Form 20-F
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20-F 1 d20f.htm FORM 20-F
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
(cid:133) REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
⌧ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2005
OR
(cid:133) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
(cid:133) SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Date of event requiring this shell company report
Commission file number: 001-32371
SINOVAC BIOTECH LTD.
(Exact name of Registrant as specified in its charter)
N/A
(Translation of Registrant’s name into English)
Antigua, West Indies
(Jurisdiction of incorporation or organization)
No. 39 Shangdi Xi Road,
Haidian District, Beijing 100085
People’s Republic of China
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act
Title of each class
Name of each exchange on which registered
Common Shares, par value $0.001 per share
American Stock Exchange
Securities registered or to be registered pursuant to Section 12(g) of the Act
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Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None
(Title of Class)
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period
covered by the annual report.
39,055,528
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. (cid:133) Yes ⌧ No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934. (cid:133) Yes ⌧ No
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. ⌧ Yes (cid:133) No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
(cid:133) Large accelerated filer (cid:133) Accelerated filer ⌧ Non-accelerated filer
Indicate by check mark which financial statement item the registrant has elected to follow: (cid:133) Item 17 ⌧ Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). (cid:133) Yes ⌧ No
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS.)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of
the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a
court. (cid:133) Yes (cid:133) No
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Table of Contents
TABLE OF CONTENTS
INTRODUCTION
PART I
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Information on the Company
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other than Equity Securities
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions from the Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
PART III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
1
3
3
3
29
51
67
75
78
80
80
87
88
88
88
88
89
89
90
90
90
90
90
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Unless otherwise indicated, references in this annual report on Form 20-F to:
• “$” and “U.S. dollars” are to the legal currency of the United States;
INTRODUCTION
• “China” and the “PRC” are to the People’s Republic of China, excluding, for the purposes of this annual report on Form
20-F only, Taiwan and the special administrative regions of Hong Kong and Macau;
• “common shares” are to our common shares, par value $0.001 per share;
• “GAAP” refers to general accepted accounting principles;
• “RMB” and “Renminbi” are to the legal currency of China;
• “Sinovac,” “we,” “us,” “our company” and “our” are to Sinovac Biotech Ltd., its predecessor entities and its
consolidated subsidiaries;
• “Sinovac Beijing” are to Sinovac Biotech Co., Ltd., our majority-owned subsidiary incorporated in China; and
• “Tangshan Yian” are to Tangshan Yian Biological Engineering Co., Ltd., our wholly-owned subsidiary in China.
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FORWARD-LOOKING INFORMATION
This annual report on Form 20-F contains forward-looking statements that relate to future events, including our future
operating results and conditions, our prospects and our future financial performance and condition, all of which are largely based
on our current expectations and projections. The forward-looking statements are contained principally in the sections entitled
“Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company” and “Item 5. Operating and Financial
Review and Prospects.” These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation
Reform Act of 1995. You can identify these forward-looking statements by terminology such as “may,” “will,” “expect,”
“anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to” or other and similar expressions. Forward-
looking statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially
from those contained in any forward-looking statement, including but not limited to the following:
• our ability to maximize sales of our existing products within the Chinese market;
• our ability to develop new vaccines;
• our ability to improve our existing vaccines and lower our production costs;
• our ability to expand our manufacturing facilities to meet need of the growing Chinese market and other geographic
markets;
• our ability to acquire new technologies and products;
• uncertainties in and the timeliness of obtaining necessary foreign governmental approvals and licenses for marketing and
sale of our vaccines in certain overseas markets;
• our ability to compete successfully against our competitors;
• risks associated with our corporate structure and the regulatory environment in China; and
• other risks outlined in our filings with the Securities and Exchange Commission, or the SEC, including this annual report
on Form 20-F.
The forward-looking statements made in this annual report on Form 20-F relate only to events or information as of the date
on which the statements are made in this annual report on Form 20-F. Except as required by law, we undertake no obligation to
update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after
the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report
on Form 20-F completely and with the understanding that our actual future results may be materially different from what we
expect.
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ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
PART I
ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3.
KEY INFORMATION
A.
Selected Financial Data
The following table presents the selected consolidated financial information for our company. Selected consolidated
statement of operations and balance sheet data for the three years ended and as at December 31, 2003, 2004 and 2005 have been
derived from our audited consolidated financial statements, which are included in this annual report beginning on page F-1. Our
selected consolidated statement of operations and balance sheet data for the year ended and as at December 31, 2002 have been
derived from our audited consolidated financial statements which are not included in this annual report. Our selected consolidated
statement of operations and balance sheet data for the year ended and as at December 31, 2001 have been derived from our
unaudited consolidated financial statements which are not included in this annual report, but have been prepared on the same basis
as our consolidated financial statements.
Our selected consolidated financial data as at December 31, 2003 and 2004 and for the years ended December 31, 2003 and
2004 have been restated to reflect the correct accounting treatment for the acquisition of certain licenses as purchases of in-process
research and development, for the expensing of certain research and development costs that were erroneously capitalized and for
commencing the amortization of our hepatitis A vaccine license at the date of purchase. We have also revised the share
information and loss per share computation for 2004 and 2003 as a result of the retroactive restatement of equivalent shares
received in the reverse acquisition transaction.
In September 2003, we acquired a 51% equity interest in Sinovac Beijing by issuing 10 million new common shares to
Ms. Lily Wang, CFO subsequent to the acquisition, who had, immediately prior to this transaction, contracted to purchase the
51% equity interest from Sinovac Beijing’s then existing four shareholders. This transfer of 51% equity interest in Sinovac
Beijing to us was registered and approved by PRC government authorities in August 2004. In February 2005, we acquired an
additional 20.56% equity interest in Sinovac Beijing for approximately $3.3 million in cash. We currently own 71.56% of the
equity interest in Sinovac Beijing.
In January 2004, we acquired a 100% equity interest in Tangshan Yian by issuing 3.5 million new common shares and a
promissory note in the amount of $2.2 million to Mr. Heping Wang, a then director of our company, who had, immediately prior
to this transaction, contracted to purchase this 100% equity interest from Tangshan Yian’s then existing two shareholders. This
transfer of 100% equity interest in Tangshan Yian to us was registered and approved by PRC government authorities in October
2004.
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Our historical results do not necessarily indicate results expected for any future periods. The selected consolidated financial
data should be read in conjunction with our audited consolidated financial statements and related notes and Item 5 “Operating and
Financial Review and Prospects” below. Our audited consolidated financial statements are prepared and presented in accordance
with U.S. GAAP.
Balance sheet data
Cash and cash equivalents
Restricted cash
Total assets
Short-term loans
Total current liabilities
Long-term debts
Minority interest
Total stockholders’ equity
Statement of operations data
Sales
Cost of sales
Gross profit
Operating expenses:
Selling, general and administrative expenses
Research and development expenses
Purchased in process research and development
Depreciation of property, plant and equipment and
amortization of licenses and permits
Total operating expenses
Operating loss
Interest and financing expenses
Interest and other income
Loss before income taxes and minority interest
Income taxes (recovery)
Minority interest share of (earnings) loss
Net loss for the year
Loss per share – basic and diluted
Weighted average number of common shares outstanding –
basic and diluted
Exchange Rate Information
2001
2002
Year ended December 31,
2003
(in thousands)
2004
2005
1,990
129
10,923
1,570
4,142
—
—
6,781
313
469
12,345
2,074
5,251
—
—
7,094
1,420
—
13,784
752
3,407
604
4,205
5,568
2,605
391
22,420
2,605
6,656
202
3,125
12,437
2001
Year ended December 31,
2003
(in thousands, except share and per share data)
2004
2002
—
—
—
124
—
—
139
263
(263)
—
57
—
—
(206)
(0.01)
649
252
398
792
25
477
240
1,534
(1,136)
(81)
51
(1,166)
—
—
(1,166)
(0.07)
2,839
1,086
1,753
1,749
262
381
271
2,663
(910)
(269)
41
(1,138)
—
266
(872)
(0.04)
6,454
1,938
4,516
8,843
286
—
334
9,462
(4,946)
(369)
321
(4,994)
(767)
(440)
(4,667)
(0.14)
7,354
149
31,299
2,418
8,844
2,664
1,769
18,023
2005
8,608
2,346
6,262
10,278
234
233
555
11,299
(5,037)
(229)
235
(5,031)
212
132
(5,111)
(0.14)
14,709,804 15,891,700 20,081,796 32,742,837 36,353,149
We have published our financial statements in U.S. dollars. Our business is primarily conducted in China and all of our
revenues are denominated in RMB. However, periodic reports made to shareholders will include current period amounts translated
into U.S. dollars by the following manner:
The assets and liabilities of our PRC subsidiaries, Sinovac Beijing and Tangshan Yian, are translated into U.S. dollars at
exchange rates in effect at the balance sheet date. Revenue and expenses are translated at average exchange rate. Gain and losses
from such translations are included in stockholders’ equity as a component of other comprehensive income.
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We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars
or RMB, as the case may be, at any particular rate, or at all. The PRC government imposes control over its foreign currency
reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign
trade. On June 30, 2006, the noon buying rate in the City of New York for cable transfers of RMB as certified for customs
purposes by the Federal Reserve Bank of New York was RMB 7.9943 to $1.00.
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
RISKS RELATED TO OUR COMPANY
We have a history of operating losses and may never be profitable.
Biopharmaceutical product development is a highly speculative undertaking and involves a substantial degree of risk. We
have incurred substantial losses since our inception, and we expect to continue to incur losses for the foreseeable future. We
incurred net losses of $0.9 million, $4.7 million and $5.0 million in 2003, 2004 and 2005. As of December 31, 2005, the
accumulated deficit amounted to $11.6 million. Our losses have resulted principally from our research and development costs and
our selling, general and administrative expenses including our stock-based compensation. We expect to incur additional operating
losses in the future if our sales do not increase or if our expenses grow. Our losses have had, and are expected to continue to have,
an adverse impact on our working capital, total assets, stockholders’ equity and cash flow. We cannot assure you that we will ever
become profitable, or, even if we become profitable, that we would be able to sustain or increase our profitability.
We will need additional capital to expand the production capacity for our existing products, to continue development of our
product pipeline and to market existing and future products on a large scale, and we cannot guarantee that we will find
adequate sources of capital in the future.
We will need to raise further funds from the capital markets to finance expenditures for equipment, intellectual property asset
acquisitions, to expand the production capacity for our existing products, to continue the development and commercialization of
our product candidates and for other corporate purposes. As of December 31, 2005, we had approximately $7,354,451 in cash and
cash equivalents. Although we believe we have adequate near-term cash resources, we will need to undertake significant future
financings for the following reasons:
• to proceed with the research and development of other vaccine products, including clinical testing relating to new
products;
• to develop or acquire other product candidates, technologies or other lines of business;
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• to establish and expand manufacturing capabilities;
• to commercialize our products, including the marketing and distribution of new and existing products;
• to protect our intellectual property;
• to seek and obtain regulatory approvals; and
• to finance general and administrative and research activities that are not related to specific products under development.
In the past, we funded most of our research and development and other expenditures through governmental grants and
ordinary working capital. We intend to raise additional funds in the near future because our current operating and capital resources
may be insufficient to meet future requirements.
If we continue to raise additional funds by issuing equity securities, it will result in further dilution to our existing
shareholders, because the shares may be sold at a time when the market price is low, and because shares issued in equity financing
will normally be sold at a discount to the current market price. Any equity securities issued also may provide for rights,
preferences or privileges senior or otherwise preferential to those of holders of our existing common shares. Unforeseen problems,
including materially negative developments relating to, among other things, product sales, new product rollouts, clinical trials,
research and development programs, our strategic relationships, our intellectual property, litigation, regulatory issues in our
industry, the Chinese market generally or in general economic conditions, could interfere with our ability to raise additional equity
capital or materially adversely affect the terms upon which such funding is available. If we raise additional funds by issuing debt
securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common shares, and
the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through
collaborations and licensing arrangements, we might be required to relinquish significant rights to certain of our technologies,
marketing territories, product candidates or products that we would otherwise seek to develop or commercialize ourselves, or be
required to grant licenses on terms that are not favorable to us.
In the past, we have also received research grants from the PRC government to finance the development of our vaccine
products. There can be no assurance we will receive additional grants in the future.
We do not know whether additional financing will be available to us on commercially acceptable terms when needed. If
adequate funds are not available or are not available on commercially acceptable terms, we may need to downsize or suspend
some or all of our operations and may be unable to continue developing our products. In any such event, our ability to bring a
product to market and obtain revenues could be delayed, competitors could develop products sooner than us, and we could be
forced to relinquish rights to technologies, products or potential products.
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We currently have limited revenue sources and a reduction in revenues of Healive would cause our revenues to decline and
could materially harm our business.
We generate all of our revenues from sales of our vaccine products. All of our product sales in 2003 and 2004, and
approximately 96% of our product sales in 2005, were attributable to Healive. We generated revenue of $2.8 million, $6.5 million
and $8.6 million in sales of Healive in 2003, 2004 and 2005, respectively. We only began marketing and selling our new product
Bilive in 2005, but, to date, sales of this new product has been limited and we do not expect it to accelerate for some time, if at all.
In addition, because Bilive is a combination hepatitis A and B vaccine, while Healive is a hepatitis A vaccine only, an increase in
Bilive sales may result in a decrease in Healive sales as customers substitute Bilive for Healive. We expect that sales of Healive
will continue to comprise a substantial portion of our revenues in the near future. Since Healive and Bilive compete with each
other to a certain degree, this could reduce our revenues and margins, and increase pricing pressure on these products and
otherwise adversely affect our financial results. Because of this relative lack of product diversification, an investment in our
company may incur more risk than investments in companies that offer a wider variety of products or services.
Our legal counsel has advised us that we may have violated Section 402 of the Sarbanes-Oxley Act of 2002, which prohibits an
issuer from extending or maintaining personal loans to its directors or executive officers. As a result, we could become subject
to criminal, civil or administrative sanctions or penalties and we may also face potential private securities litigation.
We have extended and maintained some credit to two of our former directors, one of whom was also a former officer. Lily
Wang, our former director and CFO until March 22, 2006, owed us a loan in the amount of approximately $1.8 million as of
October 2004 arising from her earlier acquisition in September 2003 of Tangshan Yian’s equity interest in Sinovac Beijing. As of
June 30, 2006, the aggregate principal amount of the loan and the accrued interests amounted to approximately $0.55 million.
Another former director, Heping Wang, also owed us unpaid capital contribution to Tangshan Yian in the amount of $2.6 million
in early 2004, although the full amount of this capital contribution had been settled by November 2004. As of December 31, 2005,
Mr. Wang still owed us accrued interests on the $2.6 million promissory note in the amount of $156,468. The management chose
to conservatively value the amount owing and set up a 100% provision in 2005. In addition, Heping Wang, in connection with his
transfer of 100% equity interest in Tangshan Yian to us in 2004, agreed to assume and indemnify Tangshan Yian’s loan
obligations in an aggregate amount of RMB 10.8 million comprising the RMB 9 million principal amount of the loan and a RMB
1.8 million funding fee. Heping Wang has yet to repay us RMB 10.8 million.
Although we have, in an effort to take immediate remedial steps to address any potential violation of the Sarbanes-Oxley
Act, issued a loan repayment letter on June 22, 2006 to each of Lily Wang and Heping Wang demanding immediate full
repayment by them of all outstanding loan balances including accrued interests, we have not received any repayment from them as
the date of this annual report and the potential violation of the Section 402 may cause governmental authorities, such as the U.S.
Securities and Exchange Commission or other U.S. authorities, to impose certain criminal, civil, and or administrative sanctions or
penalties upon us. Similarly, private parties may also bring civil litigations against us for such violations.
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Our disclosure controls and procedures were found ineffective in the fiscal year ended December 31, 2004 and we have
concluded our disclosure controls and procedures remained not fully adequate and effective in the fiscal year ended
December 31, 2005. These shortcomings in our disclosure controls and procedures could have a material adverse effect on our
business, results of operations and the trading price of our common shares.
In 2004, we identified certain shortcomings in our disclosure controls relating to the accounting treatment of acquired
intellectual property, which caused us to believe that our disclosure controls and procedures were ineffective for the fiscal year
ended December 31, 2004. Our management has concluded that, as of the end of the period covered by this annual report, our
existing disclosure controls and procedures remained not fully adequate and effective in ensuring that the material information
required to be disclosed by us in the reports that we file with, or submit to, the SEC under the Securities Exchange Act of 1934, as
amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in by the SEC’s
rules and regulations. Although we have taken a number of remedial actions as more fully described in the section captioned
“Evaluation of the Disclosure Controls and Procedures” of Item 15 of this annual report, no assurance can be made that such
remedial actions may effectively address the inadequacy or ineffectiveness in our disclosure controls and procedures. Nor can we
guarantee that we will not identify further inadequacies and ineffectiveness in our disclosure controls and procedures that will
require additional remedial actions to be taken. Our failure to establish and maintain adequate and effective disclosure controls
and procedures could result in the loss of investor confidence in the accuracy, completeness, reliability and timeliness of our
disclosures, which in turn could harm our business and negatively impact the trading price of our common shares.
We have previously restated certain information in our consolidated financial statements for the fiscal years ended
December 31, 2002, 2003 and 2004. We again identified certain material weaknesses in our internal controls over financial
reporting in the fiscal year ended December 31, 2005, If we fail to maintain an effective system of internal controls over
financial reporting, we may not be able to accurately report our financial results and investors could lose confidence in our
financial and other reporting, which could harm our business and the trading price of our common shares.
As disclosed in our annual report on Form 20-F for the year ended December 31, 2004, we restated certain information in our
consolidated financial statements for the years ended December 31, 2002, 2003 and 2004. We erred in commencing amortization
of our hepatitis A vaccine license in July 2002 instead of April 2001, the date Tangshan Yian contributed the hepatitis A vaccine
to Sinovac Beijing as its capital contribution. We erred in not treating the acquisition of certain licenses as purchases of in-process
research and development. We also erred in capitalizing certain research and development costs that should have been expensed in
2003. Although we have corrected these errors and revised the financial statements, we concluded that, because of these
accounting errors, there were shortcomings in our internal controls over financial reporting as at December 31, 2004.
During the audit of our financial statements for the fiscal year ended December 31, 2005, we identified the following internal
control issues: (1) our failure to timely reconcile our accounts under PRC generally accepted accounting principles to U.S. GAAP;
(2) our failure to withhold the individual income tax with respect to the employees’ stock option gains; (3) the inappropriate
claims by certain of our employees of personal income tax exemptions; (4) our understatement of selling expenses and liabilities;
(5) our understatement of sales commissions and liabilities; and (6) our understatement of income tax expenses and tax liabilities.
In response, we have corrected these errors, and our management initiated a review of our financial and accounting systems and
identified material weaknesses in our internal control system over financial reporting related to our lack of personnel with U.S.
GAAP reporting experience. This was compounded by the resignation of Lily Wang on March 22, 2006 as our CFO, which
resulted in a lack of sufficient oversight over our financial reporting and other compliance matters. We have not appointed a
formal successor CFO, but we have identified a CFO candidate who just commenced his probation period with our company on
July 3, 2006. We have also appointed Ms. Jinling Qin, manager of our finance department, as the Acting CFO during the
transition period. We are in the process of adopting some other remedial actions to rectify the identified material weaknesses in
the internal control over our financial reporting. Such remedial actions include retaining professional consultants to advise on the
internal control over our financial reporting, recruiting a new staff member who is familiar with U.S. GAAP and implementing
procedures to withhold the individual income tax in connection with our employee’s exercise of stock options.
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The efficacy of the steps we have taken to date and the steps we are still in the process of taking to improve the reliability of
our financial statements is subject to continued management review. We cannot be certain that these measures will ensure that we
implement and maintain adequate internal control over financial reporting in the future. Any failure to implement required new or
improved controls, or difficulties encountered in their implementation, could adversely affect our operating results or cause us to
fail to meet our reporting obligations. We cannot guarantee that we will not identify further material weaknesses or significant
deficiencies in our internal control over financial reporting in the future or that future restatements will not be required.
Failure to achieve and maintain effective internal controls could have a material adverse effect on our business, results of
operations and the trading price of our common shares.
We are subject to the reporting obligations under the U.S. securities laws. The SEC, as required by Section 404 of the
Sarbanes-Oxley Act, has adopted rules requiring public companies to include a report of management on such companies’ internal
control over financial reporting in their annual reports that contain an assessment by management of the effectiveness of their
internal control over financial reporting. In addition, an independent registered public accounting firm for a public company must
attest to and report on management’s assessment of the effectiveness of the company’s internal control over financial reporting.
These requirements will first apply to our annual report on Form 20-F for the fiscal year ending December 31, 2007. In an effort
to comply with such requirements by the effective date for compliance, we are working on scoping and preliminary evaluation and
performing the system and process documentation, testing, and if necessary, remediation. In that connection, we have appointed a
professional consultant to assist us in such efforts. Our efforts to implement standardized internal control procedures and develop
the internal tests necessary to verify the proper application of the internal control procedures and their effectiveness will be a key
area of focus for our board of directors, our audit committee and our senior management. We cannot be certain as to the timing of
completion of our evaluation, testing and any remedial actions or the impact of the same on our operations. In addition,
management may not eventually conclude that our internal controls over financial reporting are effective. Moreover, even if our
management does conclude that our internal controls over financial reporting are effective, if our independent registered public
accountants are not satisfied with our internal control structure and procedures, the level at which our internal controls are
documented, designed, operated or reviewed, or if the independent registered public accountants interpret the requirements, rules
or regulations differently from us, they may decline to attest to our management’s assessment or may issue a report that is
qualified. If we cannot implement the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner or with adequate
compliance, we may be subject to sanctions or investigation by regulatory authorities, such as the SEC. Our failure to achieve and
maintain effective internal control over financial reporting could result in loss of investor confidence in the reliability of our
financial statements, which in turn could harm our business and negatively impact the trading price of our common shares.
Furthermore, we anticipate that we will incur considerable costs and use significant management and other resources in an effort
to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.
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If we fail to comply with our listing obligations, we risk being de-listed from the American Stock Exchange, which could have
a material adverse effect on the trading market for our common shares, reduce our ability to raise funds and otherwise have
significant negative consequences to us.
Although we believe we currently comply with the continued listing requirements of the American Stock Exchange in all
material respects, this has not always been true in the past, and we cannot assure you that we will continue to be in compliance
with those requirements in the future. For example, until April 2006, we were not in full compliance with the American Stock
Exchange corporate governance deadlines requiring maintenance of an independent board of directors with a majority of
independent directors, establishment of a compensation committee, corporate governance and nominating committee, and
adoption of a code of ethics. In the event that we were to cease being in compliance with these requirements again, or other
exchange requirements, at some time in the future, the American Stock Exchange could de-list our stock from trading on that
exchange. If our common shares were to be de-listed by the American Stock Exchange, we might be unable to list our common
shares with another stock exchange. In that event, trading of our common shares might be limited to the over-the-counter market.
De-listing of our common shares could have a material adverse effect on the liquidity and price of our common shares and
make it more difficult for us to raise additional capital on favorable terms, if at all. In addition, de-listing by the American Stock
Exchange might negatively impact our reputation and, as a consequence, our business.
If we are unable to successfully compete in the highly competitive biotechnology industry, our business could be harmed.
We operate in a highly competitive environment, and the competition is expected to increase. Competitors include large
pharmaceutical and biotechnology companies and academic research institutions, in each case both within and outside China.
Some of these competitors, particularly large pharmaceutical and biotechnology companies, have greater resources than us. New
competitors may also enter into the markets where we currently compete. Accordingly, even if we are successful in launching a
product, we may find that a competitive product dominates the market for any number of reasons, including:
• The possibility that the competitor may have launched its product first;
• The competitor may have greater access to certain raw materials;
• The competitor may have more efficient manufacturing processes;
• The competitor may have greater marketing capabilities; or
• The competitive product may have therapeutic or other advantages.
The technologies applied by our competitors and us are rapidly evolving, and new developments frequently result in price
competition and product obsolescence. In addition, we may be impacted by competition from generic forms of our products,
substitute products or imports of products from lower priced markets.
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We may not be able to capture market share of China’s increasing “inactive” hepatitis A vaccine market, which could
adversely affect our ability to increase our revenues.
In China, we estimate that approximately 90% of the hepatitis A vaccine sales in 2005 were of the “active” variety and that
only 10% of the hepatitis A vaccine sales were of the “inactive” variety. We estimate GlaxoSmithKline Biologicals S.A.
accounted for 45% of the sales in inactivated hepatitis A vaccine, while we believe we accounted for approximately 55% of these
sales. Effective January 1, 2006, liquid attenuated (active) hepatitis A vaccines were removed from the vaccines batch approval
list that was issued on December 23, 2005 by the National Institute for the Control of Pharmaceutical and Biological Products, or
the NICPBP. Because of this event and the fact that liquid attenuated vaccines manufactured prior to the removal from the batch
approval list have a shelf life of approximately six months, we expect the use of inactive vaccines in China to increase
considerably over the next several years. We believe that Western pharmaceutical companies should benefit from this increasing
market for inactive vaccines since they manufacture the majority of inactive vaccines worldwide. Western pharmaceutical
companies should also benefit because inactive vaccines are more expensive to manufacture and they typically have more
financial resources than Chinese pharmaceutical companies. We may not be able to compete with Western pharmaceutical
companies in the expanding inactive vaccine market, which could adversely affect our ability to grow our revenues.
If end-users, such as hospitals, physicians and vaccinees, do not accept our products, we may be unable to generate significant
revenue.
Even where our vaccines obtain regulatory approval for commercialization, they still may not gain market acceptance among
CDCs, hospitals, physicians, vaccinees and the medical community, which would limit our ability to generate revenue and would
adversely affect our results of operations. CDCs, hospitals and physicians may not recommend products developed by us or our
collaborators until clinical data or other factors demonstrate the safety and efficacy of our products as compared to other available
treatments. Even if the clinical safety and efficacy of our products is established, hospitals and physicians may elect not to
recommend these products for a variety of factors, including the reimbursement policies of government and third-party payors.
There are other vaccines and treatment options for the conditions that many of our products and product candidates target, such as
hepatitis A and B and influenza. In order to successfully launch a product, we must educate physicians and vaccinees about the
relative benefits of our products. If our products are not perceived as easy and convenient to use, are perceived to present a greater
risk of side effects or are not perceived to be as effective as other available treatments, CDC, hospitals, physicians and vaccinees
might not adopt our products. A failure of our products to gain commercial acceptance would have a material adverse effect on
our business, financial condition and results of operations.
Our growth may be adversely affected if market demand for our Anflu vaccine product does not meet our expectations.
The 2006-2007 flu season will be the first flu season for which our Anflu vaccine is expected to be available at the start of
the flu season. Many vaccinees receive their flu vaccinations in the three-month period from September to November in
anticipation of an upcoming flu season, and we expect this period to be one of the most significant sales periods for this product
each year. In anticipation of the 2006-2007 flu season, we intend to build up inventory of our Anflu product in line with what we
believe will be the anticipated demand for the product. If actual demand does not meet our expectations, we may be required to
write off significant inventory and may otherwise experience adverse consequences in our financial condition.
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Even if our pandemic influenza product candidate obtains regulatory approval, by the time we complete development, the
pandemic influenza threat may have abated or alternative vaccines or technologies may have been adopted.
We are devoting significant resources to research and develop a new vaccine for pandemic influenza. Our pandemic
influenza vaccine candidate has only recently completed phase I clinical trials.
The development and clinical testing of our vaccine for pandemic influenza may take several years. Even if our vaccine for
pandemic influenza obtains regulatory approval, by that time the threat of a pandemic influenza outbreak may be reduced, or
government health organizations may have adequate stockpiles of pandemic influenza vaccine or have adopted other technologies
or strategies to prevent or limit outbreaks.
Our business is highly seasonal. This seasonality will contribute to considerable fluctuations of our operating results.
Our business is highly seasonal. For example, the flu season generally runs from November through March of the next year,
and the largest percentage of flu vaccinations is administered between September and November of each year. As a result, we
expect to realize most of our annual revenues from Anflu during this period. We also experience an increase in demand for
Healive and Bilive towards the end of a calendar year as our CDC customers tend to stockpile their vaccine inventory for the
following year during the year-end procurement period. You should expect this seasonality in our business to contribute to
significant quarterly fluctuations in our operating results.
If any of our third-party suppliers or manufacturers cannot adequately meet our needs, the stability of our business operations
could be harmed.
While we use raw materials and other supplies that are generally available from multiple commercial sources, certain raw
materials such as embryonated eggs we use to cultivate our influenza vaccines are in short supply or difficult for suppliers to
produce in accordance with our specifications. We also purchase supplies such as pre-filled syringes for our Healive, Bilive and
Anflu vaccines. If the third-party suppliers were to cease production or otherwise fail to supply us with quality raw materials, and
we were unable to contract on acceptable terms for these materials with alternative suppliers, our ability to produce our products
or to conduct preclinical testing and clinical trials of product candidates would be adversely affected.
In addition, if we fail to secure long-term supply relationship for some of the raw materials we use, our business could be
harmed. For example, we do not have a long-term supply agreement for hepatitis B vaccine we use for Bilive production. The
hepatitis B vaccine we use for Bilive production has been sourced entirely from Beijing Temple of Heaven Biological Products
Co., Ltd. In an agreement dated October 15, 2002, we agreed to purchase all hepatitis B vaccine to be used in our Bilive
production exclusively from Beijing Temple of Heaven for 10 years and to enter into a separate supply agreement in the future to
specify the pricing, quantity, delivery and payment terms of the hepatitis B vaccine supply relationship. However, this agreement
is silent on whether Beijing Temple of Heaven is obligated to furnish us with hepatitis B vaccine for 10 years.
From time to time, concerns are raised with respect to potential contamination of biological materials that are supplied to us.
These concerns can further tighten market conditions for materials that may be in short supply or available from limited sources.
Moreover, regulatory approvals to market our products may be conditioned upon obtaining certain materials from specified
sources. Any efforts to substitute material from an alternate source may be delayed pending regulatory approval of such alternate
source. Although we work to mitigate the risks associated with relying on sole suppliers, there is a possibility that material
shortages could impact product development and production.
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We are controlled by a small number of shareholders and their affiliated entities and their interests may not be aligned with
the interests of our other shareholders.
Our directors and executive officers and their affiliates collectively control approximately 45% of our outstanding common
shares as of March 31, 2006. These stockholders, if they act together, will be able to influence our management and affairs and all
matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. The
concentration of ownership of these shareholders may discourage, delay or prevent a change in control of our company, which
could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might
reduce the price of our common shares. These actions may be taken even if they are opposed by our other shareholders. In cases
where the interests of our significant shareholders are aligned and they vote together, these shareholders may also have the power
to prevent or cause a change in control. In addition, these shareholders could divert business opportunities from us to themselves
or others.
The interests of the existing minority shareholder in our Sinovac Beijing subsidiary may diverge from our own and this may
adversely affect our ability to manage Sinovac Beijing.
Sinovac Beijing, our principal operating subsidiary, is a Sino-foreign equity joint venture in which we directly own a 71.56%
interest and China Bioway Biotech Group Co., Ltd., or China Bioway, an affiliate of Peking University, owns a 28.44% interest.
China Bioway’s interest may not be aligned with our interest at all times. If our interests diverge, China Bioway may exercise its
right under PRC laws to protect its own interest, which may be adverse to us. For example, under China’s joint venture
regulations, unanimous approval of members of a joint venture’s (such as Sinovac Beijing) board of directors who are present at a
board meeting is required for any amendment to the joint venture’s articles of association, the termination or dissolution of the
joint venture company, an increase or decrease in the registered capital of the joint venture company or a merger or de-merger of
the joint venture. China Bioway appoints two of the five directors of Sinovac Beijing’s board. Accordingly, China Bioway has the
ability to block any action that requires unanimous board approval. Further, should we wish to transfer our equity interest in
Sinovac Beijing, in whole or in part, to a third-party, China Bioway has a right of first refusal under China’s joint venture
regulations.
In addition to its statutory rights as a minority shareholder, China Bioway has additional rights under the joint venture
contract and under the articles of association of Sinovac Beijing. The joint venture contract and articles of association require the
consent of each of Sinovac Beijing’s shareholders and/or unanimous board approval on matters such as a major change in the
business line of the company, expansion or amendment of the business scope of the company, transfer of the registered capital by
a shareholder, creation of a mortgage or pledge upon the company’s assets, a change in the organizational form of the company
and designation or removal of the general manager.
Other matters may be decided by a simple majority of Sinovac Beijing’s board of directors. However, under the current
board structure, directors appointed by China Bioway must be present to form a quorum, so China Bioway can effectively block
any action by Sinovac Beijing which requires board approval.
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China Bioway has thus far been cooperative with us in handling matters with respect to the business of Sinovac Beijing.
There is no assurance, however, that China Bioway will continue to act in a cooperative manner in the future.
Some of the predecessor shareholders of Sinovac Beijing and Tangshan Yian were enterprises owning state-owned assets, or
EOSAs. Their failure to comply with PRC legal requirements in asset or share transfers may, under certain circumstances,
result in such transfers being invalidated by government authorities. If this would occur, we may lose our ownership of certain
intellectual property rights that are vital to our business and our equity ownership in Sinovac Beijing and Tangshan Yian.
Sinovac Beijing is currently 71.56% owned by us and 28.44% by China Bioway. Tangshan Yian is currently 100% owned by
us. Some of the predecessor shareholders of Sinovac Beijing and Tangshan Yian, including Shenzhen Kexing Biological
Engineering Ltd., China Bioway, Tangshan Medicine Biotech Co., Ltd., Tangshan Yikang Biotech Co., Ltd. and Tangshan Yian
itself (as Sinovac Beijing’s former shareholder) were EOSAs. Under applicable PRC laws, when EOSAs sell, transfer or assign
assets or equity investments in their possession or under their control to third parties, they are required to obtain an independent
appraisal of the transferred assets or shares and file such appraisal with or obtain approval of such appraisal from PRC
government authorities. After 2004, EOSAs are also required to make such assets or equity transfers at the government-designated
marketplaces. Our acquisitions of intellectual property rights and some of equity interests were subject to these requirements. The
technologies related to hepatitis A vaccine, hepatitis A&B vaccine and influenza vaccine that are vital to our business were
directly or indirectly transferred by Tangshan Yian to us.
Tangshan Yian failed to file with government authorities the appraisal of the hepatitis A vaccine technology that it
transferred in 2001 to Sinovac Beijing as Tangshan Yian’s capital contribution to Sinovac Beijing. Under PRC laws, Tangshan
Yian may also have failed to (1) obtain the appraisal of the hepatitis A&B vaccine technology that it transferred for nil
consideration to Beijing Keding Investment Co., Ltd., or Beijing Keding, in 2002 (Beijing Keding then transferred the technology
to Sinovac Beijing as Beijing Keding’s capital contribution to Sinovac Beijing) and to file such appraisal with government
authorities and (2) obtain the appraisal of the influenza vaccine technology that it transferred to Sinovac Beijing in 2004 and to file
such appraisal with government authorities, if book value of the hepatitis A&B vaccine technology and the influenza vaccine
technology, as applicable, at the time of their transfers, were more than RMB 1 million or 20% of the total fixed assets of
Tangshan Yian. These failures may potentially subject us to the risk of losing the ownership or control of these vaccine
technologies.
In addition, before we acquired our 71.56% equity interest in Sinovac Beijing and 100% equity interest in Tangshan Yian,
both companies had undergone multiple changes in their shareholders and these shareholders’ shareholdings. Some of the EOSA
shareholders of Sinovac Beijing and Tangshan Yian, including China Bioway and Tangshan Medicine Biotech Co., Ltd., have
sold, transferred or assigned their respective equity interests in Sinovac Beijing and Tangshan Yian without fully complying with
laws to appraise the equity interests, to file such appraisals with or obtain regulatory approval of such appraisals from PRC
government authorities or to make equity interest transfers at the government-designated marketplaces as required for transactions
completed after 2004. Similar to the assets transfer, such failure may potentially subject us to the risk of losing the ownership or
control of our equity interests in Sinovac Beijing and Tangshan Yian.
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PRC government authorities may take court actions to invalidate the transfers of the assets or equity investments discussed
above for non-compliance with applicable appraisal, filing and approval requirement. We cannot guarantee that government
authorities will not take such legal actions or that such legal actions, if commenced, will not be successful. Because we depend on
these technologies and because Sinovac Beijing and Tangshan Yian constitute all of our operations, our loss of these technologies
or equity interests in Sinovac Beijing and Tangshan Yian would materially and adversely affect our business operations and
financial condition.
The landlord that leases us our two buildings in Beijing has not yet obtained ownership certificates for the buildings. We may
face the risk that PRC government authorities or third-parties may challenge or invalidate the landlord’s ownership of the two
buildings.
In August 2004, we signed two 20-year leases in Beijing with China Bioway Biotech Group Co., Ltd., pursuant to which we
leased two buildings of approximately 28,000 and 13,300 square feet, respectively, located at the Peking University Biological
Park. We house our Anflu manufacturing and R&D center in these buildings. China Bioway has yet to obtain building ownership
certificates for the two building. Under the two leases, China Bioway agreed to hold us harmless and indemnify us for any
damages or losses we may suffer as a result of its failure to obtain building ownership certificates. China Bioway also pledged its
land use certificate relating to these two leases to a commercial lender in October 2002 for 5 years. In June 2006, China Bioway
guaranteed to us in writing that we have all the legal rights and privileges to use the two buildings as agreed to in the two leases
and that it will indemnify us any losses or damages that could be incurred if our rights and privileges to use such buildings are
impeded or hampered by the commercial lender. We cannot guarantee that China Bioway will ever be able to obtain the necessary
building ownership certificates or that PRC government authorities or third-parties will not challenge or invalidate China
Bioway’s ownership even if it does obtain such ownership certificates. If that happens, we may need to vacate our existing
facilities and build alternative facilities, causing material and adverse disruptions to our business operations.
We became a public company through our acquisition of a public shell company, where we were the accounting acquirer and
assumed all known and unknown potential liabilities of our predecessor entity.
Our share exchange with Net-Force Systems Inc. was accounted for as a reverse merger in which Sinovac Beijing was
deemed the accounting acquirer and Net-Force, which was originally incorporated in 1999, was the legal acquirer. Although we
have disposed of all the assets and liabilities of Net Force to a company controlled by its then president and CEO, we cannot
guarantee that we will not liable for any liabilities related to the conduct by Net-Force of its on-line gaming business prior to its
acquisition by us.
We could be subject to costly and time-consuming product liability actions.
We manufacture vaccines that are injected into vaccinees to protect against infectious illnesses. A failure of our products to
function as anticipated, whether as a result of the design of these products, unanticipated health consequences or side effects, or
misuse or mishandling by third parties of such products or because of faulty or contaminated supplies, could result in injury and as
a result subject us to product liability lawsuits. Claims also could be based on failure to immunize as anticipated. Any product
liability claim brought against us, with or without merit, could have a material adverse effect on us. Even a meritless or
unsuccessful product liability claim could be time consuming, expensive to defend, and could result in the diversion of
management’s attention from managing our core business or result in associated negative publicity.
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Our business exposes us to potential product liability risks that are inherent in the testing, manufacturing and marketing of
biopharmaceutical products. Although we carry regular product liability insurance for Healive (we have yet to purchase product
liability insurance for Bilive or Anflu), we cannot be certain that we will be able to maintain adequate product liability insurance
at a reasonable cost. In addition, we have no clinical trial liability insurance for our clinical trials because such coverage is not
available in mainland China. Any insurance coverage we do have may not be sufficient to satisfy any liability resulting from
product liability claims. A successful product liability claim or series of claims could have a material adverse impact on our
business, financial condition and results of operations.
We depend on our key personnel, the loss of whom would adversely affect our operations. If we fail to attract and retain the
talent required for our business, our business will be materially harmed.
We are a small company with 238 full-time employees as of June 30, 2006, and we depend to a great extent on principal
members of our management and scientific staff. If we lose the services of any key personnel, in particular, Dr. Weidong Yin, our
President and Chief Executive Officer, it could significantly impede the achievement of our research and development objectives
and delay our product development programs and the approval and commercialization of our product candidates. We do not
currently have any key man life insurance policies. We have entered into employment agreements with our executive officers
under which they have agreed to restrictive covenants relating to non-competition and non-solicitation. The employment
agreements do not ensure that we may be able to retain the services of our executive officers for an indefinite period of time in the
future. In addition, recruiting and retaining qualified scientific, technical and managerial personnel and research partners will be
critical to our success. Competition among biopharmaceutical and biotechnology companies for qualified employees in China is
intense and turnover rates are high. There is currently a shortage of employees in China with expertise in our areas of research and
clinical and regulatory affairs, and this shortage is likely to continue. We may not be able to retain existing personnel or attract
and retain qualified staff in the future. If we fail to hire and retain personnel in key positions, we may be unable to develop or
commercialize our product candidates in a timely manner.
We may encounter difficulties in managing our growth, which could adversely affect our results of operations.
We have experienced a period of rapid and substantial growth that has placed and, if such growth continues, will continue to
place a strain on our administrative and operational infrastructure. If we are unable to manage this growth effectively, our
business, results of operations or financial condition may be materially and adversely affected. Our ability to manage our
operations and growth effectively requires us to continue to improve our operational, financial and management controls,
reporting systems and procedures and hiring programs. We may not be able to successfully implement these required
improvements.
RISKS RELATED TO GOVERNMENT REGULATION
We can only sell products that have received regulatory approval and many factors affect our ability to obtain such approvals.
Pre-clinical and clinical trials of our products, and the manufacturing and marketing of our technologies, are subject to
extensive, costly and rigorous regulation by governmental authorities in the PRC and in other countries. Even if we complete
preclinical and clinical trials successfully, we may not be able to obtain applicable regulatory approvals. We cannot market any
product candidate until we have both completed our clinical trials and obtained the necessary regulatory approvals for that product
candidate.
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Conducting clinical trials and obtaining regulatory approvals are uncertain, time consuming and expensive processes. The
process of obtaining required regulatory approvals from the China State Food and Drug Administration, or the China SFDA, and
other regulatory authorities often takes many years to complete and can vary significantly based on the type, complexity and
novelty of the product candidates. For example, it took us approximately ten years to develop and obtain regulatory approval to
commercialize Healive, and it took us 5.5 years and 4.5 years, respectively, to develop and obtain regulatory approval to
commercialize Bilive and Anflu.
There can be no assurance that all of the clinical trials pertaining to our vaccines in development will be completed within
the time frames anticipated by us. We could encounter difficulties in enrolling vaccinees for trials or encounter setbacks during the
conduct of trials that result in delays or trial cancellation. Data obtained from preclinical and clinical studies are subject to varying
interpretations that could delay, limit or prevent regulatory approval, and failure to observe regulatory requirements or inadequate
manufacturing processes are examples of other problems that could prevent approval. In addition, we may encounter delays or
rejections in the event of additional government regulations from future legislation, administrative action or changes in China
SFDA policy or if unforeseen health risks become an issue with the participants of clinical trials. Clinical trials may also fail at
any stage of testing. Results of early trials frequently do not predict results of later trials, and acceptable results in early trials may
not be repeated. For these reasons, we do not know whether regulatory authorities will grant approval for any of our product
candidates in the future.
The process of obtaining regulatory approvals is also lengthy, expensive and uncertain for products that have been developed
by others but which we work to market and sell in China. For example, LG Life Sciences Ltd. granted us a five-year exclusive
right to market and distribute its hepatitis B vaccine in mainland China, subject to our ability to obtain the required regulatory
approvals for this product by February 2009. Under the agreement with LG Life Sciences, we have a limited period of time to
obtain those approvals before it may terminate the agreement. It may take several years or more to obtain the regulatory approvals
necessary for us to be able to market and distribute LG Life Sciences’ hepatitis B vaccine in mainland China, if we are able to
obtain such regulatory approvals at all.
Delays in obtaining China SFDA or foreign approvals of our products could result in substantial additional costs and
adversely affect our ability to compete with other companies. Even if regulatory approval is ultimately granted, there can be no
assurance that we can maintain the approval or that the approval will not be withdrawn. Any approval received may also restrict
the intended use and marketing of the product we want to commercialize.
Outside the PRC, our ability to market any of our potential products is contingent upon receiving marketing authorizations
from the appropriate regulatory authorities. These foreign regulatory approval processes include all of the risks associated with the
China SFDA approval process described above and may include additional risks.
If we are unable to enroll sufficient vaccinees and identify clinical investigators to complete our clinical trials, our
development programs such as pandemic influenza vaccine and Japanese encephalitis could be delayed or terminated.
The rate of completion of our clinical trials, and those of our collaborators, is significantly dependent upon the rate of
enrollment of vaccinees and clinical investigators. Vaccinee enrollment is a function of many factors, including:
• efforts of the sponsor and clinical sites involved to facilitate timely enrollment;
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• vaccinee referral practices of physicians;
• design of the protocol;
• eligibility criteria for the study in question;
• perceived risks and benefits of the drug under study;
• the size of the vaccinee population;
• availability of competing therapies;
• availability of clinical trial sites; and
• proximity of and access by vaccinees to clinical sites.
We may have difficulty obtaining sufficient vaccinee enrollment or clinician participation to conduct our clinical trials as
planned, and we may need to expend substantial additional funds to obtain access to resources or delay or modify our plans
significantly. These considerations may lead us to consider the termination of ongoing clinical trials or development of a product
for a particular indication.
A setback in any of our clinical trials would likely cause a decline in the price of our common shares.
We recently completed phase I clinical trials of a vaccine against the H5N1 strain of pandemic influenza in collaboration
with the China Center for Disease Control and Prevention, or China CDC, in June 2006. The preliminary results of phase I clinical
trial showed good immunogenicity, with a sero-positive rate exceeding the criteria for assessment of vaccines established by
Committee for Proprietary Medicinal Products of the European Union. We intend to apply for authorization from the China SFDA
to begin our phase II trial. We are also planning to develop a vaccine against Japanese encephalitis. Setbacks in any phase of the
clinical development of our product candidates could have a material adverse effect on our business and our future prospects and
financial results and would likely cause a decline in the price of our common shares.
We may not achieve our projected development goals in the time frames we announce and expect. If we fail to achieve one or
more milestones as contemplated, the market price of our common shares could decline.
We set goals for and make public statements regarding our anticipated timing of the accomplishment of objectives material
to our success, such as the commencement and completion of clinical trials and other milestones. The actual timing of these events
can vary dramatically due to factors such as delays or failures in our clinical trials, the uncertainties inherent in the regulatory
approval process and delays in achieving manufacturing or marketing arrangements sufficient to commercialize our products.
There can be no assurance that our clinical trials will be completed, that we will make regulatory submissions or receive
regulatory approvals as planned or that we will be able to adhere to our currently anticipated schedule for the launch of any of our
products. If we fail to achieve one or more milestones as contemplated, the market price of our common shares could decline.
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We rely on third parties to conduct our clinical trials, and those third-parties may not perform satisfactorily, including failing
to meet established deadlines for the completion of such trials.
After we obtain approval to conduct clinical trials for our product candidates, we rely on qualified research organizations,
medical institutions and clinical investigators to enroll qualified vaccinees and conduct our clinical trials. Our reliance on these
third parties for clinical development activities reduces our control over these activities. Furthermore, these third parties may also
have relationships with other entities, some of which may be our competitors. If these third parties do not successfully carry out
their contractual duties or meet expected deadlines, our efforts to obtain regulatory approvals for and commercialize our vaccine
candidates may be delayed or prevented.
Because the medical conditions our vaccines are intended to prevent represent significant public health threats, we are at risk
of governmental actions detrimental to our business, such as product seizure, resumed price controls and additional
regulations.
A pandemic or the perceived risk of a pandemic could result in China or other countries taking actions to protect their
citizens that could affect our ability to control the production and sales of pandemic vaccines or otherwise impose burdensome
regulations on our business. For example, an outbreak of influenza or SARS may subject our manufacturing locations to possible
seizure by the Chinese government. China may also require that we grant compulsory licenses to allow our competitors to
manufacture products using our proprietary technologies or may resume its price control over vaccines although such control has
recently been lifted in China.
We may not be able to comply with applicable good manufacturing practice requirements and other regulatory requirements,
which could have a material adverse affect on our business, financial condition and results of operations.
We are required to comply with applicable good manufacturing practice regulations, which include requirements relating to
quality control and quality assurance as well as corresponding maintenance, record-keeping and documentation standards.
Manufacturing facilities must be approved by governmental authorities before we can use them to commercially manufacture our
products and are subject to inspection by regulatory agencies.
If we fail to comply with applicable regulatory requirements, including following any product approval, we may be subject
to sanctions, including:
• fines;
• product recalls or seizure;
• injunctions;
• refusal of regulatory agencies to review pending market approval applications or supplements to approval applications;
• total or partial suspension of production;
• civil penalties;
• withdrawals of previously approved marketing applications; or
• criminal prosecution.
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We deal with hazardous materials that may cause injury to others and are regulated by environmental laws that may impose
significant costs and restrictions on our business.
Our research and development programs and manufacturing operations involve the controlled use of potentially harmful
biological materials and other hazardous materials. We cannot completely eliminate the risk of accidental contamination or injury
to our employees or others from the use, manufacture, storage, handling or disposal of hazardous materials and certain waste
products. In the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed
our resources or any applicable insurance coverage we may have. We are also subject to PRC laws and regulations governing the
use, manufacture, storage, handling or disposal of hazardous materials and waste products, such as the “Prevention and Control of
Water Pollution Act” and “Environmental Protection Act” enacted by the PRC legislature on May 11, 1984 and December 6,
1989, respectively, as well as waste-disposal standards set by the relevant governmental agencies. It is likely that China will adopt
stricter pollution controls as the country is experiencing increasingly serious environmental pollution. Although we have passed
an environmental examination of our facilities conducted by Beijing Environment Protection Bureau on our hepatitis A vaccine
production line, we can not assure you that we will continue to pass similar environmental examinations in future. If we fail to
comply with applicable environmental laws and regulations or with the environmental conditions attached to our operating
licenses, our operating licenses could be revoked and we could be subject to civil, criminal and administrative penalties. We may
also have to incur significant costs to comply with future environmental laws and regulations. Moreover, we do not currently have
a pollution and remediation insurance policy to mitigate against any risk related to environmental pollution or violation of
environmental law.
RISKS RELATED TO OUR INTELLECTUAL PROPERTY
If we are unable to protect our intellectual property, we may not be able to operate our business profitably.
Our success depends, in part, on our ability to protect our proprietary technologies. We try to protect the technology that we
consider important to our business by filing PRC patent applications and relying on trade secret and pharmaceutical regulatory
protection.
We have five patent applications pending in the PRC relating to our SARS vaccine technology. There are no issued patents
or any pending patent application with respect to our existing vaccine products. The process of seeking patent protection can be
lengthy and expensive, and we cannot assure you that these patent applications, or any patent applications we may make in the
future in respect of other products, will result in patents being issued, or that any patents issued in the future will be able to
provide us with meaningful protection or commercial advantage. Our patent applications may be challenged, invalidated or
circumvented in the future.
In addition to patents, we rely on trade secrets and proprietary know-how to protect our intellectual property. We have
entered into confidentiality agreements (which include, in the case of employees, non-competition provisions) with many of our
employees, consultants, outside scientific collaborators, sponsored researchers and other advisors. These agreements provide that
all confidential information developed or made known to the individual during the course of the individual’s relationship with us
is to be kept confidential and not disclosed to third parties except in specific circumstances. In the case of our employees, the
agreements provide that all of the technology which is conceived by the individual during the course of employment is our
exclusive property. These agreements may not provide meaningful protection or adequate remedies in the event of unauthorized
use or disclosure of our proprietary information. In addition, it is possible that third parties could independently develop
proprietary information and techniques substantially similar to ours or otherwise gain access to our trade secrets.
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We cannot assure you that our current or potential competitors, many of which have substantial resources and have made
substantive investments in competing technologies, do not have and will not develop, products that compete directly with our
products despite our intellectual property rights.
A third party, Shenzhen Kexing Biotech Co., Ltd. in China and granted us a non-exclusive license to the trademark. This
license agreement allows us to use the trademark on our biopharmaceutical products. The current license agreement expires on
December 31, 2006. We have renewed the license agreement with Shenzhen Kexing which will extend our right to use the
trademark on our biopharmaceutical products until December 31, 2011. The license agreement is non-exclusive and terminates
automatically if Mr. Weidong Yin is no longer in control of Sinovac. We are planning to remove the trademark from our
biopharmaceutical products since we have our separate trademarks for each of our products. If the license agreement is
terminated, we may also need to change the Chinese name of Sinovac Beijing.
Intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other
countries. For example, implementation and enforcement of PRC intellectual property-related laws have historically been
deficient and ineffective and may be hampered by corruption and local protectionism. Policing unauthorized use of proprietary
technology is difficult and expensive, and we might need to resort to litigation to enforce or defend patents issued to us or to
determine the enforceability, scope and validity of our proprietary rights or those of others. The experience and capabilities of
PRC courts in handling intellectual property litigation varies, and outcomes are unpredictable. Further, such litigation may require
significant expenditure of cash and management efforts and could harm our business, financial condition and results of operations.
An adverse determination in any such litigation could materially impair our intellectual property rights and may harm our
business, prospects and reputation.
We may depend on market exclusivity for certain of our products, which will afford us less protection than patents.
Assuming regulatory approvals are obtained, our ability to successfully commercialize certain drugs may depend on the
availability of market exclusivity under PRC law, which provides protection for certain new products. Under the PRC’s former
Regulation on the Protection of New Pharmaceuticals and Technology Transfer, new drugs were afforded exclusivity protection
of six, eight or twelve years, depending on the category of the drug in question. During the protection period, the China SFDA
would not accept third parties’ applications for manufacturing the drug under protection.
After China joined the WTO in 2001, the PRC government amended and implemented many laws and regulations in the area
of pharmaceuticals. Currently, the Drug Administration Law, Implementing Regulations on Drug Administration and Drug
Registration Regulation are the primary laws and regulations governing the exclusive protection regime for new drugs.
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The Implementing Regulations on Drug Administration provide that the China SFDA may establish a monitoring period for
up to five years for a certain new drugs to monitor the safety of these products. During the monitoring period, the China SFDA
will not accept third parties’ application for manufacturing or importing the same drug. The China SFDA’s regulations provide
that the monitoring period shall be 3, 4 or 5 years. The China SFDA determines the availability and length of the monitoring
period depending on the approval conditions of the same or similar drugs in China and in overseas markets. According to the
Regulations on the Drug Registration promulgated by the China SFDA in 2005, in case there is more than one application for the
same new drug pending, after the issuance of the first production license afforded with a monitoring period, the other co-pending
applications should be rejected unless a clinical trial application has been approved.
The period of market exclusivity under these Chinese pharmaceutical regulations is considerably shorter than the exclusivity
period afforded by patent protection, which, in the case of invention patents, may last up to 20 years from the national filing date
of the patent directed to the product, its use or method of manufacture. We are relying on market exclusivity under Chinese law
for our vaccines products such as Healive and Bilive. The market exclusivity period for Healive is from December 8, 1999 to
December 7, 2007 and that for Bilive is from January 7, 2005 to January 6, 2008.
If our products infringe the intellectual property rights of third parties, we may incur substantial liabilities, and we may be
unable to sell these products.
Our commercial success depends significantly on our ability to operate without infringing the patents and other proprietary
rights of third parties. Patent applications are maintained incognito until their publication 18 months from the filing date. The
publication of discoveries in the scientific or patent literature frequently occurs substantially later than the date on which the
underlying discoveries were made and patent applications are filed. China, similar to many other countries, adopts the first-to-file
system under which whoever first files a patent application (instead of the one who makes first actual discoveries) will be awarded
patent. Even after reasonable investigation we may not know with certainty whether we have infringed upon a third-party’s patent
because such third-party may have filed a patent application without our knowledge while we are still developing that product. If a
third-party claims that we infringe upon its proprietary rights, any of the following may occur:
• we may become involved in time-consuming and expensive litigation, even if the claim is without merit;
• we may become liable for substantial damages for past infringement if a court decides that our technology infringes upon
a competitor’s patent;
• a court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be
available on commercially acceptable terms, if at all, or which may require us to pay substantial royalties or grant cross
licenses to our patents; and
• we may have to reformulate our product so that it does not infringe upon others’ patent rights, which may not be possible
or could be very expensive and time-consuming.
If any of these events occurs, our business will suffer and the market price of our common shares could decline.
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The success of our business may depend on licensing biologics from, and entering into collaboration arrangements with, third
parties. We cannot be certain that our licensing or collaboration efforts will succeed or that we will realize any revenue from
them.
The success of our business strategy may be, in part, dependent on our ability to enter into licensing and collaboration
arrangements and to manage effectively the resulting relationships. For example, we believe our exclusive right to distribute the
hepatitis B vaccine produced by LG Life Sciences in China is important to our success. We are seeking necessary approval from
PRC government authorities including the China SFDA to market and sell such hepatitis B in China. We cannot assure you that
LG Life Sciences will not terminate its relationship with us, or enter into relationships with third-party competitor of ours in the
future. We also consider important to our business the continuous and stable supply of hepatitis B vaccines from Beijing Temple
of Heaven Biological Products Co., Ltd. for our production of Bilive, our contemplated collaboration with LG Life Sciences in
marketing and distributing our vaccine products in Korea and other countries, our cooperation with China CDC in pandemic
influenza research and market exploration in Mexico with Glovax C.V.
Our ability to enter into agreements with commercial partners depends in part on our ability to convince them of the value of
our technology and know-how. This may require substantial time and effort on our part. While we anticipate expending
substantial funds and management effort, we cannot assure you that strategic relationships will result or that we will be able to
negotiate additional strategic agreements in the future on acceptable terms, if at all. Furthermore, we may incur significant
financial commitments to collaborators in connection with potential licenses and sponsored research agreements. In addition, we
may not be able to control the areas of responsibility undertaken by our strategic partners and may be adversely affected should
these partners prove unable to carry a product candidate forward to full commercialization or should they lose interest in
dedicating the necessary resources toward developing any such product quickly.
Third parties may terminate our licensing and other strategic arrangements if we do not perform as required under these
arrangements. Generally, we expect that agreements for rights to develop technologies will require us to exercise diligence in
bringing product candidates to market and may require us to make milestone and royalty payments that, in some instances, could
be substantial. Our failure to exercise the required diligence or make any required milestone or royalty payments could result in
the termination of the relevant license agreement, which could have a material adverse effect on us and our operations. In addition,
these third parties may also breach or terminate their agreements with us or otherwise fail to conduct their activities in connection
with our relationships in a timely manner. If we or our partners terminate or breach any of our licenses or relationships, we:
• may lose our rights to develop and market our product candidates;
• may lose trade secret protection for our product candidates;
• may experience significant delays in the development or commercialization of our product candidates;
• may not be able to obtain any other licenses on acceptable terms, if at all; and
• may incur liability for damages.
Licensing arrangements and strategic relationships in our industry can be very complex, particularly with respect to
intellectual property rights. Disputes may arise in the future regarding ownership rights to technology developed by or with other
parties. These and other possible disagreements between us and third parties with respect to our licenses or our strategic
relationships could lead to delays in the research, development, manufacture and commercialization of our product candidates.
These disputes could also result in litigation or arbitration, both of which are time-consuming and expensive. These third parties
also may pursue alternative technologies or product candidates either on their own or in strategic relationships with others in
direct competition with us.
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Any cessation or suspension of our collaborations with scientific advisors and academic institutions may increase our costs in
research and development and lengthen our new vaccines development process and lower our efficiency in new products
development.
We work with scientific advisors and academic collaborators who assist us in our research and development efforts. We
generally benefit considerably from the resources, technology and experience such academic collaboration may bring us. Any
cessation or suspension of our collaborations with scientific advisors and academic institutions may increase our costs in research
and development and lengthen our new vaccines development process and lower our efficiency in new products development.
RISKS RELATED TO DOING BUSINESS IN CHINA
Adverse changes in political, economic and other policies of the Chinese government could have a material adverse effect on
the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect
our competitive position.
All of our business operations are conducted in China, and all of our sales are currently made in China. Accordingly, our
business, financial condition, results of operations and prospects are affected significantly by economic, political and legal
developments in China. The Chinese economy differs from the economies of most developed countries in many respects,
including:
• the extent of government involvement;
• the level of development;
• the growth rate;
• the control of foreign exchange;
• the allocation of resources;
• an evolving regulatory system; and
• lack of sufficient transparency in the regulatory process.
While the Chinese economy has experienced significant growth in the past 20 years, growth has been uneven, both
geographically and among various sectors of the economy. The Chinese government has implemented various measures to
encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy,
but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely
affected by government control over capital investments or changes in tax regulations that are applicable to us.
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The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in
recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic
reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business
enterprises, a substantial portion of the productive assets in China is still owned by the Chinese government. The continued
control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect
our business. The Chinese government also exercises significant control over Chinese economic growth through the allocation of
resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential
treatment to particular industries or companies. Efforts by the Chinese government to slow the pace of growth of the Chinese
economy could result in decreased expenditures by hospitals and other users of our products, which in turn could reduce demand
for our products.
Moreover, the political relationship between the United States, Europe, or other Asian nations and China is subject to sudden
fluctuation and periodic tension. Changes in political conditions in China and changes in the state of foreign relations are difficult
to predict and could adversely affect our operations or cause our products to become less attractive. This could lead to a decline in
our profitability.
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on
overall economic growth and the level of healthcare investments and expenditures in China, which in turn could lead to a
reduction in demand for our products and consequently have a material adverse effect on our businesses.
Future changes in laws, regulations or enforcement policies in China could adversely affect our business.
Laws, regulations and enforcement policies in China, including those regulating our business, are evolving and subject to
future change. Future changes in laws, regulations or administrative interpretations, or stricter enforcement policies by the Chinese
government, could impose more stringent requirements on us, including fines or other penalties. Changes in applicable laws and
regulations may also increase our operating costs. Compliance with such requirements could impose substantial additional costs or
otherwise have a material adverse effect on our business, financial condition and results of operations. These changes may relax
some requirements, which could be beneficial to our competitors or could lower market entry barriers and increase competition.
Further, regulatory agencies in China may periodically, and sometimes abruptly, change their enforcement practice. Therefore,
prior enforcement activity, or lack of enforcement activity, is not necessarily predictive of future actions. Any enforcement actions
against us could have a material and adverse effect on us and the market price of our common shares. In addition, any litigation or
governmental investigation or enforcement proceedings in China may be protracted and may result in substantial cost and
diversion of resources and management attention, negative publicity, damage to our reputation and decline in the price of our
common shares.
We rely on dividends paid by our subsidiaries for our cash needs. If they are unable to pay us sufficient dividends due to the
statutory or contractual restrictions on their abilities to distribute dividends to us, our various cash needs may not be met.
We are a holding company, and we rely on dividends paid by our majority-owned subsidiary, Sinovac Beijing, and wholly-
owned subsidiary, Tangshan Yian, for our cash needs, including the funds necessary to pay any dividends and other cash
distributions to our shareholders, service any debt we may incur and pay our operating expenses. The payment of dividends in
China is subject to limitations. Regulations in the PRC currently permit payment of dividends by our PRC subsidiaries only out of
accumulated profits as determined in accordance with accounting standards and regulations in China. To comply with such
accumulated profits requirements, Tangshan Yian is required to set aside at least 10% of its after-tax profits each year to
contribute to its reserve fund until the accumulated balance of such reserve fund reaches 50% of the registered capital of Tangshan
Yian. Tangshan Yian is also required to allocate a portion of its after-tax profits to its employee welfare and bonus fund, the
amount of which is subject to its board of directors. Sinovac Beijing is required to set aside, at the discretion of its board of
directors, a portion of its after-tax profits to its reserve fund, enterprise development fund and employee welfare and bonus funds.
These funds are not distributable in cash dividends. In addition, if Sinovac Beijing or Tangshan Yian incurs debt on its own behalf
in the future, the instruments governing the debt may restrict either company’s ability to pay dividends or make other distributions
to us.
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Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
We receive all of our revenues in Renminbi, which currently is not a freely convertible currency. A portion of our revenues
may be converted into other currencies to meet our foreign currency obligations, including, among others, payment of dividends
declared by our subsidiaries. Under China’s existing foreign exchange regulations, both Sinovac Beijing and Tangshan Yian are
able to pay dividends in foreign currencies without prior approval from the State Administration of Foreign Exchange, or the
SAFE, by complying with certain procedural requirements. However, we cannot assure you that the PRC government will not
take future measures to restrict access to foreign currencies for current account transactions.
Our PRC subsidiaries’ ability to obtain foreign currency is subject to significant foreign exchange controls and, in the case of
amounts under the capital account, requires the approval of and/or registration with PRC government authorities, including the
SAFE. In particular, if our PRC subsidiaries borrow foreign currency loans from us or other foreign lenders, the amount is not
allowed to exceed the difference between the amount of total investment and the amount of the registered capital as approved by
the Ministry of Commerce and registered with the SAFE. Further, such loans must be registered with the SAFE. If we finance our
PRC subsidiaries by means of additional capital contributions, the amount of these capital contributions must first be approved by
the relevant government approval authority. These limitations could affect the ability of our PRC subsidiaries to obtain foreign
exchange through debt or equity financing.
Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.
The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things,
changes in China’s political and economic conditions. The conversion of Renminbi into foreign currencies, including U.S. dollars,
has historically been set by the People’s Bank of China. On July 21, 2005, the PRC government changed its policy of pegging the
value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a band against a
basket of certain foreign currencies. This change in policy resulted initially in an approximately 2.0% appreciation in the value of
the Renminbi against the U.S. dollar. Since the adoption of this new policy, the value of Renminbi against the U.S. dollar has
fluctuated on a daily basis within narrow ranges, but overall has continued to strengthen against the U.S. dollar. There remains
significant international pressure on the PRC government to further liberalize its currency policy, which could result in a further
and more significant appreciation or depreciation in the value of the Renminbi against the U.S. dollar. We rely entirely on
dividends paid to us by our subsidiaries Sinovac Beijing and Tangshan Yian, any significant revaluation of the Renminbi may
have a material adverse effect on our revenues and financial condition, and the value of, and any dividends payable on, our
common shares in foreign currency terms. For example, to the extent that we need to convert U.S. dollars into Renminbi for our
operations, appreciation of the Renminbi against the U.S. dollar would reduce the Renminbi amount we receive from the
conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making dividend payments on
our common shares or for other business purposes, appreciation of the U.S. dollar against the Renminbi would reduce the U.S.
dollar amount available to us.
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Our business benefits from certain government incentives. Expiration of, or changes to, these incentives could have a material
adverse effect on our operating results by significantly increasing our tax expenses.
The PRC government has provided various incentives to foreign-invested companies, including Sinovac Beijing and
Tangshan Yian, in order to encourage development of investment by foreigners. Such incentives include reduced tax rates and
other measures. Under the PRC tax laws, the average domestically-owned companies are subject to an enterprise income tax rate
of 33% and a VAT rate of 17%. Currently, Sinovac Beijing is subject to a 7.5% enterprise income tax rate until 2006 and a 15%
tax rate thereafter, and subject to a preferential VAT rate of 6%. Tangshan Yian is subject to a reduced EIT rate of 24% and a
preferential VAT rate of 6%.
However, changes to the PRC’s enterprise income tax law are scheduled for consideration in 2006 and could, if passed into
law, adversely affect the taxation of Sinovac Beijing and Tangshan Yian and/or remittances by Sinovac Beijing and Tangshan
Yian to us. While the specifics of possible revisions to the law have not been determined, a director of the Department of
International Taxation at the PRC State Administration of Taxation, or the SAT, has publicly indicated that some of the key
elements may include a unified tax rate for foreign and domestic invested enterprises (which is likely to be set at a higher rate than
Sinovac Beijing and Tangshan Yian have been paying) and a restructuring of China’s tax incentives that could include the
elimination of certain tax holidays and incentives. The director stated that the SAT is likely to implement transitional measures for
foreign invested enterprises like Sinovac Beijing and Tangshan Yian but added that the transition period is likely to be short.
Other changes in PRC tax law that would adversely effect us about which there has been speculation include the possible
introduction of a dividend withholding tax.
As noted above, historically, we have benefited from tax holidays and incentives. The extent and timing of any changes in
the PRC’s tax laws is uncertain. However, the first review of the new law is scheduled for August 2006. The director indicated the
SAT’s goal is for the law to be enacted in March 2007 effective on or around January 2008. The director’s comments, of course,
are not binding on the PRC government and there can be no assurance as to the nature, extent and scope or timing of changes in
the PRC’s tax laws or their possible effect on us. If adopted, we believe certain of these changes could significantly increase our
tax expenses.
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Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our
PRC resident shareholders to personal liability and limit our ability to acquire PRC companies or to inject capital into our
PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise adversely affect us.
SAFE issued a public notice in October 2005, SAFE Notice 75, requiring PRC residents to register with the local SAFE
branch before establishing or controlling any company outside of China, or “an offshore special purpose company,” for the
purpose of acquiring assets or equities of PRC companies. In addition, a PRC resident who is the shareholder of an offshore
special purpose company is required to amend its SAFE registration with the local SAFE branch, with respect to that offshore
special purpose company, to reflect any increase or decrease of capital, transfer of shares, merger, division, equity investment or
creation of any security interest over the assets located in China. If any PRC shareholder fails to make the required SAFE
registration or amendment, the PRC subsidiaries of that offshore special purpose company may be prohibited from distributing
their profits and the proceeds from any reduction in capital, share transfer or liquidation, to the offshore special purpose company.
Moreover, failure to comply with SAFE registration and amendment requirements described above could result in liability under
PRC laws for evasion of applicable foreign exchange restrictions. SAFE Notice 75 applies retroactively to PRC residents who
have established or controlled an offshore special purpose company that has made onshore investments in the PRC prior to the
issuance of SAFE Notice 75, in which case such PRC residents were required to complete the registration procedures by
March 31, 2006. Mr. Weidong Yin, our chairman of the board of directors, chief executive officer and president and Mr. Heping
Wang are subject to the above registration requirements, but only Mr. Weidong Yin has made the required SAFE registration with
respect to his investments in our company. The failure of Mr. Heping Wang to make the registration, or these beneficial owners to
timely amend their SAFE registrations, where required, pursuant to the SAFE Notice 75 or the failure of future beneficial owners
of our company who are PRC residents to comply with the registration procedures set forth in SAFE Notice 75 may result in a
restriction on our PRC subsidiaries’ ability to distribute profits to us or otherwise adversely affect our business.
As it remains uncertain how SAFE Notice 75 will be interpreted or implemented, we cannot predict how and to what extent
it will affect our business operations or future strategy. For example, we may be subject to a more stringent review and approval
process with respect to our foreign exchange activities, such as remittance of dividends, re-investments of profits and foreign
currency-denominated borrowings, which may adversely affect our results of operations and financial condition. In addition, if we
decide to acquire a PRC company with equity interests or assets, we or the owners of such company, as the case may be, may not
be able to complete the necessary approvals, filings and registrations for the acquisition. This may restrict our ability to implement
our acquisition strategy and adversely affect our business and prospects.
PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from
making loans or additional capital contributions to our PRC operating subsidiaries and affiliated entities.
We must comply with PRC legal requirements relating to foreign debt registration and foreign-invested companies’
“registered capital” and “total investment.” “Registered capital” refers to the capital contributed to or paid into a foreign-invested
company in cash, technology, land use rights or other tangible or intangible properties of value and “total investment” normally
refers to the amount of such company’s registered capital plus all external borrowings by such company. The amounts of a
foreign-invested company’s registered capital and total investment are set forth in the company’s constitutional documents and
approved by the competent PRC government authority in advance. Change of the foreign-invested company’s registered capital
and total investment in the case of Sinovac Beijing, must be approved by its minority shareholder, China Bioway.
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Loans by us to Sinovac Beijing or Tangshan Yian cannot exceed the difference between such company’s registered capital
and total investment, unless the company has obtained the approval of the approval authority and, in Sinovac Beijing’s case, the
approval of China Bioway, to increase the amount of total investment. Further, such loans must be registered with the SAFE or its
local counterpart.
We may also decide to finance our PRC subsidiaries by making additional capital contributions. These additional
contributions must be approved by the government approval authority and, in the case of Sinovac Beijing, by China Bioway. We
cannot assure you that we will be able to obtain these government registrations or approvals, or the approval of China Bioway, on
a timely basis, if at all, with respect to future loans or additional capital contributions by us to our subsidiaries or affiliates. If we
fail to receive such registrations or approvals, our ability to capitalize our PRC operations would be negatively affected, which
could adversely and materially affect the liquidity of our subsidiaries and our ability to expand our business.
ITEM 4.
INFORMATION ON THE COMPANY
A. History and Development of the Company
We are a holding company and conduct our business in China through our 71.56% majority-owned subsidiary, Sinovac
Beijing, and our wholly-owned subsidiary, Tangshan Yian. Sinovac Beijing was incorporated on April 28, 2001 and Tangshan
Yian was incorporated on February 9, 1993.
We were incorporated in Antigua and Barbuda on March 1, 1999. Before we adopted our current name on October 21, 2003,
we were called “Net-Force System Inc.” and were primarily engaged in the online gaming business. We were quoted on the OTC
Bulletin Board on February 21, 2003. In September 2003, we issued 10 million new shares to Lily Wang, one of our current
principal shareholders, to acquire a 51% equity interest in Sinovac Beijing that Ms. Wang had contracted to purchase from certain
of Sinovac Beijing’s then shareholders for cash immediately before the above 51% share transfer. However, this 51% equity
interest in Sinovac Beijing was transferred to us directly from these shareholders and was recorded under applicable PRC law
transfer documents as a cash transaction. Lily Wang was responsible for paying the cash to these shareholders. The transfer of the
Sinovac Beijing equity interest to us was registered and approved by PRC government authorities in August 2004. In February
2005, we acquired an additional 20.56% equity interest in Sinovac Beijing for approximately $3.3 million in cash. We currently
own 71.56% of the equity interest in Sinovac Beijing.
In January 2004, we entered into a share purchase agreement with Heping Wang and issued him 3.5 million of our common
shares (1.5 million of 3.5 million common shares were pledged with us and have not been released to him) and a promissory note
in the amount of $2.2 million to acquire from him a 100% equity interest in Tangshan Yian that Mr. Wang had contracted to
purchase from Tangshan Yian’s then two shareholders immediately before the above 100% share transfer. However, this 100%
equity interest in Tangshan Yian was transferred to us directly from these shareholders and was recorded under applicable PRC
law transfer documents as a cash transaction. Heping Wang was responsible for paying the cash to the two shareholders. The
transfer of the Tangshan Yian equity interest by Mr. Wang to us was registered and approved by PRC government authorities in
October 2004.
On December 8, 2004, we transferred our listing venue from the OTC Bulletin Board to the American Stock Exchange after
satisfying all of the latter’s listing requirements.
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Our principal executive offices are located at No. 39 Shangdi Xi Road, Haidian District, Beijing 100085, People’s Republic
of China. Our telephone number at this address is (86-10) 8289-0088. Investor inquiries should be directed to us at this address
and telephone number. Our website is www.sinovac.com. The information contained on our website is not part of this annual
report. Our agent for service of process in the U.S. is CT Corporation System located at 111 Eighth Avenue, New York, New
York 10011.
B. Business Overview
We are a China-based biopharmaceutical company that focuses on the research, development, manufacturing and
commercialization of vaccines that protect against human infectious diseases. Our portfolio of regulatory-approved products
consists of vaccines against the hepatitis A, hepatitis B and influenza viruses. In 2002, we successfully launched our first product,
Healive, which is the first inactivated hepatitis A vaccine developed, produced and marketed in China. In 2005, we received
regulatory approvals in China for the production and sales of our Bilive and Anflu vaccines. Bilive is a combined hepatitis A and
B vaccine and Anflu is a flu vaccine. We are currently developing vaccines against the SARS virus, the H5N1 strain of pandemic
influenza virus, and the Japanese Encephalitis virus.
To date, we have successfully developed three vaccines.
• Healive. In May 2002, we obtained final PRC regulatory approval for production of Healive. Healive is the first
inactivated hepatitis A vaccine developed in China. The hepatitis A virus, which is endemic in China and other
developing countries, primarily impacts the liver by causing it to swell and preventing it from functioning properly. A
person with hepatitis A often shows no signs or symptoms, though jaundice or yellowing of the eyes and skin and fever
are common. Hepatitis A can incapacitate or weaken victims for several weeks or even months. The disease is highly
contagious and can be spread by close personal contact with someone carrying the virus, by contaminated consuming
food prepared by someone with the disease or by drinking water that has been contaminated by hepatitis A. The safest
and most effective form of protection from hepatitis A is vaccination. We sold approximately 0.5 million, 1.0 million and
1.3 million doses of Healive in 2003, 2004, and 2005, respectively.
Hepatitis A vaccines utilize either a dead or weakened form of the infectious pathogen to elicit an immune response in
the vaccinee without causing the medical complications associated with the disease. Inactivated hepatitis A vaccines such
as Healive, which use a dead form of the virus, offer a favorable alternative to attenuated vaccines, which use a live virus
that has been weakened through chemical or physical processes. Attenuated hepatitis A vaccines are seldom used
internationally because of their limitations, principally a shorter shelf life and shorter immunization period. In 2005, we
estimate that approximately 17 million doses, or approximately 90% of all hepatitis A vaccines sold in China, were
attenuated vaccines; with the remainder 10% inactivated vaccines. The market share of liquid formulations of attenuated
hepatitis A vaccines is expected to decrease dramatically because they have been, effective January 1, 2006, excluded
from the vaccines batch approval list issued by the National Institute for the Control of Pharmaceutical and Biological
Products, or the NICPBP, on December 23, 2005. When taking into account this new regulation and the fact that the
shelf life of liquid attenuated vaccines is approximately six months, which is significantly shorter than Healive’s 2.5
years, we expect this will present us with substantial growth opportunities for our Healive vaccine in terms of sales and
market share.
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• Bilive. In June 2005, we obtained final PRC regulatory approval for the production of our combined hepatitis A and B
vaccine, Bilive, and began selling this product in July 2005. Bilive is a combination vaccine formulated with purified
inactivated hepatitis A virus antigen, which we manufacture, and recombinant (yeast) hepatitis B surface antigen, which
we source from a third-party supplier. The vaccine acts by inducing the body’s immune system to generate antibodies as
a reaction to exposure to hepatitis A and hepatitis B antigens. Similar to hepatitis A, hepatitis B is endemic in China, a
major worldwide disease and a serious global public health issue. It is preventable with safe and effective vaccines that
have been available since 1982; however, information, education and cost have often prevented the mass vaccination
programs that would help defeat the virus, particularly in China. A substantial proportion of people who have been
infected with the hepatitis B virus will carry chronic or lifelong infections. The chronically infected are at high risk of
death from cirrhosis of the liver or liver cancer.
• Anflu. In October 2005, we received final PRC regulatory approval for the production of our Anflu vaccine against
influenza. The primary type of influenza vaccines used worldwide is the split virus vaccine, which contains specially
treated virus particles. Our Anflu vaccine is an inactivated split flu vaccine formulated from three split inactivated virus
solutions. Anflu is standardized according to the WHO annual recommendation each year. We expect to produce 300,000
doses of Anflu in 2006 for the 2006-2007 flu season.
We are currently developing vaccines against three other types of viruses.
• Pandemic Influenza. Signs of a possible pandemic flu have emerged initially in Southeast Asia, and have been reported
in other parts of the globe, as lethal infections of poultry and humans with the H5N1 strain of influenza virus continue to
be reported. While there is no confirmed evidence of human-to-human transmission, there have been suspected cases
identified in Indonesia in May 2005. It is feared that if the H5N1 influenza virus undergoes either a genetic alteration or
recombination with a human influenza virus, a new subtype could emerge which could be both highly contagious and
highly lethal in humans. Such a subtype could potentially cause a global influenza pandemic. The WHO has led global
efforts to develop a viable vaccine against the H5N1 virus and, in order to encourage the development of influenza flu
vaccines, has been providing, since early 2004, the H5N1 bird flu virus strain, developed through reverse genetics at no
cost to vaccine manufacturers, including us, around the world. We recently completed the phase I clinical trial of the
pandemic influenza vaccine in China in June 2006. The preliminary results of phase I clinical trial showed good
immunogenicity, with a sero-positive rate exceeding the criteria for assessment of vaccines established by Committee for
Proprietary Medicinal Products of the European Union. This vaccine has been developed in collaboration with the China
CDC. Although we are required to provide a certain amount of funding for research and development, to date, all of the
funding of our development of the vaccine has been from the Chinese government. We plan to apply for additional
government grants to fund further development of this product. Under our collaboration with the China CDC, we would
retain commercialization and intellectual property rights to the final product. However, we have agreed to provide
funding, after we gain profits from the sale of pandemic influenza vaccines, to the China CDC for future research and
policy making relating to the pandemic influenza.
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• Japanese Encephalitis (or JE). The JE virus is a mosquito-borne virus that can infect the central nervous system in
human beings and animals. JE is a significant public health problem in Southeast Asia and the Western Pacific. In China,
the transmission of JE is usually seasonal, occurring in summer and autumn, mainly from July to September. Currently
available inactivated vaccines derived from animal cells require multiple inoculations and may cause undesirable side
effects. We are in pre-clinical stage of development for a new, potentially safer and more effective vero-cell, or animal
cell, derived inactivated JE vaccine that we believe will be more efficacious than other animal cell derived vaccines. This
cell line is immortalized and genetically stable, and can be cultivated in large-scale, micro-carrier bioreactor systems.
These systems can increase the yield of cells, simplify the operation and stabilize the cultivation condition, all of which
facilitates large scale automated production. The PRC government has recommended JE vaccinations be undertaken
since 2005, and many provincial CDCs have included JE vaccinations into their expanded programs of immunization.
We believe that JE will serve as our entrance into this public market where immunization is sponsored by PRC
government authorities.
• SARS. The SARS epidemic claimed 774 lives worldwide in 2003. At a WHO-sponsored convention of leading SARS
researchers and scientists from 15 nations in late 2003, it was concluded that a recurrence of SARS, which spread to
more than 35 countries in a matter of months in 2003, could develop into a full-blown global pandemic. We were the first
company to complete the phase I clinical trial of our inactivated SARS vaccine. The phase I trial was completed in
December 2004, and the trial demonstrated no serious adverse reactions. Currently, because the SARS epidemic has
subsided, we are not proceeding with further clinical trials. However, should another outbreak happen in the future, we
believe that we could rapidly initiate the phase II and phase III trials. Although we have not completed the development
and commercialization of the SARS vaccine, we believe that our efforts have raised our profile internationally and given
us valuable experience in working with government and international organizations in the fight against infectious
diseases.
MARKET OVERVIEW
The immune system and vaccines
The immune system is the body’s natural defense mechanism for fighting disease caused by infectious pathogens, which are
organisms such as bacteria, viruses and other microbes. An immune response may be induced by natural exposure to a pathogen
or by a controlled exposure to the antigens embodied in a pathogen by using a vaccine. A vaccine contains a dead or weakened
form, or a derivative, of an infectious pathogen, including the antigens that allow the -body to recognize the pathogen. Exposure to
a vaccine enables the immune system to rapidly recognize and ultimately destroy the pathogen and prevent it from further
infecting the body. Several doses of a vaccine may be needed for a full and effective immune response. In addition, the immunity
provided by some vaccines is not life long. In such cases, the immune response may decrease over time, requiring subsequent
doses of a vaccine, or boosters, to restore or increase immunity toward a specific pathogen.
Our target markets
Hepatitis A
Hepatitis A is endemic in developing nations such as China. According to a research report published in 1997 entitled
“Epidemiology Investigation from 1992 to 1995”, so far the most recent national survey containing hepatitis A data, China’s
hepatitis A infection rate in some areas is as high as 80% of the population. Annually, this translates into approximately
2.4 million documented cases of hepatitis A. However, this figure is believed to represent only a fraction of the actual number of
new cases, particularly among China’s poor, rural population, among whom hepatitis cases often go undiagnosed or unreported.
Hepatitis A is caused by a virus called hepatitis A virus, or HAV. It infects the liver by making it swell and preventing it from
functioning properly. Hepatitis A is contagious and can be spread by close personal contact with someone carrying the virus.
Hepatitis A can also be contracted by consuming food that has been prepared by someone with the disease or by drinking water
that has been contaminated by the virus. Hepatitis A can be passed to anyone, but those who are more likely to contract the virus
are persons who live with someone who has hepatitis A, either through frequent contact, people who travel to foreign countries,
and intravenous drug users. Persons with hepatitis A virus infection may not have any signs or symptoms of the disease. If
symptoms are present, they usually occur abruptly and usually last less than two months. Vaccinees who recover from hepatitis A
develop antibodies that provide life-long protection from future infections.
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Hepatitis B
The Hepatitis B virus, or HBV, is regarded as the leading cause of liver cancer worldwide. HBV can cause chronic lifelong
infection, cirrhosis (scarring) of the liver, liver cancer, liver failure and death. We estimate HBV infection rate to be 60%-70% of
the population in China. Symptoms for hepatitis B are similar to hepatitis A. Transmission of hepatitis B occurs when blood or
body fluids from an infected person enters the body of a person who is not immune. HBV can be passed to anyone; but those who
are more likely to contract the virus are persons who remain in the vicinity of HBV, use illicit intravenous drugs, receive
therapeutic blood products or dialysis treatment and receive long term blood dialysis. HBV is typically spread by having
unprotected sexual intercourse with an infected person, by sharing needles, or from an infected mother to her child during birth.
According to the Evaluation Report on Chinese National Expanded Immunization Plan in 2004, the hepatitis B vaccination rate
from 2001 to 2004 in China was approximately 76% for children born in hospitals and approximately 28% for children born at
home. During the same period of 2001 to 2004, an average of 16.4 million babies were born in China every year according to the
China Population & Development Research Center.
Influenza
Influenza, commonly known as flu, is an infection of the respiratory tract caused by an influenza virus. Influenza is highly
contagious and occurs mainly in the late fall, winter and early spring. Influenza affects all age groups and commonly causes
moderate to severe illness that results in absences from school and work and lost productivity. Some individuals, however,
develop serious complications, such as pneumonia, that require hospitalization and may even result in death. Flu-related
complications can occur at any age; however, the elderly and those with weakened or impaired immune systems are much more
likely to develop serious complications than are younger, healthier people.
Pandemic influenza
When a new, highly infectious and dangerous strain of the influenza virus appears, the general lack of immunity to this strain
in the general population can lead to a pandemic outbreak that quickly spreads. Three influenza pandemics have occurred in the
20th century, the most recent of which occurred in 1968. By United States government estimates, pandemic flu has a greater
potential to cause more deaths and illnesses than virtually any other natural health threat. Signs of a possible pandemic flu have
emerged in Southeast Asia, as lethal infections of poultry and humans with H5N1 influenza virus continue. This virus is now
endemic in bird populations, which increases the likelihood of continued human exposure and the risk of a pandemic flu outbreak.
The symptoms of human influenza include fever, sore throat, cough and in severe cases pneumonia. The symptoms of pandemic
influenza in humans, however, may be much more serious. Human deaths from the H5N1 virus were unknown until 1997, when
six people in Hong Kong died from the virus. Vaccines are the principal medical intervention for protecting individuals against
pandemic influenza. If available rapidly and in sufficient quantities, they can reduce the morbidity and mortality of a pandemic
influenza outbreak.
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Japanese encephalitis
Japanese encephalitis is a mosquito-born virus that can infect the central nervous system in human beings and animals. JE is
a significant public health problem in Southeast Asia and the Western Pacific. In China, the transmission of JE is usually seasonal,
occurring in summer and autumn, mainly from July to September. At present, therapy of JE involves supportive care to control the
symptoms of the disease. Children are particularly susceptible to the JE virus. The typical symptoms of JE include unusual
increase of body temperature, headaches, and unconsciousness. The course of disease is about two weeks and it can result in a
mortality rate of about 30%. In endemic areas, 85% of cases are children under 15 years old, and those under 10 years old are
susceptible to serious neurological and psychiatric complications such as inability to speak, paralysis, imbecility, dementia,
malformation of limbs and convulsions. Currently available inactivated vaccines derived from animal cells require multiple
inoculations and may cause side effects.
OUR STRATEGY
Our near-term goal is to become the leader in the discovery, development, manufacture and commercialization of vaccines
against human infectious diseases in China and our long-term goal is to become an international leader in this area. The key
elements of our strategy are to:
• Maximize sales of our existing products within the Chinese market. We believe that there is significant opportunity to
increase sales of our vaccines within the Chinese market. We plan to seek opportunities to build our brand awareness and
increase the market penetration of our existing products in the PRC by increasing our marketing efforts, expanding our
distribution network and continuing to build relationships with CDCs, hospitals and physicians.
• Develop new vaccines that address unmet medical needs and improve existing vaccines to enhance their efficacy. We
intend to continue to evaluate and develop additional product candidates to expand our pipeline where we perceive a
significant unmet medical need and commercial potential, and to improve existing vaccines to enhance their efficacy in
preventing diseases.
• Improve the quality of our vaccine products and lower our production costs. We intend to continue to improve the
quality of our vaccine products to rival the quality of our key international competitors’ vaccine products such as their
hepatitis A vaccines and their combined hepatitis A and hepatitis B vaccines. While improving the quality of our vaccine
products, we also intend to lower our productions costs by securing stable supply of more affordable raw materials,
reducing the marketing and sales cost and other administrative costs.
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• Expand our manufacturing facilities to meet need of the growing Chinese market and other geographic markets. To the
extent practicable, we intend to continue to develop and expand our manufacturing capabilities to meet growing demands
in China and abroad. We currently maintain a production plant for our marketed hepatitis vaccines, and in October 2005
we completed the build-out and GMP validation of a manufacturing facility for our influenza vaccine. We intend to
increase the production capacity of our influenza vaccine by constructing an additional new vaccine production line.
While we believe we currently have the capacity to meet our near term anticipated production needs, we may seek to
expand our manufacturing facilities to meet the growing demand of Chinese and other worldwide markets.
• Acquire new technologies and products that target large potential market opportunities. We seek suitable opportunities
to partner on, or in-license or acquire, new products or innovative technologies, particularly those that could help us gain
market share and that target large potential market opportunities and significant unmet medical needs. We believe that
pursuing selective acquisitions of companies or technologies in businesses that complement ours could enhance our
competitiveness and strengthen our market position. We believe that our relationships with many industry participants
such as LG Life Sciences Ltd., China CDCs and our knowledge of, and experience in, the biopharmaceutical industry in
China allow us to understand industry trends, technological developments and practical applications, which will assist us
in making acquisition decisions.
• Seek foreign regulatory approvals and expand beyond the Chinese domestic market to markets such as Mexico, Latin
America and Southeast Asia. We intend to increase our sales to international markets and enhance awareness of our
products outside of China. We plan to seek regulatory approval to sell a number of our products in several developing
countries, particularly certain Southeast Asian and South American countries and Mexico, where Glovax C.V. is
assisting us with regulatory matters and marketing efforts. We will continue to develop products targeting these and other
potential international markets.
OUR PRODUCTS
We specialize in the sales, marketing, manufacturing, and development of vaccines for infectious disease with significant
unmet medical need. Below is a table that outlines our current marketed products and those which we have developed or are
developing.
Product
Healive
Bilive
Anflu
Pandemic Influenza Vaccine
Japanese Encephalitis Vaccine
SARS Vaccine
Indication
Hepatitis A
Combination Hepatitis A & B
Influenza
Pandemic Influenza Virus
Japanese Encephalitis
SARS
35
Stage
Development
Marketed
(cid:57)
(cid:57)
(cid:57)
(cid:57)
(cid:57)
(cid:57)
(cid:57)
(cid:57)
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Healive
Healive is an inactivated hepatitis A vaccine that is administered intramuscularly. Available in different doses for use by both
adults (1.0 ml dose) and children (0.5 ml dose), Healive is the first and currently the only inactivated hepatitis A vaccine
developed in China. Healive took approximately 10 years to develop and was granted a New Drug Certificate by the China SFDA
in 1999. We began marketing and sales of Healive in May 2002. Our current manufacturing capacity for hepatitis A vaccines is
6 million doses per year. In 2003, 2004, and 2005, we sold approximately 0.5 million, 1.0 million and 1.3 million doses of Healive
that amounted to approximately $2.8 million, $6.5 million and $8.3 million in revenues, respectively. In 2005, approximately 90%
of aggregate hepatitis A vaccines sold in China to date have been attenuated vaccines, with only 10% of hepatitis A vaccines sold
in China being inactivated vaccines. Since January 1, 2006, however, liquid attenuated hepatitis A vaccines, which have
historically represented approximately 80% of the hepatitis A vaccine sales, have been excluded from the vaccines batch approval
list issued by the NICPBP on December 23, 2005. When taking into account this new regulation and the fact that the shelf life of
liquid attenuated vaccines is approximately six months, which is significantly shorter than Healive’s 2.5 years, we expect that
there may be a significant increase in demand for inactive hepatitis A vaccines after that time, and that this represents a significant
opportunity for us.
As of December 31, 2005, nine post-marketing clinical trials had been conducted on Healive. In each of these nine clinical
trials, participating volunteers were vaccinated with either Healive or a control vaccine. In these clinical trials, Healive
demonstrated a better safety profile and immunogenicity than the control vaccine. Since the launch of Healive, we estimate over
2 million doses have been sold.
Healive has demonstrated a good safety profile. The most common reactions following vaccination of Healive that have been
recorded include pain at the site of injection, warmth, redness and indurations. Systemic events include fever, dizziness, nausea,
fatigue and headache. These events were transient, only rarely reported and were considered by the subjects as mild.
Bilive
Bilive is a combined vaccine formulated by purified inactivated hepatitis A virus antigen, available from Healive, and a
recombinant yeast-derived hepatitis B surface antigen that we source. Bilive is used to prevent the infection of hepatitis A and
hepatitis B. Bilive is available in different doses for use in both adults and children. 1.0ml dose is for non-immune adults and
adolescents 16 years of age and older. 0.5ml dose is for pediatric use in non-immune infants, children and adolescents from one
year up to and including 15 years of age. We produce hepatitis A used in producing Bilive on our own and the hepatitis B is
sourced from Beijing Temple of Heaven Biological Products Co., Ltd., one of our key suppliers.
Bilive is the first, and currently the only combined inactivated hepatitis A and B vaccine developed and marketed in China.
Bilive took approximately 5 years to develop and was granted a New Drug Certificate by the China SFDA in January 2005. In
June 2005, we obtained a GMP Certificate issued by the China SFDA to our Bilive manufacturing facilities. We began marketing
and sales of Bilive in July 2005. The standard Bilive vaccination schedule consists of three doses. The second dose is administered
one month after the first dose and the third dose is administered six months after the first dose. Booster vaccinations of hepatitis B
vaccines are recommended five years after the initial immunization. Bilive vaccinations must be privately paid by the recipients
under China’s current vaccination program. Accordingly, we do not expect to generate more sales from Bilive than Healive. Since
Bilive’s launch into the market in July 2005, we have sold approximately 40,000 doses of Bilive in 2005. We sold approximately
10,000 doses of Bilive in the first half of 2006.
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Clinical trials on Bilive were performed in two different locations in China between 2002 and 2003. Young adults and
children were tested separately. Within each group, those young adults and children were further subdivided into three groups to
be vaccinated by either hepatitis A, hepatitis B or a combined hepatitis A and B vaccine. No severe adverse effects were reported
in the clinical trials. The data of these clinical trials suggested that the combined hepatitis A and B vaccine is safe and that its
immunogenicity is as good as that of the monovalent inactivated hepatitis A vaccine and recombinant hepatitis B vaccine.
Bilive has demonstrated a good safety profile. The most common reactions have been at the site of injection, and include
transient pain, redness and swelling. Systemic adverse events include fever, headache, fatigue, nausea and vomiting. These events
were transient, only rarely reported and were considered by the subjects as mild.
Anflu
The split virus vaccine, containing specially treated virus particles, is the primary type of influenza vaccines used worldwide.
Our Anflu vaccine is an inactivated split flu vaccine formulated from three split inactivated virus solutions. Anflu is standardized
according to the WHO annual recommendation each year. In October 2005, we received final PRC regulatory approval for the
production of our Anflu vaccine against influenza. We expect to produce 300,000 doses of Anflu in 2006 for the 2006-2007 flu
season.
Anflu took approximately five years to develop. We began the research and development of our split virus inactivated
influenza vaccine in 2001. In 2003, approximately 1,300 healthy volunteers aged over 6 months were enrolled to receive Anflu
and a control vaccine in a clinical trial carried out for six months. The results of the clinical trial indicated that Anflu is safe with a
low rate of local reactions and systemic reactions and that Anflu’s immunogenicity is suitable for wide use. Our development of
the flu vaccine is closely related to our development of a vaccine against pandemic influenza (discussed below). Many
governments in the world encourage and incentivize vaccine manufacturers to develop influenza vaccines and build influenza
vaccine production lines, because these manufacturing facilities can be easily converted for the production of pandemic influenza
vaccines should an outbreak of pandemic influenza occur.
Anflu has demonstrated a good safety profile. Only mild red swelling has been observed as a local reaction in very few cases.
Systemic reaction only includes mild to moderate fever, the occurrence rate of which is statistically low.
We filed our new drug application with the China SFDA in June 2004. We received the New Drug Certificate for Anflu from
the China SFDA on February 25, 2005. Our Anflu production line is currently located in Beijing and being finalized. We received
the Anflu GMP certificate in October 2005, which enables us to manufacture Anflu for the 2006-2007 flu season. To date, we
have not sold any Anflu vaccines. We intend to build another larger Anflu vaccine production facility in Beijing.
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OUR PRODUCT PIPELINE
Pandemic influenza vaccine
The pandemic influenza virus, or H5N1 virus, is a flu virus that is highly contagious and deadly to birds. H5N1 virus does
not usually infect people, but infections in humans with these viruses can and have occurred. Most of these cases have resulted
from people having direct or close contact with H5N1-infected poultry or H5N1-contaminated surfaces. Since 2003, a growing
number of human H5N1 cases have been reported in many parts of Asia including China. More than half of the people infected
with the H5N1 virus have died. There is a significant concern that H5N1 will evolve into a virus capable of human-to-human
transmission because there have been suspected cases identified in Indonesia in May 2006.
There is little or no immune protection against the H5N1 virus in the human population. If H5N1 virus were to gain the
ability to spread easily from person to person, it is feared that a worldwide outbreak of disease could begin. However, experts
from around the world are watching the H5N1 situation very closely and are preparing for the possibility that the virus may begin
to spread more easily and widely from person to person.
The WHO has been the key driver in gathering global resources to develop a viable vaccine that may prevent the pandemic
influenza. Since early 2004, the WHO has been providing the reverse genetic bird flu virus strain at no cost to vaccine
manufacturers around the world to assist in their pandemic influenza R&D efforts. In March 2004, we were provided by the WHO
such reverse genetic bird flu virus strain and began to develop our own vaccine. As part of our efforts, in December 2004, we
signed a pandemic influenza vaccine co-development agreement with the China CDC to jointly develop a pandemic influenza
vaccine. Pursuant to this co-development agreement, we agreed, among other things, to conduct pandemic influenza vaccine R&D
based on our established vaccine R&D technical platform and to apply for a New Drug Certificate, production license and patents
for a pandemic influenza vaccine, and the China CDC agreed, among other things, to strategize development of the pandemic
influenza vaccine, provide us with scientific guidance to vaccine technicalities and conduct certain pandemic related research and
vaccine development-related analysis and testing. Both parties agreed to be responsible for certain specified expenditures
associated with the vaccine development and to jointly apply for government R&D funds. However, the co-development
agreement expressly provides that we will be the applicant for and owner of the future New Drug Certificate, production license
and any patent or know-how in connection with the pandemic influenza vaccine. In return, we have agreed to fund and support the
China CDC’s influenza-related investigation and other pandemic control efforts after we gain profits from the sale of pandemic
influenza vaccines. We are applying for grants from the PRC and local governments to further help fund our pandemic influenza
vaccine development initiatives.
We began human clinical trials for the pandemic influenza vaccine in December 2005. In April 2006, we announced the
completion of the immunization schedule of the phase I clinical trial of H5N1 in which 120 volunteers aged from 18 to 60 have
completed the two shot regimen of either the vaccine or a placebo. We completed the phase I clinical trial of H5N1 in June 2006
after we took blood samples from volunteers to analyze the antibody growth and effectiveness of the vaccine. The preliminary
results of phase I clinical trial showed good immunogenicity, with a sero-positive rate exceeding the criteria for assessment of
vaccines established by Committee for Proprietary Medicinal Products of the European Union. We intend to apply for
authorization from the China SFDA to begin our phase II trial.
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Japanese Encephalitis Vaccine
Japanese encephalitis is a mosquito-born virus that can infect the central nervous system in human beings and animals. JE is
a significant public health problem in Southeast Asia and the western Pacific. In China, the transmission of JE is usually seasonal,
occurring in summer and autumn-mainly July to September. At present, there is no JE-specific therapy once a person becomes
infected, other than supportive care to control the symptoms of the disease in hospital. Humans, especially children, are
susceptible to JE virus. JE is clinically characterized by seasonal outbreak, emergent occurrence, hyperpyrexia, headache and
unconsciousness. The course of disease is about two weeks and it can result in a mortality rate of about 30%. In endemic areas,
85% of cases are children under 15 years old, and those under 10 years old are susceptible to serious neurological and psychiatric
complications such as inability to speak, paralysis, imbecility, dementia, malformation of limbs and convulsion. Currently
available inactivated vaccines derived from animal cells require multiple inoculations and may cause undesirable side effects. We
are in pre-clinical stage of development for a new, potentially safer and more effective inactivated JE vaccine using our micro-
carrier technology for the cultivation of viruses. This technology can increase manufacturing yield, simplify operations, and
stabilize cultivation conditions, all of which facilitate large scale automated production.
Microcarrier technology is a multilayer large-scale cell cultivation process to propagate anchorage-dependent animal cells
for the purposes of producing vaccines. Microcarrier is small and beaded material used to support the growth of the anchorage-
dependent animal cells. These cells are usually suspended in the cultivation medium after they are gently stirred. During this
process, cells grow as either monolayer on the surface of small spheres or as multilayer in the pores of macroporous structures.
The conventional monolayer cultivation method in producing vaccines has to use thousands of rolling bottles or stacking flat
plates and is labor-intensive. Microcarrier provides a multilayer surface for more cells to be attached to a large surface area. We
believe microcarrier technology is a better method of cultivating anchorage-dependent animal cells because it can cultivate more
anchorage-dependent cells while saving virus antigens.
SARS vaccine
On January 19, 2004, the China SFDA authorized us to conduct the phase I clinical test of a potential SARS vaccine. We
were the first institution approved by the China SFDA to conduct human clinical trials of a SARS vaccine. Thirty-six healthy
volunteers between 21 years of age to 40 years of age were selected and divided into four groups for clinical testing. Twenty-four
subjects (two groups of 12 each) received the vaccine in two doses, while 12 others (two groups of six) received a placebo. The
first group of volunteers received their injection on May 22, 2004. By September 1, 2004, all 36 subjects who participated in the
clinical trial had been vaccinated with two doses of either the SARS vaccine or the placebo. On December 5, 2004, the PRC
Ministry of Science and Technology, the Ministry of Health and the China SFDA jointly announced that the phase I human test of
a SARS vaccine, independently developed by Chinese scientists, proved safe and effective in preliminary tests. We have
suspended our subsequent clinical trials of our SARS vaccine as there are currently no new reported cases of SARS. If the disease
reemerges, we intend to resume the remaining process required to obtain an approval to market and sell the SARS vaccine.
RESEARCH AND DEVELOPMENT
We believe that, among China-based pharmaceutical companies, we are a leader in the research and development of
vaccines. Our research and development personnel leverages its significant years of combined experience with what we believe
are low operating costs, strong relationships with relevant governmental authorities and research institutes and leading
technologies to develop and commercialize our vaccines. We believe our R&D capabilities provide us with a key competitive
advantage and we intend to continue to focus our research and development efforts on developing vaccines for infectious diseases
with significant unmet medical needs, such as pandemic influenza and SARS and improving on traditional vaccines such as those
for Japanese encephalitis.
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In order to achieve our R&D goal, we have entered into collaborations with a group of leading universities, colleges and
research institutes that have strong vaccine research capabilities and proven track record in China. In most cases, in our existing
R&D strategic collaborations we will own the commercial rights to the products that result from the collaboration. Set forth below
are examples of projects on which we have collaborated:
R&D Collaborations
Partner
Institute of Laboratory Animal Science, Chinese Academy of Medical Science
National Institute For the Control of Pharmaceutical and Biological Products
Projects
SARS
Hepatitis A, JE, Hepatitis A &
B
National Institute for Viral Disease Control and Prevention, China Center for Disease Control
and Prevention
National Institute for Epidemic Disease, China Center for Disease Control and Prevention
Department of Microbiology, University of Hong Kong
Hepatitis A & B, SARS,
Pandemic Influenza
SARS
Pandemic Influenza
We regularly obtain financial support from the PRC government to research government-sponsored vaccine programs,
including SARS and pandemic influenza. We received government funding in the amount of $664,000, $1,688,000 and
$1,222,000 for 2003, 2004 and 2005, respectively. These grants were to fund research in the areas of pre-clinical and clinical
trials. We are again applying for government grants in 2006, to fund research in areas of clinical trials of pandemic influenza
vaccine and expansion of our production capacity.
SALES AND MARKETING
We market and sell our vaccine products primarily through various provincial and municipal CDCs. We enter into sales
agreements with CDCs each time a CDC places a purchase order. CDCs typically place a large number of orders at the end of the
year when they begin to stockpile vaccine products for the next year. We usually generate a significant portion of our sales around
this time of the year. Pursuant to these sales agreements, CDCs typically agree not to re-sell our products to regions outside the
territory the pertinent CDC covers administratively. The PRC government recently decentralized its distribution system for
vaccine products, to permit vaccine manufacturers to market and sell their vaccines to certain local CDCs and certain inoculation
centers and wholesalers in addition to those provincial CDCs. Notwithstanding this change, to date we have not shifted our
marketing strategy and have no plans to do so in the near future due to significantly higher sales and marketing costs that a wider
sales network may entail.
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Our sales and marketing strategy is to develop a stable, solid and long-term relationship with the various provincial and
municipal CDCs that constitute our key customer base. To this end, we engage in various marketing activities to promote our
products and services. For instance, we regularly hold academic symposia for our CDC customers during which a group of experts
and scholars invited by us give lectures to the CDC personnel and update them on the latest research progress in diseases and
vaccines. We also assist our CDC customers in “grass roots” disease prevention efforts. In addition, we collaborate with
provincial and municipal CDCs to produce education programs related to disease control and prevention with a view to enhancing
the public’s awareness and knowledge about epidemic prevention and control. We also employ traditional marketing tools to
promote our products such as exhibiting posters at scientific conferences, publishing academic papers in academic journals, such
as the Chinese Journal of Vaccines and Immunization and Chinese Journal of Epidemiology. We provide a free hotline number
(800-810-5856) and the bulletin board on our website at www.sinovac.com to answer questions from vaccinees, CDCs, doctors
and the general public.
As of March 31, 2006, we have a sales and marketing team comprising approximately 60 professionals who are assigned to
13 sales districts designated geographically within China that include 25 provinces and municipalities. Our sales department and
marketing department are supported by other departments within our company, such as our logistics department, clinical research
department, quality assurance department and information center.
SAFETY AND QUALITY ASSURANCE
All of our facilities are designed and maintained with a view towards conforming with the WHO recommended bio-safety
standards. Our Healive, Bilive and Anflu facilities received their GMP certificates in March 2002, June 2005 and October 2005,
respectively. To comply with GMP operational requirements, we have implemented a quality assurance plan setting forth our
quality assurance procedures, and a complete documentation system.
Our facilities are designed to conform to international standards in bio-pharmaceutical manufacturing. Our production
equipment for Healive vaccine was supplied by, and the related facilities were designed by, a European company in accordance
with the U.S. FDA and China GMP guidelines, with major equipment and facilities imported from Europe and North America.
Our key equipment has passed the inspection conducted by SVS, a GMP validation consulting company.
We closely manage our staff, plant environment, support facilities, raw materials, hygiene, validation, documentation,
manufacturing process, quality control, product selling and sales follow-up resolution. Our personnel are trained with respect to
these procedures and documentations are routinely undertaken in an effort to ensure comprehensive quality assurance system and
the quality of finished product. Our products are required to comply with national standards for products and each batch of our
products is required to be tested or verified by the China National Institute for the Control of Pharmaceutical and Biological
Products and to obtain a certificate of approval issued by the China SFDA before they can be sold in the market. We utilize
vaccine deepfreeze equipment to produce vaccine freeze packages that may facilitate our clinic trials. Each vaccine sold by us is
identifiable by a series number which allows us to trace back to each batch if any quality problem or adverse event occurs.
We believe we have an effective internal reporting system to report any serious accidents related to drug use to the China
SFDA promptly as mandated by the China SFDA and PRC Ministry of Public Health.
At Tangshan Yian, we own and operate a bio-safety level III laboratory, where we conduct the studies of deadly infectious
viruses such as SARS. This laboratory was constructed and managed in accordance with the WHO bio-safety manual.
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MANUFACTURING
The production process of our Healive, Bilive and Anflu vaccines can be broadly divided into 5 stages: cultivation and
harvest, purification, inactivation, formulation and filling and packaging. The diagram below illustrates the major steps in each
stage of production.
* For Bilive, the hepatitis B component is added to hepatitis A bulk after absorption.
Healive
Hepatitis A virus, or HAV, is our raw material for manufacturing Healive. In the cultivation stage, we add diluted HAV to
cell cultures where HAV can effectively propagate for a period of 21 to 28 days. By the end of the cultivation period, we harvest
the virus by using chemical agents and then we filtrate the virus-containing fluid and discard the cell debris. We subsequently
extract the HAV and further purify it. We then inactivate the purified HAV solution by adding certain quantity of chemical
reagent at an appropriate temperature to eliminate the viability and infectivity of HAV. Finally, we formulate the vaccine. The
fluid is then diluted to the approved specification, filled into vials or pre-filled syringes and labeled and packaged into cartons.
Bilive
After HAV is cultivated, harvested, purified, inactivated and formulated as described above with respect to Healive, it is
combined with a recombinant hepatitis B surface antigen (procured from our third-party supplier Beijing Temple of Heaven
Biological Products Co. Ltd.). It is subsequently mixed and diluted with the specified antigen content or active ingredient. The
formulated hepatitis A/hepatitis B fluid is filled into pre-filled vials or syringes and then labeled and packaged into cartons.
Anflu
Three types of influenza viruses, selected based on the WHO recommendation for the upcoming flu season, are diluted and
injected into the embryonated eggs to be propagated in large quantities at appropriate temperature for approximately three days.
At the end of this cultivation period, we harvest the virus and filtrate the virus-containing fluid and discard the cell debris. We
then inactivate the harvested virus by adding a certain quantity of chemical reagent at appropriate temperature to eliminate the
infectivity of the influenza virus. The inactivated virus is subsequently purified. Thereafter, we disrupt the purified virus solution
to complete the split of the viruses. The virus solution of the three types of influenza virus, prepared separately according to the
process described above, are mixed and diluted to the approved specification. The formulated influenza vaccine is filled into vials
or pre-filled syringes and then labeled and packaged into cartons.
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Shelf Life
Set forth below is certain information on the shelf lives of our vaccines and our production capacity.
Healive
Bilive
Anflu
* combined capacity of Healive and Bilive
COLLABORATIONS
Shelf life
(year)
2.5
2
1
Current production Capacity
(million doses)
4-6*
4-6*
2
In May 2005, we entered into a letter of intent with LG Life Sciences Ltd., a leading pharmaceutical company in Korea,
concerning a possible collaboration between our two companies where LG Life Sciences expressed interest in marketing our
Healive vaccine worldwide and we expressed interest in the possibility of using LG Life Sciences’ hepatitis B vaccines in our
production of Bilive. In February 2006, we entered into an exclusive distribution agreement with LG Life Sciences, Ltd. under
which LG Life Sciences granted us an exclusive right to market and distribute its hepatitis B vaccine, Euvax B, in mainland China
for five years from the date we obtain regulatory approval for the sale of the product in China. This is the first strategic alliance
that we have made with a major vaccine supplier to capitalize upon our local knowledge and technology expertise in the vaccine
industry. We are currently in the process of applying for regulatory approval for sale of Euvax B in China. In March 2006, we
entered into an additional letter of intent with LG Life Sciences under which we expressed our intention to appoint LG Life
Sciences as the exclusive distributor of our pandemic influenza vaccines in Korea, subject to a definitive agreement being signed
on or before December 31, 2006.
In August 2005, we entered into a distribution agreement with Glovax C.V., a Dutch biopharmaceutical company with
operations in Mexico, pursuant to which we appointed Glovax to be the exclusive distributor of our vaccine products in the
Mexican market. Glovax is currently preparing the documentation for the registration, which may take as long as several years to
complete.
In December 2004, we signed a pandemic influenza vaccine co-development agreement with the China CDC to jointly
develop a pandemic influenza vaccine. Pursuant to this co-development agreement, we agreed, among other things, to conduct
pandemic influenza vaccine R&D based on our established vaccine R&D technical platform and to apply for the new drug
certificate, production license and patents for the pandemic influenza vaccine. The China CDC agreed, among other things, to
strategize development of the pandemic influenza vaccine, provide us with scientific guidance to vaccine technicalities and
conduct certain pandemic related research and vaccine development-related analysis and testing. Both parties agreed to be
responsible for certain specified expenditures associated with the vaccine development and to jointly apply for government R&D
funds. However, the co-development agreement expressly provides that we will be the applicant for and owner of the future new
drug certificate, production license and any patent or know-how in connection with the pandemic influenza vaccine. In return, we
have agreed to fund and support the China CDC’s influenza-related investigation and other pandemic control efforts after we gain
profits from the sale of pandemic influenza vaccines.
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COMPETITION
The pharmaceutical, biopharmaceutical and biotechnology industries both within China and globally are intensely
competitive and are characterized by rapid and significant technological progress, and our operating environment is increasingly
competitive. According to the Chinese SFDA, there are approximately 30 vaccine companies in China, of which we believe
approximately 8 to 10 are our direct competitors.
Even with the advent of private medical and healthcare insurance programs in China, most Chinese citizens must pay for
their own vaccines, because these insurance programs do not typically cover vaccines. We believe the consumer market is health
conscious yet price sensitive and accordingly would favor our products over cheaper but less safe vaccines provided by local
manufacturers and over comparable quality but more expensive vaccines manufactured by some of our international competitors.
Our competitors, both domestic and international, include large integrated pharmaceutical and biotechnology companies,
universities, and public and private research institutions that currently engage in have engaged in or may engage in efforts related
to the discovery and development of new biopharmaceuticals and vaccines. Many of these entities have substantially greater
research and development capabilities and financial, scientific, manufacturing, marketing and sales resources than we do, as well
as more experience in research and development, clinical trials, regulatory matters, manufacturing, marketing and sales.
There are multiple vaccines products approved for sale worldwide. Many of these vaccine products are marketed by our
major competitors and are in the areas of hepatitis A, hepatitis B and influenza. Specifically, with respect to inactivated hepatitis A
vaccine, we consider GlaxoSmithKline Biologicals S.A., MSD, Berna Biotech AG, Institute of Medical Biology, Chinese
Academy of Medical Sciences and Kunming Institute of Biological Products our major competitors. With respect to hepatitis A
and B vaccine, we consider GlaxoSmithKline Biologicals S.A. our significant competitor. Finally, with respect to influenza
vaccine, we consider GlaxoSmithKline Biologicals S.A., Aventis Pasteur S.A. and Chiron Corporation our major international
competitors and Zhejiang Hangzhou Tianyuan Biological Products Co., Ltd., Changchun Changsheng Life Sciences Limited,
Shanghai Institute of Biological Products, Changchun Institute of Biological Products, Jiangsu Changzhou Yanshen and Lanzhou
Institute of Biological Products our major domestic competitors.
We believe we enjoy a number of advantages over our PRC domestic competitors. For example, we are not required, as are
most Chinese vaccine manufacturers, to allocate up to 70% of our vaccine production capacity to the central government directed
immunology programs because all of our products are paid by private parties rather than any government. The profit margins for
these central government directed programs are often quite low. Generally, we believe that the principal competitive factors in the
markets for our product candidates will include:
• safety and efficacy profile;
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• product price;
• ease of application;
• product supply;
• enforceability of patent and other proprietary rights; and
• marketing and sales capability.
INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY
Protection of our intellectual property and proprietary technology is very important for our business. We rely primarily on a
combination of trademark, patent and trade secret protection laws in China and other jurisdictions, as well as employee and third-
party confidentiality agreements to safeguard our intellectual property, know-how and our brand. Our ability to protect and use
our intellectual property rights in the continued development and commercialization of our technologies and products, operate
without infringing the proprietary rights of others, and prevent others from infringing our proprietary rights, is crucial to our
continued success. We will be able to protect our products and technologies from unauthorized use by third parties only to the
extent that they are covered by valid and enforceable patents, trademarks or copyrights, or are effectively maintained as trade
secrets, know-how or other proprietary information.
We have five patent applications pending in the PRC relating to our SARS vaccine technology. There are no issued patents
or any patent application pending with respect to our existing vaccine products or our pandemic influenza or JE product
candidates. The process of seeking patent protection can be lengthy and expensive, and we cannot assure you that these patent
applications, or any patent applications we may make in the future in respect of other products, will result in patents being issued,
or that any patents issued in the future will be able to provide us with meaningful protection or commercial advantage. Our patent
applications may be challenged, invalidated or circumvented in the future.
Our five patent applications relate to our new technology for SARS vaccines, including the process for making the SARS
vaccine, the actual vaccine product against SARS, the process of manufacturing and monitoring the quality of the SARS vaccine
and the process for detecting an antigen of SARS virus. We intend to pursue the prosecution of these patent applications in order
to obtain patent protection for our vaccine candidates and process for making our SARS vaccine candidates. However, our patent
applications may be rejected by the State Intellectual Property Office if relevant prior art documents are found in anticipation of
our inventions or making our inventions obvious over the prior art.
We maintain six registered trademarks in China, including Sinovac, Healive and its Chinese name, Bilive and its Chinese
name and our company logo. We also use a trademark owned by Shenzhen Kexing Biotech Co., Ltd. through a nonexclusive
royalty-free license, expiring December 31, 2006, from Shenzhen Kexing, We have entered into another license agreement with
Shenzhen Kexing which will extend our right to use Shenzhen Kexing’s trademark on certain of our biopharmaceutical products
until December 31, 2011. This latest license agreement, not yet in effect, is non-exclusive and terminates automatically if
Weidong Yin were to cease his managerial control of Sinovac Beijing. We intend to register additional trademarks including
Anflu, Panflu and their Chinese names and associated logos with the Trademark Office of the State Administration for Industry
and Commerce in China. We have registered the “Sinovac” trademark in Thailand, Korea and Canada. We are in the process of
registering our “Sinovac” and logos as trademarks in such other major countries as the United States, the United Kingdom,
Germany and France. We have registered our domain names, including www.sinovac.com.cn, with the CNNIC. As our brand
name is becoming more recognized in the vaccine market, we are working to maintain, increase and enforce our rights in our
trademark portfolio, the protection of which is important to our reputation and branding.
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With respect to, among other things, proprietary know-how that is not patentable and processes for which patents are
difficult to enforce, we rely on trade secret protection and confidentiality agreements to safeguard our interests. We believe that
many elements of our vaccine products, clinical trial data and manufacturing processes involve proprietary know-how, technology
or data that are not covered by patents or patent applications. We have taken appropriate security measures to protect these
elements. We have entered into confidentiality, non-compete and invention assignment agreements with our executive officers and
research and development personnel. These agreements address intellectual property protection issues and require our employees
to assign to us all of their inventions, designs and technologies they develop during their terms of employment with us and
cooperate with us to secure patent protection for these inventions if we wish to pursue such protection. Any of these parties may
breach the agreements and disclose our confidential information or our competitors might learn of the information in some other
way. If any of our trade secrets, know-how or other proprietary information that is not protected by a patent were to be disclosed
to or independently developed by a competitor, our business, results of operations and financial condition could be materially and
adversely affected.
We also rely on administrative protection afforded new drugs through the protection period or monitoring period provided by
the China SFDA. During the protection period or monitoring period, third parties’ applications for manufacturing or importing the
same drug are not accepted by the China SFDA. Our vaccines, Healive and Bilive, have been granted with protection periods of
eight years and three years, respectively, from the issuance of their respective production licenses until December 2007 and
January 2008, respectively.
Despite any measures we take to protect our intellectual property, no assurance can be made that unauthorized parties will
not attempt to copy aspects of our products or manufacturing processes or otherwise our proprietary technology or to obtain and
use information that we regard as proprietary.
EMPLOYEES
As of June 30, 2006, we had 238 full-time employees. Of our workforce, 53 employees are engaged in research and
development and 59 employees are engaged in sales and marketing. None of our employees is represented by a labor union or
covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
INSURANCE
We maintain property insurance coverage from Ping An Property & Casualty Insurance Company of China, Ltd., with an
annual aggregate insured amount of approximately $7.7 million to cover our property and facilities from claims arising from fire,
earthquake, flood and a wide range of other natural disasters. We also maintain product liability insurance from PICC Property
and Casualty Company Limited to cover any personal injury or property damages arising from the use of Healive for an aggregate
limit of indemnification for approximately $10,000. We do not carry product liability insurance for Bilive or Anflu because we
believe the risk of incurring personal injury or property damages arising from the use of Bilive is low, the aggregate sales volume
of Bilive is low and because we have not formally marketed or distributed Anflu. Moreover, we do not carry liability insurance to
cover liability claims that may arise from the incidents relating to the clinical trails of our vaccine products because such insurance
program has not become available in mainland China. Our insurance coverage may not be sufficient to cover any claim for
product liability or damage to our fixed assets.
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LEGAL PROCEEDINGS
We are not currently involved in any legal proceedings. We are not aware of any legal proceedings being contemplated or
threatened by any governmental authority or any other party. However, our legal counsel has advised us that we may have
violated Section 402 of the Sarbanes-Oxley Act that prohibits an issuer from, among others, extending or maintaining credit to its
directors or executive officers. We have extended and maintained some credit to two of our former directors, one of whom was
also a former officer. Lily Wang, our former director and CFO until March 22, 2006, owed us a loan in the amount of
approximately $1.8 million as of October 2004 arising from her earlier acquisition of Tangshan Yian’s equity interest in Sinovac
Beijing. As of June 30, 2006, the aggregate principal amount of the loan and the accrued interests are approximately $0.55
million. Another former director, Heping Wang, also owed us unpaid capital contribution in the amount of $2.6 million in earlier
2004 although the full amount of this capital contribution had been settled by November 2004. As of December 31, 2005,
Mr. Wang still owed us accrued interests on the $2.6 million promissory note in the amount of $156,468. The management chose
to conservatively value the amount owing and set up a 100% provision in 2005. In addition, Heping Wang, in connection with his
transfer of 100% equity interest in Tangshan Yian to us in 2004, agreed to assume and indemnify Tangshan Yian’s loan
obligations in an aggregate amount of RMB 10.8 million comprising principal amount of the loan in RMB 9 million and the RMB
1.8 million funding fee. Heping Wang has yet to repay us RMB 10.8 million. In an effort to take immediate remedial steps to
address any potential violation of the Sarbanes-Oxley Act, we issued a loan repayment letter on June 22, 2006 to each of Lily
Wang and Heping Wang demanding immediate full repayment by them of all outstanding loan balances including accrued
interests. Although we have not received any repayment from them as the date of this annual report, we intend to aggressively
seek their prompt and full repayment. For more detailed description of the foregoing transactions, see Section B captioned
“Related Party Transactions” of Item 7 of this annual report.
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REGULATORY FRAMEWORK OF THE PHARMACEUTICAL INDUSTRY IN THE PRC
The testing, approval, manufacturing, labeling, advertising and marketing, post-approval safety reporting, and export of our
vaccine products or product candidates are extensively regulated by governmental authorities in the PRC and other countries.
In the PRC, the China SFDA regulates and supervises biopharmaceutical products under the Pharmaceutical Administration Law,
the Implementing Regulations on Pharmaceutical Administration Law, the Administration of Registration of Pharmaceuticals
Procedures, and other relevant rules and regulations which are applicable to manufacturers in general. Every step of our
biopharmaceutical production is subject to the requirements on the manufacture and sale of pharmaceutical products as provided
by these laws and regulations, including but not limited to, the standards of clinical testing, declaration, approval and transfer of
new medicine registrations, applicable industry standards of manufacturing, distribution, packaging, advertising and pricing.
Under the relevant laws and regulations, our vaccine products are not officially approved for sale in the market until the following
procedures have been followed.
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Preclinical Laboratory Tests and Animal Tests. Preclinical tests include in-vitro laboratory evaluation of the product candidate,
as well as in-vivo animal studies to assess the potential safety and efficacy of the product candidate. Preclinical tests must be
conducted in compliance with Good Laboratory Practice for Non-clinical Tests of Pharmaceuticals, or GLP. With respect to
vaccines, the preclinical tests should also comply with Technical Guidance for Preclinical Tests on Prophylactic Vaccines and, in
the case of SARS, the Technical Requirements on Preclinical Tests of Inactivated Vaccines against SARS promulgated by the
China SFDA that strictly control the registration, procurement, manipulation and tests of SARS strains. We must submit the
results of the preclinical tests, together with manufacturing information, analytical data and the sample of product candidate to the
provincial SFDA as part of an investigational new drug application, or IND, which must be approved before we may commence
human clinical trials. We cannot assure that submission of an IND will result in the China SFDA allowing human clinical trials to
begin, or that, once begin, issues will not arise that result in the suspension or termination of such human clinical trials.
Human Clinical Trials. Clinical trials involve the administration of the product candidate to healthy volunteers or vaccinees
under the supervision of principal investigators, who are generally physicians or an independent third party not employed by us or
under our control. Clinical trials typically are conducted in three sequential phases, but the phases may overlap or be combined. In
Phase I, the initial introduction of the drug into human subjects, the drug is usually tested for safety (adverse effects), dosage
tolerance, and pharmacologic action. Phase II usually involves studies in a limited vaccinee population to evaluate preliminarily
the efficacy of the drug for specific, targeted conditions; to determine dosage tolerance and appropriate dosage and to identify
possible adverse effects and safety risks. Phase III trials generally further evaluate clinical efficacy and test further for safety
within an expanded vaccinee population. Clinical trials have to be conducted in compliance with the Good Clinical Trial Practice
of Pharmaceuticals, or GCP. With respect to vaccines, we also have to comply with the China SFDA’s Requirements on
Application for Clinical Trial of New Prophylactic Biological Products. The sample vaccine products must be inspected by the
China Medicine and Biological Products Examination Institute before they may be used in the clinical trials. We or the China
SFDA may suspend clinical trials at any time on various grounds, including a finding that subjects are being exposed to an
unacceptable health risk.
After three phases of human clinical trials, we will submit to the provincial level SFDA a report containing the results of the
preclinical and clinical studies, together with other detailed information, including information on the manufacture and
composition of the product candidate, to apply for a new drug certificate. For vaccines, we have to comply with the China SFDA’s
Guidelines for Clinical Trial Report on Vaccines. In the meantime, we will submit raw materials of the product candidate to the
China Medicine and Biological Products Examination Institute.
New Drug Certificate. The provincial level SFDA will conduct a preliminary examination of our application for a new drug
certificate. Once it decides to accept our application based upon such preliminary examination, the provincial level SFDA will,
within 5 days, conduct an on-site examination on our production facilities and draw samples from three consecutive batches of our
products. A medicine inspection institute designated by the provincial level SFDA will inspect the selected samples and later
submit its inspection report to the China SFDA. At the same time, the provincial level SFDA will submit its opinion, and
examination report on our product candidates, together with our application materials to the China SFDA. If the China SFDA is
satisfied with the examination results, it will issue a new drug certificate to us.
Production Permit. Simultaneously with the application of new drug certificate, we also apply to the provincial level SFDA for a
production license to manufacture the new drug to be approved by the China SFDA. The production license application will be
examined with similar two-stage procedure as for the new drug certificate, first by the provincial level SFDA followed by the
China SFDA. After the provincial level SFDA accepts the application, conducts the on-site examination and forms its opinion, the
provincial level SFDA will transfer the file to the China SFDA. When the China SFDA decides to issue the new drug certificate, it
will further examine whether the applicant holds a License for Pharmaceutical Production and whether the applicant has proper
production facilities. With the criteria met, the China SFDA will issue the production permit together with the new drug
certificate. The production permit is valid for a term of five years and must be renewed before its expiration. During the renewal
process, our production facilities will be re-evaluated by the appropriate governmental authorities and must comply with the then
effective standards and regulations.
Under certain circumstances, for instance, where drugs are developed to prevent or cure such epidemics as SARS, the China
SFDA provides for an accelerated proceeding for its review of the new drug certificate application and production permit
application relating to such drugs.
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The China SFDA will specify a monitoring period ranging from 3 to 5 years when approving the first production permit for most
new drugs. During this monitoring period, the manufacturers holding the new drug certificates have to report regularly to the
provincial level SFDA, among others, the production process, efficacy, stability and side effects of the new drugs involved.
During the same period, the China SFDA will not accept any new application for approval of the same drug involved. However if
a third party has filed an application for the same drug and obtained the clinical trial permit before the monitoring period
commences, the third party may still obtain a new drug certificate and production permit for the same drug.
We are not required, in most cases, to conduct clinical trials prior to commencing the manufacture of pharmaceutical products for
which there are published state pharmaceutical standards on safety and effectiveness, although we have to apply for a production
permit from the China SFDA.
GMP Certificate. After receiving a new drug certificate and production permit, we will further need to submit to the China SFDA
an application for a Good Manufacturing Practice Certificate, or GMP Certificate. A GMP Certificate is used to approve the
manufacturing equipment, process and workshop used in producing a particular drug. The China SFDA has issued GMP standards
for pharmaceutical manufacturers to minimize the risks arising out of the production process of drugs that will not be identified or
eliminated through testing the final products. The application for a GMP Certificate should be approved or rejected within six
months from the application date.
A GMP Certificate is valid for five years. However, prior to October 2005, a GMP certificate for a drug is valid for only one year
except for drugs approved before the GMP practice was implemented by the China SFDA in 2005 (5 years). The manufacturers
should apply for a reassessment of their one-year term GMP Certificate no later than three month prior to the expiration of such
GMP Certificates and, if approved, would receive a five-year GMP Certificate subject to reassessment by the relevant authority.
According to the current practice, we receive a five-year GMP Certificate directly and should apply for a renewal of our GMP
Certificate no later than six months prior to the expiration of our GMP Certificate.
We cannot commence the manufacture of a new drug unless and until we have obtained a valid new drug certificate, production
permit and GMP certificate.
Batch Approval. Our vaccine products cannot be distributed in the market before they are approved for sale by relevant medicine
inspection institute. We have to apply for examination and/or inspection of each batch of our products by the relevant inspection
institute. For each batch of products, we will provide the inspection institute with samples together with manufacturing records,
internal inspection records and other quality control documents. The inspection institute will review the documents and inspect the
samples and issue a batch approval within approximately two months, if our manufacture procedures and quality of the products
are ascertained to meet the standards as approved by the China SFDA. With the batch approval, we may distribute the approved
batch of vaccines to the market.
C. Organizational Structure
The following diagram illustrates our company’s organizational structure, and the place of incorporation, ownership interest
and affiliation of each of our subsidiaries.
* China Bioway Biotech Group Co., Ltd., an affiliate of Peking University, owns the remaining 28.44% equity interest in Sinovac
Beijing.
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D.
Property, Plant and Equipment
We are headquartered in the Peking University Biological Industry Park in Beijing in a 48,900 square-foot and state-of-the-
art facility, of which approximately 16,700 square feet are used as office space and approximately 32,200 square feet are used for
the production plant for Healive and Bilive where the production equipment for hepatitis vaccine was supplied, and the related
facilities were designed by a European pharmaceutical engineering company in accordance with the China GMP and U.S. FDA
safety guidelines. We own the above-described 48,900 square-foot facility in Beijing.
In August 2004, we signed two 20-year leases in Beijing with China Bioway, pursuant to which we leased two buildings of
approximately 28,000 and 13,300 square feet, respectively, located at the Peking University Biological Industry Park. We house
our Anflu manufacturing and R&D center in these buildings. China Bioway has yet to obtain building ownership certificates for
the two buildings. Under the two leases, China Bioway agreed to hold us harmless and indemnify us for any damages or losses we
may suffer as a result of its failure to obtain building ownership certificates. China Bioway also pledged its land use certificate
relating to these two leases to a commercial lender in October 2002 for 5 years. In June 2006, China Bioway guaranteed to us in
writing that we have all the legal rights and privileges to use the two buildings as agreed to in the two leases and that it will
indemnify us any losses or damages that could be incurred if our rights and privileges to use such buildings are impeded or
hampered by the commercial lender.
Our approximately 40,000 square-foot Tangshan Yian facility in Tangshan, Hebei Province, where research and pilot
production for vaccine candidates are carried out, houses a bio-safety level III laboratory, a cell culturing workshop, a pilot trial
production workshop and a reagents manufacture workshop. In Tangshan, we obtained a state-owned land use certificate of a
granted land with area of approximately 214,200 square feet, 21,700 square feet of which are occupied by cottages of others.
Tangshan Yian entered into an agreement with the Tangshan local government, pursuant to which Tangshan Yian will not pay for
or use the above approximately 21,700 square feet of the occupied land until the cottages are removed by the government. This
situation has no impact on Tangshan Yian’s use of the other part of the land. Tangshan Yian owned the facilities built thereon. We
believe that our existing facilities are adequate to meet our current and foreseeable future requirements.
ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction
with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This
discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our
actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors,
including those set forth under “Item 3. Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F.
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A. Operating Results
OVERVIEW
We are a China-based biopharmaceutical company that focuses on the research, development, manufacturing and
commercialization of vaccines that protect against human infectious diseases. Our portfolio of regulatory-approved products
consists of vaccines against the hepatitis A, hepatitis B and influenza viruses. In 2002, we successfully launched our first product,
Healive, which is the first inactivated hepatitis A vaccine developed, produced and marketed in China. In 2005, we received
regulatory approvals in China for the sale of Bilive, a combination hepatitis A and B vaccine, and Anflu, a split virus influenza
vaccine. Our pipeline consists of three vaccine product candidates in the pre-clinical and clinical development phases in China,
including a vaccine for the H5N1 strain of pandemic influenza virus which has completed phase I clinical trial, a vaccine for the
Japanese encephalitis (JE) virus currently in pre-clinical development, and a vaccine for the SARS virus which has completed
phase I clinical trial.
In May 2002, we obtained final PRC regulatory approval for the production of Healive. We sold approximately 0.5 million,
1.0 million and 1.3 million doses of Healive in 2003, 2004, and 2005, respectively. In June 2005, we obtained final PRC
regulatory approval for the production of Bilive, and began selling this product in July 2005. We sold approximately 40,000 doses
of Bilive in 2005. In October 2005, we received final PRC regulatory approval for the production of our Anflu vaccine against
influenza. We expect to produce 300,000 doses of Anflu in 2006-2007 for the upcoming flu season.
Our proprietary rights
Healive was co-developed by Tangshan Yian and the National Institute for the Control of Pharmaceutical and Biological
Products, or the NICPBP. Tangshan Yian and NICPBP agreed in 2000 that Tangshan Yian will own nearly all proprietary rights
to Healive, and that Tangshan Yian, in return, should pay NICPBP Healive technology consulting fee in the amount of
approximately $1 million. In April 2001, Tangshan Yian contributed its proprietary rights to Healive to Sinovac Beijing as its
capital contribution to Sinovac Beijing. In 2002, NICPBP, Tangshan Yian and Sinovac Beijing agreed that Sinovac Beijing owns
the right to market and sell Healive, and that Sinovac Beijing was required to pay NICPBP approximately $1 million of Healive
technology consulting fee that Tangshan had not paid by that time. We obtained final PRC regulatory approval for production of
Healive in May 2002, by which time we already received Healive’s new drug certificate from the China SFDA in December 1999
and the production license in May 2002. Production of Healive commenced in July 2002.
Bilive was initially developed by Tangshan Yian. In March 2002, Tangshan Yian and Beijing Keding entered into an
agreement under which Tangshan Yian transferred to Beijing Keding its proprietary rights to Bilive at no cost. In August 2002,
Sinovac Beijing acquired the proprietary rights to Bilive from Beijing Keding in consideration of a 10.71% equity interest in
Sinovac Beijing and a cash payment of $18,116. Beijing Keding is owned by Weidong Yin and three other senior officers of
Sinovac Beijing. In June 2005, we obtained final PRC regulatory approval for production of Bilive. We received the production
license for Bilive from the China SFDA in January 2005. The cost of the proprietary rights to Bilive was expensed as purchased
in-process research and development. Production of Bilive commenced in June 2005.
In March 2003, Sinovac Beijing acquired the proprietary rights to Anflu from Tangshan Yian at the vendor’s cost. In
November 2004, we completed the acquisition of 100% of the shares of Tangshan Yian. We received final PRC regulatory
approval for the production of Anflu in October 2005. The cost of the proprietary rights to Anflu was expensed as purchased in-
process research and development.
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Amortization expense for these proprietary rights was $194,343, $194,326 and $317,518 for 2003, 2004 and 2005,
respectively.
Research and development programs
Due to the risks inherent in the clinical trial process and the early stage of development of our products, we did not track our
internal research and development costs for each of our research and development programs. We use our research and
development resources, including employees and our technology, across multiple product development programs. As a result, we
cannot state precisely the costs incurred for each of our research and development programs or our clinical and preclinical product
candidates. However, the table below presents our best estimate of our total research and development costs allocable to our
leading research and development programs for the periods indicated. We have allocated direct and indirect costs to each program
based on certain assumptions and our review of the status of each program, payroll related expenses and other overhead costs
based on estimated usage by each program.
Research and development programs
Healive
Bilive
Anflu
Pandemic influenza vaccine
Japanese encephalitis vaccine
SARS vaccine
Total
Years ended December 31,
2003
2004
(in thousands)
2005
0 $
$ 1,697 $
0
$ 10,435 $
0 $
0
$ 56,984 $ 244,305 $
75,151
$
48,244 $1,167,813
$
41,521 $ 158,844
0
$857,630 $ 670,976 $
$926,746 $1,005,046 $1,401,808
0 $
0 $
Significant additional expenditures are generally required to complete clinical trials, start new trials, apply for regulatory
approvals, continue development of our technologies, expand our operations and bring product candidates to market. The eventual
total cost of each clinical trial is dependent on a number of uncertain variables such as trial design, the length of trials, the number
of clinical sites and the number of subjects. The process of obtaining and maintaining regulatory approvals for new therapeutic
products is lengthy, expensive and uncertain. We anticipate that we will determine which of our early stage product candidates is
best suited for further development, as well as how much funding to direct to each program, on an on-going basis in response to
the scientific and clinical success and commercial potential of each product candidate. Because of these and other uncertainties,
we cannot reliably estimate completion dates, completion costs and capital requirements for our lead programs, and, therefore, we
cannot reliably estimate when we might receive material net cash inflows from our research and development projects.
SARS and Pandemic influenza
We commenced the study and research of a SARS vaccine after the SARS outbreak in 2003. In 2004, we became the first
company in the world approved to commence a human clinical trial of a SARS vaccine. On May 22, 2004, the commencement of
the phase I clinical trial was announced when the first clinical trial volunteer received his first inoculation. A research grant from
the PRC Ministry of Science and Technology and other PRC government agencies on behalf of the PRC have provided sufficient
funding for the phase I clinical trial and demonstrates the support for our SARS vaccine research.
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The PRC government provided grants to us which are taken into income in the period in which the research and development
expenses are recorded and the conditions imposed by government authorities are fulfilled. We received government funding in the
amount of $664,000, $1,688,000 and $1,177,000 for 2003, 2004 and 2005. We recognized government research grant income of
$664,251, $719,220 and $1,167,814 in 2003, 2004 and 2005, respectively.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial information has been prepared in accordance with generally accepted accounting principles in the
United States, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets
and liabilities, (2) the disclosure of our contingent assets and liabilities at the end of each fiscal period and (3) the reported
amounts of revenues and expenses during each fiscal period. We continually evaluate these estimates based on our own historical
experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on
available information and reasonable assumptions, which together form our basis for making judgments about matters that are not
readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our
actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others
in their application.
When reviewing our financial statements, you should consider (1) our selection of critical accounting policies, (2) the
judgment and other uncertainties affecting the application of those policies, and (3) the sensitivity of reported results to changes in
conditions and assumptions. We believe the following accounting policies involve the most significant judgment and estimates
used in the preparation of our financial statements.
Stock-based compensation
Stock-based compensation is a very significant expense for us, but is based on estimates that have a subjective element. We
employ the Black-Scholes option pricing model which in turn is based upon (among other things) assumptions regarding interest
rates, expected life and stock volatility. To estimate the risk-free interest rate, we use the U.S. Treasury bill rate for instruments
with a similar term to the expected life of the option being granted. Since we have a relatively short trading history, we look at the
volatility of the stock of other publicly traded companies in the same industry and use them as a guide.
The following table shows the assumptions used in determining stock-based compensation costs under the Black-Scholes
option pricing model:
Expected volatility
Risk-free interest rate
Expected life (years)
Dividend yield
Weighted average fair value of options granted
2005
59.9%
4.51%
5.0
Nil
$2.93
2004
74.0%
3.44%
5.0
Nil
$2.85
2003
74.0%
3.42%
4.0
Nil
$0.74
Given the nature of the estimated volatility of a stock, it is not practical to provide a meaningful assessment of historical
accuracy of the estimated volatility used. It is very likely that the expected volatility will change in future periods and the changes
could be material.
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Amortization of intangible assets
We have amortized the value of intangible assets, being licenses and permits, over an estimated 10-year useful life. The
estimated life of intangible assets is inevitably subjective, however at least once per year, we reevaluate the market opportunities
for its products and determines whether the remaining useful life estimate is still reasonable.
The following table shows the effect of a change in the estimated useful life of licenses and permits of 10% for 2005:
Useful life
Amortization expense
Loss for the year
Loss per share
Hypothetical
10% Decrease
in Useful Life As Reported
10 years
317,518 $
Hypothetical
10% Increase
in Useful Life
11 years
$
288,653
$(5,145,907) $(5,110,627) $(5,081,762)
(0.14)
$
9 years
352,798 $
(0.14) $
(0.14) $
Given the nature of estimating the useful life of long-term assets, it is not yet possible to provide a meaningful assessment of
historical accuracy of the useful life estimates employed. It is very likely that the useful life of the licenses and permits will be
different from the estimate employed, and the changes could be material. Changes in the estimated life of the licenses and permits
will not have a bearing on the total amount charged to operations over the life of the assets, but could change the results of
operations and financial position in any given period.
Allocation of intangible assets
When we acquired our additional 20.56% interest in Sinovac Beijing in February 2005, we had to allocate the purchase price
over the fair value of the net assets acquired. We usually based such allocation upon a third party’s appraisal reports as well as the
projected cash flows to be earned from each product.
Given the nature of estimating the relative value of long-term assets, it is not possible to provide a meaningful assessment of
historical accuracy of the valuation allocation estimates employed. It is very likely that the actual values of the licenses and
permits will be different from the estimates employed and the changes could be material. Changes in the relative value of each of
the licenses and permits will not have a bearing on the total amount charged to operations over the life of the assets, but could
change the results of operations and financial position in any given period.
The following table summarizes the amortization expense for each component of licenses and permits, allowing investors to
draw inferences regarding the sensitivity of earnings to different allocation models.
Asset
Inactive hepatitis A
Recombinant hepatitis A and B
Total
55
Amortization
Expense
in the Year
Ended
December 31,
2005
$ 283,603
33,915
$
$ 317,518
Purchase Price
Allocation
$
$
$
609,649
366,903
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The cost of the influenza virus vaccine was written off as in-process research and development expenses at the date of
acquisition.
Income tax valuation allowance
In 2005, we recorded a $652,300 deferred income tax asset based on the difference in timing of certain deductions for
income tax and accounting purposes. The ability of us to ultimately derive a benefit from the deferred tax asset depends on the
existence of sufficient taxable income of the appropriate character within the carry forward period available under the tax law. We
have reviewed available information, both positive and negative, and have concluded that realization is more likely than not. If our
evaluation of the circumstances is not correct, we will have to record a charge to operations in respect of any over-accrual of the
benefit.
RESULTS OF OPERATIONS
Statement of operations data
Sales
Cost of sales
Gross profit
Operating expenses:
Selling, general and administrative expenses
Research and development expenses
Purchased in process research and development
Depreciation of property, plant and equipment and amortization
of licenses and permits
Total operating expenses
Operating loss
Interest and financing expenses
Interest and other income
Loss before income taxes and minority interest
Income taxes (recovery)
Minority interest share of (earnings) loss
Net loss for the year
2003
Year ended December 31,
2004
2005
$
% of net
revenues
$
% of net
revenues
$
% of net
revenues
(in thousands, except percentages)
2,839
1,086
1,753
100.0
6,454
38.2 1,938
4,516
61.8
100.0
30.0
70.0
8,608
2,346
6,262
1,749
262
381
271
2,663
(910)
(269)
41
(1,138)
—
266
(872)
56
61.6 8,843
286
9.2
4.4
— —
13.4
137.0 10,278
234
233
334
9.5
93.8 9,462
(32.1) (4,946)
(369)
(9.5)
321
1.4
(40.1) (4,994)
(767)
(440)
(30.7) (4,667)
—
9.4
5.2
555
(5.7)
5.0
146.6 11,299
(76.6) (5,037)
(229)
235
(77.4) (5,031)
(11.9)
(6.8)
212
132
(72.3) (5,111)
100.0
27.3
72.7
119.4
2.7
2.7
6.4
131.3
(58.5)
(2.7)
2.7
(58.4)
2.5
1.5
(59.4)
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Sales
Revenues from sales represent the invoiced value of goods, net of value added taxes, or VAT, sales returns, trade discounts
and allowances. See “—Taxes and Incentives.” We recognize revenues at the time when our products are delivered, persuasive
evidence of an arrangement exists, the price is fixed and final and there is reasonable assurance of collection of the sales proceeds.
Our revenues, growth and results of operations depend on several factors, including the level of acceptance of our products
among doctors, hospitals and vaccinees and our ability to maintain prices for our products at levels that provide favorable
margins. The level of acceptance among doctors, hospitals and vaccinees is influenced by the performance and pricing of our
products.
We market and sell our vaccine products primarily through various provincial and municipal CDCs. We enter into sales
agreements with CDCs each time a CDC places a purchase order. CDCs typically place a large number of orders at the end of the
year when they begin to stockpile vaccine products for next year. We usually generate significant sales around this time of the
year. Pursuant to these sales agreements, CDCs typically agree not to re-sell our products to regions outside the territory the
pertinent CDC covers administratively. The PRC government recently decentralized its distribution system for vaccine products,
to permit vaccine manufacturers to market and sell their vaccines to certain local CDCs in addition to those provincial CDCs.
Notwithstanding this change, to date we have not shifted our marketing strategy and have no plans to do so in the near future due
to significantly higher sales and marketing costs a wider sales network may entail.
Pricing
To gain market penetration, we price our Healive at levels that we believe offer attractive economic returns to CDCs and
their end customers, such as hospitals, taking into account the prices of competing products in the market. We believe that our
Healive and Bilive are competitively priced compared to hepatitis vaccines available in China. We intend to price Anflu
competitively to offer attractive economic returns to our distributors. The prices of our products are significantly lower than those
of foreign imports.
The provincial governments in China may adjust the fee rates from time to time. If they reduce the fee rates, some hospitals
and distributors may be discouraged from purchasing our products, which would reduce our sales. In that event, we may need to
decrease the price of our products to provide our customers acceptable returns on their purchases. We cannot assure you that our
business, financial condition and results of operations will not be adversely affected by any reduction in fees for the vaccines in
the future.
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Cost of sales
Our cost of sales primarily consists of material and component costs. Depreciation of property, plant and equipment
attributable to manufacturing activities is capitalized as part of inventory, and expensed as cost of sales when product is sold. Cost
of goods sold in 2003, 2004 and 2005 amounted to $1,086,000, $1,938,000 and $2,346,000, respectively. We produce our own
products and conduct the final product packaging in-house.
As we source a significant portion of our components and raw materials in China, we currently have a relatively low cost
base compared to vaccines manufacturers in more developed countries. We expect the costs of components and raw materials in
China will increase in the future as a result of further economic development in China. In addition, our focus on new generations
and applications of our products may require higher cost components and raw materials. We plan to offset increases in our cost of
raw materials and components through more efficient product designs and product assembly enhancements as well as through
savings due to economies of scale.
Sales, general and administrative expense
Sales and marketing expenses consist primarily of salaries and related expenses for personnel engaged in sales, marketing
and customer support functions and costs associated with advertising and other marketing activities. Going forward, we expect to
increase our expenditures on sales and marketing, both on an absolute basis and as a percentage of revenue, to promote our
products, especially our new products Bilive and Anflu.
General and administrative expense consists primarily of compensation for employees in executive and operational
functions, including finance and accounting, business development and corporate development. Other significant costs include
facilities costs, professional fees for accounting and legal services and the income taxes we assumed for our employees as a result
of their exercising the stock options.
Our general and administrative expenses also increase due to increased costs for insurance, professional fees, public
company reporting requirements, Sarbanes-Oxley Act compliance and investor relations costs associated with operating as a
publicly-traded company. These increases will also likely include the hiring of additional personnel.
Research and development expenses
Our research and development expenses consist primarily of:
• salaries and related expenses for personnel;
• fees paid to consultants and clinical research organizations in conjunction with their independent monitoring our clinical
trials and acquiring and evaluating data in conjunction with our clinical trials;
• consulting fees paid to third parties in connection with other aspects of our product development efforts;
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• costs of materials used in research and development; and
• depreciation of facilities and equipment used to develop our products.
We expense both internal and external research and development costs as incurred, other than those capital expenditures that
have alternative future uses, such as the build-out of our plant. We expect our research and development costs will continue to be
substantial and that they will increase as we advance our current portfolio of product candidates through clinical trials and move
other product candidates into preclinical and clinical trials.
Taxes and incentives
Under the current laws of Antigua, we are not subject to tax on our income or capital gains. In addition, no Antigua
withholding tax will be imposed on payments of dividends by us to our shareholders.
Substantially all of our sales are conducted in the PRC. Under the current PRC laws, Sinovac Beijing and Tangshan Yian are
both subject to enterprise income tax, or EIT, and VAT. Sinovac Beijing is classified as a “New Technology Enterprise” and
operates as a Sino-foreign joint venture. As such, it has been and will be subject to a reduced EIT rate of 7.5% for three years until
December 31, 2006, compared to a statutory rate of 33% for most domestically-owned companies in China. This classification
also reduced Sinovac Beijing’s EIT rate to 15% after December 31, 2006 as long as Sinovac Beijing maintains its qualification as
a “New Technology Enterprise.” For the three fiscal years ended December 31, 2003, 2004 and 2005, Sinovac Beijing incurred
income tax expenses of $0, $92,833 and $220,111, respectively. VAT is charged based on the selling price of our products at a
preferential rate of 6%. Tangshan Yian is subject to a reduced EIT rate of 24% and a preferential VAT rate of 6%.
Comparison of the years ended December 31, 2005 and 2004
Sales. Sales increased 33.4% to $8,608,000 in 2005 from $6,454,000 in 2004. Our sales in 2005 comprised sales of Healive
and Bilive . Our sales in 2004 comprised entirely sales of Healive. We generated $8,228,000 and $6,454,000 in sales of Healive
for the years ended December 31, 2005 and December 31, 2004, respectively. We generated revenue of $380,000 in sales of
Bilive in 2005. The number of doses sold increased from 1.0 million in 2004 to 1.3 million in 2005.
Cost of Sales. Cost of sales increased 21.1% to $2,346,000 in 2005 from $1,938,000 in 2004. The increase was in line with
the increased sales.
Gross Profit. Gross profit increased 38.7% to $6,262,000 in 2005 from $4,516,000 in 2004. Gross profit margin was 72.7%
and 70.0% for the years ended December 31, 2005 and 2004, respectively. These gross profit amounts are exclusive of
depreciation and amortization of land-use right, licenses and permits in the amounts of $333,770 for 2005 and $201,785 for 2004.
If these depreciation and amortization amounts had been included in the determination of gross profit, the gross profit margin
would have been 68.9% and 66.8% for the years ended December 31, 2005 and December 31, 2004, respectively. The increase in
gross profit margin was due to economies of scale; increased production of Healive decreased the average cost per unit.
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Selling, General and Administrative Expenses. Selling, general and administrative expenses, or SG&A expenses, include
non-production related wages and salaries, stock-based compensation, consulting fees, travel, occupancy, advertising, public
company costs and professional fees. Our SG&A expenses increased 16.2% to $10,278,000 in 2005 from $8,843,000 in 2004. Our
sales expenses increased in 2005 due to exploration of new markets and efforts to improve sales networks and sales strategy. The
increase in our general and administrative expenses in 2005 was partially due to the withholding income tax liability we incurred
in the amount of $1,455,000 in connection with our employees’ exercise of their stock options. We expect to see additional
increases in SG&A expenses to support our continuing market penetration and brand awareness. We incurred stock-based
compensation of $3,356,000 and $4,428,000 for the years ended December 31, 2005 and December 31, 2004, respectively. In the
current fiscal year, 88,000 stock options were granted to the directors, employees and consultants at an exercise price of $2.40 per
share. 280,000 stock options were granted to the directors, employees and consultants at an exercise price of $3.20 per share. The
stock options granted in 2005 have weighted average estimated fair value of $2.93 per share and have different vesting schedules
and, as a result, we had unrecognized compensation costs of about $826,000. This unearned component will be recognized over
the remaining vesting period. In 2005, 1,977,000 stock options, previously granted to various directors, officers, employees and
consultants of the Company on April 14, 2004, were cancelled as we believed the relatively high exercise price of those stock
options would not effectively incentivize the optionees. $2,304,000 in stock-based compensation was charged into income as a
result of the cancellation.
Research and Development Expenses. Research and development expenses reflect amounts spent on the split flu and SARS
vaccines net of government grants to fund these activities, as discussed below. Our research and development expenses decreased
by 18.1% to $234,000 in 2005 from $286,000 in 2004, representing activities on the SARS and split flu (Anflu) vaccines. The
PRC government provided grants to us which are brought into income in the period in which the research and development
expenses are recorded and the conditions imposed by government authorities are fulfilled. In 2005, we received PRC government
SARS and pandemic influenza research grants of $0 and $1,161,000, respectively. In 2005, we recognized government research
grant income of $1,168,000, compared to $719,220 in the prior year.
Interest and Financing Expenses. Interest and financing expenses decreased by 38.1% to $229,000 in 2005 from $369,000
in 2004, largely due to less interest expenses.
Income Taxes. We incurred an income tax expense of $212,000 in 2005, compared to an income tax recovery of $767,000 in
2004. In 2005, we accrued a $220,000 liability for income taxes on profits in Sinovac Beijing and recorded a $8,000 deferred tax
recovery that offset this expense. Our taxable income in China is subject to Chinese income tax regulations for its reported
statutory income declaration at a tax rate in accordance with the relevant income tax laws and regulations applicable to Sino-
foreign joint ventures. Sinovac Beijing is subject to a 7.5% enterprise income tax rate until 2006 and 15% tax rate thereafter, and
subject to a preferential VAT rate of 6% . Tangshan Yian is subject to a reduced EIT rate of 24% and a preferential VAT rate of
6%. In 2005 and 2004, Tangshan Yian had a net loss.
Net Loss. Net loss increased by 9.5% to $5,111,000 in 2005 from $4,667,000 in 2004. The increase in net loss in the current
year over the previous period was primarily due to significant increase in selling, general and administrative expenses.
Comparison of the years ended December 31, 2004 and 2003
Sales. Sales increased 127.3% to $6,454,000 in 2004 from $2,839,000 in 2003. Our sales in 2004 and 2003 were entirely
comprised of Healive. Revenue growth in 2004 was due to an expanded sales network and improved corporate profile. The
number of doses sold increased to 1.0 million in 2004 from 0.5 million in 2003.
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Cost of Sales. Cost of sales increased 78.5% to $1,938,000 in 2004 from $1,086,000 in 2003. The increase is in line with the
increased sales.
Gross Profit. Gross profit increased 157.6% to $4,516,000 in 2004 from $1,753,000 in 2003. Gross profit margin was 70.0%
and 61.8% for the years ended December 31, 2004 and December 31, 2003, respectively. These gross profit amounts are exclusive
of depreciation and amortization of land-use rights, licenses and permits in the amounts of $201,785 for 2004 and $201,802 for
2003. If these depreciation and amortization amounts had been included in the determination of gross profit, the gross profit
margin would have been 66.8% and 54.6% for the years ended December 31, 2004 and December 31, 2003, respectively. The
increase in gross profit margin was due to economies of scale as a result of increased production of Healive which lowered the
average cost per unit.
Selling, General and Administrative Expenses. SG&A expenses increased significantly to $8,843,000 in 2004 from
$1,749,000 in 2003. Our sales expenses increased in 2004 due to exploration of new markets and efforts to improve sales
networks and sales strategy. We expect to see additional increases in SG&A expenses to support continuing market penetration
and brand awareness. We incurred stock-based compensation of $4,428,000 and $120,000 for the years ended December 31, 2004
and 2003, respectively. In 2004, 2,004,500 stock options were granted to the directors, employees and consultants at an exercise
price of $4.55 per share. The stock options granted in 2004 have an estimated fair value of $2.85 per share and have different
vesting schedules and, as a result, we have unrecognized compensation costs of about $3,400,000 as of December 31, 2004. This
unearned component will be recognized over the remaining vesting period. This item does not reduce our cash balance but reflects
the fair value of the above-mentioned stock options.
Research and Development Expenses. Research and development expenses increased 8.9% to $286,000 in 2004 from
$262,000 in 2003, representing activities on the SARS and split flu (Anflu) vaccines. The PRC government provided grants to us
which are brought into income in the period in which the research and development expenses are recorded and the conditions
imposed by government authorities are fulfilled. In 2004, we received PRC government SARS and pandemic influenza research
grants of $1,640,000 and $48,000, respectively. In 2004, we recognized government research grant income of $719,220, compared
to $664,251 in the prior year.
Income Taxes. We generated an income tax recovery of $767,000 in 2004 while we did not have any income tax recovery in
2003. In 2004, we incurred $93,000 income taxes on profits in Sinovac Beijing and recorded a $860,000 deferred tax recovery in
2005 that offset this expense. Our taxable income in China is subject to Chinese income tax regulations for its reported statutory
income declaration at a tax rate in accordance with the relevant income tax laws and regulations applicable to Sino-foreign joint
ventures. Sinovac Beijing is subject to a 7.5% enterprise income tax rate until 2006 and 15% tax rate after that, and subject to a
preferential VAT rate of 6%. Tangshan Yian is subject to a reduced EIT rate of 24% and a preferential VAT rate of 6%. Tangshan
Yian had a net loss in 2004.
Interest and Financing Expenses. Interest and financing expenses increased 37.5% to $369,000 in 2004 from $269,000 in
2003. The 2004 increase reflected higher levels of debt, largely due to the acquisition of Tangshan Yian.
Net Loss. Net loss increased 435.0% to $4,667,000 in 2004 from $872,000 in 2003. The increase in net loss in the current
year over the previous period was primarily due to increased stock-based compensation since the increase in SG&A was largely
funded by an increased contribution from product sales.
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B. Liquidity and Capital Resources
We have incurred annual operating losses since inception, and, as of December 31, 2005, we had an accumulated deficit of
$11.6 million. We expect to incur loss over the next few years as we continue our clinical trials, apply for regulatory approvals,
continue development of our technologies, and expand our operations. Since our inception, we have financed our operations
primarily through sales revenue, sale of equity securities, interest income earned on cash and cash equivalents. We have also
generated funds from debt financing and from government research grants.
We made capital expenditures of $0.3 million, $1.7 million and $2.4 million in 2003, 2004 and 2005, respectively. We
believe that our current cash and cash equivalents, anticipated cash flow form operations will be sufficient to meet our anticipated
cash needs, including our cash needs for working capital and capital expenditure, for the next 12 months. We may, however,
require additional cash because of changing business conditions or other future developments. If our existing cash is insufficient
to meet our requirements, we may need to raise additional money and may seek to do so by: (1) out-licensing technologies or
products, (2) securing debt financing or (3) selling additional equity securities. Our ability to successfully enter into any such
arrangements is uncertain and if funds are not available, or not available on terms acceptable to us, we may be required to revise
our planned clinical trials, other development activities, capital expenditure requirements and the scale of our operations. We
expect to attempt to raise additional funds in advance of depleting funds; however, we may not be able to raise funds or raise
amounts sufficient to meet the long-term needs of the business. Satisfying long-term needs will require the successful
commercialization of our product candidates and, at this time, we cannot reliably estimate if or when that will occur, and the
process may require additional capital as discussed above.
The following table sets forth a summary of our net cash flows for the periods indicated:
Net cash provided by (used in) operating activities
Net cash provided by (used in) investing activities
Net cash provided by (used in) financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Operating activities
Year ended March 31,
2003 2004 2005
(in thousands)
(1,723) (1,538) (1,570)
(729) (3,050) (4,883)
3,560 5,775 11,144
1,107 1,185 4,749
2,605
7,354
313 1,420
1,420 2,605
Net cash used in operating activities was $1,570,000 in 2005, compared to net cash used in operating activities of $1,537,000
in 2004. Net cash used in operating activities in 2005 was a result of a net loss of $5,111,000, increased by $1,232,000 cash paid
for research and development expenditures qualified for government grants, and adjusted by certain non-cash charges including
stock-based compensation ($3,356,000), a provision for doubtful debts ($447,000) and depreciation of property, plant and
equipment and amortization of licenses and permits ($1,102,000).
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Net cash used in operating activities was $1,538,000 in 2004, compared to net cash used in operating activities of $1,723,000
in 2003. Net cash used in operating activities in 2004 was a result of a net loss of $4,667,000, increased by $407,000 cash paid for
research and development expenditures qualified for government grants, and adjusted by certain non-cash charges of stock-based
compensation ($4,428,000), a provision for doubtful debts ($374,000) and depreciation of property, plant and equipment and
amortization of licenses and permits ($784,000), offset in part by accounts receivable (2,214,000) and deferred income tax
($860,000). Net cash used in 2003 was a result of a net loss of $872,000, increased by $664,000 cash paid for research and
development expenditures qualified for government grants, and adjusted by stock-based compensation ($120,000), acquired
research and development ($381,000), depreciation of property, plant and equipment and amortization of licenses and permits
($684,000), increased accounts receivable ($1,150,000) and decreased accounts payable and accrued liabilities ($461,000).
Investing activities
Net cash used in investing activities was $4,883,000 in 2005, compared to net cash used in investing activities of $3,050,000
in 2004. In 2005, cash used in investing activities included $2,444,000 used to acquire property, plant and equipment, $2,260,000
used in relation to the purchase of a further 20.56% interest in Sinovac Beijing (another $1,050,000 was used in 2004 for this
same purchase) and $428,000 used as deposit in relation to land use rights. The cash used in investing activities was partially
offset by $249,000 released from restricted cash.
Net cash used in investing activities was $3,050,000 in 2004, compared to net cash used in investing activities of $729,000 in
2003. In 2004, cash used in investing activities included $1,650,000 used to acquire property, plant and equipment, offset by cash
of $42,000 acquired with the purchase of Tangshan Yian. During such period, we negotiated agreements that govern the purchase
of a further 20.56% interest in Sinovac Beijing. In connection with these negotiations, we paid $1,050,000 to two non-controlling
shareholders of Sinovac Beijing in 2004 and the remaining $2,260,000 in 2005 for an aggregate share purchase consideration of
$3,310,000. The Share Purchase Agreement for the acquisition of the additional 20.56% of Sinovac Beijing closed on February 4,
2005. In 2003, cash used in investment activities included $348,000 used to acquire property, plant and equipment and $381,000
used to acquire drug licenses.
Financing activities
Net cash provided by financing activities was $11,144,000 in 2005 compared to $5,775,000 in 2004. In 2005, net cash
provided by our financing activities included proceeds of $5,529,000 from issuance of common shares, $1,424,000 proceeds from
shares subscribed, $1,204,000 of advances from related parties and $1,222,000 proceeds from government funding. We paid
$379,000 as dividend to minority shareholders in Sinovac Beijing. We also received loan proceeds of $3,667,000 and made loan
payments of $1,523,000 in 2005.
Net cash provided by financing activities was $5,775,000 in 2004 compared to $3,560,000 in 2003. In 2004, net cash
provided by our financing activities included proceeds of $5,288,000 from issuance of common shares, $207,000 from shares
subscribed, and $1,688,000 proceeds from government funding. We also received loan proceeds of $3,268,000 and made loan
payments of $3,099,000. We also paid $1,576,000 to related parties.
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In 2003, net cash provided by our financing activities included $1,032,000 proceeds from the subscribed shares, $1,208,000
loan proceeds and $1,917,000 of advances from related parties. We also received proceeds from government funding of $664,000.
We made loan payments of $1,261,000.
We are a holding company, and we rely on dividends paid by our subsidiaries, Sinovac Beijing and Tangshan Yian, for our
cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, service any debt we
may incur and pay our operating expenses. The payment of dividends in China is subject to limitations. Regulations in the PRC
currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and
regulations in China. Our subsidiary is also required to set aside at least a portion of its after-tax profit based on PRC accounting
standards each year to fund certain reserve funds. These reserves can be used to recoup previous years’ losses, if any, and, subject
to the approval of the relevant PRC government authority, may be converted into share capital in proportion to their existing
shareholdings, or by increasing the par value of the shares currently held by them. Such reserves, however, are not distributable as
cash dividends. In addition, at the discretion of its board of directors, our subsidiary may allocate a portion of its after-tax profits
based on PRC accounting standards to its enterprise development funds and employee welfare and bonus funds. These funds also
are not distributable as cash dividends. In addition, if Sinovac Beijing or Tangshan Yian incurs debt on its own behalf in the
future, the instruments governing the debt may restrict Sinovac Beijing’s or Tangshan Yian’s ability, as the case may be, to pay
dividends or make other distributions to us.
The ability of our subsidiary to convert Renminbi into U.S. dollars and make payments to us is subject to PRC foreign
exchange regulations. Under these regulations, the Renminbi is convertible for current account items, including the distribution of
dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account
items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval
of the SAFE.
C. Research and Development
See discussions under “Research and Development Programs” of Section A. “Operating Results” in Item 5 “Operating and
Financial Review and Prospects.”
D. Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments
or events for the period from January 1, 2003 to December 31, 2005 that are reasonably likely to have a material adverse effect on
our net revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not
necessarily indicative of future operating results or financial conditions.
E. Off-Balance Sheet Arrangements
We do not, and did not, have any interest in variable interest entities or any other off-balance sheet arrangements that require
disclosure.
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F.
Tabular Disclosure of Contractual Obligations
The following summarizes our long-term contractual obligations as of December 31, 2005:
Payments due by period
Total
Less than
1 year
1-3 years
(in thousands)
3-5 years
More than 5
years
$2,664
—
$3,220 $
$5,884 $
— $ 2,664(2)
—
—
171 $ 342
357 $ 2,820
—
—
$ 342 $
$ 342 $
—
—
2,365
2,365
Contractual obligations
Long-Term Debt (1)
Capital Lease Obligations
Operating Lease Obligations
Total
(1)
Includes interest payable in the period.
(2) Of which $186,000 was paid out in January 2006.
G.
Safe Harbor
This annual report on Form 20-F contains forward-looking statements that relate to future events, including our future
operating results and conditions, our prospects and our future financial performance and condition, all of which are largely based
on our current expectations and projections. The forward-looking statements are contained principally in the sections entitled
“Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company” and “Item 5. Operating and Financial
Review and Prospects.” These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation
Reform Act of 1995. You can identify these forward-looking statements by terminology such as “may,” “will,” “expect,”
“anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to” or other and similar expressions. Forward-
looking statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially
from those contained in any forward-looking statement, including but not limited to the following:
• our ability to maximize sales of our existing products within the Chinese market;
• our ability to develop new vaccines;
• our ability to improve our existing vaccines and lower our production costs;
• our ability to expand our manufacturing facilities to meet need of the growing Chinese market and other geographic
markets;
• our ability to acquire new technologies and products;
• uncertainties in and the timeliness of obtaining necessary governmental approvals and licenses for marketing and sale of
our vaccines in certain overseas markets;
• our ability to compete successfully against our competitors;
• risks associated with our corporate structure and the regulatory environment in China; and
• other risks outlined in our filings with the Securities and Exchange Commission, or the SEC, including this annual report
on Form 20-F.
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The forward-looking statements made in this annual report on Form 20-F relate only to events or information as of the date
on which the statements are made in this annual report on Form 20-F. Except as required by law, we undertake no obligation to
update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after
the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report
on Form 20-F completely and with the understanding that our actual future results may be materially different from what we
expect.
H.
Sarbanes-Oxley Act Compliance, Disclosure Controls and Procedures and Internal Control Over Financial Reporting
Our legal counsel has advised us that we may have violated Section 402 of the Sarbanes-Oxley Act that prohibits an issuer
from, among others, extending or maintaining credit to its directors or executive officers. We have extended and maintained credit
to two of our former directors, one of whom was also a former officer. Lily Wang, our former director and CFO until March 22,
2006, owed us a loan in the amount of approximately $1.8 million as of October 2004 arising from her earlier acquisition of
Tangshan Yian’s equity interest in Sinovac Beijing. As of June 30, 2006, the aggregate principal amount of the loan and the
accrued interests amounted to approximately $0.55 million. Another former director, Heping Wang, also owed us unpaid capital
contribution in the amount of $2.6 million in earlier 2004 although the full amount of this capital contribution had been settled by
November 2004. As of December 31, 2005, Mr. Wang still owed us accrued interests on the $2.6 million promissory note in the
amount of $156,468. The management chose to conservatively value the amount owing and set up a 100% provision in 2005. In
addition, Heping Wang, in connection with his transfer of 100% equity interest in Tangshan Yian to us in 2004, agreed to assume
and indemnify Tangshan Yian’s loan obligations in an aggregate amount of RMB 10.8 million comprising the RMB 9 million
principal amount of the loan and a RMB 1.8 million funding fee. Heping Wang has yet to repay us RMB 10.8 million. In an effort
to take immediate remedial steps to address any potential violation of the Sarbanes-Oxley Act,, we issued a loan repayment letter
on June 22, 2006 to each of Lily Wang and Heping Wang demanding immediate full repayment by them of all outstanding loan
balances including accrued interests. Although we have not received any repayment from them as of the date of this annual report,
we intend to aggressively seek their prompt and full repayment. For more detailed description of the foregoing transactions, see
Section B captioned “Related Party Transactions” of Item 7 of this annual report.
Our management has concluded that, as of the end of the period covered by this annual report, our existing disclosure
controls and procedures are not fully adequate and effective in ensuring that the material information required to be disclosed by
us in the reports that we file with, or submit to, the SEC under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in by the SEC’s rules and regulations. We have taken a number of remedial actions to cure such
inadequacy or ineffectiveness. For more details, please see the section captioned “Evaluation of the Disclosure Controls and
Procedures” of Item 15 of this annual report.
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During the audit of our financial statements for the fiscal year ended December 31, 2005, we identified the following internal
control issues: (1) our failure to timely reconcile our accounts under PRC generally accepted accounting principles to U.S. GAAP;
(2) our failure to withhold the individual income tax with respect to the employees’ stock option gains; (3) the inappropriate
claims by certain of our employees of personal income tax exemptions; (4) our understatement of selling expenses and liabilities;
(5) our understatement of sales commissions and liabilities; and (6) our understatement of income tax expenses and tax liabilities.
In response, we have corrected these errors, and our management initiated a review of our financial and accounting systems and
identified material weaknesses in our internal control system over financial reporting related to our lack of personnel with U.S.
GAAP reporting experience. This was compounded by the resignation of Lily Wang on March 22, 2006 as our CFO, which
resulted in a lack of sufficient oversight over our financial reporting and other compliance matters. We have not appointed a
formal successor CFO, but we have identified a CFO candidate who just commenced his probation period with our company on
July 3, 2006. We have also appointed Ms. Jinling Qin, manager of our finance department, as the Acting CFO during the
transition period. We are in the process of adopting some other remedial actions to rectify the identified material weaknesses in
the internal control over our financial reporting. Such remedial actions include retaining professional consultants to advise on the
internal control over our financial reporting, recruiting a new staff member who is familiar with U.S. GAAP and implementing
procedures to withhold the individual income tax in connection with our employee’s exercise of stock options.
The efficacy of the steps we have taken to date and the steps we are still in the process of taking to improve the reliability of
our financial statements is subject to continued management review. We cannot be certain that these measures will ensure that we
implement and maintain adequate internal control over financial reporting in the future. Any failure to implement required new or
improved controls, or difficulties encountered in their implementation, could adversely affect our operating results or cause us to
fail to meet our reporting obligations. We cannot guarantee that we will not identify further material weaknesses or significant
deficiencies in our internal control over financial reporting in the future or that future restatements will not be required.
ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and Senior Management
The following table sets forth information regarding our directors and executive officers as of June 30, 2006.
Directors and Executive Officers
Weidong Yin
Xianping Wang
Simon Anderson(1)(2)(3)
Yuk Lam Lo(1)(2)(3)
Chup Hung Mok (1)(2)(3)
Jinling Qin
Jiansan Zhang
Nan Wang
Changjun Fu
Age Position/Title
42 President, Chief Executive Officer, Secretary and Director
52 Director
45 Director
58 Director
49 Director
61 Acting Chief Financial Officer
51 Vice General Manager
40 Vice General Manager
47 Vice General Manager
(1) Member of the audit committee.
(2) Member of the corporate governance and nominating committee.
(3) Member of the compensation committee.
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Mr. Weidong Yin has served as the president, CEO, secretary and a director of our company since September 2003. Mr. Yin
is also the general manager of our subsidiary, Sinovac Biotech. Mr. Yin has been dedicated to hepatitis research for over 20 years
and was instrumental in the development of our Healive vaccine. In addition, Mr. Yin has been appointed as the principal
investigator by the Chinese Ministry of Science and Technology for many key governmental R&D programs such as “Inactivated
Hepatitis A vaccine R&D”, “Inactivated SARS vaccine R&D” and “New Human Influenza Vaccine (H5N1) R&D.” He obtained
his Masters degree in Business Administration from the National University of Singapore.
Mr. Xianping Wang has served as a director of our company since March 2006. He has also been the president and CEO of
Xinhua China Ltd. since September 2004, which is a company listed on the NASD Over-the-Counter Bulletin Board under the
symbol “XHUA”. He has also served as the president of Asia-Durable (Beijing) Investments Co., Ltd. since 2002, and from 1992-
1997 he served as the president of Beijing New Fortune Investment Co., Ltd. as well as general manager of Beijing Fuhua
Constructions and Development Co., Ltd. Mr. Wang has worked in a diverse range of industries, such as medicine, the health care
industry, construction projects, investment consultation and real estate development. Since 1993, he has participated in various
real estate investment projects in China, managing the development of Fuhua Mansion, Meihui Mansion, Jinhua Garden and
others. Mr. Wang is brother of Lily Wang, a former director and CFO of our company, and Heping Wang, a former director of our
company. Mr. Wang has a bachelor’s degree in engineering from the Navy Engineering Institute and a master’s degree in
economics from Tsinghua University.
Mr. Simon Anderson has been a director of our company since July 2004. Mr. Anderson is a member of the audit,
compensation and corporate governance and nominating committees. Mr. Anderson has been a partner and Vice President of
MCSI Consulting Services Inc. since 1996. Mr. Anderson is a chartered accountant and from 1994 to 1996, he was a partner with
BDO Dunwoody, an international accounting and consulting firm, where he specialized in mergers, acquisitions and valuations.
Mr. Anderson was admitted as a member of the Institute of Chartered Accountants in British Columbia in 1986. Mr. Anderson
also serves as a director and/or chief financial officer of three other public companies including Ikona Gear International, Inc.,
SHEP Technologies, Inc. and Buffalo Gold Ltd.
Mr. Yuk Lam Lo has served as a director of our company since March 2006. Mr. Lo is a member of the audit, compensation
and corporate governance and nominating committees. He is currently serving as the vice president of PerkinElmer Life and
Analytical Sciences, Pacific Rim, the chairman of the Industry Technology Committee of the Chinese Manufacturers’ Association
of Hong Kong and the director of the Chinese Manufacturers’ Association of Hong Kong. Professor Lo also served as the
chairman of the Innovation and Technology Fund (Biotechnology Projects) Vetting Committee, HKSAR, and as chairman of the
Biotechnology Committee, Industry & Technology Development Council, HKSAR. He also served the director of the Hong Kong
Applied R&D Fund Co., Ltd., HKSAR. Professor Lo was also heavily involved in several committees of the Industry Department
of the HKSAR Government. Professor Lo has been named an Honorary Fellow by the Hong Kong University of Science and
Technology as well as the Honorary Chairman of the City University Committee of Co-operative Education Centre. Prof. Lo has
extensively served the societies of greater China. He is currently a member of the Advisory Committee of the World Trade Centre
Association (Hong Kong), an adjunct professor of the Chinese University of Hong Kong, the special advisor of the Hong Kong
University of Science & Technology (HKUST), a committee member of the Biotechnology Research Institute (BRI) of HKUST,
and a member of the Advisory Committee of the City University of Hong Kong and the Hong Kong Polytechnic University. In
mainland China, Professor Lo is a consultant to the Economic Bureau, Changchun, a member of the advisory committee of the
Shenzhen Municipal Science and Technology Bureau, an honorary consultant of the Beijing Medical University, an honorary
professor of Chengdu University of TCM and a visiting professor at Xiamen University, China and at Shanghai Jiao Tong
University.
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Ms. Chup Hung Mok has served as a director of our company since March 2006. Ms. Mok is a member of the audit,
compensation and corporate governance and nominating committees. She is currently the Financial Controller of Zero Spot
Laundry Service Private Limited where she is responsible for the financial affairs of that company and also leads the human
resource department. Prior to joining Zero Spot Laundry Service Private Limited, Mok worked for more than 28 years in banking.
Mok worked in Bank of China’s Singapore Branch from January 2002 to June 2005. During that period, she led the Internal Audit
and Treasury Settlements departments. Ms. Mok was also a member of the bank’s Assets and Liabilities Management Committee,
its Prevention of Money Laundering Committee and its Business Continuity Management Committee. Prior to joining the Bank of
China, Ms. Mok began her career with Kwangtung Provincial Bank’s Singapore Branch in the retail banking division. From 1992
to 2001, as part of the senior management of the Kwangtung Provincial Bank, she had oversight responsibilities in accounting,
treasury settlements, human resource management and credit management functions. Ms. Mok was also responsible for setting up
the Kwangtung Provincial Bank’s Treasury Department. In addition, she was a member of Kwangtung Provincial Bank’s Credit
Committee and a member of the Prevention of Money Laundering Committee. Ms. Mok holds a Master of Business
Administration from the National University of Singapore.
Ms. Jinling Qin has served as our acting CFO since March 22, 2006. Prior to that, she had been the Manager of the Finance
Department of Sinovac Beijing since January 2001. During 1993 and 2000, Ms. Qin was the Director of the Finance Department
of Tangshan Yian. She served as the Director of the Audit Department of the Economics Commission of Tangshan City, Hebei
Province during 1988 and 1993. Ms. Qin holds an associate degree in accounting from Hebei Provincial Academy of Machinery
and Electronics.
Mr. Jiansan Zhang has as served the vice general manager of Sinovac Beijing since April 2001 and the deputy general
manager of Tangshan Yian since 1998. At Sinovac Beijing, he oversees the production, engineering, research and development
and quality assurance departments. At Tangshan Yian, he oversees the P3 Lab. From 1995-1997, Mr. Zhang served as the
production manager and the assistant to the general manager of Shenzhen Kangtai Biological Product Co., Ltd. From 1988-1995,
he served as the vice general manager of Shenzhen Guangxin Biological Product Co., Ltd. and from 1992-1995, he served as a
consultant to Tangshan Yian. Mr. Zhang received his bachelor’s degree in medical treatment from Sun Yat-sen University of
Medical Sciences and an EMBA degree from Tsinghua University. In 1980, Mr. Zhang completed advanced training courses in
management and quality control of biological products in Holland.
Ms. Nan Wang has served as the vice general manager of Sinovac Beijing since 2001 where she oversees business
development and clinical research. From 1998 to 1993, Ms. Wang was a researcher in biology at the Life Science College of
Peking University. From 1993 to 2001, she worked as a manager at China Bioway Biotech Group Co., Ltd. Ms. Wang received
her bachelor’s degree in biology from Peking University and her master degree from University of International Business and
Economics. Ms. Wang also received a diploma in financial management from Beijing College for Entrepreneurs in 2003.
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Mr. Changjun Fu has served as Sinovac Beijing’s vice general manager since March 2002. Mr. Fu currently oversees the
sales and marketing department and business development of Sinovac Beijing. Prior to joining Sinovac Beijing, Mr. Fu was the
sales director at Changchun Changsheng Biological Product Co., Ltd. from 1986 to 1997 where he oversaw the marketing of
vaccine products, particularly hepatitis vaccines. From 1997 to 2002, Mr. Fu served as the Vice President of Shenzhen Shukang
Biological Products Co. Ltd. where he was responsible for the marketing and sales of vaccines and blood products. Mr. Fu
received a bachelor’s degree in 1984 from Norman Bethune University of Medical Sciences, the PRC.
B. Compensation of Directors and Executive Officers
In 2005, the aggregate cash compensation paid to our executive officers, including all the directors, was approximately
$203,576. No executive officer is entitled to any severance benefits upon termination of his or her employment with our company.
For options granted to officers and directors, see “2003 Stock Option Plan.”
Our board of directors and shareholders approved the issuance of up to 5,000,000 common shares upon exercise of options
granted under our 2003 stock option plan. As of December 31, 2005, options to purchase 1,869,300 common shares are
outstanding. The following table summarizes, as of December 31, 2005, the outstanding options that we granted to several of our
directors, executive officers, principal shareholders and to other individuals as a group under our 2003 stock option plan.
Name
Weidong Yin
Simon Anderson
Jinling Qin
Lily Wang
Heping Wang
Jiansan Zhang
Nan Wang
Changjun Fu
Other individuals as a group
2003 STOCK OPTION PLAN
Ordinary Shares
Underlying
Outstanding
Options
406,000
150,000
18,000
200,000
170,000
27,000
24,000
24,000
850,300
Exercise Price
($/Share)
1.31
3.20
1.31
1.31
1.31
1.31
1.31
1.31
Grant Date
Expiration Date
November 13, 2003 November 12, 2008
November 4, 2005 November 3, 2010
November 13, 2003 November 12, 2008
November 13, 2003 November 12, 2008
November 13, 2003 November 12, 2008
November 13, 2003 November 12, 2008
November 13, 2003 November 12, 2008
November 13, 2003 November 12, 2008
From 1.31 to
3.36
November 13, 2003
earliest
November 3, 2010
latest
Our board of directors has adopted a stock option plan on November 1, 2003. The purpose of the plan is to attract and retain
the best available personnel for positions of substantial responsibility, provide additional incentive to employees, directors and
consultants and promote the success of our business. Our board of directors believes that our company’s long-term success is
dependent upon our ability to attract and retain superior individuals who, by virtue of their ability, experience and qualifications,
make important contributions to our business.
Set forth below is a summary of the principal terms of our stock option plan.
• Size of plan. We have reserved an aggregate of 5,000,000 of our common shares for issuance under our 2003 stock
option plan. As of December 31, 2005, options to purchase an aggregate of 1,869,300 of our common shares were issued
and outstanding and an aggregate 1,388,200 common shares have been issued pursuant to options issued under the plan.
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• Termination of options. Where the option agreement permits the exercise of the options granted for a certain period of
time following the recipient’s termination of services with us, the options will terminate to the extent any is not exercised
or purchased on the last day of the specified period or the last day of the original term of the options, whichever occurs
first.
• Administration. Our stock option plan is administered by our board of directors. The board will determine the
provisions, terms and conditions of each option grant, including without limitation the option vesting schedule or
exercise installment, the option exercise price, payment contingencies and satisfaction of any performance criteria.
• Vesting schedule. The vesting schedules of options granted will be specified in the applicable option agreements.
• Option agreement. Options granted under our stock option plan are evidenced by option agreements that contain,
among other things, provisions concerning exercisability and forfeiture upon termination of employment or consulting
arrangements by reason of death or otherwise, as determined by our board. In addition, the option agreement also
provides no option shares will be issued under the plan unless the Securities Act has been fully complied with.
• Option term. The term of options granted under the 2003 stock option plan may not exceed ten years from the date of
grant.
• Change of control. If a third-party acquires us through the purchase of all or substantially all of our assets, a merger or
other business combination, all outstanding stock options will become fully vested and exercisable immediately prior to
such transaction.
• Termination of plans. Unless terminated earlier, the 2003 stock option plan will expire in 2023. Our board of directors
has the authority to terminate our stock option plan prior to the expiry of the plan provided that such early termination
shall not affect the options then outstanding under the plan.
C. Board Practices
BOARD OF DIRECTORS
Our Articles of Association prescribes that we should have a minimum of 1 and a maximum of 15 directors. Currently,
our board of directors comprises 5 board members, three of them are independent. Under Antigua law, our directors have a duty of
loyalty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the skill they
actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In
fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and by-laws, as amended and re-
stated from time to time. A shareholder has the right to seek damages if a duty owed by our directors is breached.
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The functions and powers of our board of directors include, among others:
• convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings;
• declaring dividends and distributions;
• appointing officers and determining the term of office of officers;
• exercising the borrowing powers of our company and mortgaging the property of our company; and
• approving the transfer of shares of our company, including the registering of such shares in our share register.
Terms of directors and Executive Officers
Our officers are elected by and serve at the discretion of the board of directors. Our directors are not subject to a term of
office and hold office until such time as they are removed from office by special resolution or the unanimous written resolution of
all shareholders. A director will be removed from office automatically if, among other things, the director (i) becomes bankrupt or
makes any arrangement or composition with his creditors; or (ii) dies or is found by our company to be or becomes of unsound
mind.
COMMITTEES OF THE BOARD OF DIRECTORS
Our board of directors has established an audit committee, a compensation committee and a corporate governance and
nominating committee as of April 12, 2006.
Audit committee
Our audit committee consists of our independent directors Messrs. Simon Anderson, Yuk Lam Lo and Chup Hung Mok, and
is chaired by Simon Anderson, who is a financial expert. The audit committee oversees our accounting and financial reporting
processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:
• selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by
our independent auditors;
• reviewing with our independent auditors any audit problems or difficulties and management’s response;
• reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K under the
Securities Act;
• discussing the annual audited financial statements with management and our independent auditors;
• reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of material
control deficiencies;
• annually reviewing and reassessing the adequacy of our audit committee charter;
• such other matters that are specifically delegated to our audit committee by our board of directors from time to time;
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• meeting separately and periodically with management and our internal and independent auditors; and
• reporting regularly to the full board of directors.
Compensation Committee
Our compensation committee consists of our independent directors Messrs. Simon Anderson, Yuk Lam Lo and Chup Hung
Mok, and is chaired by Yuk Lam Lo. Our compensation committee assists the board in reviewing and approving the compensation
structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive
officers. Members of the compensation committee are not prohibited from direct involvement in determining their own
compensation. Our chief executive officer may not be present at any committee meeting during which his compensation is
deliberated. The compensation committee is responsible for, among other things:
• approving and overseeing the compensation package for our executive officers;
• reviewing and making recommendations to the board with respect to the compensation of our directors;
• reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer,
evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the
compensation level of our chief executive officer based on this evaluation; and
• reviewing periodically and making recommendations to the board regarding any long-term incentive compensation or
equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.
Corporate Governance and Nominating Committee
Our corporate governance and nominating committee consists of our independent directors Messrs. Simon Anderson, Yuk
Lam Lo and Chup Hung Mok, and is chaired by Chup Hung Mok. The corporate governance and nominating committee assists
the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board
and its committees. The corporate governance and nominating committee is responsible for, among other things:
• identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill
any vacancy;
• reviewing annually with the board the current composition of the board in light of the characteristics of independence,
age, skills, experience and availability of service to us;
• identifying and recommending to the board the directors to serve as members of the board’s committees;
• advising the board periodically with respect to significant developments in the law and practice of corporate governance
as well as our compliance with applicable laws and regulations, and making recommendations to the board on all matters
of corporate governance and on any corrective action to be taken; and
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• monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness
of our procedures to ensure proper compliance.
DUTIES OF DIRECTORS
Under Antigua law, our directors have a duty of loyalty to act honestly, in good faith and with a view to our best interests.
Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent
person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance
with our memorandum and by-laws, as amended and re-stated from time to time. A shareholder has the right to seek damages if a
duty owed by our directors is breached.
The functions and powers of our board of directors include, among others:
• convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings;
• declaring dividends and distributions;
• appointing officers and determining the term of office of officers;
• exercising the borrowing powers of our company and mortgaging the property of our company; and
• approving the transfer of shares of our company, including the registering of such shares in our share register.
TERMS OF DIRECTORS AND EXECUTIVE OFFICERS
Our officers are elected by and serve at the discretion of the board of directors. Our directors are not subject to a term of
office and hold office until such time as they are removed from office by special resolution or the unanimous written resolution of
all shareholders. A director will be removed from office automatically if, among other things, the director (i) becomes bankrupt or
makes any arrangement or composition with his creditors; or (ii) dies or is found by our company to be or becomes of unsound
mind.
INTERESTED TRANSACTIONS
A director may vote in respect of any contract or transaction in which he or she is interested, provided that the nature of the
interest of any directors in such contract or transaction is disclosed by him or her at or prior to its consideration and any vote in
that matter.
REMUNERATION AND BORROWING
The directors may determine remuneration to be paid to the directors. The compensation committee assists the directors in
reviewing and approving the compensation structure for the directors. The directors may exercise all the powers of the company to
borrow money and to mortgage or charge its undertaking, property and uncalled capital, and to issue debentures or other securities
whether outright or as security for any debt obligations of our company or of any third-party.
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D. Employees
As of June 30, 2006, we had 238 full-time employees. Of our workforce, 53 employees are engaged in research and
development and 59 employees are engaged in sales and marketing. None of our employees is represented by a labor union or
covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
E.
Share Ownership
The following table sets forth information with respect to the beneficial ownership of our common shares, as of the date of
June 30, 2006, the most recent practicable date, by:
• each of our directors and executive officers; and
• each person known to us to own beneficially more than 5% of our common shares.
Directors and Executive Officers:
Weidong Yin
Simon Anderson
Xianping Wang
Jinling Qin
Jiansan Zhang
Nan Wang
Changjun Fu
Principal Shareholders:
Lily Wang
Heping Wang
Shares Beneficially
Owned(1)(2)
Number %
Nil
6,000,000 15.10
*
504,500 1.27
*
13,400
*
35,000
*
43,000
*
17,400
4,653,121 11.71
2,547,600 6.41
*
(1)
(2)
Owns less than one percent of the common shares, based on 39,726,028 common shares outstanding as of June 30, 2006,
Beneficial ownership is determined in accordance with Rule 13d-3 of the General Rules and Regulations under the Exchange
Act, and includes voting or investment power with respect to the securities.
The number of common shares outstanding in calculating the percentages for each listed person includes the common shares
underlying options held by such person. Percentage of beneficial ownership of each listed person is based on 39,726,028
common shares outstanding as of June 30, 2006, as well as the common shares underlying share options exercisable by such
person within 60 days of the date of this annual report on Form 20-F.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
Please refer to “Item 6. Directors, Senior Management and Employees — Share Ownership.”
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B. Related Party Transactions
TRANSACTIONS WITH LILY WANG
Lily Wang, a principal shareholder of our company, was also our director from September 2003 to March 2006.
In September 2003, we issued 10 million new common shares to Lily Wang in exchange for a 51% equity interest in Sinovac
Beijing that Ms. Wang had contracted to buy from certain of Sinovac Beijing’s then four shareholders for cash immediately before
the above 51% share transfer. This 51% equity interest in Sinovac Beijing was transferred to us directly from these shareholders
and was recorded in the applicable transfer instrument as a cash transaction. The cash due to these shareholders was payable by
Ms. Wang. The transfer of the 51% equity interest to us was registered and approved by relevant PRC government authorities in
August 2004. The common shares we issued to Ms. Wang were issued at a price of $0.60 per share, representing approximately
37% of our outstanding common shares immediately after the issuance.
Tangshan Yian was one of the shareholders from whom Ms. Wang contracted to buy the Sinovac Beijing equity interest
described above. Ms. Wang agreed to buy from Tangshan Yian a 15.72% equity interest in Sinovac Beijing for a cash
consideration of approximately $1.8 million. This 15.72% equity interest was transferred to us directly in our partial acquisition of
Sinovac Beijing described above. When we acquired Tangshan Yian as a wholly-owned subsidiary in November 2004, its assets
included a promissory note from Ms. Wang for the approximately $1.8 million purchase consideration. In October 2004, we and
Ms. Wang entered into a pledge and escrow agreement under which Ms. Wang pledged 3 million of her shares in our company to
us as collateral for this $1.8 million unpaid purchase consideration. Under the agreement, Ms. Wang will pay by November 15,
2006, the unpaid purchase consideration together with interest thereon at 5% per annum in quarterly installments of $200,000
each. As of June 30, 2006, approximately $0.55 million in accrued interests of the purchase consideration remained outstanding.
TRANSACTIONS WITH HEPING WANG
Heping Wang was our director from September 2003 to April 2006. Mr. Wang is also brother of Lily Wang.
In January 2004, we entered into a share purchase agreement with Heping Wang to acquire from Mr. Wang a 100% equity
interest in Tangshan Yian that he had contracted to purchase from Tangshan Yian’s then existing two shareholders immediately
before the above 100% share transfer. This 100% equity interest in Tangshan Yian was transferred to us directly from these
shareholders and was recorded in the applicable transfer instrument as a cash transaction. The purchase consideration we paid
Mr. Wang was (1) 3.5 million of our new common shares, issued at a price of $0.76 per share and (2) a promissory note from us in
the amount of $2.2 million. The foregoing purchase consideration took into account the value of Tangshan Yian with an increased
registered capital by $2.6 million that Mr. Wang had agreed to subscribe for but had not yet paid. In connection with this
acquisition, Mr. Wang issued us a promissory note in the amount of $2.6 million in respect of such unpaid capital contribution.
The transfer of the 100% equity interest to us was registered and approved by relevant PRC government authorities on
October 25, 2004. In October 2004, our $2.2 million promissory note to Mr. Wang was canceled and Mr. Wang’s $2.6 million
promissory note was reduced by $2.2 million. Mr. Wang paid the $400,000 balance of the promissory note in November 2004. As
of December 31, 2005, Mr. Wang still owed us accrued interests on the $2.6 million promissory note in the amount of $156,468.
The management chose to conservatively value the amount owing and set up a 100% provision for it in 2005.
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At the time of the above equity interest transfer from Mr. Wang to us, Tangshan Yian owed to China High Tech Investment
Co., Ltd. a loan in the principal amount of RMB 9 million that occurred in 2001 and 2002. In 2005, Tangshan Yian agreed to pay
China High Tech Investment an aggregate amount of RMB 10.8 million comprising the RMB 9 million principal amount of the
loan and a RMB 1.8 million funding fee, in two equal installments by September 30, 2005 and December 31, 2005, respectively.
Tangshan Yian further agreed, if it fails to make either of these two loan installment payments, to pay China High Tech
Investment a default penalty at 0.1% of the aggregate outstanding loan balance per day. So far the only payment Tangshan Yian
made to China High Tech Investment was RMB 2 million in November 2005.
In connection with the above equity interest transfer, Mr. Wang agreed to assume and indemnify Tangshan Yian’s loan
obligations owed to China High Tech Investment. In October 2004, we and Mr. Wang entered into a pledge and escrow
agreement, under which Mr. Wang pledged 1.5 million of his shares in our company to us as collateral to secure his
indemnification obligation owed to us in respect of the loan. When the above two loan installment payments became due,
Mr. Wang, however, did not fulfill his promise to assume and pay us the then outstanding loan amount.
In 2006, we once extended Mr. Wang’s loan payment due date to May 31, 2006. In early June 2006, we further extended his
loan payment due date to September 30, 2006. On June 22, 2006, however, we sent a loan repayment letter to Mr. Wang
demanding him to immediately pay us in full all outstanding loan amount and its accrued interests to comply with the Sarbanes-
Oxley Act. We have not received any loan repayment from him as of the date of this annual report.
TRANSACTIONS WITH CERTAIN OTHER DIRECTORS AND AFFILIATES
We made a loan to Shenzhen Bio-Port Co., Ltd., a previous non-controlling shareholder of Sinovac Beijing, in 2004 in an
aggregate amount of approximately $421,327 for the purposes of funding Shenzhen Bio-Port’s working capital. The loans bore
interest at the prevailing commercial lending rates in China and were payable on demand. As of the date of this annual report,
Shenzhen Bio-Port has fully repaid such loan to us.
We made a loan to Shenzhen Bio-Port Co., Ltd., a previous non-controlling shareholder of Sinovac Beijing, in 2005 in an
aggregate amount of approximately $1,250,000 for the purposes of funding Shenzhen Bio-Port’s working capital. The loans bore
interest at the prevailing commercial lending rates in China and were payable on demand. As of the date of this annual report,
Shenzhen Bio-Port has fully repaid such loan to us.
Beijing Xinfu Investments Ltd., a corporation of which Xianping Wang was General Manager, a director of Sinovac Beijing,
made a three-month short-term loan to us in September 2001 in an aggregate amount of approximately $625,000 for the purposes
of funding Sinovac Beijing’s working capital. The loans bore interest at the prevailing commercial lending rates in China. The
loan was later extended to December 30, 2003. As of the date of this annual report, we have fully repaid such loans to Beijing
Xinfu Investments.
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We entered into two operating leases with China Bioway Biotech Group Co., Ltd., the current minority shareholder of
Sinovac Beijing, in 2004, with respect to Sinovac Beijing’s production plant and laboratory in Beijing for total annual lease
payment of $170,988. The leases commenced on August 12, 2004 and have a term of 20 years.
In 2005, we made a deposit of $433,694 to Beijing Xingchang Dabo Real Estate Development Ltd., a company controlled by
Xianping Wang, a director of Sinovac Beijing, in respect of the acquisition of certain land-use rights. We decided not to pursue
the acquisition, and the deposit was returned to us.
We paid $72,000 to Lily Wang, our former director and CFO, in each of 2004 and 2005 for her management consulting
services.
In 2004, we paid $36,000 to Bin Zou, then treasurer of the company and Xianping Wang’s wife, for her services as treasurer
in managing the company’s account in Canada.
In June 2003, Shenzhen Bio-Port Co., Ltd. a corporation controlled by Xianping Wang, one of Sinovac Beijing’s directors,
agreed to settle the debt owed by Sinovac Beijing in the amount of $2,608,696 in exchange for 16% interest in Sinovac Beijing.
In 2005, we paid $25,944 to a management services company 50% owned by Simon Anderson, one of our directors, for his
services provided in the capacity of a director and a member of the audit committee. This management services company did not
separately provide us any service.
SHARE OPTIONS
See Item 6.B. “Directors, Senior Management and Employees – 2003 Stock Option Plan.”
ITEM 8.
FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
We have appended consolidated financial statements filed as part of this annual report.
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Legal and Administrative Proceedings
We are currently not a party to any material legal or administrative proceedings, and we are not aware of threatened material
legal or administrative proceedings against us. We may from time to time become a party to various legal or administrative
proceedings arising in the ordinary course of our business. However, our legal counsel has advised us that we may have violated
Section 402 of the Sarbanes-Oxley Act that prohibits an issuer from, among others, extending or maintaining credit to its directors
or executive officers. We have extended and maintained some credit to two of our former directors, one of whom was also a
former officer. Lily Wang, our former director and CFO until March 22, 2006, owed us a loan in the amount of approximately
$1.8 million as of October 2004 arising from her earlier acquisition of Tangshan Yian’s equity interest in Sinovac Beijing. As of
June 30, 2006, the aggregate principal amount of the loan and the accrued interests amounted to approximately $0.55 million.
Another former director, Heping Wang, also owed us unpaid capital contribution in the amount of $2.6 million in earlier 2004
although the full amount of this capital contribution had been settled by November 2004. As of December 31, 2005, Mr. Wang
still owed us accrued interests on the $2.6 million promissory note in the amount of $156,468. The management chose to
conservatively value the amount owing and set up a 100% provision in 2005. In addition, Heping Wang, in connection with his
transfer of 100% equity interest in Tangshan Yian to us in 2004, agreed to assume and indemnify Tangshan Yian’s loan
obligations in an aggregate amount of RMB 10.8 million comprising the RMB 9 million principal amount of the loan in RMB
9 million and a RMB 1.8 million funding fee. Heping Wang has yet to pay us the RMB 10.8 million. In an effort to take
immediate remedial steps to address any potential violation of the Sarbanes-Oxley Act, we issued a loan repayment letter on
June 22, 2006 to each of Lily Wang and Heping Wang demanding immediate full repayment by them of all outstanding loan
balances including accrued interests. Although we have not received any repayment from them as the date of this annual report,
we intend to aggressively seek their prompt and full repayment. For more detailed description of the foregoing transactions, see
Section B captioned “Related Party Transactions” of Item 7 of this annual report.
Dividend Policy
We have never declared or paid any dividends, nor do we have any present plan to pay any cash dividends on our ordinary
shares in the foreseeable future. We currently intend to retain most, if not all, of our available funds and any future earnings to
operate and expand our business.
Our board of directors has complete discretion on whether to pay dividends, subject to the approval of our shareholders.
Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations
and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board
of directors may deem relevant. Cash dividends on our common shares, if any, will be paid in U.S. dollars.
B.
Significant Changes
We have not experienced any significant changes since the date of our audited consolidated financial statements included in
this annual report.
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ITEM 9.
THE OFFER AND LISTING
A. Offer and Listing Details
The following table indicates the high and low market prices of our common shares over (1) the last three fiscal years,
(2) each quarter since first quarter of 2004 and (3) each month since January 2006. Our common shares commenced trading on the
OTC Bulletin Board on February 21, 2003 and then became listed on the American Stock Exchange under the symbol “SVA” on
December 8, 2004.
Annual Highs and Lows
2005
2004
2003 (1)
Quarterly Highs and Lows
Second Quarter 2006
First Quarter 2006
Fourth Quarter 2005
Third Quarter 2005
Second Quarter 2005
First Quarter 2005
Fourth Quarter 2004
Third Quarter 2004
Second Quarter 2004
First Quarter 2004
Monthly Highs and Lows
January 2006
February 2006
March 2006
April 2006
May 2006
June 2006
Sales Price
High
Low
$7.92 $1.65
$6.95 $1.71
$1.80 $0.75
$4.97 $2.30
$5.28 $3.24
$7.92 $3.91
$4.83 $2.35
$3.24 $1.65
$3.90 $2.60
$4.45 $3.30
$3.85 $2.64
$6.01 $2.93
$6.95 $1.71
$5.25 $3.92
$4.48 $3.62
$5.28 $3.24
$4.65 $3.85
$4.97 $3.30
$3.61 $2.30
(1) Our common shares commenced trading on the OTC Bulletin Board on February 21, 2003.
B.
Plan of Distribution
Not applicable.
C. Markets
Our common shares traded on the OTC Bulletin Board from February 21, 2003 to December 7, 2004. Since December 8,
2004, our common shares have been listed on the American Stock Exchange under the symbol “SVA.”
D.
Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F.
Expenses of the Issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A.
Share Capital
Not applicable.
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B. Memorandum and Articles of Association
We are an Antigua company with limited liability, and our affairs are governed by our articles of incorporation, by-laws and
the International Business Corporations Act.
The following are summaries of material provisions of our articles of incorporation, by-laws and the International Business
Corporations Act insofar as they relate to the material terms of our common shares.
COMMON SHARES
General
All of our outstanding common shares are fully paid and non-assessable. The common shares are issued in registered form.
Holders of common shares are entitled to receive share certificates. Our shareholders who are non-residents of Antigua may freely
hold and vote their common shares.
Dividends
The holders of our common shares are entitled to such dividends as may be declared by our board of directors subject to the
International Business Corporations Act.
Voting rights
Each common share is entitled to one vote on all matters upon which the common shares are entitled to vote. A quorum
required for a meeting of shareholders consists of shareholders who hold at least a majority of our shares at the meeting present in
person or by proxy. Shareholders’ meetings are held annually and may be convened by our board of directors on its own initiative
or upon a request to the directors by shareholders holding in aggregate at least five percent of our issued share capital. Advance
notice of at least 21 days is required for the convening of our annual general meeting and other shareholders meetings.
An ordinary resolution to be passed by the shareholders requires the affirmation vote of a simple majority of the shares
entitled to vote. A special resolution requires the affirmative vote of no less than two-thirds of the votes entitled to vote. Unless
the International Business Corporations Act otherwise requires, resolutions to be passed by the shareholders requires the
affirmative vote of a simple majority of the votes cast in a shareholders’ meeting. Important matters such as a change of our name
or making changes to our by-laws require a special resolution passed by a majority of not less than two-thirds of the votes cast by
the shareholders who voted in respect of the resolution.
Transfer of common shares
Our shareholders may transfer common shares by endorsing the relevant share certificates or by other proper evidence of
succession, assignment or authority to transfer.
Liquidation
On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of common shares),
assets available for distribution among the holders of common shares shall be distributed among the holders of the common shares
on a pro rata basis. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be
distributed so that the losses are borne by our shareholders proportionately.
Inspection of books and records
Holders of our common shares will have no general right under Antigua law to inspect or obtain copies of our list of
shareholders or our corporate records.
Changes in capital
We may from time to time by special resolution:
• increase the share capital by such sum, to be divided into shares of such classes and amount, as the resolution shall
prescribe;
• consolidate and divide all or any of our share capital into shares of a larger amount than our existing shares;
• sub-divide our existing shares, or any of them into shares of a smaller amount provided that in the subdivision the
proportion between the amount paid and the amount, if any unpaid on each reduced share shall be the same as it was in
case of the share from which the reduced share is derived;
• cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any
person and diminish the amount of our share capital by the amount of the shares so cancelled; and
• reduce our share capital and any capital redemption reserve in any manner authorized by law.
DIFFERENCES IN CORPORATE LAW
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The International Business Corporation Law is modeled after English law but does not follow many recent English law
statutory enactments. In addition, the International Business Corporation Law differs from laws applicable to United States
corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of the
International Business Corporation Law applicable to us and the laws applicable to companies incorporated in the United States
and their shareholders.
Mergers and similar arrangements
Antigua law does not provide for mergers as that expression is understood under United States corporate law. However, there
are statutory provisions for amalgamation that facilitate the consolidation of companies, provided that the arrangement is approved
by a majority number of each class of shareholders and creditors with whom the arrangement is to be made, and who must in
addition represent three-fourths in value of each such class of shareholders or creditors, as the case may be, that are present and
voting either in person or by proxy at a meeting, or meetings, convened for that purpose. The convening of the meetings and
subsequently the arrangement may be, but is not required to be, sanctioned by the High Court of Antigua. In some instances, the
Court of Appeal of Antigua, a tier higher than the High Court, may be called upon to approve a proposed arrangement. While a
dissenting shareholder has the right to express to the court his view that the transaction ought not to be approved, the court can be
expected to approve the arrangement if it determines that:
• the statutory provisions as to the dual majority vote have been met;
• the shareholders have been fairly represented at the meeting in question;
• the arrangement is such that a businessman would reasonably approve; and
• the arrangement is not one that would more properly be sanctioned under some other provision of the International
Business Corporation Law.
When a take-over offer is made and accepted (within four months) by holders of 90.0% of the shares affected, the offerer
may, within a two month period, require the holders of the remaining shares to transfer such shares on the terms of the offer. An
objection can be made to the High Court of Antigua but this is unlikely to succeed unless there is evidence of fraud, bad faith or
collusion.
If the arrangement and reconstruction is thus approved, the dissenting shareholder would have no rights comparable to
appraisal rights, which would otherwise ordinarily be available to dissenting shareholders of United States corporations, providing
rights to receive payment in cash for the judicially determined value of the shares.
Shareholders’ suits
We are not aware of any reported class action or derivative action having been brought in a court in Antigua. In principle, the
company itself will normally be the proper plaintiff in actions against directors, and derivative actions may not generally be
brought by a minority shareholder. However, based on English authorities, which would in all likelihood be of persuasive
authority in Antigua, there are exceptions to the foregoing principle, including when:
• a company acts or proposes to act illegally or ultra vires;
• the act complained of, although not ultra vires, required a special resolution, which was not obtained; and
• those who control the company are perpetrating a “fraud on the minority.”
Directors’ fiduciary duties
Under Delaware corporate law, a director of a Delaware corporation has a fiduciary duty to the corporation and its
shareholders. This duty has two components: the duty of care and the duty of loyalty. The duty of care requires that a director act
in good faith, with the care that an ordinarily prudent person would exercise under similar circumstances. Under this duty, a
director must inform himself of, and disclose to shareholders, all material information reasonably available regarding a significant
transaction. The duty of loyalty requires that a director act in a manner he reasonably believes to be in the best interests of the
corporation. He must not use his corporate position for personal gain or advantage. This duty prohibits self-dealing by a director
and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a
director, officer or controlling shareholder and not shared by the shareholders generally. In general, actions of a director are
presumed to have been made on an informed basis, in good faith and in the honest belief that the action taken was in the best
interests of the corporation. However, this presumption may be rebutted by evidence of a breach of one of the fiduciary duties.
Should such evidence be presented concerning a transaction by a director, a director must prove the procedural fairness of the
transaction, and that the transaction was of fair value to the corporation. As a matter of Antigua law, a director of an Antigua
company is in the position of a fiduciary with respect to the company and therefore it is considered that he owes the following
duties to the company—a duty to act bona fide in the best interests of the company, a duty not to make a profit out of his position
as director (unless the company permits him to do so) and a duty not to put himself in a position where the interests of the
company conflict with his personal interest or his duty to a third-party. A director of an Antigua company owes to the company a
duty to act with skill and care. It was previously considered that a director need not exhibit in the performance of his duties a
greater degree of skill than may reasonably be expected from a person of his knowledge and experience. However, English and
Commonwealth courts have moved towards an objective standard with regard to the required skill and care and these authorities
are likely to be followed in Antigua.
Shareholder action by written consent
Under the Delaware General Corporation Law, a corporation may eliminate the right of shareholders to act by written
consent by amendment to its certificate of incorporation. Antigua law and our by-laws provide that shareholders may approve
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corporate matters by way of a unanimous written resolution signed by or on behalf of each shareholder who would have been
entitled to vote on such matter at a general meeting without a meeting being held.
Shareholder proposals
Under the Delaware General Corporation Law, a shareholder has the right to put any proposal before the annual meeting of
shareholders, provided it complies with the notice provisions in the governing documents. A special meeting may be called by the
board of directors or any other person authorized to do so in the governing documents, but shareholders may be precluded from
calling special meetings. Antigua law and our by-laws allow our shareholders holding not less than five per cent of the paid up
voting share capital of our company to requisition a shareholder’s meeting. As an exempted Antigua company, we are not obliged
by law to call shareholders’ annual general meetings. However, our by-laws require us to call such meetings.
Cumulative voting
Under the Delaware General Corporation Law, cumulative voting for elections of directors is not permitted unless the
corporation’s certificate of incorporation specifically provides for it. Cumulative voting potentially facilitates the representation of
minority shareholders on a board of directors since it permits the minority shareholder to cast all the votes to which the
shareholder is entitled on a single director, which increases the shareholder’s voting power with respect to electing such director.
As permitted under Antigua law, our by-laws do not provide for cumulative voting. As a result, our shareholders are not afforded
any less protections or rights on this issue than shareholders of a Delaware corporation.
Removal of directors
Under the Delaware General Corporation Law, a director of a corporation with a classified board may be removed only for
cause with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides
otherwise. Under our by-laws, directors can be removed by a majority vote of the shareholders.
Transactions with interested shareholders
The Delaware General Corporation Law contains a business combination statute applicable to Delaware public corporations
whereby, unless the corporation has specifically elected not to be governed by such statute by amendment to its certificate of
incorporation, it is prohibited from engaging in certain business combinations with an “interested shareholder” for three years
following the date that such person becomes an interested shareholder. An interested shareholder generally is a person or group
who or which owns or owned 15% or more of the target’s outstanding voting stock within the past three years. This has the effect
of limiting the ability of a potential acquirer to make a two-tiered bid for the target in which all shareholders would not be treated
equally. The statute does not apply if, among other things, prior to the date on which such shareholder becomes an interested
shareholder, the board of directors approves either the business combination or the transaction which resulted in the person
becoming an interested shareholder. This encourages any potential acquirer of a Delaware public corporation to negotiate the
terms of any acquisition transaction with the target’s board of directors.
Antigua law has no comparable statute. As a result, we cannot avail ourselves of the types of protections afforded by the
Delaware business combination statute. However, although Antigua law does not regulate transactions between a company and its
significant shareholders, it does provide that such transactions must be entered into bona fide in the best interests of the company
and not with the effect of constituting a fraud on the minority shareholders.
Dissolution; Winding up
Under the Delaware General Corporation Law, unless the board of directors approves the proposal to dissolve, dissolution
must be approved by shareholders holding 100% of the total voting power of the corporation. Only if the dissolution is initiated by
the board of directors may it be approved by a simple majority of the corporation’s outstanding shares. Delaware law allows a
Delaware corporation to include in its certificate of incorporation a supermajority voting requirement in connection with
dissolutions initiated by the board. Under the International Business Corporations Law and our by-laws, our company may be
dissolved, liquidated or wound up only by the vote of holders of two-thirds of our shares voting at a meeting or the unanimous
written resolution of all shareholders.
Variation of rights of shares
Under the Delaware General Corporation Law, a corporation may vary the rights of a class of shares with the approval of a
majority of the outstanding shares of such class, unless the certificate of incorporation provides otherwise. Under Antigua law and
our by-laws, if our share capital is divided into more than one class of shares, we may vary the rights attached to any class only
with the vote at a class meeting of holders of two-thirds of the shares of such class or unanimous written resolution.
Amendment of governing documents
Under the Delaware General Corporation Law, a corporation’s governing documents may be amended with the approval of a
majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise. As permitted by
Antigua law, our by-laws may only be amended with the vote of holders of two-thirds of our shares voting at a meeting or the
unanimous written resolution of all shareholders.
Indemnification of directors and executive officers and limitation of liability
Antigua law does not limit the extent to which a company’s by-laws may provide for indemnification of officers and
directors, except to the extent any such provision may be held by the Antigua courts to be contrary to public policy, such as to
provide indemnification against civil fraud or the consequences of committing a crime. Our by-laws permits indemnification of
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officers and directors for losses, damages, costs and expenses incurred in their capacities as such unless such losses or
damages arise from negligence or illegal action of such directors or officers. This standard of conduct is generally the same as
permitted under the Delaware General Corporation Law to a Delaware corporation. In addition, we have entered into
indemnification agreements with our directors and senior executive officers that provide such persons with additional
indemnification beyond that provided in our by-laws.
Anti-takeover provisions in the by-laws
Some provisions of our by-laws may discourage, delay or prevent a change in control of our company or management that
shareholders may consider favorable, including provisions that authorize our board of directors to issue preference shares in one
or more series and to designate the price, rights, preferences, privileges and restrictions of such preference shares without any
further vote or action by our shareholders.
However, under Antigua law, our directors may only exercise the rights and powers granted to them under our by-laws for
what they believe in good faith to be in the best interests of our company.
Rights of non-resident or foreign shareholders
There are no limitations imposed by our by-laws on the rights of non-resident or foreign shareholders to hold or exercise
voting rights on our shares. In addition, there are no provisions in our by-laws governing the ownership threshold above which
shareholder ownership must be disclosed.
C. Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those described
in Item 4, “Information on the Company” or elsewhere in this annual report on Form 20-F.
D. Exchange Controls
Foreign Currency Exchange
Foreign currency exchange regulation in China is primarily governed by the following rules:
• Foreign Currency Administration Rules (1996), as amended, or the Exchange Rules; and
• Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules;
Under the Exchange Rules, the Renminbi is convertible for current account items, including the distribution of dividends,
interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items,
such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of the
PRC State Administration of Foreign Exchange, or SAFE.
Under the Administration Rules, foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those
banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital
account item transactions, obtaining approval from the SAFE. Capital investments by foreign-invested enterprises outside of
China are also subject to limitations, which include approvals by the Ministry of Commerce, the SAFE and the State Reform and
Development Commission.
Taxation
E.
ANTIGUA TAXATION
We and our securities holders, other than those residents in Antigua, are exempt from Antigua income, corporation or profits
tax, withholding tax, capital gains tax, capital transfer tax, estate duty or inheritance tax. We are not subject to stamp or other
similar duty on the issuance, transfer or redemption of our common shares. Under Section 276 of the International Business
Corporations Act of Antigua and Barbuda, the tax exemption we and our securities holders currently enjoy will continue in effect
for a period of 50 years from our date of incorporation, which is March 1, 1999. No reciprocal income tax treaty exists between
Antigua and Barbuda and the United States.
UNITED STATES FEDERAL INCOME TAXATION
The following discussion describes the material U.S. federal income tax consequences to U.S. Holders (defined below) under
present law of an investment in our common shares. This summary applies only to investors that hold our common shares as
capital assets and that have the U.S. dollar as their functional currency. This discussion is based on the tax laws of the United
States as in effect on the date of this Annul Report and on U.S. Treasury regulations in effect or, in some cases, proposed, as of the
date of this Annul Report, as well as judicial and administrative interpretations thereof available on or before such date. All of the
foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences
described below.
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The following discussion does not deal with the tax consequences to any particular investor or to persons in special tax
situations such as:
• banks;
• certain financial institutions;
• insurance companies;
• broker dealers;
• U.S. expatriates;
• traders that elect to mark to market;
• tax-exempt entities;
• persons liable for alternative minimum tax;
• persons holding a common share as part of a straddle, hedging, conversion or integrated transaction;
• persons that actually or constructively own 10% or more of our voting stock;
• partnerships or other pass-through entities; or
• persons holding our common shares through partnerships or other pass-through entities.
PROSPECTIVE PURCHASERS ARE URGED TO CONSULT THEIR TAX ADVISORS ABOUT THE APPLICATION
OF THE U.S. FEDERAL INCOME TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE
ESTATE AND GIFT AND STATES LOCAL AND FOREIGN TAX CONSEQUENCES TO THEM OF THE
PURCHASE, OWNERSHIP AND DISPOSITION OF OUR COMMON SHARES.
The discussion below of the U.S. federal income tax consequences to “U.S. Holders” will apply if you are a beneficial owner
of our common shares and you are, for U.S. federal income tax purposes:
• a citizen or resident of the United States;
• a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) created or organized under
the laws of the United States, any State or the District of Columbia;
• an estate whose income is subject to U.S. federal income taxation regardless of its source; or
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• a trust that (1) is subject to the supervision of a court within the United States and the control of one or more U.S.
persons or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.
If a partnership is a beneficial owner of our common shares, the tax treatment of a partner in the partnership generally will
depend upon the status of the partner and the activities of the partnership.
Taxation of Dividends and Other Distributions on Our Common Shares
Subject to the PFIC rules discussed below, the gross amount of all our distributions to you with respect to our common
shares generally will be included in your gross income in the year received as dividend income to the extent that the distribution is
paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). To the extent
that the amount of the distribution exceeds our current and accumulated earnings and profits, it will be treated first as a tax-free
return of your tax basis in your common shares, and to the extent the amount of the distribution exceeds your tax basis, the excess
will be taxed as capital gain. The dividends will not be eligible for the dividends-received deduction allowed to corporations in
respect of dividends received from other U.S. corporations.
With respect to non-corporate U.S. Holders, including individual U.S. Holders, for taxable years beginning before January 1,
2011, dividends may constitute “qualified dividend income” eligible to be taxed at the preferential rate applicable to capital gains
(currently a maximum rate of 15 percent), provided that (1) our common shares are readily tradable on an established securities
market in the United States, (2) we are not a PFIC (as discussed below) for either our taxable year in which the dividend was paid
or the preceding taxable year, and (3) certain holding period requirements are met. Under Internal Revenue Service authority,
common shares are considered for the purpose of clause (1) above to be readily tradable on an established securities market in the
United States if they are listed on the American Stock Exchange, as our common shares are. You should consult your tax advisors
regarding the availability of the lower rate for dividends paid with respect to our common shares.
Dividends generally will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are
qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the U.S.
foreign tax credit limitation generally will be limited to the gross amount of the dividend, multiplied by the reduced rate divided
by the highest rate of tax normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated
separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to our common
shares generally will constitute “passive income” or, in the case of certain U.S. Holders, “financial services income.” For taxable
years beginning after December 31, 2006, dividends distributed by us with respect to our common shares generally would
constitute “passive category income” but could, in the case of certain U.S. Holders, constitute “general category income.” The
rules and limitations with respect to foreign tax credits are complicated, and you should consult your tax advisors regarding the
availability of foreign tax credits to you in your circumstances.
Taxation of Disposition of Our Common Shares
Subject to the PFIC rules discussed below, you will recognize taxable gain or loss on any sale, exchange or other taxable
disposition of a common share equal to the difference between the amount realized for the common share and your tax basis in the
common share. Your tax basis in our common shares will generally equal the cost of such shares. The gain or loss generally will
be capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, who has held the common
share for more than one year, you will be eligible for reduced tax rates. The deductibility of capital losses is subject to limitations.
Any such gain or loss that you recognize generally will be treated as U.S. source income or loss for foreign tax credit limitation
purposes.
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Passive Foreign Investment Company
We believe we were not a PFIC for our taxable year ended December 31, 2005, and we do not expect to be a PFIC for United
States federal income tax purposes for our current taxable year. Our actual PFIC status for the current taxable year ending
December 31, 2006 will not be determinable until the close of the current taxable year ending December 31, 2006, and,
accordingly, there is no guarantee that we will not be a PFIC for the current taxable year. A non-U.S. corporation is considered to
be a PFIC for any taxable year if either:
• at least 75% of its gross income is passive income, or
• at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is
attributable to assets that produce or are held for the production of passive income (and/or cash).
We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any
other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock.
We must make a separate determination each year as to whether we are a PFIC. As a result, our PFIC status may change. In
particular, our PFIC status may be determined in large part based on the market price of our common shares, which is subject to
fluctuation (and potentially considerable fluctuation given that market prices of biotechnology companies have been especially
volatile). Accordingly, fluctuations in the market price of our common shares may result in our being a PFIC for any year. If we
are a PFIC for any year during which you hold our common shares, we generally will continue to be treated as a PFIC for all
succeeding years during which you hold our common shares.
If we are a PFIC for any taxable year during which you hold our common shares, you will be subject to special tax rules with
respect to any “excess distribution” that you receive and any gain you realize from a sale or other disposition (including a pledge)
of the common shares, unless you make either a “mark-to-market” or a “qualified electing fund” election as discussed below. In
addition, a step-up in the tax basis of stock in a PFIC may not be available upon the death of an individual U.S. Holder.
Under the “excess distribution” rules, distributions you receive in a taxable year that are greater than 125% of the average
annual distributions you received during the shorter of the three preceding taxable years or your holding period for the common
shares will be treated as an excess distribution. Under these special tax rules:
• the excess distribution or gain will be allocated ratably over your holding period for the common shares,
• the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we became a
PFIC, will be treated as ordinary income, and
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• the amount allocated to each other year will be subject to the highest tax rate in effect for that year and the interest charge
generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.
The tax liability for amounts allocated to years prior to the year of disposition or “excess distribution” cannot be offset by
any net operating losses for such years, and gains (but not losses) realized on the sale of the common shares cannot be treated as
capital, even if you hold the common shares as capital assets.
Alternatively, a U.S. Holder of “marketable stock” (as defined below) in a PFIC may make a mark-to-market election for
such stock of a PFIC to elect out of the tax treatment discussed above. If you make a mark-to-market election for the common
shares, you will include in income each year an amount equal to the excess, if any, of the fair market value of the common shares
as of the close of your taxable year over your adjusted basis in such common shares. You are allowed a deduction for the excess,
if any, of the adjusted basis of the common shares over their fair market value as of the close of the taxable year. However,
deductions are allowable only to the extent of any net mark-to-market gains on the common shares included in your income for
prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other
disposition of the common shares, are treated as ordinary income. Ordinary loss treatment also applies to the deductible portion of
any mark-to-market loss on the common shares, as well as to any loss realized on the actual sale or disposition of the common
shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such
common shares. If you make a valid mark-to-market election, your basis in the common shares will be adjusted to reflect any such
income or loss amounts. The tax rules that apply to distributions by corporations that are not PFICs would apply to distributions
by us except that the preferential rates with respect to “qualified dividend income” would not apply.
The mark-to-market election is available only for “marketable stock,” which generally is defined as stock that is traded in
other than de minimis quantities on at least 15 days during each calendar quarter on a qualified exchange, including the American
Stock Exchange, or other market, as defined in applicable U.S. Treasury regulations. Our common shares are listed on the
American Stock Exchange and, consequently, if you are a holder of common shares the mark-to-market election would be
available to you were we to be or become a PFIC, provided that our common shares are traded in sufficient quantities.
In general, if a non-U.S. corporation is a PFIC, as an alternative to the mark-to-market election, a holder of shares in that
corporation may avoid taxation under the PFIC rules described above by making a “qualified electing fund” election to include in
income its share of the corporation’s income on a current basis, or a “deemed sale” election once the corporation no longer
qualifies as a PFIC. However, you may make a qualified electing fund election with respect to your common shares only if we
furnish you annually with certain tax information, and we do not currently intend to prepare or provide such information.
If you hold common shares in any year in which we are a PFIC, you will be required to file Internal Revenue Service Form
8621 regarding distributions received on the common shares and any gain realized on the disposition of the common shares.
You are urged to consult your tax advisor regarding the application of the PFIC rules to your investment in our common
shares.
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Information Reporting and Backup Withholding
Dividend payments with respect to our common shares and proceeds from the sale, exchange or redemption of our common
shares may be subject to information reporting to the Internal Revenue Service and possible U.S. backup withholding at a current
rate of 28%. Backup withholding will not apply, however, to a U.S. Holder who furnishes a correct taxpayer identification number
and makes any other required certification or who is otherwise exempt from backup withholding. U.S. Holders who are required
to establish their exempt status generally must provide such certification on Internal Revenue Service Form W-9. U.S. Holders
should consult their tax advisors regarding the application of the U.S. information reporting and backup withholding rules.
Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S.
federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by
filing the appropriate claim for refund with the Internal Revenue Service and furnishing any required information.
F. Dividends and Paying Agents
Not applicable.
G.
Statement by Experts
Not applicable.
H. Documents on Display
We previously filed with the SEC our registration statement on Form F-1, as amended and prospectus under the Securities
Act of 1933, with respect to our common shares.
We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange Act,
we are required to file reports and other information with the SEC. Specifically, we are required to file annually a Form 20-F no
later than six months after the close of each fiscal year, which is December 31. Copies of reports and other information, when so
filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the
Securities and Exchange Commission at Judiciary Plaza, 100 F Street, N.E., Washington, D.C. 20549, and at the regional office of
the Securities and Exchange Commission located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the Commission at
1-800-SEC-0330. The SEC also maintains a web site at www.sec.gov that contains reports, proxy and information statements, and
other information regarding registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private
issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy
statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery
provisions contained in Section 16 of the Exchange Act.
Our financial statements have been prepared in accordance with U.S. GAAP.
We will furnish our shareholders with annual reports, which will include a review of operations and annual audited
consolidated financial statements prepared in conformity with U.S. GAAP.
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I.
Subsidiary Information
For a listing of our subsidiaries, see Item 4. C. of this annual report, “Information on the Company – Organizational
Structure”.
J.
Recent Developments
On March 22, 2006, Lily Wang resigned as the company’s CFO. Her departure was first announced in a Form 6-K
submission dated June 6, 2006 and was then confirmed by a subsequent Form 6-K submission dated June 20, 2006. We are in the
process of identifying a successor CFO to Ms. Wang. With effect from March 22, 2006, Ms. Jinling Qin, manager of the
company’s finance department, has been named Acting CFO.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Risk
Our revenues and costs and our expenses (other than U.S. dollar denominated professional, investor relations and
miscellaneous fees related to our operations as a public company) are currently denominated entirely in Renminbi, but the
Renminbi prices of some of the materials and supplies for reagent kits that are imported from companies in the United States,
Finland and Sweden may be affected by fluctuations in the value of Renminbi against the currencies of those countries. We do not
believe that we currently have any significant direct foreign currency exchange rate risk and have not hedged exposures
denominated in foreign currencies or any other derivative financial instruments. On July 21, 2005, the PRC government changed
its policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi will be permitted to
fluctuate within a band against a basket of certain foreign currencies. This change in policy resulted initially in an approximately
2.0% appreciation in the value of the Renminbi against the U.S. dollar. Since the adoption of this new policy, the value of
Renminbi against the U.S. dollar has fluctuated on a daily basis within narrow ranges but overall has further strengthened against
the U.S. dollar. There remains significant international pressure on the PRC government to further liberalize its currency policy,
which could result in a further and more significant appreciation or depreciation in the value of the Renminbi against the U.S.
dollar. Furthermore, a decline in the value of Renminbi against the U.S. dollar could reduce the U.S. dollar equivalent amounts of
our financial results, the value of your investment in our company and the dividends we may pay in the future, if any, all of which
may have a material adverse effect on the prices of our shares.
Our financial statements are expressed in U.S. dollars but our functional currency is Renminbi. The value of our shares will
be affected by the foreign exchange rate between U.S. dollars and Renminbi. To the extent we hold assets denominated in U.S.
dollars, any appreciation of the Renminbi against the U.S. dollar could result in a change to our statement of operations and a
reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of Renminbi against the
U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in our company
and the dividends we may pay in the future, if any, all of which may have a material adverse effect on the prices of our shares.
Interest Rate Risk
Our exposure to interest rate risk relates primarily to the interest expenses associated with our short-term and/or long-term
bank borrowings as well as interest income provided by excess cash invested in demand and time deposits. Such borrowing and
interest-earning instruments carry a degree of interest rate risk. We have not historically used, and do not expect to use in the
future, any derivative financial instruments to manage our exposure to interest risk. We have not been exposed nor do we
anticipate being exposed to material risks due to changes in interest rates. The weighted effective interest rate on our outstanding
loans was 5.79% and 6.60% for the years ended December 31, 2005 and 2004. A hypothetical increase in interest rates of 1%
would increase our annual interest and financing expenses by $50,817 based on our outstanding indebtedness as of December 31,
2005.
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ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
PART II
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report, our management, with the participation of our chief executive
officer and acting chief financial officer, has performed an evaluation of the effectiveness of our disclosure controls and
procedures within the meaning of Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based upon that evaluation, our
management has concluded that, as of the end of the period covered by this annual report, our existing disclosure controls and
procedures are not fully adequate and effective in ensuring that the material information required to be disclosed by us in the
reports that we file with, or submit to, the SEC under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in by the SEC’s rules and regulations.
We have taken a number of remedial actions to cure such inadequacy or ineffectiveness. First, we have formalized our
existing disclosure controls and procedures, which include regular reporting to our CEO Weidong Yin by our finance department,
marketing and sales department and research and development department. Second, we recently established a disclosure
committee on July 4, 2006 and adopted a disclosure committee charter effective the same day, setting forth the key responsibilities
of the committee. Third, we have appointed Helen G. Yang, our international finance manager, as our Disclosure Committee
Coordinator to coordinate the activities of the disclosure committee and all aspects of regulatory compliance.
Internal Controls over Financial Reporting
During the audit of our financial statements for the fiscal year ended December 31, 2005, we identified the following internal
control issues: (1) our failure to timely reconcile our accounts under PRC generally accepted accounting principles to U.S. GAAP;
(2) our failure to withhold the individual income tax with respect to the employees’ stock option gains; (3) the inappropriate
claims by certain of our employees of personal income tax exemptions; (4) our understatement of selling expenses and liabilities;
(5) our understatement of sales commissions and liabilities; and (6) our understatement of income tax expenses and tax liabilities.
In response, we have corrected these errors, and our management initiated a review of our financial and accounting systems and
identified material weaknesses in our internal control system over financial reporting related to our lack of personnel with U.S.
GAAP reporting experience. This was compounded by the resignation of Lily Wang on March 22, 2006 as our CFO, which
resulted in a lack of sufficient oversight over our financial reporting and other compliance matters. We have not appointed a
formal successor CFO, but we have identified a CFO candidate who just commenced his probation period with our company on
July 3, 2006. We have also appointed Ms. Jinling Qin, manager of our finance department, as the Acting CFO during the
transition period. We are in the process of adopting some other remedial actions to rectify the identified material weaknesses in
the internal control over our financial reporting. Such remedial actions include retaining professional consultants to advise on the
internal control over our financial reporting, recruiting a new staff member who is familiar with U.S. GAAP and implementing
procedures to withhold the individual income tax in connection with our employee’s exercise of stock options.
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The efficacy of the steps we have taken to date and the steps we are still in the process of taking to improve the reliability of
our financial statements is subject to continued management review. We cannot be certain that these measures will ensure that we
implement and maintain adequate internal control over financial reporting in the future. Any failure to implement required new or
improved controls, or difficulties encountered in their implementation, could adversely affect our operating results or cause us to
fail to meet our reporting obligations. We cannot guarantee we will not identify further material weaknesses or significant
deficiencies in our internal control over financial reporting in the future or that future restatements will not be required.
Changes in Internal Controls over Financial Reporting
There were no adverse changes in our internal controls over financial reporting that occurred during the period covered by
this annual report on Form 20-F that have materially affected, or are reasonably likely to materially affect our internal controls
over financial reporting.
In addition, under the supervision and with the participation of our senior management, including our chief executive officer
and chief financial officer, we are in the process of conducting further evaluation of our internal controls over financial reporting
for compliance with the requirements of Section 404 under the Sarbanes-Oxley Act. In this regard, we have engaged professional
consultants to assist us with evaluating, designing, implementing and testing internal controls over financial reporting intended to
comply with the requirements of Section 404. As we are still in the evaluation process, we may identify material weaknesses or
significant deficiencies in the future. Should we discover such conditions, we intend to remediate them. We are committed to
taking appropriate steps for remediation, as needed.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
See Item 6.C. of this annual report, “Directors, Senior Management and Employees — Board Practices.”
ITEM 16B. CODE OF ETHICS
Our board of directors has adopted a code of ethics that applies to our directors, officers, employees and agents, including
certain provisions that specifically apply to our chief executive officer, chief financial officer, vice presidents and any other
persons who perform similar functions for us. We have filed our code of business conduct and ethics as an exhibit to this annual
report on Form 20-F, and posted the code on our website at www.sinovac.com. We hereby undertake to provide to any person
without charge, a copy of our code of business conduct and ethics within ten working days after we receive such person’s written
request.
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ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees by categories specified below in connection with certain professional
services rendered by Moore Stephens Ellis Foster Ltd., our principal external auditor, for 2003 and 2004, and by Ernst & Young,
our principal external auditor for 2005. We did not pay any tax related or other fees to our auditors during the periods other than
as disclosed below.
Audit fees(1)
Audit-related fees(2)
Tax fees(3)
All other fees
2003
2005
2004
$68,850 $77,800 $279,047
$22,295 $25,950 $ 20,873
Nil $ 4,800
Nil
Nil
Nil
Nil
(1) “Audit fees” means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our
principal auditors for the audit of our annual financial statements and review of financial statements included in the
Company’s Form 20-Fs or services that are normally provided by accountants in connection with statutory and regulatory
engagements for those fiscal years.
(2) “Audit-related fees” means the aggregate fees billed in each of the fiscal years listed for assurance and related services by
our principal auditors that are reasonably related to the performance of the audit or review of our financial statements and are
not reported under “Audit fees.” The services comprising the fees under this category include the issue of comfort letter,
rendering of listing advice, and other audit-related services for the years ended December 31, 2003, December 31, 2004 and
December 31, 2005.
(3) “Tax fees” include fees billed for tax compliance services, including the preparation of original and amended tax returns
and claims for refund; tax consultations, such as assistance and representation in connection with tax audits and appeals, tax
advice related to mergers and acquisitions, transfer pricing and requests for rulings or technical advice from taxing
authorities; tax planning services and expatriate tax compliance, consultation and planning services.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
None.
ITEM 17. FINANCIAL STATEMENTS
We have elected to provide financial statements pursuant to Item 18.
PART III
ITEM 18. FINANCIAL STATEMENTS
The following consolidated financial statements of Sinovac and its subsidiaries are included at the end of this annual report
together with the report of the independent auditors.
• Consolidated Balance Sheets as of December 31, 2003, 2004 and 2005
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• Consolidated Statements of Operations for the years ended December 31, 2003, 2004 and 2005
• Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2003, 2004 and 2005
• Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 and 2005
• Notes to the Consolidated Financial Statements
ITEM 19. EXHIBITS
Exhibit Number
Description of Document
1.1
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8*
4.9*
8.1
11.1
12.1
12.2
13.1
13.2
Articles of Incorporation and By-laws of the Registrant, as last amended on March 21, 2006
Translation of a Lease between Sinovac Beijing and China Bioway Biotech Group Co., Ltd. related to a
building of approximately 28,000 square feet , dated August 12, 2004
Translation of a Lease between Sinovac Beijing and China Bioway Biotech Group Co., Ltd. related to a
building of approximately 13,300 square feet , dated August 12, 2004
Translation of a Supplement Agreement to the Leases between Sinovac Beijing and China Bioway
Biotech Group Co., Ltd.
Stock Option Plan adopted on November 1, 2003
Form of Employment Agreement between the Registrant and Weidong Yin, dated July 7, 2006
Translation of Form of Employment Agreement between the Registrant or its subsidiary and any other
senior executive officers of the Registrant or its subsidiary
Form of Non-disclosure, Non-competition and Proprietary Information Agreement between the
Registrant or its subsidiary and any other senior executive officers of the Registrant or its subsidiary
Pledge, Escrow and Promissory Note Agreement between the Registrant and the Registrant and Lily
Wang, dated October 12, 2004 (incorporated by reference to Exhibit 10.7 from our annual report on
Form 20-F (file no. 001-32371) filed with the Securities and Exchange Commission on May 27, 2005)
Pledge, Escrow and Indemnity Agreement between the Registrant and Heping Wang, dated October 12,
2004 (incorporated by reference to Exhibit 10.8 from our annual report on Form 20-F (file no. 001-
32371) filed with the Securities and Exchange Commission on May 27, 2005)
List of Subsidiaries
Code of Business Conduct and Ethics of the Registrant
CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Filed by incorporation by reference.
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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing its annual report on Form 20-F and that it has
duly caused and authorized the undersigned to sign this annual report on its behalf.
Date: July 14, 2006
SINOVAC BIOTECH LTD.
/s/ Weidong Yin
By:
Name: Weidong Yin
Title: Chief Executive Officer
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SINOVAC BIOTECH LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Index
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2005, 2004 and 2003
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2005, 2004 and 2003
F-2
F-4
F-5
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2005, 2004 and 2003 F-8
Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
F-9
F-10
F-1
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Sionvac Biotech Ltd.
We have audited the consolidated balance sheet of Sinovac Biotech Ltd. as at December 31, 2005 and the consolidated
statements of stockholders’ equity, operations and comprehensive loss and cash flows for the year then ended. These
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion in these
financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Oversight Board (United States). Those
standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial
reporting. Our audit includes consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial
position of the Company as at December 31, 2005 and the consolidated results of its operations and comprehensive loss and
its cash flows for the year then ended in accordance with U.S. generally accepted accounting principles.
Vancouver, Canada
February 28, 2006 except for note 19(c)
which is as of June 2, 2006
/s/ Ernst & Young LLP
Chartered Accountants
F-2
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MOORE STEPHENS
ELLIS FOSTER LTD.
CHARTERED ACCOUNTANTS
1650 West 1st Avenue
Vancouver, BC Canada V6J 1G1
Telephone: (604) 734-1112 Facsimile: (604) 714-5916
E-Mail: generaldelivery@ellisfoster.com
Website: www.ellisfoster.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
SINOVAC BIOTECH LTD.
We have audited the consolidated balance sheets of Sinovac Biotech Ltd. (formerly Net-Force Systems Inc.) (“the Company”) as
at December 31, 2004 and 2003, and the related consolidated statements of stockholders’ equity, operations and comprehensive
loss and cash flows for the years ended December 31, 2004 and 2003. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the
Company as at December 31, 2004 and 2003 and the results of its operations and its cash flows for the years ended December 31,
2004 and 2003 in conformity with generally accepted accounting principles in the United States of America.
As discussed in note 2, the accompanying consolidated financial statements of the Company as at December 31, 2004 and 2003,
and the related consolidated statements of stockholders’ equity, operations and comprehensive loss and cash flows for the years
ended December 31, 2004 and 2003 have been restated.
Vancouver, Canada
March 11, 2005 except for note 2 which
is as of November 18, 2005
MSEF A partnership of incorporated professionals
“MOORE STEPHENS ELLIS FOSTER LTD.”
Chartered Accountants
An independently owned and operated member of Moore Stephens North America Inc., a member of Moore Stephens
International Limited - members in principal cities throughout the world
F-3
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SINOVAC BIOTECH LTD.
Consolidated Balance Sheets
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
ASSETS
Current assets
Cash and cash equivalents
Restricted cash
Accounts receivable – net (note 4)
Inventories (note 5)
Deposit to a related party for land-use right (note 13f)
Prepaid expenses and deposits (note 13d)
Due from related parties (note 13a)
Total current assets
Property, plant and equipment (note 6)
Due from related parties (note 13a)
Deferred tax asset (note 11)
Licenses and permits (note 9)
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Loans payable (note 10)
Accounts payable and accrued liabilities (note 12)
Due to related parties (note 13b)
Dividends payable to minority interest of Sinovac Beijing
Deferred research grants
Total current liabilities
Long-term debts (note 10)
Total liabilities
Minority interest
Commitments (notes 13d)
STOCKHOLDERS’ EQUITY
Preferred stock
Authorized 50,000,000 shares at par value of $0.001 each Issued and
outstanding: nil
Common stock
Authorized: 100,000,000 shares at par value of $0.001 each Issued and
outstanding: 39,055,528 (2004 – 35,815,015, 2003 - 27,091,033) Shares
to be issued for services
Subscriptions received
Additional paid in capital
Accumulated other comprehensive income (loss)
Dedicated reserves
Accumulated deficit
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these financial statements.
F-4
2004
Restated
– Note 2
2003
Restated
– Note 2
2005
149,391
391,481
$ 7,354,451 $ 2,605,051 $ 1,420,047
—
5,454,249 3,353,287 1,470,761
487,243 1,047,920
—
13,723
—
16,273,654 8,470,554 3,952,451
—
438,614
1,755,997 1,194,878
837,666
433,694
288,206
12,455,971 10,042,063 7,459,883
— 1,816,998
947,267
652,300
860,300
—
1,917,172 1,230,315 1,424,503
$ 31,299,097 $22,420,230 $13,784,104
$ 2,417,779 $ 2,605,314 $
752,415
4,782,226 2,519,102 1,483,690
29,190 1,170,474
—
470,301
—
1,049,583 1,032,036
8,843,635 6,655,943 3,406,579
55,826
538,221
2,663,895
603,865
11,507,530 6,858,379 4,010,444
1,768,953 3,124,640 4,205,292
202,436
—
—
—
39,056
35,815
27,091
—
42,750
1,423,710
—
206,950 1,031,959
27,240,563 18,151,878 5,798,220
206
—
(11,550,928) (6,155,425) (1,289,108)
18,022,614 12,437,211 5,568,368
$ 31,299,097 $22,420,230 $13,784,104
(1,613)
199,606
342,981
484,482
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SINOVAC BIOTECH LTD.
Consolidated Statements of Stockholders’ Equity
(Expressed in U.S. Dollars)
Common stock
Shares
Amount
Subscript- ions
received
Additional
paid in
capital
Accumulated
other
compre-
hensive
income
Dedicated
reserves
Accumulated
earnings
(deficit)
Total
stockholders’
Equity
16,470,588 $16,471
— $ 8,450,034
— — $(1,372,460) $ 7,094,045
3,137,255 3,137
— 2,605,559
— —
—
2,608,696
— —
— (5,426,848)
— —
955,659 (4,471,189)
Spin-off of minority
interest on
recapitalization
Recapitalization to effect
the acquisition of Net-
Force (note 1)
Balance after
recapitalization
adjustment
Imputed interest on
(9,607,843) (9,608)
—
9,608
— —
—
17,091,033 17,091
—
(16,991)
— —
—
—
100
27,091,033 27,091
— 5,621,362
— —
(416,801)
5,231,652
— —
—
57,277
— —
— —
— —
—
1,031,959
119,581
—
— —
— —
—
—
—
57,277
119,581
1,031,959
— —
— —
—
—
—
—
206 —
— —
—
(872,307)
206
(872,307)
Balance, December 31,
2002 – Restated (note
2)
Debt exchange for shares
(note 13h)
Recapitalization
adjustment (note 1)
advances from related
parties
Stock-based
compensation
Subscriptions received
Other comprehensive
income (loss)
- Foreign currency
translation
Net loss for the year
Balance, December 31,
2003 – Restated (note
2)
27,091,033 $27,091 $ 1,031,959 $ 5,798,220 $
206 $ — $(1,289,108) $ 5,568,368
The accompanying notes are an integral part of these financial statements.
F-5
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connection with
acquisition of
Tangshan Yian
Private placement
Exercise of stock
options
Exercise of warrants
Stock issued for services
Subscriptions received
Other comprehensive
income (loss)
- Foreign currency
translation
Net loss for the year
Transfer to dedicated
reserves (note 16)
Form 20-F
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Table of Contents
SINOVAC BIOTECH LTD.
Consolidated Statements of Stockholders’ Equity
(Expressed in U.S. Dollars)
Common stock
Shares
Amount
Subscriptions
Received
Additional
paid in capital
Accumulated
Other
compre-
hensive
income
Dedicated
reserves
Accumulated
earnings
(deficit)
Total
stockholders’
equity
Balance, December 31,
2003 – Restated (note
2)
27,091,033 $27,091 $ 1,031,959 $ 5,798,220 $
206 $ — $(1,289,108) $ 5,568,368
Imputed interest on
advances from
related parties
Stock-based
compensation
Common stock issued in
— —
—
1,329
—
— —
—
4,428,032
—
—
3,500,000 3,500
4,179,200 4,179 (1,031,959)
1,569,543
4,745,821
40,500
991,782
12,500
41
991
13
— —
—
—
—
206,950
53,014
1,515,432
40,487
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1,329
— 4,428,032
— 1,573,043
— 3,718,041
—
53,055
— 1,516,423
—
40,500
—
206,950
— —
— —
— —
—
—
—
—
—
—
(1,819)
—
—
—
(1,819)
— (4,666,711) (4,666,711)
—
199,606
(199,606)
—
Balance, December 31,
2004 – Restated (note
2)
35,815,015 $35,815 $
206,950 $18,151,878 $
(1,613) $199,606 $(6,155,425) $12,437,211
The accompanying notes are an integral part of these financial statements.
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Form 20-F
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Table of Contents
SINOVAC BIOTECH LTD.
Consolidated Statements of Stockholders’ Equity
(Expressed in U.S. Dollars)
Common stock
Shares to
be issued
for
services
Subscriptions
received
Additional
paid in capital
Accumulated
other
compre-
hensive
income
Dedicated
reserves
Accumulated
earnings
(deficit)
Total
stockholders’
equity
Balance,
Shares
Amount
December 31,
2004 –
Restated
(note 2)
Stock-based
compensation
Private
placement
Exercise of
stock
options
Exercise of
35,815,015 $35,815 $ — $ 206,950 $18,151,878 $
(1,613) $199,606 $ (6,155,425) $12,437,211
— — —
—
3,355,708
561,667
562 —
(206,950)
1,516,800
—
—
1,345,700 1,346 —
—
1,780,136
—
—
—
—
—
— 3,355,708
— 1,310,412
— 1,781,482
— 2,437,374
warrants 1,333,146 1,333 —
—
2,436,041
—
Shares to be
issued
subsequent
to year-end
for services
Subscriptions
received
(note 15)
Other
comprehensive
income
(loss)
- Foreign
currency
translation
Net loss for the
year
Transfer to
dedicated
reserves
(note 16)
Balance,
— — 42,750
—
—
—
—
—
42,750
— — — 1,423,710
—
—
—
— 1,423,710
— — —
—
—
344,594
—
—
344,594
— — —
—
—
—
—
(5,110,627) (5,110,627)
— — —
—
—
—
284,876
(284,876)
—
December 31,
2005
39,055,528 $39,056 $42,750 $1,423,710 $27,240,563 $ 342,981 $484,482 $(11,550,928) $18,022,614
The accompanying notes are an integral part of these financial statements.
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Form 20-F
Page 106 of 134
Table of Contents
SINOVAC BIOTECH LTD.
Consolidated Statements of Operations and Comprehensive Loss
Years ended December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
Sales
2003
Restated
– Note 2
$ 8,607,948 $ 6,454,043 $ 2,838,933
2004
Restated
– Note 2
2005
Cost of sales – exclusive of depreciation of land use rights and amortization of
licenses and permits of $333,770 (2004 - $201,785; 2003 - $201,802)
Gross profit
Selling, general and administrative expenses (notes 12, 13 and 14)
2,346,204 1,937,983 1,085,881
6,261,744 4,516,060 1,753,052
10,277,620 8,842,596 1,748,699
Research and development expenses – net of $1,167,814 in government research
grants (2004 - $719,220; 2003 - $664,251) (note 3l)
Purchased in-process research and development (notes 2 and 7)
Depreciation and amortization
Total operating expenses
Operating loss
Interest and financing expenses (notes 10, 13c)
Interest and other income (note 13c)
Loss before income taxes and minority interest
Income taxes (recovery) (note 11)
Loss before minority interest
Minority interest share of (earnings) loss
Net loss for the year
Cumulative translation adjustment
Comprehensive loss
Loss per share – basic and diluted
Weighted average number of shares of common stock outstanding
233,994
285,826
262,495
232,531
—
381,058
554,600
333,881
(5,037,001) (4,946,243)
(369,491)
321,460
271,115
11,298,745 9,462,303 2,663,367
(910,315)
(268,758)
40,869
(5,030,830) (4,994,274) (1,138,204)
—
(5,242,941) (4,226,807) (1,138,204)
(228,693)
234,864
(767,467)
212,111
132,314
(439,904)
265,897
$ (5,110,627) $ (4,666,711) $ (872,307)
206
$ (4,766,033) $ (4,668,530) $ (872,101)
(0.04)
$
344,594
(1,819)
(0.14) $
(0.14) $
- Basic and diluted
36,353,149 32,742,837 20,081,796
The accompanying notes are an integral part of these financial statements.
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Table of Contents
SINOVAC BIOTECH LTD.
Consolidated Statements of Cash Flows
Years ended December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
Cash flows from (used in) operating activities
Net loss for the year
Adjustments to reconcile net loss to net cash used by operating activities:
- deferred income taxes
- stock-based compensation
- common stock issued or to be issued for services
- In-process research and development acquired with acquisition of 20.56%
Sinovac Beijing interest
- In-process research and development acquired
- research and development expenditures qualified for government grants
- provision for doubtful debts
- interest accrued on promissory notes, related parties
- imputed interest on advances from related parties
- written-off equipment
- depreciation of property, plant and equipment and amortization of licenses
and permits
- amortization of deferred charge
- minority interest
Change in other assets and liabilities (net effect of acquisition of subsidiary)
- accounts receivable
- inventories
- prepaid expenses and deposits
- accounts payable and accrued liabilities
Net cash used in operating activities
Cash flows from (used in) financing activities
Loans proceeds
Loans repayment
Proceeds from issuance of common stock
Proceeds from shares subscribed
Dividends paid to minority shareholders of Sinovac Beijing
Government grant received
Advances from (to) related parties
Net cash provided by financing activities
Cash flows from (used in) investing activities
Restricted cash
Deposit relating to land use rights
Cash acquired in connection with acquisition of Tangshan Yian
Acquisition of 20.56% interest in Sinovac Beijing from minority interest
Acquisition of property, plant and equipment
Acquisition of drug licenses and related costs
Net cash used in investing activities
Exchange gain (loss) on cash and equivalents
Increase in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Supplemental disclosure of cash flow information:
Cash paid for interest, net of interest capitalized
Cash paid for income taxes
The accompanying notes are an integral part of these financial statements.
F-9
2005
2004 Restated
- Note 2
2003 Restated
- Note 2
$ (5,110,627) $(4,666,711) $ (872,307)
(8,000)
(860,300)
3,355,708 4,428,032
40,500
42,750
232,531
—
(1,231,652)
447,431
—
(62,300)
—
—
—
(407,290)
373,519
(164,770)
1,329
4,775
1,101,526
—
(132,314)
784,324
114,861
439,904
—
119,581
—
—
381,058
(664,251)
148,551
—
57,277
—
683,795
—
(265,897)
(3,361,922) (2,214,266)
629,591
(425,194)
384,169
(1,150,133)
307,129
(7,002)
(460,906)
$ (1,570,113) $(1,537,527) $(1,723,105)
(333,223)
159,639
3,330,340
3,667,482 3,268,029
(1,523,227) (3,098,806)
5,529,268 5,287,519
1,423,710
206,950
—
(379,123)
1,222,494 1,688,188
1,203,838 (1,576,402)
1,207,730
(1,261,269)
—
1,031,959
—
664,251
1,917,373
$11,144,442 $ 5,775,473 $ 3,560,044
248,881
(427,873)
—
(391,481)
—
42,216
(2,260,000) (1,050,000)
(2,443,700) (1,650,248)
—
—
—
—
—
(348,190)
(381,058)
$ (4,882,692) $(3,049,513) $ (729,248)
(238)
$ 4,749,400 $ 1,185,004 $ 1,107,453
$ 2,605,051 $ 1,420,047 $
312,594
$ 7,354,451 $ 2,605,051 $ 1,420,047
57,763
—
(3,429)
$
$
141,163 $
124,326 $
131,379 $
8,896 $
180,180
—
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
1. Nature of Business and Basis of Presentation
These consolidated financial statements are those of Sinovac Biotech Ltd., formerly Net-Force Systems Inc., (“parent
company”), its 71.56% (see note 7) owned subsidiary Sinovac Biotech Co., Ltd. (“Sinovac Beijing”) and its 100% owned
subsidiaries Tangshan Yian Bioengineering Co., Ltd. (“Tangshan Yian”) and Sinovac Biotech (Canada) Ltd. (“Sinovac
Canada”). Collectively, they are referred to as “the Company”.
The Company, through its subsidiaries, Sinovac Beijing and Tangshan Yian, primarily operates in China and it is in the
business of research and development, production and sales of pharmaceutical products. Sinovac Beijing was incorporated
under the laws of China on April 28, 2001. In January 2004, the Company acquired a 100% interest in Tangshan Yian (see
note 8). Tangshan Yian was incorporated under the laws of China on February 9, 1993.
On September 24, 2003, Net-Force Systems Inc. (“Net-Force”), a company incorporated on March 1, 1999 under the
International Business Corporations Act No. 28 of 1982 of the laws of Antigua and Barbuda, entered into a share exchange
agreement (“Agreement”) with Sinovac Beijing, whereby Net-Force issued 10,000,000 shares of its common stock in
exchange for a 51% interest in Sinovac Beijing. As part of the agreement, Net-Force disposed of its wholly owned
subsidiary, Net Force Entertainment, Inc. and all of its assets and liabilities to a company controlled by its president and chief
executive officer for $100 and then become a non-operating shell company. Immediately prior to the Agreement, Net-Force
had 17,091,033 shares of common stock issued and outstanding. The acquisition was accounted for as recapitalization of
Sinovac Beijing because the management and shareholders (or their nominees) of Sinovac Beijing controlled Net-Force after
the acquisition. Sinovac Beijing was treated as the acquiring entity for accounting purposes and Net-Force was the surviving
entity for legal purposes. The combined company is considered to be a continuation of the operations of Sinovac Beijing.
Outside the Agreement, a member of Sinovac management purchased 6,544,830 shares of the 17,091,032 Net-Force shares
of common stock outstanding before the acquisition, resulting in shareholders (or their nominees) and management of
Sinovac Beijing having control of the combined entity. The issued and outstanding common stock of Sinovac Beijing prior to
the completion of acquisition was restated to reflect the 10,000,000 common stock issued by Net-Force. Effective on
October 21, 2003, Net-Force changed its name to Sinovac Biotech Ltd. Until December 2005, the Company maintained an
office in Vancouver, Canada. Net-Force had no operations between May 1, 2003 and September 23, 2003.
The Company incorporated a 100% owned subsidiary called Sinovac Biotech (Canada) Ltd., under the Canadian Business
Corporations Act, on May 12, 2004. Sinovac Canada had no operations since the incorporation.
Ownership in Chinese subsidiaries as well as the licenses and permits involves certain inherent risks due to the complexity of
the rules in China. Such ownership could be challenged by China government authorities. Each of these matters is subject to
uncertainties, and it is possible that some of these matters may be resolved unfavorably to the Company.
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
2. Restatements
Management has determined that, in 2003 and 2002, the Company should have treated the acquisition of certain licenses as
purchases of in-process research and development. Management has also determined that in 2003, the Company capitalized
certain research and development costs that should have been expensed. Management has further determined that, in 2001,
the Company should have commenced amortization of its hepatitis A vaccine license at the date of purchase, in April 2001,
instead of in July 2002. The Company has restated its financial statements as at December 31, 2004 and 2003 and for the
years ended December 31, 2004 and 2003 to correct these errors. The Company has also revised the share information and
loss per share computation resulting from the retroactive restatement of equivalent shares received in the reverse acquisition
transaction. This change affects loss per share amounts for 2004 and 2003.
The effect of these adjustments on the Company’s consolidated financial condition is as follows:
Licenses and permits
Deferred tax asset
Total assets
Minority interest
Accumulated deficit
December 31, 2004
December 31, 2003
Restated
$ 1,230,315
860,300
22,420,230
3,124,640
(6,155,425)
Originally
Reported
$ 2,343,927
693,300
23,366,842
3,575,004
(5,659,177)
Restated
$ 1,424,503
—
13,784,104
4,205,292
(1,289,108)
Originally
Reported
$ 2,538,115
—
14,897,716
4,737,656
(707,860)
The effect of these adjustments on the Company’s consolidated results of operations is as follows:
Period ended
Purchased in-process research and
development
Income taxes
Net loss for the period
Weighted average number of shares of
common stock outstanding
Loss per share
December 31, 2004
December 31, 2003
Restated
Originally
Reported
Restated
Originally
Reported
$
—
(767,467)
(4,666,711)
$
—
(600,467)
(4,751,711)
$
381,058
—
(872,307)
$
—
—
(461,539)
32,742,837
32,742,837
$
(0.14)
$
(0.15)
20,081,796
(0.04)
$
13,842,225
(0.03)
$
F-11
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Form 20-F
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
3.
Significant Accounting Policies
(a) Basis of Presentation
These consolidated financial statements include the accounts of the parent company, its 71.56% owned subsidiary,
Sinovac Beijing and its 100% owned subsidiaries, Tangshan Yian and Sinovac Canada. All significant intercompany
transactions have been eliminated.
(b) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from those estimates.
(c) Cash and Cash Equivalents
Cash equivalents usually consist of highly liquid investments that are readily convertible to cash with maturities of three
months or less when purchased.
(d) Restricted Cash
Restricted cash is cash held as collateral for letters of credit issued and is classified based on the expected expiration of
such facilities.
(e) Inventories
Inventories are stated at the lower of cost or replacement cost with respect to raw materials and the lower of cost and net
realizable value with respect to finished goods. Cost of work in progress and finished goods is generally determined on
a first-in, first-out basis and includes direct material, direct labour and overheads. Net realizable value represents the
anticipated selling price less estimated costs of completion and distribution.
(f) Property, Plant and Equipment
Property, plant and equipment are recorded at cost, including capitalized interest and internal engineering costs.
Significant additions and improvements are capitalized, while repairs and maintenance are charged to expenses as
incurred. Equipment purchased for specific research and development projects with no alternative uses are expensed.
Depreciation of property, plant and equipment generally is computed using the straight-line method based on the
estimated useful lives of the assets as follows:
30 years
Plant and building
term of leases
Land-use rights
Machinery and equipment
8 to 10 years
5 years
Motor vehicles
Office equipment and furniture 5 years
Leasehold improvement
20 years (term of lease)
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
3.
Significant Accounting Policies (continued)
(g) Licenses and Permits
The Company capitalizes the purchase cost of vaccines if the vaccine has received a new drug certificate from the
Chinese Food and Drug Administration (“SFDA”). If the vaccine has not received a new drug certificate, the purchase
cost is expensed as in-process research and development.
Licenses and permits, in relation to the production and sales of pharmaceutical products in China, are amortized on a
straight-line basis over their useful lives of 10 years. Carrying values of such assets are reviewed at least annually and
whenever events or changes in circumstances indicate that the carrying value may not be recoverable from future
undiscounted net cash flows expected to be generated by the asset. If the asset is not fully recoverable, an impairment
loss would be recognized for the difference between the carrying value of the asset and its estimated fair value based on
discounted net future cash flows or quoted market prices. There were no impairment adjustments to the carrying value
of the licenses and permits for the years ended December 31, 2005, 2004 and 2003.
(h)
Impairment of Long-Lived Assets
The Company has adopted Statement of Financial Accounting Standards (“SFAS”) No. 144 “Accounting for the
Impairment or Disposal of Long-Lived Assets”. Long-lived assets and intangible assets subject to amortization are
reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may
not be recoverable from the future, undiscounted net cash flows expected to be generated by the asset. If the asset were
not fully recoverable, an impairment loss would be recognized for the difference between the carrying value of the asset
and its estimated fair value based on discounted net future cash flows or quoted market prices. There have been no
impairment losses recognized to date.
(i)
Income Taxes
The Company has adopted Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income
Taxes”, which requires the Company to recognize deferred tax liabilities and assets for the expected future tax
consequences of events that have been recognized in the Company’s financial statements or tax returns using the
liability method. Under this method, deferred tax liabilities and assets are determined based on the temporary
differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect in the
years in which the differences are expected to reverse.
F-13
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Form 20-F
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
3.
Significant Accounting Policies (continued)
(j) Revenue Recognition
Sales revenue is recognized when persuasive evidence of an arrangement exists, the price is fixed and final, delivery has
occurred and there is reasonable assurance of collection of the sales proceeds. The Company generally obtains purchase
authorizations from its customers for a specified amount of products at a specified price and considers delivery to have
occurred when the customer takes possession of the products. The Company provides its customers with a limited right
of return. Revenue is recognized upon delivery and a reserve for sales returns is recorded. The Company has
demonstrated the ability to make reasonable and reliable estimates of products returns in accordance with SFAS No. 48,
Revenue Recognition When Right of Return Exists.
Shipping and handling fees billed to customers are included in sales. Costs related to shipping and handling are part of
selling, general and administrative expenses in the consolidated statements operations. EITF No. 00-10, Accounting for
Shipping and Handling Fees and Costs allows for the presentation of shipping and handling expenses in line items
other than cost of sales. In 2005, $118,810 (2004 - $39,633 and 2003 - $16,347) related to shipping and handling costs
was included in selling, general and administrative expenses in the accompanying consolidated statements of
operations.
(k) Advertising Expenses
Advertising costs are expensed as incurred and included in selling expenses. Advertising costs were $12,543 for the
year ended December 31, 2005 (2004 - $71,399 and 2003 - $14,875).
(l) Research and Development
Research and development costs are charged to operations as incurred and are listed as a separate line item on the
Company’s statements of operations.
Government research grants to reimburse expenses issued are taken into income in the period in which the development
expenses are recorded and the conditions imposed by the government authorities are fulfilled. Government grants
recognized are offset against research and development expenses in the Company’s statement of operations.
F-14
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
3.
Significant Accounting Policies (continued)
(m) Foreign Currency Transactions
The parent company and its subsidiaries maintain their accounting records in their functional currencies, i.e. U.S.
dollars and Renminbi Yuan (“RMB”) respectively. The Company translates foreign currency transactions into its
functional currency in the following manner:
At the transaction date, each asset, liability, revenue and expense is translated into the functional currency by the use of
the exchange rate in effect at that date. At the period end, foreign currency monetary assets, and liabilities are re-
evaluated into the functional currency by using the exchange rate in effect at the balance sheet date. The resulting
foreign exchange gains and losses are included in operations.
The assets and liabilities of the foreign subsidiaries, Sinovac Beijing and Tangshan Yian, are translated into U.S. dollars
at exchange rates in effect at the balance sheet date. Revenue and expenses are translated at average exchange rate. Gain
and losses from such translations are included in stockholders’ equity as a component of other comprehensive income.
(n) Stock-based Compensation
The Company has adopted the fair value method of accounting for stock-based compensation recommended by of
Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-based Compensation”. The
Company has a stock option plan that is described more fully in note 14.
(o) Comprehensive Income
The Company has adopted SFAS No. 130, “Reporting Comprehensive Income”, which establishes standards for
reporting and display of comprehensive income, its components and accumulated balances. The Company discloses this
information on its Statement of Stockholders’ Equity. The Company’s comprehensive income consists of net earnings
(loss) and foreign currency translation adjustments.
(p) Earnings (Loss) Per Share
Basic earning (loss) per share is computed using the weighted average number of shares outstanding during the period.
The Company has adopted SFAS No. 128, “Earnings per Share”. 1,500,000 shares held in escrow and contingently
cancelable are excluded in the computation of loss per share until the conditions for their release are satisfied (note 8).
Diluted loss per share is equal to the basic loss per share for the periods presented because common stock equivalents
that are outstanding are anti-dilutive. However, they may be dilutive in future.
F-15
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
3.
Significant Accounting Policies (continued)
(q) Financial Instruments and Concentration of Credit Risks
The fair values of financial instruments are estimated at a specific point in time, based on relevant information about
financial markets and specific financial instruments. As these estimates are subjective in nature, involving uncertainties
and matters of significant judgement, they cannot be determined with precision. Changes in assumptions can
significantly affect estimated fair values.
The carrying value of cash and cash equivalents, restricted cash, accounts receivable, other receivables, short-term loans
payable, accounts payable and accrued liabilities, and due from and to related parties approximate their fair value. The
fair value of long-term debt is based on the discounted value of contractual cash flows and at December 31, 2005,
approximates its carrying value. The discount rate is estimated using the rates currently offered for debt with similar
remaining maturities.
The Company operates in China, which may give rise to significant foreign currency risks from fluctuations and the
degree of volatility of foreign exchange rates between US dollars and the Chinese currency RMB. Financial instruments
that potentially subject the Company to concentration of credit risks consist principally of cash and trade receivables,
the balances of which are stated on the consolidated balance sheets. The Company places its cash in high credit quality
financial institutions. The Company’s customers are primarily government agencies. Two customers accounted for 24%
total sales for year ended December 31, 2005. One customer accounted for 21% and 16% of total sales for the years
ended December 31, 2004 and 2003, respectively. As at December 31, 2005, $4,213,075 (RMB34,000,358) (2004 -
$2,221,365 (RMB18,392,898), 2003 - $1,077,880 (RMB8,924,843) of cash is demonstrated in Chinese RMB and is
held in China. The Company places its cash with high credit quality financial institutions. Concentration of credit risks
with respect to trade receivables is linked to the concentration of revenue. To manage credit risk, the Company
performs ongoing credit evaluations of customers’ financial condition and the Company provides for potential credit
losses if necessary. The Company does not require collateral or other security to support financial instruments subject to
credit risks. The Company is not subject to significant interest risk.
(r) Accounting for Derivative Instruments and Hedging Activities
The Company has adopted the Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for
Derivative Instruments and Hedging Activities, which requires companies to recognize all derivatives contracts as either
assets or liabilities in the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may
be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the
hedging derivative with the recognition of (i) the changes in the fair value of the hedged asset or liability that are
attributable to the hedged risk or (ii) the earnings effect of the hedged forecasted transaction. For a derivative not
designated as a hedging instrument, the gain or loss is recognized in income in the period of change.
F-16
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
3.
Significant Accounting Policies (continued)
The Company has not entered into derivative contracts either to hedge existing risks or for speculative purposes.
(s) New Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43, Chapter 4”,
which is the result of the FASB’s project to reduce differences between U.S. and international accounting standards.
SFAS No. 151 requires idle facility costs, abnormal freight, handling costs, and amounts of wasted materials (spoilage)
be treated as current-period costs. Under this concept, if the costs associated with the actual level of spoilage or
production defects are greater than the costs associated with the range of normal spoilage or defects, the difference
would be charged to current-period expense, not included in inventory costs. SFAS No. 151 will be effective for
inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 does not
have an impact on the Company’s consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123(R), “Accounting for Stock-Based Compensation”. SFAS 123(R)
establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods
or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. SFAS 123(R) requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are performed. Prior to SFAS 123(R), only
certain pro-forma disclosures of fair value were required. SFAS 123(R) will be effective for the Company as of the
beginning of the first interim or annual reporting period that begins after December 15, 2005. The adoption of this new
accounting pronouncement does not have an impact on the Company’s consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error
Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154 requires
retrospective application to prior periods’ financial statements of a change in accounting principle unless it is
impracticable to do so. This is a change from the existing practice that requires most accounting changes to be
accounted for by including in net income in the period of the change the cumulative effect of changing to the new
accounting principle. SFAS 154 will be effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The adoption of this new accounting pronouncement does not have an impact on
the Company’s consolidated financial statements.
(t) Comparative figures
Certain 2004 and 2003 comparative figures have been reclassified to conform to the financial statement presentation
adopted for 2005.
F-17
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
4. Accounts Receivable
Trade receivables
Allowance for doubtful accounts
Other receivables
Total
5.
Inventories
Raw materials
Finished goods
Work in progress
Total
F-18
2005
$6,259,424
(830,291)
5,429,133
25,116
$5,454,249
2004
$3,839,249
(521,804)
3,317,445
35,842
$3,353,287
2003
$1,609,209
(148,551)
1,460,658
10,103
$1,470,761
2003
2005
2004
$210,810 $149,493 $ 237,974
692,673
117,273
$837,666 $487,243 $1,047,920
476,770 230,847
150,086 106,903
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
6.
Property, Plant and Equipment
Plant and building
Land-use rights
Machinery and equipment
Motor vehicles
Office equipment and furniture
Leasehold improvement
Total
Construction in progress
Plant and building
Land-use rights
Machinery and equipment
Motor vehicles
Office equipment and furniture
Total
Leasehold improvements
Plant and building
Land-use rights
Machinery and equipment
Motor vehicles
Office equipment and furniture
Total
2005
Accumulated
Amortization
Net book
Value
Cost
83,052
$ 6,073,973 $ 636,760 $ 5,437,213
971,545
1,380,906 4,226,520
288,416
141,507
159,094
141,791
34,510 1,390,486
$14,891,800 $2,435,829 $12,455,971
1,054,597
5,607,426
429,923
300,885
1,424,996
2004
Accumulated
Amortization
Net book
Value
Cost
$ 1,196,094 $
5,797,311
592,087
3,572,657
242,406
243,905
— $ 1,196,094
439,011 5,358,300
57,022
535,065
908,110 2,664,547
152,039
90,367
136,018
107,887
$11,644,460 $1,602,397 $10,042,063
Cost
$ 167,274
4,191,009
365,510
3,134,007
166,219
174,847
$8,198,866
2003
Accumulated
Amortization
16,727
$
189,342
19,892
412,862
48,834
51,326
$ 738,983
Net book
Value
$ 150,547
4,001,667
345,618
2,721,145
117,385
123,521
$7,459,883
As at December 31, 2005, land-use rights and plant building with a net book value of $4,487,501 were pledged as collateral
for the outstanding bank loans and mortgage (also see note 10). Depreciation expense for the year ended December 31, 2005
was $784,008 (2004 - $589,998; 2003 - $489,452).
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
7. Acquisition of Non-controlling Interest in Sinovac Beijing
On February 4, 2005, the Company acquired a 20.56% interest in Sinovac Beijing for total cash consideration of $3,310,000,
of which $1,050,000 was paid in 2004. Following this acquisition, the Company owns 71.56% of Sinovac Beijing.
The acquisition has been accounted for by the purchase method. The following table summarizes the fair values of the assets
acquired and liabilities assumed at the date of acquisition.
Cash and cash equivalents
Restricted cash
Accounts receivable, prepayment and deposits
Inventory
Property, plant and equipment
Licenses and permits
Deferred income tax assets
In-process research and development
Liabilities
Net assets acquired
$
164,747
80,489
1,001,063
132,024
2,219,801
1,221,910
(39,129)
232,531
(1,703,436)
$ 3,310,000
The amount assigned to in-process research and development relating to influenza virus HA vaccine, totalling $232,531, was
written off at the date of acquisition in accordance with FASB Interpretation No. 4 “Applicability of FASB Statement No. 2
to Business Combinations Accounted for by the Purchase Method”.
8. Acquisition of Tangshan Yian
On January 26, 2004, Sinovac acquired 100% of the shares of Tangshan Yian from a director (the “Vendor”) of the
Company by issuing 3,500,000 common shares and paying $2,200,000 cash in the form of a promissory note. The
$2,200,000 promissory note is non-interest bearing and payable on or before January 26, 2005. In connection with the
acquisition, the Vendor agreed to assume and pay off a $1 million debt owed by Tangshan Yian on or before January 31,
2006, subsequently extended to September 30, 2006 (see note 19c). 1,500,000 of 3,500,000 shares are placed in escrow and
contingently cancellable if the debt is not paid within the given time frame. Accordingly, these escrow shares are excluded
from the calculation of the weighted average number of shares for purposes of loss per share. The total consideration, not
including the 1.5 million escrow shares, is valued at $3.6 million.
F-20
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
8. Acquisition of Tangshan Yian (continued)
The acquisition has been accounted for by the purchase method with the fair value of the consideration paid being allocated
to the fair value of the identifiable assets and liabilities acquired as follows:
Cash and cash equivalents
Other tangible assets
Property, plant and equipment
Liabilities
Net assets acquired
$
42,216
4,672,712
1,772,510
(2,877,395)
$ 3,610,043
Tangshan Yian is in the business of research and development, production and sales of certain pharmaceutical products in
China. The operating results of the Tangshan Yian from January 26, 2004 to December 31, 2004 and for the year ended 2005
are included in the consolidated statements of operations.
Tangshan Yian did not have material operations in 2003. Accordingly, the Company has not presented pro forma
supplemental information on the results of operations in 2003, as though the acquisition had been completed at the beginning
of 2003.
9.
Licenses and Permits
Inactive hepatitis A
Recombined hepatitis A&B
Less: accumulated amortization
Total
2005
$ 2,603,086
366,903
2,969,989
(1,052,817)
$ 1,917,172
2004
Restated –
note2
$1,941,879
—
1,941,879
(711,564)
$1,230,315
2003
Restated –
note2
$1,941,879
—
1,941,879
(517,376)
$1,424,503
(a)
In February 2005, the Company acquired a further 20.56% interest in Sinovac Beijing (see note 7) resulting in an
increase in the carrying value of licenses and permits of $976,552.
(b) Amortization expense for the licenses and permits was $317,518 for the year ended December 31, 2005 (2004 -
$194,326 and 2003 - $194,343).
F-21
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
9.
Licenses and Permits (continued)
(c) The estimated amortization expenses for each of the five succeeding fiscal years ended December 31 are as follows:
2006
2007
2008
2009
2010
$329,000
$329,000
$329,000
$329,000
$329,000
The above amortization expense forecast is an estimate. Actual amounts of amortization expense may differ from
estimated amounts due to additional intangible asset acquisitions, changes in foreign currency exchange rates,
impairment of intangible assets, accelerated amortization of licenses and permits, and other events.
(d) Also see note 1.
F-22
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
Loans Payable
Bank loan: RMB5,000,000, bearing interest at 5.84% per year and due on
June 26, 2004. The loan was secured by certain machinery and equipment
(Note 6)
$
— $
— $603,865
2005
2004
2003
Bank loan: RMB5,000,000, bearing interest at 5.58% per year, interest is
payable quarterly and the principal was repayable on October 28, 2005.
The loan was secured by three apartments included in property, plant and
equipment (note 6)
Bank loan: RMB5,000,000, unsecured and bearing interest at 5.49% per year,
interest is payable quarterly and the principal was repayable on
December 19, 2005
Bank loan: RMB10,000,000, bearing interest at 5.58% per year, interest is
payable quarterly and the principal was repayable on July 6, 2006, secured
by land-use rights owned by a corporation controlled by a director of
Sinovac Beijing with a value of $4,153,000 (RMB33,520,000)
— 603,865
—
— 603,865
—
1,239,127
—
—
Unsecured employee loans: RMB940,000 (2004 – RMB1,222,000, 2004 –
RMB1,230,000) bearing interest at 15% due on demand
116,478 147,584 148,550
Loan from China High Tech Investment Co., Ltd.: RMB7,000,000 (2004 –
RMB9,000,000) unsecured and bearing interest at 5% per year. RMB
3.4 million (including principal and interest) of RMB 7 million loan is due
on September 30, 2005, the remaining balance plus interest is due on
December 31, 2005. (See below)
Total loans payable – current
F-23
1,062,174 1,250,000
—
$2,417,779 $2,605,314 $752,415
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
10. Loans Payable (continued)
Bank loan: RMB 5,000,000, bearing interest at 5.49% per year, interest is
payable quarterly and due on December 19, 2005
$
— $ — $603,865
Bank loan: RMB20,000,000, bearing interest at the bank’s floating lending rate,
which ranged from 5% to 6% in 2005; interest is payable quarterly, RMB
5 million of 20 million is due on August 15, 2007 and the remaining balance
is due on August 15, 2008. The loan is secured by the land-use right and
plant of Sinovac Beijing with a net book value of $4,151,675
(RMB33,504,856) (note 6)
2,478,253
—
—
Mortgage payable: RMB1,498,167 (2004-RMB1,676,167), bearing interest at
5.04% per year with monthly blended payments of $2,284 and due on
May 25, 2014. The mortgage is secured by three apartments included in
property, plant and equipment with a net book value of $335,826
(RMB2,710,180) (note 6)
Total loans payable – long-term
—
185,642 202,436
$2,663,895 $202,436 $603,865
The weighted average effective interest rate was 5.79%, 6.60% and 8.52% for the years ended December 31, 2005, 2004 and
2003, respectively.
Pursuant to the loan agreement with China High Tech Investment Co., Ltd, (“China High Tech Investment”), failure to make
either repayment when due will entitle China High Tech Investment to impose a penalty on Tangshan Yian at a daily rate of
0.1% of the aggregate outstanding loan balance. The Company is currently renegotiating the repayment terms.
F-24
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
11.
Income Taxes
Sinovac Beijing and Tangshan Yian are subject to income taxes in China on their taxable income as reported in their
statutory accounts at a tax rate in accordance with the relevant income tax laws applicable to foreign investment enterprises.
Tangshan Yian is eligible for a full exemption from income taxes for two years and a 50% reduction in income taxes for the
three years following its first profit making year. The tax holiday has no impact on Tangshan Yian’s operating results as
Tangshan Yian was in a tax loss position. Sinovac Beijing is granted a “New Technology Enterprise” certificate by Chinese
government, under which Sinovac Beijing is entitled to a tax holiday. It was exempt from income taxes for three years until
2003, is subject to a 7.5% corporation income tax rate until 2006 and 15% thereafter until it no longer qualifies as a “New
Technology Enterprise”. The parent company is not subject to income taxes.
The Company has structured its business and operations on an international basis. The Company’s history is that it has also
been involved in a number of business combinations and significant financing. As a result the Company could be involved in
various investigations, claims and tax reviews that arise in the ordinary course of business activities. Each of these matters is
subject to various uncertainties and it is possible that some of these matters may be resolved unfavorably to the Company.
The Company has established an accrual for matters that are probable and can be reasonably estimated. Management
believes that any liability that may ultimately result from the resolution of these matters in excess of amounts provided will
not have a materially adverse effect on the financial position or results of operations of the Company.
If the tax holiday of Sinovac Beijing described above had not existed, the income tax expenses (net of minority interest)
would have been increased by approximately $535,541 (RMB4,380,725) and $108,220 (RMB895,400) for the years ended
December 31, 2005 and 2004, respectively. Basic and diluted loss per common share would have been approximately $0.15
and $0.15 for the years ended December 31, 2005 and 2004, respectively. The tax holiday had no impact on operating results
prior to 2004 as Sinovac Beijing has no taxable income.
Income taxes are attributed to the operations in China and consist of:
Income taxes
Current
Deferred
Total income taxes
2005
2004
2003
$220,111 $ 92,833 $—
(860,300) —
$212,111 $(767,467) $—
(8,000)
F-25
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
11.
Income Taxes (continued)
The reconciliation of income taxes at the statutory income tax rate in Antigua and Barbuda to income tax rate based on
income before income taxes stated in the consolidated statements of operations is as follows:
Income taxes at the statutory income tax
Loss of the subsidiary (Tangshan Yian) at higher rate in China
Income of the subsidiary (Sinovac Beijing) at higher rate in China
Loss of the Company not subject to tax
Deferred income tax recognized
Benefit of loss carry forward
Non-deductible expenses
Tax asset value greater than net book value
Others
Income taxes
2005
—
$
(270,502)
(43,023)
270,502
(8,000)
—
281,105
(17,924)
(47)
$ 212,111
2004
$
—
(10,609)
9,791
10,609
(860,300)
(33,525)
131,131
(17,720)
3,156
$(767,467)
2003
$ —
—
(19,484)
19,769
—
—
17,422
(17,707)
—
$ —
The tax effects of temporary differences that give rise to the Company’s deferred tax assets (liabilities) are as follow:
Tax losses carried forward
Excess of tax cost over the net book value of the certain long-lived
assets
Less: valuation allowance
Total deferred tax asset
2005
$ 455,000
2004
$ 422,000
2003
139,000
$
652,300
(455,000)
$ 652,300
860,300
(422,000)
$ 860,300
878,000
(1,017,000)
—
$
The Company determines deferred taxes for each tax-paying entity in each tax jurisdiction. The potential tax benefits arising
from the losses incurred by Tangshan Yian have not been recorded in the financial statements; however, the potential
benefits arising from tax losses incurred by Sinovac Beijing have been recognized.
The Company evaluates its valuation allowance requirements on an annual basis by reviewing all available evidence, both
positive and negative, and considering whether, based on the weight of that evidence, a valuation allowance is needed. When
circumstances change and this causes a change in management’s judgement about the realizability of deferred tax assets, the
impact of the change on the valuation allowance is generally reflected in current income. The future realization of the tax
benefit of an existing deductible temporary difference ultimately depends on the existence of sufficient taxable income of the
appropriate character within the carryforward period available under applicable tax law.
F-26
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
11.
Income Taxes (continued)
With the history of three years taxable income in Sinovac Beijing, the expectation of future earnings and the availability of
certain tax planning strategies, the Company concluded that the valuation allowance relating to timing differences in respect
of long lived assets should be reversed. Management expects that taxable income from operations in the future will be
sufficient to utilize the deductions resulting from the reversal of timing differences. If taxable income from operations is not
sufficient, the Company will employ tax planning strategies that relate the realization of gains on land use rights at the time
that those assets are no longer required.
Based on these factors, the Company concluded that a valuation allowance in respect of temporary timing differences was
not required at December 31, 2005. The valuation allowance relating to losses carried forward of Tangshan Yian is still
required as realization of this element of the potential tax benefit is still uncertain.
12. Accounts payable and accrued liabilities
Accounts payable and accrued liabilities at December 31, 2005, December 31, 2004 and December 31, 2003 consisted of the
following:
Trade payable
Machinery and equipment payable
Accrued expenses
Value added tax payable
Income tax payable
Other tax payable
Withholding personal income tax (see below)
Bonus and benefit payables
Other payables
Total
2005
2004
2003
$ 696,535 $ 335,753 $ 216,246
—
114,000
82,044
673,633
43,806
188,648
—
188,929
1,363
27,835
—
1,455,000
566,121
24,942
871,525 1,059,728 1,115,289
$4,782,226 $2,519,102 $1,483,690
239,748
395,812
130,833
83,871
23,442
—
249,825
Employees of the Company have exercised stock options and incurred a tax liability as a result. The Company believes that it
may be liable to withhold income taxes on stock option exercises and has accrued a current liability of $1,455,000.
Correspondingly, the amount has been charged in selling, general and administrative expenses.
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
13. Related Party Transactions
Related party transactions not disclosed elsewhere in the consolidated financial statements are as follows:
(a) Due from related parties consist of the following (also see note 8):
Advances to Tangshan Yian, a company related by a common director,
bearing interest at 5% per year (secured by the floating charge on the
property, plant and equipment of Tangshan Yian), also see note 8.
Due from Shenzhen Bio-Port Co., Ltd. (“Shenzhen Co.”), a non-
controlling shareholder of Sinovac Beijing, bearing interest at the
prevailing lending rates in China, which ranged from 5% to 6% in
2004.
Due from Shenzhen Bio-Port Co., Ltd. (“Shenzhen Co.”), a non-
controlling shareholder of Sinovac Beijing, bearing interest at the
prevailing lending rates in China, which ranged from 5% to 6% in
2005, and due on demand. The amount was received subsequent to
the year end.
Due from China Bioway Biotech Group Holding Ltd., a non-controlling
shareholder of Sinovac Beijing, bearing interest at the prevailing
lending rates in China, which ranged from 5% to 6% in 2004.
Due from Beijing Xinfu, a corporation controlled by a director Sinovac
Beijing, bearing interest at 5% per year.
Due from a director (see below and (e) below)
Promissory note from a director, including accrued interest of $84,348
(2004 - $22,048) (see below)
Total
F-28
2005
2004
2003
$
—
$
—
$786,300
—
421,327
32,178
822,649
—
—
—
773,551
—
—
—
—
128,789
145,950
—
933,348
1,755,997
1,671,048
$3,011,876
—
$947,267
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
13. Related Party Transactions (continued)
The promissory note from a director of the Company with the principal amount of $1,849,000 was due on September 24,
2004. On October 12, 2004, the Company entered into a pledge, escrow and promissory note agreement (“Escrow
Agreement”) with this director to extend the repayment date. Pursuant to the Escrow Agreement, the promissory note was to
be paid in installments of $200,000 commencing November 15, 2004 and the like amount each three months thereafter with
any remaining sum due on November 15, 2006. The note bears interest at 5% per year. The Company received $200,000 in
2004 and $800,000 in 2005 in accordance with the payment schedule. This director placed 3,000,000 shares of the Company
in escrow as security for the amounts owing under the Escrow Agreement.
The promissory note from a director of $983,348 (2004 - $1,671,048; and 2003 - $nil) represent personal loans to executives
that are unlawful under Section 402 of the Sarbanes-Oxley Act of 2002. As a consequent, the Company has demanded
repayment of this amount. It is uncertain what is the consequence due to this potential violation.
F-29
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
13. Related Party Transactions (continued)
(b) Amounts due to related parties are unsecured, do not bear interest, are due on demand, and consist of the following:
Due to China Bioway Biotech Group Holding Ltd., a non-controlling
shareholder of Sinovac Beijing
$ — $ — $1,135,045
2005
2004
2003
Due to Beijing Keding, a non-controlling shareholder of Sinovac
Beijing
Due to Beijing Xinfu, a corporation controlled by a director of
Sinovac Beijing
—
10,481
10,487
5,611
5,611
—
Due to a director
Total
50,215
24,942
$55,826 $29,190 $1,170,474
13,098
(c) The Company entered into the following transactions in the normal course of operations at the exchange amount with
related parties:
Interest income earned on the advances to related parties
$ 95,763 $285,850 $ 38,764
2005
2004
2003
Rent paid to China Bioway Biotech Group Holding Ltd., a non-
controlling shareholder of Sinovac Beijing (see (d) below)
Interest expense incurred on the advances from related parties
(including interest imputed at the rate of 5% per year on the
interest-free advances received):
$170,988 $ 42,261 $ —
$ — $186,845 $155,334
F-30
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Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
13. Related Party Transactions (continued)
(d)
(e)
(f)
(g)
(h)
(i)
In 2004, the Company entered into two operating lease agreements with China Bioway Biotech Group Holding Ltd., a
non-controlling shareholder of Sinovac Beijing, with respect to Sinovac Beijing’s production plant and laboratory in
Beijing, China for an annual lease payments totaling $170,988 (RMB1,398,680). The leases commenced on August 12,
2004 and have a term of 20 years. Included in prepaid expenses and deposits as at December 31, 2005, is $219,774
(RMB1,773,620), (2004 - $375,276 (RMB3,107,289)) representing the lease deposit made to this related party.
In 2004, a promissory note owed by a director of the Company to Tangshan Yian approximating $2.6 million was
settled by $400,000 cash and offsetting $2.2 million promissory note owed to him. As of December 31, 2005, $156,468
representing the interest owing on the $2.6 million promissory note remained unpaid and has no stated term of
repayment. The management chose to conservatively value the amount owing and set up a 100% provision in 2005.
In 2005, the Company made a deposit of $433,694 to a company controlled by a director of Sinovac Beijing in respect
of land-use rights. As at December 31, 2005, the Company decided not to pursue the acquisition. Subsequent to the
year-end, the deposit was returned to the Company.
In 2005, the Company paid $72,000 (2004 - $72,000 and 2003 – nil) and $nil (2004 - $36,000 and 2003 – nil) to a
director of the Company and an individual related to a director of Sinovac Beijing, respectively, relating to management
consulting services.
In June 2003, Sinovac Beijing completed two debt settlements, totaling $2,608,696 with corporations controlled by one
of its directors by issuing shares equal to approximately 16% interest in Sinovac Beijing.
In 2005, the Company paid director fees of $25,944 (2004 - $nil and 2003 - $nil) to a management services company
that is 50% owned by a director of the Company.
(j) The Company entered into a license agreement with a corporation related with China Bioway (a non-controlling interest
of Sionvac Beijing) in respect to the trademark used on the Company’s products for nil consideration. This license
agreement is non-exclusive. Among the other things, this agreement expires on December 31, 2006, and subsequently
extended to December 31, 2011.
14. Stock Option Plan
The board of directors has approved a stock option plan (the “Plan”) effective on November 1, 2003, pursuant to which
directors, officers, employees and consultants of the Company are eligible to receive grants of options for the Company’s
common stock. The Plan expires on November 1, 2023. A maximum of 5,000,000 common stocks have been reserved under
the plan. Each stock option entitles its holder to purchase one common share of the Company. Options may be granted for a
term not exceeding 10 years from the date of grant. The Plan is administered by the board of directors.
F-31
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
In November 2003, 3,000,000 stock options under the Plan were granted to its directors, officers and employees with an
exercise price of $1.31 per share, being the market price
14 Stock Option Plan (continued)
at the time of the grant. These options vest from April 1, 2004 to July 1, 2006 and expire on November 12, 2008.
In April 2004, 2,000,000 stock options under the Plan were granted to its directors, officers and employees with an exercise
price of $4.55 per share, being the market price at the time of the grant. These options vest from April 14, 2004 to July 14,
2006 and expire on April 13, 2009. In June 2005, the Company canceled these 2,000,000 stock options.
In June 2004, 4,500 stock options were granted to an employee to replace the 4,500 stock options forfeited in 2004. These
options have an exercise price of $3.36 per share, being the market price at the time of the grant, and expire on June 8, 2009.
The options vest from June 9, 2004 to September 9, 2006.
In April 2005, the Company granted 60,000 stock options to employees with an exercise price of $2.40 per share, being the
market price at the time of the grant. These options vest from April 20, 2005 to July 20, 2007 and expire on April 20, 2010.
In May 2005, the Company granted 28,000 stock options to a consultant in connection with investor relation services to be
rendered, with an exercise price of $2.40 per share, being the market price at the time of the grant. These options vested on
August 1, 2005 and expire on July 31, 2010.
In November 2005, the Company granted 280,000 stock options to its directors with an exercise price of $3.20 per share,
lower than the market price at the time of the grant. These options vest from November 4, 2005 to March 4, 2007 and expire
on November 4, 2010.
A summary of the Company’s stock options activities is presented below:
Options outstanding at December 31, 2002
Granted
Options outstanding at December 31, 2003
Granted
Forfeited
Cancelled
Exercised
Options outstanding at December 31, 2004
Granted
Forfeited
Cancelled
Exercised
Options outstanding at December 31, 2005
Exercisable as at December 31, 2005
F-32
Number of
Common
Shares
—
3,000,000
3,000,000
2,004,500
(4,500)
(500)
(40,500)
4,959,000
368,000
(110,000)
(2,000,000)
(1,347,700)
1,869,300
1,319,950
$
Weighted
Average
Exercise Price
—
1.31
1.31
4.55
(1.31)
(1.31)
(1.31)
2.62
3.01
(1.31)
4.55
(1.31)
1.64
1.42
$
$
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Page 131 of 134
Table of Contents
SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
14. Stock Option Plan (continued)
Range of
Exercise
Prices
$1.01 - $2.00
$2.00 - $3.00
$3.01 - $4.00
Options Outstanding
Number
Outstanding
1,511,500
76,000
281,800
1,896,300
Weighted
Average
Remaining
Contractual
Life
Weighted
Average
Exercise
Price
Options Exercisable
Number
Exercisable
Weighted
Average
Exercise
Price
2.92 $ 1.31 1,229,500 $ 1.31
34,000 $ 2.40
3.42 $ 2.40
56,450 $ 3.20
4.83 $ 3.20
$ 1.64 1,319,950 $ 1.42
The Company charged $3,355,708, $4,428,032 and $119,581 of stock-based compensation relating to selling, general and
administrative expenses in 2005, 2004 and 2003, respectively, by applying the fair value method in accordance with SFAS
No.123.
The following table shows the assumptions used in determining stock-based compensation costs under the Black-Scholes
option pricing model:
Expected volatility
Risk-free interest rate
Expected life (years)
Dividend yield
Weighted average fair value of options granted
2005
59.9%
4.51%
5.0
Nil
$2.93
2004
74.0%
3.44%
5.0
Nil
$2.85
2003
74.0%
3.42%
4.0
Nil
$0.74
As at December 31, 2005, there was $1.01 million of total unrecognized compensation cost related to non-vested share-
based compensation arrangements granted under the Plan. This cost is expected to be recognized over a period of 19 months.
15. Common Stock
(a) Share Capital
In January 2005, the Company completed two private placements by issuing 491,667 and 70,000 units, respectively, at
$3.00 per unit for total gross proceeds of $1,685,000. Of this amount, $206,950 had been received by December 31,
2004. Each unit consisted of one share of common stock of the Company and one share purchase warrant. The
Company issued 39,333 warrants and 1,970
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
15. Common Stock (continued)
warrants as finders’ fees for the two private placements, respectively. The Company also paid finders’ fees in cash
totalling $168,200. Each warrant entitles its holder to purchase one additional share of common stock of the Company
at $3.35 per share until the one year anniversary date from the date of issuance, and:
(i)
(ii)
For the first private placement warrants, at a price of $4.00 thereafter until the two year anniversary date after the
issuance. The warrants are subject to call provisions in favour of the Company, which may accelerate the expiry
date.
For the second private placement warrants, at a price of $4.00 thereafter until October 15, 2006. The warrants are
subject to call provisions in favour of the Company, which may accelerate the expiry date.
In 2005, the Company issued 1,333,146 shares of common stock on the exercise of share purchase warrants with
exercise prices ranging from $1.50 to $3.00 per share for the total proceeds of $2,437,375.
In 2005, the Company issued 1,345,700 shares of common stock on the exercise of employee stock options with
exercise prices ranging from $1.31 to $3.36, yielding total proceeds of $1,781,482.
In 2005, the Company received cash proceeds of $1,423,710 on the exercise of share purchase warrants. The shares
were issued subsequent to the year end.
(b) Share Purchase Warrants
Number of
warrants
470,263
71,970
542,233
Exercise price
1st $3.35 January 5, 2006
Expiry date
2nd
$4.00
December 31, 2006, subject to a call provision in
favour of the Company, see note 15a(i)
1st $3.35 January 15, 2006
2nd
$4.00
October 15, 2006, subject to a call provision in
favour of the Company, see note 15a(ii)
(c) Stock issued for services
In 2005, the Company agreed to issue 15,000 shares of common stock to a consulting firm for investor relation services
rendered at a value of $42,750. As at December 31, 2005, the shares have not been issued.
In 2004, the Company issued 12,500 shares of common stock to a consulting firm for financial consulting services
rendered at a value of $40,500.
F-34
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
16. Distribution of Profit
Pursuant to Chinese company law applicable to foreign investment companies, the Company’s subsidiaries, Sinovac Beijing
and Tangshan Yian, are required to maintain dedicated reserves, which include a general reserve and an enterprise expansion
reserve. The dedicated reserves are to be appropriated from net income after taxes, determined under the relevant Chinese
accounting regulations at a rate determined by the board of directors of the respective subsidiaries, and recorded as a
component of shareholders’ equity. The dedicated reserves are not distributable other than upon liquidation.
For the year ended December 31, 2005, Sinovac Beijing appropriated 10% (2004 – 10%) and 5% (2004 – 10%) of its after-
tax profit, determined under the relevant Chinese accounting regulations, to the general reserve and the enterprise expansion
reserve, respectively. As Sinovac Beijing was in a tax loss position in 2003, no appropriation to the dedicated reserves was
made.
Pursuant to the same Chinese company law, the Company’s subsidiaries are required to transfer, at the discretion of their
boards of directors, a certain amount of its annual net income after taxes as determined under the relevant Chinese
accounting regulations to a staff welfare and bonus fund. For the year ended December 31, 2005, the board of directors of
Sinovac Beijing approved $96,689 (RMB780,300) (2004-$49,901 (RMB413,183)) for contribution to such fund which shall
be utilized for collective staff benefits such as building of staff quarters or housing. As Sinovac Beijing was in a tax loss
position in 2003, no appropriation to the staff welfare and bonus fund was made. The amounts appropriated to staff welfare
and bonus fund were charged against income and the related provisions were reflected as accrued liabilities in the
consolidated balance sheets.
Tangshan Yian recorded a net loss for each of the three years in the period ended December 31, 2005, so no appropriation to
the dedicated reserves and staff welfare and bonus fund was made.
Dividends declared by the Company’s subsidiaries are based on the distributable profits as reported in their statutory
financial statements. As of December 31, 2005, dividends payable of $538,221 (2004 - $470,301), represent the minority
interest in the share of dividends declared by Sinovac Beijing.
In addition to the above reserves accrual, transferring the profit from the Chinese subsidiaries to the countries outside of
China also requires the Company and certain shareholders to comply with the certain administrative rules governed by the
relevant Chinese government authorities.
F-35
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SINOVAC BIOTECH LTD.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
(Expressed in U.S. Dollars)
17. Segmented Information
The Company operates exclusively in the biotech sector. The Company’s business is considered as operating in one segment
based upon the Company’s organizational structure, the way in which the operation is managed and evaluated, the
availability of separate financial results and materiality considerations. All the revenues are generated in China. The
Company’s assets by geographical location are as follows:
Assets
North America
China
Total
18. Non Cash Transactions
2004
Restated
–Note 2
2003
Restated
–Note 2
2005
$ 3,134,299 $
28,164,798
342,268
21,640,230 13,441,836
$31,299,097 $22,420,230 $13,784,104
780,000 $
(a)
(b)
(c)
(d)
In January 2004, the Company issued 3,500,000 shares of common stock and $2,200,000 promissory note for the
acquisition of Tangshan Yian (note 8). The $2,200,000 promissory note was settled in 2004 by offsetting the amount
owed by this related party.
In 2005, the Company agreed to issue 15,000 restricted shares of common stocks to a consulting firm for investor
relation services at a value of $42,750 (note 15c). The shares have not been issued as at December 31, 2005.
In 2004, the Company issued 12,500 shares of common stock to a consulting firm for financial consulting services
provided to the Company (note 15c).
In 2003, Sinovac Beijing issued 3,137,255 shares of common stock for debt settlement in the amount of $2,608,696
(note 13h).
19. Subsequent Events
(a) Subsequent to the year-end, the Company issued 441,000 shares of common stock on the exercise of share purchase
warrants with an exercise price at $3.35 per share. The total proceeds were $1,477,350, of which $1,423,710 was
received in 2005.
(b) Subsequent to the year end, the Company issued 164,500 shares of common stock on the exercise of stock options with
an exercise price of $1.31 per share, yielding total proceeds of $215,495.
(c) On June 2, 2006, the Company agreed to extent the due date of the indemnity provided by a director of the Company
for the $1 million debt owed by Tangshan Yian to September 30, 2006 (also see note 8).
F-36
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