20-F 1 d298335d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

 

     ¨   REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

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

For the fiscal year ended December 31, 2011

OR

 

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

For the transition period from                      to                     

OR

 

     ¨   SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     

Commission file number: 001-34564

 

 

 

CHINA NUOKANG BIO-PHARMACEUTICAL INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

N/A

(Translation of Registrant’s Name Into English)

 

Cayman Islands

(Jurisdiction of Incorporation or Organization)

 

No. 18-1 East Nanping Road

Hunnan National New & High-tech Development Zone

Shenyang, Liaoning Province

People’s Republic of China 110171

(Address of Principal Executive Offices)

 

Tianruo Pu, Chief Financial Officer

No. 18-1 East Nanping Road

Hunnan National New & High-tech Development Zone

Shenyang, Liaoning Province

People’s Republic of China 110171

Tel: +86-024-2469-6033

Fax: +86-024-2469-6133

E-mail: ir@nkbp.com

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class        Name of Each Exchange on Which Registered

American Depositary Shares, each representing

eight ordinary shares, par value $0.0005 per share

    

The NASDAQ Stock Market LLC

(The NASDAQ Global Market)

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

158,294,358 ordinary shares, par value $0.0005 per share, as of December 31, 2011.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ¨  No  x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes  ¨  No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ¨  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨                 Accelerated filer  ¨                 Non-accelerated filer  x

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  x

    

International Financial Reporting Standards as issued

by the International Accounting Standards Board  ¨

   Other  ¨

* If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.  Item 17  ¨   Item  18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes  ¨  No  ¨

 

 

 


Table of Contents

TABLE OF CONTENTS

 

            Page  

INTRODUCTION

     1   

FORWARD-LOOKING STATEMENTS

     1   

PART I

     3   

Item 1.

    

Identity of Directors, Senior Management and Advisers

     3   

Item 2.

    

Offer Statistics and Expected Timetable

     3   

Item 3.

    

Key Information

     3   

Item 4.

    

Information on the Company

     28   

Item 4A.

    

Unresolved Staff Comments

     52   

Item 5.

    

Operating And Financial Review and Prospects

     52   

Item 6.

    

Directors, Senior Management and Employees

     68   

Item 7.

    

Major Shareholders and Related Party Transactions

     77   

Item 8.

    

Financial Information

     77   

Item 9.

    

The Offer and Listing

     78   

Item 10.

    

Additional Information

     79   

Item 11.

    

Quantitative and Qualitative Disclosures about Market Risk

     87   

Item 12.

    

Description of Securities Other than Equity Securities

     88   

PART II

     90   

Item 13.

    

Defaults, Dividend Arrearages and Delinquencies

     90   

Item 14.

    

Material Modifications to the Rights of Security Holders and Use of Proceeds

     90   

Item 15.

    

Controls and Procedures

     91   

Item 16A.

    

Audit Committee Financial Expert

     92   

Item 16B.

    

Code of Ethics

     92   

Item 16C.

    

Principal Accountant Fees and Services

     92   

Item 16D.

    

Exemptions from the Listing Standards for Audit Committees

     92   

Item 16E.

    

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

     92   

Item 16F.

    

Change in Registrant’s Certifying Accountant

     93   

Item 16G.

    

Corporate Governance

     93   

PART III

     93   

Item 17.

    

Financial Statements

     93   

Item 18.

    

Financial Statements

     93   

Item 19.

    

Exhibits

     93   


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INTRODUCTION

Unless the context otherwise requires, in this annual report on Form 20-F:

 

   

“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 Macao;

 

   

“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.

Names of certain companies provided in this annual report are translated or transliterated from their original Chinese legal names.

Discrepancies in any table between the amounts identified as total amounts and the sum of the amounts listed therein are due to rounding.

This annual report on Form 20-F includes our audited consolidated financial statements for the years ended December 31, 2009, 2010 and 2011.

We and certain selling shareholders of our company completed the initial public offering of 5,000,000 ADSs on December 15, 2009. On December 9, 2009, we listed our ADSs on the NASDAQ Global Market under the symbol “NKBP.”

FORWARD-LOOKING STATEMENTS

This annual report on Form 20-F contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

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. 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. 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 offerings;

 

   

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; and

 

   

fluctuations in general economic and business conditions in China.

 

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You should thoroughly read this annual report and the documents that we refer to with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. We would like to caution you not to place undue reliance on forward-looking statements and you should read these statements in conjunction with the risk factors disclosed in “Item 3.D. Key Information—Risk Factors” of this annual report. Those risks are not exhaustive. We operate in an emerging and evolving environment. New risk factors emerge from time to time and it is impossible for our management to predict all risk factors, and we cannot assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause our actual results to materially differ from results contained in any forward-looking statement.

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required under applicable law.

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not Applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not Applicable.

 

ITEM 3. KEY INFORMATION

A. Selected Financial Data

We have derived our consolidated statement of income data for the years ended December 31, 2009, 2010 and 2011 and our consolidated balance sheet data as of December 31, 2010 and 2011 from our audited consolidated financial statements included in this annual report. Our selected consolidated statement of income data for the years ended December 31, 2007 and 2008 and our consolidated balance sheet data as of December 31, 2007, 2008 and 2009 have been derived from our audited consolidated financial statements not included in this annual report. Our historical operating results presented below are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2012 or any other future fiscal period. Our financial statements have been prepared in accordance with the accounting principles generally accepted in the United States, or U.S. GAAP. You should read the selected consolidated financial data set forth below in conjunction with “Item 5. Operating and Financial Review and Prospects—A. Operating Results” and with our consolidated financial statements and related notes included in this annual report.

 

    Year Ended December 31,  
    2007     2008     2009     2010     2011     2011  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands, except share and per share data and percentages)  

Consolidated Statement of Income Data:

           

Net revenue

    147,875        225,399        282,911        315,789        288,269        45,801   

Cost of revenue

    (34,745 )     (30,963 )     (35,625 )     (37,304 )     (38,458     (6,110
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    113,130        194,436        247,286        278,485        249,811        39,691   

Operating expenses:

           

Research and development costs

    (7,995 )     (5,585 )     (8,297 )     (13,504 )     (15,737     (2,500

Selling, marketing and distribution expenses

    (52,443 )     (92,404 )     (110,513 )     (145,549 )     (144,228     (22,916

General and administrative expenses

    (16,796 )     (31,884 )     (47,582 )     (53,527 )     (71,188     (11,311
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (77,234 )     (129,873 )     (166,392 )     (212,580 )     (231,153     (36,727
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit

    35,896        64,563        80,894        65,905        18,658        2,964   

Interest income

    196        1,259        1,372        1,198        1,508        240   

Interest expense

    (5,190 )     (1,309 )     (3,327 )     (7,147 )     (3,096     (492

Foreign exchange gain (losses)

    2,335        7,023        178        (5,825        (5,142     (817

Other (loss) income, net

    (144 )     (679 )     2,836        2,473        (13,400     (2,129
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income tax expense

    33,093        70,866        81,953        56,604        (1,472     (234

Income tax benefit (expense)

    2,102        (7,246 )     (16,858 )     (10,606 )     (12,662     (2,012
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    35,195        63,620        65,095        45,998        (14,134     (2,246

Net loss attributable to non-controlling interest

    —          —          —          (64     (128     (20

Accretion of Series A convertible redeemable preference shares

    (30,156 )     (13,403 )     (13,886 )     —         —          —     

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

    (326 )     (9,458 )     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributed to ordinary shares

    4,713        40,759        51,209        46,062        (14,006     (2,226
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

           

Basic

    0.05        0.43        0.52        0.30        (0.09     (0.01

Diluted

    0.05        0.43        0.51        0.30        (0.09     (0.01

Shares used in net income (loss) per share computation

           

Basic

    99,850,334        95,447,648        98,885,045        158,466,428        155,872,950        155,872,950   

Diluted

    99,850,334        95,460,841        99,725,253        158,797,628        155,872,950        155,872,950   

 

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     As of December 31,  
     2007      2008      2009      2010      2011      2011  
     RMB      RMB      RMB      RMB      RMB      US$  
     (in thousands)  

Consolidated Balance Sheet Data:

                 

Cash and cash equivalents

     112,589         81,837         351,258         191,822         179,385         28,501   

Restricted cash

     —           20,000         34,200         —           5,410         860  

Accounts receivable

     30,417         71,312         103,719         132,504         60,767         9,655   

Inventories

     7,034         10,610         14,765         16,789         15,846         2,518   

Property, plant and equipment

     119,029         149,679         160,125         155,786         214,171         34,028   

Total assets

     320,724         405,031         781,454         744,879         702,314         111,586   

Short-term bank loans

     50,380         72,430         125,618         47,000         7,000         1,112   

Total current liabilities

     95,293         119,760         167,246         72,107         49,332         7,837   

China Nuokang Bio-Pharmaceutical Inc. shareholders’ equity

     77,157         127,721         580,384         635,711         612,868         97,375   

Total liabilities and equity

     320,724         405,031         781,454         744,879         702,314         111,586   

Exchange Rate Information

Our business is primarily conducted in China and all of our revenues are denominated in RMB. This annual report contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the readers. Unless otherwise noted, all translations from RMB to U.S. dollars in this annual report were made at a rate of RMB6.2939 to US$1.00, the noon buying rate in effect as of December 30, 2011 in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On April 20, 2012, the noon buying rate was RMB6.3080 to US$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 annual report or will use in the preparation of our future periodic reports or any other information to be provided to you. The source of these rates is the Federal Reserve Bank of New York.

 

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Noon Buying Rate

(RMB per US$1.00)

 
Period    Period
End
     Average(1)      Low      High  

2007

     7.2946         7.5806         7.8127         7.2946   

2008

     6.8225         6.9193         7.2946         6.7800   

2009

     6.8259         6.8295         6.8470         6.8176   

2010

     6.6000         6.7603         6.8330         6.6000   

2011

           

October

     6.3547         6.3710         6.3825         6.3534   

November

     6.3765         6.3564         6.3839         6.3400   

December

     6.2939         6.3482         6.3733         6.2939   

2012

           

January

     6.3080         6.3119         6.3330         6.2940   

February

     6.2935         6.2997         6.3120         6.2935   

March

     6.2975         6.3125         6.3315         6.2975   

April (through April 20, 2012)

     6.3080         6.3052         6.3150         6.2975   

 

(1) 

Annual averages are calculated using the average of month-end rates of the relevant year. Monthly averages are calculated using the average of the daily rates during the relevant period.

B. Capitalization and Indebtedness

Not Applicable.

C. Reasons for the Offer and Use of Proceeds

Not Applicable.

D. Risk Factors

You should consider carefully all of the information in this annual report, including the risks described below. If any risk disclosed below or elsewhere in this annual report actually occurs, our business, financial condition or results of operations could be harmed. In such an event, the trading price of our ADS could decline and you might lose all or part of your investment. Some information in this Item 3.D may be a summary of more detailed discussions contained elsewhere in this annual report.

The risks described below are not the only ones concerning us. Our business is also subject to the risks not specifically addressed below that affect many other companies, such as employment relations, general economic conditions, geopolitical events, etc. Further, additional risks not currently known to us or that we currently believe are immaterial also may impact our business, operations, financial condition and ADS price materially and adversely.

Risks Related to Our Business

We are dependent and 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 2009, 2010 and 2011, we sold 13.1 million, 14.8 million and 15.2 million units of Baquting, respectively. Revenues from Baquting sales accounted for 93.5%, 94.2% and 94.7% of our total revenues in 2009, 2010 and 2011, respectively. We plan to dedicate additional resources toward maintaining and expanding Baquting’s market share, such as for improved quality control, 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;

 

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new product introductions to the market;

 

   

government-imposed pricing constraints;

 

   

problems with raw material supplies;

 

   

disruptions in manufacturing or distribution;

 

   

newly discovered safety issues arising from misuse of or adverse reactions from 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 by the medical community. If our products do not attain market acceptance by 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 receive from the medical community, particularly physicians and hospital administrators. Physicians may not prescribe or recommend our products to patients and hospital procurement departments may not purchase our products if physicians or hospital pharmacists do not find our products attractive. The acceptance and use of our products by the medical community depend upon a number of factors, including:

 

   

perceptions of physicians, patients and other members of the medical community regarding the safety and effectiveness of our products;

 

   

the prevalence and severity of any side effects;

 

   

the efficacy, pharmacological benefit and potential advantages of our products relative to competing products and products under development;

 

   

the relative convenience and ease of administration of our products;

 

   

effectiveness of our and our distributors’ education, marketing and distribution efforts;

 

   

publicity concerning our products or competing products; and

 

   

the price for our products and competing products.

In addition, the continued success of Baquting depends in part upon perceptions of blood transfusion risk and blood supply quality in China. If our products fail to gain market acceptance by 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 for our products, including Aiduo and Aiwen, or pass on-site inspections of our production facilities. Failure to obtain approvals for our products or pass on-site inspections of our production facilities could materially harm our operations and business prospects.

All medicines must be approved by the PRC State Food and Drug Administration, or 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 granting manufacturing approval for the new medicine. 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. For example, in June 2010, we entered into an exclusive distribution agreement with a Swiss company, HCB Lubricants GmbH, to register, market and distribute Dianatal ® Obstetric Gel exclusively in Mainland China, Taiwan, Hong Kong and Macao. We have started marketing Dianatal ® Obstetric Gel in Hong Kong. In March 2011, we submitted our application for the SFDA approval, which is necessary to sell this product in Mainland China. This product is currently in the last stage of the SFDA approval process, and we aim to receive approval and launch this product by 2013. If the SFDA approval for Dianatal ® Obstetric Gel is delayed or not granted at all, we will not be able to launch this product in the Chinese market. Even if we obtain these approvals, such approvals may be modified or revoked or subject to limitations on the indicated uses for which we may market the product, which may limit the size of its market. We will not be able to manufacture and market our new products if we do not obtain required governmental approvals.

 

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Furthermore, even after we obtain such approvals, we may not be able to pass the on-site inspections of our facilities required prior to the launch of our products. For example, in 2004, we entered into agreements for the acquisition of Aiduo, our cardiovascular stress imaging agent, and Aiwen, our anti-arrhythmic agent, from Shenyang Guangda Pharmaceutical Co., Ltd., or Shenyang Guangda, and Shenyang Wanjia Biotechnology Research Institute, or Shenyang Wanjia. We need approval from the SFDA for the transfer of the production permit for Aiduo and Aiwen from Shenyang Guangda to us. Additionally, we need Good Manufacturing Practice, or GMP, certification for our Shenyang facility to commence production of these products and their active pharmaceutical ingredient, adenosine, at our production facility. In March 2012, we passed the on-site inspection in connection with GMP certification for production of adenosine. We will commence production of adenosine once we receive the GMP certificate from the SFDA. However, if we fail to pass the on-site inspections in connection with our application to transfer the production permits of Aiduo and Aiwen or in connection with production permits or GMP certification for other products in development, we will not be able to commence production and sale of these products and our business may be materially and adversely affected. See “Item 4. Information on the Company—B. Business Overview—Certificates and Permits” for a description of our current licenses and permits. Failure to obtain or renew approvals for our existing or future products or pass on-site inspections of our facilities could materially harm our business and operations.

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, there may 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 declines in revenues from and margins of our existing products with new products, our overall results of operations will suffer.

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

We operate in a highly competitive environment and our products compete with other products or treatments. Baquting competes with existing hemocoagulase products and potential new drug candidates. In China, our major competitors in the hemocoagulase market include Aohong Pharma’s Bangting, Lee’s Pharm’s Sulejuan and Beijing Kangchen’s Suling, which in 2011 held approximately 31.1%, 16.9% and 10.9% market share, by volume, respectively. Our products may compete against products with lower prices, superior performance, greater ease of administration or other advantages compared to our products. We do not have patents of any commercial significance for many of our products and product candidates to protect these products and product candidates from direct competition. Our inability to compete effectively could reduce sales or margins, which could materially and adversely affect 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, or usage purposes, for existing products. Our products compete with new drugs in development, drugs that may be approved for the same indications as our products and drugs approved for other indications that are used off-label. Additionally, an increasing number of foreign pharmaceutical companies have introduced their pharmaceutical products into the Chinese market. If less expensive alternatives to our products are dispensed or prescribed to patients, our sales may be adversely impacted.

 

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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, certain 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 indications that these competitors may bring to market. Our competitors in the pharmaceutical industry may also consolidate and acquire 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 competitive practices 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, which may harm our business and operations.

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 our success, and that maintaining and enhancing these brands is critical to maintaining our competitive advantage. We may not be successful in promoting our brands. If we are unable to enhance our brand recognition and increase awareness of our products, or if we incur excessive expenses 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 our brands or reputation are impaired by actions taken by our distributors, competitors, third-party marketing firms or regulatory authorities.

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 PRC national medical insurance catalog and certain other medicines are subject to the regulation of the PRC National Development and Reform Commission, or the NDRC, and authorized provincial or local price control authorities, in the form of fixed prices or price ceilings. From time to time, the NDRC publishes a list of medicines subject to price controls. Our principal products, Baquting and Kaitong, are subject to price ceilings set by the NDRC. The limitation on our ability to raise the wholesale prices of our products may prevent us from absorbing or offsetting any increase in the costs of producing our products, which would lower our margins. In aggregate, eight out of our sixteen products, sales of which accounted for 96.5%, 95.2% and 95.6% of our total sales in 2009, 2010 and 2011, respectively, are subject to price controls imposed by the NDRC and provincial price control authorities. Furthermore, the prices of our products may be adjusted downward by the relevant governmental authorities in the future. On March 28, 2011, the NDRC lowered the price ceilings of 162 medicines in China. As a result, the maximum retail price at which lipid emulsion alprostadil products such as Kaitong may be sold to patients was reduced from RMB145.0 per unit to RMB123.0 per unit, representing a decrease of 15.2%. If we are required to lower wholesale prices of our principal products in the future as a result of any government-mandated reduction in the price ceilings, our future results of operation 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 with a pre-defined price range for Baquting, Kaitong, Aiduo, Aiwen and our other products every one or two years. The competitive bidding effectively sets price ceilings for our products, thereby limiting our profitability. We may stop manufacturing certain products if their price range designated by the local or provincial government falls below production costs.

 

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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 depend to a large extent on the reimbursement policies of the PRC government. The PRC Ministry of Labor and Social Security 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 two years, 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 of the drug. Depending on the tier under which a drug is classified in the provincial medicine catalog, a 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 Tier 2 medicine. Our principal products, Baquting and Kaitong, are currently included in the national medical insurance catalog as Tier 2 medicines. Aiduo and Aiwen are Tier 2 medicines in the medical insurance catalogs of Zhejiang, Hubei, Gansu, Hunan, Shaanxi, Jilin, Fujian and Ningxia. If our products are removed from medical insurance catalogs by relevant government authorities, sales of these products and our revenues in turn may be materially adversely affected. Furthermore, if our new products are not included in national, provincial or local medical insurance catalogs, sales of these products may be materially 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 and Kaitong to hospitals as prescription medicines. In 2009, 2010 and 2011, substantially all of the end-customers of Baquting 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. Every one or two years, bidding is organized on a provincial or municipal basis. A medicine manufacturer is invited to participate in the tender based on the level of interest that hospitals have in purchasing the medicine. A hospital’s interest in a medicine is evidenced by:

 

   

the inclusion of the medicine on the hospital’s formulary, which lists medicines its physicians may prescribe; and

 

   

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

We believe that effective marketing efforts are critical to maintaining hospital interest in Baquting and to developing the same in Kaitong. If our marketing efforts are ineffective, hospital administrators may not want to include Baquting or Kaitong in their formularies and physicians may not be interested in prescribing Baquting or Kaitong to their patients, which would decrease our chances of being invited to and succeeding at tenders. 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

 

   

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 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. Any recurrence of the economic and financial market crisis may cause, 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 revenues. In addition, some of our distributors and their customers, primarily hospitals and other healthcare institutions, may be adversely affected by the economic crisis, resulting in delays in payment to us or defaults of payments by our distributor customers. The global economic and financial market crisis could have a material adverse effect on our business, financial condition, results of operations and cash flow.

 

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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 annual report 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 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.

 

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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 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 “Item 4. Information on the Company—B. Business Overview—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 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 “Item 4. Information on the Company—B. Business Overview—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.

 

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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.

We have in the past been, and may in the future be, subject to claims of intellectual property infringement by third parties, and any of the following may arise from such claims:

 

   

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.

 

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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 two third-party suppliers.

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, and Amazon’s Life S.A.C., an unaffiliated third-party supplier in Peru. Export of Bothrops atrox venom is subject to the laws and administrative rules and regulations related to export control in Brazil and Peru, 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 and Peruvian governments 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 and Peru 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 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 a limited number of 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 42.1%, 51.0% and 43.4% of our net revenue in 2009, 2010 and 2011, 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.

 

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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.

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, third-party marketing agents and contract sales partners, sales of our products may be materially and adversely affected.

We rely on our direct sales force, third-party marketing agents and contract sales partners 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, third-party marketing agents and contract sales partners. 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 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 about our products and promote awareness of our brand. In the past, there were 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 in past years and expect to continue to grow. We expect to incur more expenses, particularly in the areas of research and development, regulatory affairs and sales and marketing, and enhance our facilities and corporate infrastructure, further increasing the size of our organization. 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. In 2011, we explored certain strategic alternatives to increase shareholder value, which subsequently negatively impacted our short-term results in the fourth quarter of 2011 and the first quarter of 2012. 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.

 

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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 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, in July 2009, we entered into a joint venture with QRxPharma Limited, a publicly listed biopharmaceutical company in Australia, to develop and commercialize two bleeding control product candidates in China. We invested $5.0 million in the joint venture 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, potential 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.

 

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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, or 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.

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 outline 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 “Item 4. Information on the Company—B. Business Overview—Regulations.”

The pharmaceutical industry is extremely competitive and China’s entry into 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 World Trade Organization, or 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 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 into 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.

 

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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 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 rules 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 government authorities, which conduct scheduled or unscheduled inspections of our facilities and our 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 obligations 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 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 rules 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 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.

 

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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, Shandong Province, 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 encountered power shortages historically due to restricted power supply to industrial users during summers when the usage of electricity was high and supply was 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., or Penglai Nuokang, are located on land leased from a third party, Shandong Penglai Pharmaceutical Plant. The lease will expire on December 31, 2014, and Penglai Nuokang and Shangdong Penglai Pharmaceutical Plant have entered into a supplemental agreement for continued cooperation until December 31, 2021. 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 and RMB1.5 million for each year remaining under the supplemental agreement. In addition, Shandong Penglai Pharmaceutical Plant has not obtained the building 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;

 

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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 maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and investor confidence in and the market price of our ADSs may be adversely impacted.

We are subject to reporting obligations under U.S. securities laws. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules adopted by the Securities and Exchange Commission, every public company is required to include a management report on the company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. This requirement was first applied to our annual report on Form 20-F for the fiscal year ended December 31, 2010. Our independent registered public accounting firm is not required to conduct an audit of our internal controls over financial reporting.

In connection with the preparation and audit of our consolidated financial statements as of and for the fiscal year ended December 31, 2011, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting. As defined in the standards established by the U.S. Public Company Accounting Oversight Board, a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The material weakness identified primarily related to inadequate control procedures for contract review. We have taken measures and plan to continue to take measures to remedy the identified material weakness. See “Item 15. Controls and Procedures.” However, the implementation of these measures may not fully address this material weakness in our internal control over financial reporting, and we may not conclude that it has been fully remedied. Our failure to address this material weakness or our failure to discover and address other control deficiencies could result in material misstatements in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, may be materially and adversely affected. Moreover, ineffective internal control over financial reporting could significantly hinder our ability to prevent fraud.

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.

Based on the market price of our ADSs, the value of our assets, and the composition of our income and assets, we do not believe we were a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our taxable year ended December 31, 2011. However, the application of the PFIC rules is subject to uncertainty in several respects, and we cannot assure you the U.S. Internal Revenue Service will not take a contrary position. 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. A separate determination must be made after the close of each taxable year as to whether we were a PFIC for that year. Because 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, fluctuations in the market price of our ADSs and ordinary shares may cause us to become a PFIC. In addition, changes in the composition of our income or assets may cause us to become a PFIC. If we are a PFIC for any taxable year during which a U.S. Holder (as defined in “Item 10. Additional Information—E. 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. See “Item 10. Additional Information—E. Taxation—U.S. Federal Income Taxation—Passive Foreign Investment Company.”

The audit report included in this annual report are prepared by auditors who are not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit reports included in our annual reports, as auditors of companies that are traded publicly in the United States and a firm registered with the US Public Company Accounting Oversight Board (United States), the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditors are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

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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., or Liaoning Nuokang, Shenyang Shouzheng Bio-technology Co., Ltd., or 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 January 30, 2012, 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 of changes in government policy on foreign investment, our business, financial condition and results of operations may be materially and adversely affected.

 

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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, or 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 guarantees. 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 approximately 59.7% of our outstanding share capital as of December 31, 2011. Mr. Xue has registered with the SAFE under the relevant SAFE regulations and updated his registration upon the completion of our initial public offering in December 2009. 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 February 15, 2012, the SAFE further promulgated the Notice on Certain Matters on Administration of Foreign Exchange regarding PRC Individuals’ Participation in Stock Incentive 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 who 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 rules 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 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. Each of our subsidiaries is required to allocate at least 10% of its net profit after tax to its 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 ability 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.

 

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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 “Item 8. Financial Information—Dividend Policy” for a discussion of our dividend policy.

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, or 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 by more than 20% against the U.S. dollar over the subsequent five years. 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 Peru 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. 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.

 

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Our business benefits from certain government tax 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 tax 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, or the new EIT law. Such tax 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, or 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. Our former variable interest entity and current wholly-owned subsidiary, Liaoning Nuokang Medicines Co., Ltd., or Nuokang Distribution, currently does not enjoy any preferential tax treatment.

Under the new EIT law and its implementation rules, enterprises that are “high and new technology enterprises strongly supported by the State” are entitled to a reduced EIT rate of 15%. Enterprises may choose to benefit from the two-year tax exemption and three-year tax reduction of 50% tax holidays or the reduced EIT rate of 15% during the transition period before the expiration of the tax holidays. In 2008, the relevant PRC authorities recognized Liaoning Nuokang and Penglai Nuokang as “high and new technology enterprises.” This status was renewed for the three years ending December 31, 2013. We will also apply for the “high and new technology enterprise” qualification for Shenyang Shouzheng, whose existing preferential tax treatment expires in 2012. Liaoning Nuokang, Penglai Nuokang and Shenyang Shouzheng have chosen to benefit from the tax holidays during the transition period. However, after the expiration of the tax holidays, Liaoning Nuokang, Penglai Nuokang or Shenyang Shouzheng may not continue to be qualified as “high and new technology enterprises.”

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

 

Subsidiary    2007     2008     2009     2010     2011  

Liaoning Nuokang

     0     12.5     12.5     12.5     15.0

Shenyang Shouzheng

     0     0     12.5     12.5     12.5

Penglai Nuokang

     0     12.5     12.5     12.5     15.0

Nuokang Distribution

     33     25.0     25.0     25.0     25.0

Any discontinuation of preferential tax treatments or any increase of the EIT rate applicable to our subsidiaries could increase our tax expense and materially adversely affect 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, or 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.

If the approval of the China Securities Regulatory Commission was required in connection with our initial public offering in December 2009, we could be subject to sanctions, fines and other penalties. 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, or the 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 our initial public offering in December 2009.

Although this regulation was adopted over five 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.

 

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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 avian flu, SARS or other epidemics or outbreaks. In recent years, 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 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 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 ADSs

The market price for our ADSs may be volatile.

The market price for our ADSs is likely to be 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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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.

Additional sales of our ADSs in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. If any existing shareholder or shareholders sell a substantial amount of ordinary shares in the form of ADSs, the market price of our ADSs could decline. In addition, we may issue additional ordinary shares as considerations for future acquisitions. If we do so, your ownership interests in our company would be diluted and this in turn could have an adverse effect on the price of our ADSs.

Our principal shareholder has substantial influence over our company and his interests may not be aligned with the interests of our other shareholders.

Mr. Baizhong Xue, our chairman and chief executive officer, beneficially owned approximately 59.7% of our outstanding share capital as of December 31, 2011. 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 is at least 21 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 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.

 

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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.

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.

Although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), a judgment obtained in such jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (a) is given by a foreign court of competent jurisdiction, (b) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given, (c) is final, (d) is not in respect of taxes, a fine or a penalty; and (e) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

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 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. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or our officers and directors predicated upon the civil liability provisions of the securities laws of the United States or any state. Our PRC counsel has advised us that China does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts. It is also uncertain whether the Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or our officers and directors predicated upon the securities laws of the United States or any state.

 

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

Our amended and restated articles of association 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 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.

 

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

Our legal and commercial name is China Nuokang Bio-Pharmaceutical Inc. 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, prior to June 2011, 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, one of our wholly-owned subsidiaries in the PRC. 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 cash considerations 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 was 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, or 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. In October 2009, we invested $5.0 million in Venomics Hong Kong Limited, a company incorporated in Hong Kong, for its 93% equity interest.

In December 2009, we completed our initial public offering of 5,000,000 ADSs and listed our ADSs on the NASDAQ Global Market.

Prior to June 2011, due to restrictions placed by PRC rules and regulations on the ability of wholly-foreign owned enterprises to distribute pharmaceutical products manufactured by third parties, we conducted certain of our pharmaceutical distribution activities via Nuokang Distribution through a series of contractual arrangements with Nuokang Distribution and its former shareholder and our chairman and chief executive officer, Mr. Baizhong Xue. In June 2011, we terminated these contractual arrangements due to new developments in PRC rules and regulations which removed some of the aforementioned restrictions, and our wholly-owned subsidiary, Liaoning Nuokang, purchased all of the equity interests of Nuokang Distribution from Mr. Xue for RMB11.7 million ($1.9 million), which was repatriated to Penglai Nuokang, the primary beneficiary of Nuokang Distribution.

 

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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 and our fax number is +86-24-2469-6133. Our registered office in the Cayman Islands is located at the offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104 Cayman Islands.

For information regarding our principal capital expenditures, see “— D. Property, Plant and Equipment.”

Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website is http://www.nkbp.com. The information contained on our website does not form part of this annual report. 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.

B. Business Overview

Overview

We are a fully integrated, China-based biopharmaceutical company focused on the research, development, manufacture, marketing and sales of hospital-based medical products. We currently sell a portfolio of sixteen products, including three principal products: (i) Baquting LOGO , our flagship bleeding control product, (ii) Kaitong LOGO , our lipid emulsion alprostadil product for the treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis, and (iii) alpha lipoic acid capsules, or ALA, an antioxidant product that addresses diabetic neuropathy. We plan to launch dipyridamole aspirin sustained release capsules in the third quarter of 2012. Our product pipeline includes two product candidates under development to address growing market and medical needs for bleeding control and 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 36.9% market share by volume in 2011, according to an independent study conducted by the China Pharmaceutical Association, a national organization of pharmacists and pharmaceutical scientists in China. Through March 31, 2012, we had sold an aggregate of approximately 75 million units of Baquting to our end-customer base of approximately 4,000 hospitals across China. Sales of Baquting accounted for 93.5%, 94.2% and 94.7% of our total net revenue in 2009, 2010 and 2011, respectively. 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.

In December 2008, we entered into a ten-year exclusive distribution agreement with Jilin Yuhua, amended in June and December 2009, April 2010 and January 2011, to market and distribute Kaitong exclusively in China, Taiwan, Hong Kong and Macao. Kaitong is an intravenous injectable lipid emulsion of vasodilator alprostadil for the treatment of peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis. Jilin Yuhua received the production permit for Kaitong in December 2010 and commenced its production in January 2011. We commenced the sale of Kaitong in the first quarter of 2011.

In June 2010, we entered into an exclusive distribution agreement with a Swiss company, HCB Lubricants GmbH, to register, market and distribute Dianatal ® Obstetric Gel exclusively in Mainland China, Taiwan, Hong Kong and Macao. We have started marketing Dianatal ® Obstetric Gel in Hong Kong. We submitted our application for the SFDA approval in March 2011. We expect to launch this product in early 2013 when we receive the SFDA approval.

In December 2011, we entered into an agreement to acquire the manufacturing license and marketing rights for ALA from Shandong Qidu Pharmaceutical Co., Ltd., or Qidu Pharma, for RMB16 million ($2.5 million) in cash. Upon the completion of the transfer of the manufacturing license from Qidu Pharma, we will be one of the two pharmaceutical companies in China licensed to manufacture ALA. ALA will be in its new drug monitoring period through October 2014, during which there will be no additional market entrants due to current PRC regulations.

We expect to begin manufacturing ALA in our production facilities in Penglai, Shandong province, in 2014 upon the expected completion of the transfer of the ALA manufacturing license. Until that time, Qidu Pharma has agreed to fulfill our full production needs for ALA on a contractual basis at a pre-determined, fixed price. We have started to actively participate in provincial tendering processes for ALA and expect to begin recognizing revenues from it in the second half of 2012.

 

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Our product pipeline consists of two product candidates at different stages of development:

 

   

hemocoagulase derived from the venom of the snake species Agkistrodon acutus for bleeding control; 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. Our end-customer base has expanded from approximately 100 hospitals in 2001 to over 4,200 hospitals in all 31 provinces and municipalities in China as of March 31, 2012. 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. Prior to 2011, our sales force consisted of direct sales offices and third-party marketing agents. In 2011, we converted a number of our direct sales offices to independent contract sales partners who provide marketing and promotional services to us on a contractual basis. As of March 31, 2012, our sales force consisted of six direct sales offices with 140 sales personnel, complemented by sixteen third-party marketing agents with over 200 sales personnel and nine contract sales partners with over 210 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 of our products and the clinical differences between our products. Our sales and marketing activities receive strong academic support from a specialist network comprising over 200 national and provincial key opinion leaders and physicians in various clinical areas, and over 200 peer-reviewed academic articles have been published in recognized academic magazines or periodicals regarding the use of our principal products. As of March 31, 2012, our distribution network included approximately 230 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, Shandong Province, China commenced operations in 2002. At this facility, we maintain six GMP-certified formulation production lines, including injectables, freeze-dried powders, aerosols, tablets, hard capsules and granules, and five GMP-certified active pharmaceutical ingredient production lines. In February 2008, we completed the construction of a 24,000-square-meter integrated facility in Shenyang, Liaoning Province, 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, or API, production line, a new research and development center and a warehouse. Both research and development center and warehouse are operational. We have obtained the rights to the drug production permits for these three production lines and passed the GMP certification on-site inspection for the API, while their GMP certifications are currently pending. In July 2010, we obtained the land use right of a parcel of land in Penglai, where we plan to build another production facility. We commenced the construction of the new facility in 2011, and we expect the facility to receive GMP certification by the end of 2013 and become operational in 2014.

Our net revenue was RMB282.9 million, RMB315.8 million and RMB288.3 million ($45.8 million) in 2009, 2010 and 2011, respectively. Our net income was RMB65.1 million in 2009, RMB46.1 million in 2010 and our net loss was RMB14.0 million ($2.2 million) in 2011.

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 development of our principal products, product under exclusive distributorship and product candidates include three phases, which 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.

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 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 twenty 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 during surgeries, 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.

In 2009, 2010 and 2011, we sold 13.1 million, 14.8 million and 15.2 million units of Baquting, respectively. According to the China Pharmaceutical Association, Baquting was the leading hemocoagulase in China with an approximately a 33.5% market share in 2010 and a 36.9% market share in 2011 based on volume.

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;

 

   

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.

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.

 

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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.

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, and completed Phase IIa clinical trials in 2011. We will commence Phase IIb clinical trials in the second half of 2012. 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, as well as in the U.S. and Australia. We have completed preclinical toxicity research and pharmacodynamics studies that demonstrate the potential efficacy and safety of lanthanum polystyrene sulfonate and in March 2010, we applied to the SFDA for commencement of clinical trials of this product. 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

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, (ii) pain caused by microcirculation disorders, and other cardiocerebral microcirculation disorders, (iii) use as an anti-thrombotic agent after organ transplants, and (iv) ductal-dependent congenital heart disease in 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 and December 2009, April 2010 and January 2011, under which we have the rights to exclusively market and distribute Kaitong in China, Taiwan, Hong Kong and Macao. 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. This fixed wholesale price was lowered in January 2011 as part of our agreement with Jilin Yuhua in exchange for prepayments made by us. 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 became effective on January 1, 2011 and we have a priority right to renew this agreement upon the expiration of this agreement on December 31, 2020. Jilin Yuhua received the production permit for Kaitong in December 2010 and commenced its production in January 2011. We commenced the sale of Kaitong in the first quarter of 2011.

Alpha Lipoic Acid Capsule

In December 2011, we entered into an agreement to acquire the manufacturing license and marketing rights for ALA from Qidu Pharma for RMB16 million ($2.5 million) in cash. Upon the completion of the transfer of the manufacturing license from Qidu Pharma, we will be one of the two pharmaceutical companies in China licensed to manufacture ALA. ALA will be in its new drug monitoring period through October 2014, during which there will be no additional market entrants due to current PRC regulations.

We expect to begin manufacturing ALA in our production facilities in Penglai, Shandong province, in 2014 upon the expected completion of the transfer of the ALA manufacturing license. Until that time, Qidu Pharma has agreed to fulfill our full production needs for ALA on a contractual basis at a pre-determined, fixed price. We have started to actively participate in provincial tendering processes for ALA and expect to begin recognizing revenues from it in the second half of 2012.

We believe that the evolving lifestyles and food consumption habits of the PRC population and the more than 90 million diabetic patients in China serves as a growing market for diabetes-related medical products in China. ALA has been clinically proven to be able to lower or maintain blood glucose levels and help manage diabetic peripheral neuropathy by killing free radicals. ALA has been used for years as a prescription drug to treat peripheral neuropathy in several European and South American countries, including Germany, Russia and Argentina. It has also been widely used as a nutraceutical product in the United States.

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 entered into agreements to acquire the rights of manufacturing Aiduo and Aiwen from two third parties, Shenyang Guangda and Shenyang Wanjia, in 2004. The rights acquired from Shenyang Wanjia were transferred to us 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 commence production of Aiduo and Aiwen at our Shenyang facility, we need 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. We were granted the production license and passed the on-site GMP inspection for production of adenosine in May 2011 and March 2012, respectively. We will commence production adenosine once we receive the GMP certificate from the SFDA. However, if the SFDA approval for the transfer of the Aiduo and Aiwen production permits and the GMP certification for the production of these products are delayed or not granted at all, we will only be able to continue serving as the distributor and marketer of Aiduo and Aiwen manufactured by Shenyang Guangda.

 

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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. Food and Drug Administration 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 myocardial perfusion imaging, or 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.

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.

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.

Dipyridamole Aspirin Sustained Release Capsules

We have developed 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 European Stroke Prevention Study 2, or 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.

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.

 

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We submitted our bioequivalence clinical trial data to the SFDA in December 2007 and received an SFDA request in June 2009 for supplementary research data. In March 2010, the SFDA advised us that it has completed all technical reviews of our dipyridamole aspirin sustained release capsules and recommended minor label modifications. The SFDA completed the on-site inspection of our facilities and quality verification of this product in the third quarter of 2010, the final steps for it to issue a manufacturing license. We received the manufacturing license for dipyridamole aspirin sustained release capsules in December 2010 and the GMP certification in February 2011. We plan to launch this product in the third quarter of 2012.

Our Other Products

In addition to Baquting, Kaitong, ALA, Aiduo and Aiwen, we also manufacture and sell the following eleven 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
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
Dipyridamole Aspirin Sustained Release Capsules    Secondary strokes
Cilostazol Tablets    Strokes caused by blood clots or blood ischemia

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 November 2009. Baquting, Kaitong and six of these products, including salbutamol aerosol, erythromycin ethylsuccinate tablets, metformin hydrochloride tablets, ribavirin spray and asarone for injection, are subject to price controls imposed by the NDRC and provincial price control authorities.

International Collaboration

In August 2010, we entered into a framework agreement to exclusively market an imported cardiovascular product in China. This product is currently undergoing clinical trials and we expect to launch this product in early 2013 after it receives the import license from the SFDA.

In June 2010, we entered into an exclusive distribution agreement with a Swiss company, HCB Lubricant GmbH, to register, market and distribute Dianatal ® Obstetric Gel exclusively in Mainland China, Taiwan, Hong Kong and Macao. We have started marketing Dianatal ® Obstetric Gel in Hong Kong. We submitted our application for the SFDA approval in March 2011. We expect to launch this product in early 2013 when we receive the SFDA approval.

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 products to a new subsidiary, Venomics Pty Ltd., or VPL. We have invested $500,000 for a 10% interest in VPL through our subsidiary, Surplus International. VPL in turn formed a joint venture company, Venomics Hong Kong Limited, or VHK, in Hong Kong with our subsidiary, Nuokang Distribution, to develop and commercialize QrxPharma’s two bleeding control product candidates in China. Under the terms of the VHK share subscription agreement, we invested $5.0 million in October 2009 for a 93% interest in VHK. In exchange for a 7% interest, VPL granted VHK a royalty-free exclusive license to commercialize in China Textilinin, an antifibrinolytic agent, and Haempatch, a potent pro-coagulant. VHK currently performs research and development activities.

 

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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. Prior to 2011, our sales force consisted of direct sales offices and third-party marketing agents. In 2011, we converted a number of our direct sales offices to independent contract sales partners who provide marketing and promotional services to us on a contractual basis. As of March 31, 2012, our sales force included six direct sales offices with 140 sales personnel, complemented by 16 marketing agents with over 200 sales personnel and nine contract sales partners with over 210 sales personnel. We entered into contracts with these contract sales partners, who undertake to market our Baquting and other products according to marketing plans and in geographical areas designated by us within a one-year period. We compensate these contract sales partners with selling and marketing expenses. Our marketing agents are instead compensated for their marketing and promotional activities by distributors.

We allocate our direct sales offices, marketing agents and contract sales partners according to geographic areas.

Direct sales teams, marketing agents and contract sales partners 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. 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 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 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 above 200 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 200 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.

 

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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.

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 230 distributors. Our hospital coverage in China has increased from 100 hospitals in 2001 to over 4,200 hospitals as of March 31, 2012, including 80% of the Class 3A hospitals in major cities.

The table below sets forth the aggregate sales to our top five distributors, expressed in RMB and as a percentage of our total sales, for the period indicated.

 

    Year Ended December 31, 2011  
    Sales revenue     Sales revenue  
    (RMB in thousands)     (% of total sales)  

China National Medicines Corporation Ltd.

    57,050        19.8   

Beijing Shangyao Aixin Weiye Medicine Co., Ltd.

    32,431        11.3   

Liaoning Pacific Medicine Co., Ltd.

    15,856        5.5   

Zhongjian Zhikang Supply Chain Services Co., Ltd.

    11,077        3.8   

Hebei Dongming Medicines Co., Ltd.

    8,792        3.1   

Total

    125,206        43.5   
 

 

 

   

 

 

 

Our distributors do not sell our products on an exclusive basis. We typically enter into an annual distribution agreement with each distributor which provides general terms for the distribution arrangement, such as the designated sales area, place and method for delivery, targets for annual sales volume and receivable collection. Under our standard distribution agreement, a distributor cannot sell our products outside the designated geographical area without first obtaining our written consent. The term of a distribution agreement is typically for one year, reflecting the prevailing pricing arrangement under the local competitive bidding process.

Intellectual Property

We rely primarily on a combination of patent, trademark and trade secret protections, as well as employee and third-party confidentiality agreements to protect our intellectual property rights. As of March 31, 2012, we had twelve invention patents and one design patent registered in the PRC, and had twenty pending patent applications in the PRC and three internationally, including Japan, Europe and Canada. In China, patents relating to pharmaceutical inventions are effective for 20 years from the initial filing date of the patent application. Our design patent relates to the packaging box design of Baquting and will expire in July 2016. We own one registered patent in the U.S. and one in Australia.

 

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The following chart lists the invention patents that we own, the product or product candidate the patents relate to and their respective expiration dates as of March 31, 2012:

 

Name of Patents

  

Products or Product Candidates

  

Jurisdiction

  

Expiration Dates

Hemocoagulase of Agkistrodon Acutus and its preparative methods

   Agkistrodon Acutus hemocoagulase    PRC    April 2021

A type of hemocoagulase of Agkistrodon Acutus and its preparative methods

   Agkistrodon Acutus hemocoagulase    PRC    April 2021

A type of haemostatic compound prepared from snake venom

   Baquting    PRC    September 2025

A type of medication for the treatment of hyperphosphatemia and its preparative method

   Lanthanum polystyrene sulfonate    PRC    March 2026

Genetic engineering batroxobin with targeted mutation and its use

   Baquting    PRC    September 2025

Compound drugs for treating various disease related to the heart blood

   Aiduo    PRC    September 2025

A type of bleeding control compound

   Hemocoagulase    PRC    September 2026

The preparative method for thymopolypeptides of sheep

   Thymopolypeptides    PRC    April 2026

A type of polymerase chain reaction DNA engineered-batroxobin and its use

   Baquting    PRC    June 2027

A type of emulsifier containing prostaglandin E1 for vein infusion and its preparative method

   Kaitong    PRC    June 2027

A drug for hyperphosphatemia and its preparative method

  

Lanthanum polystyrene

sulfonate

   U.S.    February 2020

The medicament for treating hyperphospheremia and preparation thereof

  

Lanthanum polystyrene

sulfonate

   Australia    September 2020

In addition, we own 48 registered trademarks in China (including Hong Kong, Macao and Taiwan), such as LOGO (Baquting), LOGO (Aiduo) LOGO (Aiwen) and LOGO (Shunxin) in connection with our marketed products with expiration dates ranging from 2012 to 2021. We also own four international trademarks registered under the jurisdiction of Japan, the European Union, Australia and Spain.

We also rely on trade secrets, proprietary know-how and continuing technological innovation to develop and maintain a competitive position in our product areas. We generally require our employees, consultants and advisors to enter into confidentiality agreements. These agreements provide that all confidential information developed or made known to the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties except under specific circumstances. In the case of our employees, the agreements provide that all of the technology which is conceived by the individual during the course of employment is our exclusive property. The development of our technology and many of our processes are dependent upon the knowledge, experience and skills of key scientific and technical personnel. Further, as a matter of company policy, all key scientific and technical employees have entered into agreements that generally require disclosure and assignment to us of ideas, developments, discoveries and inventions made by them.

Manufacturing

Our Penglai-based manufacturing operations consist of bulk manufacturing, formulation, fill and finish activities that produce products and product candidates for both clinical and commercial purposes. All of the eleven production lines at our 11,000-square-meter Penglai facility are certified in accordance with current GMP, and we hold a valid GMP certificate. Five of these eleven production lines are active pharmaceutical ingredient production lines while the other six are finished product/formulation production lines. We expanded the production capacity of our freeze-dried powder production line at our Penglai facility in by installing additional equipment and ancillary facilities. The expanded production line was GMP-certified in November 2009. As part of our overall strategy to increase our manufacturing capacity, in February 2008, we completed the construction of a 24,000-square-meter integrated facility in Shenyang, China with 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. We obtained the drug production permit and passed on-site GMP inspection for production of adenosine in May 2011 and March 2012, respectively. We will commence production adenosine once we receive the GMP certificate from the SFDA. In July 2010, we obtained the land use right of a parcel of land in Penglai, where we plan to build another production facility. We commenced the construction of this new facility in 2011, and we expect the facility to receive GMP certification by the end of 2013 and become operational in 2014.

 

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We generally produce our products based on our sales plans and reasonable order forecasts. We have not experienced any disruptions in the supply of these raw materials in the past. If any one of these supply arrangements or agreements is terminated or the ability of any one of these suppliers to perform under our agreements were to be materially adversely affected, we believe that we will be able to locate, qualify and enter into an agreement with a new supplier on a timely basis. We maintain long-term relationships with most of our suppliers and place orders from these suppliers from time to time on an as-needed basis.

Quality Control and Assurance

We have our own independent quality control system and devote significant attention to quality control for the designing, manufacturing and testing of our products. We have established a strict quality control system in accordance with SFDA regulations. Our laboratories fully comply with the Chinese GMP guidelines and are staffed with highly educated and skilled technicians to ensure the quality of all batches of product released. We monitor in real time our operations throughout the entire production process, from inspection of raw and auxiliary materials, manufacture, delivery of finished products, clinical testing at hospitals, to ethical sales tactics. Our quality assurance team is also responsible for ensuring that we are in compliance with all applicable regulations, standards and internal policies. Our senior management team is actively involved in setting quality policies and managing internal and external quality performance.

Raw Materials

Raw materials for the manufacturing of Baquting primarily comprise the venom of Bothrops atrox snakes. We implemented manufacturing technology upgrades 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 from suppliers in Brazil and Peru instead of purchasing the partially purified venom from third-party suppliers in China, which significantly lowered our costs of raw materials. We currently purchase a majority of our Bothrops atrox venom requirements from Centro De Extracão De Toxinas Animais, or Centro, a producer located in Brazil. We have entered into a supply agreement with Centro with basic supply terms such as volumes and prices, shipment schedules, quality guarantees and defaults and claims. Unit prices are fixed, subject to annual adjustments caused by currency rate fluctuations, changes in production costs, environmental law changes and changes in government taxes and availability of the product. We are required to purchase $119,000, $204,000 and $85,000 worth of Bothrops atrox venom from Centro in 2012, 2013 and 2014.

Failure by either party to meet the minimum quantity required under our agreement with Centro would result in a penalty of 50% of the total shortfall, calculated from an average unit price based off our previous invoices. We have agreed to make full payments in advance under the contract. In August 2011, we extended the term of this agreement to August 1, 2014, subject to renewal upon further negotiation. This fixed venom supply arrangement guarantees the consistent quality of venom we use. Our unique extraction and purification technology and large-scale production allow us to extract batroxobin of reliable quality from the venom. We have also entered into a two year agreement to purchase a portion of our Bothrops atrox venom from Amazon’s Life S.A.C., a supplier based in Peru.

Other raw materials that we use in production such as vessels, bottles, caps and other packing materials are readily available in China at reasonable costs.

Certificates and Permits

Our Penglai facility received its pharmaceutical manufacturing permit from the local SFDA in June 2002, which was renewed in January 2011 and will expire in December 2015.

Our Shenyang facility passed the on-site GMP inspection for production of adenosine and its formal GMP certification by the SFDA is currently pending. The two formulation production lines for injectables in our Shenyang facility are still pending drug production permit from the SFDA.

Nuokang Distribution’s pharmaceutical distribution permit was issued by local SFDA in 1999, renewed in December 2009 and will expire in November 2019. Nuokang Distribution’s GSP certificate was issued in September 2003, renewed in September 2008 and will expire in September 2013.

The GMP certificate for our injectable production line was issued in 2005, which was renewed in November 2009 and will expire in November 2014.

 

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The GMP certificate for our three active pharmaceutical ingredient production lines was renewed in April 2009 and will expire in April 2014.

The GMP certificate for Baquting was issued by the SFDA in 2004 and expired in November 2009. The new GMP certificate for our expanded Baquting production capacity was issued in November 2009 and will expire in November 2014.

The GMP certificate in relation to Aiduo and Aiwen was issued by the SFDA to a third party in 2003, which was renewed in January 2011 and will expire in December 2015. We are in the process of obtaining GMP certification for our own Aiduo, Aiwen and adenosine production facility.

The GMP certificate in relation to dipyridamole aspirin sustained release capsules was issued by the SFDA to us in February 2011 and will expire in February 2016.

We expect to renew these permits and certifications upon their expiration.

Competition

The market for hematological and cardiovascular products is competitive and rapidly evolving on a global basis. Increased competition has resulted in industry-wide price reductions or reduced margins. In particular, we face competition from domestic and foreign pharmaceutical companies in each of our potential product areas. Certain of these companies have substantially greater capital resources, research and development personnel, facilities and experience at conducting clinical trials and obtaining regulatory approvals, and greater experience and expertise in developing and commercializing products. In China, our flagship product Baquting competes primarily with, Aohong Pharma’s Bangting, Lee’s Pharm’s Sulejuan and Beijing Kangchen Pharmaceutical’s Suling.Kaitong primarily competes with Beijing Tide Pharma’s Kaishi, Hayao Bio’s Manxintuo, Sihuan Pharma’s Beichang, Hainan Bikai Pharma’s Bikaiqing, Xi’an Libang Pharma’s Libang, and YaoPharma’s Youdier. Our ALA competes with Jiangsu Tohope Pharma’s alpha lipoic acid product.

We believe that competition and leadership in our industry are based on managerial and technological superiority, and the ability to identify and exploit commercially viable products. Other factors affecting our competitive position include time to market, patent position, product efficacy, safety, convenience, reliability, availability and pricing. We believe we are well-positioned to compete in the fast-developing Chinese biopharmaceutical market with our well recognized Nuokang and Baquting brand, diverse product portfolio, market exclusivity, proven research and development and in-licensing capabilities, established sales and marketing network, management experience and favorable cost structure.

Seasonal Variations

We experience insignificant seasonal variations in the sales of our principal products. We usually experience business declines during significant holiday seasons, such as Chinese New Year in the first quarter and National Day in the fourth quarter, both of which last over two weeks. The number of patients and surgeries tend to decrease during these holiday seasons, which in turn decreases the sales of our principal products.

Regulations

This section sets forth a summary of the most significant regulations or requirements that affect our business activities in China.

Regulation of Pharmaceutical Industry in China

Regulatory Authorities

In the PRC, the SFDA is the authority that monitors and supervises the administration of pharmaceutical products and medical appliances and equipment as well as food, health food and cosmetics. The SFDA’s predecessor, the State Drug Administration, or the SDA, was established on April 16, 1998 as an organization under the State Council to assume the responsibilities previously handled by the Ministry of Health of the PRC, or the MOH, the State Pharmaceutical Administration Bureau of the PRC and the State Administration of Traditional Chinese Medicine of the PRC. The SFDA was founded in March 2003 to replace the SDA.

 

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The primary responsibilities of the SFDA include:

 

   

monitoring and supervising the administration of pharmaceutical products, medical appliances and equipment as well as food, health food and cosmetics in the PRC;

 

   

formulating administrative rules and policies concerning the supervision and administration of food, health food, cosmetics and the pharmaceutical industry; evaluating, registering and approving of new drugs, generic drugs, imported drugs and traditional Chinese medicine, or TCM;

 

   

approving and issuing permits for the manufacture and export/import of pharmaceutical products and medical appliances and equipment and approving the establishment of enterprises to be engaged in the manufacture and distribution of pharmaceutical products; and

 

   

examining and evaluating the safety of food, health food and cosmetics and handling significant accidents involving these products.

The MOH is an authority at the ministerial level under the State Council and is primarily responsible for national public health. Following the establishment of the SFDA in 2003, the MOH was put in charge of the overall administration of the national health in the PRC excluding the pharmaceutical industry. In March 2008, the State Council placed the SFDA under the management and supervision of the MOH. The MOH performs a variety of tasks in relation to the health industry such as establishing social medical institutes and producing professional codes of ethics for public medical personnel. The MOH is also responsible for overseas affairs, such as dealings with overseas companies and governments.

Healthcare System Reform

The PRC government recently promulgated several healthcare reform policies and regulations to reform the healthcare system. On March 17, 2009, the Central Committee of the PRC Communist Party and the State Council jointly issued the Guidelines on Strengthening the Reform of Healthcare System. On March 18, 2009, the State Council issued the Implementation Plan for the Recent Priorities of the Healthcare System Reform (2009-2011). On July 22, 2009, the General Office of the State Council issued the Five Main Tasks of Healthcare System Reform in 2009. On February 13, 2011, the General Office of the State Council issued the Five Main Tasks of Healthcare System Reform. On February 14, 2012, the General Office of the State Council issued the Main Tasks of Strengthening the Healthcare System Reform.

Highlights of these healthcare reform policies and regulations include the following:

 

   

The overall objective of the reform is to establish a basic healthcare system to cover both urban and rural residents and provide the Chinese people with safe, effective, convenient and affordable healthcare services. The PRC government aims to extend basic medical insurance coverage to at least 95% of the country’s population by 2012 and increase the amount of subsidies on basic medical insurance for urban residents and rural cooperative medical insurance to RMB240 per person per year by 2012. By 2020, a basic healthcare system covering both urban and rural residents should be established.

 

   

The reforms aim to promote orderly market competition and improve the efficiency and quality of the healthcare system to meet the various medical needs of the Chinese population. From 2009, basic public healthcare services such as preventive healthcare, maternal and child healthcare and health education will be provided to urban and rural residents. In the meantime, the reforms also encourage innovations by pharmaceutical companies to eliminate low-quality and duplicative products.

 

   

The main tasks of the reform in 2012 are as follows: (1) to accelerate the formation of a medical insurance system that covers the whole population, (2) to improve the national essential drug system and the new operational mechanism of the community-level medical and health care institutions, (3) to promote the reform of public hospitals, and (4) to promote the reform of the relevant supporting systems, such as the public healthcare services and the distribution of drugs.

Drug Administration Laws and Regulations

The PRC Drug Administration Law as promulgated by the Standing Committee of the National People’s Congress in 1984 and the Implementing Measures of the PRC Drug Administration Law as promulgated by the MOH in 1989 have laid down the legal framework for the establishment of pharmaceutical manufacturing enterprises, pharmaceutical trading enterprises and for the administration of pharmaceutical products including the development and manufacturing of new drugs and medicinal preparations by medical institutions. The PRC Drug Administration Law also regulates the packaging, trademarks and the advertisements of pharmaceutical products in the PRC.

 

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Certain revisions to the PRC Drug Administration Law took effect on December 1, 2001. They were formulated to strengthen the supervision and administration of pharmaceutical products, and to ensure the quality of pharmaceutical products and the safety of pharmaceutical products for human use. The revised PRC Drug Administration Law applies to entities and individuals engaged in the development, production, trade, application, supervision and administration of pharmaceutical products. It regulates and prescribes a framework for the administration of pharmaceutical manufacturers, pharmaceutical trading companies, medicinal preparations of medical institutions and the development, research, manufacturing, distribution, packaging, pricing and advertisements of pharmaceutical products.

The PRC Drug Administration Implementation Regulations promulgated by the State Council took effect on September 15, 2002 to provide detailed implementation regulations for the revised PRC Drug Administration Law.

Examination and Approval of New Medicines

On July 10, 2007, the SFDA promulgated the Administrative Measures on the Registration of Pharmaceutical Products, or the Registration Measures, which became effective on October 1, 2007. Under the Registration Measures, new medicines generally refer to those medicines that have not yet been marketed in the PRC. In addition, certain marketed medicines may also be treated as new medicines if the type or application method of such medicines has been changed or new therapeutic functions have been added to such medicines. According to the Registration Measures, the approval of new medicines requires the following steps:

 

   

upon completion of the pre-clinical research of the new medicine, application for registration of the new medicine will be submitted to the drug regulatory authorities at the provincial level for review in formalities. If all the formality requirements are met, the drug regulatory authorities at the provincial level will issue a notice of acceptance and conduct site inspections on the research and original data of the new medicine. The drug regulatory authorities at the provincial level will subsequently issue a preliminary opinion and notify a medical examination institute to conduct a sample examination on the new medicine (if the new medicine is a biological product);

 

   

the drug regulatory authorities at the provincial level will then submit their preliminary opinion, inspection report and application materials to the Drug Review Center of the SFDA and notify the applicant of the progress;

 

   

after receiving the application materials, the Drug Review Center of the SFDA will arrange for pharmaceutical, medical or other professionals to conduct a technical review on the application materials and request for supplemental materials and explanations, if necessary. After completion of the technical review, the Drug Review Center of the SFDA will issue an opinion and submit such opinion to the SFDA, along with the application materials;

 

   

after receiving the technical opinion from the Drug Review Center, the SFDA will assess whether or not to grant the approval for conducting the clinical research on the new medicine;

 

   

after obtaining the SFDA’s approval for conducting the clinical research, the applicant may proceed with the relevant clinical research (which is generally conducted in three phases for a new medicine under the Registration Measures) at institutions with appropriate qualification:

 

   

Phase I refers to the preliminary clinical trial for clinical pharmacology and body safety. It is conducted to observe the human body tolerance for new medicine and pharmacokinetics, so as to provide a basis for determining the prescription plan.

 

   

Phase II refers to the stage of preliminary evolution of clinical effectiveness. The purpose is to preliminarily evaluate the clinical effectiveness and safety of the medicine used on patients with targeted indication, as well as to provide a basis for determining the Phase III clinical trial research plan and the volume under the prescription plan.

 

   

Phase III is a clinical trial stage to verify the clinical effectiveness. The purpose is to test and determine the clinical effectiveness and safety of the medicine used on patients with targeted indication, to evaluate the benefits and risks thereof, and, eventually, to provide sufficient basis for review of the medicine registration application.

 

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Phase IV refers the stage of surveillance and research after the new medicines is launched. The purpose is to observe the clinical effectiveness and adverse effects of the medicine over a much larger patient population and longer time period than in Phase I to III clinical trials, and evaluate the benefits and risks when it is administered to general or special patient population in larger prescription volume.

 

   

after completion of the relevant clinical research, the applicant shall submit its clinical research report together with the relevant supporting documents to the drug regulatory;

 

   

authorities at the provincial level and shall provide raw materials of the standard products and research result on relevant standard products to the PRC National Institute for the Control of Pharmaceutical and Biological Products;

 

   

the drug regulatory authorities at the provincial level will then review the relevant documents in formalities. If all the formality requirements are met, the drug regulatory authorities at the provincial level will issue a notice of acceptance and within five days of notice and start conducting site inspections. The drug regulatory authorities at the provincial level will issue a preliminary opinion and then collect three samples of the new medicine (if the new medicine is not a biological product) and notify the relevant medicine examination institute to review the medicine standards;

 

   

the drug regulatory authorities at the provincial level will then submit their preliminary opinion, inspection report and application materials to the Drug Review Center of the SFDA and notify the applicant of the progress;

 

   

the medical examination institute will review the medicine standards and report its opinion to the Drug Review Center of the SFDA and send a copy of the opinion to the applicant;

 

   

after receiving the application materials, the Drug Review Center of the SFDA will arrange for pharmaceutical, medical or other professionals to conduct a technical review on the application materials and request for supplemental materials and explanations, if necessary. After completion of the technical review and if all the requirements are complied with, the Drug Review Center of the SFDA will report so to the Certification Center of the SFDA and notify the applicant that it may apply to the Certification Center of the SFDA for a site inspection;

 

   

the applicant will apply to the Certification Center of the SFDA for a site inspection within six months after receiving the notice from the Drug Review Center of the SFDA;

 

   

the Certification Center of the SFDA will arrange a site inspection on the process of manufacturing samples within thirty days after the application from the applicant to ensure the feasibility of the manufacturing process. The Certification Center of the SFDA will collect a sample (three samples if the new medicine is a biological product) for the medicine examination institute to examine. The Certification Center of the SFDA will prepare an inspection report within 10 days after the site inspection and submit the report to the Drug Center of the SFDA;

 

   

the sample(s) will be manufactured at a GMP certified workshop. The medicine examination institute will examine the sample(s) under the reviewed medicine standards and prepare a report after completion the examination and submit the report to the Drug Review Center of the SFDA. A copy of the report will be available to the applicant;

 

   

the Drug Review Center of the SFDA will form a comprehensive opinion based on the technical opinion previously received, the report on site inspection and the result of sample examination and submit the comprehensive opinion and the application materials to the SFDA; and

 

   

if all the regulatory requirements are satisfied, the SFDA will grant a new drug certificate and a pharmaceutical approval number (assuming the applicant has a valid Pharmaceutical Manufacturing Permit and the requisite production conditions for the new medicine have been met).

Any applicant who is not satisfied with the SFDA’s decision to deny the application can appeal within 60 days of its receipt of the SFDA’s decision. If the applicant is dissatisfied with the result of the appeal, it may apply for an administrative review with a special committee consisting of senior officials of the SFDA or file an administrative lawsuit with a people’s court in China.

 

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Drug Technology Transfer Regulations

On August 19, 2009, the SFDA promulgated the Administrative Regulations for Technology Transfer Registration of Drugs to standardize the registration process of drug technology transfer, which includes application for, and evaluation, examination, approval and monitoring of, drug technology transfer. Drug technology transfer refers to the transfer of drug production technology by the owner to a drug manufacturer and the application for drug registration by the transferee according to the provisions in the new regulations. Drug technology transfer includes new drug technology transfer and drug production technology transfer.

Conditions for the application for new drug technology transfer

Applications for new drug technology transfer may be submitted prior to the expiration date of the monitoring period of the new drugs with respect to:

 

   

drugs with new drug certificates only; or

 

   

drugs with new drug certificates and drug approval numbers.

For drugs with new drug certificates only and not yet in the monitoring period, or drug substances with new drug certificates, applications for new drug technology transfer should be submitted prior to the respective expiration date of the monitoring periods for each drug registration category set forth in the new regulations and after the issue date of the new drug certificates.

Conditions for the application of drug production technology transfer

Applications for drug production technology transfer may be submitted if:

 

   

the transferor holds new drug certificates or both new drug certificates and drug approval numbers, and the monitoring period has expired or there is no monitoring period; or

 

   

with respect to drugs without new drug certificates, both the transferor and the transferee are legally qualified drug manufacturing enterprises, one of which holds over 50% of the equity interests in the other, or both of which are majority-owned subsidiaries of the same drug manufacturing enterprise.

With respect to imported drugs with imported drug licenses, the original applicants for the imported drug registration may transfer these drugs to local drug manufacturing enterprises.

Application for, and examination and approval of, drug technology transfer

Applications for drug technology transfer should be submitted to the provincial food and drug administration. If the transferor and the transferee are located in different provinces, the provincial food and drug administration where the transferee is located should provide examination opinions. The provincial food and drug administration where the transferee is located is responsible for examining application materials for technology transfer and organizing inspections on the production facilities of the transferee. Food and drug control institutes are responsible for testing three batches of drug samples.

The Center for Drug Evaluation of the SFDA should further review the application materials, provide technical evaluation opinions and form a comprehensive evaluation opinion based on the site inspection reports and the testing results of the samples. The SFDA should determine whether to approve the application according to the comprehensive evaluation opinion of the Center for Drug Evaluation of the SFDA. An approval letter of supplementary application and a drug approval number will be issued to qualified applications. An approval letter of clinical trials will be issued when necessary. For rejected applications, a notification letter of the examination opinions will be issued with the reasons for rejection.

Permits and Licenses for Manufacturing and Registration of Drugs

Production License. To manufacture pharmaceutical products in the PRC, a pharmaceutical manufacturing enterprise must first obtain a Pharmaceutical Manufacturing Permit issued by the relevant pharmaceutical administrative authorities at the provincial level where the enterprise is located. Among other things, such a permit must set forth the permit number, the name, legal representative and registered address of the enterprise, the site and scope of production, issuing institution, date of issuance and effective period.

 

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Each Pharmaceutical Manufacturing Permit issued to a pharmaceutical manufacturing enterprise is effective for a period of five years. Any enterprise holding a Pharmaceutical Manufacturing Permit is subject to review by the relevant regulatory authorities on an annual basis. The enterprise is required to apply for renewal of such permit within six months prior to its expiry and will be subject to reassessment by the issuing authorities in accordance with then prevailing legal and regulatory requirements for the purposes of such renewal.

Business Licenses. In addition to a Pharmaceutical Manufacturing permit, the manufacturing enterprise must also obtain a business license from the administrative bureau of industry and commerce at the local level after it has obtained the requisite Pharmaceutical Manufacturing Permit. The name, legal representative and registered address of the enterprise specified in the business license must be identical to that set forth in the Pharmaceutical Manufacturing Permit.

Registration of Pharmaceutical Products. All pharmaceutical products that are produced in the PRC must bear a registered number issued by the SFDA, with the exception of Chinese herbs and Chinese herbal medicines in soluble form. The medicine manufacturing enterprises must obtain the medicine registration number before manufacturing any medicine.

GMP Certificates. The World Health Organization encourages the adoption of good manufacturing practice, or GMP, standards in pharmaceutical production in order to minimize the risks involved in any pharmaceutical production that cannot be eliminated through testing the final products.

The Guidelines on Good Manufacturing Practices, as amended in 1998, or the Guidelines, took effect on August 1, 1999 and set the basic standards for the manufacture of pharmaceuticals. These Guidelines cover issues such as the production facilities, the qualification of the personnel at the management level, production plant and facilities, documentation, material packaging and labeling, inspection, production management, sales and return of products and customers’ complaints. On October 23, 2003, the SFDA issued the Notice on the Overall Implementation and Supervision of Accreditation of Good Manufacturing Practice Certificates for Pharmaceuticals, which required all pharmaceutical manufacturers to apply for the GMP certificates by June 30, 2004. Those enterprises that failed to obtain the GMP certificates by December 31, 2004 would have their Pharmaceutical Manufacturing Permit revoked by the drug administrative authorities at the provincial level. On October 24, 2007, the SFDA issued revised Guidelines on Good Manufacturing Practices which became effective on January 1, 2008. On January 17, 2011, the MOH issued a revised Guidelines on Good Manufacturing Practices which became effective on March 1, 2011. The GMP certificate is valid for a term of five years and application for renewal must be submitted six months prior to its expiration date.

Administrative Protection and Monitoring Periods for New Drugs

According to the Registration Measures, with a view to protecting public health, the SFDA may provide for administrative monitoring periods of up to five years for new drugs approved to be manufactured, to continually monitor the safety of those new drugs.

During the monitoring period of a new drug, the SFDA will not approve any other enterprise’s application to manufacture, change the dosage of or import a similar new drug. The only exception is that the SFDA will continue to handle any application if, prior to the commencement of the monitoring period, the SFDA has already approved the applicant’s clinical trial for a similar new drug. If such application conforms to the relevant provisions, the SFDA may approve such applicant to manufacture or import the similar new drug during the remainder of the monitoring period.

Distribution of Pharmaceutical Products

According to the PRC Drug Administration Law and its implementing regulations and the Administrative Measures on Oversight of Distribution of Pharmaceutical Products, a manufacturer of pharmaceutical products in the PRC can only engage in the trading of the pharmaceutical products that the manufacturer has produced itself. In addition, such manufacturer can only sell its products to:

 

   

wholesalers and distributors holding Pharmaceutical Distribution Permits;

 

   

other holders of Pharmaceutical Manufacturing Permits; or

 

   

medical practitioners holding Medical Practice Permits.

 

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A pharmaceutical manufacturer in the PRC is prohibited from selling its products to end-users, or individuals or entities other than holders of Pharmaceutical Distribution Permits, the Pharmaceutical Manufacturing Permits or the Medical Practice Permits.

The granting of a Pharmaceutical Distribution Permit to wholesalers shall be subject to approval of the provincial level drug regulatory authorities, while the granting of a retailer permit shall be subject to the approval of the drug regulatory authorities above the county level. Unless otherwise expressly approved, no pharmaceutical wholesaler may engage in the retail of pharmaceutical products, and neither may pharmaceutical retailers engage in wholesale.

A pharmaceutical distributor shall satisfy the following requirements:

 

   

personnel with pharmaceutical expertise as qualified according to law;

 

   

business site, facilities, warehousing and sanitary environment compatible to the distributed pharmaceutical products;

 

   

quality management system and personnel compatible to the distributed pharmaceutical products; and

 

   

rules and regulations to ensure the quality of the distributed pharmaceutical products.

Operations of pharmaceutical distributors shall be conducted in accordance with the Pharmaceutical Operation Quality Management Rules and shall be granted a GSP certificate under such rules by the SFDA.

Pharmaceutical distributors must keep true and complete records of any pharmaceutical products purchased, distributed or sold with the generic name of such products, specification, approval code, term, manufacturer, purchasing or selling party, price and date of purchase or sale. A pharmaceutical distributor must keep such record at least until one year after the expiry date of such products and in any case, such record must be kept for no less than three years. Penalties may be imposed for any violation of record-keeping.

Pharmaceutical distributors can only distribute pharmaceutical products obtained from those with a Pharmaceutical Manufacturing Permit and a Pharmaceutical Distribution Permit.

Price Control

The administration of price control of pharmaceutical products is vested in the national and provincial price administration authorities. Depending on the categories of pharmaceutical products in question, the prices of pharmaceutical products listed in the State Basic Medical Insurance Drug Catalogue, drugs with patents and other drugs whose production or trading may constitute monopolies are subject to the control of the National Development and Reform Commission of the PRC, or the NDRC, and the relevant provincial or local price administration authorities. With respect to pharmaceutical products manufactured in the PRC, the national price administration authority from time to time publishes price control lists setting out the names of pharmaceutical products and their respective price ceilings. The provincial price administration authorities also publish price control lists in respect of the pharmaceutical products which are manufactured within their respective areas. The main purpose of the price control policy is to set an upper limit to the prices of pharmaceutical products to prevent excessive increases in the prices of such products. Pursuant to the Measures for Medicine Pricing by the Government, the price ceiling is determined mainly by reference to the quality of the product, whether the products are newly developed products, and the status of implementing the GMP Guidelines by the manufacturer of the relevant product.

The prices of pharmaceutical products included in the price control lists are subject to adjustment upon approval by the price administration authorities from time to time. Pharmaceutical enterprises in the PRC are required to submit cost-related information such as raw material prices regularly to the relevant authorities, so that the authorities could take into account the prevailing market conditions when setting the prices. The price administration authorities may approve adjustments to the price of pharmaceutical products upon the pharmaceutical manufacturer’s request if material changes in the cost structure in producing the pharmaceutical products or significant changes in demand for these pharmaceutical products are recognized.

 

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Tender Requirements for Hospital Purchases of Medicines

Provincial and municipal government agencies such as provincial or municipal health departments also operate a mandatory tender process for purchases by hospitals of a medicine included in provincial medicine catalogs. These government agencies organize tenders in their province or city and typically invite manufacturers of provincial catalog medicines that are on the hospitals’ formularies and are in demand by these hospitals to participate in the tender process. A government-approved committee consisting of physicians, experts and officials is delegated by these government agencies the power to review bids and select one or more medicines for the treatment of a particular medical condition. The selection is based on a number of factors, including bid price, quality and a manufacturer’s reputation and service. The bidding price of a wining medicine will become the price required for purchases of that medicine by all hospitals in that province or city. This price, however, is effective only until the next tender, where the manufacturer of the winning medicine must submit a new bid.

The tender requirement was first introduced in 2001 and has since been implemented across China. We understand that the level of present implementation of the tender requirement varies among different provinces in China. Our principal products are subject to the tender requirement.

Product Liability

In addition to the strict new drug approval process, certain PRC laws have been promulgated to protect the rights of consumers and to strengthen the control of medical products in the PRC. Under current PRC law, manufacturers and vendors of defective products in the PRC may incur liability for loss and injury caused by such products. Pursuant to the General Principles of the Civil Law of the PRC, or the PRC Civil Law, promulgated on April 12, 1986, and the Tort Law of the PRC, or the PRC Tort Law, promulgated on December 26, 2009, a defective product which causes property damage or physical injury to any person may subject the manufacturer or vendor of such product to civil liability for such damage or injury.

On February 22, 1993 the Product Quality Law of the PRC, or the Product Quality Law, was promulgated to supplement the PRC Civil Law aiming to protect the legitimate rights and interests of the end-users and consumers and to strengthen the supervision and control of the quality of products. The Product Quality Law was revised by the Ninth National People’s Congress on July 8, 2000. Pursuant to the revised Product Quality Law, manufacturers who produce defective products may be subject to civil or criminal liability and have their business licenses revoked.

On October 31, 1993, the PRC Law on the Protection of the Rights and Interests of Consumers, or the Consumers Protection Law, was promulgated which provides further protection to the legal rights and interests of consumers in connection with the purchase or use of goods and services. At present, all business operations must observe and comply with the Consumers Protection Law when they provide their goods and/or consumer services.

Health Insurance System

According to the State Council Decision on the Establishment of the Basic Medical Insurance System of Staff in Cities and Town promulgated by the State Council in December 1998, the Ministry of Labor and Social Security assumed the responsibilities for the reform of the social medical insurance system. As part of the reform of the state basic medical insurance system for employees in the urban areas, the Ministry of Labor and Social Security, the MOH, the SFDA and various other governmental departments jointly issued the State Basic Medical Insurance Drug Catalogue with a view to enhancing the management of the use of drugs under the medical insurance system. The drugs listed in the catalogue are covered by the medical insurance system. The labor and social security authorities at the provincial level may, subject to ratification by the Ministry of Labor and Social Security, make amendments to the list of Tier 2 drugs in the catalog to a small extent to suit local needs.

Other National and Provincial Level Laws and Regulations

We are subject to changing regulations under many other laws and regulations administered by governmental authorities at the national, provincial and municipal levels, some of which are or may become applicable to our business. Our hospital customers are also subject to a wide variety of laws and regulations that could affect the nature and scope of their relationships with us.

For example, regulations control the confidentiality of patients’ medical information and the circumstances under which patient medical information may be released for inclusion in our databases, or released by us to third parties. These laws and regulations governing both the disclosure and the use of confidential patient medical information may become more restrictive in the future.

We also comply with numerous additional state and local laws relating to matters such as safe working conditions, manufacturing practices, environmental protection and fire hazard control. We believe that we are currently in compliance with these laws and regulations; however, we may be required to incur significant costs to comply with these laws and regulations in the future. Unanticipated changes in existing regulatory requirements or adoption of new requirements could therefore have a material adverse effect on our business, results of operations and financial condition.

 

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Regulation of Patent and Trademark Protection

Patent Law

The PRC first allowed patents for the protection of proprietary rights, as set forth in the Patent Law, promulgated in 1984 and amended in 1992 and 2000. Pharmaceutical inventions were not patentable under the Patent Law until 1993. On December 27, 2008, the Standing Committee of the National People’s Congress issued the amended China Patent Law, which will become effective on October 1, 2009 (the Patent Law Amendment 2009).

Patents relating to pharmaceutical inventions are effective for 20 years from the initial date the patent application was filed.

Patent Prosecution

The Chinese patent prosecution system is different from the U.S. system in a number of ways. The Chinese patent system, like most countries other than the United States, adopts the principle of “first to file.” This means that, where more than one person files a patent application for the same invention, a patent will be granted to the person who first filed the application. The United States uses a principle of “first to discover” to determine the granting of patents. In addition, the PRC requires absolute novelty in order for an invention to be patentable. If a technology that is the subject of an invention patent application has been known to the public prior to the filling of the application, then such technology is not qualified to be patented as an invention. Conversely, inventors in the United States have a one-year grace period after publication of the invention in which they may file a patent. Patents issued in the PRC are not enforceable in Hong Kong, Taiwan or Macao, which each have independent patent systems. Patents are filed at the State Intellectual Property Office, or SIPO, in Beijing.

Patent Enforcement

A patent holder who believes the patent is being infringed may either file a civil legal suit or file an administrative complaint with a provincial or municipal office of SIPO. A PRC court may issue a preliminary injunction upon the patent holder’s or an interested party’s request before instituting any legal proceedings or during the proceedings. Damages for infringement are calculated as either the loss suffered by the patent holder arising from the infringement or the benefit gained by the infringer from the infringement. If it is difficult to ascertain damages in this manner, damages may be determined in the range of from one to three times of the license fee under a contractual license. If damages cannot still be determined, statutory damages from RMB10,000 to 1,000,000 may be requested. As in other jurisdictions, with one notable exception, the patent holder in the PRC has the burden of proving that the patent is being infringed. However, if the holder of a manufacturing process patent alleges infringement of such patent, the alleged infringing party has the burden of proving that there has been no infringement.

Compulsory License

Pursuant to the Patent Law Amendment 2009, SIPO may, upon the application of any entity or individual possessing the means to utilize a patented technology, grant a compulsory license to such entity or individual under the circumstances: 1) where, within three years from the date of being granted the patent right and within four years from the date of patent application, the patent holder has not utilized the patent, or has not utilized the patent adequately without any reasonable basis; or 2) where the patent holder’s act of utilizing the patent is defined as a monopoly act pursuant to the PRC laws, to eliminate or alleviate the negative impact of such act on competition. A compulsory license can also be granted where a national emergency or any extraordinary state of affairs occurs or where the public interest so requires. We do not believe a compulsory license has yet been granted by the SIPO.

International Patent Treaties

The PRC is also a signatory to all major intellectual property conventions, including Paris Convention for the Protection of Industrial Property, Madrid Agreement on the International Registration of Marks (Madrid Agreement) and Madrid Protocol, Patent Cooperation Treaty, Budapest Treaty on the International Recognition of the Deposit of Microorganisms for the Purposes of Patent Procedure and the Agreement on Trade-Related Aspects of Intellectual Property Rights, or TRIPs.

 

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Although patent rights are national rights, there is also a large degree of international co-operation under the Patent Cooperation Treaty, or the PCT, to which China is a signatory. Under the PCT, applicants in one country can seek patent protection for an invention simultaneously in a number of other member countries by filing a single international patent application. The fact that a patent application is pending is no guarantee that a patent will be granted, and even if granted, the scope of a patent may not be as broad as the subject of the initial application.

Trademarks

The PRC Trademark Law was promulgated in 1982 and was amended on February 2, 1993 and October 27, 2001. The PRC Trademark Law Implementation Regulation was promulgated on August 3, 2002 and became effective on September 15, 2002. As noted above, the PRC is a signatory to the Madrid Agreement and the Madrid Protocol. These agreements provide a mechanism whereby an international registration produces the same effects as an application for registration of the mark made in each of the countries designated by the applicant.

The PRC Trademark Office is responsible for the registration and administration of trademarks throughout the country. Like patents, the PRC has adopted a “first-to-file” principle with respect to trademarks.

PRC law provides that the following acts constitute infringement of the exclusive right to use a registered trademark:

 

   

use of a trademark that is identical with or similar to a registered trademark in respect of the same or similar commodities without the authorization of the trademark registrant;

 

   

sale of commodities infringing upon the exclusive right to use the trademark;

 

   

counterfeiting or making, without authorization, representations of a registered trademark of another person, or sale of such representations of a registered trademark as were counterfeited, or made without authorization;

 

   

changing a registered trademark and putting commodities on which the changed registered trademark is used into the market without the consent of the trademark registrant; and

 

   

otherwise infringing upon the exclusive right of another person to use a registered trademark.

In the PRC, a trademark owner who believes the trademark is being infringed has three options:

 

   

The trademark owner can provide his trademark registration certificate and other relevant evidence to the State or local Administration for Industry and Commerce, or AIC, which can, at its discretion, launch an investigation. The AIC may take such actions as: order the infringer to immediately cease the infringing behavior, seize and destroy the representations of the trademark in question and impose a fine. If the trademark owner is dissatisfied with the SAIC’s decision, he may apply to have the decision reconsidered.

 

   

The trademark owner may institute civil proceedings directly with the court. Civil redress for trademark infringement includes:

 

   

injunctions;

 

   

requiring the infringer to take steps to mitigate the damage (i.e., print notices in newspapers); and

 

   

damages (i.e. compensation for the economic loss and injury to reputation as a result of trademark infringement suffered by the trademark holder).

 

   

The amount of compensation is calculated according to either the gains acquired by the infringer from the infringement during the infringement, or the loss suffered by the trademark owner, including expenses incurred by the trademark holder to deter such infringement. If it is difficult to determine the gains acquired by the infringer from the infringement, or the loss suffered by the trademark owner, the court may elect to award compensation of not more than RMB500,000.

 

   

If the case is so serious as to constitute a crime, the trademark owner may lodge a complaint with the relevant public security organization.

 

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Regulation on Foreign Currency Exchange

Foreign Currency Exchange

Foreign currency exchange regulation in China is primarily governed by the following rules:

 

   

Foreign Currency Administration Rules (1996), as amended, or the Exchange Rules; and

 

   

Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.

Under the Exchange Rules, the Renminbi is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of the PRC State Administration of Foreign Exchange, or SAFE.

Under the Administration Rules, foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from the SAFE. Capital investments by foreign-invested enterprises outside of China are also subject to limitations, which include approvals by the Ministry of Commerce, the SAFE and the NDRC.

Foreign Exchange Registration of Offshore Investment by PRC Residents

Pursuant to the SAFE’s Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage in Financing and Inbound Investment via Overseas Special Purpose Vehicles, generally known in China as SAFE Circular No. 75, issued on October 21, 2005 and became effective on November 1, 2005, (i) a person residing in the PRC, who is referred to as a PRC resident in SAFE Circular 75, shall register with the local branch of the SAFE before it establishes or controls an overseas special purpose vehicle, or SPV, for the purpose of overseas equity financing (including convertible debts financing); (ii) when a PRC resident contributes the assets of or its equity interests in a domestic enterprise into an SPV, or engages in overseas financing after contributing assets or equity interests into an SPV, such PRC resident shall register his or her interest in the SPV and the change thereof with the local branch of the SAFE; and (iii) when the SPV undergoes a material event outside of China, such as change in share capital or merger and acquisition, the PRC resident shall, within 30 days from the occurrence of such event, register such change with the local branch of the SAFE. PRC residents who are shareholders of SPVs established before November 1, 2005 were required to register with the local SAFE branch before March 31, 2006.

Under SAFE Circular No. 75, failure to comply with the registration procedures set forth above may result in the penalties, including imposition of restrictions on a PRC subsidiary’s foreign exchange activities and its ability to distribute dividends to the SPV. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—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.”

On December 25, 2006, the People’s Bank of China promulgated the “Measures for the Administration of Individual Foreign Exchange,” and on January 5, 2007, the SAFE further promulgated the implementation rules on those measures. Both became effective on February 1, 2007. According to the implementation rules, PRC citizens who are granted shares or share options by a company listed on an overseas stock market according to its employee share option or share incentive plan are required, through the PRC subsidiary of such overseas listed company or any other qualified PRC agent, to register with the SAFE and to complete certain other procedures related to the share option or other share incentive plan. Foreign exchange income received from the sale of shares or dividends distributed by the overseas listed company may be remitted into a foreign currency account of such PRC citizen or be exchanged into Renminbi. Our PRC citizen employees who have been granted share options are subject to the Individual Foreign Exchange Rules as a result of the listing of our ADSs on the NASDAQ Global Market.

Regulation on Dividend Distribution

The principal regulations governing distribution of dividends paid by wholly foreign-owned enterprises include:

 

   

Wholly Foreign-Owned Enterprise Law (1986), as amended; and

 

   

Wholly Foreign-Owned Enterprise Law Implementation Rules (1990), as amended.

Under these regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a wholly foreign-owned enterprise in China is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reach 50.0% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.

 

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Regulation on Overseas Listings

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, or the MOFCOM, and the CSRC, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. The M&A Rule, among other things, purports to require an offshore special purpose vehicle, or SPV, formed for the purpose of listing the SPV’s securities on an offshore securities exchange and controlled directly or indirectly by PRC companies or individuals, to obtain the approval of the CSRC prior to such offshore listing and trading. On September 21, 2006 the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, substantial uncertainty remains regarding the scope and applicability of the M&A Rule to overseas listings of offshore SPVs.

Our PRC counsel, Tian Yuan Law Firm, has advised us that, based on its understanding of the current PRC laws, regulations and rules, it was not necessary for us to obtain the CSRC’s approval for our initial public offering because we obtained approvals from local branches of MOFCOM for the acquisition of Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang, three of our wholly-owned subsidiaries in the PRC, before September 8, 2006, the effective date of the new regulation.

See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—If the approval of the China Securities Regulatory Commission was required in connection with our initial public offering in December 2009, we could be subject to sanctions, fines and other penalties. The regulation also establishes more complex procedures for acquisitions by foreign investors, which could make it more difficult to pursue growth through acquisitions.”

C. Organizational Structure

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

 

LOGO

 

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D. Property, Plant and Equipment

Our manufacturing facilities of 11,000 square meters are located in Penglai, Shandong Province, China. Our facilities in Penglai consist of office, research and development and manufacturing facilities. We lease the land and buildings on which our Penglai manufacturing facilities are located from a third party, Shandong Penglai Pharmaceutical Plant. Our current lease agreement expires December 31, 2014, and in November 2011, we entered into an agreement with Shandong Penglai Pharmaceutical Plant to lease this land and building from 2015 to 2021. In February 2008, we completed the construction of a 24,000-square-meter integrated facility in Shenyang, Liaoning Province, China with three additional production lines, a new research and development center and a warehouse. Both research and development center and warehouse are operational. We have obtained the drug production permits for these three production lines while their GMP certification is currently pending. In July 2010, we obtained the land use right of a parcel of land in Penglai, where we plan to build another production facility. We commenced the construction of the new facility in 2011, and we expect the facility to received GMP certification by the end of 2013 and become operational in 2014. We believe that our existing facilities, as well as the planned facility, are adequate for our current and foreseeable production requirements of our principal products.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included in this annual report. This report contains forward-looking statements. See “—G. Safe Harbor.” In evaluating our business, you should carefully consider the information provided under the caption “Item 3. Key Information—D. Risk Factors” in this annual report. We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.

A. Operating Results

Overview

We are a fully integrated, China-based biopharmaceutical company focused on the research, development, manufacture, marketing and sales of hospital-based products. We currently sell a portfolio of 16 products, including our three principal products of Baquting LOGO , Kaitong LOGO and ALA. Our product pipeline includes two product candidates under development that seek to better address the growing market and medical needs for bleeding control and 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, and beginning in the first quarter of 2011, Kaitong, a lipid emulsion alprostadil product treating peripheral vascular diseases, cardiocerebral microcirculation disorders and post-surgery thrombosis. In 2009, 2010 and 2011, Baquting accounted for 93.5%, 94.2% and 94.7% of our total net revenue, respectively, while our other marketed products collectively accounted for 6.5%, 5.8% and 5.3% of our total net revenue in the same periods. In January 2012, we acquired the manufacturing license and marketing rights for ALA from Qidu Pharma. We have begun to actively participate in the provincial tendering process for ALA and expect to begin recognizing revenues from this product in the second half of 2012.

 

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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 expanded from approximately 100 hospitals in 22 provinces in 2001 to over 4,200 hospitals in all 31 provinces in China as of March 31, 2012, including approximately 80% of the Class 3A hospitals in major Chinese cities. As of March 31, 2012, our sales force included six direct sales offices with 140 sales personnel, complemented by 16 third-party marketing agents with over 200 sales personnel. Our sales force also included nine contract sales partners with over 210 sales personnel, which were converted from our direct sales offices as a result of our ongoing sales force restructuring process beginning in January 2011. 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 13.1 million, 14.8 million and 15.2 million units of Baquting in 2009, 2010 and 2011. Our pharmaceutical products are distributed through Penglai Nuokang and Nuokang Distribution.

Our net revenue was RMB282.9 million, RMB315.8 million and RMB288.3 million ($45.8 million) in 2009, 2010 and 2011, respectively. Our net income was RMB65.1 million in 2009, RMB46.1 million in 2010 and our net loss was RMB14.0 million ($2.2 million) in 2011.

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, or 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 Baquting accounted for substantially all of our net revenue in 2009, 2010 and 2011. 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,  
     2009      2010      2011  
     RMB      %      RMB      %      RMB      $      %  
     (in thousands, except percentages)  

Baquting

     264,533         93.5         297,402         94.2         272,940         43,365         94.7   

Others marketed products

     18,378         6.5         18,387         5.8         15,329         2,436         5.3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     282,911         100.0         315,789         100.0         288,269         45,801         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 a one-year term that is generally renewed. As is typical in China, our distributors do not sell our products on an exclusive basis. In each of 2009 and 2010, Liaoning Pacific Medicine Co., Ltd., or Liaoning Pacific, contributed 10% or more of our total net revenue. Sales to Liaoning Pacific accounted for 5.5% of our total net revenue in the year ended December 31, 2011. Two customers, namely China National Medicines Corporation Ltd. and Beijing Shangyao Aixin Weiye Medicine Co., Ltd., each accounted for more than 10% of total net revenue in the year ended December 31, 2011. Our top five distributors in the aggregate accounted for 42.1%, 51.0% and 43.5% of our net revenue in 2009, 2010 and 2011, 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 marketing efforts are delineated into geographical regions, each covered exclusively by either our direct sales offices, third-party marketing agents or beginning in January 2011, contract sales partners. In 2009, 2010 and 2011, net revenue from Baquting sales made through our direct sales offices accounted for 67.7%, 65.3% and 54.5%, respectively, of our total Baquting sales revenue, and net revenue from Baquting sales made through third-party marketing agents accounted for the balance of 32.3%, 34.7% and 45.5%, 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 13.1 million, 14.8 million and 15.2 million units of Baquting in 2009, 2010 and 2011, respectively. 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.

 

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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, 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.

Product Mix

In 2009, 2010 and 2011, approximately 93.5%, 94.2% and 94.7% of the total net revenue was generated by sales of Baquting, respectively. Our other marketed products accounted for approximately 4.5%, 5.8% and 5.3% of our total net revenue in 2009, 2010 and 2011, respectively. Baquting is available in three differently-priced dosages, 0.5 unit/vial, 1 unit/vial and 2 units/vial. 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 2009 to 2011, 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,  
     2009      2010      2011  
     RMB      %      RMB      %      RMB      $      %  
     (in thousands, except percentages)  

0.5 unit/vial

     17,184         6.5         20,948         7.0         21,490         3,414         7.9   

1 unit/vial

     219,863         83.1         250,717         84.3         205,364         32,629         75.2   

2 units/vial

     27,486         10.4         25,738         8.7         46,086         7,322         16.9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     264,533         100.0         297,402         100.0         272,940         43,365         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We expect our product mix to diversify as we launch new products to market. We launched Kaitong in the first quarter of 2011 after Jilin Yuhua, the manufacturer of Kaitong, received the production permit from the SFDA in December 2010 and commenced production in January 2011. In December 2011, we entered into an agreement to acquire the manufacturing license and marketing rights for ALA from Qidu Pharma, and expect to begin recognizing revenues from ALA in the second half of 2012. We received the manufacturing license for dipyridamole aspirin sustained release capsules in December 2010 and the corresponding GMP certification in February 2011, and we plan to launch this product in the third quarter of 2012.

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 been increasingly accepted and recognized by 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, which focuses on detailing and promoting our products by providing physicians and hospitals with information on the benefits of our products and the clinical differences between our products.

 

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Product Pricing and Our Ability to Compete 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 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 eight 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 other marketed products that are not subject to price controls based on the prices of competing pharmaceuticals, if any, in the market. The maximum retail price at which lipid emlusion alprostadil products such as Kaitong may be sold to patients was reduced from RMB145 per unit to RMB123 per unit, as a result of the price control order issued by the NRDC on March 28, 2011, which lowered the price ceilings of 162 medicines in China.

Tender Process. The end-customers of our products, hospitals and healthcare institutions, purchase Baquting, Kaitong ALA, Aiduo and Aiwen 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 did not conduct sales and marketing activities for our other 11 products by ourselves and are not directly involved in the tender process for these products.

Patent. 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 enables us to be even more competitive in the tender processes. This patent will expire in 2025.

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,  
     2009      2010      2011  
     RMB      %      RMB      %      RMB      $      %  
     (in thousands, except percentages)  

Net revenue

     282,911         100.0         315,789         100.0         288,269         45,801         100.0   

Cost of revenue

     35,625         12.6         37,304         11.8         38,458         6,110         13.3   

Research and development costs

     8,297         2.9         13,504         4.3         15,737         2,500         5.5   

Selling, marketing and distribution expenses

     110,513         39.1         145,549         46.1         144,228         22,916         50.0   

General and administrative expenses

     47,582         16.8         53,527         17.0         71,188         11,311         24.7   

Total operating expenses

     166,392         58.8         212,580         67.3         231,153         36,727         80.2   

Cost of Revenue

Our cost of revenue includes costs of raw materials, packaging, labor costs and manufacturing overhead. Raw material costs include the cost of acquiring Bothrops atrox venom and other raw materials. Packaging costs primarily consists of costs of packaging materials for our products. Labor costs are primarily related to salaries and benefits for our personnel involved in the production of our products. Manufacturing overhead primarily comprises allocated utilities and depreciation of our production facilities.

 

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Our cost of revenues is affected by our ability to control raw material costs, achieve economies of scale in our operations and improve our manufacturing productivity and efficiency.

Operating Expenses

Our operating expenses include research and development costs, selling, marketing and distribution expenses and general and administrative expenses. We expect our operating expenses to increase in line with growth in our net revenue.

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 addition, our research and development costs also include 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 enhance our research and development efforts and capabilities. We have also received government grants for certain of our projects, which we record as reductions in our research and development costs after certain conditions or performance obligations attached to these grants have been satisfied. In 2009, 2010 and 2011, we received RMB1.6 million, RMB3.0 million and RMB0.2 million ($31,777) in government grants, respectively, which were required to be used in research and development activities.

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.

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.

Non-controlling Interest

In July 2009, we entered into a cooperative arrangement with QrxPharma Limited, which has spun off its snake venom-related products to a new subsidiary, VPL. We have invested $500,000 for a 10% interest in VPL through our subsidiary, Surplus International.

 

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Taxation

The Cayman Islands and Hong Kong

We are an 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 16.5% 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, 2009, 2010 and 2011. 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.

Enterprise Income Tax

Our four wholly-owned subsidiaries, Liaoning Nuokang, Shenyang Shouzheng, Penglai Nuokang and Nuokang Distribution, are incorporated in the PRC and therefore are subject to 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 EIT law on January 1, 2008, domestic companies were generally subject to the EIT at a statutory rate of 33%. Liaoning Nuokang, Shenyang Shouzheng and Penglai Nuokang 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 “high and new technology enterprises” located in the Shenyang Economic and Technology Development Zone in Liaoning Province of 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%. Enterprises may choose to benefit from the two-year tax exemption and three-year tax reduction of 50% tax holidays or the reduced EIT rate of 15% during the transition period before the expiration of the tax holidays. In 2008, relevant PRC authorities recognized Liaoning Nuokang and Penglai Nuokang as “high and new technology enterprises.” This status was renewed for the three years ending December 31, 2013. Shenyang Shouzheng received its “high and new technology enterprise” qualification commencing 2010, and we will apply for an extension of this qualification when it expires in December 31, 2012. Liaoning Nuokang, Penglai Nuokang and Shenyang Shouzheng have chosen to benefit from the tax holidays during the transition period. However, after the expiration of the tax holidays, Liaoning Nuokang, Penglai Nuokang and Shenyang Shouzheng may not continue to be qualified as “high and new technology enterprises.” See “Item 3. Key Information—D. 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 for the periods indicated.

 

Subsidiary    2007     2008     2009     2010     2011  

Liaoning Nuokang

     0 %     12.5 %     12.5 %     12.5 %     15.0

Shenyang Shouzheng

     0 %     0 %     12.5 %     12.5 %     12.5

Penglai Nuokang

     0 %     12.5 %     12.5 %     12.5 %     15.0

Nuokang Distribution

     33 %     25.0 %     25.0 %     25.0 %     25.0

 

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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.

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.

Revenue Recognition

We record revenue when the criteria of FASB Accounting Standards Codification, or 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) collectability is reasonably assured. More specifically, our sales arrangements are evidenced by individual sales agreements or purchase orders based on master sales agreements. 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 consist of personnel-related expenses for internal research and development activities or costs incurred for research and development activities performed by third party service providers. Research and development costs are expensed as incurred.

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 collectability 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.

Allowance for doubtful accounts amounted to RMB393,860, RMB393,860 and RMB393,860 ($62,578) as of December 31, 2009, 2010 and 2011, respectively, representing 0.4%, 0.3% and 0.6% 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.

 

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Inventories and Allowance for Obsolescence

We state inventories at the lower of cost or market value, determined using the weighted average cost method. Costs of raw materials and consumables and packaging materials are based on purchase costs while costs of work-in-progress and finished goods comprise direct materials, direct labor and an allocation of manufacturing overhead costs. 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 or asset group and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets or asset group, we would recognize an impairment loss based on the excess of the carrying amount of the assets or 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 ASC Topic 740, or ASC 740, “Income Taxes.” ASC 740 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 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 December 31, 2011.

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. In October 2008, we adopted another share option scheme. We cancelled all of our outstanding share options in December 2011.

We granted a total of 681,000 and 591,000 restricted share units our executive officers and certain directors in July 2010 and June 2011, respectively, under our 2008 share option scheme.

We accounted for share options or restricted share units granted to employees and non-employees under ASC Topic 718, “Compensation—Stock Compensation” and 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. We have elected to recognize compensation expense using the straight-line method 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, or 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. The binomial option pricing model was applied 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. For expected volatilities, reference was made 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.

 

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Cancellation of an award accompanied by the concurrent grant of a replacement award is accounted for as a modification of the terms of the cancelled award. Cancellation of an award not accompanied by the concurrent grant of or an offer to grant a replacement award is accounted for as a repurchase for no consideration. Accordingly, there is no reversal of previously recognized compensation cost, and any previously measured but unrecognized cost is accelerated at the cancellation date.

Options granted to employees

Prior to our initial public offering, we accounted for our options granted to employees as liability awards because the options are indexed to the U.S. dollar to RMB exchange rate in addition to the fair value of the underlying shares, and the exercise price is dominated in U.S. dollar while our functional currency is RMB. Upon our initial public offering, we started to account for our options granted to employees as equity awards, because our shares are publicly traded in the United States and as a result, the options are no longer considered dual-indexed. The fair value of the options granted to employees are remeasured on the date of our initial public offering, with the fair value of the options reclassified to equity and the fair value of the unvested options to be recognized over the remaining requisite service period as compensation expenses using the straight-line method.

We calculated the estimated fair value of the options on the date of our initial public offering using the binomial option pricing model with the following assumptions:

 

     December 9, 2009

Suboptimal exercise factor

   1.5

Risk-free interest rates

   1.28%-2.67%

Expected volatility

   63.10%-78.10%

Expected dividend yield

   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.

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. Upon the completion of our initial public offering in December 2009, we incurred RMB4.3 million of share-based compensation expenses relating to the 960,000 options granted to non-employees. The compensation expense was determined using the Black-Scholes option pricing model which takes into account a number of variables including the fair value of our ordinary shares at the measurement date.

Restricted Share Units

Pursuant to the restricted share grant agreement, one third of total restricted share units will become vested at each anniversary of the three years from the grant date, and all unvested restricted shares continue to vest even though employment or service is terminated due to retirement, voluntary resignation or layoff due to our strategic restructuring. As the service condition is not considered substantive, we fully recognized the entire compensation cost relating to the restricted share units on their respective grant dates.

We recorded compensation expenses of RMB2.7 million relating to 681,000 restricted share units granted on July 1, 2010 and RMB2.3 million ($0.4 million) relating to 591,000 restricted share units granted on June 1, 2011.

 

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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 annual report. 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,  
     2009     2010     2011  
     RMB     RMB     RMB     $  
     (in thousands)  

Consolidated statement of income data

        

Net revenue

     282,911        315,789        288,269        45,801   

Cost of revenue

     (35,625 )     (37,304 )     (38,458     (6,110
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     247,286        278,485        249,811        39,691   

Operating expenses

        

Research and development costs

     (8,297 )     (13,504 )     (15,737     (2,500

Selling, marketing and distribution expenses

     (110,513 )     (145,549 )     (144,228     (22,916

General and administrative expenses

     (47,582 )     (53,527 )     (71,188     (11,311
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit

     80,894        65,905        18,658        2,964   

Interest income

     1,372        1,198        1,508        240   

Interest expense

     (3,327 )     (7,147 )     (3,096     (492

Foreign exchange gain (losses)

     178        (5,825 )     (5,142     (817

Other (losses) income, net

     2,836        2,473        (13,400     (2,129
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income tax expense and non-controlling interest

     81,953        56,604        (1,472     (234

Income tax benefit (expense)

     (16,858 )     (10,606 )     (12,662     (2,012

Net income (loss)

     65,095        45,998        (14,134     (2,246

Net loss attributable to non-controlling interest

     —          (64     (128     (20

Net income (loss) attributable to shareholders

     65,095        46,062        (14,006     (2,226

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

 

     Year Ended December 31,  
     2009     2010     2011  

Net revenue

     100.0        100.0        100.0   

Cost of revenue

     (12.6 )     (11.8 )     (13.3

Gross profit

     87.4        88.2        86.7   

Operating expenses

      

Research and development costs

     (2.9 )     (4.3 )     (5.5

Selling, marketing and distribution expenses

     (39.1 )     (46.1 )     (50.0

General and administrative expenses

     (16.8 )     (17.0 )     (24.7

Total operating expenses

     (58.8 )     (67.3 )     (80.2

Operating profit

     28.6        20.9        6.5   

Interest income

     0.5        0.4        0.5   

Interest expense

     (1.2 )     (2.3 )     (1.1

Foreign exchange gain (losses)

     0.1        (1.8 )     (1.8

Other (losses) income, net

     1.0        0.8        (4.6

Income (loss) before income tax expense and non-controlling interest

     29.0        17.9        (0.5

Income tax benefit (expense)

     (6.0 )     (3.4 )     (4.4

Non-controlling interest

     —          —       

Net income/(loss)

     23.0        14.6        (4.9

 

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Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Net revenue. Our net revenue decreased by RMB27.5 million, or 8.7%, from RMB315.8 million for the year ended December 31, 2010 to RMB288.3 million ($45.8 million) for the year ended December 31, 2011. Although sales volume for Baquting, our primary product, increased slightly from 14.8 million units in 2010 to 15.2 million units in 2011, our net revenue decreased due to a greater percentage of revenues from lower-priced marketing agent sales of Baquting as a result of our restructuring efforts.

Cost of revenue. Our cost of revenue increased by RMB1.2 million, or 3.2%, from RMB37.3 million for the year ended December 31, 2010 to RMB38.5 million ($6.1 million) for the year ended December 31, 2011. Cost of revenue as a percentage of our net revenue increased to 13.3% in the year ended December 31, 2011 from 11.8% in the year ended December 31, 2010. The increase in our cost of revenue as a percentage of our net revenue is primarily due to cost of revenue remaining stable while net revenue decreased due to the aforementioned increase in percentage of revenues from lower-margin marketing agent sales.

Operating expenses. Our operating expenses increased by RMB18.6 million, or 8.7%, from RMB212.6 million for the year ended December 31, 2010 to RMB231.2 million ($36.7 million) for the year ended December 31, 2011. Operating expenses as a percentage of our net revenue increased from 67.3% in 2010 to 80.2% in 2011.

 

   

Research and development costs. Our research and development costs increased by 16.3% from RMB13.5 million for the year ended December 31, 2010 to RMB15.7 million ($2.5 million) for the year ended December 31, 2011. This increase was primarily attributable to increased research and development costs for our new and pipeline products.

 

   

Selling, marketing and distribution expenses. Our selling, marketing and distribution expenses remained stable at RMB145.5 million for the year ended December 31, 2010, compared to RMB144.2 million ($22.9 million) for the year ended December 31, 2011.

 

   

General and administrative expenses. Our general and administrative expenses increased by 33.1% from RMB53.5 million for the year ended December 31, 2010 to RMB71.2 million ($11.3 million) for the year ended December 31, 2011, primarily due to the incurrence of significant one-time charges, such as costs associated with our exploration of strategic alternatives of approximately RMB11.6 million ($1.8 million), and an increase in allowance for non-trade receivables of RMB8.6 million ($1.4 million).

Interest income. Our interest income increased by 25.0% from RMB1.2 million for the year ended December 31, 2010 to RMB1.5 million ($0.2 million) for the year ended December 31, 2011. This increase was primarily due to increased interest-bearing fixed cash deposits from the fourth quarter of year 2010, which contributed more interest income in year 2011.

Interest expense. Our interest expense decreased by RMB4.0 million, or 56.3%, from RMB7.1 million for the year ended December 31, 2010 to RMB3.1 million ($0.5 million) for the year ended December 31, 2011. This decrease was primarily due to the repayment of short-term bank loans of approximately RMB40.0 million ($6.4 million).

Other income/(loss). Our other loss for the year ended December 31, 2011 was RMB13.4 million ($2.1 million), compared to other income of RMB2.5 million for the year ended December 31, 2010. Our other loss in 2011 was primarily due to one-time settlement costs for certain lease obligations. We also had a one-time government grant in 2010 which contributed to other income in 2010.

 

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Income tax expense. Our income tax expense increased from RMB10.6 million for the year ended December 31, 2010 to RMB12.7 million ($2.0 million) for the year ended December 31, 2011. This increase was primarily due to the increase from valuation allowance of Nuokang Distribution and tax donation income received by Penglai Nuokang from Mr. Xue upon termination of the VIE Agreements in June 2011.

Net income/(loss). As a result of the foregoing, we had net loss of RMB14.0 million ($2.2 million) for the year ended December 31, 2011, compared to a net income of RMB46.0 million for the year ended December 31, 2010.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

Net revenue. Our net revenue increased by RMB32.9 million, or 11.6%, from RMB282.9 million for the year ended December 31, 2009 to RMB315.8 million for the year ended December 31, 2010. This increase was due to an increase of RMB32.9 million, or 12.4%, in sales of Baquting.

The increase in Baquting sales was primarily due to an increase in the sale volume of Baquting from 13.1 million units in the year ended December 31, 2009 to 14.8 million units in the year ended December 31, 2010. This increase was attributable to 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 remained stable. Sales of our other products experienced modest growth.

Cost of revenue. Our cost of revenue increased by RMB1.7 million, or 4.7%, from RMB35.6 million for the year ended December 31, 2009 to RMB37.3 million for the year ended December 31, 2010. Cost of revenue as a percentage of our net revenue decreased to 11.8% in the year ended December 31, 2010 from 12.6% in the year ended December 31, 2009. The decrease in our cost of revenue as a percentage of our net revenue is primarily due to increased sales of higher margin products such as Baquting and improved economies of scale and efficiencies in manufacturing processes.

Operating expenses. Our operating expenses increased by RMB46.2 million, or 27.8%, from RMB166.4 million for the year ended December 31, 2009 to RMB212.6 million for the year ended December 31, 2010. Operating expenses as a percentage of our net revenue increased from 58.8% in 2009 to 67.3% in 2010.

 

   

Research and development costs. Our research and development costs increased by 62.8% from RMB8.3 million for the year ended December 31, 2009 to RMB13.5 million for the year ended December 31, 2010. This increase was primarily attributable to an increase in expenses associated with the development of our pipeline products, including Agkistrodon Acutus hemocoagulase, as well as our general hemocoagulase research activities.

 

   

Selling, marketing and distribution expenses. Our selling, marketing and distribution expenses increased by 31.7% from RMB110.5 million for the year ended December 31, 2009 to RMB145.5 million for the year ended December 31, 2010. The increase was primarily due to the preparation costs for the launch of our new products, Kaitong and dipyridamole aspirin, as well as the increase in the sales and marketing expenses for Baquting in response to the increasingly intense competition.

 

   

General and administrative expenses. Our general and administrative expenses increased by 12.5% from RMB47.6 million for the year ended December 31, 2009 to RMB53.5 million for the year ended December 31, 2010, primarily due to the increase in our professional service fees as a U.S. listed public company.

Interest income. Our interest income decreased by 12.7% from RMB1.4 million for the year ended December 31, 2009 to RMB1.2 million for the year ended December 31, 2010. This decrease was primarily due to a decrease in the average balance of interest-bearing savings accounts.

Interest expense. Our interest expense increased by RMB3.8 million, or 114.8%, from RMB3.3 million for the year ended December 31, 2009 to RMB7.1 million for the year ended December 31, 2010. This increase was primarily due to a decrease in interest expense reimbursements from the amortization of deferred government grants.

Other income. Our other income decreased by RMB0.5 million from RMB2.8 million for the year ended December 31, 2009 to RMB2.5 million for the year ended December 31, 2010.

 

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Income tax expense. Our income tax expense decreased from RMB16.9 million for the year ended December 31, 2009 to RMB10.6 million for the year ended December 31, 2010. This decrease was primarily due to a decrease in our taxable income.

Net income. As a result of the foregoing, we had net income of RMB46.0 million for the year ended December 31, 2010, compared to a net income of RMB65.1 million for the year ended December 31, 2009.

B. Liquidity and Capital Resources

We have financed our operations primarily through cash flows from operations, short-term bank borrowings, the sale of preferred shares in private placements and proceeds from our initial public offering in December 2009. We believe that our current levels of cash and cash flows from operations and bank borrowings, combined with the net proceeds from our initial public offering in December 2009, 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.

As of December 31, 2009, 2010 and 2011, we had RMB351.2 million, RMB191.8 million and RMB179.4 million ($28.5 million), respectively, in cash and cash equivalents. Our cash and cash equivalents primarily consist of cash on hand and demand deposits with original maturities of three months or less that are placed with banks and other financial institutions.

As of December 31, 2009, 2010 and 2011, we had RMB125.6 million, RMB47.0 million and RMB7.0 million ($1.1 million) in outstanding short-term bank loans and borrowings, respectively. Our outstanding short-term bank loans and borrowings as of December 31, 2011 bore a weighted average interest rate of 7.216% per annum. These short-term bank loans and borrowings have terms one year 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 certain of the facilities shortly before they mature. These loans are secured by certain of our property, plant and equipment and land use rights.

Cash Flows and Working Capital

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,  
     2009     2010     2011  
     RMB     RMB     RMB     $  
     (in thousands)  

Net cash provided by (used in) operating activities

     9,109        (21,168 )     82,054        13,037   

Net cash used in investing activities

     (33,241 )     (79,556 )     (27,435     (4,359

Net cash provided by (used in) financing activities

     293,553        (52,167 )     (62,191     (9,881

Net increase (decrease) in cash and cash equivalents

     269,421        (159,436 )     (12,437     (1,976

Cash and cash equivalents at beginning of the period

     81,837        351,258        191,822        30,477   

Cash and cash equivalents at end of the period

     351,258        191,822        179,385        28,501   

Operating Activities

Net cash provided by operating activities was RMB82.1 million ($13.0 million) in 2011, compared to net cash used in operating activities of RMB21.2 million in 2010, primarily due to RMB49.1 million of cash inflow from a decrease in accounts receivable and bills receivable resulting from decrease in sales in 2011, especially in the fourth quarter, compared to 2010, RMB13.2 million in cash inflow from decreases in accrued expenses and other payables and increases in non-cash costs such as share-based compensation, depreciation and amortization and one-time allowance for other receivables.

 

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Net cash used in operating activities was RMB21.2 million in 2010, as opposed to net cash provided by operating activities of RMB9.1 million in 2009. Although our growing business generated an RMB32.9 million increase in our net revenue from 2009 to 2010, we experienced a cash outflow because our accounts and bills receivables increased by RMB22.5 million for 2010 compared to 2009, as our account receivable turnover days increased from 111 days to 135 days as a result of our market promotion efforts.

Investing Activities

Net cash used in investing activities amounted to RMB27.4 million ($4.4 million) in the year ended December 31, 2011, mainly as a result of purchase of property, plant and equipment of RMB57.1 million ($9.1 million) primarily related to the construction of our new facility in Penglai, partially offset by proceeds from sales of short-term investments of RMB30.1 million ($4.8 million).

Net cash used in investing activities amounted to RMB79.6 million in the year ended December 31, 2010, mainly as a result of (1) the upgrade and construction of our facilities in Penglai for RMB32.7 million, (2) purchases of or investments in certificates of deposit of RMB29.9 million, (3) purchase of land use right for the construction of our new facility in Penglai for RMB10.2 million, and (4) prepayment of RMB10.0 million for exclusive distribution rights in connection with an in-licensed cardiovascular products.

Net cash used in investing activities amounted to RMB33.2 million in the year ended December 31, 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 RMB26.8 million, (2) prepayment of RMB6.0 million for exclusive distribution rights, (3) payment of RMB3.4 million for our investment in a joint venture, (4) payment of RMB2.0 million for our investment in an investment fund offset by proceeds from the disposal of plant, property and equipment of RMB1.2 million and loan repayment from a related party of RMB3.8 million.

Financing Activities

Net cash used in financing activities amounted to RMB62.2 million ($9.9 million) in the year ended December 31, 2011, mainly as a result of repayment of short-term bank loans of RMB40.0 million ($6.4 million) and our repurchase of our ordinary shares for RMB22.4 million ($3.6 million).

Net cash used in financing activities amounted to RMB52.1 million in the year ended December 31, 2010, mainly as a result of repayment of RMB166.8 million of short-term bank loans and payment of RMB8.3 million of IPO expenses, which was partially offset by the receipt of RMB88.5 million of short-term bank loans and the release of restricted cash of RMB34.2 million.

Net cash provided by financing activities amounted to RMB293.6 million in the year ended December 31, 2009, mainly as a result of proceeds from our initial public offering of RMB257.3 million, proceeds of RMB128.4 million from short-term borrowings, partially offset by the repayment of RMB75.2 million of short-term bank loans, the pledge of cash amounts of RMB14.2 million for guarantees related to our operations and the repayment of RMB5.8 million to a related party.

Capital Expenditures

We had capital expenditures of RMB26.9 million, RMB32.7 million and RMB57.1 million ($9.1 million) for the years ended December 31, 2009, 2010 and 2011, respectively. 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 2012, we expect to incur capital expenditures of approximately RMB61.5 million ($9.8 million). We expect our capital expenditures in 2012 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 our initial public offering.

 

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Recent Accounting Pronouncements

In May 2011, the FASB issued ASU No. 2011-04, or ASU 2011-04, “Fair Value Measurement”, or ASC 820, which amends the fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. We adopted ASU 2011-04 beginning January 1, 2012 and does not expect the adoption to have a material impact on our consolidated financial statements and disclosures.

In June 2011, the FASB issued ASU No. 2011-05, or ASU 2011-05, “Comprehensive Income (Topic 220), Presentation of Comprehensive Income”, which eliminates the current option to report other comprehensive income, or OCI, and its components in the statements of shareholders’ equity. Instead, an entity will be required to present items of net income and OCI in one continuous statement or in two separate, but consecutive, statements. In December 2011, the FASB issued ASU No. 2011-12, or AUS 2011-12, “Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” This ASU defers the ASU 2011-05 requirement that companies present reclassification adjustments for each component of OCI in both net income and OCI on the face of the financial statements and the requirement to report reclassification adjustments in interim periods. The amendments in ASU 2011-05 and ASU 2011-12 should be applied retrospectively and are effective for fiscal years and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. We adopted ASU 2011-05 beginning January 1, 2012 and do not expect the adoption to have a material impact on our consolidated financial statements and disclosure.

C. Research and Development

As of March 31, 2012, our research and development team consisted of 34 research personnel and medical professionals. Our research and development personnel comprises medical and biopharmaceutical professionals, many of whom have experience in healthcare and biotechnological research, including experience working in research institutions and hospitals and in proceeding through the SFDA drug approval process. Our research and development management committee oversees our research and development activities and consists of senior management members, company scientists and senior scientific advisors with extensive academic and industry experiences in the healthcare and biotechnology research fields.

Currently, we conduct our research and development activities in our facilities in Shenyang and Penglai, where we have the full spectrum of in-house research and development capabilities, from drug discovery to regulatory approval. Our research and development facility in Shenyang has five laboratories, including a protein extraction and analysis lab, a compound process lab, a biological engineering lab, an analysis lab, a polypeptide pharmaceutical lab and a clinical research lab. Our research and development facility in Penglai has two laboratories, including a pharmaceutical formulation lab and a pilot-scale lab. Our research and development facilities are equipped with modern branded equipment.

To date, our primary sources of new clinical products have been our research and development activities, including engaging in research and innovation of our key existing technologies, leveraging our key technologies in support of enhanced quality, expanded indications and clinical development of our existing products, and the acquisition and commercialization of new technologies and products from third parties through acquisitions and partnerships. Our research and development team has experience identifying, developing and commercializing product development candidates at various stages of development with commercial potential in our core therapeutic areas.

Our research and development team also maintains cooperative relationship and collaborates closely with domestic and international research institutions, laboratories and universities on new drug development. We believe by complementing our internal research and development efforts with a disciplined strategy of entering into collaborative relationships, we can further build a pipeline of diversified pharmaceuticals to drive sustainable revenue growth. We are carrying out several major research projects in hematological and cardiovascular areas that were sponsored by provincial and municipal health departments and we also serve as a post-doctoral scientific research station designated by relevant local authorities in Shenyang, China. Our research and development expenses were RMB8.3 million, RMB13.5 million and RMB15.7 million ($2.5 million) in 2009, 2010 and 2011, respectively, representing 2.9%, 4.3% and 5.5% of our net revenue in those respective periods.

D. Trend Information

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the period from January 1, 2011 to December 31, 2011 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

 

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E. Off-Balance Sheet Commitments and Arrangements

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.

F. Tabular Disclosure of Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2011:

 

     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)

     22,000         2,100         4,200         4,200         11,500   

Operating lease obligations

     458         458         —           —           —     

Purchase obligations (2)

     17,536         14,701         2,835         —           —     

Unrecognized tax benefit

     2,656         809         1,847         —           —     

Total

     42,650         18,068         8,882         4,200         11,500   

 

(1) In connection with the acquisition of a non-controlling interest in Penglai Nuokang, we have a total contractual obligation of RMB22.0 million ($3.5 million) as of December 31, 2011 to Shandong Penglai Pharmaceutical Plant, of which RMB2.1 million ($0.3 million) will be paid annually until December 31, 2016 and RMB2.3 million ($0.4 million) will be paid annually until December 31, 2021.
(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.

G. Safe Harbor

This annual report on Form 20-F contains statements of a forward-looking nature. These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. 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; and

 

   

fluctuations in general economic and business conditions in China.

 

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Any or all of our forward-looking statements in this annual report 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 “Item 3. Key Information—D. Risk Factors.” In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this annual report 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 annual report. 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 annual report. See “Item 10. Additional Information—H. Documents on Display.”

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. Directors and Senior Management

Set forth below is the name, age, position and a brief account of the business experience of each of our executive officers and directors as of the date of this annual report. The business address for each of our executive officers and directors is No. 18-1 East Nanping Road, Hunnan National New & High-tech Development Zone, Shenyang, Liaoning Province, People’s Republic of China 110171.

 

Name    Age    Position/Title

Baizhong Xue

   47   

Chairman and Chief Executive Officer

Qiang Liu

   46   

Director

Neil Nanpeng Shen

   45   

Director

Sean Shao

   55   

Independent Director

David Xiaoying Gao

   62   

Independent Director

Mingde Yu

   66   

Independent Director

Huining Cao

   46   

Independent Director

Tianruo Pu

   44   

Chief Financial Officer

Hongying Wang

   39   

Executive Vice President

Felix Chungfai Wong

   52   

Finance Director

Tong Le

   45   

Vice President of Sales & Marketing

Yan Xue

   35   

Director of Research and Development

Shizheng Duan

   44   

Vice President of Investor Relations and Board Secretary

 

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Baizhong Xue is the founder of our company and has been our chairman and chief executive officer since our inception in November 1997. Mr. Xue has extensive experience in research and development, sales and marketing and corporate management. From 1994 to 1997, Mr. Xue was the chief scientist at Xinmin Biotechnology Research Institute, a company engaged in biotechnology research and development. Prior to July 1994, he conducted research related to biotechnology commercialization at Shenyang New Technology Commercialization Research Institute since 1992. Mr. Xue is currently the vice chairman of the China Biochemical Industrial Association and the executive vice chairman of Liaoning Biotechnology Association. Mr. Xue holds a bachelor’s degree in biochemistry from Jilin University, China and a master’s degree in microbiology from the Microorganism Research Institute of Shandong University, China.

Qiang Liu has been our vice president of business development since January 2006 and has served as our director since December 2007. Mr. Liu has over ten years of experience in sales, marketing, corporate finance and financial analysis. Since June 2006, Mr. Liu has been the founding managing director of Tangent Capital Inc., an investment firm providing equity capital and corporate finance advisory services to Chinese companies. From August 2007 to December 2008, Mr. Liu served as the president of BCTech Investments Inc., a Toronto-based environmental business service firm. Mr. Liu received his bachelor’s degree in biochemistry from Jilin University, China in 1989, a master’s degree in biotechnology from the University of New South Wales in Australia in 1996 and an MBA from the Schulich School of Business at York University, Canada in 2000.

Neil Nanpeng Shen has been our company’s director since December 2007. Mr. Shen is the founding managing partner of Sequoia Capital China. Mr. Shen co-founded Ctrip.com International Ltd., the largest travel consolidator in China, and served as its chief financial officer from 2000 to October 2005 and as its president from August 2003 to October 2005. He also co-founded Home Inns and Hotels Management, a leading economy hotel chain in China. Prior to founding Ctrip and Home Inns, Mr. Shen had worked at Deutsche Bank, Chemical Bank, Lehman Brothers and Citibank, possessing over eight years of investment banking experience in New York and Hong Kong. Currently, Mr. Shen is a co-chairman of Home Inns, a director of Ctrip, a director of E-House (China) Holdings Limited, a NYSE-listed real estate service company in China, a director of China Real Estate Information Corporation, a NASDAQ-listed real estate information service company in China and a director of Peak Sport Products, a Hong Kong Stock Exchange listed sports apparel company in China, a director of Qihoo 360 Technology Co. Ltd., a NYSE-listed Internet security products company in China, a director of Le GaGa Holdings Limited, a NASDAQ-listed farmland and greenhouse vegetable producer in China, a director of Mecox Lane Limited, a NASDAQ-listed online apparel platform provider in China. He is also an independent director of Focus Media Holding Limited, a NASDAQ-listed media advertising company based in China and a director of a number of privately owned companies based in China. Mr. Shen received a bachelor’s degree from Shanghai Jiao Tong University, China in 1988 and a master’s degree from the School of Management at Yale University in 1992.

Sean Shao has been our company’s independent director since August 2008. He currently serves as (i) independent director and chairman of the audit committee of: Xueda Education Group, a Chinese personalized tutoring services company listed on NYSE since March 2010; China Biologic Products, Inc., a biopharmaceutical company listed on NASDAQ since July 2008 and Yongye International, Inc., a Chinese agricultural company listed on NASDAQ since April 2009; (ii) independent director and chairman of the compensation committee of AsiaInfo-Linkage, Inc., a Chinese telecom software solutions provider listed on NASDAQ since July 2010 (iii) independent director and chairman of the nominating committee of Agria Corporation, a Chinese agricultural company listed on NYSE since November 2008; and (iv) independent director and chairman of the audit committee and compensation committee of China Nuokang Bio-Pharmaceutical, Inc., a biopharmaceutical company listed on NASDAQ since September 2008. He served as the chief financial officer of Trina Solar Limited from 2006 to 2008. In addition, Mr. Shao served from 2004 to 2006 as the chief financial officer of ChinaEdu Corporation, an educational service provider, and of Watchdata Technologies Ltd., a Chinese security software company. Prior to that, Mr. Shao worked at Deloitte Touche Tohmatsu CPA Ltd. for approximately a decade. Mr. Shao received his master’s degree in health care administration from the University of California at Los Angeles in 1988 and his bachelor’s degree in art from East China Normal University in 1982. Mr. Shao is a member of the American Institute of Certified Public Accountants.

David Xiaoying Gao has been our company’s independent director since December 2011. Mr. Gao served as the chief executive officer and a director of BMP Sunstone (Nasdaq:BJGP) from February 2004 until its acquisition by Sanofi-aventis in February 2011. Following the acquisition, he transitioned to become a senior integration advisor for Sanofi-aventis from February 2011 to August 2011. Previously, Mr. Gao served as chairman of the board of directors and CEO of Abacus Investments Ltd., a private wealth management company, and also held various executive positions at Motorola, Inc. including vice-president and director of the integrated electronic system sector, Asia-Pacific operations; and served as a member of the management board of Motorola Asia Pacific, Motorola Japan Ltd. and Motorola China. Mr. Gao holds a B.S. in mechanical engineering from the Beijing Institute of Technology, a M.S. in mechanical engineering from Hanover University in Germany and an M.B.A. from the Massachusetts Institute of Technology. Mr. Gao also currently serves as an independent director for China Biologic Products Inc., a company listed on NASDAQ.

 

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Mingde Yu has been our company’s independent director since August 2008. Mr. Yu has extensive experience in manufacturing and distribution management in the pharmaceutical industry in China. He has held a number of senior positions both in the government and the private sectors, including as the vice-bureau chief of the Economic Operations Department of the National Development and Reform Commission from 1998 to 2003, the drug department chief of the Economic Operations Bureau of the State Economic and Trade Committee from 1997 to 1998, the bureau chief of the Liaoning Provincial Food & Drug Administration from 1991 to 1997, the bureau chief of the Fuxin City Food & Drug Administration from 1983 to 1991 and the chief technology officer and the head of manufacturing at both Liaoning Fuxin Pharmaceutical Co. and Fuxin Traditional Chinese Medicine Co. from 1978 to 1983. Mr. Yu is currently the honorary chairman and director of the Beijing Pharmaceutical Group and is the vice committee chairman for the China Pharmaceutical Enterprises Administrative Association and China Medical Entrepreneur Association. In addition, Mr. Yu holds senior consultancy roles with the China Chemical Drug Association and the National Pharmaceutical Industry & Commerce Association. Mr. Yu also serves as an independent director of 3Sbio Inc., a biotechnology company in China listed on the NASDAQ Global Market, an independent director of North China Pharmaceutical Co., Ltd., a Shanghai Stock Exchange listed company, and an independent director of Shandong Wohua Pharmaceuticals Technology Corporation, a Shenzhen Stock Exchange listed company. Mr. Yu graduated from the Macromolecule Materials and Engineering Department of the Chemical Technology School at the Dalian University of Technology in China.

Huining Cao has been our company’s independent director since August 2010. Mr. Cao is currently a professor of finance and serves as academic director for the Finance MBA program at the Cheung Kong Graduate School of Business. Before joining the Cheung Kong Graduate School of Business, Mr. Cao held various faculty positions at the University of California, Berkeley, the University of California, San Diego, Ohio State University, Carnegie Mellon University and the University of North Carolina at Chapel Hill. Mr. Cao’s research has been published in various journals, including the Journal of Finance, Review of Financial Studies and the Journal of Financial Economics. Mr. Cao is an independent director of Shenzhen Focus Technology Co., Ltd., a company listed on the Shenzhen Stock Exchange, the editor of International Financial Review and sitting on the editorial board of the Annals of Economics and Finance and China Financial Review. Mr. Cao holds a Ph.D. in finance from the University of California, Los Angeles and a Ph.D. in pathology from Yale University.

Tianruo Pu has been our chief financial officer since September 2008. Mr. Pu has over 10 years of experience in accounting, finance and management. Prior to joining our company, Mr. Pu was the chief financial officer of Global Data Solutions, a Chinese information technology services outsourcing company, which he joined in June 2006. From September 2000 to May 2006, he worked as a management consultant with Accenture, CSC Consulting Group and Mitchell Madison Consulting Group, where he provided various management consulting services. He worked as an accountant at GATX Corporation from July 1997 to May 1999, and an auditor at Bernstein Brown CPAs from June 1994 to May 1997. Mr. Pu received his MBA degree from Northwestern University Kellogg School of Management in 2000, his Master of Science degree in accounting from the University of Illinois College of Business Administration in 1995 and Bachelor of Art degree in English from China Foreign Affairs College in 1992.

Hongying Wang has been our executive vice president since October 2007. Ms. Wang joined our company in July 1998 and has been responsible for managing our marketing department and our research and development facilities, production base and quality control system. She has also participated in the research and development of our hemocoagulase formulation project. Prior to 1998, Ms. Wang worked as a technology supervisor at Shenyang Lantian Group Xinbei Pharmaceutical Co., Ltd. Ms. Wang received a bachelor’s degree in microbiology from Liaoning University, China in 1996 and an MBA degree from Northeastern University, China in 2006.

Felix Chungfai Wong has been our finance director since February 2012. Mr. Wong has three decades of experience in finance, management and accounting in the U.S. and Greater China. He joins Nuokang from ITT Corporation, a company listed on the New York Stock Exchange, where he held various senior financial management positions including finance business expert for ITT China & India and finance controller for ITT China. Prior to that, he held various senior finance positions across a broad range of industries, including finance manager of Roche (China) Investment Ltd., one of the world’s leading pharmaceutical and diagnostics firms. He also has a decade of auditing experience in large multinational accounting firms in Hong Kong and Singapore, including management roles such as assistant manager. Mr. Wong graduated from the Accountancy Faculty of the Hong Kong Polytechnic University and is a member of the Hong Kong Institute of Certified Public Accountants, the Association of Chartered Certified Accountants and the Institute of Chartered Accountants in England & Wales.

 

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Tong Le has been our vice-president of sales and marketing since February 2012. Mr. Le has two decades of sales and marketing experience in both Chinese and multinational pharmaceutical companies. Mr. Le joins Nuokang from Dawnrays Pharmaceutical, a company listed on the Hong Kong Stock Exchange, where he held various roles including marketing director and deputy general manager of the New Drug Section. Prior to Dawnrays, Mr. Le has also held a variety of key sales and marketing roles, including national marketing manager of Health Vision Enterprise, a subsidiary of German-listed Stada AG; product manager at Shenzhen Taitai Pharmaceutical; regional manager at Baker Norton Pharmaceutical, the Asia subsidiary of TEVA Pharmaceutical; and sales representative at Merck. Mr. Le holds a bachelor’s degree in stomatology from Wuhan University School of Medicine, a master’s degree in trade and economics from Wuhan Institute of Water Transportation Engineering and an EMBA from the International East-West University.

Yan Xue has been our director of research and development since October 2006. Ms. Xue joined our company in July 2002 and was the manager of research and development of Shouzheng Bio-tech from May 2003 to October 2006. Ms. Xue is our chief scientist on enzymes and is the developer of our core homeostatic technology. Ms. Xue focuses on the research of separation and extraction techniques relating to proteins and peptides. Ms. Xue is responsible for the development of homeostatic drugs, pre-clinical research and technology modifications related to our flagship product Baquting. Ms. Xue received a bachelor’s degree and a master’s degree in biochemistry from Jilin University, China in 1999 and 2002, respectively.

Shizheng Duan has been our vice-president of investor relations and board secretary since February 2012. Mr. Duan has held other various positions in our company, including director of investor relations, manager of corporate strategic planning and manager of product strategic planning since he joined us in August 2004. From June 2001 to September 2001, Mr. Duan worked for Eli Lilly & Company (UK) as an e-business consultant to their new product launch team. From November 2002 to August 2004, Mr. Duan was the general manager of the Beijing sales and marketing center of Shenyang Guangda Pharmaceutical Co., Ltd., a Chinese biopharmaceutical company. Mr. Duan received a bachelor’s degree in technical English from Shenyang Television University in 1989 and an MBA degree from Manchester Business School, United Kingdom in 2002.

Employment Agreements

We have entered into employment agreements with our senior executive officers. Under these employment agreements, each of our executive officers is employed for a specified time period, subject to automatic extension unless either we or the executive officer gives a one-month prior notice to terminate such employment. We may terminate the employment for cause, at any time, without notice or remuneration, for certain acts of the employee, including but not limited to a conviction or plea of guilty to certain crimes, negligence or dishonesty to our detriment and failure to perform the agreed-to duties after a reasonable opportunity to cure the failure. An executive officer may terminate his employment at any time with one-month prior written notice if there is a material reduction in his authority, duties and responsibilities or if there is a material reduction in his annual salary before the next annual salary review. Furthermore, we may terminate the employment at any time without cause upon advance written notice to the executive officer. These agreements do not provide for any special termination benefits, nor do we have other arrangements with these executive officers for special termination benefits.

Each executive officer has agreed to hold, both during and after the employment agreement expires or is earlier terminated, in strict confidence and not to use, except as required in the performance of his duties in connection with the employment, any confidential information, trade secrets and know-how of our company or the confidential information of any third party, including our subsidiaries, received by us. In addition, each executive officer has agreed to be bound by non-competition restrictions set forth in his or her employment agreement. Specifically, each executive officer has agreed not to, for a period of two years following the termination or expiration of the employment agreement, (i) carry on or be engaged or interested, directly or indirectly, as shareholder, director, employee, partner, agent or otherwise carry on any business in direct competition with our business; (ii) solicit or entice away from us, or attempt to solicit or entice away from us, any person or entity who has been our customer, client or our representative or agent or in the habit of dealing with us within two years prior to such executive officer’s termination of employment; (iii) solicit or entice away from us, or attempt to solicit or entice away from us, any person or entity who has been our officer, manager, consultant or employee within 12 months prior to such executive officer’s termination of employment; or (iv) use a name including the word “Nuokang” or any other words used by us in our name or in the name of any of our products or services, in such a way as to be capable of or likely to be confused with our name or the name of our products or services.

 

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B. Compensation

Compensation of Directors and Executive Officers

Our directors and executive officers receive compensation in the form of annual salaries and bonuses. While we do not have a specific bonus plan setting the calculation of our annual bonuses, each director and executive officer is entitled to receive an annual discretionary bonus based upon his or her performance of such amount as shall be determined by the board of directors.

In 2011, the aggregate cash compensation we paid to our directors and executive officers named in this annual report was approximately $1.1 million, excluding any pension or retirement plan payments.

Share Incentive Plans

Our board of directors and shareholders have adopted share incentive plans in December 2007 and October 2008, respectively, to attract and retain the best available personnel for positions of substantial responsibility, provide additional incentive to employees, directors and consultants and promote the success of our business. We have reserved an aggregate of 9,538,998 of our ordinary shares for issuance under our share incentive plans. Our future option grants will be made pursuant to our share incentive plans. The following paragraphs describe the principal terms of our share incentive plans.

Types of awards. The types of awards we may grant under our plans include the following:

 

   

options to purchase our ordinary shares; and

 

   

restricted shares.

Awards may be designated in the form of ADSs instead of ordinary shares. If we designate an award in the form of ADSs, the number of shares issuable under the share incentive plans will be adjusted to reflect the ratio of ADSs to ordinary shares.

Eligibility. We may grant awards to employees, directors and consultants of our company and our subsidiaries or any entities in which we, directly or indirectly, beneficially hold a majority of the outstanding voting shares or voting power.

Plan administration. The compensation committee of our board of directors, or a committee of one or more members of the board of directors designated by the compensation committee, will administer the plan. However, awards made to our independent directors and executive officers must be approved by the board of directors. The compensation committee or the full board of directors acting by a majority of its members, as appropriate, will determine the individuals who will receive grants, the types of awards to be granted and terms and conditions of each award grant, including any vesting or forfeiture restrictions.

Award agreement. Awards granted under our plans will be evidenced by an award agreement that will set forth the terms, conditions and limitations for each award which may include the terms of the award, the provisions applicable in the event that the employee’s employment or service terminates, and our authority to unilaterally or bilaterally amend, modify, suspend, cancel or rescind the award.

Acceleration of awards upon corporate transactions. The outstanding awards will accelerate upon occurrence of a change-of-control corporate transaction where the successor entity does not assume our outstanding awards under the plans. In such event, each outstanding award will become fully vested and immediately exercisable, and the transfer restrictions on the awards will be released and any forfeiture provisions will terminate immediately before the date of the change-of-control transaction. If the successor entity assumes our outstanding awards or replaces our outstanding awards with a cash incentive program of the successor which preserves the compensation element of such award existing at the time of the corporate transaction and provides for subsequent payout in accordance with the same vesting schedule applicable to such award and later terminates the grantee’s service without cause within 12 months of the change-of-control transaction, the outstanding awards will automatically become fully vested, exercisable and payable and will be released from any restrictions on transfer, repurchase or disposal rights.

Exercise price and term of awards. In general, the compensation committee determines the exercise price of an award and sets forth the price in the award agreement. The exercise price may be fixed or variable price related to the fair market value of our ordinary shares. The compensation committee is also permitted to adjust the exercise price of the outstanding options granted under the plans with the consent of the option holders. However, incentive share options, or ISOs, may not be granted to any employee if the fair market value of the shares underlying such ISOs that are exercisable in any calendar year exceeds $100,000 or other limitations imposed by law. Also, if we grant an ISO to an employee, who, at the time of that grant, owns shares representing more than 10% of the total combined voting power of all classes of our share capital, the exercise price cannot be less than 110% of the fair market value of our ordinary shares on the date of that grant. The term of each award will be stated in the award agreement. The term of an award shall not exceed 10 years from the date of the grant, except that five years is maximum term of an ISO granted to an employee who holds more than 10% of the total combined voting power of our share capital.

 

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Amendment and termination. With the approval of our board of directors, the compensation committee or the committee designated by the compensation committee may at any time amend, suspend or terminate the plans. Amendments to the plans are subject to shareholder approval to the extent required by law, or stock exchange rules or regulations. Additionally, shareholder approval will be specifically required to increase the number of shares available for issuance under the plans or to extend the term or the exercise period of an option beyond ten years from the date of grant, or if amendments result in material increases in benefits or a change in eligibility requirements. Unless terminated earlier, the plans will expire and no further awards may be granted after the tenth anniversary of the shareholders’ approval of the plans.

We granted 681,000 and 591,000 restricted share units to our executive officers and certain directors in July 2010 and June 2011, respectively, under our 2008 Share option scheme. In December 2011, we cancelled all of our outstanding share options.

C. Board Practices

Board of Directors

Our board of directors currently consists of seven directors. A director is not required to hold any shares in our company by way of qualification. A director may vote with respect to any contract, proposed contract or arrangement in which he is materially interested as long as he or she has made a declaration of the nature of such interest. Our board of directors may exercise all the powers of our company to borrow money, to mortgage or charge its undertaking, property and uncalled capital, or any part thereof, and to issue debentures, debenture stock or other securities whether outright or as security for any debt, liability or obligation of our company or of any third party.

Committees of the Board of Directors

Our board of directors established an audit committee and a compensation committee in February 2009 and a corporate governance and nominating committee in October 2009.

Audit Committee

Our audit committee consists of Messrs. Sean Shao, Huining Cao and David Xiaoying Gao, and is chaired by Mr. Sean Shao. Messrs. Shao, Cao and Gao satisfy the independence requirements of Rule 5605 of NASDAQ Stock Market Rules. Messrs. Shao, Cao and Gao also satisfy the independence requirements of Rule 10A-3 under the Securities Exchange Act of 1934. Our audit committee will consist solely of independent directors that satisfy NASDAQ and SEC requirements within one year of the completion of our initial public offering in December 2009. Our board also has determined that each of Messrs. Sean Shao and Huining Cao qualifies as an audit committee financial expert within the meaning of the SEC rules. The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:

 

   

selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;

 

   

regularly reviewing the independence of the independent auditors;

 

   

reviewing all related-party transactions on an ongoing basis;

 

   

discussing the annual audited financial statements with management and our independent auditors;

 

   

annually reviewing and reassessing the adequacy of our audit committee charter;

 

   

such other matters that are specifically delegated to our audit committee by our board of directors from time to time;

 

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meeting separately and periodically with management and our internal and independent auditors; and

 

   

reporting regularly to the full board of directors.

In 2011, our audit committee held four meetings and passed two resolutions by unanimous written consent.

Compensation Committee

Our compensation committee consists of Messrs. Sean Shao, Huining Cao and Mingde Yu and is chaired by Mr. Sean Shao. Messrs. Shao, Cao and Yu satisfy the independence requirements of Rule 5605 of NASDAQ Stock Market Rules. Our compensation committee assists the board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Members of the compensation committee are not prohibited from direct involvement in determining their own compensation. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The compensation committee is responsible for, among other things:

 

   

reviewing the compensation plans, policies and programs adopted by the management;

 

   

reviewing and approving the compensation package for our executive officers;

 

   

reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and

 

   

reviewing periodically and making recommendations to the board regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

In 2011, our compensation committee held one meeting and passed three resolutions by unanimous written consent.

Corporate Governance and Nominating Committee.

Our corporate governance and nominating committee consists of Messrs. Mingde Yu, David Xiaoying Gao and Sean Shao and is chaired by Mr. Mingde Yu. Messrs. Yu, Gao and Shao satisfy the independence requirements of Rule 5605 of the NASDAQ Stock Market Rules. The corporate governance and nominating committee assists our board of directors in identifying individuals qualified to become our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee is responsible for, among other things:

 

   

identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy;

 

   

reviewing annually with the board the current composition of the board in light of the characteristics of independence, skills, experience and availability of service to us;

 

   

identifying and recommending to the board the names of directors to serve as members of the audit committee and the compensation committee, as well as the corporate governance and nominating committee itself;

 

   

advising the board periodically with respect to significant developments in the law and practice of corporate governance as well as our compliance with applicable laws and regulations, and making recommendations to the board on all matters of corporate governance and on any corrective action to be taken; and

 

   

monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.

In 2011, our corporate governance and nominating committee did not hold any meetings and passed two resolutions by unanimous written consent.

Duties of Directors

Under Cayman Islands law, our directors have a duty of loyalty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association, as amended and re-stated from time to time. A shareholder has the right to seek damages if a duty owed by our directors is breached.

 

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The functions and powers of our board of directors include, among others:

 

   

convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings;

 

   

declaring dividends and distributions;

 

   

appointing officers and determining the term of office of officers;

 

   

exercising the borrowing powers of our company and mortgaging the property of our company; and

 

   

approving the issuance and transfer of shares of our company, including the registering of such shares in our share register.

Terms of Directors and Officers

All directors hold office until their successors have been duly elected and qualified. A director may be removed by special resolutions of the shareholders. Officers are elected by and serve at the discretion of the board of directors.

D. Employees

We had 642, 698 and 454 employees as of December 31, 2009, 2010 and 2011, respectively. The following table sets forth the number of our employees by function as of March 31, 2012.

 

     Number of Employees  

Manufacturing and services

     170   

Research and development

     34   

General and administration

     73   

Sales and marketing personnel

     140   

Other

     23   
  

 

 

 

Total

     449   
  

 

 

 

We have a workers’ union that protects our employees’ rights and benefits, and assists in mediating any disputes that may arise between us and our employees. We have not had any strikes or other labor disturbances that have interfered with our operations, and we believe that we have a good working relationship with our employees.

E. Share Ownership

The following table sets forth information with respect to the beneficial ownership of our shares as of December 31, 2011 by:

 

   

each of our directors and executive officers; and

 

   

each person known to us to own beneficially more than 5% of our shares.

 

     Ordinary Shares
Beneficially  Owned
     %  

Directors and Executive Officers:

     

Baizhong Xue (1)

     94,508,704         59.7   

Qiang Liu

     *         *   

Neil Nanpeng Shen (2)

     20,106,222         12.7   

Sean Shao

     *         *   

David Xiaoying Gao

     *         *   

Mingde Yu

     *         *   

Huining Cao

     *         *   

Tianruo Pu

     *         *   

Hongying Wang

     *         *   

Felix Chungfai Wong

     *         *   

Tong Le

     *         *   

Yan Xue

     *         *   

Shizheng Duan

     *         *   

All directors and executive officers as a group

     117,576,426         74.3   

Principal Shareholders:

     

Anglo China Bio-technology Investment Holdings Limited (3)

     85,447,648         54.0   

Sequoia Capital China Growth Fund I., L.P. and its affiliates (4)

     20,106,222         12.7   

Britain Ukan Technology Investment Holdings (Group) Limited (5)

     9,061,056         5.7   

 

* The person beneficially owns less than 1% of our outstanding ordinary shares.

 

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(1) Includes 9,061,056 shares held by Britain Ukan Technology Investment Holdings (Group) Limited, a British Virgin Islands company wholly-owned by Yuhuan Zhu, Mr. Xue’s wife and a Canadian citizen, and 85,447,648 shares held by Anglo China Bio-technology Investment Holdings Limited, a British Virgin Islands company 49% owned by Mr. Xue and 51% ultimately owned by an irrevocable trust constituted under the laws of Singapore with Mrs. Yuhuan Zhu as the settler and certain family members of Mr. Xue as the beneficiaries. Mr. Xue is the sole director of Britain Ukan Technology Investment Holdings (Group) Limited and Anglo China Bio-technology Investment Holdings Limited and is deemed to be the beneficial owner, under SEC rules, of all the shares held by Britain Ukan Technology Investment Holdings (Group) Limited and Anglo China Bio-technology Investment Holdings Limited. Mr. Xue disclaims the beneficial ownership in the shares held by these companies except to the extent of his economic interest in those shares.
(2) Includes 17,540,668 ordinary shares held by Sequoia Capital China Growth Fund I, L.P., 414,188 ordinary shares held by Sequoia Capital China Growth Partners Fund I, L.P. and 2,151,366 ordinary shares held by Sequoia Capital China GF Principals Fund I, L.P. (together with Sequoia Capital China Growth Fund I, L.P. and Sequoia Capital China GF Principals Fund I, L.P., the “Sequoia Funds”). The Sequoia Funds are managed by Sequoia Capital China Advisors Limited, a company incorporated in the Cayman Islands. The Sequoia Funds’ general partner is Sequoia Capital China Growth Fund Management I, L.P., whose general partner is SC China Holding Limited which is a company incorporated in the Cayman Islands. SC China Holding Limited is wholly-owned by Max Wealth Enterprises Limited, a company wholly-owned by Neil Nanpeng Shen. The registered address of Sequoia Capital China Growth Fund I., L.P. is Cricket Square, Hutchins Dr., P.O. Box 2681, Grand Cayman KY1-1111, Cayman Islands. Mr. Shen disclaims any beneficial ownership in the shares owned by the Sequoia Funds except to the extent of his pecuniary interest therein.
(3) Anglo China Bio-technology Investment Holdings Limited, a British Virgin Islands company, is 49% owned by Mr. Baizhong Xue and 51% ultimately owned by an irrevocable trust constituted under the laws of Singapore with Mrs. Yuhuan Zhu as the settler and certain family members of Mr. Xue as the beneficiaries. Mr. Xue is the sole director of Anglo China Bio-technology Investment Holdings Limited and is deemed to be the beneficial owner, under SEC rules, of all the shares held by Anglo China Bio-technology Investment Holdings Limited. Mr. Xue disclaims the beneficial ownership in the shares held by this company except to the extent of his economic interest in those shares. The registered address of Anglo China Bio-technology Investment Holdings Limited is P.O. Box 957, Offshore Incorporations Center, Road Town, Tortola, British Virgin Islands.
(4) Includes 17,540,668 ordinary shares held by Sequoia Capital China Growth Fund I, L.P., 414,188 ordinary shares held by Sequoia Capital China Growth Partners Fund I, L.P. and 2,151,366 ordinary shares held by Sequoia Capital China GF Principals Fund I, L.P as reported by Sequoia Capital China Growth Fund I, L.P. and its affiliates on the Schedule 13G/A filed with the Securities and Exchange Commission, or SEC, on February 10, 2011. The Sequoia Funds are managed by Sequoia Capital China Advisors Limited, a company incorporated in the Cayman Islands. Sequoia Capital China Growth Fund I, L.P.’s general partner is Sequoia Capital China Growth Fund Management I, L.P., whose general partner is SC China Holding Limited which is a company incorporated in the Cayman Islands. SC China Holding Limited is wholly-owned by Max Wealth Enterprises Limited, a company wholly-owned by Neil Nanpeng Shen. The registered address of Sequoia Capital China Growth Fund I., L.P. is Cricket Square, Hutchins Dr., P.O. Box 2681, Grand Cayman KY1-1111, Cayman Islands.
(5) Britain Ukan Technology Investment Holdings (Group) Limited, a British Virgin Islands company, is wholly-owned by Yuhuan Zhu, Mr. Baizhong Xue’s wife. Mr. Xue is the sole director of Britain Ukan Technology Investment Holdings (Group) Limited and is deemed to be the beneficial owner, under SEC rules, of all the shares held by Britain Ukan Technology Investment Holdings (Group) Limited. Mr. Xue disclaims the beneficial ownership in the shares held by this company except to the extent of his economic interest in those shares. The registered address of Britain Ukan Technology Investment Holdings (Group) Limited is P.O. Box 957, Offshore Incorporations Center, Road Town, Tortola, British Virgin Islands.

 

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As of December 31, 2012, 158,294,358 of our ordinary shares were issued and outstanding. Based on a review of the register of members maintained by our Cayman Islands registrar, we believe that 40,834,216 ordinary shares, or approximately 25.8% of our issued and outstanding shares, were held by the record shareholders in the United States, represented by 5,104,277 ADSs held of record by JPMorgan Chase Bank, N.A., the depositary of our ADS program.

None of our shareholders has different voting rights from other shareholders as of the date of this annual report. We are currently not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. Major Shareholders

Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”

B. Related Party Transactions

Transactions with Certain Directors, Shareholders and Affiliates

Transactions with Mr. Baizhong Xue

From time to time, Mr. Baizhong Xue, our chairman and chief executive officer, has extended loans to us and paid business-related expenses on our behalf. We from time to time make advances in respect of business-related expenses incurred by Mr. Xue on our behalf. As of December 31, 2009, 2010 and 2011 amounts due to Mr. Xue were nil, nil and nil, respectively.

Loans and Guarantees

In March 2009, Dengzhou Credit Union extended to us a short-term loan of RMB3.0 million at the interest rate of 7.7%. In September 2009, Industrial Bank Co., Ltd. and China Merchants Bank extended to us short-term loans of RMB60.0 million and RMB15.0 million, respectively, each at an interest rate of 6.372%. While these loans were secured by certain of our property, plant and equipment or land use rights, Mr. Baizhong Xue, our chairman and chief executive officer, also provided guarantees for all these loans. As of December 31, 2011, these loans have all been repaid.

Restructuring

See “Item 4. Information on the Company—C. Organizational Structure.”

Employment Agreements

See “Item 6. Directors, Senior Management and Employees—Employment Agreements.”

Share Incentive Plans

See “Item 6. Directors, Senior Management and Employees—B. Compensation—Share Incentive Plans.”

C. Interests of Experts and Counsel

Not applicable.

 

ITEM 8. FINANCIAL INFORMATION

A. Consolidated Statements and Other Financial Information

We have appended consolidated financial statements filed as part of this annual report.

 

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Legal and Administrative Proceedings

From time to time, we may be subject to various claims and legal actions arising in the ordinary course of business. We are not aware of any proceedings being contemplated by any governmental authority.

We are currently not a party to any material legal or administrative proceedings, and we are not aware of threatened material legal or administrative proceedings against us. We may from time to time become a party to various legal or administrative proceedings arising in the ordinary course of our business.

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. 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.

B. Significant Changes

Except as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.

 

ITEM 9. THE OFFER AND LISTING

A. Offering and Listing Details.

Our ADSs have been listed on the NASDAQ Global Market under the symbol “NKBP” since December 9, 2009. The following table provides the high and low trading prices for our ADSs on the NASDAQ Global Market for the indicated periods.

 

     Sales Price
(US$1.00)
 
     High      Low  

Annual High and Low

     

2009 (from December 9, 2009)

     9.30         7.01   

2010

     9.24         3.25   

2011

     5.88         2.30   

Quarterly High and Low

     

Second Quarter 2010

     6.85         4.50   

Third Quarter 2010

     6.49         4.40   

Fourth Quarter 2010

     5.00         3.25   

First Quarter 2011

     4.74         3.52   

Second Quarter 2011

     4.65         3.80   

Third Quarter 2011

     5.88         3.88   

Fourth Quarter 2011

     4.85         2.30   

First Quarter 2012

     3.23         2.25   

Monthly High and Low

     

October 2011

     4.85         3.51   

November 2011

     3.84         2.58   

December 2011

     3.37         2.30   

January 2012

     2.95         2.25   

February 2012

     3.20         2.40   

March 2012

     3.23         2.50   

April 2012 (through April 23)

     3.70         3.16   

 

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B. Plan of Distribution

Not applicable.

C. Markets

Our ADSs, each representing eight ordinary shares, have been listed on the NASDAQ Global Market since December 9, 2009 under the symbol “NKBP.”

D. Selling Shareholders

Not applicable.

E. Dilution

Not applicable.

F. Expenses of the Issue

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

A. Share Capital

Not applicable.

B. Memorandum and Articles of Association

The following are summaries of material provisions of our amended and restated memorandum and articles of association, as well as the as provided by Section 27(2) of The Companies Law (2011 Revision), as the same may be amended from time to time, of the Cayman Islands, which is referred to as the “Companies Law” below, insofar as they relate to the material terms of our ordinary shares. This summary is not complete, and you should read our amended and restated memorandum and articles of association.

Registered Office and Objects

The Registered Office of our company is at the offices of Maples Corporate Services Limited, P.O. Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands or at such other place as our directors may from time to time decide. The objects for which our company is established are unrestricted and we have full power and authority to carry out any object not prohibited by the Companies Law or as the same may be revised from time to time, or any other law of the Cayman Islands.

Board of Directors

See “Item 6. Directors, Senior Management and Employees—C. Board Practices—Board of Directors.”

 

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Ordinary Shares

All of our outstanding ordinary shares are fully paid and non-assessable. Certificates representing the ordinary shares are issued in registered form. Shareholders who are nonresidents of the Cayman Islands may freely hold and vote their shares.

Dividends

The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors subject to the Companies Law.

Voting Rights

Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to vote. Voting at any shareholders’ meeting is by show of hands unless a poll is demanded. A poll may be demanded by our chairman or any one or more shareholders holding together at least 10% of the paid-up voting share capital given a right to vote at the meeting, present in person or by proxy.

A quorum required for a meeting of shareholders consists of shareholders who hold at least one-third of the issued voting share capital at the meeting present in person or by proxy or, if a corporation or other non-natural person, by its duly authorized representative. Although not required by the Companies Law, we expect to hold annual shareholders’ meetings as required by NASDAQ and such meetings may be convened by our board of directors on its own initiative or upon a request to the directors by shareholders holding in aggregate at least one-third of our voting share capital. Advance notice of at least 21 calendar days is required for the convening of our annual general meeting and other shareholders’ meetings.

An ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-thirds of the votes cast attaching to the ordinary shares. A special resolution is required for important matters, including reducing the amount of our share capital, removing a director before the expiration of his or her term, amending the memorandum or articles of association, and changing the corporate name. Holders of the ordinary shares may effect certain changes by ordinary resolution, including increasing the amount of our authorized share capital, consolidating and dividing all or any of our share capital into shares of larger amount than our existing share capital, and canceling any shares.

Transfer of Shares

Subject to the restrictions of our memorandum and articles of association, as applicable, a shareholder may transfer all or any of his or her ordinary shares by an instrument of transfer in writing and in the usual or common form or any other form approved by our board.

Our board of directors may, in its sole discretion, decline to register any transfer of any ordinary share that is not fully paid up or on which we have a lien. Our directors may also decline to register any transfer of any ordinary share unless (a) the instrument of transfer is lodged with us, accompanied by the certificate for the ordinary shares to which it relates and such other evidence as our board of directors may reasonably require to show the right of the transferor to make the transfer; (b) the instrument of transfer is in respect of only one class of ordinary shares; (c) the instrument of transfer is properly stamped, if required; (d) in the case of a transfer to joint holders, the number of joint holders to whom the ordinary share is to be transferred does not exceed four; or (e) the shares conceded are free of any lien in favor of us.

If our directors refuse to register a transfer they must, within two months after the date on which the instrument of transfer was lodged, send to each of the transferor and the transferee notice of such refusal. The registration of transfers may, on 14 calendar days’ notice being given by advertisement in such one or more newspapers or by electronic means, be suspended and our register of members closed at such times and for such periods as our board of directors may from time to time determine. However, the registration of transfers may not be suspended, and the register may not be closed, for more than 30 calendar days in any year.

Liquidation

On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of shares), assets available for distribution among the holders of ordinary shares must be distributed among the holders of the ordinary shares on a pro rata basis. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.

 

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Calls on Shares and Forfeiture of Shares

Our board of directors may from time to time make calls upon shareholders for any amounts unpaid on their shares in a notice served to such shareholders at least 14 calendar days prior to the specified time or times of payment. The shares that have been called upon and remain unpaid on the specified time are subject to forfeiture.

Redemption of Shares

Subject to the provisions of the Companies Law, we may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such manner as may be determined by our board, before the issue of such shares.

Variation of Rights of Shares

All or any of the special rights attached to any class of shares may, subject to the provisions of the Companies Law, be varied either with the written consent of the holders of a majority of the issued shares of that class or with the sanction of a special resolution passed at a general meeting of the holders of the shares of that class.

Inspection of Books and Records

Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements. See “Item 10. Additional Information—H. Documents on Display.”

Anti-takeover Provisions in Our Amended and Restated Memorandum and Articles of Association

Some provisions of our amended and restated memorandum and articles of association may discourage, delay or prevent a change of control of our company or management that shareholders may consider favorable, including a provision that authorizes our board of directors to issue preference shares in one or more series and to designate the price, rights, preferences, privileges and restrictions of such preference shares without any further vote or action by our shareholders.

Such 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 these 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.

However, under Cayman Islands law, our directors may only exercise the rights and powers granted to them under our amended and restated memorandum and articles of association for a proper purpose and for what they believe in good faith to be in the best interests of our company.

C. Material Contracts

We have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4. Information on the Company” or elsewhere in this annual report.

D. Exchange Controls

See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulation on Foreign Currency Exchange” and “—Regulation on Dividend Distribution.”

E. Taxation

Cayman Islands Taxation

The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by the Government of the Cayman Islands except for stamp duties which may be applicable, from time to time, on certain instruments executed in, or brought within the jurisdiction of the Cayman Islands. The Cayman Islands are not party to any double tax treaties that are applicable to any payments made to or by the Company. There is no exchange control legislation under Cayman Islands law and accordingly there are no exchange control regulations imposed under Cayman Islands law.

 

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PRC Taxation

Under the former PRC Income Tax Law for Enterprises with Foreign Investment and Foreign Enterprises, any dividends payable by foreign-invested enterprises to non-PRC investors were exempt from any PRC withholding tax. In addition, any interest or dividends payable, or distributions made, by us to holders or beneficial owners of our ADSs or ordinary shares would not have been subject to any PRC tax, provided that such holders or beneficial owners, including individuals and enterprises, were not deemed to be PRC residents under the PRC tax law and had not become subject to PRC tax.

Under the new EIT law, which took effect as of January 1, 2008, enterprises established under the laws of non-PRC jurisdictions but whose “de facto management body” is located in China are considered “resident enterprises” for PRC tax purposes. Under the implementation regulations issued by the State Council relating to the new EIT law, “de facto management bodies” are defined as the bodies that have material and overall management control over the business, personnel, accounts and properties of an enterprise. Substantially all of our management are currently based in China, and may remain in China in the future. If we were treated as a “resident enterprise” for PRC tax purposes, we would be subject to PRC income tax on our worldwide income at a uniform tax rate of 25%, but dividends received by us from our PRC subsidiaries may be exempt from the income tax.

Under the new EIT law and its implementation regulations, dividends paid to a non-PRC investor are generally subject to a 10% PRC withholding tax, if such dividends are derived from sources within China and the non-PRC investor is considered to be a non-resident enterprise without any establishment or place of business within China or if the dividends paid have no connection with the non-PRC investor’s establishment or place of business within China, unless such tax is eliminated or reduced under an applicable tax treaty. Similarly, any gain realized on he transfer of ADSs or shares by such investor is also subject to a 10% PRC withholding tax if such gain is regarded as income derived from sources within China, unless such tax is eliminated or reduced under an applicable tax treaty.

If we were considered a PRC “resident enterprise,” it is possible that the dividends we pay with respect to our ADSs or ordinary shares, or the gain you may realize from the transfer of our ADSs or ordinary shares, would be treated as income derived from sources within China and be subject to the 10% PRC withholding tax.

U.S. Federal Income Taxation

The following discussion describes certain U.S. federal income tax consequences to U.S. Holders (as defined below) under present law of an investment in our ADSs or ordinary shares. This discussion applies only to U.S. Holders that hold the ADSs or ordinary shares as capital assets (generally, property held for investment) and that have the U.S. dollar as their functional currency. This discussion is based on the tax laws of the United States as of the date of this annual report and on U.S. Treasury regulations in effect or, in some cases, proposed as of the date of this annual report, as well as judicial and administrative interpretations thereof available on or before such date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below.

The following discussion neither deals with the tax consequences to any particular investor nor describes all of the tax consequences applicable to persons in special tax situations such as:

 

   

banks;

 

   

certain financial institutions;

 

   

insurance companies;

 

   

regulated investment companies;

 

   

real estate investment trusts;

 

   

broker-dealers;

 

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traders that elect to mark to market;

 

   

U.S. expatriates;

 

   

tax-exempt entities;

 

   

persons liable for alternative minimum tax;

 

   

persons holding an ADS or ordinary share as part of a straddle, hedging, conversion or integrated transaction;

 

   

persons that actually or constructively own 10% or more of the total combined voting power of all classes of our voting stock;

 

   

persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee share option or otherwise as compensation; or

 

   

partnerships or pass-through entities, or persons holding ADSs or ordinary shares through such entities.

In addition, the discussion below does not describe any tax consequences arising out of the recently enacted Medicare tax on certain “net investment income.”

INVESTORS ARE URGED TO CONSULT THEIR TAX ADVISORS ABOUT THE APPLICATION OF THE U.S. FEDERAL TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE STATE, LOCAL, NON-U.S. AND OTHER TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ADSs OR ORDINARY SHARES.

The discussion below of the U.S. federal income tax consequences to “U.S. Holders” will apply to you if you are the beneficial owner of our ADSs or ordinary shares and you are, for U.S. federal income tax purposes:

 

   

an individual who is a citizen or resident of the United States;

 

   

a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) created or organized in the United States or under the laws of the United States, any State thereof or the District of Columbia;

 

   

an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or

 

   

a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.

If you are a partner in a partnership or other entity taxable as a partnership that holds common shares, your tax treatment will depend on your status and the activities of the partnership. If you are a partner in such a partnership, you should consult your tax advisor.

The discussion below assumes the representations contained in the deposit agreement are true and the obligations in the deposit agreement and any related agreement have been and will be complied with in accordance with their terms. If you own ADSs, you should be treated as the owner of the underlying ordinary shares represented by those ADSs for U.S. federal income tax purposes.

The U.S. Treasury has expressed concerns that intermediaries in the chain of ownership between the holder of an ADS and the issuer of the security underlying the ADS may be taking actions that are inconsistent with the beneficial ownership of the underlying security (for example, pre-releasing ADSs to persons that do not have the beneficial ownership of the securities underlying the ADSs). Accordingly, the creditability of any PRC taxes and the availability of the reduced tax rate for any dividends received by certain non-corporate U.S. Holders, including individuals U.S. Holders (as discussed below), could be affected by actions taken by intermediaries in the chain of ownership between the holders of ADSs and our company if as a result of such actions the holders of ADSs are not properly treated as beneficial owners of underlying ordinary shares.

 

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Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares

Subject to the PFIC rules discussed below, the gross amount of any distributions we make to you with respect to our ADSs or ordinary shares (including the amount of any taxes withheld therefrom) generally will be includible in your gross income as dividend income on the date of receipt by the depositary, in the case of ADSs, or by you, in the case of ordinary shares, but only to the extent the distribution is paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). Any such dividends will not be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations. To the extent the amount of the distribution exceeds our current and accumulated earnings and profits (as determined under U.S. federal income tax principles), such excess amount will be treated first as a tax-free return of your tax basis in your ADSs or ordinary shares, and then, to the extent such excess amount exceeds your tax basis in your ADSs or ordinary shares, as capital gain. We currently do not, and we do not intend to, calculate our earnings and profits under U.S. federal income tax principles. Therefore, a U.S. Holder should expect that a distribution will generally be reported as a dividend even if that distribution would otherwise be treated as a non-taxable return of capital or as capital gain under the rules described above.

With respect to certain non-corporate U.S. Holders, including individual U.S. Holders, for taxable years beginning before January 1, 2013, any dividends may be taxed at the lower capital gains rate applicable to “qualified dividend income,” provided (1) either (a) the ADSs are readily tradable on an established securities market in the United States or (b) we are eligible for the benefits of a qualifying income tax treaty with the United States that includes an exchange of information program, (2) we are neither a PFIC nor treated as such with respect to you (as discussed below) for the taxable year in which the dividend was paid and the preceding taxable year, and (3) certain holding period and other requirements are met. Under U.S. Internal Revenue Service authority, ADSs are considered for purposes of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on the NASDAQ Global Market, as are our ADSs. However, based on existing guidance, it is not entirely clear whether dividends you receive with respect to the ordinary shares will be taxed as qualified dividend income, because the ordinary shares are not themselves listed on a U.S. exchange. If we are treated as a “resident enterprise” for PRC tax purposes under the new EIT law, we may be eligible for the benefits of the income tax treaty between the United States and the PRC. You should consult your tax advisors regarding the availability of the lower capital gains rate applicable to qualified dividend income for any dividends paid with respect to the ADSs or ordinary shares.

Any dividends we pay generally will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are taxed as qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation will in general be limited to the gross amount of the dividend, multiplied by the reduced tax rate applicable to qualified dividend income and divided by the highest tax rate normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to our ADSs or ordinary shares will generally constitute “passive category income” but could, in the case of certain U.S. Holders, constitute “general category income.” If PRC withholding taxes apply to any dividends paid to you with respect to our ADSs or ordinary shares, the amount of the dividend would include withheld PRC taxes and, subject to certain conditions and limitations, such PRC withholding taxes generally will be treated as foreign taxes eligible for credit against your U.S. federal income tax liability. The rules relating to the determination of the foreign tax credit are complex, and you should consult your tax advisors regarding the availability of a foreign tax credit in your particular circumstances, including the effects of any applicable income tax treaties, as well as the effects of any change in applicable law after the date of this annual report.

Taxation of Disposition of ADSs or Ordinary Shares

Subject to the PFIC rules discussed below, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition of an ADS or ordinary share equal to the difference between the amount realized for the ADS or ordinary share and your tax basis in the ADS or ordinary share. The gain or loss generally will be capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, that has held the ADS or ordinary share for more than one year, you may be eligible for reduced tax rates. The deductibility of capital losses is subject to limitations. Any gain or loss you recognize on a disposition of ADSs or ordinary shares will generally be treated as U.S. source income or loss for foreign tax credit limitation purposes. However, if we are treated as a “resident enterprise” for PRC tax purposes, we may be eligible for the benefits of the income tax treaty between the United States and the PRC. In such event, if PRC tax were to be imposed on any gain from the disposition of the ADSs or ordinary shares, a U.S. Holder that is eligible for the benefits of the income tax treaty between the United States and the PRC may elect to treat the gain as PRC source income for foreign tax credit purposes. You should consult your tax advisors regarding the proper treatment of gain or loss in your particular circumstances, including the effects of any applicable income tax treaties.

 

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Passive Foreign Investment Company

Based on the market price of our ADSs, the value of our assets, and the composition of our income and assets, we do not believe we were a PFIC for U.S. federal income tax purposes for our taxable year ended December 31, 2011. However, the application of the PFIC rules is subject to uncertainty in several respects, and we cannot assure you that the U.S. Internal Revenue Service will not take a contrary position. A non-U.S. corporation will be a PFIC for U.S. federal income tax purposes for any taxable year if either:

 

   

at least 75% of its gross income for such year is passive income, or

 

   

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.

For this purpose, we will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, more than 25% (by value) of the stock. In applying this rule, while it is not clear, we believe the contractual arrangements between us and our affiliated entities should be treated as ownership of stock.

A separate determination must be made after the close of each taxable year as to whether we were a PFIC for that year. Because 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, fluctuations in the market price of our ADSs and ordinary shares may cause us to become a PFIC. In addition, changes in the composition of our income or assets may cause us to become a PFIC. If we are a PFIC for any taxable year during which you hold ADSs or ordinary shares, we generally will continue to be treated as a PFIC with respect to you for all succeeding years during which you hold ADSs or ordinary shares, unless we cease to be a PFIC and you make a “deemed sale” election with respect to the ADSs or ordinary shares. If such election is made, you will be deemed to have sold ADSs or ordinary shares you hold at their fair market value on the last day of the last taxable year in which we qualified as a PFIC, and any gain from such deemed sale would be subject to the consequences described in the following two paragraphs. After the deemed sale election, your ADSs or ordinary shares with respect to which the deemed sale election was made will not be treated as shares in a PFIC unless we subsequently become a PFIC.

For each taxable year that we are treated as a PFIC with respect to you, you will be subject to special tax rules with respect to any “excess distribution” you receive and any gain you recognize from a sale or other disposition (including a pledge) of the ADSs or ordinary shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the ADSs or ordinary shares will be treated as an excess distribution. Under these special tax rules:

 

   

the excess distribution or recognized gain will be allocated ratably over your holding period for the ADSs or ordinary shares,

 

   

the amount allocated to the current taxable year, and any taxable years in your holding period prior to the first taxable year in which we were a PFIC, will be treated as ordinary income, and

 

   

the amount allocated to each other taxable year will be subject to the highest tax rate in effect for individuals or corporations, as applicable, for each such year, and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.

The tax liability for amounts allocated to taxable years prior to the year of disposition or excess distribution cannot be offset by any net operating losses for such years, and gains (but not losses) realized on the sale or other disposition of our ADSs or ordinary shares cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.

If we are treated as a PFIC with respect to you for any taxable year, to the extent any of our subsidiaries are also PFICs or we make direct or indirect equity investments in other entities that are PFICs, you may be deemed to own shares in such lower-tier PFICs that are directly or indirectly owned by us in that proportion which the value of the ADSs or ordinary shares you own bears to the value of all of our ADSs and ordinary shares, and you may be subject to the adverse tax consequences described in the preceding two paragraphs with respect to the shares of such lower-tier PFICs that you would be deemed to own. You should consult your tax advisors regarding the application of the PFIC rules to any of our subsidiaries.

 

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A U.S. Holder of “marketable stock” (as defined below) in a PFIC may make a mark-to-market election for such stock to elect out of the PFIC rules described above regarding excess distributions and recognized gains. If you make a mark-to-market election for our ADSs or ordinary shares, you will include in income for each year we are a PFIC an amount equal to the excess, if any, of the fair market value of the ADSs or ordinary shares as of the close of your taxable year over your adjusted basis in such ADSs or ordinary shares. You will be allowed a deduction for the excess, if any, of the adjusted basis of the ADSs or ordinary shares over their fair market value as of the close of the taxable year. However, deductions will be allowable only to the extent of any net mark-to-market gains on the ADSs or ordinary shares included in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs or ordinary shares, will be treated as ordinary income. Ordinary loss treatment will also apply to the deductible portion of any mark-to-market loss on the ADSs or ordinary shares, as well as to any loss realized on the actual sale or other disposition of the ADSs or ordinary shares, to the extent the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs or ordinary shares. Your basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss amounts. If you make a mark-to-market election, any distributions we make would generally be subject to the rules discussed above under “—Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares,” except the lower rate applicable to qualified dividend income would not apply.

The mark-to-market election is available only for “marketable stock,” which is stock that is regularly traded on a qualified exchange or other market, as defined in applicable U.S. Treasury regulations. Our ADSs are listed on the NASDAQ Global Market, which is a qualified exchange or other market for these purposes. Consequently, if the ADSs continue to be listed on the NASDAQ Global Market and are regularly traded, and you are a holder of ADSs, we expect the mark-to-market election would be available to you if we were to become a PFIC. Because a mark-to-market election cannot be made for equity interests in any lower-tier PFICs that we own, a U.S. Holder may continue to be subject to the PFIC rules with respect to its indirect interest in any investments held by us that are treated as an equity interest in a PFIC for U.S. federal income tax purposes. You should consult your tax advisors as to the availability and desirability of a mark-to-market election, as well as the impact of such election on interests in any lower-tier PFICs.

Alternatively, if a non-U.S. corporation is a PFIC, a holder of shares in that corporation may avoid taxation under the PFIC rules described above regarding excess distributions and recognized gains by making a “qualified electing fund” election to include in income its share of the corporation’s income on a current basis. However, you may make a qualified electing fund election with respect to your ADSs or ordinary shares only if we agree to furnish you annually with certain tax information, and we currently do not intend to prepare or provide such information.

Unless otherwise provided by the U.S. Treasury, each U.S. Holder of a PFIC is required to file an annual report containing such information as the U.S. Treasury may require. If we are or become a PFIC, you should consult your tax advisor regarding any reporting requirements that may apply to you.

You are strongly urged to consult your tax advisor regarding the application of the PFIC rules to your investment in ADSs or ordinary shares.

Information Reporting and Backup Withholding

Any dividend payments with respect to ADSs or ordinary shares and proceeds from the sale, exchange or redemption of ADSs or ordinary shares may be subject to information reporting to the U.S. Internal Revenue Service and possible U.S. backup withholding. Backup withholding will not apply, however, to a U.S. Holder that furnishes a correct taxpayer identification number and makes any other required certification or that is otherwise exempt from backup withholding.

Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the U.S. Internal Revenue Service and furnishing any required information in a timely manner.

U.S. Holders should consult their tax advisor regarding the application of the U.S information reporting and backup withholding rules.

Additional Reporting Requirements

Certain U.S. Holders who are individuals are required to report information relating to an interest in our ADSs or ordinary shares, subject to certain exceptions (including an exception for ADSs or ordinary shares held in accounts maintained by certain financial institutions). U.S. Holders should consult their tax advisors regarding the effect, if any, of these rules on their ownership and disposition of the ADSs and ordinary shares.

 

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F. Dividends and Paying Agents

Not applicable.

G. Statement by Experts

Not applicable.

H. Documents on Display

We have previously filed with the Commission our registration statement on Form F-1 (File Number 333-163250), as amended, and a prospectus under the Securities Act with respect to our ordinary shares represented by our ADSs. We also filed with the SEC a related registration statement on Form F-6 (File Number 333-163398) with respect to our ADSs.

We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange Act, we are required to file reports and other information with the SEC. Specifically, we are required to file annually a Form 20-F: (1) within six months after the end of each fiscal year, which is December 31, for fiscal years ending before December 15, 2011; and (2) within four months after the end of each fiscal year for fiscal years ending on or after December 15, 2011. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the Securities and Exchange Commission at Judiciary Plaza, 100 F Street, N.E., Washington, D.C. 20549, and at the regional office of the Securities and Exchange Commission located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the Commission at 1-800-SEC-0330. The SEC also maintains a web site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system.

As a foreign private issuer, we are exempt from the rules of the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and our executive officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements with the SEC as frequently or as promptly as U.S. companies whose securities are registered under the Exchange Act.

We will furnish JPMorgan Chase Bank, N.A., the depositary of our ADSs, with all notices of shareholders’ meeting and other reports and communications that are made generally available to our shareholders. The depositary will make such notices, reports and communications available to holders of ADSs and, upon our written request, will mail to all record holders of ADSs the information contained in any notice of a shareholders’ meeting received by the depositary from us.

In accordance with NASDAQ Stock Market Rule 5250(d), we will post this annual report on Form 20-F on our website at http://ir.nkbp.com. In addition, we will provide hard copies of our annual report free of charge to shareholders and ADS holders upon request.

I. Subsidiary Information

For a listing of our subsidiaries, see “Item 4. Information on the Company—C. Organizational Structure.”

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 -0.7%, 3.3% and 5.4% in 2009, 2010 and 2011, 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.

 

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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 denominated in U.S. dollars as a result of our issuance of ADSs representing ordinary shares in our initial public offering. 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 our ADSs are 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 more than 20% appreciation of the RMB against the U.S. dollar over the following five years. 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 received from our initial public offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect 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.

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

A. Debt Securities

Not applicable.

B. Warrants and Rights

Not applicable.

C. Other Securities

Not applicable.

D. American Depositary Shares

JPMorgan Chase Bank, N.A., our depositary, may charge each person to whom ADSs are issued, including, without limitation, issuances against deposits of shares, issuances in respect of share distributions, rights and other distributions, issuances pursuant to a stock dividend or stock split declared by us or issuances pursuant to a merger, exchange of securities or any other transaction or event affecting the ADSs or deposited securities, and each person surrendering ADSs for withdrawal of deposited securities in any manner permitted by the deposit agreement or whose ADRs are cancelled or reduced for any other reason, $5.00 for each 100 ADSs (or any portion thereof) issued, delivered, reduced, cancelled or surrendered, the case may be. The depositary may sell (by public or private sale) sufficient securities and property received in respect of a share distribution, rights and/or other distribution prior to such deposit to pay such charge.

 

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The following additional charges shall be incurred by the ADR holders, by any party depositing or withdrawing shares or by any party surrendering ADSs or to whom ADSs are issued (including, without limitation, issuance pursuant to a stock dividend or stock split declared by us or an exchange of stock regarding the ADRs or the deposited securities or a distribution of ADSs), whichever is applicable:

 

   

a fee of $1.50 per ADR or ADRs for transfers of certificated or direct registration ADRs;

 

   

a fee of up to $0.05 per ADS (or portion thereof) for any cash distribution made pursuant to the deposit agreement;

 

   

a fee of up to $0.05 per ADS per calendar year (or portion thereof) for services performed by the depositary in administering our ADR program (which fee may be charged on a periodic basis during each calendar year and shall be assessed against holders of ADRs as of the record date or record dates set by the depositary during each calendar year and shall be payable in the manner described in the next succeeding provision);

 

   

reimbursement of such fees, charges and expenses incurred by the depositary and/or any of the depositary’s agents (including, without limitation, the custodian and expenses incurred on behalf of holders in connection with compliance with foreign exchange control regulations or any law or regulation relating to foreign investment) in connection with the servicing of the shares or other deposited securities, the delivery of deposited securities or otherwise in connection with the depositary’s or its custodian’s compliance with applicable law, rules or regulations (which charge shall be assessed on a proportionate basis against holders as of the record date or dates set by the depositary and shall be payable at the sole discretion of the depositary by billing such registered holders or by deducting such charge from one or more cash dividends or other cash distributions);

 

   

a fee for the distribution of securities (or the sale of securities in connection with a distribution), such fee being in an amount equal to the fee for the execution and delivery of ADSs which would have been charged as a result of the deposit of such securities (treating all such securities as if they were shares) but which securities or the net cash proceeds from the sale thereof are instead distributed by the depositary to those holders entitled thereto;

 

   

stock transfer or other taxes and other governmental charges;

 

   

cable, telex and facsimile transmission and delivery charges incurred at your request;

 

   

transfer or registration fees for the registration of transfer of deposited securities on any applicable register in connection with the deposit or withdrawal of deposited securities; and

 

   

expenses of the depositary in connection with the conversion of foreign currency into U.S. dollars.

We will pay all other charges and expenses of the depositary and any agent of the depositary (except the custodian) pursuant to agreements from time to time between us and the depositary. The fees described above may be amended from time to time.

Our depositary has agreed to reimburse us for certain expenses we incur that are related to establishment and maintenance of the ADR program, including investor relations expenses and exchange application and listing fees. The amount of reimbursement available to us is not based upon the amounts of fees the depositary collects from investors. The depositary collects its fees for issuance and cancellation of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deduction from cash distributions, or by directly billing investors, or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide services to any holder until the fees and expenses owing by such holder for those services or otherwise are paid. In the year ended December 31, 2011, we received $158,500 in reimbursements from the depositary.

 

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PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

None.

 

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

A.—D. Material Modifications to the Rights of Security Holders

None.

E. Use of Proceeds

The following “Use of Proceeds” information relates to our initial public offering, at $9.00 per ADS, of 5,000,000 ADSs, each representing eight ordinary shares, of which 4,526,979 ADSs were offered by our company and 473,021 ADSs were offered by a selling shareholder. The aggregate offering price was $45,000,000, with $40,742,811 for the ADSs offered by us and $4,257,189 for the ADSs offered by the selling shareholder. The registration statement on Form F-1 (File No. 333-163250) for our initial public offering was declared effective by the SEC on December 9, 2009. On December 15, 2009, we completed our initial public offering after all of the registered securities were sold. Jefferies & Company, Inc. and Oppenheimer & Co. Inc. were the underwriters for our initial public offering.

The total expenses incurred for our company’s account in connection with our initial public offering were approximately $5.6 million, including underwriting discounts and commissions of approximately $2.9 million, SEC registration fees of $6,000, FINRA filing fees of $10,560, Nasdaq Global Market listing fees of $106,000, printing expenses of approximately $349,200, legal fees of approximately $1.3 million, audit and audit-related fees of approximately $337,900, other professional fees of approximately $357,600 and roadshow costs and expenses of approximately $198,000. None of the above expenses included direct or indirect payments to directors or officers of our company or their associates, persons owning 10% or more of our equity securities or our affiliates.

We received net proceeds of approximately $35.1 million from our initial public offering. From December 9, 2009, the effective date of our registration statement on Form F-1 for the offering, to December 31, 2011, we used approximately $10.0 million to fund the construction of our Penglai production facilities. We intend to use the remainder of our net proceeds as follows:

 

   

approximately $6.0 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 million used to develop the manufacturing process of dipyridamole aspirin sustained release capsules, $1.2 million for Phase II and Phase III clinical trials of hemocoagulase derived from the venom of the snake species Agkistrodon acutus, $0.7 million for preclinical trials of adenosine for myocardial protection and $1.9 million for preclinical trials of lanthanum polystyrene sulfonate;

 

   

approximately $8.0 million to fund the improvement of our production systems, the expansion of our production facilities and the enhancement of our production lines;

 

   

approximately $5.0 million to fund the expansion and enhancement of our sales and marketing network; and

 

   

the balance for general corporate purposes.

None of the net proceeds from our initial public offering were paid directly or indirectly to directors or officers of our company or their associates, persons owning 10% or more of our equity securities or our affiliates.

 

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ITEM 15. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, has performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the