ITEM 1.
BUSINESS.
Overview of Our Business
We are a biopharmaceutical company principally engaged in the research, development, manufacturing and sales of human plasma-based pharmaceutical products in China. We have two majority owned subsidiaries, Shandong Taibang, a company based in Tai’an, Shandong Province and Guizhou Taibang, a company based in Guiyang, Guizhou Province. We also hold a minority equity interest in Huitian, a company based in Xi’an, Shaanxi Province. The human plasma-based biopharmaceutical manufacturing industry in China is highly regulated by both provincial and central governments. Accordingly, the manufacturing process of our products is strictly monitored from the initial collection of plasma from human donors to finished products.
Our principal products are human albumin and immunoglobulin products. Albumin has been used for almost 50 years to treat critically ill patients by replacing lost fluid and maintaining adequate blood volume and pressure. Immunoglobulin is used for certain disease prevention and treatment by enhancing specific immunity. These products use human plasma as the principal raw material. Human albumin and human immunoglobulin for intravenous injection, or IVIG products, are our top-selling products. Sales of human albumin products represented approximately 44.1%, 44.6% and 54.5% of our total sales for each of the years ended December 31, 2013, 2012 and 2011, respectively. Sales of IVIG products represented approximately 38.0%, 39.0% and 32.3% of our total sales for each of the years ended December 31, 2013, 2012 and 2011, respectively. All of our products are prescription medicines administered in the form of injections.
We sell our products primarily to hospitals and inoculation centers in the PRC directly or through approved distributors. We usually sign short-term contracts with customers and therefore our largest customers have changed over the years. For the years ended December 31, 2013, 2012 and 2011, our top 5 customers accounted for approximately 11.0%, 10.8% and 13.2%, respectively, of our total sales. As we continue to diversify our geographic presence, customer base and product mix, we expect that our largest customers will continue to change from year to year.
We operate and manage our business as a single segment. We do not account for the results of our operations on a geographic or other basis.
Our principal executive offices are located at 18th Floor, Jialong International Building, 19 Chaoyang Park Road, Chaoyang District, Beijing 100125, the People’s Republic of China. Our corporate telephone number is (86)10-6598-3111 and our fax number is (86)10-6598-3222. We maintain a website at
http://www.chinabiologic.com
that contains information about our company, but that information is not part of this report.
Our History and Background
China Biologic Products, Inc. was originally incorporated on December 20, 1989 under the laws of the State of Texas as Shepherd Food Equipment, Inc. On November 20, 2000, Shepherd Food Equipment, Inc. changed its corporate name to Shepherd Food Equipment, Inc. Acquisition Corp., which is the survivor of a merger with GRC Holdings, Inc. on May 28, 2003. On January 10, 2007, the Company was converted into a Delaware corporation and changed its name to China Biologic Products, Inc.
Taibang Biological and Shandong Taibang
On July 19, 2006, we completed a reverse merger with Taibang Biological, whereby we issued to the shareholders of Taibang Biological 18,484,715 shares of our common stock in exchange for 100% of the issued and outstanding shares of capital stock of Taibang Biological and its majority-owned Chinese operating subsidiary, Shandong Taibang. As a result of the merger, Taibang Biological became our wholly owned subsidiary, the former shareholders of Taibang Biological became our controlling stockholders holding 96.1% of our common stock and Shandong Taibang became our 82.76% majority-owned indirect subsidiary. Shandong Taibang is a sino-foreign joint venture company.
The remaining 17.24% equity interest of Shandong Taibang is held by the Shandong Institute of Biological Products (“Shandong Institute”), a stated-owned entity established in 1971. Directly administrated by the Shandong Provincial health department as its research arm, Shandong Institute specializes in the research, development and production of biological and plasma-based biopharmaceutical products. In 2002, as the consideration for its equity interest in Shandong Taibang, the Shandong Institute transferred all of its business and the licenses necessary to carry on its business to Shandong Taibang and seconded certain of its employees to Shandong Taibang.
Plasma Collection Stations of Shandong Taibang
Shandong Taibang has eight plasma collection stations in Shandong Province and two in Guangxi Province. The assets of these plasma stations are held through separate subsidiaries of Shandong Taibang, specially formed for this purpose. The subsidiaries holding the ten plasma stations are Xia Jin Plasma Company, Qi He Plasma Company, He Ze Plasma Company, Huan Jiang Plasma Company, Liao Cheng Plasma Company, Zhang Qiu Plasma Company, Fang Cheng Plasma Company, Ning Yang Plasma Company, Yishui Plasma Company and Cao Xian Plasma Company. Among these ten plasma stations, the one operated by Cao Xian Plasma Company was the latest addition. It was established in January 2013,
obtained the operating permits on April 1, 2013, and commenced plasma collection shortly thereafter.
In June 2008, we received approval from the Guangxi Province Bureau of Health to set up an additional plasma station in Pu Bei County, Guangxi Province. We plan to locate this plasma station
in the Centralized Industry Zone of Pu Bei County and when it commences operation, it could replace our existing Fang Cheng Plasma Collection Station with a more strategic location to increase collection volumes. However, due to disagreement among local government branches on the approval of the plasma station, the management is uncertain whether this station will be approved or when it will be approved. The management is still working with the local government for the approval of the Pu Bei Plasma Station.
Dalin and Guizhou Taibang
We hold our equity interest in Guizhou Taibang through Dalin, our indirect wholly-owned subsidiary.
According to the records of the local Administration for Industry and Commerce, or AIC, Dalin is a 54% shareholder of Guizhou Taibang (formerly Guiyang Qianfeng Biological Products Co., Ltd.).
Guizhou Taibang initially owned 85% equity interest in seven plasma collection stations at the time of our acquisition, of which two plasma stations remain in operation as of the date of this report. The remaining 15% equity interest in these plasma stations was owned by certain non-controlling shareholders through their holdings in an intermediate company, Guiyang Qianfeng Renyuan Bio Material Co., Ltd. (“Renyuan”). In January 2013, Guizhou Taibang purchased from these non-controlling shareholders their equity interest in Renyuan. In May 2013, Guizhou Taibang further restructured its equity interest in these two plasma stations, making them its direct wholly-owned subsidiaries.
In June 2013, Guizhou Taibang suspended the production of plasma-based products and commenced a comprehensive upgrade to its plasma production facility.
In January 2014, the upgrade was completed
and the CFDA conducted an on-site inspection on the upgraded plasma production facility.
Guizhou Taibang expects to obtain the GMP certification for such upgraded facilities in April 2014 and will resume commercial production at such production facility thereafter.
Guizhou Taibang completed the GMP upgrade of its placenta polypeptide production facility in November 2013 and received the GMP certification for such upgraded facilities from CFDA in January 2014.
Minority Equity Interest in Huitian
We hold a 35% interest in Huitian, a manufacturer of plasma-based biopharmaceutical products in Xi’an, Shaanxi Province. Huitian produces about 80 tons of plasma-based products per year and has 200 tons of annual production capacity. Huitian has been approved by the CFDA for the production of human albumin, human immunoglobulin, IVIG, and human hepatitis B immunoglobulin products.
To meet the New GMP Standard, Huitian started to construct a new production facility and suspended the production at its current facility at the end of 2013. Huitian expects to complete the construction of the new facility in 2015 and obtain the GMP certificate for such new facility from CFDA thereafter.
Corporate Structure
The following chart reflects our current corporate organizational structure as of December 31, 2013:
Our Industry
Plasma Collection in China
The collection of human plasma in China is generally influenced by a number of factors such as government regulations, geographical locations of plasma collection stations, sanitary conditions of plasma stations, living standards of the donors, and cultural and religious beliefs. Until 2006, only licensed plasma stations owned and operated by the government could collect human plasma. Furthermore, each plasma station was only allowed to supply plasma to the one manufacturer that had signed the “Quality Responsibility” statement with them. However, in March 2006, the Ministry of Health promulgated certain “Measures on Reforming Plasma Collection Stations,” or the Blood Collection Measures, whereby the ownership and management of PRC plasma stations are required to be transferred to plasma-based biopharmaceutical companies and the local government is charged with regulatory supervision and administrative control in accordance with the policies of the central government. These measures also tightened operational standard for plasma stations. As a result, all plasma stations are now having direct supply relationship with their parent fractionation facilities. In 2011, on the 11
th
National People’s Congress which contemplated the China’s 12
th
Five-Year Plan, Mr. Zhu Chen, China’s Minister of Health, encouraged China’s plasma industry to double plasma supply from 2011 to 2015 to meet China’s needs. As a result, more plasma stations are expected to be built throughout China in the foreseeable future.
We believe that these regulatory changes, including measures which limit illegal selling of blood, have improved the quality of blood and plasma by increasing hygiene standards at plasma stations. As the operation of the plasma stations become more regulated and the donor population expands, we believe that the overall quality of plasma supply will continue to improve, leading to a safer, more reliable finished product.
The supply of plasma for plasma-based products in the PRC has been on the decline since 2003 from the historical high of annual supply of approximately 7,000 metric tons to approximately 3,130 metric tons in 2008 and gradually recovering to approximately 4,180 metric tons in 2010. We believe that the decline prior to 2008 was a direct result of the government’s industry reforms of the country’s collection practices which led to the closure of many stations that did not meet the new industry standards. In July 2011, the Guizhou Provincial Health Department issued and implemented the revised “Plan for Guizhou Provincial Blood Collection Institutional Setting (2011-2014)” which limited the territories permitted to set up plasma stations in Guizhou Province to four counties only. As a result, 16 plasma stations, including four plasma stations of Guizhou Taibang, were closed down in July 2011. As a result, the supply of plasma in 2011 declined to approximately 3,540 metric tons. Based on reports promulgated by the PRC Ministry of Health and taking into consideration both the growth of the collection volume of existing plasma stations and the establishment of new plasma stations during 2012 and 2013, we estimate that the annual supply of plasma in China amounts to approximately 4,200 metric tons, as compared to 38,000 metric tons in the global market in 2013. The five largest manufacturers of plasma products in China are estimated to account for more than 50% of the annual plasma collection. We estimate revenues from the sale of plasma products in China amounted to approximately $2.2 billion in 2013, of which revenues from the sale of human albumin and IVIG products accounted for about 89% in 2013.
Plasma-Based Products Industry in China
We produce approved human albumin and immunoglobulin products, with human plasma as the primary raw material. Compared to the more developed countries, China has a lower usage level of plasma products and the make-up and range of the plasma-based pharmaceutical products is significantly different. Based on our analysis, in most developed countries, immunoglobulin products account for the majority of the plasma-based biopharmaceutical products, while in China, human albumin products account for the vast majority of such products. We estimated that total immunoglobulin products and human albumin products accounted for approximately 42% and 12%, respectively, of the total annual plasma-derived products in developed countries in 2013, and accounted for approximately 31% and 67%, respectively, of China’s during the same period.
Our Growth Strategy
Our mission is to become a first-class biopharmaceutical enterprise in China. To achieve this objective, we have implemented the following strategies:
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Securing the supply of plasma
. Due to the shortage of plasma, we plan to build new plasma collection stations throughout China as well as to expand collection territories of existing plasma stations in order to secure our plasma supply. By the end of 2013, we have a total of twelve plasma stations in operation, of which eight in Shandong Province, two in Guangxi Province, and two in Guizhou Province. In addition, we are working with the local government to obtain the plasma collection permit of our subsidiary located in Pu Bei, Guangxi Province. In the meanwhile, we carried out various promotion activities to stabilize and expand our donor base for the existing plasma stations. All of our plasma stations recorded increases in plasma collection volume in 2013 as compared to 2012.
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Acquisition of competitors and/or other biologic related companies
. In addition to organic growth, acquisition is an important part of our expansion strategy. Although there are about 33 approved plasma-based biopharmaceutical manufacturers in the market, we believe that there are only 25 manufacturers in operation, and only about half of them are competitive. The top five manufacturers in China are estimated to account for more than 50% market share (excluding imports) as of December 31, 2013. Furthermore, we believe that the regulatory authorities are considering further industry reform and those smaller, less competitive manufacturers will face possible revocation of their manufacturing permits by the regulators, making them potential targets for acquisition. If we are presented with appropriate opportunities, we may acquire additional companies, products or technologies in the biologic related sectors (including but not limited to medical, pharmaceutical and biopharmaceutical) to complement our current business operations.
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Further strengthening of research and development capability
. We believe that, unlike other more developed countries such as the U.S., China’s plasma-based biopharmaceutical products are at the initial stage of development. There are many other plasma-based products that are being used in the U.S. which are not currently being manufactured in China. We intend to strengthen our research and development capability so as to expand our product line to include plasma-based biopharmaceutical products that have higher margins and are technologically more advanced. We believe that our increased focus on research and development will give us a competitive advantage in China over our competitors.
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Market development and network expansion
. Leveraging on the high quality and excellent safety record of our products, we intend to (i) enhance our product penetration with our existing customers by introducing new products and (ii) expand our geographic market to include other provinces where we envision significant market potential.
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Our Products
Our principal products are our approved human albumin and immunoglobulin products. Human albumin is principally used to treat critically ill patients by replacing lost fluid and maintaining adequate blood volume and pressure. Human immunoglobulin products are primarily used to enhance specific immunity, a defense mechanism by which the human body generates certain immunoglobulin, or antibodies, against invasion by potentially dangerous substances. In a situation where the human body cannot effectively react with these foreign substances, injection of our products will provide sufficient antibodies to neutralize such substances. We are currently approved to produce 26 biopharmaceutical products in nine major categories as follows:
Approved Products
(1)(2)
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Treatment/Use
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Human albumin: - 20%/10ml, 20%/25ml, 20%/50ml,10%/100ml, 10%/20ml, 10%/50ml, 25%/50ml and 20%/50ml(10g, from factor IV)
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Shock caused by blood loss trauma or burn; raised intracranial pressure caused by hydrocephalus or trauma; oedema or ascites caused by hepatocirrhosis and nephropathy; prevention and treatment of low-density-lipoproteinemia; and Neonatal hyperbilirubinemia.
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Human hepatitis B immunoglobulin 100 International Units, or IU, 200IU, 400IU
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Prevention of measles and contagious hepatitis. When applied together with antibiotics, its curative effect on certain severe bacteria or virus infection may be improved.
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Human immunoglobulin 10%/3ml and 10%/1.5ml
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Original immunoglobulin deficiency, such as X chain low immunoglobulin, familiar variable immune deficiency, immunoglobulin G secondary deficiency; secondary immunoglobulin deficiency, such as severe infection, newborn sepsis; and auto-immune deficiency diseases, such as original thrombocytopenia purpura or kawasaki disease.
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IVIG 5%/25ml, 5%/50ml, 5%/100ml and 5%/200ml
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Same as above
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Thymopolypeptides injection 20mg/2ml,5mg/2ml
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Treatment for various original and secondary T-cell deficiency syndromes, some auto-immune deficiency diseases and various cell immunity deficiency diseases, and assists in the treatment for tumors.
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Human rabies immunoglobulin 100IU, 200IU and 500IU
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Mainly for passive immunity from bites or claws by rabies or other infected animals. All patients suspected of being exposed to rabies will be treated with a combined dose of rabies vaccine and human rabies immunoglobulin.
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Human tetanus immunoglobulin 250IU
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Mainly used for the prevention and therapy of tetanus. Particularly applied to patients who have allergic reactions to tetanus antitoxin.
(3)
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Placenta polypeptide 4ml/vial
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Treatment for cell immunity deficiency diseases, viral infection and leucopenia caused by various reasons, and assist in postoperative healing
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Human coagulation factor VIII (“FVIII”) 200IU and 300IU
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Treatment for coagulopathie such as hemophilia A and increase concentration of coagulation factor VIII
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Notes:
(1)
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“%” represents the degree of dosage concentration for the product and each product has its own dosage requirement. For example, human albumin 20%/10ml means 2g of human albumin is contained in each 10ml packaging and human immunoglobulin 10%/3ml means 300mg of human immunoglobulin is contained in each 3ml packaging. Under PRC law, each variation in the packaging, dosage and concentration of medical products requires separate registration and approval by the CFDA before it may be commercially available for sale. For example, among our human albumin products, only human albumin 20%/10ml, 20%/25ml, 20%/50ml, 10%/100ml, 10%/20ml, 10%/50ml, 25%/50ml and 20%/50ml (10g, from factor IV) products are currently approved and are commercially available.
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(2)
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“IU” means International Units, or IU. IU is a unit used to measure the activity of many vitamins, hormones, enzymes, and drugs. An IU is the amount of a substance that has a certain biological effect. For each substance there is an international agreement on the biological effect that is expected for 1 IU. In the case of immunoglobulin, it means the number of effective units of antibodies in each package.
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(3)
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Tetanus antitoxin is a cheaper injection treatment for tetanus. However it is not widely used because most people are allergic to it.
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We received the manufacturing approval certificate from CFDA for FVIII (200IU) in June 2012, obtained the GMP certification for our production facility of such product in October 2012 and commenced the commercial production shortly thereafter. We also received the manufacturing approval certificate from CFDA for FVIII (300IU) in July 2013 and commenced the commercial production in second half 2013. FVIII is widely used in the treatment of hemophilia A. In China, there is a large hemophilia patient population whose treatment requires lifelong medication. Currently, only three domestic companies produce plasma-based FVIII products. We plan to further expand our production for FVIII to capitalize on the market demand of coagulation products in China.
Our approved human albumin, immunoglobulin, and FVIII products all use human plasma as the primary raw material. All of our approved products are prescription medicines administered in the form of injections.
We have two product liability insurances covering Shandong Taibang’s and Guizhou Taibang’s products in the amount of RMB20 million (approximately $3,231,000) each. Since our establishment in 2002, there has not been any product liability claims nor has any legal action been filed against us by patients related to our products.
Raw Materials
Plasma
Plasma is the principal raw material for our biopharmaceutical products. As of December 31, 2013, we operate ten plasma stations through Shandong Taibang and two plasma stations through Guizhou Taibang. We believe that our plasma stations give us a stable source of plasma supply and control over product quality. Also, we believe that we have enjoyed benefits of economies of scale, including sharing certain administration and management expenses across our several plasma stations. We currently maintain sufficient plasma supply for approximately six months of production.
Other Raw Materials and Packaging Materials
Other raw materials used in the production of our biopharmaceutical products include reagents and consumables such as filters and alcohol. The principal packaging materials we use include glass bottles for our injection products as well as external packaging and printed instructions for our biopharmaceutical products. We acquire our raw materials and packaging materials from our approved suppliers in China and overseas. We select our suppliers based on quality, consistency, price and delivery of the raw materials which they supply.
Our five largest suppliers in the aggregate accounted for approximately 39.3%, 38.0% and 52.7% of our total procurement for the years ended December 31, 2013, 2012 and 2011, respectively. We have not experienced any shortage of supply or significant quality issue with respect to any raw materials and packaging materials.
Plasma Collection
All of our plasma was collected through plasma stations of Shandong Taibang and Guizhou Taibang. These stations purchase, collect, examine and deepfreeze plasma on behalf of Shandong Taibang and Guizhou Taibang and are subject to provincial health bureau’s rules, regulations and specifications for quality, packaging and storage. Each station is only allowed to collect plasma from healthy donors within its respective districts and in accordance with a time table set by its respective parent company, Shandong Taibang or Guizhou Taibang. The plasma must be tested negative for HBsAb, HCV and HIV antibodies and the RPR test, contain ALT ≤25 units (ALT) and plasma protein ≥55g/l, and contain no virus pollution or visible erythrolysis, lipemia, macroscopic red blood cell or any other irregular finding. The plasma is packaged in 25 separate 600g bags in each box and then stored at -20°C within limited time after collection to ensure that it will congeal within 6 hours. Each bag is labeled with a computer-generated tracking code. Shandong Taibang and Guizhou Taibang are responsible for the overall technical and quality supervision of the plasma collection, packaging and storage at each plasma station.
Sales, Marketing and Distribution
Because all of our products are prescription drugs, we can only sell to hospitals and inoculation centers directly or through approved distributors. For the years ended December 31, 2013, 2012 and 2011, direct sales to hospitals and inoculation centers represented approximately 66.8%, 66.4% and 62.8%, respectively, of our total sales. Our five largest customers in the aggregate accounted for approximately 11.0%, 10.8% and 13.2% of our total sales for the years ended December 31, 2013, 2012 and 2011, respectively. Our largest customer accounted for approximately 2.7%, 3.6% and 6.2% of our total sales for the years ended December 31, 2013, 2012 and 2011, respectively.
As part of our effort to ensure the quality of our distributors, we conduct due diligence to verify whether potential distributors have obtained necessary permits and licenses and facilities (such as cold storage) for the distribution of our biopharmaceutical products. We also assess a distributor’s financial condition before appointing it as our distributor. Certain of our regional distributors are appointed on an exclusive basis within a specified geographic territory. Our supply contracts set out the quantity and price of products to be supplied by us. For distributors, our contracts also contain guidelines for the sale and distribution of our products, including restrictions on the geographical territory in which the products may be sold. We provide our distributors with training in relation to our products and on sales techniques. We generally ask our distributors to pay in advance before we deliver products, with few exceptions for a credit period of no longer than 30 days. For hospitals and clinics, we generally grant a credit period of no longer than 90 days, with exceptions to certain high credit-worthy customers of up to 6 months. During 2013, we have not incurred any significant bad debts from our customers.
As of December 31, 2013, our largest geographic market is Shandong province, representing approximately 27.3%, 24.1% and 23.0% of our total sales for the years ended December 31, 2013, 2012 and 2011, respectively. Jiangsu is our second largest geographic market, representing 8.4%, 7.6% and 6.7% of our total sales for the years ended December 31, 2013, 2012 and 2011, respectively. In addition to Shandong and Guizhou provinces, we also have sales presence in 24 other provinces and four municipal cities.
Our marketing and after-sales services department currently employs 132 employees.
We believe that due to the nature of our products, the key factors of our competitiveness centers on product safety, brand recognition, timely availability and pricing. As all of our products are prescription medicines, we are not allowed to advertise our products in the mass media. For the years ended December 31, 2013, 2012 and 2011, total sales and marketing expenses amounted to approximately $10.6 million, $14.4 million and $14.6 million, respectively, representing approximately 5.2%, 7.8% and 9.5%, respectively, of our total sales.
Our Research and Development Efforts
Shandong Taibang and Guizhou Taibang each has its own research and development department (together, our “R&D Departments”). Our R&D Departments are equipped with specialized equipment including advanced testing and analytical equipment, such as atomic absorptimeter, fully automated blood coagulation analyzer, high performance liquid chromatograph, gas chromatograph, radioimmunoassay analyzer, ultraviolet-visible spectrophotometer, and protein chromatograph, most of which were imported from the U.S., Japan, Italy, Germany and Australia. All of our R&D researchers hold degrees in medicine, pharmacy, biology, biochemistry or other relevant field. Our R&D Departments are responsible for the development and registration of our products. We also cooperate with third-party biological research institutes in China to strengthen our R&D capacity.
We employ a market driven approach to initiate research and development projects, including both product and production technique development. We believe that the key to the industry developments revolves around (i) safety of products and (ii) maximizing the yield per unit volume of plasma. Our research and development efforts are focused around the following areas:
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broaden the breadth and depth of our portfolio of plasma-based biopharmaceutical products;
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enhance the yield per unit volume of plasma through new collection techniques;
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maximize manufacturing efficiency and safety;
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promote product safety through implementation of new technologies; and
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refine production technology for existing products.
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All the products we currently manufacture have been developed in-house. The following table outlines our research and development work in progress:
Products Currently in
Development
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Treatment/Use
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Status of Product
Development
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Stage*
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Human prothrombin complex concentrate
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Used for the prophylaxis and treatment of bleeding in patients with single or multiple congenital deficiencies of factor II or X and in patients with single or multiple acquired prothrombin complex factor deficiency requiring partial or complete reversal.
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Application made to the CFDA for official production permit and product certification. Commercial production expected in late 2014.
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4
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Human hepatitis B immunoglobulin (pH4) for intravenous injection
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Prevention of measles and contagious hepatitis. When applied together with antibiotics, its curative effect on certain severe bacteria or virus infection may be improved.
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Application made to the CFDA for official production permit and product certification. Commercial production expected in 2015.
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4
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Human fibrinogen
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Treatment for lack of fibrinogen and increase human fibrinogen concentration.
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Clinical trial program under CFDA review. Commercial production expected in 2016.
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3
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Varicella hyperimmune globulins
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Used for treatment of eczema vaccinatum, vaccinia necrosum, and ocular vaccinia
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Develop scope and technique for testing the new medicine.
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Immune Globulin Intravenous (Human), Caprylate/Chromatography Purified & 20 nm virus filtration
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Treatment for original immunoglobulin deficiency; secondary immunoglobulin deficiency and auto-immune deficiency diseases
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Application made to the National Institutes for Food and Drug Control (“NIFDC”) for official virus inactivation. Approval of clinical trials expected in 2015.
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Human Antithrombin III (concentration)
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Treatment for (i) hereditary antithrombin III deficiency in connection with surgical or obstetrical procedures and (ii) thromboembolism
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Pre-validation of viral inactivation and removal. Approval of clinical trials expected in 2015.
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* These stages refer to the stages in the regulatory approval process for our products disclosed under the heading “Regulation” in this report.
For the years ended December 31, 2013, 2012 and 2011, total research and development expenses amounted to approximately $4.2 million, $3.0 million and $4.0 million, respectively, representing approximately 2.1%, 1.6% and 2.6%, respectively, of our total sales.
Competition
We are subject to intense competition. There are both local and overseas pharmaceutical enterprises that are engaged in the manufacture and sale of potential substitute or similar biopharmaceutical products as our products in the PRC. These competitors may have more capital, better research and development resources, more manufacturing and marketing capability and experience than we do. In our industry, we compete based upon product quality, product cost, ability to produce a diverse range of products and logistical capabilities.
We believe that we have a strong competitive position in the marketplace with our 82.76% majority-owned operating subsidiary, Shandong Taibang, 54% majority-owned operating subsidiary, Guizhou Taibang and 35% equity interest in Huitian.
Our profitability may be adversely affected if (i) competition intensifies; (ii) competitors drastically reduce prices; (iii) PRC government’s interference on prices of our products; or (iv) competitors develop new products or product substitutes having comparable medicinal applications or therapeutic effects which are more effective and /or less costly than those produced by us.
There are currently about 33 approved manufacturers of plasma-based pharmaceutical products in China. Many of these manufacturers are essentially producing the same type of products that we produce: human albumin and various types of immunoglobulin. However, due to Ministry of Health regulations, we believe that it is difficult for new manufacturers to enter into the industry. We believe that our major competitors in China are Hua Lan Biological Engineering, China National Biotec Group, Shanghai RAAS Blood Products Co., Ltd., Shanxi Kangbao Biological Product Co., Ltd., Sichuan Yuanda Shuyang Pharmaceutical Co and Jiangxi Boya Bio pharmaceutical Co., Ltd.
In addition, we also face competition from imported products. The PRC became a member of the WTO in December 2001 and as a result imported biopharmaceutical products enjoy lower tariffs. Since 2009, we have seen a substantial increase in volume of imported human albumin in China. If the trend of importation of human albumin continues, we may face more fierce competition in domestic human albumin market.
We believe that we continued to be one of the top ranked plasma-based biopharmaceutical companies in China in 2013 based on our analysis of plasma product approval announcement published by China National Institute for the Control of Pharmaceutical and Biological Products throughout the year. To solidify our market position, we have also expanded our product portfolio to include FVIII in 2012. We received the manufacturing approval certificate and the GMP certification for production facility from CFDA for FVIII in 2012. We also have obtained the manufacturing approval certificate for human prothrombin complex concentrate (“PCC”) in July 2013, and expect to obtain the GMP certification for the production facility of PCC in 2014.
We will continue to meet challenges and secure our market position by enhancing our existing products, introducing new products to meet customer demand, delivering quality products to our customers in a timely manner and maintaining our established industry reputation.
Seasonality of our business
Our business, operating results and operating cash flows historically have not been subject to significant seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions.
Our Intellectual Property
We have 42 registered patents and four pending patent applications in the PRC for certain manufacturing processes and packing designs as of December 31, 2013. We also have one registered Trademark “CTBB” in the PRC.
In addition, we have registered the following domain names:
www.chinabiologic.com,
www.ctbb.com.cn
and
www.taibanggz.com
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Regulation
This section summarizes the major PRC regulations relating to our business.
Due to the nature of our products, we are supervised by various levels of the PRC Ministry of Health and/or CFDA. Such supervision includes the safety standards regulating our raw material supplies (mainly plasma), our manufacturing process and our finished products.
We are also subject to other PRC regulations, including those relating to taxation, foreign currency exchange and dividend distributions.
Plasma Collection
Substantially all plasma donations for commercialized plasma-based biopharmaceutical products are done through plasma stations. Plasma donation means donors give only selected blood components platelets, plasma, red cells, infection-fighting white cells called granulocytes, or a combination of these, depending on donors blood type and the needs of the community. Plasma stations in China are commonly used to collect plasma. In China, current regulations only allow an individual donor to donate blood in 14-day intervals, with a maximum quantity of 580ml (or about 600 gram) per donation.
The following are the regulatory requirements to establish a plasma station in China:
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meet the overall plan in terms of the total number, distribution, and operational scale of plasma stations;
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have the required professional health care technicians to operate a station;
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have the facility and a hygienic environment to operate a station;
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have an identification system to identify donors;
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have the equipment to operate a station; and
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have the equipment and quality control technicians to ensure the quality of the plasma collected.
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Plasma stations were historically owned and managed by the PRC health authorities. In March 2006, the Ministry of Health promulgated the Blood Collection Measures whereby the ownership and management of the plasma stations are required to be transferred to plasma-based biopharmaceutical companies while the regulatory supervision and administrative control remain with the government. As a result, all plasma stations are now having direct supply relationship with their parent fractionation facilities.
Set out below are some of the safety features at China’s plasma stations:
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Plasma stations can only source plasma from donors within the assigned district approved by the provincial health authorities.
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Plasma stations must perform a health check on the donor. Once the donor passes the health check, a “donor permit” is issued to the donor. The standards of the health check are established by the health authorities at the State Council level.
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The designing and printing of the “donor permit” is administrated by the provincial health authorities, autonomous region or municipality government, as the case maybe. The “donor permit” cannot be altered, copied or assigned.
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Before donors can donate plasma, the station must verify their identities and the validity of their “donor permits.” The donors must pass the verification procedures before they are given a health check and blood test. For those donors who have passed the verification, health check and blood test and whose plasma were donated according to prescribed procedures, the station will set up a record.
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All plasma stations are subject to the regulations on the prevention of communicable diseases. They must strictly adhere to the sanitary requirements and reporting procedures in the event of an epidemic situation.
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The operation of plasma collection stations is subject to stringent regulations by the PRC government. We estimated that there are approximately 150 plasma stations in operation in China as of December 31, 2013.
Importation of Blood Products
According to current Chinese regulations, the following blood products are banned from importation into China:
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Plasma frozen, liquid and freeze-dried human plasma;
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Immunoglobulin human normal immunoglobulin, specific immunoglobulin, human anti-tetanus immunoglobulin, human anti-hemophilia globulin, human anti-HBs immunoglobulin, human anti-D(Rho) immunoglobulin and immunoglobulin for intravenous administration;
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Factor VIII cryoprecipitated Factor VIII and Factor VIII concentrate (only Bayer is allowed, under a special arrangement with PRC government, to import this product into PRC, commencing November 2007);
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Factor IX concentrate;
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Human fibrinogen;
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Platelet concentrate;
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Human prothrombin complex; and
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Whole blood or blood components.
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Production of Plasma-based Products
The manufacture and sale of plasma-based biopharmaceutical products are subject to stringent regulations by the PRC government. Under PRC law, each variation in the packaging, dosage and concentration of medical products requires separate registration and approval by the CFDA before it may be commercially available for sale. For example, among our human albumin products, only human albumin 20%/10ml, 20%/25ml, 20%/50ml, 10%/100ml, 10%/20ml, 10%/50ml, 25%/50ml and 20%/50ml (10g, from factor IV) products are currently approved and are commercially available. All references, in this report, to our manufacture and sale of human albumin relate to our approved human albumin products.
The table below shows the PRC approval process for the manufacture and sale of new medicines:
Stage
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Activities
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1
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Pre-clinical Research
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The pre-clinical research stage mainly involves the following steps:
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Initiate the research project, study the project feasibility and develop a plan for testing and producing the new medicine;
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Develop the scope and the techniques for testing the new medicine in the laboratory;
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Develop laboratory-scale manufacturing process for the new medicine;
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Develop the manufacturing process for the new medicine on an expanded basis in the workshop;
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Develop the virus inactivation process/techniques, engage qualified institution to assess the virus inactivation process/techniques, and report the related documents to the related government authority for re-assessment.
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Clinical trial application
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The clinical trial application stage mainly involves the following steps:
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Submit required sample products and documents to the Provincial Food and Drug Administration (“PFDA”). PFDA will perform an on-site examination on the documents and equipment, and then transfer all the required materials to the China Food and Drug Administration (“CFDA”), who will further review the documents and test the sample products;
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Submit a draft clinical trial program to CFDA for the application of the clinical trial;
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Approval of the clinical trial.
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3
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Clinical trials
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Clinical trials range from Phase I to IV:
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Phase I: preliminary trial of clinical pharmacology and human safety evaluation studies. The primary objective is to observe the pharmacokinetics and the tolerance level of the human body to the new medicine as a basis for ascertaining the appropriate delivery methods or dosage.
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Phase II: preliminary exploration on the therapeutic efficacy. The purpose is to assess preliminarily the efficacy and safety of the new medicine on patients and to provide the basis for designing dosage tests in phase III.
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Phase III: confirm the therapeutic efficacy. The objective is to further verify the efficacy and safety of the new medicine on patients, to evaluate the benefits and risks and finally to provide sufficient experimental evidence to support the registration application of the new medicine.
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Phase VI: application research conducted after the launch of a new medicine. The objective is to observe the efficacy and adverse reaction of the new medicine under extensive use, to perform an evaluation of the benefits and risks of the application among ordinary or special group of patients, and to ascertain and optimize the appropriate dosage and formula for application.
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4
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Registration
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The registration stage mainly involves the following steps:
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Submit documents related to pre-clinical and clinical trials to PFDA, which will perform on-site inspection on the clinical trials and then transfer the related documents to CFDA for further review;
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On-site inspection by CFDA on three consecutive sample productions at the production facilities;
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Grant of the manufacturing approval certificate following the public notification period;
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Grant of GMP certificate following the public notification period.
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New GMP Standard
All of our production facilities are required to obtain GMP certificates for their pharmaceutical production activities. In February 2011, CFDA enacted the New GMP Standard, which has significantly increased standards for quality control, documentation, and overall manufacturing processes of blood products, vaccines, injections and other sterile pharmaceutical products. The New GMP Standard, among others, requires us to maintain and operate a comprehensive and effective product quality control system throughout the production process. In addition, it imposes higher standards for our production facility. The New GMP Standard has become applicable to all of our production facilities at the end of 2013. After respective upgrades on this production facilities, Shandong Taibang obtained the renewed GMP certificate in June 2013, and Guizhou Taibang expects to obtain the renewed GMP certificate in April 2014 following the on-site inspection conducted by CFDA in January 2014. See Item 1A “Risk Factors Risk related to our business
One of our production facilities has suspended production for technical upgrade and is awaiting the renewed GMP certificate. We may not be able to carry on our business if we lose any of the permits and licenses required by the PRC government in order to carry on our business.
”
Pricing
Retail prices of certain pharmaceutical products are subject to various regulations. According to the “Regulations on controlling blood products” promulgated by the State Council in 1996, regional offices of the Pricing Bureau and the Ministry of Health have the authority to regulate retail prices for controlled plasma products. In addition, retail prices of pharmaceutical products fully or partially covered under the national insurance system are also subject to the price ceilings set out in the National (Medical) Insurance Catalog (the “NIC”), which may be adjusted by Chinese National Development and Reform Commission (“NDRC”) from time to time. The hospitals as participants of the national insurance program cannot sell the products to patients at prices exceeding such retail price ceilings. The provincial governments in turn often establish a tender price ceiling for product tender offer made to hospitals based on, amongst other things, the regional living standards, cost of production of the manufacturers and the corresponding retail price ceiling. The ex-factory prices and the distributor’s wholesale prices cannot exceed the tender price ceiling. Five of our principal products, human albumin, IVIG, human rabies immunoglobulin, human tetanus immunoglobulin and FVIII, are included in the NIC and are subject to tender price ceilings. Two of our principal products, placenta polypeptide and human hepatitis B immunoglobulin, although not included in the NIC, are also subject to tender price ceilings in certain provinces. Our profit margin for any price-controlled product is effectively controlled by the tender price ceiling. When a tender price ceiling puts significant pressure on the profit margin of a given product, we may appeal to the provincial governments for lifting of such tender price ceiling.
In an announcement published in September 2012 (the “2012 Adjustment”), NDRC adjusted retail price ceilings for 95 oncology, immunology and hematology drug products, which came into effect on October 8, 2012. Two of our approved products, IVIG and FVIII are affected by the 2012 Adjustment. The new retail price ceilings for IVIG products are lower than the current prevailing market retail prices in some of our regional markets while those for FVIII are close to the current prevailing market retail prices. As a result, some local governments revised tender price ceilings for IVIG products. In January 2013, NDRC further adjusted retail price ceilings for certain drug products, which came into effect on February 1, 2013 (the “2013 Adjustment”). Three of our approved products, human albumin, human rabies immunoglobulin and human tetanus immunoglobulin are affected by the 2013 Adjustments. The 2013 Adjustment slightly increased retail price ceilings for both human albumin and human tetanus immunoglobulin products and subject human rabies immunoglobulin products to a retail price ceiling for the first time. The retail price ceiling imposed on human rabies immunoglobulin products by the 2013 Adjustment is close to the prevailing market retail price.
Taxation
On March 16, 2007, the National People’s Congress of China passed the Enterprise Income Tax Law, or the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Before the implementation of the EIT Law, foreign invested enterprises, or FIEs, established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an earned income tax, or EIT, rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax. The EIT Law and its implementing rules impose a unified EIT of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions. However, the EIT Law gives FIEs established before March 16, 2007, or Old FIEs, a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. During this five-year grandfather period, Old FIEs that enjoyed tax rates lower than 25% under the original EIT Law can gradually increase their EIT rate by 2% per year until their tax rate reaches 25%. In addition, the Old FIEs that are eligible for the “two-year exemption and three-year half reduction” or “five-year exemption and five-year half-reduction” under the original EIT law, are allowed to continue enjoying their preference until these holidays expire.
In addition to the changes to the tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A “Risk Factors Risks Related to Doing Business in China
Under the Enterprise Income Tax Law, we may be classified as a ‘resident enterprise’ of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders
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Foreign Currency Exchange
The principal regulation governing foreign currency exchange in China is the Foreign Currency Administration Rules (1996), as amended (2008). Under these Rules, RMB is freely convertible for current account items, such as trade and service-related foreign exchange transactions, but not for capital account items, such as direct investment, loan or investment in securities outside China unless the prior approval of, and/or registration with, the State Administration of Foreign Exchange of the People’s Republic of China, or SAFE, or its local counterparts (as the case may be) is obtained.
Pursuant to the Foreign Currency Administration Rules, FIEs in China may purchase foreign currency without the approval of SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange (subject to a cap approved by SAFE) to satisfy foreign exchange liabilities or to pay dividends. In addition, if a foreign company acquires a company in China, the acquired company will also become an FIE. However, the relevant PRC government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside China are still subject to limitations and require approvals from, and/or registration with, SAFE.
Dividend Distributions
Under applicable PRC regulations, FIEs 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 FIE in China is required to set aside at least 10% 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% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a FIE also 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.
In addition, under the EIT law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, which was issued on January 29, 2008, the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, or the Double Taxation Treaty, which became effective on December 8, 2006, and the Notice of the State Administration of Taxation Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, which became effective on October 27, 2009, dividends from our PRC subsidiary, Taibang Biotech, paid to us through our Hong Kong subsidiary, Taibang Holdings, may be subject to a withholding tax at a rate of 10%, or at a rate of 5% if Taibang Holdings is considered a “beneficial owner” that is generally engaged in substantial business activities
in Hong Kong
and entitled to treaty benefits under the Double Taxation Treaty.
Our Employees
As of December 31, 2013, we employed 1,533 full-time employees, of which approximately 66 were seconded to us by the Shandong Institute.
We believe we are in material compliance with all applicable labor and safety laws and regulations in the PRC. We participate in various employee benefit plans that are organized by municipal and provincial governments, including retirement, medical, unemployment, work injury and maternity benefit plans for our managerial and key employees. In addition, we provide short term insurance plans for all our employees while on duty to cover work related accidents.
We believe that we maintain a satisfactory working relationship with our employees and we have not experienced any significant labor disputes or any difficulties in recruiting staff for our operations.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports, are available free of charge through our web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, at the following address: www.chinabiologic.com. The information within, or that can be accessed through, the web site is not part of this report.
ITEM 1A.
RISK FACTORS.
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. You should read the section entitled “Special Note Regarding Forward Looking Statements” above for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this report.
RISKS RELATED TO OUR BUSINESS
If the PRC government bans or limits plasma-based biopharmaceutical products, our operations, revenues and profitability would be adversely affected.
The principal raw materials of our existing and planned biopharmaceutical products is human source plasma, which, due to its unique nature, is subject to various quality and safety control risks which include, but are not limited to, contaminations and blood-borne diseases. In addition, current technology cannot eliminate entirely the risk of biological hazards inherent in plasma that have yet to be discovered, which could result in a wide spread epidemic due to blood infusion. The primary law that regulates plasma products in China is the PRC Pharmaceutical Law, the Implementation Rules on the PRC Pharmaceutical Law and the Regulations on the Administration of Blood Products. These rules and regulations require entities producing blood products to comply strictly with certain hygienic standards and specifications promulgated by the government. In the event that human plasma is discovered to be not compliant with the government’s hygienic standards and specifications, the health department may revoke its approval of the blood product in general, or otherwise limit the use of such blood product. If the PRC government bans or limits plasma-based biopharmaceutical products, our operations, revenues and profitability would be adversely affected.
If the plasma we source is found to be contaminated, our operation, revenues and profitability would be severely and adversely affected and we may be subject to civil and criminal liabilities.
We currently source plasma from human donations to our plasma stations in Shandong, Guangxi and Guizhou Provinces. If any of our human donors is infected with diseases, then the plasma from such donor may be infected. Although we pre-screen all donors in order to ensure that they are not infected with HIV and Hepatitis C and have not contracted liver disease, technical limitation and human errors in the screening test may fail to identify and exclude from our supply the plasma from infected donors. If such contaminated plasma is not appropriately screened out, our entire plasma source for the relevant plasma station may become contaminated. If the plasma from our collection is found to be contaminated, we could be subject to civil liability from suits brought by consumers. Further, we may lose our registration and incur criminal liability if we are found by the government to have been criminally negligent. If this occurs, our business, prospects, results of operations and financial condition will be materially and adversely affected.
If our supply of quality plasma is interrupted, our results of operations and profitability will be adversely affected.
The production of plasma-based biopharmaceutical products relies on the supply of plasma of suitable quality. For the years ended December 31, 2013, 2012 and 2011, the cost of plasma used by us for production accounted for approximately 74%, 74% and 67%, respectively, of total production cost. The supply and market prices of plasma may be adversely affected by factors such as regulatory restrictions, living standard or outbreak of diseases which would impact our costs of production. We may not be able to pass on any resulting increase in costs to our customers and therefore any substantial fluctuation in supply or market prices of plasma may adversely affect our results of operations and profitability.
The biopharmaceutical industry in the PRC is strictly regulated and changes in such regulations may have an adverse effect on our business.
The biopharmaceutical industry in the PRC is strictly regulated by the government. The regulatory regime, such as administrative approval of medicines and production approvals, establishes regulations and administrative rules. The PRC regulatory authorities may amend these regulations and rules and promulgate new ones from time to time. Changes in these regulations and administrative rules could have a material and adverse impact on our business, prospects, financial conditions and results of operation.
One of our production facilities has suspended production for technical upgrade and is awaiting the renewed GMP certificate. We may not be able to carry on our business if we lose any of the permits and licenses required by the PRC government in order to carry on our business.
All pharmaceutical manufacturing and distribution enterprises in the PRC are required to obtain from various PRC governmental authorities certain permits and licenses, including, in the case of manufacturing enterprises, pharmaceutical manufacturing permit and GMP certificate and, in the case of distribution enterprises, pharmaceutical distribution permit.
All of our production facilities are required to obtain GMP certificates for their pharmaceutical production activities. In February 2011, CFDA enacted the New GMP Standard, which has significantly increased standards for quality control, documentation, and overall manufacturing processes. The New GMP Standard has become applicable to all of our production facilities at the end of 2013. In order for us to meet the New GMP Standard, we have upgraded the related production facilities in Shandong Taibang and Guizhou Taibang. Shandong Taibang obtained the renewed GMP certificate in June 2013. Guizhou Taibang suspended production since June 2013 to upgrade its plasma production facility. In January 2014, the upgrade was completed and the CFDA conducted on-site inspection on the upgraded plasma production facility. Guizhou Taibang expects to obtain the renewed GMP certificate and resume production of plasma-based products in April 2014. We cannot assure you, however, that Guizhou Taibang will not experience any delay in obtaining renewed GMP certificate. If this occurs, our business, financial conditions and results of operation may be materially and adversely affected.
Moreover, Huitian has suspended its production since the end of 2013 and is constructing a new production facility to meet the New GMP Standard. The suspension of Huitian’s production may have a negative effect on its business operation and profitability, which may in turn affect our income derived from our minority investment in Huitian and materially and adversely affect our business, financial condition and results of operations.
Other than discussed above, we have obtained permits and licenses and the GMP certificates, required for the manufacturing and sales of our pharmaceutical products. Our permits and licenses are subject to periodic renewal and/or reassessment by the relevant PRC governmental authorities, and the standards of compliance required in relation thereto may from time to time be subject to changes. We intend to apply for the renewal of such permits and licenses when required by applicable laws and regulations. However, there is no guarantee that we may renew such permits and licenses in a timely manner, or at all. If this happens, our business, prospects, financial conditions and results of operation may be materially and adversely affected.
In addition, any changes in compliance standards, or any new laws or regulations that may prohibit or render it more restrictive for us to conduct our business or increase our compliance costs may adversely affect our operations or profitability. For example, we expect our on-going compliance cost to increase under the New GMP Standard as compared to the former GMP standard. As a result, our business and financial condition may be materially and adversely affected.
We do not have discretion to increase our ex-factory price of our price-controlled products.
Retail prices of certain pharmaceutical products are subject to various regulations. According to the “Regulations on controlling blood products” promulgated by the State Council in 1996, regional offices of the Pricing Bureau and the Ministry of Health have the authority to regulate retail prices for controlled plasma products. In addition, retail prices of pharmaceutical products fully or partially covered under the national insurance system are also subject to the price ceilings set out in the National (Medical) Insurance Catalog (the “NIC”), which may be adjusted by Chinese National Development and Reform Commission ("NDRC") from time to time. The hospitals as participants of the national insurance program cannot sell the products to patients at prices exceeding such retail price ceilings. The provincial governments in turn often establish a tender price ceiling for product tender offer made to hospitals based on, amongst other things, the regional living standards, cost of production of the manufacturers and the corresponding retail price ceiling. The ex-factory prices and the distributor’s wholesale prices cannot exceed the tender price ceiling. Five of our principal products, including human albumin, IVIG, human rabies immunoglobulin, human tetanus immunoglobulin and FVIII, are included in the NIC and are also subject to tender price ceilings. Two of our principal products, placenta polypeptide and human hepatitis B immunoglobulin, although not included in the NIC, are also subject to tender price ceilings in certain provinces.
In an announcement published in September 2012 (the “2012 Adjustment”), NDRC adjusted retail price ceilings for 95 oncology, immunology and hematology drug products, which came into effect on October 8, 2012. Two of our approved products, IVIG and FVIII are affected by the 2012 Adjustment. The new retail price ceilings for IVIG products are lower than the current prevailing market retail prices in some of our regional markets while those for FVIII are close to the current prevailing market retail prices. As a result, some local governments revised tender price ceilings for IVIG products.
In January 2013, NDRC further adjusted retail price ceilings for certain drug products, which came into effect on February 1, 2013 (the “2013 Adjustment”). Three of our approved products, human albumin, human rabies immunoglobulin and human tetanus immunoglobulin are affected by the 2013 Adjustments. The 2013 Adjustment slightly increased retail price ceilings for both human albumin and human tetanus immunoglobulin products and subject human rabies immunoglobulin products to a retail price ceiling for the first time. The retail price ceiling imposed on human rabies immunoglobulin products by the 2013 Adjustment is close to the prevailing market retail price.
We do not have discretion to increase
our ex-factory price of the price-controlled products above the relevant controlled tender price ceiling. Although we may appeal to the local governments for favorable pricing policy support in lifting the tender price ceiling, such support is only granted on a case-by-case basis and there is no guarantee that we may be able to obtain any such support in the future when needed. Since the tender price ceiling may prevent us from absorbing or offsetting the effect resulting from any increase in the cost of raw materials or other costs, our revenue and profitability could be adversely affected. If the margin of any of these products becomes prohibitively low, we may be forced to stop manufacturing such product, in which case our revenue and profitability would be further adversely affected.
If we are unable to adequately monitor our plasma collection stations, failure to follow proper procedure or comply with safety requirements may subject us to sanctions by the government, civil and criminal liability, any of which would have a material adverse effect on our business.
We currently operate ten plasma collection stations through Shandong Taibang and two plasma stations through Guizhou Taibang. Huitian, our minority owned subsidiary, operates three plasma stations in Shaanxi province. To ensure our development, we are seeking opportunities to build more plasma stations and expect to start operating one additional plasma station through Shandong Taibang by the end of 2014. While we monitor our plasma intake procedures through frequent unscheduled inspections of our stations, there remain risks that our plasma stations may fail to comply with hygiene and procedure requirements in plasma screening, collection, storage and tracking. If we fail to comply with any of these requirements, we may lose our plasma collection permits or even incur criminal liability if we are found by the government to have been criminally negligent. In the case of plasma contamination, we may also be subject to civil liability from suits brought by consumers. In addition, failure to comply with hygiene and procedure requirements may cause harm to donors, including contracting disease from other donors. Any such incident may subject us to government sanctions, civil or criminal liabilities. If this occurs, our business operation, reputation and prospects may be materially and adversely affected.
Our operations, sales, profit and cash flow will be adversely affected if our plasma-based biopharmaceutical products fail to pass inspection in a timely manner.
Each batch of our plasma-based biopharmaceutical products requires inspection by Chinese government regulators before we can ship it to our customers. The CFDA has a quality standard which considers, among other things, the appearance, packing capacity, thermal stability, pH value, protein content and percentage of purity of the product. We must strictly comply with relevant rules and regulations in our whole production procedures including plasma collection, delivery, production and packaging. For example, in order to pass inspection, our plasma must be tested negative for any blood irregularities, including Hepatitis C, HIV and liver disease. The plasma must be packaged in 25 to 30 separate 600g bags in each box and each bag must be labeled with a computer-generated tracking code. The plasma must be stored at -20°C as soon as possible after collection to ensure that it will congeal within 6 hours. Government regulators usually take more than one month to inspect a batch of plasma products. The process begins when the regulator randomly selects samples of our products and delivers them to the National Institute for the Control of Pharmaceutical and Biological Products, or the NICBPB, for testing, and the process ends when the products are given final approval by the NICBPB. In the event that the regulators delay the approval of or reject our products, change the requirements in such a way that we are unable to comply with those requirements, our operations, sales, profit and cash flow will be adversely affected.
We face risks related to general domestic and global economic conditions. Disruptions in the capital and credit markets could adversely affect our results of operations, cash flows and financial condition, or those of our customers, suppliers and creditors.
We currently generate sufficient operating cash flows, which combined with access to the credit markets, provide us with significant discretionary funding capacity. However, any uncertainty arising out of domestic and global economic conditions, including any disruption in credit markets, may impact our ability to manage normal relationships with our customers, suppliers and creditors and adversely impact our results of operations, cash flows and financial condition, or those of our customers, suppliers and creditors. Disruptions in the capital and credit markets as a result of uncertainty, changing or increased regulation, reduced alternatives or failures of significant financial institutions could adversely affect our access to liquidity needed to conduct or expand our businesses or conduct acquisitions or make other discretionary investments. Such disruptions may also adversely impact the capital needs of our customers and suppliers, which, in turn, could adversely affect our results of operations, cash flows and financial condition.
In addition, the demand for our products is largely affected by the general economic conditions in China as our products are still not affordable to many patients. As China’s economy grows, we expect more Chinese people will become consumers of medical treatments and procedures, including procedures requiring human plasma. However, any potential global economic slowdown may result in slower economic growth in China and an unfavorable economic environment which in turn may make our products less affordable to more patients and result in an overall decreased demand for our products. Such reductions and disruptions could have a material adverse effect on our business operations.
If we are unable to obtain additional capital or if we experience any shortage of raw materials in future years, we may be unable to proceed with our long-term business plan and we may be forced to curtail or cease our operations or further business expansion.
We will require additional working capital to support our long-term business plan, which includes identifying suitable targets for horizontal or vertical mergers or acquisitions, so as to enhance the overall productivity and benefit from economies of scale. Our working capital requirements and the cash flow provided by future operating activities, if any, will vary greatly from quarter to quarter, depending on the volume of business during the period and payment terms with our customers. We may not be able to obtain adequate levels of additional financing, whether through equity financing, debt financing or other sources, especially during time of market downturn. To raise funds, we may need to issue new equities or bonds which could result in additional dilution to our shareholders and investors. Additional financings could result in significant dilution to our earnings per share or the issuance of securities with rights superior to our current outstanding securities or contain covenants that would restrict our operations and strategy. In addition, we have granted and may in the future grant further registration rights to investors purchasing our equity or debt securities. If we are unable to raise additional financing, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures on a timely basis. In addition, a lack of additional financing could force us to substantially curtail or cease operations.
In addition, our production volume, capacity utilization and future expansion are affected by the supply of raw materials, especially plasma. If we experience any shortage of plasma supply or fail to secure sufficient plasma supply for our production, we may not be able to fully utilize our production capacity or proceed with our plan for expansion.
Our cash flow could be negatively affected as a result of our extension of relatively long payment terms to customers that we believe are credit worthy.
As is customary in our industry, we extend relatively long payment terms (up to six months) to customers that we believe are credit worthy. Our accounts receivable, net of our allowance for doubtful accounts as of December 31, 2013, 2012 and 2011 was $17,270,132, $11,206,244 and $16,757,368, respectively. Almost all of our accounts receivables are due from hospitals and clinics. Although we attempt to establish appropriate reserves for our receivables, those reserves may not prove to be adequate in view of actual levels of bad debts. The failure of our customers to pay us timely would negatively affect our working capital, which could in turn adversely affect our cash flow.
We rely on a Secondment Agreement with the Shandong Institute, which is expected to terminate upon the future privatization of the Shandong Institute, for certain of our employees. If the Secondment Agreement is breached or terminated, it could have an adverse effect on our operations and on our financial results.
The Shandong Institute has provided us with approximately 66 of our employees, including certain key management personnel, out of our total of approximately 1,533 employees, pursuant to a secondment agreement, or Secondment Agreement, dated October 28, 2002, between Shandong Taibang and the Shandong Institute. Pursuant to the Secondment Agreement, we are responsible for the salaries of these employees, as well as for their social benefits such as insurance. Our Secondment Agreement with the Shandong Institute will expire on the sooner to occur of October 2032 or upon the privatization of the Shandong Institute, which was originally expected to occur before the end of 2008. However, the completion of privatization of Shandong Institute has been delayed indefinitely due to delay by the Shandong Ministry of Health in implementing the privatization plan. Upon expiration or termination of the Secondment Agreement, we plan to hire the seconded employees directly. However, we cannot be sure that all of the employees will accept our employment offers at that time. Guangli Pang, Shandong Taibang’s Chief Executive Officer is employed through the Secondment Agreement. Although none of our seconded employees have indicated that they do not plan to continue working for our Company after the privatization, if the Secondment Agreement is terminated or expires and we are unable to hire those employees or replacement employees on time, our operations, as well as our financial results, may be materially and adversely affected.
If the distributors on whom we rely do not purchase our products, our business and results of operations will be adversely affected.
We sell a third of our products in China through our network of about 208 distributors located in about 25 provinces and four municipal cities throughout China. While we have established working relationships with many of our distributors and strictly regulate their sales and marketing activities by annual distribution agreements, there are no restrictions in these distribution agreements preventing our distributors from also sourcing products produced by our competitors. Our own marketing and sales staff work to develop and maintain relationships with our distributors, but there can be no assurance that we will be able to maintain such relationships. For the years ended December 31, 2013, 2012 and 2011, sales to distributors represented approximately 33.2%, 33.6% and 37.2%, respectively, of our total revenues. If a number of our distributors cease to purchase our products and we are unable to find suitable replacements, our business and results of operations will be materially and adversely affected.
Our inability to successfully research and develop new biopharmaceutical products could have an adverse effect on our future growth.
We believe that the successful development of biopharmaceutical products can be affected by many factors. Products that appear to be promising in the early phases of research and development may fail to be commercialized for various reasons, including the failure to obtain the necessary regulatory approvals. In addition, the research and development cycle for any new medicine is a relatively lengthy process. In our experience, the process of conducting research and various tests on new products before obtaining a Certificate of New Medicine from the PRC Ministry of Health and subsequent procedures may take approximately three to five years. There is no assurance that our future research and development projects will be successful or that they will be completed within the anticipated time frame or budget. Also, there is no guarantee that we will receive the necessary approvals from relevant authorities for the production of our newly developed products. Even if such products could be successfully commercialized, there is no assurance that they will be accepted by the market as anticipated.
Our financial position and operations may be materially and adversely affected if our product liability insurance does not sufficiently cover our liabilities.
Under current PRC laws, 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, which became effective in 1987, 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.
The Product Quality Law of the PRC, or the Product Quality Law, was enacted in 1993 and revised in 2000. The Product Quality Law was enacted to protect the rights and interests of end-users and consumers and to strengthen the supervision and control of the quality of products. Under the Product Quality Law, manufacturers who produce defective products may be subject to fines and production suspension, and in severe cases, be subject to criminal liability and may have their business licenses revoked.
The PRC Law on the Protection of the Rights and Interests of Consumers, or the Consumers’ Rights Law, was enacted in 1993 to further protect the legal rights and interests of consumers in connection with the purchase or use of goods and services. All businesses, including our business, must observe and comply with the Consumers’ Rights Law.
The Tort Liability Law of the PRC was enacted in December 2009, which states that manufacturers are liable for damages caused by defects in their products. If the defects are caused by third parties such as transporters or storekeepers, manufactures may be entitled to claim for compensation from such third parties after paying the compensation amount to the consumer.
We maintain two product liability insurances for sales in the PRC for Shandong Taibang and Guizhou Taibang’s products in the amount of RMB20 million (approximately $3.2 million) each. If our products are found to be defective and our insurance coverage is insufficient to cover a successful claim against us, our financial position and operations may be materially and adversely affected.
We are subject to intense competition and may encounter increased competition from both local and overseas pharmaceutical enterprises if the PRC regulatory relaxes the approval process for plasma-based biopharmaceutical products or international trade restrictions. A change in our competitive environment could adversely affect our profitability and prospects.
We are subject to intense competition. There are both local and overseas pharmaceutical enterprises that are engaged in the manufacture and sale of potential substitute or similar biopharmaceutical products as our products in the PRC. These competitors may have more capital, better research and development resources, more manufacturing and marketing capability and experience than we do. In addition, our continued ability to compete depends on the development of the plasma-based biopharmaceutical manufacturing industry in China. The plasma-based biopharmaceutical manufacturing industry in China is highly regulated by both provincial and central governments. Prior to engaging in the collection and production of plasma products, companies such as ours are required to obtain collection permits from the central health department and production permits and certificates for each new product formulation from the various provincial food and drug authorities. Although we believe that the regulatory requirements pose a competitive barrier to entry into the biopharmaceutical industry, over time, however, there may be new entrants. If the government relaxes these restrictions and allows more competitors to enter into the market, these competitors may have more capital, better research and development resources, more manufacturing and marketing capability and experience than us. Our profitability may be adversely affected if (i) competition intensifies; (ii) competitors drastically reduce prices; or (iii) competitors develop new products having comparable medicinal applications or therapeutic effects which are more effective or less costly than those produced by us.
In addition, we also face competition from imported products. China became a member of the WTO in December 2001 and as a result imported biopharmaceutical products enjoy lower tariffs. Since 2009, we have seen a substantial increase in volume of imported human albumin in China. If the trend of importation of human albumin continues, we may face more fierce competition in domestic human albumin market. In addition, China becomes more accessible to foreign biopharmaceutical manufacturers who may wish to set up production facilities in the PRC and compete directly with domestic manufacturers. The increased supply of both domestic and foreign competitively priced biopharmaceutical products in the PRC will result in increased competition. There is no assurance that our strategies to remain competitive can be implemented successfully as scheduled or at all. Our inability to remain competitive may have an adverse effect on our profitability and prospects.
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
Our success, to a certain extent, is attributable to the expertise and experience of our senior management and key research and technical personnel who carry out key functions in our operation. If we lose the service of any of our senior management or key research or technical personnel or fail to attract additional personnel with suitable experience and qualification, our business operations and research capability may be adversely affected.
Future acquisitions may have an adverse effect on our ability to manage our business.
Selective acquisitions form part of our strategy to further expand our business. If we are presented with appropriate opportunities, we may acquire additional companies, products or technologies. Future acquisitions and the subsequent integration of new companies into ours would require significant attention from our management. Potential problems encountered by each organization during mergers and acquisitions would be unique, posing additional risks to the company. The diversion of our management’s attention and any difficulties encountered in any integration process could have an adverse effect on our ability to manage our business. Future acquisitions would expose us to potential risks, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden liabilities, the diversion of resources from our existing businesses and technologies, the inability to generate sufficient revenue to offset the costs and expenses of acquisitions, and potential loss of, or harm to, relationships with employees, customers and suppliers as a result of integration of new businesses.
We may lose our competitive advantage and our operations may suffer if we fail to prevent the loss or misappropriation of, or disputes over, our intellectual property or proprietary information.
We regard our intellectual property, particularly our patents and trade secrets, to be of considerable value and importance to our business and our success. We rely on a combination of patent, trademark and trade secret laws, as well as confidentiality agreements to protect our intellectual property rights. Failure to protect our intellectual property could harm our brands and our reputation, and adversely affect our ability to compete effectively. Further, enforcing or defending our intellectual property rights, including our patents and trade secrets, could result in the expenditure of significant financial and managerial resources.
As of December 31, 2013, we own 42 registered patents and have four pending patent applications in the PRC for certain manufacturing processes and packaging designs.
The patent application will be subject to approval from the relevant PRC authorities. We may not be able to successfully obtain the approval of the PRC authorities for our patent applications. We also have one trademark “CTBB” registered in the PRC.
While we are not aware of any infringement on our intellectual property and we have not been notified by any third party that we are infringing on their intellectual property, our ability to compete successfully and to achieve future revenue growth will depend, in significant part, on our ability to protect our proprietary technology and operate without infringing upon the intellectual property rights of others. Policing unauthorized use of proprietary technology is difficult and expensive. The steps we have taken may not be adequate to prevent unauthorized use of our intellectual property rights.
The legal regime in China for the protection of intellectual property rights is still at its early stage of development. Despite many laws and regulations promulgated and other efforts made by China over the years with a view to tightening up its regulation and protection of intellectual property rights, private parties may not enjoy intellectual property rights in China to the same extent as they would in many Western countries, including the United States, and enforcement of such laws and regulations in China have not achieved the levels reached in those countries. Both the administrative agencies and the court system in China are not well-equipped to deal with violations or handle the nuances and complexities between compliant technological innovation and noncompliant infringement.
We also rely on confidentiality agreements with our management and employees to protect our confidential proprietary information. However, the protection of our intellectual properties may be compromised as a result of:
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departure of any of our management members or employees in possession of our confidential proprietary information;
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breach by such departing management member or employee of his or her confidentiality and non-disclosure undertaking to us;
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infringement by others of our proprietary information and intellectual property rights; or
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refusal by relevant regulatory authorities to approve our patent or trademark applications.
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Any of these events or occurrences may have a material adverse effect on our operations.
There can be no assurance that the steps taken by us to protect our intellectual property rights will be adequate or that third parties will not infringe or misappropriate our patents, trademarks, confidential proprietary information or similar proprietary rights. Litigation may be necessary to enforce our intellectual property rights and the outcome of any such litigation may not be in our favor. Given the relative unpredictability of China’s legal system and potential difficulties enforcing a court judgment in China, there is no guarantee that we would be able to halt the unauthorized use of our intellectual property through litigation in a timely manner.
Furthermore, there can be no assurance that other parties will not assert infringement claims against us, and we may have to pursue litigation against other parties to assert our rights. Any such claim or litigation could be costly and we may lack the resources required to defend against such claims. If we are unsuccessful in defending against such infringement claims, we may be required to pay damages, modify our products or suspend the production and sale of such products. We cannot guarantee that we will be able to modify our products on commercially reasonable terms.
Finally, any event that would jeopardize our proprietary rights or any claims of infringement by third parties could have a material adverse effect on our ability to market or sell our brands, and profitably exploit our products.
A disruption in the supply of utilities, fire or other calamity at our manufacturing plant would disrupt production of our products and adversely affect our sales.
Our products are manufactured at our production facilities located in Tai’an, Shandong Province and Guiyang, Guizhou Province in the PRC. While we have not in the past experienced any calamities which disrupted production, any disruption in the supply of utilities, in particular, electricity or power supply, or any outbreak of fire, flood or other calamity resulting in significant damage at our facilities would severely affect our production and have a material adverse effect on our business, financial condition and results of operations.
We maintain insurance policies covering losses with respect to damages to our properties and products. We do not have insurance coverage for inventories of raw materials or business interruption. There is no assurance that our insurance would be sufficient to cover all of our potential losses.
If we do not maintain strong financial controls, investor confidence in us may decline and our stock price may decline as a result.
The SEC as required by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, adopted rules requiring every public company to include a management report on such company’s internal control over financial reporting in its annual report, which must also contain management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, the independent registered public accounting firm auditing the financial statements must also attest to the operating effectiveness of the company’s internal controls.
A report of our management and attestation by our independent registered public accounting firm is included under Item 9A of this report. Our management has concluded that our internal controls over financial reporting as of December 31, 2013 were effective. We have in the past and may in the future discover material weakness in our internal controls. For example, we identified material weaknesses related to review controls on the accounting for income taxes and derivative instrument valuation as described under Item 9A of our annual report in form 10-K for fiscal year ended December 31, 2010, which were subsequently remediated in fiscal year 2011 as described under Item 9A of our annual report in form 10-K for the year ended December 31, 2011. However, there is no guarantee that these remedies will continue to be effective. Failure to achieve and maintain an effective internal control environment could result in us not being able to accurately report our financial results, prevent or detect fraud or provide timely and reliable financial and other information pursuant to the reporting obligations we have as a public company, which could have a material adverse effect on our business, financial condition and results of operations. This could reduce investors’ confidence in our reported financial information, which in turn could result in lawsuits being filed against us by our stockholders, otherwise harm our reputation or negatively impact the trading price of our common stock.
RISKS RELATED TO DOING BUSINESS IN CHINA
Changes in China’s political or economic situation could harm us and our operating results.
Economic reforms adopted by the Chinese government have had a positive effect on the economic development of the country. The reformed economic infrastructure and legal systems, however, may be subject to abrupt adjustments by the government. These adjustments, especially that in the following areas, could either benefit or damage our operations and profitability:
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Level of government involvement in the economy;
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Control of foreign exchange;
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Methods of allocating resources;
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International trade restrictions; and
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International conflict.
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The Chinese economy differs from the economies of most member countries of the Organization for Economic Cooperation and Development (the “OECD”) in many ways. For example, state-owned enterprises still constitute a large portion of the Chinese economy, and weak corporate governance and the lack of a flexible currency exchange policy still prevail in China. As a result of these differences, we may not develop in the same way or at the same rate as might be expected if the Chinese economy was similar to those of the OECD member countries.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to FIEs. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiary.
You may have difficulty enforcing judgments against us.
Most of our assets are located outside of the United States and most of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States and substantially all the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors.
There is also uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our counsel as to PRC law has advised us that although recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law, reorganization and enforcement of a foreign judgment by PRC courts depend on treaties or reciprocity between China and the country where the judgment is made. China does not have any treaties or other arrangements with U.S. that provide for the reciprocal recognition and enforcement of U.S. judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security, or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property, and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy and any regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
Future inflation in China may inhibit our ability to conduct business in China.
In recent years, the Chinese economy experienced rapid expansion but also highly fluctuating rates of inflation. During the past ten years, the rate of inflation in China has been as high as 5.9% and as low as -0.8%. The fluctuating rates of inflation have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or to regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other actions, which could inhibit economic activity in China, and thereby adversely affect the market for our products and consequently our profitability and operating results.
Restrictions on currency exchange may limit our ability to receive and use our sales effectively.
The majority of our sales will be settled in RMB, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that FIEs may only buy, sell or remit foreign currencies after providing valid commercial documents at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investments and loans, is subject to governmental approval and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Currently, some of our raw materials and major equipment are imported. In addition, we have interest expenses for our U.S. dollar denominated loans. In the event that the U.S. dollars appreciate against RMB, our costs will increase. If we cannot pass the resulting cost increases on to our customers, our profitability and operating results will suffer. In addition, if our sales to international customers grow, we will be increasingly subject to the risk of foreign currency depreciation.
Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you and otherwise fund and conduct our business.
Substantially all of our sales are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent companies. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of their registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.
In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China (the “Circular 75”) which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations. Failure to comply with the requirements of Circular 75 may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
We have asked the beneficial holders of our stock who are PRC residents as defined in Circular 75 to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.
In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75 could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations.
In August 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission, or CSRC, promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors (“Circular 10”), which became effective in September 2006. This regulation, among other things, governs the approval process by which a PRC company may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, Circular 10 will require the PRC parties to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with Circular 10 is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to Circular 10, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction.
Circular 10 allows PRC government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to the PRC Ministry of Commerce, or MOFCOM, and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our stockholders’ economic interests.
Under the Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
The EIT Law and its implementing rules became effective on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.
On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies (the “Notice”) further interpreting the application of the EIT Law and its implementation on non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on imposition of tax from non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares. Finally, if we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax. We are actively monitoring the possibility of “resident enterprise” treatment for the 2013 tax year and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises’ Share Transfer that was released in December 2009 with retroactive effect from January 1, 2008.
The Chinese State Administration of Taxation, or SAT, released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.
The SAT released the Announcement on Several Issues concerning the Administration of Income Tax of Non-tax-resident Enterprises (“Public Notice 24”), which went into effect on April 1, 2011, to clarify several issues related to Circular 698. Under Public Notice 24, the term “effective tax” refers to the effective tax on the gain derived from the disposition of equity interests of an overseas holding company; and the term “does not impose income tax” refers to cases where the gain derived from disposition of the equity interests of an overseas holding company is not subject to income tax in the country or region where the overseas holding company is a resident.
There is uncertainty as to the application of Circular 698. For example, while the term “indirectly transfer” is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct link with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698.
As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act (the “FCPA”) and other U.S. laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the relevant statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties, and make most of our sales in China. PRC anti-corruption laws also strictly prohibit bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our Company, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our Company may engage in conduct for which we might be held responsible. Particularly, most of the hospitals and inoculation centers in China are state-owned entities, which employees may be recognized as foreign government officials for the purpose of FCPA. Therefore, any payments, expensive gifts or other benefits provided to an employee of the state-owned hospital or inoculation center may be deemed violation of FCPA. Violations of the FCPA or PRC anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, prospects, operating results and financial condition. In addition, the U.S. government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
If we become directly subject to the scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
In recent years, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed the so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely impacted and your investment in our stock could be rendered worthless.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where substantially all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, substantially all of our operations are located in China. Since substantially all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of the CSRC, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.
The Chinese member firm of the KPMG network, of which our independent registered public accounting firm is also a member, may be temporarily suspended from practicing before the SEC. If a delay in completion of our audit process occurs as a result, we could be unable to timely file certain reports with the SEC, which may lead to the delisting of our stock.
In the year ended December 31, 2013, the majority of our sales were to customers in China, and we have all of our operations in China. Certain of our independent registered public accounting firm’s audit documentation related to their audit reports included in this Report are located in China, and certain audit procedures take place within China’s borders. The Public Company Accounting Oversight Board (“PCAOB”) is currently unable to conduct inspections in China or review audit documentation located within China without the approval of Chinese authorities. Like many U.S. companies with significant operations in China, our independent registered public accounting firm may rely on a Chinese member firm for assistance in completing the audit work associated with our operations in China.
On January 22, 2014, Judge Cameron Elliot, an SEC administrative law judge, issued an initial decision suspending the Chinese member firms of the “Big Four” accounting firms, among others, from practicing before the SEC for six months as a result of their failure to provide certain including KPMG documents to the SEC because to do so would violate Chinese law. The decision is not yet effective and will only become effective when and if the SEC endorses it. If the decision goes into effect, the work of our auditors could be delayed and it will be difficult for us to engage qualified independent auditors.
A delay in completion of the audit process could delay the timely filing of our quarterly or annual reports with the SEC. A delinquency in our filings with the SEC may result in Nasdaq initiating delisting procedures, which could have a material adverse effect on our results of operation and financial condition.
Our independent registered public accounting firm’s audit documentation related to their audit reports included in our annual report may include audit documentation located in the Peoples’ Republic of China. PCAOB currently cannot inspect audit documentation located in China and, as such, you may be deprived of the benefits of such inspection.
Our independent registered public accounting firm issued an audit opinion on the financial statements included in our annual report filed with SEC. As auditors of companies that are traded publicly in the United States and a firm registered with the PCAOB, our auditor is required by the laws of the United States to undergo regular inspections by the PCAOB. However, the significant portion of the audit conducted in China and the relevant work papers located in China are not currently inspected by the PCAOB because the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities.
Inspections of certain 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. However, the PCAOB is currently unable to inspect an auditor’s audit work related to a company’s operations in China and where such documentation of the audit work is located in China. As a result, our investors may be deprived of the benefits of PCAOB’s oversight of our auditors through such inspections.
The inability of the PCAOB to conduct inspections of our auditors’ work papers 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 consequently lose confidence in our reported financial information and procedures and the quality of our financial statements.
RISKS RELATED TO THE MARKET FOR OUR STOCK
Although publicly traded, the trading market in our common stock has been substantially less liquid than the average trading market for a stock quoted on the NASDAQ Stock Market and this low trading volume may adversely affect the price of our common stock.
Our common stock is traded on the NASDAQ Global Select Market under the symbol “CBPO.” The trading market in our common stock has been substantially less liquid than the average trading market for companies trading on the NASDAQ Stock Market. Reported average daily trading volume in our common stock for the three months immediately prior to March 1, 2014, was approximately 23,211 shares. Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for you to sell your shares of common stock at a price that is attractive to you.
The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you want to sell your holdings.
The market price of our common stock is volatile, and this volatility may continue. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include, among others:
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our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
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changes in financial estimates by us or by any securities analysts who might cover our stock;
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speculation about our business in the press or the investment community;
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significant developments relating to our relationships with our customers or suppliers;
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stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the our industry;
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customer demand for our products;
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investor perceptions of the our industry in general and our company in particular;
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the operating and stock performance of comparable companies;
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general economic conditions and trends;
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major catastrophic events;
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announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
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changes in accounting standards, policies, guidance, interpretation or principles;
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loss of external funding sources;
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sales of our common stock, including sales by our directors, officers or significant stockholders;
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additions or departures of key personnel; and
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investor perception of litigation, investigation or other legal proceedings involving certain of our individual shareholders or their family members.
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Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.
Our shareholder rights plan and Provisions in our amended and restated certificate of incorporation and bylaws or of Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore depress the trading price of the common stock.
Upon stockholders’ approval on July 20, 2012, we have adopted amended and restated certificate of incorporation and bylaws, which contained provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the raider and to encourage prospective acquirers to negotiate with our Board rather than to attempt a hostile takeover.
These provisions include, among others:
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the right of our Board to issue preferred stock without stockholder approval;
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a Board of Directors that is divided into three classes with staggered terms;
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elimination of the right of our stockholders to act by written consent;
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prohibiting stockholders from calling a special meeting of the stockholders;
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rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings; and
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requiring super majority stockholder vote to amend certain provisions of the amended and restated certificate of incorporation and bylaws.
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In addition, Section 203 of the Delaware General Corporation Law generally limits our ability to engage in any business combination with certain persons who own 15% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past three years have owned 15% or more of our outstanding voting stock.
On November 19, 2012, our Board adopted a stockholder rights plan, which provides, among other things, that when specified events occur, our stockholders will be entitled to purchase from us a newly created series of preferred stock. The preferred stock purchase rights are triggered by the earlier to occur of (i) ten business days (or a later date determined by our Board of Directors before the rights are separated from our common stock) after the public announcement that a person or group has become an “acquiring person” by acquiring beneficial ownership of 10% or more of our outstanding common stock or (ii) ten business days (or a later date determined by our Board before the rights are separated from our common stock) after a person or group begins a tender or exchange offer that, if completed, would result in that person or group becoming an acquiring person. The issuance of preferred stock pursuant to the stockholder rights plan would cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board.
We believe these provisions protect our stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with our Board and by providing our Board with more time to assess any acquisition proposal. These provisions, however, may have the effect of entrenching our management team and may deprive you of the opportunity to sell your shares to potential acquirers at a premium over prevailing prices. This potential inability to obtain a control premium could reduce the price of our common stock.
We do not intend to pay dividends for the foreseeable future.
For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.