HUTCHMED (China) Annual Report 2012

Plain-text annual report

China Healthcare Drug Research & Dev elopment Consumer Prod ucts Corporate Information COMPANY SECRETARY Edith SHIH NOMINATED ADVISER Panmure Gordon (UK) Limited CORPORATE BROKERS Panmure Gordon (UK) Limited UBS Limited AUDITOR PricewaterhouseCoopers BOARD OF DIRECTORS Executive Chairman Simon TO, BSc, ACGI, MBA Executive Directors Christian HOGG, BSc, MBA Chief Executive Officer Johnny CHENG, BEc, CA Chief Financial Officer Non-executive Directors Shigeru ENDO, BA Christian SALBAING, BA, LLL, JD Edith SHIH, BSE, MA, MA, EdM, Solicitor, FCIS, FCS (PE) Independent Non-executive Directors Christopher NASH, BSc, MBA, ACGI Senior Independent Director Michael HOWELL, MA, MBA, HonFCGI Christopher HUANG, BA, BMBCh, PhD, DM, DSc, FSB AUDIT COMMITTEE Michael HOWELL (Chairman) Christopher HUANG Christopher NASH REMUNERATION COMMITTEE Simon TO (Chairman) Michael HOWELL Christopher NASH TECHNICAL COMMITTEE Christopher HUANG (Chairman) Simon TO Christian HOGG COMPLAINTS COMMITTEE Simon TO Christian HOGG Michael HOWELL Edith SHIH 1 Contents Corporate Information Contents Our Business Highlights Chairman’s Statement Chief Executive Ofﬁ cer’s Statement Biographical Details Of Directors Report Of The Directors Corporate Governance Report Independent Auditor’s Report Consolidated Income Statement Consolidated Statement Of Comprehensive Income Consolidated Statement Of Financial Position Consolidated Statement Of Changes In Equity Consolidated Statement Of Cash Flows Notes To The Accounts Information For Shareholders 1 2 3 4 8 29 31 36 45 46 47 48 49 50 51 2 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Our Business Chi-Med is the holding company of a healthcare group based primarily in China and was listed on the Alternative Investment Market of the London Stock Exchange in May 2006. It is focused on researching, developing, manufacturing and selling pharmaceuticals and health oriented consumer products. China Healthcare We have three companies o p e r a t i n g i n t h e f a s t growing China Healthcare market. These companies are increasingly strong cash generators from the development, manufacture and marketing of both prescription and over-the- counter pharmaceuticals and health supplements. Drug Research and Development T h r o u g h H u t c h i s o n M e d i P h a r m a L i m i t e d , Chi-Med researches and develops botanical and small molecule drugs for t h e g l o b a l m a r k e t . W e focus on the oncology and immunology therapeutic areas. Consumer Products Chi-Med is engaged in the development of a health oriented consumer products business. This includes several brands of botanical, natural, and organic food and personal care products primarily in the China and Asian markets. 3 3 Highlights Consolidated Group Results Revenue from continuing operations up 18% to $195.4 million (2011: $165.0m). Operating profit up 65% to $8.9 million (2011: $5.4m) - China Healthcare and Drug R&D gains partially offset by Consumer Products Division restructuring costs. Net profit attributable to Chi-Med equity holders up 412% to $3.6 million (2011: $0.7m). Cash and cash equivalents and unutilised bank loan facilities of $85.9 million. Net cash $23.9 million. China Healthcare Division - Increasingly significant source of profit and cash for the Group Sales of subsidiaries and jointly controlled entities (“JCE”) up 29% to $350.5 million (2011: $271.0m). Organic expansion of own brands (up 15% to $300.0m) with prescription drug sales remaining the key driver. Growth of over-the-counter (“OTC”) drug distribution business (up 351% to $50.5m). Net profit attributable to Chi-Med equity holders up 11% to $15.5 million (2011: $14.0m). Positive impact expected in 2013 as OTC raw material prices continue to normalise. Drug R&D Division – Greatest driver of major step-change value creation Revenue $7.4 million (2011: $14.8m). Net profit attributable to Chi-Med equity holders $2.8 million (2011: net loss $3.7m) due to lower licensing income, increased clinical trial costs, and a one-time dilution gain of $11.5 million from establishment of Nutrition Science Partners Limited (“NSP”). Progressing five high potential small molecule oncology drug candidates in Phase I/II trials in China and Australia, one in partnership with AstraZeneca Plc (“AstraZeneca”). Proof-of-concept data on several clinical drug candidates expected in 2013. Establishment of 50/50 joint venture, NSP, with Nestlé Health Science SA (“Nestlé Health Science”) to progress HMPL-004 into global Phase III trials in early 2013, and to research and develop a pipeline of innovative gastrointestinal medicine products. Transaction subject to regulatory approvals. Immunology collaboration with Janssen Pharmaceuticals, Inc. (“J&J”) progressing well - decision point in 2013. Consumer Products Division – Re-structuring year with closure of loss makers Sales on continuing operations down 9% to $10.0 million (2011: $11.1m) as we scale down loss making consumer businesses and focus on Hutchison Hain Organic and Sen in Asia. Non-recurring $7.2 million Consumer Products Division restructuring costs include $3.2 million charge on discontinuation of Sen UK business, and $4.0 million scale down costs from Sen France and China infant formula businesses. Net loss attributable to Chi-Med equity holders on continuing operations of $3.6 million (2011: -$1.4m). Continuing operations of Consumer Products Division are expected to be cash neutral in 2013. 4 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Chairman's Statement Simon To Chairman With each year, the potential of Chi-Med becomes clearer, and the business strengthens its platform for future growth and takes steps forward. I am delighted to report another year of considerable progress. With each year, the potential of Chi-Med becomes clearer, and the business strengthens its platform for future growth and takes steps forward in building a major, China-based pharmaceutical and health related products group, with strong potential in global markets. The highlight of 2012 was the 50/50 joint venture with Nestlé Health Science we announced in November 2012, which will take our lead drug candidate for the treatment of ulcerative colitis and Crohn’s disease, HMPL-004, into global Phase III trials early this year, and will actively research and develop a pipeline of innovative gastrointestinal medicine products. Taken together with our deal with AstraZeneca, in late December 2011, for the development of Volitinib (HMPL-504), a novel targeted treatment for cancer, these deals demonstrate how we can fund our broader discovery programme and pipeline of both internal and partnered clinical drug candidates with development cost sharing, milestone payments and, ultimately, royalty streams. We look forward to further news on pharmaceutical partnerships during 2013. + 18% Organic sales growth of existing operations (% change 2012 vs. 2011) Operating Proﬁ t (US$ million) 8.9 Net Proﬁ t Attributable to Equity Holders (US$ million) 3.6 Chairman’s Statement 5 together with the growth of personal incomes, fuels demand for pharmaceutical products, both prescription and OTC. On the other hand, China is increasingly becoming recognised as an emerging centre of pharmaceutical drug research and development. Our Drug R&D Division is recognised to be one of the leaders in this ﬁ eld, continuing also to beneﬁ t from the inherently lower cost operating base in China and massive patient populations as Alongside this, our China Healthcare business opposed to Western economies. continues to grow quickly with overall sales up 29% driven by its prescription drug and OTC drug We also continue to benefit from our deep distribution business. The sales growth of its own understanding of the China market and the long- brand products, which have powerful positions in standing benefits of the scale and experience their market, was 15% but net profit growth was of Hutchison Whampoa Limited (“Hutchison slightly muted at 11% due to sharp increases in raw Whampoa”) in this market, which adds synergies to material costs between 2009 and 2011, but these the increasing economies of scale of our business. costs are now normalising, and we look therefore to a resulting expansion in the rate of sales and proﬁ t growth. In addition, our share of value of the China Healthcare Division Our China Healthcare Division is now a well- important land holdings of the China Healthcare e s t a b l i s h e d , s t a b l e a n d d i v e r s i f i e d C h i n a Division will be clariﬁ ed during 2013 by the result of p h a r m a c e u t i c a l s o p e r a t i o n w i t h r o b u s t the likely land auction of part of these holdings. growth prospects. It competes in the domestic pharmaceutical market that has grown 20% per In our Consumer Products Division, we have year since 2005 behind reforms that have driven undertaken a restructuring to scale down loss- government healthcare spending to increase making operations and focus on the segments of over six-fold from approximately $14.1 billion in this business with clear growth potential. We will see 2005 to approximately $89.5 billion in 2011. This the beneﬁ ts of this in 2013. translates directly into greater consumption of pharmaceuticals. Looking forward, this rapid growth For 2012, Chi-Med and its subsidiaries (the is set to continue as China catches up with the “Group”) showed continued solid revenue growth developed world in terms of per capita healthcare from continuing operations of 18% and a healthy spending since the US healthcare spending per financial position with cash and cash equivalents capita was over forty-three times and Germany and unutilised bank facilities of $85.9 million and was twenty-seven times that of China in 2009. net cash of $23.9 million. Our net proﬁ t attributable Furthermore, to augment government spending, to Chi-Med equity holders of $3.6 million includes the Chinese people, who place a high priority on the $7.2 million at the operating level of non-recurring healthcare of their families, are turning to private restructuring costs in our Consumer Products Division, healthcare with 12% of disposable income spent on along with an $11.5 million dilution gain from our healthcare and 28% of the hospitals in China in 2011 joint venture transaction with Nestlé Health Science. being privately run. This transaction also led to the elimination of $18.5 million of HMPL-004 capitalised development costs. The scale and potential of China’s economy remains a key strength. We read reports of the China economy slowing in its growth rate, but this is not true of the pharmaceutical sector. On the one hand, the growth of China’s national healthcare plan, 6 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Our household name brands and core products compete in the two biggest and most prescribed therapeutic areas in China, cardiovascular and cold/ flu. Our China Healthcare Division products are all traditional Chinese medicine (“TCM”), or botanical drugs, a sub-category of healthcare that represented approximately 43% of the entire prescription and OTC drug sales in China in 2011. TCM has, over the past ten years, grown faster than synthetic medicine in China, primarily due to its lower cost per dose, good efficacy/safety profiles, and cultural acceptance in China. Our Drug R&D Division focus has been on creating truly innovative, first-in-class or best-in-class, drug candidates in therapeutic areas, oncology and immunology, with major China and global potential. Our leading drug candidate HMPL-004 which is We have major scale in these operations which when We believe that these macro trends combined with about to start a global Phase III registration trial compared to the domestic Chinese TCM market in our competitive advantages and the above raw addresses major un-met medical needs in the $7.9 terms of sales, placed us in the top 15 TCM producers material and property impacts will translate into our billion inflammatory bowel disease (“IBD”) market in 2011. We manufacture and distribute several China Healthcare Division providing an increasingly (the United States, Japan, Germany, United Kingdom, billion doses of medicines a year through our well- significant source of profit and cash flows for the France, Italy and Spain). Our five oncology drug established Good Manufacturing Practice (“GMP”) Group. manufacturing base and our very sizable, over 2,000 people, sales team which covers all geographies and channels in the China prescription and OTC drug Drug R&D Division We have built Hutchison MediPharma Limited the global oncology market, which is forecasted to reach $32.7 billion by 2016. Our innovation record candidates in clinical trials are aimed at tyrosine kinase inhibition, the fastest growing segment of markets. Over the past couple of years, we have (“HMP”) into one of China’s leading end-to-end is outstanding and puts us in the enviable position faced sharp increases in the costs of raw materials oncology and immunology drug R&D operations. of now owning approximately 22% of all new small for some of our OTC drugs. We therefore increased Stability in its purpose and funding has enabled molecule tyrosine kinase inhibitors in development prices and reduced marketing support to protect HMP to build and maintain a unique and highly in China. Simple cross-reference to Morgan Stanley’s margins and as a result saw a decline in sales volume productive discovery team, which has built a broad recent China pharmaceuticals innovation pipeline on some of our generic products. As we expected, and diversified pipeline of new drugs which we Net Present Value (“NPV”) analysis, explained in the raw material costs have in most cases now fallen believe have great potential, both in the fast growth depth later in this report, puts the approximate risk- back, and we believe this will accelerate their rate of China market and, in a number of cases, on a global adjusted NPV of our five clinical stage oncology sales and proﬁ t growth in 2013/2014. level. drug candidates in China at over $450 million. We believe that the clinical proof-of-concept data that As reported, we are planning to move and The drug discovery and development arena in China these programmes will generate in 2013/2014 will considerably expand the manufacturing base of has made major advances in the past thirteen years validate this valuation. our joint ventures in Shanghai and Guangzhou. The since we began our effort. The China State Food and existing sites, which we will be vacating over the Drug Administration (“SFDA”), in the interests of the Strategically, we have adopted a practical approach coming years, have considerable value. In 2013, the public health, has modernised the drug registration to funding the considerable costs of our clinical value will likely be put to the test by the auction pathway so that now the average time from programmes. We partner with multi-national of the smallest of our three plots, a 30,000 square Investigational New Drug application (“IND”) to New pharmaceutical companies on drugs with global metre site in Guangzhou. We expect the gain from Drug Approval (“NDA”) is 73 months and oncology is appeal such as our Volitinib collaboration with this transaction will be used to cover our relocation faster at 60 months – this is becoming comparable AstraZeneca and our NSP joint venture with Nestlé and expansion costs. with the developed world. The biotech ecosystem Health Science – these deals will allow for partners in China has advanced also, driven by the massive to fund almost all clinical trial costs while allowing trend by multi-national pharmaceutical companies us to retain value through milestone payments and to outsource discovery work to China – this has now ultimately the royalty streams. We will continue made world-class drug R&D and innovation possible to do more deals on our broader pipeline as it in China. progresses, but ultimately we intend to bring our innovations to the market in China ourselves, and based on our commercial success in the China Healthcare Division, we are confident that we can build great value. Chairman’s Statement 7 (“SHPL”) and Hutchison Whampoa Guangzhou Baiyunshan Chinese Medicine Company Limited (“HBYS”) joint ventures within our China Healthcare Division will be treated as equity investments in Chi- Med’s consolidated accounts. The most noticeable Consumer Products Division Our Consumer Products Division enables Chi-Med to impact will be how we report revenues, as revenues from SHPL and HBYS will no longer be proportionally capture part of the growing consumer trend towards consolidated. If 2012 results were reported under healthy living and to capitalise on the considerable this new standard, Chi-Med Group revenue from consumer products synergies with the broader continuing operations would be $22.2 million Hutchison Whampoa group. We have reviewed the versus the $195.4 million reported under the old structure of this division, and have cut the loss- proportionally consolidated standard. The new making activities in Sen UK and are scaling down standard will however not affect either the way we our Sen France and China infant formula businesses. operate SHPL and HBYS, the synergies the Group We will focus on the future growth of our successful gains from these operations, or most importantly partnership with The Hain Celestial Group, Inc. (“Hain the considerable net profit attributable to Chi-Med Celestial”) and our access to the broad retail and shareholders from these JCEs. distribution network of Hutchison Whampoa. Cash and Finance We have maintained a steady cash position. Overall, The Board The Chi-Med Board (the “Board”) continues to exercise good corporate governance and our we ended 2012 with cash and cash equivalents of Independent Non-executive Directors bring a wealth $62.0 million, unutilised bank loan facilities of $23.9 of expertise and experience. They have made, and million, and a net cash position of $23.9 million. continue to make a valuable contribution to the Dividend The Board has decided not to recommend a dividend evolution of Chi-Med. I very much appreciate their involvement and I thank them all for their efforts. for the year ended 31 December 2012. We continue to believe we can create greater shareholder value Employees All that Chi-Med has achieved and will achieve is due by investing in the growth opportunities we see in to the dedication and expertise of its employees and, China. Future Change to IFRS Accounting Rule In 2012, I reported that The International Accounting Standards Board (“IASB”) had published a new standard on the accounting treatments for JCEs, IFRS 11 “Joint Arrangements” (“IFRS 11”). This came into on behalf of the Board, I thank all of them. Chi-Med’s potential is considerable, and we shall continue to work hard to realise this. effect on 1 January 2013 and means that income Simon To statements and statements of financial position of Chairman JCEs will no longer be consolidated on a proportional basis. For Chi-Med, the effect is that in future the 25 March 2013 50/50 Shanghai Hutchison Pharmaceuticals Limited 8 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Chief Executive Ofﬁ cer's Statement Christian Hogg Chief Executive Ofﬁ cer 2012 has been a great year for Chi-Med, making particularly strong progress in our China Healthcare and Drug R&D Divisions. Group Results Chi-Med again delivered solid revenue growth, with 2012 consolidated Group revenue on continuing operations up 18% to $195.4 million (2011: $165.0m). This reﬂ ected continued organic growth in our China Healthcare Division, with proportionally consolidated sales up 28% to $178.0 million (2011: $139.2m). This was partially offset by a drop in revenue in our Drug R&D Division to $7.4 million – 2011 having beneﬁ ted from a greater proportion of the up-front licensing income from the AstraZeneca deal in respect of Volitinib – and a drop in the Consumer Products Division sales on continuing operations to $10.0 million (2011: $11.1m) from scaling down the Sen France and China infant formula projects. The Group recorded a full year operating profit of $8.9 million (2011: $5.4m), reflecting the above points as well as $7.2 million restructuring costs associated with the discontinuation of the Sen UK operation ($3.2m) and the scaling down of Sen France ($0.7m) and the China infant formula project ($3.3m). Also reﬂ ected in the 2012 Group results is the impact of establishing the NSP joint venture with Chief Executive Ofﬁ cer’s Statement 9 2012 Performance by Division US$ million (% change 2012 vs. 2011) China Healthcare Drug R&D Consumer Products (Continuing operations) 15.5 (+11%) 7.4 (-50%) 2.8 (+176%) 10.0 (-9%) (3.6) (-154%) 350.5 (+29%) Sales(1) Net profit/(loss) attributable to Chi-Med equity holders Nestlé Health Science. These impacts include a one- to a net proﬁ t of $0.7 million in 2011, and proﬁ t per time dilution gain of $11.5 million and elimination share of 7.0 US cents in 2012 compared to a 1.4 US of $18.5 million HMPL-004 capitalised development cent proﬁ t in 2011. costs associated with the NSP joint venture. The Group continues to maintain a stable financial Group net overhead costs increased to $6.0 million position. As at 31 December 2012, net assets were (2011: $5.8m) reﬂ ecting an increase of $0.3 million $83.6 million, including cash and cash equivalents driven by staff costs but offset in part by reduced totalling $62.0 million (31 December 2011: costs associated with the employee share option $53.8m). In aggregate, total bank borrowing was schemes of Chi-Med. $38.1 million (31 December 2011: $30.0m) giving the Group a net cash position of $23.9 million (31 Finance costs were $1.2 million (2011: $0.6m) December 2011: $23.7m) and a debt to equity ratio primarily reflecting the continued borrowing at of 54.0% (31 December 2011: 46.4%). Cash available Hutchison Healthcare Limited (“HHL”) in the China to the Group, including cash and cash equivalents Healthcare Division, and interest on a partial draw- on hand and unutilised bank loan facilities, totalled down of the credit facility of Chi-Med. $85.9 million (31 December 2011: $85.7m). Losses attributable to minority interests were $0.1 The growth of China’s pharmaceutical industry has million (2011: proﬁ t of $1.0m) as the share of scale generated increasing interest from most global down costs carried by Hain Celestial on the China players in the industry. This is evidenced by the infant formula project offset the proﬁ ts attributable extensive research and analysis that is now available to HBYS minority interests. from major investment banks including ones from Citigroup, Barclays Capital and Morgan Stanley, Chi-Med’s tax charge was $4.2 million (2011: $3.1m) which we have referred to in order to help illustrate reflecting the growth in profitability of the China the market in which both the China Healthcare and Healthcare Division, which continues to benefit Drug R&D Divisions operate. from the low enterprise income tax rates of 15% on both HBYS and SHPL resulting from their High Overview of Operations and New Technology Enterprise status. In addition to enterprise income tax in China, we pay 5% withholding tax on dividends remitted outside China China Healthcare Division The China Healthcare Division is an established, – the accrual for which totalled $1.0 million (2011: stable, and diversified China pharmaceuticals $0.7m). operation. Aside from the rapid expansion and evolution of the broader pharmaceutical industry in In total, the Group recorded a net proﬁ t attributable China and our key competitive advantages as laid to Chi-Med equity holders of $3.6 million compared out below, we believe that our China Healthcare Division will be positively affected in the near-term China Healthcare Division Sales(1) (US$ million) 2012 2011 2010 350.5 271.0 231.2 Net Profit Attributable to Equity Holders (US$ million) 15.5 2012 2011 2010 14.0 12.7 (1) Sales of subsidiaries and jointly controlled entities 10 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report China Healthcare China Healthcare Division Product Portfolio 2012 Sales(1) US$ million (% change 2012 vs. 2011) She Xiang Bao Xin pills Cardiovascular (+29%) 102.2 Ban Lan Gen granules Anti-Viral (+14%) 65.4 Sales by Sub-sector(1) US$ million (% change 2012 vs. 2011) 5.3 (-28%) 116.5 (+26%) RX OTC Health Food 228.7 (+34%) RX OTC Health Food Fu Fang Dan Shen tablets Angina (+6%) 60.2 Xiao Yan Li Dan tablets Liver/Gallbladder (+10%) 11.5 Kou Yan Qing granules Periodontitis (+6%) 16.4 Dan Ning tablets Gallbladder (+17%) 11.6 Zhi Ling Tong capsules Foetal/Infant Development (-28%) 4.4 Others (+123%) 78.8 Total Sales(1) 350.5 (+29%) (1) Sales of subsidiaries and jointly controlled entities Chief Executive Ofﬁ cer’s Statement - China Healthcare 11 Per capita Healthcare Spending (US$) USA $7,410/ capita 43x China $169/ capita Source: Barclays Capital in sales, marketing, and grown faster due to healthcare reforms. Healthcare distribution operations reforms have in our view been an important across China. This level pillar of the Chinese Government’s economic and of scale when compared societal development strategy. Most notably, these to the domestic Chinese healthcare reforms, through the expansion of T C M m a r k e t , p l a c e d enrolment in State sponsored medical insurance us in the top 15 TCM schemes, have increased medical insurance fund producers in 2011 in expenditure from approximately $14.1 billion in terms of sales, albeit 2005 to approximately $89.5 billion in 2011, a in a highly fragmented compound average growth rate of 36%, that is industry in which the correlated with pharmaceutical cost reimbursement top 15 local China-based and sales growth. TCM producers accounted for only 12.4% of total Looking ahead, the room for continued growth industry sales in 2011. of the pharmaceutical industry is significant. Total healthcare spending in China in 2009 remained T h e D i v i s i o n low at 4.6% of GDP as compared with 16.2% in the m a n u f a c t u r e s a n d US and 11.4% in Germany. The Ministry of Health’s s e l l s t w o h o u s e h o l d healthcare blueprint “Healthy 2020” targets for n a m e b r a n d s i n t h e healthcare spending as a percent of GDP to grow by the reduction in key raw material prices, and pharmaceutical industry in China, the OTC brand to 6.5%-7.0% by 2020. Importantly, in absolute realisation of signiﬁ cant property assets. In total, we Bai Yun Shan (meaning “White Cloud Mountain”, terms, healthcare spending in China lags developed believe, these factors will combine to translate into a famous scenic area in Guangzhou) and the economies by a large margin. Latest data shows an increasingly material source of proﬁ t and cash for Shang Yao brand (literally meaning “Shanghai that the US spends forty-three times and Germany the Group. Pharmaceuticals”). Our products have extensive twenty-seven times more than China on a per capita Financial Performance: Sales of Chi-Med’s subsidiaries for the National Basic Medical Insurance, Labour representation on the current Medicines Catalogue basis. and JCEs of the China Healthcare Division grew 29% Injury Insurance and Childbirth Insurance Systems Healthcare coverage for the approximately 473 to $350.5 million in 2012 (2011: $271.0m) driven (“NMC”) as well as the current National Essential million people enrolled in the Medical insurance by solid 15% organic sales growth in our own brand Medicines List (“Essential Medicines List”) that scheme for urban employees and residents is prescription and OTC drug products and significant mandates distribution of drugs in China. We focus reasonably comprehensive at an estimated average new business growth from HBYS’ Good Supply mainly on products and brands that have leadership expenditure of about $169 per capita in 2011. The Practice (“GSP”) OTC drug distribution subsidiary. market shares in the Chinese cardiovascular and almost 640 million people covered by the rural Consolidated net profit attributable to Chi-Med cold/ﬂ u drug markets. Our product portfolio is well cooperative medical scheme receive less coverage equity holders from the Division increased 11% to diversified. We own product licenses for over 200 with only an average of about $44 per capita of $15.5 million (2011: $14.0m). drugs and registered health supplements in China, expenditure on medical benefits. This imbalance Operating Entities and Scope: We operate three sales in 2012 coming from nine core products – six addressed by the Chinese government through companies under the China Healthcare Division, a of them are OTC drugs, two prescription drugs, and accelerated growth in funding of the rural scheme. with over 80% of our China Healthcare Division’s between urban and rural coverage is gradually being prescription drug company, SHPL, which is a 50/50 one nutritional supplement. joint venture with a wholly-owned subsidiary of In addition to these state/employer sponsored Shanghai Pharmaceuticals Holding Co., Ltd. (SHA: China Pharmaceutical Market Dynamics: There have healthcare insurance schemes, the private healthcare 601607) (“SPG”); an OTC drug business, HBYS, which been two main drivers behind the compound annual system is growing rapidly in China. In 2011 is a 50/50 joint venture with Guangzhou Baiyunshan growth rate of approximately 20% in the China approximately 28% of all hospitals (6,137) were Pharmaceutical Co., Ltd. (SHE: 000522) (“GBP”); and pharmaceutical industry between 2005 and 2011. privately run and average out of pocket spending on a wholly-owned nutritional supplements company, The primary driver has been the GDP growth in healthcare reached approximately $97 per capita. A HHL. We employ over 3,000 full-time staff in two China which grew at an average rate of 11% per year total of approximately 12% of household disposable large-scale factories in Shanghai and Guangzhou, and during that period, however pharmaceuticals have income in China was spent on healthcare in 2011, 12 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report China Government Healthcare Spending (US$ billion) 89.5 36% CAGR (2005-2011) 72.0 58.7 19% CAGR (2000-2005) 40.0 25.5 5.9 6.9 7.7 9.4 10.3 16.3 14.1 01 03 05 07 09 11 Source: Deutsche Bank, CEIC, Ministry of Health indicating that healthcare is a very high priority to and 2011 as compared to 21.3% for chemical drugs. Healthcare Division has several key competitive Chinese families. We believe that with the continued Government support for TCM manifests itself in advantages namely: 1) our focus on the fast growth development of China, increasing urban migration many areas, possibly the most important being TCM sub-sector; 2) our involvement in two of the and employment combined with the expansion of TCM’s higher cap on hospital mark-ups of 25% as biggest and most widely distributed TCM therapeutic the private health system to augment government compared to only 15% on chemical/biologic drugs areas, cardiovascular and cold/ﬂ u; 3) leading market schemes, that growth in the China pharmaceutical – thereby making it a more proﬁ table category for shares and both commercial and manufacturing industry will continue to outpace growth of the hospitals and leading to heavier focus. scale in key sub-segments of theses therapeutic overall Chinese economy over the coming years. areas; and 4) our commercial know-how and well Our China Healthcare Division TCM business is established track record. TCM Market Sub-sector: TCM represents approximately focused on cardiovascular and cold/flu, the two 46% of the drugs listed in the National Drug leading common diseases diagnosed/treated R e i m b u r s e m e n t C a t a l o g u e i n 2 0 1 0 a n d and two of the top three fastest growing disease approximately 43% of the $158 billion prescription categories in rural markets. We have strong market and OTC drug sales in China in 2011. TCM remains a shares in these two therapeutic areas, with She Xiang stable and growing industry in China and is heavily Bao Xin pill (“SXBXP”) and supported by the Chinese Government because of Fu Fang Dan Shen (“FFDS”) its proven efﬁ cacy and generally lower cost. TCM is tablets in cardiovascular considered a highly efficient form of mainstream and Banlangen in cold/ﬂ u. healthcare particularly in lower income areas and China Pharmaceutical Market rural China – this has led to compound annual Chi-Med’s competitive growth in TCM drug sales of 23.1% between 2002 a d v a n t a g e : O u r C h i n a (US$ billion) 152.4 TCM Drugs Biotech Drugs Chemical Drugs 7.8 (41.9%) 2.2 (11.6%) 8.7 (46.5%) 18.7 23.1% 30.1% 21.3% 65.4 (42.9%) 23.5 (15.4%) 63.5 (41.7%) 2002 CAGR 2011 Source: Morgan Stanley Chief Executive Ofﬁ cer’s Statement - China Healthcare 13 SHPL China Sales Distribution - 2012 Sales-by-Province SHPL has continued to make solid progress in expanding beyond its eastern China base where it held leadership market share. Sales Level > US$10.0 million Net Sales US$5.0 - 10.0 million Net Sales US$1.0 - 4.9 million Net Sales < US$1.0 million Net Sales She Xiang Bao Xin pills (Cardiovascular) SHPL Main Products by Sales: 1% 1% 10% 88% Cardiovascular (SXBXP) Gallbladder (Dan Ning tablets) Immunity (Sheng Mai Injection) Others 2012 Total SHPL Sales: $116.5 million (up +26%) > US$10.0 million US$5.0 - 10.0 mi US$1.0 - 4.9 mill < US$1.0 million 2011 Sales-by-Province 14 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Shanghai Hutchison Pharmaceuticals Limited Prescription Drugs – SHPL SHPL grew prescription drug sales 26% to $116.5 from 2008 to 2011, with over 80% of responders SHPL has continued to make solid progress in to a recent Citigroup rural hospital survey stating expanding beyond its eastern China base where it million in 2012 (2011: $92.4m) all of which was that cardiovascular is the fastest growing disease held leadership market share of approximately 37% from existing products. Since 2005, its compound category in rural China. The development of the among the main TCM cardiovascular prescription annual sales growth has averaged 26%. This high cardiovascular market is directly related to the drugs in Shanghai in 2012. Geographical expansion level of organic growth has been sustained in recent average age of the population which is set to has been helped by the gradual roll-out of the years due primarily to the effective expansion of our continue to increase in line with the trend in China Essential Medicines List. In 2012, SHPL’s sales in its commercial network across China and the strong of people living longer lives. In 2011, 12% of the long established and mature east China markets of position of our main drugs on both the Essential total Chinese population were over 65 years old as Shanghai, Jiangsu and Zhejiang provinces grew 19% Medicines List and the NMC. compared to 7% in 2000, and just 4% in 1964. to $56.2 million (2011: $47.2m) while at the same time, its sales outside east China again surged 33% SHPL holds a portfolio of 73 registered drug licenses Sales of SXBXP grew 29% to $102.2 million (2011: to $60.3 million (2011: $45.3m). Sales outside east in China. At the end of 2012, a total of 32 SHPL $79.4m) again making it the China Healthcare China represented 52% of SHPL’s total sales in 2012, products (2011: 34) were included in the NMC with Division’s single largest product. SHPL is the only compared to 49% in 2011, indicating continued 17 designated as Type-A and 15 as Type-B and that manufacturer of SXBXP in China, and the intellectual broadening of our national presence as well as 99.5% of all SHPL sales in 2012 could be reimbursed property of the drug remains well protected. SXBXP signiﬁ cant further geographical expansion potential. under the National Basic Medical Insurance, Labour is included in the Essential Medicines List and SHPL also continued to build its second ranked Injury Insurance and Childbirth Insurance Systems holds Type-A NMC drug status, which means it is product, Dan Ning tablet (gallbladder/inﬂ ammation) (“National Insurance Systems”). In addition, a total of fully reimbursed in all provinces under the NMC. with sales growth of 17% to $11.6 million (2011: 14 SHPL drugs, of which 3 are in active production, The “Confidential State Secret Technology” status $9.9m). Dan Ning tablet is a unique Type-B NMC were included on the Essential Medicines List with protection on SXBXP, as certiﬁ ed by China’s Ministry drug with patent protection lasting until 2027. one of these drugs being SXBXP, SHPL’s proprietary of Science and Technology and State Secrecy Bureau cardiovascular prescription drug. has been extended by seven years until late 2016. In As well as its strong portfolio of reimbursed The cardiovascular drug market is the largest efforts to patent SXBXP for the long-term and one brand, SHPL’s main strength remains its powerful, therapeutic class in China with a 13.1% share of 20-year patent and three 10-year patents have been regimented, and scalable commercial team. At the the entire pharmaceutical market in 2011. The awarded and ﬁ ve remain under review. end of 2012, SHPL had over 1,500 medical sales addition, SHPL has in the past ﬁ ve years redoubled prescription drugs and its trusted Shang Yao market has grown at 19% compounded annually Chief Executive Ofﬁ cer’s Statement - China Healthcare 15 HBYS China Sales Distribution - 2012 Sales-by-Province HBYS continues to expand across China with particular strength in central and southern China. Geographical expansion potential lies in both eastern and southwest China. CHINA HEALTHCARE Sales Level > US$10.0 million Net Sales US$5.0 - 10.0 million Net Sales US$1.0 - 4.9 million Net Sales < US$1.0 million Net Sales Fu Fang Dan Shen tablets (Angina) Ban Lan Gen granules (Anti-Viral) HBYS Main Products by Sales: 32% 1% 5% 7% 26% 29% Angina (FFDS) Anti-Viral (BLG) Periodontitis (Kou Yan Qing granules) Gallbladder (Xiao Yan Li Dan tablets) Inflammation (Chuan Xin Lian) Others 2012 Total HBYS Sales: $228.7 million (up +34%) US$5.0 - 10.0 million US$1.0 - 4.9 million < US$1.0 million Net 2011 Sales-by-Province 16 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Hutchison Whampoa Guangzhou Baiyunshan Chinese Medicine Company Limited representatives and marketing staff (2011: approx. In 2012, HBYS’ six main products accounted for scheme now at over 90% of the rural population in 1,300), managing distribution and sales of SXBXP 71.0% of HBYS sales (2011: 85.5%) indicating a move China, more people are visiting hospitals than before, in over 10,000 hospitals (2011: approx. 9,600) in towards product diversification through both the with approximately 6.3 billion outpatient visits made China. This still only covers some 43% of over 23,000 growth of the broader HBYS line as well as expansion in 2011 as compared to about 4.0 billion in 2004. hospitals in China in 2012, indicating that substantial of our GSP distribution activities. These products are We expect these trends to lead to substantial growth remaining channel expansion potential exists. Banlangen granules, an anti-viral treatment; FFDS in the cold/ﬂ u drug market in China and given HBYS’ OTC Drugs – HBYS OTC drug sales in HBYS increased 34% in 2012 for periodontitis; Xiao Yan Li Dan tablets for liver/ subcategory, a subcategory that represented about gallbladder; Chuan Xin Lian tablets for inﬂ ammation; 7% of the entire cold/ﬂ u market in China in 2010, we to $228.7 million (2011: $171.3m), which was a and Nao Xin Qing tablets for coronary diseases and believe the outlook for HBYS growth is positive. tablets, principally for angina; Kou Yan Qing granules leadership market share in the generic Banlangen combination of 8% growth to $178.2 million in sales cerebral arteriosclerosis. of HBYS’ own brand OTC products (2011: $160.0m) Sales of Banlangen, HBYS’ market leading generic and 351% growth to $50.5 million in sales of third The disease categories in which our two main OTC anti-viral, grew 14% in 2012 to $65.4 million (2011: party products through HBYS’ GSP distribution products compete are cardiovascular (FFDS) and $57.2m), a solid return to growth after normalisation subsidiary (2011: $11.2m). cold/ﬂ u (Banlangen). The cardiovascular category has of raw material pricing, which had increased sharply been reviewed above in the context of SHPL’s SXBXP in 2009 and 2010. These raw material prices HBYS holds a portfolio of 147 registered drug and the growth potential also applies to FFDS tablets. increased due to both negative climatic events licenses in China. By the end of 2012, a total of 62 With regards to the second key category in which (drought/ﬂ oods) and increased consumption around HBYS products (2011: 62) were included in the China HBYS competes, cold/flu, it is also a very relevant the 2009 H1N1 outbreak and forced us to materially NMC with 28 designated as Type-A and 34 as Type-B category in China. According to a recent Citigroup raise ex-factory prices to protect margins. This led to and that 87% of all HBYS sales in 2012 could be rural hospital survey, over 80% of responders some volume softness in late 2010 and early 2011. reimbursed under the National Insurance Systems. identified cold/flu as the most common disease As predicted however, the relatively short six-month In addition, a total of 24 HBYS drugs, of which 7 are diagnosed/treated in rural areas and cold/flu also planting-to-harvest cycle for Banlangen led to an in active production, were included on the Essential rated as the third fastest growing disease category. increase in the supply of Banlangen raw materials Medicines List. With enrolment in the rural cooperative medical during 2011, and a collapse in the raw material price which is now not materially higher than it was in 2009. Chief Executive Ofﬁ cer’s Statement - China Healthcare 17 FFDS tablet, HBYS’ OTC treatment for angina, sales In 2011, HBYS invested approximately $3.2 million All HHL’s sales were accounted for by its Zhi Ling grew 6% in 2012 to $60.2 million (2011: $57.0m). for a 60% equity interest in a GSP China drug Tong (“ZLT”) infant and pregnant mother supplements During early 2010 HBYS implemented major price distribution company named Nanyang Baiyunshan brand, which we have successfully developed in increases on FFDS of 24%, a further 24% in 2011 and Hutchison Whampoa Guanbao Pharmaceutical partnership with our exclusive distributor into an 4% in 2012 which led to some softness in volume. Company Limited (“NBHG”). Our strategy for NBHG effective hospital and mother/baby store distribution These ex-factory price increases were driven by is to use it as a vehicle to sell complementary third model across China. Pregnancy supplementation is dramatic increases in the prices for the raw materials party products in China through the HBYS sales an important market in China, due in part to China’s used in FFDS during 2009 and 2010. Raw material organisation. This has allowed HBYS to generate one-child policy and the importance a mother and price increases were caused, we believe, more due synergies from its OTC sales team and distributor her family places on her single pregnancy. HHL to speculation triggered by drought-driven supply network in China. During late 2011, NBHG entered currently sells three ZLT licensed health supplement constraints as several companies in China stockpiled into two strategic product distribution agreements products: ZLT DHA capsules, the omega-3 product for the raw materials in order to profit by selling to with afﬁ liates of GBP thereby materially broadening use by pregnant and lactating women to promote manufacturers at higher prices. According to an the range of OTC products it sells. While contributing brain and retinal development in babies; ZLT calcium article in the National Business Daily, the supply of a lower margin than our core HBYS own brand powder for bone growth; and ZLT probiotic powder Sanqi, the key herb in FFDS which takes three years manufacturing business, NBHG has grown quickly for toddler immunity. to grow, averaged approximately 4,500, 4,900, 4,700 with 2012 sales of third party products of $50.5 tons per year in 2009, 2010 and 2011 respectively million (2011: $11.2m) and represents an important compared to an estimated current demand of about OTC distribution and marketing platform in China. 7,000 tons per year which led to an over five-fold increase in the market price of Sanqi from 2009 to the end of 2012. The harvest in 2012 was about Nutritional Supplements – HHL In 2012, the sales of our wholly-owned subsidiary Property Update on SHPL/HBYS Production Expansion As reported in 2011 and 2012, driven by the rapid growth of our China Healthcare Division over the past seven years, combined with the implementation 6,500 tons and based on actual plantation areas, HHL declined 28% to $5.3 million (2011: $7.3m) of new GMP standards by SFDA for pharmaceuticals assuming no adverse climatic effects, the harvest in as a result of tightening of working capital – key in China, we are actively working on the relocation, 2013 (which starts to come to market in spring) and distributor inventories were reduced by $3.1 million expansion, and new GMP certification of both the 2014 will be no less than 10,000 and 20,000 tons during the year. We concluded in 2011, that while SHPL and HBYS manufacturing sites over the next respectively. This we believe will drive raw material HHL represents a good platform for future activity in ﬁ ve years. prices down dramatically and allow FFDS to return to the nutritional supplements ﬁ eld in China, we should normal growth – this trend being consistent with the not chase growth by tying up cash in working capital. HBYS Property Update: The factory in HBYS currently broader market in which overall TCM industry gross Chi-Med as a group has more important priorities occupies two pieces of land totaling 89,000 square margins bottomed out in the third quarter of 2011 for its cash and consequently we have migrated metres with the main HBYS factory on a 59,000 and since have been on the rise. HBYS remained HHL, which is profitable, to a less cash intensive square metre plot (“Plot 1”) and a disused printing one of the market leaders in the China generic FFDS smaller-scale operation for the moment. This could facility on the second 30,000 square metre plot market in 2011. change as we move forward if we are able to secure (“Plot 2”). Our strategy is to transact and develop the further unique, genuinely science-based, nutritional disused Plot 2 immediately followed by the phased supplement products through partnerships to launch relocation of the HBYS factory from Plot 1 over the into the China market. next ﬁ ve years. Plot 2 plan: Plot 2 was rezoned as a residential development area in 2012. Pursuant to the redevelopment policy for old towns, old villages and old factories of the Guangdong Province (“Redevelopment Policy”), Plot 2 will be collected into the land bank of the Guangzhou Municipal Government and then sold to land developers by auction, 60% of the auction proceeds will be paid to HBYS, the land owner, as compensation (“Total Compensation”). As the Total Compensation is dependent on the auction price and the area available for auction, it is critical for HBYS to monitor closely the development design/type and plot ratio Zhi Ling Tong capsules (Foetal/Infant Development) 18 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report of Plot 2 before the start of the auction process. we require. Phase three will be the relocation of the consolidated statement of financial position and The preliminary designs for Plot 2’s residential main HBYS factory to Zhong Luo Tan District, an area consolidated statement of cash flows of the new redevelopment utilising a plot ratio of 2.2 have been approximately 40 kilometers north of Guangzhou standard. submitted to Guangzhou Municipal Government for – the process of this move can be managed ﬁ nal review and approval. Upon approval, this would systematically over the coming five years. Once The China Healthcare Division has two JCEs, SHPL indicate a residential floor area of approximately relocation to the new facilities in Bozhou and Zhong and HBYS. For SHPL, Chi-Med and our partner, SPG, 60,000 square metres as the actual ﬁ nal residential Luo Tan are complete, it will be possible for HBYS to each assign three directors to a six-person board, floor area available for auction will be slightly redevelop Plot 1 under the Redevelopment Policy. and Chi-Med holds the unilateral right to nominate reduced given that certain space will need to be the general manager. For HBYS, the offshore 80% taken up to build roads and pathways within Plot 2. SHPL Property Update: The re-location of the SHPL Chi-Med controlled holding company of the HBYS In parallel to the Guangzhou Municipal Government factory (currently in Pu Tuo District) to a new facility shares and our partner, GBP, assign three directors to review, HBYS has engaged with multiple property in Feng Pu District, an area approximately 40 a six-person board and each party holds the right to developers to lay out framework agreements on how kilometers south west of Shanghai city is underway. nominate the general manager for a four year term HBYS would work with them to maximize return. Approximately 78,000 square metres of land has on a rotating basis. We understand that before the auction, Plot 2 will been purchased and material local government be injected into the Guangzhou city land bank and incentives have been secured, final designs of the Through our rights to nominate the general manager, HBYS will then receive from the Guangzhou Municipal new factory are currently under ﬁ nal review by the we effectively control day-to-day operations of Government an initial compensation equal to 60% of local Feng Pu District Government and construction both JCEs, an important threshold of control but such the product of the residential ﬂ oor area of Plot 2 and is expected to commence this year. Negotiations control which, we believe, is not being recognised the base land price of approximately $700/square continue with both Pu Tuo District and multiple under IFRS 11. While we fully intend to comply with metre of residential floor area as pre-determined property developers on timing of relocation from IFRS 11, henceforth we will discuss the results of by the Guangzhou Municipal Government. After the SHPL’s existing approximately 58,000 square metre the China Healthcare Division in the manner used in auction, HBYS will receive the balance of the Total site as well as details on the compensation and/or this announcement: 1) total sales of subsidiaries and Compensation. Based on comparable precedent development carried interest that will be payable to JCEs; and 2) consolidated net profit attributable to land auctions in Baiyun District, Guangzhou city, in SHPL, the land owner. Chi-Med equity holders. 2012, the average auction price of similar land was approximately $1,400/square metre of residential ﬂ oor area. IFRS Rule Change In May 2011, after several years of consultation, IASB published IFRS 11, which establishes new Plot 1 plan: The plans to relocate and expand the principles for the ﬁ nancial reporting by parties to a main HBYS factory are divided into three main joint arrangement. The primary accounting change phases. Phase one will be the establishment of a under IFRS 11 will be that from 1 January 2013, large scale HBYS extraction facility in Bozhou, Anhui the income statement and statement of financial province which will provide all extraction support, position of a JCE will no longer be consolidated and some formulation capacity, for HBYS. This Anhui on a proportional basis and both SHPL and HBYS facility will also provide extraction services to the will be treated as equity investments in Chi-Med’s broader Guangzhou Pharmaceutical Holdings Group, consolidated Group accounts. This will affect neither the ultimate parent of GBP and one of China’s largest the way we operate SHPL and HBYS, the synergies pharmaceutical groups. The reason for relocation the Group gains from these operations or the net of extraction to Anhui is two-fold; firstly, Anhui profit attributable to Chi-Med shareholders from province is in central China close to the majority of these JCEs, but it will affect the way we prepare our relevant herb growing and wholesaling operations accounts. The most obvious impact will be how we – leading to major cost savings on raw material report revenues, as revenues from SHPL and HBYS logistics; and second, Anhui is a low cost province will no longer be proportionally consolidated. If where labour, land, and construction are cost 2012 results were reported under this new standard, efficient compared to Guangdong. Phase two will Chi-Med Group revenue from continuing operations involve the GMP certiﬁ cation renewal of the existing would be $22.2 million versus the $195.4 million main HBYS factory on Plot 1 before the end of reported under the old standard. Note 2 of these 2015. This will enable production to continue in the annual accounts lays out in detail the estimated existing main HBYS factory unimpeded for as long as effect on the 2012 consolidated income statement, Drug Research & Development Chief Executive Ofﬁ cer’s Statement - Drug Research & Development 19 Hutchison MediPharma Limited Drug R&D Division Our Operation: Since its beginning in 2001 we have invested approximately $145 million in establishing what we believe is now China’s leading end-to-end oncology and immunology drug R&D operation, Hutchison MediPharma Holdings Limited (“HMHL”). We are creating highly innovative therapies for launch in the fast growth China market and the global market. ultimately royalty streams. We have secured considerable cash to progress the Volitinib (HMPL- 504) and HMPL-004 clinical programmes on a global basis while retaining a major part of the up- side on these two very high potential projects. Our collaboration with J&J (NYSE: JNJ) is also something we are very proud of and the three years of effort of our respective teams is now approaching a decision point on our joint discoveries. This business is likely to be Chi-Med’s greatest driver of transformational value creation. Substantial progress has been made in the past eighteen months with breakthrough partnerships with both AstraZeneca (LSE: AZN) in oncology and Nestlé SA (SIX:NESN) (“Nestlé”) in the gastrointestinal botanical drug space which have served to validate our strategy and pipeline and demonstrate how we can fund our discovery and clinical trial programmes, through up-front and milestone payments and As well as these collaborations, we are making rapid progress in our internal drug development programmes. Fruquintinib (HMPL-013) is showing superb clinical response and as a result we believe it is a serious candidate for licensing. Epitinib (HMPL- 813) and Theliatinib (HMPL-309) are progressing rapidly in the clinic in China and will, in the next six to nine months, prove if they indeed are differentiated and/or superior to the EGFR therapies that are on the global market today. We believe that proof of this differentiation and/or superiority on Epitinib and/or Theliatinib will lead to global licensing activity and step-change value creation for the Group. Market Dynamics: During the past ten to ﬁ fteen years the China biotech industry has grown from almost nothing to an ecosystem that is catching up to the US and Europe in certain aspects. This biotech ecosystem has made world-class drug R&D and innovation possible in China. For their part the SFDA has made major strides in formalising, communicating, and expediting the new drug registration process in order to meet the public health need. Since 2001, for example, the average time from submission of an IND through to approval of a NDA is 73 months, with oncology being the fastest at an average 60 months for the 14 oncology NDA approvals. It should be noted, to help guide when HMP’s products might start to reach market in China, that our ﬁ ve oncology 20 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report INDs were submitted approximately 46 months ago (Sulfatinib); 43 months ago (Fruquintinib); 35 months ago (Epitinib); 30 months ago (Theliatinib); and 15 months ago (Volitinib). Beyond the SFDA’s positive actions, a vibrant infrastructure of contract research organisations (“CROs”) has evolved, driven primarily by the trend over the past ten years for global outsourcing of discovery work to China. Global pharmaceutical companies allocated an estimated $1 billion to discovery chemistry outsourcing in China alone in 2012, not to mention the spending in other CRO areas such as biological screening and pharmacological testing, toxicology, dosage formulation and stability, and clinical studies. These reliable, global standard CRO services have allowed HMP research to focus on what it does best, innovation in drug discovery, while outsourcing non- strategic activities such as Good Laboratory Practice toxicology and clinical supply manufacture. 2012 Drug R&D Division Financial Performance: HMP revenues were $7.4 million in 2012 (2011: $14.8m) reflecting continued payments from discovery collaborations with J&J and income from the global licensing deal with AstraZeneca. This was lower than last year, which beneﬁ ted from $10.8 million of the $20.0 million AstraZeneca upfront payment being allocated to 2011 versus $4.6 million to 2012 (and a further $4.6 million to 2013). Net proﬁ t attributable to Chi-Med equity holders rose to $2.8 million (2011: net loss $3.7m). 2012 Primary Drug R&D Division Transactions: These results include the financial impact of the establishment of our joint venture with Nestlé Health Science, NSP, which was announced in November 2012. This has created an $11.5 million dilution gain in our consolidated income statement and the elimination of $18.5 million of capitalised development costs for HMPL-004 from our consolidated statement of financial position. The transaction is subject to regulatory approvals, ﬁ lings for which were triggered because of the size of both ultimate parents to the deal, Nestlé (market capitalisation $230 billion) and Hutchison Whampoa (market capitalisation $44 billion). Regulatory approvals are procedural in nature given that neither Nestlé nor Hutchison Whampoa has any market share in the IBD prescription drug market in any country in the world. While adhering to all regulatory requirements, the HMPL-004 Phase III programme is progressing at full speed with the intention to recruit the ﬁ rst patient in early 2013. The purpose of NSP is to research, develop, manufacture and market worldwide novel medicines and nutritional products derived from botanical plant origins. NSP will focus on gastrointestinal indications, and may in the future expand into the metabolic disease and brain health areas. HMP will provide its best-in- class botanical drug research and development capability, including exclusive rights in the field of gastrointestinal disease to its extensive botanical library and well- established botanical R&D platform, which will be the basis of NSP’s future pipeline. Nestlé will bring unique competencies in nutritional sciences, diagnostics and commercial capabilities. NSP will also progress HMPL-004, a novel, oral therapy for IBD developed by HMP and derived from a botanical extract, through Phase III registration trials for ulcerative colitis and Crohn’s disease. Signing ceremony for Nutrition Science Partners Limited joint venture Christian Hogg, CEO of Chi-Med and Luis Cantarell, President and CEO of Nestlé Health Science In 2012, Chi-Med was approached by SBCVC Fund III Company Limited (“SBCVC”), the holder of a 7.5% share in HMHL, with a request to sell their shares back to Chi-Med. A transaction was concluded in October 2012 for Chi-Med to purchase SBCVC’s approximate 2.8 million shares at about $2.3 per share, a 15% discount versus the price they paid in December 2010. This buy-back leaves Chi-Med as the 87.8% majority shareholder in HMHL with Mitsui & Co., Ltd. (“Mitsui”) as the sole minority shareholder with 12.2%. A further related matter is that upon completion of the NSP joint venture, which meets Mitsui’s adjustment event criteria, Mitsui’s original investment in HMHL of $12.5 million will be converted from a long-term liability (its pre- NSP joint venture accounting treatment) to equity in HMHL and the Mitsui shareholding will remain 12.2%. HMP Research and Development Strategy Our HMP organisation is set up to support and fund research and development of our drug candidates against targets, generally proteins or enzymes, associated with the pathogenesis of cancer or inflammation. We employ a diversified portfolio approach focusing on three main categories: Synthetic compounds against novel targets: We conduct research and development of small molecule cancer and immunology drugs against highly novel targets such as c-Met, PI3K-mTOR, Syk and FGFR. These targets present global opportunities with ﬁ rst-in-class or best-in-class potential and are appealing to global pharmaceutical companies with the ability to invest in targets which have not yet been fully validated in human trials. Our approach in this area is to partner our products at earlier development phases in order to mitigate risk while accelerating drug development globally. In addition to Volitinib, HMP’s three late-stage internal discovery programmes as well as the J&J collaboration compounds ﬁ t into this category. Synthetic compounds against validated targets: Our second area of focus is the research and development of small molecule drugs against validated targets, such as Epidermal Growth Factor Receptor (“EGFR”) and Vascular Endothelial Growth Factor Receptor (“VEGFR”), which already have had therapies approved and launched on the global market, but are only approved for limited applications in China. The rationale for this approach is two-fold: 1) rapid development of such products Chief Executive Ofﬁ cer’s Statement - Drug Research & Development 21 for launch in the fast growth China market, and 2) if differentiated/superior properties are identified on our drug candidates in China clinical trials we would license out and launch in global markets through partnership. HMP’s EGFR inhibitors, Epitinib and Theliatinib, and VEGFR inhibitors Fruquintinib and Sulfatinib ﬁ t into this category. Botanical Drugs against multiple targets: The third area of research and development focus is botanical drug development in accordance with the US Food and Drug Administration’s (“FDA”) publication of guidelines for botanical drugs products in 2004. Botanical product development provides a new source of innovation for the global pharmaceutical industry with its multiple active components often acting synergistically on multiple targets. This new FDA botanical drug products registration pathway was validated on 31 December 2012 when the FDA approved it ﬁ rst oral botanical prescription drug, Fulyzaq® (Crofelamer) from Salix Pharmaceuticals, Inc., a botanical drug for severe diarrhoea in HIV patients on anti-retroviral drugs. This approval, we believe, will lead to a move by multinational pharmaceutical companies to better understand the drug innovation potential in the botanical ﬁ eld. Already multinational pharmaceutical companies including GlaxoSmithKline and Sanofi have announced their intention to pursue this space. HMP is well positioned to be an attractive partner for multinationals interested in botanical drugs, as evidenced by the Nestlé deal. Over the past ten years, HMP, through its presence in China and global development and regulatory activities, has built unrivalled expertise in the field of botanical drug development and has achieved clinical success with HMPL-004, our drug candidate for IBD. HMP’s internal botanical component library, which contains over 1,500 puriﬁ ed natural products and over 50,000 extracts/fractions from over 1,200 different plants, also provides new substrates for small molecule drug discovery. Under the NSP joint venture agreement, HMP and NSP will exclusively work with Nestlé Health Science in both the development of HMPL-004 and botanical drug research and development in the ﬁ eld of gastrointestinal disease. Beyond the gastrointestinal disease category HMP may either work independently, or through future expansion of NSP’s field of research, or with other third party partners. Product Pipeline Progress HMPL-004: A proprietary botanical drug for the treatment of IBD, namely ulcerative colitis and Crohn’s disease. Subject to the conditions of NSP joint venture agreement, and as part of the broader gastrointestinal disease research and development collaboration, HMPL-004 is now in the process of being taken into ﬁ nal global Phase III registration trials. Current Treatments for IBD: The current standard of care for IBD starts with 5-aminosalicyclic acids (5-ASAs) which can induce and maintain clinical response and remission in approximately 50% of IBD patients. For the 5-ASA non-responding patients with moderate-to-severe active diseases, various forms of corticosteroids and immune suppressors and anti-TNF (Tumour Necrosis Factor) agents such as biologics are prescribed. These agents, though effective, are associated with many side effects, sometimes serious, and are not often suitable for prolonged usage. The market for IBD drug sales was approximately $7.9 billion in 2012 across the seven major markets (the United States, Japan, France, Germany, Italy, Spain and the United Kingdom) according to Datamonitor, with sales in the US alone expected to reach $6.8 billion by 2021. IBD is estimated to affect approximately 1.4 million people in the US today, about 1 in 200, according to the Crohn’s and Colitis Foundation of America. Moreover, in those seven major markets total sales of 5-ASAs in 2012 were estimated at approximately $1.6 billion with Warner Chilcott (AsacolTM) and Shire (LialdaTM and PentasaTM) accounting for approximately $0.8 billion and $0.7 billion respectively, mostly in the US. Sales of biologics for treatment of IBD in the seven major markets in 2012 were estimated at about $5.4 billion with J&J (RemicadeTM) and AbbVie (HumiraTM) accounting for approximately $3.2 billion and $1.7 billion respectively. PROGRAM TARGET/ INDICATION LEAD CANDIDATE PRE-CLINICAL PHASE I PHASE II PHASE III BOTANICAL MULTI-TARGET CANDIDATES HMPL-004 HMPL-004 Ulcerative colitis Crohn's disease SMALL MOLECULE VALIDATED TARGET CANDIDATES FRUQUINTINIB HMPL-013 SULFATINIB (HMPL-012) EPITINIB (HMPL-813) THELIATINIB (HMPL-309) VOLITINIB (HMPL-504) VEGFR gastric, CRC, Lung, other VEGFR/ FGFR HCC, Breast EGFR NSCLC brain mets, GBM Wild Type EGFR NSCLC Selective c-Met Gastric, Lung, RCC SMALL MOLECULE NOVEL TARGET CANDIDATES HMPL-518 HMPL-523 FGFR program PI3K/m TOR Breast, Lung Syk RA, MS, Lupus; (pot, Lymphoma, CLL) Selective FGFR Lung SCC, Breast, Gastric, Bladder, MM Oncology Inﬂ ammation & Immunology HCC – Hepatocellular carcinoma or liver cancer; CRC – Colorectal cancer or colon cancer; NSCLC – Non small cell lung cancer; RCC – Renal cell carcinoma or kidney cancer; GBM – Glioblastoma or brain cancer. 22 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report HMPL-004 Unique multi-target MOA(1) IL-1b TNFa LPS P38a ERK STAT IKKß IkB p50 p65 Intestinal lumen Mucosa Bacteria Epithelium M DC T Oncology Portfolio: HMP has a portfolio of five small molecule targeted cancer drugs all of which are in Phase I clinical trials. Our strategy over the past eight years has been to discover small molecule drugs which target both validated targets such as EGFR and VEGFR as well as more novel, clinically un-validated targets which have not yet received marketing approval, such as c-Met, PI3K-mTOR, Syk and FGFR. Four of our oncology drugs have received IND approval by the SFDA through the Green NF-kB Pro-inﬂammatory cytokines IL-1b IL6 TNF-α Neutrophils Channel expedited application process, highlighting Activated lymphocytes Indicates where HMPL- 004 activity has been demonstrated their potential and relevance for the China market. The ﬁ fth drug, Volitinib, has been approved for Phase I trials in Australia and is under review in China. (1) Mechanism of Action Inflammatory Bowel Disease. HMPL-004 Phase IIb ulcerative colitis trial (HMPL-004 plus 5-ASA) 1,800mg HMPL-004 Placebo 71% HMPL-004 1,800 mg/day n = 51 Placebo n = 52 35% 39% 17% 53% 27% P=0.001 P=0.01 P=0.007 Clinical Response Remission Mucosal Healing 8 k e e W t a s t n e i t a P f o % 80% 60% 40% 20% 0% Given the scale and growth in the China oncology market, there is a great deal of innovation and clinical activity underway by many companies in China. It was estimated that in 2011, over 2.8 million people were diagnosed with cancer in China and almost 2.0 million died, this compares to less than 0.6 million deaths due to cancer in the US during 2010. According to four National Health surveys in China, the prevalence rate of cancer has doubled since 1993 and the number of cancer patients grew approximately 57% compound annually between 2003 and 2008. The anti-cancer drug market in China was approximately $1.5 billion in 2011 with targeted cancer therapies in particular, including small molecule tyrosine kinase inhibitors (“TKI”) and monoclonal antibody drugs, being the fastest growth sub-segment with compound annual growth of 48% between 2006 and 2011. Sales of the respective top five small molecule TKI and monoclonal antibody targeted cancer therapies in Unmet needs in IBD: There remain clear unmet have been established in multiple clinical trials. In the China totaled approximately $440 million in 2011. medical needs in the treatment of IBD, namely, aggregate, the data have demonstrated HMPL-004’s HMP’s focus is on this fast growth sub-segment of the the need for novel agents which can induce and high potential to address IBD’s unmet medical needs. China oncology market as well as the global market maintain remission among 5-ASA non-responding for small molecule targeted cancer therapies, which or intolerant patients, and the need for safer agents HMPL-004 Next Steps: NSP expects to start a global Visiongain forecasts will reach $32.7 billion by 2016. without the side effects of corticosteroids and Phase III ulcerative colitis induction and maintenance immune suppressors. study shortly. The total HMPL-004 Phase III clinical Within the ﬁ eld of cancer, HMP has focused discovery study will enrol over 2,700 patients suffering from and development pipeline activities against five of Pre-clinical and Clinical Performance of HMPL-004: ulcerative colitis or Crohn’s disease, primarily in the 2010’s top seven causes of mortality from cancer, Extensive preclinical studies indicate that HMPL- US and Europe. The cost of the HMPL-004 Phase among the population aged between 30 and 70, 004 exhibits its anti-inflammatory effects through III programme and all gastrointestinal disease in China including lung (521/452 new cases/deaths the inhibition of multiple cytokines (proteins), both research and development activities will be funded per 100,000), liver (401/371 new cases/deaths per systemically and locally, which are involved in primarily by Nestlé Health Science through the initial 100,000), gastric/stomach (463/352 new cases/ causing digestive tract inflammation. HMPL-004’s capital investment in NSP and further milestone deaths per 100,000), colorectal (220/109 new cases/ efﬁ cacy in induction of clinical response, remission, payments to NSP linked to the success of clinical and deaths per 100,000) and breast (169/44 new cases/ and mucosal healing, as well as a clean safety proﬁ le commercial activities. deaths per 100,000). Chief Executive Ofﬁ cer’s Statement - Drug Research & Development 23 As at late 2012 there were a total of 66 oncology Factor. Activation of EGFR can lead to a series sales grow to $16 million in the ﬁ rst eight months drugs in development in China (i.e. between IND of downstream signalling activities that activate of launch in 2012. HMP’s intent with our EGFR submission and NDA submission inclusive). Of these tumour cell proliferation, migration, invasion, and inhibitor programme is not to compete with Icotinib drug candidates in development in China, 23 are the suppression of cell death. Tumour cell division in China but to prove that our drug candidates are small molecule TKIs, or targeted therapies of which can occur uncontrollably when EGFR-activating differentiated and/or superior versus TarcevaTM HMP owns ﬁ ve (22% of all relevant candidates). Of mutations occur. Treatment strategies for certain and IressaTM and thereby can provide benefit/new the 23 drug candidates in development, 12 are in cancers relate to inhibiting EGFRs with small indications currently unavailable in both the China clinical trials (Phase I through III) and HMP owns molecule TKIs. Once the tyrosine kinase is disabled, and potentially global markets. four (33% of all relevant candidates) Fruquintinib, it cannot activate the EGFR pathway and cancer cell Sulfatinib, Epitinib, and Theliatinib as well as one of growth is suppressed, however, EGFR-mutations HMP has two EGFR inhibitors, Epitinib, which entered the eleven (9% of all relevant candidates) Volitinib, can become drug resistant through secondary Phase I trials in late 2011, and Theliatinib, which under China IND review/approval. mutation meaning that the ﬁ eld of EGFR inhibition is entered Phase I trials in late 2012. At the end of The value of HMP’s small molecule TKI cancer drug continuously evolving. Phase I we will judge the functional differentiation of these two molecules both against each other and pipeline is of course difﬁ cult to quantify. However, Since 2003, several EGFR inhibitors have been current marketed EGFR therapies and decide upon the Morgan Stanley China Pharmaceuticals report approved globally and in China and are used for the a licensing and commercialisation strategy going “Pipeline NPV Analysis Uncovers Hidden Value” 30 treatment of non-small cell lung cancer, particularly forward. January 2013, published risk-adjusted NPV analysis for patients with EGFR-activating mutations, who of nine of the above 23 small molecule TKIs in make up approximately 10-30% of non-small cell Epitinib: Epitinib (HMPL-813) is a highly potent development in China. Their analysis of risk-adjusted lung cancer patients. The approved EGFR inhibitors inhibitor of the EGFR tyrosine kinase involved in NPV yielded averages of: (i) $53.0 million for the include both small molecule drugs such as TarcevaTM tumour growth, invasion and migration. Epitinib one candidate under IND submission (Simcere’s (Roche) and IressaTM (AstraZeneca) with 2012 sales has good kinase selectivity and demonstrated a Tofacitinib); (ii) $73.8 million for the four candidates of approximately $1.4 billion and $0.6 billion broad spectrum of anti-tumour activity via oral that have received IND approval (Sinobiopharm’s respectively and monoclonal antibodies such as dosing in multiple xenografts in preclinical studies. two VEGFR1-3/c-Kit/PDGFR inhibitors and Simcere’s ErbituxTM (indicated for head and neck cancer and Importantly, in addition to non-small cell lung cancer, OSI-930 and c-Met/KDR compound); (iii) $92.0 colorectal cancer) (Bristol-Myers Squibb and Merck EGFR-activating mutations are also found in 30- million for the two candidates in Phase I trials KGaA) with 2012 sales of approximately $1.8 billion. 40% of glioblastoma patients, the most aggressive (Hengrui’s Pyrotinib and Simcere’s Simotinib); (iv) The success of these drugs has validated EGFR malignant primary brain tumour in humans. The $294.0 million for the one candidate in Phase II inhibition as a new class of cancer therapy. currently available EGFR inhibitors lack satisfactory trials (Hengrui’s Famitinib); and (v) $540.0 million clinical efficacy against primary brain tumours or for the one candidate in Phase III trials/under EGFR inhibitors are available on the market in tumours metastasised to the brain, largely due to submission (Hengrui’s Apatinib). In contrast, HMP China, with Tarceva TM, Iressa TM, and Erbitux TM insufﬁ cient drug penetration into the brain through has four oncology compounds in Phase I and one achieving reasonable, albeit niche, commercial the blood brain barrier. Brain metastasis occurs in entering Phase II. A simple cross-reference to HMP’s success with 2011 China sales of $51 million, $66 8-10% of cancer patients and is a signiﬁ cant cause of oncology pipeline in China to these risk-adjusted million, and $33 million respectively. These sales cancer-related morbidity and mortality worldwide. NPV estimates of competitive compounds at similar are despite the high global pricing that Chinese Primary tumours of the lung are the most common stage yields an aggregate NPV, for HMP’s oncology patients pay out-of-pocket for these products (e.g. cause of brain metastasis, as it has been estimated pipeline, for the China market only, of over $450 TarcevaTM approximately $3,000 per month, IressaTM that 50% of patients with lung cancer will ultimately million. Based on the information laid out below, approximately $2,600 per month and ErbituxTM develop brain metastasis. HMP would in each case argue that its clinical-stage approximately $13,700 per month). Furthermore, oncology drug candidates are differentiated and/or local Chinese companies have begun to enter the superior to those of its competitors in the ﬁ eld. EGFR inhibitor market in China with me-too EGFR therapies and are performing very well because We believe that HMP owns one of the deepest, they are not constrained by having to charge global fastest moving and most relevant small molecule pricing, an issue that holds back multinationals in targeted cancer drug pipelines in China today, and China as they have to price global drugs the same, that given the rapid growth of this segment, as well or at least close to the same, in all countries in as the overall attractiveness of both the China and the world thereby pricing themselves out of the global oncology market, we are well positioned to broad China market. The example of Zhejiang Beta increase shareholder value rapidly in the near term. Pharma’s Icotinib (brand name: ConmanaTM), a small EGFR Inhibitors: EGFR is a protein that is a to Gefitinib (IressaTM), was launched in China at an cell-surface receptor for Epidermal Growth approximate 30% discount to IressaTM, and has seen molecule EGFR inhibitor that showed non-inferiority 24 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Epitinib’s point of differentiation: In pre-clinical studies, Epitinib demonstrated excellent brain penetration, superior to that of current globally marketed EGFR inhibitors, and good efficacy in orthotopic brain tumour models and reached drug concentrations in the brain tissue that are expected to result in robust efficacy when given orally at doses well below toxic levels. The Phase I clinical trial started in China in mid-2011 and the dose- escalating study has been progressing throughout 2012. Initial clinical response has been observed in this Phase I study thereby indicating that Epitinib is an effective EGFR inhibitor. During the balance of the Phase I study we will include glioblastoma patients and quickly get a read on Epitinib efficacy in the brain. The final study results are anticipated to be available during 2013. We believe that if the pre-clinical findings of brain penetration and effective glioblastoma treatment in humans are confirmed in our Phase I clinical study, Epitinib could quickly become a breakthrough development candidate for patients with primary brain tumours or tumours metastasised to brain carrying EGFR-activating mutations, making it potentially a next-generation differentiated alternative to IressaTM and TarcevaTM with attractive China prospects and major global sales potential. Theliatinib: Theliatinib (HMPL-309) is a novel small molecule EGFR inhibitor. In preclinical testing, it was found to have potent anti-EGFR activity against the growth of not only the tumours with EGFR – activating mutations, but those without (the majority, also known as wild-type EGFR). Furthermore, it has demonstrated interesting activity against tumours with resistant EGFR mutations. Aberrant EGFR activity can be detected in many cancers through activating mutations, gene amplification, or over expression. Other than non-small cell lung cancer tumours, most other tumour types have no EGFR-activating mutations. The current EGFR inhibitor products have limited response for these cancers and therefore are limited to only non-small cell lung cancer patients with the EGFR-activating mutations. Theliatinib’s point of differentiation: If the potent pre-clinical activity of Theliatinib against wild-type EGFR found in pre-clinical xenograft models can be conﬁ rmed in humans in Phase I clinical trials, it could provide an effective therapy for cancers not targeted by current EGFR products. This would make Theliatinib a therapy that could address a major global unmet medical need with attractive China prospects and substantial global sales potential. The Phase I clinical trial started in China in late- 2012 and the dose-escalating study has been progressing quickly in 2013. The ﬁ nal study results are anticipated to be available in early 2014. market, aggressively priced targeted therapies have high potential in China. Our VEGFR inhibitors have demonstrated good safety, potency and selectivity in pre-clinical and clinical testing. VEGF/VEGFR Inhibitors: At an advanced stage, tumours secrete large amounts of Vascular Endothelial Growth Factor (“VEGF”), a protein, to stimulate formation of excessive vasculature (angiogenesis) around the tumour in order to provide greater blood flow, oxygen, and nutrients to the tumour. VEGFR inhibitors stop the growth of veins around the tumour and thereby starve the tumour of the nutrients it needs to grow rapidly. Several ﬁ rst generation VEGF/VEGFR inhibitors have been approved globally since 2005 and 2006, including both small molecule receptor inhibitor drugs such as NexavarTM (Bayer) and SutentTM (Pﬁ zer) with 2012 sales of approximately $1.0 billion and $1.2 billion respectively; and monoclonal antibodies such as Avastin TM (Roche) with 2012 sales of approximately $6.1 billion. The success of these drugs validated VEGFR inhibition as a new class of therapy for the treatment of cancer. While VEGF/VEGFR inhibitors are available on the market in China, 2011 sales of NexavarTM, SutentTM, and AvastinTM in China were only $34 million, $11 million and $22 million respectively because of their very high global pricing (e.g. NexavarTM approximately $8,000 per month, Sutent TM approximately $9,000 per month and AvastinTM approximately $6,000 per month) which makes these products only accessible to a miniscule small portion of the Chinese population – based on the above sales and cost data, theoretically only about 800 patients took NexavarTM, SutentTM, and AvastinTM per month in 2011 in China. Broadly speaking, we believe HMP’s VEGFR inhibitor drugs are highly attractive from two angles: 1) if proven in the clinic to be superior and/or differentiated from existing global VEGFR drugs, then our VEGFR inhibitors could have global market best-in-class potential and become a global rival to NexavarTM, SutentTM, and AvastinTM; and 2) if clinical trials show non-inferiority, undifferentiated, performance versus existing global VEGFR drugs then we will have a competitive advantage in China as we will not be limited to charging global prices and will be able to undercut existing VEGFR drugs in China thereby offering them to a far broader patient population. As has been shown above in the case of Icotinib (Zhejiang Beta Pharma) in the EGFR Fruquintinib: Fruquintinib (HMPL-013) is a novel small molecule compound that is highly selective in only inhibiting certain VEGF receptors, namely VEGFR1, VEGFR2, and VEGFR3 which makes it highly potent at low dosages. Furthermore, preclinical data for NexavarTM and SutentTM shows that as a result of being less selective than Fruquintinib, and inhibiting multiple non-VEGF related TKIs, they have poorer tolerability and hence safety at higher doses. Fruquintinib’s high kinase selectivity (and therefore tolerability) leads to high drug exposure at the maximum tolerated dose, higher sustained target inhibition to maximise strong clinical efﬁ cacy. Fruquintinib’s point of differentiation: Fruquintinib has shown highly potent inhibitory effects on multiple human tumour xenografts, including some refractory tumours such as pancreatic cancer and melanoma and anti-tumour and anti-angiogenic effect compares favourably to approved VEGF drugs. The Phase I clinical trial is complete and a Clinical Trial Application (“CTA”) to expand to a Phase II/ III study has been submitted to the SFDA. So far Fruquintinib has been well tolerated at doses up to a 4mg single dose per day (and at 5mg per day under a 3 weeks on, 1 week off regimen) to date and demonstrated excellent pharmacokinetic properties. Very good preliminary clinical activity has been observed in multiple tumour types, including partial response (greater than 30% reduction in tumour size) in breast, colorectal, gastric and non-small cell lung cancer patients. This shows an excellent correlation of the pre-clinical and clinical data with respect to Fruquintinib anti-tumour activity and drug exposure. Across all dose cohorts, overall response rate was 38%, and in the 4mg single dose per day cohort overall response rate was over 46%. In separate Phase I studies, overall response rates for SutentTM and NexavarTM were approximately 18% and 2%, respectively. Furthermore, across all dose cohorts in the Phase I Fruquintinib study, Progression Free Survival (“PFS”) among colorectal cancer patients was 6.0 months and NSCLC patients was 5.9 months. These PFS results are highly encouraging given the fact that the patients enrolled in this Phase I study were all late-stage cancer patients that had reached a point where they no longer responded to any available treatments on the market. Chief Executive Ofﬁ cer’s Statement - Drug Research & Development 25 We believe that if the Fruquintinib clinical efficacy (PFS) and safety that we have seen in the Phase I study is carried through to Phase II/III, that Fruquintinib has the potential to become a major Phase I PR in Evaluable Patients (Overall Response Rate) Phase I PR in All Patients Phase I PR in CRC Patients targeted therapy on both the China and global FRUQUINTINIB(1) 13/34 (38%) 13/40 (32%) markets over the coming years with substantial global sales potential. Fruquintinib Phase I 69-year old female; Advanced colon cancer 9/81 (11%) 8/51 (15%) APATINIB(2) FAMITINIB(3) 9/65 (13%) 8/48 (16%) REGOREFANIB(7) 3/47 (6.3%)(4) SUNITINIB(8) SORAFENIB(9) 18% 2% 3/10 (30%) 3/28 (10%) N/A Phase 3 (1.6%)(5) Baseline RAMUCIRUMAB(6) 4/27 (15%) 4/37 (11%) 0/6 (0%) (1) Dr. Jin Li (PI for Fruquintinib Phase I trial). RECIST 1.0 used; (2) Dr. Jin Li presentation at CSCO conference 2009. RECIST 1.0 used; (3) Famitinib clinical data published in a Chinese Journal. Unclear RECIST criteria used; (4) Clin Cancer Res; 18[9] May 1, 2012. RECIST 1.0 used; (5) 2012 ASCO Gastrointestinal Cancer Symposium in San Francisco, CA; (6) Clin Oncol, 28[5]:780-787, 2010. Unclear RECIST criteria used; (7) Bayer StivargaTM; (8) Pfizer SutentTM; (9) Bayer NexavarTM. Fruquintinib Phase I Waterfall Plot - Tumour size change vs. baseline 24 weeks later 40% 20% 0 -20% -40% -60% -80% -100% 2 6 % 1 7 % 1 6 % * * 8 % 8 % 6 % * * 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 - 1 % - 3 % - 4 % * * . - 5 2 % - 7 % - 1 2 % - 1 5 % * * - 1 5 % - 1 5 % - 1 7 % - 1 8 % - 1 9 % - 2 1 % - 2 1 % - 3 1 % - 3 2 % - 3 3 % - 3 4 % - 3 4 % - 3 5 % overall PD (non-target lesion, new lesion appeared) ** *** overall PD (PR on D49 assessment was not conﬁ rmed 4wks later) - 3 8 % - 4 0 % - 5 9 % * * * - 4 3 % - 4 7 % - 5 9 % - 6 9 % - 1 0 0 % ) D L S ( e n i l e s a b m o r f ) % 0 0 1 ( e g n a h c Sulfatinib: Sulfatinib (HMPL-012) is a novel small The Phase I clinical trial is nearing completion Since selective c-Met inhibitors are a new family of molecule that selectively inhibits the tyrosine kinase in China and a Phase II/III CTA is expected to be targeted cancer treatments, none have yet reached activity associated with VEGFR and ﬁ broblast growth submitted to the SFDA in 2013. Sulfatinib was approval stage in the US, Europe or Asia. One of the factor receptors (“FGFR”). Pre-clinical data shows well tolerated at doses up to 300mg per day and most clinically advanced selective c-Met inhibitors that Sulfatinib has demonstrated a narrow kinase demonstrated preliminary anti-tumour activity. is a monoclonal antibody named Onartuzumab inhibition proﬁ le, affecting mainly VEGFR and FGFR1, Pharmacodynamics marker analysis indicates the (MetMAbTM) from Roche. It is being investigated in a and consequently has an attractive anti-tumour dual inhibition of VEGFR and FGFR. Pharmacokinetic late-stage trial for use in Met-positive advanced non- profile. This compound is a potent suppressor optimisation is in progress. of angiogenesis and exhibits higher potency as small cell lung cancer in combination with TarcevaTM. Mid-stage results presented in 2011 showed the compared to approved VEGF drugs. It targets major Volitinib: Volitinib (HMPL-504) is a novel targeted combination of Onartuzumab and TarcevaTM tripled cancer types such as hepatocellular carcinoma, therapy and inhibitor of the c-Met receptor tyrosine the time Met-positive patients lived compared with colorectal cancer and breast cancer. The first-in- kinase for the treatment of cancer. The c-Met (also TarcevaTM alone thereby helping to begin to validate human Phase I clinical trial is an open-label, dose known as HGFR) signalling pathway has specific the c-Met pathway as a relevant target in the escalation study, primarily to establish the maximum roles particularly in normal mammalian growth and treatment of cancer. tolerated dose and assess the safety and tolerability development; however this pathway has been shown in patients with advanced solid tumours. to function abnormally in a range of different cancers. Volitinib Inhibitor of the c-Met receptor tyrosine kinase 26 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Volitinib is a potent and highly selective c-Met inhibitor, which has been demonstrated to inhibit the growth of tumours in a series of pre-clinical disease models, especially for those tumours with aberrant c-Met signalling such as gene ampliﬁ cation or c-Met over expression. In addition, these biomarkers provide the potential to explore patient selection strategies in later stage clinical trials. In December 2011, HMP entered into a global licensing, co-development, and commercialisation agreement for Volitinib with AstraZeneca. Under the terms of the agreement, development costs for Volitinib in China will be shared between HMP and AstraZeneca, with HMP continuing to lead the development in China. AstraZeneca will lead and pay for the development of Volitinib for the rest of the world. An initial cash payment of $20 million was paid by AstraZeneca to HMP upon signing of the agreement. In addition, HMP will receive up to $120 million contingent on the successful achievement of clinical development and first sale milestones. The agreement also contains possible signiﬁ cant future commercial sale milestones and up to double-digit percentage royalties on net sales. Volitinib entered ﬁ rst-in-human Phase I clinical trial in Australia in February 2012, designed to ﬁ nd the maximum tolerated dose and recommended Phase expectations for the success of this very important Science that, amongst other beneﬁ ts, facilitates the II dose. A great deal of progress has been made strategic collaboration. funding of HMPL-004’s Phase III clinical trials and the broader gastrointestinal disease research and since then and the preliminary study results are anticipated to be available in 2013. A China Phase I/ II clinical trial is also expected to initiate in 2013. Discovery programmes Our fully integrated discovery teams in oncology and HMP Financing Strategy HMP capitalises on the cost efficiencies and development program without increasing our cash burn. Looking ahead we will continue to adopt a speed benefits associated with performing drug pragmatic approach to financing HMP, preferring research and development in China, maintaining this non-dilutive approach until the progress of an approximately 180-person highly productive our clinical portfolio justiﬁ es a material increase in immunology made considerable progress during organisation that is progressing six clinical and the value of HMP and/or biotech market sentiment 2012. We staff and resource our discovery team with multiple discovery phase programmes. HMP’s improves, at which point equity investment at the the objective of producing one or two new internally average annual cash burn in the past four years, HMP level might once again become appealing. discovered drug candidates per year. In 2012, the before any income to offset this, has been discovery team progressed two highly novel small approximately $20 million. During late 2010, we molecule drug candidates through to candidate raised $20.1 million in cash through third party selection stage, a PI3K-mTOR inhibitor in oncology venture capital investments in HMP. In 2011, driven and a Syk inhibitor in inflammation. If successful primarily by difﬁ culties in the biotech venture capital, in further toxicity testing, IND submissions will be private equity, and capital markets, we moved away made on both these new drug candidates in 2013 or from what we assessed would be an overly dilutive early 2014. One further HMP discovery programme equity investment approach in HMP towards a non- against the FGFR target in oncology has been dilutive fund raising approach through expanding underway for over two years and we intend to reach research collaborations and drug-development candidate selection stage in 2013. In addition to our partnerships. That year we signed a collaboration internal discovery activities, our collaboration with agreement with AstraZeneca that included a $20 J&J in inﬂ ammation is progressing well, with a key million cash payment upfront. In 2012, we signed decision point approaching in 2013. We have great a joint venture agreement with Nestlé Health Consumer Products Chief Executive Ofﬁ cer’s Statement - Consumer Products 27 mainly through third party local distributors, in nine territories in Asia. Importantly, this HHO Distribution business turned to profit in the second half of 2012. While the natural and organic consumer products category is still in its infancy in Asia, and especially China, we expect this to evolve quickly over the coming years, making it an appealing and sustainable business for Chi-Med. The second activity, which HHO was involved in over the past two years, has been the launch of HHO’s ZLT/Earth’s Best® organic infant formula. After an encouraging start, in 2011, major issues quickly emerged with the supply chain and product quality that have now led HHO to re-evaluate this initiative. During 2012, we cleaned up the market by accepting returns of unsellable stock and began to scale down this project. Consumer Products Division Our Consumer Products Division is an extension of our China Healthcare operation which enables Chi- Med to capture part of the growing consumer trend towards healthy living and to capitalise on the considerable consumer products synergies with the broader Hutchison Whampoa group. We aim to build a proﬁ table scale business systematically over time behind a portfolio of relevant and unique health- related consumer products. In 2012, we made clear decisions to refocus the Consumer Products Division and discontinue/scale down operations which we judged to either have low long-term value creation potential, were a distraction to the Chi-Med management team or difficult to manage due to geographical isolation, or were a cash drain. Given this we decided to formally discontinue the Sen UK business, and in-so-doing take a non- recurring loss from discontinued operation of $3.2 million. Furthermore, we decided to scale down both the Sen France and China infant formula businesses and make them non-loss making. In order to achieve this, we took total restructuring charges of $4.0 million in 2012 which is the vast majority of the outstanding liabilities of these two projects. These decisions have led to $7.2 million of non- recurring restructuring costs in 2012. This move allows us to focus on our core China Healthcare Division, Drug R&D Division, and our profitable/ higher potential Consumer Products Division in the Asia/China market. Overall, the Consumer Products Division saw sales on continuing operations decline 9% in 2012 to $10.0 million (2011: $11.1m). The drop was driven by solid growth in the Hutchison Hain Organic and Hutchison Consumer Products distribution business which grew over 33% to $10.0 million (2011: $7.6m) offset by steep declines on the combined Sen France and China infant formula businesses which recorded -$0.1 million in sales (2011: $3.5m) as we scaled them down. Net loss attributable to Chi-Med equity holders for the Consumer Products Division widened to $6.8 million (2011: $2.9m), however, 2013 is now set to be cash neutral on the Consumer Products Division continuing operations level and thereby allow the Division to grow systematically without being a drain on the Chi-Med group. The Consumer Products Division has three operating entities: an organic and natural products business, Hutchison Hain Organic Holdings Limited (“HHO”), which is a joint venture with Hain Celestial; a wholly-owned proprietary botanical based beauty care business operated under the Sen® brand; and a wholly-owned consumer products distribution business, Hutchison Consumer Products Limited (“HCPL”). Through its operating entities, the Consumer Products Division distributes and markets 31 brands of primarily healthy living focused products in 48 food, beverage, baby, and beauty care categories. The top seven brands we market include Sen® and Avalon Organics® natural/organic beauty care; Earth’s Best® organic baby food; Imagine® organic soups; Terra® natural snacks; Walnut Acres Organic® sauces; and Health Valley® organic cereals and snacks. The Consumer Products Division now employs approximately 45 staff in both the commercial and product supply areas primarily in Hong Kong and mainland China. Hutchison Hain Organic HHO has made most progress in the distribution of the broad range of over 500 imported Hain Celestial organic and natural products, which having commenced in 2010, continued solid progress in 2012 with sales growing 28% to $8.3 million (2011: $6.5 million), driven by like-for-like retail sales growth of 19.3% in PARKnSHOP Hong Kong. While our focus is Hong Kong and mainland China, we have also expanded distribution of our brands, 28 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Hutchison Consumer Products Limited HCPL is a small and opportunistic business which Current Trading and Outlook for the Group We believe that 2013 will be a very good year for sells non-organic health related consumer products Chi-Med across all three divisions. through our distribution network in Asia, thereby helping to carry some administrative and overhead Sales and profit in the China Healthcare Division costs. Sales in 2012 were $1.8 million (2011: $1.1m). has started the year well ahead of 2012 levels as Sen Medicine Company Trading conditions in the UK and France deteriorated a result of effective commercial execution and a continued normalisation of certain raw material prices. We also expect to create considerable value materially since 2008 with consumer spending through our plans to relocate and expand our China clearly dropping and rents and operating costs manufacturing during the year. increasing thereby making it very difﬁ cult to survive. A further difﬁ culty has been the distance of the Sen In the Drug R&D Division, we will continue to UK and France from the Chi-Med management team. progress our broad pipeline of drugs in the clinic, In June 2012, we made the decision to discontinue thereby further proving their efﬁ cacy and safety and the Sen UK business and actively begin scaling down potentially leading to a rapid increase in their market the Sen France operation. value through milestone payments from existing partners and/or further licensing and collaboration We have however, after significant planning over activity. Through NSP, our joint venture with Nestlé the past three years, decided to proceed with the Health Science, we are also now ready to start the Hong Kong launch of Sen by Kim Robinson (“SBKR”), global Phase III trial on HMPL-004. a range of mass-market salon hair care products. Kim Robinson is Hong Kong’s most famous celebrity The Consumer Products Division continuing stylist and has granted Sen the exclusive right to operations have started the year well and we expect manufacture and commercialise a range of SBKR with our focus on HHO and the Division’s continuing products in the region. SBKR products were launched operations will be operating cash neutral in 2013. in Hong Kong on over 240 outlets in late 2012 and are making a major splash with consumer interest, We look forward to 2013 with the expectation of as expected, being very high. making continued great strides forward on all Chi- Med’s businesses. As a result of the changes in Sen strategy in 2012, sales on continuing operations totalled $0.8 million (2011: $1.5m) and net loss attributable to Chi-Med equity holders was $1.0 million (2011: -$0.6m), $0.7 million of which was a non-recurring loss Christian Hogg attributable to the scale down costs in France. Chief Executive Officer 25 March 2013 Biographical Details of Directors 29 1 Simon TO Executive Director and Chairman 2 Christian HOGG Executive Director and Chief Executive Ofﬁ cer 3 Johnny CHENG Executive Director and Chief Financial Ofﬁ cer Mr To, aged 61, has been a Director since 2000 and an Executive Director and Chairman since 2006. He is also Chairman of the Remuneration Committee, a member of the Technical Committee and the Complaints Committee of the Company. He is managing director of Hutchison Whampoa (China) Limited (“Hutchison China”) and has been with Hutchison China for over thirty years, building its business from a small trading company to a billion dollar investment group. He has negotiated major transactions with multinationals such as Procter & Gamble (“P&G”), Lockheed, Pirelli, Beiersdorf, United Airlines and British Airways. Mr To’s career in China spans more than thirty years and he is well known to many of the top Government leaders in China. Mr To is the original founder of Hutchison Whampoa Limited’s (“Hutchison Whampoa”) TCM business and has been instrumental in the acquisitions made to date. He received a First Class Honours Bachelor’s Degree in Mechanical Engineering from Imperial College, London and an MBA from Stanford University’s Graduate School of Business. Mr Hogg, aged 47, has been an Executive Director and Chief Executive Ofﬁ cer since 2006. He is also a member of the Technical Committee and the Complaints Committee of the Company. He joined Hutchison China in 2000 and has since led all aspects of the creation, implementation and management of the Company’s strategy, business and listing. This includes the creation of the Company’s start-up businesses and the acquisition and operational integration of assets that led to the formation of the Company’s China joint ventures. Prior to joining Hutchison China, Mr Hogg spent ten years with P&G starting in the US in Finance and then Brand Management in the Laundry and Cleaning Products Division. Mr Hogg then moved to China to manage P&G’s detergent business followed by a move to Brussels to run P&G’s global bleach business. Mr Hogg received a Bachelor’s degree in Civil Engineering from the University of Edinburgh and an MBA from the University of Tennessee. Mr Cheng, aged 46, has been an Executive Director since 2011 and Chief Financial Ofﬁ cer of the Company since 2008. He is also a director of Hutchison MediPharma (Hong Kong) Limited, Sen Medicine Company Limited and Hutchison MediPharma Limited and was a director of Hutchison Healthcare Limited during 2009. Prior to joining the Company, Mr Cheng was Vice President, Finance of Bristol Myers Squibb in China and was a director of Sino-American Shanghai Squibb Pharmaceuticals Ltd. and Bristol-Myers Squibb (China) Investment Co. Ltd. in Shanghai between late 2006 and 2008. Mr Cheng started his career as an auditor with Price Waterhouse in Australia and then KPMG in Beijing before spending eight years with Nestle China where he was in charge of a number of ﬁ nance and control functions in various operations. Mr Cheng received a Bachelor of Economics, Accounting Major from the University of Adelaide and is a member of the Institute of Chartered Accountants in Australia. 3 7 4 5 1 2 9 6 8 9 Christopher NASH Independent Non-executive Director Mr Nash, aged 54, has been an Independent Non- executive Director since 2006 and was appointed as Senior Independent Director in September 2006. He is also a member of the Audit Committee and the Remuneration Committee of the Company. He is a non-executive director of NTR plc and GKN Evo eDrive Systems Ltd, chairman of Gasrec Limited and a Director of Current OpenGrid Limited. Mr Nash has had over thirty years business career during which he was senior vice president and group head of strategy and corporate ﬁ nance at Global Crossing Ltd., where he also served on the management board and several divisional boards. In the mid-1990s he was group head of corporate ﬁ nance at Cable & Wireless Plc., and before that a director of North West Water International Ltd. Earlier in his career Mr Nash worked for S.G. Warburg and Co. Ltd. and also spent some time in the venture capital sector. During his career, Mr Nash has spent signiﬁ cant periods of time in Asia. Mr Nash received a Bachelor’s degree in Civil Engineering from Imperial College, London and an MBA from Manchester Business School. 30 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report 4 Shigeru ENDO Non-executive Director Mr Endo, aged 78, has been a Non-executive Director since 2008. He is chief executive ofﬁ cer and a director of Hutchison Whampoa Japan K.K. He worked for over 40 years with Mitsui & Co., Ltd (“Mitsui”), where he became senior executive managing director and a member of the main board of Mitsui. Mr Endo received a Bachelor of Arts degree in Economics from Keio University. During his career, Mr Endo, a Japanese citizen and fluent English and Mandarin speaker, has managed large-scale business operations in Japan, China and the United States. 5 Christian SALBAING Non-executive Director Mr Salbaing, aged 63, has been a Non-executive Director since 2006. He is deputy chairman of Hutchison Whampoa (Europe) Limited, the European headquarters company of Hutchison Whampoa. He is also deputy chairman of Hutchison Whampoa Luxembourg Holdings S.à r.l., the principal holding company for the businesses of Hutchison Whampoa in Europe. Mr Salbaing was previously a partner at Freshfields Bruckhaus Deringer, an international law firm. He represents Hutchison Whampoa across its European businesses, in particular with key strategic partners of the Group, the European Commission and member governments and in relation to regulatory and public affairs matters. He is a member of the ITU Telecom Board, the GSMA Limited Board and the Asia Task Force set up by the UK Government in 2010. Mr Salbaing received an LL.L. degree in Civil Law from the University of Montreal in 1970 and a Juris Doctor degree from the University of San Francisco in 1974. He is a member of the Bars of Quebec, California (inactive status since 2006) and Paris. 6 Edith SHIH Non-executive Director and Company Secretary Ms Shih, aged 61, has been a Non-executive Director and Company Secretary since 2006 and company secretary of Group companies since 2000. She is also a member of the Complaints Committee of the Company. She is head group general counsel and company secretary of Hutchison Whampoa, an executive director and alternate director of Hutchison Harbour Ring Limited, a company listed on The Stock Exchange of Hong Kong Limited, a director of Hutchison International Limited, as well as director and company secretary of numerous companies in the Hutchison Whampoa group. Ms Shih has been employed by Hutchison Whampoa since 1991 and oversees all legal, regulatory, compliance and corporate secretarial affairs of the Hutchison Whampoa group. Ms Shih is President of The Hong Kong Institute of Chartered Secretaries and a lay member of the Council of The Hong Kong Institute of Certiﬁ ed Public Accountants. Ms Shih received a Bachelor of Science degree in Education and a Master of Arts degree from the University of the Philippines and a Master of Arts degree and a Master of Education degree from Columbia University, New York. Ms Shih is a qualiﬁ ed solicitor in England and Wales, Hong Kong and Victoria, Australia and a Fellow of both The Institute of Chartered Secretaries and Administrators and The Hong Kong Institute of Chartered Secretaries. 7 Michael HOWELL Independent Non-executive Director Mr Howell, aged 65, has been an Independent Non- executive Director since 2006. He is also Chairman of the Audit Committee and a member of the Remuneration Committee and the Complaints Committee of the Company. From 2002 to 2006, Mr Howell was chief executive of Transport Initiatives Edinburgh Ltd., a public-sector company responsible for major transportation projects in Scotland, including a new tram system for Edinburgh. From 1998 to 2002, he was executive chairman of FPT Group Limited, a global distribution company. Mr Howell’s prior career was in manufacturing, and transportation services where, after beginning his career in the UK motor industry, he went on to hold senior positions at Cummins Engine and General Electric in the USA and Europe, and Railtrack Group plc in the UK. Mr Howell holds directorships in other private and public companies in the UK and USA. Mr Howell attended Trinity College, Cambridge receiving his Master’s degree in Engineering/Economics from Cambridge University (UK), followed by MBAs from INSEAD (France) and Harvard University (USA). 8 Christopher HUANG Independent Non-executive Director Professor Huang, aged 61, has been an Independent Non-executive Director since 2006. He is also Chairman of the Technical Committee and a member of the Audit Committee of the Company. He is currently Professor of Cell Physiology, and Fellow and Director of Studies in Medicine at Murray Edwards College, University of Cambridge, UK. Professor Huang has spent over twenty years in academia and research in the ﬁ eld of cellular and systems physiology. He has authored over 280 publications in the form of monographs, books, papers and articles whilst pursuing research collaborations with major pharmaceutical companies and holding editorships of Biological Reviews, the Journal of Physiology and Europace. Professor Huang completed his Bachelor’s degrees in Physiological Sciences (B.A.) and Clinical Medicine (B.M., B.Ch.) at The Queen’s College, Oxford, and his postgraduate (Ph.D.) degree at the University of Cambridge. He has also been awarded higher medical (D.M.) and scientiﬁ c (D.Sc.) degrees by both Oxford and Cambridge. He is also a Fellow of the Society of Biology (FSB). Report of The Directors 31 The Directors have pleasure in submitting to shareholders their report and statement of audited accounts for the year ended 31 December 2012. PRINCIPAL ACTIVITIES The principal activity of the Company is that of a holding company of a healthcare group whose main country of operation is China. It engages in research, development, manufacturing and sales of pharmaceuticals, health supplements and other consumer health and personal care products derived from traditional Chinese medicine and botanical ingredients. BUSINESS REVIEW A detailed review of the performance, business activities and future development of the Company and its subsidiaries (the “Group”) are set out in the Chairman’s Statement and the Chief Executive Ofﬁ cer’s Statement. RESULTS The Consolidated Income Statement is set out on page 46 and shows the Group’s results for the year ended 31 December 2012. DIVIDENDS No interim dividend for the year ended 31 December 2012 was declared and the Directors do not recommend the payment of a ﬁ nal dividend for the year ended 31 December 2012. RESERVES Movements in the reserves of the Group during the year are set out in the Consolidated Statement of Changes in Equity on page 49. NON-CURRENT ASSETS Particulars of the movements of non-current assets of the Group are set out in notes 14 to 19 to the accounts. SHARE CAPITAL Details of the share capital of the Company are set out in note 23 to the accounts. DIRECTORS The Directors of the Company as at 31 December 2012 were: Executive Directors: Mr Simon To Mr Christian Hogg Mr Johnny Cheng 32 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Report of The Directors Non-executive Directors: Mr Shigeru Endo Mr Christian Salbaing Ms Edith Shih Independent Non-executive Directors: Mr Michael Howell Prof Christopher Huang Mr Christopher Nash Mr Simon To, Mr Christian Hogg and Mr Christian Salbaing will retire by rotation at the forthcoming annual general meeting under the provisions of Article 91(1) of the Articles of Association of the Company and, being eligible, will offer themselves for re-election. The Directors’ biographical details are set out on pages 29 to 30. DIRECTORS’ INTERESTS IN SHARES As at 31 December 2012, the interests in the shares of the Company held by the Directors and their families were as follows: Name of Directors Christian Hogg Johnny Cheng Michael Howell Christopher Nash Christopher Huang Number of Ordinary Shares held 320,000 192,108 153,600 18,000 2,475 SHARE OPTION SCHEMES AND DIRECTORS’ RIGHTS TO ACQUIRE SHARES (i) Share option scheme of the Company On 4 June 2005, the Company adopted a share option scheme (the “Share Option Scheme”), the rules of which were subsequently amended by the Board of Directors of the Company on 21 March 2007. Pursuant to the Share Option Scheme, the Board of Directors of the Company may, at its discretion, offer any employees and directors (including Executive and Non-executive directors but excluding Independent Non-executive directors) of the Company, holding companies of the Company and any of their subsidiaries, and subsidiaries or afﬁ liates of the Company options to subscribe for shares of the Company. Report Of The Directors 33 The following share options were outstanding under the Share Option Scheme during the year ended 31 December 2012: Effective date of Number of share Granted Exercised Expired/lapsed/ Number of share Name or category grant of share options held at of participants options 1 January 2012 during 2012 during cancelled options held at Exercise period of Exercise price of 2012 during 2012 31 December 2012 share options share options 19.5.2006 (1), (2) 25.8.2008 (3) 19.5.2006 (1), (2) 11.9.2006 (2) 18.5.2007 (4) 28.6.2010 (3) 1.12.2010 (3) 24.6.2011 (3) 768,182 256,146 128,030 80,458 52,182 102,628 227,600 150,000 1,765,226 – – – – – – – – – – (192,108) (51,212) (53,650) (8,325) – – – (305,295) – – – – – – – – – 768,182 19.5.2006 to 3.6.2015 64,038 25.8.2008 to 24.8.2018 76,818 26,808 43,857 19.5.2006 to 3.6.2015 11.9.2006 to 18.5.2016 18.5.2007 to 17.5.2017 102,628 28.6.2010 to 27.6.2020 227,600 1.12.2010 to 30.11.2020 150,000 24.6.2011 to 23.6.2021 1,459,931 £ 1.090 1.260 1.090 1.715 1.535 3.195 4.967 4.405 Directors Christian Hogg Johnny Cheng Employees in aggregate Total: Notes: (1) (2) The share options were granted on 4 June 2005, conditionally upon the Company’s admission which took place on 19 May 2006. The share options granted to certain founders of the Company are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of 50% on 19 May 2007 and 25% on each of 19 May 2008 and 19 May 2009. The share options granted to non-founder of the Company are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of one-third on each of 19 May 2007, 19 May 2008 and 19 May 2009. (3) The share options granted are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of 25% on each of the ﬁ rst, second, third and fourth anniversaries of the date of grant of share options. (4) The share options granted are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of one-third on each of the first, second and third anniversaries of the date of grant of share options. (ii) Share option scheme for existing shares of Hutchison MediPharma Holdings Limited (“HMHL”) On 6 August 2008, HMHL, a subsidiary of the Company, adopted a share option scheme (the “HMHL Share Option Scheme”), the rules of which were subsequently amended by the Board of Directors of HMHL on 15 April 2011, as the sole share-based incentive programme for the employees of Hutchison MediPharma Limited, an indirect wholly-owned subsidiary of HMHL. Pursuant to the HMHL Share Option Scheme, any employee or director of HMHL and any of its subsidiaries and afﬁ liates is eligible to participate in the HMHL Share Option Scheme and options may be granted to eligible participants to acquire existing shares in HMHL subject to the rules of the HMHL Share Option Scheme. 34 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Report of The Directors The following share options were outstanding under the HMHL Share Option Scheme during the year ended 31 December 2012: Effective date of Number of share Granted Exercised Expired/lapsed/ Number of share Category of participants grant of share options held at options 1 January 2012 during 2012 during cancelled options held at Exercise period of Exercise price of 2012 during 2012 31 December 2012 share options share options Employees in aggregate 6.8.2008 (1) 5.10.2009 (1) 1.2.2010 (1) 3.5.2010 (1) 2.8.2010 (1) 22.11.2010 (1) 18.4.2011 (1) 17.10.2012 (1) 1,984,750 310,500 90,000 360,000 266,000 240,000 799,357 – – – – – – – N/A 299,120 4,050,607 299,120 – – – – – – – – – (741,750) (76,500) (90,000) – (60,000) – (236,972) – 1,243,000 6.8.2008 to 5.8.2014 234,000 5.10.2009 to 4.10.2015 – 1.2.2010 to 31.1.2016 360,000 206,000 3.5.2010 to 2.5.2016 2.8.2010 to 1.8.2016 240,000 22.11.2010 to 21.11.2016 562,385 18.4.2011 to 17.4.2017 299,120 17.10.2012 to 16.10.2018 (1,205,222) 3,144,505 US$ 1.28 1.52 2.06 2.12 2.24 2.36 2.36 2.73 Total: Note: (1) The share options granted are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of 25% on each of the ﬁ rst, second, third and fourth anniversaries of the date of grant of share options. SIGNIFICANT SHAREHOLDINGS As at 26 March 2013, being the latest practicable date prior to the publication of this report, according to the records of the Company, the following holders held interests in 3% or more of the issued share capital of the Company:– Names Hutchison Healthcare Holdings Limited (1) (“HHHL”) Computershare Company Nominees Limited (2) (“CCNL”) Depositary Interest held under CCNL: Chase Nominees Limited Slater Investments Limited (3) FIL Limited (3) Notes: Number of Ordinary Approximate % of Issued Shares held Share Capital 36,666,667 15,297,660 70.44% 29.39% 2,809,440 5.40% 3,602,441 2,640,514 6.92% 5.07% (1) HHHL is a private company registered in the British Virgin Islands and carries on business as a holding company. HHHL is an indirect wholly-owned subsidiary of Hutchison Whampoa Limited which is registered in Hong Kong. (2) (3) CCNL is a company registered in Scotland, United Kingdom under company number SC167175 and is acting as the custodian of the depository interests register. Major interests in shares of the Company notiﬁ ed to the Company under the Vote Holder and Issuer Notiﬁ cation Rules of the Disclosure Rules and Transparency Rules. Report Of The Directors 35 AUDITOR The accounts have been audited by PricewaterhouseCoopers who will retire and, being eligible, will offer themselves for re-appointment. ANNUAL GENERAL MEETING The annual general meeting (“AGM”) of the Company will be held on Friday, 10 May 2013 at 10:00 am (UK time) at 4th Floor, Hutchison House, 5 Hester Road, Battersea, London. Details of the resolutions proposed are set out in the Notice of the AGM. By Order of the Board Edith Shih Director and Company Secretary 25 March 2013 36 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Corporate Governance Report The Company strives to attain and maintain high standards of corporate governance best suited to the needs and interests of the Company and its subsidiaries (the “Group”) as it believes that effective corporate governance practices are fundamental to safeguarding shareholder interests and enhancing shareholder value. Accordingly, the Company has adopted sound corporate governance principles that emphasise a quality board of Directors (the “Board”), effective internal control, stringent disclosure practices and transparency and accountability. It is, in addition, committed to continuously improving these practices and inculcating an ethical corporate culture. The Company has applied the principles of the UK Corporate Governance Code (the “Code”) notwithstanding that the Company’s shares are admitted to trade on the Alternative Investment Market (“AIM”), and it is therefore not required to comply with the Code. Set out below are the corporate governance practices adopted by the Company. THE BOARD The Board is responsible for directing the strategic objectives of the Company and overseeing the management of the business. Directors are charged with the task of promoting the success of the Company and making decisions in the best interest of the Company. The Board is satisﬁ ed that it meets the Code’s requirement for effective operation. The Board, led by the Chairman, Mr Simon To, approves and monitors the Group’s long term objectives and commercial strategies, annual operating and capital expenditure budgets and business plans, evaluates the performance of the Company, and supervises the management of the Company (the “Management”). Management is responsible for the day-to-day operations of the Group under the leadership of the Chief Executive Ofﬁ cer. As at 31 December 2012, the Board comprised nine Directors, including the Executive Chairman, Chief Executive Ofﬁ cer, Chief Financial Ofﬁ cer, three Non-executive Directors and three Independent Non-executive Directors (one of whom is Senior Independent Director). Biographical details of the Directors are set out in the “Biographical Details of Directors” section on pages 29 to 30 and on the Company’s website (www.chi-med.com). For a Director to be considered independent, the Board must be satisﬁ ed that the Director does not have any direct or indirect material relationship with the Group. In determining the independence of Directors, the Board follows the requirements of the Code. The role of the Chairman is separate from that of the Chief Executive Ofﬁ cer. Such division of responsibilities helps to reinforce their independence and accountability. The Chairman is responsible for the effective conduct of the Board, ensuring that it as a whole plays an effective role in the development and determination of the Group’s strategy and overall commercial objectives and acts as the guardian of the Board’s decision-making processes. He is responsible for setting the agenda for each Board meeting, taking into account, where appropriate, matters proposed by the Directors. He also ensures that the Board receives accurate, timely and clear information on the Group’s performance, the issues, challenges and opportunities facing the Group and matters reserved to it for decision. With the support of the Executive Directors and the Company Secretary, the Chairman ensures that the Board complies with approved procedures, including the schedule of Reserved Matters to the Board for its decision and Terms of Reference of all Board Committees. The Board, under the leadership of the Chairman, has adopted good corporate governance practices and procedures and taken appropriate steps to provide effective communication with shareholders, as outlined later in the report. Corporate Governance Report 37 The Chief Executive Ofﬁ cer, Mr Christian Hogg, is responsible for managing the businesses of the Group, formulating and developing the Group’s strategy and overall commercial objectives in close consultation with the Chairman and the Board. With the executive team, the Chief Executive Ofﬁ cer implements the decisions of the Board and its Committees. He maintains an ongoing dialogue with the Chairman to keep him fully informed of all major business development and issues. He is also responsible for ensuring that the development needs of senior management reporting to him are identiﬁ ed and met as well as leading the communication programme with shareholders. The Board meets regularly. Between scheduled meetings, senior management of the Group provides information to Directors on a regular basis with respect to the activities and development of the Group. Throughout the year, Directors participate in the consideration and approval of routine and operational matters of the Company by way of circular resolutions with supporting explanatory materials, supplemented by additional verbal and/or written information or notiﬁ cation from the Company Secretary and other executives as and when required. Whenever warranted, additional Board meetings are held. In addition, Directors have full access to information on the Group and independent professional advice at all times whenever deemed necessary by the Directors and they are at liberty to propose appropriate matters for inclusion in Board agendas. With respect to regular meetings of the Board, Directors receive written notice of the meetings generally about a month in advance and an agenda with supporting Board papers no less than three days prior to the meeting. With respect to other meetings, Directors are given as much notice as is reasonable and practicable in the circumstances. Except for those circumstances permitted by the Articles of Association of the Company, a Director who has a material interest in any contract, transaction, arrangement or any other kind of proposal put forward to the Board for consideration abstains from voting on the relevant resolution and such Director is not counted for quorum determination purposes. The Company held six Board meetings in 2012 with 100% attendance of its members. Position Name of Directors Attended/Eligible to attend Executive Chairman Executive Directors: Non-executive Directors: Independent Non-executive Directors: Simon To Christian Hogg (Chief Executive Officer) Johnny Cheng (Chief Financial Officer) Shigeru Endo Christian Salbaing Edith Shih Michael Howell Christopher Huang Christopher Nash 6/6 6/6 6/6 6/6 6/6 6/6 6/6 6/6 6/6 In addition to Board meetings, the Chairman held two meetings with Non-executive Directors without the presence of the Executive Directors, with full attendance, to review the performance of the Executive Directors. The Senior Independent Director, Mr Christopher Nash, also held a meeting with all Non-executive Directors without the presence of the Chairman, with full attendance, for the appraisal of the Chairman’s performance. In addition, evaluation of the performance of the Board and its Committees together with the Chairman of each Committee was conducted by questionnaires. The objective of such evaluation is to ensure that the Board, its Committees and the Chairman of each Committee continued to act effectively in fulﬁ lling the duties and responsibilities expected of them. 38 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Corporate Governance Report All Non-executive Directors are engaged on service contracts which are automatically renewed for successive 12 month periods unless terminated by written notice given by either party. The Chairman of the Board is of the view that the performance of each of the Non-executive Directors continues to be effective and they all demonstrate commitment to their role as a Non-executive Director. All Directors are subject to re-election by shareholders at annual general meetings and at least once every three years on a rotation basis in accordance with the Articles of Association of the Company. A retiring Director is eligible for re-election and re-election of retiring Directors at general meetings is dealt with by separate individual resolutions. Save as mentioned herein, there are no existing or proposed service contracts between any of the Directors and the Company which cannot be terminated by the Company within 12 months without payment of compensation. Where vacancies arise at the Board, candidates are proposed and put forward to the Board for consideration and approval, with the objective of appointing to the Board individuals with expertise in the businesses of the Group and leadership qualities to complement the capabilities of the existing Directors thereby enabling the Company to retain as well as improve its competitive position. Upon appointment to the Board, the Director receives a package of orientation materials on the Group and is provided with a comprehensive induction to the Group’s businesses by senior executives. Continuing education and information are provided to Directors regularly to help ensure that they are apprised of the latest changes in the commercial, legal and regulatory environment in which the Group conducts its businesses. BOARD COMMITTEES The Company has established four permanent board committees: an Audit Committee, a Remuneration Committee, a Technical Committee and a Complaints Committee, details of which are described later in this report. Other board committees are established by the Board as and when warranted to take charge of speciﬁ c duties. COMPANY SECRETARY The Company Secretary, Ms Edith Shih, is responsible to the Board for ensuring that Board procedures are followed and Board activities are efﬁ ciently and effectively conducted. These objectives are achieved through adherence to proper Board processes and the timely preparation and dissemination to Directors comprehensive agendas and papers. The Company Secretary is responsible for ensuring that the Board is fully apprised of the relevant legislative, regulatory and corporate governance developments relating to the Group and that it takes these into consideration when making decisions for the Group. From time to time, she organises seminars on speciﬁ c topics of signiﬁ cance and interest and disseminate relevant reference materials to the Directors for their information. The Company Secretary is also directly responsible for the Group’s compliance with all obligations of the AIM Rules for Companies (“AIM Rules”), including the preparation, publication and despatch of annual reports and interim reports within the time limits laid down in the AIM Rules, the timely dissemination to shareholders and the market of announcements and information relating to the Group and assisting in the notiﬁ cation of Directors’ dealings in securities of the Group. Furthermore, the Company Secretary advises the Directors on their obligations for disclosure of interests and dealings in the Company’s securities, related party transactions and price-sensitive information and ensures that the standards and disclosures required by the AIM Rules are observed and, where required, reﬂ ected in the Report of the Directors in the annual report of the Company. In relation to related party transactions, detailed analyses are performed on all potential related party transactions to ensure full compliance and for Directors’ consideration. ACCOUNTABILITY AND AUDIT Financial Reporting The responsibility of Directors in relation to the ﬁ nancial statements is set out below. It should be read in conjunction with, but distinguished from, the Independent Auditor’s Report on page 45 which acknowledges the reporting responsibility of the Group’s Auditor. Annual Report and Accounts The Directors acknowledge their responsibility for the preparation of the annual report and ﬁ nancial statements of the Company, ensuring that the ﬁ nancial statements give a fair presentation in accordance with Cayman Islands Companies Law and the applicable accounting standards. Corporate Governance Report 39 Accounting Policies The Directors consider that in preparing the financial statements, the Group has applied appropriate accounting policies that are consistently adopted and made judgements and estimates that are reasonable and prudent in accordance with the applicable accounting standards. Accounting Records The Directors are responsible for ensuring that the Group keeps accounting records which disclose the ﬁ nancial position of the Group upon which ﬁ nancial statements of the Group could be prepared in accordance with the Group’s accounting policies. Safeguarding Assets The Directors are responsible for taking all reasonable and necessary steps to safeguard the assets of the Group and to prevent and detect fraud and other irregularities within the Group. Going Concern The Directors, having made appropriate enquiries, are of the view that the Group has adequate resources to continue in operational existence for the foreseeable future and that, for this reason, it is appropriate to adopt the going concern basis in preparing the ﬁ nancial statements. Audit Committee Under the terms of reference of the Audit Committee, the Audit Committee is required to review the Group’s interim and ﬁ nal results and interim and annual ﬁ nancial statements, oversee the relationship between the Company and its external auditor, monitor and review the effectiveness of the Company’s internal audit function in the context of the Company’s overall risk management systems giving due consideration to laws and regulations and the provisions of the Code. The Committee is authorised to obtain, at the Company’s expense, external legal or other professional advice on any matters within its terms of reference. In addition, the Audit Committee assists the Board in meeting its responsibility for maintaining an effective system of internal control. It reviews the process by which the Group evaluates its control environment and risk assessment process, and the way in which business and control risks are managed. It receives and considers the presentations of Management in relation to the review on the effectiveness of the Group’s internal control systems and the adequacy of resources, qualiﬁ cations and experience of staff in the Group’s accounting and ﬁ nancial reporting function, as well as their training programmes and budget. In addition, it reviews with the internal auditor of the Group’s holding company the work plan for their audits for the Group together with their resource requirements and considers the report of the Group’s internal auditor to the Audit Committee on the effectiveness of internal controls in the Group business operations. Further, it also receives the report from the Company Secretary on the Group’s material litigation proceedings and compliance status on regulatory requirements. These reviews and reports are taken into consideration by the Audit Committee when it makes its recommendation to the Board for approval of the consolidated ﬁ nancial statements for the year. The Terms of Reference for the Audit Committee adopted by the Board is published on the Company’s website. The Audit Committee comprises three Independent Non-executive Directors who possess the relevant business and ﬁ nancial management experience and skills to understand ﬁ nancial statements and contribute to the ﬁ nancial governance, internal controls and risk management of the Company. It is chaired by Mr Michael Howell with Professor Christopher Huang and Mr Christopher Nash as members. None of the Committee Members is related to the Company’s external auditor. The Audit Committee held three meetings in 2012 with 100% attendance of its members. Name of Members Michael Howell (Chairman) Christopher Huang Christopher Nash Attended/Eligible to attend 3/3 3/3 3/3 40 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Corporate Governance Report The Audit Committee meets with the Chief Financial Ofﬁ cer and other senior management of the Company from time to time to review the interim and ﬁ nal results and the interim report and annual report and other ﬁ nancial, internal control and risk management matters of the Company. It considers and discusses the reports and presentations of Management and the Group’s internal and external auditors, with a view of ensuring that the Group’s consolidated ﬁ nancial statements are prepared in accordance with International Financial Reporting Standards. It also meets with the Group’s principal external auditor, PricewaterhouseCoopers (“PwC”), to consider their reports on the scope, strategy, progress and outcome of their independent review of the interim ﬁ nancial report and their annual audit of the consolidated ﬁ nancial statements. In addition, the Audit Committee holds regular private meetings with the external auditor, the Chief Financial Ofﬁ cer and internal auditor separately without the presence of Management. External Auditor The Audit Committee reviews and monitors the external auditor’s independence, objectivity and effectiveness of the audit process. It receives each year the letter from the external auditor conﬁ rming their independence and objectivity and holds meetings with representatives of the external auditor to consider the scope of its audit, approve its fees, and the scope and appropriateness of non-audit services, if any, to be provided by it. The Audit Committee also makes recommendations to the Board on the appointment and retention of the external auditor. The Group’s policy regarding the engagement of PwC for the various services listed below is as follows: • Audit services – include audit services provided in connection with the audit of the consolidated ﬁ nancial statements. All such services are to be provided by external auditor. • Audit related services – include services that would normally be provided by an external auditor but not generally included in the audit fees, for example, audits of the Group’s pension plans, due diligence and accounting advice related to mergers and acquisitions, internal control reviews of systems and/or processes, and issuance of special audit reports for tax or other purposes. The external auditor is to be invited to undertake those services that it must, or is best placed, to undertake in its capacity as auditor. • Taxation related services – include all tax compliance and tax planning services, except for those services which are provided in connection with the audit. The Group uses the services of the external auditor where it is best suited. All other signiﬁ cant taxation related work is undertaken by other parties as appropriate. • Other services – include, for example, audits or reviews of third parties to assess compliance with contracts, risk management diagnostics and assessments, and non-ﬁ nancial systems consultations. The external auditor is also permitted to assist Management and the Group’s internal auditor with internal investigations and fact-ﬁ nding into alleged improprieties. These services are subject to speciﬁ c approval by the Audit Committee. • General consulting services – the external auditor is not eligible to provide services involving general consulting work. For the year ended 31 December 2012, all the fees paid to PwC were for audit services. INTERNAL CONTROL, LEGAL AND REGULATORY CONTROL AND GROUP RISK MANAGEMENT The Board has overall responsibility for the Group’s system of internal control and assessment and management of risks. In meeting its responsibility, the Board seeks to increase risk awareness across the Group’s business operations and has put in place policies and procedures, including parameters of delegated authority, which provide a framework for the identiﬁ cation and management of risks. It also reviews and monitors the effectiveness of the systems of internal control to ensure that the policies and procedures in place are adequate. Reporting and review activities include review by the Executive Directors and the Board and approval of detailed operational and ﬁ nancial reports, budgets and plans provided by the management of the business operations, review by the Board of actual results against budget, review by the Audit Committee of the ongoing work of the Internal Audit Department of the Group’s holding company and risk management functions, as well as regular business reviews by Executive Directors and the executive management team of each core business division. Whilst these procedures are designed to identify and manage risks that could adversely impact the achievement of the Group’s business objectives, they do not provide absolute assurance against material mis-statement, errors, losses or fraud. Corporate Governance Report 41 Internal Control Environment and Systems Executive Directors are appointed to the boards of all material operating subsidiaries and associates for monitoring those companies, including attendance at board meetings, review and approval of business strategies, budgets and plans, and setting of key business performance targets. The executive management team of each core business division is accountable for the conduct and performance of each business in the division within the agreed strategies and similarly the management of each business is accountable for its conduct and performance. The Group’s internal control procedures include a comprehensive system for reporting information to the executive management team of each core business division and the Executive Directors. Business plans and budgets are prepared annually by the management of individual businesses and subject to review and approval by both the executive management team and the Executive Directors as part of the Group’s ﬁ ve-year corporate planning cycle. Reforecasts for the current year are prepared on a quarterly basis, reviewed for variances to the budget and for approval. When setting budgets and reforecasts, management identiﬁ es, evaluates and reports on the likelihood and potential ﬁ nancial impact of signiﬁ cant business risks. The Executive Directors review monthly management reports on the ﬁ nancial results and key operating statistics of each business and discuss with the executive management team and senior management of business operations to review these reports, business performance against budgets, forecasts, signiﬁ cant business risk sensitivities and strategies. In addition, ﬁ nancial controllers of the executive management team of each of the major business division discuss with the representatives of the Finance Department to review monthly performance against budget and forecast, and to address accounting and ﬁ nance related matters. The Finance Department has established guidelines and procedures for the approval and control of expenditures. Operating expenditures are subject to overall budget control and are controlled within each business with approval levels set by reference to the level of responsibility of each executive and ofﬁ cer. Capital expenditures are subject to overall control within the annual budget review and approval process, and more speciﬁ c control and approval prior to commitment by the Finance Department or Executive Directors are required for unbudgeted expenditures and material expenditures within the approved budget. Quarterly reports of actual versus budgeted and approved expenditures are also reviewed. The General Manager of the Internal Audit Department of the Group’s holding company, reporting directly to the Audit Committee, provides independent assurance as to the existence and effectiveness of the risk management activities and controls in the Group’s business operations in various countries. Using risk assessment methodology and taking into account the dynamics of the Group’s activities, internal audit derives its yearly audit plan which is reviewed by the Audit Committee, and reassessed during the year as needed to ensure that adequate resources are deployed and the plan’s objectives are met. Internal Audit Department of the Group’s holding company is responsible for assessing the Group’s internal control systems, formulating an impartial opinion on the system, and reporting its ﬁ ndings to the Audit Committee, the Chief Executive Ofﬁ cer, the Chief Financial Ofﬁ cer and the senior management concerned as well as following up on all reports to ensure that all issues have been satisfactorily resolved. In addition, a regular dialogue is maintained with the Group’s external auditor so that both are aware of the signiﬁ cant factors which may affect their respective scope of work. Depending on the nature of business and risk exposure of individual business units, the scope of work performed by the internal audit function includes ﬁ nancial and operations reviews, recurring and surprise audits, fraud investigations and productivity efﬁ ciency reviews. Reports from the external auditor on internal controls and relevant ﬁ nancial reporting matters are presented to the General Manager of the Internal Audit Department of the Group’s holding company and, as appropriate, to the Chief Financial Ofﬁ cer. These reports are reviewed and appropriate actions are taken. The Board, through the Audit Committee, has conducted a review of the effectiveness of the Group’s internal control systems for the year ended 31 December 2012 covering all material ﬁ nancial, operational and compliance controls and risk management functions, and is satisﬁ ed that such systems are effective and adequate. In addition, it has reviewed and is satisﬁ ed with the adequacy of resources, qualiﬁ cations and experience of the staff of the Group’s accounting and ﬁ nancial reporting function, and their training programmes and budget. 42 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Corporate Governance Report Legal and Regulatory Control The Legal Department of the Group, with the assistance of the legal team of its holding company, has the responsibility of safeguarding the legal interests of the Group. The team is responsible for monitoring the day-to-day legal affairs of the Group, including preparing, reviewing and approving all legal and corporate secretarial documentation of Group companies, working in conjunction with ﬁ nance, corporate secretarial and business unit personnel on the review and co-ordination process, and advising Management of legal and commercial issues of concern. In addition, the Group Legal Department is also responsible for overseeing regulatory (business and AIM) compliance matters of all Group companies. It analyses and monitors the regulatory framework within which the Group operates, including reviewing applicable laws and regulations and preparing and submitting response to relevant regulatory and/or government consultations. It also determines and approves the engagement of external legal advisors, ensuring the requisite professional standards are maintained as well as most cost effective services are rendered. Further, the Group Legal Department organises and holds continuing education seminars/conferences on legal and regulatory matters of relevance to the Group for its legal counsels. Having regard to the recent changes and developments of the regulatory and legal requirements relevant to the Group, the Board had updated or established various policies and procedures in areas including handling of conﬁ dential and price-sensitive information, securities dealing and prevention of bribery and corruption. Group Risk Management The Chief Executive Ofﬁ cer and the Group Risk Management Department of the Group’s holding company have the responsibility of developing and implementing risk mitigation strategies including the deployment of insurance to transfer the ﬁ nancial impact of risks. The Group Risk Management Department of the Group’s holding company, working with the business operations worldwide, is responsible for arranging appropriate insurance coverage and organising Group-wide risk reporting. Directors and Ofﬁ cers Liability Insurance is also in place to protect Directors and ofﬁ cers of the Group against their potential legal liabilities. Workplace Safety The Group is committed to providing a healthy and safe workplace for all its employees and complying with all applicable health and safety laws and regulations. Health and safety considerations are incorporated into the design, operations and maintenance of the Group’s premises. Employees are provided appropriate job skills and safety training and are educated with regard to their responsibilities for achieving the health and safety objectives of the Group. The Group also communicates with its employees on occupational health and safety issues. REMUNERATION OF DIRECTORS AND SENIOR MANAGEMENT Remuneration Committee The responsibilities of the Remuneration Committee are to assist the Board in achieving its objective of attracting, retaining and motivating employees of the highest calibre and experience needed to shape and execute strategy across the Group’s substantial, diverse and international business operations. It assists the Group in the administration of a fair and transparent procedure for setting remuneration policies including assessing the performance of Executive Directors and senior executives of the Group and determining their remuneration packages. The Terms of Reference for the Remuneration Committee adopted by the Board is published on the Company’s website. The Remuneration Committee comprises three members, chaired by the Chairman Mr Simon To with Messrs Michael Howell and Christopher Nash, both Independent Non-executive Directors, as members who possess experience in human resources and personnel emoluments. Mr To has experience in the traditional Chinese medicine industry as well as expertise in human resources and personnel in China. The Remuneration Committee meets towards the end of each year for the determination of the remuneration package of Executive Directors and senior management of the Group and during the year to consider share options grant and other remuneration related matters. The Remuneration Committee held one meeting in 2012 with 100% attendance of its members to review background information on market data (including economic indicators, statistics and the Remuneration Bulletin) and headcount and staff costs. The Remuneration Committee also reviewed and approved the proposed 2013 directors’ fees, year end bonus and 2013 remuneration package of Executive Directors and senior executives of the Company and made recommendation to the Board on the directors’ fees for Non-executive Directors. Executive Directors do not participate in the determination on their own remuneration. Corporate Governance Report 43 Remuneration Policy The remuneration of Messrs Christian Hogg and Johnny Cheng, the Executive Directors, and senior executives is determined with reference to their expertise and experience in the industry, the performance and proﬁ tability of the Group as well as remuneration benchmarks from other local and international companies and prevailing market conditions. Senior management also participates in bonus arrangements which are determined in accordance with the performance of the Group and the individual’s performance. The Chairman, Mr Simon To, does not receive performance related remuneration from the Company and is remunerated through his service agreement. All Non-executive Directors have entered into service agreements with the Company and are remunerated with ﬁ xed fees as determined by the Board. Directors’ emoluments comprise payments to Directors from the Company and its subsidiaries. The emoluments of each of the Directors exclude amounts received from the subsidiaries of the Company and paid to a subsidiary or an intermediate holding company of the Company. The amounts paid to each Director for 2012 are as below: Taxable beneﬁ ts Pension contributions Share option beneﬁ ts Name of Directors Executive Directors: Simon To Christian Hogg Johnny Cheng Non-executive Directors: Shigeru Endo Christian Salbaing Edith Shih Independent Non-executive Directors: Michael Howell Christopher Huang Christopher Nash Salary and fees US$ 19,808(1) (5) 330,706(2) (5) 252,045(3) 19,808(4) 19,808(1) 19,808(4) (5) 52,292 52,292 52,292 Bonus US$ – 551,282 192,308 – – – – – – US$ – 14,434 – – – – – – – US$ – 22,151 19,301 – – – – – – Total US$ US$ – –(6) 9,886(7) 19,808 918,573 473,540 – – – – – – 19,808 19,808 19,808 52,292 52,292 52,292 Aggregate emoluments 818,859 743,590 14,434 41,452 9,886 1,628,221 Notes: (1) (2) (3) (4) (5) (6) (7) Such Director’s fees were paid to Hutchison Whampoa (China) Limited. Emoluments paid include Director’s fees of US$19,808. Emoluments paid include Director’s fees of US$19,808. Such Director’s fees were paid to Hutchison Whampoa Limited. Director’s fees received from the subsidiaries of the Company during the period he/she served as director that were paid to a subsidiary or an intermediate holding company of the Company are not included in the amounts above. The fair value of share options granted to the Executive Director had been fully recognised as expenses in past few years and no such expenses is recognised in 2012. Share option beneﬁ ts represent the fair value of share options granted under the Company’s share option scheme, which is calculated in accordance with the methodology disclosed in note 2(v)(ii) to the accounts. This methodology does not take into account of the actual share price at the date of exercise and whether the share options have been exercised. The signiﬁ cant inputs to the valuation model are disclosed in note 23(b)(i) to the accounts and details of the share options granted are set out on pages 33 and 83 of this Annual Report. TECHNICAL COMMITTEE The Technical Committee comprises three members, chaired by Professor Christopher Huang with Messrs Simon To and Christian Hogg, both Executive Directors, as members. The Technical Committee members consider from time to time matters relating to the technical aspects of the business and in research and development. It also invites such executives as it thinks ﬁ t to attend meetings as and when required. 44 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Corporate Governance Report The Terms of Reference for the Technical Committee adopted by the Board is published on the Company’s website. The Technical Committee held one meeting in 2012 with 100% attendance of its members. COMPLAINTS COMMITTEE The Complaints Committee comprises Messrs Simon To, Christian Hogg, Michael Howell and Edith Shih as members. The Complaints Committee was established mainly for processing complaints and concerns that could be raised anonymously by employees of the Group regarding the business and operations of the Group through a dedicated phone line and website. The members also monitor the investigative actions taken by the Company and the outcome of investigations. CODE OF ETHICS The Group places utmost importance on employees’ ethical, personal and professional standards. Every employee is provided with the Group’s Code of Ethics booklet, and all employees are expected to achieve the highest standards set out in the Code of Ethics including avoiding conﬂ ict of interest, discrimination or harassment and bribery etc. The employees are required to report any non-compliance with the Code of Ethics to the Management. INVESTOR RELATIONS AND SHAREHOLDERS’ RIGHTS The Group actively promotes investor relations and communication with the investment community when the interim and year end ﬁ nancial results are announced and during the course of the year. Through its Chairman and Chief Executive Ofﬁ cer, the Group responds to requests for information and queries from the investment community including institutional shareholders, analysts and the media through regular brieﬁ ng meetings, conference calls and presentations. The other Directors, including Non-executive Directors, develop an understanding of the views of the major shareholders about the Company by periodic meetings on the subject with the Chairman and the Chief Executive Ofﬁ cer. The Board is committed to providing clear and full information on the Group to shareholders through the publication of notices, announcements, interim and annual reports. An updated version of the Memorandum and Articles of Association of the Company is published on the Company’s website. Moreover, additional information on the Group is also available to shareholders through the Investor Relations page on the Company’s website. Shareholders are encouraged to attend all general meetings of the Company, such as the annual general meeting for which at least 20 working days’ notice is given and at which the Chairman and Directors are available to answer questions on the Group’s businesses. All shareholders have statutory rights to call for extraordinary general meetings and put forward agenda items for consideration by shareholders by sending to the Company Secretary a written request for such general meetings together with the proposed agenda items. Regularly updated ﬁ nancial, business and other information on the Group is made available on the Company’s website for shareholders. The latest shareholders’ meeting of the Company was the 2012 Annual General Meeting which was held on 11 May 2012 at 4th Floor, Hutchison House, 5 Hester Road, Battersea, London attended by PwC and all the Directors including the Chairman of the Board, Audit Committee, Remuneration Committee and Technical Committee with 100% attendance. The Directors are requested and encouraged to attend shareholders’ meetings albeit presence overseas for the Group businesses or unforeseen circumstances might prevent Directors from attending such meetings. The Group values feedback from shareholders on its efforts to promote transparency and foster investor relationships. Comments and suggestions to the Board or the Company are welcome and can be addressed to the Company Secretary by mail/e-mail or to the Company by e-mail at info@chi-med.com. By Order of the Board Edith Shih Director and Company Secretary 25 March 2013 Independent Auditor’s Report 45 TO THE SHAREHOLDERS OF HUTCHISON CHINA MEDITECH LIMITED (incorporated in the Cayman Islands with limited liability) We have audited the consolidated accounts of Hutchison China MediTech Limited (the “Company”) and its subsidiaries (together, the “Group”) set out on pages 46 to 96, which comprise the consolidated statement of ﬁ nancial position as at 31 December 2012, and the consolidated income statement, the consolidated statement of comprehensive income, the consolidated statement of changes in equity and the consolidated statement of cash ﬂ ows for the year then ended, and a summary of signiﬁ cant accounting policies and other explanatory information. Directors’ responsibility for the consolidated accounts The directors of the Company are responsible for the preparation and fair presentation of consolidated accounts in accordance with International Financial Reporting Standards, and for such internal control as the directors determine is necessary to enable the preparation of consolidated accounts that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated accounts based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated accounts are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated accounts. The procedures selected depend on the auditor’s judgement, including the assessment of the risks of material misstatement of the consolidated accounts, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of consolidated accounts in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the directors, as well as evaluating the overall presentation of the consolidated accounts. We believe that the audit evidence we have obtained is sufﬁ cient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated accounts present fairly, in all material respects, the ﬁ nancial position of the Group as at 31 December 2012, and of the Group’s ﬁ nancial performance and cash ﬂ ows for the year then ended in accordance with International Financial Reporting Standards. Other matters This report, including the opinion, has been prepared for and only for you, as a body, and for no other purpose. We do not assume responsibility towards or accept liability to any other person for the contents of this report. PricewaterhouseCoopers Certified Public Accountants Hong Kong, 25 March 2013 46 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Consolidated Income Statement For the year ended 31 December 2012 Continuing operations Revenue Cost of sales Gross proﬁ t Selling expenses Administrative expenses Other net operating income Gain on disposal of a business Operating proﬁ t Finance costs Proﬁ t before taxation Taxation charge Proﬁ t for the year from continuing operations Discontinued operation Loss for the year from discontinued operation Proﬁ t for the year Attributable to: Equity holders of the Company — Continuing operations — Discontinued operation Non-controlling interests Earnings per share for proﬁ t from continuing operations attributable to equity holders of the Company for the year (US$ per share) — basic — diluted Earnings per share for proﬁ t from continuing and discontinued operations attributable to equity holders of the Company for the year (US$ per share) — basic — diluted Note 5 6 (a) 6 (b) 7 8 9 10 11(a) 11(b) 11(a) 11(b) 2012 US$’000 195,392 (99,400) 95,992 (62,681) (35,730) 3,054 11,476 12,111 (1,208) 10,903 (4,162) 6,741 (3,201) 3,540 6,839 (3,201) 3,638 (98) 3,540 0.1317 0.1299 0.0701 0.0691 2011 US$’000 165,029 (73,921) 91,108 (54,198) (31,200) 1,075 – 6,785 (561) 6,224 (3,142) 3,082 (1,397) 1,685 2,107 (1,397) 710 975 1,685 0.0407 0.0400 0.0137 0.0135 Consolidated Statement Of Comprehensive Income For the year ended 31 December 2012 Proﬁ t for the year Other comprehensive income: Exchange translation differences Total comprehensive income for the year (net of tax) Attributable to: Equity holders of the Company — Continuing operations — Discontinued operation Non-controlling interests 47 2012 US$’000 2011 US$’000 3,540 1,685 814 4,354 7,587 (3,219) 4,368 (14) 4,354 3,844 5,529 5,628 (1,507) 4,121 1,408 5,529 48 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Consolidated Statement Of Financial Position As at 31 December 2012 ASSETS Non-current assets Property, plant and equipment Leasehold land Goodwill Other intangible assets Investment in an associated company Deferred tax assets Current assets Inventories Trade and bills receivables Other receivables and prepayments Amount due from a related party Cash and bank balances Total assets EQUITY Capital and reserves attributable to the Company’s equity holders Share capital Reserves Non-controlling interests Total equity LIABILITIES Current liabilities Trade payables Other payables, accruals and advance receipts Amounts due to related parties Bank borrowings Current tax liabilities Non-current liabilities Deferred income Deferred tax liabilities Convertible preference shares Bank borrowing Total liabilities Total equity and liabilities Simon To Director Christian Hogg Director Note 14 15 16 17 18 19 20 21 32 22 23 24 25 32 26 27 19 28 26 2012 US$’000 22,848 10,440 8,311 15,585 32 1,639 58,855 25,318 44,343 3,940 15,000 62,009 150,610 209,465 52,048 18,530 70,578 13,070 83,648 18,897 43,715 6,303 11,202 951 81,068 2,692 2,667 12,467 26,923 125,817 209,465 2011 US$’000 23,277 6,175 8,248 14,858 31 1,550 54,139 28,720 51,573 5,063 1,516 53,763 140,635 194,774 51,743 13,042 64,785 12,545 77,330 16,451 35,568 5,345 30,038 1,074 88,476 6,919 1,911 20,138 – 117,444 194,774 Consolidated Statement Of Changes In Equity For the year ended 31 December 2012 49 Attributable to equity holders of the Company Share capital US$’000 Share premium US$’000 Share-based compensation reserve US$’000 Exchange reserve US$’000 General reserves US$’000 Accumulated losses US$’000 Total US$’000 Non– controlling interests US$’000 Total equity US$’000 As at 1 January 2011 51,743 92,955 3,854 5,239 488 (94,727) 59,552 9,254 68,806 Proﬁ t for the year Other comprehensive income: Exchange translation differences Total comprehensive income for the year (net of tax) Share-based compensation expenses Transfer between reserves Loan from a non-controlling shareholder of a subsidiary (Note 32(b)) Capital contribution from a non-controlling share holder of a subsidiary of a jointly controlled entity Dividend paid to a non-controlling shareholder of a subsidiary (Note 32(a)) – – – – – – – – – – – – – – – – – – – 1,112 (218) – – – – 3,411 3,411 – – – – – As at 31 December 2011 51,743 92,955 4,748 8,650 As at 1 January 2012 51,743 92,955 4,748 8,650 Proﬁ t/(loss) for the year Other comprehensive income: Exchange translation differences Total comprehensive income/(loss) for the year (net of tax) Issue of shares (Note 23) Share-based compensation expenses Transfer between reserves Loan from a non-controlling shareholder of a subsidiary (Note 32(b)) Capital contribution from a non-controlling shareholder of a subsidiary of a jointly controlled entity Dividend paid to a non-controlling shareholder of a subsidiary (Note 32(a)) – – – 305 – – – – – – – – 714 – – – – – – – – (390) 796 (180) – – – – 730 730 – – – – – – – – – – 8 – – – 496 496 – – – – – – – – – 1,685 3,844 5,529 1,112 – 2,000 710 – 710 – 210 – – – 710 3,411 975 433 4,121 1,408 – – 2,000 1,112 – – – – 1,024 1,024 (1,141) (1,141) (93,807) 64,785 12,545 77,330 (93,807) 64,785 12,545 77,330 3,638 3,638 – 730 (98) 84 3,540 814 3,638 4,368 (14) 4,354 – – 180 – – – 629 796 – – – – – – – 629 796 – 1,000 1,000 77 77 (538) (538) As at 31 December 2012 52,048 93,669 4,974 9,380 496 (89,989) 70,578 13,070 83,648 50 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Consolidated Statement Of Cash Flows For the year ended 31 December 2012 Cash ﬂ ows from operating activities Net cash generated from operations Interest received Finance costs paid Income tax paid Net cash generated from operating activities Cash ﬂ ows from investing activities Purchase of property, plant and equipment Purchase of leasehold land Purchase of trademarks and patents Payments for development costs Proceeds from disposal of property, plant and equipment Acquisition of additional interest in a jointly controlled entity Acquisition of an associated company by a jointly controlled entity Net cash acquired from the acquisition of a subsidiary by a jointly controlled entity Capital contribution from non-controlling shareholders of a subsidiary of jointly controlled entity Net cash used in investing activities Cash ﬂ ows from ﬁ nancing activities Decrease in amount due from a non-controlling shareholder of a subsidiary Decrease in amount due to a non-controlling shareholder of a subsidiary Dividend paid to a non-controlling shareholder of a subsidiary Loan from a non-controlling shareholder of a subsidiary New long-term bank loans Repayment of short-term bank loans Net proceeds from issuance of ordinary shares Buy back of convertible preference shares Net cash generated from ﬁ nancing activities Net increase in cash and cash equivalents Cash and cash equivalents at 1 January Exchange differences Cash and cash equivalents at 31 December Analysis of cash and cash equivalents – Cash and bank balances Note 29(a) 29(b) 18 29(c) 29(c) 28 2012 US$’000 2011 US$’000 19,909 578 (1,208) (3,618) 15,661 (3,533) (4,357) (22) (4,169) 26 – – – 77 9,059 135 (561) (3,297) 5,336 (2,754) – (2) (3,548) 2 (48) (31) 465 – (11,978) (5,916) 1,516 – (538) 1,000 26,923 (18,836) 629 (6,519) 4,175 7,858 53,763 388 62,009 1,494 (13) (1,141) 2,000 6,484 (946) – – 7,878 7,298 45,310 1,155 53,763 22 62,009 53,763 Notes To The Accounts 51 1 GENERAL INFORMATION Hutchison China MediTech Limited (the “Company”) and its subsidiaries (together the “Group”) is principally engaged in the manufacturing, distribution and sales of traditional Chinese medicine (“TCM”) and healthcare products. The Group is also engaged in carrying out pharmaceutical research and development. The Group and its jointly controlled entities have manufacturing plants in Shanghai and Guangzhou in the People’s Republic of China (the “PRC”) and sell mainly in the PRC, United Kingdom (“UK”), France and Hong Kong. During the year, the Group had discontinued its consumer products operation in UK as detailed in Note 10. The Company was incorporated in the Cayman Islands on 18 December 2000 as an exempted company with limited liability under the Companies Law (2000 Revision), Chapter 22 of the Cayman Islands. The address of its registered ofﬁ ce is P.O. Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. The Company’s ordinary shares were admitted to trading on the Alternative Investment Market operated by the London Stock Exchange plc. These consolidated accounts are presented in thousands of United States dollars (“US$’000”), unless otherwise stated, and were approved for issue by the Board of Directors on 25 March 2013. 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated accounts of the Company have been prepared in accordance with International Financial Reporting Standards (“IFRS”). These consolidated accounts have been prepared under the historical cost convention except that certain ﬁ nancial assets and liabilities (including derivative instruments) are measured at fair values, as appropriate. During the year, the Group has adopted all of the new and revised standards, amendments and interpretations issued by the International Accounting Standards Board that are relevant to the Group’s operations and mandatory for annual periods beginning 1 January 2012. The adoption of these new and revised standards, amendments and interpretations did not have any material effect on the Group’s results of operations or ﬁ nancial position. (a) Basis of consolidation The consolidated accounts of the Group include the accounts of the Company and all its direct and indirect subsidiaries made up to 31 December and also incorporate the Group’s interests in jointly controlled entities and an associated company on the basis set out in Notes 2(d) and 2(e) below. The accounting policies of subsidiaries, jointly controlled entities and an associated company have been changed where necessary to ensure consistency with the policies adopted by the Group. All signiﬁ cant intercompany transactions and balances within the Group are eliminated on consolidation. Non-controlling interests represent the interests of outside shareholders in the operating results and net assets of subsidiaries and subsidiaries of jointly controlled entities. (b) Subsidiaries A subsidiary is an entity that the Company has the power, directly or indirectly, to govern the ﬁ nancial and operating policies, so as to obtain beneﬁ ts from their activities. The consolidated accounts of the Group include the accounts of the Company and all its direct and indirect subsidiaries made up to 31 December and also incorporate the Group’s interests in jointly controlled entities and an associated company on the basis set out in Notes 2(d) and 2(e) below. 52 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (b) Subsidiaries (Continued) Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated from the date that control ceases. When the Group ceases to have control or signiﬁ cant inﬂ uence, any retained interest in the entity is remeasured to its fair value, with the change in carrying amount recognised in income statement. The fair value is the initial carrying amount for the purposes of subsequently accounting for the retained interest as an associate, joint venture or ﬁ nancial asset. In addition, any amounts previously recognised as other comprehensive income in respect of that entity are accounted for as if the Group had directly disposed of the related assets or liabilities. This may mean that amounts previously recognised as other comprehensive income are reclassiﬁ ed to income statement. (c) Transactions with non-controlling interests The Group treats transactions with non-controlling interests as transactions with equity owners of the Group. For purchases from non-controlling interests, the difference between any consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary is recorded in equity. Gains or losses on disposals to non-controlling interests are also recorded in equity. (d) Jointly controlled entities Jointly controlled entities are joint ventures in respect of which a contractual arrangement is established between the participating venturers and whereby the Group together with the other venturers undertake an economic activity which is subject to joint control and none of the venturers have unilateral control over the economic activity. The Group’s interests in jointly controlled entities are accounted for by using proportionate consolidation. Under this method, the Group combines its share of the joint ventures’ individual income and expenses, assets and liabilities and cash ﬂ ows on a line-by-line basis with similar items in the Group’s consolidated accounts from the date that joint control commences until the date that joint control ceases. The Group recognises the portion of gains or losses on the sale of assets by the Group to the jointly controlled entities that is attributable to the other venturers. The Group does not recognise its share of proﬁ ts or losses from the jointly controlled entities that result from the Group’s purchase of assets from the jointly controlled entities until it resells the assets to an independent party. However, a loss on the transaction is recognised immediately if the loss provides evidence of a reduction in the net realisable value of current assets, or an impairment loss. (e) Associated company An associated company is an entity, other than a subsidiary or a jointly controlled entity, in which the Group has a long-term equity interest and over which the Group is in a position to exercise signiﬁ cant inﬂ uence over its management, including participation in the ﬁ nancial and operating policy decisions. The Group’s interest in an associated company is accounted for by using the equity method, except when the investment is classiﬁ ed as held for sale, in which case it is accounted for under IFRS 5, “Non-current assets held for sale and discontinued operations”. The total carrying amount of such investments is reduced to recognise any identiﬁ ed impairment loss in the value of individual investment. Notes To The Accounts 53 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (f) Foreign currency translation Items included in the accounts of each of the Group’s companies are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The functional currency of the Company and most of its principal subsidiaries, jointly controlled entities and associated company is Renminbi (“RMB”) whereas the consolidated accounts are presented in United States dollars (“US dollars”), which is the Company’s presentation currency, as the Company holds investments in various countries and US dollars is considered as a common currency. Transactions in foreign currencies are converted at the rates of exchange ruling at the transaction dates. Monetary assets and liabilities are translated at the rates of exchange ruling at end of the reporting period. Exchange differences are included in the determination of income statement. The accounts of the Company, overseas subsidiaries and jointly controlled entities are translated into the Company’s presentation currency using the year end rates of exchange for the statement of ﬁ nancial position items and the average rates of exchange for the year for the income statement items. Exchange differences are recognised directly in the consolidated statement of comprehensive income. On consolidation, exchange differences arising from the translation of the net investments in foreign operations are recognised directly in the consolidated statement of comprehensive income. When a foreign operation is disposed of, exchange differences that were recorded in equity are recognised in the consolidated income statement as part of the gain or loss on disposal. Exchange differences arising from translation of inter-company loan balances among the Group’s companies and jointly controlled entities are taken to the exchange reserve when such loans form part of the Group’s net investment in a foreign entity. When such loans are repaid, the related exchange gains or losses are transferred out of the exchange reserve and are recognised in the consolidated income statement. (g) Property, plant and equipment Property, plant and equipment other than construction in progress are stated at historical cost less accumulated depreciation and any accumulated impairment losses. Historical cost includes the purchase price of the asset and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic beneﬁ ts associated with the item will ﬂ ow to the Group and the cost of the item can be measured reliably. All other repairs and maintenance are charged to the income statement during the ﬁ nancial period in which they are incurred. Depreciation is calculated using the straight-line method to allocate their costs less accumulated impairment losses over their estimated useful lives. The principal annual rates are as follows: Buildings Leasehold improvements Plant and equipment Furniture and ﬁ xtures, other equipment and motor vehicles 20-30 years Over the unexpired period of the lease or 3-5 years, whichever is shorter 10 years 4-5 years The assets’ useful lives are reviewed, and adjusted if appropriate, at end of each reporting period. An asset’s carrying amount is written down immediately to its recoverable amount if the asset’s carrying amount is greater than its estimated recoverable amount (Note 2(m)). Gains and losses on disposals are determined by comparing net sales proceeds with the carrying amount of the relevant assets and are recognised in income statement. 54 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (h) Construction in progress Construction in progress represents buildings, plant and machinery under construction and pending installation and is stated at cost less accumulated impairment losses (if any). Cost includes the costs of construction of buildings and the costs of plant and machinery. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for intended use. When the assets concerned are brought into use, the costs are transferred to property, plant and equipment and depreciated in accordance with the policy as stated in Note 2(g). (i) Leasehold land Leasehold land is stated at cost less accumulated amortisation and accumulated impairment losses (if any). Cost mainly represents consideration paid for the rights to use the land on which various plants and buildings are situated for a period of 50 years from the date the respective right was granted. Amortisation of leasehold land is calculated on a straight-line basis over the period of the land use rights. (j) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identiﬁ able assets of the acquired subsidiary, jointly controlled entity or associated company at the date of acquisition. Goodwill on acquisition of a foreign operation is treated as an asset of the foreign operation. Goodwill arising on acquisition is retained at the carrying amount as a separate asset, and subject to impairment test annually and when there are indications that the carrying value may not be recoverable. If the cost of acquisition is less than the fair value of the Group’s share of the net identiﬁ able assets of the acquired subsidiary or jointly controlled entity, the difference is recognised directly in the consolidated income statement. The proﬁ t or loss on disposal of a subsidiary or jointly controlled entity is calculated by reference to the net assets at the date of disposal including the attributable amount of goodwill but does not include any attributable goodwill previously eliminated against reserves. (k) Trademarks, patents and others Trademarks, patents and others have deﬁ nite useful lives and are carried at historical cost less accumulated amortisation and accumulated impairment losses. Amortisation is calculated using the straight-line method to allocate the costs of trademarks, patents and others over their estimated useful lives of four to ten years. (l) Research and development Research expenditure is recognised as an expense as incurred. Costs incurred on development projects (relating to the design and testing of new or improved products) are recognised as intangible assets when it is probable that the project will generate future economic beneﬁ ts by considering its commercial and technological feasibility, and costs can be measured reliably. Other development expenditures are recognised as an expense as incurred. Development costs previously recognised as an expense are not recognised as an asset in a subsequent period. Development costs with a ﬁ nite useful life that have been capitalised (if any) are amortised on a straight-line basis over the period of expected beneﬁ t not exceeding ﬁ ve years. The capitalised development costs are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets exceeds its recoverable amount. Where the research phase and the development phase of an internal project cannot be clearly distinguished, all expenditure incurred on the project is charged to the income statement. Notes To The Accounts 55 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (m) Impairment of assets Assets that have an indeﬁ nite useful life are tested for impairment annually. Assets are reviewed for impairment to determine whether there is any indication that the carrying value of these assets may not be recoverable and have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss, if any. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. Such impairment loss is recognised in the income statement. (n) Available-for-sale ﬁ nancial assets Available-for-sale ﬁ nancial assets are non-derivatives that are either designated in this category or not classiﬁ ed as loans and receivables, held-to-maturity investments or ﬁ nancial assets at fair value through proﬁ t or loss. These investments are initially recognised in the statement of ﬁ nancial position at fair value plus transaction costs and measured at each subsequent reporting date at fair value, except for equity investments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured, they are measured at cost less impairment losses. Changes in fair value are dealt with as movements in reserve except for impairment losses which are charged to the income statement. Dividends from available-for-sale ﬁ nancial assets are recognised when the right to receive payment is established. When available-for-sale ﬁ nancial assets are sold, the cumulative fair value gains or losses previously recognised in reserve is recognised in the income statement. (o) Inventories Inventories are stated at the lower of cost and net realisable value. Cost is determined using the weighted average cost method. The cost of ﬁ nished goods and work in progress comprises raw materials, direct labor, other direct costs and related production overheads (based on normal operating capacity). Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. (p) Trade and other receivables Trade and other receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. A provision for impairment of trade and other receivables is established when there is objective evidence that the asset is impaired. The amount of the provision is the difference between the asset’s carrying amount and the present value of estimated future cash ﬂ ows, discounted at the effective interest rate. The amount of the provision is recognised in the income statement. (q) Cash and cash equivalents Cash and cash equivalents comprise cash on hand and demand deposits. (r) Borrowings Borrowings are recognised initially at fair value, net of transaction costs incurred. Borrowings are subsequently stated at amortised cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest method. 56 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (s) Financial liabilities and equity instruments Financial liabilities and equity instruments issued by the Group are classiﬁ ed according to the substance of the contractual arrangements entered into and the deﬁ nitions of a ﬁ nancial liability and an equity instrument. Financial liabilities (including trade and other payables) are initially measured at fair value, and are subsequently measured at amortised cost, using the effective interest method. An equity instrument is any contract that does not meet the deﬁ nition of ﬁ nancial liability and evidences a residual interest in the assets of the Group after deducting all of its liabilities. Ordinary shares are classiﬁ ed as equity. Incremental costs, net of tax, directly attributable to the issue of new shares are shown in equity as a deduction from the proceeds. (t) Convertible preference shares A subsidiary of the Group has issued convertible preference shares that are convertible to ordinary shares of the subsidiary, the number of which varies subject to conditions, as set out in the relevant agreements, that are ultimately linked to the value of the unquoted ordinary shares of the subsidiary that issued the instruments. The convertible preference shares have no maturity date, no obligation to pay dividends nor to be redeemed for cash but can be required to be settled by the delivery of the unquoted ordinary shares of the subsidiary concerned. The contractual obligation to issue a variable number of ordinary shares means that the instruments do not meet the deﬁ nition of an equity instrument and consequently the convertible preference shares are ﬁ nancial liabilities that are recognised initially at fair value being the transaction price. As the variability in the range of reasonable fair value estimates of the unquoted ordinary shares of the subsidiary is signiﬁ cant and the probabilities of the various estimates cannot be reasonably assessed, it is not possible to measure the fair value of the ordinary shares of the subsidiary reliably, and hence for the fair value of the convertible preference shares that are linked to that value. Consequently, these instruments are measured at cost. If a reliable fair value becomes available for the convertible preference shares they will be measured at fair value and the difference between their carrying amount and fair value at that time, and subsequently, will be recognised in the income statement. (u) Deferred income tax Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated accounts. Deferred income tax assets are recognised to the extent that it is probable that future taxable proﬁ t will be available against which the temporary differences can be utilised. (v) Employee beneﬁ ts (i) Pension plans The Group operates various deﬁ ned contribution plans. The Group’s contributions to the deﬁ ned contribution plans are charged to the income statement in the year incurred. Pension costs are charged against the income statement within employee beneﬁ t expenses. The pension plans are generally funded by the relevant group companies and by payments from employees of the contributory plans. Notes To The Accounts 57 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (v) Employee beneﬁ ts (Continued) (ii) Share-based payments The Group operates certain equity-settled share-based compensation plans. The fair value of the employee services received in exchange for the grant of the options is recognised as an expense. The total amount to be expensed is determined by reference to the fair value of the options granted: i) including any market performance conditions; ii) excluding the impact of any service and non-market performance vesting conditions (for example, proﬁ tability and sales growth targets); and iii) including the impact of any non-vesting conditions. Non-market vesting conditions are included in assumptions about the number of options that are expected to vest. The total expense is recognised over the vesting period, which is the period over which all of the speciﬁ ed vesting conditions are to be satisﬁ ed. At end of each reporting period, the Group revises its estimates of the number of options that are expected to vest based on non-market vesting conditions. It recognises the impact of the revision of original estimates, if any, in the income statement, with a corresponding adjustment to equity. The proceeds received net of any directly attributable transaction costs are credited to share capital (nominal value) and share premium when the options are exercised. When the share options are forfeited after the vesting date or are still not exercised at the expiry date, the amount previously recognised in the share-based compensation reserve will be transferred to retained proﬁ ts. (w) Provisions Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events; it is probable that an outﬂ ow of resources will be required to settle the obligation; and the amount has been reliably estimated. Provisions are not recognised for future operating losses. (x) Operating leases Leases in which a signiﬁ cant portion of the risks and rewards of ownership are retained by the lessor are classiﬁ ed as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the leases. (y) Borrowing costs Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, which are assets that necessarily take a substantial period of time to get ready for their intended use or sale, are added to the cost of those assets, until such time as the assets are substantially ready for their intended use or sale. All other borrowing costs are recognised in the income statement in the period in which they are incurred. (z) Government incentives Incentives from government are recognised at their fair values where there is a reasonable assurance that the incentives will be received and all attached conditions will be complied with. Government incentives relating to costs are deferred and recognised in the income statement over the period necessary to match them with the costs that they are intended to compensate. 58 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) (aa) Revenue and income recognition Revenue comprises the fair value of the consideration received and receivable for the sales of goods and services in the ordinary course of the Group’s activities. Revenue is shown net of value-added tax, returns, volume rebates and discounts after eliminated sales within the Group. Revenue and income are recognised as follows: (i) Sales of goods – wholesales Sales of goods are recognised when a group entity has delivered products to the customer, the customer has accepted the products and collectability of the related receivables is reasonably assured. (ii) Sales of goods – retail Sales of goods are recognised at the point of sales less an estimate for sales return based on past experience where goods are sold with a right to return. Retail sales are usually in cash or by credit card. The recorded revenue is the gross amount of sales, including credit card fees payable for the transaction. Such fees are included in selling expenses. (iii) Other service income Other service income is recognised when services are rendered. (iv) Income from research and development projects Income from the provision of pharmaceutical research and development service is recognised when services are rendered. The Group receives payment from third parties under the licensing, co-development and commercialisation agreement. Considerations for development services are initially reported as deferred income and are recognised as revenue over the period of each development phase by using the percentage-of-completion method, based on the percentage of costs to date compared to the total estimated development costs for each development phase, contractual milestone or performance. (v) Interest income Interest income is recognised on a time-proportion basis using the effective interest method. Notes To The Accounts 59 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) At the date of authorisation of these consolidated accounts, the following standards, amendments and interpretations were in issue but not yet effective and have not been early adopted by the Group: IAS 1 (Amendment) (1) IAS 19 (Amendment) (1) IAS 27 (Revised 2011) (1) IAS 28 (Revised 2011) (1) IAS 32 (Amendments) (2) IFRS 1 (Amendment) (1) IFRS 7 (Amendment) (1) IFRS 9 (3) IFRS 7 and IFRS 9 (Amendments) (3) IFRS 10 (1) IFRS 11 (1) IFRS 12 (1) IFRS 10, 11 and 12 (Amendments) (1) Presentation of Financial Statements Employee Beneﬁ ts Separate Financial Statements Associates and Joint Ventures Financial instruments: Presentation – Offsetting ﬁ nancial assets and ﬁ nancial liabilities First time adoption – Government Loans Financial instruments: Disclosures – Offsetting ﬁ nancial assets and ﬁ nancial liabilities Financial Instruments Mandatory Effective Date and Transition Disclosures Consolidated Financial Statements Joint Arrangements Disclosure of Interests in Other Entities Consolidated Financial Statements, Joint Arrangements and Disclosure of Interests in other entities: IFRS 10, 11 and 12 (Amendments) (2) Annual Improvements 2009-2011 Cycle (1) IFRS 13 (1) Transition Guidance Investment Entities Improvements to IFRS Fair Value Measurements (1) (2) (3) Effective for the Group for annual periods beginning on or after 1 January 2013. Effective for the Group for annual periods beginning on or after 1 January 2014. Effective for the Group for annual periods beginning on or after 1 January 2015. IFRS 11 “Joint Arrangements” was issued in May 2011 which required a party to a joint arrangement to determine the type of joint arrangement it is involved by assessing the contractual rights and obligations arising from the arrangement. Proportionate consolidation would no longer be allowed to account for the interests in joint ventures. In accordance with IFRS 11, joint arrangements are classiﬁ ed into two types: (i) Joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. A joint operator shall recognise in relation to its interest in a joint operation i) its assets, including its share of any assets held jointly; ii) its liabilities, including its share of any liabilities incurred jointly; iii) its revenue from the sale of its share of the output arising from the joint operation; iv) its share of the revenue from the sale of the output by the joint operation; and v) its expenses, including its share of any expenses incurred jointly; and (ii) Joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. A joint venturer shall recognise its interest in a joint venture as an investment and shall account for that investment using the equity method in accordance with IAS 28 Investments in Associates and Joint Ventures unless the entity is exempted from applying the equity method as speciﬁ ed in that standard. Under the current rights and obligations of operations in the Group’s jointly controlled entities (“JCE”), the management of the Group has assessed the existing arrangement and believed that these JCE would be regarded as joint venture arrangements. As the Group is currently using proportionate consolidation to account for its interests in jointly controlled entities, management expects that the adoption of IFRS 11 would result in a change to the presentation of the Group’s ﬁ nancial performance and position in its consolidated accounts. It is expected that the adoption of IFRS 11 would not result in a signiﬁ cant change in the Group’s overall results and net assets. 60 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The Group will adopt IFRS 11 on 1 January 2013. To demonstrate the potential impact on the change to the presentation of the Group consolidated accounts, the estimated effect, as if IFRS 11 is adopted for the year 2012, are summarised as follows: (i) Estimated effect on the consolidated income statement for the year ended 31 December 2012 Revenue and other incomes Cost of sales and expenses Share of proﬁ ts less losses after tax of jointly controlled entities Proﬁ t for the year (ii) Estimated effect on the consolidated statement of ﬁ nancial position as at 31 December 2012 Non current assets Current assets Non-current liabilities Current liabilities (iii) Estimated effect on the consolidated statement of cash ﬂ ows for the year ended 31 December 2012 Cash ﬂ ows from operating activities Cash ﬂ ows from investing activities Cash ﬂ ows from ﬁ nancing activities Net change in cash and cash equivalents Increase/(decrease) US$’000 (174,247) (157,097) 17,150 – Increase/(decrease) US$’000 58,273 (107,162) (2,831) (46,058) Increase/(decrease) US$’000 (34,933) 7,390 7,835 (19,708) Notes To The Accounts 61 3 FINANCIAL RISK MANAGEMENT (a) Financial risk factors The Group’s activities expose it to a variety of ﬁ nancial risks, including foreign exchange risk, credit risk, cash ﬂ ow interest rate risk and liquidity risk. The Group does not use any derivative ﬁ nancial instruments for speculative purpose. (i) Foreign exchange risk The Group mainly operates in the PRC with most of the transactions settled in RMB. The Group also has retail and trading operations in various jurisdictions. The Group’s assets and liabilities, and transactions arising from its operations that are exposed to foreign exchange risk are primarily with respect to the US dollars and UK pound sterling. Management has a policy to require group companies to manage their foreign exchange risk against functional currency. It mainly includes managing the exposures arising from sales and purchases made by the relevant group companies in currencies other than their own functional currencies. The Group also manages its foreign exchange risk by performing regular reviews of the Group’s net foreign exchange exposures. The Group has not used any hedging arrangement to hedge its exposure during the year as foreign currency risk is considered relatively insigniﬁ cant. As the assets and liabilities of each company within the Group are mainly denominated in the respective company’s functional currency, management considers that the Group’s volatility against changes in exchange rates of foreign currencies would not be signiﬁ cant. Accordingly, no sensitivity analysis is presented for foreign exchange risk. (ii) Credit risk The carrying amounts of cash at bank, short-term bank deposits, trade and bills receivables, other receivables and amount due from a related party included in the consolidated statement of ﬁ nancial position represent the Group’s maximum exposure to credit risk of the counterparty in relation to its ﬁ nancial assets. Substantially all of the Group’s cash at banks are deposited in major ﬁ nancial institutions, which management believes are of high credit quality. The Group has a policy to limit the amount of credit exposure to any ﬁ nancial institution. The Group has no signiﬁ cant concentrations of credit risk. The Group has policies in place to ensure that wholesales of products are made to customers with an appropriate credit history and the Group performs periodic credit evaluations of its customers. Normally the Group does not require collaterals from trade debtors. Management makes periodic assessment on the recoverability of trade and bills receivables, other receivables and amount due from a related party. The Group’s historical experience in collection of receivables falls within the recorded allowances. It is considered that adequate provision for uncollectible receivables has been made. 62 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 3 FINANCIAL RISK MANAGEMENT (Continued) (a) Financial risk factors (Continued) (iii) Cash flow interest rate risk The Group has no signiﬁ cant interest-bearing assets except for bank deposits and cash at bank, details of which have been disclosed in Notes 22.The Group’s exposure to changes in interest rates is mainly attributable to its bank borrowings, which bear interest at ﬂ oating interest rates and expose the Group to cash ﬂ ow interest rate risk. Details of the Group’s bank borrowings are disclosed in Note 26. The Group has not used any interest rate swaps to hedge its exposure to interest rate risk as it is considered not cost efﬁ cient. The Group has performed sensitivity analysis for the effects on the Group’s proﬁ t after taxation for the year as a result of changes in interest expense on ﬂ oating rate borrowings. The sensitivity to interest rate used is based on the market forecasts available at the end of the reporting period and under the economic environments in which the Group operates, with other variables held constant. According to the analysis, the impact on the proﬁ t/loss after taxation of a 100 basis-point shift would be a maximum increase/decrease of US$316,000 and US$278,000 for the years ended 31 December 2012 and 2011 respectively. (iv) Liquidity risk Prudent liquidity management implies maintaining sufﬁ cient cash and cash equivalents and the availability of funding when necessary. The Group’s policy is to regularly monitor current and expected liquidity requirements to ensure that it maintains sufﬁ cient cash balances and adequate credit facilities to meet its liquidity requirements in the short and long term. The Group’s primary cash requirements have been for additions of and upgrades on property, plant and equipment, investment in intangible assets, settlement of bank loans, settlement of payables and payment for operating expenses. The Group mainly ﬁ nances its working capital requirements through a combination of internal resources and bank borrowings. As at 31 December 2011 and 2012, the Group’s current ﬁ nancial liabilities were due for settlement contractually within twelve months. The Group’s non-current ﬁ nancial liabilities were disclosed in Note 26 and 28. Interest element in connection with bank loans payable in the next twelve months calculated in accordance with the contractual undiscounted cash ﬂ ows amounted to US$475,000 (2011: US$189,000). (b) Capital risk management The Group’s objectives when managing capital are to safeguard the Group’s ability to provide returns for shareholders and beneﬁ ts for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. The Group regularly reviews and manages its capital structure to ensure optimal capital structure to maintain a balance between higher shareholders’ return that might be possible with higher levels of borrowings and advantages and security afforded by a sound capital position, and makes adjustments to the capital structure in light of changes in economic conditions. The Group monitors capital on the basis of the gearing ratio. This ratio is calculated as total bank borrowings divided by total equity attributable to the Company’s equity holders as shown on the consolidated statement of ﬁ nancial position. Notes To The Accounts 63 3 FINANCIAL RISK MANAGEMENT (Continued) (b) Capital risk management (Continued) Currently, it is the Group’s strategy to maintain a reasonable gearing ratio. The gearing ratios as at 31 December 2012 and 2011 were as follows: Total bank borrowings (Note 26) Total equity attributable to the Company’s equity holders Gearing ratio 2012 US$’000 38,125 70,578 54.0% 2011 US$’000 30,038 64,785 46.4% The increase in the gearing ratio was primarily resulted from the drawdown of a new long-term bank loan during 2012. (c) Fair value estimation The carrying amounts of the Group’s current ﬁ nancial assets, including cash and bank balances, trade and bills receivables, other receivables, amount due from a related party, and current ﬁ nancial liabilities, including trade payables, other payables and accruals, bank borrowings, and balances with related parties, approximate their fair values due to their short-term maturities. The carrying amounts of the Group’s ﬁ nancial instruments carried at cost or amortised cost are not materially different from their fair value except that the Group’s convertible preference shares are measured at cost as their fair value cannot be reliably measured, details of which have been disclosed in Note 2(t). These convertible preference shares have no obligation to be redeemed for cash and will be reclassiﬁ ed as equity of the relevant subsidiary when the relevant conditions are met. The face values less any estimated credit adjustments for ﬁ nancial assets and liabilities with a maturity of less than one year are assumed to approximate their fair values. The fair value of ﬁ nancial liabilities for disclosure purposes is estimated by discounting the future contractual cash ﬂ ows at the current market interest rate that is available to the Group for similar ﬁ nancial instruments. 4 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS Note 2 includes a summary of the signiﬁ cant accounting policies used in the preparation of the accounts. The preparation of accounts often requires the use of judgements to select speciﬁ c accounting methods and policies from several acceptable alternatives. Furthermore, signiﬁ cant estimates and assumptions concerning the future may be required in selecting and applying those methods and policies in the accounts. The Group bases its estimates and judgements on historical experience and various other assumptions that it believes are reasonable under the circumstances. Actual results may differ from these estimates and judgements under different assumptions or conditions. The following is a review of the more signiﬁ cant assumptions and estimates, as well as the accounting policies and methods used in the preparation of the accounts. 64 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 4 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS (Continued) (a) Revenue recognition The Group accounts for licensing, co-development and commercialisation agreement in respect of the research and development project using the percentage-of-completion method, recognising revenue when they are received or receivable, non-refundable and in substance consideration for achievement of speciﬁ c deﬁ ned goals. The identiﬁ cation of speciﬁ c deﬁ ned goals requires signiﬁ cant judgment and considerations include extent of effort involved in rendering each milestone and fair value of each distinct service. The percentage-of-completion method places considerable importance on accurate estimates of the extent of progress towards completion for each milestone, and the signiﬁ cant estimates include total estimated development costs, remaining costs to completion, corresponding risks and other judgements for each milestone. (b) Useful lives of property, plant and equipment The Group has made substantial investments in property, plant and equipment. Changes in technology or changes in the intended use of these assets may cause the estimated period of use or value of these assets to change. (c) Impairment of assets The Group tests annually whether goodwill has suffered any impairment. Other assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset exceeds its recoverable amount in accordance with the accounting policy stated in Note 2(m). The recoverable amount of an asset or a cash-generating unit is determined based on the higher of the asset’s or the cash-generating unit’s fair value less costs to sell and value-in-use. The value-in-use calculation requires the entity to estimate the future cash ﬂ ows expected to arise from the asset and a suitable discount rate in order to calculate present value, and the growth rate assumptions in the cash ﬂ ow projections which has been prepared on the basis of management’s assumptions and estimates. (d) Impairment of receivables The Group makes provision for impairment of receivables based on an assessment of the recoverability of the receivables. This assessment is based on the credit history of the relevant counterparty and the current market condition. Provisions are made where events or changes in circumstances indicate that the receivables may not be collectible. The identiﬁ cation of impairment in receivables requires the use of judgement and estimates. Where the expectation is different from the original estimate, such difference will impact the carrying amount of receivables and impairment is recognised in the period in which such estimate has been changed. (e) Research and development costs Research expenditure is recognised as an expense as incurred. Where the research phase and the development phase of an internal project cannot be clearly distinguished, all expenditure incurred on the project is charged to the income statement. In determining whether the development costs can be capitalised, management assesses the probability that the project will generate future economic beneﬁ ts by considering its commercial and technical feasibility. This assessment could change when there are subsequent technological advancement and innovations (Note 17). (f) Deferred income tax The Group has signiﬁ cant tax losses carried forward and has not recognised the deferred income tax assets on these losses. Deferred income tax assets in respect of tax losses are recognised to the extent that it is probable that future taxable proﬁ t will be available against which the temporary differences can be utilised. No deferred income tax assets are recognised when it is uncertain whether there are sufﬁ cient future taxable proﬁ ts available before such tax losses expire. Where the ﬁ nal outcome of these uncertainties are different from the estimation, such differences will impact the carrying amount of deferred tax assets in the period in which such determination is made. Notes To The Accounts 65 4 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS (Continued) (g) Disposal of business During the year ended 31 December 2012, the Group contributed certain of its assets and business processes including (i) the global development and commercial rights of a novel, oral therapy for Inﬂ ammatory Bowel Disease for a drug candidate previously recognized by the Group as intangible assets and (ii) the exclusive rights to its extensive botanical library and well-established botanical research and development platform in the ﬁ eld of gastrointestinal (“GI”) disease previously developed by the Group ((i) & (ii) collectively referred as the “Business”), into a joint venture that would be jointly owned by a subsidiary of the Group and an unrelated third party as disclosed in Note 6 (b). In accordance with IFRS 3 “Business Combinations”, management had exercised signiﬁ cant judgement in determining whether this contribution constitutes a transfer of a business. The Business comprises an integrated set of activities including inputs in the form of a botanical library and a team of scientists engaged in the ﬁ eld of GI area, and critical processes in the form of well-established botanical research and development platform that are used to generate outputs in the form of novel medicines and nutritional products. Although the related team of scientists was not transferred as a result of this transaction, management believes that it did not involve the use of speciﬁ ed knowledge that is unique to an individual scientist or team and this team of scientists can be easily replicated by a market participant to run the business. Accordingly, management considered the transaction met the requirements under IFRS 3 to be classiﬁ ed and accounted for as the disposal of a business. 5 REVENUE AND SEGMENT INFORMATION The Group is principally engaged in the manufacturing, distribution and sales of TCM and healthcare products, and carrying out pharmaceutical research and development. Revenues recognised for the year are as follows: Continuing operations: Sales of goods Income from research and development projects (note) Note: 2012 US$’000 187,949 7,443 2011 US$’000 150,241 14,788 195,392 165,029 Income from research and development projects include upfront income of US$4.6 million (2011: US$10.8 million) from a global licensing, co-development and commercialisation agreement (Note 27) and income from the provision of research and development services of US$2.8 million (2011: US$4.0 million). The Chief Executive Ofﬁ cer (the chief operating decision maker) has reviewed the Group’s internal reporting in order to assess performance and allocate resources, and has determined that the Group has three reportable operating segments as follows: – – – China healthcare: comprises the development, manufacture, distribution and sale of over-the-counter products, prescription products and health supplements products. Drug research and development (“Drug R&D”): relates mainly to drug discoveries and other pharmaceutical research and development activities, and the provision of research and development services. Consumer products: relates to sales of health oriented consumer products and services. 66 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 5 REVENUE AND SEGMENT INFORMATION (Continued) China healthcare and Drug R&D segments are primarily located in the PRC and the locations for consumer products segment are further segregated into the PRC, UK, France and Hong Kong. The operating segments are strategic business units that offer different products and services. They are managed separately because each business requires different technological advancement and marketing approach. The performance of the reportable segments are assessed based on a measure of earnings or losses before interest income, ﬁ nance costs and tax expenses (“EBIT/(LBIT)”). In June 2012, the Group discontinued its consumer products operation in the UK. Details of the discontinued operation are included in Note 10. The segment information for the reportable segments for the year is as follows: Continuing operations As at and for the year ended 31 December 2012 China healthcare Drug R&D Consumer products Reportable segment PRC US$’000 PRC US$’000 PRC US$’000 France Hong Kong US$’000 US$’000 total Unallocated US$’000 US$’000 Total US$’000 177,914 20,467 198 20,665 219 7,443 2,639 153 2,792 – 787 (3,195) 3 (3,192) – 643 (747) – (747) – 8,605 (1,378) 1 195,392 17,786 355 – (6,253) 223 195,392 11,533 578 (1,377) – 18,141 219 (6,030) 989 12,111 1,208 7,483 2,571 137,640 19,516 1,398 45,643 5 1 2,137 1 1 1,568 6 18 7,631 27,011 3,989 194,619 114 25 14,483 27,125 4,014 209,102 Revenue from external customers EBIT/(LBIT) Interest income Operating proﬁ t/(loss) Finance costs Additions to non-current assets (other than ﬁ nancial instrument and deferred tax assets) Depreciation/amortisation Total assets Notes To The Accounts 67 5 REVENUE AND SEGMENT INFORMATION (Continued) Discontinued operation China healthcare PRC US$’000 Drug R&D PRC US$’000 As at and for the year ended 31 December 2012 Consumer products Reportable segment PRC US$’000 UK US$’000 France Hong Kong US$’000 US$’000 total Unallocated US$’000 US$’000 Total US$’000 Revenue from external customers LBIT Interest income Operating loss Finance costs Additions to non-current assets (other than ﬁ nancial instrument and deferred tax assets) Depreciation/amortisation Total assets Continuing operations Revenue from external customers EBIT/(LBIT) Interest income Operating proﬁ t/(loss) Finance costs Additions to non-current assets (other than ﬁ nancial instrument and deferred tax assets) Depreciation/amortisation Total assets – – – – – – – – – – – – – – – – – – – – – – – – 344 (3,201) – (3,201) – – 35 363 – – – – – – – – – – – – – – – – 344 (3,201) – (3,201) – – 35 363 – – – – – – – – 344 (3,201) – (3,201) – – 35 363 China healthcare PRC US$’000 Drug R&D PRC US$’000 139,153 18,327 123 18,450 285 3,098 2,745 123,907 14,788 (3,696) 5 (3,691) – 4,104 1,557 45,167 As at and for the year ended 31 December 2011 Consumer products Reportable segment PRC US$’000 France US$’000 Hong Kong US$’000 total US$’000 Unallocated US$’000 Total US$’000 2,011 (847) 1 (846) – 3 – 4,538 1,528 (679) – (679) – – 1 763 7,549 (619) 1 (618) – 38 13 8,588 165,029 12,486 130 12,616 285 7,243 4,316 182,963 – (5,836) 5 (5,831) 276 165,029 6,650 135 6,785 561 9 14 9,105 7,252 4,330 192,068 68 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 5 REVENUE AND SEGMENT INFORMATION (Continued) Discontinued operation China healthcare PRC US$’000 Drug R&D PRC US$’000 As at and for the year ended 31 December 2011 Consumer products Reportable segment PRC US$’000 UK US$’000 France Hong Kong US$’000 US$’000 total Unallocated US$’000 US$’000 Total US$’000 Revenue from external customers LBIT Interest income Operating loss Finance costs Additions to non-current assets (other than ﬁ nancial instrument and deferred tax assets) Depreciation/amortisation Total assets – – – – – – – – – – – – – – – – – – – – – – – – 1,895 (1,397) – (1,397) – – 233 2,706 – – – – – – – – – – – – – – – – 1,895 (1,397) – (1,397) – – 233 2,706 – – – – – – – – 1,895 (1,397) – (1,397) – – 233 2,706 Revenue from external customers is after elimination of inter-segment sales. The amount eliminated attributable to consumer products segment from UK to France is US$414,000 (2011: US$852,000) and from Hong Kong to the PRC is US$485,000 (2011: US$2,225,000). Sales between segments are carried out at mutually agreed terms. Unallocated expenses mainly represent corporate expenses which include corporate employee beneﬁ t expenses and the relevant share-based compensation expenses. Unallocated assets mainly comprise cash at banks and deferred tax assets. A reconciliation of EBIT for reportable segments to proﬁ t before taxation and discontinued operation is provided as follows: EBIT for reportable segments Unallocated expenses Interest income Finance costs Proﬁ t before taxation 2012 US$’000 17,786 (6,253) 578 (1,208) 10,903 2011 US$’000 12,486 (5,836) 135 (561) 6,224 As at 31 December 2012, the total non-current assets, other than investment in an associated company and deferred tax assets, located in the PRC, UK, France and Hong Kong were US$57,039,000 (2011: US$52,338,000), US$ Nil (2011: US$145,000), US$1,000 (2011: US$1,000) and US$144,000 (2011: US$74,000) respectively. Notes To The Accounts 69 2012 US$’000 2011 US$’000 578 315 122 982 (95) 1,152 3,054 135 49 229 685 (23) – 1,075 6 (a) OTHER NET OPERATING INCOME Continuing operations: Interest income Net foreign exchange gains Government incentives Other operating income Other operating expenses Proﬁ t on buy back of convertible preference shares (Note 28) 6 (b) GAIN ON DISPOSAL OF A BUSINESS On 27 November 2012, Hutchison MediPharma (Hong Kong) Limited (a subsidiary of the Group) and Nestlé Health Science S.A. (“Nestlé”), a fully-owned subsidiary of Nestlé S.A., a company specialized in the development of science-based personalized nutritional solutions, entered into a joint venture agreement (“JV agreement”) in which Nestlé agreed to contribute cash and the Group agreed to contribute the Business as deﬁ ned in Note 4(g) into Nutrition Science Partners Limited (the “JV”). The JV would be jointly owned with each of the Group and Nestlé having a 50% equity interest. As at 31 December 2012, the Group had contributed the Business into the JV (Note 17). Although the legal formation of the JV is still subject to regulatory approval, management considered the Group had effectively lost control over the Business since 27 November 2012. Accordingly, the Group had recorded a gain on disposal of the business, being the difference between the contribution to be received from the JV partner and the carrying values of net assets contributed into the JV. 7 OPERATING PROFIT Operating proﬁ t is stated after charging the following: Continuing operations: Auditor’s remuneration Amortisation of trademarks and patents recognised in administrative expenses Amortisation of leasehold land Cost of inventories recognised as expense Depreciation of property, plant and equipment Write-off of inventories (note) Provision for inventories (note) Provision for receivables Loss on disposal of property, plant and equipment Operating lease rentals in respect of land and buildings Research and development expense Employee beneﬁ t expenses (Note 13) Note: 2012 US$’000 2011 US$’000 427 67 182 97,009 3,765 800 1,591 83 214 1,143 7,443 34,922 415 91 145 73,799 4,094 2 120 19 149 1,383 7,291 26,836 Provision for inventories and write-off of inventories amounted to US$1,591,000 (2011: US$120,000) and US$800,000 (2011: US$2,000) respectively mainly relate to obsolete or damaged inventories. 70 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 8 FINANCE COSTS Continuing operations: Interest expense on bank loans Guarantee fee on bank loan 9 TAXATION CHARGE Continuing operations: Current tax – PRC Deferred income tax (Note 19) Taxation charge 2012 US$’000 2011 US$’000 737 471 1,208 531 30 561 2012 US$’000 2011 US$’000 3,495 667 4,162 3,130 12 3,142 (a) The Group has no estimated assessable proﬁ t in Hong Kong and France for the year (2011: Nil). (b) Hutchison MediPharma Limited (“HMPL”), a subsidiary of the Group, has been granted Technology Advancement Service Entity status and is subject to a preferential income tax rate of 15% for three years up to 2013 and is renewable subject to approval by the relevant tax authorities. Hutchison Healthcare Limited (“HHL”), a subsidiary of the Group, is entitled to a two-year exemption from income taxes followed by a 50% reduction in income taxes for the ensuing three years. These tax beneﬁ ts were expired in 2012 and thereafter HHL will be subject to a tax rate of 25%. In addition, Hutchison Whampoa Guangzhou Baiyunshan Chinese Medicine Company Limited (“HBYS”) and Shanghai Hutchison Pharmaceuticals Limited (“SHPL”), jointly controlled entities of the Group, have been granted High and New Technology Enterprise status (“HNTE status”). Accordingly, HBYS & SHPL are subject to a preferential income tax rate of 15% up to 2014 (2011: 15%) and are renewable subject to approval by the relevant tax authorities. Notes To The Accounts 71 9 TAXATION CHARGE (Continued) (c) The taxation charge on the Group’s proﬁ t before taxation differs from the theoretical amount that would arise using the Group’s weighted average tax rate as follows: Continuing operations: Proﬁ t before taxation Tax calculated at the domestic tax rates of respective companies Effect of tax concession Expenses not deductible for taxation purposes Tax losses for which no deferred tax asset was recognised Withholding tax on unremitted earnings Others Taxation charge 2012 US$’000 2011 US$’000 10,903 1,745 (2,030) 113 3,774 1,005 (445) 4,162 6,224 2,840 (1,672) 116 1,675 740 (557) 3,142 The weighted average tax rate calculated at the domestic tax rates of respective companies for the year was 16.0% (2011: 45.6%). The ﬂ uctuation in the weighted average applicable tax rate arose because of the changes in the relative proﬁ tability of the Group’s operations in different tax jurisdictions. 10 RESULTS AND CASH FLOWS OF DISCONTINUED OPERATION In June 2012, the Group discontinued its consumer products operation in the UK, which represented a geographical area of the Group’s business, as its performance was below expectation in light of increased competitive activities in the UK consumer product market. The results and cash ﬂ ows of the discontinued operation are set out below. The 2011 comparative ﬁ gures in the consolidated income statement have also been reclassiﬁ ed to conform to the current year presentation. 72 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 10 RESULTS AND CASH FLOWS OF DISCONTINUED OPERATION (Continued) Revenue and income (Note 1) Expenses (Note 2) Loss before taxation from discontinued operation Taxation charge Loss for the year from discontinued operation Cash ﬂ ow from discontinued operation Net cash ﬂ ows from operating activities Net cash ﬂ ows from investing activities Net cash ﬂ ows from ﬁ nancing activities Net cash outﬂ ows Note 1 Revenue and income include: Sales of goods Service income Other income Note 2 Expenses include: Cost of inventories recognised as expense Depreciation of property, plant and equipment Employee beneﬁ t expenses Loss on disposal of property, plant and equipment Operating lease rentals in respect of land and building Write-off of inventories 2012 US$’000 584 (3,785) (3,201) – (3,201) (238) 5 – (233) 178 166 240 584 131 35 1,266 106 672 1,083 2011 US$’000 2,069 (3,466) (1,397) – (1,397) (94) – – (94) 446 1,449 174 2,069 208 233 1,428 99 1,054 29 Notes To The Accounts 73 11 EARNINGS PER SHARE (a) Basic earnings/(losses) per share Basic earnings/(losses) per share is calculated by dividing the proﬁ t attributable to equity holders of the Company by the weighted average number of ordinary shares in issue during the year. Weighted average number of outstanding ordinary shares in issue 51,918,898 51,743,153 2012 2011 Proﬁ t/(loss) for the year attributable to equity holders of the Company – Continuing operations (US$’000) – Discontinued operation (US$’000) Earnings/(losses) per share attributable to equity holders of the Company – Continuing operations (US$ per share) – Discontinued operation (US$ per share) (b) Diluted earnings/(losses) per share 6,839 (3,201) 3,638 0.1317 (0.0616) 2,107 (1,397) 710 0.0407 (0.0270) 0.0701 0.0137 Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares outstanding to assume conversion of the share options that have been granted under the Company’s share option scheme to reﬂ ect the dilutive potential ordinary shares of the Company. A calculation is prepared to determine the number of shares that could have been acquired at fair value (determines as the average market share price of the Company’s shares over the period) based on the monetary value of the subscription rights attached to outstanding share options. The number of shares calculated as above is compared with the number of shares that would have been issued assuming the exercise of share options. Weighted average number of outstanding ordinary shares in issue Adjustment for share options Proﬁ t/(loss) for the year attributable to equity holders of the Company – Continuing operations (US$’000) – Discontinued operation (US$’000) Diluted earnings per share for proﬁ t from continuing operations attributable to equity holders of the Company (US$ per share) 2012 2011 51,918,898 731,464 51,743,153 910,571 52,650,362 52,653,724 6,839 (3,201) 3,638 2,107 (1,397) 710 0.1299 0.0400 Diluted earnings per share for proﬁ t from continuing and discontinued operations attributable to equity holders of the Company (US$ per share) 0.0691 0.0135 74 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 11 EARNINGS PER SHARE (Continued) (b) Diluted earnings/(losses) per share (Continued) Diluted losses per share from discontinued operation for the years ended 31 December 2012 and 2011 were the same as the basic losses per share from discontinued operation since the share options had anti-dilutive effect. 12 DIRECTORS’ EMOLUMENTS Fees (note) Basic salaries, housing allowances, other allowances and beneﬁ ts in kind Contributions to pension schemes Share-based compensation expenses Note: 2012 US$’000 276 1,301 41 10 1,628 2011 US$’000 269 1,087 38 25 1,419 The emoluments of each of the Directors exclude amounts received from the Company’s subsidiaries and paid to a subsidiary or an intermediate holding company of the Company. 13 EMPLOYEE BENEFIT EXPENSES (INCLUDING DIRECTORS’ EMOLUMENTS) Wages, salaries and bonuses Pension costs – deﬁ ned contribution plans Staff welfare Share-based compensation expenses 2012 US$’000 26,247 3,367 4,556 752 34,922 2011 US$’000 19,392 2,111 4,390 943 26,836 Notes To The Accounts 75 14 PROPERTY, PLANT AND EQUIPMENT Buildings situated in the PRC under medium term leases US$’000 Leasehold improvements US$’000 Plant and equipment US$’000 Furniture and ﬁ xtures, other equipment and motor vehicles US$’000 Construction in progress US$’000 21,479 186 – (26) 1,316 5,293 49 401 (1,610) 85 12,014 107 724 (485) 701 14,229 128 1,346 (1,328) 40 1,967 7 1,062 (34) (2,142) Total US$’000 54,982 477 3,533 (3,483) – Cost As at 1 January 2012 Exchange differences Additions Disposals Transfers As at 31 December 2012 22,955 4,218 13,061 14,415 860 55,509 Accumulated depreciation and impairment As at 1 January 2012 Exchange differences Charge for the year Disposals 8,774 81 1,064 (3) 5,032 45 244 (1,543) 7,619 68 827 (373) 10,280 99 1,665 (1,218) As at 31 December 2012 9,916 3,778 8,141 10,826 – – – – – 31,705 293 3,800 (3,137) 32,661 Net book value As at 31 December 2012 13,039 440 4,920 3,589 860 22,848 76 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 14 PROPERTY, PLANT AND EQUIPMENT (Continued) Buildings situated in the PRC under medium term leases US$’000 20,219 1,041 82 – 137 Furniture and ﬁ xtures, other equipment and motor vehicles US$’000 Construction in progress US$’000 Leasehold improvements US$’000 Plant and equipment US$’000 5,238 209 185 (314) (25) 10,926 571 541 (217) 193 13,053 638 653 (206) 91 1,001 69 1,293 – (396) Total US$’000 50,437 2,528 2,754 (737) – Cost As at 1 January 2011 Exchange differences Additions Disposals Transfers As at 31 December 2011 21,479 5,293 12,014 14,229 1,967 54,982 Accumulated depreciation and impairment As at 1 January 2011 Exchange differences Charge for the year Disposals As at 31 December 2011 Net book value As at 31 December 2011 7,370 399 1,005 – 8,774 3,919 165 1,085 (137) 6,820 358 641 (200) 8,410 424 1,596 (150) 5,032 7,619 10,280 – – – – – 26,519 1,346 4,327 (487) 31,705 12,705 261 4,395 3,949 1,967 23,277 As at 31 December 2012, the net book value of buildings pledged as security for the short-term bank loan amounted to US$85,000 (2011: US$174,000) (Note 26). Notes To The Accounts 77 15 LEASEHOLD LAND The Group and its jointly controlled entities’ interests in leasehold land represent prepaid operating lease payments and are located in the PRC. Cost As at 1 January Exchange differences Additions As at 31 December Accumulated amortisation As at 1 January Exchange differences Amortisation charge (Note 7) As at 31 December Net book value As at 31 December 2012 US$’000 2011 US$’000 7,268 101 4,357 11,726 1,093 11 182 1,286 6,914 354 – 7,268 899 49 145 1,093 10,440 6,175 As at 31 December 2012, the net book value of leasehold land pledged as security for the short-term bank loan amounted to US$74,000 (2011: US$75,000) (Note 26). 16 GOODWILL Cost As at 1 January Exchange differences Additions As at 31 December 2012 US$’000 2011 US$’000 8,248 63 – 8,311 7,709 378 161 8,248 Goodwill is allocated to HHL, a subsidiary of the Group, and Qing Yuan Baiyunshan Hutchison Whampoa ChuanXinLian R&D Limited (“CXL”), SHPL and HBYS, jointly controlled entities of the Group, to the extent of US$407,000 (2011: US$407,000), US$70,000 (2011: US$70,000), US$3,179,000 (2011: US$3,154,000) and US$4,655,000 (2011: US$4,617,000), respectively. 78 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 16 GOODWILL (Continued) For the purposes of impairment reviews, the recoverable amount of goodwill is determined based on value-in-use calculations. The value-in-use calculations use cash ﬂ ow projections based on ﬁ nancial budgets approved by management covering a ﬁ ve-year period. Projections in excess of ﬁ ve years are used to take into account increasing market share and growth momentum. There are a number of assumptions and estimates involved for the preparation of cash ﬂ ow projections for the period covered by the approved budget. Key assumptions include the expected growth in revenues and gross margin, and pre-tax discount rate of 11% (2011: 11%), to reﬂ ect the risks involved. Management prepared the ﬁ nancial budgets taking into account actual and prior year performance and market development expectations. Cash ﬂ ows beyond that ﬁ ve-year period have been extrapolated using steady growth rate of 4%. Judgment is required to determine key assumptions adopted in the cash ﬂ ow projections and changes to key assumptions can signiﬁ cantly affect these cash ﬂ ow projections. 17 OTHER INTANGIBLE ASSETS Development costs 2012 US$’000 2011 US$’000 Trademarks, patents and others 2012 US$’000 2011 US$’000 Total 2012 US$’000 2011 US$’000 14,233 78 4,213 (18,524) 10,218 298 3,717 – 2,668 24 15,022 – 1,951 97 620 – 16,901 102 19,235 (18,524) 12,169 395 4,337 – – – – – – – 14,233 17,714 2,668 17,714 16,901 – – – – 2,043 19 67 1,857 95 91 2,043 19 67 2,129 2,043 2,129 1,857 95 91 2,043 14,233 15,585 625 15,858 14,858 Cost As at 1 January Exchange differences Additions (i) & (iii) Disposal (ii) As at 31 December Accumulated amortisation and impairment As at 1 January Exchange differences Amortisation charge (Note 7) As at 31 December Net book value As at 31 December (i) During the year, the Group capitalised additional development costs totaling US$4,213,000 (2011: US$3,717,000) in respect of a drug candidate for the treatment of Inﬂ ammatory Bowel Disease for which management are of the opinion that the technical feasibility of completing the candidate making it available for use or sale can be demonstrated and it is probable that future economic beneﬁ ts can be generated to the Group. (ii) As at 31 December 2012, the Group had contributed the drug candidate as stated in note (i) with cumulative capitalised costs amounted to US$18,524,000, into a joint venture with an unrelated third party as explained in Note 6 (b), which constituted a disposal of intangible assets of the same amount. (iii) Additions of US$15,022,000 for the year mainly represent the Group’s 50% share of fair value of intangible assets of the joint venture as explained in Note 6 (b). Trademarks, patents and others are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets exceeds its recoverable amount. Management is of the opinion that there is no indication of impairment on these assets as of 31 December 2012. 18 INVESTMENT IN AN ASSOCIATED COMPANY Unlisted investment As at 1 January Exchange differences Addition As at 31 December Notes To The Accounts 79 2012 US$’000 2011 US$’000 31 1 – 32 – – 31 31 Investment in an associated company represented a 20% interest in an unlisted company established in the PRC acquired by a jointly controlled entity of the Group. 19 DEFERRED INCOME TAX Deferred tax assets Deferred tax liabilities Net deferred tax liabilities The movements in net deferred income tax liabilities are as follows: At 1 January Credited/(charged) to the consolidated income statement – accrued expenses, provisions and depreciation allowances – tax losses – withholding tax on unremitted earnings – expiry of deferred tax asset Relating to acquisition of a subsidiary by a jointly controlled entity At 31 December 2012 US$’000 1,639 (2,667) (1,028) 2011 US$’000 1,550 (1,911) (361) 2012 US$’000 2011 US$’000 (361) 215 – (771) (111) – (1,028) (195) 594 134 (740) – (154) (361) 80 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 19 DEFERRED INCOME TAX (Continued) The deferred tax assets and liabilities are offset when there is a legally enforceable right to set off and when the deferred income taxes related to the same ﬁ scal authority. The Group’s deferred tax assets are mainly related to accrued expenses, provisions, depreciation allowances and tax losses, and deferred tax liabilities are mainly related to unremitted earnings from jointly controlled entities. The potential deferred tax assets in respect of tax losses which have not been recognised in the consolidated accounts amounted to approximately US$24,124,000 as at 31 December 2012 (2011: US$19,488,000). These unrecognised tax losses can be carried forward against future taxable income and will expire in the following years: No expiry date 2012 2013 2014 2015 2016 2017 20 INVENTORIES Raw materials Work in progress Finished goods As at 31 December 2012 US$’000 64,385 – 10,590 8,437 10,829 350 10,281 104,872 2012 US$’000 11,116 4,707 9,495 25,318 2011 US$’000 54,078 9,624 10,590 8,437 10,829 350 – 93,908 2011 US$’000 9,137 5,244 14,339 28,720 21 TRADE AND BILLS RECEIVABLES Trade receivables from third parties Trade receivables from related parties (Note 32) Bills receivables Notes To The Accounts 81 2012 US$’000 19,519 2,751 22,073 44,343 2011 US$’000 18,568 3,514 29,491 51,573 Substantially all the trade and bills receivables are denominated in RMB and are due within one year from the end of the reporting period. The carrying value of trade and bills receivables approximates their fair values due to their short-term maturities. There is no concentration of credit risk with respect to trade and bills receivables as the Group and its jointly controlled entities have a large number of customers. Bills receivables represent non-interest bearing bank acceptance bills with a maturity period of 1 to 6 months. Movements on the provision for trade receivables are as follows: At 1 January Provision Exchange difference At 31 December 2012 US$’000 1,605 83 14 1,702 2011 US$’000 1,511 19 75 1,605 The impaired and provided receivables of US$1,702,000 (2011: US$1,605,000) are aged over 6 months. As at 31 December 2012, trade receivables of approximately US$342,000 (2011: US$2,234,000) were past due but not impaired. These related to a number of independent customers for whom there is no recent history of default. The ageing analysis of these receivables is as follows: Up to 3 months 4 to 6 months Over 6 months 2012 US$’000 163 179 – 342 2011 US$’000 350 29 1,855 2,234 The credit quality of trade receivables neither past due nor impaired has been assessed by reference to historical information about the counterparty default rates. The existing counterparties do not have defaults in the past. 82 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 22 CASH AND BANK BALANCES Cash at bank and in hand Short-term bank deposits (note (a)) Denominated in: US dollars RMB (note (b)) UK Pound Sterling HK$ Euro 2012 US$’000 45,190 16,819 62,009 2012 US$’000 4,163 53,920 311 2,231 1,384 62,009 2011 US$’000 53,763 – 53,763 2011 US$’000 26,578 18,917 607 7,183 478 53,763 Notes: (a) (b) The weighted average effective interest rate on short-term bank deposits, with maturity ranging from 50 to 92 days, was 2.7% (0.2% for deposits obtained and redeemed during 2011) per annum. Cash at bank earns interest at ﬂ oating rates based on daily bank deposit rates. Certain cash and bank balances denominated in RMB were deposited with banks in the PRC. The conversion of these RMB denominated balances into foreign currencies is subject to the rules and regulations of foreign exchange control promulgated by the PRC government. 23 SHARE CAPITAL (a) Authorised and issued share capital Authorised: As at 1 January 2011, 31 December 2011, 1 January 2012 and 31 December 2012 Issued and fully paid: As at 1 January 2011, 31 December 2011 and 1 January 2012 Issue of shares under share option scheme (note) As at 31 December 2012 Note: Issue date Number of ordinary shares of US$1 each allotted and issued by the Company Issue price Aggregate cash consideration (US$’000) Weight average share price at the exercise date All the above new shares rank pari passu in all respects with the then existing shares. Number of shares of US$1 each Nominal amount US$’000 75,000,000 75,000 Number of shares 51,743,153 305,295 52,048,448 US$’000 51,743 305 52,048 9 January 2012 14 June 2012 4 September 2012 4 September 2012 51,212 £1.090 86 £3.68 192,108 £1.260 377 £3.98 53,650 £1.715 145 £3.83 8,325 £1.535 21 £3.83 Notes To The Accounts 83 23 SHARE CAPITAL (Continued) (b) Share option schemes (i) Share option scheme of the Company On 4 June 2005, the Company adopted a share option scheme (the “HCML Share Option Scheme”), the rules of which were subsequently amended by the Board of Directors of the Company on 21 March 2007. Pursuant to the HCML Share Option Scheme, the Board of Directors of the Company may, at its discretion, offer any employees and directors (including executive and non-executive directors but excluding independent non- executive directors) of the Company, holding companies of the Company and any of their subsidiaries or afﬁ liates, and subsidiaries or afﬁ liates of the Company options to subscribe for shares of the Company. As of 31 December 2012, options representing approximately 2.8% of the issued share capital of the Company were granted to directors of the Company and certain employees of the Group and its jointly controlled entities under the HCML Share Option Scheme which are exercisable within a period of ten years from the offer date subject to the vesting schedules of the respective share options. The following share options were outstanding under the HCML Share Option Scheme as at 31 December 2012: Name or category Effective date of participants of grant of share options Exercise period of share options Exercise price of share options Number of shares subject to the options Directors Christian Hogg 19 May 2006 (notes (i) & (ii)) On Admission to 3 June 2015 Johnny Cheng 25 August 2008 (note (iii)) From 25 August 2008 to 24 August 2018 Employees in aggregate 19 May 2006 (notes (i) & (ii)) On Admission to 3 June 2015 11 September 2006 (note (ii)) From 11 September 2006 to 18 May 2016 £1.090 £1.260 £1.090 £1.715 18 May 2007 (note (iv)) From 18 May 2007 to 17 May 2017 £1.535 28 June 2010 (note (iii)) From 28 June 2010 to 27 June 2020 £3.195 1 December 2010 (note (iii)) From 1 December 2010 to 30 November 2020 £4.967 24 June 2011 (note (iii)) From 24 June 2011 to 23 June 2021 £4.405 768,182 64,038 76,818 26,808 43,857 102,628 227,600 150,000 1,459,931 84 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 23 SHARE CAPITAL (Continued) (b) Share option schemes (Continued) (i) Share option scheme of the Company (Continued) Movements in the number of share options outstanding and their related weighted average exercise prices are as follows: 2012 2011 Average exercise price in £ per share 2.06 – 1.32 2.22 Number of options 1,765,226 – (305,295) 1,459,931 Average exercise price in £ per share 1.84 4.41 – 2.06 Number of options 1,615,226 150,000 – 1,765,226 As at 1 January Granted Exercised As at 31 December The Company has no legal or constructive obligation to repurchase or settle the share options in cash. Save as mentioned above, no other share options under the HCML Share Option Scheme were cancelled or exercised or lapsed during the year ended 31 December 2012. Notes: (i) The share options were granted on 4 June 2005, conditionally upon the Company’s Admission which took place on 19 May 2006. (ii) The share options granted to certain founders of the Company are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of 50% on 19 May 2007 and 25% on each of 19 May 2008 and 19 May 2009. The share options granted to non-founder of the Company are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of one-third on each of 19 May 2007, 19 May 2008 and 19 May 2009. (iii) The share options granted are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of 25% on each of the ﬁ rst, second, third and fourth anniversaries of the date of grant of share options. (iv) The share options granted are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of one-third on each of the ﬁ rst, second and third anniversaries of the date of grant of share options. (v) As at 31 December 2012, the fair value of share options in connection with the 1,459,931 share options outstanding as at the same date remain unvested was amounting to £219,000 (equivalent to US$353,000). The amount is to be recognised as expense of the Group over the remaining vesting periods of the relevant share options as mentioned in the note (iii) above. The amount recognised as expenses for the year ended 31 December 2012 amounted to US$416,000 (2011: US$575,000). Notes To The Accounts 85 23 SHARE CAPITAL (Continued) (b) Share option schemes (Continued) (i) Share option scheme of the Company (Continued) The fair value of options granted under the HCML Share Option Scheme determined using the Binomial Model is as follows: Effective date of grant of share options 19 May 11 September 2006 2006 18 May 2007 25 August 28 June 1 December 2008 2010 2010 24 June 2011 Value of each share option £1.546 £0.553 £0.533 £0.569 £1.361 £1.995 £1.841 Signiﬁ cant inputs into the valuation model: Exercise price Share price at effective grant date Expected volatility (notes (i) to (iv)) Risk-free interest rate Expected life of options Expected dividend yield Notes: £1.090 £2.5050 38.8% 4.540% £1.715 £1.7325 38.8% 4.766% £1.535 £1.5400 40.0% 5.098% £1.260 £1.2600 35.0% 4.700% £3.195 £3.1500 49.9% 3.340% £4.967 £4.6000 48.43% 3.360% £4.405 £4.3250 46.6% 3.130% 1.2 to 3.9 years 3.4 to 5.3 years 3.9 to 5.7 years 7.1 to 8.0 years 6.25 years 6.25 years 6.25 years 0% 0% 0% 0% 0% 0% 0% (i) For share options granted on or before 18 May 2007, the volatility of the underlying stock during the life of the options is estimated based on the historical volatility of the comparable companies for the past one to two years as of the valuation date, that is, the effective grant date, since there were no or only a relatively short period of trading record of the Company’s shares at the respective grant dates. (ii) For share options granted on 25 August 2008, the volatility of the underlying stock during the life of the options is estimated with reference to the volatility of the Company two years prior to the issuance of share options. (iii) For share options granted on 28 June 2010 and 1 December 2010, the volatility of the underlying stock during the life of the options is estimated with reference to the volatility of the Company four years prior to the issuance of share options. (iv) For share options granted on 24 June 2011, the volatility of the underlying stock during the life of the options is estimated with reference to the volatility of the Company ﬁ ve years prior to the issuance of share options. 86 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 23 SHARE CAPITAL (Continued) (b) Share option schemes (Continued) (ii) Share option scheme of a subsidiary On 6 August 2008, Hutchison MediPharma Holdings Limited (“HMHL”), a subsidiary of the Company, adopted a share option scheme (the “HMHL Share Option Scheme”), the rules of which were subsequently amended by the Board of Directors of HMHL on 15 April 2011, pursuant to which any employee or director of HMHL and any of its subsidiaries and afﬁ liates is eligible to participate in the HMHL Share Option Scheme subject to the discretion of the board of directors of HMHL. As of 31 December 2012, options representing approximately 10.5% of HMHL’s total issued ordinary shares were granted to certain employees of Hutchison MediPharma Limited, a subsidiary of HMHL under the HMHL Share Option Scheme which are exercisable within a period of six years from the offer date subject to the vesting schedules of 25% on each of the ﬁ rst, second, third and fourth anniversaries of the date of grant of share options. The following share options were outstanding under the HMHL Share Option Scheme as at 31 December 2012: Category of participants Effective date of grant of share options Exercise period of share options Exercise price of share options Number of shares subject to the options Employees in aggregate 6 August 2008 (note (i)) 5 October 2009 (note (i)) 3 May 2010 (note (i)) 2 August 2010 (note (i)) From 6 August 2008 to 5 August 2014 From 5 October 2009 to 4 October 2015 From 3 May 2010 to 2 May 2016 From 2 August 2010 to 1 August 2016 22 November 2010 (note (i)) 18 April 2011 (note (i)) From 22 November 2010 to 21 November 2016 From 18 April 2011 to 17 April 2017 US$1.28 1,243,000 US$1.52 234,000 US$2.12 360,000 US$2.24 206,000 US$2.36 240,000 US$2.36 562,385 17 October 2012 (note (i)) From 17 October 2012 to US$2.73 299,120 16 October 2018 3,144,505 Notes To The Accounts 87 23 SHARE CAPITAL (Continued) (b) Share option schemes (Continued) (ii) Share option scheme of a subsidiary (Continued) Movements in the number of share options outstanding and their related weighted average exercise prices are as follows: 2012 2011 Average exercise price in US$ per share 1.73 2.73 1.61 1.87 Average exercise price in US$ per share 1.48 2.36 1.53 1.73 Number of options 4,050,607 299,120 (1,205,222) 3,144,505 Number of options 5,593,500 1,342,769 (2,885,662) 4,050,607 As at 1 January Granted Lapsed As at 31 December The Group has no legal or constructive obligation to repurchase or settle the share options in cash. Save as mentioned above, no other share options under the HMHL Share Option Scheme were cancelled or exercised or lapsed during the year ended 31 December 2012. Notes: (i) The share options granted are exercisable subject to, amongst other relevant vesting criteria, the vesting schedule of 25% on each of the ﬁ rst, second, third and fourth anniversaries of the date of grant of share options. (ii) As at 31 December 2012, the fair value of share options in connection with the 3,144,505 share options outstanding as at the same date remain unvested was amounting to US$236,000. The amount is to be recognised as expense of the Group over the remaining vesting periods of the relevant share options as mentioned in the note (i) above. The amount recognised as expenses for the year ended 31 December 2012 amounted to US$336,000 (2011: US$368,000) and of which US$44,000 (2011: US$169,000) has been capitalised as intangible assets during the year (Note 16). 88 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 23 SHARE CAPITAL (Continued) (b) Share option schemes (Continued) (ii) Share option scheme of a subsidiary (Continued) The fair value of options granted under the HMHL Share Option Scheme determined using the Binomial Model is as follows: Effective date of grant of share options 6 August 5 October 2008 2009 3 May 2010 2 August 22 November 18 April 17 October 2010 2010 2011 2012 Value of each share option US$0.034 US$0.027 US$0.361 US$0.258 US$0.900 US$0.923 US$0.923 Signiﬁ cant inputs into the valuation model: Exercise price Share price at effective grant date Expected volatility (note) Risk-free interest rate Expected life of options Expected dividend yield Note: US$1.280 US$0.270 53% 3.293% 4.6 to 5.8 years 0% US$1.520 US$0.261 53% 2.564% 6 years 0% US$2.120 US$1.098 54% 2.772% 6 years 0% US$2.240 US$1.030 49% 2.007% 6 years 0% US$2.360 US$2.048 55% 1.790% 6 years 0% US$2.360 US$2.048 55% 2.439% 6 years 0% US$2.730 US$2.048 54% 2.439% 6 years 0% The volatility of the underlying stock during the life of the options is estimated based on the historical volatility of the comparable companies for the past one to seven years as of the valuation date, that is, the effective grant date. 24 TRADE PAYABLES Trade payables due to third parties Trade payable due to a related party (Note 32) 2012 US$’000 17,222 1,675 18,897 2011 US$’000 13,156 3,295 16,451 Substantially all the trade payables due to third parties are denominated in RMB and due within one year from the end of the reporting period. Trade payable due to a related party is denominated in US dollars and due within one year from the end of the reporting period. The carrying value of trade payables approximates their fair values due to their short-term maturities. Notes To The Accounts 89 2012 US$’000 2011 US$’000 10,836 4,888 – 9,958 25,682 9,387 4,095 4,551 18,033 43,715 6,660 4,197 3,154 9,910 23,921 4,707 2,389 4,551 11,647 35,568 25 OTHER PAYABLES, ACCRUALS AND ADVANCE RECEIPTS Other payables and accruals Accrued operating expenses Accrued salaries Amounts due to joint venture partners Other payables Advance receipts Payments in advance from customers Deferred government incentives Deferred upfront income (note) Note: In 2011, the Group entered into a global licensing, co-development and commercialisation agreement in respect of its research and development project with a third party for which an initial cash payment of US$20 million (“Upfront Income”) was received by the Group. The Group will receive further milestones income contingent upon the successful achievement of clinical development and future commercialisation of the products. Upfront Income of US$4.6 million (2011: US$10.8 million) was recognised during the year and the remaining upfront income amounted to US$4.6 million will be recognised as income in the 2013 which was determined by reference to the stage of completion of the project. The balance represents the current portion of the remaining upfront income of US$4.6 million (Note 27). 26 BANK BORROWINGS Bank borrowings Non-current (Note i) Current (Note ii) Total borrowings Weighted average effective interest rate 2012 US$’000 2011 US$’000 26,923 11,202 38,125 1.87% – 30,038 30,038 1.86% 90 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 26 BANK BORROWINGS (Continued) Notes: (i) The long-term bank loan is unsecured, interest bearing, denominated in Hong Kong dollars and the carrying amount of the bank loan approximates its fair values. It is guaranteed by Hutchison Whampoa Limited, the ultimate holding company of the Company. (ii) As at 31 December 2012, the RMB denominated short-term bank loans of US$310,000 are secured by certain leasehold land and buildings of a subsidiary of a jointly controlled entity (Notes 14 and 15). All short-term bank loans are unsecured and interest bearing and the carrying amount of these bank loans approximates their fair values. (a) As at 31 December 2012, the Group’s borrowings were repayable as follows: Within 1 year Between 2 and 5 years (b) The carrying amounts of the group’s borrowings are denominated in the following currencies: HK$ RMB 27 DEFERRED INCOME 2012 US$’000 11,202 26,923 38,125 2012 US$’000 37,179 946 38,125 2011 US$’000 30,038 – 30,038 2011 US$’000 25,000 5,038 30,038 Deferred income represents the non-current portion of upfront income of US$ Nil (2011: US$4.6 million) and government incentives of US$2.7 million (2011: US$2.3 million) received by the Group and its jointly controlled entities in relation to certain research and development projects. 28 CONVERTIBLE PREFERENCE SHARES In 2010, HMHL issued an aggregate number of 7,390,029 convertible preference shares at US$2.725 per share each to two independent third parties (“preference shares holders”) for a total cash consideration of approximately US$20.1 million. These preference shares shall be convertible into a variable number of ordinary shares of HMHL subject to, amongst other terms and conditions as set out in the relevant agreements, an adjustment event that the occurrence or non-occurrence has not yet been determined at the inception date. Consequently, the convertible preference shares are classiﬁ ed as ﬁ nancial liabilities at the reporting date. These convertible preference shares will be reclassiﬁ ed as equity of the relevant subsidiary when the relevant aforementioned conditions are met. In October 2012, the Company had purchased 2,815,249 convertible preference shares amounted to US$7.67 million from one of the preference shares holders for a consideration of approximately US$6.52 million. As a result, a gain of approximately US$1.15 million (Note 6 (a)) was recognized in the consolidated income statement for the year ended 31 December 2012. 29 NOTES TO THE CONSOLIDATED STATEMENT OF CASH FLOWS (a) Reconciliation of proﬁ t for the year to net cash generated from operations: Proﬁ t for the year Adjustments for: Taxation charge Share-based compensation expenses Amortisation of trademarks and patents Amortisation of leasehold land Write-off of inventories Provision for inventories Provision for receivables Depreciation on property, plant and equipment Loss on disposal of property, plant and equipment Gain on disposal of a business Proﬁ t on buy back of convertible preference shares Interest income Finance costs Exchange differences Notes To The Accounts 91 2012 US$’000 2011 US$’000 3,540 1,685 4,162 752 67 182 1,883 1,591 83 3,800 320 (11,476) (1,152) (578) 1,208 5 3,142 943 91 145 31 120 19 4,327 248 – – (135) 561 506 Operating proﬁ t before working capital changes 4,387 11,683 Changes in working capital: – increase in inventories – decrease/(increase) in trade and bills receivables – decrease in other receivables and prepayments – increase in trade payables – increase in other payables, accruals and advance receipts – (decrease)/increase in deferred income – increase in amount due to immediate holding company – increase in amount due to a fellow subsidiary (72) 7,147 1,123 2,446 8,147 (4,227) 872 86 (2,241) (20,854) 14 5,894 7,835 4,984 1,744 – Net cash generated from operations 19,909 9,059 Attributable to: – Continuing operations – Discontinued operation 20,147 (238) 19,909 9,153 (94) 9,059 92 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 29 NOTES TO THE CONSOLIDATED STATEMENT OF CASH FLOWS (Continued) (b) Acquisition of additional interest in a jointly controlled entity In 2011, HMPL, a subsidiary of the Group, acquired a 50% interest in the enlarged capital of CXL by injection of RMB2 million (equivalent to US$308,000) to CXL as additional capital. CXL was formerly a wholly-owned subsidiary of HBYS, which is a jointly controlled entity of the Group. After the transaction, the Group’s effective interest in CXL increased from 40% to 70%. (c) Capital contribution from non-controlling shareholders of a subsidiary of a jointly controlled entity In 2012, HBYS, a jointly controlled entity of the Group, established a subsidiary with 51% interest by injection of RMB1,020,000 (equivalent to US$161,000) and RMB980,000 (equivalent to US$154,000) contributed by non-controlling shareholders as share capital. In 2011, HBYS acquired a 60% interest in Nanyang Baiyunshan Hutchison Whampoa Guanbao Pharmaceutical Company Limited by injection of RMB21 million (equivalent to approximately US$3.2 million) as additional capital and capital reserve. 30 COMMITMENTS (a) Capital commitments The Group had the following capital commitments at 31 December 2012: Property, plant and equipment Authorised but not contracted for Contracted but not provided for (b) Operating lease commitments 2012 US$’000 2011 US$’000 – 137 137 – 174 174 The Group leases various factories, ofﬁ ces and retail stores under non-cancellable operating lease agreements. As at 31 December 2012, the future aggregate minimum lease payments in respect of land and buildings under non-cancellable operating leases were as follows: Not later than one year Later than one year and not later than ﬁ ve years Later than ﬁ ve years 2012 US$’000 889 1,076 623 2,588 2011 US$’000 1,382 2,259 1,236 4,877 Notes To The Accounts 93 31 JOINTLY CONTROLLED ENTITIES Particulars of the principal jointly controlled entities of the Group are set out in Note 35. The following amounts represent the Group’s share of the assets, liabilities, income, results, and commitments of the jointly controlled entities. They are included in the consolidated statement of ﬁ nancial position and consolidated income statement: Assets Non-current assets Current assets Liabilities Non-current liabilities Current liabilities Net assets Income Expenses Proﬁ t after taxation Operating lease commitments 2012 US$’000 34,919 92,048 2011 US$’000 29,653 77,718 126,967 107,371 2,831 45,311 48,142 78,825 2,522 36,286 38,808 68,563 173,367 (156,236) 132,650 (117,402) 17,131 15,248 375 383 There are no contingent liabilities relating to the Group’s interests in the jointly controlled entities and these jointly controlled entities did not have any material contingent liabilities as at 31 December 2012. 94 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 32 SIGNIFICANT RELATED PARTY TRANSACTIONS Save as disclosed above, the Group has the following signiﬁ cant transactions during the year with related parties which were carried out in the normal course of business at terms determined and agreed by the relevant parties: (a) Transactions with related parties: Sales of goods to – Fellow subsidiaries Purchase of goods from 2012 US$’000 2011 US$’000 6,967 6,860 – A non-controlling shareholder of a subsidiary 4,802 5,855 Royalty fee paid to – A non-controlling shareholder of a subsidiary Rendering of marketing services from – Fellow subsidiaries Management service fee to – An intermediate holding company Guarantee fee on bank loan to – The ultimate holding company Dividend paid to – A non-controlling shareholder of a subsidiary 4 591 914 471 538 – 526 878 30 1,141 No transactions have been entered into with the directors of the Company (being the key management personnel) during the years ended 31 December 2011 and 2012 other than the emoluments paid to them (being the key management personnel compensation) as disclosed in Note 12. Notes To The Accounts 95 2012 US$’000 2011 US$’000 – 15,000 15,000 1,516 – 1,516 2,751 3,514 32 SIGNIFICANT RELATED PARTY TRANSACTIONS (Continued) (b) Balances with related parties included in: Amounts due from a related party: – A non-controlling shareholder of a subsidiary (note (i)) – A joint venture partner (note (iv)) Trade receivables from related parties: – Fellow subsidiaries (Note 21) (note (ii)) Trade payable due to a related party: – A non-controlling shareholder of a subsidiary (Note 24) (note (ii)) 1,675 3,295 Amounts due to related parties: – Immediate holding company (note (ii)) – A fellow subsidiary (note (ii)) 6,217 86 6,303 5,345 – 5,345 Non-controlling shareholders: – Loans from non-controlling shareholders of subsidiaries (note (iii)) 5,379 4,379 Notes: (i) The amount due from a non-controlling shareholder of a subsidiary is dominated in US dollars and bears interest at LIBOR plus 3%. The amount is wholly repayable before December 2012 and is secured by the shareholder’s 20% equity interest in Hutchison BYS (Guangzhou) Holding Limited, an 80% owned subsidiary of the Group. (ii) Other balances with related parties are unsecured, interest-free and repayable on demand. The carrying values of balances with related parties approximate their fair values due to their short-term maturities. (iii) Loans from non-controlling shareholders of subsidiaries are unsecured, interest-free and are recorded in non-controlling interests. (iv) The balance represents Group’s share of cash to be received from a joint venture partner. 33 HOLDING COMPANIES The immediate holding company is Hutchison Healthcare Holdings Limited, a company incorporated in the British Virgin Islands. The Company’s directors regard Hutchison Whampoa Limited, a company incorporated and listed in Hong Kong, as the ultimate holding company and also ultimate controlling party of the Company. 34 APPROVAL OF ACCOUNTS The consolidated accounts set out on pages 46 to 96 were approved by the Board of Directors on 25 March 2013. 96 HUTCHISON CHINA MEDITECH LIMITED 2012 Annual Report Notes To The Accounts 35 PARTICULARS OF PRINCIPAL SUBSIDIARIES AND JOINTLY CONTROLLED ENTITIES AS AT 31 DECEMBER 2012 Place of establishment and operation Nominal value of issued ordinary share capital/ registered capital Type of legal entity Equity interest attributable to the Group As at 31 December 2012 2011 Principal activities Name Subsidiaries Hutchison Healthcare Limited The PRC RMB207,460,000 100% 100% Hutchison MediPharma Limited The PRC US$37,500,000 100% 100% Sen Medicine Company France Euro1,107,500 100% 100% (France) SARL Hutchison Hain Organic (Hong Kong) Limited (“HHOL”) (note) Hutchison Consumer Products Limited Hutchison Hain Organic (Guangzhou) Limited (‘HHOGZL”) (note) Jointly controlled entities Shanghai Hutchison Pharmaceuticals Limited Hutchison Whampoa Guangzhou Baiyunshan Chinese Medicine Company Limited Note: Hong Kong HK$1,000,000 50% 50% Hong Kong HK$1 100% 100% The PRC US$3,000,000 50% 50% The PRC RMB88,000,000 50% 50% The PRC RMB200,000,000 40% 40% Limited liability company Manufacture and distribution of healthcare products Limited liability company Research and development of pharmaceutical products Limited liability company Distribution of TCM based consumer products Limited liability company Wholesale and trading of healthcare and consumer products Limited liability company Wholesale and trading of healthcare and consumer products Limited liability company Wholesale and trading of healthcare and consumer products Limited liability company Manufacture and distribution of TCM products Limited liability company Manufacture and distribution of TCM products HHOL and HHOGZL are regarded as subsidiaries of the Group as the Group has the power to govern the ﬁ nancial and operating policies of HHOL and HHOGZL. Information For Shareholders Depositary Computershare Investor Services PLC The Pavilions Bridgwater Road Bristol BS99 6ZY United Kingdom Telephone: Facsimile: +44 (0)906 999 0000 +44 (0)870 703 6114 Shareholders Contact Please direct enquires to: 22nd Floor, Hutchison House 10 Harcourt Road Hong Kong Attn: Facsimile: E-mail: Registered ofﬁ ce Ms Edith Shih Non-executive Director & Company Secretary +852 2128 1778 ediths@hwl.com.hk Investor Information Corporate press releases, ﬁ nancial reports and other investor information on the Company are available online at the Company’s website. Investor Relations Contact Please direct enquires to: E-mail: Telephone: Facsimile: ir@chi-med.com +852 2121 8200 +852 2121 8281 Website Address www.chi-med.com Listing The Company’s ordinary shares are listed on the Alternative Investment Market operated by London Stock Exchange plc Code HCM Financial Calendar Closure of Register of Members Annual General Meeting Interim Results Announcement 9 May 2013 to 10 May 2013 10 May 2013 July 2013 Registered Ofﬁ ce P.O. Box 309, Ugland House Grand Cayman, KY1-1104 Cayman Islands Telephone: Facsimile: +1 345 949 8066 +1 345 949 8080 Principal Place of Business 22nd Floor, Hutchison House 10 Harcourt Road Hong Kong Telephone: Facsimile: +852 2128 1188 +852 2128 1778 Principal Executive Ofﬁ ce 21st Floor, Hutchison House 10 Harcourt Road Hong Kong Telephone: Facsimile: +852 2121 8200 +852 2121 8281 Share Registrar Computershare Investor Services (Jersey) Limited Queensway House Hilgrove Street, St. Helier Jersey, Channel Islands JE1 1ES Telephone: Facsimile: +44 (0)870 707 4040 +44 (0)870 873 5851 Forward Looking Statements This annual report contains forward looking statements. Forward looking statements include statements concerning plans, objective goals and strategies, future events or performance, and underlying assumptions and other statements that are other than statements of historical fact. These statements are subject to uncertainties and risks including but not limited to, the ability to meet on-going capital needs, products and service demand and acceptance, changes in technology, economic conditions, the impact of competition, the need to protect proprietary rights to technology, government regulation and other risks as noted herein and in statements ﬁ led from time to time with applicable securities regulating authorities. China Healthcare Drug Research & Dev elopment Consumer Prod ucts

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