or otherwise dispose of any equity interests in Nuokang Distribution, except as required under applicable law;

 

   

Nuokang Distribution may not (i) transfer, grant security interest in or otherwise dispose of any assets, business, revenue or interest valued at RMB2 million or more; (ii) enter into any material contract in the amount of RMB2 million or more (except for those incurred in the ordinary course of business); or (iii) incur any liabilities (except for those incurred in the ordinary course of business);

 

   

Nuokang Distribution may not declare or pay any dividends and Mr. Xue must remit in full any funds received from Nuokang Distribution to Penglai Nuokang; and

 

   

Nuokang Distribution may not merge with any third parties, or purchase or transfer any assets or businesses from or to any third parties.

Business Operation Agreement

Under the business operation agreement among Nuokang Distribution, Mr. Xue and Penglai Nuokang, Mr. Xue may not enter into any transaction that could materially affect Nuokang Distribution’s assets, liabilities, interests or operations without the prior written consent of Penglai Nuokang, and Mr. Xue must appoint Penglai Nuokang’s nominees to Nuokang Distribution’s board of directors and to act as the general manager, financial controller and other senior managers. In addition, if Nuokang Distribution requires a guarantor for its borrowings, it will first make such request to Penglai Nuokang. Despite the fact that Penglai Nuokang retains the contractual right to object to such request, it is our intention to facilitate

 

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such guarantee if and when such request is made. The term of this agreement is ten years from December 14, 2007 and is renewable at Penglai Nuokang’s sole discretion.

Power of Attorney

Mr. Xue has executed a power of attorney appointing Chinese natural persons designated by Penglai Nuokang to be his attorneys, and irrevocably authorizing them to vote on his behalf on all of the matters of Nuokang Distribution requiring shareholders’ approval.

Exclusive Technology Support and Management Consulting Service Agreement

Under the exclusive technology support and management consulting service agreement between Nuokang Distribution and Penglai Nuokang, Penglai Nuokang has the exclusive right to provide to Nuokang Distribution technology support and consulting services related to the business operations of Nuokang Distribution. Nuokang Distribution agrees to pay monthly service fees to Penglai Nuokang in the amount of 80% of Nuokang Distribution’s total monthly revenue after deducting sales expenses and operational costs approved by Penglai Nuokang, which is adjustable at the sole discretion of Penglai Nuokang. In addition, Penglai Nuokang agrees to provide full financial support for Nuokang Distribution’s working capital requirement for its business operations. If Nuokang Distribution is unable to repay its obligations owing to Penglai Nuokang, Penglai Nuokang agrees not to enforce these obligations. This agreement will remain valid and effective as long as Nuokang Distribution is in existence.

 

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BUSINESS

Overview

We are a fully integrated, profitable China-based biopharmaceutical company focused on the research, development, manufacture, marketing and sales of hematological and cardiovascular products. We currently sell a portfolio of fourteen products, including three principal products, Baquting ( LOGO®), our flagship bleeding control product, Aiduo ( LOGO®), our cardiovascular stress imaging agent, and Aiwen ( LOGO®), our anti-arrhythmic agent. We have also entered into an exclusive agreement for the marketing and distribution in China of Kaitong ( LOGO), an intravenous injectable lipid emulsion of vasodilator alprostadil for the treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis. Our product pipeline includes four product candidates under development that seek to better address the growing market and medical needs for bleeding control, and in hematological, cardiovascular and cerebrovascular disease diagnosis, treatment and prevention.

Developed in-house and launched in 2001, Baquting is China’s leading hemocoagulase and is prescribed to hospital patients for the treatment and prevention of bleeding. A hemocoagulase is an enzyme obtained from the venom of the snake species Bothrops atrox that can be used as a plasma clotting agent for wound and tissue repair. Baquting commanded an approximately 38% market share by volume in 2007 and maintained this market share in 2008, according to an independent study conducted by China Pharmaceutical Association, a national organization of pharmacists and pharmaceutical scientists in China. In 2007, Baquting’s market share surpassed that of Solco Basel’s Reptilase, the long-time market leader, for the first time. Reptilase, a competing Swiss brand, had an approximately 33% market share by volume in 2007. Through September 30, 2009, we had sold an aggregate of over 38 million units of Baquting to our end-customer base of over 2,400 hospitals across China. Sales of Baquting accounted for 90.1% and 94.1% of our total net revenue in 2008 and the nine months ended September 30, 2009. Baquting’s brand is well-recognized by the medical community in China, where traditional medicine and culture emphasize the importance of blood and limiting its loss and where there are higher clinical risks related to blood transfusions than in some Western countries. Our patent in China for Baquting with enhanced quality will expire in 2025.

Aiduo and Aiwen are the first adenosine products to be manufactured in China. Adenosine is a nucleoside that plays important biological roles, including dilating the coronary arteries and regulating the pacemaker activity of the heart. Aiduo is our diagnostic stress-test agent for coronary arterial diseases and Aiwen is used in the diagnosis and treatment of PSVT, an abnormal conduction of electrical signals that causes the heart to beat very rapidly. We entered into agreements to acquire Aiduo and Aiwen from two third parties, Shenyang Guangda and Shenyang Wanjia, in 2004. Aiduo and Aiwen are currently manufactured by Shenyang Guangda, and we have been the exclusive distributor and marketer of Aiduo and Aiwen in China since January 2005. In order to complete the acquisition and to commence production of Aiduo and Aiwen at our Shenyang facility, we require approval from the SFDA for the transfer of the production permit for these drugs from Shenyang Guangda to us and GMP certification for our Shenyang facility. We submitted our application for the SFDA approval in July 2008. If the SFDA approval and the GMP certification are delayed or not granted at all, we will continue to be the exclusive distributor and marketer of Aiduo and Aiwen but manufacturing will continue to be conducted by Shenyang Guangda.

In December 2008, we entered into a ten-year exclusive distribution agreement with Jilin Yuhua to market and distribute Kaitong exclusively in China with the exception of Jilin and

 

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Heilongjiang Provinces. Jilin Yuhua is in the process of obtaining a production permit for Kaitong to allow it to manufacture this product at its GMP-certified new facilities in Changchun, Jilin Province. If the production permit for Kaitong is delayed or not granted at all, Jilin Yuhua will not be able to commence its production and we will not be able to launch this product in the market.

We intend to continue to pursue product and technology in-licensing opportunities. For example, in June 2009 we entered into a joint venture with QRxPharma Limited, an Australian company, to develop and commercialize two bleeding control products based on technologies developed by QRxPharma and the University of Queensland. We invested $5.0 million in October 2009 for a 93% interest in the joint venture to fund clinical trials in China for the commercialization of Textilinin, an antifibrinolytic agent, and Haempatch, a potent pro-coagulant, under an exclusive royalty-free license.

Our product pipeline consists of four product candidates at various stages of development:

 

   

dipyridamole aspirin sustained release capsules, which combines the anti-clotting or blood thinning properties of aspirin with the antiparticle and thrombus formation inhibition properties of dipyridamole, for the prevention of secondary strokes;

 

   

hemocoagulase derived from the venom of the snake species Agkistrodon acutus for bleeding control;

 

   

adenosine for myocardial protection; and

 

   

lanthanum polystyrene sulfonate for the treatment of hyperphosphatemia, or high levels of blood phosphate typically found in chronic renal failure patients undergoing dialysis.

Substantially all of our sales are made to pharmaceutical distributors, which in turn sell our products primarily to hospitals and other healthcare institutions in China. As of September 30, 2009, our end-customer base had expanded from approximately 100 hospitals in 2001 to over 2,400 hospitals in all 31 provinces and municipalities in China. Our end-customer base includes approximately 80% of the Class 3A hospitals, considered the best and largest under the China Ministry of Health hospital classification system, in major Chinese cities. As of September 30, 2009, our sales force consisted of 24 direct sales offices with 302 sales personnel, complemented by 16 third-party marketing agents with over 200 sales personnel. We believe the reputation of our Nuokang ( LOGO) brand name and our well-known branded pharmaceutical, Baquting, enable our sales and marketing team to effectively promote our principal products and help to stimulate the sales of our other pharmaceuticals. We employ a physician-targeted marketing model that is focused on promoting our products by providing physicians and hospitals with information on the benefits and differentiating clinical aspects of our products. Our sales and marketing activities receive strong academic support from a specialist network comprising approximately 100 national key opinion leaders and physicians in various clinical areas, and over 100 peer-reviewed academic articles have been published in recognized academic magazines or periodicals regarding the use of our principal products. As of September 30, 2009, our distribution network included approximately 200 distributors.

We have built our market reputation through our strict adherence to high product safety standards and our quality control and monitoring system that spans the entire production and sales process, including inspection of raw and auxiliary materials, manufacturing, delivery of finished products, clinical testing at hospitals and ethical sales practices. Our 11,000-square-meter manufacturing facility in Penglai, China commenced operations in 2002. At this facility, we maintain five GMP-certified formulation production lines, including injectables, freeze-dried powder, aerosols, tablets and granules, and three GMP-certified active pharmaceutical

 

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ingredient production lines. In February 2008, we completed the construction of a 24,000-square-meter integrated facility in Shenyang, China. The Shenyang facility was designed to have the capacity for three additional production lines, including two formulation production lines for injectables and one active pharmaceutical ingredient production line, a new research and development center and a warehouse. Both research and development center and warehouse are operational while the GMP certification of these three production lines is currently pending.

Our net revenue was RMB121.7 million, RMB147.9 million and RMB225.4 million ($33.0 million) in 2006, 2007 and 2008, respectively. Our net income was RMB26.3 million in 2006, RMB35.2 million in 2007 and RMB63.6 million ($9.3 million) in 2008, representing a CAGR of 55.5% over that period. For the nine months ended September 30, 2009, our net revenue was RMB200.1 million ($29.3 million) and our net income was RMB41.6 million ($6.1 million), compared to net revenue of RMB153.5 million and net income of RMB41.7 million for the nine months ended September 30, 2008.

Competitive Strengths

We believe our principal competitive strengths are as follows:

Established Flagship Product with Leading Market Share and Recognized Brand Name

According to the China Pharmaceutical Association, our flagship product Baquting was China’s leading hemocoagulase prescribed to hospital patients for the treatment and prevention of bleeding, commanding the largest market share by volume. As a result of our successful brand building efforts, Baquting has broad geographic coverage among the larger and more modernized hospitals, primarily Class 3 and Class 2 hospitals, in both large- and mid-sized Chinese cities. Baquting has become the leading hemocoagulase brand that is well-recognized by the Chinese medical community. Baquting is currently included as one of the hemocoagulase products on the national medical insurance catalog in China, which we believe increases its affordability for patients who have access to medical insurance and likelihood of prescription by physicians. Baquting is also the first hemocoagulase in the Chinese market available in three distinct dosages, offering physicians the flexibility in prescribing the drug to suit diverse patient profiles or medical situations. We believe this provides us a distinct advantage in the tender processes. We believe Baquting’s leading market position and well-recognized brand name give us a significant competitive advantage in marketing Baquting to more hospitals and promoting our other products to the medical community.

Established Nationwide Sales and Marketing Network

We employ a physician-targeted marketing model that is focused on detailing and promoting our products by providing physicians and hospitals with information on the benefits and differentiating clinical aspects of our products, which are also supported by a specialist network comprising key opinions leaders, physicians and pharmacists. We built our broad market coverage of over 2,400 hospitals and over 10,000 frequent prescribing physicians in all of the 31 provinces and municipalities in China through our direct sales personnel and third-party regional marketing agents. As of September 30, 2009, our sales force comprised 24 direct sales offices that supported 302 sales personnel, complemented by 16 regional marketing agents which support an additional 200 sales personnel. We believe we will be able to further expand our market reach and enhance the market penetration of our various pharmaceutical products and quickly grow the future revenue of our product candidates, if such candidates are approved by SFDA, by leveraging our established nationwide sales and marketing platform, the high level

 

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of market recognition for our Nuokang and Baquting brands and our strong relationships with distributors, hospitals and physicians.

Diverse Portfolio of Marketed Products and Product Candidates Targeting Attractive Commercial Opportunities in Hematological and Cardiovascular Markets

In an effort to capitalize on the rapid growth of the Chinese pharmaceutical industry, we have established a diverse portfolio of marketed products and product candidates targeting attractive commercial opportunities in the Chinese hospital market, focusing in particular on the hematological market and the cardiovascular market, which ranked as the fourth and second largest markets in 2006 among all therapeutics in China in terms of sales revenue, respectively, according to PICO. Our near-term product candidates include Kaitong, a lipid emulsion of alprostadil for the treatment of peripheral vascular diseases, cardiocerebral microcirculation disorder and post-surgery thrombosis. We are developing cardiovascular product candidates such as dipyridamole aspirin sustained release capsules. Our product candidate portfolio also includes hematological products such as a hemocoagulase derived from the venom of the snake species Agkistrodon acutus and lanthanum polystyrene sulfonate for the treatment of hyperphosphatemia.

Demonstrated Research and Development and Commercialization Capabilities

We have successfully developed, launched and marketed our flagship product Baquting and we have four additional products in the pipeline. Our product development team has demonstrated the ability and capacity to identify, develop, and commercialize product candidates in our targeted therapeutic areas in order to create opportunities for the sustainable growth of our business. To maintain and enhance the existing technological advantages of Baquting and our adenosine products, we are dedicated to their continuing modifications and improvements. Our research and development team is experienced in complex process development, reformulating validated product candidates that we acquire from third parties and developing them into commercially viable compounds with advantages over the original products. We implement life-cycle management strategies for our marketed products and product candidates to address the growing medical and market demand in our core therapeutic areas. Our life-cycle management strategies involve the expansion of indications for our products, promotional marketing studies as well as the development of next generations or line extensions that improve quality, safety or convenience to enhance therapeutic value, clinical utility or both.

Integrated Biopharmaceutical Operations with Internal Manufacturing Capability to Ensure Quality and Supply

Our integrated production facilities, optimized manufacturing processes and strict quality control system allow us to adhere to our high quality standards, ensure stable and ample supply and enhance the competitiveness of our products. As of September 30, 2009, we operated five formulation production lines and three active pharmaceutical ingredient production lines at our 11,000-square-meter GMP-certified facility in Penglai, China. We have completed the construction of a 24,000-square-meter integrated facility in Shenyang, China which is designed to support three additional production lines, a new research and development center and a warehouse. The new research and development center and warehouse are currently operational and the GMP certification of these three production lines is pending. Furthermore, our capability to manufacture six primary formulations in China and our proprietary production know-how allow us to timely in-license and commercialize product candidates at various stages of development, a process that may otherwise require a long time and poses a significant barrier of entry for our competitors.

 

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Experienced and Entrepreneurial Management Team

Our management team has extensive experience in the research and development, manufacture, commercialization, and in-licensing and acquisition of products and companies in China’s biopharmaceutical industry. In particular, Mr. Baizhong Xue, our founder, chairman and chief executive officer, has over 10 years’ experience in clinical development, marketing and management in China’s pharmaceutical industry and is the vice president of China Biochemical Pharmaceutical Industry Association, a leading association of Chinese biopharmaceutical industry participants. Experienced in managing fast-growing enterprises, our entrepreneurial management team takes the initiative to adapt our business strategies to market, industry and therapeutic trends. Our management team has successfully developed and commercialized Baquting to be the leading hemocoagulase in China, established a deep product pipeline, and built an integrated research and development, production, and sales and marketing infrastructure. Our success in existing product development and branding reflects the significant experience that members of our management team have in their respective fields of expertise and their in-depth knowledge of the regulatory framework in China.

Strong Record of Growth and Profitability

We are profitable and we believe we are well positioned to capitalize on the rapid growth of the Chinese pharmaceutical market and to leverage the leading market position of our flagship product in order to continue our rapid expansion and growth. We sold 4.2 million, 6.3 million and 9.7 million units of Baquting in 2006, 2007 and 2008, respectively, representing a CAGR of 52.0% from 2006 to 2008. We sold 9.1 million units of Baquting in the nine months ended September 30, 2009, compared to 6.8 million units of Baquting in the nine months ended September 30, 2008. Our net income was RMB26.3 million in 2006, RMB35.2 million in 2007 and RMB63.6 million ($9.3 million) in 2008, representing a CAGR of 55.5% over that period. For the nine months ended September 30, 2009, our net income was RMB41.6 million ($6.1 million), compared to net income of RMB41.7 million for the nine months ended September 30, 2008.

Strategy

Our goal is to become the leader in the commercialization of innovative and branded biopharmaceutical products in China. To achieve our goal, we intend to implement the following elements of our strategy:

Leverage the Leading Position and Brand Name of Baquting in China to Further Enhance Brand Awareness of Baquting and Our Other Key Products and Effectively Launch Our Product Candidates

We plan to build on Baquting’s leading market position to extend our lead over our competition and take advantage of its brand recognition and favorable national health insurance coverage. We believe we can leverage our successful product improvement and branding experience to enhance brand awareness and grow the sales of our other key products and effectively launch our product candidates, if approved. We plan to use our established sales, marketing and distribution platform, further develop our existing commercial infrastructure and leverage our broad industry relationships to maximize the sales of our existing and future products in China.

 

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Develop and Commercialize Candidates in Our Product Pipeline and New In-licensed or Acquired Products that Address Growing Medical Needs in the Commercially Attractive Hematological and Cardiovascular Markets

We are developing a diversified portfolio of hematological and cardiovascular product candidates. Our pipeline includes novel product candidates in addition to new enhanced versions of our existing products and expanded therapeutic uses for our currently marketed products. Our pre-clinical trial programs are focused on significant commercial opportunities, including the use of biological enzymes and endogenous biologically active factors in hematological and cardiovascular therapeutic areas. In addition, we intend to continue to evaluate and develop additional product candidates through in-house drug development, strategic alliances, in-licensing and acquisitions to expand our pipeline where we perceive a significant unmet medical need and attractive commercial potential. We plan to focus our capital resources, technologies and management on commercially attractive hematological and cardiovascular markets to establish or extend our market leading positions in these areas.

Increase Our Market Share and Commercial Opportunities through Expanding Our Sales and Distribution Network and Further Strengthening Our Science-based Promotion Efforts

We will continue to promote our products to hospitals, physicians and pharmacists by focusing on their differentiating clinical aspects, and will strive to improve the sales execution skills of our sales and marketing personnel to increase the brand awareness and recognition of our principal products. We believe that there is significant market potential for our principal products and product candidates, and we plan to continue to enhance our coverage and penetration of the Chinese pharmaceutical market in order to increase our market share and commercial opportunities. We believe that we can benefit from the growing market demand resulting from the increased medical insurance coverage and reimbursement amounts under the proposed PRC healthcare reform, greater levels of disposable income within our target market, increased per capita healthcare spending as well as increased national drug stockpiling. We intend to hire more sales personnel and engage more marketing agents to increase the reach and effectiveness of our sales efforts. We also plan to expand the footprint of our sales and marketing presence and further allocate the geographic coverage among our direct sales offices and regional marketing agents to increase penetration of our key products in their respective end markets. We aim to expand into more Class 3 hospitals to broaden our network as well as further increase the use of our products in hospitals in our existing network. In addition, we plan to further expand into hospitals of smaller size and lesser complexity to complement our product distribution in the Class 3 hospitals in China. Additionally, we plan to include more distributors in our distribution network to expand the scope of our market coverage and continue to select high-quality distributors to enhance our distribution capacity.

Acquire New Technologies or Companies and In-license New Products or Technologies

We continually seek attractive product candidates and innovative technologies to in-license or acquire. We intend to focus on product candidates that we believe address unmet medical needs, that can leverage our existing sales infrastructure, and that represent large potential market opportunities. We plan to take advantage of the fragmented nature and rapid growth of the pharmaceutical industry in China to acquire suitable companies, businesses, or technologies that complement our existing strategies. We believe that our relationships with many industry participants and our knowledge of, and experience in, the biopharmaceutical industry in China allow us to better understand industry trends, technological developments and practical applications. We believe that our expertise and experience will assist us in making prudent acquisition decisions and position us to be a more desirable partner to companies whose

 

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products we may endeavor to add to our portfolio. We plan to develop collaborations with Chinese and international pharmaceutical and biotechnology companies through product co-development and strategic alliances. For example, we entered into a joint venture with QRxPharma Limited, an Australian company, to develop and commercialize two bleeding control products based on technology developed by QRxPharma and the University of Queensland.

Industry Overview

Chinese Pharmaceutical Market Overview

The Chinese healthcare market was the seventh largest in the world in 2008 and is expected to become the fifth largest by 2010, according to Frost & Sullivan. Healthcare expenditure in China has been steadily increasing, evidenced by the rapid growth of China’s gross domestic product, or GDP, and the increasing percentage of China’s GDP spent on healthcare. In 2008, China registered an annual GDP growth rate of 9.0%, and annual healthcare spending increased to 4.2% of GDP in 2005, up from 3.7% of GDP in 1995. Frost & Sullivan estimates annual healthcare spending in China as a percentage of GDP will further increase to 8.0% by 2010. By comparison, it is estimated that 2007 U.S. annual healthcare spending as a percentage of GDP was 16%. Other factors driving growth of healthcare spending in China include the country’s population growth, aging population, longer life expectancy, accelerating urbanization, rising disposable income, growing awareness of healthcare and available therapeutic options and increasing government support for healthcare programs.

Approximately 80% of prescription drugs in China were dispensed through hospitals, according to Frost & Sullivan. It is estimated that there are approximately 20,000 hospitals in China which are where the majority of medical procedures are performed. Only about 1,000 of these institutions receive the Government’s highest ranking of Class 3, and those hospitals tend to be concentrated in the larger cities and more populated coastal regions, creating a more targeted market for pharmaceutical companies to focus their sales and marketing efforts.

The pharmaceutical industry in China is highly fragmented, with an estimated more than 4,000 pharmaceutical companies. The top 10 domestic pharmaceutical manufacturers only accounted for 10.6% of total pharmaceutical sales in 2005, according to Datamonitor. As most Chinese pharmaceutical companies lack scale and size, we believe manufacturers with large-scale production capacity, an effective distribution network and strong research and development and sales and marketing capabilities have the opportunity to consolidate and become industry leaders in China.

We believe that to successfully compete in the Chinese pharmaceutical industry, a company needs to develop a strong research and development, manufacturing and sales and marketing infrastructure, which, once established, will be a competitive advantage in the market that may be difficult for other competitors to reproduce. Additionally, we believe once a therapeutic has established a strong brand name and is trusted by physicians, it often maintains its market position even in the face of strong competition. This concept is even more prominent in biologics such as Baquting, which are more difficult to manufacture and require strict quality control measures.

Chinese Pharmaceutical Market Growth

The healthcare industry’s rapid growth in China is mainly attributed to expansion of the pharmaceutical segment. According to Business Monitor International, in 2008, the Chinese

 

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pharmaceutical market, including prescription and over-the-counter medicines, grew to approximately $37.0 billion from approximately $13.5 billion in 2003, representing a CAGR of 22.3%. The China market is expected to reach $74.1 billion by 2013.

LOGO

 

Source: Business Monitor International

Generics have traditionally dominated the Chinese market. However, the share of innovative branded drugs is rising in relation to generics. Frost & Sullivan projects innovative branded drugs to increase to 21.0% of the drug market in 2011 from an estimated 9.0% in 2007.

 

2007   2011
LOGO   LOGO

 

Source: Frost & Sullivan

Proposed Chinese Healthcare Reform

On April 6, 2009, the PRC government outlined a healthcare reform proposal that will involve an expenditure of approximately RMB850 billion ($124.5 billion), approximately 3% of China’s GDP, from 2009 to 2011 to revamp the healthcare system in China. The proposal covers various aspects of the healthcare system in China and established five near-term objectives: (1) to accelerate the formation of a basic medical insurance system providing universal coverage, (2) to establish a national essential drug system, (3) to establish a basic healthcare service system and improve the quality and reliability of patient care, (4) to improve basic public healthcare services with an emphasis on early diagnosis and disease control, and (5) to promote the reform of public hospitals. Although further details on the implementation of the proposal have yet to be announced, based on these stated near-term objectives of the healthcare reform and other related information that has been released by the PRC government relating to these objectives, we believe we will likely benefit from the following aspects:

 

   

Extending basic medical insurance coverage and increasing insurance subsidies. The Chinese government aims to extend basic medical insurance coverage to at least 90% of

 

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the country’s population by 2011 and increase the amount of insurance subsidies to RMB 120 per person per year by 2010. We believe the increase in basic medical insurance coverage will encourage patients who previously could not afford medical treatment to seek treatment, thereby increasing the overall demand for surgical procedures that will require the use of bleeding control agents, such as Baquting, and increase the size of Baquting’s market.

 

   

Improving the quality and reliability of patient care. The PRC government aims to improve the overall quality and reliability of healthcare, which will promote standardized treatment procedures and better quality drugs. As we believe Baquting has gained considerable acceptance by physicians for the treatment and prevention of bleeding, Baquting should benefit from this development, particularly if the use of bleeding control agents becomes part of the standard procedures for surgeries in China.

 

         Based on similar trends in other countries, we believe the drive for higher quality healthcare will also promote more stringent pharmaceutical manufacturing and distribution standards. This may lead to the closure of smaller companies that lack sufficient cash flow. We believe we can take advantage of the consolidation opportunities in the biopharmaceutical industry in China given our strong cash flow and manufacturing, R&D and sales and marketing capabilities.

 

   

Promoting early diagnosis of diseases. The proposed healthcare reform promotes early diagnosis of diseases in order to reduce the overall long-term burden to the healthcare system. We believe a wider acceptance of the importance of early prevention will increase the use of diagnostic tests, and increase demand for diagnostic agents, such as Aiduo, our cardiovascular stress imaging agent.

Chinese Biopharmaceutical Market Overview

Development of the Chinese biopharmaceutical market has been rapid since the first biological product, human interferon-a 1b, was introduced in 1989. According to Business Monitor International, there were more than 500 biopharmaceutical manufacturers. In 2007, over 30 domestically produced protein therapeutic drugs and over 40 vaccines have been commercialized in China. While 95% of the Chinese biopharmaceutical market is comprised of biosimilars and biogenerics, development and commercialization of innovative biotech drugs and vaccines continues to grow.

The Chinese government emphasizes the biopharmaceutical industry in its 11th Five-Year Plan period and has announced its commitment to the biopharmaceutical sector. According to Business Monitor International, the PRC government has recently approved more than 20 biopharmaceutical products and granted GMP certification to more than 130 companies. The government is estimated to spend more than $600 million on biotechnology R&D, including by granting state support to over 60 local companies. The government support for local R&D is expected to be $14 billion by 2015. In addition, according to Business Monitor International, the Chinese biopharmaceutical market was valued at approximately $10 billion in 2007.

Chinese Pharmaceuticals Regulation Overview

Since China’s entry to the World Trade Organization in 2001, the Chinese government has made significant efforts to standardize regulations, develop its pharmaceutical regulatory system and strengthen intellectual property protection.

Before 1993, products in China were protected only by process patents and not by product patents. In 1993, in line with international patent standards, product patents were introduced as

 

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a part of the Chinese patent protection standard. Since the introduction, all eligible products may be protected by new product patents. In addition, patented products enjoy separate pricing policies, which make such products more likely to be selected during the tendering process.

The SFDA is the equivalent of the Food and Drug Administration in the U.S. and regulates the pharmaceutical industry in China. The SFDA has implemented good manufacturing practice standards for the manufacture of pharmaceutical products, as well as good supplies practices for the distribution of pharmaceutical products, to ensure that Chinese pharmaceutical products meet global standards. The SFDA also monitors clinical trials, and approves new drugs only following successful completion of clinical trials in China under an approval process similar in nature to that in the United States or Europe.

We believe these higher regulatory standards and more rigorous intellectual property protection and enforcement are making it more difficult for smaller, poorly managed companies or companies with no product differentiation or intellectual property protection to compete. For example, due to the implementation of China GMP, the number of Chinese pharmaceutical companies reduced dramatically from approximately 6,700 in 2004 to approximately 3,600 as of 2007. In addition, in 2007 the China Ministry of Health promulgated a new regulation on prescription management, which states that for either injectable or oral formulation, hospitals may not purchase the same type of drugs from more than two manufacturers. We believe the new regulation on prescription management may significantly reduce the number of manufacturers that hospitals can source from. Additionally, we believe that these trends will create opportunities for companies that are well capitalized and have leading market positions, patented products as well as established brand names to further accelerate their growth at the expense of their smaller competitors.

Chinese Medical Reimbursement Overview

Historically, most of Chinese healthcare costs have been borne by patients out-of-pocket, which has limited the growth of more expensive pharmaceutical products. However, in recent years the number of people covered by government and private insurance has increased. According to the PRC National Bureau of Statistics, as of December 31, 2008, 317 million people in China were enrolled in the national medical insurance program, representing an increase of 42.1% from December 31, 2007. The PRC government has announced a plan to give every person in China access to basic healthcare by year 2020.

While most insured patients reside in major cities, the government is making an effort to expand insurance coverage beyond the major cities with initiatives such as the rural medical insurance program, that is jointly funded by allocations from the central government, subsidies from local governments, and premiums collected from the farmers who join the system voluntarily. The China Ministry of Health announced plans to rollout the system nationwide in 2008 and have most of the rural residents covered by 2010. We believe the expansion of the rural medical insurance coverage will further increase the sales potential of prescribed drugs.

The Bleeding Control Market

Overview

Bleeding due to trauma, surgery or a bleeding disorder can cause the body not to function properly and can be fatal in certain circumstances. The concept of a hemocoagulant, such as Baquting, in medical practice has gained broad and growing acceptance among the Chinese medical community. We believe that our ability to continue to successfully penetrate our

 

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domestic market is positively influenced by the importance of blood in traditional Chinese medicine, decreasing blood supply and the risk of receiving contaminated blood during transfusion.

Traditional Chinese medicine has been widely used in China for thousands of years and is therefore deeply ingrained in Chinese culture. The theory underlying traditional Chinese medicine is that the human body is a dynamic energy system, or Qi, that needs to harmonize and balance the different energies within it. Under this theory, a person becomes ill because his or her body experiences disharmony or an imbalance of energy. Blood and Qi are fundamentally linked in traditional Chinese medicine, as blood carries Qi and provides nutrients for its movement. Losing large amounts of blood causes an overall Qi deficiency, which is believed to contribute to illness. While hemocoagulant products, such as Baquting, are not traditional Chinese medicine products, and prescribing physicians are generally not traditional Chinese medicine prescribing doctors, the overtones of traditional medicine still impact prescribing decisions. Therefore, if a physician can prescribe, or suggest that the patient consider, a drug either during or prior to surgery, for example, that could limit the loss of blood, the patient may choose to agree to receive a hemocoagulant as a result of the influence of traditional Chinese medicine.

The abundance of blood supply has been decreasing in China after the government adopted the Blood Donation Law in 1997 to prohibit the buying and selling of blood and to establish principles and regulations for the safe handling of blood supplies. According to China Economic Information Network, the number of blood centers in China has decreased from over 200 to about 100, and total volume of blood collected decreased from over 4,000 tons in 2004 to less than 3,000 tons in 2007. As a result of the significant shortage of blood supply in China, the government increased the price of human serum albumin, a major blood product, by 40% in September 2007 compared to the price as of January 2007, making it more expensive to receive transfusions. As the population continues to grow, the availability of blood may become even more limited. Given these dynamics and the shortage of supply, physicians seek to find ways to limit the need for blood transfusions.

There have recently been a number of well publicized cases of patients receiving transfusions of contaminated blood in China, which we believe have led to general concerns about the quality of the Chinese blood supply. The risk of blood transfusion contamination is not specific to China alone. While there have been many recent instances of contaminated blood being used in hospitals throughout rural China, in the US alone, there were close to 10,000 cases of HIV that were caused by contaminated blood transfusion. Blood transfusion contamination can also lead to virus infections such as Cytomegalovirus, Hepatitis A, B, C, Human T Lymphotropic Virus I & II, West Nile Virus, as well as parasitic infection such as Babesiosis, Chagas Disease, Lyme Disease, and Malaria. Other risks associated with blood transfusion reactions include allergic reaction, febrile reaction, iron overload, transfusion-related acute lung injury, acute immune hemolytic reaction, delayed hemolytic reaction, and graft-versus-host disease. Given all of these risks and China’s recent highly publicized cases of contamination, doctors, if they have a choice, seek to limit the need for transfusions.

Market Size

According to PICO, there were more than 30 million cases of bleeding incidence that required treatment in China in 2004. The hematological market is ranked fourth, after the anti-infective market, cardiovascular market and cancer market, among all therapeutic markets in China in terms of sales value. The market for bleeding control in China increased to approximately RMB2.0 billion ($291.2 million) in 2008. Hemocoagulases, such as Baquting,

 

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increased their market share, by revenue, from approximately 34.3% in 2006 to 49.9% in 2008, and, according to PICO, are forecasted to continue to increase their market share in future years. In addition, PICO forecasts that sales volume of hemocoagulases in China will increase from 14.9 million units in 2007 to 50.0 million units in 2013.

Hemocoagulases are the most prescribed type of treatment for bleeding control in China. According to PICO, the sales volume of hemocoagulase to Chinese hospitals increased from 8.4 million units in 2004 to 24.4 million units in 2008 and reached RMB991 million ($145.2 million) in total sales in 2008. The key market drivers of the bleeding market in China primarily include the aging population and the higher prevalence rate of blood disorder in those over the age of 35 and the expansion of healthcare market among the rural households due to increasing awareness.

Globally, rising cases of surgical procedures and bleeding disorder contribute to the growth of bleeding treatment market. According to PICO, the number of surgical procedures performed in China is estimated to grow from approximately 15 million procedures in 2003 to 19 million in 2008. In comparison, according to the US National Center for Health Statistics, there were approximately 45 million cases of surgery procedures performed in over 5,700 US hospitals during 2005. Blood disorders such as thrombocytopenia, anemia, and hemophilia may also cause bleeding problems.

The Cardiovascular Market

Cardiovascular diseases are disorders of the heart and blood vessels. They refer to a variety of indications and can feature acute or chronic symptoms. An acute cardiovascular disease is typically diagnosed in the hospital setting following a cardiac event. Thrombosis, hypertension, dyslipidemia and diabetes are the most frequently diagnosed cardiovascular diseases.

According to World Health Organization (WHO) estimates, cardiovascular disease was the leading cause of death worldwide, and in 2005 there were about 17.5 million cardiovascular-related deaths, which represented nearly 30% of worldwide mortality. Out of these, 7.6 million people died of heart attacks and 5.7 million people died of strokes. According to the China Statistical Yearbook 2008, cardiovascular disease was ranked second among the top 10 causes of death in urban China in 2006, accounting for approximately 18.0% of the mortality in those areas. Despite advances in pharmacological therapies for cardiovascular diseases, there is an increasing number of global deaths from cardiovascular diseases. By 2015, Frost & Sullivan estimates that more than 20 million people will die from some form of cardiovascular disease every year, with the leading causes being heart attack and stroke.

As the global standards of care are undergoing shifts toward early detection, preventative medicine, non-invasive, evidence-based medicine and personalized treatment in all clinical areas including cardiology, diagnostic imaging is increasingly being used to detect, prevent, and monitor cardiovascular diseases. Stress tests, echocardiography and minimally invasive catheterization procedures are among the most commonly used procedures to diagnose cardiovascular health. In addition, the demand for diagnostic cardiology procedures is expected to increase proportionately with the ageing of the population.

Market Size

China is the largest market in the Asian region for cardiovascular treatments and cardiovascular drugs also have the second largest market share among all the prescription drugs in China. The Chinese cardiovascular market was estimated to be $1.3 billion in 2004,

 

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according to Business Insights. The market for cardiac therapies including therapeutics for angina, heart failure, arrhythmia and atrial fibrillation was $220 million in 2004, and the market for anti-thrombotics in particular was $130 million in 2004.

According to Business Insights, the size of the global cardiovascular disorders market was estimated at $143.9 billion in 2007. Anti-thrombotics sales were estimated at $19.2 billion in 2007. Cardiac therapies represented $5.9 billion sales.

The associated large cardiac imaging market is also estimated to show sustained growth. According to Frost & Sullivan, an estimated 47.1 million cardiovascular stress imaging procedures were performed in North America in 2007. Cardiovascular stress imaging volumes are further expected to grow at a CAGR of 7.8 percent to reach a 63.5 million volume in 2011.

Myocardial perfusion imaging is a widely used diagnostic test used for assessing blood flow to the heart during exercise or stress and at rest. More than 8 million MPI procedures were performed in the US in 2004, according to China Pharmaceutical Newspaper, and, in China, MPI is continually gaining a greater acceptance. Approximately 100,000 MPI procedures were estimated to occur in 2006. Adenosine, the stress agent used to facilitate MPI, was estimated to have a potential market of RMB2 billion ($293 million), which will be similar in size to the U.S. sales of $330 million in 2007, assuming the MPI market were fully developed in China. Furthermore, as MPI’s importance in early detection, treatment option, and monitoring of coronary arterial diseases is increasingly recognized, it was recommended to be included in the national medical insurance catalog.

Market Trends

With a progressive increase of lifestyle disease across the globe as countries become more industrialized and people live longer, the number of sufferers from cardiovascular disorders was forecast to increase. The following are some of the important trends of the cardiovascular market:

 

   

Rapid growth in the prevalence rate of cardiovascular and cerebrovascular diseases in China.

 

   

Combination drugs are increasing in popularity among cardiovascular disorders such as hypertension and dyslipidemia. Given the chronic nature of these diseases and the increased co-morbidities associated with these diseases, combination drugs provide patients with an increased convenience through the reduction of pill burden, thus further increasing compliance.

 

   

There was an observed increase in the number of potential treatments being developed for the treatment of acute coronary syndrome and associated diseases.

Our Product Portfolio

Our principal products target large markets with growing medical needs in bleeding control as well as hematological, cardiovascular and cerebrovascular disease diagnosis, treatment and prevention. We are currently focused on expanding the indication for our marketed products, developing next generation, enhanced versions of our marketed products, and bringing novel therapeutics to market.

 

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The table below summarizes the development status of our principal products, product under exclusive distributorship and product candidates:

LOGO

Phases I, II and III described in the table above are comparable to the similar phases of clinical trials involved in obtaining marketing approval from the U.S. Food and Drug Administration. Under the Administrative Measures on the Registration of Pharmaceutical Products promulgated by the SFDA, the three phases refer to:

“Phase I”: Preliminary evaluation of safety.

“Phase II”: Evaluation of safety, dosing and efficacy.

“Phase III”: Larger scale evaluation of safety and efficacy.

“Pre-launch”: Awaiting final SFDA approval.

Our Hematological Products and Product Candidates

Baquting ( LOGO®)

Baquting is our flagship hemocoagulase product. Baquting contains the proteolytic enzyme batroxobin, which is derived from the venom of the pit viper Bothrops atrox. Batroxobin’s main

 

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function is to cleave and activate a protein called fibrinogen, and is similar in structure and function to thrombin, an endogenous human enzyme that plays a key role in the blood coagulation pathway. Baquting also contains trace amounts of a blood clotting activating factor FXA, a metalloprotease that promotes the conversion of factor X to factor Xa, which is another essential step in the coagulation pathway. We receive the venom from our South American supplier in the form of a freeze-dried powder that contains a cocktail of over 20 different active proteins and peptides, which we then purify to extract batroxobin and FXA. Batroxobin and FXA promote the blood coagulation process, and a drug containing both is more effective than either agent acting alone to reduce and stop bleeding.

Batroxobin belongs to a class of proteins known as snake venom thrombin-like enzymes and as such promotes the conversion of fibrinogen to fibrin monomer, a key step in the coagulation cascade. These effects ultimately lead to the adhesion of platelets and the formation of an interlacing fibrin monomer network. This adhesion of platelets establishes the coagulation of blood to stop bleeding. Importantly, Baquting only catalyzes the conversion of fibrinogen to fibrin in the damaged areas of blood vessels and does not promote coagulation in healthy blood vessels and therefore can be safely administered systemically.

Baquting is clinically proven to reduce and stop bleeding in various medical settings, including, but not limited to, bleeding control and bleeding disorders. It is widely used in China in the surgical setting, internal medicine, gynecology and obstetrics, ophthalmology, otorhinolaryngology and stomatology. In surgery, it is also often administered as a pre-operative prophylactic to prevent or reduce bleeding during or after an operation.

We developed Baquting in-house and were the first Chinese biopharmaceutical company to obtain regulatory approval for and introduce a form of injectable hemocoagulase into our domestic market. In August 2001, we received the Certificate of Chinese Chemical New Drug and the production permit for Baquting. In November 2001, we launched Baquting in the Chinese market. We originally sold Baquting in a 1 unit/vial formulation, and, in 2006, we launched two additional dosages, 0.5 unit/vial and 2 units/vial. We believe we are the first hemocoagulase manufacturer in the world to offer three distinct dosages, which provides physicians greater flexibility in prescribing the product to suit diverse patient profiles or clinical and surgical settings. We have filed a patent application in China relating to the composition of matter of Baquting. Baquting is also included as one of the hemocoagulases on the national medical insurance catalog in China, which we believe increases both its affordability for patients who have access to medical insurance and the likelihood of its prescription by physicians. In 2006, 2007 and 2008, we sold 4.2 million, 6.3 million and 9.7 million units of Baquting, respectively. In the nine months ended September 30, 2008 and 2009, we sold 6.8 million and 9.1 million units of Baquting, respectively. According to the China Pharmaceutical Association, Baquting was the leading hemocoagulase in China with an approximately 38% market share in 2007 based on volume and maintained this market share by volume in 2008.

Baquting can be administered systemically and locally. For systemic administration, Baquting may be injected intramuscularly or intravenously. Baquting is also approved by the SFDA to be administered locally in five ways, depending upon the indication:

 

   

applying Baquting with absorbent gauze on wounds to stop bleeding;

 

   

spraying Baquting directly to the bleeding intracavitary areas with the aid of a gastroscope, bronchoscope or other similar telescopes;

 

   

applying Baquting locally to exposed wounds;

 

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diffusing or injecting Baquting through intracavitary tubes placed in the chest, abdomen or pelvis; and

 

   

injecting Baquting through gastrojejunal tubes or orally taking Baquting to treat upper gastrointestinal bleeding.

In 2000, we completed a prospective, randomized, double-blind, controlled, parallel-group, multicenter Phase III clinical trial with Baquting in 217 patients undergoing surgery. This trial compared the safety and efficacy of our product to those of Reptilase, an approved batroxobin product manufactured by Solco Basel, and Mannitol, which served as the placebo. In this trial, 97 patients received Baquting, 60 patients received Reptilase and 60 patients received Mannitol. Patients were treated with either Baquting, Reptilase or Mannitol twice, one time 16 to 18 hours before the surgery and another time thirty minutes before the surgery. The primary endpoints in the trial, including bleeding time, blood loss and blood loss per unit area, are illustrated in the following table:

 

Product

   Number of
patients
   Dosage    Bleeding time (s)    Blood loss (g)    Blood loss per
unit area (g/cm2)

Baquting

   97    1 unit/vial × 2    125.6±46.9    9.6±2.8    0.2±0.12

Reptilase

   60    1 unit/vial × 2    118.9±40.8    10.0±6.0    0.2±0.15

Placebo

   60    30 mg/vial × 2    159.2±39.2    12.5±5.4    0.29±0.16

The data demonstrated that Baquting and Reptilase had comparable bleeding time and blood loss per unit area, and Baquting outperformed the placebo in reducing bleeding time (p=0.0011) and decreasing blood loss per unit area (p=0.0016). The p value is the probability of obtaining a result at least as extreme as the one that was actually observed. A p value of less than 0.05 indicates that the two sets of data have a statistically significant difference. This trial also demonstrated that the occurrence of adverse reactions to Baquting, primarily allergic reactions, was low. The product’s positive safety profile confirms that Baquting does not promote blood coagulation in healthy blood vessels, the risk of blood clots from systemic administration of Baquting to the whole body is minimal.

After we launched Baquting in 2001, independent studies in various specialty fields such as oncology, gastrointestinal endoscopy, extracorporeal circulation and plastic surgery in 70 hospitals in China involved targeted clinical trials with Baquting to observe its utility, dosage, safety and efficacy in accordance with their respective clinical needs in different clinical settings. Over 60 articles have been published in connection with these clinical trials, which further validate the expanded uses and growing adoption of Baquting.

To maintain and enhance Baquting’s market leadership, we are dedicated to improving product quality and hemocoagulase production technology and to this end we are engaged in researching product modifications and enhancements. We are utilizing an FXA quantitative measurement technology that is designed to promote the bioactivity and clinical reliability of Baquting.

We believe our marketing efforts have established Baquting as a well-recognized domestic brand that has an established reputation for quality and efficacy in China. We endeavor to enhance physicians’ and hospital administrators’ knowledge of the therapeutic benefits of Baquting by using our in-house and third-party clinical study results, organizing academic seminars and conferences, and sponsoring clinical trials and testing of Baquting’s efficacy in bleeding treatment. Currently our Baquting products are primarily sold to Class 3 and Class 2 hospitals, the larger, more advanced hospitals, in big- and mid-sized cities in China.

 

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Agkistrodon Acutus Hemocoagulase

In order to maintain our competitive advantage in the hemocoagulase market, we are developing a new type of hemocoagulase that is extracted and purified from the venom of Agkistrodon acutus snakes, which are indigenous to China. Similar to Baquting based on the Bothrops atrox venom, Agkistrodon acutus hemocoagulase catalyzes fibrinogen locally in damaged blood vessels without activating the blood clotting factors in healthy blood vessels. Agkistrodon acutus snakes are prevalent in several regions in China including Guangxi, Fujian and Yunnan. We believe the domestic supplies of Agkistrodon acutus venom would make the production costs of Agkistrodon acutus hemocoagulase lower than those of Baquting and allow us to maintain our competitive position in the hemocoagulase market.

We co-developed the Agkistrodon acutus hemocoagulase with the Chinese Science Academy Kunming Animal Research Institute. We completed a randomized and open-label Phase I clinical trial to test the safety of this new product in 78 healthy males. Twenty-eight subjects were administered a single-dose of Agkistrodon acutus hemocoagulase, twenty subjects were administered multiple doses and thirty subjects were involved in pharmacokinetic trials. The primary endpoints were the sustainability and safety and the rate of absorption, distribution, metabolism and excretion of this new product. These results, combined with the data from our preclinical studies, have demonstrated that this hemocoagulase was well tolerated and highlight its potential as a next generation hemocoagulase. We hold two PRC patents relating to the process technology for Agkistrodon acutus hemocoagulase that will expire in 2021. We have received SFDA approval for Phase II and Phase III clinical trials. We expect to commence Phase II clinical trials by the end of 2009. We intend to leverage our current sales and marketing network for Baquting in promoting this new product if approved.

Lanthanum Polystyrene Sulfonate

We are developing a lanthanum polystyrene sulfonate product candidate for the treatment of hyperphosphatemia. Hyperphosphatemia is the presence of abnormally elevated levels of phosphate in the blood. Hyperphosphatemia occurs in at least 70% of patients with renal insufficiency or acute or chronic renal failure and may lead to hyperparathyroidism, the overactivity of the parathyroid glands resulting in excess production of parathyroid hormone and abnormal metabolic activity, and a variety of other cardiovascular complications that could be life-threatening.

We believe that, when administered orally, lanthanum polystyrene sulfonate releases lanthanum ions in the gastrointestinal tract that combine with phosphate ions from food to form an insoluble, non-poisonous complex that can not be absorbed by the human body and is discharged in fecal matter. As a result, we believe this compound may have the potential to reduce the phosphate level in the blood and improve the health condition of patients with chronic renal failure and reduce the frequency of their dialysis treatments. Our lanthanum polystyrene sulfonate product candidate contains a new compound derived from resin that can be easily combined with phosphate without relying on a high pH environment and can therefore remove phosphates from various segments of gastrointestinal tracts.

We hold a patent for our lanthanum polystyrene sulfonate product candidate in China. We have completed preclinical toxicity research and pharmacodynamics studies that demonstrate the potential efficacy and safety of lanthanum polystyrene sulfonate. We are continuing to conduct long-term toxicity research and other preclinical research of our lanthanum polystyrene sulfonate product candidate.

 

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Our Cardiovascular Products and Product Candidates

Adenosine

Aiduo and Aiwen are the first adenosine products manufactured in China. Aiduo and Aiwen consist of the same compound, but are administered at different dosages. Aiduo ( LOGO®), our cardiovascular stress imaging agent, is administered at 30ml/90mg per dose, and Aiwen ( LOGO®), our product used in the diagnosis and treatment of PSVT, is administered at 2ml/6mg per dose. We are also developing an adenosine product for myocardial protection.

We entered into agreements to acquire Aiduo and Aiwen from two third parties, Shenyang Guangda and Shenyang Wanjia, in 2004. Aiduo and Aiwen are currently manufactured by Shenyang Guangda, and we have been the exclusive distributor and marketer of Aiduo and Aiwen in China since 2005. In order to complete the acquisition and to commence production of Aiduo and Aiwen at our Shenyang facility, we require approval from the SFDA for the transfer of the production permit for these drugs from Shenyang Guangda to us and GMP certification for our Shenyang facility. We submitted our application for the SFDA approval in July 2008. If the SFDA approval and the GMP certification are delayed or not granted at all, we will have to continue to be the exclusive distributor and marketer of Aiduo and Aiwen that are manufactured by Shenyang Guangda.

Aiduo ( LOGO®)

Aiduo is an injectable coronary vasodilator that is approved for use in China as a diagnostic agent in connection with MPI stress tests. Such tests are routinely performed in a nuclear cardiology suite to diagnose coronary arterial diseases. Aiduo dilates blood vessels by activating the A2 receptor, which binds to adenosine, relaxing smooth muscles, thereby adjusting sympathetic nerve transmission and reducing blood vessel tension.

When used in MPI stress tests, adenosine significantly increases the blood flow in the healthy coronary arteries while the blood flow within the narrow segments of the coronary arteries increases insignificantly or remains the same, which changes the patterns of myocardial blood flow. A radio labeled imaging agent co-injected during cardiac imaging can therefore more effectively demonstrate the locations, scopes and levels of stenosis areas and helps the diagnosis of coronary artery disease. Adenosine is one of the only two stress agents approved by the U.S. FDA and is also recommended in Guidelines for the Clinical Use of Cardiac Radionuclide Imaging released by the committee comprising the American College of Cardiology, the American Heart Association and the American Society of Nuclear Cardiology (the ACC/AHA/ASNC committee) in 2003. Since 2004, the use of adenosine in MPI stress tests has gained increasing acceptance in the global medical community. The Guidelines for Chronic Stable Angina Diagnosis and Treatment provided by the China Medical Association, which set forth protocol procedures to physicians, described the use of adenosine in MPI stress tests as useful and effective.

Chinese drug registration laws provided Shenyang Guangda with administrative protection for the manufacture of Aiduo as a diagnostic agent in connection with MPI stress tests in China until 2007. Administrative protection in China prevents other companies from manufacturing, importing or selling a similar drug for the same indication, unless they have received approval for the clinical trials of similar drugs prior to the commencement of the protection period. We are not aware of any other adenosine product in development in China. We believe that, given the time necessary to obtain a drug registration, Aiduo will continue to be the only adenosine product approved for use as a diagnostic agent in connection with MPI stress tests in the near term. We began sales and marketing activities for Aiduo in January 2005 and sold 6,207, 13,579,

 

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25,550 and 19,400 units in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.

In 2000 and 2004, randomized, placebo-controlled, open-label multicenter clinical trials with Aiduo were conducted in 60 and 89 patients with suspected coronary arterial diseases to test the efficacy of our product in echo stress tests and MPI stress tests, respectively. In these two clinical trials, patients received Aiduo for six minutes. The endpoint was the sensitivity and specificity in the diagnosis of coronary artery disease. Our clinical trial demonstrated that our Aiduo-induced stress tests had good sensitivity and specificity.

Our marketing efforts for Aiduo products focus on its application in MPI stress tests and include promoting the drafting and application of Chinese Nuclear Cardiology Guidelines and encouraging physicians to test the performance of Aiduo based on clinical observation. To promote adenosine as the first-choice stress-test agent in China, we also provided our Aiduo products to a research project on the use of image analysis for the diagnosis and treatment of coronary artery disease as part of the state-sponsored National Eleventh Five-year Plan.

Aiwen ( LOGO®)

Aiwen is an intravenous anti-arrhythmic agent approved in China for the diagnosis and treatment of PSVT. Aiwen slows the conduction of electrical impulses in the heart and helps the heart to beat regularly during supraventricular tachycardia, a type of heart rhythm disorder, or a heart attack. While the Chinese market for Aiwen is still relatively underdeveloped, an example of the potential for Aiwen is that adenosine was designated as the drug of first choice to treat PSVT in the Guidelines for the Management of Patients with Supraventricular Arrhythmias released by the ACC/AHA/ESC committee in 2003.

In 2000, a third party completed a randomized, controlled and multicenter clinical trial with Aiwen in 122 patients with PSVT to test the safety and efficacy of our product in treating PSVT. In this trial, 60 patients received Aiwen and 62 patients received Verapamil, a standard medicine administered by injection for treating PSVT. Patients were treated with Aiwen and Verapamil for three times with a different dosage each time within 1 or 2 minutes after each administration. The data demonstrated that patients treated with Aiwen experienced significantly shorter recovery time and had a better recovery rate compared to patients treated with Verapamil. There were 18 cases of minor adverse reactions relating to Aiwen treatment but patients recovered within one minute without discontinuing treatment.

Adenosine for Myocardial Protection

We are also developing adenosine as a myocardial protection agent in various cardiovascular-related clinical settings. We believe adenosine may be useful as a myocardial protection agent due to its ability to attenuate or prevent post-ischemic myocardial damage that occurs as a result of acute myocardial infarction, or a heart attack, and during and after heart surgery. When administered, adenosine quickly enters into the ischemic areas through the arteries, dilates the microvessel, increases blood flow in the coronary artery and protects the vascular endothelium, the layer of cells that line the interior surface of blood vessels. According to scientific literature, adenosine can effectively mitigate reperfusion injury, damage to tissue caused when blood supply returns to the area after a period of ischemia, or inadequate blood supply.

We have completed preclinical studies of adenosine for such application. We plan to apply to the SFDA for commencement of clinical trials of adenosine for myocardial protection after the

 

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transfer of the production permit for Aiduo and Aiwen from Shenyang Guangda to us is approved by the SFDA. We intend to apply for Class A new medicine status for this new indication and in April 2006 we filed a PRC patent application related to this product.

Kaitong ( LOGO)

Kaitong is an intravenous injectable lipid emulsion of alprostadil for treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis. Alprostadil has been shown to dilate blood vessels, inhibit platelet aggregation, increase pulmonary blood flow, promote vasodilation and stimulate intestinal and uterine smooth muscle contraction. The total sales of alprostadil products in China was approximately RMB700 million ($102.5 million) in 2007. PICO estimates that this market may exceed RMB1.3 billion ($190.4 million) in 2011, representing a CAGR of 16.0%. Kaitong’s lipid emulsion provides it with a series of advantageous characteristics, such as specificity for the narrow segments of blood vessels, lower effective dosage and decreased side effects. It has been approved in China for (i) limb ulceration caused by chronic artery occlusion such as thromboangiitis obliterans and arteriosclerosis obliterans, pain caused by microcirculation disorders, and other cardiocerebral microcirculation disorders, (ii) use as an anti-thrombotic agent after organ transplants, and (iii) ductal-dependent congenital heart disease in the newborns, to prevent premature closure of the ductus arteriosus until surgical correction is possible.

In December 2008, we entered into an exclusive distribution agreement with Jilin Yuhua, amended in June 2009, under which we have the rights to exclusively market and distribute Kaitong in China with the exception of Jilin and Heilongjiang Provinces. Under this distribution agreement, Jilin Yuhua will sell Kaitong to us at a fixed wholesale price below the price at which we will sell Kaitong to our distributor customers. We do not pay Jilin Yuhua any royalties for Kaitong and instead paid a RMB16 million upfront fee to Jilin Yuhua which was fully paid by August 31, 2009. This agreement will become effective upon the earlier of 12 months after the date of the agreement and the first delivery of Kaitong by Jilin Yuhua. The term of this agreement is 10 years after it becomes effective and we have a priority right to renew this agreement upon the expiration of this agreement. Jilin Yuhua is in the process of obtaining a production permit for Kaitong to allow it to manufacture this product at its GMP-certified new facilities in Changchun, Jilin Province. If the production permit for Kaitong is delayed or not granted at all, Jilin Yuhua will not be able to commence its production and we will not be able to launch this product in the market.

Dipyridamole Aspirin Sustained Release Capsules

We are developing dipyridamole aspirin capsules in a sustained release formulation for the prevention of strokes in patients who have previously suffered a stroke. Dipyridamole and aspirin are two different antiplatelet agents that, when used together, have been clinically demonstrated to be more effective than either agent alone in the secondary prevention of strokes.

Aspirin is an antiplatelet agent that inhibits platelet aggregation and controls active substance release in blood vessels. Dipyridamole inhibits platelet aggregation, dilates coronary vessels, significantly increases coronary blood flow and increases myocardial oxygen supply. Both drugs can inhibit platelet function and blood clot formation at different stages and can achieve better results in the secondary prevention of stroke when used together. The clinical efficacy of this product was demonstrated by the data from ESPS 2, the largest stroke prevention trial to date. This clinical study was conducted with Aggrenox, an over-the-counter dipyridamole aspirin drug that is manufactured and sold in Europe by Boehringer-Ingelheim, a

 

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German pharmaceutical company. The ESPS 2 data demonstrated that a low dose aspirin combined with an extended release dipyridamole prevented twice as many strokes as aspirin alone and also reduced the risk of stroke in patients with high blood pressure and heart disease.

In May 2007, we completed the required bioequivalence clinical trials of our dipyridamole aspirin sustained release capsules in a double-blind, double-cycle, double crossover, controlled study in 22 stroke patients. The controlled drug we used was Aggrenox which contains the same active ingredients. Our clinical trials show that both medicines are bioequivalent and there were no significant differences between the two.

We submitted our bioequivalence clinical trial data to the SFDA in December 2007 and we received an SFDA request in June 2009 for supplementary research data. We are in the process of compiling these data. We expect to receive the SFDA approval for manufacturing and marketing this product and launch it in the market in 2010.

Our Other Products

In addition to Baquting, Aiduo and Aiwen, we also manufacture and sell the following 11 medicines:

 

Medicine

  

Indication

Salbutamol Aerosol

   Asthma and chronic obstructive pulmonary disease

Erythromycin Ethylsuccinate Tablets

  

Infections caused by gram-positive bacteria

Metformin Hydrochloride Tablets

  

Type 2 diabetes

Ribavirin Spray

  

Influenza

“Kanglai Baby” Pediatric Paracetamol, Artificial Cow-bezoar and Chlorphenamine Maleate Granules    Cold symptoms of children and infants, such as fever, headache and nasal congestion

Isoprenaline Hydrochloride Aerosol

  

Asthma and complications

Asarone for Injection

  

Asthma

Clemastine Fumarate Tablets

  

Allergic rhinitis and urticaria

Gavlacon Tablets

   Pain and heartburn caused by acid reflex and chronic gastric disease

Lidocaine and Chlorhexine Acetate Aerosol

   Cuts, abrasions, soft tissue injuries, mosquito or insect bites, miliaria, pruritus, burns and sunburns

Shengxue Tablets

  

Anemia

Three of these products, salbutamol aerosol, erythromycin ethylsuccinate tablets and metformin hydrochloride tablets, have been included in the PRC National Essential Drugs List published in August 2009. Baquting and six of these products, including salbutamol aerosol, erythromycin ethylsuccinate tablets, metformin hydrochloride tablets, Ribavirin spray, isoprenaline hydrochloride aerosol and asarone for injection, are subject to price controls imposed by the NDRC and provincial price control authorities.

International Collaboration

In July 2009, we entered into a joint venture with QRxPharma Limited, a publicly listed biopharmaceutical company in Australia. QRxPharma has spun off its snake venom-related

 

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products to a new subsidiary, Venomics Pty Ltd. (VPL). We have invested $500,000 for a 10% interest in VPL through our subsidiary, Surplus International. VPL will in turn form a joint venture company, Venomics Hong Kong Limited (VHK), in Hong Kong with our VIE, Nuokang Distribution, to develop and commercialize QRxPharma’s two bleeding control product candidates in China. Under the terms of the share subscription agreement relating to VHK, we invested $5.0 million in October 2009 for a 93% interest in VHK, and in exchange for a 7% interest, VPL granted VHK a royalty-free exclusive license to commercialize Textilinin, an antifibrinolytic agent, and Haempatch, a potent pro-coagulant, in China.

Textilinin is a novel recombinant peptide that inhibits plasmin, a key enzyme in the fibrinolytic pathway, and has potential to reduce blood loss during major surgeries. In pre- clinical testing, Textilinin has compared favorably with other antifibrinolytic products such as Trasylol (aprotinin), a product used to reduce peri-operative blood loss in patients undergoing coronary artery bypass graft surgery.

Haempatch is a novel prothrombin activating protease, with properties similar to the FXA clotting factor. It is effective in clotting blood and stopping blood flow (haemostasis) and has compared favorably to thrombin in pre-clinical testing. Both Haempatch and the native form of Textilinin were originally isolated from the venom of the Australian Common Brown snake (Pseudonaja textilis) by researchers at the University of Queensland. QRxPharma and the University of Queensland had collaborated to develop Textilinin and Haempatch and screen Australian snake venoms for therapeutic leads.

Textilinin and Haempatch have not yet been approved for production and sale in any jurisdiction, pending the completion of clinical trials. The $5.0 million investment we made under the VHK share subscription agreement will fund the clinical trials for these product candidates in China, regardless of whether we are able to obtain regulatory approvals for their production and sale. We are not contractually committed to make any investment beyond this $5.0 million.

Sales and Marketing

We maintain our sales and marketing force in all of the 31 provinces and municipalities in China. As of September 30, 2009, our sales force consisted of 24 direct sales offices with 302 sales personnel, complemented by 16 marketing agents with over 200 sales personnel. We allocate our direct sales offices and marketing agents according to geographic areas and in certain regions such as Shanghai and Jiangsu Province with more significant market demand for our products, we maintain multiple direct sales offices. We review and improve the geographical allocation among our direct sales offices and marketing agents in response to respective market conditions and customer feedback.

Both direct sales teams and marketing agents market our principal products to physicians and hospital administrators using a physician-targeted marketing model, focusing on promoting the differentiating clinical aspects of our products. Our direct sales teams focus on raising our brand awareness and recognition by organizing academic seminars and conferences, sponsoring clinical trials and testing of our products by physicians, providing academic consulting services and developing collaborative clinical solutions. Our marketing agents focus on effective market coverage and penetration to meet rapidly growing demand for our products in their respective regions. The key management members of our current sales team have an average of over eight years of sales experience in the pharmaceutical industry. We provide in-house education and training to our sales force to improve their sales skills and efficiency and to ensure they provide our current and prospective clients with comprehensive information

 

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about our products. We employ centralized information technology to integrate market information from various sources into a unified system to increase the efficiency and effectiveness of our market data collection and analysis. Our performance-linked compensation structure and career-oriented training are key drivers that motivate our sales employees.

We select our marketing agents based on their reputation, market coverage, sales experience and the size of their sales force. We do not have an exclusive agency arrangement with any of our marketing agents though we believe that our marketing agents do not market competing brands. Before September 2006, we primarily relied on the joint sales and marketing efforts of our direct sales offices and marketing agents to promote our flagship product Baquting. In September 2006, we changed our sales and marketing strategy and delineated our marketing efforts into geographic regions, each covered exclusively by either our direct sales offices or third-party marketing agents.

We have established a highly integrated and well-organized sales and marketing system with five teams to manage and control our national sales and marketing activities:

 

   

Our marketing team is responsible for developing the sales strategies and marketing plans, which are then approved by the senior management. The marketing team also provides technical support to the sales force.

 

   

Our sales management team collects and analyzes the latest market information in support of sales and develops strategies and marketing plans.

 

   

Our sales team executes the sales and marketing strategies.

 

   

Our agent management team focuses on the identification of new regional marketing agents and the management of existing marketing agents.

 

   

Our commerce team manages inventory, establishes policies relating to payment collection, receivables and other sales and distribution activities and provides pricing in regional bidding processes.

We have established strong relationships with physicians, hospital administrators and leading experts in the hematological and cardiovascular fields. We maintain a specialist network of approximately 100 national key opinion leaders and physicians associated with national academic institutions or organizations such as the China Medical Association, China Physician Association and China Pharmaceutical Association, and provincial-level expert physicians and pharmacists in the surgery, anesthesiology, urology, neurosurgery and gastroenterology fields. Over 100 peer-reviewed academic articles have been published by recognized academic magazines or periodicals regarding the usage of our principal products. We believe our relationships with these physicians, hospital administrators and experts raise our profile, enhances awareness of our products among patients and in the medical community, provide us with valuable clinical data to improve our products and keep us abreast of industry trends and developments, all of which in turn helps us market and sell our products.

Provincial and municipal government agencies in China operate a mandatory tender process for purchases of medicines by hospitals included in provincial medicine catalogs. The tender requirement was first introduced in 2004 and has since been implemented across China. We believe effective sales and marketing efforts in promoting our products to physicians and hospitals are critical in the success of our products in the tender process. Our patents also provide our products with significant competitive advantages in the tender process in terms of pricing and success rates.

 

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We maintain strict anti-corruption policies among our direct sales offices and distributors in our sales and marketing activities and we believe we will therefore be less affected by the increasingly stringent anti-corruption measures taken by the PRC government to correct corruptive practices in the pharmaceutical industry.

Distribution and Customers

Substantially all of our sales are made to pharmaceutical distributors, which in turn sell our products primarily to hospitals and other healthcare institutions in China. Currently our distribution network includes approximately 200 distributors. Our hospital coverage in China has increased from 778 hospitals in 2003 to over 2,400 hospitals as of September 30, 2009, including 80% of the Class 3A hospitals in major cities.

The tables below set forth the aggregate sales to our top five distributors, expressed in RMB and as a percentage of our total sales, for the periods indicated.

 

     Nine Months Ended
September 30, 2009
 

Sales to Top Five Distributors

   Sales revenue    Sales revenue  
     (RMB in
thousands)
   (% of total
sales)
 

Liaoning Pacific Medicine Co., Ltd.

   65,600    28.0

Beijing Xidan Medicine Co., Ltd.

   14,696    6.3

Sinopharm Medicine Holdings Co., Ltd.

   7,928    3.4

Chongqing Medicine Co., Ltd.

   7,292    3.1

Zhejiang Cifutang Medicine Co., Ltd.

   6,412    2.7
           

Total

   101,928    43.5 %