Drug research and development business

HMP revenues jumped to $14.8 million in 2011 (2010: $4.1m) reflecting continued research and milestone payments from discovery collaborations with Eli Lilly and Company ("Eli Lilly") and Ortho-McNeill-Janssen Pharmaceuticals, Inc. ("J&J") and income from the global licensing deal with AstraZeneca on our small molecule targeted cancer drug, Volitinib. Consequently, net loss attributable to Chi-Med equity holders dropped 70% to $3.7 million (2010: -$12.3m).

Our global licensing deal with AstraZeneca on Volitinib, represents what we believe is the first deal of this type to progress a China discovered targeted oncology drug towards the global market. The scale of this deal is a clear validation of the discipline and capability of the HMP discovery, pharmaceutical sciences, and clinical organisations. It earned a $20 million upfront payment with up to $120 million contingent upon the successful achievement of clinical development and first sale milestones, together with significant future commercial sale milestones and up to double-digit percentage royalties on net sales. We believe this should raise confidence in the value of the balance of the HMP drug portfolio which, as at the end of 2011, included six active drug candidates in clinical trials – one successfully through Phase IIb, two nearing the end of Phase I, and three, including Volitinib, at the start of Phase I – as well as two further internal drug candidates in late-stage discovery.

Our HMP organisation is set up to support and fund research and development of our drug candidates against targets, generally proteins or enzymes, associated with the pathogenesis of cancer or inflammation. We employ a diversified portfolio approach focusing on three main areas:

• Synthetic compounds against novel targets:
  We conduct research and development of small molecule cancer drugs against highly novel targets such as c-Met. These targets present global opportunities with best-in-class or first-in-class potential and are appealing to global pharmaceutical companies with the ability to invest in targets which have not yet been validated in human trials. Our approach in this area is to partner our products at earlier development phases in order to mitigate risk while accelerating drug development globally. In addition to Volitinib, HMP's two late-stage discovery programmes fit into this area.
• Synthetic compounds against validated targets:
  Our second area of focus is the research and development of small molecule drugs against validated targets, such as Epidermal Growth Factor Receptor ("EGFR") and Vascular Endothelial Growth Factor Receptor ("VEGFR"), which already have had therapies launched on the global market, but are only approved for limited applications in China. The rationale for this approach is two-fold: 1) rapid development of such products for launch in the fast growth China market, and 2) if unique properties are identified on our drugs we would launch in global markets through partnership. HMP's EGFR inhibitors, Epitinib and Theliatinib, and VEGFR inhibitors Sulfatinib and Fruquintinib fit into this area.
• Botanical Drugs against multiple targets:
  The third area of research and development focus is botanical drug development in accordance with the US Food and Drug Administration's ("FDA") publication of guidelines for botanical drugs products in 2004. Botanical product development provides a new source of innovation for the global pharmaceutical industry with its multiple active components often acting synergistically on multiple targets. Over the past ten years, HMP, through its presence in China and global development and regulatory activities, has built unique expertise in the field of botanical drug development and has achieved clinical success with HMPL-004, our drug candidate for Inflammatory Bowel Disease ("IBD"). HMP's internal botanical component library, which contains over 1,500 purified natural products and over 50,000 extracts/fractions from over 1,200 different plants, also provides new substrates for small molecule drug discovery. HMP has worked with various global pharmaceutical partners, such as Merck Serono and Procter & Gamble, on botanical drug research using its established botanical technology platforms.

Our fully integrated discovery teams in oncology and immunology made considerable progress during 2011. We staff and resource our discovery team with the objective of producing one or two new internally discovered drug candidates per year. In 2011, the discovery team have progressed two highly novel small molecule drug candidates through to candidate selection stage, the penultimate stage in the pre-clinical process. We expect candidate selection to be completed during the first half of 2012 which will trigger execution of formal regulatory toxicity testing, which if successful will lead to IND submissions in late 2012 or early 2013. In addition to our internal discovery activities, our collaboration with J&J in inflammation is progressing as planned and we continue to look for ways to expand this very important strategic relationship.

HMP capitalises on the cost efficiencies associated with performing drug research and development in China, maintaining an approximately 180-person highly productive organisation that is progressing six clinical and multiple discovery phase programmes. HMP's average annual cash burn in the past three years, before any income to offset this, has been approximately $20 million. During late 2010, we raised $20.1 million in cash through third party venture capital investments in HMP. In 2011, driven primarily by difficulties in the biotech venture capital, private equity, and capital markets, we moved away from what we assessed would be an overly dilutive equity investment approach in HMP towards a non-dilutive fund raising approach through expanding research collaborations and drug-development partnerships. Looking ahead we will continue to adopt a pragmatic approach to financing HMP, preferring the latter approach until the progress of our clinical portfolio justifies a material increase in the value of HMP and/or biotech market sentiment improves, at which point equity investment might once again become appealing.