UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 20-F

 

 

Commission file number: 001-33036

Mindray Medical International Limited

(Exact name of Registrant as specified in its charter)

 

Not applicable
(Translation of Registrant’s name into English)

 

Cayman Islands
(Jurisdiction of incorporation or organization)

 

Mindray Building, Keji 12th Road South,
Hi-tech Industrial Park, Nanshan, Shenzhen 518057
(Address of principal executive offices)

 

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

 

 

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

 

None

 

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

 

None

 

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: 75,537,753 Class A ordinary shares and 32,362,610 Class B ordinary shares.

 

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

 

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

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

 

 

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

 

 

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

 

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

 

Indicate by check mark which financial statement item the registrant has elected to follow: Item 17 o Item 18 þ

 

 

TABLE OF CONTENTS

 

 

Except where the context otherwise requires and for purposes of this annual report only:

 

 

This annual report on Form 20-F includes our audited consolidated statements of operation data for the years ended December 31, 2006, 2007, and 2008 and audited consolidated balance sheet data as of December 31, 2007, and 2008.

 

We and certain of our shareholders completed the initial public offering of 23,000,000 ADSs, each representing one Class A ordinary share, on September 29, 2006. On September 26, 2006, we listed our ADSs on the New York Stock Exchange under the symbol “MR.” Some of our shareholders completed a secondary offering of 11,301,303 ADSs in February 2007.

 

FORWARD-LOOKING STATEMENTS

 

This annual report on Form 20-F contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about us and our industry. All statements other than statements of historical fact in this annual report are forward-looking statements. These forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “believe,” “is/are likely to” or other similar expressions. The forward-looking statements included in this annual report relate to, among others:

 

 

 

These forward-looking statements involve various risks, assumptions and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, our expectations may turn out to be incorrect. Our actual results could be materially different from our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in Item 3.D of this annual report, “Key information — Risk Factors” and elsewhere in this annual report.

 

The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. All forward-looking statements included herein attributable to us or other parties or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Except to the extent required by applicable laws and regulations, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events, except as required by law.

 

Market Data and Forecasts

 

This annual report also contains data related to the medical device industry. These market data include projections that are based on numerous assumptions. The medical device industry may not grow at the projected rates or at all. The failure of the medical device industry to grow at projected rates may have a material adverse effect on our business and the market price of our ADSs. In addition, the rapidly changing nature of the medical device industry subjects any projections or estimates relating to growth prospects or future conditions to significant uncertainties. You should not place undue reliance on these forward-looking statements.

 

Unless otherwise indicated, information in this annual report concerning economic conditions and the medical device industry is based on information from independent industry analysts and publications, as well as our estimates. Except where otherwise noted, we derive our estimates from publicly available information released by third parties, as well as data from our internal research, and are based on such data and our knowledge of our industry, which we believe to be reasonable.

 

 

Not applicable.

 

 

Not applicable.

 

 

 

The selected consolidated balance sheet data as of December 31, 2007 and 2008, and the selected consolidated financial data for the three years ended December 31, 2006, 2007 and 2008, were derived from our audited consolidated financial statements appearing in this annual report beginning on page F-1. The selected consolidated financial data for the years ended December 31, 2004 and 2005 were derived from our audited consolidated financial statements that are not included in this annual report. The following summary consolidated financial data for the periods and as of the dates indicated should be read in conjunction with, and are qualified in their entirety by reference to our consolidated financial statements and related notes and Item 5, “Operating and Financial Review and Prospects”.

 

Our audited consolidated financial statements as of and for the year ended December 31, 2008 are prepared in accordance with U.S. GAAP, and have been audited by PricewaterhouseCoopers, an independent registered public accounting firm. The report of PricewaterhouseCoopers on those consolidated financial statements is included elsewhere in this annual report.

 

Our audited consolidated financial statements as of December 31, 2007 and for the years ended December 31, 2006 and 2007 are prepared in accordance with U.S. GAAP, and have been audited by Deloitte Touche Tohmatsu CPA Ltd., an independent registered public accounting firm. The report of Deloitte Touche Tohmatsu CPA Ltd. on those consolidated financial statements is included elsewhere in this annual report.

 

Our historical results for any prior years are not necessarily indicative of future results.

 

 

 

 

 

 

 

 

 

Not applicable.

 

 

Not applicable.

 

RISKS RELATING TO OUR BUSINESS AND INDUSTRY

 

We may fail to effectively develop and commercialize new products, which would materially and adversely affect our business, financial condition, results of operations and prospects.

 

The medical device market is developing rapidly and related technology trends are constantly evolving. This results in frequent introduction of new products, short product life cycles and significant price competition. Consequently, our success substantially depends on our ability to anticipate technology development trends and identify, develop and commercialize in a timely and cost-effective manner new and advanced products that our customers demand. New products contribute significantly to our net revenues. Products introduced since 2006 accounted for more than 25.0% of our net revenues in 2008. We expect the medical device market to continue evolving toward newer and more advanced products, many of which we do not currently produce. Commercialization of any new product requires relevant government approval, the timing of which may not be under our control, and is subject to change from time to time. Moreover, it may take an extended period of time for our new products to gain market acceptance, if at all. Furthermore, as the life cycle for a product matures, the average selling price generally decreases. Although we have previously offset the effects of declining average sales prices with sales volume increases and manufacturing cost reductions, we may be unable to continue doing so. Lastly, during a product’s life cycle, problems may arise regarding regulatory, intellectual property, product liability or other issues which may affect its continued commercial viability.

 

Our success in developing and commercializing new products is determined by our ability to:

 

 

The acquisition of Datascope’s patient monitoring device business may not be effectively integrated and exposes us to additional potential risks, each of which may materially and adversely affect our business.

 

We completed the acquisition of Datascope’s patient monitoring device business in May 2008. The acquisition requires that our management develop expertise in new areas, manage new business relationships and attract new types of customers. The diversion of our management’s attention and any difficulties encountered in the integration of Datascope’s patient monitoring device business could materially and adversely affect our ability to manage our business.

 

Realizing the benefits of our acquisition of Datascope’s patient monitoring device business depends in substantial part on the successful integration of technologies, operations and personnel. Since completing the acquisition, we have begun operating as a combined organization and begun utilizing common business, information and communication systems, operating procedures, financial controls and human resource practices, including benefits, training and professional development programs. We face significant challenges in the integration process, which include:

 

 

 

• adding products to the acquired business’ platform;

 

 

We are currently experiencing a global economic crisis, which could materially and adversely affect our business, financial condition and results of operations.

 

We are currently experiencing a global economic crisis which affects all areas of business, including health care, in all the regions we operate in.

 

Disruptions in orderly financial markets in recent months, resulting from, among other factors, severely diminished liquidity and credit availability plus volatile and declining valuations of securities and other investments have caused business and consumer confidence to ebb, business activities to slow down, and unemployment to increase. These factors along with the interconnectivity and interdependence of international economies have created a global downturn in economic activity.

 

We are unable to predict how long the economic downturn will last. A continuing economic downturn may adversely affect our business in a number of ways, including:

 

 

 

The economic crisis is particularly focused on the U.S. and Europe, which is the focus of the majority of our revenues from our recently acquired operations. It is unclear how the current economic crisis will affect medical product purchasing in the U.S., Europe, and other markets which might be viewed as more immune or better buffered from the current economic crisis.

 

We maintain a direct sales force in the United States and Europe following our acquisition of Datascope’s patient monitoring device business that is costly and the maintenance of which could have a material adverse effect on our business.

 

We acquired a substantial direct sales force in the United States and Europe through our acquisition of Datascope’s patient monitoring device business, and rely on direct sales for a significant portion of our revenues from these areas. Maintaining a direct sales force is costly. We typically provide our direct sales personnel with payroll and other benefits that we do not provide independent distributors. Many of these benefits are fixed costs that do not depend on revenue generation. If our direct sales force fails to generate projected revenues, it could have a material adverse effect on our business.

 

Maintaining a direct sales force and independent distribution network in the United States and Europe could result in potential sales conflicts that would negatively impact our revenue and results of operations.

 

Prior to our acquisition of Datascope’s patient monitoring device business, we maintained independent distributor relationships in the United States and Europe. With the addition of a direct sales force in these areas, we are currently directly selling Datascope-branded products, Mindray-branded ultrasound systems and DPM-branded patient monitoring devices. This creates the potential for conflict between our independent distributors and direct sales force. If our independent distributors and direct sales force compete with each other, our independent

distributors could reduce their selling prices for our products to make sales. Because we generate higher revenues from direct sales, this would negatively impact our revenue. Further, independent existing and potential distributors may decide not to sell our products or cease selling our products because of this potential conflict. Moreover, sales conflicts could negatively impact the morale of our direct sales force.

 

We depend on distributors for a significant majority of our revenues and a significant portion of our revenue growth. Failure to maintain relationships with our distributors would materially and adversely affect our business.

 

We depend on distributors for more than 65% of our revenues and for a significant portion of our revenue growth. We typically do not have long-term distribution agreements. As our existing distribution agreements expire, we may be unable to renew with our desired distributors on favorable terms or at all. In addition, we seek to limit our dependence on any single distributor by limiting and periodically redefining the scope of each distributor’s territory and the range of our products that it sells, which may make us less attractive to some distributors. Furthermore, competition for distributors is intense. We compete for distributors domestically and internationally with other leading medical equipment and device companies that may have higher visibility, greater name recognition and financial resources, and a broader product selection than we do. Our competitors also often enter into long-term distribution agreements that effectively prevent their distributors from selling our products. Consequently, maintaining relationships with existing distributors and replacing distributors may be difficult and time consuming. Any disruption of our distribution network, including our failure to renew our existing distribution agreements with our desired distributors, could negatively affect our ability to effectively sell our products and would materially and adversely affect our business, financial condition and results of operations.

 

We may be unable to effectively structure and manage our distribution network, and our business, prospects and brand may be materially and adversely affected by actions taken by our distributors.

 

We have limited ability to manage the activities of our distributors, who are independent from us. Our distributors could take one or more of the following actions, any of which could have a material adverse effect on our business, prospects and brand:

 

 

Furthermore, although we attempt to structure our distribution network so that each of our products is sold with similar effort, our distributors may focus selling efforts only on those products that provide them with the largest margins at the expense of products that offer them smaller margins.

 

Failure to adequately manage our distribution network, or non-compliance by distributors with our distribution agreements could harm our corporate image among end users of our products and disrupt our sales, resulting in a failure to meet our sales goals. Furthermore, we could be liable for actions taken by our distributors, including any violations of applicable law in connection with the marketing or sale of our products, including China’s anti-corruption laws and the U.S. Foreign Corrupt Practices Act, or FCPA. In particular, we may be held liable for actions taken by our distributors even though almost all of our distributors are non-U.S. companies that are not subject to the FCPA. Our distributors may violate these laws or otherwise engage in illegal practices with respect to their sales or marketing of our products. If our distributors violate these laws, we could be required to pay damages or fines, which could materially and adversely affect our financial condition and results of operations. In addition, our brand and reputation, our sales activities or the price of our ADSs could be adversely affected if our company becomes the target of any negative publicity as a result of actions taken by our distributors.

We may undertake acquisitions, which may have a material adverse effect on our ability to manage our business, and may end up being unsuccessful.

 

Our growth strategy may involve acquisitions of new technologies, businesses, products or services or the creation of strategic alliances in areas in which we do not currently operate. Future acquisitions could require that our management develop expertise in new areas, manage new business relationships and attract new types of customers. The diversion of our management’s attention and any difficulties encountered in the integration of acquired businesses could have an adverse effect on the ability to effectively manage our business.

 

International expansion may be costly, time consuming and difficult. If we do not successfully expand internationally, our profitability and prospects would be materially and adversely affected.

 

Our success significantly depends upon our ability to expand in our existing international markets and enter into new international markets. In expanding our business internationally, we have entered and intend to continue to enter markets in which we have limited or no experience and in which our brand may be less recognized. To further promote our brand and generate demand for our products so as to attract distributors in international markets, we expect to spend more on marketing and promotion than we do in our existing markets. We may be unable to attract a sufficient number of distributors, and our selected distributors may not be suitable for selling our products. Furthermore, in new markets we may fail to anticipate competitive conditions that are different from those in our existing markets. These competitive conditions may make it difficult or impossible for us to effectively operate in these markets. If our expansion efforts in existing and new markets are unsuccessful, our profitability and prospects would be materially and adversely affected.

 

We are exposed to other risks associated with international operations, including:

 

 

Consolidation of our customer base and the formation of group purchasing organizations could adversely affect our revenues.

 

In recent years, consolidation among health care providers and the formation of purchasing groups has imposed pricing pressures. Our success in areas of health care provider consolidation and where purchasing organizations have been formed depends partly on our ability to enter into contracts with group purchasing organizations and integrated health networks. If we are unable to enter into contracts with group purchasing organizations and integrated health networks on satisfactory terms or at all, our revenues would be adversely affected.

We depend on our key personnel, and our business and growth may be severely disrupted if we lose their services.

 

Our success significantly depends upon the continued service of our key executives and other key employees. In particular, we are highly dependent on our co-chief executive officers, Mr. Xu Hang and Mr. Li Xiting, to manage our business and operations, and on our other key senior management for the operation of our business. If we lose the services of any key senior management, we may not be able to locate suitable or qualified replacements, and may incur additional expenses to recruit and train new personnel, which could severely disrupt our business and growth. Furthermore, as we expect to continue to expand our operations and develop new products, we will need to continue attracting and retaining experienced management, key research and development personnel, and salespeople.

 

Competition for personnel in the medical technology field is intense, and the availability of suitable and qualified candidates in China, particularly Shenzhen, is limited. We compete to attract and retain qualified research and development personnel with other medical device companies, universities and research institutions. Competition for these individuals could cause us to offer higher compensation and other benefits in order to attract and retain them, which could materially and adversely affect our financial condition and results of operations. We previously awarded share-based compensation in connection with our initial public offering, some of which is still subject to vesting. We additionally awarded a one-time retention bonus in connection with our acquisition of Datascope’s patient monitoring device business, which will be paid out subject to certain minimum employment conditions. Such retention awards may cease to be effective to retain our current employees once the shares are vested and bonus amounts are paid out. Additionally, our previously awarded equity grants were issued at exercise prices close to the current depressed market price of our shares. We may need to increase our total compensation costs to attract and retain experienced personnel required to achieve our business objectives and failure to do so could severely disrupt our business and growth.

 

Our business is subject to intense competition, which may reduce demand for our products and materially and adversely affect our business, financial condition, results of operations and prospects.

 

The medical device market is highly competitive, and we expect competition to intensify. In particular, competition in the government tender arena has continued to intensify in recent years, creating significant pricing pressure. We face direct competition in China, the U.S. and globally across all product lines and price points. Our competitors also vary significantly according to business segments. Our competitors include publicly traded and privately held multinational companies, as well as local companies in the markets where we sell our products. We face competition from companies that have local operations in the markets in which we sell our products who may have lower cost structures, domestic support, or local protect through tariff and non-tariff barriers. In the U.S., where we compete with a direct sales force and services team, we face competition from companies that have a better capitalization, a wider range of products, and greater understanding of the market given their longer history of operations. Some of our larger competitors may have:

 

 

As a result, we may be unable to offer products similar to, or more desirable than, those offered by our competitors, market our products as effectively as our competitors or otherwise respond successfully to competitive pressures. In addition, our competitors may be able to offer discounts on competing products as part of a “bundle” of non-competing products, systems and services that they sell to our customers, and we may not be able to profitably match those discounts. Furthermore, our competitors may develop technologies and products that are more effective than those we currently offer or that render our products obsolete or uncompetitive. In addition, the timing of the introduction of competing products into the market could affect the market acceptance and market share of our products. Our failure to compete successfully could materially and adversely affect our business, financial condition, results of operation and prospects.

 

Moreover, some of our competitors based outside China have established or are in the process of establishing production and research and development facilities in China, while others have entered into cooperative business arrangements with Chinese manufacturers. If we are unable to develop competitive products, obtain regulatory approval or clearance and supply sufficient quantities to the market as quickly and effectively as our competitors, market acceptance of our products may be limited, which could result in decreased sales. In addition, we may not be able to maintain our manufacturing cost advantage. In other emerging markets, we have also seen larger competitors setting up sizable local businesses or acquiring local competitors or distributors, which allow them to be more competitive in their pricing and distribution infrastructure.

 

In addition, we believe that corrupt practices in the medical device industry in China and certain emerging markets still occur. To increase sales, certain manufacturers or distributors of medical devices may pay kickbacks or provide other benefits to hospital personnel who make procurement decisions. Our company policy prohibits these practices by our direct sales personnel and our distribution agreements require our distributors to comply with applicable law. As a result, as competition intensifies in the medical device industry in these markets, we may lose sales, customers or contracts to competitors.

 

If we fail to accurately project demand for our products, we may encounter problems of inadequate supply or oversupply, especially with respect to our international markets, which would materially and adversely affect our financial condition and results of operations, as well as damage our reputation and brand.

 

Our distributors typically order our products on a purchase order basis. We project demand for our products based on rolling projections from our distributors, our understanding of anticipated hospital procurement spending, and distributor inventory levels. Lack of significant order backlog and the varying sales and purchasing cycles of our distributors and other customers, however, make it difficult for us to forecast future demand accurately.

 

Our projections of market demand for our products in countries where we lack a direct sales force are generally less reliable than in countries where we do have a direct sales force because we have less information available on which to base our projections. Specifically, we do not have consistently reliable information regarding international distributor inventory levels in these markets, and we sometimes lack extensive knowledge of local market conditions or about distributor purchasing patterns, preferences, or cycles. Furthermore, because shipping finished products to international distributors typically takes longer than shipping to domestic distributors, inaccurate demand projections can result more quickly in unmet demand. We additionally may have unpredictably large tender sales orders for which we may have insufficient inventory to fill along with the additional orders in our pipeline.

 

If we overestimate demand, we may purchase more raw materials or components than required. If we underestimate demand, our third party suppliers may have inadequate raw material or product component inventories, which could interrupt our manufacturing and delay shipments, and could result in lost sales. In particular, we are seeking to manage our procurement and inventory costs by matching our inventories closely with our projected manufacturing needs and by, from time to time, deferring our purchase of raw materials and components in anticipation of supplier price reductions. As we seek to balance reduced inventory costs and production flexibility, we may fail to accurately forecast demand and coordinate our procurement and production to meet demand on a timely basis. Our underestimation of demand, coupled with our decision to defer our purchase of new raw materials and components in anticipation of a reduction in pricing for certain raw materials and components at the beginning of a new calendar year, resulted in up to three-week delays in our product deliveries

internationally. Our inability to accurately predict our demand and to timely meet our demand could materially and adversely affect our financial conditions and results of operations as well as damage our reputation and corporate brand.

 

We currently principally rely on three manufacturing, assembly and storage facilities for our products and are developing two additional facilities. Any disruption to our current manufacturing facilities or in the development of these new facilities could reduce or restrict our sales and harm our reputation.

 

We manufacture, assemble and store a substantial majority of our products, as well as conduct some of our research and development activities at our two facilities located in Shenzhen, China. We also manufacture, assemble and store a significant number of products at our Mahwah, New Jersey facility. We conduct some of our primary research and development activities at our headquarters. We do not maintain other back-up facilities, so we depend on these facilities for the continued operation of our business. A natural disaster or other unanticipated catastrophic events, including power interruptions, water shortage, storms, fires, earthquakes, terrorist attacks and wars, could significantly impair our ability to manufacture our products and operate our business, as well as delay our research and development activities. Our facilities and certain equipment located in these facilities would be difficult to replace and could require substantial replacement lead-time. Catastrophic events may also destroy any inventory located in our facilities. The occurrence of such an event could materially and adversely affect our business.

 

We are developing a new research and development center adjacent to our headquarters in Shenzhen, and, pursuant to an agreement with the Government of the Nanjing Jiangning Development Zone, are developing a new research and development and manufacturing facility in Nanjing. These facilities require significant build-out before they will be fully operational. We may experience difficulties that disrupt our manufacturing activities, management and administration, or research and development as we migrate or expand to these facilities. Moreover, we may not realize their anticipated benefits. Any of these factors could reduce or restrict our sales and harm our reputation and have a material adverse effect on our business, financial condition, results of operations and prospects.

 

If we are unable to obtain adequate supplies of required materials and components that meet our production standards at acceptable costs or at all, our ability to accept and fulfill product orders with the required quality and at the required time could be restricted, which could materially and adversely affect our business, financial condition and results of operations.

 

We purchase raw materials and components from third party suppliers and manufacture and assemble our products at our facility. Our purchases are generally made on a purchase order basis and we do not have long-term supply contracts. As a result, our suppliers may cease to provide components to us with little or no advance notice. In addition, to optimize our cost structure, we rely on single source suppliers to provide approximately 25% by value of our raw materials and components, primarily for proprietary integrated circuits for products across our business segments. No single source supplier accounted for more than 5% of our total supply purchases in 2008. Interruptions in certain material or component supplies could delay our manufacturing and assembly processes. We also may be unable to secure alternative supply sources in a timely and cost-effective manner. If we are unable to obtain adequate supplies of required materials and components that meet our production standards at acceptable costs or at all, our ability to accept and fulfill product orders with the required quality, and at the required time could be restricted. This could harm our reputation, reduce our sales or gross margins, and cause us to lose market share, each of which could materially and adversely affect our business, financial condition and results of operations.

 

Failure to successfully manage our growth could strain our management, operational and other resources, which could materially and adversely affect our business and prospects.

 

Our growth strategy includes building our brand, increasing market penetration of our existing products, developing new products, increasing our targeting of large-sized hospitals in China, and increasing our exports.

Pursuing these strategies has resulted in, and will continue to result in substantial demands on management resources. In particular, the management of our growth will require, among other things:

 

 

If we are unable to successfully manage our growth, our business and prospects would be materially and adversely affected.

 

We may need additional capital, and we may be unable to obtain such capital in a timely manner or on acceptable terms, or at all.

 

For us to grow, remain competitive, develop new products, and expand our distribution network, we may require additional capital. Our ability to obtain additional capital is subject to a variety of uncertainties, including:

 

 

We may be unable to obtain additional capital in a timely manner or on acceptable terms or at all. Furthermore, the terms and amount of any additional capital raised through issuances of equity securities may result in significant shareholder dilution.

 

We depend on information technology, or IT, to support our business operations, the failure of which would materially and adversely affect our business, results of operations and prospects.

 

We are currently in the process of implementing an SAP ERP system to replace the existing system of our U.S. and European operations. When we acquired the patient monitoring device business of Datascope, it shared many hardware and software resources with the business of Datascope that we did not acquire and was subsequently acquired by another company. This shared architecture significantly complicates the task of migrating hardware and software to a standalone IT system. The migration may lead to unforeseen complications and expenses, and our failure to efficiently migrate the IT system could substantially disrupt our business. Once the migration is complete, we intend to build a single, globally integrated IT infrastructure consistent across our China, U.S. and European operations. This integration is complicated by broad geographies, differing languages and business models between historic Mindray and our acquired operations. Our failure to successfully integrate our IT systems across our China, U.S. and European operations could result in substantial costs and diversion of resources and management attention, which could harm our business and competitive position.

 

If we fail to protect our intellectual property rights, it could harm our business and competitive position.

 

We rely on a combination of patent, copyright, trademark and trade secret laws and non-disclosure agreements and other methods to protect our intellectual property rights. We have patents and patent applications pending in China covering various products and aspects of our products. We have patents and have also filed patent applications in the United States and Europe, which cover some of the more commercially significant aspects of our products and technologies.

 

Due to the different regulatory bodies and varying requirements in the United States, China and elsewhere, we may be unable to obtain patent protection for certain aspects of our products or technologies in either or both of these countries.

The process of seeking patent protection can be lengthy and expensive, our patent applications may fail to result in patents being issued, and our existing and future patents may be insufficient to provide us with meaningful protection or commercial advantage. Our patents and patent applications may also be challenged, invalidated or circumvented.

 

We also rely on trade secret rights to protect our business through non-disclosure provisions in employment agreements with employees. If our China-based employees breach their non-disclosure obligations, we may not have adequate remedies in China, and our trade secrets may become known to our competitors.

 

Implementation of PRC intellectual property-related laws has historically been lacking, primarily because of ambiguities in the PRC laws and enforcement difficulties. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention, which could harm our business and competitive position.

 

We may be exposed to intellectual property infringement and other claims by third parties which, if successful, could disrupt our business and have a material adverse effect on our financial condition and results of operations.

 

Our success depends, in large part, on our ability to use and develop our technology and know-how without infringing third party intellectual property rights. As we increase our product sales internationally, and as litigation becomes more common in China, we face a higher risk of being the subject of claims for intellectual property infringement, invalidity or indemnification relating to other parties’ proprietary rights. Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products in China, the U.S. or Europe. The validity and scope of claims relating to medical device technology patents involve complex scientific, legal and factual questions and analysis and, as a result, may be highly uncertain. In addition, the defense of intellectual property suits, including patent infringement suits, and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. Furthermore, an adverse determination in any such litigation or proceedings to which we may become a party could cause us to:

 

 

each of which could effectively prevent us from pursuing some or all of our business and result in our customers or potential customers deferring or limiting their purchase or use of our products, which could have a material adverse effect on our financial condition and results of operations.

 

Unauthorized use of our brand names by third parties, and the expenses incurred in developing and preserving the value of our brand name, may adversely affect our business.

 

We regard our brand names as critical to our success. Unauthorized use of our brand names by third parties may adversely affect our business and reputation, including the perceived quality and reliability of our products. We rely on trademark law, company brand name protection policies, and agreements with our employees, customers, business partners and others to protect the value of our brand names. Despite our precautions, we may be unable to prevent third parties from using our brand names without authorization. In the past, we have experienced unauthorized use of our brand names in China and have expended resources and the attention and time of our

management to successfully prosecute those who used our brand names without authorization. Moreover, litigation may be necessary to protect our brand names. However, because the validity, enforceability and scope of protection of trademarks in the PRC are uncertain and still evolving, we may not be successful in prosecuting these cases. Future litigation could also result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial condition and results of operations. In addition, we are in the process of registering our brand names and logos as trademarks in countries outside of China. Our registration applications may not be successful in certain countries, which could weaken the protection of our brand names in those countries or may require that we market our products under different names in those countries.

 

If we fail to obtain or maintain applicable regulatory clearances or approvals for our products, or if such clearances or approvals are delayed, we will be unable to commercially distribute and market our products at all or in a timely manner, which could significantly disrupt our business and materially and adversely affect our sales and profitability.

 

The sale and marketing of the medical device products we offer in China are subject to regulation in China and in most other countries where we conduct business. For a significant portion of our sales, we need to obtain and renew licenses and registrations with the PRC State Food and Drug Administration, or SFDA, the United States FDA, and the European regulators administering CE marks in the European Union. The processes for obtaining regulatory clearances or approvals can be lengthy and expensive, and the results are unpredictable. In addition, the relevant regulatory authorities may introduce additional requirements or procedures that have the effect of delaying or prolonging the regulatory clearance or approval for our existing or new products. For example, personnel and policy changes at SFDA has slowed the approval process and delayed some of our planned product launches in 2008. If we are unable to obtain clearances or approvals needed to market existing or new products, or obtain such clearances or approvals in a timely fashion, our business would be significantly disrupted, and our sales and profitability could be materially and adversely affected. See Item 4.B, “Information on the Company — Business Overview — Regulation”.

 

We are subject to product liability exposure and have limited insurance coverage. Any product liability claims or potential safety-related regulatory actions could damage our reputation and materially and adversely affect our business, financial condition and results of operations.

 

Our main products are medical devices used in the diagnosis and monitoring of patients, exposing us to potential product liability claims if their use causes or results in, or is alleged to have caused or resulted in, in each case either directly or indirectly, personal injuries or other adverse effects. Any product liability claim or regulatory action could be costly and time-consuming to defend. If successful, product liability claims may require us to pay substantial damages. We maintain limited product liability insurance to cover potential product liability arising from the use of our products. As a result, future liability claims could be excluded or could exceed the coverage limits of our policy. As we expand our sales internationally and increase our exposure to these risks in many countries, we may be unable to maintain sufficient product liability insurance coverage on commercially reasonable terms, or at all. A product liability claim or potential safety-related regulatory action, with or without merit, could result in significant negative publicity and materially and adversely affect the marketability of our products and our reputation, as well as our business, financial condition and results of operations.

 

Moreover, a material design, manufacturing or quality failure or defect in our products, other safety issues or heightened regulatory scrutiny could each warrant a product recall by us and result in increased product liability claims. If authorities in the countries where we sell our products decide that these products failed to conform to applicable quality and safety requirements, we could be subject to regulatory action. In China, violation of PRC product quality and safety requirements may subject us to confiscation of related earnings, penalties, an order to cease sales of the violating product or to cease operations pending rectification. Furthermore, if the violation is determined to be serious, our business license to manufacture or sell violating and other products could be suspended or revoked.

Our quarterly revenues and operating results are difficult to predict and could fall below investor expectations, which could cause the trading price of our ADSs to decline.

 

Our quarterly revenues and operating results have fluctuated in the past and may continue to fluctuate significantly depending upon numerous factors. In particular, the first and third quarters of each year historically have lower, and the fourth quarter historically has higher, revenues and operating results than the other quarters of the year. We believe that our weaker first quarter performance has been largely due to the Chinese Lunar New Year holiday and that our weaker third quarter performance has largely been due to summer holidays. We believe our stronger fourth quarter performance has been largely due to our customers spending their remaining annual budget amounts. Other factors that may affect our quarterly results include:

 

 

Many of these factors are beyond our control, making our quarterly results difficult to predict, which could cause the trading price of our ADSs to decline below investor expectations. You should not rely on our results of operations for prior quarters as an indication of our future results.

 

Fluctuations in exchange rates could result in foreign currency exchange losses.

 

As of December 31, 2008, our cash and cash equivalents were denominated in Renminbi, U.S. dollars, euro and the British pound. In 2007, we began requiring payment in euro from customers located in jurisdictions where the euro is the official currency. As a result, fluctuations in exchange rates between the Renminbi, the U.S. dollar, the euro and the pound affect our relative purchasing power, revenue, expenses and earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the Renminbi, euro and the pound relative to the U.S. dollar could affect our financial results prepared and reported in U.S. dollar terms without giving effect to any underlying change in our business, financial condition or results of operations. The Renminbi is pegged against a basket of currencies, determined by the People’s Bank of China, against which it can rise or fall by as much as 0.5% each day. The Renminbi may appreciate or depreciate significantly in value against the U.S. dollar, the euro or the pound in the long term, depending on the fluctuation of the basket of currencies against which it is currently valued, or it may be permitted to enter into a full float, which may also result in a significant appreciation or depreciation of the Renminbi against the U.S. dollar, the euro or the pound. Fluctuations in exchange rates will also affect the relative value of any dividends we issue, which will be exchanged into U.S. dollars and earnings from and the value of any U.S. dollar-denominated investments we make.

 

Appreciation of the Renminbi relative to other foreign currencies could decrease the per unit revenues generated from international sales. If we increased our international pricing to compensate for the reduced purchasing power of foreign currencies, we would decrease the market competitiveness, on a price basis, of our products. This could result in a decrease in our international sales volumes.

Very limited hedging instruments are available in China to reduce our exposure to Renminbi exchange rate fluctuations. While we may decide to enter into Renminbi hedging transactions, the effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure at all. In addition, PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currencies could magnify our currency exchange risks. While we may enter into hedging transactions in an effort to reduce our exposure to other foreign currency exchange risks, the effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure at all.

 

Our revenues and profitability could be materially and adversely affected if there is a disruption in our existing arrangements with our original design manufacturing and original equipment manufacturing customers.

 

In 2007 and 2008, ODM and OEM customers together accounted for 5.9% and 1.1%, respectively, of our net revenues. We have invested significant time and resources in cultivating these relationships. In particular, we are typically required to undergo lengthy product approval processes with these customers, which in some cases can take up to 16 months. The length of the approval process may vary and is affected by a number of factors, including customer priorities, customer budgets and regulatory issues. Delays in the product approval process could materially and adversely affect our business, financial condition and results of operations. Moreover, our ODM and OEM customers may develop their own solutions or adopt a competitor’s solution for products that they currently purchase from us. We may be unable to maintain our existing arrangements with our ODM and OEM customers. In particular, any failure in generating orders from these customers or decrease in sales to these customers, as well as any adoption by these customers of their own or our competitors’ product solutions, could have a material adverse effect on our revenues and profitability.

 

Our corporate actions are substantially controlled by our principal shareholders. Our dual-class ordinary share structure with different voting rights could discourage others from pursuing any change of control transactions that our shareholders may view as beneficial.

 

Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are entitled to five votes per share.

 

As of the date of this annual report, three of our shareholders and their affiliated entities owned approximately 33.5% of our outstanding ordinary shares, representing approximately 68.8% of our voting power due to our dual-class ordinary share structure. Our co-chief executive officers, Mr. Xu Hang and Mr. Li Xiting, and our executive vice president of strategic development, Mr. Cheng Minghe, through their respective affiliates, hold all of our Class B ordinary shares. These shareholders will continue to exert control over all matters subject to shareholder vote until they collectively own less than 20% of our outstanding ordinary shares. This concentration of voting power may discourage, delay or prevent a change in control or other business combination, which could deprive you of an opportunity to receive a premium for your ADSs as part of a sale of our company and might reduce the trading price of our ADSs. The interests of Mr. Xu, Mr. Li, and Mr. Cheng as officers and employees of our company may differ from their interests as shareholders of our company or from your interests as a shareholder.

 

Anti-takeover provisions in our charter documents may discourage our acquisition by a third party, which could limit our shareholders’ opportunity to sell their shares, including Class A ordinary shares represented by our ADSs, at a premium.

 

Our amended and restated memorandum and articles of association include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change of control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares, including Class A ordinary shares represented by ADSs, at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of us in a tender offer or similar transaction.

 

For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix the powers and rights of these shares, including dividend rights,

conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our Class A ordinary shares. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control or make removal of management more difficult. In addition, if our board of directors authorizes the issuance of preferred shares, the trading price of our ADSs may fall and the voting and other rights of the holders of our Class A ordinary shares may be materially and adversely affected.

 

Certain actions require the approval of at least two-thirds of our board of directors which, among other things, would allow our non-independent directors to block a variety of actions or transactions, such as a merger, asset sale or other change of control, even if our independent directors unanimously voted in favor of such action, thereby further depriving our shareholders of an opportunity to sell their shares at a premium. In addition, our directors serve staggered terms of three years each, which means that shareholders can elect or remove only a limited number of our directors in any given year. The length of these terms could present an additional obstacle against the taking of action, such as a merger or other change of control, that could be in the interest of our shareholders.

 

We may become a passive foreign investment company, or PFIC, which could result in adverse U.S. federal income tax consequences to U.S. holders.

 

Depending upon the value of our ordinary shares and ADSs and the nature of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes.

 

We will be classified as a PFIC in any taxable year if either: (1) the average percentage value of our gross assets during the taxable year that produce passive income or are held for the production of passive income is at least 50% of the value of our total gross assets or (2) 75% or more of our gross income for the taxable year is passive income. According to these technical rules, we would likely become a PFIC if the value of our outstanding ordinary shares and ADSs were to decrease significantly while we hold substantial cash and cash equivalents.

 

We believe we were not a PFIC for U.S. federal income tax purposes for our taxable year ended December 31, 2008. Although we intend to conduct our business activities in a manner to reduce the risk of our classification as a PFIC in the future, we currently hold, and expect to continue to hold, a substantial amount of cash and other passive assets, and, because the value of our assets is likely to be determined in large part by reference to the market prices of our ADSs and ordinary shares, which are likely to fluctuate, there can no assurance that we will not be classified as a PFIC for 2009 or any future taxable year. If we are a PFIC for any taxable year during which a U.S. investor held our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences would apply to the U.S. investor. For more information on the U.S. federal income tax consequences to U.S. investors that would result from our classification as a PFIC, please see Item 10.E, “Taxation — U.S. Federal Income Taxation — U.S. Holders — Passive Foreign Investment Company”.

 

We may be unable to ensure compliance with United States economic sanctions laws, especially when we sell our products to distributors over which we have limited control.

 

The U.S. Department of the Treasury’s Office of Foreign Assets Control, or OFAC, administers certain laws and regulations that impose penalties upon U.S. persons and, in some instances, foreign entities owned or controlled by U.S. persons, for conducting activities or transacting business with certain countries, governments, entities or individuals subject to U.S. economic sanctions, or U.S. Economic Sanctions Laws. We will not use any proceeds, directly or indirectly, from sales of our ADSs, to fund any activities or business with any country, government, entity or individual with respect to which U.S. persons or, as appropriate, foreign entities owned or controlled by U.S. persons, are prohibited by U.S. Economic Sanctions Laws from conducting such activities or transacting such business. However, we sell our products in international markets through independent non-U.S. distributors which are responsible for interacting with the end-users of our products. Some of these independent non-U.S. distributors are located in or conduct business with countries subject to U.S. economic sanctions such as Cuba, Sudan, Iran, Syria and Myanmar, and we may not be able to ensure that such non-U.S. distributors comply with any applicable U.S. Economic Sanctions Laws.

 

Moreover, if a U.S. distributor or one of our United States subsidiaries, Mindray USA Corp. or Mindray DS USA Inc., conducts activities or transacts business with a country, government, entity or individual subject to U.S. economic sanctions, such actions may violate U.S. Economic Sanctions Laws. As a result of the foregoing,

actions could be taken against us that could materially and adversely affect our reputation and have a material and adverse effect on our business, financial condition, results of operations and prospects.

 

We may be unable to maintain an effective system of internal control over financial reporting, and as a result we may be unable to accurately report our financial results or prevent fraud.

 

We are subject to provisions of the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act, or Section 404, requires that we include a report from management on our internal control over financial reporting in our annual reports on Form 20-F. In addition, our independent registered public accounting firm must attest to and report on the operating effectiveness of our internal control over financial reporting. While our management concluded that our internal control over financial reporting is effective as of December 31, 2008, and our independent registered public accounting firm reported on our internal controls over financial reporting, our management may conclude in the future that our internal controls are not effective. Furthermore, our acquisition of Datascope’s patient monitoring device business presents new Section 404 challenges, as the related financial reporting must be included in our Section 404 assessment for the year ending December 31, 2009. Our or our independent public accounting firm’s failure to conclude that our internal control over financial reporting is effective could result in a loss of investor confidence in the reliability of our reporting processes, which could materially and adversely affect the trading price of our ADSs.

 

Our reporting obligations as a public company will continue to place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Our failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial reporting processes, which in turn could harm our business and negatively impact the trading price of our ADSs.

 

RISKS RELATED TO DOING BUSINESS IN CHINA

 

Changes in China’s economic, political and social condition could adversely affect our financial condition and results of operations.

 

We conduct a substantial majority of our business operations in China and derived approximately half of our 2008 revenues from sales in China. Accordingly, our business, financial condition, results of operations and prospects are affected to a significant degree by economic, political and social conditions in China. The PRC economy differs from the economies of most developed countries in many respects, including the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. The PRC government has implemented various measures to encourage, but also to control, economic growth and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by changes in tax regulations applicable to us.

 

The PRC legal system embodies uncertainties that could limit the legal protections available to you and us.

 

The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have limited precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly increased the protections afforded to various forms of foreign investment in China. Our PRC operating subsidiary, Shenzhen Mindray, is a foreign-invested enterprise and is subject to laws and regulations applicable to foreign investment in China as well as laws and regulations applicable to foreign-invested enterprises. These laws and regulations change frequently, and their interpretation and enforcement involve uncertainties. For example, we may have to resort to administrative and court proceedings to enforce the legal protections that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may also impede our ability to enforce the

contracts we have entered into. As a result, these uncertainties could materially and adversely affect our business and operations.

 

Recent PRC regulations relating to offshore investment activities by PRC residents may increase the administrative burden we face and create regulatory uncertainties that could restrict our overseas and cross-border investment activity, and a failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.

 

In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, promulgated regulations that require PRC residents and PRC corporate entities to register with and obtain approvals from relevant PRC government authorities in connection with their direct or indirect offshore investment activities. These regulations apply to our shareholders who are PRC residents in connection with our prior and any future offshore acquisitions.

 

The SAFE regulation required registration by March 31, 2006 of direct or indirect investments previously made by PRC residents in offshore companies prior to the implementation of the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies on November 1, 2005. If a PRC shareholder with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for foreign exchange evasion.

 

We previously notified and urged our shareholders, and the shareholders of the offshore entities in our corporate group, who are PRC residents to make the necessary applications and filings, as required under this regulation. However, as these regulations are relatively new and there is uncertainty concerning their reconciliation with other approval requirements, it is unclear how they, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. While we believe that these shareholders submitted applications with local SAFE offices, some of our shareholders may not comply with our request to make or obtain any applicable registrations or approvals required by the regulation or other related legislation. The failure or inability of our PRC resident shareholders to obtain any required approvals or make any required registrations may subject us to fines and legal sanctions, prevent us from being able to make distributions or pay dividends, as a result of which our business operations and our ability to distribute profits to you could be materially and adversely affected.

 

We rely principally on dividends and other distributions on equity paid by our operating subsidiary to fund cash and financing requirements, and limitations on the ability of our operating subsidiary to pay dividends to us could have a material adverse effect on our ability to conduct our business.

 

We are a holding company, and we rely principally on dividends and other distributions on equity paid by our operating subsidiary Shenzhen Mindray for our cash and financing requirements, 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. If Shenzhen Mindray incurs debt on its own behalf, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Furthermore, relevant PRC laws and regulations permit payments of dividends by Shenzhen Mindray only out of its retained earnings, if any, determined in accordance with PRC accounting standards and regulations.

 

Under PRC laws and regulations, Shenzhen Mindray is required to set aside a portion of its net income each year to fund certain statutory reserves. These reserves, together with the registered equity, are not distributable as cash dividends. As of December 31, 2008, the amount of these restricted portions was approximately RMB525.0 million ($76.7 million). As a result of these PRC laws and regulations, Shenzhen Mindray is restricted in its ability to transfer a portion of its net assets to us whether in the form of dividends, loans or advances. Limitations on the ability of Shenzhen Mindray to pay dividends to us could adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.

Restrictions on currency exchange may limit our ability to utilize our revenues effectively.

 

A significant portion of our revenues and a majority of our operating expenses are denominated in Renminbi. The Renminbi is currently convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, Shenzhen Mindray may purchase foreign exchange for settlement of “current account transactions,” including payment of dividends to us, without the approval of SAFE. However, the relevant PRC governmental authorities may limit or eliminate our ability to purchase foreign currencies. Since a significant portion of our future revenues will be denominated in Renminbi, any existing and future restrictions on currency exchange may limit our ability to utilize revenues generated in Renminbi to fund our business activities outside of China denominated in foreign currencies. Foreign exchange transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities. This could affect the ability of Shenzhen Mindray to obtain foreign exchange through debt or equity financing, including by means of loans or capital contributions from us.

 

The discontinuation of any of the preferential tax treatments or the financial incentives currently available to us in the PRC could adversely affect our financial condition and results of operations.

 

Before 2008, China maintained a dual tax system that contained one set of tax rules for PRC domestic enterprises and one for foreign-invested enterprises, or FIEs. Though both domestic enterprises and FIEs were subject to the same income tax rate of 33%, there are various preferential tax treatments that were generally only available to FIEs, which resulted in the effective tax rates of FIEs being generally lower than those of domestic enterprises. The PRC government had provided various incentives to Shenzhen Mindray, which is an FIE. These incentives included reduced tax rates and other measures. For example, Shenzhen Mindray enjoyed preferential tax treatment, in the form of reduced tax rates or tax holidays, provided by the PRC government or its local agencies or bureaus. Shenzhen Mindray benefited from a 15% preferential corporate income tax rate and the preferential policy of “two years of exemption and six years of 50% reduction” of corporate income tax from the year it became profitable, resulting in an effective income tax rate of 7.5% through the end of 2006. Beijing Mindray is entitled to an enterprise income tax exemption for three years from its first year of operations and 50% tax reduction for the fourth to sixth year. Without these tax holidays and concessions, we would have had to pay additional tax totaling $4.1 million, $Nil and $Nil in 2006, 2007, and 2008, respectively.

 

The China Unified Enterprise Income Tax Law, or the New EIT Law, and its implementing rules became effective on January 1, 2008. The New EIT Law significantly curtails tax incentives granted to FIEs under the previous tax law. The New EIT Law, however, (i) reduces the top rate of enterprise income tax from 33% to 25%, (ii) permits companies to continue to enjoy their existing tax incentives, subject to certain transitional phase-out rules, and (iii) introduces new tax incentives, subject to various qualification criteria. The New EIT Law and its implementing rules permit qualified “New and Hi-Tech Enterprises” to enjoy a reduced 15% EIT rate. The recently published qualification criteria are significantly higher than those prescribed by the old tax rules under which we had been granted preferential treatment. Shenzhen Mindray and Beijing Mindray had obtained the qualification certificates of New and Hi-Tech Enterprises status in 2008 with a valid period of three years starting from 2008 to 2010. However, the continued qualification of a New and Hi-Tech Enterprise for calendar years of 2009 and 2010 will be subject to annual evaluation by the relevant government authority in China. In addition, Shenzhen Mindray and Beijing Mindray will need to apply for an additional three-year extension upon the expiration of the current qualification certificate if they desire to continue to enjoy the 15% reduced rate. We cannot assure you that Shenzhen Mindray and Beijing Mindray will continue to qualify as New and Hi-Tech Enterprises under the New EIT Law, or that the local tax authorities will not, in the future, change their position and revoke any of our past preferential tax treatments. The discontinuation of any of our preferential tax treatments could materially increase our tax obligations. Under the phase-out rules of New EIT Law, enterprises established before the promulgation date of the New EIT Law and which were granted preferential EIT treatment under the then effective tax laws or regulations may continue to enjoy their preferential tax treatments until their expiration. Accordingly, Beijing Mindray, an enterprise established before the promulgation date of the New EIT Law, will continue to enjoy its preferential treatment under the phase-out rules, under which it will continue to enjoy the 50% reduction of the EIT for the taxable years of 2008 to 2010. The 50% reduction may result in a tax rate of 7.5% to 12.5%.

In addition, under the New Law, dividends from our PRC subsidiaries for post 2007 retained earnings will be subject to a withholding tax of 5% and 10%, respectively, depending on the percentage of ownership. At this stage, we intend to retain the post 2007 retained earnings in PRC for permanent reinvestment. Should we change the intention in future, we will be required to adjust certain long term deferred tax liabilities which will result in a loss in the period the change takes effect.

 

Pursuant to a PRC tax policy intended to encourage the development of software and integrated circuit industries, our primary operating subsidiary in the PRC, Shenzhen Mindray, was previously entitled to a refund of value-added tax paid at a rate of 14% of the sale value of self-developed software that is embedded in our products. In 2006, due to changed regulation by the PRC government, sales of our embedded software were temporarily disqualified from receiving the value-added tax refund. In July 2008, pursuant to Cai Shui [2008] No. 92 jointly issued by the PRC government’s Ministry of Finance and the State Administration of Taxation, we were able to receive a value-added tax refund for sales of our embedded software on a retroactive basis since 2006. Refund due from sales of our embedded software during January 2006 to July 2008 amounting to $21.8 million was received in 2008.

 

Any increase in the enterprise income tax rate applicable to us or discontinuation or reduction of any of the preferential tax treatments or financial incentives currently enjoyed by our PRC subsidiaries and affiliated entity could adversely affect our business, operating results and financial condition.

 

Under the New EIT Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and U.S. holders of our ADSs or ordinary shares.

 

Under the New EIT Law, an enterprise established outside of China with its “de facto management body” in China is considered a “resident enterprise,” meaning that it can be treated the same as a Chinese enterprise for enterprise income tax purposes. The implementing rules of the New EIT Law defines “de facto management body” as an organization that exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of an enterprise. Currently no interpretation or application of the New EIT Law and its implementing rules is available for non-Chinese enterprises or group enterprise controlled entities; therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

 

If the PRC tax authorities determine that our Cayman Islands holding company is a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we will be subject to enterprise income tax at a rate of 25% on our worldwide income as well as PRC enterprise income tax reporting obligations. This would mean that income such as interest earned on funds held by our holding company and other non-China source income would be subject to PRC enterprise income tax at a rate of 25%, in comparison to no taxation in the Cayman Islands. Second, although under the New EIT Law and its implementing rules dividends paid to us by our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, a 10% withholding tax will be imposed on dividends we pay to our non-PRC shareholders, and future guidance may extend the withholding tax to gains derived by our non-PRC shareholders from transferring our ADSs or ordinary shares.

 

 

 

We commenced operations in 1991 through our predecessor entity. We are a Cayman Islands holding company and conduct substantially all of our business through our consolidated operating subsidiary Shenzhen Mindray, which was established in 1999. To enable us to raise equity capital from investors outside of China, we set up a holding company structure by establishing our current Cayman Islands holding company, Mindray International, on June 10, 2005. Mindray International became our holding company in September 2005 when the majority of our existing shareholders, transferred through a series of linked transactions, approximately 91.1% of the equity of Shenzhen Mindray to Mindray International. In April 2006 we acquired approximately 8.9% of the equity in Shenzhen Mindray with the result that our holding company owns approximately 99.99% of the equity of Shenzhen

Mindray. In May 2006, we changed our name to Mindray Medical International Limited. In May 2008, we completed the acquisition of the patient monitoring device business from Datascope Corp. For additional information on our organizational structure, see Item 4.C, “Information on the Company — Organizational Structure.”

 

We completed our acquisition of the patient monitoring device business of Datascope Corp. in May 2008 pursuant to the terms of a definitive agreement entered into in March 2008. The total purchase price was US$209.0 million in cash, as adjusted for working capital at the closing date. The acquisition was primarily financed through an acquisition financing loan provided by Bank of China (Hong Kong). See Item 5.B, “Operating and Financial Review and Prospects — Liquidity and Capital Resources — Financing Activities”. With this acquisition, we believe we are the third-largest global patient monitoring device producer and furthers our goal of becoming a leading provider of high-quality medical devices to markets worldwide. Datascope’s patient monitoring revenue was historically generated from sales in North America, with the remainder from markets largely in Europe. We intend to maintain Datascope’s existing branded product lines and to continue manufacturing Datascope products in the United States. With the Datascope acquisition, we currently offer over 60 products across our three product segments.

 

Our principal executive offices are located at Mindray Building, Keji 12th Road South, Hi-tech Industrial Park, Nanshan, Shenzhen, 518057, People’s Republic of China, and our telephone number is (86-755) 2658-2888. Our website address is http://www.mindray.com. The information on our website does not form a part of this annual report. On September 29, 2006, we completed our initial public offering, which involved the sale by us and some of our shareholders of 23,000,000 of our ADSs, representing 23,000,000 of our Class A ordinary shares. In February 2007, we completed a secondary public offering of 11,301,303 American Depositary Shares representing 11,301,303 Class A ordinary shares. We did not receive any proceeds from this offering.

 

 

Overview

 

We are a leading developer, manufacturer and marketer of medical devices worldwide. We maintain global headquarters in Shenzhen, China, U.S. headquarters in Mahwah, New Jersey and multiple sales offices in major international markets. From our main manufacturing and engineering base in China and through our worldwide distribution network, we supply internationally a broad range of products across three primary business segments, comprised of patient monitoring and life support products, in-vitro diagnostic products and medical imaging systems. We provide after-sales services to distributors and hospitals in China through 30 local offices based in provincial capital cities. We also provide after-sales services to our hospitals in the U.S., U.K. and France in our direct sales channel in these countries.

 

In China, we sell our products primarily to distributors, and the balance directly to hospitals, clinics, government agencies and ODM customers and OEM customers. With over 1,100 exclusive distributors and 950 sales and sales support personnel at the end of 2008, we believe our nationwide distribution, sales and service network is the largest of any medical device manufacturer in China. This extensive platform allows us to be closer than our competitors to end-users and enables us to be more responsive to local market demand. In addition, we believe we hold a leading market share position in China in in-vitro diagnostic products and grayscale ultrasound systems. We believe we have a number of competitive advantages in China that are difficult for competitors to duplicate including our large and cost-effective research and development team, our national sales infrastructure, and our widely recognized brand name.

 

Outside China, we sell our products through distributors and our direct sales personnel. Our established and expanding international sales and distribution networks provide us with a platform from which to build and enhance our market position globally. Our recently acquired direct sales platform contributed a significant portion of sales in the U.S., U.K., and France. We also maintain research and development, and marketing functions in the U.S., and after sales service in the U.S., U.K., and France.

 

We employ a vertically integrated operating model that enables us to efficiently develop, manufacture and market quality products at competitive prices. Our research and development team and our manufacturing

department work closely together to optimize manufacturing processes and develop commercially viable products. In addition, they incorporate regular feedback from our sales and marketing personnel, enabling us to timely and cost-effectively introduce products tailored to end-user needs. Furthermore, our research and development and manufacturing operations, which are based primarily in China, provide us with a distinct competitive advantage in international markets by enabling us to leverage low-cost technical expertise, labor, raw materials and facilities.

 

To enhance our leading market position, we have a target/guideline of investing approximately 10% of our net revenues in research and development. We have established what we believe is the largest China-based research and development team of any medical device manufacturer, with more than 1,400 engineers on our staff at the end of 2008. We also maintain research and development offices in the U.S. and Sweden to work with our China-based research and development staff in Shenzhen, Beijing, and Nanjing on product development targeted towards the U.S. and developed country markets. We believe our current spending, as a percentage of net revenues, is comparable to many of our international competitors and greater than most of our China-based competitors. We continually seek to broaden our market reach by introducing new and more advanced products and new product lines that address different end-user segments. Since 2006, we have introduced more than 30 new products, including 10 new products in 2008.

 

Products

 

We have three primary product business segments — patient monitoring and life support products, in-vitro diagnostic products and medical imaging systems — and produce a range of medical devices across these business segments.

 

Over the past three years, we have significantly expanded our geographic scope and increased the percentage of our revenues generated by international sales. Our products have been sold in more than 160 countries, and international sales grew from 48.6% of our net revenues in 2006 to 57.2% of our net revenues in 2008.

 

To facilitate international sales, the majority of our products have a CE mark, which certifies full compliance with the Medical Device Directives of the European Union, thus enabling our products to be marketed in any member state of the European Union. The CE mark for in-vitro diagnostic products are declared by ourselves pursuant to the relevant regulation of European Union, the remaining are issued by TUV. The CE mark issued by TUV demonstrates that not only has a representative sample of the product been evaluated, tested, and approved for safety, but also that the production line has been inspected on an annual basis. FDA 510(k) clearance from the FDA is required to market any of the medical devices in our current product portfolio in the United States, and we currently have more than 30 products with FDA clearance.

The chart below provides selected summary information about certain products we introduced in 2008:

 

 

The chart below provides selected summary information about some of the products that we introduced or intend to introduce in 2009:

 

 

Patient monitoring and life support products

 

Patient monitoring devices.  Our patient monitoring devices track the physiological parameters of patients, such as heart rate, blood pressure, respiration and temperature. We offer 29 different patient monitoring devices that are suitable for adult, pediatric and neonatal patients and are used principally in hospital intensive care units, operating rooms and emergency rooms. Our product line offers customers a broad range of functionality, such as single- and multiple-parameter monitors, mobile and portable multifunction monitors, central stations that can collect and display multiple patient data on a single screen, and an electro-cardiogram monitoring device. Our multi-parameter monitoring devices can be networked, allowing hospitals to remotely gather patient data from patient rooms and centralize that data in a single location. Our patient monitoring devices also have built-in

recorders and have batteries for portability in most models, as well as power backup in the event of power failure in mobile models. We also offer a line of veterinary monitoring devices.

 

Life support products.  We are also actively expanding the range of our life support products. We currently offer five anesthesia machines and a defibrillator, which we introduced in 2008. We plan to introduce surgical beds and surgical lights in 2009.

 

Sales of our patient monitoring and life support products accounted for 40.1%, 36.2%, and 44.5% of our net segment revenues in 2006, 2007, and 2008, respectively.

 

In-vitro diagnostic products

 

Our in-vitro diagnostic products provide data and analysis on blood, urine and other bodily fluid samples for clinical diagnosis and treatment. We offer a range of semi-automated and fully-automated in-vitro diagnostic products for laboratories, clinics and hospitals to perform analysis to detect and quantify various substances in the patient samples. Our current product portfolio consists of 19 in-vitro diagnostic products in two primary product categories: hematology analyzers and biochemistry analyzers.

 

Hematology analyzers.  Our hematology analyzers test blood samples to detect abnormalities or foreign substances. For example, our hematology analyzers can be used to detect blood diseases, such as anemia, and to screen to differentiate between illnesses caused by viruses from those caused by bacteria. We currently offer semi-automated and fully-automated three-part differential analyzers and fully-automated five-part differential analyzers (analyzers of three or five different types of white blood cells) with the ability to analyze a broad range of parameters through the use of reagents. Our two top-selling hematology analyzers in terms of revenues in 2008, the BC-2800 and BC-3000 series, utilize color LCD screens, can process 30 to 60 samples per hour and can store 10,000 to 20,000 patient results.

 

Biochemistry analyzers.  Our biochemistry analyzers measure the concentration or activity of substances such as enzymes, proteins and substrates. These analyzers may also be used as therapeutic drug monitors or to check for drug abuse. Our leading biochemistry analyzer, the BS-200 automated analyzer, which accounted for 11.9% of our in-vitro diagnostic products segment revenues in 2008, can hold up to 40 samples at a time with up to 40 reagents, allowing for up to 200 tests per hour. In April 2007, we introduced the BS-400, our fully-automated biochemistry analyzer; The BS-400 is our highest throughput biochemistry analyzer, which we believe will help us further expand our customer base by appealing to labs with high daily testing volumes.

 

We also offer reagents for use with our in-vitro diagnostic products. A reagent is a substance used in the chemical reactions analyzed by our in-vitro diagnostic products. We offer more than 55 reagents for hematology analyzers and more than 55 reagents for biochemistry analyzers. We also offer reagents that can be used in diagnostic laboratory instruments produced by other international and China-based manufacturers. This ongoing consumption and resulting need to order additional reagents creates a recurring revenue stream for us. As we expand our line of reagents available for sale in China and continue to grow our installed base of in-vitro diagnostic products and offer products with the ability to run more tests per hour, we anticipate that the recurring revenue stream from domestic reagent sales will likewise grow. Reagent sales accounted for 10.3%, 12.6% and 15.3% of our in-vitro diagnostic products segment revenue in 2006, 2007 and 2008, respectively.

 

Sales of our in-vitro diagnostic products, including sales of reagents, accounted for 29.3%, 31.2% and 25.1% of our net segment revenues in 2006, 2007 and 2008, respectively.

 

Medical imaging systems

 

Our medical imaging systems segment includes both ultrasound systems and digital radiography systems. Our ultrasound systems use computer-managed sound waves to produce real time images of anatomical movement and blood flow. Ultrasound systems are commonly employed in medical fields such as urology, gynecology, obstetrics and cardiology. We currently sell 12 portable and mobile ultrasound systems, and offer a broad range of transducers to enhance the adaptability of these products for a variety of applications. We believe this variety and adaptability increases customer appeal and broadens our potential client base.

We currently offer four color ultrasound systems. In 2006, we introduced our first color Doppler ultrasound system, the DC-6. The DC-6 was our leading ultrasound system in 2008, accounting for 30.4% of our medical imaging system segment revenues, and has received FDA 510(k) clearance. In 2007, we introduced the M5, a laptop-size color portable ultrasound system, which has received FDA 510(k) clearance. We believe the M5 has the potential to broaden our market penetration.

 

Our digital radiography systems use flat-panel detectors to capture images. Digital radiography systems allow patient to shorten X-ray exposure time compared to traditional film based radiography systems. The detector design eliminates manual activities, hastens treatment, improves patient comfort and provides greater cost efficiency. In 2008, we introduced our first digital radiography system, the DigiEye560T. In 2009, we plan to introduce an additional digital radiography system, the DigiEye760.

 

Our medical imaging systems segment accounted for 29.3%, 31.1% and 25.4% of our total net revenues in 2006, 2007 and 2008, respectively.

 

Distribution, Direct Sales

 

Third Party Distributor Network in China.

 

As of December 31, 2008, our nationwide distribution and sales network in China consisted of more than 1,100 exclusive distributors and 950 sales and sales support personnel located in 30 offices in almost every province in China. Our distribution network broadens our customer reach and enhances our ability to further penetrate the market in China within a short period of time. Exclusive distributors have the exclusive right to sell one or more of our products in a defined territory. In a given territory we may have several exclusive distributors selling different products on an exclusive basis if their customers or use-fields are specified differently. We often select exclusive distributors from our pool of non-exclusive distributors based on their prior sales performance for us. We also make selections based on factors such as sales experience, knowledge of medical equipment, contacts in the medical community, reputation and market coverage. We grant the majority of our distributors in China an exclusive right to sell a particular product or set of products within a specified territory or country. We actively manage our distribution network, regularly reviewing distributor performance and terminating distributors due to underperformance. Our distribution agreements are typically negotiated and renewed on an annual basis. None of our distributors accounted for more than 2% of our net revenues in each of the past three years. Prior to shipment, our exclusive distributors in China typically pay between 30% and 100% of the purchase price, for products.

 

Tender Sales in China

 

We make tender sales in China through government run tender sale processes. When we make tender sales to central or provincial level medical equipment purchasing agents, we enter into a binding contract for each sale. The payment terms for these contracts vary widely and are dictated by non-negotiable, standard government bidding contracts, which often provide for a smaller percentage of the total purchase price paid at the time of delivery. China-based tender sales and after-sales services provided to government agency customers accounted for 14.4%, 24.8% and 15.3% of our net domestic revenues, in 2006, 2007, and 2008, respectively.

 

Our international third party distribution network.

 

Our international distribution and sales network consisted of more than 2,000 distributors and more than 470 sales personnel covering more than 160 countries. We grant a minority of our international distributors an exclusive right to sell a particular product or set of products within a specified territory or country.

 

Our international distributors typically pay the entire purchase price or provide a letter of credit for the products they order. We also extend credit to selected distributors in the United States and Europe. As we expand our international sales to distributors in developed countries, we sometimes provide credit terms to qualified distributors that we believe are consistent with prevailing market practices in their distribution areas. The majority of our credit extended to international distributors is covered by our export credit insurance. To those distributors who both meet their sales targets and pay their receivables, we provide a predetermined amount of credit which can be

exchanged for our products. Over the last three years, we have not recognized any significant losses relating to payment terms provided to our distributors.

 

International direct sales

 

We have direct sales channels in the United States, United Kingdom and France. We employ a direct sales team in these regions of approximately 130 sales agents, who have relationships with hospitals, medical clinics and doctors throughout their sales regions. Typical credit terms to direct sales customers are 90 to 100 days, which we believe are lower than the industry average.

 

Marketing

 

We focus our marketing on establishing business relationships and growing our brand recognition, which primarily involves attending and sponsoring exhibitions and seminars pertaining to our product offerings. In 2008, we attended or sponsored more than 700 medical exhibitions and seminars. Furthermore, we conduct on-site demonstrations of our products at hospitals on a regular basis, and often offer new customers one of our products at a discounted rate. We also advertise in industry publications that cater to distributors of medical devices, industry experts or doctors.

 

Customers

 

We have three categories of customers: distributors, ODM and OEM customers, and hospitals and government agencies to whom we sell directly. Our customer base is widely dispersed on both a geographic and revenues basis. Our largest customer in each of the past three years was an ODM customer that accounted for 2.6%, 1.7% and 0.9% of our net revenues in 2006, 2007, and 2008, respectively. Our ten largest customers based on net revenues collectively accounted for 11.5%, 10.0% and 6.4% of our net revenues in 2006, 2007 and 2008, respectively.

 

Our distributors.  Sales to our distributors make up the substantial majority of our revenues, both on a segment by segment basis and in the aggregate. Sales to our distributors accounted for 82.9%, 80.5% and 67.3% of our net revenues in 2006, 2007 and 2008, respectively. As of December 31, 2008, we had more than 2,100 distributors in China and more than 2,000 additional distributors internationally, and our international distributors have sold our products into more than 160 countries.

 

ODM and OEM customers.  We manufacture products for ODM clients based on our own designs and employing our own intellectual property, while we manufacture these products for OEM customers based on their product designs. Although ODM and OEM products’ gross margins tend to be lower than those of our own branded products, ODM and OEM products provide us with an additional source of income generally generated through bulk orders. Our ODM customers also pay us a fee to help offset the research and development costs of developing the technologies associated with the ODM products they purchase from us. ODM and OEM clients accounted for 9.6%, 5.9% and 1.1% of our net revenues in 2006, 2007 and 2008, respectively.

 

Hospital and government agency customers.  In China, our hospital and government agency customers primarily include hospitals, as well as central and provincial level public health bureaus and population and family planning bureaus. These customers typically place large volume orders that are awarded based on bids submitted by competing medical equipment companies through a state-owned bidding agent, and we count them as government tender sales. In some cases, they do not engage a bidding agent to solicit competitive bids from several vendors, and we are allowed to negotiate directly with these customers, and we count these sales as direct sales.

 

Internationally, our direct sales force in the United States, United Kingdom and France sells primarily to hospitals with 300 or fewer beds, as well as surgery centers, private clinics, and veterinary clinics.

 

Hospital and government agency sales accounted for 7.5%, 12.0% and 26.2% of our net revenues in 2006, 2007 and 2008, respectively.

Customer Support and Service

 

China

 

We believe that we have the largest customer support and service team for medical devices in China, with more than 180 employees located in our headquarters in Shenzhen and our 30 offices in China as of December 31, 2008. This enables us to provide domestic training, technical support, and warranty, maintenance and repair services to end-users of our products, as well as distributor support and service.

 

 

We also provide our distributors with technical support, including training in the basic technologies of the products they sell, participating in presentations to potential customers, and assisting in preparing bidding documents for large volume purchase contracts awarded through competitive bidding and tenders. By working closely with our domestic distributors, our customer support and service employees are able to provide us valuable insights into the operations of each local distributor, which help us ensure that each distributor is able to operate effectively for us.

 

International

 

In several of the countries where we have direct sales, particularly the United States, United Kingdom and France, we also provide substantial after-sales services. Our service solutions business provides support with an array of integrated solutions, from project management and network installations, to comprehensive technology maintenance programs. The dedicated service offers clinical engineering partnership programs and rapid emergency service response, optimizing product performance and clinical results.

 

In our other international markets, we rely on our distributors to provide after-sales services. We provide technical support and training to our international distributors on an ongoing basis. When we conduct our training and technical support trips to the locations of our international distributors, we also take the opportunity to meet with a sample of end-users in that market to gather feedback on our products as well as market information such as levels of satisfaction, price information and specific functions desired from end-users serviced by our distributors.

 

We currently have international sales and service offices located in Amsterdam, Frankfurt, Istanbul, London, Mexico City, Milan, Moscow, Mumbai, Paris, Sao Paulo, Seattle, Toronto, and Vancouver. As our international markets mature, we will consider adding additional offices to assist with sales and support.

 

Manufacturing and Assembly

 

We currently have two principal manufacturing facilities in China and a final assembly and testing facility in Mahwah, New Jersey for some of our products.

 

Both of our China-based facilities are ISO 9001 and ISO 13485 certified. We continue to manufacture and assemble our in-vitro diagnostic products in our older China-based facility which is approximately 280,000 square feet in size. We manufacture and assemble patient monitoring and life support products and medical imaging systems in our new China-based facility which is approximately 820,000 square feet in size.

As part of our overall strategy to lower production costs through our vertically integrated operating model, we have made substantial investments in our in-house manufacturing infrastructure to complement our research and development and product design activities. In particular, we seek to achieve the following objectives:

 

 

We believe that by increasingly using common resources, manufacturing components in-house and using common manufacturing and assembly practices, we will be able to maintain or improve our competitive cost structure.

 

Our manufacturing strategy also incorporates strategic outsourcing. In particular, we outsource components that we believe can more efficiently and cost-effectively be produced by third party providers. Major outsourced components include integrated circuits, electronic components, raw materials and chemicals for reagents, and valves. Other components outsourced in the manufacturing process include various types of other electrical and plastic parts that are generally readily available in sufficient quantities from our local suppliers.

 

As is consistent to our overall strategy of maintaining a China-based manufacturing infrastructure and leveraging our vertically integrated operating model, we have taken steps to transfer traditionally outsourced manufacturing contracts by our acquired U.S. operations to our in-house manufacturing infrastructure in China. The ongoing process to transfer our manufacturing from outsourcing to in-sourcing in China is part of our effort to realize cost synergies from our acquisition of Datascope’s patient monitoring device business.

 

We purchase components for our products from approximately 400 suppliers, most of whom have long-term business relationships with us. No single supplier accounted for more than 5% of our supply purchases in 2007 or 2008, except in cases in 2007 where the supplies are readily available from multiple sources and we can gain a significant cost savings from volume. Since we have multiple suppliers for most of our components, we believe it is beneficial not to have long-term supply contracts with our suppliers; accordingly we generally enter into annual contracts. In particular, having the ability to negotiate price reductions on a periodic basis has allowed us to reduce our component costs and to maintain our profit margins.

 

We have our own independent quality control system, and devote significant attention to quality control for the designing, manufacturing, assembly, and testing of our products. In particular, we have established a quality control system in accordance with SFDA regulations. In addition, we obtained ISO 9001 certification and ISO 13485 certification issued by both TUV and Beijing Hua Guang. We have received international certifications for various products including FDA clearance letters, Canadian Medical Device Licenses and CE marks. We inspect components prior to assembly, and inspect and test our products both during and after their manufacture and assembly.

Each of our products is typically sold with a 12 to 24 month warranty against technical defects. If necessary, we will exchange a defective product. However, we do not accept any returns for a refund of the purchase price. The costs associated with our warranty claims have historically been low though we do accrue a liability for potential warranty costs at the time of sale based on historical default rates and estimated associated costs.

 

Intellectual Property

 

We believe we have developed a valuable portfolio of intellectual property rights to protect the technologies, inventions and improvements that we believe are significant to our business, which includes issued patents in China and pending patent applications in China, the United States and Europe. Moreover, we possess proprietary technology and know-how in manufacturing processes, design, and engineering. We plan to expand our portfolio of intellectual property rights in overseas markets as we increase our sales in those markets.

 

We have not filed for patent protection in Asian countries other than China based on our assessment of risks of third party infringement of our intellectual property in those markets and the costs of obtaining patent protection there. In general, while we seek patent protection for our proprietary technologies in major markets such as China, the United States and Europe, we do not rely solely on our patents to maintain our competitive position, and we believe that development of new products and improvements of existing products at competitive costs has been and will continue to be important to maintaining our competitive position. We will continue to evaluate our patent filing decisions on cost/benefit analysis. In order to protect our other types of intellectual property rights, we have filed for trademark protection for our brand name “Mindray” and associated logos in North American, European and Asian countries in which we market our products, and will continue to follow our brand management policy to build brand name recognitions in “Mindray” and associated marks in these countries. See Item 3.D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — Unauthorized use of our brand name by third parties, and the expenses in developing and preserving the value of our brand name, may adversely affect our business”.

 

Our success in the medical equipment industry depends in substantial part on effective management of both intellectual property assets and infringement risks. In particular, we must be able to protect our own intellectual property as well as minimize the risk that any of our products infringes on the intellectual property rights of others.

 

We perform IP due diligence studies on trademarks and patents, using both in-house and hired IP resources. Our IP department and program are led by an experienced, licensed in-house U.S. patent attorney. However, due to the complex nature of medical equipment technology patents and the uncertainty in construing the scope of these patents, as well as the limitations inherent in freedom-to-operate searches, the risk of infringing on third party intellectual properties cannot be eliminated. See Item 3.D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — We may be exposed to intellectual property infringement and other claims by third parties which, if successful, could disrupt our business and have a material adverse effect on our consolidated financial condition and results of operations”.

 

We enter into agreements with all our employees involved in research and development, under which all intellectual property during their employment belongs to us, and they waive all relevant rights or claims to such intellectual property. All our employees involved in research and development are also bound by a confidentiality obligation, and have agreed to disclose and assign to us all inventions conceived by them during their term of employment. Despite measures we take to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or our proprietary technology or to obtain and use information that we regard as proprietary. See Item 3.D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — If we fail to protect our intellectual property rights, it could harm our business and competitive position”.

 

We have no material license arrangements with any third party. We often purchase components that incorporate the supplier’s intellectual property, especially with respect to components with advanced technologies that we are currently not capable of producing ourselves.

 

We believe that we have successfully established our brand in China. We have registered trademarks in China in the U.S. and in other countries for the “Mindray” name and logo used on our own-brand products and we have trademark license rights for the use of the Datascope trademarks used in our patient monitoring devices through the year 2015. As part of our overall strategy to protect and enhance the value of our brand, we actively enforce our

registered trademarks against any unauthorized use by a third party. In a court case in 2005, where we brought suit against another medical device company for its unauthorized use of the “Mindray” name, the court determined our Mindray trademark to be a “well-known mark”. Based on part on this finding, and also on evidence of the widespread awareness of our products in China, we are also applying to the relevant governmental administrative authority to have our Mindray name designated a “well-known mark”. Since such marks in China enjoy stronger protections than the other marks without such designation, this court ruling helps strengthen our ability to protect the value of our brand in China.

 

Competition

 

The medical equipment and healthcare industries are characterized by rapid product development, technological advances, intense competition and a strong emphasis on proprietary products. Across all product lines and product tiers, we face direct competition both domestically in China and internationally. We compete based on factors such as price, value, customer support, brand recognition, reputation, and product functionality, reliability and compatibility.

 

For domestic sales, our competitors include publicly traded and privately held multinational companies and domestic Chinese companies. We believe that we can continue to compete successfully in China because our established domestic distribution network and customer support and service network allows us significantly better access to China’s small- and medium-sized hospitals. In addition, our strong investment in research and development, coupled with our low-cost operating model, allows us to compete effectively for our sales to large-sized hospitals.

 

In international markets, our competitors include publicly traded and privately held multinational companies. These companies typically focus on the premium segments of the market. We believe we can successfully penetrate certain international markets by offering products of comparable quality at substantially lower prices. We also face competition in international sales from companies that have local operations in the markets in which we sell our products. We believe that we can compete successfully with these companies by offering products of substantially better quality at comparable prices.

 

Set forth below is a summary of our primary competitors by business segment. We expect to increasingly compete against multinational companies, both domestically and internationally, as we continue to manufacture more advanced products.

 

Patient Monitoring and Life support products.  For domestic sales of patient monitoring and life support products, our primary competitors are Draeger Medical, GE Healthcare, Biolight, Koninklijke Philips Electronics, Spacelabs and Nihon Kohden. For international sales of patient monitoring devices, our primary competitors are GE Healthcare, Koninklijke Philips Electronics, Siemens Medical and Nihon Kohden.

 

In-Vitro Diagnostic Products.  For domestic sales of hematology analyzers, our primary competitors are Abbott Laboratories, Beckman Coulter, ABX, Urit Medical, Baxter, Tecom Science Corporation Nihon Kohden, and Sysmex Corporation. For international sales of hematology analyzers, our primary competitors are Beckman Coulter, Abbott Laboratories and Sysmex Corporation.

 

For domestic sales of biochemistry analyzers, our primary competitors are Biotecnica Instruments, Beckman Coulter, Hitachi, Sysmex Corporation, Abbott and Roche Diagnostics. For international sales of biochemistry analyzers, our primary competitors are Beckman Coulter and Roche Diagnostics.

 

Medical Imaging Systems.  For domestic sales of medical imaging systems, our primary competitors are GE Healthcare, Siemens Medical, Philips Electronics, Aloka, Toshiba, Hitachi, Esaote Group and Medison. For international sales of medical imaging systems, our primary competitors are Siemens Medical, GE Healthcare, Koninklijke Philips Electronics, Esaote and Toshiba Medical Systems.

 

These and other of our existing and potential competitors may have substantially greater financial, research and development, sales and marketing, personnel and other resources than we do and may have more experience in developing, manufacturing, marketing and supporting new products. See Item 3.D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — Our business is subject to intense competition, which

may reduce demand for our products and materially and adversely affect our business, financial conditions, results of operations and prospects”.

 

We must also compete for distributors, particularly international distributors, with other medical equipment companies. Our competitors will often prohibit their distributors from selling products that compete with their own. These and other potential competitors may have higher visibility, greater name recognition and greater financial resources than we do. See Item 3D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — We depend on distributors for a significant majority of our revenues; we typically do not have long-term distribution agreements, and competition for suitable distributors is intense. Failure to maintain relationships with our distributors or to otherwise expand our distribution network would materially and adversely affect our business”.

 

Seasonality

 

Our revenues are subject to seasonal fluctuations due to our customers’ budgetary cycles and holiday schedules in markets where we sell our products. The first quarter is typically the slowest quarter for our sales due to the Chinese Lunar New Year holidays when our sales force works fewer days during the quarter, affecting both international and domestic sales revenues. In addition, hospitals in China typically have their budgets approved and begin spending only after the Chinese Lunar New Year holiday. In the second quarter revenues from sales are typically sequentially higher due to spending associated with newly approved customer budgets in China, and spending in the U.S. to fulfill budgetary requirements as many hospitals in the U.S. have a June 30 fiscal year end. In the third quarter, revenues are typically flat in our China, U.S. and European markets as customers reduce their commercial activity during summer holidays and, with respect to the U.S., certain hospitals’ new budgetary cycle begins. There is a similar but less pronounced effect on domestic revenue growth trends during the summer months due to a slight slowdown in overall commercial activity in China. The fourth quarter is the strongest quarter for our China, U.S. and European sales as many customers seek to spend all funds remaining in their annual purchasing budgets before the end of the fiscal and calendar year. Our past experience indicates that our revenues tend to be lower in the first quarter and higher in the fourth quarter of each year, assuming other factors were to remain constant.

 

Insurance

 

We maintain liability insurance coverage to cover product liability claims arising from the use of our products. We also maintain property insurance to cover certain of our fixed assets. Our insurance coverage, however, may not be sufficient to cover any claim for product liability or damage to our fixed assets.

 

Insurance companies in China offer limited business insurance products and do not, to our knowledge, offer business liability insurance. While business disruption insurance is available to a limited extent in China, we have determined that the risks of disruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. As a result, except for fire insurance, we do not have any business liability, disruption or litigation insurance coverage for our operations in China. See Item 3.D, “Key Information — Risk Factors — Risks Related to Our Business and Industry — We are subject to product liability exposure and have limited insurance coverage. Any product liability claims or potential safety-related regulatory actions could damage our reputation and materially and adversely affect our business, financial condition and results of operations”.

 

Facilities

 

See Item 4.D, “Information on the Company — Property, Plant and Equipment.”

 

Legal Proceedings

 

We are not currently a party to any material legal proceeding. From time to time, we may bring or be subject to various claims and legal actions arising in the ordinary course of business.

Regulation

 

Our patient monitoring and life support products, in-vitro diagnostic products, and medical imaging systems are medical devices and are subject to regulatory controls governing medical devices in the countries where we manufacture and sell our products. As a manufacturer of medical equipment and supplies we are subject to regulation and oversight by different levels of the food and drug administration in China, in particular the SFDA, as well as the FDA in the U.S. and various regulatory agencies in Europe and other countries in which we sell our products. We are also subject to other PRC government laws and regulations which are applicable to manufacturers in general. SFDA requirements include obtaining production certifications, medical instrument manufacturing licenses, compliance with clinical testing standards, quality standards, applicable industry standards and adverse event reporting, and advertising and packaging standards.

 

China

 

Classification of Medical Devices

 

In China, medical devices are classified into three different categories, Class I, Class II and Class III, depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Classification of a medical device is important because the class to which a medical device is assigned determines, among other things, whether a manufacturer needs to obtain a Medical Instrument Manufacturing License and the level of regulatory authority involved in obtaining such permit. Classification of a device also determines the types of registration required and the level of regulatory authority involved in effecting the product registration.

 

Class I devices require product certification and are those with low risk to the human body and are subject to “general controls”. Class I devices are regulated by the city level food and drug administration where the manufacturer is located. Class II devices are those with medium risk to the human body and are subject to “special controls”. Class II devices require product certification, usually through a quality system assessment, and are regulated by the provincial level food and drug administration where the manufacturer is located. Class III devices are those with high risk to the human body, such as life-sustaining, life-supporting or implantable devices. Class III devices also require product certification and are regulated by the SFDA under the strictest regulatory control.

 

The majority of our products that manufactured in China are classified as Class II or Class III devices. All our in-vitro diagnostic products are Class II medical devices; Beneview series, PM series and MEC series patient monitors, TMS-6016 telemetry monitoring system, WATO series anesthesia machines, are classified as Class III medical devices, while the remainder of our patient monitors and operating tables and surgical lights are classified as Class II medical devices. Our DC-6 Expert, DC-6,M-5, DC-3,N80, N70 are classified as Class III medical devices, while the remainder of our medical imaging systems are classified as Class II medical devices. Our various reagents are classified as either Class II or Class III devices. We produce a small number of Class I products, such as cables for cardiographs, diluent and lead wires.

 

In China, our reagents used with our in-vitro diagnostic products are divided into the categories of biological reagents and chemical and bio-chemical reagents. A part of biological reagents are subject to regulatory controls similar to those governing pharmaceutical products. However, all the reagents manufactured by us are subject to regulatory controls similar to those governing medical devices.

 

Medical Instrument Manufacturing License

 

A manufacturer must obtain a manufacturing license from the provincial level food and drug administration before commencing the manufacture of Class II and Class III medical devices. No manufacturing license is required for the manufacture of Class I devices, but the manufacturer must notify the provincial level food and drug administration where the manufacturer is located and file for record with it. A manufacturing license, once obtained, is valid for five years and is renewable upon expiration.

 

Our manufacturing license for the manufacture of our patient monitoring and life support products, in-vitro diagnostic products and medical imaging systems will expire on February 28, 2011. To renew a manufacturing

license, a manufacturer needs to submit to the provincial level food and drug administration an application to renew the permit, along with required information six months before the expiration date of the permit.

 

Medical Instrument Distribution License

 

A manufacturer or distributor must obtain a distribution license in order to engage in sales and distribution of Class II and Class III medical devices in China. A distribution license is valid for five years and is renewable upon expiration. To renew a distribution license, a manufacturer or distributor needs to submit to the provincial level food and drug administration an application to renew the license, along with required information six months before the expiration date of the license. Our distribution license will expire on April 6, 2011.

 

Registration Requirement

 

Before a medical device can be manufactured for commercial distribution, a manufacturer must effect medical device registration by proving the safety and effectiveness of the medical device to the satisfaction of respective levels of the food and drug administration. In order to conduct a clinical trial on a Class II or Class III medical device, the SFDA requires manufacturers to apply for and obtain in advance a favorable inspection result for the device from an inspection center jointly recognized by the SFDA and the Administration of Quality Supervision, Inspection and Quarantine. The application to the inspection center must be supported by appropriate data, such as animal and laboratory testing results. If the Ethics Committee in the institutions approves the application for clinical trial, and the respective levels of the food and drug administration approve the institutions which will conduct the clinical trials, the manufacturer may begin the clinical trial. A registration application for a Class II or Class III device must provide required pre-clinical and clinical trial data and information about the device and its components regarding, among other things, device design, manufacturing and labeling. The provincial level food and drug administration, within 60 business days of receiving an application for the registration of a Class II device, and the SFDA, within 90 business days of receiving an application for the registration of a Class III device, will notify the applicant whether the application for registration is approved. If approved, a registration certificate will be issued within ten days of written approval. If the food and drug administration requires supplemental information, the approval process may take much longer. The registration is valid for four years.

 

The SFDA may change its policies, adopt additional regulations, revise existing regulations or tighten enforcement, each of which could block or delay the approval process for a medical device.

 

Regulation of Reagents

 

Under a regulation enacted by the SFDA in April 17, 2007, all our IVD reagents products are subject to regulatory controls similar with medical devices.

 

To date, more than 80 IVD reagents which are manufactured and sold by Shenzhen Mindray have obtained medical device registration certificates as required from respective levels of food and drug administration.

 

Continuing SFDA Regulation

 

We are subject to continuing regulation by the SFDA. In the event of significant modification to an approved medical device, its labeling or its manufacturing process, a new premarket approval or premarket approval supplement may be required. Our products are subject to, among others, the following regulations:

 

 

Class II and III devices may also be subject to special controls applicable to them, such as supply purchase information, performance standards, quality inspection procedures and product testing devices which may not be required for Class I devices. We believe we are in compliance with the applicable SFDA guidelines, but we could be

required to change our compliance activities or be subject to other special controls if the SFDA changes or modifies its existing regulations or adopts new requirements.

 

We are also subject to inspection and market surveillance by the SFDA to determine compliance with regulatory requirements. If the SFDA decides to enforce its regulations and rules, the agency can institute a wide variety of enforcement actions such as:

 

 

Radio Transmission Equipment Type Approval Certificate

 

As we produce multi-parameter monitoring devices that can share data remotely through network connections, we are required to obtain a Radio Transmission Equipment Type Approval Certificate issued by the PRC Ministry of Information Industry. Our certificate will expire on November 6, 2010.

 

China Compulsory Certification Requirements

 

China Compulsory Certification, or CCC, inclusive of a certificate and a mark, serves as evidence that the covered products can be imported, marketed or used in China. The CCC mark is administered by the China National Certification and Accreditation Administration, which designates the China Quality Certification Center to process CCC mark applications. Some medical devices are required to have a CCC mark. We have received a certificate and a mark for each of our products for which a CCC mark is required.

 

United States

 

For any of our products that we distribute in the United States, the labeling, distribution and marketing are subject to regulation by the FDA and other regulatory bodies. The FDA regulates our currently marketed products as medical devices and we are required to obtain review and clearance or approval from the FDA prior to commercial sales of our devices.

 

FDA premarket clearance and approval requirements

 

Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either prior 510(k) clearance or prior premarket approval from the FDA. The FDA classifies medical devices into one of three classes depending on the degree of risk posed to patients by the medical device. Devices deemed to pose lower risk are placed in either Class I or II, which requires the manufacturer to obtain 510(k) clearance from the FDA prior to marketing such devices. Some low-risk Class I devices are exempt from the 510(k) requirement altogether. Devices deemed by the FDA to pose greater risk, or devices deemed not substantially equivalent to a previously cleared 510(k) device are placed in Class III, most of which require premarket approval. Both premarket clearance and premarket approval applications are subject to the payment of user fees, to be paid at the time of submission for FDA review.

 

510(k) clearance pathway

 

To obtain 510(k) clearance, a premarket notification must be submitted, demonstrating that the proposed device is substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of premarket approval applications. The FDA’s 510(k) clearance process usually takes from two to eight months from the date the application is submitted, but it can take significantly longer.

 

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new 510(k) clearance or could require premarket approval. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees

with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or premarket approval is obtained. If the FDA requires us to seek 510(k) clearance or premarket approval for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant regulatory fines or penalties.

 

All products that we currently distribute in the United States have been cleared through the 510(k) clearance pathway.

 

Premarket approval pathway

 

To obtain premarket approval, a premarket approval application must be submitted if the device cannot be cleared through the 510(k) process, and is usually utilized for Class III medical devices, or devices that pose a significant safety risk, including unknown risks related to the novelty of the device.

 

A premarket approval application must be supported by extensive data including, but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use. Technical performance data required for diagnostic laboratory instrument premarket approval applications may include validation of the performance of hardware and software under repeat testing, calibration of mechanical components and stability of reagents and other products used in specimen collection, storage and testing. Preclinical trials may include tests to determine product stability and biocompatibility, among other features.

 

Continuing FDA regulation

 

After a device is placed on the market, numerous regulatory requirements apply. These include:

 

 

Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions:

 

 

European Union

 

The European Union has promulgated rules that require commercial medical products to bear the CE mark. The CE mark is recognized by the European Union as a symbol of adherence to strict quality systems requirements set forth in the ISO 9001 and ISO 13485 quality standards, as well as compliance with 93/42/ EEC, the Medical Device Directives of the European Union. The CE mark allows us to market our products throughout the European Economic Area. Our manufacturing facilities received the most updated ISO 9001/ISO 13485 Quality Systems certification in December 2008. These certifications and repeated inspections are required in order to continue to affix the CE Mark to our approved products in Europe.

 

We have received regulatory approval to affix the CE mark to the substantial majority of our products. Failure to receive regulatory approval to affix the CE mark would prohibit us from selling these products in member countries of the European Union.

Other National and Provincial Level Laws and Regulations in China

 

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

 

Laws regulating medical device manufacturers and hospitals cover a broad array of subjects. We must comply with numerous additional state and local laws relating to matters such as safe working conditions, manufacturing practices, environmental protection and fire hazard control. We believe we are currently in compliance with these laws and regulations in all material respects. We may be required to incur significant costs to comply with these laws and regulations in the future. Unanticipated changes in existing regulatory requirements or adoption of new requirements could have a material adverse effect on our business, financial condition and results of operations.

 

Foreign Exchange Control and Administration

 

Foreign exchange in China is primarily regulated by:

 

 

Under the Foreign Currency Administration Rules, the Renminbi is convertible for current account items, including the distribution of dividends, interest payments, and trade and service-related foreign exchange transactions. Conversion of Renminbi into foreign currency for capital account items, such as direct investment, loans, investment in securities and repatriation of funds, however, is still subject to the approval of SAFE. Under the Administration Rules, foreign-invested enterprises may only buy, sell and remit foreign currencies at banks authorized to conduct foreign exchange transactions after providing valid commercial documents and, in the case of capital account item transactions, only after obtaining approval from SAFE.

 

Capital investments directed outside of China by foreign-invested enterprises are also subject to restrictions, which include approvals by the PRC Ministry of Commerce, SAFE and the PRC National Reform and Development Commission. We receive a portion of our revenues in Renminbi, which is currently not a freely convertible currency. Under our current structure, our income will be primarily derived from dividend payments from our subsidiaries in China.

 

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 been based on rates 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 will be permitted to fluctuate within a band against a basket of certain foreign currencies. There remains significant international pressure on the PRC government to adopt a substantial liberalization of its currency policy, which could result in a further and more significant appreciation in the value of the Renminbi against the U.S. dollar.

 

Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions

 

In January and April 2005, SAFE issued two rules that require PRC residents to register with and receive approvals from SAFE in connection with their offshore investment activities. SAFE has announced that the purpose of these regulations is to achieve the proper balance of foreign exchange administration and the standardization of the cross-border flow of funds. On October 21, 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Reverse Investment Activities of Domestic Residents Conducted through Offshore Special Purpose Companies, or Notice 75, which became effective as of November 1, 2005. Notice 75 superseded the two rules issued by SAFE in January and April 2005 mentioned above. According to Notice 75:

 

 

 

Moreover, Notice 75 applies retroactively.  As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in the PRC in the past are required to complete the relevant overseas investment foreign exchange registration procedures by March 31, 2006. Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore company, including the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.

 

As a Cayman Islands company, and therefore a foreign entity, if we purchase the assets or equity interest of a PRC company owned by PRC residents in exchange for our equity interests, such PRC residents will be subject to the registration procedures described in Notice 75. Moreover, PRC residents who are beneficial holders of our shares are required to register with SAFE in connection with their investment in us. As a result of the lack of implementing rules and other uncertainties relating to the interpretation and implementation of Notice 75, we cannot predict how these regulations will affect our business, operations or strategies. For example, our present or future PRC subsidiaries’ ability to conduct foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, may be subject to compliance with such SAFE registration requirements by relevant PRC residents over whom we have no control. In addition, we cannot assure you that any such PRC residents will be able to complete the necessary approval and registration procedures required by the SAFE regulations. We require all our shareholders who are PRC residents to comply with any SAFE registration requirements, but we have no control over either our shareholders or the outcome of such registration procedures. Such uncertainties may restrict our ability to implement our acquisition strategy and materially and adversely affect our business and prospects.

 

We believe that these foreign exchange restrictions may reduce the amount of funds that would be otherwise available to us to capitalize overseas subsidiaries or expand our international operations. However, we anticipate that we will require relatively small amounts of funds to capitalize overseas subsidiaries, and such funds should be readily available from us. Similarly, we anticipate that the startup capital and working capital costs for our international expansion will be borne largely by our international distributors with limited, if any, investment coming from us. We therefore do not anticipate that the restrictions set forth in the SAFE regulations will have a material adverse effect on our ability to capitalize foreign subsidiaries or expand our international operations.

 

Regulation of Overseas Listings

 

On August 8, 2006, six PRC regulatory agencies, including the PRC Ministry of Commerce, or MOFCOM, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and the SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which became effective on September 8, 2006. This regulation, among other things, has some provisions that purport to require that an offshore SPV formed for listing purposes and controlled directly or indirectly by PRC companies or individuals obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange.

On September 21, the CSRC published on its official website procedures regarding its approval of overseas listings by SPVs. The CSRC approval procedures require the filing of a number of documents with the CSRC and it would take several months to complete the approval process if a waiver is not available.

 

We completed the initial listing and trading of our ADSs on the New York Stock Exchange on September 29, 2006. The application of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement. We did not seek CSRC approval in connection with either our initial public offering or the secondary offering in February 2007.

 

Our PRC counsel, Jun He Law Offices, has advised us that because we completed our restructuring before September 8, 2006, the effective date of the new regulation, it was not and is not necessary for us to submit the application to the CSRC for its approval of our initial public offering or the secondary offering in February 2007, and the listing and trading of our ADSs on the New York Stock Exchange does not require CSRC approval. Should an application for CSRC approval be required from us, we have a legal basis to apply for a waiver from the CSRC, if and when such procedures are established to obtain such a waiver. A copy of Jun He Law Offices’ legal opinion regarding this PRC regulation is filed as an exhibit to our registration statement on Form F-1 in connection with the secondary offering in February 2007, which is available at the SEC’s website at www.sec.gov.

 

See Item 3.D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — Our failure to obtain the prior approval of the China Securities Regulatory Commission, or the CSRC, of the listing and trading of our ADSs on the New York Stock Exchange could have a material adverse effect on our business, operating results, reputation and trading price of our ADSs”.

 

In November 2008, SAFE promulgated the Notice concerning Submitting Tax Certificates for Foreign Payments under Trade in Services and Other Items, or Notice 64. According to Notice 64, any domestic institution or individual making a single foreign payment equivalent to more than $30,000 with any of the following foreign exchange capital under trade in services, benefits, current transfer and capital items shall apply to the competent tax authority for the applicable tax certificate. As one of our subsidiaries, Shenzhen Mindray, is incorporated in the PRC, any bonuses, profits, direct debt interest or guaranteed monies exceeding $30,000 transferred to us from Shenzhen Mindray will be subject to Notice 64.

 

Dividend Distributions

 

Pursuant to the Foreign Currency Administration Rules promulgated in 1996 and amended in 1997 and various regulations issued by SAFE, and other relevant PRC government authorities, the PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China.

 

Shenzhen Mindray and Beijing Mindray are regulated under the newly revised PRC Company Law which took effect on January 1, 2006. Accordingly they shall allocate 10% of after-tax profits to statutory common reserve fund. Where the accumulated amount of the statutory common reserve fund has exceeded 50% of the registered capital of the subsidiaries no further allocation is required to be made. These funds, however, may not be distributed to equity owners except in accordance with PRC laws and regulations.

 

 

We are a Cayman Islands holding company and conduct substantially all of our business through our consolidated subsidiaries Shenzhen Mindray and Mindray DS USA Inc., which currently conducts substantially all of our U.S. based operations. We own approximately 99.9% of the equity of Shenzhen Mindray through two Hong Kong holding companies, and we own 100% of Mindray DS USA Inc. through our consolidated subsidiary Mindray Medical Netherlands B.V. Our corporate structure reflects common practice for companies with operations in several different countries where separate legal entities are often required or advisable for purposes of obtaining relevant operating licenses in such jurisdictions. Our holding company structure allows our management and shareholders to take significant corporate actions without having to submit these actions for approval or consent of the administrative agencies in every country where we have significant operations. Moreover, our choice of the Cayman Islands as the jurisdiction of incorporation of our ultimate holding company was motivated in part by its

relatively well-developed body of corporate law, various tax and other incentives, and its wide acceptance among internationally recognized securities exchanges as a jurisdiction for companies seeking to list securities.

 

We commenced operations in 1991 through our predecessor entity and established Shenzhen Mindray, our current operating company in 1999. To enable us to raise equity capital from investors outside of China, we set up a holding company structure by establishing our current Cayman Islands holding company, Mindray International, on June 10, 2005. Mindray International became our holding company in September 2005 when the majority of our existing shareholders, transferred through a series of linked transactions, approximately 91.1% of the equity of Shenzhen Mindray to Mindray International. All such linked transactions involving transfer of shares in Shenzhen Mindray for cash were subject to the approval of the PRC Ministry of Commerce and its appropriate local counterpart, as well as registration with the PRC State Administration of Industry and Commerce and its appropriate local counterpart, and we have obtained those required approvals and registration. There were no conditions or contingencies upon which these approvals were based. As a result of this share transfer, our holding company Mindray International controlled approximately 91.1% of Shenzhen Mindray, with the remaining approximately 8.9% distributed among four other shareholders. In May 2006, we changed our name to Mindray Medical International Limited.

 

In April 2006, Mindray International injected additional capital of RMB174.2 million to subscribe for an additional 99 million shares of Shenzhen Mindray. In addition, we issued to offshore shareholders of Shenzhen Mindray 7,649,646 shares of our company, approximately 8.9% of our share capital, in exchange for all outstanding shares of Shenzhen Mindray not already owned by Mindray International except for 0.0002% of the enlarged share capital of Shenzhen Mindray consisting of 300 shares held by three PRC shareholders who remain as shareholders in order to fulfill corporate requirements under PRC law that a company limited by shares have at least two shareholders, at least one of which should be a PRC domestic shareholder. These 300 shares entitle their owners to identical economic and voting rights as the shares held by our subsidiaries, MR Holdings (HK) Limited and MR Investments (HK) Limited. All other Shenzhen Mindray shares are held by MR Holdings (HK) Limited and MR Investments (HK) Limited, which now collectively hold approximately 99.9% of the equity of Shenzhen Mindray.

 

Shenzhen Mindray has one subsidiary, Beijing Shen Mindray Medical Electronics Technology Research Institute Co., Ltd, or Beijing Mindray, in which Shenzhen Mindray has a 99.9% equity interest and through which we conduct some of our research and development activities. At the time that Beijing Mindray was incorporated, the PRC Company Law required that any domestic limited liability company have at least two separate legal or natural persons as equity holders. We satisfied this requirement by establishing Beijing Mindray with a principal shareholder and two additional shareholders with nominal equity holdings in the entity. The remaining 0.1% equity interest in Beijing Mindray is held in equal 0.05% interests by Mr. Xu Hang and Mr. Li Xiting, our co-CEOs, and entitles its owners to identical economic and voting rights as the equity interest held by Shenzhen Mindray. Mindray International has several subsidiaries, two of which are MR Holdings (HK) Limited and MR Investments (HK) Limited that hold the equity of Shenzhen Mindray.

 

Effective May 1, 2008, we acquired the patient monitoring business of Datascope Corp., through our U.S. subsidiary Mindray DS USA Inc., which operates in the U.S. and Europe and sells products worldwide.

The diagram below illustrates our current corporate structure and the place of formation and affiliation of our principal subsidiaries as of May 8, 2009:

 

 

 

We currently maintain our corporate headquarters at Mindray Building, Keji 12th Road South, Hi-tech Industrial Park, Nanshan, Shenzhen, 518057, People’s Republic of China. Our corporate headquarters occupy approximately 193,000 square feet. We have two existing production sites for research and development and manufacturing. We are also developing a new research and development center adjacent to our headquarters in Shenzhen, and, pursuant to an agreement with the Government of the Nanjing Jiangning Development Zone, we are establishing a new research and development and manufacturing facility in Nanjing. See Item 3.D,“Key Information — Risk Factors — Risks Related to Our Business and Industry — We currently principally rely on three manufacturing, assembly and storage facilities for our products and are developing two additional facilities. Any disruption to our current manufacturing facility or in the development of the new facilities could reduce or restrict our sales and harm our reputation”.

 

We additionally maintain a Patient Monitoring and Technology Services headquarters in Mahwah, New Jersey, which occupies approximately 130,000 square feet and is used for the manufacture, research and development, warehousing and final testing and assembly of certain of our patient monitoring and life support products.

 

We maintain a research and development center in Beijing at 5-5 (3rd Floor West), Building 5, No. 8 Chuang Ye Road, Hai Dian District, Beijing, which we operate through our subsidiary Beijing Mindray. This facility

occupies approximately 10,697 square feet. We also maintain a research and development office in Seattle, Washington. We also have 30 local sales and services offices in China and we have international sales and service offices in Amsterdam, Frankfurt, Istanbul, London, Mexico City, Milan, Moscow, Mumbai, Paris, Sao Paulo, Seattle, Toronto and Vancouver.

 

The land on which we have developed our largest production facility (BaiWang) is leased for 10 years, through 2017, and we are currently renegotiating the terms of the lease for our second largest production facility (XiLi), which we expect to complete prior to the expiration of this lease in July 2009. We are currently working to secure property rights to another location in Shenzhen where we would have a 50 year lease with land use rights which we would subsequently develop as a substitute for our currently rented production facility.

 

The following table contains information concerning our significant real property that we own or lease:

 

 

We believe that our facilities and equipment are in good working condition.

 

 

Not applicable.

 

 

The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included in this annual report on Form 20-F. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See “Introduction — Forward-Looking Statements.” In evaluating our business, you should carefully consider the information provided under Item 3.D,

“Key Information — Risk Factors.” We caution you that our businesses and financial performance are subject to substantial risks and uncertainties. See “Key Information — Risk Factors — Risks Relating to Our Business and Industry — We are currently experiencing a global economic crisis, which could materially and adversely affect our business, financial condition and results of operations.”

 

 

Overview

 

We are a leading developer, manufacturer and marketer of medical devices worldwide. We maintain global headquarters in Shenzhen, China, U.S. headquarters in Mahwah, New Jersey and multiple sales offices in major international markets. From our main manufacturing and engineering base in China and through our worldwide distribution network, we are able to supply internationally a broad range of products across three primary business segments, comprised of patient monitoring and life support products, in-vitro diagnostic products and medical imaging systems. We currently offer over 60 products across our three product segments.

 

Our net revenues increased from $190.4 million in 2006 to $294.3 million in 2007 and to $547.5 million in 2008, representing a compound annual growth rate of 69.6%. These significant increases reflect organic growth driven by success in expanding our product lines to include more advanced products and our increasing market penetration, particularly internationally. The increase in 2008 also reflects our acquisition of Datascope’s patient monitoring device business, which contributed to more than 30% of our net revenues outside China. Our net revenues outside of China grew at a faster rate than net revenues in China in both real and percentage terms from 2006 to 2008, increasing to $313.1 million, or 57.2% of our net revenues in 2008. Net revenue growth outside China has been augmented by (i) our expanded sales coverage to more than 160 countries in 2008, (ii) our increased penetration in existing markets outside China, (iii) our acquisition of Datascope’s patient monitoring device business, (iv) our enhanced distributor network, and (v) our new and enhanced product introductions.

 

In China, we sell our products primarily to distributors. In 2008, distributor sales accounted for 84.7% of our China-based net revenues. We believe we have one of the largest distribution, sales and service network for medical devices in China with more than 2,100 distributors and 950 sales and sales support personnel, and we sell our products internationally through more than 2,000 distributors and 470 sales personnel as of December 31, 2008. We also sell our products directly to hospitals, clinics, government health bureaus, and to ODM and OEM customers. Outside China, we sell our products to distributors and through our direct sales force in the U.S., the U.K. and France, which was acquired in 2008 from Datascope Corp.

 

We continually seek to broaden our market reach by introducing new and more advanced products and new product lines that address different end-user segments. Since 2006, we have introduced more than 30 new products, including color Doppler ultrasound systems, five-part hematology analyzers, our high-end Beneview series of patient monitoring devices, and anesthesia machines. With the Datascope patient monitoring device business acquisition, we obtained product lines with features specifically addressing the needs and demands of healthcare professionals in the United States, Europe and other developed markets.

 

Our investment in research and development as a percentage of net revenues has remained steady at approximately 10% of net revenues. Our investment in research and development in 2008 is consistent with our plan to annually invest approximately 10% of our net revenues in research and development activities. This level of investment demonstrates our commitment to creating and maintaining what we believe is the largest research and development team of any medical device manufacturer based in China, with more than 1,400 engineers on our staff as of December 31, 2008, and continuing to develop and commercialize new and more advanced products. We believe that our continuous emphasis on research and development is a key driver of our revenue and earnings growth. We maintain five research and development facilities ranging from more than 1,300 engineers in Shenzhen, to 80 engineers in Beijing, and to specialized teams in Nanjing, Seattle, and Mahwah. The bulk of our investment in research and development is in relatively lower cost China, with select teams in our U.S. locations with expertise in design and engineering matters generally unavailable in China. As part of the planned expansion of our research and development and manufacturing capabilities, we are developing a new facility in Nanjing.

We completed our acquisition of Datascope’s patient monitoring device business in May 2008 for US$209.0 million in cash, as adjusted for working capital at the closing date. With this acquisition, we believe we are the third-largest global patient monitoring device producer and it furthers our goal of becoming a leading provider of high-quality medical devices to markets worldwide. The acquisition added established direct sales and service infrastructure in the U.S., U.K. and France to our existing international sales operations and significantly expanded our presence in the mainstream hospital markets in these countries. With the acquisition, we also added a team of experienced research and development personnel based in the U.S., with knowledge and expertise in researching and developing products catering to the U.S. and European markets. We plan to create cost synergies through manufacturing, research and development and sales infrastructure integration. We have begun transferring higher-cost manufacturing that was previously outsourced by our operations in Mahwah, U.S. to our manufacturing sites in China. Additionally, we have been reviewing and subsequently transferring traditionally outsourced research and development projects in the U.S. to our China sites to optimize our research and development productivity. At the same time, we have been integrating sales and service infrastructure in markets where our China based operations and our newly acquired U.S. based operations teams co-exist to have coherent marketing, sales and service across different sales channels. On top of creating cost synergies, we have also made necessary personnel arrangements to cross sell Mindray branded products through our acquired direct sales channel, beginning with our patient monitoring and life support products, and continuing with other product categories once sales and service resources are in place.

 

Recent market turmoil in the global economy has made it difficult for us to predict our revenues, net income and overall liquidity. Demand for our products is likely to be impacted by the fluctuating currency exchange rates, underlying end-user demand and the credit availability negatively. We expect increased pricing pressure which may lead to lower margins. In particular, we believe a higher percentage of government tender business in China will likely negatively impact our gross margin because tender sales typically require higher discounts than sales to our distributors. In regions where local currencies have experienced significant fluctuations against the U.S. dollar, we also expect to grant a larger discount in our average selling price in order to attract more end-user demand. We have and will be negotiating as frequently as required with our suppliers in an effort to lower our overall purchasing costs and mitigate downward pressure on our margins. We also are actively seeking to increase the percentage of in-house manufactured components, which we are able to produce more cost-effectively than third-party suppliers. We have been actively eliminating personnel based on performance and cutting non-essential expenses to conserve our financial resources. However, we endeavor to continue our investments in areas such as research and development and sales and marketing where we believe will be critical to our long-term growth. Such investments will be done on a selected basis and only after careful reviews by our management. In light of deteriorating global credit environment, we will also be more selective when extending credit to our customers.

 

Pricing

 

We sell our products both through our direct sales force and to distributors.

 

To gain market penetration where we rely on distributors, we price our products at levels that we believe offer attractive economic returns to distributors, taking into account the prices of competing products and our gross margins. Average selling prices to distributors for our products are generally the same in China and internationally, although we do make pricing adjustments based on specification adjustments for international markets. We believe that we offer products of comparable quality to our international competitors at substantially lower prices.

 

The average sales prices of products we sell through our direct sales force are typically higher than the average sales prices of products we sell to distributors. However, when we sell directly to hospitals, clinics, and government health bureaus in China by participating in competitive bidding and tenders run by government bidding agents to procure large-volume purchase contracts, the average sales prices tend to be slightly lower than those of products sold to distributors. The lower pricing for these sales is more than offset by typically higher unit volumes, representing attractive sales opportunities for us. Overall, the higher average sales prices from direct sales are offset by the costs of maintaining our direct sales force.

 

Through our continuous efforts to improve manufacturing efficiencies and reduce our raw material costs, we have been able to reduce our overall production costs for existing products compared to prior years. We have

typically passed the majority of these cost savings on to our customers by offering them lower prices while maintaining targeted gross margin levels. We believe that our ability to offer price reductions without a significant impact to our gross margins allows us to generate increased sales volume and gross profits, and helps alleviate any pricing pressures we may face.

 

We are facing significant pricing pressures that we believe are related to the current global economic crisis. Coupled with anticipated increases in China government tender sales, which are high volume but tend to have lower average sales prices, we believe average sales prices could decline in the near term. Outside China, we face significant pricing uncertainty related to foreign currency fluctuations, which can substantially reduce purchasing power in international markers where our products are sold.

 

Revenues

 

We present revenues net of value-added tax. The value-added tax represents the amount we collect from our customers at 17% offset by the value-added tax refund pursuant to “Certain Policies to Encourage the Development of Software and Integrated Circuit Industries as New and High Technology Enterprises” at a rate of 14% of the sales value for self-developed software embedded in our devices.

 

Our customer base is widely dispersed on a geographic basis, with sales into more than 160 countries. China is our largest market by a significant margin, but has decreased as a percentage of our total net revenues in recent years as we expand our global market reach. In the near term, we anticipate the our China sales as a percentage of our total net revenues will increase, as China’s economy appears to have generally fared better compared to most other major markets where we sell our products.

 

In recent years, as we expanded our presence in markets outside China, our net revenues from outside China, particularly in Europe and North America, grew more quickly as a percentage of our total net revenues than China. However, due in large part to the global economic crisis, currency fluctuations and uncertainty surrounding potential United States healthcare reforms, we believe in the near term that our net revenues from sales outside China will grow more slowly than our total net revenues. Net revenues from Europe, North American and other countries in Asia constituted 17.4%, 17.3% and 10.3%, respectively, of our total net revenues in 2008.

 

In other areas, which include Eastern Europe, we believe our net revenues are more susceptible to the impact of the global economic crisis, due in large part to foreign currency fluctuations that can substantially reduce purchasing power.

 

Our customer base is also widely dispersed on a revenue basis. In each of 2006, 2007 and 2008, no single customer accounted for more than 3.0% of our total net revenues.

 

We primarily derive revenues from three business segments: patient monitoring and life support products, in-vitro diagnostic products and medical imaging systems. These business segments accounted for 44.5%, 25.1% and 25.4% of our total net segment revenues in 2008, respectively. We also have a business segments called “other,” which includes primarily services revenue and revenue from research and development contracts.

 

Patient Monitoring and Life Support Products.  We historically derived revenues for our patient monitoring and life support products segment from sales of patient monitors, life support products and related accessories. Our patient monitoring and life support products segment is our largest business segment and has the most extensive market penetration of our three segments both domestically and internationally. We expect to continue to penetrate large-sized hospitals in China and international markets with our direct sales platform in China, the United States and Europe, increased brand recognition and the introduction of additional advanced products in this business segment, including our anesthesia machines and defibrillators we introduced in 2008. Due primarily to our acquisition of Datascope’s patient monitoring device business, we anticipate that in the near term, on a percentage basis, net revenues in this segment will grow more quickly than total net revenues. However, this segment’s growth relative to 2008 should be less significant because our 2008 revenues include eight month’s net revenues from our acquisition of Datascope’s patient monitoring device business.

 

In-Vitro Diagnostic Products.  We derive revenues for our in-vitro diagnostic products segment from sales of diagnostic laboratory instruments and related reagents. Our current in-vitro diagnostic products portfolio consists of

two primary product categories: hematology analyzers and biochemistry analyzers. We also sell reagents for use with our products in both of these categories. A reagent is used each time an analysis is performed, generating a recurring revenue stream for us. Diagnostic laboratory reagent sales accounted for 3.8% of the segment’s net revenues in 2008. We anticipate that we will continue to grow in-vitro diagnostic product revenues as we further penetrate this market by developing and introducing of new advanced product offerings.

 

Medical Imaging Systems.  We derive medical imaging systems segment revenues from sales of ultrasound systems, digital radiography products and related accessories. We anticipate that, on a percentage basis, net revenues in our medical imaging systems segment in the near term will grow more quickly than total net revenues, as we further penetrate the medical imaging systems market and as we expand our products offerings, particularly with our color Doppler ultrasound systems and digital radiography products.

 

Others.  We derive revenues for our others segment revenues from after-sale services as well as research and development services performed for customers on an ODM basis. Research and development income tends to be lumpy in nature. We expect our after-sales service revenue to grow more slowly given that we do not anticipate proportionate growth from this revenue stream from our higher growth areas, such as China.

 

Our ability to increase our revenues depends in large part on our ability to (i) increase the market penetration of our existing products, (ii) successfully identify, develop, introduce and commercialize, in a timely and cost-effective manner, new and upgraded products, and (iii) successfully integrate our acquisition of Datascope’s patient monitoring device business, including increasing awareness of our brand and its quality and leveraging the acquired direct sales platform. We generally choose to devote resources to product development efforts that we believe are commercially feasible, can generate significant revenues and margins and can be introduced into the market in the near term.

 

In any period, several factors will impact our net revenues, including:

 

 

For a detailed discussion of some of the factors that may cause our net revenues to fluctuate, see Item 3.D, “Key Information — Risk Factors — Risks Relating to Our Business and Industry — Our quarterly revenues and operating results are difficult to predict and could fall below investor expectations, which could cause the trading price of our ADSs to decline”.

 

Cost of Revenues

 

Cost of revenues includes our direct costs to manufacture our products, including component and material costs, salaries and related personnel expenses, depreciation of plant and equipment used for production purposes, shipping and handling costs and provisional cost of warranty-based maintenance, repair services, and the cost of providing sales incentives.

Product mix is the most significant factor in determining our cost of revenues as a percentage of our net revenues. See “— Comparison of Years Ended December 31, 2006, December 31, 2007 and December 31, 2008 — Gross Profit and Gross Margin”.

 

The direct costs of manufacturing a new product are generally highest when a new product is first introduced. In periods when we introduce a greater than average number of new products, our cost of revenues as a percentage of net revenues tends to be higher due to start-up costs associated with manufacturing a new product and generally higher raw material and component costs due to lower initial production volumes. As production volumes increase, we typically improve our manufacturing efficiencies and are able to strengthen our purchasing power by buying raw materials and components in greater quantities. In addition, we are able to lower our raw material and component costs by identifying lower-cost raw materials and components. Moreover, when production volumes become sufficiently large, we often gain further cost efficiencies by producing additional components in-house.

 

We currently have a relatively low cost base compared to medical device companies in more developed countries because we source a significant portion of our raw materials and components and manufacture a significant portion of our products in China. We are also seeking to strategically move to China component and raw material production related to our U.S. operations. Historically, we have been able to reduce our raw material and component costs as we increase purchase volumes and make improvements in manufacturing processes. We have typically passed the majority of these cost savings on to our customers by offering them lower prices while maintaining targeted gross margin levels. However, we believe that these reductions will be increasingly offset by rising costs of raw materials, components and wages in China resulting from China’s further economic development. In particular, we expect that the costs of raw materials will increase in the near term. In addition, as we focus on more advanced products and new product lines, we may find it necessary to use higher-cost raw materials and components that may not be cheaper in China. We plan to mitigate future increases in raw material and component costs by using more common resources across our product lines, increasing in-house manufacture of components and adopting more uniform manufacturing and assembly practices.

 

Cost of revenues was impacted in 2008 by our acquisition of Datascope’s patient monitoring device business. This is due primarily to higher manufacturing costs from outsourced third parties, whereas our historical operations had a higher percentage of components manufactured in house. While the cost of revenues for revenues from this business were higher than our overall cost of revenues in 2008, we are actively seeking reductions and believe we will be able to reduce them in part through anticipated integration synergies.

 

Gross Profit and Gross Margin

 

Gross profit is equal to net revenues less cost of revenues. Gross margin is equal to gross profit divided by net revenues. Changes in our gross margins from period to period are primarily driven by changes in product mix. See “— Cost of Revenues”. Between 2006 and 2008, we were able to maintain gross margins between approximately 50% and 60%. In the near term, we anticipate that our gross margins could be negatively impacted, as we operate for our first full year with the Datascope patient monitoring device business, which had lower gross margins than our historical business. In addition, while we will continue to seek to develop and introduce high gross margin products, we will also seek to introduce complementary goods that can boost our total net revenues but may have lower gross margins. For example, to augment our suite of patient monitoring device and life support products, we intend to begin offering surgical lights and surgical beds, which typically have lower gross margins than other products we offer in this segment. However, because this is a complementary product, we believe the overall impact to net revenues and net income should be positive, as we can leverage our existing sales infrastructure.

 

Gross margins for domestic and international sales to distributors tend to be substantially similar. In some periods, a higher contribution from government tender sales in China may lead to a lower domestic gross margin. Overall gross margin for international sales is lower than domestic sales given the higher cost base from the acquired business. Although the average sales prices of each of our products generally decreases over time, these decreases have generally not had an adverse impact on our gross margins because in most instances they result from our ability to reduce our cost of revenues and our strategic decision to pass on these cost savings to our customers.

Operating Expenses

 

Our operating expenses consist of selling expenses, general and administrative expenses, research and development expenses, and employee share-based compensation expenses.

 

Selling Expenses

 

Selling expenses consist primarily of compensation and benefits for our sales and marketing staff, expenses for promotional, advertising, travel and entertainment activities, lease payments for our sales offices, and depreciation expenses related to equipment used for sales and marketing activities.

 

In China, we primarily sell our products to distributors. Consequently, our China sales and marketing expenses as a percentage of net revenues are significantly lower than manufacturers of medical devices that primarily sell their products directly to end-users. While we intend to continue to sell our products in China primarily to distributors, we also seek to build brand recognition by increasing marketing activities, which may increase our selling expenses.

 

Selling expenses as a percentage of total net revenues increased slightly in 2008, primarily due to the acquisition of Datascope’s patient monitoring device business and its direct sales platform. Compared to 2008, we expect that certain components of our selling expenses as a percentage of total net revenues will increase as we integrate this direct sales platform and we open new international sales and service offices to increase our market penetration in selected international markets. We also anticipate increased selling expenses as we localize staff in our international offices. We presently operate thirteen international sales and service offices and expect to open one more in 2009.

 

General and Administrative Expenses

 

General and administrative expenses consist primarily of compensation and benefits for our general management, finance and administrative staff, depreciation and amortization with respect to equipment used for general corporate purposes, professional advisor fees, lease payments and other expenses incurred in connection with general corporate purposes.

 

We expect that most components of our general and administrative expenses as a percentage of net revenues will increase due to our acquisition of Datascope’s patient monitoring device business, which will be offset in part by anticipated operating synergies from the integration of this business and improved operating efficiencies attributable to our increased business scale. In particular, we anticipate having higher general and administrative costs related to additional SOX 404 compliance costs relating to our U.S. operations and SAP implementation costs in our U.S. and European operations.

 

Research and Development Expenses

 

Research and development expenses consist primarily of costs associated with the design, development and testing of our products. Among other things, these costs include compensation and benefits for our research and development staff, expenditures for purchases of supplies, depreciation expenses related to equipment used for research and development activities, and other relevant costs. Research and development expenses as a percentage of net revenues remained relatively steady at close to 10% of total net revenues in 2006, 2007 and 2008. Our investment in research and development in 2006, 2007 and 2008 is consistent with our plan to annually invest approximately 10% of our net revenues in research and development activities. This level of investment demonstrates our commitment to creating and maintaining what we believe is the largest research and development team of any medical device manufacturer in China, and continuing to develop and commercialize new and more advanced products. We are aggressively in-sourcing a significant portion of the research and development related to our acquisition of Datascope’s patient monitoring device business that was previously outsourced, and believe this will provide additional cost savings.

Employee Share-Based Compensation Expenses

 

We account for employee share-based compensation expenses based on the fair value of share option or restricted share grants at the date of grant. In February 2006, we adopted an employee share-based compensation plan, pursuant to which certain members of our senior management and certain of our key employees may receive non-vested shares or options to purchase ordinary shares. These non-vested shares options generally vest over a service period of four to five years based on a graded vesting schedule and if the employees have met their performance targets based on evaluation of each individual employee. Share-based compensation expenses are recorded when the performance condition becomes probable over the service period.

 

We incurred $3.3 million, $7.7 million and $8.7 million in employee share-based compensation expenses in 2006, 2007 and 2008, respectively.

 

The table below shows the effect of the 2006, 2007 and 2008 share-based compensation charges on our operating expense line items:

 

 

Other Income (Expense)

 

Other income (expense) is the sum of the line items “other income, net” plus “interest income” less “interest expense” from our consolidated financial statements. Other income, net, has in the past consisted primarily of government subsidies for the development of new high technology medical products and government incentives for making high technology investments in our local region. In 2008, other income, net, included a non-recurring manufacturing transitional services fee of $2.7 million received in connection with our acquisition of Datascope’s patient monitoring device business. We do not receive government subsidies or government incentives on a regular basis, and the amounts that we have received in the past have tended to fluctuate significantly. While we intend to continue applying for government subsidies and government incentives, we may not receive any.

 

In 2008, interest expense of $5.2 million mainly represents interest on financing obtained for the acquisition of Datascope’s patient monitoring device business and interest on our working capital facilities.

 

Taxes and Incentives

 

Our company is a tax exempted company incorporated in Cayman Islands and is not subject to taxation under the current Cayman Islands law. Our subsidiaries operating in the PRC are subject to PRC taxes as described below and the subsidiaries incorporated in the BVI are not subject to taxation.

 

Before 2008, the basic enterprise income tax rate for the foreign-invested enterprises in the PRC was 33% (30% state tax and 3% local tax). However, being a manufacturing enterprise located in the Shenzhen special economic zone, Shenzhen Mindray should have been subject to a preferential tax rate of 15% state tax and no local tax. However, Shenzhen Mindray was entitled to a tax exemption for two years from the year of its first taxable profit and a 50% tax reduction for the third to fifth year (7.5% state tax and Nil% local tax). The first profitable year was 1999. Moreover, Shenzhen Mindray was designated as a “new and high technology enterprise” under the then applicable PRC tax law and was therefore eligible to receive a special additional enterprise income tax holiday which represented a reduction in income tax of 50% resulting in a reduced tax rate of 7.5% for three years from 2004 through 2006. Beginning in 2007, the applicable income tax rate for Shenzhen Mindray became 15%. The additional tax that would otherwise have been payable without enterprise income tax preferential treatment totaled $3.9 million in 2006, representing a reduction in basic earnings per ordinary share of $0.05 in 2006.

In March 2007, China passed the China Unified Enterprise Income Tax Law, or the New EIT Law, which became effective on January 1, 2008. The New EIT Law establishes a single unified 25% income tax rate for most companies, with some preferential income tax rates for qualified “New and High-Tech enterprises”. Shenzhen Mindray and Beijing Mindray had obtained the qualification certificates of New and Hi-Tech Enterprises status in 2008 with a valid period of three years from 2008 to 2010. However, the continued qualification of a New and Hi-Tech Enterprise for calendar years of 2009 and 2010 will be subject to annual evaluation by the relevant government authority in China. In addition, Shenzhen Mindray and Beijing Mindray will need to apply for an additional three-year extension upon the expiration of the current qualification certificate if they desire to continue to enjoy the 15% reduced rate.. See Item 3D, “Key Information — Risk Factors — Risks Related to Doing Business in China — The discontinuation of any of the preferential tax treatments or the financial incentives currently available to us in the PRC could adversely affect our financial condition and results of operations”.

 

Beijing Mindray is entitled to an enterprise income tax exemption for three years beginning from its first year of operations and 50% tax reduction for the fourth to sixth years of its operations. The 50% reduction may result in a tax rate ranging from 7.5% to 12.5%.

 

Our major subsidiary in the U.S., Mindray DS, is subject to tax at the average tax rate of 40.2% (35% Federal and 8% State).

 

Artema in Sweden is subject to tax at 28%. Beginning January 1, 2009, the tax rate shall be reduced to 26.3%.

 

Our effective income tax rates in 2006, 2007 and 2008 were 6.1%, 15.2% and 13.5% respectively. The higher effective income tax rates in 2007 and 2008 were primarily due to the expiration of tax holidays enjoyed in prior years.

 

As a result of the lapse of enterprise income tax term holiday for Shenzhen Mindray our historical operating results may not be indicative of our operating results for future periods. See Item 3.D, “Key Information — Risk Factors — Risks Related to Doing Business in China — The discontinuation of any of the preferential tax treatments or the financial incentives currently available to us in the PRC could adversely affect our business, financial condition and results of operations”.

 

Results of Operations

 

The following table sets forth our condensed consolidated statements of operations by amount for the indicated periods:

 

 

 

Note (a):

 

Comparison of Years Ended December 31, 2006, December 31, 2007 and December 31, 2008

 

Net Revenues

 

The following table sets forth net revenues by geography and the percentage of our total net revenues and net revenues by business segment for 2006, 2007 and 2008:

 

 

Net revenues did not previously include shipping and handling fees charged to customers and VAT refund for segment reporting. The measures of net revenues include such shipping and handling fees and VAT refund for the years ended December 31, 2006, 2007 and 2008.

 

Cost of revenues did not previously include shipping and handling fees from operating expenses and depreciation and amortization for fair value adjustment in property, plant and equipment and intangible assets. The measures of cost of revenues include such shipping and handling fees and depreciation and amortization for the years ended December 31, 2006, 2007 and 2008.

 

The 2006 and 2007 reported segment information has been restrospectively adjusted in order to conform to the change in measurement of segment profit or loss in 2008. The current presentation better facilitates the review of segment results by the Company’s chief operating decision makers.

 

Our total net revenues increased from $190.4 million in 2006 to $294.3 million in 2007 and $547.5 million in 2008, or 54.6% and 86.0% growth, respectively. These increases primarily resulted from improved penetration in both our domestic and international markets and our introduction of new products. Increases in 2008 were also driven by our acquisition of Datascope’s patient monitoring device business. Between 2006 and 2008, we introduced more than 30 new products, which accounted for more than 25.0% of our 2008 net revenues.

 

On a geographic basis, net revenues generated in China increased from $97.9 million in 2006 to $145.5 million in 2007 and to $234.5 million in 2008, or 48.6% and 61.1% growth, respectively. These increases reflect increased sales generated from our new products to existing and new customers as we added products that meet customer needs, and additional sales resulting from increased government spending on healthcare in China.

 

During the period from 2006 to 2008, net revenues generated outside of China grew even faster than net revenues generated in China, increasing from $92.4 million in 2006 to $148.8 million in 2007 to $313.1 million in

2008, or 61.0% and 110.4% growth, respectively. As a percentage of total net revenues, net revenues generated outside of China increased from 48.6% in 2006 to 50.6% in 2007 and 57.2% in 2008. These increases reflect our improved penetration in international markets, with sales into more than 160 countries in 2008. The 2008 increases also reflect our acquisition of Datascope’s patient monitoring device business, which contributed to more than 30% of our net revenues generated outside of China in 2008. Revenues generated from Europe increased by $21.4 million or 65.8% from 2006 to 2007, and increased by $41.0 million or 75.9% from 2007 to 2008, while our net revenues generated in Asia, other than China, increased by $11.9 million or 43.0% from 2006 to 2007 and $16.6 million or 42.0% from 2007 to 2008.

 

Each of our business segments experienced significant net revenues growth in 2006, 2007 and 2008. Net revenues in our patient monitoring and life support products segment increased from $76.4 million in 2006 to $106.6 million in 2007 and to $243.9 million in 2008, or 39.6% and 128.9% growth, respectively. Growth from 2006 to 2007 primarily resulted from increased sales of our lower- and mid-tier patient monitoring devices and the introduction of our Beneview series patient monitoring devices and our WATO anesthesia machines. Growth from 2007 to 2008 was further impacted by our acquisition of Datascope’s patient monitoring device business and increased sales of our Beneview series patient monitoring devices and our WATO anesthesia machines. We also continued gaining market acceptance from the higher-tier market in China.

 

Net revenues in our in-vitro diagnostic products segment increased from $55.7 million in 2006 to $91.8 million in 2007 and to $137.3 million in 2008, or 64.7% and 49.6% growth, respectively. This growth primarily resulted from increased sales of our existing in-vitro diagnostic products and the introduction in 2007 of our BC-5500 hematology analyzer and our BS-200 and BS-400 chemistry analyzers.

 

Net revenues in our medical imaging systems business segment increased from $55.7 million in 2006 to $91.5 million in 2007 and to $139.0 million in 2008, or 64.3% and 51.8% growth, respectively. This growth primarily resulted from increased sales of our existing medical imaging systems and the introduction of our DC-6 ultrasound system in 2006. 2008 revenues were also boosted by the introduction of our DC-3 and portable M-5 ultrasound systems.

 

Net revenues from others increased from $2.6 million in 2006 to $4.5 million in 2007 and to $27.4 million in 2008. This growth primarily benefitted from our acquisition of Datascope’s patient monitoring device business, which had higher contribution from revenues generated by services.

 

We present revenues net of value-added tax. The value-added tax represents the amount we collect from our customers at 17% offset by the value-added tax refund pursuant to “Certain Policies to Encourage the Development of Software and Integrated Circuit Industries as New and High Technology Enterprises” at a rate of 14% of the sales value for self-developed software embedded in our devices. Such refund had been a component of our net revenues prior to 2006 and was reported on an as-accrued basis. In 2006, due to PRC regulatory changes, sales of our embedded software were temporarily disqualified for the value-added tax refund, and such refund has not included in our net revenues for 2006 and 2007. In July 2008, pursuant to Cai Shui [2008] No. 92 jointly issued by the PRC government’s Ministry of Finance and the State Administration of Taxation, we are able to receive value-added tax refund for sales of our embedded software on a retroactive basis. As we did not have prior experience in claiming the value-added tax refund under Cai Shui [2008] No. 92, the refund relating to sales of our embedded software from January 2006 to July 2008 were only included in our net revenues when the refund claims have been approved by the PRC State Administration of Taxation in 2008. The refund relating to the sales of our embedded software for the period from August 2008 to December 2008, which was approved by the PRC State Administration of Taxation in the first quarter 2009, will be included in our net revenue in 2009. We anticipate the approval and receipt of such tax refund will continue going forward, hence we will recognize refund due from sales of our embedded software in 2009 on an as-accrued basis in our 2009 net revenue. Based on current PRC regulations, such refund will be available until the end of 2010. The PRC government may or may not choose to renew such policy.

 

Cost of Revenues

 

Total cost of revenues as a percentage of total net revenues was 45.4%, 45.1% and 45.8% in 2006, 2007 and 2008, respectively. This stability is attributable primarily to natural price erosion being offset by savings on raw materials and components and improved manufacturing efficiencies. In 2008, cost of revenues as a percentage of

total net revenues was negatively affected by the acquisition of Datascope’s patient monitoring device business, which has higher overall cost of revenues compared to our historical business. Total cost of revenues increased from $86.4 million in 2006 and to $132.8 million in 2007 and to $250.6 million in 2008, or 53.7% and 88.7% growth, respectively. These increases were primarily due to increased sales volumes.

 

• Patient monitoring and life support devices

 

Cost of revenues as a percentage of total net revenues remained stable at 41.5% from 2006 to 2007, and increased to 48.0% in 2008. From 2006 to 2007, savings on raw materials and components were offset by natural price erosion. In 2008, increase in cost of revenues as a percentage of net revenues mainly resulted from the acquisition of Datascope’s patient monitoring device business, which has a higher overall cost of revenues compared to our historical business. In particular, there was a $4.3 million provision for inventory obsolescence recorded in 2008 as a result of change in market conditions and estimates of forecasted net revenue levels.

 

• In-vitro diagnostic products

 

Cost of revenues as a percentage of total net revenues increased from 45.3% in 2006 to 48.3% in 2007 and decreased to 44.5% in 2008. The increase from 2006 to 2007 primarily resulted from a higher proportion of tender business in 2007, which in general has lower selling prices compared to our non-tender business. The decrease from 2007 to 2008 was mainly attributable to higher volumes of reagent sales, which have lower overall cost of revenues compared to equipment sales.

 

• Medical imaging systems

 

Cost of revenues as a percentage of total net revenues decreased from 44.8% in 2006 to 39.5% in 2007 and 34.6% in 2008. The reduction in cost of revenues as a percentage of net revenue was primarily driven by savings on components due to increasing percentage of in-house manufacturing of probes.

 

Gross Profit and Gross Margin

 

Total gross profit increased from $104.0 million in 2006 to $161.5 million in 2007 and to $297.0 million in 2008, or 55.3% and 83.8% annual growth, respectively. Our consolidated gross margin was 54.6% in 2006, 54.9% in 2007 and 54.2% in 2008.

 

Operating Expenses

 

Our operating expenses primarily consist of selling expenses, general and administrative expenses, research and development expenses and expense of in-progress research and development. Operating expense, as a percentage of total net revenue, decreased from 30.9% in 2006 to 27.7% in 2007, and increased to 32.8% in 2008. The increase from 2007 to 2008 was primarily attributable to the overall higher costs resulting from our acquisition of Datascope’s patient monitoring device business, and operating our business with localized staff and in more developed countries, particularly those areas where we maintain a direct sales force. Our operating expenses increased from $58.9 million in 2006 to $81.5 million in 2007 and to $179.4 million in 2008, or 38.4% and 120.1% growth, respectively.

 

Selling Expenses

 

Our selling expenses, as a percentage of total net revenues, remained constant at 14.0% in 2006 and 2007, and increased to 14.6% in 2008. Our selling expenses increased from $26.6 million in 2006 to $41.1 million in 2007 and to $80.1 million in 2008. The increases as a percentage of total net revenues from 2006 to 2008 were primarily attributable to the following:

 

 

 

which were largely offset by improved operating leverage in our selling structure in China as we continue to create and improve economies of scale in this area.

 

General and Administrative Expenses

 

Our general and administrative expenses increased from $9.5 million in 2006 to $12.0 million in 2007 and to $40.8 million in 2008. The increase in general and administrative expenses between 2006 and 2008 was attributable to an increase in salaries and depreciation expense.

 

Our general and administrative expenses, as a percentage of total net revenues, decreased from 5.0% in 2006 to 4.1% in 2007, and then increased to 7.5% in 2008. The increase in 2008 was primarily attributable amortization expenses of intangibles as a result of the acquisition of Datascope’s patient monitoring device business, which contributed to approximately 40% of our general and administrative expenses in 2008, and overall higher general and administrative costs in more developed countries, particularly the United States.

 

Research and Development Expenses

 

Our research and development expenses, as a percentage of total net revenues, were 9.8% in 2006, 9.6% in 2007, and 9.5% in 2008. Our research and development expenses increased from $18.7 million in 2006 to $28.4 million in 2007 and to $51.9 million in 2008. Research and development headcount and salary increases accounted for 47.2% of the increase in 2006, 58.9% of the increase in 2007, and 57.0% of the increase in 2008 as we built capacity for our new R&D facility in Shenzhen and as a result of the Datascope acquisition, which contributed to 13.5% of our research and development expenses in 2008.

 

Expense of In-Progress Research and Development

 

In 2006, we incurred a charge related to acquired intangible assets of $4.3 million (including a $4.0 million charge for in-progress R&D and $0.3 million in amortization of other acquired intangible assets included as part of selling expenses) which was recorded in connection with our acquisition of minority interests in our operating subsidiary, Shenzhen Mindray, in April 2006. In 2008, we incurred a charge related to the Datascope acquisition of $6.6 million.

 

Other Income (Expense)

 

We had other income of $0.8 million in 2006, $2.4 million in 2007 and $4.9 million in 2008. A majority of other income in 2006 and 2007 was related to government subsidies and exchange rate gain. $2.7 million of our other income in 2008 came from a non-recurring manufacturing fee as provided for in the transitional services agreement related to our acquisition of Datascope’s patient monitoring device business.

 

Our interest expense increased from $0.1 million in 2006 and $0.0 million in 2007 to $5.2 million in 2008. This increase was primarily attributable to interest on financing obtained for the acquisition of Datascope’s patient monitoring device business and interest on our working capital facilities. See Item 5.B, “Liquidity and Capital Resources.”

 

Provision for Income Taxes

 

Provision for income taxes increased from $3.0 million in 2006 to $14.0 million in 2007 and $16.9 million in 2008. Due to various special tax rates, tax holidays and incentives that have been granted to us in China, our income taxes have been relatively low. The additional income tax that would have otherwise been payable without the

various special tax rates, tax holidays and incentives in China would have been $3.9 million in 2006 and $Nil in 2007 and 2008.

 

Our overall effective tax rate was 6.1% in 2006, 15.2% in 2007 and 13.5% in 2008.

 

Minority Interests

 

Minority interests were $0.8 million in 2006, $Nil in 2007 and $Nil in 2008. In April 2006, we acquired substantially all minority interests.

 

Net Income

 

As a result of the foregoing, net income increased from $45.5 million in 2006 to $78.0 million in 2007 and $108.7 in 2008, while net margin increased from 23.9% in 2006 to 26.5% in 2007, and decreased to 19.9% in 2008.

 

Critical Accounting Policies

 

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

 

Allowance for Doubtful Accounts

 

We generally require domestic customers to make a deposit prior to shipment and we generally require that our international customers pre-pay for their products in cash or with letters of credit. However, from time to time we extend credit to domestic customers in the normal course of business and we extend credit to most of our direct customers and select qualified distributors in North America and Europe. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance is determined by (1) analyzing specific customer accounts that have known or potential collection issues and (2) applying historical loss rates to the aging of the remaining accounts receivable balances. The allowance for doubtful accounts was $0.7 million in 2006, $1.1 million in 2007 and $3.9 million in 2008. Additional allowances may be required as we extend additional credit to domestic distributors and a qualified international direct customers and distributors in North America and Europe, if we change our credit policies as our customer base expands and further diversifies, or if the financial condition of our customers deteriorates.

 

Write Down of Inventories

 

We value inventories, which include material, labor and manufacturing overhead, at the lower of cost or market using the standard cost basis that approximates the first-in-first-out method. Management evaluates inventory from time to time for obsolete or slow-moving inventory and we base our provisions on our estimates of forecasted net revenue levels, economic market conditions and quantity on hand. A significant change in the timing or level of demand for our products as compared to forecasted amounts may result in recording additional provisions for obsolete or slow-moving inventory. We record such adjustments to cost of sales in the period the condition exists.

 

Warranty Provision

 

We record a warranty provision at the time product revenue is recorded on a historical rate and review the provision during the year and if necessary, adjust the provision to reflect new product offerings or changes in experience. Actual warranty claims are tracked by product line.

Impairment of assets

 

We review our long-lived assets and finite-lived intangible assets for potential impairment in circumstances that the carrying amount of the assets may not be recoverable. If the sum of the projected undiscounted cash flows is less than the carrying amount of the assets, the carrying value is reduced to the estimated fair value as measured by the discounted cash flows. We have not experienced any events or changes that would indicate that the carrying amounts of any of our assets may not be recoverable.

 

Provisions for Income Taxes

 

We record liabilities for probable income tax assessments based on our estimate of potential tax related exposures. Recording of these assessments requires significant judgment as uncertainties often exist in respect to new laws, new interpretations of existing laws and rulings by taxing authorities. Differences between actual results and our assumptions are recorded in the period they become known. Although we have recorded all probable income tax accruals in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Tax, and SFAS No. 109, Accounting for Income Taxes, our accruals represent accounting estimates that are subject to the inherent uncertainties associated with the tax audit process, and therefore include certain contingencies. We believe that any potential tax assessments from the various tax authorities that are not covered by our income tax provision will not have a material adverse impact on our consolidated financial position or cash flows. However, they may be material to our consolidated earnings of a future period. Our overall effective tax rate was 6.1% in 2006, 15.2% in 2007 and 13.5% in 2008.

 

Revenue Recognition

 

We generate revenue from sale of medical devices. The medical devices that we sell include a software element that is essential to the functionality of the medical devices as a whole. However, since the sales arrangements do not require significant production, modification or customization of the software, revenues from the sale of medical devices are recognized when all of the following conditions have been satisfied:

 

 

All sales are based on firm customer orders with fixed terms and conditions. We do not provide our customers with the right of return, price protection or cash rebates. The sales arrangements do not include any significant post customer support services and do not provide customers with upgrades. Accordingly, revenue from the sale of products is typically recognized upon shipment, when the terms are free-on-board shipping point, or upon delivery.

 

We offer sales incentives to certain customers in the form of free products if they meet a certain level of items purchased. The costs of these sales incentives are estimated and accrued as a cost of revenues with a corresponding current liability at the time of revenue recognition based on our past experience and our customers’ purchase history, which involves significant judgement by management.

 

We present revenues net of value-added tax (“VAT”). The VAT represents a 17% tax collected from customers on behalf of the tax authority, which amounts to $16,924, $24,809 and $37,144 for 2006, 2007 and 2008, respectively, offset by a 14% VAT refund that we are entitled to for sales of products with embedded self-development software. In 2006, a change in PRC regulations around the VAT and our self-developed software specified that we no longer qualified for the 14% VAT refund. In July 2008, the PRC tax authority issued a new tax notice which had retroactive effect from year 2006 and further clarified and redefined the embedded software sales eligible for the VAT refund. Given lack of experience in collecting the VAT refund under the new tax notice, we determined to record the VAT refund only when approved. In September 2008, we received tax notices from the Shenzhen tax bureau approving an aggregate of $21,816 of VAT refund for our software sales for the periods from January 1, 2006 to July 31, 2008. Accordingly, the amount of the VAT refund included in revenues was $97, $Nil and $21,816 for the years ended December 31, 2006, 2007 and 2008, respectively.

Valuation of Share-Based Compensation

 

For option grants, we utilize the Black-Scholes option-pricing model to determine the fair value of the options. This approach requires us to make assumptions on variables such as share price volatility, expected terms of options and discount rates. Our share-based compensation arrangement includes a performance condition that affects vesting. We estimate the probability of the employees meeting the performance condition that affect the vesting amount. Changes in these assumptions and our estimates of the probability could significantly affect the amount of employee share-based compensation expense we recognize in our consolidated financial statements.

 

 

Overview

 

We anticipate that we will continue to generate operating cash flow sufficient to fund our cash needs and operations and make payments on any existing liabilities. We believe we have adequate liquidity reasonably available to meet the requirements of our currently anticipated circumstances and do not anticipate that we will need to utilize non-operational sources of cash such as debt or equity financing to meet our current cash needs.

 

 

Operating Activities

 

Net cash generated from operating activities decreased slightly to $92.9 million in 2008 from $93.4 million in 2007. This decrease was mainly attributable to increases in accounts receivable and value added tax receivables, offset by several factors, including (i) the substantial increase in net income to $108.7 million in 2008 compared to $78.0 million in 2007; and (ii) the increase in add-back of non-cash expenses, mainly consisting of depreciation and amortization, provision of inventory and in-progress research and development.

 

Our inventory balances as of December 31, 2007 and 2008 were $24.8 million and $57.5 million, respectively. Our number of inventory days, which we define as the average inventory balances during the period divided by cost of revenues and multiplied by the number of days in the period, increased from 55 days in 2007 to 60 days in 2008. This is due primarily to our acquisition of Datascope’s patient monitoring device business, which maintains higher inventory levels than our historical business. We are actively looking at ways to manage inventory days between 60 and 70. As of December 31, 2007 and 2008, the accounts receivable increased to $28.8 million and $89.7 million, respectively, compared to the prior year. Average accounts receivable days increased from 26 days in 2007 to 40 days in 2008. The increase primarily resulted from our growth in net revenues from expansion of international sales, because of our international distributors receiving longer average payment terms and in some cases paying by letter of credit, our increased volume of tender sales and the increasing frequency with which our international distributors seek to obtain export insurance, which can take a full week or longer. We anticipate that average accounts receivable days will increase as we extend credit to a limited number of qualified distributors in Europe and North America.

 

Our accounts payable as of December 31, 2007 and 2008 were $18.2 million and $29.0 million, respectively. Our average number of days of accounts payable at December 31, 2007 and 2008 were 59 and 46 days, respectively.

 

Investing Activities

 

Investing activities primarily include an acquisition, restricted cash, third party loans and purchases of property, plant and equipment. Net cash used in investing activities was $118.8 million and $335.0 million in 2007 and 2008, respectively. The acquisition of Datascope’s patient monitoring device business accounted for $211.2 million of this increase. Restricted cash increased from $Nil in 2007 to $117.5 million in 2008, relating to collateral for loans related to our acquisition of Datascope’s patient monitoring device business. See “— Financing Activities.” In

addition, purchases of and advances for property, plant and equipment and land use rights increased $23.2 million in 2008 compared to 2007. These purchases were primarily made in connection with the expansion and upgrade of our research and development and manufacturing facilities. See note 8 to our consolidated financial statements included elsewhere in this annual report. Increases in net cash used in investing activities were offset by a decrease in investments of $58.5 million in 2008 compared to 2007.

 

Financing Activities

 

Cash used in financing activities typically consists primarily of dividend payments, which totaled $15.9 million and $19.3 million in 2007 and 2008, respectively, and proceeds from option exercises, which totaled $9.1 million and $6.2 million in 2007 and 2008, respectively. Proceeds from bank loans relating to the acquisition of Datascope’s patient monitoring device business accounted for $155.3 million of net cash generated from financing activities in 2008.

 

We maintain working capital facilities with various banks in the PRC. As of December 31, 2008, we had applied $7.4 million of our credit facilities towards issuance of letters of credit used as payments to our suppliers and also as security deposits when we bid in government tenders. These activities are reflected on our balance sheet as “Notes payable.” As of December 31, 2008, the total borrowing capacity under these working capital facilities was $87.9 million, of which $80.5 million was available. In June 2008, we additionally entered into a one-year revolving working capital facility for an amount of $25.0 million to finance our working capital requirements. As of December 31, 2008, the outstanding balance was $15.1 million and was recorded on our balance sheet as “short-term bank loans.”

 

In connection with the acquisition of Datascope’s patient monitoring device business we also entered into a loan agreement with Bank of China for approximately $141.4 million, payable in three installments in May, August and November 2009, respectively. See “Item 10.C — Material Contracts.”

 

Pursuant to relevant PRC laws and regulations applicable to our subsidiaries in the PRC, these subsidiaries are required to make appropriations from net income as determined in accordance with PRC GAAP to non-distributable reserves (also referred to as “statutory common reserves”), which included a statutory surplus reserve and a statutory welfare reserve as of December 31, 2005. Based on newly revised PRC Company law which took effect on January 1, 2006, the PRC subsidiaries are no longer required to make appropriations to the statutory welfare reserve but appropriations to the statutory surplus reserve are still required to be made at 10% of the profit after tax as determined under PRC GAAP until the balance of such reserve fund reaches 50% of the subsidiaries’ registered capital. Shenzhen Mindray’s registered capital is RMB350.0 million.

 

The statutory surplus reserve is used to offset future extraordinary losses. Our subsidiaries may, upon a resolution passed by the shareholders, convert the statutory surplus reserve into capital. The statutory welfare reserve was used for the collective welfare of the employees of subsidiaries. These reserves represent appropriations of retained earnings determined according to PRC law and may not be distributed. There were no appropriations to reserves other than to those of our subsidiaries in the PRC during any of the periods presented. However, as a result of these laws, approximately $22.0 million of our retained earnings was not available for distribution as of December 31, 2008.

 

We believe that our current levels of cash and cash equivalents and cash flows from operations will be sufficient to meet our anticipated cash needs until at least June 2010. In June, September and November 2009, we are required to make three payments of approximately $47.0 million each on the acquisition financing loan from Bank of China. We are able to make all of these payments out of restricted cash funds and deposited as collateral for the loan and cash. Paying through a dividend of these funds out of China would reduce the amount payable on the loan as well as the corresponding collateral held on deposit as restricted cash, but some of the funds paid as dividends may be subject to a 5% dividend withholding tax in China. Alternatively, our board of directors and management will consider our other financing options for making this payment, including but not limited to refinancing the debt and using then-existing cash and cash equivalents.

 

We may require additional cash resources if we wish to pursue opportunities for investment, acquisition, strategic cooperation or other similar action. If we determine that our cash requirements exceed our amounts of cash

and cash equivalents on hand, we may seek to issue debt or equity securities or obtain a credit facility. Any issuance of equity securities would cause shareholder dilution. Any incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and finance covenants. It is possible that, when we need additional cash resources, financing will only be available to us in amounts or on terms that would not be acceptable to us or financing will not be available at all.

 

Capital Expenditures

 

Our capital expenditures totaled $47.9 million and $71.1 million in 2007 and 2008, respectively. Our capital expenditures consisted primarily of the purchases of and advances for property, plant and equipment and land use rights. In 2009, we anticipate spending between $40.0 million and $60.0 million on capital expenditures for normal maintenance and completion of our research and development center adjacent to our headquarters in Shenzhen. We expect to use existing cash and cash generated from operating activities to fund our planned capital expenditures.

 

 

Our success to date has in part resulted from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at competitive prices within a relatively short period of time. Between 2006 and 2008, our spending on research and development has remained relatively steady at approximately 10% of net revenues. We believe our current spending level, as a percentage of net revenues, is comparable to many of our international competitors and greater than most of our domestic competitors. As of December 31, 2008, our research and development team consisted of more than 1,400 engineers, representing more than one-fourth of our employees worldwide, and we expect to have more than 1,500 engineers on staff by the end of 2009.

 

As the average cost of a research and development engineer in China is significantly lower than in the United States or Western Europe, we have been able to build a research and development team that we believe is much larger, as a percentage of total employees, than most of our international competitors, and the largest of any domestic manufacturer of medical devices in China. Due to our strong brand reputation we have been able to recruit a strong research and development team.

 

We employ project selection procedures that focus on projects that we believe are commercially feasible, can generate significant revenue and can be introduced into the market in the near-term. We seek to develop only those products that we believe can provide us with an average gross margin of at least 50% over their life cycles. Prior to developing a product improvement or new product, we consult with our sales and service representatives and review end-user feedback to assist us in better identifying the changing needs and demands of medical service providers. We also engage outside consultants to assist us in identifying trends in the medical device market. We believe this increases the likelihood of developing commercially viable products. Once we identify a product opportunity, our sales and service, research and development, and manufacturing teams work closely together to determine potential market demand for a product and how it fits with our current design and manufacturing capabilities. We organize regular meetings in which our sales and service, research and development, and manufacturing teams review progress and, if necessary, adjust the emphases of our research and development projects.

 

If we deem a new product to be commercially feasible, our research and development team will work closely with our manufacturing team to move production forward. This integrated approach allows us to identify potential difficulties in commercializing our product or product improvement. Furthermore, it also enables us to make adjustments as necessary and develop cost-efficient manufacturing processes prior to mass production. We believe these abilities can significantly shorten the time it takes to launch a commercialized product. In the last three years, we have developed and brought to market more than 30 new products that appeal to a wide range of end-users.

 

In addition to new product development and improvements to existing products, our research and development team focuses on manufacturing and assembly process improvements to control and improve costs.

 

We maintain a research and development center in Beijing, which we operate through our subsidiary Beijing Mindray. The location of our research and development center in Beijing allows us to compete for skilled research and development technicians and managers who would otherwise be unavailable in our Shenzhen research and

development facilities. We also maintain a research and development office in Seattle, Washington to focus on more advanced medical device technologies, and as a result of the acquisition of Datascope’s patient monitoring device business, maintain research and development facilities in New Jersey and Sweden. We are further expanding our research and development capabilities by developing an additional research and development facility in Nanjing.

 

 

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, 2006 to December 31, 2008 that are reasonably likely to have a material adverse effect on our 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.

 

 

We do not have any outstanding off-balance sheet guarantees, interest rate swap transactions or foreign currency foreign contracts. We do not engage in trading activities involving non-exchange traded contracts. In our ongoing business, we do not enter into transactions involving, or otherwise form relationships with, unconsolidated entities or financials partnerships that are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

 

A summary of our contractual obligations at December 31, 2008 is as follows:

 

 

 

 

Pursuant to an agreement with the Government of the Nanjing Jiangning Development Zone, we intend to invest up to US$150 million over three and one-half years to build a research and development and manufacturing facility in Nanjing.

 

 

The following table sets forth certain information relating to our directors and executive officers as of May 8, 2009:

 

 

 

 

Xu Hang has served as the chairman of our board of directors and co-chief executive officer since 1991. Mr. Xu is one of our founders and the core managerial personnel of our company. Mr. Xu is responsible for strategic planning and business development. Mr. Xu received a bachelor’s degree from Tsinghua University Department of Computer Science and Technology, a master’s degree in biomedical engineering from Tsinghua University Department of Electrical Engineering and an EMBA degree from China-Europe International Business School. He currently serves as independent director for Wiscom System Co. Ltd., a company listed on the Shenzhen Stock Exchange.

 

Li Xiting has served as our director, president and co-chief executive officer since 1991. Mr. Li is one of our founders and the core managerial personnel of our business. Mr. Li is responsible for our business operations and management. Mr. Li received a bachelor’s degree from University of Science and Technology of China.

 

Joyce I-Yin Hsu has served as our chief financial officer from February 2006 to May 2009 and as our director since 2006. From 2000 to February 2006, Ms. Hsu was an executive director at Goldman Sachs (Asia) L.L.C. with its Principal Investment Area. From 1998 to 2000, Ms. Hsu worked as an investment banker at Goldman Sachs where she divided her responsibilities between the equity capital markets group and corporate finance. Ms. Hsu has also served on the boards of Focus Media Holding Limited, China Yurun Food Group Limited and China Haisheng Juice Holdings Company Limited. Ms. Hsu received her B.S. degree in business administration from the University of California at Berkeley.

 

Cheng Minghe has served as our executive vice president of strategic development since 2007. Previously, Mr. Cheng served as the executive vice president of sales and marketing since 2004 and vice president of sales and marketing from 2000 to 2003. Prior to that, from 1998 to 2000, he served as a vice president for Rayto Life and Analytical Sciences Limited. From 1991 to 1998, Mr. Cheng served as vice president of our sales department. Mr. Cheng received his bachelor’s degree and master’s degree in biomedical engineering from Shanghai Jiaotong University.

Liu Jie has served as our Chief Operating Officer since August, 2008. Previously, Mr. Liu has served as executive vice president of international sales and marketing since 2007 and vice president of international sales and marketing since 2005. Prior to joining Mindray, Mr. Liu worked in sales, marketing and product management roles with Hewlett-Packard and Johnson and Johnson. He holds an MBA degree the University of Michigan, an M.S. degree from the Chinese Academy of Sciences, and a bachelors degree in Engineering from Zhejiang University.

 

David Gibson has served as president of Datascope Patient Monitoring, Mindray DS USA Inc. since May 2008. From 2005 to May 2008 Mr. Gibson was president of Datascope Corp., patient monitoring division, and from 2003 to 2004 was vice president of service and interim vice president of research and development for patient monitoring. From 1996 to 2002, he served as vice president of repair operations, and regional service manager at General Electric Systems. Prior to that Mr. Gibson served for six years as a US Navy officer on a nuclear submarine. He holds a bachelor of science degree in electrical engineering from University of Florida and a masters of business administration from Brenau University.

 

Tim Fitzpatrick has served as our general counsel since September 2006. Prior to joining our company, Mr. Fitzpatrick worked as an attorney in the United States and in Hong Kong. Mr. Fitzpatrick received his J.D. from the University of California at Los Angeles, his M.A. from the University of California at San Diego, and his B.A. from Hamilton College.

 

Ronald Ede has served as director since September 2006, our group vice president of international operations since June 2008 and shall serve as our Chief Financial Officer beginning May 9, 2009. From September 2006 to June 2008, he served as our independent director and chairman of the audit committee. From 2004 until June 2008, he served as the chief financial officer, Asia Pacific for JDSU Corp. From 2003 to 2004 he served as director of Grandfield Consultancy Ltd. From 2002 to 2003 he served as a director and consultant to Ernst & Young. From 1998 to 2002 he served as the managing director, Asia for SonoSite Inc. From 1992 to 1998 he was the director of international finance for ATL Ultrasound Inc. Mr. Ede received his bachelor of business administration degree from University of Hawaii and a master of business administration degree from the University of Washington.

 

Chen Qingtai has served as our director since 2006.  He served concurrently as chairman and chief executive officer of Dongfeng Peugeot Citroen Automobile Limited from 1985 until 1992. From 1992 to 1993, he served as deputy director of the State Council Economic and Trade Office. From 1993 to 1998, Mr. Chen served as the deputy director of the State Economic and Trade Commission. In 1997, he served as a member of First session of the Monetary Policy Committee of the People’s Bank of China. From 1998 to 2004, Mr. Chen served as deputy director of the Development Research Center of the State Council. From 2000 to 2006, he served as an independent director of Sinopec Corp. Mr. Chen received his bachelor of science degree in power and dynamics engineering from Tsinghua University. He currently serves as a standing member of National Committee of the Chinese People’s Political Consultative Conference. Mr. Chen also serves as an independent director of Bank of Communications Co., Ltd. and the dean of the School of Public Policy and Management at Tsinghua University.

 

Jixun Lin has served as our director since November 1, 2007. Mr. Lin is founder and chief executive officer of ACON Laboratories Inc., a manufacturer of rapid diagnostic test products. Dr. Lin founded ACON Laboratories Inc. in 1995 and serves on its board of directors. He also serves on the board of directors for ACEA BioSciences Inc., a company providing cell-based assay systems for basic life science research and drug discovery. Mr. Lin received his Ph.D. in microbiology and immunology from the Medical University of South Carolina and a Bachelor of Medicine from Zhejiang Medical University.

 

Peter Wan has served as our director since September 2008. Mr Wan is a Hong Kong Certified Public Accountant and a former partner of PricewaterhouseCoopers, Hong Kong and China firm. He is a fellow of the Hong Kong Institute of Certified public Accountants, the Association of Chartered Certified Accountants, UK and the Hong Kong Institute of Directors. Mr Wan is currently an independent director and the chairman of the audit committee of United Commercial Bank (China) Limited in Shanghai, PRC and China Resources Land Limited, a company listed in the Hong Kong Stock Exchange. He also serves as a director and/or committee member of a number of non-government organizations and voluntary agencies in Hong Kong. Mr Wan received the higher diploma in accountancy from Hong Kong Polytechnic in 1975.

Kern Lim has served as our director since September 2008. Mr. Lim currently serves as the vice president of finance of the Venetian Macao-Resort-Hotel, and is a Singapore certified public accountant. From 2006 to 2008 Mr. Lim was the global chief financial officer of Asimco Technologies Limited, a Cayman Islands company with operations in China. From 2003 to 2006, Mr. Lim was the chief financial officer of Eastman Kodak for the Asia Pacific region. Mr. Lim also serves as a director and chair of the audit committee of China Auto Electronics Group, a Singapore public company, and as a director and member of the audit committee of China Zaino, also a Singapore public company. Mr. Lim received his bachelor’s degree in financial and management accounting from the Nanyang Technological University in Singapore.

 

Wu Qiyao has served as our director since 2006. Mr. Wu has been a professor in Beijing Institute of Technology since 1983. Mr. Wu has served as an evaluation committee member of medical device registration of the SFDA since 1996. From 1996 to 2002, he served as a deputy director of State Medical Equipment Evaluation Expert Committee. Mr. Wu currently serves as a committee member of science and technology department of National Population and Family Planning Commission of China. He also serves as a director of Chinese Institute of Electronics, and a director of the China Instrument and Control Society. Mr. Wu received his bachelor’s degree in wireless electricity from Beijing Institute of Technology.

 

The business address of our directors and executive officers is Mindray Building, Keji 12th Road South, Hi-tech Industrial Park, Nanshan, Shenzhen, 518057, People’s Republic of China.

 

 

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 our 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.

 

Compensation of Directors and Executive Officers

 

In 2008, we paid aggregate cash compensation of approximately $1.5 million to our directors and executive officers as a group. We do not pay or set aside any amounts for pension, retirement or other benefits for our officers and directors.

 

2006 Employee Share Incentive Plan

 

Our 2006 Employee Share Incentive Plan was adopted by our board of directors at a meeting in February 2006 and was subsequently amended by our Amended and Restated 2006 Share Incentive Plan by shareholders resolution on September 1, 2006. The Amended and Restated 2006 Employee Share Incentive Plan is intended to promote our success and to increase shareholder value by providing an additional means to attract, motivate, retain and reward selected directors, officers, employees and third party consultants and advisors.

 

Under the Amended and Restated 2006 Employee Share Incentive Plan, we are limited to issuing awards exercisable for or representing in the aggregate no more than 15,000,000 Class A ordinary shares.

 

Options generally do not vest unless the grantee remains under our employment or in service with us on the given vesting date. However, in circumstances where there is a death or disability of the grantee, or, for certain option holders, a change in the control of our company, the vesting of options will be accelerated to permit immediate exercise of all options granted to a grantee.

 

Our compensation committee, which administers our option plan, has wide discretion to award options. Subject to the provisions of our option plan, our compensation committee determines who will be granted options, the type and timing of options to be granted, vesting schedules and other terms and conditions of options, including the exercise price. Any of our employees may be granted options. The number of options awarded to a person, if any, is based on the person’s potential ability to contribute to our success, the person’s position with us and other factors

chosen by our board of directors. The number of options that vest for an employee in any given year is subject to performance requirements and evaluated by our human resources department.

 

Generally, to the extent an outstanding option granted under our option plan has not vested on the date the grantee’s employment by or service with us terminates, the unvested portion of the option will terminate and become unexercisable.

 

Our board of directors may amend, alter, suspend, or terminate our option plan at any time, provided, however, that in order to increase the limit on issuable options from the current limit of options exchangeable for 15,000,000 Class A ordinary shares, our board of directors must first seek the approval of our shareholders and, if such amendment, alteration, suspension or termination would adversely affect the rights of an optionee under any option granted prior to that date, the approval of such optionee. Without further action by our board of directors, the Amended and Restated 2006 Employee Share Incentive Plan will terminate in 2016.

 

Our board of directors authorized the issuance of up to 15,000,000 Class A ordinary shares upon exercise of awards granted under our Amended and Restated 2006 Employee Share Incentive Plan. As of December 31, 2008, options to purchase 10,503,910 Class A ordinary shares were outstanding. The table below sets forth the option grants made to our directors and executive officers pursuant to the Amended and Restated 2006 Employee Share Incentive Plan as of December 31, 2008.

 

 

 

 

Employment Agreements

 

We have entered into employment agreements with some of our executive officers. We may terminate their employment for cause at any time, without notice or remuneration, for certain acts by an executive officer, including but not limited acts of personal dishonesty in connection with an executive officer’s employment by us which are intended to result in the executive officer’s substantial personal enrichment or reasonably likely to materially harm us, any conviction of a crime which our board of directors reasonably believes has had or will have a material detrimental effect on our reputation or business, willful misconduct that is materially injurious to us, or continued violations of an executive officer’s obligations to us after we have delivered a written demand for performance. An executive officer may terminate employment upon the occurrence of certain events, including but not limited to a

material reduction of or removal from his or her duties, position or responsibilities without the executive officer’s express written consent and a material reduction of the executive officer’s compensation or benefits and if we fail to cure these issues within reasonable time. Upon the occurrence of any of these events, or in the case of termination without cause, the departing executive officer will be entitled to receive a severance payment equal to one year of his or her annualized base salary. An executive officer may also terminate his or her employment for other reasons or no reason at all after providing prior written notice of at least 30 days, in which case the departing executive officer will not be entitled to receive any severance payments. We may terminate the employment of any of our executive officers without cause by giving him or her prior written notice of at least 30 days.

 

Each executive officer that has executed an employment agreement with us has agreed to hold, both during and after his employment agreement expires or is terminated, in strict confidence and not to use, except for our benefit (including our affiliated entities and our subsidiaries), any proprietary or confidential information, including technical data and trade secrets of our company or the confidential information of any third party, including our affiliated entities and our subsidiaries, that we receive. Each executive officer that has executed an employment agreement with us has also agreed to disclose to us and hold in trust for us all of the inventions, ideas, designs and trade secrets conceived of by him or her during the period that he or she is employed by us, and to assign all of his or her interests in them to us, and agreed that, while employed by us and for a period of two years after termination of his or her employment, he or she will not:

 

 

As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, medical and unemployment benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses, housing funds and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date. The contributions we made to employee benefit plans in 2006, 2007 and 2008 were $2.1 million, $3.2 million and $5.7 million, respectively.

 

 

Duties of Directors

 

Under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to our best interest. Our directors also have a duty to exercise the care, diligence and skills 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 amended and restated memorandum and articles of association. 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:

 

 

Terms of Directors and Executive Officers