China - Pharmaceutical Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No: 19072 PERFORMANCE AUDIT REPORT CHINA PHARMACEUTICAL PROJECT (Loan 2943-CHA) March 23, 1999 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents (annual averages) Currency Unit = Yuan 1988 US$1.00 Yuan 3.72 1993 US$1.00 Yuan 5.76 1989 US$1.00 Yuan 3.76 1994 US$1.00 Yuan 8.62 1990 US$1.00 Yuan 4.78 1995 US$1.00 Yuan 8.35 1991 US$1.00 Yuan 5.32 1996 US$1.00 Yuan 8.31 1992 US$1.00 Yuan 5.51 1997 US$1.00 Yuan 8.29 Abbreviations and Acronyms CIB China Investment Bank FDA US Food and Drug Administration GDP Gross Domestic Product GMP Good Manufacturing Practice GOC Government of China GSP Good Shop Practice ICB International Competitive Bidding ITC International Tendering Company MCI Ministry of Chemical Industries MOF Ministry of Finance MOPH Ministry of Public Health QCC Henan Provincial Pharmaceutical Quality Control Center R&D Research and Development SOE State Owned Enterprise SPAC State Pharmaceutical Administration of China SPC State Planning Commission TCM Traditional Chinese Medicines tpd tons per day tpy tons per year WHO World Health Organization ZYPF Zhong Yuan Pharmaceuticals Factory Fiscal Year Government: January 1 - December 31 Director General, Operations Evaluation: Mr. Robert Picciotto Director, Operations Evaluation Department: Ms. Elizabeth McAllister Manager, OEDCR: Mr. Ruben Lamdany Task Manager: Mr. Farrokh Najmabadi FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.S.A. Office of the Director-General Operations Evaluation March 23, 1999 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on China: Pharmaceutical Project (Loan 2943-CHA) Attached is the Performance Audit Report (PAR) on the China Pharmaceutical Project (Loan 2943-CHA approved in FY88), prepared by the Operations Evaluations Department. This project was designed to assist the Government of China in its efforts to introduce modem technology in its pharmaceutical industry, improving and upgrading the manufacturing practices as well as quality control, and improving the efficiency and competitiveness of the industry. The project consisted of three components: (i) a large pharmaceutical manufacturing facility for the annual production of 5,000 tons of vitamin C as well as quantities of other products such as starches, dextrose, sorbitol, etc.; (ii) introduction of procedures and equipment for upgrading two demonstration plants to achieve the internationally acceptable Good Manufacturing Practice (GMP) standards of the pharmaceutical industry; and (iii) upgrading the testing capability of the Henan Pharmaceutical Quality Control Center (QCC). This project suffered from serious cost overruns during implementation. While the foreign exchange cost of the project increased by 20 percent (US$159.2 million actual versus US$130 million estimated), the cost of the project in Yuan terms escalated even more from Y888.7 million at appraisal to Y2396.7 million at completion because of devaluation of the Chinese currency and rapid inflation during implementation. The major component of the project-Zhong Yuan Pharmaceutical Factory (ZYPF) at Zhengzhou City, Henan Province, designed to produce annually 5,000 tons vitamin C-was completed with a delay of 22 months. The delay in the start up of other components ranged from 24 to 56 months. Due to problems with process design and equipment, the Zhong Yuan Pharmaceutical Factory has experienced serious difficulties in achieving sustained production at capacity. These difficulties arose from the incomplete process knowledge and the inexperience of the foreign suppliers of process design and equipment, necessitating repeated modifications to the design even during the implementation stage. They were also caused by inappropriate scaling up from pilot plant operations, and the inexperience of both the contractors' technical staff and ZYPF's operational team. By early 1996, after nearly three years of operational experience, the Zhengzhou Municipality decided to shut down the plant because of the progressive deterioration of ZYPF's financial situation, and its inability to effect the necessary modifications to the plant. The GMP demonstration plants at Shanghai and Xinhua were satisfactorily completed, though their capacities remain underutilized because of the intense competition in the domestic market. They have created considerable interest on the part of the pharmaceutical manufacturing enterprises which tend to emulate their approach. The GMP training courses were carried out in China at a number of joint venture pharmaceutical plants that received Food and Drug Administration (FDA) approval. There has also been extensive overseas training for trainers at engineering and design consultants, and at foreign companies' formulation plants. Although the Chinese pharmaceutical institutions have now developed This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. ii the necessary expertise in designing facilities to international GMP standards and inspecting facilities for GMP compliance, there has been slippage in the original GMP schedule. The Henan Pharmaceutical quality Control Center has lost some of its clients because of a relaxation in Government's regulatory mandates and as the pharmaceutical plants have increasingly assumed the responsibility of carrying out the routine analytical work for quality control. Though the project was well conceived, it did not achieve its major objective. Given the investment overruns, the production history, the accumulated losses, the state of the vitamin C market and the uncertain future of the Zhengzhou factory, it is unlikely that the project will ever show a positive economic and financial rate of return. The implementation and commissioning of this plant coincided with a period during which, with Government's encouragement, large vitamin C production capacity was created in China. The Government is now hesitant to restart the plant, thereby adding production capacity to an already glutted domestic and international market for vitamin C. Should the Government decide to proceed, there are several options: (a) to reinvest in modifications; (b) to sell the whole plant to a domestic investor through bidding; and, (c) to seek joint venture partners for the whole or a part of the plant. Major lessons from the project include: (i) borrowers and the Bank should avoid embarking on an industrial project utilizing unproven technology and a design that is based on the scaling up of a laboratory- sized pilot plant; (ii) there are high risks inherent to embarking on a greenfield and technologically complex project without ensuring that both the project management and operational teams are sufficiently skilled with long experience in the subsector; and, (iii) the need for allocation of sufficient supervisory resources by the Bank, specifically for projects that are facing serious technical and managerial problems. Contents Preface ..... .................................................... 3 Ratings and Responsibilities ........................................... 5 Abstract........................................................7 1. Introduction................................................9 The Project.................. . ..................... ....... 9 2. Implementation Experience .......................................... 11 Procurement ....................................... .............. 1 Delays ..............................1..... .................11 Project Cost................ ............................... 12 Start-Up Problems....... ............ ................. ........ 12 3. Project Results ...................... ................. 14 ZYPF Subcomponents .................................. ........ 14 Production Performance and Technical Indicators.......... ............. 14 Manpower and Training .......................................... 15 Environmental Protection .................................. 16 GMP Subcomponents ..................... .............. 16 Henan Quality Control Center Subcomponent ..................... 17 4. Overall Assessment .................................... ....... 18 Process Design and Operational Experiences........................... 18 Management Capability and Institutional Developement .................... 18 Cost Structure and Profitability ................................. 19 Outcome and Sustainability............................. ..............20 Bank/Borrower Performance ................................ .....20 5. Current Situation and Major Issues ...................... ........... 21 6. Conclusion and Lessons Learned .................................23 Tables 3. 1: ZYPF Average Process Yield.................................. 15 5. 1: Repayment of Bank loan for ZYPF ............................. 21 This report was prepared by Farrokh Najmabadi, Task Manager, who audited the project in July 1998. Brigitte Wittel and Betty Casely-Hayford provided administrative support. Annex A. Basic Data Sheets....... ......... ................. ......... 25 B. China Pharmaceutical Project, ZYPF: Process Diagram for Manufacturing of Vitamin C.................. .................... .......... 28 C. Project Dates........................ .............. 29 D. Project Costs .................................................. 30 E. ZYPF - Production Performance, Tons per Year....................... 31 ZYPF - Periods of Highest Capacity Utilization.......................32 F. ZYPF - Training Programs ............................. ........ 33 G. China Pharmaceutical Project - Henan Quality Control Center.....................34 H. China - Production and Export of Vitamin C......................... 35 I. ZYPF - Analysis of Product Costs and Prices.............................36 J. ZYPF - Income Statement ................................ .....37 K. ZYPF - Balance Sheet................ ................. .....38 L. Shanghai No.4 Pharmaceutical Company - Income Statement ..... ......... 39 M. Status of Legal Covenants................................. .....40 N. China - Trend of Average Prices for Corn, Vitamin C, and Other Products..........41 0. Comments from the State Economic and Trade Commission......... ..... 42 3 Preface 1. This is the Performance Audit Report (PAR) for the Pharmaceutical Project in China for which the Bank approved a US$127.0 million loan in May 1988. The loan was closed on December 31, 1994, one year later than originally anticipated. Final disbursement took place in May 1995, at which time a balance of US$0.344 million was canceled. 2. The PAR was prepared by the Operations Evaluation Department (OED). An OED mission visited China in June/July 1998 and discussed the effectiveness of the Bank's assistance with representatives of the Government of China, Henan Provincial Authorities, Zhengzhou Municipality, Zhong Yuan Pharmaceutical Factory, Henan Pharmaceutical Quality Control Center, and Shanghai No.4 Pharmaceutical Plant. Their kind cooperation and assistance is greatly appreciated and acknowledged. 3. The ICR was prepared by the Industry and Energy Division, China and Mongolia Department, East Asia and Pacific Region Office. The Borrower and the implementing agencies provided Part II. The PAR complement the ICR by providing a fuller account of the achievements, problems and further steps that are needed to revive and ensure the sustainability of this ill-fated project. 4. The PAR reflects the comments received from the State Economic and Trade Commission of People's Republic of China. These comments are also reproduced as Annex 0. The Region agrees with the PAR's findings.  5 Ratings and Responsibilities Performance Ratings Pharmaceutical Project (Loan 2943-CHA) Outcome Unsatisfactory Sustainability Unlikely Institutional Development Impact Modest Bank Performance Unsatisfactory Borrower Performance Unsatisfactory Key Project Responsibilities TM Division Chief Director Appraisal D.A. Caplin Nicholas Hope Shahid Javed Burki Completion R. Heath Jane Loos Nicholas Hope ICR was prepared by: R. Heath  7 Abstract Since the early 1950s, China's reliance on Western synthesized medicine has been on the rise. While all pharmaceuticals on the World Health Organization (WHO) list of 200 essential drugs were being produced in China by the mid-1980s, the manufacturing technologies were becoming increasingly out of date and inefficient, affecting quality and competitiveness. This project was designed to assist the government of China to achieve its objections through the expansion ofproduction using modern technologies and the introduction of Good Manufacturing Practice (GMP) for quality and management enhancement in the pharmaceutical industry. Unfortunately, a combination offactors including the selection of second rate process engineering contractors, supply of key equipment and technologies from different countries, failure to match western and Chinese technologies, non-performance of suppliers in meeting required specifications, and weak and unskilled construction management and operational teams led to the unsuccessful commissioning of the 5,000 ton capacity Vitamin C plant at Zhengzhou and its eventual shut down in January 1996. The project had more success with the institutional development associated with the GMP. The Chinese pharmaceutical institutions have now developed the necessary expertise in designing facilities to international GMP standards and inspecting facilities for GMP compliance. The two pilot projects for GMP, however, are operating well below capacity because of the intense competition in the domestic market.  9 1. Introduction 1.1 Since the reforms of 1978, the Chinese Authorities have adopted an industrial development strategy that emphasizes the introduction of up-to-date technology in order to enhance quality of industrial products while economizing on the use of raw materials and energy. In addition, China has been following a two track approach of opening the economy for the rapid growth of the nonstate enterprises while prodding the State Owned Enterprises (SOEs) towards higher productivity by exposing them to market forces. 1.2 By the mid-1980s, the Chinese pharmaceutical industry was producing some 60,000 tons of 1400 bulk active substances of which about 55-60% was being processed into 4000 pharmaceutical formulations, primarily for the domestic market. While all the pharmaceuticals on the World Health Organization's (WHO) list of 200 essential drugs (including Vitamin C as a nutritional supplement) were being produced in China, the technology with which those drugs were manufactured was becoming increasingly out-of-date and inefficient, affecting competitiveness, not only from the points of view of costs and yields, but also that of quality. This situation, combined with a sizable increase in life expectancy and the rising proportion of older people in the population, created the need for considerable investment in the acquisition and implementation of new technology in the pharmaceutical industry. 1.3 To promote public health, the Government of China (GOC) relies on both the Traditional Chinese Medicines (TCMs) and western synthesized medicines. In the mid-1980s, the Government's broad objectives for western medicines consisted of: (a) raising quality; (b) expanding and diversifying supply to meet changing demand; (c) improving research and development capacity; and (d) increasing export potential. In addition to encouraging the acquisition of foreign technologies and expertise through international contacts, imports of modern technologies and joint ventures with foreign firms, the Government also embarked on a program of introducing the Good Manufacturing Practice (GMP) to the pharmaceutical industry through an ambitious plan for retrofitting a large number of plants and closing down plants which did not meet the viability test. The Project 1.4 The project was designed to assist the Government of China to achieve its objectives in the pharmaceutical subsector through the expansion of pharmaceutical production using modern technologies, the introduction of improvements in the quality of pharmaceutical products and the manufacturing practices and improvements in the quality of training in plant operations, maintenance, manufacturing, management and GMP in the pharmaceutical industry. 1.5 The project comprised three components: (a) construction of a new and large Vitamin C plant at Zhong Yuan ( a suburb of the City of Zhengzhou in the Province of Henan) using 150,000 tons of corn as a feedstock to produce 41,750 tons of starch, 25,000 tons of dextrose, 20,450 tons of Sorbitol (50% solution) and 5000 tons of Vitamin C together with a range of by- 10 products such as corn oil and gluten meal and feed'; (b) provision of advanced analytical equipment for the Henan Provincial Pharmaceutical Quality Control Center (QCC); and (c) implementing investments, procedures and training for the adoption of GMP in two demonstration factories at Xin Hua and Shanghai. In parallel with the project, a training program was undertaken by the State Pharmaceutical Administration of China (SPAC) for the training of staff from SPAC, design institutes and enterprises in the techniques and methodology of GMP so that they would be able to effectively disseminate GMP practices. This training program was to be funded from other sources and monitored by the Bank. 'PAR uses production figures as reflected in the SAR. The Chinese State Economic and Trade Commission maintains the starch and Sorbitol producing capacities to be 43000 tons per year and 15000 tons per year (70% solution), respectively (See Annex 0 - letter from State Economic and Trade Commission of People's Republic of China). 11 2. Implementation Experience Procurement 2.1 Given the complexity of the procesS2, the process units were procured as packages with the suppliers responsible for design, engineering, equipment and material supply, assistance in construction supervision, training, commissioning and start-up. Because the Chinese already possessed their own technology for the production of ketogulonic acid (KGA) from Sorbitol (Annex B) and many such units were in operation in China, this package together with the KGA Recovery and Purification unit was initially selected to be supplied domestically. However, it was later decided to award the KGA Recovery and Purification package contract to the supplier of the Vitamin C plant. Delays 2.2 Although the project was well prepared and the Borrower displayed a high degree of commitment, project implementation encountered enormous difficulties with considerable delays. The delays ranged from 22 month in the case of Zhong Yuan Pharmaceutical Factory (ZYPF) to 56 months for the Shanghai No. 4 Pharmaceutical Plant (Annex C). Overall, the construction phase did not proceed smoothly. To forestall the construction difficulties associated with a greenfield plant of such complexity, the Henan Provincial Authorities and the State Pharmaceutical Administration of China (SPAC) persuaded the Ministry of Chemical Industry (MCI) to assign one of its most experienced construction companies for the construction of ZYPF facilities. Detailed engineering design interface was provided by the Shanghai Pharmaceutical Design Institute. Despite such precautions, the mechanical completion of the Starch and Dextrose plants was delayed because of late supply of key equipment by the contractor. This, in turn, caused a hiatus and impacted the construction of the KGA and Vitamin C facilities which were already being affected by the delayed supply of equipment including those subcontracted to Yugoslav suppliers who declared force majeure on account of the break-up of Yugoslavia. 2.3 For a variety of reasons, none of the other subcomponents were completed on time. Once the GMP audit was completed by expatriate GMP specialists, the need for the relocation of the Shanghai No.4 Pharmaceutical Factory expansion to a new site caused a lengthy delay and the new lines for the production of capsules and powder for injection (in vials) did not come on stream until December 1996. At Xinhua Pharmaceutical Factory, the trial runs for the new GMP facilities were carried out in April 1994. Later inspection of the plant by GMP specialists indicated that the GMP facilities at both locations meet the United States Federal Drug Administration (FDA) GMP regulations. The Henan Provincial Pharmaceutical QCC subcomponent was completed with 27 month of delay and the new analytical equipment was installed at the Center by October 1991. 2 The process requires the sequential manufacturing of a number of inter-mediate products (some of which are also sold as final products) as follows: corn to starch; starch to dextrose; dextrose to sorbitol; sorbitol to ketogulonic acid (KGA); and KGA to Vitamin C (ascorbic acid). 12 Project Cost 2.4 The total cost of the project increased by 170% from the appraised estimate of 888.7 million yuan to the actual of 2396.7 million yuan. All subcomponents of the project were completed with cost overruns, though ZYPF alone accounted for nearly 93% of the total (Annex D). These cost increases were caused by: a) the high domestic inflation rate; b) the steep depreciation of the local currency during construction; and c) the increased cost of imported equipment and the accrued interest. In dollar terms, while the foreign exchange costs of GMP subcomponents and the Henan Quality Control Center remained within the appraisal estimates, those of the ZYPF subcomponent rose from US$117.5 million at appraisal to US$148 million at completion. Start-up Problems 2.5 Despite the intense interest initially shown by the internationally well-known contractors, particularly for the Wet Corn Milling/Starch and Dextrose plants, only few participated in the bidding. The contract for the Starch and Dextrose plants was awarded to the lowest bidder that had far less of a track record than the industry leaders. As a result, the design of the plants proved to be very deficient and more than forty modifications had to be introduced up to and even during the trial runs. The contractor was not only very slow in solving the problems which delayed the production of intermediates for the other process units, it also reportedly withdrew its technical staff at the expiration of the contract when many problems remained unsolved and no performance tests has been carried out. 2.6 The KGA Recovery/Purification and the Vitamin C plants met a similar fate. Despite the claims made by the contractor, its technology had only reportedly been tested in laboratory and the plants installed at Zhong Yuan were the first scaled up units based on that technology. Since this contract expired in mid-1992, ZYPF entered into three service agreements with the contractor in order to ensure the start-up and commissioning phases of the project. During trial production of Vitamin C which started in November 1992, serious process and mechanical problems were experienced in both the KGA Recovery/Purification and Vitamin C plants. Although the former unit could produce products to specification, it could not operate continuously because of blockages in the system, thus reducing the KGA recovery. The latter unit could also not be operated continuously because decomposition during the processing resulted in high impurity levels and off specification final product.4 2.6 Throughout 1993 several unsuccessful attempts were made to modify the process parameters. Actual production of Vitamin C, however, remained at a fraction of the design value. In the meantime the contracting company went into bankruptcy and was absorbed by a 3 In fact, at the time of their departure, part of the Dextrose plant which was designed to produce anhydrous dextrose was not even commissioned and the other units had not reached the design capacities. 4 The contractor claimed that the output from the Chinese designed fermentation plant contained a lower concentration of KGA and that, in addition, the impurities were also greater than specified. Conversely, ZYPF maintained that process parameters such as high temperature of evaporation led to the decomposition of KGA during the recovery process, thus reducing the yield. Reportedly the contractor's chief process design engineer in charge of the technology development had left the company toward the end of 1992 to join a large competing industrial producer of Vitamin C. 13 different entity which, by late 1994, admitted that the technology required modification and proposed a compromise solution. This solution, which consisted of the conditional supply of additional equipment against the release of all other funds previously withheld, was not agreed to, because the Chinese authorities had lost all confidence in the contractor's ability to improve the technology. Furthermore, ZYPF had already started its own modification with relatively promising results and did not wish to allow any disturbance in its own program. All contracts with the contractor were, therefore, discontinued after the end of 1994. At the time the expatriate technical personnel left the plant, little product of the specified quality had been produced. 2.8 The Sorbitol Plant was the only one of the large process packages that was completed reasonably on time and tested for performance. During the test the plant produced at design capacity (55 tpd) and was accepted by the ZYPF management. 14 3. Project Results ZYPF Subcomponent Production Performance and Technical Indicators 3.1 The inability of ZYPF and its contractors to solve the technical problems in the KGA Recovery/Purification and the Vitamin C plants have seriously affected the capacity utilization of the upstream units, especially the Starch and Dextrose plants. The largest plant wide capacity utilization was achieved during 1995 when the corn input into the Starch plant (69,706 tons) reached 46.5% of the designed value and the production of other products such as common starch and dextrose monohydrate also amounted to 68% and 48%, respectively, of the nameplate capacity (Annex E). Vitamin C production, however, amounted to only about 88 tons which was just under 1.8% of the designed level.s The Modified Starch unit never produced starch at the correct specification for the domestic market and its output remained unsold for a long period. The Anhydrous Dextrose unit, which was never commissioned and tested, remained shut down. 3.2 After the departure of expatriate technical personnel during 1992 and 1993, and the fruitless negotiations with the Vitamin C plant contractor, considerable efforts were focused on resolving the problems. To this end, the Central and Provincial Authorities convened a meeting of the technical experts from other pharmaceutical enterprises and engineering institutions. A plan was thus drawn up which specified certain modifications to the KGA and Vitamin C plants based on a blend of Chinese technologies. The cost of modification was estimated at yuan 60 million which would cover new equipment for the KGA Recovery/Purification plant as well as the ionization exchange section of the Vitamin C synthesis plant. 3.3 In response to the recommendations of the expert group, the plant, in the second half of 1994 and early 1995, started introducing some partial modifications in the KGA plant with its available funds while making a request for extra financing for the complete program. Discussions with the Central Government resulted in an agreement to provide the plant with yuan 40 million to continue the modification project. Although reportedly allocated by the Central Authorities, the funds never reached the plant. By early 1996, after nearly three years of operational experience with the plant since start-up, a technical judgment had been reached that without any modification to either the process or the equipment, the various units would only be capable of producing at best the following ratios to their designed capacity: 80% for starch and dextrose; 80% for modified starch; 90-95% for sorbitol; and, 30% for vitamin C. The progressive deterioration of ZYPF's financial situation, together with the inability to effect the necessary modifications eventually led to the Municipality's decision to shut down the plant. 3.4 The trend in the average yields of the various process units are shown in the following Table 3.1. 5 In addition to this quantity of Vitamin C, the KGA Recovery/Purification plant also produced some 894 tons of KGA which was sold to other Vitamin C manufacturers in China. 15 Table 3.1 - ZYPF Average Process Yields Design 1993 1994 1995 1996 value % % % % D.S.** Starch to Corn 64.5 60.47 59.16 64.55 64.30 Dextrose to Starch 104 78.06 58.26 74.28 95.49 Sorbitol to Dextrose 98 77.83 92.47 94.35 --- KGA to Sorbitol 62.86 7.80 21.32 21.75 --- Vitamin C to KGA 84 N/A 45.73 56.93 --- * D.S. - Dry Substance With the reversion to the Chinese technology and the introduction of a cooling vessel after each heating/crystallization stage, the yield of the KGA plant began to increase in 1994, resulting in an overall improvement in the KGA recovery, as yet not close to the design value, but a vast improvement on the yields achieved in 1993. Notwithstanding the problem of reaching full capacity utilization, by 1995-96 the process yields of the upstream units were approaching design values as indicated above. Manpower and Training 3.5 At appraisal it was expected that ZYPF would employ about 3000 people during construction from which some 70% would transfer to positions in the operational organization at the end of the implementation phase. This group was to receive substantial training on site and elsewhere including training by the expatriate staff, especially during commissioning and start up. While the enterprise organized extensive training courses for the operators of various plants and the maintenance staff, as well as those attending to the offsite and supporting facilities, the training by expatriate staff of the contractor was marred by the problems encountered during the start up which had created a strained relationship between the ZYPF management and the contractors (notably the KGA and Vitamin C plant's contractor). The training program as implemented by ZYPF is shown in Annex F. 3.6 Despite these concentrated efforts, the weak management and its unfamiliarity with the pharmaceutical industry, combined with the complexity of the process and the total lack of relevant experience by the recruited staff, did not provide the plant with a group of operators who could solve the commissioning and start-up problems. Of the technical managers of the plant at the time of start-up, only few had previously worked in a pharmaceutical factory and only one had some experience in fermentation processes. This situation was exacerbated by a similar lack of experience by the expatriate contractors who seemed to be using the plant, as it were, as a learning venue for their own technical staff. 6 The notional yield is made up of the yield in the first and second stages of recovery (78.5% and 87%, respectively) and the final crystallization of KGA (92%). 16 Environmental Protection 3.7 The ZYPF subcomponent was designed to meet environmental standards required by the State, Henan Province and the Municipality of Zheng Zhou. An Environmental Impact Analysis was prepared and approved by the State Planning Commission. Prior to appraisal, the Municipality in turn issued its waste water discharge standards. The construction of the Waste- Water Plant was completed in time for the start-up of the Starch and Dextrose units. During the period when the plant was operational (1992-96), the Waste-Water Treatment unit operated smoothly and the discharged effluent remained within the limits of the water quality standards. A system of regular monitoring was put in place for measurement of different parameters at various stages in order to ensure the suitability of the effluent discharged into the river. Air quality is also being monitored by mobile equipment. A safety manual has been prepared and training has been given to all operators including those who might come into contact with hazardous materials. GMP Subcomponents 3.8 At both the Xin Hua and the Shanghai No. 4 Pharmaceutical Factories, the investment costs were far in excess of the appraised figures, partly because of the revisions that were made in the design of the buildings to bring them totally in line with the GMP requirements. The corporate structure of both these enterprises was changed to a joint stock company (Xin Hua in 1992 and Shanghai No. 4 in 1993) making it possible for their listing on the stock exchange. 3.9 Shanghai No. 4 Pharmaceutical Plant- This new unit was located at Pudong Industrial Zone and consisting of two parallel production lines, each with a capacity of 50 million vials per year (2 shifts operation). The plant was completed at the end of 1994, and commercial production started two years later in December 1996. This delay was caused by the need to introduce modifications to the plant and to the buildings to bring them in line with the GMP requirements and to carry out operator training. Once both lines were working, this unit produced nearly 50 million vials during 1997. The factory could not keep that rate of production during 1998,7 due primarily to machinery break-down as well as a softer market and more intense competition. Currently the new factory is manned by 170 employees. 3.10 Xinhua Pharmaceutical Plant - This company is arguably the first in China to convert an existing plant to international GMP standards, a feat that is more difficult than building a new plant to GMP standards. It is therefore acting as a demonstration project for the pharmaceutical industry in China and other plants attempting conversion to GMP standards. The new tableting plant which was put into commercial operation in mid-1994 has not yet reached full capacity utilization. During 1997 it produced at a rate of approximately 50% of its design capacity of 3 billion tablets per year. Softness of the market and competition from other domestic producers and joint venture companies are mentioned as the root causes for depressed production. 7 During the first 6 month of 1998, production dropped to around 19 million vials. 30 supervisory staff with university and college degrees; 100 operators with training at trade schools; and, 40 employees that have been transferred from other units in the company. 17 3.11 SPAC GMP Program - While the Ministry of Public Health (MOPH) has, since 1989, promulgated regulations in support of GMP, price control by the Government and its investment policies create obstacles to the wider propagation of GMP in the pharmaceutical industry. In 1992, a revised GMP standard was promulgated by the MOPH based on the recommendations of the special committee for GMP. Subsequently, SPAC announced an outline of the schedules by which substantial conversion to GMP was to be achieved throughout the industry during the 9th Five Year Development Plan (1994-1999). The outline was revised again in 1995 thereby extending the time table which now stands as follows: Powder Products 1997 Vials 1998 Small Volume Injections 2000 Oral Preparations 2005 Currently, some 1,050 enterprises-out of a total of 5,600-are engaged with the production of Chinese traditional medicines while the remaining plants produce basic pharmaceutical substances and preparations of modern drugs. Of the 300 units producing powder products, 150 have already introduced GMP and the rest are in different stage of progress. GMP has also been introduced to a small number of vial manufacturers which number roughly 250. Approximately 4000 enterprises producing oral preparations and small volume injections have not, as yet, started conversion. The schedule appears to be slipping as the State and Provincial authorities show flexibility toward the pharmaceutical companies, because of the financial difficulties being experienced by firms in the subsector. Henan Quality Control Center Subcomponent 3.12 The equipment for the Center were ordered in 1989 and arrived in China in July of 1990. The Center became operational at the end of 1990 and is currently run by a staff of 22, carrying out quality testing on some 780 batches of product per year (Annex G). The Center suffers from low capacity utilization because, in the early years of its existence, new regulations obviated the mandatory quality testing of some products. Instead, the pharmaceutical manufacturers were given discretion to use the facilities as they wished and they, in turn, limited their demands to only quality testing of new drugs, which are only occasionally introduced. However, there are still regulatory mandates that create demands for the services of the Center such as: (i) quality control of products manufactured by the newly established enterprises (usually small); (ii) sampling and testing of some products existing in the market at the request of the Provincial Pharmaceutical Bureau; (iii) quality testing of the products produced after firms introduce GMP; and (iv) quality control of specific products being produced in the old factories. The Center is looking to the Chinese traditional medicine and the pharmaceutical research centers in order to increase its workload. 18 4. Overall Assessment 4.1 Over the last decade and since this project was approved in FY88, China has become one of the largest manufacturers and exporters of Vitamin C in the world. In fact, the production of Vitamin C has grown some sixfold from 4,578 tons in 1988 to around 27,500 tons in 1996 while exports have increased from 1,986 tons to about 23,000 in the same period (Annex H). In reaching these levels, the Chinese industry has depended largely on its own technology-except for the ZYPF facilities-while taking advantage of machinery and equipment imports to upgrade its processes in order to produce Vitamin C with a higher quality. In the meantime, the domestic consumption of Vitamin C has increased at an average annual rate of 7-8 percent, increasing from 2,300-2,400 tons in 1987 to 5,000 tons in 1997. Thus the major objectives of the strategy pursued by the Chinese authorities, namely : large scale production, lower unit costs and better product quality have all been substantially realized, albeit not through the operation of Zhong Yuan Pharmaceutical Factory. Process Design and Operational Experiences 4.2 Although the project's concept was in line with the country's public health and industrial strategies (by introducing modem technology and improved manufacturing practices in a large market in need of better and more effective pharmaceuticals) and a great deal of efforts were expended in the preparation of the project, the implementation of the critical units was entrusted to foreign contractors that were not the leaders in the field, with less than the required track records. In the case of the contract for the KGA Recovery/Purification and Vitamin C synthesis plants, the design was a brand new scaling up of a small pilot plant at laboratory scale with no other similar plant (with the same technical parameters) installed anywhere in the world. 4.3 Throughout the preparation period, what remained unappreciated was the fact that the pharmaceutical industry is dominated by a relatively small number of international companies and the engineering/contracting firms, at times, prefer not to jeopardize their close relationship with these companies in the interest of their future business (hence the bidding situation for Starch and Dextrose plants). Moreover, the lack of operating and technical experience with various plants meant that the contractors could not deliver on their obligations and were happy to withdraw their technical staff once the contract period had expired without any recourse by the customer (ZYPF). Matters were not helped by the fact that a part of the plant was built with the Chinese technology which affected the integrity of the whole Vitamin C production process. Management Capability and Institutional Development 4.4 Instead of bringing together a core of experienced technical staff from other pharmaceutical plants, ZYPF relied mostly upon the training of inexperienced personnel which it had recruited from the local job market. Given the nature and complexity of pharmaceutical processes, this approach proved to be wanting. The problem was exacerbated by the departure of the expatriate technical staff before the plants had even been stabilized or, in certain instances, commissioned. In the case of the KGA Recovery/Purification and Vitamin C plants, the contractor had little experience with the process because the plant was a scaled up design from a laboratory pilot project. 19 4.5 The project had more success with the training and institutional development associated with the GMP and the Henan Pharmaceutical Quality Control Center. Through the implementation of these pilot projects and the training program carried out by SPAC, the Chinese authorities and institutions have now developed the necessary expertise in designing facilities to international GMP standards and auditing facilities for GMP compliance. The introduction of GMP at Xin Hua and Shanghai No.4 pharmaceutical plants have demonstrated the practicability of achieving results and meeting international standards. However, in view of the problems facing the pharmaceutical industry, the Government has allowed a slippage in the original GMP schedule. Considering the situation at ZYPF and the GMP scheduling revisions, the project's institutional development impact is rated as modest. Cost Structure and Profitability 4.6 The cost structure for the various products and the profitability of ZYPF is given in Annexes I and J. The balance sheet appears as Annex K. The analysis of product costs indicates the extent to which production at ZYPF has suffered from the inability to produce at capacity and the low yield of various processes. It is also clear that throughout the period (1993-96), the cash costs of producing a ton of each of the main products, remained well above the selling price. The income statement for the same period also shows the excess of expenditure over sales revenue and the annual losses. This is all without taking into account the financial charges and depreciation.9 No attempt was made to calculate an economic or a financial rate of return for this report. There can be no assurance as to when the plant will be recommissioned and it is uncertain when production might stabilize or what level of capacity utilization will be attained, making calculation of returns meaningless. 4.7 Despite their salutary demonstration effects, the GMP subcomponents also show disappointing financial results. Capacity utilization at both plants is low, reducing the profitability of their parent companies over the last few years. In the case of the Shanghai No. 4 Pharmaceutical company, operational profit has declined from 22.4 million yuan in 1994 to 20.9, 17.8, 6.7 million yuan in 1995, 1996 and 1997, respectively (Annex L). The general decline in profitability of the pharmaceutical sector is due, in part, to the intense competition in the domestic market emanating from other SOEs, joint venture operations and the marketing activities of the multinational pharmaceutical companies. What most companies are desperately looking for are new drugs that can employ their producing capacities as the older drugs lose market share and, hence, profitablity. The income statements do not contain depreciation and financial changes related to the capital investment and the balance sheets are currently drawn up without showing the investment in the production units. The claim is that as long as these fixed assets have not been formally accepted by the owners (the Municipality of Zheng Zhou), they cannot be reflected in the accounts of the enterprise. They are in effect kept in a separate account together with accrued interest, awaiting the resolution of the basic issues. As a result, the cost and expenditure figures only include the interest accruing on the working capital which has been borrowed since 1993. 20 Outcome and Sustainability 4.8 The project was well conceived, but except for helping the introduction of GMP in the pharmaceutical sector and creating a well equipped quality control center, it did not achieve its major objective. Given the investment overruns , the production history, the accumulated losses, the state of the Vitamin C market and the uncertain future of the Zhengzhou factory, it is unlikely that the project will ever show a positive economic or financial rate of return. If the plant is recommissioned and gradually brought up to capacity while remaining as a state owned enterprise, it will continue to require assistance with its debt servicing probably until all the capital investment is paid off. Based on these considerations, and despite the beneficial effects of the GMP endeavor, the outcome of the project is rated as unsatisfactory and its sustainability as unlikely. Bank/Borrower Performance 4.9 While the Bank played an important role in the identification and preparation of the project and both the Bank and the Borrower maintained an amicable and cooperative relationship during implementation, neither side appears to have fully realized the complexity of this project and the risks involved in entrusting its implementation to contractors with less than impeccable track records. It is unfortunate that under these circumstances and during a difficult inflationary period in China, the costs were allowed to skyrocket. Eventually, the weak organizational structure combined with the lack of skills, both on the part of the Chinese staff and the contractors technical personnel brought about a wholly unsatisfactory start up and commissioning experience, leading to an ongoing litigation between ZYPF and the Vitamin C plant contractor. Despite the urgency of taking remedial steps, the Borrower only took steps to strengthen management of the enterprise in 1995, i.e. at a time when the factory was facing serious financial difficulties and the Vitamin C market had already been taken over by other State pharmaceutical enterprises. It is important to note that the Bank carried out only 5 supervision missions for this very troubled project with only two visits during the very sensitive start up and commissioning period (1992-93). There is a surprising note of optimism in the ICR (dated June, 1996) in which, despite all the problems being faced by ZYPF and even the GMP facilities in respect of overruns, delays and capacity utilization, the outcome is rated as satisfactory and the sustainability as likely. Given these considerations, the Bank and the Borrower performances are rated as unsatisfactory. The status of legal covenants is shown in Annex M. 21 5. Current Situation and Major Issues 5.1 The enormous increase in Vitamin C producing capacity and production in China has been accompanied with the construction of much larger plants (up to 5,000 tons/year capacity). Moreover, the new capacity is all based on the scaling up of the Chinese technology including the two-stage fermentation of sorbitol. In the early 1990s, despite the invasion of the Vitamin C market by Chinese manufacturers, prices remained fairly strong at around $14 to $16 per kilogram for superior quality products. But toward the end of 1994, the pressure from lower- priced Chinese Vitamin C forced international prices to drop to about $10 to $12 per kilogram and won the Chinese producers an increasing market share. Thereafter, Vitamin C prices continued to decline, stabilizing in 1997 at about $6-7 per kilogram (Annex N). 5.2 The State, having encouraged other state-owned pharmaceutical enterprises to increase their Vitamin C producing capacity, is now reconsidering this position in view of the steep decline in the international prices. After losing market shares in 1997 (exports dropped from around 23,000 tons in 1996 to 19,000 tons in 1997), the Central Authorities appear to be ambivalent about the recomissioning of the Zhong Yuan Pharmaceutical Factory as its entry into the market might further depress prices. On the other hand, the Provincial and Municipal Authorities who have had to partially service the loan to the Bank (Table 5.1) and other creditors, as well as shouldering the annual losses, are keen to find a solution to production problems and quick recommissioning of the plant. Table 5.1 - Repayment of Bank loan for ZYPF Million Yuan 1994 50 1995 10 1996 150 1997 112 1998 - (up to and of June) 82.39 Total 404.39 Equivalent in dollars (million) 48.72 Principal repaid in dollars (million) 31.64 Source: Henan Provincial and Municipal Governments 5.3 Prior to the eventual closure of the plant, the Provincial and Municipal authorities had already contemplated a number of approaches to resolve ZYPF's problems. These approaches have included: sale of assets, either in whole or part, to another pharmaceutical concern; introduction of a local investor; and, joint ventures with local or foreign enterprises for the whole or individual processing units. Authorities seem to have concluded that joint ventures with reputable international companies may provide the best solution. But joint ventures for Vitamin C production (including the Sorbitol to KGA fermentation plant) is not likely to become a reality because China has already sold its two stage fermentation technology, on an exclusive basis, to an international company with a large claim on the Vitamin C market. This would effectively preclude a workable relationship with a third party for the duration of the patent agreement which will, reportedly, terminate in the year 2000. 22 5.4 Despite these complications, contacts were established between ZYPF and the IFC towards the end of 1996, resulting in a series of meetings at which the IFC explained to the Provincial and Municipal authorities their approach and the kind of advisory services they could offer in searching for foreign joint venture partners. While the discussions also envisaged a possible investment by the IFC under suitable conditions, the discussions came to an abrupt halt in mid-February 1997 when the management of ZYPF informed the Corporation that they were about to enter a contractual arrangement with an entity from Hong Kong. Unfortunately, with the onset of the Asian financial crisis, the proposal was withdrawn and the matter remains in abeyance. When the problems were again reviewed during the audit mission, the Zhengzhou Municipal Authorities indicated that they were interested to restart discussions with the IFC, subject to the approval of the Provincial and Central Government authorities. 23 6. Conclusion and Lessons Learned 6.1 With the major subcomponent of the project (ZYPF) out of operation for nearly two years and the other subcomponent facilities grossly underutilized, efforts should be focused on finding a way to solve the issues and on getting the plants into gainful operation. While the GMP subcomponents have already acted as demonstration pilots, their full utilization remains a matter of concern and the managements of the two enterprises (Xin Hua and Shanghai No.4) should continue to search for joint venture partners who can employ the installed capacities by introducing new drugs so that profitability can be restored. The Henan Pharmaceutical Quality Control Center also needs to become much more proactive in finding markets for its services, rather than depending on the government's mandates for its survival. 6.2 As for the future of ZYPF, the situation is more complex and problematic and requires a decision on the advisability of restarting the plant and adding producing capacity to an already glutted domestic and international market for Vitamin C. Should the government decide to proceed, there are several options: a) To invest in modifications using Chinese technology and restart the plant, settling for a Vitamin C quality somewhat inferior to the highest international standards; b) To sell the whole plant to a domestic investor through a bidding process; c) To break up the plant into several production units or into two upstream and downstream units and sell each part to domestic or international joint venture partners (assuming that the patent issue can be satisfactorily resolved). Whichever the chosen option, the State should be willing to engage in a realistic asset valuation and/or debt restructuring whereby a good portion of the loans are written down and assumed by the Government. 6.3 The major lesson of this project is that the Bank should avoid embarking on an industrial project utilizing unproven technology and a design that is based on the scaling up of a laboratory- sized pilot plant. The pharmaceutical industry suffers from an added problem in that technologies are often available from few sources and are covered by patents and restrictive know-how secrecy agreements. 6.4 An equally important lesson of the project is that the Bank should avoid embarking on a greenfield and technologically complex project without ensuring that both the project management and operational teams are well versed and sufficiently skilled with long experience in the subsector. This risk was not ever considered in the SAR and no mitigatory steps were envisaged. 6.5 In the case of problematic projects, especially, the Bank should assume responsibility and make resources available for a much higher supervisory effort in order to render advice and technical counsel to the Borrowers. The Bank's annual supervision missions were too infrequent, given the myriad of technical and managerial problems being faced by ZYPF.  25 Annex A Page 1 of 3 Basic Data Sheet CHINA PHARMACEUTICAL PROJECT (LOAN 2943-CHA) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current appraisal estimate estimate Total project costs (yuan million) 888.7 2396.7 269.7 Loan amount (US$ million) 127.0 126.7 99.7 Date physical components completed Dec. 1992 July 1995 --- Economic rate of return 34 % NA --- Cumulative Estimated and Actual Disbursements (amounts in US$ million) FY89 FY90 FY91 FY92 FY93 FY94 FY95 Appraisal estimate 10.2 34.6 44.5 32.0 5.7 --- --- Actual by year 4.1 19.3 64.8 19.5 12.2 4.9 1.9 Accumulated Appraisal 10.2 44.8 89.3 121.3 127.0 127.0 127.0 Estimate Accumulated Actual . 4.1 23.4 88.2 107.7 119.9 124.8 126.7 Accumulated Actual as % 40.2 52.2 98.8 88.8 94.4 98.3 99.8 of appraisal Date of final disbursement: March 29, 1995 26 Annex A Page 2 of 3 Project Timetable Steps in project cycle Date planned Date actual/latest estimate Identification November 1986 November 1986 Preparation Project Brief July 1987 July 1987 Appraisal December 1987 December 1987 Negotiations April 1988 April 1988 Board Presentation May 1988 May 1988 Signing N.A. December 1988 Effectiveness September 1988 February 1989 Project Completion December 1992 July 1995 Loan closing December 1993 December 1994 Bank Resources: Staff Inputs Actual Stage of Project Cycle Weeks $ Through Appraisal 75.9 n.a. Appraisal to Board 6.5 n.a. Board of Effectiveness 1.0 n.a Supervision 53.2 n.a. Completion 13.0 n.a Total 149.6 n.a. 27 Annex A Page 3 of 3 Bank Resources: Missions Performance Rating Implementation Development Stage of Project Mo./Yr. No. of Days in Staff Status Impact Types of Cycle Persons Field Skills Problems Through Appraisal Nov-87 6 166 Eng. Fin. Pharm. Econ. Marketing Appraisal Through n.a. n.a. n.a. n.a. Board Board Through n.a. n.a. n.a. n.a. Effectiveness Supervision Jun-89 2 14 Eng.Econ. 1 1 F Fin Oct-90 2 28 Eng.Econ. 1 1 F Fin Nov-91 1 6 Eng. 2 1 M Oct-92 2 28 Eng.Econ. 2 1 M/T Fin Dec-93 2 22 Eng.Econ. 2 1 M/T Fin Completion Jan-95 2 26 Eng.Econ. F/T Fin Eng. = Engineer Pharm. = Pharmaceutical Specialist Econ. = Economist Fin. = Financial Analyst Related Bank Loans There were no preceding nor following operations in the China Pharmaceutical Sector. China Pharmaceutical Project: ZYPF Process Diagram for Manufacture of Vitamin C x Chinese Process Wet Anaerobic KGA Corn Corn Starch Dextrose Wet Sorbitol Fermentation Purification Vitamin C Cleaning Milling Milk Syrup Monohydrate Process & KGA* Crystallization Common Modified Dextrose Anahydrous Starch Starch Monohydrate Dextrose Standard Process Same Process as above Aerobic Sorbose Fermentation to Vitamin C Process KGA Sorbose *This anaerobic process has been developed by the Chinese for the direct production of Ketogulonic acid (KGA) from sorbitol, thus eliminating one stage in the process, i.e. the production of sorbose. However, given the amount of impurities produced in the anaerobic (2 stage) fermentation process, the output needs to be purified prior to the crystallization of KGA. 29 Annex C Project Dates Key Implementation Indicators in SAR Estimated Actual A. Zhong Yuan Pharmaceutical Factory Major Process Packages Contract Award Jan-89 Aug-89 Commencement of Major Civil Works Dec-89 Jun-90 Commencement of Major Equipment Jul-90 Jun-91 Erection Completion of Equipment Testing Sep-91 Oct-92 Completion of Commissioning Dec-91 Oct-92 Commencement of Vitamin C Jan-92 Nov-93 Production Commercial Operation, 100% Capacity Jun-93 uncertain B. GMP Components Xinhua Selection of Design and Implementation Dec-88 Jan-90 Consultants Completion of Major Equipment Feb-91 Nov-92 Deliveries Commencement of Major Civil Works Apr-89 Aug-91 Completion of Erection Jul-912 Jun-93 Completion of Commissioning Dec-91 Dec-93 Commencement of Commercial Mar-92 Apr-94 Operation Shangai No. 4 Selection of Design and Implementation Dec-88 Jan-90 Consultants Completion of Major Equipment Feb-91 Jul-94 Deliveries Completion of Major Civil Works Apr-89 Jun-93 Completion of Erection Jul-91 Dec-94 Completion of Commissioning Dec-91 Apr-95 Commencement of Commercial Mar-92 Dec-96 Operation C. Henan Quality Control Center Initiation of Procurement Jun-88 Jun-89 Final Equipment Delivery Apr-89 Sep-90 Completion of QCC Jun-89 Oct-91 30 Annex D Project Costs (US$ million and Yuan million equivalent) Estimated Actual Local Foreign Total Local Foreign Total Component (yuan) ($) yuan (yuan) ($) (yuan) Equivalent 1. ZYPF Component Installed Cost 222.6 98.2 645.4 800.0 116.0 1786.0 Interest During Construction 17.7 19.3 99.3 36.9 32.0 308.9 Working Capital 72.5 0.0 72.5 110.0 0.0 110.0 Total Financing 312.8 117.5 807.2 946.9 148.0 2204.9 2. GMP Component Xinhua Installed Cost 13.5 5.0 35.4 26.3 5.0 68.7 Interest During Consruction ---- 0.9 3.6 6.0 0.8 12.5 Working Capital 1.9 ---- 1.9 3.5 ---- 3.5 Total Financing 15.4 5.9 40.8 35.8 5.8 84.7 Shanghai No.4 Installed Cost 10.2 4.9 31.5 52.5 4.2 87.9 Interest During Construction ---- 0.8 3.2 4.7 0.5 8.7 Working Capital 1.7 --- 1.7 3.6 ---- 3.6 Total Financing 11.9 5.7 36.4 60.8 4.6 100.2 3. Henan Quality Control ---- 1.0 4.3 ---- 0.8 6.8 Center Total Financing Required 340.1 130.0 888.7 1043.5 159.2 2396.7 ZYPF-Production Performance Tons per Year Design 1992 1993 1994 1995 1996 Capacity ____ ____ ____ ____ Production % of Production % of Production % of Production % of Production % of Value Capacity Value Capacity Value Capacity Value Capacity Value Capacity Corn Input 150000 18620 12.4 63629 42.4 57810 38.5 69706 46.5 35625 23.7 Final Products Comnon Starch 33000 4698 14.2 16392 49.7 17535 53.1 22482 68 14009 42.4 Modified Starch 10000 166 1.6 11 0.1 --- --- --- --- --- --- Dextrose 15000 2290 15.3 5050 33.7 3152 21.0 7236 48.2 487 3.2 Monohydrate Dextrose Anhydrous 10000 --- --- --- --- --- --- --- --- --- --- Sorbitol (70% D.S.*) 15000 563 3.7 1574 10.5 2237 14.2 613 4.1 --- --- Vitamin C 5000 0.1 --- 4.6 0.1 98.7 2.0 87.9 1.8 6.0 **0.1 Gluten Feed 36300 2902 8.0 10846 29.9 9185 25.3 11130 30.7 6302 17.4 Corn Oil 3260 401 12.3 698 21.4 561 17.2 732 22.4 475 14.6 Intermediate Products Starch Milk 49000 5070 10.3 16698 34.1 11877 24.2 16214 33.1 5691 11.6 *D.S. Dextrose Input to 21190 1260 5.9 1705 8.0 5400 25.5 4600 21.0 --- --- Sorbitol Source - ZYPF * D.S. - Dry Substance ** Vitammin C production stopped in January 1996 0 32 Annex E Page 2 of 2 ZYPF-Periods of Highest Capacity Utilization Actual Best Date of Best Performance Performance Tons Starch 24 Hours Period 109 April 10, 1996 Weekly Period 583 April 1-7, 1996 Monthly Period 2360 April, 1996 Dextrose Monohydrate 24 Hours Period 49 June 5, 1996 Weekly Period 280 June 10-16, 1996 Monthly Period 1214 June, 1996 Sorbitol 50% 24 Hours Period 55 June, 1995 KGA 24 Hour Period 145 July, 1995 Vitamin C 24 Hour Period 5 December, 1995 Source: ZYPF 33 Annex F ZYPF-Training Programs Total number trained * Type of Courses 1989 1990 1991 1992 Total 4 Years Operational Corn Washing 35 35 40 42 152 Starch Plant 115 155 156 205 631 Dextrose Plant 73 93 95 95 356 Sorbitol Plant 38 38 48 48 172 KGA and Vitamin C Plants 101 141 258 338 838 Corn Oil Section 20 21 25 25 91 Power Station 10 45 50 70 175 Chemical Water Plant 4 40 50 56 150 Waste Water Plant 3 35 40 45 123 Compressed Air 4 40 50 60 154 Laboratory 42 42 92 92 268 Maintenance Instrumentation 30 100 120 127 377 Mechanical 20 25 25 25 95 Electrical 3 40 68 68 179 Steam and Power 5 53 70 73 201 Turbine 3 38 58 58 157 Coolers and Chillers 4 40 45 45 134 Automatic Control 5 10 20 27 62 Specialized Courses Supervisory Staff 5 60 100 202 367 English Language --- 52 52 52 156 Overseas Training --- 68 --- --- 68 Others 93 105 109 122 429 Total 626 1286 1581 1885 5378 Source - ZYPF * The same individual could have attended different courses in successive years. 34 Annex G China Pharmaceutical Project - Henan Quality Control Center Year No. of No.of Batches Income Expenditure Personnel tested Yuan Yuan (thousand) (thousand) 1991 25 950 250 350 1992 25 720 160 280 1993 24 700 150 260 1994 24 730 160 270 1995 23 750 180 270 1996 22 750 200 300 1997 22 780 220 330 Source - Henan QCC 35 Annex H China - Production and Export of Vitamin C tons/year Production Export Apparent Domestic Consumption ** 1987 4178 1815 2363 1988 4578 1986 2592 1989 5794 3041 2754 1990 6056 4376 1680 1991 7356 4823 2533 1992 9977 7388 2589 1993 11866 9179 2687 1994 17364 13645 3719 1995* 22000 18000 4000 1996* 27500 23000 4500 1997* 24000 19000 5000 Source: SPAC * Estimates **Apparent domestic consumption has been calculated by deducting exports from production. While the figures appear erratic, the increasing trend for domestic consumption is unmistakable. Annex I 36 ZYPF - Analysis of Product Costs and Prices 1993 - 1996 Sales and Production in Tons - Cost and Prices in Yuan per Ton Total Unit Cost of Unit Cost of Unit total Unit Sales Unit Sales Manufacturing Marketing Cost Income Profit/Loss Tons Yuan/ton Yuan/Ton Yuan/ton Yuan/ton Corn Starch 1993 7943.5 1501.8 105.8 1607.6 1394.5 (213.1) 1994 18406.7 1597.5 46.3 1643.8 1568.3 (75.8) 1995 24116.6 2480.7 27.6 2508.3 2467.9 (40.4) 1996 13326.9 2554.1 66.3 2620.4 2207.4 (413.0) Mono Dextrose 1993 3094.4 3278.9 254.2 3533.1 3350.1 (183.0) 1994 2855.8 5706.1 99.3 5805.4 3365.3 (2440.1) 1995 6175.9 5596.0 49.4 5645.4 4425.9 (1269.4) 1996 5941.6 5628.3 121.9 5750.2 4058.0 (1692.2) 70% Sorbitol 1993 622.2 4205.4 305.7 4511.1 4028.1 (483.0) 1994 1953.2 6109.6 117.6 6227.2 3983.1 (2244.0) 1995 393.6 6352.7 55.4 6408.1 4961.6 (1446.5) 1996 167.7 7433.3 134.3 7567.6 5003.2 (2564.4) Vitamin C 1993 2.0 102,500.0 --- 102,500.0 102,500.0 --- 1994 91.7 90610.5 --- 90610.05 89666.4 (944.1) 1995 5.1 69427.7 --- 69427.7 69164.9 (262.8) 1996 110.1 53298.9 1430.8 54729.7 53298.9 (1430.8) Refined Corn Oil 1993 48.0 5626.6 --- 5626.6 6283.8 657.2 1994 225.1 6237.6 --- 6237.6 7239.5 1001.9 1995 90.1 6327.2 326.3 6653.5 8425.1 1771.6 1996 392.5 6375.9 162.5 6538.4 6053.1 (485.2) Crude Corn Oil 1993 336.3 3600.0 --- 3600.0 3842.3 242.3 1994 499.0 3746.2 --- 3746.2 5695.1 1948.9 1995 289.2 3812.2 457.6 4269.8 5075.8 806.0 1996 456.7 4387.3 128.3 4515.6 4791.9 276.3 Gluten Feed <15% 1993 4543.0 589.9 --- 589.9 451.2 (138.7) 1994 9497.5 679.5 679.5 602.4 (77.1) 1995 10747.0 733.3 --- 733.3 1071.4 338.1 1996 6240.1 1151.4 22.0 1173.4 819.0 (354.4) Gluten Feed >15% 1993 1878.4 556.7 --- 556.7 516.2 (40.5) 1994 514.6 607.3 --- 607.3 618.8 11.4 1995 357.6 865.1 --- 865.5 1047.5 182.0 1996 124.1 393.8 32.4 426.2 1207.3 781.1 Source - ZYPF 37 Annex J ZYPF - Income Statement (million yuan) 1994 1995 1996 Income Sales Revenues 71.16 143.70 79.67 Other Revenues Total Revenue 71.16 143.70 79.67 Expenditure Cost of Sales 82.42 154.70 97.99 Marketing 1.36 1.31 2.13 Depreciation* Interest** 5.20 6.68 11.64 Other 1.79 19.45 (2.98) Total Expenditure 90.77 183.14 108.78 Net Profit (loss) (19.61) (38.35) (29.11) Source: ZYPF * No depriciation has been calculated. ** Interest refers to the working capital and not the borrowing for capital investment. 38 Annex K Balance Sheet Zhong Yuan Pharmaceutical Plant (in thousand yuan) 1993 1994 1995 1996 Assets Current Assets Cash 6,907 3,993 3,679 4,439 Net Receivables 16,372 8,036 27,103 27,085 Advanced Payments --- 7,770 13,499 9,962 Inventory 39,381 47,706 50,580 50,208 Others 362 6,675 7,729 10,556 Total Current Assets 63,022 74,180 102,590 102,250 Fixed Assets Construction --- 4,824 7,742 17,535 Deferred Intangibles --- --- 39,346 47,353 Total Fixed Assets --- 4,824 47,088 64,888 Total Assets 63,022 79,004 149,678 167,138 Liabilities Current Liabilities Short Term Loans 55,391 46,962 94,504 114,960 Payable 20,946 67,153 117,591 141,368 Others 28 (2,177) 8,074 10,749 Total Current Liability 76,365 111,938 220,169 267,077 Long Term Borrowing --- 45 829 497 Equity Capital 30 --- --- --- Accumulated Project (13,373) (32,979) (71,320) (100,436) (loss) Total Equity (13,343) (32,979) (71,320) (100,436) Total Liability 63,022 79,004 149,678 167,138 Source - ZYPF 39 Annex L Income Statement - Shanghai No.4 Pharmaceutical Company (million yuan) 1994 1995 1996 1997 Revenue Sales 241.2 337.3 321.0 339.8 Expenditure Cost of Production 205.8 291.9 270.4 291.8 Marketing 1.9 2.9 3.9 3.7 Administrative 6.4 12.0 15.9 15.1 Financial Cost 3.9 8.9 12.0 20.9 Taxes 0.7 0.7 1.0 1.6 Total Expenditure 218.7 316.4 303.2 333.1 Profit (loss) 22.4 20.9 17.8 6.7 Source: Shanghai No.4 Pharmaceutical Plant 40 Annex M Status of Legal Covenants Section Present Original Description of Covenant Comments Status Fulfillment Date Loan Agreement 3.04 C Dec-90 Furnish an industry wide program for Completed introduction of GMP during 8th plan period, and exchange views. 4.01 C GMP enterprises to furnish audited In compliance accounts, audit of Special Accounts and SOEs within 6 month of the close of the financial year. Schedule 5 CD Jun-89 GMP enterprises to furnish Completed implementations Schedule 5 NC GMP enterprises to maintain: debt Not in service ratio of at least 1.5, debt/equity compliance of greater than 60:40; current ration of not less than 1.3 Project Agreement 2.01 (c) C Dec-90 Establish Zhong Yuan Factory (ZYPF) Completed and enter into a transfer agreement satisfactory to the Bank. 4.01 Furnish audited accounts, audits of In compliance special Accounts and SOEs within 6 month of the close of the financial year. Schedule C Jun-89 ZYPF to furnish recruitment and Completed training program C ZYPF to appoint marketing staff one Completed year prior to plant start up C ZYPF to prepare plant safety manual Completed for hazardous materials and emergency procedures by one year prior to start up NC Jan-94 In operation, ZYPF to maintain debt Not in service to ration of at least 1.5, compliance maintain a debt to equity ratio of at least 70:30, and a current ration of not less than 1.25. Present Status: C = Covenant complied with CD = Complied with after dealay. CP = Complield with partly NC = Not in compliance 41 Annex N China - Trend of Average Prices for Corn, Vitamin C and Other Products Yuan/ton 1992 1993 1994 1995 1996 1997 1998 Corn N/A 850 1300 1550 1300 1350 N/A Common Starch 1200 1400 1570 2470 2210 2010 2050 Dextrose Mohyse 2200 3350 3370 4430 4060 3550 3650 Monohydrate Sorbitol 3100 4030 3980 4960 5000 4500 4700 KGA 30,000 40,000 50,000 43,000 21,000 19,000 17,000 Vitamin C 90,000 102,000 89,700 69,200 53,300 50,000 50,000 Gluten Feed 400 450 600 1070 820 700 600 Corn Oil 4600 6280 7240 8420 6050 5900 5900 Source - ZYPF Annex 0 42 Page 1 of 3 'I #ARA*WEESWWUeat State Economic & Trade CommisSIon of PeOple's Republic of China 28 Xuanwmen Xidajli, Xuartwu Ditict. 9e"Ing 100063, China. Tel: 086W1M3193t72 Fax: OI01831930625 To: Roger 3,Rohin%on Country Uvaluations and Regional Relations Operations fivaluation Department, The World Bank Fax: 001-202-5273J24 r-rom; Yu Mingdo Pharnaccutical Department State 4conomic and Trade Conmission Tel: 86-10-6319- 3844 Fax: 86-10-6319-3801 Date: March 1, 1999 Dear Mr.Robinson Rv; Chona:PhaLrmetlaPret(Ln243CA I received your letter and the draft Performance Audit Report (PAR) at the end of January, 1999. Thank you very much for your contributions made on this prcject. As far as PAR concerned, I think it relative completely and objectively reflected the actual situations ol the project Loan 2943-CHA and the problems existed. 2943-Cl A Loan was the first one that the Pharmaceutical Industry of China used the World IIank's loan since China opened its door to the outside. We fool very regret thaL it Jailed to reach the expected objective due to various masons. However, it did provide valuable experience and lossons for our future itirther refonn and open, and th0T Using t1hreign capital. In addition, tho infbrmation on this project I learned is a dle bit different from those you mentioned in PAR. I'd like to refer them as follow for your reftronce: a. It is not quiet correct that there was no international well-known manufacturers tendpring in the call for tender of starch and dcxtm-se lacility, 43 Annex 0 Page 2 of 3 the ract is that there were a few of mch manufacturers tended. Among the tenders, the price olYered by Starcosa Engineering Co., ofr ermany was much lower than those offered by other international tenders, and also the bidding dCLIMents were in conformity with the requirements. In the selection Ofcontructor, Zhongyuan Pharmaceutical Plant put much emphasis on the factors of price, and readily believed the promise of the contractor. I. As to the production facility, the technology and equipment in respect of KOA concentration separation units and the Vu rulinury and transfer apparatus were imported 11rom PNCO of Switzeiand. 'rho technology was really the pilot one in laboratory, and the company was purchased by an Italy company, The loter one recognized that the technology has problems and agreed to modify the facility conditionally. It required conditional supply of additional equipment against release of all other funds previously withheld. Actually. 1LNCO unscrupulously withdrew the last installment of its performance tknd without the consent of Zhongyuan. c. In PAR, it mentioned that none of the technical and managerial staff once worked in pharmaceutical plant while the start-up of' Zhongyuan Project. It is not completely in conformity with the actual situation. TIhe fact is that there were some technical and managerial staff had work experience in pharmacoutical plants. d. The designed capability of Zhongyuan Plant is: 43,000 metric tons/year of starch (41,750 tons/year in PAR); 25,000 metric tons/year of dextrose; 15,000 metric tons/year of sorbital with 70% of content (20,450 tons/year in PAR) and 5.000 metric tons/year of Va. Among the projeuts of 2943-CHA loan, all the other subcomponents arc in normal production except Zhongyuan Plant. The critical reason for failing production of Zhongyuan plant is that the contractor breached the contract. Now Zhongyuan is claiming aBainst the contractor through the procedure of arbitration. We hope the World Bank could give support to Zhongyuan Plant's claim. China is a country with population of more than 1.2 billion, we sincerely hopc thut the World Rank could give support to China's pharmaceutical industry consistunly. Annex 0 44 Page 3 of 3 Truly youra, Yu Mingde Dircur othe ihiarmaceutical Department